Regulatory Capital Rule: Large Banking Organizations and Banking Organizations With Significant Trading Activity, 64028-64343 [2023-19200]
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Federal Register / Vol. 88, No. 179 / Monday, September 18, 2023 / Proposed Rules
DEPARTMENT OF THE TREASURY
Office of the Comptroller of the
Currency
12 CFR Parts 3, 6, 32
[Docket ID OCC–2023–0008]
RIN 1557–AE78
FEDERAL RESERVE SYSTEM
12 CFR Parts 208, 217, 225, 238, 252
[Docket No. R–1813]
RIN 7100–AG64
FEDERAL DEPOSIT INSURANCE
CORPORATION
12 CFR Part 324
RIN 3064–AF29
Regulatory Capital Rule: Large
Banking Organizations and Banking
Organizations With Significant Trading
Activity
Office of the Comptroller of the
Currency, Treasury; the Board of
Governors of the Federal Reserve
System; and the Federal Deposit
Insurance Corporation.
ACTION: Notice of proposed rulemaking.
AGENCY:
The Office of the Comptroller
of the Currency, the Board of Governors
of the Federal Reserve System, and the
Federal Deposit Insurance Corporation
are inviting public comment on a notice
of proposed rulemaking (proposal) that
would substantially revise the capital
requirements applicable to large
banking organizations and to banking
organizations with significant trading
activity. The revisions set forth in the
proposal would improve the calculation
of risk-based capital requirements to
better reflect the risks of these banking
organizations’ exposures, reduce the
complexity of the framework, enhance
the consistency of requirements across
these banking organizations, and
facilitate more effective supervisory and
market assessments of capital adequacy.
The revisions would include replacing
current requirements that include the
use of banking organizations’ internal
models for credit risk and operational
risk with standardized approaches and
replacing the current market risk and
credit valuation adjustment risk
requirements with revised approaches.
The proposed revisions would be
generally consistent with recent changes
to international capital standards issued
by the Basel Committee on Banking
Supervision. The proposal would not
amend the capital requirements
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SUMMARY:
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applicable to smaller, less complex
banking organizations.
DATES: Comments must be received by
November 30, 2023.
ADDRESSES: Comments should be
directed to:
OCC: Commenters are encouraged to
submit comments through the Federal
eRulemaking Portal, if possible. Please
use the title ‘‘Regulatory capital rule:
Amendments applicable to large
banking organizations and to banking
organizations with significant trading
activity’’ to facilitate the organization
and distribution of the comments. You
may submit comments by any of the
following methods:
• Federal eRulemaking Portal—
Regulations.gov:
Go to https://regulations.gov/. Enter
‘‘Docket ID OCC–2023–0008’’ in the
Search Box and click ‘‘Search.’’ Public
comments can be submitted via the
‘‘Comment’’ box below the displayed
document information or by clicking on
the document title and then clicking the
‘‘Comment’’ box on the top-left side of
the screen. For help with submitting
effective comments, please click on
‘‘Commenter’s Checklist.’’ For
assistance with the Regulations.gov site,
please call 1–866–498–2945 (toll free)
Monday–Friday, 9 a.m.–5 p.m. ET, or
email regulationshelpdesk@gsa.gov.
• Mail: Chief Counsel’s Office,
Attention: Comment Processing, Office
of the Comptroller of the Currency, 400
7th Street SW, Suite 3E–218,
Washington, DC 20219.
• Hand Delivery/Courier: 400 7th
Street SW, Suite 3E–218, Washington,
DC 20219.
Instructions: You must include
‘‘OCC’’ as the agency name and ‘‘Docket
ID OCC–2023–0008’’ in your comment.
In general, the OCC will enter all
comments received into the docket and
publish the comments on the
Regulations.gov website without
change, including any business or
personal information provided such as
name and address information, email
addresses, or phone numbers.
Comments received, including
attachments and other supporting
materials, are part of the public record
and subject to public disclosure. Do not
include any information in your
comment or supporting materials that
you consider confidential or
inappropriate for public disclosure.
You may review comments and other
related materials that pertain to this
action by the following method:
• Viewing Comments Electronically—
Regulations.gov:
Go to https://regulations.gov/. Enter
‘‘Docket ID OCC–2023–0008’’ in the
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Search Box and click ‘‘Search.’’ Click on
the ‘‘Dockets’’ tab and then the
document’s title. After clicking the
document’s title, click the ‘‘Browse All
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viewed and filtered by clicking on the
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on the left side of the screen checking
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checkbox. For assistance with the
Regulations.gov site, please call 1–866–
498–2945 (toll free) Monday–Friday, 9
a.m.–5 p.m. ET, or email
regulationshelpdesk@gsa.gov.
The docket may be viewed after the
close of the comment period in the same
manner as during the comment period.
Board: You may submit comments,
identified by Docket No. R–1813, RIN
7100–AG64 by any of the following
methods:
Agency Website: https://
www.federalreserve.gov. Follow the
instructions for submitting comments at
https://www.federalreserve.gov/
generalinfo/foia/ProposedRegs.cfm.
Federal eRulemaking Portal: https://
www.regulations.gov. Follow the
instructions for submitting comments.
Email: regs.comments@
federalreserve.gov. Include the docket
number and RIN in the subject line of
the message.
Fax: (202) 452–3819 or (202) 452–
3102.
Mail: Ann E. Misback, Secretary,
Board of Governors of the Federal
Reserve System, 20th Street and
Constitution Avenue NW, Washington,
DC 20551.
In general, all public comments will
be made available on the Board’s
website at www.federalreserve.gov/
generalinfo/foia/ProposedRegs.cfm as
submitted, and will not be modified to
remove confidential, contact or any
identifiable information. Public
comments may also be viewed
electronically or in paper in Room M–
4365A, 2001 C St. NW, Washington, DC
20551, between 9 a.m. and 5 p.m.
during Federal business weekdays.
FDIC: The FDIC encourages interested
parties to submit written comments.
Please include your name, affiliation,
address, email address, and telephone
number(s) in your comment. You may
submit comments to the FDIC,
identified by RIN 3064–AF29 by any of
the following methods:
Agency Website: https://
www.fdic.gov/resources/regulations/
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Federal Register / Vol. 88, No. 179 / Monday, September 18, 2023 / Proposed Rules
federal-register-publications. Follow
instructions for submitting comments
on the FDIC’s website.
Mail: James P. Sheesley, Assistant
Executive Secretary, Attention:
Comments/Legal OES (RIN 3064–AF29),
Federal Deposit Insurance Corporation,
550 17th Street NW, Washington, DC
20429.
Hand Delivered/Courier: Comments
may be hand-delivered to the guard
station at the rear of the 550 17th Street
NW, building (located on F Street NW)
on business days between 7 a.m. and 5
p.m.
Email: comments@FDIC.gov. Include
the RIN 3064–AF29 on the subject line
of the message.
Public Inspection: Comments
received, including any personal
information provided, may be posted
without change to https://www.fdic.gov/
resources/regulations/federal-registerpublications. Commenters should
submit only information that the
commenter wishes to make available
publicly. The FDIC may review, redact,
or refrain from posting all or any portion
of any comment that it may deem to be
inappropriate for publication, such as
irrelevant or obscene material. The FDIC
may post only a single representative
example of identical or substantially
identical comments, and in such cases
will generally identify the number of
identical or substantially identical
comments represented by the posted
example. All comments that have been
redacted, as well as those that have not
been posted, that contain comments on
the merits of this document will be
retained in the public comment file and
will be considered as required under all
applicable laws. All comments may be
accessible under the Freedom of
Information Act.
FOR FURTHER INFORMATION CONTACT:
OCC: Venus Fan, Risk Expert,
Benjamin Pegg, Analyst, Andrew
Tschirhart, Risk Expert, or Diana Wei,
Risk Expert, Capital Policy, (202) 649–
6370; Carl Kaminski, Assistant Director,
Kevin Korzeniewski, Counsel, Rima
Kundnani, Counsel, Daniel Perez,
Counsel, or Daniel Sufranski, Senior
Attorney, Chief Counsel’s Office, (202)
649–5490, Office of the Comptroller of
the Currency, 400 7th Street SW,
Washington, DC 20219. If you are deaf,
hard of hearing, or have a speech
disability, please dial 7–1–1 to access
telecommunications relay services.
Board: Anna Lee Hewko, Associate
Director, (202) 530–6260; Brian
Chernoff, Manager, (202) 452–2952;
Andrew Willis, Manager, (202) 912–
4323; Cecily Boggs, Lead Financial
Institution Policy Analyst, (202) 530–
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6209; Marco Migueis, Principal
Economist, (202) 452–6447; Diana
Iercosan, Principal Economist, (202)
912–4648; Nadya Zeltser, Senior
Financial Institution Policy Analyst,
(202) 452–3164; Division of Supervision
and Regulation; or Jay Schwarz,
Assistant General Counsel, (202) 452–
2970; Mark Buresh, Special Counsel,
(202) 452–5270; Andrew Hartlage,
Special Counsel, (202) 452–6483;
Gillian Burgess, Senior Counsel, (202)
736–5564; Jonah Kind, Senior Counsel,
(202) 452–2045, Legal Division, Board of
Governors of the Federal Reserve
System, 20th Street and Constitution
Avenue NW, Washington, DC 20551.
For users of TTY–TRS, please call 711
from any telephone, anywhere in the
United States.
FDIC: Benedetto Bosco, Chief Capital
Policy Section; Bob Charurat, Corporate
Expert; Irina Leonova, Corporate Expert;
Andrew Carayiannis, Chief, Policy and
Risk Analytics Section; Brian Cox,
Chief, Capital Markets Strategies
Section; Noah Cuttler, Senior Policy
Analyst; David Riley, Senior Policy
Analyst; Michael Maloney, Senior
Policy Analyst; Richard Smith, Capital
Markets Policy Analyst; Olga Lionakis,
Capital Markets Policy Analyst; Kyle
McCormick, Senior Policy Analyst;
Keith Bergstresser, Senior Policy
Analyst, Capital Markets and
Accounting Policy Branch, Division of
Risk Management Supervision;
Catherine Wood, Counsel; Benjamin
Klein, Counsel; Anjoly David, Honors
Attorney, Legal Division;
regulatorycapital@fdic.gov, (202) 898–
6888; Federal Deposit Insurance
Corporation, 550 17th Street NW,
Washington, DC 20429.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Introduction
A. Overview of the Proposal
B. Use of Internal Models Under the
Proposed Framework
II. Scope of Application
III. Proposed Changes to the Capital Rule
A. Calculation of Capital Ratios and
Application of Buffer Requirements
1. Standardized Output Floor
2. Stress Capital Buffer Requirement
B. Definition of Capital
1. Accumulated Other Comprehensive
Income
2. Regulatory Capital Deductions
3. Additional Definition of Capital
Adjustments
4. Changes to the Definition of Tier 2
Capital Applicable to Large Banking
Organizations
C. Credit Risk
1. Due Diligence
2. Proposed Risk Weights for Credit Risk
3. Off-Balance Sheet Exposures
4. Derivatives
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5. Credit Risk Mitigation
D. Securitization Framework
1. Operational Requirements
2. Securitization Standardized Approach
(SEC–SA)
3. Exceptions to the SEC–SA Risk-Based
Capital Treatment for Securitization
Exposures
4. Credit Risk Mitigation for Securitization
Exposures
E. Equity Exposures
1. Risk-Weighted Asset Amount
F. Operational Risk
1. Business Indicator
2. Business Indicator Component
3. Internal Loss Multiplier
4. Operational Risk Management and Data
Collection Requirements
G. Disclosure Requirements
1. Proposed Disclosure Requirements
2. Specific Public Disclosure Requirements
H. Market Risk
1. Background
2. Scope and Application of the Proposed
Rule
3. Market Risk Covered Position
4. Internal Risk Transfers
5. General Requirements for Market Risk
6. Measure for Market Risk
7. Standardized Measure for Market Risk
8. Models-Based Measure for Market Risk
9. Treatment of Certain Market Risk
Covered Positions
10. Reporting and Disclosure Requirements
11. Technical Amendments
I. Credit Valuation Adjustment Risk
1. Background
2. Scope of Application
3. CVA Risk Covered Positions and CVA
Hedges
4. General Risk Management Requirements
5. Measure for CVA Risk
IV. Transition Provisions
A. Transitions for Expanded Total RiskWeighted Assets
B. AOCI Regulatory Capital Adjustments
V. Impact and Economic Analysis
A. Scope and Data
B. Impact on Risk-Weighted Assets and
Capital Requirements
C. Economic Impact on Lending Activity
D. Economic Impact on Trading Activity
E. Additional Impact Considerations
VI. Technical Amendments to the Capital
Rule
A. Additional OCC Technical Amendments
B. Additional FDIC Technical
Amendments
VII. Proposed Amendments to Related Rules
and Related Proposals
A. OCC Amendments
B. Board Amendments
C. Related Proposals
VIII. Administrative Law Matters
A. Paperwork Reduction Act
B. Regulatory Flexibility Act
C. Plain Language
D. Riegle Community Development and
Regulatory Improvement Act of 1994
E. OCC Unfunded Mandates Reform Act of
1995 Determination
F. Providing Accountability Through
Transparency Act of 2023
I. Introduction
The Office of the Comptroller of the
Currency (OCC), the Board of Governors
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of the Federal Reserve System (Board),
and the Federal Deposit Insurance
Corporation (FDIC) (collectively, the
agencies) are proposing to modify the
capital requirements applicable to
banking organizations 1 with total assets
of $100 billion or more and their
subsidiary depository institutions (large
banking organizations) and to banking
organizations with significant trading
activity. The revisions set forth in the
proposal would strengthen the
calculation of risk-based capital
requirements to better reflect the risks of
these banking organizations’ exposures.
In addition, the proposed revisions
would enhance the consistency of
requirements across large banking
organizations and facilitate more
effective supervisory and market
assessments of capital adequacy.
Following the 2007–09 financial
crisis, the agencies adopted an initial set
of reforms to improve the effectiveness
of and address weaknesses in the
regulatory capital framework. For
example, in 2013, the agencies adopted
a final rule that increased the quantity
and quality of regulatory capital banking
organizations must maintain.2 These
changes were broadly consistent with an
initial set of reforms published by the
Basel Committee on Banking
Supervision (Basel Committee)
following the financial crisis.3 The
Board also implemented capital
planning and stress testing requirements
for large bank holding companies and
savings and loan holding companies 4
and an additional capital buffer
requirement to mitigate the financial
stability risks posed by U.S. global
1 The term ‘‘banking organizations’’ includes
national banks, state member banks, state
nonmember banks, Federal savings associations,
state savings associations, top-tier bank holding
companies domiciled in the United States not
subject to the Board’s Small Bank Holding
Company and Savings and Loan Holding Company
Policy Statement (12 CFR part 225, appendix C),
U.S. intermediate holding companies of foreign
banking organizations, and top-tier savings and loan
holding companies domiciled in the United States,
except for certain savings and loan holding
companies that are substantially engaged in
insurance underwriting or commercial activities
and savings and loan holding companies that are
subject to the Small Bank Holding Company and
Savings and Loan Holding Company Policy
Statement.
2 The Board and the OCC issued a joint final rule
on October 11, 2013 (78 FR 62018) and the FDIC
issued a substantially identical interim final rule on
September 10, 2013 (78 FR 55340). In April 2014,
the FDIC adopted the interim final rule as a final
rule with no substantive changes. 79 FR 20754
(April 14, 2014).
3 The Basel Committee is a committee composed
of central banks and banking supervisory
authorities, which was established by the central
bank governors of the G–10 countries in 1975.
4 See 12 CFR 225.8; 12 CFR part 238, subparts N,
O, P, R, S; 12 CFR part 252, subparts D, E, F, N,
O.
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systemically important banking
organizations (GSIBs),5 as well as other
enhanced prudential standards,
consistent with the Dodd-Frank Wall
Street Reform and Consumer Protection
Act of 2010 (Dodd-Frank Act).6
The proposal would build on these
initial reforms by making additional
changes developed in response to the
2007–09 financial crisis and informed
by experience since the crisis.
Requirements under the proposal would
generally be consistent with
international capital standards issued by
the Basel Committee, commonly known
as the Basel III reforms.7 Where
appropriate, the proposal differs from
the Basel III reforms to reflect, for
example, specific characteristics of U.S.
markets, requirements under U.S.
generally accepted accounting
principles (GAAP),8 practices of U.S.
banking organizations, and U.S. legal
requirements and policy objectives.
The proposal would strengthen riskbased capital requirements for large
banking organizations by improving
their comprehensiveness and risk
sensitivity. These proposed revisions,
including removal of certain internal
models, would increase capital
requirements in the aggregate, in
particular for those banking
organizations with heightened risk
profiles. Increased capital requirements
can produce both economic costs and
benefits. The agencies assessed the
likely effect of the proposal on
economic activity and resilience, and
expect that the benefits of strengthening
capital requirements for large banking
organizations outweigh the costs.9
Historical experience has
demonstrated the impact individual
banking organizations can have on the
stability of the U.S. banking system, in
particular banking organizations that
would have been subject to the
proposal. Large banking organizations
that experience an increase in their
capital requirements resulting from the
proposal would be expected to be able
to absorb losses with reduced disruption
to financial intermediation in the U.S.
economy. Enhanced resilience of the
banking sector supports more stable
lending through the economic cycle and
diminishes the likelihood of financial
crises and their associated costs.
5 12
CFR part 217, subpart H.
12 CFR part 252; 12 U.S.C. 5365.
7 See the consolidated Basel Framework at
https://www.bis.org/basel_framework/.
8 GAAP often serve as a foundational
measurement component for U.S. capital
requirements.
9 See the impact and economic analysis presented
in section V of this SUPPLEMENTARY INFORMATION.
6 See
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The agencies seek comment on all
aspects of the proposal.
A. Overview of the Proposal
The proposal would improve the risk
capture and consistency of capital
requirements across large banking
organizations and reduce complexity
and operational costs through changes
across multiple areas of the agencies’
risk-based capital framework. For most
parts of the framework, the proposal
would eliminate the use of banking
organizations’ internal models to set
regulatory capital requirements and in
their place apply a simpler and more
consistent standardized framework. For
market risk, the proposal would retain
banking organizations’ ability to use
internal models, with an improved
models-based measure for market risk
that better accounts for potential losses.
The use of internal models would be
subject to enhanced requirements for
model approval and performance and a
new ‘‘output floor’’ to limit the extent to
which a banking organization’s internal
models may reduce its overall capital
requirement. The proposal would also
adopt new standardized approaches for
market risk and credit valuation
adjustment (CVA) risk that better reflect
the risks of banking organizations’
exposures.
This new framework for calculating
risk-weighted assets (the expanded riskbased approach) would apply to
banking organizations with total assets
of $100 billion or more and their
subsidiary depository institutions. The
revised requirements for market risk
would also apply to other banking
organizations with $5 billion or more in
trading assets plus trading liabilities or
for which trading assets plus trading
liabilities exceed 10 percent of total
assets.
The expanded risk-based approach
would be more risk-sensitive than the
current U.S. standardized approach by
incorporating more credit-risk drivers
(for example, borrower and loan
characteristics) and explicitly
differentiating between more types of
risk (for example, operational risk,
credit valuation adjustment risk). In this
manner, the expanded risk-based
approach would better account for key
risks faced by large banking
organizations. The proposed changes
would also enhance the alignment of
capital requirements to the risks of
banking organizations’ exposures and
increase incentives for prudent risk
management.
To ensure that large banking
organizations would not have lower
capital requirements than smaller, less
complex banking organizations, the
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proposal would maintain the capital
rule’s dual-requirement structure. Under
this structure, a large banking
organization would be required to
calculate its risk-based capital ratios
under both the new expanded riskbased approach and the standardized
approach (including market risk, as
applicable), and use the lower of the
two for each risk-based capital ratio.10
All capital buffer requirements,
including the stress capital buffer
requirement, would apply regardless of
whether the expanded risk-based
approach or the existing standardized
approach produces the lower ratio.
For banking organizations subject to
Category III or IV capital standards,11
the proposal would align the calculation
of regulatory capital—the numerator of
the regulatory capital ratios—with the
calculation for banking organizations
subject to Category I or II capital
standards, providing the same approach
for all large banking organizations.
Banking organizations subject to
Category III or IV capital standards
would be subject to the same treatment
of accumulated other comprehensive
income (AOCI), capital deductions, and
rules for minority interest as banking
organizations subject to Category I or II
capital standards. This change would
help ensure that the regulatory capital
ratios of these banking organizations
better reflect their capacity to absorb
losses, including by taking into account
10 Banking organizations’ risk-based capital ratios
are the common equity tier 1 capital ratio, tier 1
capital ratio, and total capital ratio. See 12 CFR 3.10
(OCC), 12 CFR 217.10 (Board), and 12 CFR 324.10
(FDIC).
11 In 2019, the agencies adopted rules establishing
four categories of capital standards for U.S. banking
organizations with $100 billion or more in total
assets and foreign banking organizations with $100
billion or more in combined U.S. assets. Under this
framework, Category I capital standards apply to
U.S. global systemically important bank holding
companies and their depository institution
subsidiaries. Category II capital standards apply to
banking organizations with at least $700 billion in
total consolidated assets or at least $75 billion in
cross-jurisdictional activity and their depository
institution subsidiaries. Category III capital
standards apply to banking organizations with total
consolidated assets of at least $250 billion or at
least $75 billion in weighted short-term wholesale
funding, nonbank assets, or off-balance sheet
exposure and their depository institution
subsidiaries. Category IV capital standards apply to
banking organizations with total consolidated assets
of at least $100 billion that do not meet the
thresholds for a higher category and their
depository institution subsidiaries. See 12 CFR 3.2
(OCC), 12 CFR 252.5, 12 CFR 238.10 (Board), 12
CFR 324.2 (FDIC); ‘‘Prudential Standards for Large
Bank Holding Companies, Savings and Loan
Holding Companies, and Foreign Banking
Organizations,’’ 84 FR 59032 (November 1, 2019);
and ‘‘Changes to Applicability Thresholds for
Regulatory Capital and Liquidity Requirements,’’ 84
FR 59230 (November 1, 2019).
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unrealized losses or gains on securities
positions reflected in AOCI.
The proposal would expand
application of the supplementary
leverage ratio and the countercyclical
capital buffer to banking organizations
subject to Category IV capital standards.
This change would bring further
alignment of capital requirements across
large banking organizations and is
consistent with the proposal’s goal of
strengthening the resilience of large
banking organizations.
The proposal would also introduce
enhanced disclosure requirements to
facilitate market participants’
understanding of a banking
organization’s financial condition and
risk management practices. Also, the
proposal would align Federal Reserve’s
regulatory reporting requirements with
the changes to capital requirements. The
agencies anticipate that revisions to the
reporting forms of the Federal Financial
Institutions Examination Council
(FFIEC) applicable to large banking
organizations and to banking
organizations with significant trading
activity will be proposed in the near
future, which would align with the
proposed revisions to the capital rule.
The proposed changes would take
effect subject to the transition
provisions described in section IV of
this SUPPLEMENTARY INFORMATION.
The revisions introduced by the
proposal would interact with several
Board rules, including by modifying the
risk-weighted assets used to calculate
total loss-absorbing capacity
requirements, long-term debt
requirements, and the short-term
wholesale funding score included in the
GSIB surcharge method 2 score. Also,
the proposal would revise the
calculation of single-counterparty credit
limits by removing the option of using
a banking organization’s internal models
to calculate derivatives exposure
amounts and requiring the use of the
standardized approach for counterparty
credit risk for this purpose. The
proposal would also remove the
exemption from calculating riskweighted assets under subpart E of the
capital rule currently available to U.S.
intermediate holding companies of
foreign banking organizations under the
Board’s enhanced prudential standards.
In parallel, the Board is issuing a
notice of proposed rulemaking revising
the GSIB surcharge calculation
applicable to GSIBs and the systemic
risk report applicable to large banking
organizations.12
12 On October 24, 2019, the Board published in
the Federal Register a notice of proposed
rulemaking inviting comment on a proposal to
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Question 1: The Board invites
comment on the interaction of the
revisions under the proposal with other
existing rules and with the other notice
of proposed rulemaking. In particular,
comment is invited on the impact of the
proposal on the single-counterparty
credit limit framework. What are the
advantages and disadvantages of the
proposed approach? Which alternatives,
if any, should the Board consider and
why?
B. Use of Internal Models Under the
Proposed Framework
The proposal would remove the use of
internal models to set credit risk and
operational risk capital requirements
(the so-called advanced approaches) for
banking organizations subject to
Category I or II capital standards. These
internal models rely on a banking
organization’s choice of modeling
assumptions and supporting data. Such
model assumptions include a degree of
subjectivity, which can result in varying
risk-based capital requirements for
similar exposures. Moreover, empirical
verification of modeling choices can
require many years of historical
experience because severe credit risk
and operational risk losses can occur
infrequently. In the agencies’ previous
observations, the advanced approaches
have produced unwarranted variability
across banking organizations in
requirements for exposures with similar
risks.13 This unwarranted variability,
combined with the complexity of these
models-based approaches, can reduce
confidence in the validity of the
modeled outputs, lessen the
transparency of the risk-based capital
ratios, and challenge comparisons of
capital adequacy across banking
organizations.
Standardization of credit and
operational risk capital requirements
would improve the consistency of
requirements. Standardized
requirements, together with robust
public disclosure and reporting
requirements, would enhance the
transparency of capital requirements
and the ability of supervisors and
market participants to make
independent assessments of a banking
establish risk-based capital requirements for
depository institution holding companies
significantly engaged in insurance activities. See 84
FR 57240 (October 24, 2019). The Board anticipates
that any final rule based on the proposal in this
SUPPLEMENTARY INFORMATION would include
appropriate adjustments as necessary to take into
account any final insurance capital rule.
13 The Basel Committee has published analysis
illustrating the variability of credit-risk-weighted
assets across banking organizations. See https://
www.bis.org/publ/bcbs256.pdf and https://
www.bis.org/bcbs/publ/d363.pdf.
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organization’s capital adequacy,
individually and relative to its peers.
The use of robust, risk-sensitive
standardized approaches for credit and
operational risk would also improve the
efficiency of the capital framework by
reducing operational costs. Under the
advanced approaches, banking
organizations subject to Category I or II
capital standards must develop and
maintain internal modeling systems to
determine capital requirements, which
may differ from the risk measurement
approaches they use to monitor risk for
internal assessments. Further, any
material changes to a banking
organization’s internal models must be
fully documented and presented to the
banking organization’s primary Federal
supervisor for review.14 Replacing the
use of internal models with
standardized approaches would reduce
costs associated with maintaining such
modeling systems and eliminate the
associated submissions to the agencies.
Eliminating the use of internal models
to set credit and operational risk capital
requirements would not reduce the
overall risk capture of the regulatory
framework. In addition to the
calculation of expanded risk-based
approach and standardized approach
capital requirements, a large banking
organization would continue to be
required to maintain capital
commensurate with the level and nature
of all risks to which the banking
organization is exposed,15 to have a
process for assessing its overall capital
adequacy in relation to its risk profile
and a comprehensive strategy for
maintaining an appropriate level of
capital,16 and, where applicable, to
conduct internal stress tests.17 Also,
holding companies subject to the
Board’s capital plan rule would
continue to be subject to a stress capital
buffer requirement that is based on a
supervisory stress test of the holding
company’s exposures.18 Although the
proposal would remove use of internal
models for calculating capital
requirements for credit and operational
risk, internal models can provide
valuable information to a banking
organization’s internal stress testing,
capital planning, and risk management
functions. Large banking organizations
should employ internal modeling
14 See 12 CFR 3.123(a) (OCC); 12 CFR 217.123(a)
(Board); 12 CFR 324.123(a) (FDIC).
15 See 12 CFR 3.10(e)(1) (OCC); 12 CFR
217.10(e)(1) (Board); 12 CFR 324.10(e)(1) (FDIC).
16 See 12 CFR 3.10(e)(2) (OCC); 12 CFR
217.10(e)(2) (Board); 12 CFR 324.10(e)(2) (FDIC).
17 See 12 CFR 46 (OCC); 12 CFR 252 subpart B
and F (Board); 12 CFR 325 (FDIC).
18 See 12 CFR 225.8 and 12 CFR 238.170.
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capabilities as appropriate for the
complexity of their activities.
The proposal would continue to allow
use of internal models to set market risk
capital requirements for portfolios
where modeling can be demonstrated to
be appropriate. In addition, the proposal
would provide for conservative but risksensitive standardized alternatives
where modeling is not supported. In
contrast to credit and operational risk,
market risk data allows for daily
feedback on model performance to
support empirical verification. The
proposal would limit the use of models
to only those trading desks for which a
banking organization has received
approval from its primary Federal
supervisor. Ongoing use of such models
would depend upon a banking
organization’s ability to demonstrate
through robust testing that the models
are sufficiently conservative and
accurate for purposes of calculating
market risk capital requirements. In
cases where a banking organization
cannot demonstrate acceptable
performance of its internal models for a
given trading desk, the banking
organization would be required to use
the standardized measure for market
risk which acts as a risk-sensitive
alternative.
II. Scope of Application
The proposal’s expanded risk-based
approach would apply to banking
organizations with total assets of $100
billion or more and their subsidiary
depository institutions.19 These banking
organizations are large and exhibit
heightened complexity. Application of
the expanded risk-based approach to
large banking organizations would
provide granular, generally standardized
requirements that result in robust risk
capture and appropriate risk sensitivity.
By strengthening the requirements that
apply to large banking organizations, the
proposal would enhance their resilience
and reduce risks to U.S. financial
stability and costs they may pose to the
Federal Deposit Insurance Fund in case
of material distress or failure. Relative to
smaller, less complex banking
organizations, these banking
organizations have greater operational
capacity to apply more sophisticated
requirements.
Previously, the agencies determined
that the advanced approaches
19 The proposal would also apply to depository
institutions with total assets of $100 billion or more
that are not consolidated subsidiaries of depository
institution holding companies, and to depository
institutions with total assets of $100 billion or more
that are subsidiaries of depository institution
holding companies that are not assigned a category
under the capital rule.
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requirements should not apply to
banking organizations subject to
Category III or IV capital standards, as
the agencies considered such
requirements to be overly complex and
burdensome relative to the safety and
soundness benefits that they would
provide for these banking
organizations.20 The expanded riskbased approach generally is based on
standardized requirements, which
would be less complex and costly. In
addition, recent events demonstrate the
impact banking organizations subject to
Category III or IV capital standards can
have on financial stability. While the
recent failure of banking organizations
subject to Category IV capital standards
may be attributed to a variety of factors,
the effect of these failures on financial
stability supports further alignment of
the regulatory capital framework across
large banking organizations.
Banking organizations with
significant trading activities are subject
to substantial market risk and, therefore,
would be subject to market risk capital
requirements. Recognizing that the
dollar-based threshold for the
application of market risk requirements
was established in 1996, the proposal
would increase this dollar-based
threshold from $1 billion to $5 billion
of trading assets plus trading liabilities.
Banking organizations would also
continue to be subject to market risk
requirements if their trading assets plus
trading liabilities represent 10 percent
or more of total assets. The proposal
would revise the calculation of the
dollar-based threshold amount to be
based on four-quarter averages of
trading assets and trading liabilities
instead of point-in-time amounts.
Banking organizations that would no
longer meet these minimum thresholds
for being subject to market risk capital
requirements would calculate riskweighted assets for trading exposures
under the standardized approach.
Additionally, under the proposal, large
banking organizations would be subject
to market risk capital requirements
regardless of trading activities.
The proposal would expand
application of the countercyclical
capital buffer to banking organizations
subject to Category IV capital standards.
The countercyclical capital buffer is a
macroprudential tool that can be used to
increase the resilience of the financial
system by increasing capital
requirements for large banking
organizations during a period of
20 See ‘‘Prudential Standards for Large Bank
Holding Companies, Savings and Loan Holding
Companies, and Foreign Banking Organizations,’’
84 FR 59032 (November 1, 2019).
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elevated risk of above-normal losses.
Failure or distress of a banking
organization with assets of $100 billion
or more during a time of elevated risk
or stress can have significant
destabilizing effects for other banking
organizations and the broader financial
system—even if the banking
organization does not meet the criteria
for being subject to Category II or III
capital standards. Applying the
countercyclical capital buffer to banking
organizations subject to Category IV
capital standards would increase the
resilience of these banking organizations
and, in turn, improve the resilience of
the broader financial system. The
proposed approach also has the
potential to moderate fluctuations in the
supply of credit over time. The proposal
would also modify how the
countercyclical capital buffer amount is
determined to reflect the proposed
changes to market risk capital
requirements. Specifically, the riskweighted asset amount for private sector
credit exposures that are market risk
covered positions under the proposal
would be determined using the
standardized default risk capital
requirement for such positions rather
than using the specific risk add-on of
the current rule.
The proposal also would expand
application of the supplementary
leverage ratio requirement to banking
organizations subject to Category IV
capital standards. In contrast to the riskbased capital requirements, a leverage
ratio does not differentiate the amount
of capital required by exposure type.
Rather, a leverage ratio puts a simple
and transparent limit on banking
organization leverage. Leverage
requirements protect against
underestimation of risk both by banking
organizations and by risk-based capital
requirements and serve as a
complement to risk-based capital
requirements. The supplementary
leverage ratio measures tier 1 capital
relative to total leverage exposure,
which includes on-balance sheet assets
and certain off-balance sheet exposures.
The proposed change would ensure that
all large banking organizations are
subject to a consistent and robust
leverage requirement that serves as a
complement to risk-based capital
requirements and takes into account onand off-balance sheet exposures.
Question 2: What are the advantages
and disadvantages of applying the
expanded risk-based approach to
banking organizations subject to
Category III or IV capital standards? To
what extent is the expanded risk-based
approach appropriate for banking
organizations with different risk
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profiles, including from a cost and
operational burden perspective? Are
there specific areas, such as the market
risk capital framework, for which the
agencies should consider a materiality
threshold to better balance cost and
operational burden and risk sensitivity,
and if so what should that threshold be
and why? What would the appropriate
exposure treatment be for banking
organizations with such exposures
beneath any materiality threshold, and
how would that treatment be consistent
with the overall calibration of the
expanded risk-based approach? What
alternatives, if any, should the agencies
consider to help ensure that the risks of
large banking organizations are
appropriately captured under minimum
risk-based capital requirements and
why?
Question 3: What are the advantages
and disadvantages of harmonizing the
calculation of regulatory capital across
large banking organizations? What are
any unintended consequences of the
proposal and what steps should the
agencies consider to mitigate those
consequences? What are the advantages
and disadvantages of harmonizing the
calculation of regulatory capital across
large banking organizations and using
different approaches (for example, the
expanded risk-based approach and the
U.S. standardized approach) for the
calculation of risk-weighted assets?
Question 4: What are the advantages
and disadvantages of applying the
countercyclical capital buffer and
supplementary leverage ratio to banking
organizations subject to Category IV
capital standards?
III. Proposed Changes to the Capital
Rule
A. Calculation of Capital Ratios and
Application of Buffer Requirements
Under the proposal, large banking
organizations would be required to
calculate total risk-weighted assets
under two approaches: (1) the expanded
risk-based approach, and (2) the
standardized approach. Total riskweighted assets under the expanded
risk-based approach (expanded total
risk-weighted assets) would equal the
sum of risk-weighted assets for credit
risk, equity risk, operational risk, market
risk, and CVA risk, as described in this
proposal, minus any amount of the
banking organization’s adjusted
allowance for credit losses that is not
included in tier 2 capital and any
amount of allocated transfer risk
reserves. For calculating standardized
total risk-weighted assets, the proposal
would revise the methodology for
determining market risk-weighted assets
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and would require banking
organizations subject to Category III or
IV capital standards to use the
standardized approach for counterparty
credit risk (SA–CCR) for derivative
exposures.21
To determine its applicable risk-based
capital ratios, a large banking
organization would calculate two sets of
risk-based capital ratios (common equity
tier 1 capital ratio, tier 1 capital ratio,
and total capital ratio), one using
expanded total risk-weighted assets and
one using standardized total riskweighted assets. A banking
organization’s common equity tier 1
capital ratio, tier 1 capital ratio, and
total capital ratio would be the lower of
each ratio of the two approaches.
The proposal would not change the
minimum risk-based capital ratios
under the capital rule. Also, the capital
conservation buffer would continue to
apply to risk-based capital ratios as
under the capital rule, except that the
stress capital buffer requirement—a
component of the capital conservation
buffer that is applicable to banking
organizations subject to the Board’s
capital plan rule—would apply to a
banking organization’s risk-based
capital ratios regardless of whether the
ratios result from the expanded riskbased approach or the standardized
approach.
Question 5: What are the advantages
and disadvantages of banking
organizations being required to
calculate risk-based capital ratios in two
different ways and what alternatives,
such as a single calculation, should the
agencies consider and why? What
modifications, if any, to the proposed
structure of the risk-based capital
calculation should the agencies
consider?
1. Standardized Output Floor
To enhance the consistency of capital
requirements and ensure that the use of
internal models for market risk does not
result in unwarranted reductions in
capital requirements, the proposal
would introduce an ‘‘output floor’’ to
the calculation of expanded total risk21 The proposed methodology for determining
market risk-weighted assets, in certain instances,
would require a banking organization that is subject
to subpart E to apply risk weights from subpart D
for purposes of determining its standardized total
risk-weighted assets and from subpart E for
purposes of determining its expanded total riskweighted assets. This approach would apply in the
case of: (i) capital add-ons for re-designations, (ii)
term repo-style transactions the banking
organization elects to include in market risk, (iii)
the standardized default risk capital requirement for
securitization positions non-CTP, and (iv) the
standardized default risk capital requirement for
correlation trading positions, each as discussed
further below.
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weighted assets. This output floor
would correspond to 72.5 percent of the
sum of a banking organization’s credit
risk-weighted assets, equity riskweighted assets, operational riskweighted assets, and CVA risk-weighted
assets under the expanded risk-based
approach and risk-weighted assets
calculated using the standardized
measure for market risk, minus any
amount of the banking organization’s
adjusted allowance for credit losses that
is not included in tier 2 capital and any
amount of allocated transfer risk
reserves.
The output floor would serve as a
lower bound on the risk-weighted assets
under the expanded risk-based
approach. In other words, if the riskweighted assets under the expanded
risk-based approach were less than the
output floor, the output floor would
have to be used as the risk-weighted
asset amount to determine the expanded
risk-based approach capital ratios.
The proposed calibration of the
output floor aims to strike a balance
between allowing internal models to
enhance the risk sensitivity of market
risk capital requirements and ensuring
that these models would not result in
unwarranted reductions in capital
requirements. The output floor would
be consistent with the Basel III reforms,
which would promote consistency in
capital requirements for large, complex,
and internationally active banking
organizations across jurisdictions.
Question 6: What are the advantages
and disadvantages of the proposed
output floor?
approaches requirements are subject to
an advanced approaches capital
conservation buffer requirement, which
applies to their advanced approaches
risk-based capital ratios, and which is
calculated in the same manner as the
standardized approach capital
conservation buffer requirement, except
that the banking organization’s stress
capital buffer requirement is replaced
with a 2.5 percent buffer requirement.24
The stress capital buffer requirement
integrates the results of the Board’s
supervisory stress tests with the riskbased requirements of the capital rule to
determine capital distribution
limitations. As a result, required capital
levels for each banking organization
more closely align with the banking
organization’s risk profile and projected
losses as measured by the Board’s stress
test.25 The stress capital buffer
requirement is generally calculated as
(1) the difference between the banking
organization’s starting and minimum
projected common equity tier 1 capital
ratios under the severely adverse
scenario in the supervisory stress test
(stress test losses) plus (2) the sum of
the dollar amount of the banking
organization’s planned common stock
dividends for each of the fourth through
seventh quarters of the planning horizon
as a percentage of risk-weighted assets
(dividend add-on).26 A banking
organization’s stress capital buffer
requirement cannot be less than 2.5
percent of standardized total riskweighted assets.
Currently, the stress test losses and
dividend add-on portion of the stress
capital buffer requirement are calculated
using only the standardized approach
common equity tier 1 capital ratio. This
is consistent with the exclusion of the
stress capital buffer requirement from
the advanced approaches capital
conservation buffer requirement, and
with the Board’s stress testing and
capital plan rules, under which banking
organizations are not required to project
capital ratios using the advanced
approaches.
The Board is proposing to amend its
capital plan rule, stress testing rule, and
the buffer framework in its capital rule
to take into account capital ratios
calculated under the expanded riskbased approach, in addition to the
standardized approach. Under the
proposal, banking organizations subject
to the capital plan rule would be subject
to a single capital conservation buffer
requirement, which would include the
stress capital buffer requirement,
applicable countercyclical capital buffer
requirement, and applicable GSIB
surcharge, and would apply to the
banking organization’s risk-based
capital ratios, regardless of whether the
ratios result from the expanded riskbased approach or the standardized
approach. In this manner, the proposal
would ensure that the stress capital
buffer requirement contributes to the
robustness and risk-sensitivity of the
2. Stress Capital Buffer Requirement
Under the current capital rule, each
banking organization is subject to one or
more buffer requirements, and must
maintain capital ratios above the sum of
its minimum requirements and buffer
requirements to avoid restrictions on
capital distributions and certain
discretionary bonus payments.22
Banking organizations that are subject to
the Board’s capital plan rule 23 (bank
holding companies, U.S. intermediate
holding companies, and savings and
loan holding companies that have over
$100 billion or more in total
consolidated assets) are currently
subject to a standardized approach
capital conservation buffer requirement,
which is calculated as the sum of the
banking organization’s stress capital
buffer requirement, applicable
countercyclical capital buffer
requirement, and applicable GSIB
surcharge. The standardized approach
capital conservation buffer requirement
applies to a banking organization’s
standardized approach risk-based
capital ratios. In addition, banking
organizations that are subject to the
capital plan rule and the advanced
22 12 CFR 3.11 (OCC); 12 CFR 217.11 (Board); 12
CFR 324.11 (FDIC).
23 12 CFR 225.8 (bank holding companies and
U.S. intermediate holding companies of foreign
banking organizations); 12 CFR 238.170 (savings
and loan holding companies).
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24 See
12 CFR 217.11(c).
85 FR 15576 (March 18, 2020).
26 12 CFR 225.8(f)(2); 12 CFR 238.170(f)(2).
25 See
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risk-based capital requirements of these
banking organizations. Application of
the stress capital buffer requirement to
the risk-based capital ratios derived
from the expanded risk-based approach
would not introduce complexity given
the fixed balance sheet assumption
currently used in the Board stress tests
and because the expanded risk-based
approach is based in mostly
standardized requirements.27
Additionally, the proposal would
revise the calculation of the stress
capital buffer requirement for large
banking organizations. Under the
proposal, both the stress test losses and
dividend add-on components of the
stress capital buffer requirement would
be calculated using the binding common
equity tier 1 capital ratio, as of the final
quarter of the previous capital plan
cycle, regardless of whether it results
from the expanded risk-based approach
or the standardized approach.28 The
proposed calculation methodology
would limit complexity relative to
potential alternatives, such as
introducing two stress capital buffer
requirements for each banking
organization (one for each approach to
calculating total risk-weighted assets).
In addition, the proposed approach
recognizes that the binding approach for
a banking organization is unlikely to
change within the period in which a
given stress capital buffer requirement is
applicable.
As part of the capital buffer
framework, the stress capital buffer
requirement helps ensure that a banking
organization can withstand losses from
a severely adverse scenario, while still
meeting its minimum regulatory capital
requirements and thereby continuing to
serve as a viable financial intermediary.
Because this proposal aims to better
reflect the risk of banking organizations’
exposures in the calculation of riskweighted assets, without changing the
targeted level of conservatism of the
minimum capital requirements, the
Board is not proposing associated
27 Initially, the Board did not incorporate the
stress capital buffer requirement into the advanced
approaches capital conservation buffer requirement
owing to the complexity involved in doing so.
28 The Board’s Stress Testing Policy Statement
includes an assumption that the magnitude of a
banking organization’s balance sheet will be fixed
throughout the projection horizon under the
supervisory stress test. 12 CFR part 252, appendix
B. Under this assumption, because the
denominators of the common equity tier 1 capital
ratios as calculated under the standardized
approach and the expanded risk-based approach
would remain the same throughout the stress test,
the approach under which the binding common
equity tier 1 capital ratio is calculated would
remain the same throughout the final quarter of the
previous capital plan cycle and the projection
horizon.
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changes to the targeted severity of the
stress capital buffer requirement. The
Board evaluates the minimum riskbased capital requirements, which are
largely determined by risk-weighted
assets, and the stress capital buffer
requirement individually for their
specific intended purposes in the
capital framework, and holistically as
they determine the aggregate capital
banking organizations hold in the
normal course of business.
In addition to revising the stress
capital buffer requirement, the proposal
would amend the Board’s stress testing
and capital plan rules to require banking
organizations subject to Category I, II, or
III standards to project their risk-based
capital ratios in their company-run
stress tests and capital plans using the
calculation approach that results in the
binding ratios as of the start of the
projection horizon (generally, as of
December 31 of a given year). Also, the
proposal would require banking
organizations subject to Category IV
standards to project their risk-based
capital ratios under baseline conditions
in their capital plans and FR Y–14A
submissions using the risk-weighted
assets calculation approach that results
in the binding ratios as of the start of the
projection horizon. The use of the
binding approach to calculating riskbased capital ratios aims to conform
company-run stress tests and capital
plans with the binding risk-based
capital ratios in the proposed capital
rule and promote simplicity relative to
possible alternatives (such as requiring
that firms project ratios under both the
expanded risk-based approach and the
standardized approach).
Question 7: The Board invites
comment on the appropriate level of
risk capture for the risk-weighted assets
framework and the stress capital buffer
requirement, both for their respective
roles in the capital framework and for
their joint determination of overall
capital requirements. How should the
Board balance considerations of overall
capital requirements with the distinct
roles of minimum requirements and
buffer requirements? What adjustments,
if any, to either piece of the framework
should the Board consider? Which, if
any, specific portfolios or exposure
classes merit particular attention and
why?
Question 8: What are the advantages
and disadvantages of applying the same
stress capital buffer requirement to a
banking organization’s risk-based
capital ratios regardless of whether they
are determined using the standardized
or expanded risk-based approach? What
would be the advantages and
disadvantages of applying different
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64035
stress capital buffer requirements for
each set of risk-based capital ratios?
Question 9: What, if any, adjustments
should the Board consider with respect
to the buffer requirements to account for
the transitions in this proposal,
particularly related to expanded total
risk-weighted assets? For example, what
would be the advantages and
disadvantages of the Board determining
stress capital buffer requirements using
fully phased-in expanded total riskweighted assets versus transitional
expanded total risk-weighted assets?
What, if any, additional adjustments to
stress capital buffer requirements
should the Board consider during the
expanded total risk-weighted assets
transition?
B. Definition of Capital
The agencies regularly review their
capital framework to help ensure it is
functioning as intended. Consistent
with this ongoing assessment, the
agencies believe it is appropriate to
align the definition of capital for
banking organizations subject to
Category III or IV capital standards with
the definition currently applicable to
banking organizations subject to
Category I or II capital standards. The
current definition of capital applicable
to banking organizations subject to
Category I or II capital standards
provides for risk sensitivity and
transparency that is commensurate with
the size, complexity, and risk profile of
banking organizations subject to
Category III or IV capital standards. The
proposed alignment of the numerator
and denominator of regulatory capital
ratios of large banking organizations
would support the transparency of the
capital rule as it facilitates market
participants’ assessment of loss
absorbency and would promote
consistency of requirements across large
banking organizations.
As described in more detail below,
under the proposal, banking
organizations subject to Category III or
IV capital standards would be required
to recognize most elements of AOCI in
regulatory capital consistent with the
treatment for banking organizations
subject to Category I or II capital
standards. Banking organizations
subject to Category III or IV capital
standards would also apply the capital
deductions and minority interest
treatments that are currently applicable
to banking organizations subject to
Category I or II capital standards. The
proposal would also apply total loss
absorbing capacity (TLAC) holdings
deduction treatments to banking
organizations subject to Category III or
IV capital standards. The proposal
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includes a three-year transition period
for AOCI.
1. Accumulated Other Comprehensive
Income
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Under the current capital rule,
banking organizations subject to
Category I or II capital standards are
required to include most elements of
AOCI in regulatory capital; whereas all
other banking organizations including
those subject to Category III or IV capital
standards were provided an opportunity
to make a one-time election to opt-out
of recognizing most elements of AOCI
and related deferred tax assets (DTAs)
and deferred tax liabilities within
regulatory capital (AOCI opt-out
banking organizations).29 Under the
proposal, consistent with the treatment
applicable to banking organizations
subject to Category I or II capital
standards, banking organizations subject
to Category III or IV capital standards
would be required to include all AOCI
components in common equity tier 1
capital, except gains and losses on cashflow hedges where the hedged item is
not recognized on a banking
organization’s balance sheet at fair
value. This would require all net
unrealized holding gains and losses on
available-for-sale (AFS) debt
securities 30 from changes in fair value
to flow through to common equity tier
1 capital, including those that result
primarily from fluctuations in
benchmark interest rates. This treatment
would better reflect the point in time
loss-absorbing capacity of banking
organizations subject to Category III or
IV capital standards and would align
29 See 12 CFR 3.22(b) (OCC); 12 CFR 217.22(b)
(Board); 12 CFR 324.22(b) (FDIC). A banking
organization that made an opt-out election is
currently required to adjust common equity tier 1
capital as follows: subtract any net unrealized
holding gains and add any net unrealized holding
losses on available-for-sale securities; subtract any
accumulated net gains and add any accumulated
net losses on cash flow hedges; subtract any
amounts recorded in AOCI attributed to defined
benefit postretirement plans resulting from the
initial and subsequent application of the relevant
GAAP standards that pertain to such plans
(excluding, at the banking organization’s option, the
portion relating to pension assets deducted under
§ ll.22(a)(5) of the current capital rule); and,
subtract any net unrealized holding gains and add
any net unrealized holding losses on held-tomaturity securities that are included in AOCI.
30 AFS securities refers to debt securities. ASC
Subtopic 321–10 eliminated the classification of
equity securities with readily determinable fair
values not held for trading as available-for-sale and
generally requires investments in equity securities
to be measured at fair value with changes in fair
value recognized in net income. Changes in the fair
value of (i.e., the unrealized gains and losses on) a
banking organization’s equity securities are
recognized through net income rather than other
comprehensive income.
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with banking organizations subject to
Category I or II capital standards.
The agencies have previously
observed that the requirement to
recognize elements of AOCI in
regulatory capital has helped improve
the transparency of regulatory capital
ratios, as it better reflects banking
organizations’ actual loss-absorbing
capacity at a specific point in time,
notwithstanding the potential volatility
that such recognition may pose for their
regulatory capital ratios. The agencies
have also previously observed that
AOCI is an important indicator used by
market participants to evaluate the
capital strength of a banking
organization.31 More recently, the
agencies have observed generally higher
levels of securities classified as held-tomaturity (HTM) among banking
organizations that recognize AOCI in
regulatory capital.32
Changes in interest rates have led to
net unrealized losses for banking
organizations’ investment portfolios and
brought into focus the importance of
regulatory capital measures reflecting
the loss absorbing capacity of a banking
organization. The agencies have
observed that adverse trends in a
banking organization’s GAAP equity can
have negative market perception and
liquidity implications.33 Specifically,
net unrealized losses on AFS securities
included in AOCI have reduced banking
organizations’ tangible book value and
liquidity buffers,34 which can adversely
affect market participants’ assessments
of capital adequacy and liquidity.
Banking organizations are often
reluctant to sell these AFS securities as
the unrealized losses would become
realized losses upon sale, thus reducing
regulatory capital. However, banking
organizations may need to take such
steps in order to meet liquidity needs.
Recognizing elements of AOCI in
regulatory capital thus achieves a better
alignment of regulatory capital with
market participants’ assessment of lossabsorbing capacity.
31 84
FR 59230, 59249 (November 1, 2019).
set forth restrictions on the classification
of a debt security as HTM, circumstances not
consistent with the HTM classification, and
situations that call into question or taint a banking
organization’s intent to hold securities in the HTM
category.
33 See Board of Governors of the Federal Reserve
System, Supervision and Regulation Report, at 11
(November 2022); Office of the Comptroller of the
Currency, Semiannual Risk Perspective, at 22 (Fall
2022); Federal Deposit Insurance Corporation,
Fourth Quarter 2022 Quarterly Banking Profile, at
5, 22 (February 2023), Managing Sensitivity to
Market Risk in a Challenging Interest Rate
Environment (FIL–46–2013, October 8, 2013).
34 See 12 CFR part 50 (OCC); 12 CFR part 249
(Board); 12 CFR part 329 (FDIC).
Question 10: What complementary
measures should the banking agencies
consider regarding the regulatory
capital treatment for securities held as
HTM rather than AFS?
2. Regulatory Capital Deductions
The agencies have long limited the
amount of intangible and higher-risk
assets, such as mortgage servicing assets
(MSAs) and certain temporary
difference DTAs, included in regulatory
capital and required deduction of the
amounts above the limits. This is due to
the relatively high level of uncertainty
regarding the ability of banking
organizations to both accurately value
and realize value from these assets,
especially under adverse financial
conditions. The current capital rule also
limits the amount of investments in the
capital instruments of other banking
organizations that can be reflected in
regulatory capital. Furthermore, the
current capital rule limits the inclusion
of minority interest 35 in regulatory
capital in recognition that minority
interest is generally not available to
absorb losses at the banking
organization’s consolidated level and to
prevent highly capitalized subsidiaries
from overstating the amount of capital
available to absorb losses at the
consolidated organization.
Under the current capital rule,
banking organizations subject to
Category I or II capital standards must
deduct from common equity tier 1
capital amounts of MSAs, temporary
difference DTAs that the banking
organization could not realize through
net operating loss carrybacks, and
significant investments in the capital of
unconsolidated financial institutions in
the form of common stock 36
(collectively, threshold items) that
individually exceed 10 percent of the
banking organization’s common equity
tier 1 capital minus certain deductions
and adjustments.37 Banking
organizations subject to Category I or II
capital standards must also deduct from
common equity tier 1 capital the
aggregate amount of threshold items not
deducted under the 10 percent
32 GAAP
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35 Minority interest, also referred to as noncontrolling interest, reflects investments in the
capital instruments of subsidiaries of banking
organizations that are held by third parties.
36 A significant investment in the capital of an
unconsolidated financial institution is defined as an
investment in the capital of an unconsolidated
financial institution where a banking organization
subject to Category I or II capital standards owns
more than 10 percent of the issued and outstanding
common stock of the unconsolidated financial
institution. 12 CFR 3.2 (OCC); 12 CFR 217.2
(Board); 12 CFR 324.2 (FDIC).
37 See 12 CFR 3.22(c)(6), (d)(2) (OCC); 12 CFR
217.22(c)(6), (d)(2) (Board); 12 CFR 324.22(c)(6),
(d)(2) (FDIC).
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threshold deduction but that
nevertheless exceeds 15 percent of the
banking organization’s common equity
tier 1 capital minus certain deductions
and adjustments. Under the current
capital rule, banking organizations
subject to Category III or IV capital
standards are required to deduct from
common equity tier 1 capital any
amount of MSAs, temporary difference
DTAs that the banking organization
could not realize through net operating
loss carrybacks, and investments in the
capital of unconsolidated financial
institutions 38 that individually exceed
25 percent of common equity tier 1
capital of the banking organization
minus certain deductions and
adjustments.
Under the proposal, banking
organizations subject to Category III or
IV capital standards would be required
to deduct threshold items from common
equity tier 1 capital and apply other
capital deductions that are currently
applicable to banking organizations
subject to Category I or II capital
standards instead of the deductions
applicable to all other banking
organizations, thereby creating
alignment across all banking
organizations subject to the proposal.
In addition to deductions for the
threshold items, the current capital rule
requires that a banking organization
subject to Category I or II capital
standards deduct from regulatory capital
any amount of the banking
organization’s nonsignificant
investments 39 in the capital of
unconsolidated financial institutions
that exceeds 10 percent of the banking
organization’s common equity tier 1
capital minus certain deductions and
adjustments.40 Further, significant
investments in the capital of
unconsolidated financial institutions
not in the form of common stock must
be deducted from regulatory capital in
their entirety.41 Under the proposal,
38 For banking organizations that are not subject
to Category I or II capital standards, the current
capital rule does not have distinct treatments for
significant and nonsignificant investments in the
capital of unconsolidated financial institutions.
Rather, the regulatory capital treatment for an
investment in the capital of unconsolidated
financial institutions would be based on the type
of instrument underlying the investment.
39 A non-significant investment in the capital of
an unconsolidated financial institution is defined as
an investment in the capital of an unconsolidated
financial institution where a banking organization
subject to Category I or II capital standards owns 10
percent or less of the issued and outstanding
common stock of the unconsolidated financial
institution. 12 CFR 3.2 (OCC); 12 CFR 217.2
(Board); 12 CFR 324.2 (FDIC).
40 12 CFR 3.22(c)(5) (OCC); 12 CFR 217.22(c)(5)
(Board); 12 CFR 324.22(c)(5) (FDIC).
41 12 CFR 3.22(c)(6) (OCC); 12 CFR 217.22(c)(6)
(Board); 12 CFR 324.22(c)(6) (FDIC).
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banking organizations subject to
Category III or IV capital standards
would be required to make these
deductions.
Similar to the deductions for
investments in the capital of
unconsolidated financial institutions,
the current capital rule requires banking
organizations subject to Category I or II
capital standards to deduct covered debt
instruments from regulatory capital.42
Under the proposal, banking
organizations subject to Category III or
IV capital standards would be required
to apply the deduction requirements for
certain investments in unsecured debt
instruments issued by U.S. or foreign
GSIBs (covered debt instruments) that
currently apply to banking organizations
subject to Category I or II capital
standards.43 The current capital rule
generally treats investments in
unsecured debt instruments issued by
U.S. or foreign GSIBs as tier 2 capital
instruments for purposes of applying
deduction requirements.
The current capital rule also limits the
amount of minority interest that banking
organizations subject to Category I or II
capital standards may include in
regulatory capital based on the amount
of capital held by a consolidated
subsidiary, relative to the amount of
capital the subsidiary would have had
to maintain to avoid any restrictions on
capital distributions and discretionary
bonus payments under capital
conservation buffer requirements.44
Under the current capital rule, banking
organizations subject to Category III or
IV capital standards are allowed to
include: (i) common equity tier 1
minority interest comprising up to 10
percent of the parent banking
organization’s common equity tier 1
capital; (ii) tier 1 minority interest
comprising up to 10 percent of the
parent banking organization’s tier 1
capital; and (iii) total capital minority
interest comprising up to 10 percent of
the parent banking organization’s total
capital.45 Under the proposal, the
limitations on minority interests that
apply to banking organizations subject
to Category I or II capital standards
would also apply to banking
42 See 12 CFR 3.22(c) (OCC); 12 CFR 217.22(c)
(Board); 12 CFR 324.22(c) (FDIC).
43 Similar to banking organizations subject to
Category II capital standards, the definition of
excluded covered debt and the applicable capital
treatment, would not apply to banking
organizations subject to Category III and IV capital
standards. See 12 CFR 3.2 (OCC); 12 CFR 217.2)
(Board); 12 CFR 324.2 (FDIC).
44 See 12 CFR 3.21(b) (OCC); 12 CFR 217.21(b)
(Board); 12 CFR 324.21(b) (FDIC).
45 See 12 CFR 3.21(a) (OCC); 12 CFR 217.21(a)
(Board); 12 CFR 324.21(a) (FDIC).
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organizations subject to Category III or
IV capital standards.
3. Additional Definition of Capital
Adjustments
The current capital rule applies an
additional capital eligibility criterion to
banking organizations subject to
Category I or II capital standards for
their additional tier 1 and tier 2 capital
instruments. The criterion requires that
the governing agreement, offering
circular or prospectus for the instrument
must disclose that the holders of the
instrument may be fully subordinated to
interests held by the U.S. government in
the event the banking organization
enters into a receivership, insolvency,
liquidation, or similar proceeding.
Under the proposal, this eligibility
criterion would also apply to
instruments issued after the date on
which the issuer becomes subject to the
proposed rule, which generally would
be the effective date of a final rule for
banking organizations subject to
Category III or IV capital standards.
Instruments issued by banking
organizations subject to Category III or
IV capital standards prior to the
effective date of a final rule that
currently count as regulatory capital
would continue to count as regulatory
capital as long as those instruments
remain outstanding.
4. Changes to the Definition of Tier 2
Capital Applicable to Large Banking
Organizations
The current capital rule defines an
element of tier 2 capital to include the
allowance for loan and lease losses
(ALLL) or the adjusted allowance for
credit losses (AACL), as applicable, up
to 1.25 percent of standardized total
risk-weighted assets not including any
amount of the ALLL or AACL, as
applicable (and excluding in the case of
a banking organization subject to market
risk requirements, its standardized
market risk-weighted assets). Further, as
part of its calculations for determining
its total capital ratio, a banking
organization subject to Category I or II
standards must determine its advancedapproaches-adjusted total capital by (1)
deducting from its total capital any
ALLL or AACL, as applicable, included
in its tier 2 capital and; (2) adding to its
total capital any eligible credit reserves
that exceed the banking organization’s
total expected credit losses to the extent
that the excess reserve amount does not
exceed 0.6 percent of credit-riskweighted assets. Due to changes in
GAAP, all large banking organizations
are no longer using ALLL and must use
AACL. In addition, the concept of
eligible credit reserves is related to use
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of the internal ratings-based approach,
which the proposal would eliminate.
Therefore, under the proposal, a large
banking organization would determine
its expanded risk-based approachadjusted total capital by (1) deducting
from its total capital AACL included in
its tier 2 capital and; (2) adding to its
total capital any AACL up to 1.25
percent of total credit risk-weighted
assets. The proposal would define total
credit risk-weighted assets as the sum of
total risk-weighted assets for: (1) general
credit risk as calculated under
§ ll.110; (2) cleared transactions and
default fund contributions as calculated
under § ll.114; (3) unsettled
transactions as calculated under
§ ll.115; and (4) securitization
exposures as calculated under
§ ll.132.
Question 11: The agencies seek
comment on the proposed definition of
total credit risk-weighted assets in
connection with determining a banking
organization’s total capital ratio. What,
if any, modifications should the
agencies consider making to this
definition and why?
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C. Credit Risk
Credit risk arises from the possibility
that an obligor, including a borrower or
counterparty, will fail to perform on an
obligation. While loans are a significant
source of credit risk, other products,
activities, and services also expose
banking organizations to credit risk,
including investments in debt securities
and other credit instruments, credit
derivatives, and cash management
services. Off-balance sheet activities,
such as letters of credit, unfunded loan
commitments, and the undrawn portion
of lines of credit, also expose banking
organizations to credit risk.
In this section of the SUPPLEMENTARY
INFORMATION, subsection III.C.1.
describes expectations for completing
due diligence on a banking
organization’s credit risk portfolio;
subsection III.C.2. describes the riskweight treatment for on-balance sheet
exposures under the proposal;
subsection III.C.3. describes the
proposed approach to determine the
exposure amount for off-balance sheet
exposures; and subsections III.C.4.–5
provide the available approaches for
recognizing the benefits of credit risk
mitigants including certain guarantees,
certain credit derivatives and financial
collateral.
1. Due Diligence
Banking organizations must maintain
capital commensurate with the level
and nature of the risks to which they are
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exposed.46 The agencies’ safety and
soundness guidelines establish
standards for banking organizations to
have an adequate understanding of the
impact of their lending decisions on the
banking organization’s credit risk.47 A
banking organization’s performance of
due diligence on their credit portfolios
is central to meeting both of these
obligations. For example, under the
safety and soundness guidelines, a
banking organization is expected to
have established effective internal
policies, processes, systems, and
controls to ensure that the banking
organization’s regulatory reporting is
accurate and reflects appropriate risk
weights assigned to credit exposures.48
When properly performed, due
diligence may lead a banking
organization to conclude that the
minimum regulatory capital
requirements for certain exposures do
not sufficiently account for their
potential credit risk. In such instances,
the banking organization should take
appropriate risk mitigating measures
such as allocating additional capital,
establishing larger credit loss
allowances, or requiring additional
collateral. Adherence to due diligence
standards, as established through the
agencies’ safety and soundness
guidelines, directly supports and
facilitates requirements for banking
organizations to maintain capital
commensurate with the level and nature
of the risks to which they are exposed.
Question 12: The agencies seek
comment on whether due diligence
requirements should be directly
integrated into the text of the final rule.
What would be the advantages and
disadvantages of specifying increases in
risk weights that would be required to
the extent that due diligence
requirements are not met, similar to the
proposed risk-weight treatment for
securitization exposures as described in
section III.D of this SUPPLEMENTARY
INFORMATION?
2. Proposed Risk Weights for Credit Risk
The proposal would replace the use of
internal models to set regulatory capital
requirements for credit risk as set out in
subpart E of the current capital rule
with a new expanded risk-based
approach for credit risk applicable to
46 See 12 CFR 3.10(e) (OCC); 12 CFR 217.10(e)
(Board); 12 CFR 324.10(e) (FDIC).
47 See 12 CFR part 30, appendix A (OCC); 12 CFR,
appendix D–1 to part 208 (Board); 12 CFR,
appendix A to part 364 (FDIC).
48 When performing due diligence, banking
organizations must adhere to the operational and
managerial standards for loan documentation and
credit underwriting as set forth in the Interagency
Guidelines Establishing Standards for Safety and
Soundness (safety and soundness guidelines).
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large banking organizations. The
proposed expanded risk-based approach
for credit risk would retain many of the
same definitions § ll.2 of the current
capital rule including among others a
sovereign, a sovereign exposure, certain
supranational entities, a multilateral
development bank, a public sector
entity (PSE), a government-sponsored
enterprise (GSE), other assets, and a
commitment. Some elements of the
proposed expanded risk-based approach
for credit risk would apply the same
risk-weight treatment provided in
subpart D of the current capital rule
(current standardized approach) for onbalance sheet exposures, including
exposures to sovereigns, certain
supranational entities and multilateral
development banks, government
sponsored entities (GSEs) in the form of
senior debt and guaranteed exposures,
Federal Home Loan Bank (FHLB) and
Federal Agricultural Mortgage
Corporation (Farmer Mac) equity
exposures,49 public sector entities
(PSEs), and other assets. The proposal
would also apply the same risk-weight
treatment provided in the current
standardized approach to the following
real estate exposures: pre-sold
construction loans, statutory
multifamily mortgages, and highvolatility commercial real estate
(HVCRE) exposures.
Relative to the internal models-based
approaches in the advanced approaches
under the current capital rule, the
proposed expanded risk-based approach
would result in more transparent capital
requirements for credit risk exposures
across banking organizations. The
proposal would also facilitate
comparisons of capital adequacy across
banking organizations by reducing
excessive, unwarranted variability in
risk-weighted assets for similar
exposures. Relative to the current
standardized approach, the proposal
would incorporate more granular risk
factors to allow for a broader range of
risk weights.
Specifically, the proposal would
introduce the expanded risk-based
approach for exposures to depository
institutions, foreign banks, and credit
unions; exposures to subordinated debt
instruments, including those to GSEs;
and real estate, retail, and corporate
exposures. The proposal would also
increase risk capture for certain offbalance sheet exposures through a new
exposure methodology for commitments
without pre-set limits and would
49 For treatment of other exposures to GSEs, see
discussion related to equity exposures in section
III.E. and exposures to subordinated debt
instruments in section III.C.2.d. of this
SUPPLEMENTARY INFORMATION.
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modify the credit conversion factors
applicable to commitments.
Additionally, the proposal would
introduce new definitions for defaulted
exposures and defaulted real estate
exposures.
Under the proposal, a banking
organization would determine the riskweighted asset amount for an onbalance sheet exposure by multiplying
the exposure amount by the applicable
risk weight, consistent with the method
used under the current standardized
approach. The on-balance sheet
exposure amount would generally be
the banking organization’s carrying
value 50 of the exposure, consistent with
the value of the asset on the balance
sheet as determined in accordance with
GAAP, which is the same as under the
current capital rule. For all assets other
than AFS securities and purchased
credit-deteriorated assets, the carrying
value is not reduced by any associated
credit loss allowance that is determined
in accordance with GAAP. Using the
value of an asset under GAAP to
determine a banking organization’s
exposure amount would reduce burden
and provide a consistent framework that
can be easily applied across all banking
organizations of the proposal because,
in most cases, GAAP serve as the basis
for the information presented in
financial statements and regulatory
reports.51
The proposal would group credit risk
exposures into the following categories:
sovereign exposures; exposures to
certain supranational entities and
multilateral development banks;
exposures to GSEs; exposures to
depository institutions, foreign banks,
and credit unions; exposures to PSEs;
real estate exposures; retail exposures;
corporate exposures; defaulted
exposures; exposures to subordinated
debt instruments; and off-balance sheet
exposures.
The proposed categories with
amended risk-weight treatments relative
to the current standardized approach
50 Carrying value under § ll. 2 of the current
capital rule means, with respect to an asset, the
value of the asset on the balance sheet of the
banking organization as determined in accordance
with GAAP. For all assets other than available-forsale debt securities or purchased credit deteriorated
assets, the carrying value is not reduced by any
associated credit loss allowance that is determined
in accordance with GAAP. See 12 CFR 3.2 (OCC);
12 CFR 217.2 (Board); 12 CFR 324.2 (FDIC). The
exposure amount arising from an OTC derivative
contract; a repo-style transaction or an eligible
margin loan; a cleared transaction; a default fund
contribution; or a securitization exposure would be
calculated in accordance with §§ ll.113, 121, or
131 of the proposal, respectively, as described in
sections III.C.4, II.C.5.b., and III.D. of this
SUPPLEMENTARY INFORMATION.
51 See 12 U.S.C. 1831n.
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include equity exposures to GSEs and
exposures to subordinated debt
instruments issued by GSEs; exposures
to depository institutions, foreign banks,
and credit unions; exposures to
subordinated debt instruments; real
estate exposures; retail exposures;
corporate exposures; defaulted
exposures; and some off-balance sheet
exposures such as commitments. The
proposed risk weight treatments for
each of these categories are described in
the following sections of this
SUPPLEMENTARY INFORMATION.
a. Defaulted Exposures
The proposal would introduce an
enhanced definition of a defaulted
exposure that would be broader than the
current capital rule’s definition of a
defaulted exposure under subpart E.
The proposed scope and criteria of the
defaulted exposure category is intended
to appropriately capture the elevated
credit risk of exposures where the
banking organization’s reasonable
expectation of repayment has been
reduced, including exposures where the
obligor is in default on an unrelated
obligation. Under the proposal, a
defaulted exposure would be any
exposure that is a credit obligation and
that meets the proposed criteria related
to reduced expectation of repayment,
and that is not an exposure to a
sovereign entity,52 a real estate
exposure,53 or a policy loan.54 The
proposal would define a credit
obligation as any exposure where the
lender but not the obligor is exposed to
credit risk. In other words, for these
exposures, the lender would have a
claim on the obligor that does not give
rise to counterparty credit risk 55 and
52 Under the proposal, the expanded risk-based
approach would rely on the treatment of sovereign
default in the current standardized approach in the
capital rule. See 12 CFR 3.32(a)(6) (OCC); 12 CFR
217.32(a)(6) (Board); 12 CFR 324.32 (a)(6) (FDIC).
53 For the treatment of defaulted real estate
exposures, see section III.C.2.e.vii of this
SUPPLEMENTARY INFORMATION.
54 A policy loan is defined under § ll.2 of the
current capital rule to mean means a loan by an
insurance company to a policy holder pursuant to
the provisions of an insurance contract that is
secured by the cash surrender value or collateral
assignment of the related policy or contract. A
policy loan includes: (1) A cash loan, including a
loan resulting from early payment benefits or
accelerated payment benefits, on an insurance
contract when the terms of contract specify that the
payment is a policy loan secured by the policy; and
(2) An automatic premium loan, which is a loan
that is made in accordance with policy provisions
which provide that delinquent premium payments
are automatically paid from the cash value at the
end of the established grace period for premium
payments. See 12 CFR 3.2 (OCC); 12 CFR 217.2
(Board); 12 CFR 324.2 (FDIC).
55 Counterparty credit risk is the risk that the
counterparty to a transaction could default before
the final settlement of the transaction where there
is a bilateral risk of loss.
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64039
would exclude derivative contracts,
cleared transactions, default fund
contributions, repo-style transactions,
eligible margin loans, equity exposures,
and securitization exposures.
For all other exposure categories
(excluding an exposure to a sovereign
entity, real estate exposure, a retail
exposure, or a policy loan), the
proposed definition of defaulted
exposure would look to the performance
of the borrower with respect to credit
obligations to any creditor. Specifically,
if the banking organization determines
that an obligor meets any of the of the
defaulted criteria for exposures that are
not retail exposures, described further
below, the proposal would require the
banking organization to treat all
exposures that are credit obligations of
that obligor as defaulted exposures.
Additionally, the proposal would
differentiate the criteria for determining
whether an exposure is a defaulted
exposure between exposures that are
retail exposures and those that are not.
Retail exposures are originated to
individuals or small- and medium-sized
businesses. Evaluating whether a retail
borrower has other exposures that are in
default as defined by the proposal may
be difficult to operationalize for banking
organizations given many unique
obligors. For other types of exposures
that are not retail exposures, evaluating
default at the obligor level is
appropriate because those obligors are
more likely to have additional credit
obligations that are large and held by
multiple banking organizations. Default
on one of those credit obligations would
be indicative of increased riskiness of
the exposure held by a banking
organization, and hence a banking
organization should account for this in
evaluating the risk profile of the
borrower.
Under the proposal, for a retail
exposure, a credit obligation would be
considered a defaulted exposure if any
of the following has occurred: (1) the
exposure is 90 days past due or in
nonaccrual status; (2) the banking
organization has taken a partial chargeoff, write-down of principal, or negative
fair value adjustment on the exposure
for credit-related reasons, until the
banking organization has reasonable
assurance of repayment and
performance for all contractual
principal and interest payments on the
exposure; or (3) a distressed
restructuring of the exposure was agreed
to by the banking organization, until the
banking organization has reasonable
assurance of repayment and
performance for all contractual
principal and interest payments on the
exposure as demonstrated by a
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sustained period of repayment
performance, provided that a distressed
restructuring includes the following
made for credit-related reasons:
forgiveness or postponement of
principal, interest, or fees, term
extension, or an interest rate reduction.
A sustained period of repayment
performance by the borrower is
generally a minimum of six months in
accordance with the contractual terms
of the restructured exposure.
For exposures that are not retail
exposures (excluding an exposure to a
sovereign entity, a real estate exposure,
or a policy loan), a credit obligation
would be considered a defaulted
exposure if either of the following has
occurred: (1) the obligor has a credit
obligation to the banking organization
that is 90 days or more past due 56 or in
nonaccrual status; or (2) the banking
organization determines that, based on
ongoing credit monitoring, the obligor is
unlikely to pay its credit obligations to
the banking organization in full, without
recourse by the banking organization. If
a banking organization determines that
an obligor meets these proposed criteria,
the proposal would require the banking
organization to treat all exposures that
are credit obligations of that obligor as
defaulted exposures.
For purposes of the second criterion,
the proposal would require a banking
organization to consider an obligor as
unlikely to pay its credit obligations if
any of the following criteria apply: (1)
the obligor has any credit obligation that
is 90 days or more past due or in
nonaccrual status with any creditor; (2)
any credit obligation of the obligor has
been sold at a credit-related loss; (3) a
distressed restructuring of any credit
obligation of the obligor was agreed to
by any creditor, provided that a
distressed restructuring includes the
following made for credit-related
reasons: forgiveness or postponement of
principal, interest, or fees, term
extension or an interest rate reduction;
(4) the obligor is subject to a pending or
active bankruptcy proceeding; or (5) any
creditor has taken a full or partial
charge-off, write-down of principal, or
negative fair value adjustment on a
credit obligation of the obligor for
credit-related reasons. Under the
proposal, banking organizations are
expected to conduct ongoing credit
monitoring regarding relevant obligors.
The proposal would require banking
organizations to continue to treat an
exposure as a defaulted exposure until
56 Overdrafts are past due and are considered
defaulted exposures once the obligor has breached
an advised limit or been advised of a limit smaller
than the current outstanding balance.
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the exposure no longer meets the
definition or until the banking
organization determines that the obligor
meets the definition of investment
grade 57 or the proposed definition of
speculative grade.58 The proposal
would revise the definition of
speculative grade, consistent with the
current definition of investment grade,
to allow the definition to apply to
entities to which the banking
organization is exposed through a loan
or security. In addition, the proposal
would make the same revision to the
definition of sub-speculative grade.
A banking organization would assign
a 150 percent risk weight to a defaulted
exposure including any exposure
amount remaining on the balance sheet
following a charge-off, and any other
non-retail exposure to the same obligor,
to reflect the increased uncertainty as to
the recovery of the remaining carrying
value. The proposed risk weight is
intended to reflect the impaired credit
quality of defaulted exposures and to
help ensure that banking organizations
maintain sufficient regulatory capital for
the increased probability of losses on
these exposures. A banking organization
may apply a risk weight to the
guaranteed or secured portion of a
defaulted exposure based on (1) the risk
weight under § ll.120 of the proposal
if the guarantee or credit derivative
meets the applicable requirements or (2)
the risk weight under § ll.121 of the
proposal if the collateral meets the
applicable requirements.
Question 13: How does the defaulted
exposure definition compare with
banking organizations’ existing policies
relating to the determination of the
credit risk of a defaulted exposure and
the creditworthiness of a defaulted
obligor? What additional clarifications
are necessary to determine the point at
which retail and non-retail exposures
should no longer be treated as defaulted
exposures?
57 Under § ll.2 of the current capital rule,
investment grade means that the entity to which the
banking organization is exposed through a loan or
security, or the reference entity with respect to a
credit derivative, has adequate capacity to meet
financial commitments for the projected life of the
asset or exposure. Such an entity or reference entity
has adequate capacity to meet financial
commitments if the risk of its default is low and the
full and timely repayment of principal and interest
is expected. See 12 CFR 3.2 (OCC); 12 CFR 217.2
(Board); 12 CFR 324.2 (FDIC).
58 The proposal would revise the definition of
speculative grade to mean that the entity to which
a banking organization is exposed through a loan
or security, or the reference entity with respect to
a credit derivative, has adequate capacity to meet
financial commitments in the near term, but is
vulnerable to adverse economic conditions, such
that should economic conditions deteriorate, the
issuer or the reference entity would present an
elevated default risk.
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Question 14: What operational
challenges, if any, would a banking
organization face in identifying which
exposures meet the proposed definition
of defaulted exposure? In particular, the
agencies seek comment on the ability of
a banking organization to obtain the
necessary information to assess whether
the credit obligations of a borrower to
creditors other than the banking
organization would meet the proposed
criteria? What operational challenges, if
any, would a banking organization face
in identifying whether obligors on nonretail credit obligations are subject to a
pending or active bankruptcy
proceeding?
Question 15: For the purposes of retail
credit obligations, the agencies invite
comment on the appropriateness of
including a borrower’s bankruptcy as a
criterion for a defaulted exposure. What
operational challenges, if any, would a
banking organization face in identifying
whether obligors on retail credit
obligations are subject to a pending or
active bankruptcy proceeding? To what
extent would criteria (1) through (3) in
the proposed defaulted exposure
definition for retail exposures
sufficiently capture the risk of a
borrower involved in a bankruptcy
proceeding?
Question 16: What alternatives to the
proposed treatment should the agencies
consider while maintaining a risksensitive treatment for credit risk of a
defaulted borrower? For example, what
would be the advantages and
disadvantages of limiting the defaulted
borrower scope to obligations of the
borrower with the banking organization?
b. Exposures to Government-Sponsored
Enterprises
The proposal would assign a 20
percent risk weight to GSE 59 exposures
that are not equity exposures,
securitization exposures or exposures to
a subordinated debt instrument issued
by a GSE, consistent with the current
standardized approach.60 Under the
proposal, an exposure to the common
stock issued by a GSE would be an
59 Government-sponsored enterprise (GSE) under
§ ll. 2 of the current capital rule means an entity
established or chartered by the U.S. government to
serve public purposes specified by the U.S.
Congress but whose debt obligations are not
explicitly guaranteed by the full faith and credit of
the U.S. government. See 12 CFR 3.2 (OCC); 12 CFR
217.2 (Board); 12 CFR 324.2 (FDIC).
60 Similar to the treatment of senior debt
exposures to GSEs and GSE exposures that are not
equity exposures or exposures to a subordinated
debt instrument issued by a GSE, the proposal
would apply the same 20 percent risk weight to all
exposures to FHLB or Farmer Mac, including equity
exposures and exposures to subordinated debt
instruments, which continues the treatment under
the current standardized approach.
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equity exposure. An exposure to the
preferred stock issued by a GSE would
be an equity exposure or an exposure to
a subordinated debt instrument,
depending on the contractual terms of
the preferred stock instrument. Equity
exposures to a GSE must be assigned a
risk-weighted asset amount as
calculated under §§ ll.140 through
ll.142 of subpart E. An exposure to a
subordinated debt instrument issued by
a GSE must be assigned a 150 percent
risk weight, unless issued by a FHLB or
Farmer Mac. As discussed later in
sections III.E. and III.C.2.d. of this
SUPPLEMENTARY INFORMATION, equity
exposures and exposures to
subordinated debt instruments would
generally be subject to an increased riskbased capital requirement to reflect their
heightened risk relative to exposures to
senior debt.
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c. Exposures to Depository Institutions,
Foreign Banks, and Credit Unions
The proposal would define the scope
of exposures to depository institutions,
foreign banks, and credit unions in a
manner that is consistent with the
definitions and scope of exposures
covered under the current capital rule.
Under the proposal, a bank exposure
would mean an exposure (such as a
receivable, guarantee, letter of credit,
loan, OTC derivative contract, or senior
debt instrument) to any depository
institution, foreign bank, or credit
union.61
The proposed treatment for bank
exposures supports the simplicity,
transparency, and consistency
objectives of the proposal in a manner
that is appropriately risk sensitive. The
proposal would provide three categories
for bank exposures that are ranked from
the highest to the lowest in terms of
creditworthiness: Grade A, Grade B, and
Grade C. The assignment of the bank
exposure category would be based on
the obligor depository institution,
foreign bank, or credit union. As
outlined below, the proposal would rely
on the current capital rule’s definition
of investment grade and the proposed
definition of speculative grade for
61 Under § ll.2 of the current capital rule, a
depository institution means a depository
institution as defined in section 3 of the Federal
Deposit Insurance Act, a foreign bank means a
foreign bank as defined in section 211.2 of the
Federal Reserve Board’s Regulation K (12 CFR
211.2) (other than a depository institution), and a
credit union means an insured credit union as
defined under the Federal Credit Union Act (12
U.S.C. 1751 et seq.). See 12 CFR 3.2 (OCC); 12 CFR
217.2 (Board); 12 CFR 324.2 (FDIC). Exposures to
other financial institutions, such as bank holding
companies, savings and loans holding companies,
and securities firms, generally would be considered
corporate exposures. See 78 FR 62087 (October 11,
2013).
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differentiating the credit risk of bank
exposures. In addition, the proposal
would incorporate publicly disclosed
capital levels to differentiate the
financial strength of a depository
institution, foreign bank, or credit union
in a manner that is both objective and
transparent to supervisors and the
public.
More specifically, a Grade A bank
exposure would mean a bank exposure
for which the obligor depository
institution, foreign bank, or credit union
(1) is investment grade, and (2) whose
most recent publicly disclosed capital
ratios meet or exceed the higher of: (a)
the minimum capital requirements and
any additional amounts necessary to not
be subject to limitations on distributions
and discretionary bonus payments
under the capital rules established by
the prudential supervisor of the
depository institution, foreign bank, or
credit union, and (b) if applicable, the
capital ratio requirements for the wellcapitalized category under the agencies’
prompt corrective action framework,62
or under similar rules of the National
Credit Union Administration.63 For
example, an exposure to an investment
grade depository institution could
qualify as a Grade A bank exposure if
the depository institution was not
subject to limitations on distributions
and discretionary bonus payments
under the capital rules and had riskbased capital ratios that met the well
capitalized thresholds under the
agencies’ prompt corrective action
framework. Further, a bank exposure to
a depository institution that had opted
into the community bank leverage ratio
(CBLR) framework and is investment
grade would be considered to be a Grade
A bank exposure, even if the obligor
depository institution were in the grace
period under the CBLR framework.64
Under the proposal, a depository
institution that uses the CBLR
framework would not be required to
calculate or disclose risk-based capital
ratios for purposes of qualifying as a
Grade A bank exposure.
A Grade B bank exposure would mean
a bank exposure that is not a Grade A
bank exposure and for which the obligor
depository institution, foreign bank, or
credit union (1) is speculative grade or
investment grade, and (2) whose most
recent publicly disclosed capital ratios
meet or exceed the higher of: (a) the
62 The capital ratios used for this determination
are the ratios on the depository institution’s most
recent quarterly Consolidated Report of Condition
and Income (Call Report).
63 See 12 CFR part 702 (National Credit Union
Administration).
64 See 12 CFR 3.12(a)(1) (OCC); 12 CFR
217.12(a)(1) (Board); 12 CFR 324.12(a)(1) (FDIC).
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applicable minimum capital
requirements under capital rules
established by the prudential supervisor
of the depository institution, foreign
bank, or credit union, and (b) if
applicable, the capital ratio
requirements for the adequatelycapitalized category 65 under the
agencies’ prompt corrective action
framework,66 or under similar rules of
the National Credit Union
Administration.67
For a foreign bank to qualify as a
Grade A or Grade B bank exposure, the
proposal would require the applicable
capital standards imposed by the home
country supervisor to be consistent with
international capital standards issued by
the Basel Committee.
A Grade C bank exposure would mean
a bank exposure that does not qualify as
a Grade A or Grade B bank exposure.
For example, a bank exposure would be
a Grade C bank exposure if the obligor
depository institution, foreign bank, or
credit union has not publicly disclosed
its capital ratios within the last six
months. In addition, an exposure would
be a Grade C bank exposure if the
external auditor of the depository
institution, foreign bank, or credit union
has issued an adverse audit opinion or
has expressed substantial doubt about
the ability of the depository institution,
foreign bank, or credit union to continue
as a going concern within the previous
12 months.
Under the proposal, a foreign bank
exposure that is a Grade A or Grade B
bank exposure and is a self-liquidating,
trade-related contingent item that arises
from the movement of goods and that
has a maturity of three months or less
may be assigned a risk weight that is
lower than the risk weight applicable to
other exposures to the same foreign
bank. The proposed approach to
providing a preferential risk weight for
short-term self-liquidating, trade-related
contingent items would be consistent
with the current standardized approach.
The proposal would also address the
risk that capital and foreign exchange
controls imposed by a sovereign entity
in which a foreign bank is located could
prevent or materially impede the ability
of the foreign bank to convert its
currency to meet its obligations or
transfer funds. The proposal would,
therefore, provide a risk weight floor for
foreign bank exposures based on the risk
weight applicable to a sovereign
65 See 12 CFR 6.4(b)(2) (OCC); 12 CFR
208.43(b)(2) (Board); 12 CFR 324.403(b)(2) (FDIC).
66 The capital ratios used for this determination
are the ratios on the depository institution’s most
recent quarterly Call Report.
67 See 12 CFR part 702 (National Credit Union
Administration).
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exposure for the jurisdiction where the
foreign bank is incorporated when (1)
the exposure is not in the local currency
of the jurisdiction where the foreign
bank is incorporated; or (2) the exposure
to a foreign bank branch that is not in
the local currency of the jurisdiction in
which the foreign branch operates
(sovereign risk-weight floor).68 The risk
weight floor would not apply to shortterm self-liquidating, trade-related
contingent items that arise from the
movement of goods.
As provided in Table 1, the proposed
risk weights for bank exposures
generally would range from 40 percent
to 150 percent.
Question 17: What are the advantages
and disadvantages of assigning a range
of risk weights based on the bank’s
creditworthiness? What alternatives, if
any, should the agencies consider,
including to address potential concerns
around procyclicality?
Question 18: What are the advantages
and disadvantages of incorporating
specific capital levels in the
determination of each of the three
categories of bank exposures? What, if
any, other risk factors should the
banking agencies consider to
differentiate the credit risk of bank
exposures? What concerns, if any, could
limitations on available information
about foreign banks raise in the context
of determining the appropriate risk
weights for exposures to such banks and
how should the agencies consider
addressing such concerns?
Question 19: What is the impact of
limiting the lower risk weight for selfliquidating, trade-related contingent
items that arise from the movement of
goods to those with a maturity of three
months or less? What would be the
advantages and disadvantages of
expanding this risk weight treatment to
include such exposures with a maturity
of six months or less? What would be
the advantages and disadvantages of
limiting this reduced risk weight
treatment to only foreign banks whose
home country has an Organization for
Economic Cooperation and
Development (OECD) Country Risk
Classification (CRC) 69 of 0, 1, 2, or 3, or
is an OECD member with no CRC,
consistent with the current standardized
approach? 70
The proposal would define a
subordinated debt instrument as (1) a
debt security that is a corporate
exposure, a bank exposure, or an
exposure to a GSE, including a note,
bond, debenture, similar instrument, or
other debt instrument as determined by
the primary Federal supervisor, that is
subordinated by its terms, or separate
intercreditor agreement, to any creditor
of the obligor, or (2) preferred stock that
is not an equity exposure. For these
purposes, a debt security would be
subordinated if the documentation
creating or evidencing such
indebtedness (or a separate intercreditor
agreement) provides for any of the
issuer’s other creditors to rank senior to
the payment of such indebtedness in the
event the issuer becomes the subject of
a bankruptcy or other insolvency
proceeding, with the scope of applicable
bankruptcy or other insolvency
proceedings being defined in the
applicable documentation. The scope of
the definition of a subordinated debt
instrument is meant to capture the types
of entities that issue subordinated debt
instruments and for which the level of
subordination is a meaningful
determinant of the credit risk of the
instrument.
68 See § ll.111 for the proposed sovereign riskweight table, which is identical to Table 1 to
§ ll.32 in the current capital rule.
69 Under § ll. 2 of the current capital rule, a
Country Risk Classification (CRC) for a sovereign
means the most recent consensus CRC published by
the Organization for Economic Cooperation and
Development (OECD) as of December 31st of the
prior calendar year that provides a view of the
likelihood that the sovereign will service its
external debt. See 12 CFR 3.2 (OCC); 12 CFR 217.2
(Board); 12 CFR 324.2 (FDIC). For more information
on the OECD country risk classification
methodology, see OECD, ‘‘Country Risk
Classification,’’ available at https://www.oecd.org/
trade/topics/export-credits/arrangement-andsector-understandings/financing-terms-andconditions/country-risk-classification/.
70 The CRCs reflect an assessment of country risk,
used to set interest rate charges for transactions
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d. Subordinated Debt Instruments
The proposal would introduce a
definition and an explicit risk weight
treatment for exposures in the form of
subordinated debt instruments. The
proposed definition of a subordinated
debt instrument would capture
exposures that are financial instruments
and present heightened credit risk but
are not equity exposures, including: (1)
any preferred stock that does not meet
the definition of an equity exposure, (2)
any covered debt instrument, including
a TLAC debt instrument, that is not
deducted from regulatory capital, and
(3) any debt instrument that qualifies as
tier 2 capital under the current capital
rule or that would otherwise be treated
as regulatory capital by the primary
Federal supervisor of the issuer and that
is not deducted from regulatory capital.
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covered by the OECD arrangement on export
credits. The CRC methodology classifies countries
into one of eight risk categories (0–7), with
countries assigned to the zero category having the
lowest possible risk assessment and countries
assigned to the 7 category having the highest
possible risk assessment. See 78 FR 62088 (October
11, 2018).
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In addition, even though the
provision of collateral typically reduces
the risk of loss on indebtedness, the
proposal includes secured as well as
unsecured subordinated debt securities
in the scope of subordinated debt
instruments, since the effect of
subordination may result in the
collateral providing little or no real
value to the subordinated debt holder in
the event the issuer becomes to subject
of a bankruptcy or other insolvency
proceeding. A subordinated debt
instrument would not include any loan,
including a syndicated loan, a debt
security issued by a sovereign, public
sector entity, multilateral development
bank, or supranational entity, or a
security that would be captured under
the securitization framework. Due to the
contractual obligations and structures
associated with subordinated debt
instruments, such exposures generally
pose increased risk relative to a senior
loan, including a syndicated loan, or a
senior debt security to the same entity
because investments in subordinated
debt instruments are usually considered
junior creditors and subordinate to
obligations specified in the definition of
senior debt in the document governing
the junior creditors’ obligations.
The proposal generally would apply a
150 percent risk weight for exposures
that meet the definition of a
subordinated debt instrument, including
any preferred stock that is not an equity
exposure, and any tier 2 instrument or
covered debt instrument that is not
deducted from regulatory capital,
including TLAC debt instruments, and
any debt instrument that would
otherwise be treated as regulatory
capital by the primary Federal
supervisor of the issuer and that is not
deducted from regulatory capital.71
The instruments included in the
scope of subordinated debt instruments
present a greater risk of loss to an
investing banking organization relative
to more senior debt exposures to the
same issuer because subordinated debt
instruments have a lower priority of
repayment in the event of default. As a
result, the proposal would apply an
increased risk weight to recognize this
71 Covered debt instruments are subject to
deduction by banking organizations subject to
Category I or II capital standards similar to the
deduction framework for exposures to capital
instruments. See 12 CFR 3.22(c) (OCC); 12 CFR
217.22(c) (Board); 12 CFR 324.22(c) (FDIC). As
noted in section III.B.3. of this SUPPLEMENTARY
INFORMATION, under the proposal, this deduction
framework will be expanded to banking
organizations subject to Category III or IV capital
standards. As discussed in section III.C.2.b. above,
exposures to subordinated debt instruments issued
by an FHLB or by Farmer Mac would be assigned
a 20 percent risk weight.
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increase in loss given default. Since a
covered debt instrument that qualifies
as a TLAC debt instrument shares
similar risk characteristics with a
subordinated debt instrument, the
proposal would require banking
organizations to apply the same 150
percent risk weight to any such
exposures that are not otherwise
deducted from regulatory capital.
Question 20: The agencies seek
comment on the scope of the proposed
definition of a subordinated debt
instrument. What, if any, operational
challenges might the proposed
definition pose for banking
organizations, such as identifying the
level of subordination in debt securities
or similar instruments, and how should
the agencies consider addressing such
challenges?
Question 21: Would expanding the
definition of a subordinated debt
instrument to include loans that are not
securities more appropriately capture
the types of exposures that pose
elevated risk and, if so, why?
Question 22: The agencies seek
comment on applying a heightened 150
percent risk weight to exposures to
subordinated debt instruments issued by
GSEs. What would be the advantages
and disadvantages of this proposed
regulatory capital requirement? Would
there be any challenges for banking
organizations to be able to identify
which GSE exposures would be subject
to the 150 percent risk weight? Please
provide specific examples of any
challenges and supporting data.
e. Real Estate Exposures
The proposal would define a real
estate exposure as an exposure that is
neither a sovereign exposure nor an
exposure to a PSE and that is (1) a
residential mortgage exposure, (2)
secured by collateral in the form of real
estate,72 (3) a pre-sold construction
loan,73 (4) a statutory multifamily
mortgage,74 (5) a high volatility
72 For purposes of the proposal, ‘‘secured by
collateral in the form of real estate’’ should be
interpreted in a manner that is consistent with the
current definition for ‘‘a loan secured by real estate’’
in the Call Report and Consolidated Financial
Statements for Holding Companies (FR Y–9C)
instructions.
73 The Resolution Trust Corporation Refinancing,
Restructuring, and Improvement Act of 1991
(RTCRRI Act) mandates that each agency provide in
its capital regulations (i) a 50 percent risk weight
for certain one-to-four-family residential pre-sold
construction loans that meet specific statutory
criteria in the RTCRRI Act and any other
underwriting criteria imposed by the agencies, and
(ii) a 100 percent risk weight for one-to-four-family
residential pre-sold construction loans for
residences for which the purchase contract is
cancelled. See 12 U.S.C. 1831n, note.
74 The RTCRRI Act mandates that each agency
provide in its capital regulations a 50 percent risk
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64043
commercial real estate (HVCRE)
exposure,75 or (6) an acquisition,
development, or construction (ADC)
exposure. A pre-sold construction loan,
a statutory multifamily mortgage, and an
HVCRE exposure are collectively
referred to as statutory real estate
exposures for purposes of this
SUPPLEMENTARY INFORMATION. Under the
proposal, the risk weight treatment for
statutory real estate exposures that are
not defaulted real estate exposures
would be consistent with the current
standardized approach.
The proposal would differentiate the
credit risk of real estate exposures that
are not statutory real estate exposures by
introducing the following categories:
regulatory residential real estate
exposures, regulatory commercial real
estate exposures, ADC exposures, and
other real estate exposures. The
applicable risk weight for these nonstatutory real estate exposures would
depend on (1) whether the real estate
exposure meets the definitions of
regulatory residential real estate
exposure, regulatory commercial real
estate exposure, ADC exposure, or other
real estate exposure, described below;
(2) whether the repayment of such
exposures is dependent on the cash
flows generated by the underlying real
estate (such as rental properties, leased
properties, hotels); and (3) in the case of
regulatory residential or regulatory
commercial real estate exposures, the
loan-to-value (LTV) ratio of the
exposure.
These proposed criteria for
differentiating the credit risk of real
estate exposures would be based on
information already collected and
maintained by a banking organization as
part of its mortgage lending activities
and underwriting practices. Under the
proposal, regulatory residential and
regulatory commercial real estate
exposures would be required to meet
prudential criteria that are intended to
reduce the likelihood of default relative
to other real estate exposures. The
criteria in these definitions generally
align with existing Interagency
Guidelines for Real Estate Lending
Policies (real estate lending
weight for certain multifamily residential loans that
meet specific statutory criteria in the RTCRRI Act
and any other underwriting criteria imposed by the
agencies. See 12 U.S.C. 1831n, note.
75 Section 214 of the Economic Growth,
Regulatory Relief, and Consumer Protection Act
imposes certain requirements on high volatility
commercial real estate acquisition, development, or
construction loans. Section 214 of Public Law 115–
174, 132 Stat. 1296 (2018). See 12 U.S.C. 1831bb.
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guidelines).76 Real estate loans in which
repayment is dependent on the cash
flows generated by the real estate can
expose a banking organization to
elevated credit risk relative to
comparable exposures 77 as the borrower
may be unable to meet its financial
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76 See 12 CFR part 34, appendix A to subpart D
(OCC); 12 CFR part 208, appendix C (Board); 12
CFR part 365, appendix A (FDIC).
77 Comparable exposures include loans secured
by real estate where the repayment of the loan
depends on non-real estate cash flows such as
owner-occupied properties, revenue from
manufacturing or retail sales.
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commitments when cash flows from the
property decrease, such as when tenants
default or properties are unexpectedly
vacant.78 In addition, LTV ratios can be
a useful risk indicator because the
amount of a borrower’s equity in a real
estate property correlates inversely with
default risk and provides banking
organizations with a degree of
protection against losses.79 Therefore,
exposures with lower LTV ratios
generally would receive a lower risk
weight than comparable real estate
exposures with higher LTV ratios under
the proposal.80 The following chart
illustrates how the proposal would
require a banking organization to assign
risk weights to various real estate
exposures, as described in more detail
below:
BILLING CODE 6210–01–P; 6714–01–P; 4810–33–P
78 See
Board of Governors of the Federal Reserve
System, Financial Stability Report (November
2020), https://www.federalreserve.gov/publications/
files/financial-stability-report-20201109.pdf.
79 Id., at 30.
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80 The proposed LTV criterion measures the
borrower’s use of debt (leverage) to finance a real
estate purchase, with higher LTV reflecting greater
leverage and thus higher credit risk.
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i. Regulatory Residential Real Estate
Exposures
multifamily mortgage, or an HVCRE
exposure, provided the exposure meets
certain prudential criteria.81 First, the
Under the proposal, a regulatory
residential real estate exposure would
be defined as a first-lien residential
mortgage exposure (as defined in
§ ll.2) that is not a defaulted real
estate exposure (as defined in § ll.
101), an ADC exposure, a pre-sold
construction loan, a statutory
81 Consistent with the standardized approach in
the capital rule, under the proposal, when a
banking organization holds the first-lien and juniorlien(s) residential mortgage exposures and no other
party holds an intervening lien, the banking
organization must combine the exposures and treat
them as a single first-lien regulatory residential real
estate exposure, if the first-lien meets all of the
criteria for a regulatory residential real estate
exposure.
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loan would be required to be secured by
a property that is either owner-occupied
or rented. Second, the exposure would
be required to be made in accordance
with prudent underwriting standards,
including standards relating to the loan
amount as a percent of the value of the
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property.82 Third, during the
underwriting process, the banking
organization would be required to apply
underwriting policies that account for
the ability of the borrower to repay
based on clear and measurable
underwriting standards that enable the
banking organization to evaluate these
credit factors. The agencies would
expect these underwriting standards to
be consistent with the agencies’ safety
and soundness and real estate lending
guidelines.83 Fourth, the property must
be valued in accordance with the
proposed requirements included in the
proposed LTV ratio calculation, as
discussed below.
ii. Regulatory Commercial Real Estate
Exposures
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The proposal would define a
regulatory commercial real estate
exposure as a real estate exposure that
is not a regulatory residential real estate
exposure, a defaulted real estate
exposure, an ADC exposure, a pre-sold
construction loan, a statutory
multifamily mortgage, or an HVCRE
exposure, provided the exposure meets
several prudential criteria. First, the
exposure must be primarily secured by
fully completed real estate. Second, the
banking organization must hold a first
priority security interest in the property
that is legally enforceable in all relevant
jurisdictions.84 Third, the exposure
must be made in accordance with
prudent underwriting standards,
including standards relating to the loan
amount as a percent of the value of the
property. Fourth, during the
underwriting process, the banking
organization must apply underwriting
policies that account for the ability of
the borrower to repay in a timely
manner based on clear and measurable
underwriting standards that enable the
banking organization to evaluate these
credit factors. The agencies would
expect that these underwriting
standards would be consistent with the
agencies’ safety and soundness and real
estate lending guidelines. Finally, the
property must be valued in accordance
with the proposed requirements
82 For more information on value of the property,
see section III.C.2.e.iv of this SUPPLEMENTARY
INFORMATION.
83 See 12 CFR part 30, appendix A (OCC); 12 CFR
part 208, appendix C (Board); 12 CFR parts 364 and
365 (FDIC).
84 When the banking organization also holds a
junior security interest in the same property and no
other party holds an intervening security interest,
the banking organization must treat the exposures
as a single first-lien regulatory commercial real
estate exposure, if the first-lien meets all of the
criteria for a regulatory commercial real estate
exposure.
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included in the proposed LTV ratio
calculation, as discussed below.
Question 23: The agencies seek
comment on the application of prudent
underwriting standards in the proposed
definitions of regulatory residential and
regulatory commercial real estate
exposures, including standards relating
to the loan amount as a percent of the
value of the property. What, if any,
further clarity is needed and why?
iii. Exposures That Are Dependent on
the Cash Flows Generated by the Real
Estate
As noted above, the proposal would
differentiate the risk weight of
regulatory residential, regulatory
commercial, and other real estate
exposures based on whether the
borrower’s ability to service the loan is
dependent on cash flows generated by
the real estate. Exposures that are
dependent on the cash flows generated
by real estate to repay the loan can be
affected by local market conditions and
present elevated credit risk relative to
exposures that are serviceable by the
income, cash, or other assets of the
borrower. For example, an increase in
the supply of competitive rental
property can lower demand and
suppress cash flows needed to support
repayment of the loan.
If the underwriting process at
origination of the real estate exposure
considers any cash flows generated by
the real estate securing the loan, such as
from lease or rental payments or from
the sale of the real estate as a source of
repayment, then the exposure would
meet the proposal’s definition of
dependent on the cash flows generated
by the real estate. Evaluating whether
repayment of the exposure is dependent
on cash flows generated from the real
estate is a conservative and
straightforward approach for
differentiating the credit risk of real
estate exposures. Given their increased
credit risk, the proposal would assign
relatively higher risk weights to
exposures that are dependent on any
proceeds or income generated from the
real estate itself to service the debt.
Under the proposal, additional loan
characteristics can affect whether an
exposure would be considered
dependent on cash flows from the real
estate. The proposal’s definition of
dependence on the cash flows generated
by the real estate would exclude any
residential mortgage exposure that is
secured by the borrower’s principal
residence as such mortgage exposures
present reduced credit risk relative to
real estate exposures that are secured by
the borrower’s non-principal
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residence.85 For residential properties
that are not the borrower’s principal
residence, including vacation homes
and other second homes, such
properties would be considered
dependent on the cash flows generated
by the real estate unless the banking
organization has relied solely on the
borrower’s personal income and
resources, rather than rental income (or
resale or refinance of the property), to
repay the loan.
For regulatory commercial real estate
exposures, the applicable risk weights
similarly would be determined based on
whether repayment is dependent on the
cash flows generated by the real estate.
For example, the agencies would expect
that rental office buildings, hotels, and
shopping centers leased to tenants are
dependent on the cash flows generated
by the real estate for repayment of the
loan. In the case of a loan to a borrower
to purchase or refinance real estate
where the borrower will operate a
business such as a retail store or factory
and rely solely on the revenues from the
business or resources of the borrower
other than rental, resale, or other
income from the real estate for
repayment, the exposure would not be
considered dependent on the cash flows
generated by the real estate under the
proposal. Similarly, a loan to the owneroperator of a farm would not be
considered dependent on the cash flows
generated by the real estate under the
proposal if the borrower will rely solely
on the sale of products from the farm or
other resources of the borrower other
than rental, resale, or other income from
the real estate for repayment.
Question 24: What, if any, alternative
quantitative threshold should the
agencies consider in determining
whether a real estate exposure is
dependent on cash flows from the real
estate (for example, a threshold between
5 and 50 percent of the income)?
Further, if the agencies decide to adopt
an alternative quantitative threshold,
either for regulatory residential or
regulatory commercial real estate
exposures, how should it be calibrated
for regulatory residential and separately
for regulatory commercial real estate
exposures and what would be the
appropriate calibration levels for each?
Please provide specific examples of any
85 For example, if (1) a borrower purchases a twounit property with the intention of making one unit
their principal residence, (2) the borrower intends
to rent out the second unit to a third party, and (3)
the banking organization considered the cash flows
from the rental unit as a source of repayment, the
exposure would not meet the proposal’s definition
of dependent on the cash flows generated by the
real estate because the property securing the
exposure is the borrower’s principal residence.
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alternatives, including calculations and
supporting data.
Question 25: The agencies seek
feedback on the proposed treatment of
exposures secured by second homes,
including vacation homes where
repayment of the loan is not dependent
on cash flows. What are the advantages
and disadvantages of treating such
exposures as regulatory residential real
estate exposures? Would a different
category be more appropriate for these
exposures given their risk profile, and if
so, describe which other category(s) of
real estate exposures would be most
similar and why. Please provide
supporting data in your responses.86
Question 26: The agencies seek
comment on the treatment of residential
mortgage exposures where repayment is
dependent on cash flows from overnight
or short-term rentals, as such cash flows
may not be as reliable as a source of
repayment as cash flows from long-term
rental contracts or the borrower’s other
income sources. What would be the
advantages or disadvantages of treating
residential real estate exposures
dependent on cash flows from shortterm rentals similar to commercial real
estate exposures dependent on cash
flows?
iv. Calculating the Loan-To-Value Ratio
The proposal would require a banking
organization also to use LTV ratios to
assign a risk weight to a regulatory
residential or regulatory commercial
real estate exposure. Under the
proposal, LTV ratio would be calculated
as the extension of credit divided by the
value of the property. The proposed
calculation of LTV ratio would be
generally consistent with the real estate
lending guidelines except with respect
to the recognition of private mortgage
insurance, as described below.
The extension of credit would mean
the total outstanding amount of the loan
including any undrawn committed
amount of the loan. The total
outstanding amount of the loan would
reflect the current amortized balance as
the loan pays down, which may allow
a banking organization to assign a lower
risk weight during the life of the loan.
Similarly, if a loan balance increases, a
banking organization would need to
increase the risk weight if the increased
LTV would result in a higher risk
weight. For purposes of the LTV ratio
calculation, a banking organization
would calculate the loan amount
86 See Garcia, Daniel (2019). ‘‘Second Home
Buyers and the Housing Boom and Bust,’’ Finance
and Economics Discussion Series 2019–029.
Washington: Board of Governors of the Federal
Reserve System, https://www.federalreserve.gov/
econres/feds/files/2019029pap.pdf.
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without making any adjustments for
credit loss provisions or private
mortgage insurance. Not recognizing
private mortgage insurance would be
consistent with the current capital rule’s
definition of eligible guarantor, which
does not recognize an insurance
company engaged predominately in the
business of providing credit protection
(such as a monoline bond insurer or reinsurer) and also reflects the
performance of private mortgage
insurance during times of stress in the
housing market. The agencies do not
intend the proposed risk weights to be
applied to LTVs that include private
mortgage insurance.
The value of the property would mean
the value at the time of origination of all
real estate properties securing or being
improved by the extension of credit,
plus the fair value of any readily
marketable collateral and other
acceptable collateral, as defined in the
real estate lending guidelines, that
secures the extension of credit.
For exposures subject to the Real
Estate Lending, Appraisal Standards,
and Minimum Requirements for
Appraisal Management Companies or
Appraisal Standards for Federally
Related Transactions (combined, the
appraisal rule),87 the market value of
real estate would be a valuation that
meets all requirements of that rule. For
exposures not subject to the appraisal
rule, the proposal would require that (1)
the market value of real estate be
obtained from an independent valuation
of the property using prudently
conservative valuation criteria and (2)
the valuation be done independently
from the banking organization’s
origination and underwriting process.
Most real estate exposures held by
insured depository institutions are
subject to the agencies’ appraisal rule,
which also provides for evaluations in
some cases, and provides for certain
exceptions, such as where a lien on real
estate is taken as an abundance of
caution. To help ensure that the value
of the real estate is determined in a
prudently conservative manner, the
proposal would also provide that, for
exposures not subject to the appraisal
rule, the valuations of the real estate
properties would need to exclude
expectations of price increases and be
adjusted downward to take into account
the potential for the current market
prices to be significantly above the
values that would be sustainable over
the life of the loan.
87 See 12 CFR part 34, subpart C or subpart G
(OCC); 12 CFR part 208, subpart E or 12 CFR part
225, subpart G (Board); 12 CFR part 323 (FDIC).
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In addition, when the real estate
exposure finances the purchase of the
property, the value would be the lower
of (1) the actual acquisition cost of the
property and (2) the market value
obtained from either (i) the valuation
requirements under the appraisal rule (if
applicable) or (ii) as described above, an
independent valuation using prudently
conservative valuation criteria that is
separate from the banking organization’s
origination and underwriting process.
Supervisory experience has shown that
market values of real estate properties
can be temporarily impacted by local
market forces and using a value figure
including such volatility would not
reflect the long-term value of the real
estate. Therefore, the proposal would
require that the value used for the LTV
calculation be an amount that is more
conservative than the market value of
the property.
Using the value of the property at
origination when calculating the LTV
ratio protects against volatility risk or
short-term market price inflation. For
purposes of the LTV ratio calculation,
the proposal would require banking
organizations to use the value of the
property at the time of origination,
except under the following
circumstances: (1) the banking
organization’s primary Federal
supervisor requires the banking
organization to revise the property value
downward; (2) an extraordinary event
occurs resulting in a permanent
reduction of the property value (for
example, a natural disaster); or (3)
modifications are made to the property
that increase its market value and are
supported by an appraisal or
independent evaluation using prudently
conservative criteria. These proposed
exceptions are intended to constrain the
use of values other than the value of the
property at loan origination only to
exceptional circumstances that are
sufficiently material to warrant use of a
revised valuation.
For purposes of determining the value
of the property, the proposal would use
the definition of readily marketable
collateral and other acceptable collateral
consistent with the real estate lending
guidelines. Therefore, readily
marketable collateral would mean
insured deposits, financial instruments,
and bullion in which the banking
organization has a perfected security
interest. Financial instruments and
bullion would need to be salable under
ordinary circumstances with reasonable
promptness at a fair market value
determined by quotations based on
actual transactions, on an auction or
similarly available daily bid and ask
price market. Readily marketable
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collateral should be appropriately
discounted by the banking organization
consistent with the banking
organization’s usual practices for
making loans secured by such collateral.
Other acceptable collateral would mean
any collateral in which the banking
organization has a perfected security
interest that has a quantifiable value and
is accepted by the banking organization
in accordance with safe and sound
lending practices. Other acceptable
collateral should be appropriately
discounted by the banking organization
consistent with the banking
organization’s usual practices for
making loans secured by such collateral.
Under the proposal, other acceptable
collateral would include, among other
items, unconditional irrevocable
standby letters of credit for the benefit
of the banking organization. The
reasonableness of a banking
organization’s underwriting criteria
would be reviewed through the
examination and supervisory process to
help ensure its real estate lending
policies are consistent with safe and
sound banking practices.
Question 27: What are the benefits
and drawbacks of allowing readily
marketable collateral and other
acceptable collateral to be included in
the value for purposes of calculating the
LTV ratio? What are the advantages and
disadvantages of providing specific
discount factors to the value of
acceptable collateral for purposes of
calculating the LTV ratio such as the
standard supervisory market price
volatility haircuts contained in
§ ll.121 of the proposed rule? What
alternatives should the agencies
consider? Please provide specific
examples and supporting data.
v. Risk Weights for Regulatory
Residential Real Estate Exposures
While LTV ratios and dependency
upon cash flows of the real estate are
useful risk indicators, the agencies
recognize that banking organizations
consider a variety of factors when
underwriting a residential real estate
exposure and assessing a borrower’s
ability to repay. For example, a banking
organization may consider a borrower’s
current and expected income, current
and expected cash flows, net worth,
other relevant financial resources,
current financial obligations,
employment status, credit history, or
other relevant factors during the
underwriting process. The agencies are
supportive of home ownership and do
not intend the proposal to diminish
home affordability or homeownership
opportunities, including for low- and
moderate-income (LMI) home buyers or
other historically underserved markets.
The agencies are particularly interested
in whether the proposed framework for
regulatory residential real estate
exposures should be modified in any
way to avoid unintended impacts on the
ability of otherwise credit-worthy
borrowers who make a smaller down
payment to purchase a home. For
example, the agencies are considering
whether a 50 percent risk weight would
be appropriate for these loans, to the
extent they are originated in accordance
with prudent underwriting standards
and originated through a home
ownership program that the primary
Federal regulatory agency determines
provides a public benefit and includes
risk mitigation features such as credit
counseling and consideration of
repayment ability.
Question 28: The agencies seek
comment on how the proposed
treatment of regulatory residential real
estate exposures will impact home
affordability and home ownership
opportunities, particularly for LMI
borrowers or other historically
underserved markets. What are the
advantages and disadvantages of an
alternative treatment that would assign
a 50 percent risk weight to mortgage
loans originated in accordance with
88 The risk weight assigned to loans does not
impact the appropriate treatment of loans under the
agencies’ other regulations and guidance, such as
the supervisory LTV limits under the real estate
lending guidelines.
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Under the proposal, a banking
organization would assign a risk weight
to a regulatory residential real estate
exposure based on the exposure’s LTV
ratio and whether the exposure is
dependent on the cash flows generated
by the real estate, as reflected in Tables
2 and 3 below. LTV ratios and
dependence on cash flows generated by
the real estate would factor into the riskweight treatment for real estate
exposures under the proposal because
these risk factors can be determinants of
credit risk for real estate exposures. The
proposed corresponding risk weights in
each LTV ratio category are intended to
appropriately reflect differences in the
credit risk of these exposures. The risk
weights that would apply under the
proposal are provided below.88
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prudent underwriting standards and
originated through a home ownership
program that the primary Federal
regulatory agency determines provides a
public benefit and includes risk
mitigation features such as credit
counseling and consideration of
repayment ability? What, if any,
additional or alternative risk indicators
should the agencies consider, besides
loan-to-value or dependency upon cash
flow for risk-weighting regulatory
residential real estate exposures? Please
provide specific examples of mortgage
lending programs where such factors
were the basis for underwriting the
loans and the historical repayment
performance of the loans in such
programs. Please comment on whether
these risk indicators are already
collected and maintained by banking
organizations as part of their mortgage
lending activities and underwriting
practices.
In addition, the agencies considered
adopting an alternative risk-based
capital treatment in subpart E that does
not rely on loan-to-value ratios or
dependency upon cash flow generated
by the real estate. One such alternative
would be to incorporate the same
treatment for residential mortgage
exposures as found in the current U.S.
standardized risk-based capital
framework. Under this alternative, the
risk-based capital treatment for
residential mortgage exposures in
subpart D of the capital rule would be
incorporated into the proposed subpart
E. First-lien residential mortgage
exposures that are prudently
underwritten would receive a 50
percent risk weight consistent with the
treatment contained in the U.S.
standardized risk-based capital
framework. Such an approach would
allow banking organizations to continue
to offer prudently underwritten
products through lending programs with
the flexibility to meet the needs of their
communities without additional
regulatory capital implications. The
agencies note that current mortgage
rules promulgated since the global
financial crisis require lenders to
consider each borrower’s ability to
repay.89
As in subpart D, residential mortgage
exposures that do not meet the
requirements necessary to receive a 50
percent risk weight would receive a 100
percent risk weight. While such an
approach would not use loan-to-value or
dependency upon cash flow generated
by the real estate to assign a risk-weight,
it would provide for a simpler
framework where all prudently
underwritten first-lien residential
mortgage exposures would receive the
same risk-based capital treatment. Lastly
and consistent with the treatment in
subpart D, if a banking organization
holds the first and junior lien(s) on a
regulatory residential real estate
exposure and no other party holds an
intervening lien, the banking
organization would be required to treat
the combined exposure as a single loan
secured by a first lien for purposes of
assigning a risk weight.
Question 29: The agencies seek
comment on assigning risk weights to
residential mortgage exposures,
consistent with the current U.S.
standardized risk-based capital
framework. What are the pros and cons
of this alternative treatment?
Question 30: What, if any, market
effects could the proposed treatment
have on residential and commercial real
estate mortgage lending and why? What
alternatives to the proposed treatment
or calibration should the agencies
consider? Please provide supporting
data.
vii. Defaulted Real Estate Exposures
89 See
vi. Risk Weights for Regulatory
Commercial Real Estate Exposures
The proposal would require banking
organizations to apply an elevated risk
weight to defaulted real estate
12 CFR part 1026.
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In a manner similar to regulatory
residential real estate exposure, the
proposal would require a banking
organization to assign a risk weight to a
regulatory commercial real estate
exposure based on the exposure’s LTV
ratio and whether the exposure is
dependent on the cash flows generated
by the real estate, as reflected in Tables
4 and 5 below. For regulatory
commercial real estate exposures that
are not dependent on cash flows for
repayment, the main driver of risk to the
banking organization is whether the
commercial borrower would generate
sufficient revenue through its non-real
estate business activities to repay the
loan to the banking organization. For
this reason, under Table 4 the proposed
risk weight for the exposure would be
dependent on the risk weight assigned
to the borrower. For the purposes of
Table 4, if the LTV ratio of the
exposures is greater than 60 percent,
and the banking organization does not
have sufficient information about the
exposure to determine what the risk
weight applicable to the borrower
would be, the banking organization
would be required to assign a 100
percent risk weight to the exposure.
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exposures, consistent with the approach
to defaulted exposures described in
section III.C.2.a. of this SUPPLEMENTARY
INFORMATION. The proposal would
introduce a definition of defaulted real
estate exposure that would provide new
criteria for determining whether a
residential mortgage exposure or a nonresidential mortgage exposure is in
default. These new criteria are
indicative of a credit-related default for
such exposures. For residential
mortgage exposures, the definition of
defaulted real estate exposure would
require the banking organization to
evaluate default at the exposure level.
For other real estate exposures that are
not residential mortgage exposures, the
definition of defaulted real estate
exposure would require the banking
organization to evaluate default at the
obligor level, consistent with the
approach describe above for non-retail
defaulted exposures.
Since residential mortgage exposures
are primarily originated to individuals
for the purchase or refinancing of their
primary residence, most obligors of
residential real estate exposures do not
have additional real estate exposures.
Therefore, determining default at the
exposure level would account for the
material default risk of most residential
mortgage exposures. Additionally,
evaluating defaulted residential
mortgage exposures at the obligor level
may be difficult for banking
organizations to operationalize, for
example, if there are challenges
collecting information on the payment
status of other obligations of individual
borrowers.
In contrast, for other types of real
estate exposures, such as regulatory
commercial real estate and ADC
exposures, evaluating default at the
obligor level would be more appropriate
and less challenging as those obligors
frequently have other credit obligations
that are large in value and potentially
held by multiple banking organizations.
Default by an obligor on other credit
obligations, which a banking
organization should account for when
evaluating the risk profile of the
borrower, would indicate increased
credit risk of the exposure held by a
banking organization.
A defaulted real estate exposure that
is a residential mortgage exposure
would include an exposure (1) that is 90
days or more past due or in nonaccrual
status; (2) where the banking
organization has taken a partial chargeoff, write-down of principal, or negative
fair value adjustment on the exposure
for credit-related reasons, until the
banking organization has reasonable
assurance of repayment and
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performance for all contractual
principal and interest payments on the
exposure; or (3) where the banking
organization agreed to a distressed
restructuring that includes the following
credit-related reasons: forgiveness or
postponement of principal, interest, or
fees; term extension; or an interest rate
reduction. Distressed restructuring
would not include a loan modified or
restructured solely pursuant to the U.S.
Treasury’s Home Affordable Mortgage
Program.90
To determine if a non-residential
mortgage exposure would be a defaulted
real estate exposure, banking
organizations would apply the same
criteria as described above in section
III.C.2.a. of this SUPPLEMENTARY
INFORMATION that are used to determine
if a non-retail exposure is a defaulted
exposure. Banking organizations are
expected to conduct ongoing credit
reviews of relevant obligors. The
proposal would require banking
organizations to continue to treat nonresidential real estate exposures that
meet this definition as defaulted real
estate exposures until the nonresidential real estate exposure no
longer meets the definition or until the
banking organization determines that
the obligor meets the definition of
investment grade or speculative grade.
Under the proposal, a defaulted real
estate exposure that is a residential
mortgage exposure not dependent on
the cash flows generated by the real
estate would receive a risk weight of 100
percent, regardless of whether the
exposure qualifies as a regulatory real
estate exposure, unless a portion of the
real estate exposure is guaranteed under
§ ll.120 of the proposal. This
treatment is consistent with the risk
weight for past due residential mortgage
exposures under the current
standardized approach. Additionally, a
residential mortgage guaranteed by the
Federal Government through the
Federal Housing Administration (FHA)
or the Department of Veterans Affairs
(VA) generally will be risk-weighted at
20 percent under the proposal,
including a residential mortgage
guaranteed by FHA or VA that meets the
defaulted real estate exposure
definition.
Any other defaulted real estate
exposure would receive a risk weight of
150 percent, including any other nonresidential real estate exposure to the
same obligor, consistent with the
90 The
U.S. Treasury’s Home Affordable Mortgage
Program was created under the Troubled Asset
Relief Program in response to the subprime
mortgage crisis of 2008. See Emergency Economic
Stabilization Act, Public Law 110–343, 122 Stat.
3765 (2008).
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proposed risk weight of other defaulted
exposures described in section II.C.2.a.
of this SUPPLEMENTARY INFORMATION. A
banking organization may apply a risk
weight to the guaranteed portion of
defaulted real estate exposures based on
the risk weight that applies under
§ ll.120 of the proposal if the
guarantee or credit derivative meets the
applicable requirements.
Question 31: How does the defaulted
real estate exposure definition compare
with banking organizations’ existing
policies relating to the determination of
the credit risk of defaulted real estate
exposures and the creditworthiness of
defaulted real estate obligors? What, if
any, additional clarifications are
necessary to determine the point at
which residential and non-residential
mortgages should no longer be treated
as defaulted exposures? Please provide
specific examples and supporting data.
Question 32: For purposes of
commercial real estate exposures, the
agencies invite comment on the extent
to which obligors have outstanding
other exposures with multiple banking
organizations and other creditors. What
would be the advantages and
disadvantages of considering both the
obligor and the parent company or other
entity or individual that owns or
controls the obligor when determining if
the exposure meets the criteria for
‘‘defaulted real estate exposure’’?
Question 33: For purposes of
residential mortgage exposures, the
agencies invite comment on the
appropriateness of including a
borrower’s bankruptcy as a criterion for
defaulted real estate exposure. Would
criteria (1)(i) through (1)(iii) in the
proposed defaulted real estate definition
for residential mortgages sufficiently
capture the risk of a borrower involved
in a bankruptcy proceeding?
viii. ADC Exposures That Are Not
HVCRE Exposures
Under the proposal, the agencies
would define an ADC exposure as an
exposure secured by real estate for the
purpose of acquiring, developing, or
constructing residential or commercial
real estate properties, as well as all land
development loans, and all other land
loans. Some ADC exposures meet the
definition of HVCRE exposure in
§ ll.2 of the capital rule and would be
assigned a 150 percent risk weight.91
Real estate exposures that meet the
91 Section 214 of the Economic Growth,
Regulatory Relief, and Consumer Protection Act
(EGRRCPA) imposes certain requirements on high
volatility commercial real estate acquisition,
development, or construction loans. Section 214 of
Public Law 115–174, 132 Stat. 1296 (2018); 12
U.S.C. 1831bb.
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definition of ADC exposure but do not
meet the criteria of an HVCRE exposure
or a defaulted real estate exposure
would be assigned a 100 percent risk
weight under the proposal. The
proposed regulatory treatment for ADC
exposures would not take into
consideration cash flow dependency or
LTV ratio criteria. ADC exposures are
mostly short-term or bridge loans to
cover construction or development, or
lease up or sales phases of a real estate
project, rather than an amortizing
permanent loan for completed
residential or commercial real estate.
Supervisory experience has shown that
ADC exposures have heightened risk
compared to permanent commercial real
estate exposures, and these exposures
generally have been subject to a risk
weight of 100 percent or more under the
current standardized approach.
Repayment of ADC loans is often based
on the expected completion of the
construction or development of the
property, which can be delayed or
interrupted by many factors such as
changes in market condition or financial
difficulty of the obligor.
ix. Other Real Estate Exposures
The proposal would define other real
estate exposures as real estate exposures
that are not defaulted real estate
exposures, regulatory commercial real
estate exposures, regulatory residential
real estate exposures, ADC exposures, or
any of the statutory real estate
exposures.
An exposure meeting the proposed
definition of other real estate exposure
poses heightened credit risk as a result
of not meeting the proposed prudential
underwriting criteria included in the
definitions of regulatory residential and
regulatory commercial real estate,
respectively, and accordingly would be
assigned a higher risk weight.
Specifically, the proposal would require
a banking organization to assign a 150
percent risk weight to an other real
estate exposure, unless the exposure is
a residential mortgage exposure that is
not dependent on the cash flows
generated by the real estate, which must
be assigned a 100 percent risk weight.
For example, a banking organization
would assign a 150 percent risk weight
to real estate exposures that are
dependent on the cash flows generated
by the underlying real estate, such as a
rental property, and that do not meet the
regulatory residential or regulatory
commercial real estate exposure
definitions. Loans for the purpose of
acquiring real estate and reselling it at
higher value that do not qualify as ADC
loans and do not meet the definition of
regulatory residential real estate
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exposures would be assigned a 150
percent risk weight as other real estate
exposures. The proposed 150 percent
risk weight also would provide a
regulatory capital incentive for banking
organizations to originate real estate
exposures in accordance with the
prudential qualification requirements
for regulatory residential and
commercial real estate exposures,
respectively.
In other cases, if a banking
organization does not adequately
evaluate the creditworthiness of a
borrower for an owner-occupied
residential mortgage exposure, or if the
borrower has inadequate
creditworthiness or capacity to repay
the loan, the exposure would not be
considered prudently underwritten and
would be assigned a 100 percent risk
weight instead of the lower risk weights
included in Table 2 for regulatory
residential mortgage exposures not
dependent on the cash flows generated
by the real estate. The 100 percent risk
weight would also apply to junior lien
home equity lines of credit and other
second mortgages given the elevated
risk of these loans when compared to
similar senior lien loans.
f. Retail Exposures
Relative to the current standardized
approach, and as described in more
detail below, the proposal would
increase the credit risk-sensitivity of the
capital requirements applicable to retail
exposures by assigning risk weights that
would vary depending on product type
and the degree of portfolio
diversification. The proposal would
introduce a new definition of retail
exposure, which would include an
exposure to a natural person or persons,
or an exposure to a small or mediumsized entity (SME) 92 that meets the
proposed definition of a regulatory retail
exposure described below. Including an
exposure to an SME in the definition of
a retail exposure provides a benefit for
small companies, such as smaller
limited liability companies, which may
have characteristics more similar to
those of a natural person than of a larger
corporation. The proposed definition of
a retail exposure would be narrower in
scope than the current capital rule’s
existing definition of a retail exposure
92 An SME would mean an entity in which the
reported annual revenues or sales for the
consolidated group of which the entity is a part are
less than or equal to $50 million for the most recent
fiscal year. This scope is generally consistent with
the definition of an SME under the Basel III reforms
and also corresponds with the maximum receiptsbased size standard for small businesses set by the
Small Business Administration, which varies by
industry and does not exceed $47 million per year.
See 13 CFR part 121.
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under subpart E, which includes a
broader range of exposures, including
real estate-related exposures. Because
the proposal would include separate
risk-weight treatments for real estate
exposures that account for the
underlying collateral, the proposed
definition of a retail exposure would
only apply to a retail exposure that
would not otherwise be a real estate
exposure.93
The proposal would differentiate the
risk-weight treatment for retail
exposures based on whether (1) the
exposure qualifies as a regulatory retail
exposure, (2) further qualifies as a
transactor exposure; or (3) does not
qualify for either of the previous
categories and is treated as an other
retail exposure. The proposed
definitions of a regulatory retail
exposure and a transactor exposure
outlined below include key criteria for
broadly categorizing the relative credit
risk of retail exposures.
To qualify as a regulatory retail
exposure, the proposal would require
the exposure to be in the form of any of
the following credit products: a
revolving credit or line of credit (such
as a credit card, charge card, or
overdraft) or a term loan or lease (such
as an installment loan, auto loan or
lease, or student or educational loan)
(collectively, eligible products). In
addition, under the proposal, the
amount of retail exposures that a
banking organization could treat as
regulatory retail exposures would be
limited on an aggregate and granular
basis. A banking organization would
include all outstanding and committed
but unfunded regulatory retail
exposures accounting for any applicable
credit conversion factor when
aggregating the retail exposures.
Specifically, the regulatory retail
exposure category would exclude any
retail exposure to a single obligor and its
affiliates that, in the aggregate with any
other retail exposures to that obligor or
its affiliates, including both on- and offbalance sheet exposures, exceeds a
combined total of $1 million (aggregate
limit).
In addition, for any single retail
exposure, only the portion up to 0.2
percent of the banking organization’s
total retail exposures that are eligible
products (granularity limit) would be
considered a regulatory retail exposure.
93 For an exposure that qualifies as a real estate
exposure and also meets conditions (1) and (2) of
the definition of a retail exposure, the proposal
would require a banking organization to treat the
exposure as a real estate exposure and calculate
risk-based requirements for the exposure as
described in section III.C.2.e of this SUPPLEMENTARY
INFORMATION.
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The portion of any single retail exposure
that exceeds the granularity limit would
not qualify as a regulatory retail
exposure. For purposes of calculating
the 0.2 percent granularity limit for a
regulatory retail exposure, off-balance
sheet exposures would be subject to the
applicable credit conversion factors, as
discussed in § ll.112(b), and
defaulted exposures, as discussed in
§ ll.101(b) of the proposal, would be
excluded. Under the proposal, if an
exposure to an SME does not meet
criteria (1) through (3) of the definition
of a regulatory retail exposure, then
none of the exposures to that SME
would qualify as retail exposures and all
of the exposures to that SME would be
treated as corporate exposures.
The proposal would define a
transactor exposure as a regulatory retail
exposure that is a credit facility where
the balance has been repaid in full at
each scheduled repayment date for the
previous twelve months or an overdraft
facility where there has been no
drawdown over the previous twelve
months. If a single obligor had both a
credit facility and an overdraft facility
from the same banking organization, the
banking organization would separately
evaluate each facility to determine
whether each facility would meet the
definition of a transactor exposure to be
categorized as a transactor exposure.
Under the proposal, a banking
organization would assign a risk weight
of 55 percent to a regulatory retail
exposure that is a transactor exposure
and an 85 percent risk weight to a
regulatory retail exposure that is not a
transactor exposure. All other retail
exposures would be assigned a 110
percent risk weight. The proposed 55
percent risk weight for a transactor
exposure is appropriate because obligors
that demonstrate a historical repayment
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capacity generally exhibit less credit
risk relative to other retail obligors. A
regulatory retail exposure that is not a
transactor exposure warrants the
proposed 85 percent risk weight, which
would be lower than the proposed 110
percent risk weight for all other retail
exposures, due to mitigating factors
related to size or concentration risk. The
aggregate limit and granularity limit are
intended to ensure that the regulatory
retail portfolio consists of a set of small
exposures to a diversified group of
obligors, which would reduce credit risk
to the banking organization. Conversely,
banking organizations with a high
aggregate amount of retail exposures to
a single obligor, or exposures exceeding
the granularity limit, have a heightened
concentration of retail exposures. This
concentration of retail exposures
increases the level of credit risk the
banking organization has to a single
obligor, and the likelihood that the
banking organization could face
material losses if the obligor misses a
payment or defaults. Therefore, any
retail exposure that would not qualify as
a regulatory retail or a transactor
exposure warrants a risk weight of 110
percent.
The following example describes how
a banking organization would identify
the amount of retail exposures that
could be treated as regulatory retail
exposures. First, a banking organization
would identify the amount of credit
exposures that meet the eligible
products criterion within the definition
of a regulatory retail exposure. Assume
a banking organization has $100 million
in total retail exposures that meet the
eligible regulatory retail product
criterion described above. Next, for this
set of exposures, the banking
organization would identify any
amounts to a single obligor and its
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affiliates that exceed $1 million. The
banking organization in this example
determines that a single obligor and its
affiliates account for an aggregate of $20
million of the banking organization’s
total retail exposures. Because this $20
million exceeds the $1 million
threshold for amounts to a single obligor
and its affiliates, this $20 million would
be retail exposures that are not
regulatory retail exposures and subject
to a 110 percent risk weight, leaving $80
million that could be categorized as
regulatory retail exposures.
Also, assume that of the $80 million,
$1 million of the exposures are
considered defaulted exposures. This $1
million in defaulted exposures would be
subtracted from the $80 million. The
banking organization would multiply
the remaining $79 million by the 0.2
percent granularity limit, with the
resulting $158,000 representing the
dollar amount equivalent of the
granularity limit for this banking
organization’s retail portfolio. Therefore,
of the remaining $79 million, the
portion of those retail exposures to a
single obligor and its affiliates that do
not exceed $158,000 would be
considered regulatory retail exposures.
Of the regulatory retail exposures, the
portion of the exposure that would
qualify as a transactor exposure would
receive a 55 percent risk weight and the
remaining portion would receive an 85
percent risk weight. Under the proposal,
a banking organization would assign a
110 percent risk weight to the portion of
a retail exposure that exceeds the
granularity limit. Thus, the total amount
of retail exposures to a single obligor
exceeding $158,000 in this example
would receive a 110 percent risk weight
as other retail exposures. This example
is also illustrated in the following
decision tree.
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Question 34: What, if any, additional
criteria or alternatives should the
agencies consider to help ensure that
the regulatory retail treatment is limited
to a group of diversified retail obligors?
What alternative thresholds or
calibrations should the agencies
consider for purposes of retail
exposures? Please provide supporting
data in your response.
Question 35: What simplifications, if
any, to the calculation described above
for a regulatory retail exposure should
the agencies consider to reduce
operational complexity for banking
organizations? For example, what
operational challenges would arise from
assigning differing risk weights to
portions of retail exposures based on the
regulatory retail eligibility criteria?
Question 36: Is the requirement for
repayment of a credit facility in full at
each scheduled repayment date for the
previous twelve months or lack of
overdraft history an appropriate
criterion to distinguish the credit risk of
a transactor exposure from other retail
exposures, and if not, what would be
more appropriate and why? Is twelve
months of full repayment history a
sufficient amount of time to
demonstrate a consistent repayment
history of the credit or overdraft facility
to meet the definition of a transactor
and if not, what would be an
appropriate amount of time?
g. Risk-Weight Multiplier for Certain
Retail and Residential Mortgage
Exposures With Currency Mismatch
The proposal would introduce a new
requirement for banking organizations
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to apply a multiplier to the applicable
risk weight assigned to certain
exposures that contain currency
mismatches between the banking
organization’s lending currency and the
borrower’s source of repayment. The
multiplier would reflect the borrower’s
increased risk of default due to the
borrower’s exposure to foreign exchange
risk. The multiplier would apply to
exposure types where the borrower
generally does not manage or hedge its
foreign exchange risk. Exposures with
such currency mismatches pose
increased credit risk to the banking
organization as the borrower’s
repayment ability could be affected by
exchange rate fluctuations.
To capture this increased risk, the
proposal would require banking
organizations to apply a 1.5 multiplier
to the applicable risk weight, subject to
a maximum risk weight of 150 percent,
for retail and residential mortgage
exposures to a borrower that does not
have a source of repayment in the
currency of the loan equal to at least 90
percent of the annual payment from
either income generated through
ordinary business activities or from a
contract with a financial institution that
provides funds denominated in the
currency of the loan, such as a forward
exchange contract. Other types of
exposures generally account for foreign
exchange risk through hedging or other
risk mitigants and would not be subject
to the proposed multiplier. The
proposed risk weight ceiling of 150
percent aligns with the maximum risk
weight for credit exposures under the
proposal.
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Question 37: What, if any, additional
or alternative criteria of the proposed
multiplier should the agencies consider
and why?
h. Corporate Exposures
A corporate exposure under the
proposal would be an exposure to a
company that does not fall under any
other exposure category under the
proposal. This scope would be
consistent with the definition found in
§ ll.2 of the current capital rule. For
example, an exposure to a corporation
that also meets the proposed definition
of a real estate exposure would be a real
estate exposure rather than a corporate
exposure for purposes of the proposal.
As described in more detail below,
the proposal would differentiate the risk
weights of corporate exposures based on
credit risk by considering such factors
as a corporate exposure’s investment
quality and the general creditworthiness
of the borrower, level of subordination,
as well as the nature and substance of
the lending arrangement, and the degree
of reliance on the borrower’s
independent capacity for repayment of
the obligation, or reliance on the income
that the borrowing entity is expected to
generate from the asset(s) or a project
being financed. First, a banking
organization would assign a 65 percent
risk weight to a corporate exposure that
is an exposure to a company that is
investment grade, and that has a
publicly traded security outstanding or
that is controlled by a company that has
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a publicly traded security outstanding.94
Second, consistent with the current
standardized approach, a banking
organization would assign risk weights
of 2 percent or 4 percent to certain
exposures to a qualifying central
counterparty.95 Third, as discussed
further below, a banking organization
would assign a 130 percent risk weight
to a project finance exposure that is not
a project finance operational phase
exposure. Fourth, a banking
organization would assign a 150 percent
risk weight to a corporate exposure that
is an exposure to a subordinated debt
instrument or an exposure to a covered
debt instrument unless a deduction
treatment is provided as described in
section III.C.2.d. of this SUPPLEMENTARY
INFORMATION.
Finally, a banking organization would
assign a 100 percent risk weight to all
other corporate exposures. Assigning a
100 percent risk weight to all other
corporate exposures appropriately
reflects the relative risk of such
corporate exposures, as the repayment
methods for these exposures pose
greater risks than those of publiclytraded corporate exposures that are
deemed investment grade. A banking
organization would also assign a 100
percent risk weight to corporate
exposures that finance incomeproducing assets or projects that engage
in non-real estate activities where the
obligor has no independent capacity to
repay the loan. For example, corporate
exposures subject to the 100 percent risk
weight would include exposures (i) for
the purpose of acquiring or financing
equipment where repayment of the
exposure is dependent on the cash flows
generated by either the equipment being
financed or acquired, (ii) for the purpose
of acquiring or financing physical
commodities where repayment of the
exposure is dependent on the proceeds
from the sale of the physical
commodities, and (iii) project finance
operational phase exposures, as further
discussed below.
i. Investment Grade Companies With
Publicly Traded Securities Outstanding
Under the proposal, a banking
organization would assign a 65 percent
risk weight to a corporate exposure that
is both (1) an exposure to a company
that is investment grade, and (2) where
that company, or a parent that controls
that company, has publicly traded
securities outstanding.96 This twopronged test would serve as a
reasonable basis for banking
organizations to identify exposures to
obligors of sufficient creditworthiness to
be eligible for a reduced risk weight.
The definition of investment grade
directly addresses the credit quality of
the exposure by requiring that the entity
or reference entity have adequate
capacity to meet financial commitments,
which means that the risk of its default
is low and the full and timely
repayment of principal and interest is
expected. A banking organization’s
investment grade analysis is dependent
upon the banking organization’s
underwriting criteria, judgment, and
assumptions.
The proposed requirement that the
company or its parent company have
securities outstanding that are publicly
traded, in contrast, would be a simple,
objective criterion that would provide a
degree of consistency across banking
organizations. Further, publicly-traded
corporate entities are subject to
enhanced transparency and market
discipline as a result of being listed
publicly on an exchange. A banking
organization would use these simple
criteria, which complement a banking
organization’s due diligence and
internal credit analysis, to determine
whether a corporate exposure qualifies
as an investment grade exposure.
Question 38: What, if any, alternative
criteria should the agencies consider to
identify corporate exposures that would
warrant a risk weight of 65 percent or
a risk weight between 65 percent and
100 percent?
Question 39: For what reasons, if any,
should the agencies consider applying a
lower risk weight than 100 percent to
exposures to companies that are not
publicly traded but are companies that
are ‘‘highly regulated?’’ What, if any,
criteria should the agencies consider to
identify companies that are ‘‘highly
regulated?’’ Alternatively, what are the
advantages and disadvantages of
assigning lower risk weights to highly
regulated entities (such as open-ended
mutual funds, mutual insurance
companies, pension funds, or registered
investment companies)?
94 Under § ll.2 of the current capital rule, a
person or company controls a company if it: (1)
owns, controls, or holds with power to vote 25
percent or more of a class of voting securities of the
company; or (2) consolidates the company for
financial reporting purposes. See 12 CFR 3.2 (OCC);
12 CFR 217.2 (Board); 12 CFR 324.2 (FDIC).
95 See 12 CFR 3.32(f)(2) and (3) (OCC); 12 CFR
217.32(f)(2) and (3) (Board); 12 CFR 324.32(f)(2) and
(3) (FDIC).
96 Under § ll.2 of the current capital rule,
publicly-traded means traded on: (1) any exchange
registered with the SEC as a national securities
exchange under section 6 of the Securities
Exchange Act; or (2) any non-U.S.-based securities
exchange that: (i) is registered with, or approved by,
a national securities regulatory authority; and (ii)
provides a liquid, two-way market for the
instrument in question. See 12 CFR 3.2 (OCC); 12
CFR 217.2 (Board); 12 CFR 324.2 (FDIC).
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Question 40: What are the advantages
and disadvantages of applying a lower
risk weight (such as between 85 and 100
percent), to entities based on size, such
as companies with reported annual
sales of less than or equal to $50 million
for the most recent financial year? What
alternative criteria, if any, should the
agencies consider to identify small or
medium-sized entities that present
lower credit risk? For example, should
the agencies consider asset size or
number of employees to identify small
or medium-sized entities? Please
provide supporting data.
Question 41: What criteria, if any,
should the agencies consider to further
differentiate corporate exposures
according to their risk profiles and what
implications would such criteria have
for the risk weighting of these exposures
and why?
ii. Project Finance Exposures
The proposal would define a project
finance exposure as a corporate
exposure for which the banking
organization relies on the revenues
generated by a single project (typically
a large and complex installation, such as
power plants, manufacturing plants,
transportation infrastructure,
telecommunications, or other similar
installations), both as the source of
repayment and as security for the loan.
For example, a project finance exposure
could take the form of financing the
construction of a new installation, or a
refinancing of an existing installation,
with or without improvements. The
primary determinant of credit risk for a
project finance exposure is the
variability of the cash flows expected to
be generated by the project being
financed rather than the general
creditworthiness of the obligor or the
market value or sale of the project or the
real estate on which the project sits.97 A
project finance exposure also would be
required to meet the following criteria:
(1) the exposure would need to be to a
borrowing entity that was created
specifically to finance the project,
operate the physical assets of the
project, or do both, and (2) the
borrowing entity would need to have an
immaterial amount of assets, activities,
or sources of income apart from
revenues from the activities of the
project being financed. Under the
proposal, an exposure that is deemed
secured by real estate,98 would not be
97 Exposures that are guaranteed by the
government or considered a general obligation or
revenue obligation exposure to a PSE would not
qualify as a project finance exposure.
98 Although it is common for the banking
organization to take a mortgage over the real
property and a lien against other assets of the
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considered a project finance exposure
and would be assigned a risk weight as
described in section III.C.2.e. of this
SUPPLEMENTARY INFORMATION.
Under the proposal, a project finance
exposure would receive a 130 percent
risk weight during the pre-operational
phase and a 100 percent risk weight
during the operational phase. The
proposal would define a project finance
operational phase exposure as a project
finance exposure where the project has
a positive net cash flow that is sufficient
to support the debt service and expenses
of the project and any other remaining
contractual obligation, in accordance
with the banking organization’s
applicable loan underwriting criteria for
permanent financings, and where the
outstanding long-term debt of the
project is declining. Prior to the
operational phase classification, a
banking organization would be required
to treat a project finance exposure as
being in the pre-operational phase and
assign a 130 percent risk weight to the
exposure. The pre-operational phase
would be the period between the
origination of the loan and the time at
which the banking organization
determines that the project has entered
the operational phase. Relative to the
operational phase, the pre-operational
phase presents increased uncertainty
that the project will be completed in a
timely and cost-effective manner, which
warrants the application of a higher risk
weight. For example, market conditions
could change significantly between
commencement and completion of the
project. In addition, unanticipated
supply shortages could disrupt timely
completion of the project and the
expected timing of the transition to the
operational phase. These unanticipated
changes could disrupt the completion of
the project and delay it becoming
operational, and thus impact the ability
of the project to generate cash flows as
projected and to repay creditors.
Question 42: What additional
exposures, if any, should be captured by
the proposed definition of a project
finance exposure? What exposures, if
any, captured by the proposed
definition of a project finance exposure
should be excluded from the definition?
project for security and lender control purposes, a
project finance exposure would not be considered
a real estate exposure because the banking
organization does not rely on real estate collateral
to grant credit. As noted in section III.C.2.e of this
SUPPLEMENTARY INFORMATION, for purposes of the
proposal, ‘‘secured by collateral in the form of real
estate’’ in the context of the proposed real estate
exposure definition should be interpreted in a
manner that is consistent with the current
definition for ‘‘a loan secured by real estate’’ in the
Call Report and FR Y–9C instructions.
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Question 43: What clarifications or
changes, if any, should the agencies
consider to differentiate project finance
exposures from exposures secured by
real estate? What, if any, capital market
effects would the proposed treatment of
project finance exposures have and why
and what, if any, modifications should
the agencies consider to address such
effects? How material for banking
organizations are project finance
exposures that are not based on the
creditworthiness of a Federal, state or
local government?
3. Off-Balance Sheet Exposures
In addition to on-balance sheet
exposures, banking organizations are
exposed to credit risk associated with
off-balance sheet exposures. Banking
organizations often enter into
contractual arrangements with
borrowers or counterparties to provide
credit or other support. Such
arrangements generally are not recorded
on-balance sheet under GAAP. These
off-balance sheet exposures often
include commitments, contingent items,
guarantees, certain repo-style
transactions, financial standby letters of
credit, and forward agreements.
The proposal would introduce a few
updated credit conversion factors that a
banking organization would apply to an
off-balance sheet item’s notional amount
(typically, the contractual amount) in
order to calculate the exposure amount
for an off-balance sheet exposure. Under
the proposal, the credit conversion
factors, which would range from 10
percent to 100 percent, would reflect the
expected proportion of the off-balance
sheet item that would become an onbalance sheet credit exposure to the
borrower, taking into account the
contractual features of the off-balance
sheet item. For example, a guarantee
provided by a banking organization
would be subject to a 100 percent credit
conversion factor because there
generally is a high probability of the full
amount of the guarantee becoming an
on-balance sheet credit exposure. In
contrast, under the terms of most
commitments, banking organizations
generally are not expected to extend the
full amount of credit agreed to in the
contract. After determining the offbalance sheet exposure amount, the
banking organization would then
multiply it by the appropriate risk
weight, as provided under section
III.C.2. of the SUPPLEMENTARY
INFORMATION, to arrive at the riskweighted asset amount for the offbalance sheet exposure, consistent with
the calculation method under the
current standardized approach.
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a. Commitments
The proposal would maintain the
existing definition of commitment
under the current capital rule. The
current capital rule defines a
commitment as any legally binding
arrangement that obligates a banking
organization to extend credit or to
purchase assets.99 A commitment can
exist even when the banking
organization has the unilateral right to
not extend credit at any time.
Off-balance sheet exposures such as
credit cards allow obligors to borrow up
to a specified amount. However, some
off-balance sheet exposures such as
charge cards do not have an explicit
contractual pre-set credit limit and
generally require obligors to pay their
balance in full each month. For
commitments with no express
contractual maximum amount or pre-set
limit, the proposal would include an
approach to calculate a proxy for the
committed but undrawn amount of the
commitment (off-balance sheet notional
amount), based on an averaging formula
over the previous two years (averaging
methodology). A banking organization
would first calculate the average total
drawn amount of the commitment over
the prior eight quarters or, if the banking
organization has offered such products
to the obligor for fewer than eight
quarters, the average total drawn
amount since the commitment with no
pre-set limit was first issued. The
banking organization would then
multiply the average total drawn
amount by 10 to determine the offbalance sheet notional amount. Next,
the banking organization would
determine the applicable off-balance
sheet exposure amount by first
subtracting the current drawn amount
from the calculated off-balance sheet
notional amount and then multiplying
this difference by the applicable credit
conversion factor (10 percent for an
unconditionally cancelable
commitment, as described in more
detail in the following section). The
risk-weighted asset amount would be
the off-balance sheet exposure amount
multiplied by the applicable risk weight
(e.g., 55 percent for a transactor retail
exposure).
For example, assume an obligor’s
charge card had an average drawn
amount of $4,000 over the prior eight
quarters, and a drawn amount of $3,000
during the most recent reporting
quarter. To determine the off-balance
sheet exposure amount of the charge
card, a banking organization would (1)
multiply the average of $4,000 by 10
99 See 12 CFR 3.2 (OCC); 12 CFR 217.2 (Board);
12 CFR 324.2 (FDIC).
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($40,000), (2) subtract the current drawn
amount of $3,000 from $40,000
($37,000), and (3) multiply $37,000 by
the 10 percent credit conversion factor
for unconditionally cancellable
commitments ($3,700). For purposes of
this example, assume the obligor’s
charge card would qualify as a
regulatory retail exposure 100 that is a
transactor exposure. Applying the 55
percent risk weight for transactor
exposures to the exposure amount of
$3,700. would result in a risk-weighted
asset amount of $2,035.
The proposed averaging methodology
would apply a multiplier of 10 to the
average total drawn amount because
supervisory experience suggests that
obligors similar to those with charge
cards have average credit utilization
rates equal to approximately 10 percent.
This approach uses an eight-quarter
average balance, as opposed to a shorter
period, to better reflect a borrower’s
credit usage, notably by mitigating the
impact of seasonality and of short-term
trends in drawn balances from the total
credit exposure estimate.
Question 44: What are the advantages
and disadvantages of the averaging
methodology to calculate a proxy for the
undrawn credit exposure amount for
commitments with no pre-set limits?
What, if any, adjustments should the
agencies consider to better reflect a
borrower’s credit usage when
calculating the undrawn portion of the
credit exposures for commitments that
have less than eight quarters of data,
particularly those with less than a full
quarter of data? What, if any, alternative
approaches should the agencies
consider and why?
Question 45: What adjustments, if
any, should the agencies make to the
proposed multiplier of 10 for calculating
the total off-balance sheet notional
amount of the obligor under the
proposed methodology and why?
b. Credit Conversion Factors
The proposal would provide the same
credit conversion factors in the current
capital rule except with respect to
commitments. The proposal would
modify the credit conversion factors
applicable to commitments and simplify
the treatment relative to the current
standardized approach by no longer
differentiating such factors by maturity.
Under the proposal, a commitment,
regardless of the maturity of the facility,
would be subject to a credit conversion
factor of 40 percent, except for the
100 As
discussed in section III.C.2.f of this
SUPPLEMENTARY INFORMATION, a retail exposure
would need to meet certain criteria and be
evaluated against the aggregate and granularity
limits to qualify as a regulatory retail exposure.
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unused portion of a commitment that is
unconditionally cancelable 101 (to the
extent permitted under applicable law)
by the banking organization, which
would be subject to a credit conversion
factor of 10 percent.102 Although
unconditionally cancellable
commitments allow banking
organizations to cancel such
commitments at any time without prior
notice, in practice, banking
organizations often extend credit or
provide funding for reputational reasons
or to support the viability of borrowers
to which the banking organization has
significant ongoing exposure, even
when borrowers are under economic
stress. For example, banking
organizations may have incentives to
preserve substantial or core customer
relationships when there is a
deterioration in creditworthiness that
may, for less substantial customer
relationships, cause the banking
organization to cancel a commitment.
Relative to the current standardized
approach, the proposal would simplify
the applicable credit conversion factor
for all other commitments given the 10
percent applicable credit conversion
factor for unconditionally cancellable
commitments. A 40 percent credit
conversion factor for other
commitments is appropriate because
such commitments do not provide the
banking organization the same
flexibility to exit the commitment
compared with unconditionally
cancellable commitments.
Question 46: What additional factors,
if any, should the agencies consider for
determining the applicable credit
conversion factors for commitments?
4. Derivatives
The current capital rule requires
banking organizations to calculate riskweighted assets based on the exposure
amount of their derivative contracts and
prescribes different approaches for
measuring the exposure amount of
derivative contracts based on the size
and risk profile of the banking
organization. The proposal would
expand the scope of banking
organizations that would be required to
use one of the approaches, SA–CCR,
which was adopted in January 2020 (the
101 Under § ll. 2 of the current capital rule,
unconditionally cancelable means a commitment
that a banking organization may, at any time, with
or without cause, refuse to extend credit (to the
extent permitted under applicable law). See 12 CFR
3.2 (OCC); 12 CFR 217.2 (Board); 12 CFR 324.2
(FDIC).
102 Under the proposal, a 40 percent CCF would
also apply to commitments that are not
unconditionally cancelable commitments for
purposes of calculating total leverage exposure for
the supplementary leverage ratio.
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SA–CCR final rule),103 and make certain
technical revisions to that approach.
The current capital rule requires
banking organizations subject to
Category I or II capital standards to
utilize SA–CCR or the internal models
methodology to calculate their advanced
approaches total risk-weighted assets
and to utilize SA–CCR to calculate
standardized total risk-weighted
assets.104 The current capital rule
permits banking organizations subject to
Category III or IV capital standards to
utilize the current exposure
methodology or SA–CCR to calculate
standardized total risk-weighted
assets.105
As discussed in section II of this
SUPPLEMENTARY INFORMATION, the
proposal would require institutions
subject to Category III or IV capital
standards to use the expanded riskbased approach, which includes the
requirement to use SA–CCR, and would
eliminate the internal models
methodology as an available approach
to calculate the exposure amount of
derivative contracts. Therefore, under
the proposal, large banking
organizations would be required to use
SA–CCR to calculate regulatory capital
ratios under the standardized approach,
expanded risk-based approach, and
supplementary leverage ratio.
The agencies are also proposing
technical revisions to SA–CCR to assist
banking organizations in implementing
SA–CCR in a consistent manner and
with an exposure measurement that
more appropriately reflects the
counterparty credit risks posed by
derivative transactions.
a. Proposed Technical Revisions
i. Treatment of Collateral Held by a
Qualifying Central Counterparty (QCCP)
Under the current capital rule, a
clearing member banking organization
using SA–CCR must determine its
capital requirement for a default fund
contribution to a QCCP based on the
hypothetical capital requirement for the
QCCP (KCCP) using SA–CCR.106 The
calculation of KCCP requires calculating
the exposure amount of the QCCP to
each of its clearing members. In the
calculation of the exposure amount, the
SA–CCR final rule allows the exposure
amount of the QCCP to each clearing
member to be reduced by all collateral
held by the QCCP posted by the clearing
member and by the amount of
103 85
FR 4362 (January 24, 2020).
CFR 3.34 (OCC); 12 CFR 217.34 (Board); 12
CFR 324.34 (FDIC).
105 Id.
106 See 12 CFR 3.133(d) (OCC); 12 CFR 217.133(d)
(Board); 12 CFR 324.133(d) (FDIC).
104 12
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prefunded default fund contributions
provided by the clearing member to the
QCCP. However, this treatment is
inconsistent with the calculation of the
exposure amount for a netting set, in
which collateral is not subtracted from
the exposure amount but is instead a
component of the calculations of both
the replacement cost (RC) and potential
future exposure (PFE).
The proposal would change how
collateral posted to a QCCP by clearing
members and the amount of clearing
members’ prefunded default fund
contributions factor into the calculation
of KCCP. This treatment, which is more
sensitive to the risk-reducing benefits of
collateral, would allow the proper
recognition of collateral in calculating
the exposure amount of a QCCP to its
clearing members and would be
consistent with the calculation of the
exposure amount for a netting set.
Specifically, for the purpose of
calculating the exposure amount of a
QCCP to a clearing member, the net
independent collateral amount that
appears in the RC and PFE calculations
would be replaced by the sum of:
(1) the fair value amount of the
independent collateral posted to a QCCP
by a clearing member;
(2) the fair value amount of the
independent collateral posted to a QCCP
by a clearing member on behalf of a
client, in connection with derivative
contracts for which the clearing member
has provided a guarantee to the QCCP;
and
(3) the amount of the prefunded
default fund contribution of the clearing
member to the QCCP.
Both the amount of independent
collateral and the prefunded default
fund contribution would be adjusted by
the standard supervisory haircuts under
Table 1 to § ll.121 of the proposal, as
applicable.
where A is the attachment point and D
is the detachment point.
protection by the banking organization
and negative if the CDO tranches were
used to sell credit protection by the
banking organization.
The SA–CCR final rule applies a
positive sign to the resulting amount if
the banking organization purchased the
CDO tranche and applies a negative sign
if the banking organization sold the
CDO tranche. However, the appropriate
sign to account for the purchasing or
selling of CDO tranches can be
ambiguous: purchasing a CDO tranche
can be interpreted as selling credit
protection, while selling a CDO tranche
can be interpreted as purchasing credit
protection. In order to ensure the correct
sign of the supervisory delta adjustment
for CDO tranches that would result in a
proper aggregation of CDO tranches
with linear credit derivative contracts in
PFE calculations, the proposal would
revise the sign specification for the
supervisory delta adjustment for CDO
tranches as follows: positive if the CDO
tranches were used to purchase credit
107 12 CFR 3.133(c)(4)(i) (OCC); 12 CFR
217.133(c)(4)(i) (Board); 12 CFR 324.133(c)(4)(i)
(FDIC).
108 For the supervisory delta adjustment, a
banking organization applies a positive sign to the
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ii. Treatment of Collateral Held in a
Bankruptcy-Remote Manner
Both the standardized approach and
the advanced approaches under the
current capital rule require a banking
organization to determine the trade
exposure amount for derivative
contracts transacted through a central
counterparty (CCP).
When calculating its trade exposure
amount for a cleared transaction, a
banking organization under both the
standardized and advanced approaches
under the capital rule may exclude
collateral posted to the CCP that is held
in a bankruptcy-remote manner by the
iv. Supervisory Delta for Options
Contracts
Under the SA–CCR final rule, the
supervisory delta adjustment for option
contracts is calculated based on the
Black-Scholes formulas for delta
sensitivity of European call and put
option contracts. The original BlackScholes formula for a European option
contract’s delta sensitivity assumes a
lognormal probability distribution for
the value of the instrument or risk factor
underlying the option contract, thus
precluding negative values for both the
current value of the underlying
instrument or risk factor and the strike
price of the option contract. The SA–
CCR final rule uses modified BlackScholes formulas that are based on a
shifted lognormal probability
derivative contract amount if the derivative contract
is long the risk factor and a negative sign if the
derivative contract is short the risk factor. A
derivative contract is long the primary risk factor
if the fair value of the instrument increases when
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CCP or a custodian. In the SA–CCR final
rule, the agencies inadvertently imposed
heightened requirements for the
exclusion of collateral from the trade
exposure amount posted by a clearing
member banking organizations to a CCP
under the advanced approaches.107 The
expanded risk-based approach does not
include these heightened requirements
and would align the requirements for
the exclusion of collateral from the trade
exposure amount of banking
organizations under both the
standardized and expanded risk-based
approach.
iii. Supervisory Delta for Collateralized
Debt Obligation (CDO) Tranches
Under the SA–CCR final rule, a
banking organization must apply a
supervisory delta adjustment to account
for the sensitivity of a derivative
contract (scaled to unit size) to the
underlying primary risk factor,
including the correct sign (positive or
negative) to account for the direction of
the derivative contract amount relative
to the primary risk factor.108
For a derivative contract that is a CDO
tranche, the supervisory delta
adjustment is calculated using the
formula below:
distribution, which allows negative
values of the underlying instrument or
risk factor with the magnitude not
exceeding the value of a shift parameter
l (lambda). The SA–CCR final rule sets
l to zero (thus precluding negative
values) for all asset classes except the
interest rate asset class, which has
exhibited negative values in some
currencies in recent years. For the
interest rate asset class, a banking
organization must set the value of l for
a given currency equal to the greater of
(i) the negative of the lowest value of the
strike prices and the current values of
the interest rate underlying all interest
rate options in a given currency that the
banking organization has with all
counterparties plus 0.1 percent; and (ii)
zero.
However, negative values of the
instrument or risk factor underlying an
option contract can occur in other asset
classes as well. For example, whenever
the value of the primary risk factor increases. A
derivative contract is short the primary risk factor
if the fair value of the instrument decreases when
the value of the primary risk factor increases.
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an option contract references the
difference between the values of two
instruments or risk factors, the
underlying spread of this option
contract can be negative. Such option
contracts are commonly traded in the
OTC derivatives market, including
option contracts on the spread between
two commodity prices and on the
difference in performance across two
equity indices. Under the current capital
rule, banking organizations cannot
calculate the supervisory delta
adjustment for any option contract other
than an interest rate derivative contract
if the strike price or the current value of
the underlying instrument or risk factor
is negative because the SA–CCR final
rule only allows a non-zero value for l
for interest rate derivative contracts. To
ensure that a banking organization is
able to calculate the supervisory delta
adjustment for option contracts when
the underlying instrument or risk factor
has a negative value, the proposal
would extend the use of the shift
parameter l to all asset classes. More
specifically, for non-interest-rate asset
classes, the proposal would require a
banking organization to use the same
value of l for all option contracts that
reference the same underlying
instrument or risk factor. If the value of
the underlying instrument or risk factor
cannot be negative, the value of l would
be set to zero. Otherwise, to determine
the value of l for a given risk factor or
instrument, the proposal would require
a banking organization to find the
lowest value L of the strike price and the
current value of the underlying
instrument or risk factor of all option
contracts that reference this instrument
or risk factor with all counterparties.
The proposal would require a banking
organization to set l for this instrument
or risk factor according to the formula
l=max{¥1.1·L,0}. The purpose of
multiplying negative L by 1.1 (thus,
resulting in ¥1.1·L) is the same as that
for adding 0.1 percent in the case of
interest rate derivative contracts under
the SA–CCR final rule: to set the lowest
possible value of the underlying
instrument or risk factor slightly below
the lowest observed value. Because it is
challenging to determine a universal
additive offset value for all values of
non-interest-rate instruments and risk
factors, the offset would be performed
via multiplication for asset classes other
than the interest rate asset class.
The proposal would also permit a
banking organization, with the approval
of its primary Federal supervisor, to
specify a different value for l for
purposes of the supervisory delta
adjustment for option contracts other
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than interest rate option contracts, if a
different value for l would be
appropriate, considering the range of
values for the instrument or risk factor
underlying option contracts. This
flexibility would allow a banking
organization to use a specific value for
l, rather than the value resulting from
the proposed formula described above,
in the event that a different value for l
is more appropriate than the value
resulting from the formula. A banking
organization that specifies a different
value for l would be required to assign
the same value for l to all option
contracts with the same underlying
instrument or risk factor, as applicable,
with all counterparties. This proposed
provision is intended to permit a
banking organization, with approval
from its primary Federal supervisor, to
account for unanticipated outcomes in
the supervisory delta adjustment of
certain asset classes while avoiding
arbitrage between assets in that class.
Question 47: What other approaches
should the agencies consider to
calibrate the lambda parameter for noninterest-rate asset classes, such as a
formula that is different from the
proposed formula of l=max{¥1.1·L,0},
and why? What values besides 1.1, if
any, should the agencies consider for
the value of the multiplier in the
proposed formula? Why?
v. Decomposition of Credit, Equity, and
Commodity Indices
Under the capital rule, banking
organizations are permitted to
decompose indices within credit,
equity, and commodity asset classes,
such that a banking organization would
treat each component of the index as a
separate single-name derivative
contract.109 The capital rule requires
that if a banking organization elects to
decompose indices within the credit,
equity, and commodity asset classes, the
banking organization must perform all
calculations in determining the
exposure amount based on the
underlying instrument rather than the
index. While this is possible for linear
indices, for non-linear index contracts
(e.g., those with optionality and CDS
index tranches) it is not mathematically
possible to calculate the supervisory
delta for an underlying component, as
the delta associated with the non-linear
index applies at the instrument level. In
recognition of this fact, the agencies are
clarifying that the option to decompose
a non-linear index is not available under
SA–CCR. Additionally, the agencies are
109 See 12 CFR 3.132(c)(5)(vi) (OCC); 12 CFR
217.132(c)(5)(vi) (Board); 12 CFR 324.132(c)(5)(vi)
(FDIC).
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clarifying that if electing to decompose
a linear index, banking organizations
must apply the weights used by the
index when determining the exposure
amounts for the underlying instrument.
5. Credit Risk Mitigation
The current capital rule permits
banking organizations to recognize
certain types of credit risk mitigants,
such as guarantees, credit derivatives,
and collateral, for risk-based capital
purposes provided the credit risk
mitigants satisfy the qualification
standards under the rule.110 Credit
derivatives and guarantees can reduce
the credit risk of an exposure by placing
a legal obligation on a third-party
protection provider to compensate the
banking organization for losses in the
event of a borrower default.111
Similarly, the use of collateral can
reduce the credit risk of an exposure by
creating the right of a banking
organization to take ownership of and
liquidate the collateral in the event of a
default by the counterparty. Prudent use
of such mitigants can help a banking
organization reduce the credit risk of an
exposure and thereby reduce the riskbased capital requirement associated
with that exposure.
Credit risk mitigants recognized for
risk-based capital purposes must be of
sufficiently high quality to effectively
reduce credit risk. For guarantees and
credit derivatives, the current capital
rule primarily looks to the
creditworthiness of the guarantor and
the features of the underlying contract
to determine whether these forms of
credit risk mitigation may be recognized
for risk-based capital purposes (eligible
guarantee or eligible credit derivative).
With respect to collateralized
transactions, the current capital rule
primarily looks to the liquidity profile
and quality of the collateral received
and the nature of the banking
organization’s security interest to
determine whether the collateral
qualifies as financial collateral that may
be recognized for purposes of risk-based
capital.112
As stated earlier, the proposal would
eliminate the use of models for credit
risk under the current capital rule.
110 Consistent with the current capital rule, the
proposal would not require banking organizations
to recognize any instrument as a credit risk
mitigant. Credit derivatives that a banking
organization cannot or chooses not to recognize as
a credit risk mitigant would be subject to a separate
counterparty credit risk capital requirement.
111 Credit events are defined in the documents
governing the credit risk mitigant and often include
events such as failure to pay principal and interest
and entry into insolvency or similar proceedings.
112 See 12 CFR 3.2, 217.2, and 324.2 for the
definition of financial collateral.
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Therefore, the proposal would replace
certain methodologies for recognizing
the risk-reducing benefits of financial
collateral and eligible guarantees and
credit derivatives—namely, the internal
models methodology, simple VaR
approach, PD substitution approach,
LGD adjustment approach, and double
default treatment—with the
standardized approaches described
below. For eligible guarantees and
eligible credit derivatives, the proposal
would permit banking organizations to
use the substitution approach from
subpart D of the current capital rule
with a modification for eligible credit
derivatives that do not include
restructuring as a credit event. Further,
the proposal would no longer permit the
recognition of credit protection from
nth-to-default credit derivatives.113 For
all collateralized transactions, the
corporate issuer of any financial
collateral in the form of a corporate debt
security must have an outstanding
publicly traded security or the corporate
issuer must be controlled by a company
that has an outstanding publicly traded
security in order to be recognized. For
collateralized transactions where
financial collateral secures exposures
that are not derivative contracts or
netting sets of derivative contracts, the
proposal would permit banking
organizations to use the simple
approach from subpart D without any
modification. For eligible margin loans
and repo-style transactions, the proposal
would also permit banking
organizations to use the collateral
haircut approach with standard
supervisory market price volatility
haircuts 114 from subpart D with two
proposed modifications to increase risk
sensitivity: (1) adjustments to the
market price volatility haircuts and (2)
a modified formula for netting sets of
eligible margin loans or repo-style
transactions that reflects netting and
diversification benefits within netting
sets. Finally, the proposal would
introduce minimum haircut floors for
certain eligible margin loan and repostyle transactions with unregulated
financial institutions that banking
organizations must meet in order to
recognize the risk-mitigation benefits of
financial collateral.
113 See
section III.D.3.a of this SUPPLEMENTARY
INFORMATION.
114 Under subpart D, banking organizations also
are permitted to use their own estimates of market
price volatility haircuts, with prior written approval
from the primary Federal supervisors. The proposal
would not include this option in subpart E as the
agencies have found it to introduce unwarranted
variability in banking organizations’ risk-weighted
assets.
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In connection with the removal of the
internal models methodology, the
proposal would make corresponding
revisions to reflect this change in the
definition of a netting set. Compared to
the current capital rule, the proposal
would exclude cross-product netting
sets from the definition of a netting set,
as none of the proposed approaches
under the revised framework would
recognize cross-product netting. This
would be consistent with the current
capital rule, which also does not
recognize cross-product netting.
Therefore, the proposal would define a
netting set as a group of single-product
transactions with a single counterparty
that are subject to a qualifying master
netting agreement (QMNA) 115 and that
consist only of one of the following:
derivative contracts, repo-style
transactions, or eligible margin loans.
For purposes of the proposed netting set
definition, the netting set must include
the same product (i.e., all derivative
contracts or all repo-style transactions
or all eligible margin loans). Consistent
with the current capital rule, for
derivative contracts, the proposed
definition of netting set would also
include a single derivative contract
between a banking organization and a
single counterparty.
Question 48: What would be the
impact of requiring that certain debt
securities must be issued by a publiclytraded company, or issued by a
company controlled by a publiclytraded company, in order to qualify as
financial collateral and what, if any,
alternatives should the agencies
consider to this requirement?
a. Guarantees and Credit Derivatives
i. Substitution Approach
As under subpart D in the current
capital rule, under the proposal a
banking organization would be
permitted to recognize the credit-riskmitigation benefits of eligible guarantees
and eligible credit derivatives by
substituting the risk weight applicable
to the eligible guarantor or protection
provider for the risk weight applicable
to the hedged exposure.116
ii. Adjustment for Credit Derivatives
Without Restructuring as a Credit Event
Credit derivative contracts in certain
jurisdictions include debt restructuring
as a credit event that triggers a payment
obligation by the protection provider to
115 See 12 CFR 3.2, 217.2, and 324.2 for the
definition of qualifying master netting agreement.
116 Under subpart E in the current capital rule, an
eligible guarantee need not be issued by an eligible
guarantor unless the exposure is a securitization
exposure. The proposal would require all eligible
guarantees to be issued by an eligible guarantor.
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the protection purchaser. Such
restructurings of the hedged exposure
may involve forgiveness or
postponement of principal, interest, or
fees that result in a loss to investors.
Consistent with the current capital rule,
the proposal would generally require a
banking organization that seeks to
recognize the credit risk-mitigation
benefits of an eligible credit derivative
that does not include a restructuring of
the reference exposure as a credit event
to reduce the effective notional amount
of the credit derivative by 40 percent to
account for any unmitigated losses that
could occur as a result of a restructuring
of the hedged exposure.
Under the proposal, however, the 40
percent adjustment would not apply to
eligible credit derivatives without
restructuring as a credit event if both of
the following requirements are satisfied:
(1) the terms of the hedged exposure
(and the reference exposure, if different
from the hedged exposure) allow the
maturity, principal, coupon, currency,
or seniority status to be amended
outside of receivership, insolvency,
liquidation, or similar proceeding only
by unanimous consent of all parties; and
(2) the banking organization has
conducted sufficient legal review to
conclude with a well-founded basis
(and maintains sufficient written
documentation of that legal review) that
the hedged exposure is subject to the
U.S. Bankruptcy Code or a domestic or
foreign insolvency regime with similar
features that allows for a company to
reorganize or restructure and provides
for an orderly settlement of creditor
claims.
The unanimous consent requirement
would mean that, for restructurings
occurring outside of an insolvency
proceeding, all holders of the hedged
exposure (and the reference exposure, if
different from the hedged exposure)
must agree to any restructuring for the
restructuring to occur, and no holder
can vote against the restructuring or
abstain. This unanimous consent
requirement would reduce the risk that
a banking organization would suffer a
credit loss on the hedged exposure that
would not be offset by a payment under
the eligible credit derivative. Banking
organizations generally would only be
incentivized to vote for a restructuring
if the terms of the restructuring would
provide a more beneficial outcome to
the banking organization relative to
insolvency proceedings that would
trigger payment under the eligible credit
derivative. Additionally, the unanimous
consent requirement for the reference
exposure, if different from the hedged
exposure, would add an additional layer
of security by significantly reducing the
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probability of reaching a restructuring
agreement that results in a loss of
principal or interest for creditors
without triggering payment under the
eligible credit derivative. The
unanimous consent requirement would
need to be satisfied through the terms of
the hedged exposure (and the reference
exposure, if different from the hedged
exposure), which could be
accomplished through a contractual
provision of the exposure or the
application of law.
The requirement that the hedged
exposure be subject to the U.S.
Bankruptcy Code or a similar domestic
or foreign insolvency regime would help
to ensure that any restructuring is done
in an orderly, predictable, and regulated
process. In the event that the obligor of
the hedged exposure defaults and the
default is not cured, the obligor would
either be required to enter insolvency
proceedings, which would trigger
payment under the credit derivative, or
the obligor would be required to pursue
restructuring outside of insolvency,
which could not occur without the
banking organization’s consent.
Together, the proposed requirements
would ensure that credit derivatives that
do not include restructuring as a credit
event but provide similarly effective
protection as those that do contain such
provisions, are afforded similar
recognition under the capital
framework.
Question 49: The agencies seek
comment on the appropriateness of
allowing banking organizations to
recognize in full the effective notional
amount of credit derivatives that do not
include restructuring as a credit event,
if certain conditions are met. Is the
exemption from the 40 percent haircut
overly broad? If so, why, and how might
the exemption be narrowed to only
capture the types of credit derivatives
that provide protection similar to credit
derivatives that include restructuring as
a credit event?
Question 50: To what extent is the
proposed treatment of eligible credit
derivatives that do not include
restructuring of the reference exposure
as a credit event relevant outside of the
United States?
b. Collateralized Transactions
The proposal would only allow a
banking organization to recognize the
risk-mitigating benefits of a corporate
debt security that meets the definition of
financial collateral in expanded riskweighted assets if the corporate issuer of
the debt security has a publicly traded
security outstanding or is controlled by
a company that has a publicly traded
security outstanding. Corporations with
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publicly traded securities typically are
subject to mandatory regulatory and
public reporting and disclosure
requirements, and therefore debt
securities issued by such corporations
may be a more stable and liquid form of
collateral.
i. Simple Approach
Subpart D of the current capital rule
includes the simple approach, which
allows a banking organization to
recognize the risk-mitigating benefits of
financial collateral received by
substituting the risk weight applicable
to an exposure with the risk weight
applicable to the financial collateral
securing the exposure, generally subject
to a 20 percent floor. The proposal
generally would maintain the simple
approach of the current capital rule,
including restrictions on collateral
eligibility and the risk-weight floor,
except for the proposed requirement for
certain corporate debt securities.
ii. Collateral Haircut Approach
Under the current capital rule, a
banking organization may recognize the
credit risk-mitigation benefits of repostyle transactions, eligible margin loans,
and netting sets of such transactions by
adjusting its exposure amount to its
counterparty to recognize any financial
collateral received and any collateral
posted to the counterparty. Subpart E of
the current capital rule includes several
approaches that a banking organization
may use and some of those approaches
include the use of models that
contribute to variability in risk-weighted
assets. For this reason, under the
proposal a banking organization would
no longer be allowed to use the simple
VaR approach or the internal models
methodology to calculate the exposure
amount, nor would a banking
organization be permitted to use its own
internal estimates for calculating
haircuts. The proposal would broadly
retain the collateral haircut approach
with standard supervisory market
volatility haircuts with some
modifications. This approach would
require a banking organization to adjust
the fair value of the collateral received
and posted to account for any potential
market price volatility in the value of
the collateral during the margin period
of risk, as well as to address any
differences in currency. To increase the
risk-sensitivity of the collateral haircut
approach, the proposal would modify
certain market price volatility haircuts.
The proposal would also introduce a
new method to calculate the exposure
amount of eligible transactions in a
netting set and simplify the existing
exposure calculation method for
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individual transactions that are not part
of a netting set.
I. Exposure Amount
The proposal would provide two
methods for calculating the exposure
amount under the collateral haircut
approach for eligible margin loans and
repo-style transactions. One method
would apply to individual eligible
margin loans and repo-style
transactions, the other to single-product
netting sets of such transactions, as
described below. The new formula for
netting sets would allow for the
recognition of the risk-mitigating
benefits of netting and portfolio
diversification and is intended to
provide for increased risk-sensitivity of
the capital requirement for such
transactions relative to the current
capital rule.
A. Exposure Amount for Transactions
Not in a Netting Set
Under the collateral haircut approach,
the proposed exposure amount for an
individual eligible margin loan or repostyle transaction that is not part of a
netting set would yield the same result
as the exposure amount equation in the
current capital rule. However, the
proposal would change the variables
and structure to provide a simplified
calculation for an individual eligible
margin loan or repo-style transaction in
comparison with transactions that are
part of a netting set. Specifically, the
proposal would require a banking
organization to calculate the exposure
amount as the greater of zero and the
difference of the following two
quantities: (1) the value of the exposure,
adjusted by the market price volatility
haircut applicable to the exposure for a
potential increase in the exposure
amount; and (2) the value of the
collateral, adjusted by the market price
volatility haircut applicable to the
collateral for a potential decrease in the
collateral value and the currency
mismatch haircut applicable where the
currency of the collateral is different
from the settlement currency. The
banking organization would use the
market price volatility haircuts and a
standard 8 percent currency mismatch
haircut, subject to adjustments, as
described in the following section.
Specifically, the exposure amount for an
individual eligible margin loan or repostyle transaction that is not in a netting
set would be based on the following
formula:
E* = max{0; E × (1 + He)¥C ×
(1¥Hc¥Hfx)}
Where:
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• E* is the exposure amount of the
transaction after credit risk mitigation.
• E is the current fair value of the specific
instrument, cash, or gold the banking
organization has lent, sold subject to
repurchase, or posted as collateral to the
counterparty.
• He is the haircut appropriate to E as
described in Table 1 to § ll.121, as
applicable.
• C is the current fair value of the specific
instrument, cash, or gold the banking
organization has borrowed, purchased
subject to resale, or taken as collateral
from the counterparty.
• Hc is the haircut appropriate to C as
described in Table 1 to § ll.121, as
applicable.
• Hfx is the haircut appropriate for currency
mismatch between the collateral and
exposure.
The first component in the above
formula, E × (1 + He), would capture the
current value of the specific instrument,
cash, or gold the banking organization
has lent, sold subject to repurchase, or
posted as collateral to the counterparty
by the banking organization in the
eligible margin loan or repo-style
transaction, while accounting for the
market price volatility of the instrument
type. The second component in the
above formula, C × (1¥Hc¥Hfx), would
capture the current value of the specific
instrument, cash, or gold the banking
organization has borrowed, purchased
subject to resale, or taken as collateral
from the counterparty in the eligible
margin loan or repo-style transaction,
while accounting for the market price
volatility of the specific instrument as
well as any adjustment to reflect
currency mismatch, if applicable.
Where:
• E* is the exposure amount of the netting
set after credit risk mitigation.
• Ei is the current fair value of the
instrument, cash, or gold the banking
organization has lent, sold subject to
repurchase, or posted as collateral to the
counterparty.
• Ci is the current fair value of the
instrument, cash, or gold the banking
organization has borrowed, purchased
subject to resale, or taken as collateral
from the counterparty.
• netexposure = |Ss Es Hs|.
• grossexposure = Ss Es |Hs|.
• Es is the absolute value of the net position
in a given instrument or in gold (where
the net position in a given instrument or
gold equals the sum of the current fair
values of the instrument or gold the
banking organization has lent, sold
subject to repurchase, or posted as
collateral to the counterparty, minus the
sum of the current fair values of that
same instrument or gold the banking
organization has borrowed, purchased
subject to resale, or taken as collateral
from the counterparty).
• Hs is the haircut appropriate to Es as
described in Table 1 to § ll.121, as
applicable. Hs has a positive sign if the
instrument or gold is net lent, sold
subject to repurchase, or posted as
collateral to the counterparty; Hs has a
negative sign if the instrument or gold is
net borrowed, purchased subject to
resale, or taken as collateral from the
counterparty.
• N is the number of instruments in the
netting set with a unique Committee on
Uniform Securities Identification
Procedures (CUSIP) designation or
foreign equivalent, with certain
exceptions. N would include any
instrument with a unique CUSIP that the
banking organization lends, sells subject
to repurchase, or posts as collateral, as
well as any instrument with a unique
CUSIP that the banking organization
borrows, purchases subject to resale, or
takes as collateral. However, N would
not include collateral instruments that
the banking organization is not permitted
to include within the credit risk
mitigation framework (such as
nonfinancial collateral that is not part of
a repo-style transaction included in the
banking organization’s market risk
weighted assets) or elects not to include
within the credit risk mitigation
framework. The number of instruments
for N would also not include any
instrument (or gold) for which the value
Es is less than one-tenth of the value of
the largest Es in the netting set. Any
amount of gold would be given a value
of one.
• Efx is the absolute value of the net position
in each currency fx different from the
settlement currency.
• Hfx is the haircut appropriate for currency
mismatch of currency fx.
systematic risk (based on the net
exposure) and the idiosyncratic risk 117
(based on the gross exposure) of the
netting set of eligible margin loans or
repo-style transactions covered by a
QMNA. Under the proposal, the net
exposure component would allow the
formula to recognize netting at the level
of the netting set and correlations in the
movement of market prices for
instruments lent and received.
Additionally, because the contribution
from the gross exposure component to
the exposure amount would decrease
proportionally with an increase in the
number of unique instruments by CUSIP
designations or foreign equivalent, the
gross exposure would capture the
impact of portfolio diversification. The
fourth component, (Sfx (Efx × Hfx)) would
capture any adjustment to reflect
currency mismatch, if applicable.
When determining the market price
volatility and currency mismatch
haircuts, the banking organization
would use the market price volatility
haircuts described in the following
section and a standard 8 percent
currency mismatch haircut, subject to
certain adjustments.
Question 51: What are the advantages
and disadvantages of the proposed
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The first component in the above
formula, (Si Ei¥SiCi) would capture the
baseline exposure of a netting set of
eligible margin loans or repo-style
transactions after accounting for the
value of any collateral. The second, (0.4
× netexposure), and third, (0.6 ×
(grossexposure/√N)) components in the
above formula would reflect the
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B. Exposure Amount for Transactions in
a Netting Set
Under the collateral haircut approach,
the proposal would provide a new, more
risk-sensitive equation that recognizes
diversification benefits by taking into
consideration the number of securities
included in a netting set of eligible
margin loans or repo-style transactions.
Under this approach, the exposure
amount for a netting set of eligible
margin loans or repo-style transactions
would equal:
117 Systematic risk represents risks that are
impacted by broad market variables (such as
economy, region, and sector). Idiosyncratic risk
represents risks that are endemic to a specific asset,
borrower, or counterparty.
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methodology for calculating the
exposure amount for eligible margin
loans and repo-style transactions
covered by a QMNA?
Question 52: What would be the
advantages and disadvantages of an
alternative method to calculate the
number of instruments N based on the
number of legal entities that issued or
guaranteed the instruments?
BILLING CODE 6210–01–C; 6714–01–C; 4810–33–C
The proposed haircuts would strike a
balance between simplicity and risk
sensitivity relative to the supervisory
haircuts in the current capital rule by
118 This category also would include public sector
entities that are treated as sovereigns by the
national supervisor.
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II. Market Price Volatility Haircuts
collateral amount and the variation
margin amount for collateralized
derivative transactions using SA–CCR.
Consistent with the current capital rule,
the proposal would require banking
organizations to apply an 8 percent
supervisory haircut, subject to
adjustments, to the absolute value of the
net position in each currency that is
different from the settlement
currency.118 119
Under the proposal, a banking
organization would apply the market
price volatility haircut appropriate for
the type of collateral, as provided in
Table 1 to § ll.121 below, in the
exposure amount calculation for repostyle transactions, eligible margin loans,
and netting sets thereof using the
collateral haircut approach and in the
calculation of the net independent
BILLING CODE 6210–01–P; 6714–01–P; 4810–33–P
introducing additional granularity with
respect to residual maturity, which is a
meaningful driver for distinguishing
between the market price volatility of
different instruments, and by
streamlining other aspects of the
collateral haircut approach where the
exposure’s risk weight figures less
119 Includes senior securitization exposures with
a risk weight greater than or equal to 100 percent
and sovereign exposures with a risk weight greater
than 100 percent.
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prominently in the instrument’s market
price volatility, as described below.
The proposal would apply haircuts
based solely on residual maturity, rather
than a combination of residual maturity
and underlying risk weight as under the
current capital rule for investment grade
debt securities other than sovereign debt
securities. These haircuts are derived
from observed stress volatilities during
10-business day periods during the 2008
financial crisis. Debt securities with
longer maturities are subject to higher
price volatility from future changes in
both interest rates and the
creditworthiness of the issuer.
Because securitization exposures tend
to be more volatile than corporate
debt,120 the proposal would provide a
distinct category of market price
volatility haircuts for certain
securitization exposures consistent with
the current capital rule. The proposal
would distinguish between non-senior
and senior securitization exposures to
enhance risk sensitivity. Since senior
securitization exposures absorb losses
only after more junior securitization
exposures, these exposures have an
added layer of security and different
market price volatility. Therefore, the
proposal would only specify term-based
haircuts for investment grade senior
securitization exposures that receive a
risk weight of less than 100 percent
under the securitization framework.
Other securitization exposures would
receive the 30 percent market price
volatility haircut applicable to ‘‘other’’
exposure types.
The proposal would require a banking
organization to apply market price
volatility haircuts of 20 percent for main
index equities (including convertible
bonds) and gold, 30 percent for other
publicly traded equities and convertible
bonds, and 30 percent for other
exposure types. Equities in a main index
typically are more liquid than those that
are not included in a main index, as
investors may seek to replicate the
index by purchasing the referenced
equities or engaging in derivative
transactions involving the index or
equities within the index. The lower
haircuts for equities included in a main
index under the proposal would reflect
the higher liquidity of those securities
compared to other publicly traded
equities or exposure types, which would
generally help to reduce losses to
banking organizations when liquidating
those securities during stress
conditions.
120 See Basel Committee, ‘‘Strengthening the
resilience of the banking sector—consultative
document,’’ December 2009; https://www.bis.org/
publ/bcbs164.pdf.
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For collateral in the form of mutual
fund shares, the proposal would be
consistent with the collateral haircut
approach provided in the current capital
rule in which a banking organization
would apply the highest haircut
applicable to any security in which the
fund can invest. The proposal also
would include an alternative method
available to a banking organization if the
mutual fund qualifies for the full lookthrough approach described in section
III.E.1.c.ii. of this SUPPLEMENTARY
INFORMATION. This alternative method
would provide a more risk-sensitive
calculation of the haircut on mutual
fund shares collateral by using the
weighted average of haircuts applicable
to the instruments held by the mutual
fund.121 This aspect of the proposal
reflects the agencies’ observation that,
while certain mutual funds may be
authorized to hold a wide range of
investments, the actual holdings of
mutual funds are often more limited.
In addition, the proposal would
maintain the requirement for a banking
organization to apply a market price
volatility haircut of 30 percent to
address the potential market price
volatility for any instruments that the
banking organization has lent, sold
subject to repurchase, or posted as
collateral that is not of a type otherwise
specified in Table 1 to § ll.121.
Question 53: What are the advantages
and disadvantages of allowing banking
organizations to apply the full lookthrough approach for certain collateral
in the form of mutual fund shares? What
alternative approaches should the
agencies consider for banking
organizations to determine the market
price volatility haircuts for collateral in
the form of mutual fund shares?
III. Minimum Haircut Floors for Certain
Eligible Margin Loans and Repo-Style
Transactions
The proposed framework for
minimum haircuts on non-centrally
cleared securities financing transactions
would reflect the risk exposure of
banking organizations to non-bank
financial entities that employ leverage
and engage in maturity transformation
but that are not subject to prudential
regulation.
The absence of prudential regulation
makes such entities more vulnerable to
121 If the mutual fund qualifies for the full lookthrough approach described in section III.E.1.c.ii of
this SUPPLEMENTARY INFORMATION but would be
treated as a market risk covered position as
described in section III.H.3 of this SUPPLEMENTARY
INFORMATION if the banking organization held the
mutual fund directly, the banking organization is
permitted to apply the alternative method to
calculate the haircut.
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runs, leading to an increase in the credit
risk of these entities in the form of a
greater risk of default in stress
periods.122 Episodes of non-bank
financial entities’ distress, such as the
2008 financial crisis, have highlighted
banking organizations’ exposure to nonbank financial entities through
securities financing transactions, which
may give rise to credit and liquidity
risks.
Securities financing transactions may
include repo-style transactions and
eligible margin loans. The motivation
behind a specific securities financing
transaction can be either to lend or
borrow cash, or to lend or borrow a
security. Securities financing
transactions can be used by a
counterparty to achieve significant
leverage—for example, through
transactions where the primary purpose
is to finance a counterparty through the
lending of cash—and result in elevated
counterparty credit risk.
The proposal would require a banking
organization to receive a minimum
amount of collateral when undertaking
certain repo-style transactions and
eligible margin loans (in-scope
transactions) with such entities
(unregulated financial institutions). The
application of haircut floors would
determine the minimum amount of
collateral exchanged. A banking
organization would treat in-scope
transactions with unregulated financial
institutions that do not meet the
proposed haircut floors as repo-style
transactions or eligible margin loans
where the banking organization did not
receive any collateral from its
counterparty.123 The proposed
treatment is intended to limit the buildup of excessive leverage outside the
banking system and reduce the
cyclicality of such leverage, thereby
limiting risk to the lending banking
organization and the banking system.
A. Unregulated Financial Institutions
Consistent with the definition in
§ ll. 2 of the current capital rule, the
proposal would define unregulated
financial institution as a financial
institution that is not a regulated
financial institution, including any
122 See ‘‘Strengthening Oversight and Regulation
of Shadow Banking,’’ Financial Stability Board,
August 2013 https://www.fsb.org/wp-content/
uploads/r_130829b.pdf.
123 In this example, the banking organization
would be permitted to calculate the exposure
amount using the collateral haircut approach but
would be required to exclude any collateral
received from the calculation. Alternatively, the
banking organization could choose not to use the
collateral haircut approach but to risk weight any
on-balance sheet or off-balance sheet portions of the
exposure as demonstrated in the example below.
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financial institution that would meet the
definition of ‘‘financial institution’’
under § ll.2 of the current capital rule
but for the ownership interest
thresholds set forth in paragraph (4)(i) of
that definition. Unregulated financial
institutions would include hedge funds
and private equity firms. This definition
would capture non-bank financial
entities that employ leverage and engage
in maturity transformation but that are
not subject to prudential regulation.
Question 54: What entities should be
included or excluded from the scope of
entities subject to the minimum haircut
floors and why? For example, what
would be the advantages and
disadvantages of expanding the
definition of entities that are scoped-in
to include all counterparties, or all
counterparties other than QCCPs? What
impact would expanding the scope of
entities subject to the minimum haircut
floors have on banking organizations’
business models, competitiveness, or
ability to intermediate in funding
markets and in U.S. Treasury securities
markets?
B. In-Scope Transactions
Under the proposal, an in-scope
transaction generally would include the
following non-centrally cleared
transactions: (1) an eligible margin loan
or a repo-style transaction in which a
banking organization lends cash to an
unregulated financial institution in
exchange for securities, unless all of the
securities are non-defaulted sovereign
exposures, and (2) certain security-forsecurity repo-style transactions that are
collateral upgrade transactions with an
unregulated financial institution. Under
the proposal, a collateral upgrade
transaction would include a transaction
in which the banking organization lends
one or more securities that, in aggregate,
are subject to a lower haircut floor in
Table 2 to § ll.121 than the securities
received from the unregulated financial
institution.
The proposal would exempt the
following types of transactions and
netting sets of such transactions with
unregulated financial institutions from
the minimum haircut floor
requirements: (1) transactions in which
an unregulated financial institution
lends, sells subject to repurchase, or
posts as collateral securities to a
banking organization in exchange for
cash and the unregulated financial
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institution reinvests the cash at the
same or a shorter maturity than the
original transaction with the banking
organization; (2) collateral upgrade
transactions in which the unregulated
financial institution is unable to rehypothecate, or contractually agrees that
it will not re-hypothecate, the securities
it receives as collateral; or (3)
transactions in which a banking
organization borrows securities from an
unregulated financial institution for the
purpose of meeting current or
anticipated demand, such as for
delivery obligations, customer demand,
or segregation requirements, and not to
provide financing to the unregulated
financial institution. For transactions
that are cash-collateralized in which an
unregulated financial institution lends
securities to the banking organization,
banking organizations could rely on
representations made by the
unregulated financial institution as to
whether the unregulated financial
institution reinvests the cash at the
same or a shorter maturity than the
maturity of the transaction. For
transactions in which a banking
organization is seeking to borrow
securities from an unregulated financial
institution to meet a current or
anticipated demand, banking
organizations must maintain sufficient
written documentation that such
transactions are for the purpose of
meeting a current or anticipated
demand and not for providing financing
to an unregulated financial institution.
The proposal would exclude these inscope transactions from the minimum
haircut floors as these transactions do
not pose the same credit and liquidity
risks as other in-scope transactions and
serve as important liquidity and
intermediation services provided by
banking organizations.
Question 55: What alternative
definitions of ‘‘in-scope transactions’’
should the agencies consider? For
example, what would be the pros and
cons of an expanded definition of ‘‘inscope transactions’’ to include all
eligible margin loan or repo-style
transactions in which a banking
organization lends cash, including those
involving sovereign exposures as
collateral? How would the inclusion of
sovereign exposures affect the market
for those securities? What, if any,
additional factors should the agencies
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consider concerning this alternative
definition?
Question 56: What, if any, difficulties
would banking organizations have in
identifying transactions that would be
exempt from the minimum haircut
floor?
Question 57: What, if any, operational
burdens would be imposed by the
proposal to require banking
organizations to maintain sufficient
written documentation to exempt
transactions with an unregulated
financial institution where the banking
organization is seeking to borrow
securities from an unregulated financial
institution to meet a current or
anticipated demand?
C. Application of the Minimum Haircut
Floors
For in-scope transactions, the
proposal would establish minimum
haircut floors that would be applied on
a single-transaction or a portfolio basis
depending on whether the in-scope
transaction is part of a netting set. The
proposed haircut floors are derived from
observed historical price volatilities as
well as existing market and central bank
haircut conventions. If the in-scope
transaction is a single transaction, then
the banking organization would apply
the corresponding single-transaction
haircut floor. If the in-scope transaction
is part of a netting set, the banking
organization would apply a portfoliobased floor to the entire netting set.124
In-scope transactions that do not meet
the applicable minimum haircut floor
would be treated as uncollateralized
exposures.
The minimum haircut floors are
intended to reflect the minimum
amount of collateral banking
organizations should receive when
undertaking in-scope transactions with
unregulated financial institutions.
Banking organizations should require an
appropriate amount of collateral to be
provided to account for the risks of the
transaction and counterparty. Figure 1
provides a summary of the process for
determining whether an in-scope
transaction meets the applicable
minimum haircut floor.
BILLING CODE 6210–01–P; 6714–01–P; 4810–33–P
124 If a netting set contains both in-scope and outof-scope transactions, the banking organization
would apply a portfolio-based floor for the entire
netting set.
E:\FR\FM\18SEP2.SGM
18SEP2
The proposal would require a banking
organization to compare the haircut (H)
and a single-transaction or portfolio
haircut floor (ƒ), as calculated below, to
determine whether an in-scope
transaction or a netting set of in-scope
transactions meets the relevant floor. If
H is less than f, then the banking
organization may not recognize the riskmitigating effects of any financial
collateral that secures the exposure.
For a single cash-lent-for-security inscope transaction, H would be defined
as the ratio of the fair value of financial
collateral borrowed, purchased subject
to resale, or taken as collateral from the
counterparty to the fair value of cash
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lent, minus one, and ƒ would be the
corresponding haircut applicable to the
collateral in Table 2 to § ll.121. For
example, for an in-scope transaction in
which a banking organization lends
$100 in cash to an unregulated financial
institution and receives $102 in
investment-grade corporate bonds with
a residual maturity of 10 years as
collateral, the haircut would be
calculated as H = (102/100)¥1 = 2
percent. The single-transaction haircut
floor for an investment grade corporate
bond with a residual maturity of 10
years or less under Table 2 to § ll.121
would be ƒ= 3 percent Since the haircut
is less than the single-transaction
haircut floor (H = 2 percent < 3 percent
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= ƒ), the proposal would not allow the
banking organization to recognize the
risk-mitigating benefits of the collateral
and would require the banking
organization to calculate the exposure
amount of its repo-style transaction or
eligible margin loan as if it had not
received any collateral from its
counterparty.
For a single security-for-security repostyle transaction, H would be defined as
the ratio of the fair value of financial
collateral borrowed, purchased subject
to resale, or taken as collateral from the
counterparty (B) relative to the fair
value of the financial collateral the
banking organization has lent, sold
subject to repurchase, or posted as
E:\FR\FM\18SEP2.SGM
18SEP2
EP18SE23.012</GPH>
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BILLING CODE 6210–01–C; 6714–01–C; 4810–33–C
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EP18SE23.011</GPH>
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lotter on DSK11XQN23PROD with PROPOSALS2
The banking organization would be
able to recognize the risk-mitigating
benefits of the collateral received,
because the portfolio haircut is higher
than the portfolio haircut floor:
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To calculate the exposure amount for
this transaction, the banking
organization would use the collateral
portfolio level, the banking organization may, after
netting across all transactions in the same portfolio,
be either collecting the security or cash (that is, net
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The portfolio haircut floor would be:
haircut approach formula in
§ ll.121(c) and the standard market
price volatility haircuts in Table 1 to
§ ll.121 and set N to 3:
borrowed) or posting the security or cash (that is,
net lent).
E:\FR\FM\18SEP2.SGM
18SEP2
EP18SE23.019</GPH>
EP18SE23.018</GPH>
corporate bonds with a residual
maturity of 10 years (which correspond
to a haircut floor of 3 percent) as
collateral; and (2) a securities lending
transaction in which a banking
organization lends $100 of different
investment grade corporate bonds also
with a residual maturity of 10 years and
receives $104 in main index equity
securities (which correspond to a
haircut floor of 6 percent) as collateral.
For this set of in-scope repo-style
transactions, the portfolio haircut would
be:
EP18SE23.020</GPH>
For a netting set of in-scope
transactions, the haircut floor of the
netting set would be computed as
follows:
EP18SE23.017</GPH>
The portfolio would satisfy the
minimum haircut floor requirement
where the following condition is
satisfied: H ≥ fPortfolio.
If the portfolio does not satisfy the
minimum haircut floor, the banking
organization would not be able to
recognize the risk-mitigating benefits of
the collateral received.
In the following example, there are
two in-scope repo-style transactions that
are in the same netting set: (1) a reverse
repo transaction in which a banking
organization lends $100 in cash to an
unregulated financial institution and
receives $102 in investment grade
H = 3 percent > 2.971 percent = fPortfolio)
125 For a given security or cash, a banking
organization may collect the security or cash in one
transaction and post it in another. Thus, at the
VerDate Sep<11>2014
required to calculate the exposure
amount of its repo-style transaction or
eligible margin loan as if it had not
received any collateral from its
counterparty.
The single-transaction haircut floor
would be:
EP18SE23.016</GPH>
In the above formula, (CL) would be
the fair value of the net position in each
security or in cash that is net lent, sold
subject to repurchase, or posted as
collateral to the counterparty; CB is the
fair value of the net position that is net
borrowed, purchased subject to resale,
or taken as collateral from the
counterparty; and ƒL and ƒB would be
the haircut floors for the securities or
cash, as applicable, that are net lent and
net borrowed, respectively.125 This
calculation would be the weighted
average haircut floor of the portfolio.
The portfolio haircut H would be
calculated as:
where CB denotes the fair value of
collateral received and CL the fair value
of collateral lent. For example, for a
securities lending transaction in which
a banking organization lends $100 in
investment grade corporate bonds with
a residual maturity of 10 years (which
correspond to a haircut floor of 3
percent) and receives $102 in main
index equity securities (which
correspond to a haircut floor of 6
percent) as collateral, the haircut would
be:
EP18SE23.015</GPH>
Since the haircut is less than the
single-transaction haircut floor (H = 2
percent < 2.9126 percent = ƒ), the
banking organization would not be able
to recognize the risk-mitigating benefits
of the collateral received and would be
The single transaction floor then
would be compared to the haircut of the
transaction, determined as follows:
EP18SE23.014</GPH>
collateral to the counterparty (L), minus
one. The single-transaction haircut floor
(f) of the transaction would incorporate
the corresponding haircut applicable to
the collateral received (fB) and collateral
lent (ƒL) in Table 2 to § ll.121. The
single-transaction haircut floor for the
two types of collateral would be
computed as follows:
EP18SE23.013</GPH>
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Federal Register / Vol. 88, No. 179 / Monday, September 18, 2023 / Proposed Rules
126 The transaction would also result in credit
(reduction) of $100 cash, but this would have no
impact on the banking organization’s risk-weighted
assets as cash is assigned a 0 percent risk weight
under § ll.111.
127 See proposed § ll.112(b)(5)(iv).
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If the banking organization is not
permitted to sell or repledge the equity
securities in the second transaction, or
if that transaction is a securities
borrowing transaction from the
perspective of the banking organization,
the equity securities received by the
banking organization would not be
recognized on the banking
organization’s balance sheet.128 The
banking organization would still be
required to apply a 100 percent CCF to
the off-balance sheet exposure to its
counterparty,129 so the total exposure
amount would be ($100 receivable +
$100 off-balance sheet exposure) =
$200.130
Question 58: What alternative
minimum haircut floors should the
agencies consider and why? What would
be the advantages and disadvantages of
setting the minimum haircuts at a
higher level, such as at the proposed
market price volatility haircuts used for
recognition of collateral for eligible
margin loans and repo-style
transactions, or at levels between the
proposed minimum haircut floors and
the proposed market price volatility
haircuts?
Question 59: Where a banking
organization has exchanged multiple
securities for multiple other securities
under a QMNA with an unregulated
financial institution, what would be the
costs and benefits of providing banking
128 If the transaction is a securities borrowing
transaction from the perspective of the banking
organization, and if the equity securities received
are sold or if the counterparty defaults, the banking
organization would be required to record an
obligation to return the securities.
129 See proposed § ll.112(b)(5)(v)
130 In all cases, the $100 of investment grade
corporate bonds the banking organization has lent
would continue to remain on the banking
organization’s balance sheet and the banking
organization would continue to maintain risk-based
capital against these bonds.
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and the portfolio haircut floor would be:
organizations the flexibility to apply a
single-transaction haircut floor on a
transaction-by-transaction basis for inscope transactions within the netting
set, rather than applying a portfoliobased floor? Under this approach, each
in-scope transaction within a netting set
would be evaluated separately. Banking
organizations would be permitted to
recognize the risk-mitigation benefits of
collateral for individual transactions
that meet the single-transaction haircut
floor, even if the netting set did not meet
the portfolio-based floor.
Question 60: How can the proposed
formulas used for determining whether
an in-scope transaction or in-scope set
of transactions breaches the minimum
haircut floors be improved or further
clarified?
Question 61: What are the advantages
and disadvantages of the proposed
approach to minimum collateral
haircuts for in-scope transactions with
unregulated financial institutions? How
might the proposal change the behavior
of banking organizations and their
counterparties, including changes in
funding practices and potential
migration of funding transactions to
other counterparties? Commenters are
encouraged to provide data and
supporting analysis.
D. Securitization Framework
The securitization framework is
designed to provide the capital
requirement for exposures that involve
the tranching of credit risk of one or
more underlying financial exposures.
The risk and complexity posed by
securitizations differ relative to direct
exposure to the underlying assets in the
securitization because the credit risk of
those assets is divided into different
levels of loss prioritization using a wide
E:\FR\FM\18SEP2.SGM
18SEP2
EP18SE23.023</GPH>
Since the portfolio haircut is less than
the portfolio haircut floor (H= 1.5
percent < 2.9642 percent = ƒPortfolio), the
banking organization would not be able
to recognize the risk-mitigating benefits
of the collateral received.
Instead, the banking organization
would be required to separately riskweight the on-balance sheet and offbalance sheet portion of each individual
transaction. In this example, assuming
that both individual transactions are
treated as secured borrowings instead of
sales under GAAP, the first transaction
in which a banking organization lends
$100 in cash to an unregulated financial
institution and receives $101 in
investment grade corporate bonds
would result in an on-balance sheet
receivable of $100.126 If the second
transaction is a securities lending
transaction from the perspective of the
banking organization and the banking
organization is permitted to sell or
repledge the equity securities, the
transaction results in an increase in the
banking organization’s balance sheet of
$102 for the equity securities received
from the counterparty. The banking
organization would be required to apply
a 100 percent credit conversion factor
(CCF) to the off-balance sheet exposure
to its counterparty for the return of the
investment grade corporate bonds. In
this case, the off-balance sheet exposure
to the counterparty would be the $100
of lent investment grade corporate
bonds.127 The total exposure amount for
the two transactions would be ($100
receivable + $102 equity exposure +
$100 off-balance sheet exposure) = $302.
receives $102 in main index equity
securities (which correspond to a
haircut floor of 6 percent) as collateral.
For this set of in-scope repo-style
transactions, the portfolio haircut would
be:
EP18SE23.022</GPH>
lotter on DSK11XQN23PROD with PROPOSALS2
In a similar example, there are also
two in-scope repo-style transactions that
are in the same netting set: (1) a reverse
repo transaction in which a banking
organization lends $100 in cash to an
unregulated financial institution and
receives $101 in investment grade
corporate bonds with a residual
maturity of 10 years (which correspond
to a haircut floor of 3 percent) as
collateral; and (2) a securities lending
transaction in which a banking
organization lends $100 of different
investment grade corporate bonds and
EP18SE23.021</GPH>
Where:
exposurenet = |(100 × 0%) + (100 × 12%) +
(102 × (¥ 12%)) + (104 × (¥20%))| =
21.04
and
exposuregross = (100 × |0%|) + (100 × |12%| +
(102 × |¥ 12% |) + (104 × |¥ 20%|) =
45.04
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Federal Register / Vol. 88, No. 179 / Monday, September 18, 2023 / Proposed Rules
range of structural mechanisms.131 The
performance of a securitization depends
not only on the structure, but also on
the performance of the underlying assets
and certain parties to the securitization
structure, including the asset servicer
and any liquidity facility provider. The
involvement of these parties makes
securitization exposures susceptible to
additional risks as compared to direct
credit exposures.
The proposed securitization
framework would draw on many
features of the framework in subpart E
of the current capital rule with the
following modifications: (1) additional
operational requirements for synthetic
securitizations; (2) a modified treatment
for resecuritizations that meet the
operational requirements; (3) a new
securitization standardized approach
(SEC–SA), as a replacement to the
supervisory formula approach and
standardized supervisory formula
approach (SSFA), which includes,
relative to the SSFA, modified
definitions of attachment point and
detachment point, a modified definition
of the W parameter, modifications to the
definition of KG, a higher p-factor, a
lower risk-weight floor for securitization
exposures that are not resecuritization
exposures, and a higher risk-weight
floor for resecuritization exposures; (4)
a prohibition on using the securitization
framework for nth-to-default credit
derivatives; (5) a new treatment for
derivative contracts that do not provide
credit enhancement; (6) a modified
treatment for overlapping exposures; (7)
new maximum capital requirements and
eligibility criteria for certain senior
securitization exposures (the ‘‘lookthrough approach’’); (8) a modification
to the treatment for credit-enhancing
interest only strips (CEIOs); and (9) a
new framework for non-performing loan
(NPL) securitizations.132
lotter on DSK11XQN23PROD with PROPOSALS2
1. Operational Requirements
The proposed operational
requirements would be consistent with
the operational requirements in subpart
E of the current capital rule, with three
exceptions as described below. In
addition, for resecuritization exposures
131 To segment a reference portfolio into different
levels of risks for different investors, the
securitization process divides the reference
portfolio into different slices, called tranches,
which receive cash flows or absorb losses based on
a predetermined order of priority. This payment
structure is known as the ‘‘cash flow waterfall,’’ or
simply the ‘‘waterfall.’’ The waterfall schedule
prioritizes the manner in which interest or
principal payments from the reference portfolio
must be allocated, creating different risk-return
profiles for each tranche.
132 The proposal generally would use the same
approaches to determine the exposure amount of
securitization exposures.
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that meet the operational requirements,
the proposal would eliminate the option
for banking organizations to treat the
exposures as if they had not been
securitized.
a. Early Amortization Provisions
Early amortization provisions cause
investors in securitization exposures to
be repaid before the original stated
maturity when certain conditions are
triggered. For example, many
securitizations of revolving credit
facilities, most commonly credit-card
receivable securitizations, contain
provisions that require the
securitization to be wound down and
investors repaid on an accelerated basis
if excess spread falls below a certain
threshold. This decrease in excess
spread would typically be caused by
credit deterioration in the underlying
exposures. Such provisions can expose
the originating banking organization to
increased credit and liquidity risk and
potentially increased capital
requirements after the early
amortization is triggered as the banking
organization could be obligated to fund
the borrowers’ future draws on the
revolving lines of credit. In such an
instance, the originating banking
organization may have to either find a
new funding source, whether internal or
external, to cover the new draws or
reduce borrowers’ credit line
availability.
The proposal would expand the
applicability of the operational
requirements regarding early
amortization provisions to synthetic
securitizations, similar to their
application to traditional securitizations
under subpart D of the current capital
rule. Under § ll. 2 of the current
capital rule, an early amortization
provision means a provision in the
documentation governing a
securitization that, when triggered,
causes investors in the securitization
exposure to be repaid before the original
stated maturity of the securitization
exposure, with certain exceptions.133
Under the proposal, if a synthetic
securitization includes an early
amortization provision and references
one or more underlying exposures in
which the borrower is permitted to vary
the drawn amount within an agreed
limit under a line of credit, the banking
133 The exceptions to the current definition of
early amortization provision are a provision that: (1)
is triggered solely by events not directly related to
the performance of the underlying exposures or the
originating banking organization (such as material
changes in tax laws or regulations); or (2) leaves
investors fully exposed to future draws by
borrowers on the underlying exposures even after
the provision is triggered.
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organization would be required to hold
risk-based capital against the underlying
exposures as if they had not been
synthetically securitized.
Question 62: What, if any, additional
exceptions to the early amortization
provision definition should the agencies
consider and why, provided such
exceptions would not incentivize a
banking organization to provide implicit
support to a securitization exposure?
b. Synthetic Excess Spread
The proposal would prohibit an
originating banking organization from
recognizing the risk-mitigating benefits
of a synthetic securitization that
includes synthetic excess spread.
Synthetic excess spread would be
defined in the proposal as any
contractual provision in a synthetic
securitization that is designed to absorb
losses prior to any of the tranches of the
securitization structure. Synthetic
excess spread is a form of credit
enhancement provided by the
originating banking organization to the
investors in the synthetic securitization;
therefore, the originating banking
organization should maintain capital
against the credit exposure represented
by the synthetic excess spread.
However, a risk-based capital
requirement for synthetic excess spread
may not be determinable with sufficient
precision to promote comparability
across banking organizations because
the amount of synthetic excess spread
made available to investors in the
synthetic securitization would depend
upon the maturity of the underlying
assets, which itself depends on whether
any of the underlying exposures have
defaulted or prepaid. In particular, the
total amount of synthetic excess spread
made available at inception to investors
over the life of the transaction may not
be known ex ante, as the outstanding
balance of the securitization in future
years is unknown. Therefore, if a
synthetic securitization structure
includes synthetic excess spread, the
banking organization would be required
under the proposal to maintain capital
against all the underlying exposures as
if they had not been synthetically
securitized.
Question 63: What clarifications or
modifications should the agencies
consider for the above proposed
definition of synthetic excess spread
and why?
Question 64: What are the advantages
and disadvantages of the proposed
treatment of synthetic securitizations
with synthetic excess spread? If the
agencies were to permit originating
banking organizations to recognize the
credit risk-mitigation benefits of
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Federal Register / Vol. 88, No. 179 / Monday, September 18, 2023 / Proposed Rules
securitizations with synthetic excess
spread, how should the exposure
amount of the synthetic excess spread
be calculated, and what would be the
appropriate capital requirement for
synthetic excess spread?
lotter on DSK11XQN23PROD with PROPOSALS2
c. Minimum Payment Threshold
Under the proposal, the operational
requirements for synthetic
securitizations would include a new
requirement that any applicable
minimum payment threshold for the
credit risk mitigant be consistent with
standard market practice. A minimum
payment threshold is a contractual
minimum amount that must be
delinquent before a credit event is
deemed to have occurred. The proposed
minimum payment threshold criterion
is intended to prohibit an originating
banking organization from recognizing
the capital reducing benefits of a
synthetic securitization whose
minimum payment threshold is so large
that it allows for material losses to occur
without triggering the credit protection
acquired by the protection purchaser, as
such provisions would interfere with an
effective transfer of credit risk.
Question 65: What are the benefits
and drawbacks of the proposed
minimum payment threshold criterion?
What, if any, additional criteria or
clarifications should the agencies
consider and why?
d. Resecuritization Exposures
For a resecuritization that is a
traditional securitization, if the
operational requirements have been
met, an originating banking organization
would be required to exclude the
transferred exposures from the
calculation of its risk-weighted assets
and maintain risk-based capital against
any credit risk it retains in connection
with the resecuritization. Unlike in the
case of a securitization exposure that is
not a resecuritization, the proposal
would not allow a banking organization
the option to elect to treat a
resecuritization as if the underlying
exposures had not been re-securitized.
While a securitization of nonsecuritized assets can be used to
diversify or transfer credit risk of those
exposures, a resecuritization might not
offer similar risk reduction or
diversification benefits, particularly if
the underlying exposures reflect similar
high-risk tranches of other
securitizations. Therefore, these
resecuritization exposures warrant a
higher regulatory capital requirement
than that applicable to the underlying
exposures.
Similarly, for a resecuritization that is
a synthetic securitization, if the
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operational requirements have been
met, an originating banking organization
would be required to recognize for riskbased capital purposes the use of a
credit risk mitigant to hedge the
underlying exposures and must hold
capital against any credit risk of the
exposures it retains in connection with
the synthetic securitization.
2. Securitization Standardized
Approach (SEC–SA)
Under the proposal, a banking
organization would determine the
capital requirements for most
securitization exposures under the SEC–
SA, which is substantively similar to the
SSFA in the current capital rule except
for certain changes as discussed below.
Under the SEC–SA, a banking
organization would determine the risk
weight for a securitization exposure
based on the risk weight of the
underlying assets, with adjustments to
reflect (1) delinquencies in such assets,
(2) the securitization exposure’s
subordination level in the allocation of
losses, and (3) the heightened
correlation and additional risks inherent
in securitizations relative to direct
credit exposures.
To calculate the risk weight for a
securitization exposure using the SEC–
SA, a banking organization must have
accurate information on the parameters
used in the SEC–SA calculation. If the
banking organization cannot, or chooses
not to, apply the SEC–SA, the banking
organization would be required to apply
a 1,250 percent risk weight to the
exposure.
a. Definition of Attachment Point and
Detachment Point
Under the current capital rule, the
attachment point (parameter A) of a
securitization exposure equals the ratio
of the current dollar amount of
underlying exposures that are
subordinated to the exposure of the
banking organization to the current
dollar amount of underlying exposures.
Any reserve account funded by the
accumulated cash flows from the
underlying exposures that is
subordinated to the banking
organization’s securitization exposure
may be included in the calculation of
parameter A to the extent that cash is
present in the account. The calculation
in the current capital rule does not
permit a banking organization to
recognize noncash assets in a reserve
account in the calculation of parameter
A. In contrast, the proposal would
permit a banking organization to
recognize all assets, cash or noncash,
that are included in a reserve account in
the calculation of parameter A.
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64069
However, a banking organization would
not be allowed to include interest rate
derivative contracts and exchange rate
derivative contracts, or the cash
collateral accounts related to these
instruments, in the calculation of
parameters A and D. The agencies are
proposing this treatment because assets
held in a funded reserve account,
whether cash or noncash, can provide
credit enhancement to a securitization
exposure, whereas interest rate and
foreign exchange derivatives (and any
cash collateral held against these
derivatives) do not.134
The proposal would modify the
definition of attachment point so that it
refers to the outstanding balance of the
underlying assets in the pool rather than
the current dollar value of the
underlying exposures. By referencing
the outstanding balance of the
underlying assets instead of the current
dollar amount of the underlying
exposures, the revised definition would
clarify that a banking organization may
recognize a nonrefundable purchase
price discount 135 when calculating the
attachment point of a securitization
exposure. A similar modification would
be made to the definition of detachment
point.136
b. Definition of W Parameter
Under the current capital rule,
parameter W, which is expressed as a
decimal value between zero and one,
reflects the proportion of underlying
exposures that are not performing or are
delinquent, according to criteria
outlined in the rule. The proposal
would apply a similar definition of
parameter W for subpart E, but clarify
that for resecuritization exposures, any
134 For example, if a securitization SPE has assets
denominated in U.S. Dollars and liabilities
denominated in Euros, and if the securitization SPE
executes a USD–EUR foreign exchange swap, the
swap hedges the foreign exchange risk between the
SPE’s assets and liabilities but does not provide
credit enhancement to any of the tranches of the
securitization.
135 The proposal would define nonrefundable
purchase price discount to mean the difference
between the initial outstanding balance of the
exposures in the underlying pool and the price at
which these exposures are sold by the originator to
the securitization SPE, when neither originator nor
the original lender are reimbursed for this
difference. In cases where the originator
underwrites tranches of a NPL securitization for
subsequent sale, the NRPPD may include the
differences between the notional amount of the
tranches and the price at which these tranches are
first sold to unrelated third parties. For any given
piece of a securitization tranche, only its initial sale
from the originator to investors is taken into
account in the determination of NRPPD. The
purchase prices of subsequent re-sales are not
considered. See proposed definition in § ll.101.
136 For the sake of consistency, the proposal
would also use the term ‘‘outstanding balance’’ in
the calculation of W and KG.
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underlying exposure that is a
securitization exposure would only be
included in the denominator of the ratio
and would be excluded from the
numerator of the ratio. That is, for
resecuritization exposures, parameter W
would be the ratio of the sum of the
outstanding balance of any underlying
exposures of the securitization that meet
any of the criteria in paragraphs
ll.133(b)(1)(i) through (vi) of the
proposal that are not securitization
exposures to the outstanding balance of
all underlying exposures. Underlying
securitization exposures need not be
included in the numerator of parameter
W because the risk weight of the
underlying securitization exposure as
calculated by the SEC–SA already
reflects the impact of any delinquent or
otherwise nonperforming loans within
the underlying securitization exposure.
For example, if a resecuritization with a
notional amount of $10 million includes
underlying securitization exposures
with a notional amount of $5 million
and underlying non-securitization
exposures with a notional amount of $5
million, and if $500,000 of the nonsecuritization exposures are delinquent,
the numerator for the W parameter
would be $500,000 while the
denominator for the W parameter would
be $10 million. This would be true
regardless of the delinquency status of
any of the securitization exposures.
c. Delinquency-Adjusted (KA) and NonAdjusted (KG) Weighted-Average Capital
Requirement of the Underlying
Exposures
Under the proposal, KA would reflect
the delinquency-adjusted, weightedaverage capital requirement of the
underlying exposures and would be a
function of KG and W. Under this
approach, in order to calculate
parameter W, and thus KA, the banking
organization must know the
delinquency status of all underlying
exposures in the securitization. KG
would equal the weighted average total
capital requirement of the underlying
exposures (with the outstanding balance
used as the weight for each exposure),
calculated using the risk weights
according to subpart E of the proposed
rule.
The agencies are proposing two
modifications to the definition of KG for
SEC–SA compared to the current KG as
used in the SSFA. First, for interest rate
derivative contracts and exchange rate
derivative contracts, the positive current
exposure times the risk weight of the
counterparty multiplied by 0.08 would
be included in the numerator of KG but
excluded from the denominator of KG. If
amounts related to interest rate and
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exchange rate derivative contracts were
included in both the numerator and
denominator of KG, these contracts
could reduce the capital requirement of
securitization exposures even though
interest rate and exchange rate
derivative contracts do not provide any
credit enhancement to a securitization.
Second, if a banking organization
transfers credit risk via a synthetic
securitization to a securitization SPE
and if the securitization SPE issues
funded obligations to investors, the
banking organization would include the
total capital requirement (exposure
amount multiplied by risk weight
multiplied by 0.08) of any collateral
held by the securitization SPE in the
numerator of KG. The denominator of
KG is calculated without recognition of
the collateral. This ensures that if
collateral held at the SPE is invested in
credit-sensitive assets, the credit risk
associated with those assets will be
included in the banking organization’s
capital calculation. Consistent with
subpart D of the current capital rule,
under the proposal, the value of KG for
a resecuritization exposure would equal
the weighted average of two distinct KG
values, one for the underlying
securitization (which equals the capital
requirement calculated using the SEC–
SA), the other for the underlying
exposures (which equals the weighted
average capital requirement of the
underlying exposures).
Question 66: Recognizing that
banking organizations may not always
know the delinquency status of all
underlying exposures, what would be
the benefits and drawbacks of allowing
a banking organization to use the SEC–
SA if the banking organization knows
the delinquency status for most, but not
all, of the underlying exposures? For
example, if the banking organization
knew the delinquency status of 95
percent of the exposures, it could (1)
split the underlying exposures into two
subpools, (2) calculate a weighted
average of the KA of the subpool
comprising the underlying exposures for
which the delinquency status is known,
(3) assign a value of 1 for KA of the other
subpool comprising exposures for which
the delinquency status is unknown, and
(4) assign a KA for the entire pool equal
to the weighted average of the KA for
each subpool. What other approaches
should the agencies consider and why?
d. Supervisory Calibration Parameter
(Supervisory Parameter p)
Under the proposal, a banking
organization would apply a supervisory
parameter p of 1.0 to securitization
exposures that are not resecuritization
exposures and a supervisory parameter
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p of 1.5 to resecuritization exposures.
The proposed increase to the
supervisory parameter p for
securitizations that are not
resecuritization exposures from 0.5 to
1.0 would help to ensure that the
framework produces appropriately
conservative risk-based capital
requirements when combined with the
reduced risk weights applicable to
certain underlying assets under the
proposal that would be reflected in
lower values of KG and the proposed
reduction in the risk-weight floor under
SEC–SA for securitization exposures
that are not resecuritization
exposures.137
e. Supervisory Risk-Weight Floors
The SEC–SA would require banking
organizations to apply a risk weight
floor to all securitization exposures. The
SEC–SA is based on assumptions and
the risk weight floor ensures a minimum
level of capital is held to account for
modelling risks and correlation risks.138
The proposal would apply a risk weight
floor of 15 percent for securitization
exposures that are not resecuritization
exposures. The 15 percent risk weight
floor is most relevant for more senior
securitization exposures. While junior
tranches can absorb a significant
amount of credit risk, senior tranches
are still exposed to some amount of
credit risk on the underlying exposures.
Therefore, a minimum prudential
capital requirement continues to be
appropriate in the securitization
context.
For resecuritization exposures, the
proposed SEC–SA approach would
require banking organizations to apply a
risk-weight floor of at least 100 percent.
The proposed 100 percent supervisory
risk-weight floor for resecuritization
exposures is intended to capture the
greater complexity of such exposures
and heightened correlation risks
inherent in the underlying
securitization exposures.139
137 See
sections III.C.2 and III.D.2.d of this
for a more detailed
discussion of the reduced risk weights applicable to
certain underlying assets and the risk-weight floor,
respectively.
138 Default correlation is the likelihood that two
or more exposures will default at the same time.
139 In a typical securitization exposure that is not
a resecuritization, each underlying exposure is
subject to idiosyncratic default risks (for example,
the employment status of each obligor) which may
exhibit lower relative default correlation. In a
resecuritization exposure, the underlying
exposures, which are typically tranches of
securitizations, usually have credit enhancement
from more junior tranches that protects against
many idiosyncratic risks. Systematic risks are more
likely to generate defaults in the underlying
exposures of resecuritizations than idiosyncratic
risks, but systematic risks are also much more
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The proposal would also apply a
minimum risk weight of 100 percent to
NPL securitization exposures.
Compared to other securitizations, the
performance of NPL securitizations
depends more heavily on the servicer’s
ability to generate cashflows from the
workout of the underlying exposures,
typically through renegotiation of the
defaulted loans with the borrower or
enforcement against the collateral.
These idiosyncratic risks associated
with NPL securitizations merit a higher
minimum risk weight.
lotter on DSK11XQN23PROD with PROPOSALS2
3. Exceptions to the SEC–SA Risk-Based
Capital Treatment for Securitization
Exposures
Securitization exposures sometimes
contain unique features that, if not
accounted for, could produce
inconsistent outcomes under the SEC–
SA or in some cases make the
calculation of the risk weight
inoperable. Thus, notwithstanding the
general application of SEC–SA, the
proposal would include additional
approaches to account for certain types
of securitization exposures, which
would more appropriately align the
capital requirement with the risk of the
exposure.
a. Nth-to-Default Credit Derivatives
Under the current capital rule, a
banking organization that has purchased
credit protection in the form of an nthto-default credit derivative is permitted
to recognize the risk mitigating benefits
of that derivative. The proposal would
not permit banking organizations to
recognize any risk-mitigating benefit for
nth-to-default credit derivatives in
which the banking organization is the
protection purchaser under either the
proposed credit risk mitigation
framework or under the proposed
securitization framework. Purchased
credit protection through nth-to-default
derivatives often does not correlate with
the hedged exposure which inhibits the
risk mitigating benefits of the
instrument.
For nth-to-default credit derivatives in
which the banking organization is the
protection provider, the proposal would
prohibit use of the securitization
framework and instead would require
banking organizations to calculate the
risk-weighted asset amount by
multiplying the aggregate risk weights of
the assets included in the basket up to
a maximum of 1,250 percent by the
notional amount of the protection
provided by the credit derivative. In
correlated; therefore, resecuritizations typically
have higher default correlations than other types of
securitizations.
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aggregating the risk weights, the (n-1)
assets with the lowest risk weight may
be excluded from the calculation. This
approach would require banking
organizations to maintain capital based
on the risk characteristics of all the
underlying assets in the basket on
which it is providing protection, while
accounting for the fact that the banking
organization is not required to make a
payment unless ‘‘n’’ names in the basket
default.
b. Derivative Contracts That Do Not
Provide Credit Enhancements
The proposal would provide a new
treatment for certain interest rate or
foreign exchange derivative contracts
that qualify as securitization exposures.
Some securitizations either make
payments to investors in a different
currency from the underlying exposures
or make fixed payments to investors
when the cash flows received on the
securitized assets are linked to a floating
interest rate. To neutralize these foreign
exchange or interest rate risks, the
securitization SPE may enter into a
derivative contract that mirrors the
currency or interest rate mismatch
between the exposures and the tranches.
Cash flows required to be made to the
derivative counterparty tend to have a
senior claim to the principal and
interest payment of the collateral, and
therefore tend not to provide credit
enhancement.
The proposal would require a banking
organization that acts as a counterparty
to these types of interest rate and foreign
exchange derivatives to set the risk
weight on such derivatives equal to the
risk weight calculated under the SEC–
SA for a securitization exposure that is
pari passu to the derivative contract or,
if such an exposure does not exist, the
risk weight of the next subordinated
tranche of the securitization exposure. A
banking organization may otherwise not
be able to calculate a risk weight for
these derivative contracts using the
SEC–SA because the attachment and
detachment points under the proposed
formula could equal one another,
rendering the formula inoperable. The
proposed treatment is intended to
appropriately reflect how the credit risk
associated with these derivative
contracts would be commensurate with
or less than the credit risk associated
with a pari passu tranche or the next
subordinated tranche of a securitization
exposure.
The current capital rule permits
banking organizations to assign a riskweighted asset amount for certain
derivative contracts that are
securitization exposures equal to the
exposure amount of the derivative
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64071
contract (i.e., a risk weight of 100
percent). The proposal would eliminate
this option. The approaches for
derivative contracts described in
sections III.C.4. of this SUPPLEMENTARY
INFORMATION (including the treatment for
derivative contracts that do not provide
credit enhancement described above)
are more risk-sensitive and reflective of
the risks than a flat 100 percent risk
weight.
i. Overlapping Exposures
The proposal would introduce new
provisions for overlapping exposures.140
First, the proposal would allow a
banking organization to treat two nonoverlapping securitization exposures as
overlapping to the degree that the
banking organization assumes that
obligations with respect to one of the
exposures covers obligations with
respect to the other exposure. For
example, if a banking organization
provides a full liquidity facility to an
ABCP program that is not contractually
required to fund defaulted assets and
the banking organization also holds
commercial paper issued by the ABCP
program, a banking organization would
be permitted to calculate risk-weighted
assets only for the liquidity facility if
the banking organization assumes, for
purposes of calculating risk-based
capital requirements, that the liquidity
facility would be required to fund the
defaulted assets. In this case, the
banking organization would be
maintaining capital to cover losses on
the commercial paper when calculating
capital requirements for the liquidity
facility, so there is no need to assign a
separate capital requirement for the
commercial paper held by the banking
organization.
Second, the proposal would also
allow a banking organization to
recognize an overlap between relevant
risk-based requirements for
securitization exposures under subpart
E and market risk covered positions
under subpart F, provided the banking
organization is able to calculate and
compare the capital requirements for the
relevant exposures. For example, a
banking organization could hold a
correlation trading position that would
be subject to the proposed requirements
under subpart F but would preclude
losses in all circumstances on a separate
securitization exposure held by the
banking organization that would be
subject to requirements under subpart E
under the proposal. In such cases, the
140 An overlapping exposure occurs when a
banking organization is exposed to the same risk to
the same obligor through multiple direct or indirect
exposures to that obligor.
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proposal would allow the banking
organization to calculate the risk-based
requirement for the overlapping portion
of the exposures based on the greater of
the requirement under subpart E or
under subpart F.
Question 67: What challenges, if any,
would the option to recognize an
overlap between market risk covered
and noncovered positions introduce? To
what degree do banking organizations
anticipate recognizing overlaps between
market risk covered and noncovered
positions?
lotter on DSK11XQN23PROD with PROPOSALS2
ii. Look-Through Approach for Senior
Securitization Exposures
The proposal would introduce a
provision that would allow a banking
organization to cap the risk weight
applied to a senior securitization
exposure that is not a resecuritization
exposure at the weighted-average risk
weight of the underlying exposures,
provided that the banking organization
has knowledge of the composition of all
of the underlying exposures (also
referred to as the ‘‘look-through
approach’’). For purposes of calculating
the weighted-average risk weight, the
unpaid principal balance would be used
as the weight for each exposure. The
proposal would define a senior
securitization exposure as an exposure
that has a first priority claim on the cash
flows from the underlying exposures.
When determining whether a
securitization exposure has a first
priority claim on the cash flows from
the underlying exposures, a banking
organization would not be required to
consider amounts due under interest
rate derivative contracts, exchange rate
derivative contracts, and servicer cash
advance facility contracts,141 or any fees
and other similar payments to be made
by the securitization SPE to other
parties. Both the most senior
commercial paper issued by an ABCP
program and a liquidity facility that
supports the ABCP program may be
senior securitization exposures if the
liquidity facility provider’s right to
reimbursement of the drawn amounts is
senior to all claims on the cash flows
from the underlying exposures, except
amounts due under interest rate
derivative contracts, exchange rate
derivative contracts, and servicer cash
141 A servicer cash advance facility means a
facility under which the servicer of the underlying
exposures of a securitization may advance cash to
ensure an uninterrupted flow of payments to
investors in the securitization, including advances
made to cover foreclosure costs or other expenses
to facilitate the timely collection of the underlying
exposures.
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advance facility contracts, fees due, and
other similar payments.
Accordingly, under the proposed
look-through approach, if a senior
securitization exposure’s underlying
pool of assets consists solely of loans
with a weighted average risk weight of
100 percent, the risk weight for the
senior securitization exposure would be
the lower of the risk weight calculated
under the SEC–SA and 100 percent. The
proposed risk-weight cap is intended to
recognize that the credit risk associated
with each dollar of a senior
securitization exposure generally will
not be greater than the credit risk
associated with each dollar of the
underlying assets, because the nonsenior tranches of a securitization
provide credit enhancement to the
senior tranche.
Notwithstanding the proposed risk
weight cap, the proposal would require
banking organizations to floor the total
risk-based capital requirement under the
look-through approach at 15 percent,
consistent with the proposed 15 percent
floor under the SEC–SA. The proposed
15 percent floor, even if it results in a
risk weight amount greater than the risk
weight cap, is intended to appropriately
reflect the minimum amount of riskbased capital that a banking
organization should maintain for such
exposures given that the process of
securitization can introduce additional
risks that are not present in the
underlying exposures such as modelling
risks and correlation risks.
iii. Credit-Enhancing Interest Only
Strips
The proposal would require a banking
organization to deduct from common
equity tier 1 capital any portion of a
CEIO strip 142 that does not constitute an
after-tax-gain-on sale, regardless of
whether the securitization exposure
meets the proposed operational
requirements. The proposed treatment
for CEIOs would be different than under
subpart D of the current capital rule,
which requires a risk weight of 1,250
percent for these items. The agencies are
proposing to require deduction from
common equity tier 1 capital because
valuations of CEIOs can include a high
degree of subjectivity and, just like
assets subject to deduction under the
current capital rule such as goodwill
and other intangible assets, banking
organizations may not be able to fully
realize value from CEIOs based on their
balance sheet carrying amounts. While a
deduction is generally equivalent to a
1,250 percent risk weight when the
142 See § ll.2 for the definition of creditenhancing interest-only strip.
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banking organization maintains an 8
percent capital ratio, given the various
capital ratios, buffers, and add-ons
applicable to banking organizations
subject to subpart E, applying a
deduction provides a more consistent
treatment across ratios and banking
organizations.
iv. NPL Securitizations
The proposal would define an NPL
securitization as a securitization whose
underlying exposures consist solely of
loans where parameter W for the
underlying pool is greater than or equal
to 90 percent at the origination cut-off
date 143 and at any subsequent date on
which assets are added to or removed
from the pool due to replenishment or
restructuring. A securitization exposure
that meets the definition of a
resecuritization exposure would be
excluded from the definition of an NPL
securitization.
In a typical NPL securitization, the
originating banking organization sells
the non-performing loans to a
securitization SPE at a significant
discount to the outstanding loan
balances (reflecting the nonperforming
nature of the underlying exposures) and
this discount acts as a credit
enhancement to investors. Unlike the
performance of securitizations of
performing loans, which principally
depend on the cash flows of the
underlying loans, the performance of
NPL securitizations depends in part on
the performance of workouts on
defaulted loans, which are uncertain
and could be volatile, and on the
liquidation of underlying collateral for
those loans which are unable to be
cured.
The proposal would introduce a
specific approach for NPL securitization
exposures as the proposed SEC–SA may
be inappropriate for the unique risks of
such exposures. The proposal would
require a banking organization to assign
a risk weight of 100 percent to a
securitization exposure to an NPL
securitization if the following
conditions are satisfied: (1) the
transaction structure meets the
definition of a traditional securitization;
(2) the securitization has a credit
enhancement in the form of a
nonrefundable purchase price discount
greater than or equal to 50 percent of the
outstanding balance of the pool of
exposures; and (3) the banking
organization’s exposure is a senior
143 Cut-off date is the date on which the
composition of the asset pool collateralizing a
securitization transaction is established. This means
that all assets to be included in a securitization
must already be in existence and meet the NPL
criteria as of that date.
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securitization exposure as described in
section III.D.3.b.ii. of this
SUPPLEMENTARY INFORMATION.144 Using
the SEC–SA for senior securitizations of
NPLs that meet these criteria would
result in capital requirements that do
not reflect the nonrefundable purchase
price discount associated with these
transactions. The SEC–SA is calibrated
on the basis that the loans in the pool
at origination are generally performing
and is therefore inappropriate for senior
exposures to securitizations of NPLs
that meet these criteria.
If the NPL securitization exposure is
not a senior securitization exposure or
the purchase price discount is less than
50 percent, the banking organization
would be required to use the SEC–SA to
calculate the risk weight (subject to a
risk weight floor of 100 percent and
reflecting all delinquent exposures in
calculating parameter W). If the
exposure does not meet the
requirements of the SEC–SA, the
banking organization must assign a risk
weight of 1,250 to the exposure.
lotter on DSK11XQN23PROD with PROPOSALS2
I. Attachment and Detachment Points
for NPL Securitizations
Under the proposal, the
nonrefundable purchase price discount
would equal the difference between the
outstanding balance of the underlying
exposures and the price at which these
exposures are sold by the originator 145
to investors on a final basis without
recourse through the securitization SPE,
when neither the originator nor the
original lender are eligible for future
reimbursement for this difference (that
is, that the purchase price discount is
‘‘non-refundable’’). In cases where the
originator underwrites tranches of the
NPL securitization for subsequent sale,
a banking organization may include in
the calculation of the nonrefundable
purchase price discount the differences
between the outstanding balance of the
underlying nonperforming loans and the
price at which the tranches are first sold
to third parties unrelated to the
originator. For any given piece of a
securitization tranche, a banking
organization may only take into account
the initial sale from the originator to
investors in the determination of the
144 If the banking organization is an originating
banking organization with respect to the NPL
securitization, the banking organization may
maintain risk-based capital against the transferred
exposures as if they had not been securitized and
must deduct from common equity tier 1 capital any
after-tax gain-on-sale resulting from the transaction
and any portion of a CEIO strip that does not
constitute an after-tax gain-on-sale.
145 While originator typically refers to the party
originating the underlying loans, in the NPL context
it refers to the party arranging the NPL
securitization (i.e., the securitizer).
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nonrefundable purchase price discount
and may not account for any subsequent
secondary re-sales.
Since the calculation of parameters A
and D both depend on the outstanding
balance of the assets in the underlying
pool, any nonrefundable purchase price
discount associated with a
securitization would be included in
both the numerator and denominator of
parameters A and D. For example,
assume an originating banking
organization transfers a pool of mortgage
loans with an outstanding balance of
$100 million to a securitization SPE at
a price of $60 million. The
nonrefundable purchase price discount
would be the difference between the
unpaid principal balances on the
underlying mortgages at the time of sale
to the securitization SPE and the price
at which the originating banking
organization sold these mortgages to the
securitization SPE (that is, $40 million).
Assume that the securitization SPE
issues $60 million in securitization
tranches of which the banking
organization retains the senior $50
million tranche and an investing
banking organization purchases the $10
million first-loss tranche. Parameter A
for the investing banking organization’s
exposure would equal 40 percent (that
is, the ratio of $40 million to $100
million). Thus, the discount paid for the
underlying assets is effectively the ‘‘first
loss’’ position in the securitization.
Likewise, the originating banking
organization would treat both the
nonrefundable purchase price discount
and the investing banking organization’s
tranche as subordinate and would set
Parameter A at 50 percent.
If, in the example above, the
originating bank sells both tranches and
each tranche is sold at a 20 percent
discount (that is, the $10 million first
loss tranche is sold for a price of $8
million and the $50 million senior
tranche is sold for a price of $40
million), the investing banking
organization that purchases the first-loss
tranche would be permitted to assign an
attachment point of 52 percent to its
exposure, because the nonrefundable
purchase price discount would be the
difference between the original
outstanding amount of the exposures
($100 million) and the total notional
value of all the securitization tranches
($48 million). The investing banking
organization that purchases the senior
tranche would be permitted to assign an
attachment point of 60 percent to the
exposure.
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4. Credit Risk Mitigation for
Securitization Exposures
The proposal would replace the
existing credit risk mitigation
framework under subpart E with a
framework that is consistent with the
credit risk mitigation framework under
subpart D of the current capital rule,146
with one exception. A banking
organization that purchases or sells
tranched credit protection, whether
hedged or unhedged, referencing part of
a senior tranche would not be allowed
to treat the lower-priority portion that
the credit protection does not reference
as a senior securitization exposure. For
example, if a banking organization holds
a securitization exposure with an
attachment point of 20 percent and a
detachment point of 100 percent and the
banking organization purchases an
eligible guarantee with an attachment
point of 50 percent and a detachment
point of 100 percent, the banking
organization’s residual exposure, which
attaches at 20 percent and detaches at
50 percent, would be considered a nonsenior securitization exposure, and the
banking organization would not be
permitted to apply the look-through
approach to this exposure. A banking
organization that purchases a mezzanine
tranche that attaches at 20 percent and
detaches at 50 percent has a similar
economic exposure to a banking
organization that purchases a senior
tranche that attaches at 20 percent and
detaches at 100 percent and then
purchases credit protection that attaches
at 50 percent and detaches at 100
percent. Since the former transaction
would not be considered a senior
securitization exposure eligible for the
look-through approach, the agencies
believe that the latter transaction
likewise should not be eligible for the
look-through approach. Alternatively,
the banking organization may choose
not to recognize the tranched credit
protection, in which case, the banking
organization may treat the securitization
exposure (which attaches at 20 percent
and detaches at 100 percent) as a senior
securitization exposure.
E. Equity Exposures
Equity exposures present a greater
risk of loss relative to credit exposures
as equity exposures represent an
ownership interest in the issuer of an
146 In particular, the proposal would eliminate
references to model-based approaches that are
currently contained in subpart E. The proposal
would also eliminate the formula for collateral
recognition under subpart E, which includes
standard supervisory haircuts calibrated to a 65-day
holding period and permits banking organizations
to calculate their own estimates of haircuts with
prior supervisory approval.
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equity instrument and have a lower
priority of payment or reimbursement in
the event that the issuing entity fails to
meet its credit obligations. For example,
an equity exposure entitles a banking
organization to no more than the prorata residual value of a company after
all other creditors, including
subordinated debt holders, are repaid.
As a result, consistent with the current
capital rule, the proposal would
generally assign higher risk weights to
equity exposures than exposures subject
to the proposed credit risk framework.
The current capital rule’s advanced
approaches equity framework permits
use of an internal models approach for
publicly traded and non-publicly traded
equity exposures and equity derivative
contracts. The proposal would not
include an internal models approach
because of the types of equity exposures
that would likely be subject to the
equity framework. Under the proposal,
material publicly traded equity
exposures would generally be subject to
the proposed market risk framework
described in section III.H of this
SUPPLEMENTARY INFORMATION, unless
there are restrictions on the tradability
of such exposures.147 Similarly, equity
exposures to investment funds for
which the banking organization has
access to the investment fund’s
prospectus, partnership agreement, or
similar contract that defines the fund’s
permissible investments and investment
limits, and is either able to (1) calculate
a market risk capital requirement for its
proportional ownership share of each
exposure held by the investment fund,
or (2) obtain daily price quotes—would
generally be subject to the proposed
market risk framework.148 As the
proposed equity framework would
primarily cover illiquid or infrequently
traded equity exposures, the proposal
would require banking organizations to
use a standardized approach to
determine capital requirements for such
the proposal would require banking
organizations that are not subject to the proposed
market risk capital framework to calculate riskweighted assets for all publicly traded equity
exposures under the proposed equity framework,
such entities typically do not have material equity
exposures.
148 See § ll.202 for the proposed definition of
market risk covered position.
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147 While
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equity exposures. This is intended to
increase the transparency of the capital
framework and facilitate comparisons of
capital adequacy across banking
organizations.
The proposed framework would
largely maintain those sections of the
current capital rule’s equity framework
that do not rely on models, including
the definition of equity exposure,149 the
definition of investment fund, the
treatment of stable value protection, and
the methods for measuring the exposure
amount for equity exposures. The
proposal would make certain
modifications to improve the risk
sensitivity and robustness of the riskbased capital requirements for equity
exposures relative to the current capital
rule. Specifically, the proposal would:
(1) eliminate the 100 percent risk weight
threshold category under the simple
risk-weight approach for non-significant
equity exposures; (2) eliminate the
effective and ineffective hedge pair
treatment under the simple risk-weight
approach; (3) align the conversion
factors for conditional commitments to
acquire an equity exposure, consistent
with the proposed off-balance sheet
treatment for exposures subject to the
proposed credit risk framework, and (4)
increase the risk weight applicable to
equity exposures to investment firms
with greater than immaterial leverage
that the primary Federal supervisor has
determined do not qualify as a
traditional securitization. Additionally,
the proposal would enhance the risksensitivity of the current capital rule’s
look-through approaches for equity
exposures to investment funds by (1)
specifying a hierarchy of approaches
that a banking organization would be
required to use based on the nature and
quality of the information available to
the banking organization concerning the
investment fund’s underlying assets and
liabilities; (2) modifying the full lookthrough and the alternative lookthrough approaches to explicitly capture
off-balance sheet exposures held by an
investment fund, the counterparty credit
risk and CVA risk of any underlying
derivatives held by the investment fund,
149 See 12 CFR 3.2 (OCC); 12 CFR 217.2 (Board);
12 CFR 324.2 (FDIC).
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and the leverage of the investment fund;
(3) replacing the simple modified lookthrough approach with a flat 1,250
percent risk weight, and (4) flooring the
risk weight applicable to an equity
exposure to an investment fund at 20
percent, consistent with the
standardized approach in the current
capital rule.
1. Risk-Weighted Asset Amount
The proposal would retain the riskweighted asset amount calculation
under the current capital rule.
Consistent with the current capital rule,
the proposal would require a banking
organization to determine the riskweighted asset amount for each equity
exposure, except for equity exposures to
investment funds, by multiplying the
adjusted carrying value of the exposure
by the lowest applicable risk weight, as
described below in section III.E.1.b. of
this SUPPLEMENTARY INFORMATION. A
banking organization would determine
the risk-weighted asset amount for an
equity exposure to an investment fund
by multiplying the adjusted carrying
value of the exposure by either the risk
weight calculated under one of the lookthrough approaches or by a risk weight
of 1,250 percent, as described below in
section III.E.1.c. of this SUPPLEMENTARY
INFORMATION. A banking organization
would calculate its aggregate riskweighted asset amount for equity
exposures as the sum of the riskweighted asset amount calculated for
each equity exposure.150
a. Adjusted Carrying Value
Under the proposal, the adjusted
carrying value of an equity exposure,
including equity exposures to
investment funds, would be based on
the type of exposure, as described in
Table 6 below.
BILLING CODE 6210–01–P; 6714–01–P; 4810–33–P
150 The proposal would exclude from the
proposed equity framework equity exposures that a
banking organization would be required to deduct
from regulatory capital under § ll.22(d)(2)(i)(C) of
the proposal. The proposal would require a banking
organization to assign a 250 percent risk weight to
the amount of the significant investments in the
common stock of unconsolidated financial
institutions that is not deducted from common
equity tier 1 capital.
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The proposal would maintain the
current capital rule’s methods for
calculating the adjusted carrying value
for equity exposures, with one
exception. The proposal would simplify
the treatment of conditional
commitments to acquire an equity
exposure to remove the differentiation
of conversion factors by maturity. The
proposal would require a banking
organization to multiply the effective
notional principal amount of a
conditional commitment by a 40 percent
conversion factor to calculate its
adjusted carrying value. The 40 percent
conversion factor is meant to
appropriately account for the risk of
conditional equity commitments, which
provide the banking organization more
flexibility to exit the commitment
relative to unconditional equity
commitments.
b. Expanded Simple Risk-Weight
Approach (ESRWA)
151 Consistent with the current capital rule, the
proposal would allow a banking organization to
choose not to hold risk-based capital against the
counterparty credit risk of equity derivative
contracts, as long as it does so for all such contracts.
Where the equity derivative contracts are subject to
a qualified master netting agreement, the proposal
would require the banking organization to either
include all or exclude all of the contracts from any
measure used to determine counterparty credit risk
exposure. See § ll.113(d) of the proposal.
152 Consistent with the current capital rule, the
proposal includes the concept of the effective
notional principal amount of the off-balance sheet
portion of an equity exposure to provide a uniform
method for banking organizations to measure the
on-balance sheet equivalent of an off-balance sheet
exposure. For example, if the value of a derivative
contract referencing the common stock of company
X changes the same amount as the value of 150
shares of common stock of company X, for a small
change (for example, 1.0 percent) in the value of the
common stock of company X, the effective notional
principal amount of the derivative contract is the
current value of 150 shares of common stock of
company X, regardless of the number of shares the
derivative contract references. The adjusted
carrying value of the off-balance sheet component
of the derivative is the current value of 150 shares
of common stock of company X minus the adjusted
carrying value of any on-balance sheet amount
associated with the derivative.
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Under the proposal, the risk-weighted
asset amount for an equity exposure,
except for equity exposures to
investment funds, would be the product
of the adjusted carrying value of the
equity exposure multiplied by the
lowest applicable risk weight in Table 7.
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Federal Register / Vol. 88, No. 179 / Monday, September 18, 2023 / Proposed Rules
BILLING CODE 6210–01–C; 6714–01–C; 4810–33–C
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Except for the proposed zero, 20, and
400 percent risk-weight buckets and the
250 percent risk weight for significant
investments in the capital of an
unconsolidated financial institution in
the form of common stock that are not
deducted from regulatory capital, the
153 The proposal would rely on the existing
definition of publicly traded under the current
capital rule. See 12 CFR 3.2 (OCC); 12 CFR 217.2
(Board); 12 CFR 324.2 (FDIC).
154 Consistent with the current capital rule, the
proposal would require banking organizations to
apply the 250 percent risk weight to the net long
position, as calculated under § ll.22(h), that is
not deducted from capital pursuant to
§ ll.22(d)(2)(i)(C).
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proposal would revise the risk weights
applicable to other types of equity
exposures relative to those in the
current capital rule’s simple risk-weight
approach. Specifically, to enhance risk
sensitivity and simplify the equity
framework, the proposal would
eliminate the following risk weights
within the current capital rule’s simple
risk-weight approach: (1) the 100
percent risk weight for non-significant
equity exposures whose aggregate
adjusted carrying value does not exceed
10 percent of the banking organization’s
total capital, and (2) the 100 and 300
percent risk weights for the effective
and ineffective portion of hedge pairs,
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respectively. Given the removal of the
100 percent risk weight threshold
category for non-significant equity
exposures and the revised scope of
equity exposures subject to the
proposed equity framework, the
proposal would (1) assign a 100 percent
risk weight to equity exposures to Small
Business Investment Companies and (2)
generally assign a 250 percent risk
weight to publicly traded equity
exposures with restrictions on
tradability,155 as described in more
155 Banking organizations that would be subject to
the proposed enhanced risk-based capital
framework but not the proposed market risk capital
requirements would be required to assign a 250
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detail below. Finally, the proposal
would introduce a 1,250 percent risk
weight to replace the 600 percent risk
weight in the simple risk-weight
approach under subpart E of the current
capital rule for equity exposures to
investment firms that have greater than
immaterial leverage and that the
primary Federal supervisor has
determined do not qualify as a
traditional securitization exposure, as
described in more detail below.
Removing the 100 percent risk weight
for non-significant equity exposures is
intended to increase the risk sensitivity
of the equity framework by requiring
banking organizations to apply a risk
weight based on the characteristics of
each equity exposure, rather than only
for those in excess of 10 percent of the
banking organization’s total capital.
Given that primarily illiquid or
infrequently traded equity positions
would be subject to the proposed equity
framework, the proposal would remove
the 100 and 300 percent risk weights
under the current capital rule for the
effective and ineffective portions of
hedge pairs. The hedge pair treatment
under the current capital rule is only
available if each of the equity exposures
is publicly traded or has a return that is
primarily based on a publicly traded
equity exposure. As such positions
would generally be subject to the
proposed market risk capital framework
under the proposal, the agencies are
proposing to eliminate the hedge pair
treatment to simplify the risk-weighting
framework under the proposal.
i. Community Development Investments
and Small Business Investment
Companies
The current capital rule assigns a 100
percent risk weight to equity exposures
that either (1) qualify as a community
development investment under section
24 (Eleventh) of the National Bank Act,
or (2) represent non-significant equity
exposures to the extent that the
aggregate adjusted carrying value of the
exposures does not exceed 10 percent of
the banking organization’s total capital.
Under the current capital rule, when
determining which equity exposures are
‘‘non-significant’’ and thus eligible for a
100 percent risk weight, a banking
organization first must include equity
exposures to an unconsolidated small
business investment company or held
through a consolidated small business
investment company described in
section 302 of the Small Business
Investment Act of 1958 (15 U.S.C.
percent risk weight to all publicly traded equity
positions that are not equity exposures to
investment funds.
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682).156 As depository institutions are
limited by statute to only invest up to
5 percent of total capital in the equity
exposures and debt instruments of small
business investment companies, the
current capital rule effectively assigns a
100 percent risk weight to all equity
exposures to such programs.
Equity exposures to community
development investments and small
business investment companies
generally receive favorable tax treatment
and/or investment subsidies that make
their risk and return characteristics
different than equity investments in
general. Recognizing this more favorable
risk-return structure and the importance
of these investments to promoting
important public welfare goals, the
proposal would effectively retain the
treatment of equity exposures that
qualify as community development
investments and equity exposures to
small business investment companies
under the current capital rule and assign
such exposures a 100 percent risk
weight.
ii. Publicly Traded Equity With
Tradability Restrictions 157
To appropriately capture the risk of
publicly traded equity exposures with
restrictions on tradability, the proposal
would (1) eliminate the 100 percent risk
weight for non-significant equity
exposures up to 10 percent of total
capital under the current capital rule;
and (2) introduce a 250 percent risk
weight to replace the current capital
rule’s 300 percent risk weight applicable
to publicly traded exposures.158 The
revised calibration of the risk-weight for
publicly traded equity exposures with
restrictions on tradability is intended to
take into account the removal of the
non-significant equity exposures
treatment. Under the proposal, banking
organizations would no longer assign
separate risk weights (100 percent and
300 percent) to publicly traded equity
exposures based on factors that are
unrelated to the underlying risk of the
exposure. Instead, the proposal would
assign an identical 250 percent risk
weight to all publicly traded equity
exposures with restrictions on
tradability, improving the consistency
and risk-sensitivity of the framework.
156 See 12 CFR 3.152(b)(3)(iii)(B) (OCC); 12 CFR
217.152(b)(3)(iii)(B) (Board); 12 CFR
324.152(b)(3)(iii)(B) (FDIC).
157 The proposal would require banking
organizations that are not subject to the proposed
market risk capital framework to calculate riskweighted assets for all publicly traded equity
exposures under the proposed equity framework.
158 Equity exposures, including preferred stock
exposures, to the FHLBs and Farmer Mac would
continue to receive a 20 percent risk weight.
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iii. Equity Exposures to Investment
Firms With Greater Than Immaterial
Leverage and That Would Meet the
Definition of a Traditional
Securitization Were It Not for the
Application of Paragraph (8) of That
Definition
Consistent with the current capital
rule, the proposed securitization
framework generally would apply to
exposures to investment firms with
material liabilities that are not operating
companies,159 unless the primary
Federal supervisor determines the
exposure is not a traditional
securitization based on its leverage, risk
profile or economic substance.160 161 For
an equity exposure to an investment
firm that has greater than immaterial
leverage and that the primary Federal
supervisor has determined does not
qualify as a traditional securitization
exposure, the proposal would increase
the 600 percent risk weight in the
simple risk-weight approach under
subpart E of the current capital rule to
1,250 percent under the proposed
expanded simple risk-weight approach.
159 Operating companies generally refer to
companies that are established to conduct business
with clients with the intention of earning a profit
in their own right and generally produce goods or
provide services beyond the business of investing,
reinvesting, holding, or trading in financial assets.
Accordingly, an equity investment in an operating
company generally would be an equity exposure
under the proposal and subject to the proposed
enhanced simple risk-weight approach. Consistent
with the current capital rule, under the proposal,
banking organizations would be operating
companies and would not fall under the definition
of a traditional securitization. However, investment
firms that generally do not produce goods or
provide services beyond the business of investing,
reinvesting, holding, or trading in financial assets,
would not be operating companies, and would not
qualify for the general exclusion from the definition
of traditional securitization.
160 In general, such entities qualify as ‘‘traditional
securitizations’’ unless explicitly scoped out by
criterion (10) of that definition (for example
collective investment funds, as defined in 12 CFR
208.34, as well as entities registered with the SEC
under the Investment Company Act of 1940, 15
U.S.C. 80a–1, or foreign equivalents thereof). As the
definition of ‘‘traditional securitization’’ does not
include exposures to entities where all or
substantially all of the underlying exposures are not
financial exposures, equity exposures to Real Estate
Investment Trusts (REITs) generally would be
treated in a similar manner to equity exposures to
operating companies and, unless they qualify as
market risk covered positions, would be subject to
the proposed expanded simple risk-weight
approach of the equity framework.
161 For example, for an equity security issued by
a qualifying venture capital fund, as defined under
§ ll.10(c)(16) of each agency’s regulations
implementing section 13 of the BHC Act, that also
has outstanding debt securities, the proposal would
generally require a banking organization to treat the
exposure as a traditional securitization exposure if
the exposure would meet all of the criteria of the
definition of traditional securitization under
§ ll.2 of the current capital rule unless the
primary Federal supervisor determines the
exposure is not a traditional securitization.
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As under the current capital rule, the
applicable risk weight for equity
exposures to such investment firms with
greater than immaterial liabilities under
the proposed securitization framework
would depend on the size of the first
loss tranche.162 For investment firms
that have greater than immaterial
leverage, their capital structure may
result in a large first loss tranche that
understates the risk of the exposure to
the investment firm. Unlike most
traditional securitization structures,
investment firms that can easily change
the size and composition of their capital
structure (as well as the size and
composition of their assets and offbalance sheet exposures) may pose
additional risks not covered by the
securitization framework. For example,
the performance of an equity exposure
to an investment firm with greater than
immaterial liabilities may depend in
part on management discretion
regarding asset composition and capital
structure. To appropriately capture the
additional risks posed by equity
exposures to investment firms with
greater than immaterial liabilities that
may not be reflected within the
proposed securitization framework, the
proposal would permit the primary
Federal supervisor to determine that the
exposure is not a traditional
securitization and require the banking
organization to apply a 1,250 percent
risk weight to the adjusted carrying
value of equity exposures to such
investment firms.163
Question 68: The agencies request
comment on the proposed application
of a 1,250 percent risk weight to equity
exposures to investment firms with
greater than immaterial leverage and
that would meet the definition of a
traditional securitization were it not for
the application of paragraph (8) of that
162 Consistent with the current capital rule, under
the proposal, an equity exposure to an investment
firm that is treated as a traditional securitization
would be subject to due diligence requirements. If
a banking organization is unable to demonstrate to
the satisfaction of the primary Federal supervisor a
comprehensive understanding of the features of an
equity exposure that would materially affect the
performance of the exposure, the proposal would
require the banking organization to assign a risk
weight of 1,250 percent to the equity exposure to
the investment firm.
163 Consistent with the current capital rule, the
agencies will consider the economic substance,
leverage, and risk profile of a transaction to ensure
that an appropriate risk-based capital treatment is
applied. The agencies will consider a number of
factors when assessing the economic substance of
a transaction including, for example, the amount of
equity in the structure, overall leverage (whether on
or off-balance sheet), whether redemption rights
attach to the equity investor, and the ability of the
junior tranches to absorb losses without
interrupting contractual payments to more senior
tranches.
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definition. For what, if any, types of
exposures would requiring banking
organizations to apply a 1,250 percent
risk weight be inappropriate and why?
What are the advantages and
disadvantages of the proposed 1,250
percent risk weight relative to
expanding the proposed look-through
approaches for investment funds to
include such exposures?
Question 69: The agencies seek
comment on the advantages and
disadvantages of requiring banking
organizations to calculate risk-based
capital requirements for equity
exposures to investment firms with
greater than immaterial leverage under
the proposed securitization framework
relative to the proposed look-through
approaches under the equity framework.
What, if any, types of equity exposures
to investment firms with greater than
immaterial leverage may not be
appropriately captured by the
securitization framework—such as
equity exposures to investment firms
where all the exposures of the
investment firm are pari passu in the
event of a bankruptcy or other
insolvency proceeding? Between the
proposed securitization framework and
the proposed look-through approaches
under the equity framework, which
approach would be more operationally
burdensome or challenging and why?
Which approach would produce a more
appropriate capital requirement and
why? Provide supporting data and
examples.
c. Risk Weights for Equity Exposures to
Investment Funds
The separate risk-based capital
treatment for equity exposures to
investment funds under the current
capital rule reflects that the risk of
equity exposures to investment fund
structures depends primarily on the
nature of the underlying assets held by
the fund and the degree of leverage
employed by the fund. Consistent with
the current capital rule, the proposal
would require banking organizations to
determine the risk weight applicable to
the adjusted carrying value of each
equity exposure to an investment fund
using a look-through approach in the
equity framework. When more detailed
information is available about the
investment fund’s characteristics, a
banking organization is in a better
position to evaluate the risk profile of its
equity exposure to the fund and
calculate a risk weight commensurate
with that risk. Conversely, equity
exposures to investment funds that
provide less transparency or are not
subject to regular independent
verification could present elevated risk
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to banking organizations. Accordingly,
the proposal would specify a hierarchy
that banking organizations would be
required to use to identify the
applicable look-through approach for
each equity exposure to an investment
fund based on the nature and quality of
the information available to the banking
organization.
The proposal would also enhance the
risk sensitivity of the current capital
rule’s look-through approaches under
subpart E by modifying the full lookthrough and the alternative lookthrough approaches to explicitly capture
off-balance sheet exposures held by an
investment fund, the counterparty credit
risk and CVA risk of any underlying
derivatives held by the investment fund,
and the leverage of an investment fund.
The proposal would also replace the
simple modified look-through approach
under subpart E with a flat 1,250
percent risk-weight.
i. Hierarchy of Look-Through
Approaches
The proposal would require a banking
organization that is not subject to the
proposed market risk capital framework
to use the full look-through approach if
the banking organization has sufficient
verified information about the
underlying exposures of the investment
fund to calculate a risk-weighted asset
amount for each of the exposures held
by the investment fund.164 If a banking
organization is unable to meet the
criteria to use the full look-through
approach, the proposal would require
the banking organization to apply the
alternative modified look-through
approach and determine a risk-weighted
asset amount for the exposures of the
investment fund based on the
information contained in the investment
fund’s prospectus, partnership
agreement, or similar contract that
defines the investment fund’s
permissible investments. If the banking
organization is unable to apply either
the full look-through approach or the
alternative modified look-through
approach, the proposal would require
the banking organization to assign a
1,250 percent risk weight to the adjusted
carrying value of the equity exposure to
the investment fund. Banking
organizations generally would not be
permitted to apply a combination of the
164 The proposal would require banking
organizations subject to the market risk capital
requirements to apply the proposed market risk
capital framework to determine the risk-weighted
asset amount for equity exposures to investment
funds that would otherwise be subject to the full
look-through approach under the proposed equity
framework. See § ll.202 for the proposed
definition of market risk covered position.
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above approaches to determine the riskweighted asset amount applicable to the
adjusted carrying value of an equity
exposure to an investment fund, except
for equity exposures to investment
funds with underlying securitizations,
or equity exposures to other investment
funds, as described in section III.E.1.c.v.
of this SUPPLEMENTARY INFORMATION.
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ii. Full Look-Through Approach
Since the full look-through approach
is the most granular and risk-sensitive
approach, the proposal would require
banking organizations that are not
subject to the proposed market risk
capital framework to use the full lookthrough approach when verified,
detailed information about the
underlying exposures of the investment
fund is available to enhance risksensitivity of the risk-based capital
requirements. Under the proposed
hierarchy, such banking organizations
would be required to use the full lookthrough approach if the banking
organization is able to calculate a riskweighted asset amount for each of the
underlying exposures of the investment
fund as if the exposures were held
directly by the banking organization,
with the exception of securitization
exposures, derivative exposures, and
equity exposures to other investment
funds, as described in section III.E.1.c.v.
of this SUPPLEMENTARY INFORMATION.
Specifically, the proposal would
require banking organizations that are
not subject to the proposed market risk
capital framework to apply the full lookthrough approach when there is
sufficient and frequent information
provided to the banking organization
regarding the underlying exposures of
the investment fund. To satisfy this
criterion, the frequency of financial
reporting of the investment fund must
be at least quarterly, and the financial
information must be sufficient for the
banking organization to calculate the
risk-weighted asset amount for each
exposure held by the investment fund as
if each exposure were held directly by
the banking organization (except for
securitization exposures, derivatives
exposures, and equity exposures to
other investment funds). In addition,
such information would be required to
be verified on at least a quarterly basis
by an independent third party, such as
a custodian bank or management
fund.165
The proposal would largely maintain
the same risk-weight treatment as
provided under the full look-through
approach in the advanced approaches of
the current capital rule, with five
exceptions. First, to facilitate
application of the full look-through
approach, the proposal would allow
banking organizations the option to use
conservative alternative methods to
those provided under the proposed
expanded risk-weighted asset approach
to calculate the risk-weighted asset
amount attributable to any underlying
exposures that are securitizations,
derivatives, or equity exposures to
another investment fund, as described
in section III.E.1.c.v. of this
SUPPLEMENTARY INFORMATION.
Second, to increase comparability
across banking organizations, the
proposal would clarify that the total
risk-weighted asset amount for the
investment fund under the full lookthrough approach must include any offbalance sheet exposures of the
investment fund and the counterparty
credit risk and, where applicable, the
CVA risk of any underlying derivative
exposures held by the investment fund.
Accordingly, under the proposal, the
total risk-weighted asset amount for the
investment fund under the full lookthrough approach would equal the sum
of the risk-weighted asset amount for (1)
the on-balance sheet exposures,
including any equity exposures to other
investment funds and securitization
exposures; (2) the off-balance sheet
exposures; and (3) the counterparty
credit risk and CVA risk, if applicable,
of any underlying derivative exposures
held by the investment fund, as
described in section III.E.1.c.v. of this
SUPPLEMENTARY INFORMATION. A banking
organization would calculate the
average risk weight for an equity
exposure to the investment fund by
dividing the total risk-weighted asset
amount for the investment fund by the
total assets of the investment fund.
Third, to capture the risk of equity
exposures to investment funds with
leverage, the full look-through approach
under the proposal would explicitly
require banking organizations to adjust
the average risk weight for its equity
exposure to the investment fund
upwards to reflect the leverage of the
investment fund.166 Specifically, the
proposal would require banking
organizations to multiply the average
risk weight for its equity exposure to the
investment fund by the ratio of the total
assets of the investment fund to the total
equity of the investment fund.
Fourth, to avoid disincentivizing
banking organizations from obtaining
the necessary information to apply the
full-look through approach, the proposal
would cap the risk weight for an equity
exposure to an investment fund under
the full look-through approach at no
more than 1,250 percent.
Fifth, consistent with the
standardized approach under the
current capital rule, to reflect the
agencies’ and banking organizations’
experience with money market fund
investments and similar investment
funds during the 2008 financial crisis
and the 2020 coronavirus response, the
proposal would floor the minimum risk
weight that may be assigned to the
adjusted carrying value of any equity
exposure to an investment fund under
the proposed look-through approaches
at 20 percent. Accordingly, under the
proposal, a banking organization would
be required to calculate the total riskweighted asset amount for an equity
exposure to an investment fund under
the full look-through approach by
multiplying the adjusted carrying value
of the equity exposure by the applicable
risk weight, as calculated according to
the following formula provided under
§ ll.142(b) of the proposed rule:
investment funds and securitization
exposures, calculated as if each exposure
were held directly on balance sheet by
the banking organization;
• RWAoff is the aggregate risk-weighted asset
amount of the off-balance sheet
exposures of the investment fund,
calculated for each exposure as if it were
Where:
• RWAon is the aggregate risk-weighted asset
amount of the on-balance sheet
exposures of the investment fund,
including any equity exposures to other
165 As externally licensed auditors typically
express their opinions on investment funds’
accounts rather than on the accuracy of the data
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used for the purposes of applying the full lookthrough approach, an external audit would not be
required.
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166 While not done explicitly, the full lookthrough approach under the current capital rule
does capture the leverage of an investment fund.
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held under the same terms by the
banking organization;
• RWAderivatives is the aggregate risk-weighted
asset amount for the counterparty credit
risk and CVA risk, if applicable, of the
derivative contracts held by the
investment fund, calculated as if each
derivative contract were held directly by
the banking organization, unless the
banking organization applies the
alternative approach described in section
III.E.1.c.v. of this SUPPLEMENTARY
INFORMATION; 167
• Total AssetsIF is the balance sheet total
assets of the investment fund; and
• Total EquityIF is the balance sheet total
equity of the investment fund.
Question 70: What would be the
advantages and disadvantages of
allowing a banking organization that
does not have adequate data or
information to determine the risk weight
associated with its equity exposure to an
investment fund to rely on information
from a source other than the investment
fund itself, if the risk weight would be
increased (for example by a factor of
1.2)? For what types of investment funds
would a banking organization rely on a
source other than the investment fund
itself to obtain this information and
what types of entities would it rely on
to obtain this information?
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iii. Alternative Modified Look-Through
Approach
If a banking organization is unable to
meet the criteria to use the full lookthrough approach, the proposal would
require the banking organization to use
the alternative modified look-through
approach, provided that the information
contained in the investment fund’s
prospectus, partnership agreement, or
similar contract is sufficient to
determine the risk weight applicable to
each exposure type in which the
investment fund is permitted to
invest.168 To account for the uncertain
accuracy of risk assessments when
banking organizations have limited
information about the underlying
exposures of an investment fund or such
information is not verified on at least a
quarterly basis by an independent third
167 Under the proposal, a banking organization
may exclude equity derivative contracts held by the
investment fund for purposes of calculating the
RWAderivatives component of the full and alternative
modified look-through approaches, if the banking
organization has elected to exclude equity
derivative contracts for purposes of § ll.113(d) of
the proposal.
168 Under the proposal, banking organizations
subject to the proposed market risk capital
requirements would only apply the alternative
modified look-through approach to such equity
exposures to investment funds if the banking
organization is unable to obtain daily quotes for the
equity exposure to the investment fund. See
§ ll.202 for the proposed definition of market risk
covered position.
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party, the alternative modified lookthrough approach in the current capital
rule requires banking organizations to
use conservative assumptions when
calculating total risk-weighted assets for
equity exposures to investment funds.
The proposal would largely maintain
the same risk-weight treatment as
provided under the alternative modified
look-through approach in the advanced
approaches of the current capital rule,
with five exceptions. First, to increase
comparability of the risk-based capital
requirements applicable to equity
exposures to investment funds with
investment policies that permit the
investment fund to hold equity
exposures to other investment funds or
securitization exposures, the proposed
alternative modified look-through
approach would specify the methods
that banking organizations would be
required to use to calculate riskweighted assets for such underlying
exposures, as described in section
III.E.1.c.v. of this SUPPLEMENTARY
INFORMATION.
Second, to capture the risk of equity
exposures to investment funds with
investment policies that permit the use
of off-balance sheet transactions or
derivative contracts, the proposal would
require banking organizations to include
the off-balance sheet transactions as
well as the counterparty credit risk and
CVA risk, if applicable, of the derivative
contracts, when calculating the total
risk-weighted asset amount for the
investment fund. Specifically, the
proposal would require banking
organizations to assume that the
investment fund invests to the
maximum extent permitted under its
investment limits in off-balance sheet
transactions with the highest applicable
credit conversion factor and risk
weight.169 The proposal would also
require banking organizations to assume
that the investment fund has the
maximum volume of derivative
contracts permitted under its
investment limits. Under the proposal,
the total risk-weighted asset amount for
the investment fund under the
alternative modified look-through
approach would equal the sum of the
following risk-weighted asset amounts:
(1) the on-balance sheet exposures,
169 For example, if the mandate of an investment
entity permits the use of unconditional equity
commitments, the proposal would require the
banking organization to multiply the notional
amount of the commitment by a 100 percent credit
conversion factor and the risk weight applicable to
the underlying reference exposure of the
commitment. If the banking organization does not
know the type of equity underlying the
commitment, the banking organization would be
required to use the highest applicable risk-weight
to equity exposures.
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including any equity exposures to other
investment funds and securitization
exposures; (2) the off-balance sheet
exposures, and (3) the counterparty
credit risk and CVA risk, if applicable,
for derivative exposures, as described in
section III.E.1.c.v. of this
SUPPLEMENTARY INFORMATION. A banking
organization would calculate the
average risk weight for an equity
exposure to the investment fund by
dividing the total risk-weighted asset
amount for the investment fund by the
total assets of the investment fund.
Third, to capture the risk of equity
exposures to investment funds with
leverage, the alternative modified lookthrough approach under the proposal
would require a banking organization to
adjust the average risk weight for its
equity exposure to the investment fund
upwards by the ratio of the total assets
of the investment fund to the total
equity of the investment fund.
Fourth, to avoid disincentivizing
banking organizations from obtaining
the necessary information to apply the
alternative modified look-through
approach, the proposal would cap the
risk weight applicable to an equity
exposure to an investment fund under
the alternative modified look-through
approach at no more than 1,250 percent.
Fifth, consistent with the
standardized approach under the
current capital rule, to reflect the
agencies’ and banking organizations’
experience with money market fund
investments and similar investment
funds during the 2008 financial crisis
and the 2020 coronavirus response, the
proposal would floor the minimum risk
weight that may be assigned to the
adjusted carrying value of any equity
exposure to an investment fund under
the proposed look-through approaches
at 20 percent.
Accordingly, under the proposal, a
banking organization’s risk-weighted
asset amount for an equity exposure to
an investment fund under the
alternative modified look-through
approach would be equal to the adjusted
carrying value of the equity exposure
multiplied by the lesser of 1,250 percent
or the greater of either (1) the product
of the average risk weight of the
investment fund multiplied by the
leverage of the investment fund or (2) 20
percent.
iv. 1,250 Percent Risk Weight
When banking organizations have
limited information on the underlying
exposures or the leverage of the
investment fund, they have limited
ability to appropriately capture and
manage the risk and price volatility of
such equity exposures. Accordingly, if a
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banking organization does not have the
necessary information to apply the full
look-through approach or the alternative
modified look-through approach, the
proposal would require the banking
organization to assign a 1,250 percent
risk weight to the adjusted carrying
value of its equity exposure to the
investment fund.
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v. Risk Weights for Equity Exposures to
Investment Funds With Underlying
Securitizations, Derivatives, or Equity
Exposures to Other Investment Funds
Banking organizations may not always
be able to obtain the necessary
information to calculate risk-weighted
asset amounts under the full lookthough approach or the alternative
modified look-through approach for
certain types of underlying exposures
held by an investment fund. For
example, even if an investment fund
provides detailed quarterly disclosures
on all its underlying assets and
liabilities, such disclosures may not
identify the actual counterparty to each
underlying derivative exposure of the
investment fund or which of the
underlying derivative exposures of the
investment fund are subject to the same
qualified master netting agreement.
Furthermore, the information contained
in an investment fund’s prospectus,
partnership agreement, or similar
contract may not always allow banking
organizations to calculate risk-weighted
asset amounts for such underlying
exposures under the alternative
modified look-through approach.
To facilitate application of the lookthrough approaches, the proposal would
allow banking organizations to use
conservative assumptions to calculate
risk-weighted asset amounts under the
full look-through approach for
underlying exposures that are
securitization exposures, derivative
exposures, or equity exposures to
another investment fund. For purposes
of the alternative modified look-through
approach, the proposal would require
banking organizations to use these
alternative assumptions for such
underlying exposures.
I. Securitization Exposures
For any securitization exposures held
by an investment fund, the proposal
would allow a banking organization
using the full look-through approach to
apply a 1,250 percent risk weight to the
exposure, if it cannot or chooses not to
calculate the applicable risk weight
under the securitization standardized
approach (SEC–SA), as described in
section III.D. of this SUPPLEMENTARY
INFORMATION. The proposal would
require a banking organization applying
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the alternative modified look-through
approach to apply a 1,250 percent risk
weight to any securitization exposures
held by an investment fund.
II. Derivative Exposures
For derivative exposures held by an
investment fund, the proposal would
require a banking organization to
calculate the risk-weighted asset amount
for each derivative netting set by
multiplying the exposure amount of the
netting set by the risk weight applicable
to the derivative counterparty under the
proposed credit risk framework. To the
extent a banking organization cannot
determine the counterparty, the
proposal would require the banking
organization to multiply the resulting
exposure amount by a 100 percent risk
weight, as a conservative approach to
reflect the highest risk-weight that
would be likely to apply to a
counterparty to such transactions.170
For banking organizations using the
full look-through approach, the proposal
would require a banking organization to
use the replacement cost and the
potential future exposure as calculated
under SA–CCR to determine the
exposure amount for each netting set of
underlying derivative exposures
(including single derivative
contracts) 171 held by the investment
fund, where possible.172 If a banking
organization using the full look-through
approach does not have sufficient
information to calculate the replacement
cost or the potential future exposure for
each derivative netting set using SA–
CCR or is using the alternative modified
look-through approach, the proposal
would require the banking organization
to use the notional amount of each
netting set and 15 percent of the
notional amount of each netting set for
the replacement cost and potential
future exposure, respectively. The
proposal would require banking
organizations using the alternative
modified look-through approach to use
the notional amount of each netting set
170 Relatedly, to the extent a banking organization
is unable to determine the netting sets of the
underlying derivative exposures, the proposal
would require each single derivative to be its own
netting set.
171 The proposal would rely on the existing
definition of netting set under the current capital
rule, which is defined to include a single derivative
contract between a banking organization and a
single counterparty. See 12 CFR 3.2 (OCC); 12 CFR
217.2 (Board); 12 CFR 324.2 (FDIC).
172 Under the proposal, a banking organization
may exclude equity derivative contracts held by the
investment fund for purposes of calculating the
RWAderivatives component of the full and alternative
modified look-through approaches, if the banking
organization has elected to exclude equity
derivative contracts for purposes of § ll.113(d) of
the proposal.
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and 15 percent of the notional amount
of each netting set to determine the
replacement cost and potential future
exposure, respectively. A banking
organization would multiply the
resulting exposure amount by a factor of
1.4 if the banking organization
determines that the counterparty is not
a commercial end-user or cannot
determine whether the counterparty is a
commercial end-user.173 Additionally,
the proposal would require a banking
organization to further multiply the
exposure amount by a factor of 1.5 for
each derivative netting set that either
qualifies (or for which the banking
organization cannot determine whether
the exposure qualifies) as a CVA risk
covered position, as defined in section
III.I.3 of this SUPPLEMENTARY
INFORMATION. Accordingly, the proposal
would require banking organizations to
calculate the exposure amount for
derivative exposures held by an
investment fund as described in the
following formula:
Exposure Amount = C * a (Replacement
Cost + Potential Future Exposure)
Where:
• C would equal 1.5 if at least one of
the derivative contracts in the netting
set is a CVA risk covered position or if
the banking organization cannot
determine whether one or more of the
derivative contracts within the netting
set is a CVA risk covered position; C
would equal 1 if all of the derivative
contracts within the netting set are not
CVA risk covered positions;
• a would equal 1.4 if the banking
organization determines that the
counterparty is not a commercial enduser or cannot determine whether the
counterparty is a commercial end-user,
or 1 otherwise;
• Replacement Cost would equal:
➢ The replacement cost as calculated
under SA–CCR for purposes of the full
look-through approach, where possible;
or
➢ The notional amount of the
derivative contract if the banking
organization cannot determine
replacement cost under SA–CCR or is
using the alternative modified lookthrough approach;
• Potential Future Exposure would
equal:
➢ The potential future exposure as
calculated under SA–CCR 174 for
173 The proposal would rely on the existing
definition of commercial end-user under the current
capital rule. See 12 CFR 3.2 (OCC); 12 CFR 217.2
(Board); 12 CFR 324.2 (FDIC).
174 If the banking organization is not able to
calculate the replacement cost of the netting set
under SA–CCR but is able to calculate the PFE
aggregated amount, the banking organization must
set the PFE multiplier equal to 1.
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purposes of the full look-through
approach, where possible; or
➢ 15 percent of the notional amount
of the derivative contract if the banking
organization cannot determine the
potential future exposure under SA–
CCR or is using the alternative modified
look-through approach.
The proposal is intended to provide a
conservative approach for banking
organizations to calculate risk-weighted
asset amounts for the underlying
derivative exposures held by an
investment fund in a manner that
appropriately captures the risk of such
positions. For example, using 100
percent of the notional amount of the
derivative contract as a proxy for the
replacement cost is intended to provide
a standardized and simple input to the
exposure amount calculation when the
necessary information about the
replacement cost is not available. The
notional amount of the derivative
contract is typically larger than the fair
value or replacement cost of the contract
and thus providing a conservative
estimate of the maximum exposure that
could arise for a derivative contract.
Similarly, setting potential future
exposure equal to 15 percent of the
notional amount of the derivative
contract is intended to provide a
conservative estimate of the potential
losses that could arise from a
counterparty credit risk exposure when
the likelihood of significant changes in
the value of the exposure increases over
the longer term.
III. Equity Exposures to Other
Investment Funds
For an equity exposure to an
investment fund (e.g., Investment Fund
A) that itself has a direct equity
exposure to another investment fund
(e.g., Investment Fund B), the proposal
would require a banking organization to
determine the proportional amount of
risk-weighted assets of Investment Fund
A attributable to the underlying equity
exposure to Investment Fund B using
the hierarchy of approaches described
in section III.E.1.c.i. of this
SUPPLEMENTARY INFORMATION. That is,
the banking organization may be
required to apply the same or another
approach to determine the risk-weighted
asset amount for Investment Fund A’s
equity exposure to Investment Fund B
than was used for the banking
organization’s equity exposure to
Investment Fund A, based on the nature
and quality of the information available
to the banking organization regarding
the underlying assets and liabilities of
Investment Fund B.
For all subsequent indirect equity
exposure layers (e.g., Investment Fund
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B’s equity exposure to Investment Fund
C and so forth), the proposal would
generally require the banking
organization to assign a 1,250 percent
risk weight, with one exception. If the
banking organization applied the full
look-through approach to calculate riskweighted assets for the equity exposure
to the investment fund at the previous
layer, the banking organization would
be required to apply the full lookthrough approach to any subsequent
layer when there is sufficient and
frequent information provided to the
banking organization regarding the
underlying exposures of that particular
investment fund. If there is not
sufficient and frequent information to
apply the full look-through approach to
the subsequent layer, then the banking
organization would be required to
assign a 1,250 percent risk weight to the
subsequent layer.
Question 71: The agencies invite
comment on the impact of the proposed
expanded risk-based framework for
equity exposures. What are the pros and
cons of the proposal and what, if any,
unintended consequences might the
proposed treatment pose with respect to
a banking organization’s equity
exposures? Provide data to support the
response.
Question 72: The agencies solicit
comment on all aspects of the proposed
treatment of equity exposures to
investment funds. What, if any,
challenges could implementing the full
look-through approach, the alternative
modified look-through approach, or the
1,250 percent risk weight pose for
banking organizations? What, if any,
clarifications or modifications should
the agencies consider making to the
proposed look-through approaches and
why? To what extent would equity
exposures to investment funds be
captured under the proposed lookthrough approaches in equity exposure
framework as opposed to the market
risk framework? Which type(s) of
investment funds would present
challenges under the proposed
methods? What other methods should
the agencies consider to more accurately
capture such exposures’ risk that would
still help promote simplicity and
transparency of risk-based capital
requirements?
Question 73: What, if any,
modifications should the agencies
consider to more appropriately capture
the risk of underlying derivatives
exposures held by an investment fund
and why? The agencies seek comment
on the appropriateness of the proposed
alternative method for banking
organizations to calculate risk-weighted
asset amounts for derivative exposures
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held by an investment fund if the
banking organization does not have
sufficient information to use SA–CCR.
What would be the benefits and
drawbacks of excluding derivative
contracts that are used for hedging
rather than speculative purposes and
that do not constitute a material portion
of the investment entity’s exposures?
F. Operational Risk
The proposal would introduce a
capital requirement for operational risk
based on a standardized approach
(standardized approach for operational
risk). The current capital rule defines
operational risk as the risk of loss
resulting from inadequate or failed
internal processes, people, and systems,
or from external events. Operational risk
includes legal risk but excludes strategic
and reputational risk.175 Experience
shows that operational risk is inherent
in all banking products, activities,
processes, and systems.
Under the current capital rule,
banking organizations subject to
Category I or II capital standards are
required to calculate risk-weighted
assets for operational risk using the
advanced measurement approaches
(AMA),176 which are based on a banking
organization’s internal models. The
AMA results in significant challenges
for banking organizations, market
participants, and the supervisory
process. AMA exposure estimates can
present substantial uncertainty and
volatility, which introduces challenges
to capital planning processes.177 In
addition, the AMA’s reliance on internal
models has resulted in a lack of
transparency and comparability across
banking organizations. As a result,
supervisors and market participants
experience challenges in assessing the
relative magnitude of operational risk
across banking organizations, evaluating
the adequacy of operational risk capital,
and determining the effectiveness of
operational risk management practices.
To address these concerns, the proposal
would remove the AMA and introduce
a standardized approach for operational
175 See 12 CFR 3.101 (OCC), 217.101 (Board), and
12 CFR 324.101 (FDIC).
176 The agencies adopted the AMA for operational
risk as part of the advanced approaches capital
framework in 2007. See 72 FR 69288 (December 7,
2007).
177 See, e.g., Cope, E., G. Mignola, G. Antonini,
and R. Ugoccioni. 2009. Challenges and Pitfalls in
Measuring Operational Risk from Loss Data. Journal
of Operational Risk 4(4): 3–27; and Opdyke, J., and
A. Cavallo. 2012. Estimating Operational Risk
Capital: The Challenges of Truncation, the Hazards
of Maximum Likelihood Estimation, and the
Promise of Robust Statistics. Journal of Operational
Risk 7(3): 3–90.
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risk that seeks to address the operational
risks currently covered by the AMA.
The operational risk capital
requirements under the standardized
approach for operational risk would be
a function of a banking organization’s
business indicator component and
internal loss multiplier. The business
indicator component would provide a
measure of the operational risk exposure
of the banking organization and would
be calculated based on its business
indicator multiplied by scaling factors
that increase with the business
indicator. The business indicator would
serve as a proxy for a banking
organization’s business volume and
would be based on inputs compiled
from a banking organization’s financial
statements. The internal loss multiplier
would be based on the ratio of a banking
organization’s historical operational
losses to its business indicator
component and would increase the
operational risk capital requirement as
historical operational losses increase. To
help ensure the robustness of the
operational risk capital requirement, the
proposal would require that the internal
loss multiplier be no less than one.
A banking organization’s operational
risk capital requirement would be equal
to its business indicator component
multiplied by its internal loss
multiplier. Similar to the current capital
rule, risk-weighted assets for operational
risk would be equal to 12.5 times the
operational risk capital requirement.
1. Business Indicator
Under the proposal, the business
indicator would be based on the sum of
the following three components: an
interest, lease, and dividend
component; a services component; and
a financial component. Each component
would serve as a measure of a broad
category of activities in which banking
organizations typically engage. Given
that operational risk is inherent in all
banking products, activities, processes,
and systems, these components aim to
capture comprehensively the volume of
a banking organization’s financial
activities and thus serve as a proxy for
a banking organization’s business
volume. The interest, lease, and
dividend component aims to capture
lending and investment activities
through measures of interest income,
interest expense, interest-earning assets,
and dividends. The services component
aims to capture fee and commissionbased activities as well as other banking
activities, such as those resulting in
other operating income and other
operating expense. Lastly, the financial
component aims to capture trading
activity and other activities that are
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associated with a banking organization’s
assets and liabilities.
Banking organizations with higher
overall business volume are larger and
more complex, which likely results in
exposure to higher operational risk.178
Higher business volumes present more
opportunities for operational risk to
manifest. In addition, the complexities
associated with a higher business
volume can give rise to gaps or other
deficiencies in internal controls that
result in operational losses. Therefore,
higher overall business volume would
correlate with higher operational risk
capital requirements under the
proposal.
Under the proposal, all inputs to the
business indicator would be based on
three-year rolling averages. For example,
when calculating the three-year average
for a business indicator input reported
at the end of the third calendar quarter
of 2023, the values of the item for the
fourth quarter of 2020 through the third
quarter of 2021, the fourth quarter of
2021 through the third quarter of 2022,
and the fourth quarter of 2022 through
the third quarter of 2023 would be
averaged. The one exception is interestearning assets, which would be
calculated as the average of the
quarterly values of interest-earning
assets for the previous 12 quarters.179
The use of three-year averages would
capture a banking organization’s
activities over time and help reduce the
impact of temporary fluctuations.
Basing the business indicator on a
shorter time period, such as a single
year of data, would likely result in a
more volatile capital requirement,
which could make it more difficult for
banking organizations to incorporate the
operational risk capital requirement into
capital planning processes and could
result in unduly low or high operational
178 Recent research connecting operational risk to
higher business volume includes Frame, McLemore,
and Mihov (2020), Haste Makes Waste: Banking
Organization Growth and Operational Risk, Federal
Reserve Bank of Dallas, https://www.dallasfed.org/
research/papers/2020/wp2023; Curti, Frame, and
Mihov (2019), Are the Largest Banking
Organizations Operationally More Risky?, Journal of
Money, Credit and Banking Vol. 54, Issue 5, 1223–
1259, https://doi.org/10.1111/jmcb.12933; and
Abdymomunov and Curti (2020), Quantifying and
Stress Testing Operational Risk with Peer Banks’
Data, Journal of Financial Services Research Vol.
57, 287–313, https://link.springer.com/article/
10.1007/s10693-019-00320-w.
179 Unlike the other inputs used to calculate the
business indicator, interest-earning assets are
balance-sheet items, rather than income statement
items, and thus their use in the business indicator
does not represent a flow over a one-year period,
but rather a point-in-time value. The use of average
interest-earning assets for the previous 12 quarters
instead of, for example, the average interest-earning
assets for the ending quarter of the last three years
aims to increase the robustness of the average used
in the calculation.
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risk capital requirements given
temporary changes in a banking
organization’s activities. Alternatively,
basing the business indicator on too
many years of data could reduce its
responsiveness to changes in a banking
organization’s activities, which could in
turn weaken the relationship between
the capital requirements and the
banking organization’s risk profile.
Based on these considerations, the use
of three-year averages aims to balance
the stability and responsiveness of a
banking organization’s operational risk
capital requirement.
As described below, the inputs used
in each component of the business
indicator would, in most cases, use
information contained in line items
from schedules RI and RC of the Call
Report and schedules HI and HC of the
FR Y–9C report, as applicable. The
agencies are planning to separately
propose modifications to the FFIEC 101
report so that all inputs to the business
indicator (described below) as well as
total net operational losses (described
further below) would be publicly
reported as separate inputs to the
applicable calculations.
The inputs to each component of the
business indicator would not be meant
to overlap. Income and expenses would
not be counted in more than one
component of the business indicator,
consistent with instructions to the
regulatory reports and the principles of
accounting. The inputs used to calculate
the business indicator would include
data relative to entities that have been
acquired by, or merged with, the
banking organization over the period
prior to the acquisition or merger that is
relevant to the calculation of the
business indicator.
a. The Interest, Lease, and Dividend
Component
Under the proposal, the interest,
lease, and dividend component would
account for activities that produce
interest, lease, and dividend income and
would be calculated as follows:
Interest, Lease, and Dividend
Component = min (Avg3y (Abs(total
interest income ¥ total interest
expense)), 0.0225 * Avg3y (interest
earning assets)) + Avg3y (dividend
income)
The proposal includes the following
definitions:
• Total interest income would mean
interest income from all financial assets
and other interest income; 180
180 Total interest income would correspond to
total interest income in the FR Y–9C (holding
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• Total interest expense would mean
interest expenses related to all financial
liabilities and other interest
expenses; 181
• Dividend income would mean all
dividends received on securities not
consolidated in the banking
organization’s financial statements; 182
and
• Interest-earning assets would mean
the sum of all gross outstanding loans
and leases, securities that pay interest,
interest-bearing balances, Federal funds
sold, and securities purchased under
agreements to resell.183
The interest, lease, and dividend
component aims to capture a banking
organization’s interest income and
expenses from financial assets and
liabilities, as well as dividend income
from investments in stocks and mutual
funds.
The interest income and expenses
portion is calculated as the absolute
value of the difference between total
interest income and total interest
expense (which constitutes net interest
income) and is subject to a ceiling equal
to 2.25 percent of the banking
organization’s total interest-earning
assets. Net interest income is a useful
indicator of a banking organization’s
operational risk because a higher
volume of business is associated with
higher operational risk. Because
operational risk does not necessarily
increase proportionally to increases in
net interest income, the net interest
income input would be capped at 2.25
percent of interest-earning assets.
The proposal would add dividend
income to the net interest income input
to capture investment activities that do
not produce interest income (for
example, investment in equities and
mutual funds).
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b. The Services Component
Under the proposal, the services
component would account for activities
companies) and Call Report, excluding dividend
income as defined in the proposal.
181 Total interest expense would correspond to
total interest expense in the FR Y–9C (holding
companies) and Call Report.
182 Dividend income is currently included in total
interest income in the FR Y–9C (holding
companies) and Call Report.
183 Interest-earning assets would equal the sum of
interest-bearing balances in U.S. offices, interestbearing balances in foreign offices, Edge and
agreement subsidiaries, and IBFs, Federal funds
sold in domestic offices, securities purchased under
agreements to resell, loans and leases held for sale,
loans and leases, held for investment, total held-tomaturity securities at amortized cost (only
including securities that pay interest), total
available-for-sale securities at fair value (only
including securities that pay interest), and total
trading assets (only including trading assets that
pay interest) in the FR Y–9C (holding companies)
and Call Report.
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that result in fees and commissions and
other financial activities not captured by
the other components of the business
indicator. The services component
would be calculated as follows:
Services component = max (Avg3y (fee
and commission income), Avg3y(fee
and commission expense)) + max
(Avg3y (other operating income),
Avg3y(other operating expense))
The proposal includes the following
definitions:
• Fee and commission income would
mean income received from providing
advisory and financial services,
including insurance income; 184
• Fee and commission expense would
mean expenses paid by the banking
organization for advisory and financial
services received; 185
• Other operating income would
mean income not included in other
elements of the business indicator and
not excluded from the business
indicator; 186 and
• Other operating expense would
mean expenses associated with financial
services not included in other elements
of the business indicator and all
184 Fee and commission income would include
the sum of income from fiduciary activities, service
charges on deposit accounts in domestic offices;
fees and commissions from securities brokerage;
investment banking, advisory, and underwriting
fees and commissions; fees and commissions from
annuity sales; income and fees from printing and
sale of checks; income and fees from automated
teller machines; safe deposit box rent; bank card
and credit card interchange fees; income and fees
from wire transfers; underwriting income from
insurance and reinsurance activities; and income
from other insurance activities in the FR Y–9C
(holding companies) and Call Report. Fee and
commission income would also include servicing
fees on a gross basis, which would correspond to
net servicing fees in the FR Y–9C (holding
companies) and Call Report, with the modification
that expenses should not be netted, because fee and
commission expenses should not be netted in the
calculation of fee and commission income. In
addition, fee and commission income would
include other income received from providing
advice and financial services that is not currently
itemized in the regulatory reports.
185 Fee and commission expense would include
consulting and advisory expenses and automated
teller machine and interchange expenses in the FR
Y–9C (holding companies) and Call Report. Fee and
commission expense would also include any other
expenses paid for advice and financial services
received that are not currently itemized in the
regulatory reports.
Note that fee and commission expense would
include fees paid by the banking organization as a
result of outsourcing financial services, but not fees
paid for outsourced non-financial services (e.g.,
logistical, information technology, human
resources).
186 Other operating income would include rent
and other income from other real estate owned in
the FR Y–9C (holding companies) and Call Report.
Other operating income would also include all
other income items not currently itemized in the
regulatory reports, which are not included in other
business indicator items and are not specifically
excluded from the business indicator.
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expenses associated with operational
loss events (expenses associated with
operational loss events would not be
included in other business indicator
items).187 Other operating expense
would not include expenses excluded
from the business indicator.
The services component would reflect
a banking organization’s income and
expenses from fees and commissions as
well as its other operating income and
expenses.
The fee and commission elements and
the other operating elements of the
services component would be calculated
as gross amounts, reflecting the larger of
either income or expense. This
approach would account for the
different business models of banking
organizations better than a netting
approach, which may lead to variances
in the services component that
exaggerate differences in operational
risk. For example, using income net of
expense as the indicator would result in
the services component for banking
organizations that only distribute
products bought from third parties, for
which expenses would be netted from
income, being substantially lower than
the services component of banking
organizations that originate products to
distribute, which would generally not
have many financial expenses to net
from income. Therefore, a netting
approach would likely exaggerate the
difference in operational risk between
these two business models.
The proposal would include in the
services component the income and
expense of a banking organization’s
insurance activities. The agencies
intend for the operational risk capital
requirement to reflect all operational
risks to which a banking organization is
exposed, regardless of the activity or
legal entity in which the operational
risk resides.
Question 74: What are the advantages
and disadvantages of the proposed
approach to calculating the services
component, including any impacts on
specific business models? Which
alternatives, if any, should the agencies
consider and why? Similarly, should the
agencies consider any adjustments or
limits related to specific business lines,
such as underwriting, wealth
management, or custody, or to specific
fee types, such as interchange fees, and
if so what adjustment or limits should
they consider? For example, should the
agencies consider adjusting or limiting
how the services component contributes
187 Note that expenses with operational loss
events in ‘‘other operating expense’’ would not
exclude expenses associated with operational loss
events that result in less than $20,000 in net loss
amount.
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to the business indicator and, if so,
how? What would be the advantages
and disadvantages of any alternative
approach and what impact would such
an alternative approach have on
operational risk capital requirements?
For example, under the proposal, fee
income and expenses of charge cards
are included under the services
component. Would it be more
appropriate for fee income and
expenses of charge cards to be included
in net interest income of the interest,
lease, and dividend component (and
excluded from the services component)
and for charge card exposures to be
included in interest earning assets of the
interest, lease, and dividend component
and why? Please provide supporting
data with your response.
c. The Financial Component
Under the proposal, the financial
component would capture trading
activities and other activities associated
with a banking organization’s assets and
liabilities. The financial component
would be calculated as follows:
Financial Component = Avg3y (Abs
(trading revenue)) + Avg3y (Abs (net
profit or loss on assets and
liabilities not held for trading))
The proposal includes the following
definitions:
• Trading revenue would mean the
net gain or loss from trading cash
instruments and derivative contracts
(including commodity contracts); 188
and
• Net profit or loss on assets and
liabilities not held for trading would
mean the sum of realized gains (losses)
on held-to-maturity securities, realized
gains (losses) on available-for-sale
securities, net gains (losses) on sales of
loans and leases, net gains (losses) on
sales of other real estate owned, net
gains (losses) on sales of other assets,
venture capital revenue, net
securitization income, and mark-tomarket profit or loss on bank
liabilities.189
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188 Trading revenue would correspond to trading
revenue in the FR Y–9C (holding companies) and
Call Report.
189 Realized gains (losses) on held-to-maturity
securities, realized gains (losses) on available-forsale securities, net gains (losses) on sales of loans
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The financial component aims to
capture trading activities and other
activities that are associated with a
banking organization’s assets and
liabilities. Trading revenue, which
reflects net income or loss from trading
activities, would be a proxy for the
business volume associated with trading
and related activities. Net profit or loss
on assets and liabilities not held for
trading would reflect the profit or loss
of activities associated with assets and
liabilities that are not included by other
components of the business indicator
and therefore ensures that the business
indicator comprehensively captures
these activities. The use of net values for
these inputs would align with current
regulatory reporting, thereby reducing
data gathering and calculation burden.
Both of these inputs would be measured
in terms of their absolute value to better
capture business volume (for example,
negative trading revenue would not
imply that a banking organization’s
trading activities are small in volume),
which is associated with higher
operational risk.
d. Exclusions From the Business
Indicator
Under the proposal, the business
indicator would reflect the volume of
financial activities of a banking
organization; therefore, the business
indicator would exclude expenses that
do not relate to financial services
received by the banking organization.
Excluded expenses would include staff
expenses, expenses to outsource nonfinancial services (such as logistical,
human resources, and information
technology), administrative expenses
(such as utilities, telecommunications,
travel, office supplies, and postage),
expenses relating to premises and fixed
assets, and depreciation of tangible and
intangible assets. Still, the proposal
would include expenses related to
operational loss events in the services
component even when they relate to
these otherwise-excluded categories of
and leases, net gains (losses) on sales of other real
estate owned, net gains (losses) on sales of other
assets, venture capital revenue, and net
securitization income correspond to their current
definitions in the FR Y–9C (holding companies) and
Call Report.
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expenses because the objective of the
operational risk capital requirement is
to support a banking organization’s
resilience to operational risk, and
observed operational loss expenses are a
meaningful indicator of a banking
organization’s exposure to operational
risk.
The proposal also would not include
loss provisions and reversal of
provisions (except for those related to
operational loss events) or changes in
goodwill in the business indicator, as
these items do not reflect business
volume of the banking organization. In
addition, the business indicator would
not include applicable income taxes as
an expense, as they reflect obligations to
the government for which the
operational risk capital framework
should be neutral.
With prior supervisory approval, the
proposal would allow banking
organizations to exclude activities that
they have ceased to conduct, whether
directly or indirectly, from the
calculation of the business indicator,
provided that the banking organization
demonstrates that such activities do not
carry legacy legal exposure. Supervisory
approval would not be granted when,
for example, legacy business activities
are subject to potential or pending legal
or regulatory enforcement action. The
supervisory approval requirement
would help ensure that a banking
organization’s operational risk capital
requirement aligns with its existing
operational risk exposure.
2. Business Indicator Component
Under the proposal, the business
indicator component would be a
function of the business indicator, with
three linear segments. The business
indicator component would increase at
a rate of: (a) 12 percent per unit of
business indicator for levels of business
indicator up to $1 billion; (b) 15 percent
per unit of business indicator for levels
of business indicator above $1 billion
and up to $30 billion; and (c) 18 percent
per unit of business indicator for levels
of business indicator above $30 billion.
Table 8 below presents the formulas that
can be used to calculate the business
indicator component given a banking
organization’s business indicator.
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3. Internal Loss Multiplier
Where:
• Average annual total net operational
losses would correspond to the average of
annual total net operational losses over the
previous ten years (on a rolling quarter
basis).194 In this calculation, the total net
operational losses of a quarter would equal
the sum of any portions of losses or
recoveries of any material operational losses
allocated to the quarter. Material operational
loss would mean an operational loss incurred
by the banking organization that resulted in
a net loss greater than or equal to $20,000
after taking into account all subsequent
recoveries related to the operational loss.
• exp(1) is the Euler’s number, which is
approximately equal to 2.7183.
• ln is the natural logarithm.
190 $120 million is equal to 0.12 * $1 billion.
$4.47 billion is equal to 0.12 * $1 billion + 0.15 *
($30 billion¥$1 billion).
191 See Basel Committee (2014), ‘‘Operational
risk—Revisions to the simpler approaches,’’ https://
www.bis.org/publ/bcbs291.htm and Basel
Committee (2016), ‘‘Standardized Measurement
Approach for operational risk,’’ https://
www.bis.org/bcbs/publ/d355.htm.
192 See Curti, Mih, and Mihov (2022), ‘‘Are the
Largest Banking Organizations Operationally More
Risky?, Journal of Money, Credit and Banking,’’
DOI: 10.111/jmcb.12933; and Frame, McLemore,
and Mihov (2020), ‘‘Haste Makes Waste: Banking
Organization Growth and Operational Risk,’’
Federal Reserve Bank of Dallas, https://
www.dallasfed.org/research/papers/2020/wp2023.
193 See Curti and Migueis (2023), ‘‘The
Information Value of Past Losses in Operational
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Higher historical operational losses
are associated with higher future
operational risk exposure.193
Supervisory experience also suggests
that operational risk management
deficiencies can be persistent, which
can often result in operational losses.
Accordingly, under the proposal, the
operational risk capital requirement
would be higher for banking
organizations that experienced larger
operational losses in the past. To this
effect, the proposal would include a
scalar, the internal loss multiplier, that
increases operational risk capital
requirements based on a banking
organization’s historical operational loss
Average annual total net operational
losses would be multiplied by 15 in the
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experience. This multiplier would
depend on the ratio of a banking
organization’s average annual total net
operational losses to its business
indicator component.
The proposal would require the
internal loss multiplier to be no less
than one. This floor would ensure that
the operational risk capital requirement
provides a robust minimum amount of
coverage to the potential future
operational risks a banking organization
may be exposed to, as reflected by its
overall business volume through the
business indicator component, even in
situations where historical operational
losses have been low in relative terms.
The internal loss multiplier would be
calculated as follows:
internal loss multiplier formula. This
multiplication extrapolates from average
annual total net operational losses the
potential for unusually large losses and,
therefore, aims to ensure that a banking
organization maintains sufficient capital
given its operational loss history and
risk profile. The constant used is
consistent with the Basel III reforms.
Risk, Finance and Economics Discussion Series,’’
Board of Governors of the Federal Reserve System,
https://doi.org/10.17016/FEDS.2023.003.
194 For example, when calculating average annual
total net operational losses for the second calendar
quarter of 2023, total net operational losses from the
third calendar quarter of 2013 through the second
calendar quarter of 2023 would be included.
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EP18SE23.028</GPH>
The higher rate of increase of the
business indicator component as a
banking organization’s business
indicator rises above $1 billion and $30
billion would reflect exposure to
operational risk generally increasing
more than proportionally with a
banking organization’s overall business
volume, in part due to the increased
complexity of large banking
organizations. This approach is
supported by analysis undertaken by the
Basel Committee.191 Similarly,
academic studies have found that larger
U.S. bank holding companies have
higher operational losses per dollar of
total assets.192
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The natural log function (ln)
combined with an exponent of 0.8
would limit the effect that large
operational losses have on a banking
organization’s operational risk capital
requirement. This feature of the internal
loss multiplier formula is intended to
constrain the volatility of the
operational risk capital requirement. As
a result, increases in average annual
total net operational losses would
increase the operational risk capital
requirement at a decreasing rate.195
The calculation of average annual
total net operational losses would be
based on an average of ten years of data.
The use of a ten-year average for annual
total net operational losses would
balance recognition that a banking
organization’s operational risk exposure
changes over time with limiting the
volatility that would result from using a
shorter time horizon and the importance
of the calculation window providing
sufficient information regarding the
banking organization’s operational risk
profile.
The proposal would define an
‘‘operational loss’’ as all losses
(excluding insurance or tax effects)
resulting from an operational loss event,
including any reduction in previously
reported capital levels attributable to
restatements or corrections of financial
statements. An operational loss includes
all expenses associated with an
operational loss event except for
opportunity costs, forgone revenue, and
costs related to risk management and
control enhancements implemented to
prevent future operational losses.
Operational loss would not include
losses that are also credit losses and are
related to exposures within the scope of
the credit risk risk-weighted assets
framework (except for retail credit card
losses arising from non-contractual,
third-party-initiated fraud, which are
operational losses).
‘‘Operational loss event’’ would be
defined as an event that results in loss
due to inadequate or failed internal
processes, people, or systems or from
external events. This definition includes
legal loss events and restatements or
corrections of financial statements that
195 The internal loss multiplier variation depends
on the ratio of the product of 15 and the average
annual total operational losses to the business
indicator component. The 0.8 exponent applied to
this ratio reduces the effect of the variation of this
ratio on the internal loss multiplier. For example,
a ratio of 2 becomes approximately 1.74 after
application of the exponent, and a ratio of 0.5
becomes approximately 0.57 after application of the
exponent. Similarly, the application of a
logarithmic function further reduces the variability
of the internal loss multiplier for values above 1.
Taken together, these two transformations mitigate
the reaction of the operational risk capital
requirement to large historical operational losses.
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result in a reduction of capital relative
to amounts previously reported. The
proposal would retain the current
classification of operational loss events
according to seven event types:
1—Internal fraud, which means the
operational loss event type that
comprises operational losses resulting
from an act involving at least one
internal party of a type intended to
defraud, misappropriate property, or
circumvent regulations, the law, or
company policy excluding diversity and
discrimination noncompliance events.
2—External fraud, which means the
operational loss event type that
comprises operational losses resulting
from an act by a third party of a type
intended to defraud, misappropriate
property, or circumvent the law. Retail
credit card losses arising from noncontractual, third-party-initiated fraud
(for example, identity theft) are external
fraud operational losses.
3—Employment practices and
workplace safety, which means the
operational loss event type that
comprises operational losses resulting
from an act inconsistent with
employment, health, or safety laws or
agreements, payment of personal injury
claims, or payment arising from
diversity and discrimination
noncompliance events.
4—Clients, products, and business
practices, which means the operational
loss event type that comprises
operational losses resulting from the
nature or design of a product or from an
unintentional or negligent failure to
meet a professional obligation to
specific clients (including fiduciary and
suitability requirements).
5—Damage to physical assets, which
means the operational loss event type
that comprises operational losses
resulting from the loss of or damage to
physical assets from natural disasters or
other events.
6—Business disruption and system
failures, which means the operational
loss event type that comprises
operational losses resulting from
disruption of business or system
failures, including hardware, software,
telecommunications, or utility outage or
disruptions.
7—Execution, delivery, and process
management, which means the
operational loss event type that
comprises operational losses resulting
from failed transaction processing or
process management or losses arising
from relations with trade counterparties
and vendors.
By ensuring consistency, the
classification of operational loss events
according to these event types would
continue to assist banking organizations
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and the agencies in understanding the
causal factors driving operational losses.
The proposal would include a
$20,000 net loss threshold (that is,
$20,000 after taking into account all
subsequent recoveries related to the
operational loss) for inclusion of an
operational loss in the calculation of
average annual total net operational
losses. This threshold aims to balance
comprehensiveness against the
materiality of the operational losses.
The proposal would require a banking
organization to group losses with a
common underlying trigger into the
same operational loss event. For
example, losses that occur in multiple
locations or over a period of time
resulting from the same natural disaster
would be grouped into a single
operational loss event. This grouping
requirement aims to ensure
comprehensive inclusion of operational
loss events that result in $20,000 or
more of net loss in the calculation of the
internal loss multiplier and to facilitate
understanding of operational risk
exposure by banking organizations and
supervisors.
There are two main differences in
how the proposal would treat
operational losses relative to typical
practice under the AMA. First, total net
operational losses would include
operational losses in the quarter in
which their accounting impacts were
recorded, rather than aggregated into a
single event date.196 Second,
operational losses would enter the
internal loss multiplier calculation net
of related recoveries, including
insurance recoveries.197 Recoveries
would be included in the quarter in
which they are paid to the banking
organization. Insurance receivables
would not be accounted for in the
calculation as recoveries. Reductions in
the legal reserves associated with an
ongoing legal event would be treated as
recoveries for the calculation of total net
operational losses. Also, a recovery
would only offset a loss arising from a
related operational loss event. This
proposed treatment would ensure that
only applicable recoveries are
recognized.
Under the proposal, a negative
financial impact that a banking
organization books in its financial
196 For example, if an operation loss event results
in a loss impact of $500,000 in the first quarter of
2020 and a loss impact of $400,000 in the second
quarter of 2021, the banking organization would
add $500,000 to the total gross operational losses
of first quarter of 2020 and add $400,000 to the total
gross operational losses of the second quarter of
2021.
197 A recovery is an inflow of funds or economic
benefits received from a third party in relation to
an operational loss event.
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statement due to having incorrectly
booked a positive financial impact in a
previous financial statement would
constitute an operational loss (these
losses are generally known as ‘‘timing
losses’’). Examples of an incorrectly
booked positive financial impact would
include revenue overstatement,
overbilling, accounting errors, and
mark-to-market errors. Corrections that
would constitute operational losses
include refunds and restatements that
result in a reduction in equity capital.
If the initial overstatement and its
correction occur in the same financial
statement period, there would be no
operational loss under the proposal.
The proposal’s definition of
operational loss includes a clarification
regarding the boundary between
operational risk and credit risk, which
aims to ensure that all losses
experienced by a banking organization
in its financial statements are within the
scope of the credit risk, market risk, or
operational risk frameworks. Losses
resulting from events that meet the
definition of an operational loss event
which are also credit losses and are
related to exposures within the scope of
the credit risk risk-weighted assets
framework would continue to be
excluded from total operational losses
for purposes of the operational risk
capital requirement. In keeping with the
current framework and prevailing
industry practice, retail credit card
losses arising from non-contractual,
third-party-initiated fraud would
continue to be operational losses under
the proposal. In addition, operational
losses related to products that are
outside of the scope of the credit riskweighted asset framework (for example,
losses due to representations and
warranties unrelated to credit risk that
require the banking organization to
repurchase an asset) would be
operational losses even if they are
associated with obligor default events.
Operational losses that result from
boundary events with market risk (for
example, losses that are the result of
failed or inadequate model validation
processes) would also continue to be
treated as operational losses in the
proposal.
The proposal includes revisions to the
FR Y–14Q report, which is applicable to
large banking organizations subject to
the Board’s capital plan rule, to conform
with the revisions to the definitions of
operational loss and operational loss
event introduced by the proposal.
Under the proposal, a banking
organization would include in its
calculation of total net operational
losses any operational loss events
incurred by an entity that has been
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acquired by or merged with the banking
organization. In cases where historical
loss data meeting the collection
requirements is not available for a
merged or acquired entity for certain
years in the calculation window of the
internal loss multiplier, the proposal
would provide a formula for calculating
annual total net operational losses for
this merged or acquired entity for these
missing years. Annual total net
operational losses of the merged or
acquired entity for the missing years
would be such that the ratio of average
annual total net operational losses to the
business indicator contribution of this
merged or acquired entity 198 is the same
as the ratio of the average annual total
net operational losses to business
indicator of the remainder of the
banking organization:
Annual total net operational losses for
a merged or acquired business that
lacks loss data = Business indicator
contribution of merged or acquired
business that lacks loss data *
Average annual total net
operational losses of the banking
organization excluding amounts
attributable to the merged or
acquired business/Business
indicator of the banking
organization excluding amounts
attributable to the merged or
acquired business.
This approach would recognize that
historical data for operational losses
may be difficult to obtain in certain
circumstances, particularly if an
acquired or merged entity had not
previously been required to track
operational losses.199
Banking organizations that only have
five to nine years of loss data meeting
the operational loss event data
collection requirements in
§ ll.150(f)(2) of the proposal (for
example, when transitioning into the
standardized approach for operational
risk) would be expected to use as many
years of loss data meeting the internal
loss event data collection requirements
as are available in the calculation of
average annual total net operational
losses. In cases where a banking
organization’s loss collection practices
are deficient, its primary Federal
supervisor may require higher capital
requirements under the capital rule’s
reservation of authority.
198 The business indicator contribution of a
merged or acquired entity would be the business
indicator of the banking organization inclusive of
the merged or acquired entity minus the business
indicator of the banking organization when the
merged or acquired entity is excluded.
199 In contrast, the business indicator includes
only three years of financial statement data, which
should be readily available.
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Under the proposal, the internal loss
multiplier would equal one in cases
where the number of years of loss data
meeting the internal loss event data
collection requirements is less than five
years. In cases where the banking
organization’s primary Federal
supervisor determines that an internal
loss multiplier of one results in
insufficient operational risk capital, the
primary Federal supervisor may require
higher capital requirements under the
capital rule’s reservation of authority.
Under the proposal, a banking
organization would be able to request
supervisory approval to exclude
operational loss events that are no
longer relevant to their risk profile from
the internal loss multiplier calculation.
The agencies expect the exclusion of
operational loss events would generally
be rare, and a banking organization
would be required to provide adequate
justification for why operational loss
events are no longer relevant to its risk
profile when requesting supervisory
approval for exclusion. In evaluating the
relevance of operational loss events to
the banking organization’s risk profile,
the primary Federal supervisor would
consider various factors, including
whether the cause or causes of the loss
events could occur in other areas of the
banking organization’s operations. The
banking organization would need to
demonstrate, for example, that there is
no similar or residual legal exposure
and that the excluded operational loss
events have no relevance to other
continuing activities or products.
In the case of divestitures, a banking
organization would be able to request
supervisory approval to remove
historical operational loss events
associated with an activity that the
banking organization has ceased to
directly or indirectly conduct—either
through full sale of the business or
closing of the business—from the
calculation of the internal loss
multiplier. Given that divestiture has
occurred, exclusion of operational
losses relating to legal events would
generally depend on whether the
divested activities carry legacy legal
exposure, as would be the case, for
example, where such activities are the
subject of a potential or pending legal or
regulatory enforcement action.
Except in the case of divestitures, the
agencies would only consider providing
supervisory approval for exclusions
after operational losses have been
included in a banking organization’s
total net operational losses for at least
three years. This retention period would
aim to ensure prudence in the
calculation of operational risk capital
requirements, as operational risk
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exposure is unlikely to be fully
eliminated over a short time frame.
Finally, to ensure that requests for
operational loss exclusions are of a
substantive nature, the agencies would
only consider a request for exclusion
when the total net operational losses to
be excluded are equal to five percent or
more of the banking organization’s
average annual total net operational
losses.
Question 75: What are the advantages
and disadvantages of flooring the
internal loss multiplier at one? Which
alternatives, if any, should the agencies
consider and why?
Question 76: What are the advantages
and disadvantages of including the
internal loss multiplier as opposed to
setting it equal to one?
Question 77: What are the advantages
and disadvantages of the treatment
proposed for losses of merged or
acquired businesses? Which
alternatives, if any, should the agencies
consider and why? What impact would
any alternatives have on the
conservatism of the proposal?
Question 78: What are the advantages
and disadvantages of an alternative
threshold for the operational losses for
which banking organizations may
request supervisory approval to
exclude?
4. Operational Risk Management and
Data Collection Requirements
Under the proposal, banking
organizations would continue to be
required to collect operational loss
event data. As discussed above, a
banking organization would be required
to include operational losses, net of
recoveries, of $20,000 or more in the
calculation of the internal loss
multiplier. To assist the identification of
operational loss events that result in an
operational loss, net of recoveries, of
$20,000 or more, the proposal would
require banking organizations to collect
operational loss event data for all
operational loss events that result in
$20,000 or more of gross operational
loss.
Operational loss event data would
include the gross loss amount, recovery
amounts, the date when the event
occurred or began (date of occurrence),
the date when the banking organization
became aware of the event (date of
discovery), and the date when the loss
event resulted in a loss, provision, or
recovery being recognized in the
banking organization’s profit and loss
accounts (date of accounting). These
loss data collection requirements are
similar to the loss reporting
requirements currently in place for
banking organizations subject to the FR
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Y–14 reporting and are similar to the
data that banking organizations subject
to the AMA have typically collected.
To ensure the validity of its
operational loss event data, a banking
organization would be required to
document the procedures used for the
identification and collection of
operational loss event data.
Additionally, the banking organization
would be required to have processes to
independently review the
comprehensiveness and accuracy of
operational loss data, and the banking
organization would be required to
subject the aforementioned procedures
and processes to regular independent
reviews by internal or external audit
functions.
The proposal would introduce a
requirement that banking organizations
collect descriptive information about
the drivers or causes of operational loss
events that result in a gross operational
loss of $20,000 or more. This
requirement would facilitate the efforts
of banking organizations and the
agencies to understand the sources of
operational risk and the drivers of
operational loss events. The agencies
would expect that the level of detail of
any descriptive information be
commensurate with the size of the gross
loss amount of the operational loss
event.
The proposal would not include
certain data requirements included in
the AMA. Specifically, banking
organizations would not be required to
estimate their operational risk exposure
or to collect external operational loss
event data, scenario analysis, and
business, environment, and internal
control factors.
The agencies consider effective
operational risk management to be
critical to ensuring the financial and
operational resilience of banking
organizations, particularly for large
banking organizations.200 Thus,
consistent with the current advanced
approaches qualification requirements
applicable to banking organizations
subject to Category I or II capital
standards, the proposal would include
the requirement that large banking
organizations have an operational risk
management function that is
independent of business line
management. This independent
operational risk management function
would be expected to design,
200 The interagency paper titled ‘‘Sound Practices
to Strengthen Operational Resilience’’ (November 2,
2020) notes that operational resilience ‘‘is the
outcome of effective operational risk management
combined with sufficient financial and operational
resources to prepare, adapt, withstand, and recover
from disruptions.’’
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implement, and oversee the
comprehensiveness and accuracy of
operational loss event data and
operational loss event data collection
processes, and oversee other aspects of
the banking organization’s operational
risk management. Large banking
organizations would also be required to
have and document processes to
identify, measure, monitor, and control
operational risk in their products,
activities, processes, and systems. In
addition, large banking organizations
would be required to report operational
loss events and other relevant
operational risk information to business
unit management, senior management,
and the board of directors (or a
designated committee of the board).
Question 79: The proposal would
require a banking organization to collect
information on the drivers of
operational loss events, with the level of
detail of any descriptive information
commensurate with the size of the gross
loss amount. What are the advantages
and disadvantages of this requirement?
Which alternatives should the agencies
consider—for example, introducing a
higher dollar threshold for such a
requirement—and why?
G. Disclosure Requirements
1. Proposed Disclosure Requirements
Meaningful public disclosures of a
banking organization’s activities and the
features of its risk profile, including risk
appetite, work in tandem with the
regulatory and supervisory frameworks
applicable to banking organizations by
helping to support robust market
discipline. In this way, meaningful
public disclosures help to support the
safety and soundness of banking
organizations and the financial system
more broadly.
The proposal would revise certain
existing qualitative disclosure
requirements and introduce new and
enhanced qualitative disclosure
requirements related to the proposed
revisions described in this
SUPPLEMENTARY INFORMATION. The
proposal would also remove from the
disclosure tables most of the existing
quantitative disclosures, which would
instead be included in regulatory
reporting forms. Therefore, the agencies
anticipate separately proposing
revisions to the Consolidated Reports of
Condition and Income, the Regulatory
Capital Reporting for Institutions
Subject to the Advanced Capital
Adequacy Framework (FFIEC 101), and
the Market Risk Regulatory Report for
Institutions Subject to the Market Risk
Capital Rule (FFIEC 102). The Board
similarly anticipates proposing
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corresponding revisions to the
Consolidated Financial Statements for
Holding Companies (FR Y–9C), the
Capital Assessments and Stress Testing
(FR Y–14A and FR Y–14Q), and the
Systemic Risk Report (FR Y–15) to
reflect the changes to the capital rule
that would be required under this
proposal. The proposal would also
remove disclosures related to internal
ratings-based systems and internal
models, consistent with the broader
objectives of this proposal.
Under the current capital rule,
banking organizations subject to
Category I or II capital standards are
subject to enhanced public disclosure
and reporting requirements in
comparison to the disclosure and
reporting requirements applicable to
banking organizations subject to
Category III or IV capital standards.
Under the proposal, the enhanced
public disclosure requirements would
apply to all large banking organizations.
Applying enhanced disclosure and
reporting requirements to banking
organizations subject to Category III or
IV capital standards would bring
consistency across large banking
organizations and promote transparency
for market participants. Consistent with
the current capital rule, the top-tier
entity (including a depository
institution, if applicable), would be
subject to both the qualitative and
quantitative enhanced disclosure and
reporting requirements.201
The current capital rule does not
subject a banking organization that is a
consolidated subsidiary of a bank
holding company, a covered savings and
loan holding company that is a banking
organization as defined in 12 CFR 238.2,
or depository institution that is subject
to public disclosure requirements, or a
subsidiary of a non-U.S. banking
organization that is subject to
comparable public disclosure
requirements in its home jurisdiction to
the qualitative disclosure requirements
described in the current capital rule.
The proposal would not change the
current capital rule’s requirements
regarding public disclosure policy and
attestation, the frequency of required
disclosures, the location of disclosures,
or the treatment of proprietary
information.
201 In the case of a depository institution that is
not a consolidated subsidiary of a depository
institution holding company that is assigned a
category under the capital rule, the depository
institution would be considered the top-tier entity
for purposes of the qualitative and quantitative
enhanced disclosure and reporting requirements.
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2. Specific Public Disclosure
Requirements
The proposed changes to disclosure
requirements pertaining to the riskbased capital framework are described
below.202 Disclosure tables 1,203 2,204
3,205 4,206 11 207 (table 9 to § ll.162 in
the proposal), and 12 208 (table 10 to
§ ll.162 in the proposal) in § ll.173
of the current capital rule have been
retained without material modification,
although the table numbers would
change.
The proposal would retain the
requirement that a banking organization
disclose its risk management objectives
as they relate to specific risk areas (e.g.,
credit risk). The proposal would revise
the risk areas to which these disclosure
requirements apply to help ensure
consistency with the broader proposal.
In addition, the proposal would require
a banking organization to describe its
risk management objectives as they
relate to the organization overall. The
required disclosures would include
information regarding how the banking
organization’s business model
determines and interacts with the
overall risk profile; how this risk profile
interacts with the risk tolerance
approved by its board; the banking
organization’s risk governance structure;
channels to communicate, define, and
enforce the risk culture within the
banking organization; scope and
features of risk measurement systems;
risk information reporting; qualitative
information on stress testing; and the
strategies and processes to manage,
hedge, and mitigate risks. These
disclosures are intended to allow market
participants to evaluate the adequacy of
a banking organization’s approach to
risk management.
Table 5 to § ll.162, ‘‘Credit Risk:
General Disclosures,’’ would include the
disclosures a banking organization is
required to make under the current
capital rule regarding its approach to
general credit risk.209 In addition, the
202 The table numbers refer to the table numbers
included in the proposed rule.
203 See Table 1 to § 3.173 (OCC); § 217.173
(Board); § 324.173 (FDIC)—Scope of Application.
204 See Table 2 to § 3.173 (OCC); § 217.173
(Board); § 324.173 (FDIC)—Capital Structure.
205 See Table 3 to § 3.173 (OCC); § 217.173
(Board); § 324.173 (FDIC)—Capital Adequacy.
206 See Table 4 to § 3.173 (OCC); § 217.173
(Board); § 324.173 (FDIC)—Capital Conservation
and Countercyclical Capital Buffers.
207 See Table 11 to § 3.173 (OCC); § 217.173
(Board); § 324.173 (FDIC)—Equities Not Subject to
Subpart F of This Part.
208 See Table 12 to 3.173 (OCC); § 217.173
(Board); § 324.173 (FDIC)—Interest Rate Risk for
Non-Trading Activities.
209 See Table 5 to § 3.173 (OCC); § 217.173
(Board); § 324.173 (FDIC)—Credit Risk—General
Disclosures.
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proposal would require a banking
organization to disclose certain
additional information regarding its risk
management policies and objectives for
credit risk. Specifically, the proposal
would require a banking organization to
enhance its existing disclosures by
describing how its business model
translates into the components of the
banking organization’s credit risk profile
and how it defines credit risk
management policy and sets credit
limits. Additionally, a banking
organization would be required to
disclose the organizational structure of
its credit risk management and control
function as well as interactions with
other functions. A banking organization
would also be required to disclose
information on its policies related to
reporting of credit risk exposure and the
credit risk management function that are
provided to the banking organization’s
leadership.
Table 6 to § ll.162, ‘‘General
Disclosure for Counterparty Credit RiskRelated Exposures,’’ would include the
disclosures a banking organization is
required to make under the current
capital rule regarding its approach to
managing counterparty credit risk.210
The proposal would also include new
disclosure requirements regarding a
banking organization’s methodology for
assigning economic capital for
counterparty credit risk exposures as
well as its policies regarding wrong-way
risk exposures. Additionally, the
proposal would further require a
banking organization to disclose its risk
management objectives and policies
related to counterparty credit risk,
including the method used to assign the
operating limits defined in terms of
internal capital for counterparty credit
risk exposures and for CCP exposures,
policies relating to guarantees and other
risk mitigants and assessments
concerning counterparty credit risk
(including exposures to CCPs), and the
increase in the amount of collateral that
the banking organization would be
required to provide in the event of a
credit rating downgrade.
Table 7 to § ll.162, ‘‘Credit Risk
Mitigation,’’ would include the
disclosures a banking organization is
required to make under the current rule
regarding its approach to credit risk
mitigation.211 In addition, the proposal
would specify that a banking
organization must provide a meaningful
210 See Table 7 to § 3.173 (OCC); § 217.173
(Board); § 324.173 (FDIC)—General Disclosure for
Counterparty Credit Risk of OTC Derivative
Contracts, Repo-Style Transactions, and Eligible
Margin Loans.
211 See Table 8 to § 3.173 (OCC); § 217.173
(Board); § 324.173 (FDIC)—Credit Risk Mitigation.
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breakdown of its credit derivative
providers, including a breakdown by
rating class or by type of counterparty
(e.g., banking organizations, other
financial institutions, and non-financial
institutions). These disclosures would
apply to eligible credit risk mitigants
under the proposal,212 although a
banking organization would be
encouraged to also disclose information
about other mitigants. The credit risk
mitigation disclosures in Table 7 to
§ ll.162 of the proposal would not
apply to synthetic securitization
exposures, which would be included in
Table 8 to § ll.162 as part of the
banking organization’s disclosures
related to securitization exposures.
Table 8 to § ll.162,
‘‘Securitization,’’ would include the
disclosures a banking organization is
required to make under the current
capital rule regarding its approach to
securitization.213 In addition to the
existing qualitative disclosures related
to securitization, the proposal would
require disclosure of whether the
banking organization provides implicit
support to a securitization and the riskbased capital impact of such support.
Table 11 to § ll.162, ‘‘Additional
Disclosure Related to the Credit Quality
of Assets,’’ is a new disclosure table that
would require banking organizations to
provide further information on the
scope of ‘‘past due’’ exposures used for
accounting purposes, including the
differences, if any, between the banking
organization’s scope of exposures
treated as past due for accounting
purposes and those treated as past due
for regulatory capital purposes. Table 11
to § ll.162 would also describe the
scope of exposures that qualify as
‘‘defaulted exposures’’ or ‘‘defaulted
real estate exposures’’ that are not
exposures for which credit losses are
measured under ASC 214 Topic 326 and
for which the banking organization has
recorded a partial write-off or writedown. Additionally, a banking
organization would be required to
disclose the scope of exposures that
qualify as a ‘‘loan modification to
borrowers experiencing financial
difficulty’’ for accounting purposes
under ASC Topic 310 215 and the
difference, if any, between the scope of
212 See
section III.C.5 of this SUPPLEMENTARY
for a more detailed discussion on the
types of credit risk mitigants that a banking
organization would be allowed to recognize for
purposes of calculating risk-based capital
requirements.
213 See Table 9 to § 3.173 (OCC); § 217.173
(Board); § 324.173 (FDIC)—Securitization.
214 The Accounting Standards Codification is
promulgated by the Financial Accounting
Standards Board for GAAP.
215 See ASC 310–10–50–36.
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exposures treated as ‘‘defaulted
exposures’’ or ‘‘defaulted real estate
exposures.’’
Table 12 to § ll.162, ‘‘General
Qualitative Disclosure Requirements
Related to CVA’’ is a new disclosure
table that would require a banking
organization to disclose certain
information pertaining to CVA risk,
including its risk management
objectives and policies for CVA risk and
information related to a banking
organization’s CVA risk management
framework, including processes
implemented to identify, measure,
monitor, and control CVA risks and
effectiveness of CVA hedges. Table 13 to
§ ll.162, ‘‘Qualitative Disclosures for
Banks Using the SA–CVA’’ is a new
disclosure table that would require a
banking organization that has approval
to use the standardized CVA approach
(SA–CVA) to make disclosures related
to the banking organization’s risk
management framework, including a
description of the banking
organization’s risk management
framework, a description of how senior
management is involved in the CVA risk
management framework, and an
overview of the governance of the CVA
risk management framework such as
documentation, independent risk
control unit, independent review, and
independence of data acquisition from
lines of business.
Table 14 to § ll.162, ‘‘General
Qualitative Information on a Banking
Organization’s Operational Risk
Framework,’’ is a new disclosure table
that would require a banking
organization to disclose information
regarding its operational risk
management processes, including its
policies, frameworks, and guidelines for
operational risk management; the
structure and organization of its
operational risk management and
control function; its operational risk
measurement system (the systems and
data used to measure operational risk in
order to estimate the operational risk
capital requirement); the scope and
context of its reporting framework on
operational risk to executive
management and to the board of
directors; and the risk mitigation and
risk transfer used in the management of
operational risk.
Table 15 to § ll.162, ‘‘Main
Features of Regulatory Capital
Instruments and of other TLAC-Eligible
Instruments,’’ is a new disclosure table
that would require a banking
organization to disclose information
regarding the terms and features of its
regulatory capital instruments and other
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instruments eligible for TLAC.216 In
addition, the proposal would require a
banking organization to describe the
main features of its regulatory capital
instruments and provide disclosures of
the full terms and conditions of all
instruments included in regulatory
capital. A banking organization that is
also a GSIB would also be required to
describe the main features of its covered
debt positions and provide disclosures
of the full terms and conditions of all
covered debt positions.
H. Market Risk
1. Background
a. Description of Market Risk
Market risk for a banking organization
results from exposure to price
movements caused by changes in
market conditions, market events, and
issuer events that affect asset prices.
Losses resulting from market risk can
affect a banking organization’s capital
strength, liquidity, and profitability. To
help ensure that a banking organization
maintains a sufficient amount of capital
to withstand adverse market risks and
consistent with amendments to the
Basel Capital Accord, the agencies
adopted risk-based capital standards for
market risk in 1996 (1996 rule).217
Although adoption of the 1996 rule was
a constructive step in capturing market
risk, the 1996 rule did not sufficiently
capture the risks associated with
financial instruments that became
prevalent in the years following its
adoption. This became evident during
the 2007–2009 financial crisis, when the
1996 rule did not fully capture banking
organizations’ increased exposures to
traded credit and other structured
products, such as collateralized debt
obligations (CDO), credit default swaps
(CDS), mortgage-related securitizations,
and exposures to other less liquid
products.
In August 2012, the agencies issued a
final rule that modified the 1996 rule to
address these deficiencies.218
Specifically, the rule added a stressed
value-at-risk (VaR) measure, a capital
requirement for default and migration
risk (the incremental risk capital
216 For purposes of Table 15, unique identifiers
associated with regulatory capital instruments and
other instruments eligible for TLAC may include
Committee on Uniform Security Identification
Procedures number, Bloomberg identifier for
private placement, International Securities
Identification Number, or others.
217 61 FR 47358 (September 6, 1996). The
agencies’ market risk capital rules were located at
12 CFR part 3, appendix B (OCC), 12 CFR part 208,
appendix E and 12 CFR part 225, appendix E
(Board), and 12 CFR part 325, appendix C (FDIC).
218 Risk-Based Capital Guidelines: Market Risk,
77 FR 53059 (August 30, 2012).
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requirement), a comprehensive risk
measurement for correlation trading
portfolio, a modified definition of
covered position, a definition of trading
position, an expanded set of
requirements for internal models to
reflect advances in risk management,
and revised requirements for regulatory
backtesting. These changes enhanced
the calibration of market risk capital
requirements by incorporating stressed
conditions into VaR and by increasing
the comprehensiveness and quality of
the standards for internal models used
to calculate market risk capital
requirements.219
While these updates to the rule
addressed certain pressing deficiencies
in the calculation of market risk capital
requirements, a number of structural
shortcomings that came to light during
the crisis remained unaddressed (such
as an inability of a VaR metric to
capture tail risks). To address these
shortcomings, the Basel Committee
conducted a fundamental review of the
market risk capital framework.220
Following this review, the Basel
Committee in January 2016 published a
new, more robust framework, which
established minimum capital
requirements for market risk.221 The
new framework also included enhanced
templates and qualitative disclosure
requirements to increase the
transparency of banking organizations’
market-risk-weighted assets. In January
2019, the Basel Committee published an
amended framework for market risk
capital requirements that revised the
calibration of certain risk weights to
more appropriately capture the potential
losses for certain types of risks.222 The
proposal would modify subpart F of the
219 The rule was subsequently modified in 2013
with changes that included moving the market risk
requirements from the agencies’ respective
appendices to subpart F of the capital rule; making
savings associations and savings and loan holding
companies with material exposure to market risk
subject to the market risk rule, 78 FR 62018
(October 11, 2013); addressing changes to the
country risk classifications, clarifying the treatment
of certain traded securitization positions; revising
the definition of covered position, and clarifying
the timing of the market risk disclosure
requirements, 78 FR 76521 (December 18, 2013).
220 The Basel Committee has published three
consultative documents on the review and to
address the structural shortcomings identified.
‘‘Fundamental review of the trading book,’’ May
2012, www.bis.org/publ/bcbs219.pdf;
‘‘Fundamental review of the trading book: A revised
market risk framework,’’ October 2013,
www.bis.org/publ/bcbs265.pdf; and, ‘‘Fundamental
review of the trading book: Outstanding issues,’’
December 2014, www.bis.org/bcbs/publ/d305.pdf.
221 Basel Committee, ‘‘Minimum capital
requirements for market risk,’’ January 2016,
www.bis.org/bcbs/publ/d352.pdf.
222 Basel Committee, Explanatory note on the
minimum capital requirements for market risk,
January 2019, www.bis.org/bcbs/publ/d457.pdf.
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capital rule to increase risk sensitivity,
transparency, and consistency of the
market risk capital requirements in a
manner generally consistent with the
revised framework of the Basel
Committee.
b. Overview of the Proposal
The proposal would improve the risksensitivity and calibration of market risk
capital requirements relative to the
current capital rule. The proposal would
introduce a risk-sensitive standardized
methodology for calculating riskweighted assets for market risk
(standardized measure for market risk)
and a new models-based methodology
(models-based measure for market risk)
to replace the framework in subpart F of
the current capital rule. The
standardized measure for market risk
would be the default methodology for
calculating market risk capital
requirements for all banking
organizations subject to market risk
requirements. A banking organization
would be required to obtain prior
approval from its primary Federal
supervisor to use the models-based
measure for market risk to determine its
market risk capital requirements.223
In contrast to the current framework
which, subject to approval, allows the
use of internal models at the banking
organization level, the proposal would
provide for enhanced risk-sensitivity by
introducing the concept of a trading
desk and restricting application of the
proposed models-based approach to the
trading desk level. The trading desklevel approach would limit use of the
internal models approach to only those
trading desks that can appropriately
capture the risk of market risk covered
positions in banking organizations’
internal models. Notably, the proposal
would also improve the current capital
rule’s models-based measure for market
risk. Specifically, the proposal would
replace the VaR-based measure of
market risk with an expected shortfallbased measure that better accounts for
extreme losses.224 In addition, the
proposal would replace the fixed tenbusiness-day liquidity horizon in the
current capital rule with liquidity
horizons that vary based on the
underlying risk factors to adequately
223 A banking organization that has regulatory
approval to use internal models to measure market
risk would be required to obtain new approvals to
use the models-based measure for market risk under
the proposed framework.
224 The proposal would define expected shortfall
as a measure of the average of all potential losses
exceeding the VaR at a given confidence level and
over a specified horizon.
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capture the market risk of less liquid
positions.225
If after receiving approval from the
primary Federal supervisor to use the
models-based measure for market risk, a
banking organization’s trading desk fails
to satisfy either the proposed desk-level
backtesting requirements 226 or the
proposed desk-level profit and loss
attribution testing requirements,227 the
proposal would require the banking
organization to use the standardized
measure for market risk to calculate
market risk capital requirements for the
trading desk. This requirement would
limit the use of internal models to only
those trading desks for which the
models are sufficiently conservative and
accurate for purposes of calculating
market risk capital requirements for the
trading desk.
The proposed standardized measure
for market risk (as illustrated in Figure
2 below) would consist of three main
components: (1) a sensitivities-based
capital requirement that would capture
non-default market risk based on the
estimated losses produced by risk factor
sensitivities 228 under regulatorily
determined stress conditions; 229 (2) a
standardized default risk capital
requirement that would capture losses
on credit and equity positions in the
event of issuer default; and (3) a
residual risk capital requirement (a
residual risk add-on) that would address
in a simple, conservative manner any
other known risks that are not already
captured by the first two components,
such as gap risk, correlation risk, and
behavioral risks. The proposed
225 The proposal would define liquidity horizon
as the time required to exit or hedge a market risk
covered position without materially affecting
market prices in stressed market conditions.
226 The proposed desk-level backtesting
requirements are intended to measure the
conservatism of the forecasting assumptions and
valuation methods used in the desk’s expected
shortfall models.
227 The proposed desk-level profit and loss
attribution (PLA) testing requirements are intended
to measure the accuracy of the potential future
profits or losses estimated by the expected shortfall
models relative to those produced by the front
office models. For purposes of this SUPPLEMENTARY
INFORMATION, the term ‘‘front office model’’ refers to
the valuation methods used to report actual profits
and losses for financial reporting purposes.
228 A risk factor sensitivity is the change in value
of an instrument given a small movement in a risk
factor that affects the instrument’s value.
229 Under the proposal, the market risk capital
requirement for the sensitivities-based method
would equal the sum of the capital requirements for
a given risk factor for delta (a measure of impact
on a market risk covered position’s value from
small changes in underlying risk factors), vega (a
measure of the impact on a market risk covered
position’s value from small changes in volatility)
and curvature (a measure of the additional change
in the positions’ value not captured by delta arising
from changes in the value of an option or an
embedded option).
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market risk capital requirements under
subpart F or to the capital requirements
under either subpart D or E of the
capital rule, respectively, and (3) any
additional capital requirement
established by the primary Federal
supervisor. Specifically, as part of the
proposal’s reservation of authority
provisions, the primary Federal
supervisor may require a banking
organization to maintain an overall
amount of capital that differs from the
amount otherwise required under the
proposal, if the primary Federal
BILLING CODE 6210–01–C; 6714–01–C; 4810–33–C
standardized approach capital
requirements for model-ineligible
trading desks; and (3) the additional
capital requirement applied to modeleligible trading desks with shortcomings
in the internal models used for
determining risk-based capital
requirements in the form of a PLA addon,231 if applicable. To limit the
increase in capital requirements arising
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The core components of the modelsbased measure for market risk would
consist of (1) the internal models
approach capital requirements for
model-eligible trading desks; 230 (2) the
230 The internal models approach capital
requirements for model-eligible trading desks
would itself consist of four components: (1) the
internally modelled capital requirement for
modellable risk factors, (2) the stressed expected
shortfall for non-modellable risk factors, (3) the
standardized default risk capital requirement, and
(4) the aggregate trading portfolio backtesting
capital multiplier. See section III.H.8.a of this
SUPPLEMENTARY INFORMATION.
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231 The
PLA add-on would be an additional
capital requirement for model deficiencies in
model-eligible trading desks based on the profit and
loss attribution test results. See section III.H.8.b of
this SUPPLEMENTARY INFORMATION.
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supervisor determines that the banking
organization’s market risk capital
requirements under the proposal are not
commensurate with the risk of the
banking organization’s market risk
covered positions, a specific market risk
covered position, or categories of
positions, as applicable. The
standardized measure for market risk
would equal the simple sum of the
above components as shown in Figure 2.
BILLING CODE 6210–01–P; 6714–01–P; 4810–33–P
due to differences in calculating riskbased capital requirements
separately 232 between market risk
covered positions held by trading desks
subject to the internal models approach
and those held by trading desks subject
to the standardized approach, the
models-based measure for market risk
would cap the sum of these three
232 Separate capital calculations could
unnecessarily increase capital requirement because
they ignore the offsetting benefits between market
risk covered positions held by trading desks subject
to the internal models approach and those held by
trading desks subject to the standardized approach.
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standardized measure for market risk
would also include three additional
components that would apply in limited
instances to specific positions: (1) a
fallback capital requirement for
instances where a banking organization
is unable to calculate market risk capital
requirements under the sensitivitiesbased method or the standardized
default risk capital requirement; (2) a
capital add-on for re-designations for
instances where a banking organization
re-classifies an instrument after initial
designation as being subject either to the
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components at the capital required for
all trading desks under the standardized
approach.
There are four other components of
the models-based measure for market
risk; however, these would only apply
in limited circumstances. These
components include: (1) the capital
requirement for instances where the
capital requirements for model-eligible
desks under the internal models
approach exceed those under the
standardized approach; 233 (2) the
fallback capital requirement for
instances where a banking organization
is not able to apply the standardized
approach to market risk covered
positions on model-ineligible trading
desks or the internal models approach
to market risk covered positions on
model-eligible trading desks, as well as
all securitization positions and
correlation trading positions that are
excluded from the capital add-on for
ineligible positions on model-eligible
trading desks; (3) the capital add-on for
re-designations for instances where a
banking organization re-classifies an
instrument after initial designation as
being subject either to the market risk
capital requirements under subpart F or
to the capital requirements under either
subpart D or subpart E of the capital
rule, respectively, or from including
securitization positions, correlation
trading positions, or certain equity
positions in investment funds 234 on a
model-eligible trading desk, provided
such positions are not included in the
fallback capital requirement; and (4) any
additional capital requirement
established by the primary Federal
supervisor. Specifically, as part of the
proposal’s reservation of authority
provisions, and similar to the
standardize measure for market risk, the
primary Federal supervisor may require
the banking organization to maintain an
overall amount of capital that differs
from the amount otherwise required
under the proposal.
Under the proposal, the market risk
capital requirements for a banking
organization under the models-based
measure for market risk would equal the
sum of the following components as
shown in Figure 3.
The proposal would also revise the
criteria for determining whether a
banking organization is subject to the
market risk-based capital requirements
to (1) reflect the significant growth in
capital markets since adoption of the
1996 rule; (2) provide a more reliable
and stable measure of banking
organizations’ trading activity by
introducing a four-quarter average
requirement, and (3) incorporate
measures of risk identified as part of the
agencies’ 2019 regulatory tiering rule.235
In general, the revised criteria would
take into account the prudential benefits
of the proposed market risk capital
requirements and the potential costs,
including compliance costs.
In addition, the proposal would help
promote consistency and comparability
in market risk capital requirements
across banking organizations by
strengthening the criteria for identifying
positions subject to the proposed market
risk capital requirement and by
proposing a risk-based capital treatment
of transfers of risk between a trading
233 As the standardized approach is less risksensitive than the internal models approach, to the
extent that the capital requirement under the
internal models approach exceeds that under the
standardized approach for model-eligible desks, the
proposal would require this difference to be
reflected in the aggregate capital requirement under
the models-based measure for market risk.
234 Specifically, the capital add-on would apply
to equity positions in an investment fund on modeleligible trading desks where the banking
organization cannot identify the underlying
positions held by the investment fund on a
quarterly basis or there is no daily price of the fund
available.
235 See 84 FR 59230, 59249 (November 1, 2019).
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desk and another unit within the same
banking organization (internal risk
transfers). The proposal would also
improve the transparency of market risk
capital requirements through enhanced
disclosures.
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2. Scope and Application of the
Proposed Rule
a. Scope of the Proposed Rule
Currently, any banking organization
with aggregate trading assets and trading
liabilities that, as of the most recent
calendar quarter, equal to $1 billion or
more, or 10 percent or more of the
banking organization’s total
consolidated assets, is required to
calculate market risk capital
requirements under subpart F of the
current capital rule.
The proposal would revise the criteria
for determining whether a banking
organization is subject to subpart F of
the capital rule. Under the proposal,
large banking organizations, as well as
those with significant trading activity,
would be required to calculate market
risk capital requirements under subpart
F of the capital rule. Specifically, a
banking organization with significant
trading activity would be any banking
organization with average aggregate
trading assets and trading liabilities,
excluding customer and proprietary
broker-dealer reserve bank accounts,236
over the previous four calendar quarters
equal to $5 billion or more, or equal to
10 percent or more of total consolidated
assets at quarter end as reported on the
most recent quarterly regulatory report.
Under the proposal, any holding
company subject to Category I, II, III, or
IV standards or any subsidiary thereof,
if the subsidiary engaged in any trading
activity over any of the four most recent
quarters, would be subject to subpart F
of the capital rule.
The proposed scope is designed to
apply market risk capital requirements
to all large banking organizations. As
the agencies noted in the preamble to
the final regulatory tiering rule, due to
their operational scale or global
presence, banking organizations subject
to Category I or II capital standards pose
heightened risks to U.S. financial
stability which would benefit from more
stringent capital requirements being
applied to such banking
organizations.237 As banking
organizations subject to Category I or II
capital standards are generally subject to
236 The proposal would define customer and
proprietary broker-dealer reserve bank accounts as
segregated accounts established by a subsidiary of
a banking organization that fulfill the requirements
of 17 CFR 240.15c3–3 (SEC Rule 15c3–3) or 17 CFR
1.20 (CFTC Regulation 1.20).
237 See 84 FR 59230, 59249 (November 1, 2019).
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rules based on the standards published
by the Basel Committee, the proposed
scope would help promote competitive
equity among U.S. banking
organizations and their foreign peers
and competitors, and reduce
opportunities for regulatory arbitrage
across jurisdictions. In addition, given
the increasing size and complexity of
activities of banking organizations
subject to Category III and IV capital
standards and the risks such banking
organizations pose to U.S. financial
stability, it would be appropriate to
require such banking organizations to be
subject to the proposed market risk
capital requirements, which provide for
enhanced risk sensitivity.
In addition to applying subpart F of
the capital rule to large banking
organizations, the proposed rule would
retain a trading activity threshold. To
reflect inflation since 1996 and growth
in the capital markets, the agencies are
proposing to increase the trading
activity dollar threshold from $1 billion
to $5 billion. A banking organization
whose trading assets and trading
liabilities are equal to 10 percent or
more of its total assets would continue
to be subject to subpart F of the capital
rule under the proposal. This means
that a banking organization that is not
subject to Category I, II, III, or IV capital
standards may still be subject to subpart
F if it exceeds either of these
quantitative thresholds. The proposed
trading activity dollar threshold would
be measured using the average aggregate
trading assets and trading liabilities of a
banking organization, calculated in
accordance with the instructions to the
FR Y–9C or Call Report, as applicable,
over the prior four consecutive quarters,
rather than using only the single most
recent quarter.238 This approach would
provide a more reliable and stable
measure of the banking organization’s
trading activities than the current
capital rule’s quarter-end measure.239
Furthermore, for purposes of
238 For purposes of the proposed scoping criteria,
aggregate average trading assets and trading
liabilities would mean the sum of the amount of
trading assets and the amount of trading liabilities
as reported by the banking organization on the
Consolidated Financial Statements for Holding
Companies (sum of line items 5 and 15 on schedule
HC of the Y–9C) or on the Consolidated Reports of
Condition and Income (i.e., the sum of line items
5 and 15 on schedule RC of the FFIEC 031, the
FFIEC 041, or the FFIEC 051), as applicable.
239 If the banking organization has not reported
trading assets and trading liabilities for each of the
preceding four calendar quarters, the threshold
would be based on the average amount of trading
assets and trading liabilities over the quarters that
the banking organization has reported, unless the
primary Federal supervisor notifies the banking
organization in writing to use an alternative
method.
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64095
determining applicability of subpart F of
the capital rule, a banking organization
would exclude from its calculation of
aggregate trading assets and trading
liabilities securities related to certain
segregated accounts established by a
subsidiary of a banking organization
pursuant to SEC Rule 15c3–3 and CFTC
Regulation 1.20 (customer and
proprietary broker-dealer reserve bank
accounts). To protect customers against
losses arising from a broker-dealer’s use
of customer assets and cash, the SEC’s
and CFTC’s requirements for customer
and proprietary broker-dealer reserve
bank accounts limit the ability of a
banking organization to benefit from
short-term price movements on the
assets held in such accounts. When
such accounts constitute the vast
majority of a banking organization’s
trading activities, the prudential benefit
of requiring the banking organization to
measure risk-weighted assets for market
risk would be limited. The proposal
would only allow a banking
organization to exclude these amounts
from proposed trading activity
thresholds for the purpose of
determining whether the banking
organization is subject to market risk
capital requirements. If a banking
organization exceeds either of the
proposed trading threshold criteria after
excluding such accounts, the proposal
would require the banking organization
to include such accounts when
calculating market risk capital
requirements.
b. Application of Proposed Rule
The proposal would require a banking
organization to comply with the market
risk capital requirements beginning the
quarter after the banking organization
meets any of the proposed scoping
criteria. To avoid volatility in
requirements, a banking organization
would remain subject to market risk
capital requirements unless and until (1)
it falls below the trading activity
threshold criteria for each of four
consecutive quarters or is no longer a
banking organization subject to Category
I, II, III, or IV capital standards, as
applicable, and (2) has provided notice
to its primary Federal supervisor.
Implementing the proposed market
risk capital requirements would require
significant operational preparation.
Therefore, the agencies expect that that
a banking organization would monitor
its aggregate trading assets and trading
liabilities on an ongoing basis and work
with its primary Federal supervisor as it
approaches any of the proposed scoping
criteria to prepare for compliance. To
facilitate supervisory oversight, the
proposal would require a banking
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organization to notify its primary
Federal supervisor after falling below
the relevant scope thresholds.
While the proposed threshold criteria
for application of market risk capital
requirements would help reasonably
identify a banking organization with
significant levels of trading activity
given the current risk profile of the
banking organization, there may be
unique instances where a banking
organization either should or should not
be required to reflect market risk in its
risk-based capital requirements. To
continue to allow the agencies to
address such instances on a case-by-case
basis, the proposal would retain,
without modification, the authority
under subpart F of the capital rule for
the primary Federal supervisor to either:
(1) require a banking organization that
does not meet the proposed threshold
criteria to calculate the proposed market
risk capital requirements, or (2) exclude
a banking organization that meets the
proposed threshold criteria from such
calculation, as appropriate. To allow the
agencies to address such instances on a
case-by-case basis, the proposal would
retain such existing authority under
subpart F of the capital rule.
Question 80: The agencies seek
comment on the appropriateness of the
proposed scope of application
thresholds. Given the compliance costs
associated with the proposal, what, if
any, alternative thresholds should the
agencies consider and why?
Question 81: What are the advantages
or disadvantages of using a four-quarter
rolling average for the $5 billion
aggregate trading assets and trading
liabilities scope of application
threshold? What different
methodologies and time periods should
the agencies consider for purposes of
this threshold?
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3. Market Risk Covered Position
Subpart F of the capital rule applies
to a banking organization’s covered
positions, which are defined to include,
subject to certain restrictions: (i) any
trading asset or trading liability as
reported on a banking organization’s
regulatory reports that is a trading
position 240 or that hedges another
covered position and is free of any
restrictive covenants on its tradability or
for which the material risk elements
may be hedged by the banking
organization in a two-way market, and
240 The current capital rule defines a trading
position as one that is held by a banking
organization for the purpose of short-term resale or
with the intent of benefiting from actual or expected
short-term price movements or to lock-in arbitrage
profits.
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(ii) any foreign exchange 241 or
commodity position regardless of
whether such position is a trading asset
or trading liability. The definition of a
covered position also explicitly
excludes certain positions. Thus, the
definition is structured into three broad
categories, each subject to certain
conditions: trading assets or liabilities
that are covered positions, positions that
are covered positions regardless of
whether they are trading assets or
trading liabilities, and exclusions.
The proposal would retain the
structure and major elements of the
existing definition of covered position
(re-designated as ‘‘market risk covered
position’’) with several modifications
intended to better align the definition of
market risk covered position with those
positions the agencies believe should be
subject to the market risk capital
requirements as well as to reflect other
proposed changes to the framework (for
example, to incorporate the proposed
treatment of internal risk transfers). The
proposed revisions would also help
promote consistency and comparability
in the risk-based capital treatment of
positions across banking organizations.
for example by hedging its trading
positions, and therefore expose a
banking organization to significant
market risk.
a. Trading Assets and Trading Liabilities
That Would Be Market Risk Covered
Positions Under the Proposal
The proposed definition of market
risk covered position would expand to
explicitly include any trading asset or
trading liability that is held for the
purpose of regular dealing or making a
market in securities or other
instruments.242 243 In general, such
positions are held to facilitate sales to
customers or otherwise to support the
banking organization’s trading activities,
b. Positions That Would Be Market Risk
Covered Positions Under the Proposal
Regardless of Whether They Are
Trading Assets or Trading Liabilities
The proposal would include as
market risk covered positions certain
positions or hedges of such positions 244
regardless of whether the position is a
trading asset or trading liability.245
Consistent with subpart F of the current
capital rule, such positions would
continue to include foreign exchange
and commodity positions with certain
exclusions. In particular, the proposal
would continue to allow a banking
organization to exclude structural
positions in a foreign currency from
market risk covered positions with prior
approval from its primary Federal
supervisor. In addition, the proposal
would exclude from market risk covered
positions foreign exchange and
commodity positions that are eligible
CVA hedges that mitigate the exposure
component of CVA risk.246
The proposal would also expand the
types of positions that would be market
risk covered positions, even if not
categorized as trading assets or trading
liabilities, to include the following, each
discussed further below: (i) certain
equity positions in an investment fund;
(ii) net short risk positions; (iii) certain
publicly traded equity positions; 247 (iv)
embedded derivatives on instruments
issued by the banking organization that
relate to credit or equity risk and that
the banking organization bifurcates for
accounting purposes; 248 and (v) certain
241 With prior approval from its primary Federal
supervisor, a banking organization may exclude
from its market risk covered positions any
structural position in a foreign currency, which is
defined as a position that is not a trading position
and that is (i) a subordinated debt, equity or
minority interest in a consolidated subsidiary that
is denominated in a foreign currency; (ii) capital
assigned to foreign branches that is denominated in
a foreign currency; (iii) a position related to an
unconsolidated subsidiary or another item that is
denominated in a foreign currency and that is
deducted from the banking organization’s tier 1 or
tier 2 capital, or (iv) a position designed to hedge
a banking organization’s capital ratios or earnings
against the effect of adverse exchange rate
movements on (i), (ii), or (iii).
242 The proposal also would require such a
position to be free of any restrictive covenants on
its tradability or for the banking organization to be
able to hedge the material risk elements of such a
position in a two-way market.
243 The proposed definition of market risk
covered position would include correlation trading
positions and instruments resulting from securities
underwriting commitments where the securities are
purchased by the banking organization on the
settlement date, excluding purchases that are held
to maturity or available for sale purposes.
244 A position that hedges a trading position must
be within the scope of the banking organization’s
hedging strategy as described in § ll.203(a)(2) of
the proposed rule.
245 Extending market risk covered positions to
also include such hedges is intended to encourage
sound risk management by allowing a banking
organization to capture both the underlying market
risk covered position and any associated hedge(s)
when calculating its market risk capital
requirements. Consistent with current practice, the
agencies would review a banking organization’s
hedging strategies to ensure the appropriate
designation of positions subject to subpart F of the
capital rule.
246 An eligible CVA hedge generally would
include an external CVA hedge or a CVA hedge that
is the CVA segment of an internal risk transfer. See
section III.I.3.b. of this SUPPLEMENTARY INFORMATION
for more detail on the treatment and recognition of
CVA hedges either under the proposed CVA risk
framework or the market risk framework.
247 Equity positions arising from deferred
compensation plans, employee stock ownership
plans, and retirement plans would not be included
in the scope of market risk covered position.
248 This would apply to hybrid contracts
containing an embedded derivative that must be
separated from the host contract and accounted for
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positions associated with internal risk
transfer under the proposal.249
First, the proposal would include as
a market risk covered position an equity
position in an investment fund for
which the banking organization has
access to the fund’s prospectus,
partnership agreement, or similar
contract that defines the fund’s
permissible investments and investment
limits, and which meets one of two
conditions. Specifically, the banking
organization would either need to (i) be
able to use the look-through approach to
calculate a market risk capital
requirement for its proportional
ownership share of each exposure held
by the investment fund, or (ii) obtain
daily price quotes for the investment
fund.
In contrast to the current covered
position definition, which in part relies
on the legal form of the investment fund
by referencing the Investment Company
Act to determine whether an equity
position in such a fund is a covered
position, the proposed criteria would
capture equity positions for which there
is sufficient transparency to be reliably
valued on a daily basis, either from an
observable market price for the equity
position in the investment fund itself or
from the banking organization’s ability
to identify the underlying positions held
by the investment fund.
Second, the proposal would introduce
a new term, net short risk positions, to
describe over-hedges of credit and
equity exposures that are not market
risk covered positions. As the hedged
exposures from which such positions
originate are not traded, net short risk
positions would not meet the definition
of trading position even though they
expose the banking organization to
market risk.250 The agencies propose to
include net short risk positions in
market risk covered positions in order to
help ensure that such exposures are
appropriately reflected in banking
organizations’ risk-based capital
requirements.
For example, assume a banking
organization purchases an eligible credit
derivative (for example, a credit default
swap) to mitigate the credit risk arising
from a loan that is not a market risk
covered position and the notional
as a derivative instrument under ASC Topic 815,
Derivatives and Hedging (formerly FASB Statement
No. 133 ‘‘Accounting for Derivative Instruments
and Hedging Activities,’’ as amended).
249 See section III.H.4 of this SUPPLEMENTARY
INFORMATION for further detail on eligible internal
risk transfer positions.
250 The proposal would retain, without
modification, the existing definition of trading
position in subpart F of the current capital rule. See
12 CFR 3.202 (OCC); 12 CFR 217.202 (Board); 12
CFR 324.202 (FDIC).
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amount of protection provided by the
credit default swap exceeds the loan
exposure amount. The banking
organization is exposed to additional
market risk on the exposure arising from
the difference between the amount of
protection purchased and the amount of
protected exposure because the value of
the protection would fall if the credit
spread of the credit default swap
narrows. Neither subpart D nor E 251 of
the capital rule would require the
banking organization to reflect this risk
in risk-weighted assets. To capture the
market risk arising from net short risk
positions, the proposal would require
the banking organization to treat such
positions as market risk covered
positions.
To calculate the exposure amount of
a net short risk position, the proposal
would require a banking organization to
compare the notional amounts of its
long and short credit positions and the
adjusted notional amounts of its long
and short equity positions that are not
market risk covered positions.252 For
purposes of this calculation, the
notional amounts would include the
total funded and unfunded
commitments for loans that are not
market risk covered positions.
Additionally, as a banking organization
may hedge exposures at either the
single-name level or the portfolio level,
the proposal would require a banking
organization to identify separately net
short risk positions for single name
exposures and for index hedges. For
single-name exposures, the proposal
would require a banking organization to
evaluate its long and short equity and
credit exposures for all positions
referencing a single exposure to
determine if it has a net short risk
position in a single-name exposure. For
index hedges, the proposal would
require a banking organization to
evaluate its long and short equity and
credit exposures for all positions in the
portfolio (aggregating across all relevant
individual exposures) to determine if it
has a net short risk position for any
given portfolio.
The proposal would limit the
application of the proposed market risk
capital requirements to positions arising
from exposures for which the notional
amount of a short position exceeds the
notional amount of a long position by
251 Under the proposal, subpart D would cover a
Standardized Approach and subpart E would cover
an Expanded Risk-Based Approach for RiskWeighted Assets.
252 For equity derivatives, the adjusted notional
amount would be the product of the current price
of one unit of the stock (for example, a share of
equity) and the number of units referenced by the
trade.
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$20 million or more at either the singlename or index hedge level. Exposures
arising from net short risk positions are
a potential area where a banking
organization may maintain insufficient
capital relative to the market risk and
should be monitored at the single name
or portfolio level rather than in the
aggregate. The agencies nonetheless
recognize that it could be burdensome
to require a banking organization to
capture every net short exposure that
may arise, regardless of size or duration,
when calculating their market risk
capital requirements. Accordingly, the
proposed $20 million threshold is
intended to help ensure that individual
net short risk exposures that could
materially impact the risk-based capital
requirements of a banking organization
would be appropriately reflected in the
proposed market risk capital
requirements. Additionally, the
proposed $20 million threshold is
intended to strike a balance between
over-hedging concerns and aligning
incentives for banking organizations to
prudently hedge and manage risk while
capturing positions for which a market
risk capital requirement would be
appropriate. For example, if a loan
amortizes more quickly than expected,
due to a borrower making additional
payments to pay down principal, the
amount of notional protection would
only constitute a net short risk position
if it exceeds the amount of the total
committed loan balance by $20 million
or more. The operational burden of
requiring a banking organization to
capture temporary or small differences
due to accelerated amortization within
its market risk capital requirements
could inhibit the banking organization
from engaging in prudential hedging
and sound risk management. The
proposal would require a banking
organization to calculate net short risk
positions on a spot, quarter-end basis,
consistent with regulatory reporting, in
order to reduce the operational burden
of identifying such positions subject to
the proposed market risk capital
requirements.
Third, the proposal generally would
include as market risk covered positions
all publicly traded equity positions 253
253 The proposal would not change the current
capital rule’s definition of publicly traded as traded
on: (1) any exchange registered with the SEC as a
national securities exchange under section 6 of the
Securities Exchange Act of 1934 (15 U.S.C. 78f); or
(2) any non-U.S.-based securities exchange that is
registered with, or approved by, a national
securities regulatory authority and that provides a
liquid, two-way market for the instrument in
question. Consistent with the current capital rule,
the proposal would define a two-way market as a
market where there are independent bona fide
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regardless of whether they are trading
assets or trading liabilities and provided
that there are no restrictions on the
tradability of such positions.
Fourth, a banking organization may
issue hybrid instruments that contain an
embedded derivative related to credit or
equity risk and a host contract and
bifurcate the derivative and the host
contract for accounting purposes under
GAAP. Under such circumstances, the
proposal would include the embedded
derivative in the definition of market
risk covered position regardless of
whether GAAP treats the derivative as a
trading asset or a trading liability. If the
banking organization elected to report
the entire hybrid instrument at fair
value under the fair value option rather
than bifurcating the accounting, it
would be a market risk covered position
only if it otherwise met the proposed
definition, such as held with trading
intent or to hedge another market risk
covered position.254 This approach
would capture the market risk of
embedded derivatives a banking
organization faces when it issues such
hybrid instruments while being
sensitive to the operational challenges
of requiring banking organizations to
calculate the fair value such derivatives
on a daily basis, and also appropriately
excluding conventional instruments
with an embedded derivative for which
the capital requirements under subpart
D or E of the capital rule would be
appropriate.255
Fifth, the proposed definition of
market risk covered position would
include certain transactions of internal
risk transfers, as described in section
III.H.4 of this SUPPLEMENTARY
INFORMATION, based in certain cases on
the eligibility of the internal risk
transfers. The market risk covered
position would explicitly include (1) the
trading desk segment of an eligible
internal risk transfer of credit risk or
interest rate risk and the trading desk
offers to buy and sell so that a price reasonably
related to the last sales price or current bona fide
competitive bid and offer quotations can be
determined within one day and settled at that price
within a relatively short time frame conforming to
trade custom.
254 For purposes of regulatory reporting, the
instructions to the Y–9C and Call Report require a
banking organization to classify as trading securities
all debt securities that a banking organization has
elected to report at fair value under a fair value
option with changes in fair value reported in
current earnings, regardless of whether such
positions are held with trading intent. ASC 815–15–
25–4 permits both issuers of and investors in hybrid
financial instruments that would otherwise require
bifurcation of an embedded derivative to elect at
acquisition, issuance or a new basis event to carry
such instrument at fair value with all changes in
fair value reported in earnings.
255 For example, a conventional mortgage loan
contains an embedded prepayment or call option.
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segment of an internal risk transfer of
CVA risk; (2) certain external
transactions based on eligibility of the
risk transfers, executed by a trading
desk related to an internal risk transfer
of CVA, credit, or interest rate risk, and
(3) both external and internal ineligible
CVA hedges (an internal CVA hedge is
the CVA segment of an internal transfer
of CVA risk). This aspect of the proposal
is intended to help promote consistency
and comparability in the risk-based
capital treatment of such positions
across banking organizations and ensure
the appropriate capitalization of such
positions under subparts D, E, or F of
the capital rule.
c. Exclusions From the Proposed
Definition of Market Risk Covered
Position
The definition of a covered position
under subpart F of the current capital
rule explicitly excludes certain
positions.256 These excluded
instruments and positions generally
reflect the fact that they are either
deducted from regulatory capital,
explicitly addressed under subpart D or
E of the current capital rule, have
significant constraints in terms of a
banking organization’s ability to
liquidate them readily and value them
reliably on a daily basis, or are not held
with trading intent.
Consistent with subpart F of the
current capital rule, the proposal would
continue to exclude from the definition
of market risk covered positions any
intangible asset, including any servicing
asset; any hedge of a trading position
that the banking organization’s primary
Federal supervisor determines to be
outside the scope of the banking
organization’s trading and hedging
strategy; any instrument that, in form or
substance, acts as a liquidity facility that
provides support to asset-backed
commercial paper, and any position a
banking organization holds with the
intent to securitize.
The proposed definition would also
continue to exclude from market risk
covered positions any direct real estate
holdings.257 Consistent with past
guidance from the agencies, indirect
investments in real estate, such as
through REITs or special purpose
vehicles, would not be direct real estate
holdings and could be market risk
256 See 77 FR 53060, 53064–53065 (August 30,
2012) for a more detailed discussion on these
exclusions under the market risk capital rule.
257 Direct real estate holdings include real estate
for which the banking organization holds title, such
as ‘‘other real estate owned’’ held from foreclosure
activities, and bank premises used by the bank as
part of its ongoing business activities.
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covered positions if they meet the
proposed definition.258
The proposed definition would also
exclude from market risk covered
positions any non-publicly traded
equity positions, other than certain
equity positions in investment funds,
and would additionally exclude: (1) a
publicly traded equity position that has
restrictions on tradability; (2) a publicly
traded equity position that is a
significant investment in the capital of
an unconsolidated financial institution
in the form of common stock not
deducted from regulatory capital, and
(3) any equity position in an investment
fund that is not a trading asset or trading
liability or that otherwise does not meet
the requirements to be a market risk
covered position. The proposed
definition would add an exclusion for
any derivative instrument or exposure
to an investment fund that has material
exposures to any of the preceding
excluded instruments or positions
discussed in this section.
To provide additional clarity, the
proposal would also exclude from
market risk covered positions debt
securities for which the banking
organization elects the fair value option
for purposes of asset and liability
management, as such positions are not
reflective of a banking organization’s
trading activity. The proposal would
also add an exclusion for instruments
held for the purpose of hedging a
particular risk of a position in any of the
preceding excluded types of
instruments discussed in this section.
With respect to internal risk transfers
of CVA risks, the proposed definition
would exclude from market risk covered
positions the CVA segment of an
internal risk transfer that is an eligible
CVA hedge. In addition, consistent with
the Basel III reforms, only positions
recognized as eligible external CVA
hedges under either the basic or
standardized capital requirements for
CVA risk would be excluded from the
market risk capital requirements.259 To
the extent a banking organization enters
into one or more external hedges that
hedge CVA variability but do not qualify
as eligible hedges under the revised
CVA capital standards, the banking
organization would need to capture
such hedges in its market risk capital
258 See 77 FR 53060, 53065 (August 30, 2012) for
the agencies’ interpretive guidance on the treatment
of such indirect holdings under subpart F of the
capital rule.
259 External transactions executed by a trading
desk as matching transactions to all internal
transfers of CVA risk would be market risk covered
positions under the proposal. See section III.H.3.b
of this SUPPLEMENTARY INFORMATION for a more
detailed discussion on the treatment of eligible and
ineligible internal risk transfers of CVA risk.
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requirements and would not be able to
recognize the benefit of the external
hedge when calculating risk-based
capital requirements for CVA risk.
Question 82: The agencies seek
comment on the appropriateness of the
proposed definition of market risk
covered position. What, if any, practical
challenges might the proposed
definition pose for banking
organizations, such as the ability to fair
value daily any of the proposed
instruments that would be captured by
the definition? 260
Question 83: The agencies seek
comment on the extent to which limiting
the proposed definition of market risk
covered position to include equity
positions in investment funds only for
which a banking organization has
access to the fund’s investments limits
(as specified in the fund’s prospectus,
partnership agreement, or similar
contract that define the fund’s
permissible investments) appropriately
captures the types of positions that
should be subject to regulatory capital
requirements under the proposed
market risk framework. What types of
investment funds, if any, would a
banking organization have the ability to
value reliably on a daily basis that do
not meet this condition?
Question 84: The agencies seek
comment on whether the agencies
should consider allowing a banking
organization to exclude from the
definition of market risk covered
position investments in capital
instruments or covered debt instruments
of financial institutions that have been
deducted from tier 1 capital, including
investments in publicly-traded common
stock of financial institutions, and
hedges of these investments that meet
the requirements to offset such positions
for purposes of determining deductions.
What would the benefits and drawbacks
be of not providing such an optionality?
Question 85: For the purposes of
determining whether certain positions
are within the definition of market risk
covered position, is the proposed
definition of net short risk position
260 For banking organizations subject to subpart F
of the capital rule, the Volcker Rule defines the
scope of instruments subject to the proprietary
trading prohibition (trading account) based on two
prongs: market risk capital rule covered positions
that are trading positions, and instruments
purchased or sold in connection with the business
of a dealer, swap dealer, or securities-based swap
dealer that require it to be licensed or registered as
such. The proposed revisions to the definition of
covered positions under subpart F of the capital
rule could alter the scope of financial instruments
deemed to be in the trading account under the
Volcker Rule, but only to the extent that a market
risk covered position is also a trading position and
the position is not otherwise excluded from the
Volcker rule definition of trading account.
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appropriate, and why? What, if any,
alternative measures should the
agencies consider to identify net short
risk positions and why would these be
more appropriate?
Question 86: The agencies seek
comment on whether the proposed $20
million threshold is an appropriate
measure for identifying significant net
short risk exposures that warrant
capitalization under the market risk
framework. What alternative thresholds
or methods should the agencies
consider for identifying significant net
short risk positions, and why would
these alternatives be more appropriate
than the proposed $20 million
threshold?
Question 87: What, if any, challenges
might banking organizations face in
calculating the market risk capital
requirement for net short risk positions?
In particular, what, if any, alternatives
to the total commitment for loans
should the agencies consider using to
calculate notional amount—for
example, delta notional values rather
than notional amount, present value,
sensitivities—and why would any such
alternatives be a better metric? Please
provide specific details on the
mechanics of and rationale for any
suggested methodology. In addition,
which, if any, of the items to be
included in a banking organization’s net
short credit or equity risk position may
present operational difficulties and
what is the nature of such difficulties?
How could such concerns be mitigated?
Question 88: The agencies seek
comment on whether to modify the
exclusion for debt instruments for which
a banking organization has elected to
apply the fair value option that are used
for asset and liability management
purposes. Would such an exclusion be
overly restrictive, and, if so, why and
how should the exclusion be expanded?
Please specify the types and amounts of
debt instruments for which banking
organizations apply the fair value
option that should be covered under this
exclusion, and the capital implications
of expanding the exclusion relative to
the proposal.
Question 89: The agencies seek
comment on whether to modify the
criteria for including external CVA
hedges in the scope of market risk
covered position. What are the benefits
and drawbacks of requiring a banking
organization to include ineligible
external CVA hedges in the market risk
capital requirements, provided a
banking organization has effective risk
management and an effective hedging
program?
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64099
4. Internal Risk Transfers
A banking organization may choose to
hedge the risks of certain positions 261
held by a banking unit or a CVA desk
by having one of its trading desks obtain
the hedge and subsequently transfer the
hedge position through an internal
transaction to the banking unit or the
CVA desk. The current capital rule does
not address the transfers of risk from a
banking unit or a CVA desk (or a
functional equivalent thereof) to a
trading desk within the same banking
organization 262 (internal risk transfers),
for example between a mortgage
banking unit and a rates trading desk.
Thus, market risk-weighted assets do
not reflect the market risk of such
internal transactions and capture only
the external portion of the hedge,
potentially misrepresenting the risk
position of the banking organization.
Accordingly, the proposal would
define internal risk transfers and
establish a set of requirements including
documentation and other conditions for
a banking organization to recognize
certain types of internal risk transfers in
risk-based capital requirements. The
proposal would define internal risk
transfers as a transfer executed through
internal derivatives trades of credit risk
or interest rate risk arising from an
exposure capitalized under subparts D
or E of the capital rule to a trading desk,
or a transfer of CVA risk arising from a
CVA desk (or the functional equivalent
if the banking organization does not
have any CVA desks) to a trading
desk.263 The proposed definition of
internal risk transfer would not include
transfers of risk from a trading desk to
a banking unit or between trading desks
because such transactions present the
types of risks appropriately captured in
market risk-weighted assets.264
In practice, for internal risk
management purposes, most banking
261 Such risks can include credit, interest rate, or
CVA risk arising from exposures that are subject to
risk-based requirements under subpart D or E of the
capital rule.
262 For example, if the banking organization is a
depository institution within a holding company
structure, transactions conducted between the
depository institution and an affiliated brokerdealer entity would not qualify as transactions
within the same banking organization for the
depository institution. Such transactions would
qualify as transactions within the same banking
organization for the consolidated holding company.
263 An internal risk transfer transaction would
comprise two perfectly offsetting segments—one
segment for each of two parties to the transaction.
264 As described in section III.H.7.c.ii of this
SUPPLEMENTARY INFORMATION, for transfers of risk
between a trading desk that uses the standardized
measure and a trading desk that uses the internal
models approach, a banking organization may
exclude the leg of the transaction acquired by the
trading desk using the standardized approach from
the residual risk add-on.
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organizations already document the
source of risk being hedged and the
trading desk providing the hedge. As a
result, the agencies do not expect the
proposed documentation requirements
for such transactions to qualify as
eligible internal risk transfers, as
described in more detail below, to pose
a significant compliance burden on
banking organizations. The agencies
encourage prudent risk management
and believe this aspect of the proposal
will help promote consistency and
comparability in the risk-based capital
treatment of such internal transactions
across banking organizations and ensure
the appropriate capitalization of such
positions.
a. Internal Risk Transfers of Credit Risk
The Basel III reforms introduce riskbased capital treatment of internal
transfers of credit risk executed from a
banking unit to a trading desk to hedge
the credit risk arising from exposures in
the banking unit. The proposal is
generally consistent with the Basel III
reforms by specifying the criteria for
internal risk transfer eligibility and
clarifying the scope of exposures subject
to market risk capital requirements.
Specifically, the banking organization
would be required to maintain
documentation identifying the
underlying exposure under subpart D or
E of the capital rule being hedged and
its sources of credit risk. In addition, a
trading desk would be required to enter
into an external hedge that meets the
requirements of § ll.36 of the current
capital rule or § ll.120 of the
proposed rule and matches the terms,
other than amount, of the internal credit
risk transfer.
When these requirements are met, the
transaction would qualify as an eligible
internal risk transfer, for which the
banking unit would be allowed to
recognize the amount of the hedge
position received from the trading desk
as a credit risk mitigant when
calculating the risk-based capital
requirements for the underlying
exposure under subpart D or E of the
capital rule. Since the trading desk
enters into external hedges to manage
credit risk arising from banking unit
exposures, such external hedges would
be included in the scope of market risk
covered positions along with the
internal risk transfer (the trading desk
segment), where they would cancel each
other provided the amounts and terms
of both transactions match.
Nevertheless, if the internal risk transfer
results in a net short credit position for
the banking unit, the trading desk
would be required to calculate riskbased capital requirements for such
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positions under subpart F of the capital
rule. A net short risk credit position
results when the external hedge exceeds
the amount required by the banking unit
to hedge the underlying exposure under
subpart D or E of the capital rule.
For transactions that do not meet
these requirements, the proposal would
require a banking organization to
disregard the internal risk transfer (the
trading desk segment) from the market
risk covered positions. The proposal
would subject the entire amount of the
external hedge acquired by the trading
desk to the proposed market risk capital
requirements and disallow any
recognition of risk mitigation benefits of
the internal credit risk transfer under
subpart D or E of the capital rule.
b. Internal Risk Transfers of Interest
Rate Risk
The proposal would specify the riskbased capital treatment of internal
transfers of interest rate risk from a
banking unit to the trading desk to
hedge the interest rate risk arising from
the banking unit. When a banking
organization executes an internal
interest rate risk transfer between a
banking unit and a trading desk, the
transferred interest rate risk exposure
would be considered an eligible risk
transfer that the banking organization
may treat as a market risk covered
position only if such internal risk
transfer meets a set of requirements.
Specifically, the banking organization
would be required to maintain
documentation of the underlying
exposure being hedged and its sources
of interest rate risk. In addition, given
the complexity of tracking the direction
of internal transfers of interest rate risk,
the proposal would allow a banking
organization to establish a dedicated
notional trading desk for conducting
internal risk transfers to hedge interest
rate risk. The proposal would require
such a desk to receive approval from its
primary Federal supervisor to execute
such internal risk transfers.265 The
proposal would require the
capitalization of trading desks that
engage in such transactions on a
standalone basis, without regard to
other market risks generated by
activities on the trading desk.
When these requirements are met, the
transaction would qualify as an eligible
internal interest rate risk transfer, for
which the banking organization may
recognize the hedge benefit of an
internal derivative transaction. A
265 The proposal would not require banking
organizations to purchase the hedge from a third
party for such transactions to qualify as an internal
risk transfer.
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trading desk that conducts internal risk
transfers of interest rate risk may enter
into external hedges to mitigate the risk
but would not be required to do so
under the proposal. As the amount
transferred to the trading desk from the
banking unit to hedge the underlying
exposure under subpart D or E of the
capital rule would be a market risk
covered position, any such external
hedges would also be market risk
covered positions and thus also subject
to the proposed market risk capital
requirements.266
For transactions that do not meet
these requirements, a banking
organization would be required to
exclude the internal interest rate risk
transfer (the trading desk segment) from
its market risk covered positions. The
entire amount of any external hedge of
an ineligible internal risk transfer would
be a market risk covered position.
c. Internal Risk Transfers of CVA Risk
The proposal would specify the
capital treatment of internal CVA risk
transfers executed between a CVA desk
(or the functional equivalent thereof)
and a trading desk to hedge CVA risk
arising from exposures that are subject
to the proposed capital requirements for
CVA risk.
Under the proposal, an internal CVA
risk transfer would involve two
perfectly offsetting positions of a
derivative transaction executed between
a CVA desk and a trading desk. For the
CVA desk to recognize the risk
mitigation benefits of the internal risk
transfer under the risk-based capital
requirements for CVA risk, the proposal
would require the banking organization
to have a dedicated CVA desk or the
functional equivalent thereof that, along
with other functions performed by the
desk, manages internal risk transfers of
CVA risk. In either case, such a desk
would not need to satisfy the proposed
trading desk definition, given the
proposed risk-based capital
requirements for CVA risk are not
calibrated at the trading desk level.
Additionally, the proposal would
require a banking organization to
maintain an internal written record of
each internal derivative transaction
executed between the CVA desk and the
trading desk, including identifying the
underlying exposure being hedged by
the CVA desk and the sources of such
266 As the trading desk segments of eligible
internal risk transfers of interest rate risk would be
market risk covered positions, to the extent a
trading desk enters into external hedges to mitigate
the risk of such positions, the external hedge would
also be subject to the market risk capital rule and
could in whole or in part offset the market risk of
the eligible internal risk transfer.
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risk. Furthermore, if the internal risk
transfer from the CVA desk to the
trading desk is subject to curvature risk,
default risk, or the residual risk add-on
under the proposed market risk capital
rule, as described in sections
III.H.7.a.ii.III., III.H.7.b., and III.H.7.c of
this SUPPLEMENTARY INFORMATION,
respectively, the trading desk would
have to execute an external transaction
with a third party that is identical in its
terms to the risk transferred by the CVA
desk to the trading desk. This external
transaction would be included in
market risk covered positions; therefore,
there would be no impact to the market
risk capital required for the trading desk
as the external transaction would
perfectly offset the risk from the internal
risk transfer. Given the difference in
recognizing the curvature risk, the
default risk, or the residual risk add-on
under the proposed market risk capital
requirements and the CVA risk capital
requirements, as well as complexity of
tracking and ensuring the
appropriateness of internal transfers of
CVA risk, the external matching
transaction requirement is intended to
ensure the complete offsetting of the
above mentioned risks at the time the
trades are originated, facilitate the
identification by the primary Federal
supervisor of the underlying position or
sources of risk being hedged by the
internal risk transfer, and thus the
determination of whether the transfer is
an eligible internal CVA risk transfer.
In addition to the above-mentioned
requirements for the internal transaction
and the related external matching
transaction to qualify as an eligible
internal risk transfer of CVA risk, the
proposal sets forth general requirements
for the recognition of CVA hedges that
would be applicable to both internal
transfers of CVA risk and external CVA
hedges. The proposal specifies these
requirements for both the basic
approach for CVA risk and standardized
approach for CVA risk, as described in
section III.I.3 of this SUPPLEMENTARY
INFORMATION.267
For eligible internal risk transfers of
CVA risk, the banking organization
would be required to treat the transfers
of risk from the CVA desk or the
functional equivalent to the trading desk
as market risk covered positions. In this
way, the proposal would allow the CVA
desk to recognize the risk-mitigating
267 While the basic approach for CVA applies
certain restrictions on eligible instrument types for
hedges to be recognized as eligible, the
standardized approach for CVA risk allows for a
broader set of hedging instruments. Moreover, the
standardized approach for CVA risk would also
recognize as eligible hedges instruments that are
used to hedge the exposure component of CVA risk.
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benefit of the hedge position received
from the trading desk when calculating
risk-based capital requirements for CVA
risk. As the overall risk profile of the
banking organization would not have
changed, the proposed treatment would
require the trading desk to reflect the
impact of the risk transferred from the
CVA desk as part of the transaction in
the proposed market risk capital
requirements.
For transactions that do not meet
these requirements or the general hedge
eligibility requirements under the basic
approach for CVA risk or the
standardized approach for CVA risk, a
banking organization would be required
to include both the trading desk
segment and the CVA segment of the
internal transfer of CVA risk in market
risk-weighted assets. This is equivalent
to disregarding the internal CVA risk
transfer. The entire amount of the
external matching transaction executed
by the non-CVA trading desk in the
context of an internal CVA risk transfer
would be deemed a market risk covered
position. In addition, the CVA desk
would not be able to recognize any risk
mitigation or offsetting benefit from the
ineligible internal risk transfer in its
capital requirements for CVA risk.
d. Internal Risk Transfers of Equity Risk
The agencies are not proposing to
allow a banking organization to
recognize any risk mitigation benefits
for internal equity risk transfers
executed between a trading desk and a
banking unit to hedge exposures that are
subject to either subpart D or E of the
capital rule. The proposed definition of
market risk covered position would
include equity positions that are
publicly traded with no restrictions on
tradability. Given the expanded scope of
equity positions that would be subject to
the proposed market risk capital
requirements as discussed above, the
agencies believe that primarily illiquid
or irregularly traded equity positions
would remain subject to subparts D or
E of the capital rule. As a banking
organization would not be able to hedge
the material risk elements of such equity
positions in a liquid, two-way market,
consistent with the current framework,
the proposal would not allow a banking
organization to recognize internal
transfers of equity risk of such positions
for risk-based capital purposes.
Question 90: The agencies seek
comment on any operational challenges
of the proposed internal risk transfer
framework, in particular any potential
difficulties related to internal risk
transfers executed before
implementation of the proposed market
risk capital rule. What is the nature of
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64101
such difficulties and how could they be
mitigated?
Question 91: The agencies seek
comment on the extent to which the
proposed internal risk transfer
framework would incentivize hedging
and prudent risk management and/or
provide opportunity to misrepresent the
risk profile of a banking organization.
What, if any, additional requirements or
other modifications should the agencies
consider?
Question 92: The agencies seek
comment on the appropriateness of the
proposed eligibility requirements for a
banking unit to recognize the risk
mitigation benefit of an eligible internal
risk transfer of credit risk. What, if any,
additional requirements or other
modifications should the agencies
consider, and why?
Question 93: What, if any, operational
burden might the proposed exclusion
for the credit risk segment of internal
risk transfers pose for banking
organizations? What, if any, alternatives
should the agencies consider to
appropriately exclude the types of
positions that should be captured under
subpart D or E of the capital rule, but
would impose less operational burden
relative to the proposal?
Question 94: The agencies seek
comment on subjecting the internal risk
transfers of interest rate risk to the
market risk capital requirements on a
standalone basis. What are the benefits
and costs associated with this
requirement?
Question 95: The agencies seek
comment on the matching external
transaction requirements for internal
transfer of CVA risk. Should such
external matching transactions be
subject to additional requirements, such
as those applicable to external hedges of
credit risk, and if so, why?
Question 96: The agencies seek
comment on limiting an eligible internal
risk transfer of CVA risk to only internal
transactions for which the external
transaction perfectly offsets the internal
risk transfer. What, if any, challenges
might this requirement pose and what
should the agencies consider to mitigate
such challenges?
Question 97: The agencies seek
comment on the proposed requirement
that a banking organization’s trading
desk execute a matching transaction
with a third party if the internal risk
transfer of CVA risk is subject to
curvature risk, default risk, or the
residual risk add-on? What other risk
mitigation techniques would the
banking organization implement?
Question 98: The agencies seek
comment on the proposed
documentation requirements for an
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internal risk transfer of credit risk,
interest rate risk, and CVA risk to
qualify as an eligible internal risk
transfer. What, if any, alternatives
should the agencies consider that would
appropriately capture the types of
positions that should be recognized
under subpart D or E of the capital rule?
5. General Requirements for Market Risk
Subpart F of the current capital rule
requires a banking organization to
satisfy certain general risk management
requirements related to the
identification of trading positions,
active management of covered positions,
stress testing, control and oversight, and
documentation. The proposal would
maintain these requirements, as well as
introduce additional requirements. The
additional requirements are designed to
further strengthen a banking
organization’s risk management of
market risk covered positions and to
appropriately reflect other changes
under the proposal such as the
definition of market risk covered
position and the introduction of the
trading desk concept, as described in
sections III.H.3 and III.H.5.b of this
SUPPLEMENTARY INFORMATION. The
proposal would also make certain
related technical corrections to the
requirements around valuation of
market risk covered positions.268
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a. Identification of Market Risk Covered
Positions
Subpart F of the current capital rule
requires a banking organization to have
clearly defined policies and procedures
for determining which trading assets
and trading liabilities are trading
positions and which trading positions
are correlation trading positions, as well
as for actively managing all positions
subject to the rule.
The proposal would expand these
requirements to reflect the proposed
scope and definition of market risk
covered position as described in section
III.H.3 of this SUPPLEMENTARY
INFORMATION. A banking organization
also would be required to update its
policies and procedures for identifying
market risk covered positions at least
annually and to identify positions that
must be excluded from market risk
covered positions. In addition, the
proposal would introduce a new
268 Specifically, to align with the GAAP
considerations for valuation of market risk covered
positions, the proposal would eliminate the market
risk capital rule requirement that a banking
organization’s process for valuing covered positions
must consider, as appropriate, unearned credit
spreads, close-out costs, early termination costs,
investing and funding costs, liquidity, and model
risk. See 12 CFR 3.203(b)(2) (OCC); 12 CFR
217.203(b)(2) (Board); 12 CFR 324.203(b)(2) (FDIC).
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requirement for a banking organization
to establish a formal framework for redesignating a position after its initial
designation as being subject to subpart
F or to subparts D and, as applicable, E
of the capital rule. Specifically, the
proposal would require a banking
organization to establish policies and
procedures that describe the events or
circumstances under which a redesignation would be considered, a
process for identifying such events or
circumstances, any restrictions on redesignations, and the process for
obtaining senior management approval
as well as for notifying the primary
Federal supervisor of material redesignations. These proposed
requirements are intended to
complement the proposed capital
requirement for re-designations
described in section III.H.6.d of this
SUPPLEMENTARY INFORMATION by
ensuring re-designations would occur in
only those circumstances identified by
the banking organization’s senior
management as appropriate to merit redesignation.269
In addition to the requirements for
identifying market risk covered
positions, the proposal would require a
banking organization to have clearly
defined trading and hedging strategies
for its market risk covered positions that
are approved by the banking
organization’s senior management.
Consistent with the capital rule, the
trading strategy would need to specify
the expected holding period and the
market risk of each portfolio of market
risk covered positions, and the hedging
strategy would need to specify the level
of market risk that the banking
organization would be willing to accept
for each portfolio of market risk covered
positions, along with the instruments,
techniques, and strategies for hedging
such risk.
b. Trading Desk
i. Trading Desk Definition
To limit overreliance on internal
models, support more prudent market
risk management practices, and better
align operational requirements with the
level at which trading activity is
conducted, the proposal would
introduce the concept of a trading desk
and apply the proposed internal models
approach at the trading desk level.
269 As described in further detail in section
III.H.6.d of this SUPPLEMENTARY INFORMATION, the
proposal would introduce a capital requirement
(the capital add-on for re-designations) to offset any
potential capital benefit that a banking organization
otherwise might have received from re-classifying
an instrument previously treated under subparts D
or E of the capital rule as a market risk covered
position.
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Regardless of whether a banking
organization uses the standardized or
the models-based measure for market
risk, the proposal would require the
banking organization to satisfy certain
general operational requirements for
each trading desk, as described below in
section III.H.5.c of this SUPPLEMENTARY
INFORMATION. The proposal would
require the banking organization to
satisfy certain additional operational
requirements, as described below in
section III.H.5.d of this SUPPLEMENTARY
INFORMATION, in order for the banking
organization to calculate the market risk
capital requirements for trading desks
under the internal models approach.
The proposal would define trading
desk as a unit of organization of a
banking organization that purchases or
sells market risk covered positions and
satisfies three requirements. First, the
proposal would require a banking
organization to structure a trading desk
pursuant to a well-defined business
strategy. In general, a well-defined
business strategy would include a
written description of the trading desk’s
general strategy, including the
economics behind the business strategy,
the trading and hedging strategies and a
list of the types of instruments and
activities that the desk will use to
accomplish its objectives. The proposal
would require a trading desk to be
organized to ensure the appropriate
setting, monitoring, and management
review of the desk’s trading and hedging
limits and strategies. Third, the proposal
would require that a trading desk be
characterized by a clearly-defined unit
of organization that: (1) engages in
coordinated trading activity with a
unified approach to the key elements of
the proposed rule’s requirements for
trading desk policies and active
management of market risk covered
positions; (2) operates subject to a
common and calibrated set of risk
metrics, risk levels, and joint trading
limits; (3) submits compliance reports
and other information as a unit for
monitoring by management; and (4)
books its trades together.
The proposed trading desk definition
is intended to help ensure that a
banking organization structures its
trading desks to capture the level at
which trading activities are managed
and operated and at which the profit
and loss of the trading strategy is
attributed.270 This approach would
recognize the different strategies and
objectives of discrete units in a banking
270 The proposal would define trading desk in a
manner generally consistent with the Volcker Rule.
See 12 CFR 44.3(e)(14) (OCC); 12 CFR 248.3(e)(14)
(Board); 12 CFR 351.3(e)(14) (FDIC).
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organization’s trading operations. The
proposed parameters provide sufficient
specificity to enable more precise
measures of market risk for the purpose
of determining risk-based capital
requirements, while taking into account
the potential variation in trading
practices across banking organizations.
In this regard, the proposal aims to
reduce the regulatory compliance
burden for banking organizations by
providing flexibility to align the
proposed trading desk definition with
the organizational structure that banking
organizations may already have in place
to carry out their trading activities.
Question 99: What, if any, changes
should the agencies consider making to
the definition of a trading desk and
why? Are there any other key factors
that banking organizations typically use
to define trading desks for business
purposes that the agencies should
consider including in the trading desk
definition to clarify the designation of
trading desks for purposes of the market
risk capital framework?
Question 100: The agencies seek
comment on any implementation
challenges banking organizations with
cross-border operations could face in
applying the proposed trading desk
definition. What are the advantages and
disadvantages of permitting a U.S.
subsidiary of a foreign banking
organization to apply trading desk
designations consistent with its home
country’s regulatory requirements,
provided those requirements are
consistent with the Basel III reforms?
ii. Notional Trading Desk Definition
The proposed definition of market
risk covered position would include
certain types of instruments and
positions that may not arise from, and
may be unrelated to, a banking
organization’s trading activities, such as
net short risk positions, certain
embedded derivatives that are
bifurcated for accounting purposes, as
well as foreign exchange and
commodity exposures that are not
trading assets or trading liabilities.271
When a banking organization enters into
such positions, it may do so in a manner
that causes these positions to appear not
to originate from a banking
organization’s existing trading desks.
To address the issue that certain
trading desk-level requirements are not
applicable to these types of activities
and positions, the proposal would
271 As
noted in section III.H.3.c of this
identifying these
positions for treatment under the proposed rule is
necessary to enhance the rule’s sensitivity to risks
that might not otherwise be captured or adequately
captured by subparts D or E of the capital rule.
SUPPLEMENTARY INFORMATION,
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introduce the concept of a notional
trading desk 272 to which such positions
would be allocated. Under the proposal,
notional trading desks would be subject
to only a subset of the general risk
management requirements applicable to
trading desks. Specifically, the proposal
would require a banking organization to
identify any such positions and
activities allocated to notional trading
desks, as described in section
III.H.5.b.iii of this SUPPLEMENTARY
INFORMATION, but would not require a
banking organization to establish
policies and procedures describing the
trading strategy or risk management for
the notional trading desks or require a
notional trading desk to satisfy the
requirements for active management of
market risk covered positions.
Nevertheless, to qualify for use of the
internal models approach, the proposal
would require a notional trading desk to
satisfy all of the general requirements
for trading desks, as well as those
applicable for the models-based
measure.273
The agencies are proposing to require
a banking organization to identify any
notional trading desks as part of the
trading desk structure requirement,
described in section III.H.5.b.iii of this
SUPPLEMENTARY INFORMATION, to help
ensure that a banking organization
appropriately treats all market risk
covered positions under the capital rule.
The agencies would review a banking
organization’s trading desk structure,
including notional trading desks and
trading desks used for internal risk
transfers, to help ensure that they have
been appropriately identified.
Question 101: What, if any, additional
requirements should apply to notional
trading desks to clarify the level at
which market risk capital requirements
must be calculated? What, if any,
additional types of positions should be
assigned to the notional trading desk
and why?
iii. Trading Desk Structure
The proposal would require a banking
organization to define its trading desk
structure, subject to the requirement
272 The proposal would define a notional trading
desk as a trading desk created for regulatory capital
purposes to account for market risk covered
positions arising under subpart D or subpart E such
as net short risk positions, embedded derivatives on
instruments that the banking organization issued
that relate to credit or equity risk that it bifurcates
for accounting purposes, and foreign exchange
positions and commodity positions. Notional
trading desks would be exempt from certain
requirements applicable to other trading desks, as
discussed in this section III.H.5.b.iv.
273 See section III.H.5.d of this SUPPLEMENTARY
INFORMATION for further discussion on the
requirements applicable to model-eligible trading
desks.
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that the structure must define each
constituent trading desk and identify:
(1) model-eligible trading desks that are
used in the models-based measure for
market risk, (2) model-ineligible trading
desks used in both the standardized
measure and model-based measure for
market risk,274 (3) trading desks that are
used for internal risk transfers (as
applicable), and (4) notional trading
desks (as applicable).275
Additionally, before calculating
market risk capital requirements under
the models-based measure for market
risk, the proposal would require a
banking organization to receive prior
written approval from the primary
Federal supervisor of its trading desk
structure. As part of the model approval
process described in section III.H.5.d.iv
of this SUPPLEMENTARY INFORMATION, the
agencies would consider whether the
level at which a banking organization is
proposing to establish its trading desks
is consistent with the level at which
trading activities are actively managed
and operated. The agencies would also
consider whether the level at which the
banking organization defines each
trading desk is sufficiently granular to
allow the banking organization and the
primary Federal supervisor to assess the
adequacy of the internal models used by
the trading desk. For example, a banking
organization’s proposed trading desk
structure may be considered
insufficiently detailed if it reflects risk
limits, internal controls, and ongoing
management at one or more
organizational levels above the routine
management of the trading desk (for
example, at the division-wide or entity
level).
iv. Trading Desk Policies
Subpart F of the current capital rule
requires a banking organization to have
clearly defined trading and hedging
strategies for their trading positions that
are approved by senior management. In
addition to applying these requirements
at the trading desk level for trading
desks that are not notional trading
274 The list of model-eligible trading desks should
include both those for which the banking
organization has elected to calculate market risk
capital requirements under the standardized
approach as well as any trading desks that
previously received approval to use the internal
models approach but subsequently reported one or
both PLA test metrics in the red zone, as described
in more detail in section III.H.8.b.ii of this
SUPPLEMENTARY INFORMATION. A banking
organization should maintain a list of all trading
desks and make it available for the primary Federal
supervisor for review upon request.
275 A banking organization could also seek
approval for a notional trading desk to be a modeleligible trading desk. Any such desk that is
approved would be subject to backtesting and profit
and loss attribution testing at the trading desk level.
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desks, the proposal would require
policies and procedures for each trading
desk to describe the strategy and risk
management framework established for
overseeing the risk-taking activities of
the trading desk.
For each trading desk that is not a
notional trading desk, the proposal
would require a banking organization to
have a clearly defined policy, approved
by senior management, that describes
the general strategy of the trading desk,
the risk and position limits established
for the trading desk, and the internal
controls and governance structure
established to oversee the risk-taking
activities of the trading desk.276 At a
minimum, this would include the
business strategy for each trading
desk; 277 the clearly defined trading
strategy that details the market risk
covered positions in which the trading
desk is permitted to trade, identifies the
main types of market risk covered
positions purchased and sold by the
trading desk, and articulates the
expected holding period of, and market
risk associated with, each portfolio of
market risk covered positions held by
the trading desk; the clearly defined
hedging strategy that articulates the
acceptable level of market risk and
details the instruments, techniques, and
strategies that the trading desk will use
to hedge the risks of the portfolio; a brief
description of the general strategy of the
trading desk that addresses the
economics of its business strategy,
primary activities, and trading and
hedging strategies; and the risk scope
applicable to the trading desk that is
consistent with its business strategy,
including the overall risk classes and
permitted risk factors.278
Together, the proposed requirements
are intended to help ensure that each
trading desk engages only in those
activities that are permitted by senior
management and that any exceptions
would be elevated to the appropriate
organizational level. For example, the
proposed requirement for a banking
organization to document trading,
hedging, and business strategies,
including the internal controls
established to manage the risks arising
from the trading strategy, at the level of
the organization responsible for
implementing the general business
276 Under the proposal, these requirements would
generally not apply to any notional trading desk,
except those with prior approval from the primary
Federal supervisor to use the internal models
approach.
277 Under the proposal, the business strategy must
include regular reports on the revenue, costs and
market risk capital requirements of the trading desk.
278 See section III.H.7.a.i of this SUPPLEMENTARY
INFORMATION for further discussion on risk factors.
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strategy, is intended to help ensure
appropriate monitoring of the risk limits
set by senior management. Additionally,
the proposed requirements would help
to assist the primary Federal supervisor
in monitoring compliance, particularly
when assessing whether the trading
activities conducted by a trading desk
are consistent with the general strategy
of the desk and the appropriateness of
the limits established for the desk. For
example, the requirement for a trading
desk to list the types of instruments
traded by the desk to hedge risks arising
from its business strategy would help to
assist the primary Federal supervisor in
providing effective supervisory
oversight of the trading desk’s activities.
c. Operational Requirements
Subpart F of the current capital rule
requires a banking organization to
satisfy certain operational requirements
for active management of market risk
covered positions, stress testing, control
and oversight, and documentation. The
proposal would maintain these
requirements and introduce revisions
designed to complement changes under
the proposed standardized and modelsbased measures for market risk
(including the application of
calculations at the trading desk level in
the case of the models-based measure
for market risk), and to support the
proposed requirements described in
section III.H.5.a of this SUPPLEMENTARY
INFORMATION that would help ensure a
banking organization maintains robust
risk management processes for
identifying and appropriately managing
its market risk covered positions.
A key assumption of the proposed
market risk framework is that the
internal risk management models 279
used by banking organizations provide
an adequate basis for determining riskbased capital requirements for market
risk covered positions.280 To help
ensure such adequacy, the proposal also
would strengthen a banking
279 The proposal would define internal risk
management model as a valuation model that the
independent risk control unit within the banking
organization uses to report market risks and risktheoretical profits and losses to senior management.
See § ll.202 of the proposed rule.
280 Additionally, as described in more detail in
section III.H.7.a.ii of this SUPPLEMENTARY
INFORMATION, the proposal also assumes that the
valuation models used to report actual profits and
losses for purposes of financial reporting would
provide an adequate basis for purposes of
calculating regulatory capital requirements. As such
models are already subject to additional
requirements to enhance the accuracy of the
financial data produced, the proposed requirements
would only apply to those internal risk
management models that the primary Federal
supervisor has approved the banking organization
to use in calculating regulatory capital
requirements.
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organization’s prudent valuation
practices by incorporating requirements
that build on the agencies’ overall
regulatory framework for market risk
management, including the regulatory
guidance set forth in the Board’s
Supervision and Regulation (SR) Letter
11–7 and OCC’s Bulletin 2011–12,
Regulatory Guidance on Model Risk
Management. In addition to facilitating
the regulatory review process, the
proposed revisions are intended to
assist a banking organization’s
independent risk control unit and audit
functions in providing appropriate
review of and challenge to model risk
management, thereby promoting
effective model risk management.
The general risk management
requirements described in this section
would apply to all banking
organizations subject to the proposed
market risk capital framework regardless
of whether they use the standardized
measure for market risk or models-based
measure for market risk.
i. Active Management of Market Risk
Covered Positions
Subpart F of the current capital rule
requires a banking organization to have
clearly defined policies and procedures
for actively managing all positions
subject to the market risk capital rule,
including establishing and conducting
daily monitoring of position limits.281
These requirements are appropriate to
support active management and
monitoring under the current
framework; the proposal adds
enhancements to support active
management and monitoring at the
trading desk level.
Accordingly, the proposal would
require a banking organization to have
clearly defined policies and procedures
that describe its internal controls, as
well as its ongoing monitoring,
management, and authorization
procedures, including escalation
procedures, for the active management
of all market risk covered positions. At
a minimum, these policies and
procedures must identify key groups
and personnel responsible for
overseeing the activities of the banking
organization’s trading desks that are not
notional trading desks.
Further, the proposal would specify a
broader set of risk metrics for the
monitoring requirement, which would
281 The proposal would retain certain other
requirements with modifications such as policies
and procedures for active management of trading
positions subject to the market risk requirements
which include, but are not limited to, ongoing
assessment of the ability to hedge market risk
covered positions and portfolio risks. See 12 CFR
3.203(b)(1) or 12 CFR 217.203(b)(1).
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apply at the trading desk level.
Specifically, at a minimum, the
proposal would require that a banking
organization establish and conduct daily
monitoring by trading desks of: (1)
trading limits, including intraday
trading limits, limit usage, and remedial
actions taken in response to limit
breaches; (2) sensitivities to risk factors;
and (3) market risk covered positions
and transaction volumes; and, as
applicable, (4) VaR and expected
shortfall; (5) backtesting and p-values 282
at the trading desk level and at the
aggregate level for all model-eligible
trading desks; and (6) comprehensive
profit-and-loss attribution (each as
described in sections III.H.7 and III.H.8
of this SUPPLEMENTARY INFORMATION).
These risk metrics are the minimum
elements necessary to support adequate
daily monitoring of market risk covered
positions at the trading desk level.
Consistent with subpart F of the
capital rule, for a banking organization
that has approval for at least one modeleligible trading desk, the proposal
would require the banking
organization’s policies and procedures
to describe the establishment and
monitoring of backtesting and p-values
at the trading desk level and at the
aggregate level for all model-eligible
trading desks. Daily information on the
probability of observing a loss greater
than that which occurred on any given
day is a useful metric for a banking
organization and supervisors to assess
the quality of a banking organization’s
VaR model. For example, if a banking
organization that used a historical
simulation VaR model using the most
recent 500 business days experienced a
loss equal to the second worst day of the
500, it would assign a probability of
0.004 (2/500) to that loss based on its
VaR model. Applying this process many
times over a long interval provides
information about the adequacy of the
VaR model’s ability to characterize the
entire distribution of losses, including
information on the size and number of
backtesting exceptions. The requirement
to create and retain this information at
the entity-wide and trading desk level
may help identify particular products or
business lines for which a model does
not adequately measure risk. The
agencies view active management of
model risk at the trading desk level as
the best mechanism to address potential
risks of reliance on models, such as the
possible adverse consequences
282 P-value is the probability, when using the
VaR-based measure for purposes of backtesting, of
observing a profit that is less than, or a loss that
is greater than, the profit or loss that actually
occurred on a given date.
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(including financial loss) of decisions
based on models that are incorrect or
misused.
ii. Stress Testing and Internal
Assessment of Capital Adequacy
Subpart F of the capital rule requires
a banking organization to have a
rigorous process for assessing its overall
capital adequacy in relation to its
market risk. The process must take into
account market concentration and
liquidity risks under stressed market
conditions as well as other risks arising
from the banking organization’s trading
activities that may not be fully captured
by a banking organization’s internal
models. At least quarterly, a banking
organization must conduct stress tests at
the entity-wide level of the market risk
of its covered positions.
The proposal would enhance the
stress testing and internal assessment of
capital adequacy requirements in
subpart F of the capital rule to reflect
both the entity-wide and the tradingdesk level elements within the proposed
market risk capital requirement
calculation. Specifically, the proposal
would require a banking organization to
stress-test the market risk of its market
risk covered positions at both the entitywide and trading-desk level on at least
a quarterly basis. The proposal also
would require that results of such stress
testing be reviewed by senior
management of the banking organization
and reflected in the policies and limits
set by the banking organization’s
management and the board of directors,
or a committee thereof. In addition to
concentration and liquidity risks, the
proposal would require stress tests to
take into account risks arising from a
banking organization’s trading activities
that may not be adequately captured in
the standardized measure for market
risk or in the models-based measure for
market risk, as applicable.
The proposed requirements are
intended to help ensure that each
trading desk only engages in those
activities that are permitted by the
banking organization’s senior
management, and that any weaknesses
revealed by the stress testing results
would be elevated to the appropriate
management levels of the banking
organization and addressed in a timely
manner.
iii. Control and Oversight
Subpart F of the capital rule requires
a banking organization to maintain a
risk control unit that reports directly to
senior management and is independent
of the business trading units. The
internal audit function is responsible for
assessing, at least annually, the
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effectiveness of the controls supporting
the banking organization’s market risk
measurement systems (including the
activities of the business trading units
and independent risk control unit),
compliance with the banking
organization’s policies and procedures,
and the calculation of the banking
organization’s market risk capital
requirements. At least annually, the
internal audit function must report its
findings to the banking organization’s
board of directors (or a committee
thereof).
The proposal largely would retain the
control, oversight, and validation
requirements in subpart F of the capital
rule, including the requirement that a
banking organization maintain an
independent risk control unit. The
proposal would expand the required
oversight responsibilities of the
independent risk control unit to include
the design and implementation of
market risk management systems that
are used for identifying, measuring,
monitoring, and managing market risk.
The proposed change is intended to
complement other changes under the
proposal, in particular allowing a
banking organization to calculate riskbased requirements using standardized
and models-based measures for market
risk (for example, the inclusion of more
rigorous model eligibility tests that
apply at the trading desk level), as well
as the introduction of a capital add-on
requirement for re-designations.
Further, the proposal would enhance
the internal review and challenge
responsibilities of a banking
organization by requiring it to maintain
conceptually sound systems and
processes for identifying, measuring,
monitoring, and managing market risk.
In addition to its current requirements
under subpart F of the capital rule, the
banking organization’s internal audit
function would have to assess at least
annually the effectiveness of the
designations and re-designations of
market risk covered positions, and its
assessment of the calculation of the
banking organization’s measures for
market risk under subpart F, including
the mapping of risk factors to liquidity
horizons, as applicable. The proposal
would enhance the validation
requirements by requiring a banking
organization to maintain independent
validation of its valuation models and
valuation adjustments or reserves.
The agencies intend for these
elements of the proposal to enhance the
accountability of the banking
organization’s independent risk control
unit and internal audit function and
provide banking organizations with
sufficient flexibility to incorporate the
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risk management processes required for
regulatory capital purposes within those
daily risk management processes used
by the banking organization, such that
managing market risk would be more
consistent with the banking
organization’s overall risk profile and
business model. A banking
organization’s primary Federal
supervisor would evaluate the
robustness and appropriateness of the
banking organization’s internal stresstesting methods, risk management
processes, and capital adequacy.
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iv. Documentation
Similar to the enhancements to
policies and procedures described
above, the proposal would enhance the
documentation requirements under
subpart F of the capital rule to reflect
the proposed market risk capital
framework. Specifically, a banking
organization would be required to
adequately document all material
aspects of its identification,
management, and valuation of its
market risk covered positions, including
internal risk transfers and any redesignations of positions between
subpart F and subparts D and E of the
capital rule. Consistent with subpart of
F of the current capital rule, the
proposal would require a banking
organization to adequately document all
material aspects of its internal models,
and its control, oversight, validation,
and review processes and results, as
well as its internal assessment of capital
adequacy. The proposal also would
require a banking organization to
document an explanation of the
empirical techniques used to measure
market risk. Further, a banking
organization would be required to
establish and document its trading desk
structure, including identifying which
trading desks are model-eligible, modelineligible, used for internal risk
transfers, or constitute notional trading
desks, as well as document policies
describing how each trading desk
satisfies applicable requirements. These
enhancements would support the
banking organization’s ability to
distinguish between positions subject to
subpart F of the capital rule and those
that are not.
d. Additional Operational Requirements
for the Models-Based Measure for
Market Risk
Under subpart F of the capital rule, a
banking organization must use an
internal VaR based model to calculate
risk-based capital requirements for its
covered positions. The proposal would
not require a banking organization to
use an internal model but would allow
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a banking organization that has approval
from its primary Federal supervisor for
at least one model-eligible trading desk
to use the internal models approach to
calculate market risk capital
requirements.
As a condition for use of the internal
models approach, the proposal would
require a trading desk to satisfy certain
additional operational requirements,
which are intended to help ensure that
a banking organization has allocated
sufficient resources for the desk to
develop and rely on internal models
that appropriately capture the market
risk of its market risk covered positions.
Specifically, the additional operational
requirements, as well as the proposed
profit and loss attribution and
backtesting requirements, as described
in sections III.H.8.b and III.H.8.c of this
SUPPLEMENTARY INFORMATION, would
help ensure that the losses estimated by
the internal models used to calculate a
trading desk’s risk-based capital
requirements are sufficiently accurate
and sufficiently conservative relative to
the profits and losses that are reported
in the general ledger. These general
ledger reported profits and losses are
produced by front-office models.283 In
this way, the additional operational
requirements are intended to help
ensure that the internal models of a
trading desk properly measure all
material risks of the market risk covered
positions to which they are applied, and
the sophistication of the internal models
is commensurate with the complexity
and extent of trading activity conducted
by the trading desk.
As described above, the proposal
would require eligibility for use of the
internal models approach to be
determined at the trading desk level,
rather than for the entire banking
organization. By aligning the level at
which a banking organization may be
permitted to model market risk capital
requirements with the level at which the
banking organization applies its front
office controls, the proposed
requirements would enhance prudent
capital management for banking
283 The proposed backtesting requirements are
intended to measure the conservatism of the
forecasting assumptions and valuation methods in
the expected shortfall models used for determining
risk-based capital requirements while the proposed
PLA testing requirements are intended to measure
the accuracy of the potential future profits or losses
estimated by the expected shortfall models relative
to those produced by the front office models. If a
trading desk fails to satisfy either the proposed PLA
or backtesting requirements, it would no longer be
able to calculate risk-based capital requirements
using the internal models approach. In this way, the
proposal would only allow trading desks for which
the internal models are sufficiently conservative
and accurate to use the internal models approach
to calculate its market risk capital requirements.
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organizations that use the models-based
measure for market risk. Additionally,
the proposed trading desk-level
framework would provide a prudential
backstop to the internal models
approach by requiring the use of the
standardized approach for trading desks
with risks that are not adequately
captured by a banking organization’s
internal models. This avoids the risk of
an abrupt or severe change in a banking
organization’s overall market risk
capital requirement in the event that a
particular trading desk ceases to be
eligible to use the internal models
approach.
i. Trading Desk Identification
As part of the model approval
process, the proposal would require a
banking organization to identify all
trading desks within its trading desk
structure that it would designate as
model-eligible and for which it would
seek approval to use internal models
from the primary Federal supervisor.
When identifying which trading desks
to designate as model-eligible, the
banking organization would be required
to consider whether the standardized or
internal models approach would more
appropriately reflect the market risk of
the desk’s market risk covered positions.
Additionally, the proposal generally
would prohibit a banking organization
from seeking model approval for trading
desks that hold securitization positions
or correlation trading positions, with
one exception. Given the operational
difficulties of requiring a banking
organization to bifurcate trading desks
that hold an insignificant amount of
securitization or correlation trading
positions pursuant to their trading or
hedging strategy, the proposal would
allow the banking organization to
designate such desks as model-eligible.
If the primary Federal supervisor were
to approve the use of internal models for
such desks, the proposal would require
the banking organization to separately
calculate market risk capital
requirements for such securitization or
correlation trading positions held by a
model-eligible trading desk under either
the standardized approach or the
fallback capital requirement, and
otherwise treat such positions as if they
were not held by the desk.284
Question 102: The agencies seek
comment on the benefits and drawbacks
284 Specifically, the proposal would require a
banking organization to exclude any insignificant
amount of securitization positions and/or
correlation trading positions held by the modeleligible trading desk from (1) the aggregate trading
portfolio backtesting; and (2) from the relevant
desk-level backtesting and profit and loss
attribution metrics, except with the approval of the
banking organization’s primary Federal supervisor.
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of requiring trading desks that hold an
insignificant amount of securitization
positions and correlation trading
positions to exclude from the internal
models approach such positions and
any related hedges, if applicable, in
order for such desks to request approval
to calculate market risk capital
requirements under the models-based
for market risk. Commenters are
encouraged to provide data to support
their responses.
ii. Review, Risk Management, and
Validation
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To help ensure that the internal
models appropriately capture a modeleligible trading desk’s market risk
exposure on an ongoing basis, the
proposal would require a banking
organization to satisfy additional model
review and validation standards for
model-eligible trading desks in order to
calculate market risk capital
requirements under the models-based
measure for market risk.
Specifically, a banking organization
that uses the models-based measure for
market risk would be required to (1)
review its internal models at least
annually and enhance them, as
appropriate, to help ensure the models
continue to satisfy the initial approval
requirements and employ risk
measurement methodologies that are the
most appropriate for the banking
organization’s market risk covered
positions, (2) integrate its internal
models used for calculating the
expected shortfall-based measure for
market risk into its daily risk
management process, and (3)
independently 285 validate its internal
models both initially and on an ongoing
basis, and revalidate them when there is
a material change to a model, a
significant structural change in the
market, or changes in the composition
of its market risk covered positions that
might result in the internal models no
longer adequately capturing the market
risk of the market risk covered positions
held by the model-eligible trading desk.
The proposal also would require
banking organizations to establish a
validation process that at a minimum
includes an evaluation of the internal
285 Either the validation process itself would have
to be independent, or the validation process would
have to be subjected to independent review of its
adequacy and effectiveness. The independence of
the banking organization’s validation process would
be characterized by separateness from and
impartiality to the development, implementation,
and operation of the banking organization’s internal
models, or otherwise by independent review of its
adequacy and effectiveness, though the personnel
conducting the validation would not necessarily be
required to be external to the banking organization.
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models’ (1) conceptual soundness 286
and (2) adequacy in appropriately
capturing and reflecting all material
risks, including that the assumptions are
appropriate and do not underestimate
risks. Additionally, the proposal would
require a banking organization to
perform ongoing monitoring to review
and verify processes, including by
comparing the outputs of the internal
models with relevant internal and
external data sources or estimation
techniques. The results of this
comparison provide a valuable
diagnostic tool for identifying potential
weaknesses in a banking organization’s
models. As part of this comparison, a
banking organization would be expected
to investigate the source of differences
between the model estimates and the
relevant internal or external data or
estimation techniques and whether the
extent of the differences is appropriate.
In addition, the proposal would
expand on the outcomes analysis
requirements in subpart F of the capital
rule by requiring validation to include
not only any outcomes analysis that
includes backtesting at the aggregated
level of all model-eligible trading desks,
but also backtesting and profit and loss
attribution testing at the trading desk
level for each model-eligible trading
desk. The agencies recognize that
financial markets and modeling
technologies undergo continual
development. Accordingly, a banking
organization needs to continually
ensure that its models are appropriate.
The ongoing review, risk management,
and validation requirements in the
proposal are intended to help ensure
that the internal models used accurately
reflect the risks of market risk covered
positions in evolving markets.
iii. Documentation
In addition to the general
documentation requirements applicable
to all banking organizations as described
in section III.H.5.c.iv of this
SUPPLEMENTARY INFORMATION, the
proposal would require a banking
organization that uses the models-based
measure for market risk to document
policies and procedures regarding the
determination of which risk factors are
modellable and which are not
modellable (risk factor eligibility test),
including a description of how the
banking organization maps real price
observations to risk factors; the data
alignment of the profit and loss systems
used by front office and by the internal
286 The process should include evaluation of
empirical evidence supporting the methodologies
used and evidence of a model’s strengths and
weaknesses.
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risk management models; the
assignment of risk factors to liquidity
horizons, and any empirical correlations
recognized with respect to risk factor
classes.
As with the other enhanced
operational requirements applicable to a
banking organization that uses the
models-based measure for market risk,
these requirements are designed to help
ensure the use of the internal models
approach under the models-based
measure for market risk only applies to
those trading desks for which the
banking organization is able to
demonstrate that the internal models
appropriately capture the market risk of
the market risk covered positions held
by the desk.
iv. Model Eligibility
For the banking organization to use
the models-based measure for market
risk, the proposal would require a
banking organization to receive the prior
written approval from its primary
Federal supervisor for at least one
trading desk to apply the internal
models approach. Accordingly, the
proposal would establish a framework
for such approval.
I. Initial Approval
Under the proposal, the approval for
a banking organization to use internal
models would be granted at the
individual trading desk level.287 For the
primary Federal supervisor to approve
an internal model, the proposal would
require a banking organization to
demonstrate that (1) the internal model
properly measures all the material risks
of the market risk covered positions to
which it would be applied; (2) the
internal model has been properly
validated in accordance with the
validation process and requirements; (3)
the level of sophistication of the internal
model is commensurate with the
complexity and amount of the market
risk covered positions to which it would
be applied; and (4) the internal model
meets all applicable requirements.
To receive approval as a modeleligible trading desk, the proposal
would require a trading desk to satisfy
one of the following criteria. The
banking organization could provide to
the primary Federal supervisor at least
250 business days of backtesting and
PLA test results for the trading desk.
287 The proposal would require a banking
organization to receive written approval from the
primary Federal supervisor for both the expected
shortfall internal model and the stressed expected
shortfall methodology used by the trading desk. As
the initial approval process for each would be the
same, for simplicity, the term ‘‘internal models’’
used throughout this section is intended to refer to
both.
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Alternatively, the banking organization
could either (1) provide at least 125
business days of backtesting and PLA
test results for the trading desk and
demonstrate to the satisfaction of the
primary Federal supervisor that the
internal models would be able to satisfy
the backtesting and PLA requirements
on an ongoing basis; (2) demonstrate
that the trading desk consists of market
risk covered positions similar to those of
another trading desk that has received
approval from the primary Federal
supervisor and such other trading desk
has provided at least 250 business days
of backtesting and PLA results, or (3)
subject the trading desk to the PLA addon until the desk provides at least 250
business days of backtesting and PLA
test results that pass the trading-desk
level backtesting requirements and
produce PLA metrics in the green zone,
as further described in sections III.H.8.b
and III.H.8.c of this SUPPLEMENTARY
INFORMATION.
The proposed criteria would hold
trading desks to robust modeling
requirements, while providing a
banking organization sufficient
flexibility to satisfy the standard over
time and as the banking organization
adapts its business structure. The
agencies recognize that when initially
requesting approval and in subsequent
requests (for example, after a
reorganization or upon entering into a
new business), a banking organization
may not always be able to provide a full
year of backtesting and PLA results for
each trading desk, even if the internal
models used by the desk provide an
adequate basis for determining riskbased capital requirements. The
proposed criteria would allow a banking
organization to seek model approval for
trading desks with at least a six-month
track record demonstrating the accuracy
and conservatism of the internal models
used by the desk (PLA and backtesting
results) as well as for trading desks that
consist of similar market risk covered
positions to another trading desk, for
which the banking organization has
provided at least 250 business days of
trading desk level profit and loss
attribution test and backtesting results
and has received approval from its
primary Federal supervisor. Given the
difficulty in evaluating the
appropriateness of the internal models
used by trading desks that provide less
than six months of profit and loss
attribution test and backtesting results
and that do not consist of market risk
covered positions similar to those of
another trading desk that has received
approval, the agencies are proposing to
allow a banking organization to
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designate such desks as model-eligible,
but to subject any such trading desk
approved by the primary Federal
supervisor to the PLA add-on until the
desk produces one year of satisfactory
profit and loss attribution test and
backtesting results in the green zone.
Thus, the trading desk would remain
subject to an additional capital
requirement until it provides sufficient
evidence demonstrating the
appropriateness of the internal models,
at which time application of the PLA
add-on would automatically cease.
II. Ongoing Eligibility and Changes to
Trading Desk Structure or Internal
Models
Subpart F of the current capital rule
requires a banking organization to
promptly notify the primary Federal
supervisor when (1) extending the use
of a model that the primary Federal
supervisor has approved to an
additional business line or product type,
(2) making any change to an internal
model that would result in a material
change in the banking organization’s
total risk-weighted asset amount for
market risk for a portfolio of covered
positions, or (3) making any material
change to its modelling assumptions.
The proposal would expand on these
requirements to require a banking
organization to receive prior written
approval from its primary Federal
supervisor before implementing any
change to its trading desk structure or
internal models (including any material
change to its modelling assumptions)
that would (1) in the case of trading
desk structure, materially impact the
risk-weighted asset amount for a
portfolio of market risk covered
positions; or (2) in the case of internal
models, result in a material change in
the banking organization’s internally
modelled capital calculation for a
trading desk under the internal models
approach. Additionally, the proposal
would require a banking organization to
promptly notify its primary Federal
supervisor of any change, including
non-material changes, to its internal
models, modelling assumptions, or
trading desk structure.288 Whether a
banking organization would be required
to receive prior written approval or
promptly notify the primary Federal
supervisor before extending the use of
an approved model to an additional
business line or product type would
depend on the nature of and impact of
such a change.
288 In such cases, a banking organization should
notify the primary Federal supervisor in writing, in
a manner acceptable to the supervisor (such as
through email, where appropriate).
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The proposal also would require a
model-eligible trading desk to perform
and successfully pass quarterly
backtesting and the PLA testing
requirements on an ongoing basis in
order to maintain its approval status.289
As banking organizations’ quarterly
review of backtesting and PLA results
would take place after a quarter is over,
the proposal would permit a banking
organization to rely on the internal
models approach for model-eligible
trading desks that previously received
approval from the primary Federal
supervisor during the 20-day period
following quarter end while updating its
use of internal models based on the
results of the quarterly review.
Even if a model-eligible trading desk
were to satisfy the above requirements,
a banking organization’s primary
Federal supervisor could determine that
the desk no longer complies with any of
the proposed applicable requirements
for use of the models-based measure for
market risk or that the banking
organization’s internal model for the
trading desk fails to either comply with
any of the applicable requirements or to
accurately reflect the risks of the desk’s
market risk covered positions. In such
cases, the primary Federal supervisor
could (1) rescind the desk’s model
approval and require the desk to
calculate market risk capital
requirements under the standardized
approach, or (2) subject the desk to a
PLA add-on capital requirement until it
restores the desk’s full approval, in the
case of trading desk noncompliance.
The agencies recognize that even if a
banking organization’s expected
shortfall model for a trading desk
satisfies the proposed backtesting, PLA
testing, and operational requirements,
the model may not appropriately
capture the risk of the market risk
covered positions held by the desk (for
example, if the model develops specific
shortcomings in risk identification, risk
aggregation and representation, or
validation). Thus, as an alternative to
requiring a trading desk to use the
standardized approach, the proposal
would allow the primary Federal
supervisor to subject the trading desk to
the PLA add-on if the desk were to
continue to satisfy all of the proposed
backtesting, PLA testing, and
operational requirements for use of the
models-based measure for market risk.
In this way, the proposal would help to
ensure that the market risk capital
requirements for the trading desk
appropriately reflect the materiality of
the shortcomings of the expected
289 See
sections III.H.8.b and III.H.8.c of this
SUPPLEMENTARY INFORMATION.
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shortfall model, as the PLA add-on
would apply until such time that the
banking organization enhances the
accuracy and conservatism of the
trading desk’s expected shortfall model
to the satisfaction of its primary Federal
supervisor.
Similarly, after approving a banking
organization’s stressed expected
shortfall methodology to capture nonmodellable risk factors for use by one or
more trading desks, as described in
section III.H.8.a.i of this SUPPLEMENTARY
INFORMATION, the primary Federal
supervisor may subsequently determine
that the methodology no longer
complies with the operational
requirements for use of the modelsbased measure for market risk or that
the methodology fails to accurately
reflect the risks of the market risk
covered positions held by the trading
desk. In such cases, the proposal would
allow the primary Federal supervisor to
rescind its approval of the banking
organization’s methodology and require
the affected trading desk(s) to calculate
market risk capital requirements for the
trading desk under the standardized
approach. As the methodologies used to
capture the market risk of nonmodellable risk factors would not be
subject to the proposed PLA testing
requirements, which inform the
calibration of the PLA add-on as
described in section III.H.8.b of this
SUPPLEMENTARY INFORMATION, the PLA
add-on would not be an alternative if
the primary Federal supervisor rescinds
its approval of such a methodology.
6. Measure for Market Risk
Under subpart F of the current capital
rule, a banking organization must use
one or more internal models to calculate
market risk capital requirements for its
covered positions.290 A banking
organization’s market risk-weighted
assets equal the sum of the VaR-based
capital requirement, the stressed VaRbased capital requirement, specific risk
add-ons, the incremental risk capital
requirement, the comprehensive risk
capital requirement, and the capital
requirement for de minimis exposures,
plus any additional capital requirement
established by the primary Federal
supervisor, multiplied by 12.5. The
primary Federal supervisor may require
the banking organization to maintain an
overall amount of capital that differs
from the amount otherwise required
under the rule, if the regulator
290 Notably, for securitization positions subject to
subpart F, the current capital rule provides a
standardized measurement method for capturing
specific risks and a models-based measure
capturing general risks for calculating market riskweighted assets.
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determines that the banking
organization’s market risk-based capital
requirements under the rule are not
commensurate with the risk of the
banking organization’s covered
positions, a specific covered position, or
portfolios of such positions, as
applicable.
As noted in section III.H.1.b. of this
SUPPLEMENTARY INFORMATION, the
proposal would introduce a
standardized methodology for
calculating market risk capital
requirements and a new methodology
for the internal models approach to
replace the framework in subpart F of
the current capital rule. Under the
proposal, a banking organization that
has one or more model-eligible trading
desks would be required to calculate
market risk capital requirements under
both the standardized and the modelsbased measures for market risk.
Furthermore, if required by the primary
Federal supervisor, a banking
organization that has one or more
model-eligible trading desk would be
required to calculate the standardized
measure for market risk for each modeleligible trading desk as if that trading
desk were a standalone regulatory
portfolio. A banking organization with
no model-eligible trading desks would
only calculate market risk capital
requirements under the standardized
measure for market risk.
The agencies would have the
authority to require a banking
organization to calculate capital
requirements for specific positions or
categories of positions under either
subpart D or E instead of under subpart
F of the capital rule, or under subpart
F instead of under subpart D or E of the
capital rule, or under both subpart F and
subpart D or E, as applicable, to more
appropriately reflect the risks of the
positions. Alternatively, under the
proposal, the primary Federal
supervisor may require a banking
organization to apply a capital add-on
for re-designations of specific positions
or portfolios. These proposed provisions
would help the primary Federal
supervisor ensure that a banking
organization’s risk-based capital
requirements appropriately reflect the
risks of such positions.
Additionally, for a banking
organization that uses the models-based
measure for market risk, the agencies
would reserve the authority to require a
banking organization to modify its
observation period or methodology
(including the stress period) used to
measure market risk, when calculating
the expected shortfall measure or
stressed expected shortfall. In this way,
the proposal would help the primary
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Federal supervisor ensure that a banking
organization’s internal models remain
sufficiently robust to capture risks in a
dynamic market environment and
appropriately reflect the risks of such
positions.
a. Standardized Measure for Market Risk
Under the proposal, the standardized
measure for market risk would consist
of three main components: a
sensitivities-based method, a
standardized default risk capital
requirement, and a residual risk add-on
(together, the standardized approach).
The proposed standardized measure for
market risk also would include three
additional components that would
apply in more limited instances to
specific positions: the fallback capital
requirement, the capital add-on
requirement for re-designations, and any
additional capital requirement
established by the primary Federal
supervisor as part of the proposal’s
reservation of authority provisions.
The core component of the
standardized approach is the
sensitivities-based capital requirement,
which would capture non-default
market risk based on the estimated
losses produced by risk factor
sensitivities 291 under regulatorily
determined stressed conditions. The
standardized default risk capital
requirement captures losses on credit
and equity positions in the event of
obligor default, while the residual risk
add-on serves to produce a simple,
conservative capital requirement for any
other known risks that are not already
captured by first two components
(sensitivities-based measure and the
standardized default risk capital), such
as gap risk, correlation risk, and
behavioral risks such as prepayments.
The fallback capital requirement would
apply in cases where a banking
organization is unable to calculate either
the sensitivities-based capital
requirement, such as when a sensitivity
is not available, or the standardized
default risk capital requirement.292
Additionally, the capital add-on
requirement for re-designations would
apply in cases where a banking
organization re-classifies an instrument
after initial designation as being subject
either to the market risk capital
requirements under subpart F or to
capital requirements under subpart D or
291 A risk factor sensitivity is the change in value
of an instrument given a small movement in a risk
factor that affects the instrument’s value.
292 See section III.H.6.c of this SUPPLEMENTARY
INFORMATION for a more detailed discussion on the
fallback capital requirement.
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E of the capital rule, respectively.293
Each of these components is intended to
help ensure the standardized measure
for market risk provides a simple,
transparent, and risk-sensitive measure
for determining a banking organization’s
market risk capital requirements. The
standardized measure for market risk
equals the sum of the above components
and any additional capital requirement
established by the primary Federal
supervisor, as described in more detail
in section III.H.7 of this SUPPLEMENTARY
INFORMATION.
The agencies view the proposed
standardized measure for market risk as
sufficiently risk sensitive to serve as a
credible floor to the models-based
measure for market risk. If a trading
desk does not receive approval to use
the internal models approach or fails to
meet the operational requirements of the
models-based measure for market risk
on an on-going basis, the desk would be
required to continue to use the
standardized approach to calculate its
market risk capital requirements. The
conservative calibration of the risk
weights and correlations applied to a
banking organization’s market risk
covered positions would help ensure
that risk-based capital requirements
under the standardized approach
appropriately capture the market risks
to which a banking organization is
exposed. Additionally, by relying on a
banking organization’s models to
produce risk factor sensitivities, the
proposed standardized measure for
market risk would help ensure market
risk capital requirements appropriately
capture a banking organization’s actual
market risk exposure in a manner that
minimizes compliance burden and
enhances risk-capture. Furthermore, the
proposed standardized measure for
market risk would also promote
comparability in market risk capital
requirements across banking
organizations subject to the proposal.
b. Models-Based Measure for Market
Risk
To limit use of the internal models
approach to only those trading desks
that can appropriately capture the risks
of market risk covered positions in
internal models, model-eligible trading
desks would be required to satisfy the
model eligibility criteria and processes
(for example, profit and loss attribution
testing) introduced under the proposal,
as described in section III.H.5.d of this
SUPPLEMENTARY INFORMATION. Thus,
under the proposal, a banking
293 See
section III.H.6.d of this SUPPLEMENTARY
for a more detailed discussion of the
capital add-on for re-designations.
INFORMATION
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organization with prior regulatory
approval to use the models-based
measure for market risk could have
some trading desks that are eligible for
the internal models approach and others
that use the standardized approach.
Specifically, if the primary Federal
supervisor were to approve a banking
organization to calculate market risk
capital requirements for one or more
trading desks under the internal models
approach, the banking organization
would be required to calculate the
entity-wide market risk capital
requirement under the models-based
measure for market risk (IMAtotal), which
would incorporate the capital
requirements under the standardized
approach for model-ineligible trading
desks, according to the following
formula, as provided under § ll.204(c)
of the proposed rule:
IMATotal = min ((IMAG,A + PLA add-on
+ SAU), SAall desks) + max
((IMAG,A¥SAG,A),0) + fallback
capital requirement + capital addons
Under the proposal, the core
components of the models-based
measure for market risk capital
requirements are the internal models
approach capital requirements for
model-eligible trading desks, which
capture non-default market risks and the
standardized default risk capital
requirement for model-eligible desks
(IMAG,A), the standardized approach
capital requirements for modelineligible trading desks (SAU), the
standardized approach capital
requirement for market risk covered
positions and term repo-style
transactions the banking organization
elects to include in model-eligible
trading desks (SG,A) and the additional
capital requirements applied to modeleligible trading desks with shortcomings
in the internal models used for
determining regulatory capital
requirements, (PLA addon) if
applicable.
To limit the increase in capital
requirements arising due to differences
in calculating risk-based capital
requirements separately 294 between
market risk covered positions held by
trading desks subject to the internal
models approach and those held by
trading desks subject to the
standardized approach, the modelsbased measure for market risk would
cap the sum of IMAG,A, the PLA add-on,
294 Separate capital calculations could
unnecessarily increase capital requirement because
they ignore the offsetting benefits between market
risk covered positions held by trading desks subject
to the internal models approach and those held by
trading desks subject to the standardized approach.
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and SAU at the capital required for all
trading desks under the standardized
approach:
(min((IMAG,A + PLA add-on + SAU),
SAall desks))
The other components of the modelsbased measure for market risk include
four other components that would only
apply in more limited circumstances;
these include the capital requirement
for instances where the capital
requirements for model-eligible desks
under the internal models approach
exceed those under the standardized
approach, (max((IMAG,A¥SAG,A), 0)),295
the fallback capital requirement for
instances where a banking organization
is not able to apply the standardized
approach and the internal models
approach, if eligible,296 and the capital
add-on to offset any potential capital
benefit that otherwise might have been
received either from re-designating an
instrument or from including ineligible
positions on a model-eligible trading
desk,297 as well as any additional
capital requirement established by the
primary Federal supervisor pursuant to
the proposal’s reservation of authority
provisions.
The proposed models-based measure
for market risk would provide important
improvements to the risk sensitivity and
calibration of risk-weighted assets for
market risk. In addition to replacing the
VaR-based measure with an expected
shortfall measure to capture tail risk, the
models-based measure for market risk
would replace the fixed ten businessday liquidity horizon in subpart F of the
current capital rule with ones that vary
based on the underlying risk factors in
order to adequately capture the market
risk of less liquid positions. The
proposal also would limit the regulatory
capital benefit of hedging and portfolio
diversification across different asset
classes, which generally dissipates in
stress periods.
Question 103: The agencies seek
comment on all aspects of the modelsbased measure for market risk
calculation, including the capital
requirement for instances where the
capital requirement under the internal
models approach for model-eligible
295 As the standardized approach is less risksensitive than the internal models approach, to the
extent that the capital requirement under the
internal models approach exceeds that under the
standardized approach for model-eligible desks, the
proposal would require this difference to be
reflected in the aggregate capital requirement under
the models-based measure for market risk.
296 See section III.H.6.c of this SUPPLEMENTARY
INFORMATION for a more detailed discussion on the
fallback capital requirement.
297 See section III.H.6.d of this SUPPLEMENTARY
INFORMATION for a more detailed discussion on the
capital add-on requirement for re-designations.
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desks exceeds the amount required for
such desks under the standardized
approach. What would be the benefits or
drawbacks of capping the total capital
requirement under the models-based
measure for market risk at that required
for all trading desks under the
standardized approach?
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c. Fallback Capital Requirement
The agencies recognize that a banking
organization may not be able to
calculate market risk capital
requirements for one or more of its
market risk covered positions in
situations when a banking organization
is unable to calculate market risk
requirements under the standardized
approach and the internal models
approach, if eligible. For example, a
banking organization may not be able to
calculate some risk factor sensitivities or
components for one or more market risk
covered positions due to an operational
issue or a calculation failure. Such
issues could arise when a new market
product is introduced and the banking
organization has not had sufficient time
to develop models and analytics to
produce the required sensitivities or the
new data feeds for the proposed market
risk capital calculations. In such cases,
the proposal would require a banking
organization to apply the fallback
capital requirement to the affected
market risk covered positions, as further
described below.
For purposes of calculating the
standardized measure for market risk,
the proposal would require a banking
organization to apply the fallback
capital requirement to each of the
affected positions and exclude such
positions from the standardized
approach capital requirement.298
For purposes of calculating the
models-based measure for market risk,
unless the banking organization receives
prior written approval from its primary
Federal supervisor, the proposal would
require the banking organization to
exclude each market risk covered
position for which it is not able to apply
the standardized approach or the
internal models approach, as applicable,
from the respective components of
IMATotal 299 As the fallback capital
298 The respective components of the
standardized approach capital requirement are the
sensitivities-based method capital requirement, the
standardized default risk capital requirement, and
the residual risk add-on.
299 The respective components of IMA
total are:
IMAG,A, SAU, SAall desks, SAG,A, SAi (as part of the
PLA add-on calculation), the capital add-on for
certain securitization and correlation trading
positions or equity positions in an investment fund
on model-eligible trading desks, and any additional
capital requirement established by the primary
Federal supervisor. See section III.H.8.b. of this
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requirement would only apply in
instances where a banking organization
is not able to apply the internal models
approach and the standardized
approach to calculate market risk capital
requirements, the agencies consider that
applying a separate capital treatment for
such positions is appropriate to ensure
that they are conservatively
incorporated into the market risk capital
requirement.
Similar to the capital requirement for
de minimis exposures in subpart F of
the capital rule, the fallback capital
requirement would equal the sum of the
absolute fair value of each position
subject to the fallback capital
requirement, unless the banking
organization receives prior written
approval from its primary Federal
supervisor to use an alternative method
to quantify the market risk capital
requirement for such positions.
Question 104: The fair value for
derivative positions may materially
underestimate the exposure since the
fair value of derivatives is generally
lower than the derivatives’ potential
exposure (for example, fair value of a
derivative swap contract is generally
zero at origination). Is the fallback
capital requirement based on the
absolute fair value of the derivative
positions appropriate? What could be
alternative methodologies for the
fallback capital requirements for
derivatives (for example, the absolute
value of the adjusted notional amount
or the effective notional amount of
derivatives as defined in the
standardized approach for counterparty
credit risk (SA–CCR)? What, if any,
alternative techniques would more
appropriately measure the market risk
associated with market risk covered
positions for which the standardized
approach cannot be applied?
d. Re-Designations and Other Capital
Add-Ons
To reflect the proposed definition of
market risk covered position, the
proposal would require a banking
organization to have clearly defined
policies and procedures for identifying
positions that are market risk covered
positions and those that are not, as well
as for determining whether, after such
initial designation, a position needs to
be re-designated.300
for further discussion
of each of these components. Also, see section
III.H.6.d of this SUPPLEMENTARY INFORMATION for
further discussion on the capital add-on for certain
securitization and correlation trading positions held
on model-eligible desks.
300 See section III.H.5.a of this SUPPLEMENTARY
INFORMATION.
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A position’s effect on risk-weighted
assets can vary based on whether it is
a market risk covered position.
Therefore, to offset any potential capital
benefit that otherwise might be received
from re-classifying a position, the
proposal would introduce the capital
add-on requirement as a penalty for any
re-designation. With prior written
approval from its primary Federal
supervisor, the proposal would not
require a banking organization to apply
the penalty to re-designations arising
from circumstances that are outside of
the banking organization’s control (for
example, changes in accounting
standards or in the characteristics of the
instrument itself, such as an equity
being listed or de-listed). The agencies
expect re-designations to be extremely
rare, and recognize that re-designations
could occur, for example, due to the
termination of a business activity
applicable to the instrument. Given the
very limited circumstances under which
re-designations would occur, any redesignation would be irrevocable,
unless the banking organization receives
prior approval from its primary Federal
supervisor.
To calculate the capital add-on for a
re-designation, a banking organization
would be required to calculate the total
capital requirements for the redesignated positions under subparts D,
E (if applicable), and F of the capital
rule before and immediately after the redesignation of a position. The proposal
would require a banking organization
that is subject to subpart D of the capital
rule to calculate its total capital
requirements separately under subpart
D of the capital rule and under the
market risk capital requirements before
and immediately after the redesignation. If the total capital
requirement is lower as a result of the
re-designation, then the difference
between the two would be the capital
add-on for the re-designation. In cases
when a banking organization is also
subject to subpart E of the capital rule,
the proposal would require the banking
organization to calculate total capital
requirements separately under subpart
D of the capital rule and subpart E of the
capital rule and under the market risk
capital requirements before and
immediately after the re-designation. If
the total capital requirement is lower as
a result of the re-designation, then the
difference would be the capital add-on
for the re-designation. As such, the
proposal would require the banking
organization to apply a capital add-on
for re-designated positions in situations
when such re-designations result in any
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capital reduction under the market risk
capital requirements.
The proposal would require a banking
organization to calculate the capital
add-on requirement at the time of the redesignation. A banking organization
could reduce or eliminate the capital
add-on as the instrument matures, pays
down, amortizes, or expires, or the
banking organization sells or exits (in
whole or in parts) the position.
Under the standardized measure for
market risk, the capital add-on would
include the capital add-on for redesignations. Under the models-based
measure for market risk, the capital addon would include the capital add-on for
re-designations, as well as add-ons for
any securitization and correlation
trading positions, or equity positions in
an investment fund, where a banking
organization is not able to identify the
underlying positions held by an
investment fund on a quarterly basis on
model-eligible trading desks, provided
such positions are not subject to the
fallback capital requirement.
Specifically, for securitization and
correlation trading positions and equity
positions in an investment fund, where
a banking organization cannot identify
the underlying positions, on modeleligible trading desks, the models-based
measure for market risk includes a
capital add-on equal to the risk-based
capital requirement for such positions
calculated under the standardized
approach.
Question 105: What, if any,
operational challenges could the
proposed capital add-on calculation
pose? What, if any, changes should the
agencies consider making to the
proposed exceptions to the capital addon, such as to address additional
circumstances in which the capital addons for re-designations should not
apply, and why?
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7. Standardized Measure for Market
Risk
Under the proposal, the standardized
measure for market risk would consist
of the standardized approach capital
requirement and three additional
components that would apply in more
limited instances to specific positions:
the fallback capital requirement, the
capital add-on requirement for redesignations and any additional capital
requirement established by the primary
Federal supervisor.301 The proposal
would require a banking organization to
301 See
sections III.H.6.c and III.H.6.d of this
for a more detailed
discussion on the fallback capital requirement and
the capital add-on requirement for re-designations,
respectively.
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calculate the standardized measure for
market risk at least weekly.
a. Sensitivities-Based Method (SBM)
Conceptually, the proposed
sensitivities-based method is similar to
a simple stress test where a banking
organization estimates the change in
value of its market risk covered
positions by applying standardized
shocks to relevant market risk covered
positions. The sensitivities-based
method uses risk weights that represent
the standardized shocks with each
prescribed risk weight calibrated to a
defined liquidity time horizon
consistent with the expected shortfall
measurement framework under stressed
conditions. To help ensure consistency
in the application of risk-based capital
requirements across banking
organizations, the proposal would
establish the following process to
determine the sensitivities-based capital
requirement for the portfolio: (1) assign
market risk covered positions to risk
classes and establish the risk factors for
market risk covered positions within the
same risk class; (2) describe the method
to calculate the sensitivity of a market
risk covered position for each of the
prescribed risk factors; (3) describe the
shock applied to each risk factor, and (4)
describe the process for aggregating the
weighted sensitivities within each risk
class and across risk classes.
Under the proposal, a banking
organization would assign each market
risk covered position to one or more risk
buckets within appropriate risk classes
for the position. The seven prescribed
risk classes, based on standard industry
classifications, are interest rate risk,
credit spread risk for non-securitization
positions, credit spread risk for
correlation trading positions, credit
spread risk for securitization positions
that are not correlation trading
positions, equity risk, commodity risk,
and foreign exchange risk. The risk
buckets represent common risk
characteristics of a given risk class in
recognition that positions sharing such
risk characteristics are highly correlated
and therefore affect the value of a
market risk covered position in
substantially the same manner. Further,
the proposed risk buckets correspond to
common industry practice as large
trading banking organizations often use
bucketing structures similar to those set
forth in the proposal.
Once the risk buckets are identified
for a position, the bank would have to
map the positions to the appropriate
risk factors within the risk bucket. For
example, the price of a typical corporate
bond fluctuates primarily due to
changes in interest rates and issuer
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credit spreads. Therefore, a position in
a corporate bond would be placed in
two separate risk classes, one for
interest rate risk and one for credit
spread risk for non-securitization
positions.302 For positions within the
credit spread risk class, a banking
organization would group the corporate
bond position and other positions with
similar credit quality and operating in
the same sector together in one risk
bucket. Further, the banking
organization would apply the proposed
risk factors to each position within that
bucket based on credit spread curves
and tenors of each position. All market
risk covered positions would be
assigned to risk buckets within risk
classes and mapped to risk factors based
on that assignment.
For each risk bucket, the proposed
risk factors reflect the specific market
variables that impact the value of a
position. The risk factors are separately
defined to measure their individual
impact on market risk covered
positions’ value from small changes in
the value of a risk factor (the movement
in price (delta) and, where applicable,
the movement in volatility (vega)), and
the additional change in the positions’
value not captured by delta for each
relevant risk factor (curvature) in
stress.303
Under the proposal, a banking
organization would calculate the
sensitivity of a market risk covered
position as prescribed under the
proposal to each of the proposed risk
factors for delta, vega, and curvature, as
applicable. The proposed sensitivity
calculations for delta, vega, and
curvature risk factors are intended to
estimate how much a market risk
covered position’s value might change
as a result of a specified change in the
risk factor, assuming all other relevant
risk factors remain constant. For each
risk factor, the banking organization
would sum the resulting delta
sensitivities (and separately the vega
and curvature sensitivities) for all
market risk covered positions within the
same risk bucket to produce a net
sensitivity for each risk factor, which is
302 Under the proposal, a banking organization
would have to separately calculate the potential
losses arising from the position’s sensitivity to
changes in interest rates and changes in the issuer’s
credit spread.
303 Vega and curvature risk estimates are required
for instruments with optionality or embedded
prepayment option risk. For example, for an equity
option, the proposed delta risk factor (equity spot
price) would capture the impact on the option’s
value from changes in the equity spot price, the
proposed vega risk factor (implied volatility) would
capture the impact from changes in the implied
volatility, and the proposed curvature risk factors
(equity spot prices for the issuer) would capture
other higher-order factors from nonlinear risks.
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the potential value impact on all of the
banking organization’s market risk
covered positions in the risk bucket as
a result of a uniform change in a risk
factor.304
To capture how much the risk factor
might change over a defined time
horizon in stress conditions and how
that would change the value of the
market risk covered position, a banking
organization would multiply the net
delta sensitivity and the net vega
sensitivity, respectively, to each risk
factor within the risk bucket by the
proposed standardized risk weight for
the risk bucket. The proposed risk
weights are intended to capture the
amount that a risk factor would be
expected to move during the liquidity
horizon of the risk factor in stress
conditions.305 To capture curvature risk,
a banking organization would be
required to aggregate the incremental
loss above the delta capital requirement
from applying larger upward and
downward shock scenarios to each risk
factor.
To account for the potential price
impact of interactions between the risk
factors, the proposal would prescribe
aggregation formulas for calculating the
total delta, vega, and curvature capital
requirements within risk buckets and
across risk buckets. Specifically, the
risk-weighted sensitivities for delta,
vega, and curvature risk, respectively,
first would be summed for a risk factor,
then aggregated across risk factors with
common characteristics within their
respective risk buckets to arrive at
bucket-level risk positions. These
bucket-level risk positions would then
be aggregated for each risk class using
the prescribed aggregation formulas to
304 The proposed risk factors are intended to be
sufficiently granular such that only long and short
exposures without basis risk would be able to fully
offset for purposes of calculating the net sensitivity
to a risk factor. For example, by defining the risk
factors for equity risk at the issuer level, the
proposal would allow long and short equity risk
exposures to the same issuer to fully offset for
purposes of calculating the net equity risk factor
sensitivity, but only partially offset (correlations
less than one) for exposures to different issuers with
the same level of market capitalization, the same
type of economy, and the same market sector (such
as those within the same equity risk bucket).
305 The prescribed risk weights represent the
estimated change in the value of the market risk
covered position as a result of a standardized shock
to the risk factor based on characteristics of the
position and historic price movements.
Additionally, the proposed risk weights are
intended to help ensure comparability with the
proposed internal models approach described in
section III.H.8 of this SUPPLEMENTARY INFORMATION,
which generally would require banking
organizations’ internal models to follow a
methodology similar to the one used to calibrate the
risk weights when determining risk-based
requirements for market risk covered positions
under the standardized approach.
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produce the respective delta, vega, and
curvature risk capital requirements.
The aggregation formulas prescribe
offsetting and diversification benefits
via correlation parameters. Under the
proposal, the correlation parameters
specified for each risk factor pair are
intended to limit the risk-mitigating
benefit of hedges and diversification,
given that the hedge relationship
between an underlying position and its
hedge, as well as the relationship
between different types of positions,
could decrease or become less effective
in a time of stress. Specifically, taking
into account prescribed correlation
parameters, the banking organization
would need to calculate the aggregate
requirements first within a risk bucket
and then across risk buckets within one
risk class to produce the risk class-level
capital requirement for delta, vega, and
curvature risk. The resulting capital
requirements for delta, vega, and
curvature risk then would be summed
across risk classes, respectively, with no
recognition of any diversification
benefits because in stress diversification
across different risk classes may become
less effective.
To capture the potential for risk factor
correlations to increase or decrease in
periods of stress, the calculation of risk
bucket-level capital requirements and
risk class-level capital requirements for
each risk class would be repeated
corresponding to three different
correlation scenarios—assuming high,
medium and low correlations between
risk factor shocks—in order to calculate
the overall delta, vega, and curvature
capital requirements for all risk classes
to determine the overall capital
requirement for each scenario. The
prescribed correlation parameters in the
intra-bucket and inter-bucket
aggregation formulas would be those
used in the medium correlation
scenario. For the high and low
correlation scenarios, a banking
organization generally would increase
and decrease the medium correlation
parameters by 25 percent, respectively,
to appropriately reflect the potential
changes in the historical correlations
during a crisis.306
Finally, to determine the overall
capital requirements for each of the
three correlation scenarios, the banking
organization would sum the separately
306 As the degree to which a pair of variables are
linearly related (the correlation) can only range
from negative one to one, the proposal would cap
the correlation parameters under the high scenario
at no more than one (100 percent) and floor those
under the low scenario at no less than negative one.
For highly correlated positions, the low correlation
scenario also would not always reduce the
correlation parameter by 25 percent.
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calculated delta, vega, and curvature
capital requirements for all risk classes
without recognition of any
diversification benefits, given that delta,
vega, and curvature are intended to
separately capture different risks. The
sensitivities-based capital requirement
would be the largest capital requirement
resulting from the three scenarios.
Question 106: The agencies seek
comment on the sensitivities-based
method for market risk. To what extent
does the sensitivities-based method
appropriately capture the risks of
positions subject to the market risk
capital requirement? What additional
features, adjustments (such as to the
treatment of diversification of risks), or
alternative methodology could the
sensitivities-based method include to
reflect these risks more appropriately
and why? Commenters are encouraged
to provide supporting data.
i. Risk Factors
Under the proposal, a banking
organization would be required to map
all market risk covered positions within
each risk class to the specified risk
factors in order to calculate the capital
requirements for delta, vega, and
curvature. The proposed risk factors
differ for each risk class to reflect the
specific market risk variables relevant
for each risk class (for example, no tenor
is specified for the delta risk factor for
equity risk as equities do not have a
stated maturity, whereas the proposed
tenors for credit spread delta risk reflect
the common maturities of positions
within those risk classes). The granular
level at which the proposed risk factors
would be defined is intended to
promote consistency and comparability
in regulatory capital requirements
across banking organizations and to
help ensure the appropriate
capitalization of market risk covered
positions.
For risk classes that include specific
tenors or maturities as risk factors (for
example, delta risk factors for interest
rate risk), the proposal would require a
banking organization to assign the risk
factors to the proposed tenors through
linear interpolation or a method that is
most consistent with the pricing
functions used by the internal risk
management models. The banking
organization’s internal risk management
models, which are used by risk control
units and reviewed by auditors and
regulators, would provide an
appropriate basis for determining
regulatory capital requirements, without
imposing the operational burden of the
time-consuming methods used by the
front-office models. Additionally,
relying on banking organizations’
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internal risk management models, rather
than the front-office models, to identify
the relevant risk factors would help
ensure that a control function that is
independent of business-line
management would determine the
regulatory capital requirement for
market risk.
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I. Interest Rate Risk
Under the proposal, the delta risk
factors for interest rate risk would be
separately defined for each currency
along two dimensions: tenor and
interest rate curve. To value market risk
covered positions with interest rate risk,
the proposal would require a banking
organization to construct and use
interest rate curves for the currency in
which interest rate-sensitive market risk
covered positions are denominated (for
example, interest rate curves from the
overnight index swap curve (OIS) or an
alternative reference rate curve). The
proposal would require each of these
curves to be treated as a distinct interest
rate curve due to the basis risk between
them. Similarly, under the proposal, a
banking organization would be required
to treat an onshore currency curve (for
example, locally traded contracts) and
an offshore currency curve (for example,
contracts with the same maturity that
are traded outside the local jurisdiction)
as two distinct curves. A banking
organization would be allowed to treat
such curves as a single curve only with
the prior written approval from its
primary Federal supervisor.
As interest rate curves incorporate
nominal inflation, an additional delta
risk factor would be required for
instruments with cash flows that are
functionally dependent on a measure of
inflation (such as TIPS) to appropriately
account for inflation risk. Furthermore,
the proposal would require an
additional delta risk factor for
instruments with cash flows in different
currencies to appropriately reflect the
cross-currency basis risk of each
currency over USD or EUR.307 Under
the proposal, a banking organization
would not recognize the term structure
when measuring delta capital
requirements for inflation risk and
cross-currency basis risk. Additionally,
a banking organization would be
required to consider the inflation risk
factor and the cross-currency basis risk
307 Cross-currency basis is a basis added to a yield
curve in order to evaluate a swap for which the two
legs are paid in two different currencies. Market
participants use cross currency basis to price cross
currency interest rate swaps paying a fixed or a
floating leg in one currency, receiving a fixed or a
floating leg in a second currency, and including an
exchange of the notional amount in the two
currencies at the start date and at the end date of
the swap.
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factor, if applicable, in addition to the
sensitivity for the other delta risk factors
for the interest rate risk (currency, tenor
and interest rate curve) of the market
risk covered position. Accordingly, a
banking organization would be required
to allocate the sensitivities for inflation
risk and cross-currency basis risk in the
relevant interest rate curve for the same
currency as other interest rate risk
factors.
The vega risk factors for interest rate
risk would be the implied volatilities of
options referencing the interest rate of
the underlying instrument. The implied
volatilities of inflation rate risk-sensitive
options and cross-currency basis risksensitive options would be defined
along the maturity of the option,
whereas the implied volatilities of
interest-rate risk-sensitive options
would be defined along two
dimensions: the maturity of the option
and the residual maturity of the
underlying instrument at the expiration
date of the option. For example, a
banking organization would calculate
the vega sensitivity of a European
interest rate swaption that expires in 12
months referring to a one-year swap
based on the maturity of the option (12
months) as well as the residual maturity
of the underlying instrument (the
swap’s maturity of 12 months).
The proposal would define the
curvature risk factors for interest rate
risk along one dimension: the interest
rate curve of each currency (no term
structure would be considered).
Question 107: The agencies seek
comment on the appropriateness of
requiring banking organizations with
material exposure to emerging market
currencies to construct distinct onshore
and offshore curves. What, if any,
operational burden may arise from such
requirement and why?
II. Credit Spread Risk
The proposal would separately define
the credit spread risk factors for nonsecuritization positions,308
securitization positions that are not
correlation trading positions
(securitization positions non-CTP), and
correlation trading positions. The
proposal would define the delta risk
factors for credit spread risk for nonsecuritization positions along two
dimensions: the credit spread curve of
a relevant issuer and the tenor of the
position; the delta risk factors for credit
spread risk for securitization positions
308 Under the proposal, a non-securitization
position would be defined as a market risk covered
position that is not a securitization position or a
correlation trading position and that has a value
that reacts primarily to changes in interest rates or
credit spreads.
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non-CTP would be defined also along
two dimensions: the credit spread curve
of the tranche and the tenor of the
tranche; and the delta risk factors for
credit spread risk for correlation trading
positions would be defined along two
dimensions: the credit spread curve of
the underlying name and the tenor of
the underlying name. Under the
proposal, the vega risk factors for credit
spread risk are the implied volatilities of
options referencing the credit
spreads,309 defined along one
dimension: the option’s maturity.
The proposal would define the
curvature risk factors for credit spread
risk for non-securitization positions
along one dimension: the credit spread
curves of the issuer. The curvature risk
factors for credit spread risk for
securitization positions non-CTP would
be defined along the relevant tranche
credit spread curves of bond and CDS,
while for correlation trading positions
along the bond and CDS credit spread
curve of each underlying name. The
agencies recognize that requiring a
banking organization to estimate the
bond-CDS basis for each issuer would
impose a significant operational burden
with limited benefit in terms of risk
capture. To simplify the sensitivitiesbased-method calculation for curvature
risk in these cases, the proposal would
require banking organizations to ignore
any bond-CDS basis that may exist
between the bond and CDS spreads and
to calculate the credit spread risk
sensitivity as a single spread curve
across the relevant tenor points.
III. Equity Risk
Similar to interest rate risk, the delta
risk factors for equity risk would be
separately defined for each issuer as the
spot prices of each equity (for example,
for cash equity positions) and an equity
repo rate (for example, for term repostyle transactions), as appropriate.
Under the proposal, the vega risk factors
for equity risk would be the implied
volatilities of options referencing the
equity spot price, defined along the
maturity of the option. The curvature
risk factors for equity risk would be the
equity spot price. There are no
curvature risk factors for equity repo
rates.
309 When calculating the sensitivity for
securitization positions non-CTP, a banking
organization would calculate the sensitivities for
credit spread risk based on the embedded
subordination of the position, such as the spread of
the tranche. For correlation trading positions, the
credit spread risk sensitivity would be based on the
underlying names in the securitization position, or
nth-to-default position.
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IV. Commodity Risk
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Similar to interest rate and equity
risk, the delta risk factors for commodity
risk would be separately defined for
each commodity type 310 along two
dimensions: the contracted delivery
location of the commodity and the
remaining maturity of the contract. A
banking organization could only treat
separate contracts as having the same
delivery location if both contracts allow
delivery in all of the same locations.311
Additionally, the proposal would follow
the established pricing convention for
commodities and require a banking
organization to use the remaining
maturity of the contract to measure the
delta sensitivity for instruments with
commodity risk. As the price impact of
risk factor changes varies significantly
between different types of commodities,
the proposal would define the delta risk
factors for each commodity type to limit
offsetting across commodity types, as
such offsetting could drastically
understate the potential losses arising
from those positions.
To measure the price sensitivity of a
commodity market risk covered
position, the proposal would require a
banking organization to use either the
spot price or the forward price,
depending on which risk factor is used
by the internal risk management models
to price commodity transactions. For
example, if the internal risk
management model typically values
electricity contracts based on forward
prices (rather than spot prices), the
proposal would require the banking
organization to compute the delta
capital requirement using the current
prices for futures and forward contracts.
Similar to equity risk, the proposal
would define the commodity vega risk
factors based on the implied volatilities
of commodity-sensitive options as
defined along the maturity of the option
and the curvature risk factors based on
the constructed curve per commodity
spot price.
310 Under the proposal, any two commodities
would be considered distinct if the underlying
commodity to be delivered would cause the market
to treat the two contracts as distinct (e.g., West
Texas Intermediate oil and Brent oil).
311 For example, a contract that can be delivered
in four ports may have less sensitivity to each
location defined risk factor than a contract that can
only be delivered in three of those ports. If a
banking organization has entered into a contract to
deliver 1000 barrels of oil in port A, B, C or D, and
a hedge contract to receive 1000 barrels of oil on
the same date in port A, B or C, if on delivery day
ports A, B and C are closed, the banking
organization is exposed to commodity risk in that
it must deliver 1000 barrels of oil to port D without
receiving 1000 barrels. As a result, the two contracts
would have different sensitivity to location defined
risk factors.
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Question 108: What, if any, risk
factors would better serve to
appropriately capture the delta
sensitivity for positions within the
commodity risk class and why?
64115
V. Foreign Exchange Risk
The proposal would define the delta
risk factors for foreign exchange risk as
the exchange rate between the currency
in which the market risk covered
position is denominated and the
reporting currency of the banking
organization. For market risk covered
positions that reference two currencies
other than the reporting currency, the
banking organization generally would
be required to calculate the delta risk
factors for foreign exchange risk using
the exchange rates between each of the
non-reporting currencies and the
reporting currency. For example, for a
foreign exchange forward referencing
EUR/JPY, the relevant risk factors for a
USD-reporting banking organization to
consider would be the exchange rates
for USD/EUR and USD/JPY.
To reduce operational burden and
help ensure the delta capital
requirements reflect foreign exchange
risk, the proposal would also allow a
banking organization to calculate delta
risk factors for foreign exchange risk
relative to a base currency instead of the
reporting currency, if approved by the
primary Federal supervisor.312 In this
case, after designating a single currency
as the base currency, a banking
organization would calculate the foreign
exchange risk for all currencies relative
to the base currency, and then convert
the foreign exchange risk into the
reporting currency using the spot
exchange rate (reporting currency/base
currency). For example, if a USDreporting banking organization receives
approval to calculate foreign exchange
risk using JPY as the base currency, for
a foreign exchange forward referencing
EUR/JPY, the banking organization
would consider separate deltas for the
EUR/JPY exchange rate risk and USD/
JPY foreign exchange translation risk
and then translate the resulting capital
requirement to USD at the USD/JPY spot
exchange rate.
The proposal would define the vega
risk factors for foreign exchange risk as
the implied volatility of options that
reference exchange rates between
currency pairs along one dimension: the
maturity of the option. For curvature,
the foreign exchange risk factors would
be all exchange rates between the
currency in which a market risk covered
position is denominated and the
reporting currency (or the base
currency, if approved by the primary
Federal supervisor).
The proposal would allow (but not
require) a banking organization to treat
a currency’s onshore exchange rate and
an offshore exchange rate as two distinct
risk factors in the delta, vega and
curvature calculations for foreign
exchange risk. While in stress the
foreign exchange risk posed by a
currency’s onshore exchange rate and an
offshore exchange rate may differ, as
U.S. banking organizations generally do
not have material exposure to foreign
exchange risk from a currency’s onshore
and offshore basis, the prudential
benefit of requiring banking
organizations to capture risk posed by
such basis would be limited, relative to
the potential compliance burden.
Therefore, the agencies are proposing to
allow, but not require, banking
organizations with material exposure to
emerging market currencies to recognize
the different foreign exchange risks
posed by onshore and offshore exchange
rate curves when calculating risk-based
capital requirements under the
sensitivities-based method.
312 A banking organization would have to
demonstrate to its primary Federal supervisor that
calculating foreign exchange risk relative to its base
currency provides an appropriate risk
representation of the banking organization’s market
risk covered positions and that the foreign exchange
risk between the base currency and the reporting
currency is addressed. In general, the base currency
would be the functional currency in which the
banking organization generates or expends cash. For
example, a multinational banking organization
headquartered in the United States that primarily
transacts in and uses EUR to value its assets and
liabilities for internal accounting and risk
management purposes could use EUR as its base
currency. As its consolidated financial statement
must be reported in USD, this multinational
banking organization would need to translate the
value of those assets and liabilities from the base
currency (EUR) to the reporting currency (USD).
Since exchange rates fluctuate continuously, this
conversion could increase or decrease the value of
those assets and liabilities and thus generate foreign
exchange gains (or losses) from non-operating
activity.
ii. Risk Factor Sensitivities
A fundamental element of the
sensitivities-based method is the
sensitivity calculation, which estimates
the change in the value of a market risk
covered position as a result of a
regulatorily prescribed change in the
value of a risk factor, assuming all other
risk factors are held constant. To help
ensure consistency and conservatism
across banking organizations, the
proposal would set requirements on the
valuation models, currency, inputs, and
sensitivity calculation, as applicable,
that a banking organization could use to
measure the risk factor sensitivity of a
market risk covered position.
In general, the proposal would require
a banking organization to calculate risk
factor sensitivities using the valuation
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Federal Register / Vol. 88, No. 179 / Monday, September 18, 2023 / Proposed Rules
models used to report actual profits and
losses for financial reporting
purposes.313 The valuation methods
used by such models would provide an
appropriate basis for determining riskbased capital requirements because such
models are subject to requirements
intended to enhance the accuracy of the
financial data produced by the
models.314 The agencies recognize that
a banking organization can calculate
risk sensitivities for delta and vega or
estimate curvature using valuation
methods and systems from equivalent
internal risk management models. The
proposal would permit a banking
organization with prior approval of the
primary Federal supervisor to calculate
delta and vega sensitivities and
curvature scenarios using the valuation
methods used in its internal risk
management models.
For consistency and comparability in
risk-based capital requirements across
banking organizations, the proposal
would require each banking
organization to calculate all risk factor
sensitivities in the reporting currency of
the banking organization, except for the
foreign exchange risk class where, with
prior approval of the primary Federal
supervisor, the banking organization
may calculate the sensitivities relative
to a base currency instead of the
reporting currency. To appropriately
capture a banking organization’s
exposure to market risk, the proposal
would require banking organizations to
use fair values that exclude CVA in the
calculation of risk factor sensitivities.
I. Delta
lotter on DSK11XQN23PROD with PROPOSALS2
Under the proposal, a banking
organization would calculate the delta
capital requirement using the steps
previously outlined in section III.H.7.a
of this SUPPLEMENTARY INFORMATION for
its market risk covered positions except
those whose value exclusively depends
on risk factors not captured by any of
the proposed risk classes (exotic
exposures).315 The proposal would
require a banking organization to
separately calculate the market risk
capital requirements for such positions
under the residual risk add-on as
described in section III.H.7.c of this
SUPPLEMENTARY INFORMATION.
313 Banking organizations would be required to
have a prudent valuation process, including the
independent validations of the valuation models
used in the standardized approach.
314 Such requirements include the requirements
from the Sarbanes-Oxley Act of 2002. Public Law
107–204.
315 Examples of exotic exposures not captured by
any of the proposed risk classes include but are not
limited to longevity, weather, and natural disasters
derivatives.
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For purposes of calculating the delta
capital requirement, the proposal would
require a banking organization to
calculate the delta sensitivity of a
position using the sensitivity definitions
provided in the proposal for each risk
factor and the valuation models used for
financial reporting, unless a banking
organization receives prior written
approval to define delta sensitivities
based on internal risk management
models.316 Based on the proposed
sensitivity definitions, the delta
sensitivity would reflect the change in
the value of a market risk covered
position resulting from a small specified
shift of one basis point or one percent
change to a risk factor, assuming all
other relevant risk factors are held at the
current level, divided by the same
specified shift to the risk factor.
For the equity spot price, commodity,
and foreign exchange risk factors, the
delta sensitivity would equal the change
in value of a market risk covered
position due to a one percentage point
increase in the risk factor divided by
one percentage point. For the interest
rate, credit spread, and equity repo rate
risk factors, the delta sensitivity would
equal the change in value of a market
risk covered position due to a one basis
point increase in the risk factor divided
by one basis point. In the case of credit
spread risk for securitizations non-CTP,
a banking organization would calculate
the delta sensitivity for the positions
with respect to the credit spread of the
tranche rather than the credit spread of
the underlying positions. For credit
spread risk for correlation trading
positions, the delta sensitivity for credit
spread risk would be computed using a
one basis point shift in the credit
spreads of the individual underlying
names of the securitization position or
nth-to-default position.
When calculating the delta sensitivity
for positions with optionality, a banking
organization would apply either the
sticky strike rule,317 the sticky delta
rule,318 or, with the prior approval from
its primary Federal supervisor, another
316 The proposal would define internal risk
management models as the valuation models that
the independent risk control unit within the
banking organization uses to report market risks
and risk-theoretical profits and losses to senior
management.
317 Under the sticky strike rule, a banking
organization would assume that the implied
volatility for an option remains unaffected by
changes in the underlying asset price for any given
strike price.
318 Under the sticky delta rule, the banking
organization would assume that the implied
volatility for a particular maturity depends only on
the ratio of the price of the underlying asset to the
strike price (sometimes called the moneyness of the
option).
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assumption.319 Each of these methods,
or various combinations of such
methods, would measure appropriately
the sensitivity of a risk factor within any
of the risk classes.
II. Vega
For market risk covered positions
with optionality, the vega sensitivity to
a risk factor would equal the vega of an
option multiplied by the volatility of the
option, which represents approximately
the change in the option’s value as the
result of a one percentage point increase
in the value of the option’s volatility. To
measure the vega sensitivity of a market
risk covered position, the proposal
would require a banking organization to
use either the at-the-money volatility of
an option or the implied volatility of an
option, depending on which is used by
the valuation models used for financial
reporting 320 to determine the intrinsic
value of volatility in the price of the
option.
The vega capital requirement would
only apply to options or instruments
with embedded optionality, including
instruments with material prepayment
risk. For purposes of calculating the
vega capital requirement, a banking
organization would follow the steps
previously outlined and use the same
risk buckets applied in the delta capital
calculation and the proposed vega risk
weights.
Callable and puttable bonds that are
priced based on the yield to maturity of
the instrument would not be subject to
the vega capital requirement. The
agencies recognize that in practice a
banking organization may not be able to
calculate vega risk for callable and
puttable bonds, as implied volatility for
credit spread typically is not used as an
input for the pricing of such
instruments, and thus implied volatility
is not captured by the internal models.
Therefore, the agencies are proposing to
allow banking organizations to exclude
from the vega capital requirement
callable and puttable bonds that are
priced based on the yield to maturity of
the instrument, as the delta capital
requirement in these cases would be
sufficiently conservative to capture the
potential vega risk arising from such
exposures.
To calculate the vega sensitivity, the
proposal would require a banking
319 With prior approval from the primary Federal
supervisor, a banking organization could calculate
risk factor sensitivities based on internal risk
management models provided the method would be
most consistent with the valuation methods.
320 With the prior approval of the primary Federal
supervisor, a banking organization could use the
type of volatility used in the internal risk
management models.
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organization to assign options to buckets
based on their maturity. As the proposal
defines the vega risk factors for interest
rate risk along two dimensions: the
maturity (or expiry) of the option and
the maturity of the option’s underlying
instrument—a banking organization
would be required to group options
within the interest rate risk class along
both of these two dimensions. To help
ensure appropriately conservative
capital requirements, the proposal
would require a banking organization to
(1) assign instruments with optionality
that either do not have a stated maturity
(for example, cancellable swaps) or that
have an undefined maturity to the
longest prescribed maturity tenor for
vega, and (2) subject such instruments
to the residual risk add-on, as described
in section III.H.7.c of this
SUPPLEMENTARY INFORMATION. Similarly,
for options that do not have a stated
strike price or that have multiple strike
prices, or that are barrier options, the
proposal would require a banking
organization to apply the maturity and
strike price used in its valuation models
for financial reporting, unless the
banking organization has received
approval to use internal risk
management models, to value the
position and apply a residual risk addon.321 The agencies are proposing these
constraints as a simple and conservative
approach for market risk covered
positions that are difficult to value in
practice.
Question 109: As the pricing
conventions for certain products (for
example, callable and puttable bonds)
do not explicitly use an implied
volatility, the agencies seek comment on
the merits of allowing banking
organizations to ignore the optionality
of callable and puttable bonds that are
priced using yield-to-maturity of the
instrument if the option is not exercised
relative to the merits of specifying a
value for implied volatility (for example,
35 percent) to be used in calculating the
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321 Tranches of correlation trading positions that
do not have an implied volatility would not be
subject to the vega risk capital requirement. Such
instruments would not be exempt from delta and
curvature capital requirements.
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vega capital requirement for credit
spread risk positions when the implied
volatility cannot be measured or is not
readily available in the market. What
are the benefits and drawbacks of
specifying a value for the implied
volatility for such products and what
should the specified value be set to and
why? What, if any, alternative
approaches would better serve to
appropriately capture the vega
sensitivity for positions within the credit
spread risk class when the implied
volatility is not available?
Question 110: The agencies solicit
comment on the appropriateness of
relying on a banking organization’s
internal pricing methods for
determining the maturity and strike
price of positions without a stated strike
price or with multiple strike prices.
What, if any, alternative approaches
(such as using the average maturity of
options with multiple exercise dates)
would better serve to promote
consistency and comparability in riskbased capital requirements across
banking organizations? What are the
benefits and drawbacks of such
alternatives compared to the proposed
reliance on the internal pricing models
of banking organizations?
III. Curvature
The proposed curvature capital
requirements are intended to capture
the price risks inherent in instruments
with optionality that are not already
captured by delta (for example, the
change in the value of an option that
exceeds what can be explained by the
delta of the option alone). Under the
proposal, only options or positions that
contain embedded optionality,
including positions with material
prepayment risk, which present material
price risks not captured by delta, would
be subject to the curvature capital
requirement. While linear instruments
may also exhibit a certain degree of nonlinearity, it is not always material for
such instruments. Therefore, to allow
for a more accurate representation of
risk, the proposal would permit a
banking organization, at its discretion,
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64117
to make an election for a trading desk 322
to include instruments without
optionality risk in the curvature capital
requirement, provided that the trading
desk consistently includes such
positions through time.
The proposal would require a banking
organization to use the same risk
buckets applied in the delta capital
calculation to calculate curvature
capital requirements. To calculate the
risk-weighted sensitivity for each
curvature risk factor within a risk
bucket, the proposal would require a
banking organization to fully revalue all
of its market risk covered positions with
optionality or that a banking
organization has elected to include in
the calculation of its curvature capital
requirement after applying an upward
shock and a downward shock to the
current value of the market risk covered
position. To avoid double counting, the
banking organization would calculate
the incremental loss in excess of that
already captured by the delta capital
requirement for all market risk covered
positions subject to the curvature capital
requirements. The larger incremental
loss resulting from the upward and the
downward shock would be the
curvature risk-weighted sensitivity.323
The below graphic provides a
conceptual illustration of the
calculation of the curvature riskweighted sensitivity based on the
upward and the downward shock
scenarios.
322 For a banking organization that has
established a trading desk structure with a single
trading desk that uses the standardized measure to
calculate market risk capital requirements, the
proposal would allow such banking organization to
make such an election for the entire organization
rather than on a trading desk by trading desk basis.
If such an election is made at the enterprise-wide
level, the proposal would require the banking
organization to consistently include positions
without optionality within the curvature
calculation.
323 To promote consistency and comparability in
regulatory capital requirements across banking
organizations, the proposal would require that in
cases where the incremental loss resulting from the
upward and the downward shock is the same, the
banking organization must select the scenario in
which the sum of the capital requirements of the
curvature risk factors is greater.
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In calculating the curvature riskweighted sensitivity for the interest rate,
credit spread, and commodity risk
classes, the banking organization would
apply the upward and downward
shocks assuming a parallel shift of all
tenors for each curve based on the
highest prescribed delta risk weight for
the applicable risk bucket.324 325 The
proposal would require a banking
organization to apply the highest risk
weight across risk buckets to each tenor
point along the curve (parallel shift
assumption) for conservatism and to
help ensure the curvature capital
requirements reflect incremental losses
from curvature and not those due to
changes in the shape or slope of the
curve. The proposal would require a
banking organization to perform this
calculation at the risk bucket level (not
the risk class level). To the extent that
applying the downward shocks results
in negative credit spreads, the proposal
would allow banking organizations to
324 As
described in section III.H.7.a.iii.I of this
the proposed risk
bucket structure used to group the delta risk factors
for interest rate risk (and the corresponding risk
weight for each risk bucket) is solely based on the
tenor of market risk covered position. For purposes
of calculating the curvature sensitivity for interest
rate risk, the proposal would require a banking
organization to disregard the bucketing structure
and apply the highest prescribed delta risk weight
(the 1.7 percent risk weight applicable to the 0.25year tenor, or 1.7 percent divided by √2 if the
interest rate curve references a currency that is
eligible for a reduced risk weight) to all tenors
simultaneously for each yield curve.
325 As the curvature capital requirements would
capture an option’s change in the value above that
captured by delta, a banking organization would
calculate the curvature sensitivity to credit spread
risk for securitization positions non-CTP and
correlation trading positions using the spread of the
tranche and the spread of the underlying names,
respectively.
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SUPPLEMENTARY INFORMATION,
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floor credit spreads at zero, which is the
natural floor for credit spreads given
that negative CDS spreads are not
meaningful.
For the foreign exchange and equity
risk classes, the upward and downward
shocks represent a relative shift of the
foreign exchange spot prices or equity
spot prices, respectively, equal to the
delta risk weight prescribed for the risk
factor. The agencies recognize that the
conversion of other currencies into
either the reporting currency or base
currency, if applicable, would capture
exchange rate fluctuations, and thus
overstate the sensitivity for foreign
exchange risk. Thus, for options that do
not reference the reporting or base
currency of the banking organization as
an underlying exposure, the proposal
would allow the banking organization to
divide the net curvature risk positions
by a scalar of 1.5. The proposal would
allow a banking organization to apply
the scalar of 1.5 to all market risk
covered positions subject to foreign
exchange risk, provided that the
banking organization consistently
applies the scalar to all market risk
covered positions with foreign exchange
risk through time.
To aggregate the risk bucket-level
capital requirements and risk class-level
capital requirements for curvature, a
banking organization would bifurcate
positions into those with positive
curvature and those with negative
curvature. For the purposes of
calculating risk-based capital
requirements for curvature, positions
with negative curvature represent a
capital benefit—as they reduce rather
than increase risk and thus risk-based
capital requirements. For example, the
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downward shock as depicted in the
above graphic produces less of an
estimated price reduction under the
curvature scenario than under the linear
delta shock (negative curvature). To
prevent negative curvature capital
requirements from decreasing the
overall capital required under the
sensitivities-based method, both the
intra-bucket and inter-bucket
aggregation formulas would floor the
curvature capital requirement at zero.
Additionally, both formulas include a
variable 326 to allow a banking
organization to recognize the riskreducing benefits of market risk covered
positions with negative curvature in
offsetting those with positive curvature,
while preventing the aggregation of
market risk covered positions with
negative curvature from resulting in an
overall reduction in capital.
Question 111: The agencies solicit
comment on the appropriateness of
calculating the curvature risk-weighted
sensitivity for the commodity risk class
using the upward and downward shocks
assuming a parallel shift of all tenors for
each curve. Would a relative shift be
more appropriate for calculating riskweighted sensitivity for the commodity
risk class and why?
iii. Risk Buckets and Corresponding
Risk Weights
After determining the net sensitivity
for each of the proposed risk factors
within each risk class, a banking
organization would calculate the riskweighted sensitivity by multiplying the
326 Specifically, this refers to the psi variable (Y)
within the intra and inter-bucket aggregation
formulas in § ll.206(d)(2) and § ll.206(d)(3) of
the proposed rule.
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net sensitivity for each risk factor by the
risk weight prescribed for each risk
bucket.327 The proposed risk buckets
and corresponding risk weights are
largely consistent with the framework
issued by the Basel Committee.
However, to reflect the potential
systematic risks that positions may
experience in a time of stress and avoid
reliance on external ratings in
accordance with U.S. law, the agencies
are proposing to use alternative criteria
to define the bucketing structure for risk
factors related to credit spread risk and
to clarify the application of the credit
spread risk buckets for certain U.S.
products, as described in section
III.H.7.a.iii.II of this SUPPLEMENTARY
INFORMATION.328 Additionally, to
appropriately reflect a jurisdiction’s
stage of economic development, the
agencies are proposing to use objective
market economy criteria to define the
bucketing structure for risk factors
related to equity risk, as described in
section III.H.7.a.iii.III of this
SUPPLEMENTARY INFORMATION.
Furthermore, the agencies are proposing
to include electricity in the same risk
bucket as gaseous combustibles in view
of the inherent relationship between the
price of electricity and natural gas and
to simplify the proposal, as described in
section III.H.7.a.iii.IV of this
SUPPLEMENTARY INFORMATION.
The proposed risk weight buckets and
associated risk weights would be
appropriate to capture the specific,
idiosyncratic risks of market risk
covered positions (for example, negative
betas or variations in capital structure).
These components of the proposal also
are largely consistent with the Basel III
reforms and would promote consistency
and comparability in market risk capital
requirements among banking
organizations domestically and across
jurisdictions. The sections that follow
describe the proposed risk buckets and
associated risk weights for each risk
factor.
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I. Interest Rate Risk
Table 1 to § ll.209 of the proposed
rule sets forth the ten proposed risk
buckets for the interest rate risk factors
of market risk covered positions and the
corresponding risk weight applicable to
each risk bucket.329 The proposal would
327 Vega and curvature capital requirements
would use the same risk buckets as prescribed for
delta. See § ll.209(c) and (d) of the proposed rule.
Table 11 to § ll.209 of the proposed rule provides
the proposed vega risk weights for each risk class,
which incorporate the liquidity horizons for each
risk class (risk of market illiquidity) from the Basel
III reforms.
328 See 15 U.S.C. 78o–7 note.
329 The buckets reflect that interest rates at a
longer tenor have less uncertainty and thus lower
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require a banking organization to use
separate risk buckets for each currency,
for each of ten proposed tenors to
capture most commonly traded
instruments across market risk covered
positions held by a banking organization
and align with bucketing structures
used by trading firms.
By delineating interest rate risk
factors based on currency 330 and tenor,
the granularity of the proposed risk
buckets is intended to appropriately
balance the risk sensitivity of the
proposed framework with providing
consistency in risk-based requirements
across banking organizations by
assigning similar risk weights to similar
kinds of positions.
Factors such as the stage of the
economic cycle and the role of exchange
rates can cause interest rate risk to
diverge significantly across different
currencies, particularly in stress
periods. Accordingly, the proposal
would require banking organizations to
establish separate interest rate risk
buckets for each currency.
OTC interest rate derivatives for
liquid currencies have significant
trading activity relative to non-liquid
currencies, which means a banking
organization faces a shorter liquidity
horizon to offload exposure to interest
rate risk factors in liquid currencies.
Therefore, the proposal would allow a
banking organization to divide the
proposed risk weight applicable to each
interest rate risk factor bucket by the
square root of two if the interest rate risk
factor relates to a liquid currency listed
in § ll.209(b)(1)(i) of the proposed
rule or any other currencies specified by
the primary Federal supervisor. This
approach would allow a banking
organization to apply a lower risk
weight for purposes of the delta capital
requirements for interest rate risk factors
for the listed liquid currencies and any
other currencies specified by the
primary Federal supervisor.
II. Credit Spread Risk
Tables 3, 5, and 7 to § ll.209 of the
proposed rule set forth the risk buckets
and corresponding risk weights for the
credit spread risk factors of nonsecuritization positions, correlation
trading positions, and securitization
positions non-CTP, respectively. Under
the proposal, a banking organization
would group the credit spread risk
factors for non-securitization positions,
correlation trading positions, and
volatility than interest rates at a shorter tenor that
are more receptive to changes in interest rate risk.
330 As noted in section III.H.7.a.i.I of this
SUPPLEMENTARY INFORMATION, under the proposal,
each currency would represent a separate risk factor
for interest rate risk.
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securitization positions non-CTP into
one of nineteen, seventeen, or twentyfive proposed risk buckets, respectively,
based on market sector and credit
quality. The credit quality of a market
risk covered position in a given sector
is inversely related to its credit spread.
Accordingly, the risk buckets for credit
spread risk consider the credit quality of
a given market risk covered position.
More specifically with respect to the
consideration of credit quality, the
agencies are proposing to generally use
the same approach to delta credit spread
risk buckets and corresponding risk
weights provided in the Basel III
reforms for non-securitization positions,
correlation trading positions, and
securitization positions non-CTP, but to
define the risk buckets using alternative
criteria to capture the creditworthiness
of the obligor. The delta credit spread
risk buckets in the Basel III reforms are
defined based on the applicable credit
ratings of the reference entity. Section
939A of the Dodd-Frank Act required
the agencies to remove references to
credit ratings in Federal regulations.331
Therefore, the agencies are proposing an
approach that would allow for a level of
risk sensitivity in the delta credit spread
risk buckets and corresponding risk
weights applicable to nonsecuritizations, correlation trading
positions, and securitization positions
non-CTP that would be generally
consistent with the Basel III reforms and
not rely on external credit ratings.
Specifically, the agencies are proposing
to define the delta credit spread risk
buckets and corresponding risk weights
for non-securitizations, correlation
trading positions, and securitization
positions non-CTP based on the
definitions for investment grade as
defined in the agencies’ existing capital
rule 332 and the definitions of
speculative grade 333 and subspeculative grade 334 as defined in the
proposal.
331 15
U.S.C. 78o–7 note.
12 CFR 3.2 (OCC); 12 CFR 217.2 (Board);
and 12 CFR 324.2 (FDIC).
333 The proposal would define speculative grade
to mean that the entity to which a banking
organization is exposed through a loan or security,
or the reference entity with respect to a credit
derivative, has adequate capacity to meet financial
commitments in the near term, but is vulnerable to
adverse economic conditions, such that should
economic conditions deteriorate, the issuer or the
reference entity would present an elevated default
risk.
334 The proposal would define sub-speculative
grade to mean that the entity to which a banking
organization is exposed through a loan or a security,
or the reference entity with respect to a credit
derivative, depends on favorable economic
conditions to meet its financial commitments, such
that should economic conditions deteriorate, the
332 See
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The credit spread risks of industries
within the proposed sectors react
similarly to the same market or
economic events by principle of shared
economic risk factors (for example,
technology and telecommunications).
Furthermore, the proposal would
provide sectors similar to those
contained in the Basel III reforms and
specify a treatment for certain U.S.specific sectors (for example, GSE debt
and public sector entities). Specifically,
the proposal would include GSE debt
and public sector entities in the sector
for government-backed non-financials,
education, and public administration to
appropriately reflect the potential
variability in the credit spreads of such
positions in the industry. Accordingly,
assigning the same risk weight to these
positively correlated sectors would
reduce administrative burden and not
have a material effect on risk sensitivity.
Some proposed sectors consist of
different industries, for example basic
materials, energy, industrials,
agriculture, manufacturing, and mining
and quarrying. Positions within the
same industry that are investment grade
would be assigned to the same risk
bucket because from a market risk
perspective an economic event causing
volatility in an industry tends to
similarly affect all positions in the
industry, even if there may be
differences in credit quality between
individual issuers within an industry.
The agencies recognize that there may
be sectors that are not expressly
categorized by the proposed risk
buckets, and that specifying all sectors
for such purpose may not be possible.
The proposed risk buckets would
include an ‘‘other sector’’ category for
market risk covered positions that do
not belong to any of the other risk
buckets.
The proposed risk weights are based
on empirical data which reflect the
historical stress period for which the
risk factors within the risk bucket
caused the largest cumulative loss at
various liquidity horizons. As such, for
speculative grade sovereigns and
multilateral development banks, the
agencies are proposing a 3 percent risk
weight for such positions that are nonsecuritization positions (Table 3 to
§ ll.209) and a 13 percent risk weight
for such positions that are correlation
trading positions (Table 5 to § ll.209).
Based on the agencies’ quantitative
analysis of the historical data, the credit
spreads of speculative grade sovereign
bonds have typically widened more
than 2 percent after a downgrade, and
issuer or the reference entity likely would default
on its financial commitments.
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significantly more for sub-speculative
grade sovereigns.335 Additionally, for
non-securitization positions and
correlation trading positions, the
agencies are proposing a separate risk
bucket with higher risk weights (7
percent and 16 percent, respectively) for
sub-speculative grade sovereigns and
multilateral development banks than for
those of speculative grade, because of
the additional risk posed by subspeculative exposures.
For non-securitization positions, the
agencies are proposing a 2.5 percent risk
weight for all investment grade covered
bonds 336 to reduce variability in riskbased capital requirements across
banking organizations and appropriately
account for the preferential treatment
provided in the standardized default
risk capital requirement.337 As most
U.S. banking organizations hold limited
or no covered bonds, the proposed 2.5
percent risk weight should have an
immaterial impact on the sensitivitiesbased capital requirement.
For securitization positions non-CTP
(Table 7 to § ll.209), the proposal
would clarify the treatment of personal
loans and dealer floorplan loans within
the delta credit spread risk buckets.
Specifically, the proposal would require
a banking organization to include
personal loans within the risk bucket for
credit card securitizations and dealer
floorplans within the risk bucket for
auto securitizations in order to
appropriately reflect the lower credit
spread risk of these positions relative to
those within the other sector risk
bucket.338
335 The agencies are applying a similar
methodology for calibration of credit spread risk
weight for sovereigns as the Basel Committee used
for calibrating risk weights for other asset classes,
which aligns the sensitivities-based method risk
weight calibration to the liquidity horizon adjusted
stressed expected shortfall specified in the internal
model approach. The Basel Committee used IHS
Markit Credit Default Swap (CDS) data and
calculated ten day overlapping returns (such as
absolute changes in CDS spreads of sovereigns). For
the period of stress, the agencies used the European
sovereign crisis as it was more representative of
stress risk for these exposures. The standard
deviation obtained was multiplied by 2.34 to reflect
the expected shortfall quantile of 97.5. In the last
step, the estimate was adjusted to meet the
sovereign liquidity horizon specified for internal
models.
336 As defined in § ll.201 of proposed subpart
F of the capital rule, a covered bond would mean
a bond issued by a financial institution that is
subject to a specific regulatory regime under the law
of the jurisdiction governing the bond designed to
protect bond holders and satisfies certain other
criteria.
337 See section III.H.7.b of this SUPPLEMENTARY
INFORMATION for a more detailed description of the
preferential treatment applied to covered bonds
under the proposed standardized default risk
capital requirement.
338 The other sector risk bucket refers to bucket
25 in Table 7 to § ll.209 of the proposed rule.
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For securitization positions non-CTP,
the proposal would also clarify the delta
credit spread risk buckets for residential
mortgage-backed securities to help
ensure consistency in bucketing
assignments across banking
organizations. Specifically, the agencies
are proposing to define prime
residential mortgage-backed securities
based on the definition of qualified
residential mortgages in the credit risk
retention rule 339 and to define subprime residential mortgage-backed
securities based on the definitions of
higher-priced mortgage loans and highcost mortgages in Regulation Z,340
respectively.
Under the proposal, prime residential
mortgage-backed securities would be
defined as securities in which the
underlying exposures consist primarily
of qualified residential mortgages as
defined under the credit risk retention
rule. The eligibility criteria of the
qualified residential mortgage definition
are designed to help ensure the
borrower’s ability to repay.341
Residential mortgage-backed securities
that are primarily backed by qualified
residential mortgage loans carry
significantly lower credit risk than those
backed primarily by non-qualifying
loans. Therefore, the agencies are
proposing to use the existing definition
of qualified residential mortgage in the
credit risk retention rule, which refers to
the Regulation Z definition of qualified
mortgage to identify residential
mortgage-backed securities that are
primarily backed by underlying loans
with sufficiently low credit risk to be
classified as prime.
Similarly, the proposal would define
a sub-prime residential mortgage-backed
security as a security in which the
underlying exposures consist primarily
of higher-priced mortgage loans as
defined under Regulation Z (12 CFR
1026.35), high-cost mortgages as defined
under Regulation Z (12 CFR 1026.32), or
both. In general, Regulation Z defines
339 The credit risk retention rule generally
requires a securitizer to retain not less than 5
percent of the credit risk of certain assets that the
securitizer, through the issuance of an asset-backed
security, transfers, sells, or conveys to a third party.
See 12 CFR part 43 (OCC); 12 CFR part 244 (Board);
12 CFR part 373 (FDIC).
340 To help ensure that credit terms are disclosed
in a meaningful way so consumers can compare
credit terms more readily and knowledgeably,
Regulation Z mandates regulations on how lenders
may calculate and disclose loan costs. See 12 CFR
part 1026.
341 Under the general definition for qualified
mortgages in 12 CFR 1026.43(e)(2), a creditor must
satisfy the statutory criteria restricting certain
product features and points and fees on the loan,
consider and verify certain underwriting
requirements that are part of the general ability-torepay standard, and meet certain other
requirements.
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higher-priced mortgage loans 342 and
high-cost mortgages 343 to include
consumer credit transactions secured by
the consumer’s principal dwelling with
an annual percentage rate 344 that
exceeds the average prime offer rate
(APOR) 345 for a comparable transaction.
Consistent with Regulation Z, the best
way to identify the subprime market is
by loan price rather than by borrower
characteristics, which could present
operational difficulties and other
problems. Therefore, the agencies are
proposing to use the existing definitions
in Regulation Z, which rely on a loan’s
annual percentage rate and other
characteristics, to identify residential
mortgage-backed securities that are
primarily backed by underlying loans
with sufficiently high credit risk to be
classified as sub-prime. In addition, the
proposal would reduce compliance
burden for banking organizations by
allowing them to leverage criteria
already being used to evaluate mortgage
loans for coverage under the prescribed
Regulation Z thresholds.
The agencies recognize that a
securitization vehicle that holds
residential mortgage-backed securities
may hold assets other than the
342 Under Regulation Z, a higher-priced mortgage
loan is defined as a closed-end consumer credit
transaction secured by the consumer’s principal
dwelling with an annual percentage rate that
exceeds the average prime offer rate for a
comparable transaction as of the date the interest
rate is set by a certain amount of percentage points
depending on the type of loan. See 12 CFR
1026.35(a)(1).
343 Under Regulation Z, a high-cost mortgage is
defined as a closed- or open-end consumer credit
transaction secured by the consumer’s principal
dwelling and in which the annual percentage rate
exceeds the average prime offer rate for a
comparable transaction by a certain amount, or the
transaction’s total points and fees exceed a certain
amount, or under the terms of the loan contract or
open-end credit agreement, the creditor can charge
a prepayment penalty more than 36 months after
consummation or account opening, or prepayment
penalties that can exceed, in total, more than 2
percent of the amount prepaid. See 12 CFR
1026.32(a).
344 Annual percentage rates are derived from
average interest rates, points, and other loan pricing
terms currently offered to consumers by a
representative sample of creditors for mortgage
transactions that have low-risk pricing
characteristics. Other pricing terms include
commonly used indices, margins, and initial fixedrate periods for variable-rate transactions. Relevant
pricing characteristics include a consumer’s credit
history and transaction characteristics such as the
loan-to-value ratio, owner-occupant status, and
purpose of the transaction.
345 Loans with higher annual percentage rates or
that have higher points and fees or prepayment
penalties generally are extended to less
creditworthy borrowers (for example, weaker
borrower credit histories, higher borrower debt-toincome ratios, higher loan-to-value ratios, less
complete income or asset documentation, less
traditional loan terms or payment schedules, or
combinations of these or other risk factors) and thus
pose higher credit risk.
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residential mortgage loans, such as
interest rate swaps, to support its
liabilities. Furthermore, not all mortgage
loans that satisfy the requirements of the
proposed definitions when the
securitization vehicle acquires the
residential mortgage-backed securities
will continue to do so throughout the
lifecycle of the position. To minimize
variability in risk-based capital
requirements, reduce the operational
burdens imposed on banking
organizations and help ensure
consistency and comparability in riskbased capital requirements across
banking organizations, the agencies are
proposing to define prime and subprime as those vehicles that primarily
hold qualified residential mortgages or
high-priced mortgage loans and highcost mortgages, respectively. All other
mortgage-backed securities would be
defined as mid-prime mortgage-backed
securities.
Question 112: The agencies seek
comment on the appropriateness of
adding the sub-speculative grade
category for non-securitizations and for
correlation trading positions. What, if
any, operational challenges might the
proposed bucketing structure pose for
banking organizations and why? What,
if any, alternatives should the agencies
consider to better capture the risk of
these positions?
Question 113: The agencies seek
comment on the risk weight for covered
bonds. What, if any, alternative
approaches would better serve to
differentiate the credit quality of highly
rated covered bonds without referring to
credit ratings and why?
Question 114: The agencies seek
comment on whether the proposed
definitions for each sector bucket
appropriately capture the
characteristics to distinguish between
the categories of residential mortgagebacked securities. What would be the
benefits and drawbacks of using the
definition of qualified residential
mortgage in the credit risk retention
rule? What, if any, alternative
approaches should the agencies
consider to more appropriately
distinguish between the categories of
residential mortgage-backed securities?
Question 115: The agencies seek
comment on whether the proposed
sector bucket definitions for residential
mortgage-backed securities are
sufficiently clear. What, if any,
additional criteria should the agencies
consider to define ‘‘primarily’’ in the
context of residential mortgage-backed
securities (for example, quantitative
limits or other thresholds) and what are
the associated benefits and drawbacks
of doing so?
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Question 116: What, if any,
operational challenges might the
proposed sector bucket definitions pose
for banking organizations in allocating
the credit spread risk sensitivities of
existing mortgage exposures to the
respective buckets and why? To what
extent would using one metric (for
example, average prime offer rate) to
define the sector buckets address any
such concerns?
Question 117: What, if any, other
sector buckets require additional
clarification, and why?
III. Equity Risk
Table 8 to § ll.209 of the proposed
rule provides the proposed delta risk
buckets and corresponding risk weights
for market risk covered positions with
equity risk, which would be generally
consistent with those in the Basel III
reforms.346 Under the proposal, a
banking organization would group the
equity risk factors for market risk
covered positions into one of thirteen
risk buckets based on market
capitalization, market economy, and
sector.
The proposed risk buckets and
associated risk weights for market
capitalization would differentiate
between large and small market
capitalization issuers to appropriately
reflect the relatively higher volatility
and increased equity risk of small
market capitalization issuers.347 Under
the proposal, issuers with a
consolidated market capitalization equal
to or greater than $2 billion would be
classified as large market capitalization
issuers, and all other issuers would be
classified as small market capitalization
issuers. The proposed large market
capitalization designation would help
ensure an amount of information and
trading activity related to an issuer that
is suitable for the assignment of
different risk weights relative to small
market capitalization issuers. The
market capitalization data of publiclytraded firms is readily available and
346 Vega and curvature capital requirements use
the same risk buckets as prescribed for delta. See
§ ll.209(c)(1), (d)(1) of the proposed rule.
347 Relative to large market capitalization issuers,
instruments issued by those with small market
capitalization are typically less liquid and thus pose
greater equity risk, as investors holding these
instruments may encounter difficulty in buying or
selling shares particularly during a stress event.
Small market capitalization issuers also typically
have less access to capital (such that they are less
capable of obtaining sufficient financing to bridge
gaps in cash flow) and have a relatively shorter
operational history and thereby less evidence of a
durable business model. During downturns in the
economic cycle, such complications can increase
the volatility (and therefore the equity risk) of
investments in such issuers.
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therefore would not be burdensome to
identify.
For purposes of the market economy
criteria, the agencies are proposing to
differentiate between ‘‘liquid market
economy’’ countries and territorial
entities and emerging market economy
countries and territorial entities to
appropriately reflect the higher
volatility associated with emerging
market equities. Under the proposal, a
banking organization would use the
following criteria to identify annually a
country or territorial entity with a liquid
market economy: $10,000 or more in per
capita income, $95 billion or more in
market capitalization of all domestic
stock markets, no single export sector or
commodity comprises more than 50
percent of the country or entity’s total
annual exports, no material controls on
liquidation of direct investment, and
free of sanctions imposed by the U.S.
Office of Foreign Assets Control against
a sovereign entity, public sector entity,
or sovereign-controlled enterprise of the
country or territorial entity.348 Countries
or territorial entities that satisfy all five
criteria or that are in a currency
union 349 with at least one country or
territorial entity that satisfies all five
criteria would be classified as liquid
market economies, and all others would
be classified as emerging market
economies.
In relying on a set of objective criteria,
the proposed approach for market
economy risk buckets is designed to
increase risk sensitivity by delineating
equities with lower volatility or higher
volatility in a manner consistent with
the Basel III reforms while also
providing sufficient flexibility to a
banking organization to reflect changes
to the list of market economies as more
data become available.
For market risk trading positions with
exposure to large market capitalization
issuers, the proposal would group
trading positions into one of four sectors
for equity risk for each of the emerging
market and liquid market economy
categories: (1) consumer goods and
348 According to the agencies’ analysis of the data,
the initial list of ‘‘Liquid Market Economies’’ would
include: United States, Canada, Mexico, the 19 Euro
area countries (Austria, Belgium, Cyprus, Estonia,
Finland, France, Germany, Greece, Ireland, Italy,
Latvia, Lithuania, Luxembourg, Malta, the
Netherlands, Portugal, Slovakia, Slovenia, and
Spain), non-Eurozone, western European nations
(the United Kingdom, Sweden, Denmark and
Switzerland), Japan, Australia, New Zealand,
Singapore, Israel, South Korea, Taiwan, Chile, and
Malaysia.
349 The proposal would define a currency union
as an agreement by treaty among countries or
territorial entities, under which the members agree
to use a single currency, where the currency used
is described in § ll.209(b)(1)(i) of the proposed
rule.
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services, transportation and storage,
administrative and support service
activities, healthcare, and utilities; (2)
telecommunications and industrials; (3)
basic materials, energy, agriculture,
manufacturing, and mining and
quarrying; and (4) financials including
government-backed financials, real
estate activities, and technology.
The proposed equity risk buckets are
intended to reflect differences in the
extent to which equity prices in varying
sectors are affected by the business
cycle (such as GDP growth).
Differentiating sectors for purposes of
assigning risk weights to exposures to
large market capitalization issuers is
relevant because some sectors are more
sensitive than others to the given phase
in a business cycle. The proposal groups
together industries into sectors that tend
to have similar economic sensitivities,
and therefore are sufficiently
homogenous from a risk perspective.
Conversely, among small market
capitalization issuers, volatility is more
attributable to whether the trading
position is related to an emerging
market economy or liquid market
economy, regardless of the sector.
Therefore, the proposed risk buckets for
small market capitalization issuers
delineate emerging market economies
from liquid market economies but do
not delineate sectors.
In addition, the proposal includes
three risk buckets representing other
sectors; equity indices that are both
large market capitalization and liquid
market economy (non-sector specific);
and other equity indices (non-sector
specific). As is the case with credit
spread risk buckets, the agencies
recognize that specifying all sectors for
the purpose of applying risk buckets is
infeasible. Accordingly, the last three
risk buckets set forth in Table 8 to
§ ll.209 are intended to strike a
balance between the risk sensitivity of
these risk buckets and operational
burden. Equity indices aggregate risk
across different sectors, and accordingly
require separate treatment from sectorspecific risk buckets. Nonetheless,
equity indices that are both large market
capitalization and liquid market
economy are relatively less risky than
other equity indices and can be
identified in the course of determining
large market capitalization issuers and
liquid market economies, such that it
would not impose a great burden to
delineate them as a separate risk bucket.
Question 118: The agencies solicit
comment on the proposed definition of
liquid market economy. Specifically,
would the proposed criteria sufficiently
differentiate between economies that
have liquid and deep equity markets?
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What, if any, alternative criteria should
the agencies consider and why? What, if
any, of the proposed criteria should the
agencies consider eliminating and why?
Question 119: The agencies solicit
comment related to the proposed risk
bucket structure for equity risk. What, if
any, other relationships should the
agencies consider for highly correlated
risks among different equity types that
are currently in different risk buckets
and why? Please describe the historical
correlations between such equities, and
historical price shocks for purposes of
assigning the appropriate risk weight.
IV. Commodity Risk
Table 9 to § ll.209 of the proposed
rule provides the proposed delta risk
buckets and corresponding risk weights
for positions with commodity risk.
Under the proposal, a banking
organization would group commodity
risk factors into one of eleven risk
buckets based on the following
commodity classes: energy—solid
combustibles; energy—liquid
combustibles; energy—carbon trading;
freight; metals—non-precious; gaseous
combustibles and electricity; precious
metals (including gold); grains and
oilseed; livestock and dairy; forestry and
agriculturals; and other commodity.
The proposed risk buckets and
associated risk weights for commodity
risk would be distinguished by the
underlying commodity types described
above to appropriately reflect
differences in volatility (and therefore
market risk) between those commodity
types. In general, the price sensitivity of
a commodity to changes in global
supply and demand can vary between
commodity types due to production and
storage cycles, along with other factors.
For example, energy commodities are
generally delivered year-round, whereas
grain production is seasonal such that
deliverable futures contracts are
available on dates to coincide with
harvest. Further, commodities within
the proposed commodity types have
historically similar levels of volatility.
The proposed commodity risk buckets
are intended to strike a balance between
the risk sensitivity of measuring market
risk for the delineated commodity
groups and the operational burden of
capturing the market risk of all
commodities. As is the case with credit
spread risk buckets and equity risk
buckets, the agencies recognize that
specifying all commodities for the
purpose of applying risk buckets is
operationally difficult. Accordingly, the
proposal includes an additional ‘‘other
commodity’’ risk bucket to include
commodities that do not fall into the
prescribed categories.
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As is the case with other risk buckets,
the proposed risk weights for
commodity risk factors are based on
empirical data during historical periods
of stress. The agencies are proposing to
align the delta risk factor buckets and
corresponding risk weights with those
provided in the Basel III reforms, with
one exception. The Basel III reforms
prescribe separate risk buckets with
different risk weights for electricity and
gaseous combustibles. The agencies are
proposing to move electricity into the
risk bucket for gaseous combustibles to
allow for greater recognition of hedges
between these two commodities. The
proposed bucketing structure would
reflect appropriately the inherent
relationship between the price of
electricity and natural gas, as empirical
evidence demonstrates a strong
correlation between price movements of
natural gas and electricity contracts.350
Question 120: The agencies solicit
comment related to the proposed risk
bucket structure and risk weights for
commodities. What, if any, other
relationships should the agencies
consider for highly correlated risks
among different commodity types that
are currently in different risk buckets
and why? Please describe the historical
correlations between such commodities,
and historical price shocks for purposes
of assigning the appropriate risk weight.
Question 121: The agencies solicit
comment on the risk bucket for energy—
carbon trading. To what extent is the
proposed 60 percent risk weight
reflective of the risk in carbon trading
under stressed conditions?
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V. Foreign Exchange Risk
The proposal would require a banking
organization to establish separate risk
buckets for each exchange rate between
the currency in which a market risk
covered position is denominated and
the reporting currency (or, as applicable,
alternative base currency). To calculate
the risk-weighted delta sensitivity for
foreign exchange risk, the proposal
would require a banking organization to
apply a 15 percent risk weight to each
currency pair, with one exception.
Similar to the proposed risk weights for
interest rate risk, the proposal would
allow a banking organization to divide
the proposed 15 percent risk weight by
the square root of two for certain liquid
350 The
agencies are proposing to include
electricity and gas in the same bucket based on an
analysis of correlations between natural gas and
electricity futures prices pairs across multiple
geographical regions. The analysis shows that
pairwise correlations between gas and electricity
prices within the same region are high and stable
and in excess of the inter bucket correlation that
would be applied if the two financial instruments
were bucketed separately.
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currency pairs specified under the
proposal,351 as well as any additional
currencies specified by the primary
Federal supervisor. Given high trading
activity and use of such liquid currency
pairs relative to non-liquid pairs, the
proposal incorporates the effect of a
shorter liquidity horizon for liquid
currency pairs and would allow a
banking organization to appropriately
reflect the lower foreign exchange risk
posed by such liquid currency pairs.
iv. Correlation Parameters
In general, the proposed correlation
parameters closely follow those in the
Basel III reforms, which are calibrated to
capture market correlations observed
over a long time horizon that included
a period of stress based on empirical
data.352 To appropriately reflect the
risk-mitigating benefits of hedges and
diversification, the proposal would
prescribe the correlation parameters that
a banking organization would be
required to use for each risk factor pair
when calculating the aggregate risk
bucket and risk class level capital
requirements for delta, vega, and
curvature.353 To determine the
applicable correlation parameter for
purposes of calculating the risk bucket
or risk class level capital requirements,
a banking organization would apply the
same criteria used to define the risk
factors within each risk class, as
described in section III.H.7.a.i of this
SUPPLEMENTARY INFORMATION, with two
exceptions.
First, in addition to the proposed risk
factors for credit spread risk of nonsecuritizations, securitization positions
non-CTP, and correlation trading
positions,354 the proposal would require
a banking organization to consider the
name (in the case of non-securitization
positions and correlation trading
positions) and tranche (in the case of
securitization positions non-CTP) to
determine the applicable correlation
parameters for risk factors within the
same risk bucket when calculating the
351 The proposal would allow a banking
organization to apply a lower risk weight for any
currency pair formed of the following currencies:
USD, EUR, JPY, GBP, AUD, CAD, CHF, MXN, CNY,
NZD, HKD, SGD, TRY, KRW, SEK, ZAR, INR, NOK,
and BRL.
352 For example, the correlation parameters for
vega, curvature, delta interest rate risk, and delta
equity risk are identical to those in the Basel III
reforms.
353 As there is only one risk factor prescribed for
foreign exchange risk, the proposal does not specify
an intra-bucket correlation parameter.
354 As described in section III.H.7.a.i.II of this
SUPPLEMENTARY INFORMATION, the proposal would
define the delta risk factors for credit spread risk
along two dimensions: the credit spread curve of
the reference entity and the tenor of the position.
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aggregate risk bucket level capital
requirements for delta and vega.
In the case of credit spread risk for
securitization positions non-CTP, the
agencies generally are proposing to
require a 100 percent intra-bucket
correlation parameter for securitization
positions in the same bucket and related
to the same securitization tranche with
more than 80 percent overlap in
notional terms and a 40 percent intrabucket correlation parameter otherwise.
Furthermore, in the case of credit spread
risk for non-securitization and
correlation trading positions, banking
organizations would need to apply a 35
percent intra-bucket correlation factor
for Uniform Mortgage-Backed Securities
(UMBS) as such positions would be
treated as a separate name from Fannie
Mae and Freddie Mac.355
Second, for risk factors allocated to
the ‘‘other sector’’ bucket within the
credit spread and equity risk classes,356
the risk bucket level capital requirement
would equal the sum of the absolute
values of the risk-weighted sensitivities
for both the delta capital requirement
and the vega capital requirement (no
correlation parameters would apply to
such exposures). Additionally, the
proposal would require a banking
organization to assign a zero percent
correlation parameter when aggregating
the delta risk-weighted sensitivity of
exposures within the ‘‘other sector’’ risk
bucket with those in any of the other
bucket-level capital requirements for
credit spread and equity risk.
By requiring a banking organization to
determine the maximum possible loss
under three correlation scenarios, the
proposed correlation parameters are
sufficiently conservative to
appropriately capture the potential
interactions between risk factors that the
market risk covered positions may
experience in a time of stress.
Question 122: Related to
securitization positions non-CTP, the
agencies seek comments on requiring
banking organizations to apply a 100
percent delta correlation parameter for
cases where the securitization positions
are in the same bucket, are related to
the same securitization tranche, and
have more than 80 percent overlap in
notional terms. What, if any, alternative
criteria should the agencies consider for
355 In the to-be-announced (TBA) market, Freddie
Mac and Fannie Mae securities are not
interchangeable and would be treated as separate
names under the proposal. As part of the single
security initiative, UMBS allows for either Fannie
Mae or Freddie Mac to deliver, thus creating the
basis risk between the GSEs for such securities.
356 The other sector buckets refer to buckets 17 in
Tables 3 and 5 as well as buckets 25 and 11 in
Tables 7 and 8, respectively, of § ll.209 of the
proposed rule.
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application of the 100 percent
correlation parameter and why? For
example, what are benefits and
drawbacks of allowing a banking
organization to apply a 100 percent
delta correlation parameter if the
securitization tranches can offset all or
substantially all of the price risk of the
position? What challenges exist, if any,
with respect to banking organizations’
ability to implement such criteria? What
quantitative measures can be used to
implement these criteria? How would a
market stress impact the basis risk
between securitization tranches within
the same risk buckets, and the ability to
adequately hedge all or substantially all
of the price risk using similar but
unrelated securitized tranches?
Question 123: The agencies request
comment on the appropriateness of
allowing banking organizations to apply
a higher intra-bucket correlation
parameter of 99.5 percent to 99.9
percent for energy—carbon trading.
What would be the benefits and
drawbacks of such a higher correlation
parameter relative to the correlation
parameter of 40 percent currently
contained in the proposal?
Question 124: The agencies request
comment on requiring banking
organizations to apply a 35 percent
correlation parameter for Uniform
Mortgage Backed Securities. What
alternative correlation parameter should
the agencies consider for Uniform
Mortgage Backed Securities and why?
b. Standardized Default Risk Capital
Requirement
The standardized default risk capital
requirement is intended to capture the
incremental loss if the issuer of an
equity or credit position were to
immediately default (the additional
losses from jump-to-default risk), which
are not captured by the credit spread or
equity shocks under the sensitivitiesbased method. Thus, the proposed
standardized default risk capital
requirement would apply only to nonsecuritization debt or equity positions
(except for U.S. sovereigns and
multilateral development banks),
securitization positions non-CTP, and
correlation trading positions.
Under the proposal, a banking
organization would be required to
separately calculate the standardized
default risk capital requirement for each
of the three default risk categories (three
risk classes that could incur default risk)
using the following five steps.
First, for each of the three default risk
categories, the banking organization
would be required to group instruments
with similar risk characteristics
throughout an economic cycle into the
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defined default risk buckets as
described in more detail below.
Second, to estimate the position-level
losses from an immediate issuer default,
the banking organization would be
required to calculate the gross default
exposure separately for each default risk
position. Additionally, the banking
organization would be required to
determine the long and short direction
of the gross default exposure based on
whether it would experience a loss
(long) or gain (short) in the event of a
default.
Third, to estimate the portfolio-level
losses of a trading desk from an
immediate issuer default, the banking
organization would be required to
calculate the net default exposure for
each obligor by offsetting the gross long
and short default exposures to the same
obligor, where permitted.
Fourth, to estimate and recognize
hedging benefit between net long and
net short position of different issuers
within the same default bucket, the
banking organization would be required
to calculate the hedge benefit ratio and
apply the prescribed risk weights 357 to
the net default exposures within the
same default risk bucket for the class of
instruments.358 In general, the proposed
risk buckets and associated risk weights
closely follow those in the Basel III
reforms, which are calibrated to reflect
a through-the-cycle probability of
default. The hedge benefit ratio is
calculated based on the aggregate net
long default positions and the aggregate
net short default positions. It is
intended to recognize the partial
hedging of net long and net short default
positions in distinct obligors due to
systematic credit risk. The bucket-level
default risk capital requirement would
equal (1) the sum of the risk-weighted
net long default positions minus (2) the
product of the hedge benefit ratio and
357 The proposal would require a banking
organization to apply the highest risk weight that
is applicable under the investment limits of an
equity position in an investment fund that may
invest in primarily high-yield or distressed names
under the fund’s mandate by first applying the
highest risk weight that is applicable under the
fund’s investment limits to defaulted instruments,
followed by sub-speculative grade, then speculative
grade, then investment grade securities. A banking
organization may not recognize any offsetting or
diversification benefit when calculating the average
risk weight of the fund. See § ll.205(e)(3)(iii) of
the proposed rule.
358 Specifically, a banking organization would
first calculate the hedge benefit ratio (the total net
long jump-to-default risk positions (numerator)
divided by the sum of the total net long jump-todefault risk positions and the sum of the absolute
value of the total net short positions (denominator),
and then calculate the risk-weighted exposure for
each risk bucket by multiplying the aggregate total
net jump-to-default exposure by the risk weight
prescribed for the applicable risk bucket.
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the sum of the risk-weighted absolute
value of the net short default positions.
For non-securitization debt and equity
positions and securitization positions
non-CTP, the results of this calculation
would be floored at zero.
Fifth, to calculate the default risk
capital requirement for each default risk
category, the banking organization
would sum the risk bucket-level capital
requirements (except for correlation
trading positions). The aggregation for
correlation trading positions is not the
simple sum but is the sum of the riskbucket level capital requirements for the
net long default exposures plus half of
the sum of the risk-weighted exposures
for the net short default exposures as
further described in in section
III.H.7.b.iii of this SUPPLEMENTARY
INFORMATION. For conservatism, the
proposal would require a banking
organization to calculate the total
standardized default risk capital
requirement as the sum of each of the
default risk category level capital
requirements without recognizing any
diversification benefits across different
types of default risk categories.
i. Non-Securitization Debt or Equity
Positions
I. Gross Default Exposure
Under the proposal, the standardized
default risk capital requirement for nonsecuritization debt or equity positions
would generally follow the calculation
steps described above. To calculate the
gross default exposure for each nonsecuritization debt or equity position,
the proposal would require a banking
organization to multiply the notional
amount (face value) of the instrument
and the prescribed loss given default
(LGD) rate 359 to determine the total
potential loss of principal at default and
then add the cumulative profits (losses)
already realized on the position to avoid
double-counting realized losses, with
one exception.360 For defaulted
positions, the proposal would require a
banking organization to multiply the
current market value and the prescribed
LGD rate to determine the gross default
exposure for the position. The proposed
calculation methodology is intended to
appropriately quantify the gross default
risk for most securities, including those
that are less common.
For the purpose of calculating the
gross default exposure for each nonsecuritization debt or equity position,
the agencies are proposing the following
359 The loss rate from default is one minus the
recovery rate.
360 As losses are recorded as a negative value,
effectively they would be subtracted from the
overall exposure amount.
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LGD rates, which are generally
consistent with those in the Basel III
reforms: 100 percent for equity and nonsenior debt instruments and defaulted
positions, 75 percent for senior debt
instruments, 75 percent for GSE debt
issued but not guaranteed by the GSEs,
25 percent for GSE debt guaranteed by
the GSEs, 25 percent for covered bonds,
and zero percent for instruments whose
value is not linked to the recovery rate
of the issuer.361 GSE debt issued and
guaranteed by the GSEs is secured by
residential properties that satisfy the
rigorous underwriting standards of the
GSEs (for example, loan-to-value ratios
of less than 80 percent), and include a
guarantee on the repayment of principal
by the GSE. As these characteristics are
economically similar to the
requirements for covered bonds, the
agencies are proposing to extend the
LGD rate applied to covered bonds to
GSE debt issued and guaranteed by the
GSEs to appropriately capture the
expected losses of such positions in the
event of default. As GSE debt
instruments issued but not guaranteed
by the GSEs are similarly secured by
high-quality residential mortgages, the
proposal would allow banking
organizations to treat such exposures as
senior debt (subject to a 75 percent LGD
rate) rather than apply the higher
proposed risk weight for equity and
non-senior debt instruments. For credit
derivatives, a banking organization
would be required to use the LGD rate
of the reference exposure.
For consistency across banking
organizations, the proposal specifies
that a banking organization would be
required to reflect the notional amount
of a non-securitization debt or equity
position that gives rise to a long gross
default exposure as a positive value and
the corresponding loss as a negative
value, and those that produce a short
exposure as a negative value and the
corresponding gain as a positive value.
If the contractual or legal terms of a
derivative contract allow for the
unwinding of the instrument, with no
exposure to default risk, the gross
default exposure would equal zero.
Question 125: The agencies request
comment on whether the proposed
formula for calculating gross default
exposure appropriately captures the
gross default risk for all types of nonsecuritization debt and equity
instruments. What, if any, positions
361 For example, in the case of a call option on
a bond, the notional amount to be used in the jumpto-default calculation would be zero given that in
the event of default the call option would not be
exercised (the default would extinguish the call
option’s value, with the loss captured through the
reduced fair value of the position).
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Full offsetting would be permitted for
short and long market risk covered
positions with maturities greater than
one year or positions with perfectly
matching maturities provided other
criteria are met such as if both long and
short positions reference the same
obligor and the short positions have the
same or lower seniority as the long
positions. To determine the offsetting
treatment for market risk covered
positions with maturities of one year or
less, a banking organization would be
required to scale the gross default
exposure by the fraction of a year
corresponding to the maturity of the
instrument, subject to a three-month
floor. In the case where long and short
gross default exposures both have
II. Net Default Exposure
maturities of one year or less, scaling
would apply to both the long and short
To calculate the net default exposure
gross default exposure. By allowing only
for non-securitization debt or equity
partial offsetting, the proposed scaling
positions, the proposal would permit a
banking organization to recognize either approach is intended to appropriately
reflect the risk posed by maturity
full or partial offsetting of the gross
mismatch between exposures and their
default exposures for long and short
hedges within the one-year capital
positions if both reference the same
obligor and the short positions have the horizon. For example, under the
proposal, the gross default exposure for
same or lower seniority as the long
positions.362 To appropriately reflect the an instrument with a six-month
maturity would be weighted by onenet default risk, the proposed
half, whereas that for a one-week
calculation would not allow a banking
repurchase agreement would be
organization to recognize any offsetting
prescribed a three-month maturity and
of the gross default exposure for market
risk covered positions where the obligor weighted by one-fourth.
The proposal would permit a banking
is not identified, such as equity
organization to assign a maturity of
positions in an investment fund, index
either three months or one year to cash
instruments, and multi-underlying
equity positions that do not have a
options for which a banking
stated maturity. For derivative
organization elects to calculate a single
transactions, the proposal would require
risk factor sensitivity (not to apply the
a banking organization to use the
look-through approach).
maturity of the derivative contract,
As the GSEs can default
rather than that of the underlying, to
independently of one another, the
determine the applicable scaling factor.
agencies are clarifying that banking
To prevent broken hedges for equity and
organizations should treat Federal
derivative positions, the proposal would
National Mortgage Association (Fannie
allow banking organizations to assign
Mae), Federal Home Loan Mortgage
the same maturity to a cash equity
Corporation (Freddie Mac), and the
position as the maturity of the
Federal Home Loan Bank System as
derivative contract it hedges (permit full
separate obligors. As the single security
offsetting). Similarly, the proposal
initiative led by Fannie Mae and
would allow a banking organization to
Freddie Mac has homogenized the
align the maturity of an instrument with
mortgage pool and security
that of a derivative contract for which
characteristics for Uniform MortgageBacked Securities (UMBS), the proposal that instrument could be delivered to
would allow the banking organization to satisfy the derivative contract, and thus
permit full offsetting between the
fully offset Uniform Mortgage Backed
instrument and the derivative. For
Securities that are issued by two
example, a banking organization may
different obligors.
assign the maturity of a derivative
contract in the to-be-announced (TBA)
362 For a market risk covered position that has an
market that is hedging a security interest
eligible guarantee, to determine if the exposure is
to the underlying obligor or an exposure to the
in a pool of mortgages to that security
eligible guarantor, the credit risk mitigation
interest provided that the delivery of the
requirements set out in the capital rule would
security interest would satisfy the
apply. See 12 CFR 3.36, 3.134 and 3.135 (OCC); 12
delivery terms of the TBA derivative
CFR 217.36, 217.134 and 217.135 (Board); 12 CFR
contract.
324.36, 324.134 and 324.135 (FDIC).
exist for which the formula cannot be
applied? What is the nature of such
difficulties and how could such
concerns be mitigated? In particular, the
agencies seek comment on whether the
proposed formula appropriately
captures the gross default risk of
convertible instruments.
Question 126: The agencies request
comment on the appropriateness of the
proposed LGD rates for nonsecuritization debt or equity positions.
What, if any, changes should the
agencies consider making to the
categories to appropriately differentiate
the LGD rates for various instruments or
for instruments with different seniority
(for example, senior versus non-senior)?
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The net default exposure to an issuer
would be the sum of the maturityweighted default exposures to the
issuer.
Question 127: The agencies request
comment on the appropriateness of
allowing banking organizations to net
the gross default exposures of derivative
contracts and the underlying positions
that are deliverable to satisfy the
derivative contract. What, if any,
additional criteria should the agencies
consider to further clarify the netting of
gross default exposures and why? What,
if any, positions should the agencies
consider allowing to net that would not
exhibit default risk? For example, what
are the advantages and disadvantages of
the agencies allowing Uniform Mortgage
Backed Securities that are issued by two
different obligors to fully offset, even
though such a treatment would not
eliminate the default risk of either
obligor independently?
Question 128: The agencies seek
comment on the appropriateness of the
proposed treatment of GSE exposures.
What, if any, alternative methods
should the agencies consider to measure
more appropriately the default risk
associated with such positions? What
would be the benefits and drawbacks of
such alternatives compared to the
proposed treatment?
Question 129: The agencies seek
comment on the appropriateness of not
allowing banking organizations to
recognize any offsetting benefit for
market risk covered positions where the
obligor is not identified. What, if any,
alternative methods should the agencies
consider to measure more appropriately
the default risk associated with such
positions? What would be the benefits
and drawbacks of such alternatives
compared to the proposed treatment?
buckets for non-securitization positions
in the Basel III reforms are defined
based on the applicable credit ratings of
the reference entity. As discussed
previously in section III.H.7.a.iii.II of
this SUPPLEMENTARY INFORMATION, the
agencies are proposing an approach that
does not rely on external credit ratings
but allows for a level of granularity in
the default risk buckets (and
corresponding risk weights) applicable
to non-securitization positions and that
is also generally consistent with the
Basel III reforms. Specifically, the
agencies are proposing to define the
default risk buckets and corresponding
risk weights for non-securitization
positions based on the definition for
Investment Grade in the agencies’
existing capital rule and the proposed
definitions of Speculative Grade and
Sub-speculative Grade.363
Question 130: The agencies solicit
comment on the appropriateness of the
proposed risk weights and granularity in
Table 1 to § ll.210. What, if any,
alternative approaches should the
agencies consider for assigning risk
weights that would be consistent with
the prohibition on the use of credit
ratings? Commenters are encouraged to
provide specific details on the
mechanics of and rationale for any
suggested methodology.
III. Risk Buckets and Corresponding
Risk Weights
Table 1 to § ll.210 of the proposed
rule provides the proposed default risk
buckets and corresponding risk weights
for non-securitization debt or equity
positions, which reflect counterparty
type and credit quality, respectively.
Under the proposal, the risk buckets and
applicable risk weights would
distinguish between the type of obligor
based on whether the exposure is to a
non-U.S. sovereign, a public sector
entity or GSE, or a corporate and
include a single bucket for defaulted
positions.
To capture the credit quality of the
obligor, the agencies are proposing
default risk buckets that are generally
consistent with those provided in the
Basel III reforms but defined using
alternative criteria. The default risk
I. Gross Default Exposure
Under the proposal, the gross default
exposure for a securitization position
non-CTP equals the position’s fair value.
As the proposed bucket-level risk
weights described in section III.H.7.a.iii
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ii. Securitization Positions Non-CTP
For securitization positions non-CTP,
the process to calculate the standardized
default risk capital requirement would
be identical to that for nonsecuritization positions, except for the
gross default exposure calculation, the
offsetting of long and short exposures in
the net default exposure calculation,
and the proposed risk buckets and
corresponding risk weights.
363 Specifically, the agencies are proposing to
apply a methodology similar to prior rules, where
the risk weights in the Basel III reforms are adjusted
based on a weighted average risk weight calculated
from the notional amount of issuance since 2007 for
each category. For this analysis, the agencies used
the Mergent Fixed Income Securities database to
identify notional issuance amounts for several
lookback periods. The weighted average risk weight
for each category was then slightly modified to
account for rounding, to reflect internal consistency
(so that a corporate or PSE exposure would not have
a lower risk weight than a sovereign) and to help
ensure risk weights were stable through an entire
credit cycle. The agencies believe the amended risk
weight table appropriately satisfies the
requirements of the Dodd-Frank Act, while also
meeting the intent of the Basel III reforms. See 15
U.S.C. 78o–7 note.
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of this SUPPLEMENTARY INFORMATION
would already reflect the LGD rates for
such positions, a banking organization
would not apply an LGD rate to
calculate the gross default exposure.
II. Net Default Exposure
First, the proposal would allow
offsetting between securitization
exposures with the same underlying
asset pool and belonging to the same
tranche. No offsetting would be
permitted between securitization
exposures with different underlying
asset pools, even where the attachment
and detachment points are the same.
Second, the proposal would permit a
banking organization to offset the gross
default exposure of a securitization
position non-CTP with one or more nonsecuritization positions by decomposing
the exposure of non-tranched index
instruments and replicating the
exposures that make up the entire
capital structure of the securitized
position. Additionally, a banking
organization would be required to
exclude non-securitization positions
that are recognized as offsetting the
gross default exposure of a
securitization position non-CTP from
the calculation of the standardized
default risk capital requirement for nonsecuritization debt and equity positions.
Third, the proposal would allow a
banking organization to offset the gross
default exposure of a securitization
position non-CTP through
decomposition if a collection of short
securitization positions non-CTP
replicates a collection of long
securitization positions non-CTP. For
example, if a banking organization holds
a long position in the securitization, and
a short position in a mezzanine tranche
that attaches at 3 percent and detaches
at 10 percent, the proposal would
permit the banking organization to
decompose the securitization into three
tranches and offset the gross default
exposures for the common portion of
the securitization (3–10 percent). In this
case, the net default exposure would
reflect the long positions in the 0–3
percent tranche and in the 10–100
percent tranche.
Question 131: The agencies seek
comment on the proposed netting and
decomposition criteria for calculating
the net default exposure for
securitization positions non-CTP. What,
if any, alternative non-model-based
methodologies should the agencies
consider that would conservatively
recognize some hedging benefits but still
capture the basis risk between nonidentical positions?
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III. Risk Buckets and Corresponding
Risk Weights
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To promote consistency and
comparability in risk-based capital
requirements across banking
organizations, the proposal would
define the risk bucket structure that a
banking organization would be required
to use to group securitization positions
non-CTP. Specifically, the proposal
would require a banking organization to
classify securitization positions nonCTP as corporate positions or based on
the asset class and the region of the
underlying assets, following market
convention.364 Under the proposal, a
banking organization would assign each
position to one risk bucket, and those
with underlying exposures in the same
asset class and region to the same risk
bucket. Additionally, the proposal
would require a banking organization to
assign any position that is not a
corporate position and that it cannot
assign to a specific asset class or region
to one of the ‘‘other’’ buckets.365
For consistency in the capital
requirements for securitizations under
either subpart D or subpart E of the
capital rule and to recognize credit
subordination,366 the proposed risk
weights for securitization positions nonCTP are based on the risk weights
calculated for securitization exposures
under either subpart D or subpart E of
the capital rule.367
To calculate the standardized default
risk capital requirement for
securitization positions non-CTP, a
banking organization would sum the
risk bucket-level capital requirements,
except that a banking organization could
cap the standardized default risk capital
requirement for an individual cash
securitization position non-CTP at its
fair value. For cash positions, the
maximum loss on the exposure would
not exceed the fair value of the position
364 The proposal would define the asset class
buckets along two dimensions: asset class and
region. The region risk buckets would include Asia,
Europe, North America, and other. The asset class
risk buckets would include asset-backed
commercial paper, auto loans/leases, residential
mortgage-backed securities, credit cards,
commercial mortgage-backed securities,
collateralized loan obligations, collateralized debt
obligations squared, small and medium enterprises,
student loans, other retail, and other wholesale.
365 Under the proposal, the other buckets would
include other retail and other wholesale (for asset
class) and other (for region).
366 For example, the general credit risk framework
would apply the SSFA to calculate the risk weight.
The SSFA calculates the risk weight based on
characteristics of the tranche, such as the
attachment and detachment points and quality of
the underlying collateral.
367 12 CFR 3.43, 3.143, 3.144 (OCC); 12 CFR
217.43, 217.143, 217.144 (Board); 12 CFR 324.43,
324.143, 324.144 (FDIC).
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even if each of the underlying assets of
the securitization were to immediately
default. Furthermore, the proposed
treatment would align with the
maximum potential capital requirement
for securitizations under either subpart
D or the proposed subpart E of the
capital rule.368
Question 132: The agencies request
comment on the proposed risk buckets.
What are the potential benefits and
drawbacks of aligning the default risk
bucketing structure with the proposed
delta risk buckets for securitization
positions non-CTP in the sensitivitiesbased method? Commenters are
encouraged to provide information
regarding any associated burden,
complexity, and capital impact of such
an alignment.
iii. Correlation Trading Positions
The process to calculate the
standardized default risk capital
requirement for correlation trading
positions would be the same as that for
non-securitization debt and equity
positions, except for the metrics used to
measure gross default exposure, the
offsetting of long and short exposures in
the net default exposure calculation, the
risk buckets, and the aggregation of the
bucket level exposures across risk
buckets.
I. Gross Default Exposure
Under the proposal, the gross default
exposure for a correlation trading
position equals the position’s market
value. To calculate the gross default
exposure for correlation trading
positions that are nth-to-default
positions, the proposal would require a
banking organization to treat such
positions as tranched positions and to
calculate the attachment point as (N–1)
divided by the total number of single
names in the underlying basket or pool
and the detachment point as N divided
by the total number of single names in
the underlying basket or pool. The
proposed calculation is intended to
appropriately reflect the credit
subordination of such positions.
II. Net Default Exposure
Similar to securitization positions
non-CTP, to increase risk sensitivity and
permit greater offsetting of substantially
similar exposures, the proposal would
permit banking organizations to offset
gross long and short default exposures
in specific cases.
First, the proposal would allow a
banking organization to offset the gross
default exposure of correlation trading
368 12 CFR 3.44(a) (OCC); 12 CFR 217.44(a)
(Board); 12 CFR 324.44(a) (FDIC).
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positions that are otherwise identical
except for maturity, including index
tranches of the same series. This means
the offsetting positions would need to
have the same underlying index family
of the same series, and the same
attachment and detachment points.
Second, the proposal would allow a
banking organization to offset the gross
default exposure of long and short
exposures of tranches that are perfect
replications of non-tranched correlation
trading positions. For example, the
proposal would allow a banking
organization to offset the gross default
exposure of a long position in the
CDX.NA.IG.24 index with short
positions that together comprise the
entire index position (for example, three
distinct tranches that attach and detach
at 0–3 percent, 3–10 percent, and 10–
100 percent, respectively).
Third, the proposal would allow a
banking organization to offset the gross
default exposure of indices and singlename constituents in the indices
through decomposition when the long
and the short gross default exposures
are otherwise equivalent except for a
residual component. Under the
proposal, a banking organization would
account for the residual exposure in the
calculation of the net default exposure.
In such cases, the proposal would
require that the decomposition into
single-name equivalent exposures
account for the effect of marginal
defaults of the single names in the
tranched correlation trading position,
where in particular the sum of the
decomposed single name amounts
would be required to be consistent with
the undecomposed value of the
tranched correlation trading position.
Such decomposition generally would be
permissible for correlation trading
positions (for example, vanilla CDOs,
index tranches or bespoke indices), but
would be prohibited for exotic
securitizations (for example, CDO
squared).
Fourth, the proposal would allow a
banking organization to offset the gross
default exposure of different series (nontranched) of the same index through
decomposition when the long and the
short gross default exposures are
otherwise equivalent except for a
residual component. Under the
proposal, a banking organization would
account for the residual exposure in the
calculation of the net default exposure.
For example, assume that a banking
organization holds a long position in a
CDS index that references 125
underlying credits and a short position
in the next series of the index that also
references 125 credits. The two indices
share the same 123 reference credits,
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such that there are two unique credits
in each index. Under the proposal, a
banking organization could offset the
123 names through decomposition, in
which case the net default exposure
would reflect only the two unique
credits for the long index position and
the two unique credits for the short
index position. Similarly, a banking
organization could offset the long
exposure in 125 credits by selling short
an index that contains 123 of those same
credits. In this case, only the two
residual names would be reflected in
the net default exposure.
Fifth, the proposal would allow a
banking organization to offset different
tranches of the same index and series
through replication and decomposition
and calculate a net default exposure on
the unique component only, if the
residual component has the attachment
and detachment point nested with the
original tranche or the combination of
tranches. For example, assume that a
banking organization holds long
positions in two tranches, one that
attaches at 5 percent and detaches at 10
percent and another that attaches at 10
percent and detaches at 15 percent. To
hedge this position, the banking
organization holds a short position in a
tranche on the same index that attaches
at 5 percent and detaches at 20 percent.
In this case, the banking organization’s
net default exposure would only be for
the residual portion of the tranche that
attaches at 15 percent and detaches at
20 percent.
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III. Risk Buckets and Corresponding
Risk Weights
For correlation trading positions, the
proposal would define risk buckets by
index, each index would comprise its
own risk bucket.369 Under the proposal,
a bespoke correlation trading position
would be assigned to its own unique
bucket, unless it is substantially similar
to an index instrument, in which case
the bespoke position would be assigned
to the risk bucket corresponding to the
index. For a non-securitization position
that hedges a correlation trading
position, a banking organization would
be required to assign such position and
the correlation trading position to the
same bucket.
For consistency in the capital
requirements for securitizations under
either subpart D or subpart E of the
capital rule and to recognize credit
369 A
non-exhaustive list of indices include: the
CDX North America IG, iTraxx Europe IG, CDX HY,
iTraxx XO, LCDX (loan index), iTraxx LevX (loan
index), Asia Corp, Latin America Corp, Other
Regions Corp, Major Sovereign (G7 and Western
Europe) and Other Sovereign.
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subordination,370 the proposed risk
weights corresponding to the proposed
risk buckets for correlation trading
positions are based on the treatment
under either subpart D or subpart E of
the capital rule.371
The agencies recognize that the
granularity of the proposed risk bucket
structure could result in several
individual risk buckets containing only
net short exposures and thus overstate
the offsetting benefits of non-identical
exposures if the total standardized
default risk capital requirement for
correlation trading positions was
calculated as a sum of the bucket-level
capital requirements. To appropriately
limit the benefit of risk buckets with
short default exposures offsetting those
with long exposures, the total
standardized default risk capital
requirement for correlation trading
positions would be calculated as the
sum of the risk-bucket level capital
requirements for the net long default
exposures plus half of the sum of the
risk-weighted exposures for the net
short default exposures.
c. Residual Risk Capital Requirement
It is not possible in a standardized
approach to sufficiently specify all
relevant distinctions between different
market risks to capture appropriately
existing and future financial products.
Accordingly, the agencies are proposing
the residual risk add-on capital
requirement (residual risk add-on) to
reflect risks that would not be fully
reflected in the sensitivities-based
capital requirement or the standardized
default risk capital requirement.
Specifically, the residual risk add-on is
intended to capture exotic risks, such as
weather, longevity, and natural
disasters, as well as other residual risks,
such as gap risk, correlation risk, and
behavioral risks such as prepayments.
To calculate the residual risk add-on,
the proposal would require a banking
organization to risk weight the gross
effective notional amount of a market
risk covered position by 1 percent for
market risk covered positions that are
not subject to the standardized default
risk capital requirement and that have
an exotic exposure and by 0.1 percent
for other market risk covered positions
with residual risks (described in the
next section). The total residual risk
370 For example, the general credit risk framework
would apply the SSFA to calculate the risk weight.
The SSFA calculates the risk weight based on
characteristics of the tranche, such as the
attachment and detachment points and quality of
the underlying collateral.
371 12 CFR 3.43, 3.143, 3.144 (OCC); 12 CFR
217.43, 217.143, 217.144 (Board); 12 CFR 324.43,
324.143, 324.144 (FDIC).
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add-on capital requirement would equal
the sum of such capital requirements
across subject market risk covered
positions.
i. Positions Subject to the Residual Risk
Add-On
The proposal would require a banking
organization to calculate a residual risk
add-on for market risk covered positions
that have an exotic exposure, and
certain market risk covered positions
that carry residual risks. As the
potential losses of market risk covered
positions with exotic exposures
(longevity risk, weather, natural
disaster, among many) would not be
adequately captured under the
sensitivities-based method, the agencies
are proposing a capital requirement
equal to 1 percent of the gross effective
notional amount of the market risk
covered position, as an appropriately
conservative capital requirement for
such exposures.
In contrast, market risk covered
positions with other residual risks
would include those for which the
primary risk factors are mostly captured
under the sensitivities-based method,
but for which there are additional,
known risks that are not quantified in
the sensitivities-based method.
Specifically, the proposal would
include: (1) correlation trading positions
with three or more underlying
exposures that are not hedges of
correlation trading positions; (2) options
or positions with embedded optionality,
where the payoffs could not be
replicated by a finite linear combination
of vanilla options or the underlying
instrument; and (3) options or positions
with embedded optionality that do not
have a stated maturity or strike price or
barrier, or that have multiple strike
prices or barriers.372 As the residual risk
add-on is intended as a supplement to
the capital requirement under the
sensitivities-based method for these
known risks, the agencies are proposing
a capital requirement equal to 0.1
percent of the gross effective notional
amount for market risk covered
positions with other residual risks.
In addition to positions with exotic or
other residual risks, a primary Federal
supervisor may require a banking
organization to subject other market risk
covered positions to the residual risk
add-on, if the proposed framework
would not otherwise appropriately
372 As proposed, the criteria are intended to
capture (1) correlation risks for basket options, best
of options, basis options, Bermudan options, and
quanto options; (2) gap risks for path dependent
options, barrier options, Asian options and digital
options; and (3) behavior risks that might arise from
early exercise (call or put features, or pre-payment).
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capture the material risks of such
positions. While the agencies believe
that the proposed definitions would
reasonably identify positions with risks
not appropriately captured by other
aspects of the proposed framework,
there could be instances where a market
risk covered position should be subject
to the residual risk add-on in order to
capture appropriately the associated
market risk of the exposure in risk-based
capital requirements. To allow the
agencies to address such instances on a
case-by-case basis, the proposal would
allow the primary Federal supervisor to
make such determinations, as
appropriate.
ii. Excluded Positions
To promote appropriate capitalization
of risk, the proposal would allow certain
positions to be excluded from the
calculation of the residual risk add-on if
such positions would meet the
following set of exclusions. Specifically,
the proposal would permit a banking
organization to exclude positions, other
than those that have an exotic exposure,
from the residual risk add-on, if the
position is either (1) listed on an
exchange; (2) eligible to be cleared by a
CCP or QCCP; or (3) an option that has
two or fewer underlying positions and
does not contain path dependent payoffs. The proposed exclusions would
permit a banking organization to
exclude simple options, such as spread
options, which have two underlying
positions, but not those for which the
payoffs cannot be replicated by a
combination of traded financial
instruments. As spread options would
be subject to the vega and curvature
requirements under the sensitivitiesbased method, the agencies believe that
subjecting spread options to the residual
risk add-on would be incommensurate
with the risks of such positions and
could increase inappropriately the cost
of hedging without a corresponding
reduction in risk. Additionally, as most
agency mortgage-backed securities and
certain convertible instruments (for
example, callable bonds) are eligible to
be cleared, the proposal would allow a
banking organization to exclude these
instruments that are eligible to be
cleared from the residual risk add-on,
despite the pre-payment risk of such
instruments.373
The proposal would also allow a
banking organization to exclude
positions, including those with exotic
373 As
discussed in section III.H.7.c.ii of this
callable bonds that are
priced as yield-to-maturity would not be subject
vega risk, as the risk factors for such instruments
would already be sufficiently captured under the
sensitivities-based method.
SUPPLEMENTARY INFORMATION,
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exposures, from the residual risk add-on
if the banking organization has entered
into a third-party transaction that
exactly matches the market risk covered
position (a back-to-back transaction). As
the long position and short position of
two identical trades would completely
offset, excluding such transactions from
the residual risk add-on would
appropriately reflect the lack of residual
risk inherent in such transactions.
Furthermore, the proposal would
allow a banking organization to exclude
certain offsetting positions that may
exhibit insignificant residual risks and
for which the residual risk add-on
would be overly punitive. Specifically,
the proposal would allow a banking
organization to exclude the following
from the residual risk add-on: (1)
positions that can be delivered into a
derivative contract where the positions
are held as hedges of the banking
organization’s obligation to fulfill the
derivative contract (for example, TBA
and security interests in associated
mortgage pools) as well as the
associated derivative exposure; (2) any
GSE debt issued or guaranteed by GSEs
or any securities issued and guaranteed
by the U.S. government; (3) internal
transactions between two trading desks,
if only one trading desk is modeleligible; (4) positions subject to the
fallback capital requirement; and (5) any
other types of positions that the primary
Federal supervisor determines are not
required to be subject to the residual
risk add-on, as the material risks would
be sufficiently captured under other
aspects of the proposed market risk
framework. For example, the agencies
consider the following risks sufficiently
captured under the proposed market
risk framework such that banking
organizations would not need to
calculate a residual risk add-on for
positions that exhibit these risks: risks
from cheapest-to-deliver options;
volatility smile risk; correlation risk
arising from multi-underlying European
or American plain vanilla options;
dividend risk; and index and multiunderlying options that are welldiversified or listed on exchanges for
which sensitivities are captured by the
capital requirement under the
sensitivities-based method.
Question 133: The agencies seek
comment on all aspects of the proposed
residual risk add-on. Specifically, the
agencies request comment on whether
there are alternative methods to identify
more precisely exotic exposures and
other residual risks for which the
residual risk capital requirement is
appropriate. What, if any, additional
instruments and offsetting positions
should be excluded from the residual
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64129
risk add-on and why? What, if any,
quantitative measures should the
agencies consider to identify or
distinguish residual risks and why?
Question 134: Would characterizing
volatility and variance swaps as bearing
other residual risk more appropriately
reflect the risks of such exposures and
why?
d. Treatment of Certain Market Risk
Covered Positions
To promote consistency in risk-based
capital requirements across banking
organizations and to help ensure
appropriate capitalization under the
market risk capital rule, the proposal
would prescribe the treatment of market
risk covered positions that are hybrid
instruments, index instruments, and
multi-underlying options under the
standardized approach, as described
below.
i. Hybrid Instruments
Hybrid instruments are instruments
that have characteristics in common
with both debt and equity instruments,
including traditional convertible bonds.
As hybrid instruments primarily react to
changes in interest rates, issuer credit
spreads, and equity prices, the proposal
would require a banking organization to
assign risk sensitivities for these
instruments into the interest rate risk
class, credit spread risk class for nonsecuritization positions, and equity risk
class, as applicable, when calculating
the delta, curvature, and vega under the
sensitivities-based method. For the
standardized default risk capital
requirement, the proposal would require
a banking organization to decompose a
hybrid instrument into a nonsecuritization position and an equity
position and calculate default risk
capital for each position respectively.
For example, a convertible bond can be
decomposed into a vanilla bond and an
equity call option. The notional amount
to be used in the default risk capital
calculation for the vanilla bond is the
notional amount of the convertible
bond. The notional amount to be used
in the default risk capital calculation for
the call option is zero (because, in the
event of default, the call option will not
be exercised). In this case, a default of
an issuer of the convertible bond would
extinguish the call option’s value and
this loss would be captured through the
profit and loss component of the gross
default exposure amount calculation.
The standardized default risk capital
requirement for the convertible bond
would be the sum of the default risk
capital of the vanilla bond and the
default risk capital requirement for the
equity option.
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ii. Index Instruments and MultiUnderlying Options
When calculating the delta and
curvature capital requirements under
the sensitivities-based method for index
instruments and multi-underlying
options, the proposal generally would
require a banking organization to apply
a look-through approach. However, it
could treat listed and well-diversified
credit or equity indices 374 as a single
position. The look-through approach
would require a banking organization to
identify the underlying positions of the
index instrument or multi-underlying
option and calculate market risk capital
requirements as if the banking
organization directly held the
underlying exposures. Under the
proposal, a banking organization would
be required to apply consistently the
look-through approach through time
and consistently for all positions that
reference the same index. The proposed
look-through approach would align the
treatment of such instruments with that
of single-name positions and thus
provide greater hedging recognition by
allowing such instruments to net with
single-name positions issued by the
same company. Specifically, a banking
organization would be able to net the
risk factor sensitivities of such positions
of the index instrument or multiunderlying option and single-name
positions without restriction when
calculating delta and curvature capital
requirements under the sensitivitiesbased method.
In certain situations, a banking
organization may choose not to apply a
look-through approach to listed and
well-diversified indices, in which case a
single sensitivity for the index would be
used to calculate the delta and curvature
capital requirements. To assign the
sensitivity of the index to the relevant
sector or index bucket, the agencies are
proposing a waterfall approach as a
simple and risk-sensitive method to
appropriately capture the risk of such
positions based on the risk and
diversification of the underlying assets.
For indices where at least 75 percent of
the notional value of the underlying
constituents relate to the same sector
(sector-specific indices), taking into
account the weightings of the index, the
sensitivity would be assigned to the
corresponding sector bucket. For equity
indices that are not sector specific, the
sensitivity would be assigned to the
large market cap and liquid market
374 An
equity or credit index would be considered
well diversified if it contains a large number of
individual equity or credit positions, with no single
position representing a substantial portion of the
index’s total market value.
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economy (non-sector specific) bucket if
least 75 percent of the market value of
the index constituents met both the
large market cap and liquid market
economy criteria, and to the other
equity indices (non-sector specific)
bucket otherwise. For credit indices that
are not sector specific, the sensitivity
would be assigned to the investment
grade indices bucket if the credit quality
of at least 75 percent of the notional
value of the underlying constituents was
investment grade, and to the speculative
grade and sub-speculative grade indices
bucket otherwise.375 To the extent a
credit or an equity index spans multiple
risk classes, the proposal would require
the banking organization to allocate the
index proportionately to the relevant
risk classes following the above
methodology.
When calculating vega capital
requirements for multi-underlying
options (including index options), the
proposal would permit, but not require,
a banking organization to apply the
look-through approach required for
delta and calculate the vega capital
requirements based on the implied
volatility of options on the underlying
constituents. Alternatively, under the
proposal, a banking organization could
calculate the vega capital requirement
for multi-underlying options based on
the implied volatility of the option,
which typically is the method used by
banking organizations’ financial
reporting valuation models for multiunderlying options. For indices, the
proposal would require a banking
organization to calculate vega capital
requirements based on the implied
volatility of the underlying options by
applying the same approach used for
delta and curvature and using the same
sector-specific bucket or index bucket.
The default risk of multi-underlying
options that are non-securitization debt
or equity positions is primarily a
function of the idiosyncratic default risk
of the underlying constituents.
Accordingly, to capture appropriately
the default risk of such positions, the
proposal would require a banking
organization to apply the look-through
approach when calculating the
standardized default risk capital
requirement for multi-underlying
options that are non-securitization debt
or equity positions. When decomposing
multi-underlying exposures or index
options, a banking organization would
be required to set the gross default
exposure assigned to a single name,
375 See
section III.H.7.a of this SUPPLEMENTARY
INFORMATION for a more detailed description on the
assignment of delta sensitivities to the prescribed
risk buckets under the proposed sensitivities-based
method.
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referenced by the instrument, equal to
the difference between the value of the
instrument assuming only the single
name defaults (with zero recovery) and
the value of the instrument assuming
none of the single names referenced by
the instrument default.
Similarly, for positions in credit and
equity indices, the proposal would
allow a banking organization to
decompose the index position when
calculating the standardized default risk
capital requirement. By aligning the
treatment of positions in credit and
equity indices with that of single-name
positions, the proposal would provide
greater hedging recognition as the
banking organization would be able to
offset the gross default exposure of long
and short positions in indices with that
of single-name positions included in the
index. Alternatively, as the underlying
assets of credit and equity indices could
react differently to the same market or
economic event, the proposal would
also allow a banking organization to
treat such indices as a single position
for purposes of calculating the
standardized default risk capital
requirement.
Question 135: The agencies seek
comment on the proposed threshold of
75 percent for assigning a credit or
equity index to the corresponding sector
or the investment grade indices bucket.
What would be the benefits and
drawbacks of the proposed threshold?
What, if any, alternative thresholds
should the agencies consider that would
more appropriately measure the
majority of constituents in listed and
well-diversified credit and equity
indices?
Question 136: The agencies seek
comment on all aspects of the proposed
treatment of index instruments and
multi-underlying options under the
standardized measure for market risk.
Specifically, the agencies request
comment on any potential challenges
from requiring the look-through
approach for all index instruments and
multi-underlying options that are nonsecuritization debt or equity positions
for the standardized default risk capital
calculation. What, if any, alternative
methods should the agencies consider
that would more appropriately measure
the default risk associated with such
positions? What would be the benefits
and drawbacks of such alternatives
compared to the proposed look-through
requirement?
8. Models-Based Measure for Market
Risk
The core components of the proposed
models-based measure for market risk
capital requirements are internal models
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approach capital requirements for
model-eligible trading desks (IMAG,A),
the standardized approach capital
requirements for model-ineligible
trading desks (SAU), and the PLA addon that addresses deficiencies in the
banking organization’s internal models,
if applicable.
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a. Internal Models Approach
The internal models approach capital
requirements for model-eligible trading
desks (IMAG,A) would consist of four
components: (1) the internally modelled
capital calculation for modellable risk
factors (IMCC); (2) the stressed expected
shortfall for non-modellable risk factors
(SES); (3) the standardized default risk
capital requirement as described in
section III.H.7.b of this SUPPLEMENTARY
INFORMATION; and (4) the aggregate
trading portfolio backtesting capital
multiplier.
The first two components, IMCC and
SES, would capture risk and distinguish
between risk factors for which there are
sufficient real price observations to
qualify as modellable risk factors and
those for which there are not (nonmodellable risk factors or NMRFs).376
The proposal would require banking
organizations to separately calculate the
capital requirement for both types of
risk factors using an expected shortfall
methodology. Under the proposal, the
capital requirement for both modellable
and non-modellable risk factors would
reflect the losses calibrated to a 97.5
percent threshold over a period of
substantial market stress and
incorporate the prescribed liquidity
horizons applicable to each risk factor.
Relative to the IMCC for modellable
risk factors, the SES calculation for nonmodellable risk factors would provide
significantly less recognition for
hedging and portfolio diversification
due to the lower quality inputs to the
model; for example, limited data are
available to estimate the correlations
between non-modellable risk factors
used by the model. These data
limitations also increase the possibility
that a banking organization’s internal
models overstate the diversification
benefits (and therefore, understate the
magnitude of potential losses), as
correlations increase during periods of
stress relative to levels in normal market
conditions. Furthermore, the
conservative treatment of nonmodellable risk factors under the SES
calculation would provide appropriate
376 To be deemed modellable, a risk factor must
pass the Risk Factor Eligibility Test (RFET) and
satisfy data quality requirements, as described in
more detail in section III.H.8.a.i of this
SUPPLEMENTARY INFORMATION.
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incentives for banking organizations to
enhance the quality of model inputs.
The third component of the internal
models approach is the standardized
default risk capital requirement, as
described in section III.H.7.b of this
SUPPLEMENTARY INFORMATION.
To calculate the overall capital
required under the internal models
approach at the trading desk level, a
banking organization would add the
standardized default risk capital
requirement (DRCSA) to the greater of (i)
the sum of the capital requirements for
modellable and non-modellable risk
factors as of the most recent reporting
date (IMCCt¥1 and SESt¥1,
respectively), or (ii) the sum of the
average capital requirements for nonmodellable risk factors over the prior 60
business days (SESaverage) and the
product of the average capital
requirements for modellable risk factors
over the prior 60 business days
(IMCCaverage) and a multiplication factor
(mc) of at least 1.5, which serves to
capture model risk (the aggregate
trading portfolio backtesting
multiplier).377 The overall capital
requirement under the internal models
approach can be expressed by the
following formula:
IMAG,A = DRCSA + (max ((IMCCt¥1 +
SESt¥1), ((mc × IMCCaverage) +
SESaverage)))
Due to the capital multiplier (mc), the
agencies generally expect the capital
requirements for modellable and nonmodellable risk factors to reflect those
based on the prior 60 business day
average, which would reduce quarterly
variation. The proposal would require a
banking organization to take into
account the capital requirements as of
the most recent reporting date to capture
situations where the banking
organization has significantly increased
its risk taking. Thus, the max function
in the above formula would capture
cases where risk has risen significantly
throughout the quarter so that the
average over the quarter is significantly
less than the risk the banking
organization faces at the end of the
quarter.
Question 137: The agencies seek
comment on the internal models
approach for market risk. To what
extent does the approach appropriately
capture the risks of positions subject to
the market risk capital requirement?
377 The size of the multiplication factor could
vary from 1.5 to 2 based on the results of the entitywide backtesting. See section III.H.8.c. of this
SUPPLEMENTARY INFORMATION for further discussion
on the entity-wide backtesting, otherwise known as
the aggregate trading portfolio backtesting
multiplier.
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What additional features, adjustments
(such as to the treatment of
diversification of risks), or alternative
methodology could the approach
include to reflect these risks more
appropriately and why? Commenters
are encouraged to provide supporting
data.
i. Risk Factor Identification and Model
Eligibility
Under the proposal, a banking
organization that intends to use the
internal models approach would be
required to identify an appropriate set of
risk factors that is sufficiently
representative of the risks inherent in all
of the market risk covered positions
held by model-eligible trading desks.
Specifically, the proposal would require
a banking organization’s expected
shortfall models to include all the
applicable risk factors specified in the
sensitivities-based method under the
standardized approach, with one
exception, as well as those used in
either the banking organization’s
internal risk management models or in
the internal valuation models it uses to
report actual profits and losses for
financial reporting purposes. If the risk
factors specified in the sensitivitiesbased method are not included in the
expected shortfall models used to
calculate risk-based capital for market
risk under the internal models
approach, the banking organization
would be required to justify the
exclusions to the satisfaction of its
primary Federal supervisor. As a check
on the greater flexibility provided under
the internal models approach,378 in
comparison to the proposed
sensitivities-based method, modeleligible trading desks would be subject
to PLA add-on and backtesting
requirements, which would help ensure
the accuracy and conservativism of the
risk-based capital requirements
estimated by the expected shortfall
models.
For the identified risk factors, the
proposal would require a banking
organization to conduct the risk factor
eligibility test to determine which risk
factors are modellable, and thus subject
to the IMCC, and which are non378 Unlike the proposed standardized approach,
which would require a banking organization to
obtain a prior written approval of its primary
Federal supervisor to calculate risk factor
sensitivities using the banking organization’s
internal risk management models, as described in
section III.H.7.a.ii of this SUPPLEMENTARY
INFORMATION, the internal models approach would
allow a banking organization to use either the
banking organization’s internal risk management
models or the internal valuation models used to
report actual profits and losses for financial
reporting purposes.
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modellable, and thus subject to the SES
capital requirements. For a risk factor to
be classified as a modellable risk factor,
a banking organization would be
required to identify a sufficient number
of real prices that are representative of
the risk factor (those that could be used
to infer the value of the risk factor), as
described in section III.H.8.a.i.I of this
SUPPLEMENTARY INFORMATION. Evidence
of a sufficient number of real prices
demonstrates the liquidity of the
underlying risk factor and helps to
ensure there is a sufficient quantity of
historical data to appropriately capture
the risk factor under expected shortfall
models used in the IMCC calculation.
Question 138: The agencies request
comment on the appropriateness of the
proposed requirements for the risk
factors included in the internal models
approach. What, if any, alternative
requirements should the agencies
consider, such as requiring risk factor
coverage to align with the front office
models, and why? Specifically, please
describe any operational challenges and
impact on banking organizations’
minimum capital requirements that
requiring the expected shortfall model
to align with the front-office models
would create relative to the proposal.
I. Real Price
To perform the risk factor eligibility
test, a banking organization would be
required to map real prices observed to
the risk factors that affect the value of
the market risk covered positions held
by model-eligible trading desks. For
example, a banking organization could
map the price of a corporate bond to a
credit spread risk factor. The proposal
would define a real price as a price at
which the banking organization has
executed a transaction, a verifiable price
for an actual transaction between third
parties transacting at arm’s length, or a
price obtained from a committed quote
made by the banking organization itself
or another party, subject to certain
conditions discussed below. Prices
obtained from collateral reconciliations
or valuations would not be considered
real price observations for purposes of
the risk factor eligibility test because
these transactions do not indicate
market liquidity of the position.
The agencies recognize that a banking
organization may need to obtain pricing
information from third parties to
demonstrate the market liquidity of the
underlying risk factors, and this may
pose unique challenges for validation
and other model risk management
activities. Therefore, the proposed
definition of a real price would limit
recognition of prices obtained from
third-party providers to prices (1) from
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a transaction or committed quote that
has been processed through a thirdparty provider 379 or (2) for which there
is an agreement between the banking
organization and the third party that the
third party would provide evidence of
the transaction or committed quote to
the banking organization upon request.
In certain cases, obtaining information
on the prices of individual transactions
from third parties may raise legal
concerns for the banking organization,
the third-party provider, or both.380
Therefore, the proposal would allow a
banking organization to consider
information obtained from a third party
on the number of corresponding real
prices observed and the dates at which
they have been observed in determining
the model eligibility of risk factors, if
the banking organization is able to
appropriately map this information to
the risk factors relevant to the market
risk covered positions held by modeleligible trading desks. For a banking
organization to be able to use such
information for determining the model
eligibility of risk factors, the proposal
would require that either the third-party
provider’s internal audit function or
another external party audit the validity
of the third-party provider’s pricing
information. Additionally, the proposal
would require the results and reports of
the audit to either be made public or
available upon request to the banking
organization.381
The additional requirements for
prices or other information obtained
from third parties to qualify as a real
price under the proposed definition
would allow banking organizations to
appropriately demonstrate the market
liquidity of a risk factor, while also
ensuring there is sufficient
documentation for the banking
organization and the primary Federal
supervisor to assess the validity of the
prices or other information obtained
from a third party.
Question 139: What, if any, other
information should the agencies
consider in defining a real price that
379 Prices from a transaction or quote processed
through a trading platform or exchange would
satisfy this requirement for purposes of the
proposed definition of real price.
380 Banking organizations must ensure that
exchanges of price information among competitors
or with third parties are not likely to include acts
or omissions that could result in a violation of
Federal antitrust laws, including the Sherman Act,
15 U.S.C. 1 et seq., and the Federal Trade
Commission Act, 15 U.S.C. 41 et seq.
381 If the audit on the third-party provider is not
satisfactory to the primary Federal supervisor (for
example, the auditor does not meet the
independence or expertise standards of U.S.
securities exchanges), the supervisor may determine
that data from the third-party provider may not be
used for purposes of the risk factor eligibility test.
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would better demonstrate the market
liquidity for risk factors, such as
valuations provided by an exchange or
central counterparty or valuations of
individual derivative contracts for the
purpose of exchanging variation
margin? What, if any, conditions or
limitations should the agencies consider
applying to help ensure the validity of
such information, such as only allowing
information related to individual
derivative transactions to qualify as a
real price and not information provided
on a pooled basis?
II. Bucketing Approach
To determine whether a risk factor
satisfies the risk factor eligibility test, a
banking organization would be required
to (1) map real prices to each relevant
risk factor or set of risk factors, such as
a curve, and (2) define risk buckets at
the risk factor level. Under the proposal,
a banking organization could choose
either its own bucketing approach or the
standard bucketing approach. As the
choice of approach is at the risk factor
level, the proposal would allow a
banking organization to adopt its own
bucketing approach for some risk factors
and the standard bucketing approach for
others. The number of risk factor
buckets should be driven by the banking
organization’s trading strategies. For
example, a banking organization with a
complex portfolio across many points
on the yield curve could elect to define
more granular risk factor buckets for
interest rate risk, such as separate 3month and 6-month buckets, than those
prescribed under the standard bucketing
approach, which puts all maturities of
less than 9 months in one bucket.
Conversely, a banking organization with
less complex products could elect to use
the less granular standard bucketing
approach.
Table 1 to § ll.214 of the proposal
provides the proposed risk factor
buckets a banking organization would
be required to use to group real prices
under the standard bucketing approach.
The proposal would define the risk
factor buckets under the standard
bucketing approach based on the type of
risk factor, the maturity of the
instruments used for the real prices, and
the probability that an option has value
(is ‘‘in the money’’) at the maturity of
the instrument.382 The proposed
buckets are intended to balance between
382 Whether an option has value (is ‘‘in the
money’’) at the maturity of the instrument depends
on the relationship between the strike price of the
option and the market price for the underlying
instrument (the spot price). A call option has value
at maturity if the strike price is below the spot
price. A put option has value at maturity if the
strike price is above the spot price.
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the granularity of the risk factors
allocated to each standardized bucket
and the compliance burden of tracking
and mapping the allocation of real
prices to more granular buckets,
especially as market conditions change.
Too frequent re-allocation of real prices
may lead to artificial and unwarranted
regulatory capital requirement volatility.
When using its own bucketing
approach, a banking organization would
be able to define more granular risk
factor buckets than those prescribed
under the standard bucketing approach,
provided that the internal risk
management model uses the same
buckets or segmentation of risk factors
to calculate profits and losses for
purposes of the PLA test.383 While the
use of more granular buckets could
facilitate a model-eligible trading desk’s
ability to pass the proposed PLA test, it
would also render the risk factor
eligibility test more challenging as the
banking organization would need to
source a sufficient number of real prices
for each additional risk factor bucket.
Therefore, the proposal would provide
the banking organization the flexibility
to define its own bucketing structures
and would place an additional
operational burden on the banking
organization to demonstrate the
appropriateness of using a more
granular bucketing structure.
As positions mature, a banking
organization could continue to allocate
real prices identified within the prior 12
months to the risk factor bucket that the
banking organization initially used to
reflect the maturity of such positions.
Alternatively, the banking organization
could re-allocate the real prices for
maturing positions to the adjacent
(shorter) maturity bucket. To avoid
overstating the market liquidity of a risk
factor, the proposal would allow the
banking organization to count a real
price observation only once, either in
the initial bucket or the adjacent bucket
to which it was re-allocated, but not in
both.
To enable banking organizations’
internal models to capture market-wide
movements for a given economy, region,
or sector, the proposal would allow, but
not require, a banking organization to
decompose risks associated with credit
or equity indices into systematic risk
383 § ll.213(c) of the proposed rule describes
trading desk-level profit and loss attribution test
requirements.
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factors 384 within its internal models.385
The proposal would only allow the
banking organization to include
idiosyncratic risk factors 386 related to
the credit spread or equity risk of a
specific issuer if there are a sufficient
number of real prices to pass the risk
factor eligibility test. Otherwise, such
idiosyncratic risk factors would be a
non-modellable risk factor. The
proposal would allow a banking
organization, where possible, to
consider real prices of market indices
(for example, CDX.NA.IG and S&P 500
Index) and instruments of individual
issuers as representative for a systematic
risk factor as long as they share the same
attributes (for example, economy,
region, sector, and rating) as the
systematic risk factor. The proposed
treatment would allow the banking
organization to align the treatment of
real prices for market indices with those
for single-name positions and, thus,
provide greater hedging recognition.
To determine whether the risk factors
in a bucket pass the risk factor eligibility
test, the proposal would require a
banking organization to allocate a real
price to any risk bucket for which the
price is representative of the risk factors
within the bucket and to count all real
prices mapped to a risk bucket. A real
price may often be used to infer values
for multiple risk factors. By requiring
real prices to evidence the model
eligibility of all risk factors related with
the observation, the proposal would
more accurately capture the market
liquidity for the relevant risk factors.
Question 140: The agencies request
comment on what, if any, modifications
to the proposed bucketing structure
should be considered to better reflect
the risk factors used to price certain
classes of products. What would be the
benefits or drawbacks of such
alternatives compared to the proposed
bucketing structure?
384 The proposal would define systematic risk
factors as categories of risk factors that present
systematic risk, such as economy, region, and
sector. Systematic risk would be defined as the risk
of loss that could arise from changes in risk factors
that represent broad market movements and that are
not specific to an issue or issuer.
385 As a banking organization may not always be
able to model each constituent of the index, the
agencies are not proposing to require the banking
organization to always decompose credit spread
and equity risk factors.
386 Idiosyncratic risk factors would be defined as
categories of risk factors that present idiosyncratic
risk. Idiosyncratic risk would be defined as the risk
of loss in the value of a position that arise from
changes in risk factors unique to the issuer. These
risks would include the inherent risks associated
with a specific issuance or issuer that would change
a position’s value but are not correlated with
broader market movements (for example, the impact
on the position’s value from departure of senior
management or litigation).
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III. Model Eligibility of Risk Factors
For a risk factor to pass the risk factor
eligibility test, a banking organization
would be required on a quarterly basis
to either identify for each risk factor (i)
at least 100 real prices in the previous
twelve-month period or (ii) at least 24
real prices in the previous twelve-month
period, if each 90-day period contains at
least four real prices.387 The proposed
criteria are intended to help ensure real
prices capture products that exhibit
either a minimum level of trading
activity throughout the year, or seasonal
periods of liquidity, such as
commodities.
For any market risk covered position,
the banking organization could not
count more than one real price
observation in any single day and would
be required to count the real price as an
observation for all of the risk factors for
which it is representative. Together,
these requirements are intended to help
ensure that real prices capture more
accurately the market liquidity for the
relevant risk factors and prevent
outdated prices from being used as
model inputs.388
The agencies recognize that the
banking organization may use a
combination of internal and external
data for the risk factor eligibility test.
When a banking organization relies on
external data, the real prices may be
provided with a time lag. Therefore, the
proposal would allow the banking
organization to use a different time
period for purposes of the risk factor
eligibility test than that used to calibrate
the current expected shortfall model, if
such difference is not greater than one
month. For consistency in the time
periods used for internal and external
data, the proposal would also allow the
period used for internal data for
purposes of the risk factor eligibility test
to differ from that used to calibrate the
expected shortfall model, but only if the
period used for internal data is exactly
the same as that used for external data.
For risk factors associated with new
issuances, the observation period for the
risk factor eligibility test would begin on
the issuance date and the number of real
prices required to pass the risk factor
eligibility test would be pro-rated until
387 As
described in section III.H.8.a.i.I of this
in certain cases, a
banking organization would be allowed to obtain
information on the prices of individual transactions
from third parties in determining the model
eligibility of risk factors.
388 For example, if several transactions occur on
day one, followed by a long period for which there
are no real price observations, the proposal would
prevent a banking organization from using the
outdated day-one prices to estimate the fair value
of its current holdings.
SUPPLEMENTARY INFORMATION,
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12 months after the issuance date. For
example, a bond that was issued six
months prior would require 50 real
prices over the prior six-month period
to pass the risk factor eligibility test or
at least 12 real price observations with
no 90-day period in which fewer than
four real price observations were
identified for the risk factor. For market
risk covered positions that reference
new reference rates, the proposal would
allow the banking organization to use
quotes of discontinued reference rates
that the new reference rate is replacing
to pass the risk factor eligibility test
until the new reference rate liquidity
improves.
If a standard or own bucket for risk
factor eligibility contains a sufficient
number of real prices to pass the risk
factor eligibility test and the risk factors
also satisfy the data quality
requirements for modellable risk factors
described in the following section, all
risk factors within the bucket would be
deemed modellable. Risk factors within
a bucket that fail to pass the risk factor
eligibility test or that do not satisfy the
data qualify requirements would be
classified as non-modellable risk factors.
Question 141: What, if any,
restrictions on the minimum
observation period for new issuances
should the agencies consider and why?
Question 142: The agencies request
comment on whether certain types of
risk factors should be considered to pass
the risk factor eligibility test based on
sustained volume over time and through
crisis periods. What if any conditions
should be met before these can be
considered real price observations and
why?
IV. Data Quality Requirements
Under the proposal, once a risk factor
has passed the risk factor eligibility test,
the banking organization would be
required to choose the most appropriate
data for calculating the IMCC for
modellable risk factors. In calculating
the IMCC, a banking organization could
use other data than that used to
demonstrate the market liquidity of a
risk factor for purposes of the risk factor
eligibility test, provided that such data
meet the data quality requirements
listed below. Alternative sources may
provide updated data more frequently
than would otherwise be available from
those used to obtain real prices. For
example, banking organizations may be
able to obtain updated data more
frequently from internal systems than
from third-party providers.
Additionally, in certain cases, a banking
organization may not be able to use the
real prices to calculate the IMCC. For
example, a banking organization may
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receive data from a third-party provider
on the dates and number of real prices,
as described in section III.H.8.a.i.I of
this SUPPLEMENTARY INFORMATION. While
such data demonstrates the liquidity of
a risk factor for purposes of the risk
factor eligibility test, without the
transaction prices, such real prices
would not provide any value to calibrate
potential losses for a particular risk
factor.
To help ensure the appropriateness of
the data and other information used to
calibrate the expected shortfall models
for IMCC, the proposal would establish
data quality requirements for risk factors
to be deemed modellable risk factors.
Under the proposal, any risk factor that
passes the risk factor eligibility test but
subsequently fails to meet any of the
following seven proposed data quality
requirements would be a nonmodellable risk factor.
First, the proposal would generally
require that the data reflect prices
observed or quoted in the market. For
any data not derived from real prices,
the proposal would require the banking
organization to demonstrate that such
data are reasonably representative of
real prices. A banking organization
should periodically reconcile the price
data used to calibrate its expected
shortfall models for IMCC with that
used by the front office and internal risk
management models, to confirm the
validity of the price data used to
calculate the IMCC under the internal
models approach.389
Second, the proposal would require
the data used in the expected shortfall
models for IMCC to capture both the
systematic risk and idiosyncratic risk (as
applicable) of modellable risk factors so
that the IMCC appropriately reflects the
potential losses arising from modellable
risk factors.
Third, the proposal would require the
data used to calibrate the IMCC
expected shortfall model to
appropriately reflect the volatility and
correlation of risk factors of market risk
covered positions. Different data sources
can provide dramatically different
volatility and correlation estimates for
asset prices. When selecting the data
sources to be used in calculating the
IMCC, a banking organization should
assess the quality and relevance of the
data to ensure it would be appropriately
representative of real prices, not
understate price volatility, and
accurately reflect the correlation of asset
389 If real prices are not widely available, a
banking organization may use the prices estimated
by the front office and risk management models for
this comparison.
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prices, rates across yield curves, and
volatilities within volatility surfaces.
Fourth, the proposal would allow the
data used to calibrate the IMCC
expected shortfall model to include
combinations of other modellable risk
factors. However, a risk factor derived
from a combination of modellable risk
factors would be modellable only if this
risk factor also passes the risk factor
eligibility test. Alternatively, banking
organizations may decompose the
derived risk factor into two components:
a modellable component and a nonmodellable component that represents
the basis between the modellable
component and the non-modellable risk
factor. To derive modellable risk factors
from combinations of other modellable
risk factors, banking organizations could
use common approaches, such as
interpolation or principal component
analysis, if such approaches are
conceptually sound. In connection with
implementation of any final rule based
on this proposal, the agencies would
intend to use the supervisory process to
supplement the proposal through
horizontal reviews to evaluate the
appropriateness of banking
organizations’ use of combinations of
risk factors to determine whether a risk
factor is modellable. For example, the
agencies could require risk factors to be
treated as non-modellable if the banking
organization were to use unsound
extrapolation or irregular bucketing
approaches for modellable risk factors.
Fifth, the proposal would require a
banking organization to update the data
inputs at a sufficient frequency and on
at least a weekly basis. While generally
the banking organization should strive
to update the data inputs as frequently
as possible, the agencies would require
the data to be updated weekly as
requiring large data sets to be updated
more frequently may pose significant
operational challenges. For example, a
banking organization that relies on a
third-party provider may not be able to
receive updated data on a real time or
daily basis. The proposal would require
a banking organization that uses
regressions to estimate risk factor
parameters to re-estimate the parameters
on a regular basis. In addition, the
agencies would expect a banking
organization to calibrate its expected
shortfall models to current market
prices at a sufficient frequency, ideally
no less frequently than the calibration of
front office models. A banking
organization would be required to have
clear policies and procedures for
backfilling and gap-filling missing data.
Sixth, in determining the liquidity
horizon-adjusted expected shortfallbased measure, a banking organization
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would be required to use data that are
reflective of market prices observed or
quoted in periods of stress. Under the
proposal, banking organizations should
source the data directly from the
historical period, whenever possible.
Even if the characteristics of the market
risk covered positions currently being
traded differ from those traded during
the historical stress period, the proposal
would require a banking organization to
empirically justify the use of any prices
in the expected shortfall calculation in
a stress period that differ from those
actually observed during a historical
stress period. For market risk covered
positions that did not exist during a
period of significant financial stress, the
proposal would require banking
organizations to demonstrate that the
prices used match changes in the prices
or spreads of similar instruments during
the stress period.
Seventh, the data for modellable risk
factors could include proxies if the
banking organization were able to
demonstrate the appropriateness of such
proxies to the satisfaction of the primary
Federal supervisor. At a minimum, a
banking organization would be required
to have sufficient evidence
demonstrating the appropriateness of
the proxies, such as an appropriate track
record for their representation of a
market risk covered position.
Additionally, any proxies used would
be required to (1) exhibit sufficiently
similar characteristics to the
transactions they represent in terms of
volatility level and correlations and (2)
be appropriate for the region, credit
spread cohort, quality, and type of
instrument they are intended to
represent. Under the proposal, a
banking organization’s proxying of new
reference rates would be required to
appropriately capture the risk-free rate
as well as credit spread, if applicable.
Even if a risk factor passes the risk
factor eligibility test and satisfies each
of the seven proposed data quality
requirements, the primary Federal
supervisor may determine the data
inputs to be unsuitable for use in
calculating the IMCC. In such cases, the
proposal would require a banking
organization to exclude the risk factor
from the expected shortfall model and
subject it to the SES capital
requirements for non-modellable risk
factors.
Question 143: The agencies request
comment on the appropriateness of the
proposed data quality requirements for
modellable risk factors. What, if any,
challenges might the proposed
requirements pose for banking
organizations? What, if any, additional
requirements should the agencies
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consider to help ensure the data used to
calculate the IMCC appropriately
capture the potential losses arising from
modellable risk factors?
Question 144: The agencies request
comment on the appropriateness of
requiring banking organizations to
update the data inputs used in
calculating the IMCC on at least a
weekly basis. What, if any, challenges
might this pose for banking
organizations? How could such
concerns be mitigated while ensuring
the integrity of the data inputs used to
calculate regulatory capital
requirements for modellable risk
factors?
Question 145: The agencies request
comment on the appropriateness of
requiring banking organizations to reestimate parameters in line with the
frequency specified in their policies and
procedures. What, if any, challenges
might this pose for banking
organizations?
Question 146: The agencies request
comment on the operational burden of
requiring banking organizations to
model the idiosyncratic risk of an issuer
that satisfies the risk factor eligibility
test and data quality requirements using
data inputs for that issuer. What, if any,
alternative approaches should the
agencies consider such as allowing
banking organizations to use data from
similar names that would appropriately
capture the idiosyncratic risk of the
issuer? What would be the benefits and
drawbacks of such alternatives relative
to the proposal?
ii. Internally Modelled Capital
Calculation (IMCC) for Modellable Risk
Factors
The IMCC for modellable risk factors
is intended to capture the estimated
losses for market risk covered positions
on model-eligible trading desks arising
from changes in modellable risk factors
during a period of substantial market
stress. As described in this section, the
IMCC for modellable risk factors would
begin with the calculation each business
day of the expected shortfall-based
measure for an entity-wide level for
each risk class and across risk classes
for all model-eligible trading desks, and
also for a trading desk level throughout
a twelve-month period of stress, which
then would be adjusted using risk-factor
specific liquidity horizons.
The proposal would require a banking
organization to use one or more internal
models to calculate on an entity-wide
level for each risk class and across risk
classes a daily expected shortfall-based
measure under stressed market
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conditions.390 While the proposal
would allow a banking organization’s
expected shortfall internal models to
use any generally accepted modelling
approach (for example, variancecovariance models, historical
simulations,391 or Monte Carlo
simulations) to measure the expected
shortfall for modellable risk factors, the
proposal would require the models to
satisfy the proposed backtesting and
PLA testing requirements to
demonstrate on an on-going basis that
such models are functioning effectively
and to assess their performance over
time as conditions and model
applications change.392
Additionally, the proposal would
require a banking organization’s
expected shortfall internal models to
appropriately capture the risks
associated with options, including nonlinear price characteristics, within each
of the risk classes as well as correlation
and relevant basis risks, such as basis
risks between credit default swaps and
bonds. For options, at a minimum, the
proposal would require a banking
organization’s expected shortfall
internal models to have a set of risk
factors that capture the volatilities of the
underlying rates and prices and model
the volatility surface across both strike
price and maturity, which are necessary
inputs for appropriately valuing the
options.
I. Expected Shortfall-Based Measure
To reflect the potential losses arising
from modellable risk factors on modeleligible trading desks throughout an
appropriately severe twelve-month
period of stress (as described in section
III.H.8.a.ii.III of this SUPPLEMENTARY
INFORMATION), the proposal would
require a banking organization to use
one or more internal models to calculate
each business day an expected shortfallbased measure using a one-tail, 97.5th
percentile confidence interval at the
390 As
discussed in section III.H.8.a.ii.I of this
a banking
organization may elect to either use (1) the full set
of risk factors employed by its internal risk
management models and directly calculate the daily
expected shortfall measure under the selected
twelve-month period of stress or (2) an appropriate
subset of modellable risk factors to estimate the
potential losses that would be incurred throughout
the selected stress period, which would require the
banking organization to estimate a daily expected
shortfall measure for both the current and stress
period.
391 The proposal would allow a banking
organization to use filtered historical simulation, as
the approach generally reflects current volatility
and would maintain equal weighting of the
observations by rescaling all of the observations.
392 See sections III.H.8.b and III.H.8.c of this
SUPPLEMENTARY INFORMATION for further discussion
on the PLA testing and backtesting requirements,
respectively.
SUPPLEMENTARY INFORMATION,
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calculations to approximate the entitywide liquidity horizon-adjusted
expected shortfall-based measures for
the full set of risk factors in stress.
Under the proposal, the banking
organization would multiply the
liquidity horizon-adjusted expected
shortfall-based measure for the stress
period based on the reduced set of risk
factors (ESR,S) by the ratio of the
liquidity horizon-adjusted expected
shortfall-based measure in the current
period based on the full set of risk
factors (ESF,C) to the lesser of the current
liquidity-horizon adjusted expected
shortfall-based measure using the
reduced set of risk factors or ESF,C
(ESR,C), as provided according to the
following formula under
§ ll.215(b)(6)(ii)(B) of the proposed
rule, ES:
entity-wide level for each risk class and
across all risk classes for all modeleligible trading desks.393
Under the proposal, the requirement
to exclude non-modellable risk factors
from expected shortfall-based internal
models used to calculate the IMCC
could pose significant operational
burden for entity-wide backtesting and
may also cause anomalies in the
expected shortfall-based calculation that
render the IMCC relatively unstable.394
Accordingly, the proposal would allow
a banking organization, with approval
from its primary Federal supervisor, to
also capture in its internal models the
non-modellable risk factors on modeleligible trading desks, though such
positions would still be required to be
included in the SES measure for nonmodellable risk factors, described in
section III.H.8.a.iii of this
SUPPLEMENTARY INFORMATION. The
agencies view that this will provide a
banking organization an appropriate
incentive to integrate the expected
shortfall-based internal models used to
calculate the IMCC into its daily risk
management processes,395 which may
not distinguish between modellable and
non-modellable risk factors.
To calculate the daily expected
shortfall-based measure, a banking
organization would apply a base
liquidity horizon of 10 days (the
shortest liquidity horizon for any risk
factor bucket in each risk factor class) to
either the full set of modellable risk
factors on its model-eligible trading
desks or an appropriate subset of
modellable risk factors throughout a
twelve-month stress period (base
expected shortfall).
The agencies view that requiring a
banking organization to directly
estimate the potential change in value of
each of its market risk covered positions
held by model-eligible trading desks
arising from the full set of modellable
risk factors throughout a twelve-month
period of stress may pose significant
operational challenges. For example, a
banking organization may not be able to
source sufficient data for all modellable
risk factors during the identified twelvemonth stress period. Thus, the proposal
would allow a banking organization to
use either the full set of modellable risk
factors employed by the expected
shortfall model (direct approach) or an
appropriate subset (indirect approach)
of the entire portfolio of modellable risk
factors for the stress period.
Under the direct approach, the
banking organization would directly
calculate the expected shortfall measure
at the entity-wide level for each risk
class and across all risk classes
throughout a twelve-month period of
stress and then apply the liquidity
horizon adjustments discussed in the
following section.
Under the indirect approach, a
banking organization would use a
reduced set of modellable risk factors to
estimate the losses that would be
incurred throughout the stress period
for the full set of modellable risk factors.
The proposal would require a banking
organization using the indirect approach
to perform three separate expected
shortfall calculations at the entity-wide
level for each risk class and at the
entity-wide level across risk classes: one
using a reduced set of risk factors for the
stress period, one using the same
reduced set of risk factors for the current
period, and one using the full set of risk
factors for the current period. Similar to
the direct approach, the proposal would
require the banking organization to
apply the liquidity horizon adjustments
discussed in the following section to
each of the three expected shortfall
Mean(ESF,C) would be the mean of ESF,C
over the previous 60 business days. This
formula is intended to help ensure that
the potential losses estimated under the
indirect approach appropriately reflect
those that would be produced by the
full set of modellable risk factors, if
such a stress were to occur in the
current period.
Furthermore, to help ensure the
accuracy of this comparison, the
proposal would require a banking
organization that uses the indirect
approach to update the reduced set of
393 The proposal would also require banking
organizations to calculate a daily expected shortfallbased measure at the trading desk level for the
purposes of backtesting and PLA testing to
determine whether a model-eligible trading desk is
subject to the PLA add-on. See sections III.H.8.b
and III.H.8.c of this SUPPLEMENTARY INFORMATION for
further discussion.
394 For example, when a single tenor point is
excluded from the shock to an interest rate curve,
the resulting shock across the curve may be
unrealistic.
395 As described in more detail in section
III.H.5.d.ii of this SUPPLEMENTARY INFORMATION, the
proposal would require a banking organization that
calculates the market risk capital requirements
under the models-based measure for market risk to
incorporate its internal models, including its
expected shortfall internal models, into its daily
risk management process.
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The proposal would floor this ratio at
one to prevent a reduction in capital
requirements due to using the reduced
set of risk factors.
Additionally, the proposal would
require the entity-wide liquidity
horizon-adjusted expected shortfallbased measure for the current period
based on the reduced set of risk factors
(ESR,C),to explain at least 75 percent of
the variability of the losses estimated by
the liquidity horizon-adjusted expected
shortfall-based measure in the current
period for the full set of risk factors
(ESF,C) over the preceding 60 business
days. Under the proposal, compliance
with the 75 percent variation
requirement would be determined based
on an out-of-sample R2 measure, as
defined according to the following
formula under § ll.215(b)(5)(ii)(C) of
the proposed rule:
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risk factors whenever it updates its
twelve-month stress period, as
described in section III.H.8.a.ii.III of this
SUPPLEMENTARY INFORMATION. The
proposal would also require the reduced
set of modellable risk factors used to
calculate the liquidity horizon-adjusted
expected shortfall-based measure for the
stress period to have a sufficiently long
history of observations that satisfies the
data quality requirements for
modellable risk factors, as described in
section III.H.8.a.i.IV of this
SUPPLEMENTARY INFORMATION. In this
manner, the proposal would hold the
inputs used for the indirect approach to
the same data quality requirements as
those required of the inputs used in the
direct approach.
Question 147: What operational
difficulties, if any, would be posed by
requiring banking organizations to
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exclude non-modellable risk factors
from the expected shortfall models for
the purpose of the IMCC calculation and
entity-wide daily backtesting
requirement?
Question 148: The agencies request
comment on the appropriateness of
requiring the election of either the direct
or the indirect approach to apply to the
entire portfolio of modellable risk
factors for market risk covered positions
on model-eligible trading desks. What, if
any, alternatives should the agencies
consider that would enable banking
organizations’ expected shortfall models
to more accurately measure potential
losses under the selected stress period,
such as allowing banking organizations
to make this election at the level of the
trading desk, risk class, or risk factor? If
this election is allowed at a more
granular level, how should the agencies
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consider addressing the operational
challenges associated with aggregating
the various direct and indirect expected
shortfall measures into a single entitywide expected shortfall measure? What
would be the benefits and drawbacks of
such alternatives compared to the
proposed entity-wide election?
II. Liquidity Horizon Adjustments
To capture appropriately the potential
losses from the longer periods of time
needed to reduce the exposure to certain
risk factors (for example, by selling
assets or entering into hedges), a
banking organization would assign each
modellable risk factor to the proposed
liquidity horizons specified in Table 2
to § ll.215 of the proposed rule.
BILLING CODE 6210–01–P; 6714–01–P; 4810–33–P
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The proposed liquidity horizons (10,
20, 40, 60, and 120 days) would vary
across risk factors, with longer horizons
assigned to those that would require
longer periods of time to sell or hedge,
except for instruments with a maturity
shorter than the respective liquidity
horizon. For instruments with a
maturity shorter than the respective
liquidity horizon assigned to the risk
factor, the banking organization would
be required to use the next longer
liquidity horizon compared to the
396 Any currency pair formed by the following list
of currencies: USD, EUR, JPY, GBP, AUD, CAD,
CHF, MXN, CNY, NZD, HKD, SGD, TRY, KRW,
SEK, ZAR, INR, NOK, BRL, and any additional
currencies specified by the primary Federal
supervisor.
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maturity of the market risk covered
position. For example, if an investment
grade corporate bond matures in 19
days, the proposal would require a
banking organization to assign the
associated credit spread risk factor a
liquidity horizon of 20 days rather than
the proposed 40-day liquidity horizon.
To map liquidity horizons for multiunderlying instruments, such as credit
and equity indices, the proposal would
require a banking organization to take a
weighted average of the liquidity
horizons of risk factors corresponding to
the underlying constituents and the
respective weighting of each within the
index and use the shortest liquidity
horizon that is equal to or longer than
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the weighted average.397 Furthermore,
the proposal would require a banking
organization to apply a consistent
liquidity horizon to both the inflation
risk factors and interest rate risk factors
for a given currency.
In general, the proposed liquidity
horizons closely follow the Basel III
reforms. The proposal would clarify the
applicable liquidity horizon for nonsecuritization positions issued or
guaranteed by the GSEs. Under the
proposal, a banking organization would
assign a liquidity horizon of 20 days to
GSE debt guaranteed by a GSE, and a
liquidity horizon of 40 days to all other
397 A weighted average would be based on the
market value of the instruments with the same
liquidity horizon.
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positions issued by the GSEs. The
proposed 20-day liquidity horizon
would recognize that GSE debt
instruments guaranteed by the GSEs
consistently trade in very large volumes
and, similar to U.S. Treasury securities,
have historically been able to rapidly
generate liquidity for a banking
organization, including during periods
of severe market stress. Consistent with
the agencies’ current capital rule, the
proposal would assign a longer 40-day
liquidity horizon to all other positions
issued by the GSEs, as such positions
are not as liquid or readily marketable
as those that are guaranteed by the
GSEs. Together, the proposed treatment
is intended to promote consistency and
comparability in regulatory capital
requirements across banking
organizations and to help ensure
appropriate capitalization of such
positions under subpart F of the capital
rule.
To encourage sound risk management
and enable a banking organization and
the agencies to appropriately evaluate
the conceptual soundness of the
expected shortfall models used to
calculate the IMCC, the proposal would
require a banking organization to
establish and document procedures for
performing risk factor mappings
consistently over time. Additionally, the
proposal would require a banking
organization to map each of its risk
factors to one of the risk factor
categories and the corresponding
liquidity horizon in a consistent manner
on a quarterly basis to help ensure that
the selected stress period continues to
appropriately reflect potential losses for
the risk factors of model-eligible trading
desks over time.
To conservatively recognize empirical
correlations across risk factor classes,
the proposal would require a banking
organization to calculate the liquidity
horizon-adjusted expected shortfallbased measure both at the entity-wide
level for each risk class and across risk
classes for all model-eligible trading
desks. To calculate the entity-wide
liquidity horizon-adjusted expected
shortfall-based measure for each risk
class, the banking organization would
be required to scale up the 10-day base
expected shortfall measure using the
longer proposed liquidity horizons for
modellable risk factors within the same
risk class and assign either the same or
a longer liquidity horizon; all other
modellable risk factors, including those
within the same risk class but assigned
a shorter liquidity horizon, would be
held constant to appropriately reflect
the incremental losses attributable to the
specific risk factors over the longer
proposed liquidity horizon. The banking
organization would calculate separately
the liquidity horizon-adjusted expected
shortfall-based measure for modellable
risk factors within the same risk class at
each proposed liquidity horizon
consecutively, starting with the shortest
(10 days). Specifically, a banking
organization would first compute the
potential loss over the 0- to 10-day
period,398 then the potential loss over
the subsequent 10- to 20-day period—
assuming that its exposure to risk
factors within the 10-day liquidity
horizon has been eliminated—and
continue this calculation for each of the
proposed liquidity horizons, as
described in Table 1 to § ll.215 of the
proposed rule. A banking organization
would then aggregate the losses for each
period to determine the total liquidity
horizon-adjusted expected shortfallbased measure for the risk class.
The liquidity horizon-adjusted
expected shortfall-based measure for
each risk class would reflect both the
losses under the expected shortfallbased measure and the incremental
losses at each proposed liquidity
horizon, according to the following
formula, as provided under
§ ll.215(b)(3) of the proposed rule:
Where:
ES is the regulatory liquidity horizonadjusted expected shortfall;
T is the length of the base liquidity horizon,
10 days;
EST(P) is the ES at base liquidity horizon T
of a portfolio with market risk covered
positions P;
EST(P,j) is the ES at base liquidity horizon T
of a portfolio with market risk covered
positions P for all risk factors whose
liquidity horizon corresponds to the
index value, j, specified in Table 1 to
§ ll.215 of the proposed rule;
LHj is the liquidity horizon corresponding to
the index value, j, specified in Table 1
to § ll.215 of the proposed rule.
would scale up the 10-day expected
shortfall-based measure for all
modellable risk factors assigned either
the same or a longer liquidity horizon,
without distinguishing between risk
classes. Otherwise, the process to
calculate the entity-wide liquidity
horizon-adjusted expected shortfallbased measure would be the same as the
risk-class level calculation.
For example, assume that a banking
organization would be required to
calculate the liquidity horizon-adjusted
expected shortfall-based measure for a
single, USD denominated, investment
grade corporate bond, whose price is
only driven by two risk factors, interest
rate risk and credit spread risk. Under
the proposal, the banking organization
would calculate the expected shortfallbased measure for both interest rate risk
and credit risk factors using the 10-day
liquidity horizon, as expressed by
EST(P) in the above formula. According
to Table 2 to § ll.215 in the proposed
rule, the liquidity horizon for interest
rate risk denominated in USD is 10 days
and the liquidity horizon for credit
spread risk of investment grade issuers
is 40 days. Therefore, the banking
organization would not extend the
liquidity horizon for interest rate risk
but would for the credit spread risk. To
determine the liquidity horizonadjusted expected shortfall-based
measure for credit spread risk, the
banking organization would (1) scale the
credit spread risk by the square root of
still calculate the potential losses assuming a 10day liquidity horizon.
399 The incremental increase in time is
represented by the difference in the liquidity
horizons, LHj¥LHj¥1. In the example, from
liquidity horizon 20 days to 40 days, this amount
is 20 days, or 40 days¥20 days. The incremental
increase in time is divided by the base horizon of
10 days. Thus, the time scaling factor for credit
spread risk is the square root of 2.
To calculate the liquidity horizonadjusted expected shortfall-based
measure at the entity-wide level across
risk classes, the banking organization
398 When computing losses over the 0- to 10-day
period, the proposal would require a banking
organization to floor the time period for
extinguishing its exposure to a risk factor exposure
at 10 days. For example, if an instrument would
mature in two days, the banking organization must
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Federal Register / Vol. 88, No. 179 / Monday, September 18, 2023 / Proposed Rules
lotter on DSK11XQN23PROD with PROPOSALS2
As described above, the proposal
would require the banking organization
to perform this calculation at the
aggregate level, which combines the risk
factors for all risk classes and separately
for each risk class, such as interest rate
risk and credit spread risk. The proposal
would require the banking organization
to use the results of these calculations
as inputs into the overall capital
calculation, described in more detail
below in section III.H.8.a.ii.IV of this
SUPPLEMENTARY INFORMATION.
Question 149: What, if any, risk
factors exist that would not be captured
by the proposal for which the agencies
should consider designating a specific
liquidity horizon and why?
Question 150: The agencies request
comment on the appropriateness of
assigning a liquidity horizon for multiunderlying instruments based on the
weighted average of the liquidity
horizons for the risk factors
corresponding to the underlying
constituents and the respective
weighting of each within the index.
What, if any, alternative methodologies
should the agencies consider, such as
assigning the liquidity horizon for credit
and equity indices based on the longest
liquidity horizon applicable to the risk
factors corresponding to the underlying
constituents? What would be the
benefits and drawbacks of such
alternatives compared to the proposal?
Commenters are encouraged to provide
data to support their responses.
Question 151: The agencies request
comment on the appropriateness of
requiring banking organizations to use
the next longer liquidity horizon for
instruments with a maturity shorter
than the respective liquidity horizon
assigned to the risk factor. What, if any,
operational challenges might this pose
for banking organizations? How could
such concerns be mitigated while still
ensuring consistency and comparability
in regulatory capital requirements
across banking organizations?
III. Stress Period
To appropriately account for potential
losses in stress, the proposal would
require a banking organization to
calculate the entity-wide expected
shortfall-based measures for each risk
class and across risk classes described
in section III.H.8.a.ii.I of this
SUPPLEMENTARY INFORMATION using the
twelve-month period of stress for which
its market risk covered positions on
model-eligible trading desks would
experience the largest cumulative loss.
To identify the appropriate period of
stress, the proposal would require a
banking organization to consider all
twelve-month periods spanning back to
at least 2007 and, depending on whether
the banking organization elected to
employ the direct or indirect approach,
select that in which either the full or
reduced set of risk factors would incur
the largest cumulative loss.400 The
proposal would require a banking
organization to equally weight
observations within each twelve-month
stress period when selecting the
appropriate stress period.
To help ensure that the stress period
continues to appropriately reflect
potential losses for the modellable risk
factors of model-eligible trading desks
over time, the proposal would require a
banking organization to review and
update, if appropriate, the twelve-month
stress period on at least a quarterly basis
or whenever there are material changes
in the risk factors of model-eligible
trading desks.
Question 152: The agencies seek
comment on the appropriateness of
requiring banking organizations to use
the same reduced set of risk factors to
both identify the appropriate stress
period and calculate the IMCCs. To
what extent does the proposed
approach provide banking organizations
sufficient flexibility to appropriately
capture the risk factors that may be
present in some, but not all stress
periods? What, if any, alternative
approaches should the agencies
consider that would better serve to
capture such risk factors relative to the
proposal?
IV. Total Internal Models Capital
Calculations (IMCC)
The proposal would require a banking
organization to use the liquidity
horizon-adjusted expected shortfallbased measures calculated throughout
the stress period at the entity-wide level
for each risk (IMCC(Ci)) and at the
entity-wide level across risk classes
(IMCC(C)) to calculate the IMCC for the
modellable risk factors of model-eligible
trading desks. To constrain the
empirical correlations and provide an
appropriate balance between perfect
diversification and no diversification
between risk factor classes, the IMCC
would equal half of the entity-wide
liquidity horizon-adjusted expected
shortfall-based measure across all risk
classes plus half of the sum of the
liquidity horizon-adjusted expected
shortfall measures for each risk class,
according to the following formula, as
provided under § ll.215(c)(4) of the
proposed rule:
Where:
i indexes the following risk classes: interest
rate risk, credit spread risk, equity risk,
commodity risk and foreign exchange
risk.
iii. Stressed Expected Shortfall (SES) for
Non-Modellable Risk Factors
Under the proposal, the SES capital
requirement for non-modellable risk
factors would be similar to the IMCC for
modellable risk factors, except that the
SES calculation would provide
significantly less recognition for
hedging and portfolio diversification
relative to the IMCC.
Under the proposal, a banking
organization would have to use a stress
scenario that is calibrated to be at least
as prudent as the expected shortfall-
400 Under the proposal, a banking organization
that has elected to use the direct approach would
select the relevant stress period using the full set
of modellable risk factors, while that using the
indirect approach would use the reduced set of risk
factors to select the stress period.
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the incremental increase in time (1 for
liquidity horizon from 10 days to 20
days and the square root of 2 for
liquidity horizon from 20 days to 40
days),399 (2) add the resulting liquidity
horizon adjustment for credit spread
risk, as expressed by the second term in
the above formula and repeated below,
to the base 10-day liquidity horizon
squared, and (3) calculate the square
root of the sum of (1) and (2):
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based measure for modellable risk
factors and calculate the liquidity
horizon-adjusted expected shortfallbased measure for non-modellable risk
factors in stress using the same general
process as proposed for modellable risk
factors, with three key differences. First,
the proposal would require a banking
organization to separately carry out such
calculation for each non-modellable risk
factor, as opposed to at the risk class
level. Second, the proposal would
require a banking organization to apply
a minimum liquidity horizon
adjustment of at least 20 days, rather
than 10 days. Third, the proposal would
require a banking organization to
separately identify for each risk class
the stress period for which its market
risk covered positions on model-eligible
trading desks would experience the
largest cumulative loss, except that a
common twelve-month period of stress
could be used for all non-modellable
risk factors arising from idiosyncratic
credit spread or equity risk due to spot,
futures and forward prices, equity repo
rates, dividends and volatilities.
To calculate the aggregate SES capital
requirement for non-modellable risk
factors, the proposal would require a
banking organization to separate nonmodellable risk factors (the ESNMRF) into
those with idiosyncratic credit spread
risk, those with idiosyncratic equity
risk, and those with systematic risk,
according to the following formula as
provided under § ll.215(d)(2) of the
proposed rule:
Where:
ISESNM,i is the stress scenario capital measure
for non-modellable idiosyncratic credit
spread risk, i, aggregated with zero
correlation, and where I is a nonmodellable idiosyncratic credit spread
risk factor;
ISESNM,j is the stress scenario capital measure
for non-modellable idiosyncratic equity
risk, j, aggregated with zero correlation,
and where J is a non-modellable
idiosyncratic equity risk factor;
SESNM,k is the stress scenario capital measure
for the remaining non-modellable
systematic risk factors, k, and where K is
the remaining non-modellable risk
factors in a model-eligible trading desk;
and
r is equal to 0.6.
magnitude of potential losses of nonmodellable risk factors).
In recognition of the data limitations
of non-modellable risk factors, the
proposal would allow a banking
organization to use proxies in designing
the stress scenario for each risk class of
non-modellable risk factors, as long as
such proxies satisfy the data quality
requirements for modellable risk factors.
Additionally, with approval from its
primary Federal supervisor, a banking
organization may use an alternative
approach to design the stress scenario
for each risk class of non-modellable
risk factors. However, when a banking
organization is not able to model a stress
scenario for a risk factor class, or a
smaller subset of non-modellable risk
factors, that is acceptable to the primary
Federal supervisor, the proposal would
require the banking organization to use
a methodology that produces the
maximum possible loss.
Question 153: The agencies seek
comment on the treatment of nonmodellable risk factors. Specifically, is
the treatment for non-modellable risk
factors appropriate and commensurate
with their risks? What other treatments
should the agencies consider and why?
Should the agencies consider scaling the
resulting aggregate SES capital
requirement for non-modellable risk
factors by a multiplier to better reflect
the risk profile of these risk factors and,
if so, how should that multiplier be
calibrated and why?
commissions, reserves, net interest
income, and intraday trading) with the
corresponding daily VaR-based measure
calibrated to a one-day holding period
and at a one-tail, 99.0 percent
confidence level. Depending on the
number of exceptions in the entity-wide
backtesting results, a banking
organization must apply a
multiplication factor, which can range
from 3 to 4, to a banking organization’s
VaR-based and stressed VaR-based
capital requirements for market risk.
The proposal generally would retain
the backtesting requirements in subpart
F of the current capital rule, with two
modifications. First, the proposal would
require backtesting of VaR-based
measures against both actual profit and
loss as well as against hypothetical
profit and loss.402 Specifically, for the
most recent 250 business days,403 a
banking organization would be required
to separately compare each business
day’s aggregate actual profit and loss for
transactions on model-eligible trading
desks and aggregate hypothetical profit
and loss for transactions on modeleligible trading desks with the
corresponding aggregate VaR-based
measures for that business day
For non-modellable risk factors with
systematic risk, the third term would
allow for a limited and appropriate
diversification benefit that depends on
the level of r parameter. For
idiosyncratic non-modellable risk
factors that the banking organization
demonstrates are not related to broader
market movements,401 the proposal
would provide greater diversification
benefit by allowing such nonmodellable risk factors to be aggregated
with zero correlation.
Given the limited data available for
non-modellable risk factors from which
to estimate correlations between such
factors, the proposed conservative
capital treatment would address the
potential risk of lower quality inputs
being used in calculating market risk
capital requirements for non-modellable
risk factors (for example, the limited
data set overstates the diversification
benefits and, therefore, understates the
401 One way to show this is to regress equity
return or changes in credit spreads on systematic
risk factors and show that the residuals of these
regressions are uncorrelated with each other.
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iv. Aggregate Trading Portfolio
Backtesting Capital Multiplier
Under subpart F of the current capital
rule, each quarter, a banking
organization must compare each of its
most recent 250 business days of entitywide trading losses (excluding fees,
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402 The proposal would define hypothetical profit
and loss as the change in the value of the market
risk covered positions that would have occurred
due to changes in the market data at end of current
day if the end-of-previous-day market risk covered
positions remained unchanged. Valuation
adjustments that are updated daily would have to
be included, unless the banking organization
receives approval from its primary Federal
Supervisor to exclude them. Valuation adjustments
for which separate regulatory capital requirements
have been otherwise specified, commissions, fees,
reserves, net interest income, intraday trading, and
time effects would have to be excluded. See
§ ll.202 of the proposed rule.
403 In its first year of backtesting, a banking
organization would count the number of exceptions
that have occurred since it began backtesting.
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calibrated to a one-day holding period at
a one-tail, 99.0 percent confidence level
for market risk covered positions on all
model-eligible trading desks. Second,
the proposal generally would require a
banking organization to apply a lower
capital multiplier (mc), that could range
from a factor of 1.5 to 2, to the 60-day
average estimated capital required for
modellable risk factors, based on the
number of exceptions in the entity-wide
backtesting results.404
CA = max((IMCCt¥1 + SESt¥1), ((mc ×
IMCCaverage) + SESaverage))
The proposed backtesting
requirements would measure the
conservatism of the forecasting
assumptions and the valuation methods
in the expected shortfall models used
for determining risk-based capital
requirements by comparing the daily
VaR-based measure against the actual
and hypothetical profits and losses.
Such comparisons are a critical part of
a banking organization’s ongoing risk
management, as they improve a banking
organization’s ability to make prompt
adjustments to the internal models used
for determining risk-based capital
requirements to address factors such as
changing market conditions and model
deficiencies. A high number of
exceptions could indicate modeling
issues (for example, insufficiently
conservative risk factor shocks) and
warrant increased capital requirements.
The proposed PLA add-on, as
described in section III.H.8.b of this
SUPPLEMENTARY INFORMATION, would
require a banking organization’s market
risk capital requirement to reflect an
additional capital requirement for
deficiencies in the accuracy of a banking
organization’s internal models.
Accordingly, the backtesting
requirements and associated
multiplication factor provide
appropriate incentives for banking
organizations to regularly update the
internal models used for determining
regulatory capital requirements.
Question 154: What, if any,
alternative techniques should the
agencies consider that would render the
capital multiplier a more appropriate
404 The mechanics of the backtesting
requirements for the aggregate trading portfolio
backtesting multiplier would be the same as those
at the trading desk level. Consistent with the
trading desk level backtesting requirements, the
proposal would allow banking organizations to
disregard backtesting exceptions related to official
holidays and, in certain instances, those related to
non-modellable risk factors and technical issues.
See section III.H.8.c of this SUPPLEMENTARY
INFORMATION for a detailed description of the
mechanics of the proposed backtesting
requirements, including circumstances in which a
banking organization may disregard a backtesting
exemption.
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measure of the robustness of a banking
organization’s internal models? What
are the benefits and drawbacks of such
alternatives compared to the proposed
calculation for the aggregate trading
portfolio backtesting capital multiplier?
v. Default Risk Capital Requirement
Under the Internal Models Approach
The agencies propose to require all
banking organizations to use the
standardized default risk capital
requirement regardless of whether they
use the IMCC plus SES or the
sensitivities-based method plus the
residual risk add-on for non-default
market risk factors. The agencies
propose this simplification to the
internally modelled approach for market
risk in order to reduce the operational
burden for a banking organization and
to further promote consistency in riskbased capital requirements across
banking organizations and within the
capital rule.
b. PLA Add-On
Under the proposal, use of the
internal models approach for a modeleligible trading desk fundamentally
would depend on the accuracy of the
potential future profits or losses
estimated under the banking
organization’s expected shortfall models
relative to those produced by the
valuation methods used to report actual
profits and losses for financial reporting
purposes (front office models). The
proposed profit and loss attribution test
metrics 405 would help ensure that the
theoretical changes in a model-eligible
trading desk’s revenue produced by the
internal risk management models are
sufficiently close to the hypothetical
changes produced by valuation methods
used by the banking organization in the
end-of-day valuation process and
adequately capture the risk factors used
in such models. Thus, the proposed
PLA test metrics would measure the
materiality of the simplifications of the
internal risk management models used
by a model-eligible trading desk relative
to the front-office models and remove
the eligibility of any trading desk for
which such simplifications are deemed
material from using the internal models
approach to calculate its regulatory
capital requirement for market risk.
The proposal would impose an
additional capital requirement (the PLA
add-on) on model-eligible trading desks
405 The proposed PLA test metrics include (1) the
Spearman correlation metric which assesses the
correlation between the risk-theoretical profit and
loss and the hypothetical profit and loss; and (2) the
Kolmogorov-Smirnov metric which assesses the
similarity of the distributions of the risk-theoretical
profit and loss and the hypothetical profit and loss.
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for which either or both of the two desklevel PLA test metrics demonstrate
deficiencies in the ability of the banking
organization’s internal models to
appropriately capture the market risk of
a model-eligible trading desk’s market
risk covered positions. The PLA add-on
would help ensure that model-eligible
trading desks with model deficiencies,
but not disqualifying failures of the PLA
test metrics, are subject to more
conservative capital requirements
relative to model-eligible trading desks
without model deficiencies.
Additionally, the PLA add-on provides
appropriate incentives for such trading
desks to address the potential gaps in
data and model deficiencies. However,
a model-eligible trading desk that passes
both of the PLA test metrics could still
be subject to the PLA add-on if the
primary Federal supervisor determines
that the trading desk no longer complies
with all applicable requirements, as
described in section III.H.5.d of this
SUPPLEMENTARY INFORMATION.
i. PLA Test
To measure the materiality of the
simplifications (for example, missing
risk factors and differences in the way
positions are valued) within the
expected shortfall models used by each
model-eligible trading desk, the PLA
test would require a banking
organization, for each model-eligible
trading desk, to compare the daily profit
and loss values produced by its internal
risk management models (risktheoretical profit and loss) 406 against
the hypothetical profit and loss
produced by the front office models.
I. Data Input Requirements
For the sole purpose of the PLA test,
the proposal would permit a banking
organization to align the risk factor
input data used in the valuations
calculated by the internal risk
management models with that used in
the front office models, if the banking
organization demonstrates that such an
alignment would be appropriate. If the
input data for a given risk factor that is
common to both the front office models
and the internal risk management
models differs due to data acquisition
complications (specifically, different
market data sources, time fixing of
market data sources, or transformations
of market data into input data suitable
406 The proposal would define risk-theoretical
profit and loss as the daily trading desk-level profit
and loss on the end-of-previous-day market risk
covered positions generated by the banking
organization’s internal risk management models.
The risk-theoretical profit and loss would have to
take into account all risk factors, including nonmodellable risk factors, in the banking
organization’s internal risk management models.
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such positions using the more
conservative capital treatment under the
standardized approach or the fallback
capital requirement, as described in
sections III.H.7 and III.H.6.c of this
SUPPLEMENTARY INFORMATION,
respectively.
for the risk factors of the underlying
valuation engines), a banking
organization may adjust the input data
used by the front office models into a
format that can be used by the internal
risk management models. When
transforming the input data of the front
office models into a format that can be
applied to the risk factors used in
internal risk management models, the
banking organization would be required
to demonstrate that no differences in the
risk factors or in the valuation models
have been omitted. The proposal would
require a banking organization to assess
the effect of these input data alignments
on both the valuations produced by the
internal risk management models and
the PLA test when designing or
changing the input data alignment
process, or at the request of the primary
Federal supervisor.
Additionally, the proposal would
require a banking organization to treat
time effects 407 in a consistent manner in
the hypothetical profit and loss and the
risk-theoretical profit and loss.408
The proposed flexibility would allow
the results of the PLA test metrics to
more accurately assess the consistency
of the risk-theoretical and hypothetical
profit and loss for a particular modeleligible trading desk, by focusing on
differences due to the pricing function
and risk factor coverage rather than
those arising from use of different data
inputs.
Furthermore, the proposal would
allow, subject to approval by the
primary Federal supervisor, a banking
organization, for a model-eligible
trading desk that holds a limited
amount of securitization positions or
correlation trading positions pursuant to
its trading or hedging strategy, to
include such positions for the purposes
of the PLA tests. Allowing such
positions to be included would enable
securitization positions held as hedges
to be recognized with the underlying
positions they are intended to hedge
and thus minimize the potential of PLA
testing to incorrectly identify model
deficiencies for model-eligible trading
desks due solely to the bi-furcation of
such hedges. For model-eligible trading
desks with approval of the primary
Federal supervisor to incorporate
securitization positions in their PLA test
metrics, the proposal would require the
banking organization to calculate the
market risk capital requirements for
where cov(RHPL, RRTPL) is the covariance
between RHPL and RRTPL and sRHPL and
sRRTPL are the standard deviations of rank
orders RHPL and RRTPL, respectively.
As a testing metric, the Spearman
correlation coefficient is intended to
support sound risk management by
assessing the correlation between the
daily risk-theoretical profit and loss and
the hypothetical profit and loss for a
model-eligible trading desk. A high
degree of correlation would indicate
directional consistency between the two
measures.
To calculate the Kolmogorov-Smirnov
metric, the banking organization, for
each model-eligible trading desk, would
identify the number of daily
observations over the most recent 250
business days where the risk-theoretical
profit and loss or separately the
hypothetical profit and loss is less than
or equal to the specified value. To
appropriately weight the probability of
each daily observation,409 the proposal
407 Time effects can include various elements
such as the sensitivity to time, or theta effect, and
carry or costs of funding.
408 In particular, when time effects are included
in (or excluded from) the hypothetical profit and
loss, they must also be included in (or excluded
from) the risk-theoretical profit and loss.
409 For example, if the internal risk management
model generates the same value for the modeleligible trading desk’s portfolio on two separate
days, the proposal would require the banking
organization to assign a larger probability by
requiring each daily observation to be weighted at
0.004.
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II. PLA Test Metrics
For the PLA test, the banking
organization, for each model-eligible
trading desk, would be required to
compare, for the most recent 250
business days, the risk-theoretical profit
and loss and the hypothetical profit and
loss using two test metrics: the
Spearman correlation and the
Kolmogorov-Smirnov metric.
To calculate the Spearman correlation
metric, the banking organization, for
each model-eligible trading desk, must
compute, for each of the most recent 250
business days, the rank order of the
daily hypothetical profit and loss,
(RHPL), and the rank order of the daily
risk-theoretical profit and loss, (RRTPL),
with the lowest profit and loss value in
the time series receiving a rank of 1, the
next lowest value receiving a rank of 2,
etc. The Spearman correlation
coefficient for the two rank orders, RHPL
and RRTPL, would be based on the
following formula:
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would define the empirical cumulative
distribution function as the number of
daily observations multiplied by 0.004
(1/250). Under the proposal, the
Kolmogorov-Smirnov metric would be
the largest absolute difference observed
between these two empirical cumulative
distributions of profit and loss at any
value, which could be expressed as:
KS = max(abs(DHPL¥DRTPL))
where DHPL is the empirical cumulative
distribution of hypothetical profit and
loss produced by the front office models
and DRTPL the empirical cumulative
distribution of risk-theoretical profit and
loss produced by the internal risk
management models.
As a testing metric, the KolmogorovSmirnov metric is intended to support
good risk management by requiring
banking organizations to assess the
similarity of the distribution of the daily
portfolio values for a model-eligible
trading desk generated by the internal
risk management models and the front
office models. The closeness of the
distributions would indicate how
accurately the internal risk-management
models capture the range of losses
experienced by the model-eligible
trading desk across different market
conditions with closer distributions
indicating greater accuracy with respect
to pricing and risk factor coverage.
Applying this process over a given
period would provide information about
the accuracy of the internal risk
management model’s ability to
appropriately reflect the shape of the
whole distribution of values for the
model-eligible trading desk’s portfolio
compared to the distribution of values
generated by the front office models,
including information on the size and
number of valuation differences.
Based on the PLA test results for the
two above metrics, a banking
organization would be required to
allocate each model-eligible trading
desk to a PLA test zone as set out in
Table 1 to § ll.213 of the proposed
rule.
The proposal would permit a banking
organization to consider a modeleligible trading desk to be in the green
zone only if both of the PLA test metrics
fall into the green zone. Conversely, a
banking organization would consider a
model-eligible trading desk to be in the
red zone if either of the PLA test metrics
fall within the red zone. The proposal
would require a banking organization to
consider all other model-eligible trading
desks (such as those with both metrics
in the amber zone or one metric in the
amber zone and the other in the green
zone) in the amber zone. Additionally,
under the proposal, the primary Federal
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supervisor could require a banking
organization to assign a different PLA
test zone to a model-eligible trading
desk than that based on PLA test metrics
of the model-eligible trading desk.410
Question 155: The agencies seek
comment on all aspects of the PLA test
metrics. What, if any, modifications
should the agencies consider that would
enable the PLA tests to more
appropriately measure the robustness of
a banking organization’s internal
models?
Question 156: The agencies seek
comment on the appropriateness of
allowing banking organizations to align
the risk input data between the internal
risk management models and the frontoffice models. What other instances, if
any, should the agencies consider to
ensure accurate and consistent
assessment of the profit and losses
produced by the internal risk
management models with those
produced by the front office models for
a particular model-eligible trading desk?
Question 157: The agencies request
comment on the benefits and drawbacks
of allowing banking organizations, with
regulatory approval, to include nonmodellable risk factors for purposes of
the PLA tests. Should non-modellable
risk factors be excluded from the PLA
tests? Why or why not? What, if any,
further conditions should the agencies
consider including to appropriately
limit the inclusion of non-modellable
risk factors for purposes of the PLA
tests? Commenters are encouraged to
provide data to support their responses.
ii. Calculation of the PLA Add-On
lotter on DSK11XQN23PROD with PROPOSALS2
Under the proposal, a banking
organization would consider modeleligible trading desks in the green zone
or amber zone as passing the PLA test
for model eligibility purposes but would
be required to apply the PLA add-on to
model-eligible trading desks within the
amber zone. The proposal would require
a banking organization to calculate the
PLA add-on as the greater of zero and
the aggregate capital benefit to the
banking organization from the internal
models approach (the difference
between the capital requirements for all
410 As discussed in more detail in section
III.H.5.d.iv. of this SUPPLEMENTARY INFORMATION, if
for initial or on-going model eligibility, the primary
Federal supervisor subjects a model-eligible trading
desk to the PLA add-on, the model-eligible trading
desk would remain subject to the PLA add-on until
either the model-eligible trading desk (1) provides
at least 250 business days of backtesting and PLA
test results that pass the trading-desk level
backtesting requirements and produce PLA metrics
in the green zone, or (2) receives written approval
from the primary Federal supervisor that the PLA
add-on no longer applies.
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model-eligible trading desks 411 in the
green or amber zone under the
standardized approach (SAG,A) and
those under the internal models
approach (IMAG,A)), multiplied by a
multiplication factor of k, as defined
according to the following formula
under § ll.213(c)(4) of the proposed
rule:
PLA add-on = k × max
((SAG,A¥IMAG,A),0)
Under the proposal, the value of k
would equal half of the ratio of the sum
of the standardized approach capital
requirements for each model-eligible
trading desk within the amber zone and
those for each of the model-eligible
trading desks within either the green or
amber zone as defined according to the
following formula under
§ ll.213(c)(4)(i) of the proposed rule:
Thus, the value of k would gradually
increase from 0 to 0.5 as the number of
model-eligible trading desks within the
amber zone increases, which is intended
to mitigate the potential cliff effect of
significantly increasing market risk
capital requirements as a model-eligible
trading desk transitions from using the
internal models approach to the
standardized approach.
iii. Application of the PLA Add-On
If, in the most recent 250 business day
period, a trading desk that the primary
Federal supervisory previously
approved to use the internal models
approach produces results in the PLA
test red zone, the proposal would
require the banking organization to use
the standardized approach and calculate
market risk capital requirements for the
positions held by the trading desk
together with all other trading desks
subject to the standardized approach.412
Under the proposal, since deficiencies
identified by the PLA test metrics relate
solely to the expected shortfall models,
if the expected shortfall model used by
a trading desk subsequently fails the
411 In calculating the PLA add-on, a banking
organization must exclude any securitization
positions, including correlation trading positions,
held by a model-eligible desk, as such positions
must be subject to either the standardized approach
or the fallback capital requirement.
412 As discussed in section III.H.5.d.i of this
SUPPLEMENTARY INFORMATION, model-eligible trading
desks that hold limited amounts of securitization
and correlation trading positions must calculate
regulatory capital requirements for such positions
under the standardized approach or fallback capital
requirement, as applicable. With regulatory
approval, a banking organization may include such
positions within its internal models for the
purposes of the PLA tests and backtesting.
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PLA test, the banking organization
would calculate the market risk capital
requirement for the trading desk using
the sensitivities-based method and the
residual risk add-on, as applicable. The
proposal would not permit the banking
organization to use the internal models
approach to calculate market risk capital
requirements for the trading desk until
the trading desk (i) produces PLA test
results in either the green or amber zone
and passes specific trading desk level
backtesting requirements over the most
recent 250 business days, or (ii) receives
approval from the primary Federal
supervisor.
c. Backtesting Requirements for ModelEligible Trading Desks
Under the proposal, a banking
organization may treat a trading desk
that conducts and successfully passes
both backtesting and the PLA test at the
trading desk level on an ongoing
quarterly basis as a model-eligible
trading desk. For determining the model
eligibility of a trading desk, the proposal
would require the banking organization
to perform backtesting at the trading
desk level. For the purpose of desk-level
backtesting, for each trading desk, a
banking organization would be required
to compare each of its most recent 250
business days’ actual profit and loss and
hypothetical profit and loss produced
by the front office models with the
corresponding daily VaR-based measure
calculated by the banking organization’s
expected shortfall model under the
internal models approach. The proposal
would require the banking organization,
for each trading desk, to calibrate the
VaR-based measure to a one-day holding
period and at both the 97.5th percentile
and the 99.0th percentile one-tail
confidence levels.
Under the proposal, a backtesting
exception would occur when the daily
actual profit and loss or the daily
hypothetical profit and loss of the
trading desk exceeds the corresponding
daily VaR-based measure calculated by
the banking organization’s expected
shortfall model. A banking organization
must count separately the number of
backtesting exceptions that occurred in
the most recent 250 business days for
actual profit and loss at each confidence
level and those that occurred for
hypothetical profit and loss at each
confidence level. A trading desk would
become model-ineligible if, in the most
recent 250 business day period, the
trading desk experiences any of the
following: (1) 13 or more exceptions for
actual profit and loss at the 99.0th
percentile; (2) 13 or more exceptions for
hypothetical profit and loss at the 99.0th
percentile; (3) 31 or more exceptions for
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actual profit and loss at the 97.5th
percentile; or (4) 31 or more exceptions
for hypothetical profit and loss at the
97.5th percentile. In the event that
either the daily actual or hypothetical
profit and loss is unavailable or the
banking organization is unable to
compute them, or the banking
organization is unable to compute the
VaR-based measure for a particular
business day, the proposal would
require the banking organization to treat
such an occurrence as a backtesting
exception unless related to an official
holiday, in which case the banking
organization may disregard the
backtesting exception. In addition, with
approval of the primary Federal
supervisor, the banking organization
must disregard the backtesting
exception if the banking organization
could demonstrate that the backtesting
exception is due to technical issues that
are unrelated to the banking
organization’s internal model; or if the
banking organization could show that a
backtesting exception relates to one or
more non-modellable risk factors and
the market risk capital requirement for
these non-modellable risk factors
exceeds either (a) the difference
between the banking organization’s
VaR-based measure and actual loss or
(b) the difference between the banking
organization’s VaR-based measure and
hypothetical loss for that business day.
In these cases, the banking organization
must demonstrate to the primary
Federal supervisor that the nonmodellable risk factor has caused the
relevant loss.
If in the most recent 250 business day
period a trading desk experiences either
13 or more backtesting exceptions at the
99.0th percentile, or 31 or more
backtesting exceptions at the 97.5th
percentile, the proposal would require
the banking organization to use the
standardized approach to determine the
market risk capital requirements for the
market risk covered positions held by
the trading desk. If a model-eligible
trading desk is approved with less than
250 business days of trading desk level
backtesting and PLA test results, the
proposal would require a banking
organization to use all backtesting data
for the model-eligible trading desk and
to prorate the number of allowable
exceptions by the number of business
days for which backtesting data are
available for the model-eligible trading
desk. The proposal would allow the
banking organization to return to using
the full internal models approach to
calculate market risk capital
requirements for the trading desk if the
banking organization (1) remediates the
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internal model deficiencies such that
the trading desk successfully passes
trading desk-level backtesting and
reports PLA test metrics in the green or
amber zone or (2) receives approval of
the primary Federal supervisor.
Question 158: Should non-modellable
risk factors be excluded from the
proposed backtesting requirements?
Why or why not? What, if any, further
conditions should the agencies consider
including to limit appropriately the
inclusion of non-modellable risk factors
for purposes of the backtesting
requirements? Commenters are
encouraged to provide data to support
their responses.
Question 159: The agencies invite
comment on what, if any, challenges
requiring banking organizations to
directly calculate the internally
modelled capital requirement for
modellable risk factors using a 10-day
liquidity horizon for the purposes of the
daily expected shortfall-based measure
for modellable risk factors could pose
and a 1-day VaR for the purposes of
backtesting could pose. What, if any,
alternative methodologies should the
agencies consider?
9. Treatment of Certain Market Risk
Covered Positions
To promote consistency and
comparability in the risk-based capital
requirements across banking
organizations and to help ensure
appropriate capitalization of positions
subject to subpart F of the capital rule,
the proposal would clarify the treatment
of certain market risk covered positions
under the standardized and modelsbased measures for market risk.
a. Net Short Risk Positions
The proposal would require a banking
organization to calculate on a quarterly
basis its exposure arising from any net
short credit or equity position.413 A
banking organization would be required
to include net short risk positions
exceeding $20 million in its total market
risk capital requirement for the entire
quarter, under both the standardized
measure for market risk and the modelsbased measure for market risk, as
applicable.
The proposed quarterly approach is
intended to reduce operational burden
of requiring a banking organization to
capture temporary or small differences
arising from fluctuations in the value of
positions subject to the credit risk
framework. Further, the proposed
quarterly calculation requirement
413 See
section III.H.3.c of this SUPPLEMENTARY
for a more detailed discussion on net
short risk positions.
INFORMATION
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should help ensure that banking
organizations are appropriately
managing and monitoring net short risk
positions arising from exposures subject
to subpart D or E of the capital rule at
intervals of sufficient frequency to
prevent the formation of non-negligible
net short risk positions.
As proposed it may be difficult for a
banking organization to apply the
standardized approach or internal
models approach to net short risk
positions given that the composition of
any particular net short position could
contain a different combination of
various underlying instruments.
Therefore, if unable to calculate a risk
factor sensitivity for a net short risk
position, the proposal would require the
banking organization to calculate market
risk capital requirements using the
fallback capital requirement as
described in section III.H.6.c of this
SUPPLEMENTARY INFORMATION.
b. Securitization Positions and
Defaulted and Distressed Market Risk
Covered Positions
The proposal would require a banking
organization to calculate market risk
capital requirements for securitization
positions using the standardized
approach or the fallback capital
requirement, as applicable. The
proposed treatment would address
regulatory arbitrage concerns as well as
deficiencies in the modelling of
securitization positions that became
more evident during the course of the
financial crisis that began in mid-2007.
The proposal would require a banking
organization to include defaulted and
distressed market risk covered positions
in only the standardized default risk
capital requirement. Such positions are
not required to be included in the
sensitivities-based method or the
residual risk add-on of the standardized
approach, or in the non-default capital
requirement for modellable and nonmodellable risk factors. Generally,
distressed and defaulted positions trade
based on recovery, which is not driven
by or reflective of the credit spread of
the issuer. Therefore, in addition to
being operationally difficult, requiring a
banking organization to calculate the
sensitivity of such positions to changes
in credit spreads may not be appropriate
for the purposes of quantifying the risk
posed by such positions. Additionally,
subjecting defaulted and distressed
positions to capital requirements under
the sensitivities-based method, residual
risk add-on, or expected shortfall
measures for modellable and nonmodellable risk factors would increase
the capital requirements for such
positions beyond the maximum
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potential loss of such holdings, as the
standardized default risk capital
requirement already assigns a 100
percent risk weight and LGD to such
exposures. If unable to calculate the
standardized default risk capital
requirement for such positions, the
proposal would require the banking
organization to calculate market risk
capital requirements using the fallback
capital requirement.414
As the amount of regulatory capital
required under the fallback capital
requirement would equal the absolute
fair value of the position, the proposal
would cap the overall market risk
capital requirement for defaulted,
distressed, and securitization positions
at the maximum loss of the position. By
capping the amount of regulatory capital
requirement for such positions at the
total potential loss that a banking
organization could incur from holding
such positions, the proposal would
align the risk-based requirements under
the standardized and internal models
approaches, as applicable, with those
under the fallback capital requirement.
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c. Equity Positions in an Investment
Fund
i. Standardized Approach
For equity positions in an investment
fund for which the banking organization
is able to use the look-through approach
to calculate a market risk capital
requirement for its proportional
ownership share of each exposure held
by the investment fund, the proposal
would require a banking organization to
apply the look-through approach under
the standardized measure for market
risk. Alternatively, a banking
organization could elect not to apply the
look-through approach for such
positions if the investment fund closely
tracks an index benchmark or holds a
listed and well-diversified index
position. Generally, the agencies would
consider an equity position in an
investment fund to closely track the
index if the standard deviation of the
returns of the investment fund (ignoring
fees and commissions) over the prior
year differs from those of the index by
only a small percentage (for example,
less than 1 percent). For an equity
position in an investment fund that
closely tracks an index benchmark, the
proposal would allow a banking
organization to treat the equity position
in the investment fund as if it was the
414 As
described in more detail in section III.H.6.c
of this SUPPLEMENTARY INFORMATION, the fallback
capital requirement would apply in instances where
a banking organization is unable to apply the
internal models approach and the standardized
approach to calculate market risk capital
requirements.
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tracked index in calculating the delta,
vega, and curvature capital
requirements, given the high correlation
of the equity position with that of the
index.415 Further, for equity positions in
an investment fund that holds a listed
and well-diversified index, the proposal
would allow a banking organization to
calculate the delta, vega, and curvature
capital requirements for the underlying
index position using the treatment for
indices 416 and apply the look-through
approach to the other underlying
exposures of the investment fund.
For equity positions in an investment
fund for which the banking organization
is not able to use the look-through
approach to calculate a market risk
capital requirement for its proportional
ownership share of each exposure held
by the investment fund, but where the
banking organization has access to daily
price quotes for the investment fund
and to the information contained in the
fund’s mandate, the proposal would
allow the banking organization to
calculate capital requirements in one of
three ways under the standardized
measure for market risk. For equity
positions in an investment fund that
closely tracks an index benchmark, the
banking organization could assume that
the investment fund is the tracked index
and treat the equity position as an index
instrument when calculating the delta,
vega, and curvature capital
requirement.417 Alternatively, the
proposal would allow the banking
organization to calculate the delta, vega,
and curvature capital requirements for
the equity position based on the
hypothetical portfolio of the investment
fund or allocate the equity position in
the investment fund to the other sector
risk bucket.
Under the proposed hypothetical
portfolio approach, the banking
organization would need to assume that
the investment fund invests to the
maximum extent permitted under its
mandate in those exposures with the
highest applicable risk weight and
continues to make investments in the
order of the exposure type with the next
highest applicable risk weight until the
maximum total investment level is
reached. If more than one risk weight
can be applied to a given exposure, the
415 In this situation, the banking organization
would apply the treatment for index instruments
described in section III.H.7.d.ii of this
SUPPLEMENTARY INFORMATION.
416 In this situation, the banking organization
would apply the treatment for index instruments
described in section III.H.7.d.ii of this
SUPPLEMENTARY INFORMATION.
417 In this situation, the banking organization
would apply the treatment for index instruments
described in section III.H.7.d.ii of this
SUPPLEMENTARY INFORMATION.
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proposal would require the banking
organization to use the maximum
applicable risk weight in calculating the
sensitivities-based method requirement.
Alternatively, the banking organization
may assume that the investment fund
invests based on the most recent
quarterly disclosure of the fund’s
historical holdings of underlying
positions. The proposal would require a
banking organization to weight the
constituents of the investment fund
based on the hypothetical portfolio.
Further, the proposal would require a
banking organization to calculate market
risk-based capital requirements for the
hypothetical portfolio on a stand-alone
basis for all positions in the fund,
separate from any other position subject
to market risk capital requirements.
Alternatively, the proposal’s fallback
method would allow a banking
organization to allocate equity positions
in an investment fund to the applicable
other sector risk bucket.418 Under this
approach, the banking organization
would determine whether, given the
mandate of the investment fund, to
apply a higher risk weight in calculating
the standardized default risk capital
requirement and whether to apply the
residual risk add-on. For example, if a
banking organization determines that
the residual risk add-on applies, the
banking organization must assume that
the investment fund has invested in
such exposures to the maximum extent
permitted under its mandate. For equity
positions in publicly traded real estate
investment trusts, the proposal would
require a banking organization to treat
such exposures as a single exposure and
apply the risk weight applicable to
exposures allocated to the other sector
risk bucket when calculating the delta,
vega, and curvature capital
requirements under the sensitivitiesbased method.419 While equity positions
in publicly traded real estate investment
trusts are traded on the market, the
underlying assets of such trusts
generally are not. Thus, often a banking
organization will not be able to calculate
the risk factor sensitivity for each of the
underlying assets of the real estate
investment trust. Requiring a banking
organization to treat equity positions in
real estate investment trusts as a single
position would help ensure that market
risk capital requirements appropriately
capture a banking organization’s market
418 Table 8 to § ll.209 of the proposed rule
provides the proposed delta risk buckets and
corresponding risk weights for positions within the
equity risk class.
419 Under the proposal, such exposures would
receive the 70 percent risk weight applicable to
equity risk factors allocated to bucket 11 in Table
8. See § ll.209(b)(5) of the proposed rule.
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risk exposure arising from such
positions in a manner that minimizes
compliance burden and enhances riskcapture. As each of the proposed
alternative approaches would reflect a
highly conservative capital requirement,
the agencies consider that the proposed
alternatives would help ensure a
banking organization maintains
sufficient capital against potential losses
arising from equity positions in an
investment fund for which the banking
organization is unable to identify the
underlying positions held by the fund.
Similar to index instruments and
multi-underlying options that are nonsecuritization debt or equity positions,
the default risk of equity positions in an
investment fund is primarily a function
of the idiosyncratic default risk of the
underlying constituents. Accordingly, to
capture appropriately the default risk of
such positions, the proposal would
require a banking organization to apply
the look-through approach when
calculating the standardized default risk
capital requirement for equity positions
in an investment fund that are nonsecuritization debt or equity positions,
with one exception. For equity positions
in an investment fund for which the
banking organization applies the
hypothetical portfolio approach or the
fallback method described above, a
banking organization would have to
assume that the fund invests in
exposure types with the highest
applicable risk weights to the maximum
extent permitted by the fund’s mandate.
For equity positions in publicly traded
real estate investment trusts that are
non-securitization debt or equity
positions, the proposal would require a
banking organization to treat the
exposures as a single exposure. As
discussed above, often a banking
organization will not be able to calculate
the default risk for each of the
underlying assets of the real estate
investment trust due to the idiosyncratic
nature of the underlying assets. The
proposed treatment would help ensure
the risk-based requirements
appropriately capture the default risk of
such positions in a manner that is
consistent across banking organizations
and minimizes operational burden.
Question 160: The agencies seek
comment on whether a banking
organization’s ability under the
proposal to treat an equity position in
an investment fund as an index position
when the investment fund closely tracks
an index benchmark provides sufficient
specificity to help ensure consistent
application across banking
organizations. To what extent would a
specific quantitative measure more
appropriately capture the types of
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positions that should be treated as
index positions? What, if any,
alternatives should the agencies
consider (such as specifying an absolute
value of one percent) to better capture
the types of positions whose risks would
more appropriately be captured by the
proposed market risk capital
requirements for index positions and
why? Commenters are encouraged to
provide specific details on the
mechanics, capital implications and
rationale for any suggested
methodology.
Question 161: The agencies seek
comment on requiring banking
organizations to calculate the residual
risk add-on for equity positions in
investment funds, if, based on its
mandate, the fund would invest in the
types of exposures that would be subject
to the residual risk add-on to the
maximum extent permitted under the
mandate. What, if any, alternatives—
such as allowing banking organizations
to use the historical risk characteristics
of the fund—should the agencies
consider to better capture the residual
risks of such positions? Commenters are
encouraged to provide specific details
on the mechanics, capital implications
and rationale for any suggested
methodology.
ii. Internal Models Approach
The proposal would only allow a
banking organization to use the internal
models approach for equity positions in
an investment fund for which the
banking organization is able to identify
the underlying positions held by the
fund on a quarterly basis. Otherwise,
these positions would be calculated
using the standardized approach or the
fallback capital requirement. Under the
proposal, a banking organization would
be required to calculate the market risk
capital requirement for such positions
held by a model-eligible desk by
applying the look-through approach or
the hypothetical portfolio approach
based on the most recent quarterly
disclosure of the investment fund’s
historical holdings of underlying
positions. In addition, a banking
organization also may use any other
modelling approach to calculate the
internal models approach capital
requirement after receiving a prior
approval from its primary Federal
supervisor.
Question 162: What would be the
advantages and drawbacks of allowing
banking organizations to decompose
equity positions in investment funds
into the underlying holdings of the fund
or based on the hypothetical portfolio,
for purposes of calculating capital
requirements under the internal models
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approach? Please provide specific
details on the mechanics, capital
implications and rationale for any
suggested methodology, in particular
the extent to which the proposed
backtesting and PLA requirements
would help ensure appropriate risk
capture for positions in which the
banking organization is only able to
perform a look-through on a quarterly
basis.
d. Treatment of Term Repo-Style
Transactions
Subpart F of the current capital rule
permits a banking organization to
calculate a market risk capital
requirement for securities subject to
repurchase and lending agreements with
an original maturity of more than one
business day (term repo-style
transactions), regardless of whether
such transactions meet the short-term
trading intent criterion of the definition
of a market risk covered position.420
Under the current capital rule, this
optionality is only available for term
repo-style transactions for which the
banking organization separately
calculates risk-based requirements for
counterparty credit risk using the
collateral haircut approach under
subpart D or subpart E of the capital
rule.421 Subparts D and E of the capital
rule permit a banking organization to
recognize the credit risk mitigation
benefits of non-financial collateral
under the collateral haircut approach for
these term repo-style transactions.
The proposal similarly would permit
a banking organization to include term
repo-style transactions in market risk
covered positions, where the
transactions are marked to market and
provided that it includes all of such
term repo-style transactions in market
risk covered positions consistently over
time. To help ensure appropriate
calibration of the market risk capital
requirements, under the proposal, a
banking organization with the
operational capability to capture the
market risk of both the collateral leg and
420 While such transactions are similar to trading
activities, not all such transactions meet the shortterm trading intent criterion of the definition of
covered position. For example, certain repo-style
transactions operate in economic substance as
secured loans and do not in normal practice
represent trading positions.
421 Under subpart F of the capital rule, a banking
organization that uses the simple VaR approach for
purposes of calculating counterparty credit risk
capital requirements may also include term repostyle transactions within the VaR-based measure for
market risk. As noted in section III.C.5.b.ii of this
SUPPLEMENTARY INFORMATION, the proposal would
eliminate the simple VaR approach for calculating
risk-based requirements for counterparty credit
risk—and thus this optionality would only apply in
the context of the collateral haircut approach.
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the cash leg of the transaction could opt
into this treatment. In such cases, the
proposal would permit a banking
organization to include term repo-style
transactions in the sensitivities-based
method or the expected shortfall model
if held by a model-eligible trading desk.
For purposes of calculating market risk
capital requirements under the
sensitivities-based method, the proposal
would require a banking organization to
capture the risk factor sensitivities of
the cash leg to general interest rate risk
and of the security leg to credit spread
risk, equity risk, commodity risk, and
foreign exchange risk, as applicable. The
proposal would also require a banking
organization to separately calculate the
standardized default risk capital
requirement to capture losses on the
underlying reference exposure in the
event of issuer default as described in
section III.H.7.b.i of this SUPPLEMENTARY
INFORMATION and the risk-based capital
requirements for counterparty credit
risk using the collateral haircut
approach as described in section
III.H.9.d of this SUPPLEMENTARY
INFORMATION.
10. Reporting and Disclosure
Requirements
The reporting and public disclosures
required under the proposal would
strike a balance between the information
necessary for ensuring that a banking
organization is conforming to the
requirements of the proposed market
risk rule, the public policy benefits that
result from transparency of information,
and a banking organization’s
compliance burden. The proposal does
not change the requirements under
subpart F regarding public disclosure
policy and attestation, the frequency of
required disclosures, the location of
disclosures, or the treatment of
proprietary and confidential
information except that each of these
aspects of the proposal is discussed not
only in regard to a banking
organization’s public disclosures, but
also in regard to its reporting (public
regulatory reports and, as applicable,
confidential supervisory reports).
lotter on DSK11XQN23PROD with PROPOSALS2
a. Scope
The quantitative and qualitative
disclosures required by this section
would not apply to a banking
organization that is a consolidated
subsidiary of a bank holding company,
savings and loan holding company, or a
depository institution that is subject to
these requirements, or of a non-U.S.
banking organization subject to
comparable public disclosure
requirements in its home jurisdiction.
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The information contained within
both public regulatory reports and, as
applicable, confidential supervisory
reports described in the proposal would
be necessary for the primary Federal
supervisor to assess whether a banking
organization has adequately
implemented the proposed market risk
capital framework. Therefore, under the
proposal, any banking organization that
is subject to the proposed market risk
capital requirements must provide
public regulatory reports in the manner
and form prescribed by its primary
Federal supervisor, including any
additional information and reports that
the primary Federal supervisor may
require. Any such banking organization
that also uses the models-based measure
for calculating market risk capital
requirements must provide confidential
supervisory reports as discussed below
to its primary Federal supervisor in a
manner and form prescribed by that
supervisor.
b. Quantitative and Qualitative
Disclosures
The current capital rule requires a
banking organization subject to the
market risk capital framework to
disclose information related to the
composition of portfolios of covered
positions as well as the internal models
used to calculate the market risk of
covered positions. The proposal would
eliminate the existing quantitative
disclosures related to the calculations of
VaR and incremental and
comprehensive risk capital
requirements, which would no longer be
necessary for calculating risk-based
capital requirements for market risk
under the proposal. The proposal
would, however, retain existing
quantitative disclosures related to the
aggregate amount of on-balance sheet
and off-balance sheet securitization
positions by exposure type, as well as
the aggregate amount of correlation
trading positions. Together, these
disclosures would ensure transparency
regarding a banking organization’s
securitizations, which have historically
been sources of uncertainty for
regulators and market participants
during periods of financial stress.
Finally, the proposal would add a
quantitative disclosure requiring a
banking organization that uses the
models-based measure for calculating
market risk capital requirements to
disclose a comparison of VaR-based
estimates to actual gains or losses for
each material portfolio of market risk
covered positions with an analysis of
important outliers. In addition to the
requirement to disclose a general
description of a banking organization’s
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internal capital adequacy assessment
methodology, a banking organization
that uses the models-based measure for
calculating market risk capital
requirements would also be required to
include such assessment for categories
of non-modellable risk factors.422 These
additional disclosures, along with the
retained disclosures, would support the
agencies’ efforts to supervise banking
organizations subject to the market risk
framework.
The proposal would also retain the
existing qualitative disclosures for
material portfolios but with certain
revisions reflecting the changes to the
market risk framework under the
proposal. Specifically, the requirement
that a banking organization disclose
characteristics of internal models would
be revised to also require that the
banking organization disclose
information related to the models used
to calculate expected shortfall (ES), the
frequency with which data is updated,
and a description of the calculation
based on current and stress
observations. The existing requirement
that a banking organization disclose its
internal capital adequacy assessment,
including a description of the
methodologies used to achieve a capital
adequacy assessment consistent with
the soundness standard, would be
subsumed into the quarterly
quantitative disclosure requirements
described above. Qualitative disclosures
that typically do not change each
quarter may be disclosed annually,
provided any significant changes are
disclosed in the interim.
The proposal would add new
qualitative disclosures related to a
banking organization’s processes and
policies for managing market risk.
Specifically, the proposed qualitative
disclosures include (i) a description of
the structure and organization of the
market risk management system,
including a description of the market
risk governance structure established to
implement the strategies and processes
described below; (ii) a description of the
polices and processes for determining
whether a position is designated as a
market risk covered position and the
risk management policies for monitoring
market risk covered positions; (iii) a
description of the scope and nature of
risk reporting and/or measurement
422 The agencies would expect a banking
organization to have sound internal capital
assessment processes which would include, but not
be limited to, identification of capital adequacy
goals with respect to risks, taking into account the
strategic focus and business plan of the banking
organization, risk identification, measurement, and
documentation, as well as a process of internal
controls, reviews and audits.
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systems and the strategies and processes
implemented by the banking
organization to identify, measure,
monitor, and control the banking
organization’s market risks, including
polices for hedging; and (iv) a
description of the trading desk structure
and the types of market risk covered
positions included on the trading desks
or in trading desk categories, including
a description of the model-eligible
trading desks for which a banking
organization calculates the non-default
risk capital requirement and any
changes in the scope of model-ineligible
trading desks and the market risk
covered positions on those desks.
Together, the additional disclosure
requirements in the proposal would
increase transparency, encourage sound
risk management practices, and assist
the regulatory review process of a
banking organization subject to the
proposed market risk framework by
providing clear information on the
policies and procedures that each
banking organization has adopted to
manage and mitigate potential losses
arising from market fluctuations.
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c. Public Reports
In addition to the public disclosure
requirements, the proposal would
require that a banking organization
provide a quarterly public regulatory
report of its measure for market risk.
This public report, the form of which
would be specified by the agencies,
would contain information that the
agencies deem necessary for assessing
the manner in which a banking
organization has implemented the
proposed market risk rule. This, in turn,
would help ensure the safety and
soundness of the financial system by
facilitating the identification of
problems at a banking organization and
ensuring that a banking organization has
implemented any corrective actions
imposed by the agencies.
d. Confidential Supervisory Reports
Under the proposal, a banking
organization using the models-based
measure to calculate market risk capital
requirements would be required to
submit, via confidential regulatory
reporting in the manner and form
prescribed by the primary Federal
supervisor, data pertaining to its
backtesting and PLA testing.
To reflect the proposed changes to the
market risk framework, the proposal
would require a banking organization to
submit backtesting information at both
the aggregate level for model-eligible
trading desks as well as for each trading
desk and PLA testing information for
model-eligible trading desks at the
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trading desk level on a quarterly basis.
This information would cover the
previous 500 business days, or all
business days if 500 business days are
not available, and would have to be
reported with no more than a 20-day
lag. At the aggregate level, the data
would include the daily VaR-based
measures calibrated to the 99.0th
percentile; the daily ES-based measure
calibrated at the 97.5th percentile; the
actual profit and loss; the hypothetical
profit and loss; and the p-value of the
profit or loss for each day. At the trading
desk level, the data would include the
daily VaR-based measure for the trading
desk calibrated at both the 97.5th and
99.0th percentile; the daily ES-based
measure calibrated at the 97.5th
percentile; the actual profit and loss; the
hypothetical profit and loss; the risktheoretical profit and loss; and the pvalues of the profit or loss for each day.
The information in the proposed
report would enable the agencies to
identify changes to the risk profiles of
reporting banking organizations as well
as to monitor the risk inherent in the
broader banking system. Specifically,
the collection of backtesting and PLA
data included in the proposed reports
would enable the agencies to determine
the validity of a banking organization’s
internal models, and whether these
models accurately account for the risk
associated with exposure to price
movements, changes in market
structure, or market events that affect
specific assets. If the agencies find these
models to be flawed, the banking
organization must then use the
standardized approach for calculating
its market risk capital requirements,
thereby preventing divergence between
a banking organization’s risk profile and
its capital position. In addition, the
proposed report would be a valuable
tool for a banking organization subject
to the market risk capital requirements
under the proposal to verify that the
proposed market risk framework has
been appropriately implemented.
11. Technical Amendments
a. Definition of Securitization
The proposal would streamline the
definitions related to securitizations in
subpart F with those in subparts D and
E of the capital rule. Specifically, the
proposal would eliminate the definition
of ‘‘securitization’’ from subpart F of the
capital rule and revise the definitions of
‘‘securitization position’’ and
‘‘resecuritization position’’ to refer to
the terms ‘‘securitization exposure’’ and
‘‘resecuritization exposure,’’ which are
defined in § ll.2 of the capital
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rule.’’ 423 These modifications would
not change the scope of positions that
would be considered securitization
positions and resecuritization positions
under subpart F of the capital rule, as
further described below. Rather, the
proposed revisions would clarify that
the same types of positions are captured
under subpart F as under subparts D
and E of the capital rule, which
currently use substantially similar, but
separate definitions.
As discussed in section III.D. of this
SUPPLEMENTARY INFORMATION, only
exposures that involve tranching of
credit risk would qualify as
securitization exposures. The
designation of securitization exposures
or resecuritization exposures and the
calculation of risk-based requirements
for securitization exposures would
generally depend upon the economic
substance of the transaction rather than
its legal form. Provided there is
tranching of credit risk, securitization
exposures could include, among other
things, asset-backed securities and
mortgage-backed securities, loans, lines
of credit, liquidity facilities, financial
standby letters of credit, credit
derivatives and guarantees, loan
servicing assets, servicer cash advance
facilities, reserve accounts, creditenhancing representations and
warranties, and credit-enhancing
interest-only strips (CEIOs).
Securitization exposures would also
include assets sold with retained
tranches. In contrast, mortgage-backed
pass-through securities (for example,
those guaranteed by the Federal Home
Loan Mortgage Corporation or the
Federal National Mortgage Association)
that feature various maturities but do
not involve tranching of credit risk do
not meet the definition of a
securitization exposure. This treatment
would not change under the proposal,
423 Section 2 of the capital rule defines a
securitization exposure as an on- or off-balance
sheet credit exposure (including credit-enhancing
representations and warranties) that arises from a
traditional or synthetic securitization (including a
resecuritization), or an exposure that directly or
indirectly references a securitization exposure. The
agencies’ capital rule defines a traditional
securitization, in part, as a transaction in which all
or a portion of the credit risk of one or more
underlying exposures is transferred to one or more
third parties (other than through the use of credit
derivatives or guarantees), where the credit risk
associated with the underlying exposures has been
separated into at least two tranches reflecting
different levels of seniority. The definition includes
certain other conditions, such as requiring all or
substantially all of the underlying exposures to be
financial exposures. See 12 CFR 3.2 s.v.
securitization exposure, traditional securitization
(OCC); 12 CFR 217.2 securitization exposure,
traditional securitization (Board); and 12 CFR 324.2
securitization exposure, traditional securitization
(FDIC).
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and consistent with subpart F of the
capital rule, only those securities that
involve tranching of credit risk would
be considered securitization positions.
I. Credit Valuation Adjustment Risk
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1. Background
In general, OTC derivative contracts
are bilateral agreements either to make
or receive payments or to buy or sell an
underlying asset on a certain date, or
dates, in the future. The value of an
OTC derivative contract, and thus a
party’s exposure to its counterparty,
changes over the life of the contract
based on movements in the value of the
reference rates, assets, commodity
prices, or indices underlying the
contract. In addition to the exposure to
changes in the market value of OTC
derivative contracts, there is also credit
risk associated with such contracts.
Specifically, if a counterparty to an OTC
derivative contract, or a portfolio of
such contracts subject to a QMNA,424
defaults prior to the contract’s
expiration, the non-defaulting party will
experience a loss if the market value of
the contract, or of the portfolio of
contracts under a QMNA, is positive at
the time of default. The risk of such a
loss, known as counterparty credit risk,
exists even if the current market value
of the contract, or the portfolio under a
QMNA, is negative because the future
market value may become positive if
market conditions change. Under the
current capital rule, a banking
organization determines risk-based
capital requirements for counterparty
credit risk using the credit risk
framework, with exposure amounts
determined via either the SA–CCR,
current exposure method (CEM), or
internal models methodology, as
applicable.425
The valuation change of OTC
derivative contracts resulting from the
risk of the counterparty’s defaulting
prior to the expiration of the contracts,
known as the credit valuation
adjustment (CVA), depends on (1)
counterparty credit spreads, which
reflect the creditworthiness of the
counterparty perceived by the market;
424 ‘‘Qualifying master netting agreement’’
(QMNA) is defined in § ll.2 of the capital rule.
In order to recognize an agreement as a QMNA, a
banking organization must meet the operational
requirements in § ll.3(d) of the capital rule. See
12 CFR 3.2, and 3.3(d) (OCC); 12 CFR 217.2 and
217.3(d) (Board); and 12 CFR 324.2, and 324.3(d)
(FDIC). In general, a QMNA means a netting
agreement that permits a banking organization to
accelerate, terminate, close-out on a net basis and
promptly liquidate or set off collateral upon default
of the counterparty. The proposal would retain
these definitions.
425 See §§ ll.34 and ll.132 of the current
capital rule.
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and (2) credit exposure generated by
CVA risk covered positions 426 that the
market would expect at various future
points in time. Thus, CVA risk has two
components: a counterparty credit
spread component (CVA increases as a
result of the deterioration in the
creditworthiness of a counterparty
perceived by the market) and an
exposure component (CVA increases as
a result of an increase in the expected
future exposure).
The proposal would require a banking
organization subject to Category I, II, III
or IV standards to reflect in riskweighted assets the potential losses on
OTC derivative contracts resulting from
increases in CVA for all OTC derivative
contract counterparties, subject to
certain exceptions.427 The proposal
would provide two measures for
calculating CVA risk capital
requirements: (1) the basic measure for
CVA risk which includes the basic CVA
approach (BA–CVA) capital
requirement, which recognizes only the
credit spread component of CVA risk
and is similar to the current capital
rule’s simple CVA approach, and (2) a
standardized measure for CVA risk
which includes a new standardized
CVA approach (SA–CVA) capital
requirement and the basic CVA
approach capital requirement. The SA–
CVA would account for both credit
spread and exposure components of
CVA risk and would allow a banking
organization to recognize hedges for the
exposure component of CVA risk. The
proposal would require a banking
organization to receive a prior approval
from the primary Federal supervisor to
calculate the CVA risk capital
requirements under the standardized
measure for CVA risk.
2. Scope of Application
The proposed capital requirements for
CVA risk would apply to large banking
organizations and their subsidiary
depository institutions subject to
Category I standards, and to large
banking organizations subject to
Category II, III or IV standards. Under
the proposal, these banking
organizations would be required to
calculate a risk-weighted asset amount
for the CVA risk arising from their
portfolio of OTC derivative transactions
that would be subject to the CVA risk
426 CVA risk covered positions are described in
section III.I.3 of this SUPPLEMENTARY INFORMATION.
427 The proposal would allow a banking
organization to exclude certain OTC derivative
contracts recognized as a credit risk mitigant and
that receive substitution treatment under § ll.36
of the current capital rule or § ll.120 of the
proposed rule from the portfolio of OTC derivative
contracts that are subject to the CVA risk capital
requirements (under both BA–CVA and SA–CVA).
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capital requirement, as described in the
following section of this SUPPLEMENTARY
INFORMATION. The proposed scope would
apply CVA risk capital requirements to
all large, complex banking organizations
that, due to their significant trading
activity, operational scale, and domestic
and global presence, are subject to more
stringent capital requirements.
Under the proposal, the primary
Federal supervisor of a banking
organization that does not meet the
proposed scoping criteria for CVA risk
capital requirements could require the
banking organization to apply the riskbased capital requirements for CVA risk
if the supervisor deems it necessary or
appropriate because of the level of CVA
risk of the banking organization’s
portfolio of OTC derivative contracts or
to otherwise ensure safe and sound
banking practices. The primary Federal
supervisor could also exclude from
application of the proposed CVA risk
capital requirements a banking
organization that meets the scoping
criteria if the supervisor determines that
(1) the exclusion is appropriate based on
the level of CVA risk of the banking
organization’s CVA risk covered
positions, and (2) such an exclusion
would be consistent with safe and
sound banking practices. While the
agencies believe that the proposed
scoping criteria for application of CVA
risk capital requirements would
reasonably identify a banking
organization with significant CVA risk
given the current risk profile of a
banking organization, there may be
unique instances where a banking
organization either should or should not
be required to reflect CVA risk in its
risk-based capital requirements. As
such, the proposal would allow the
primary Federal supervisor to exercise
its authority to address such instances
on a case-by-case basis.
3. CVA Risk Covered Positions and CVA
Hedges
a. Definition of CVA Risk Covered
Position
The proposal would define a CVA risk
covered position as a derivative contract
that is not a cleared transaction. In
addition, the proposal would allow a
banking organization to choose to
exclude an eligible credit derivative for
which the banking organization
recognizes credit risk mitigation benefits
from the calculation of CVA risk.428
428 A cleared transaction includes an exposure
resulting from a transaction that a CCP has
accepted. For purposes of the CVA risk capital
requirement, a banking organization that is not a
clearing member may treat its exposure as directly
facing the CCP (that is, the banking organization
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This approach would align the scope of
the CVA framework with the scope of
instruments that present CVA risk. The
proposal would allow a banking
organization to exclude certain OTC
derivative contracts that are credit risk
mitigants from the CVA risk covered
position definition in order not to create
a disincentive to hedge against credit
default risk in subpart D and E of the
capital rule. For example, a CDS on a
loan that is recognized as a credit risk
mitigant and receives substitution
treatment under § ll.120 of the
proposed rule would not be included in
the portfolio of OTC derivative contracts
that are subject to the CVA risk capital
requirements.
The proposed definition of CVA risk
covered position would also exclude
cleared derivative transactions because
the primary risk of a banking
organization facing a CCP lies in the risk
that a CCP participant, not the CCP
itself, defaults.429 Clearing members of
the CCP would be responsible for
covering losses of a defaulted clearing
member’s portfolio with the CCP;
clearing member banking organizations
are subject to a capital requirement for
such risk in § ll.35 of the current
capital rule.
A banking organization generally does
not calculate CVA for cleared
transactions or for securities financing
transactions (SFTs) for financial
reporting purposes. Consistent with this
industry practice, the proposal would
not consider a cleared transaction or an
SFT to be a CVA risk covered position
and therefore would not extend the CVA
risk-based capital requirements to such
positions.
The proposed definition of a CVA risk
covered position would include clientfacing derivative transactions and
would recognize the potential CVA risk
of such exposures through the riskbased requirements for these exposures,
as described in sections III.I.3.a and
III.I.4 of this SUPPLEMENTARY
INFORMATION.
would have no exposure to the clearing member)
and may exclude that cleared transaction from CVA
risk covered positions. However, in a client-facing
derivative contract, where a clearing member
banking organization either is acting as a financial
intermediary and enters into an offsetting
transaction with a QCCP or where it provides a
guarantee on the performance of its client to a
QCCP, the exposures would be included in CVA
risk covered positions. See the definitions of
cleared transaction and client-facing derivative
transaction in 12 CFR 3.2 (OCC), 12 CFR 217.2
(Board), 12 CFR 324.2 (FDIC).
429 A CCP could only default if a sufficient
number of members default at the same time and
the remaining clearing members of this CCP are
unable to contribute sufficient funds to make the
counterparties to the defaulting members whole.
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b. Recognition of CVA Hedges
The proposal would set forth general
requirements for the recognition of CVA
hedges, as well as specific requirements
under BA–CVA and SA–CVA. The
proposal would allow a banking
organization to include certain CVA
hedges as risk-reducing elements in
risk-weighted asset calculations for CVA
risk (eligible CVA hedges). The proposal
would define a CVA hedge as a
transaction the banking organization
enters into with a counterparty that is a
third party (external CVA hedge) or an
internal trading desk (internal CVA
hedge),430 as described in section
III.I.3.b of this SUPPLEMENTARY
INFORMATION and manages for the
purpose of mitigating CVA risk. An
internal CVA hedge is an internal
derivative transaction that is usually
executed between a CVA risk
management function, such as a CVA
desk (or a functional equivalent thereof),
and a trading desk of the banking
organization. Every such internal CVA
hedge has two offsetting positions: the
position of the CVA risk management
function (the CVA segment) and the
position of the trading desk (the trading
desk segment). In addition to its ability
to reduce CVA risk, a CVA hedge may
also contribute to CVA risk arising from
the counterparty of the hedge, in which
case the CVA hedge, a derivative
contract that is not a cleared transaction,
could also be a CVA risk covered
position. Whether a CVA hedge is a
CVA risk covered position has no
impact on its qualification as an eligible
CVA hedge. Specifically, a non-CVA
risk covered position could be an
eligible CVA hedge if it meets the
proposed eligibility criteria as described
below. For example, a banking
organization could hedge its CVA risk
using a cleared transaction; in such
cases, the CVA hedge would effectively
reduce the CVA risk of the banking
organization, though the transaction
itself would not be a CVA risk covered
position. The proposed treatment of
CVA hedges intends to provide better
alignment between the economic risks
posed by such transactions and the riskbased capital requirement for CVA risk.
In this manner, the proposal would
provide incentives for a banking
organization to manage CVA risk
prudently.
As described below, the proposal
would include two approaches for
430 Both
BA–CVA and SA–CVA would recognize
internal CVA hedges that satisfy eligibility
requirements of the specific approach and require
that a banking organization have a CVA risk
management function to manage internal CVA risk
transfers as described in section III.H.4. of this
SUPPLEMENTARY INFORMATION.
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calculating CVA capital requirements:
the basic approach or BA–CVA 431 and
the standardized approach or SA–
CVA.432 The BA–CVA is simpler, but
less risk sensitive, than the SA–CVA.
For this reason, these two approaches
have different eligibility requirements
for recognizing the risk-mitigating
benefits of CVA hedges.
Under the BA–CVA, the proposal
would allow a banking organization to
recognize in the CVA risk capital
calculation the risk-mitigating benefit of
hedges of the counterparty credit spread
component of CVA risk. The only
instruments that could be recognized as
eligible hedges under the BA–CVA are
the following instruments that hedge
credit spread risk: index CDS, singlename CDS, and single-name contingent
CDS. The proposal would expand the
set of instruments recognized as eligible
CVA hedges in the current capital rule.
In addition to single-name CDS and
single-name contingent CDS that
reference the counterparty directly, the
proposal would allow a banking
organization to recognize as an eligible
CVA hedge a single-name credit
instrument that references an affiliate of
the counterparty or that references an
entity that belongs to the same sector
and region 433 as the counterparty
(together, eligible indirect single-name
CVA hedges). Although a banking
organization generally can hedge the
credit spread risk of a counterparty
whose credit risk is actively traded (that
is, liquid counterparties) by using credit
instruments that directly reference that
counterparty, instruments referencing
illiquid counterparties are thinly traded,
if at all. For illiquid counterparties, a
banking organization typically uses
credit instruments that reference a
sufficiently liquid entity whose credit
spread is highly correlated with the
credit spread of the illiquid
counterparty such as counterparties that
belong to the same sector and region.
For this reason, the BA–CVA would
allow a banking organization to
recognize the risk-mitigating benefit of
eligible indirect single-name CVA
hedges, but, given the potentially
significant basis risk between the
counterparty and the hedge reference
name, the BA–CVA would require a
banking organization to use a nonperfect correlation parameter between
the counterparty credit spread and the
431 The basic approach capital requirement is
discussed below in section III.I.5.a of this
SUPPLEMENTARY INFORMATION.
432 The standardized approach capital
requirement is discussed below in section III.I.5.b
of this SUPPLEMENTARY INFORMATION.
433 Under the proposal, for BA–CVA purposes, a
region would refer to a country or territorial entity.
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hedge reference name credit spread in
order to constrain the risk-mitigating
benefit of such indirect but eligible CVA
hedges.434 The restrictions on hedging
instruments as stated above apply to
both external and internal hedging
transactions. Additionally, for a banking
organization to recognize an internal
CVA hedging transaction as an eligible
CVA hedge under the BA–CVA, the
transaction would have to satisfy the
requirements of an eligible internal risk
transfer of CVA risk, as described in
section III.H.4.c of this SUPPLEMENTARY
INFORMATION.
Under the SA–CVA, hedges of the
counterparty credit spread component
of CVA risk would be recognized
without the BA–CVA restriction on
eligible instrument types described
above. Furthermore, the SA–CVA would
recognize as eligible CVA hedges
instruments that are used to hedge the
exposure component of CVA risk. The
SA–CVA would also recognize both
external and internal CVA hedging
transactions as eligible CVA hedges.
Similar to the BA–CVA, a banking
organization would be able to recognize
an internal CVA hedging transaction as
an eligible CVA hedge under the SA–
CVA if the transaction satisfies the
requirements of an eligible internal risk
transfer of CVA risk, as described in
section III.H.4.c of this SUPPLEMENTARY
INFORMATION.
Under both the BA–CVA and SA–
CVA, the proposal would not allow a
banking organization to recognize a
fraction of an actual transaction as an
eligible CVA hedge. Instead, a banking
organization would only be permitted to
recognize whole transactions as eligible
CVA hedges. For example, if a banking
organization for internal risk
management purposes uses an interest
rate swap to hedge interest rate risk for
both CVA and margin valuation
adjustment, the banking organization
would either have to recognize the
entire swap when calculating its riskbased capital requirements for CVA risk
or exclude the entire swap. The
proposed treatment intends to prevent a
banking organization from choosing a
fraction of a hedging transaction to
minimize its capital charge.
Finally, under both the BA–CVA and
SA–CVA, the proposal would not allow
a banking organization to recognize the
434 The aggregation formula in the BA–CVA
calculation would introduce new regulatory
correlation parameters that quantify the
relationship between the credit spreads of the
counterparty and of the entity referenced by the
hedge, thus restricting hedging benefits. See section
III.I.5.a.i of this SUPPLEMENTARY INFORMATION for a
more detailed description of the BA–CVA
calculation.
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risk mitigating benefits of CVA hedges
that are securitization positions or
correlation trading positions when
calculating risk-based capital
requirements for CVA risk. As reliably
pricing such instruments is difficult, the
agencies are concerned with the ability
of a banking organization to measure
reliably the price sensitivity of such
positions to the proposed risk factors
under the SA–CVA. The BA–CVA, as a
very simplistic approach, is even less
suitable than the SA–CVA for
adequately capturing the risk of such
instruments.
Question 163: The agencies seek
comments on the proposed
interpretation of region for the purposes
of BA–CVA. Would limiting a region to
a country or a territorial entity pose any
challenges for hedge recognition under
BA–CVA? What, if any, other criteria or
interpretations should the agencies
consider and why?
4. General Risk Management
Requirements
The proposal would require a banking
organization to satisfy certain general
risk management requirements related
to the identification and management of
CVA risk covered positions and eligible
CVA hedges and also to comply with
additional operational requirements as
described in section III.I.4.c. of this
SUPPLEMENTARY INFORMATION.
a. Identification and Management of
CVA Risk Covered Positions and CVA
Hedges
Identification of CVA risk covered
positions and CVA hedges is the
prerequisite of prudent CVA risk
management. The proposal would
therefore require a banking organization
subject to the proposed CVA framework
to identify all CVA risk covered
positions, all transactions that hedge or
are intended to hedge CVA risk, and all
eligible CVA hedges. A banking
organization that received approval
from its primary Federal supervisor to
use the standardized measure for CVA
risk would be required to identify all
eligible CVA hedges for the purposes of
calculating the BA–CVA and all eligible
CVA hedges for the purpose of
calculating the SA–CVA. Furthermore, a
banking organization that hedges its
CVA risk must have a clearly defined
hedging policy for CVA risk that is
reviewed and approved by senior
management at least annually. The
hedging policy would be required to
quantify the level of CVA risk that the
banking organization is willing to accept
and detail the instruments, techniques,
and strategies that the banking
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organization would use to hedge CVA
risk.
b. Documentation
The proposal would also require a
banking organization to have policies
and procedures for determining its CVA
risk capital requirement and to
document adequately all material
aspects of its management and
identification of CVA risk covered
positions and eligible CVA hedges, and
its control, oversight, and review
processes. Such general documentation
requirements are intended to facilitate
regulatory review and a banking
organization’s internal risk management
and oversight processes.
The proposed requirements are
intended to appropriately support the
active risk management and monitoring
of CVA risk under the proposed
framework.
c. Additional Risk Management
Requirements for Use of the
Standardized Measure for CVA Risk
In addition to the general risk
management requirements, a banking
organization that has received approval
from its primary Federal supervisor to
use the standardized measure for CVA
risk would be required to comply with
additional operational requirements on
documentation, initial approval and
ongoing performance of regulatory CVA
models as described below.
i. Documentation
The proposal would require a banking
organization using the SA–CVA to
adequately document policies and
procedures of the CVA desk, or similar
dedicated function, and the
independent risk control unit.
Furthermore, the banking organization
would be required to document the
internal auditing process; the internal
policies, controls, and procedures
concerning the banking organization’s
CVA calculations for financial reporting
purposes; the initial and ongoing
validation of models used to calculate
regulatory CVA (including exposure
models); and the banking organization’s
process to assess the performance of
models used for calculating regulatory
CVA (including exposure models) and
implement remedies to mitigate model
deficiency. The agencies expect that a
banking organization would document
any adjustments, if applicable, made to
the CVA models to satisfy the
operational requirements described in
section III.I.4.c. of this SUPPLEMENTARY
INFORMATION under SA–CVA. These
enhanced documentation requirements
are designed to help ensure that
exposure models under the SA–CVA
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appropriately capture the CVA risk of
CVA risk covered positions and that a
banking organization has effective and
sound risk management and oversight
processes.
ii. Initial Approval
To receive approval from its primary
Federal supervisor to use the SA–CVA
for any of its CVA risk covered
positions, a banking organization must
be capable of calculating, on at least a
monthly basis, regulatory CVA (as
described in section III.I.5.b.i of this
SUPPLEMENTARY INFORMATION), as well as
the sensitivities of regulatory CVA to
counterparty credit spreads and market
risk factors. Due to the computational
intensity associated with calculating
regulatory CVA and its sensitivities, the
proposal would permit a banking
organization to choose to recognize in
its risk-based capital requirement
certain netting sets of CVA risk covered
positions under BA–CVA and other
netting sets under SA–CVA.
Furthermore, the prior approval from
the primary Federal supervisor could
specify which CVA risk covered
positions must be included in the
calculation of the BA–CVA, and which
could be included in the calculation of
the SA–CVA. If a banking organization
were to use both SA–CVA and BA–CVA
for the calculations of risk-based capital
requirements for CVA risk, the proposal
would require the banking organization
to assign each CVA hedge that the
banking organization intends to
recognize in these calculations to one of
the two approaches (SA–CVA or BA–
CVA). This assignment would have to
satisfy the eligibility requirements of the
SA–CVA or the BA–CVA. For example,
a single-name CDS hedging the
counterparty credit spread component
of CVA risk could be assigned to either
the SA–CVA or the BA–CVA, while an
interest rate swap hedging the interest
rate component of CVA risk could only
be assigned to the SA–CVA. With this
proposed requirement, the agencies
intend to support appropriate risk
measurement and monitoring of CVA
risk and help ensure that a banking
organization appropriately reflects the
respective hedges in the calculation of
risk-based capital requirements for CVA
risk.
To better align regulatory CVA with
accounting CVA and to help ensure that
CVA capital requirements more
accurately reflect CVA risk, the proposal
would require a banking organization to
use CVA models that it uses for
financial reporting purposes (accounting
CVA models) to calculate regulatory
CVA under the SA–CVA, adjusted, if
necessary, to satisfy the additional
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requirements as described in section
III.I.5.b of this SUPPLEMENTARY
INFORMATION.
Furthermore, to support active
management of CVA risk, the proposal
would require a banking organization
that intends to use the SA–CVA to have
a CVA desk, or similar dedicated
function, responsible for risk
management and hedging of CVA risk
consistent with the banking
organization’s CVA risk management
and hedging policies and procedures.
The agencies view a designated CVA
desk or designated function as the best
mechanism to support the active
management of CVA risk.
The primary Federal supervisor may
rescind its approval of the use of the
standardized measure for CVA risk in
whole or in part, if it determines that
the banking organization’s model no
longer complies with all applicable
requirements or fails to reflect
accurately the CVA risk. If the primary
Federal supervisor determines that a
banking organization’s implementation
of the SA–CVA risk no longer complies
with proposed requirements or fails to
accurately reflect CVA risk, the primary
Federal supervisor could specify one or
more CVA risk covered positions or
eligible CVA hedges must be included
in the BA–CVA or prescribe an
alternative capital requirement.
iii. Ongoing Eligibility
For a banking organization approved
to use the standardized measure for
CVA risk, the proposal would require
the exposure models used in the
calculation of regulatory CVA to be part
of a CVA risk management framework
that includes the identification,
management, measurement, approval,
and internal reporting of CVA risk.
I. Control and Oversight
A banking organization that receives
prior written approval from its primary
Federal supervisor to use the
standardized measure for CVA risk
would be required to maintain an
independent risk control unit that is
responsible for the effective initial and
ongoing validation of the models used
for calculating regulatory CVA
(including exposure models), reports
directly to senior management, and is
independent of the banking
organization’s trading desks and CVA
desk, or similar dedicated function, as
well as the business unit that evaluates
counterparties and sets limits.
Senior management of the banking
organization would be required to have
oversight of the CVA risk control
process. In addition, the banking
organization would be required to have
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a regular independent audit review of
the overall CVA risk management
process, including both the activities of
the CVA desk (or similar dedicated
function) and of the independent risk
control unit. The agencies intend that,
together, the independent risk control
unit and internal audit would provide
appropriate review and credible
challenge of the effectiveness of CVA
risk management function.
II. Exposure Model Eligibility
The proposal would introduce
requirements for a banking organization
that calculates the CVA risk-based
capital requirements under SA–CVA to
further strengthen its CVA risk
management processes and promote
effective CVA risk management
pertaining specifically to CVA exposure
models. Such requirements would guide
the banking organization’s internal CVA
risk control unit and audit functions in
providing appropriate review and
challenge of CVA risk management. In
particular, the proposal would require
the banking organization to (1) include
exposure models for the regulatory CVA
calculation in its CVA risk management
framework and (2) define criteria on
which to assess the exposure models
and their inputs and have a written
policy in place describing the process
for assessing the performance of
exposure models and for remedying
unacceptable performance.
To help ensure that the CVA capital
requirements are commensurate with
CVA risk, the proposal would require a
banking organization to have the
exposure models used in regulatory
CVA calculation be part of its ongoing
CVA risk management framework,
including identification, measurement,
management, approval, and internal
reporting of CVA risk. Such
requirements would subject the
regulatory CVA exposure models to
ongoing effective measurement and
management.
Specifically, the proposal would
require a banking organization to
document the process for initial and
ongoing validation of its models used
for calculating regulatory CVA,
including exposure models, with
sufficient detail to enable a third party
to understand the model’s operations,
limitations, and key assumptions. A
banking organization would be required
to validate, no less than annually, its
CVA models including exposure
models, and would account for other
circumstances, such as a sudden change
in market behavior, under which
additional validation would need to be
conducted more frequently. In addition,
a banking organization would be
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required to sufficiently document how
the validation is conducted with respect
to data flows and portfolios, what
analyses are used, and how
representative counterparty portfolios
are constructed. As part of the
independent model validation, a
banking organization would be required
to test the pricing models used to
calculate exposure for given paths of
market risk factors against appropriate
independent benchmarks for a wide
range of market states as part of the
initial and ongoing model validation
process. The proposal would require the
pricing models for CVA risk covered
positions that are options to account for
the non-linearity of option value with
respect to market risk factors.
Additionally, a banking organization
would be required to obtain current and
historical market data that are either
independent of the line of business or
validated independently of the line of
business, to be used as an input for an
exposure model, as well as comply with
applicable financial reporting standards.
The proposal would require welldeveloped data integrity processes to
handle the data of erroneous and
anomalous observations, and that data
be input into exposure models in a
timely and complete fashion and
maintained in a secure database that is
subject to formal periodic audits. Where
data used in the exposure model are
proxies for actual market data, the
proposal would require a banking
organization to set internal policies to
identify suitable proxies and be able to
demonstrate, empirically on an ongoing
basis, that the proxy data are a
conservative representation of the
underlying risk under adverse market
conditions.
To accurately calculate simulated
paths of a discounted future exposure
required for regulatory CVA calculations
as discussed below, a banking
organization’s exposure models would
need to capture and accurately reflect
transaction-specific information (for
example, terms and specifications). A
banking organization would be required
to verify that transactions are assigned
to the appropriate netting set within the
model. The terms and specifications
would need to reside in a secure
database subject to at least annual
formal audit. The transmission of the
transaction terms and specifications
data to the exposure model would also
be subject to internal audit. The
proposal would require a banking
organization to establish formal
reconciliation processes between the
internal model and source data systems
to verify on an ongoing basis that
transaction terms and specifications are
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being reflected correctly or at least
conservatively.
5. Measure for CVA Risk
To calculate the risk-based capital
requirement for CVA risk, the proposal
would provide a basic measure for CVA
risk and a standardized measure for
CVA risk. Under the proposal, the basic
measure for CVA risk would include
risk-based capital requirements for all
CVA risk covered positions and eligible
CVA hedges calculated using the BA–
CVA, and any other additional capital
requirement for CVA risk established by
a banking organization’s primary
Federal supervisor if the primary
Federal supervisor determines that the
capital requirement for CVA risk as
calculated under the BA–CVA is not
commensurate with the CVA risk of the
banking organization’s CVA risk
covered positions. The standardized
measure for CVA risk would include
risk-based capital requirements
calculated under (1) the SA–CVA for all
standardized CVA risk covered
positions 435 and standardized CVA
hedges, (2) the BA–CVA for all basic
CVA risk covered positions 436 and basic
CVA hedges, and (3) any additional
capital requirement for CVA risk
established by a banking organization’s
primary Federal supervisor if the
primary Federal supervisor determines
that the capital requirement for CVA
risk as calculated under the SA–CVA
and BA–CVA is not commensurate with
the CVA risk of the banking
organization’s CVA risk covered
positions. The primary Federal
supervisor may require the banking
organization to maintain an overall
amount of capital that differs from the
amount otherwise required under the
proposal, if the primary Federal
supervisor determines that the banking
organization’s CVA risk capital
requirements under the rule are not
commensurate with the risk of the
banking organization’s CVA risk
covered positions, a specific CVA risk
435 The proposal would define standardized CVA
risk covered positions as all CVA risk covered
positions that are not basic CVA risk covered
positions; these terms are used in the standardized
measure for CVA risk.
436 The proposal would define basic CVA risk
covered positions as CVA risk covered positions
that must be included in the BA–CVA because: (i)
the banking organization does not have supervisory
approval to use the SA–CVA for these CVA risk
covered positions; (ii) the banking organization
chooses to exclude the netting sets with these CVA
risk covered positions from the SA–CVA; or (iii)
these CVA risk covered positions are in a partial
netting set designated for inclusion in the BA–CVA
by the banking organization with prior approval
from its primary Federal supervisor.
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covered position, or portfolios of such
positions, as applicable.
A banking organization would be
required to use the basic measure for
CVA risk unless it has received prior
written approval from the primary
Federal supervisor to use the
standardized measure for CVA risk.
A banking organization that has
received prior written approval from its
primary Federal supervisor to use the
standardized measure for CVA risk
would be required to include all CVA
risk covered positions that are outside of
the approval scope of the SA–CVA in
the BA–CVA. Furthermore, a banking
organization could choose to exclude
any number of in-scope netting sets
from SA–CVA calculations and
recognize them instead in the BA–CVA.
Given that the calculation of CVA
sensitivities to market risk factors in the
SA–CVA is computationally intensive
for large netting sets, the proposal
would allow a banking organization to
restrict application of the SA–CVA only
to netting sets with the most material
CVA risk, for example. A banking
organization may also bifurcate CVA
risk covered positions of a single netting
set between SA–CVA and BA–CVA,
subject to a prior written supervisory
approval for each such case. Thus, for
a banking organization that has received
prior written approval from its primary
Federal supervisor to use the
standardized measure for CVA risk, the
CVA capital requirement generally
would equal the SA–CVA capital
requirement for its CVA risk covered
positions and eligible CVA hedges
recognized under SA–CVA (these CVA
risk covered positions and eligible CVA
hedges are referred to as ‘‘standardized’’
in the proposal), plus the BA–CVA
capital requirement for its CVA risk
covered positions and eligible CVA
hedges recognized under BA–CVA
(these CVA risk covered positions and
eligible CVA hedges are referred to as
‘‘basic’’ in the proposal), if applicable.
After calculating the CVA capital
requirement using either the basic
measure for CVA risk or the
standardized measure for CVA risk, a
banking organization’s total capital
requirements for CVA risk would equal
the CVA capital requirement multiplied
by 12.5. Additionally, the primary
Federal supervisor could require the
banking organization to maintain an
amount of regulatory capital that differs
from the amounts required under the
basic measure for CVA risk or the
standardized measure for CVA risk.
a. Basic Approach for CVA Risk
Similar to the simple CVA approach
in the current capital rule, the capital
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The first term under the square root
in the formula ((ρ · SCSCVAC)2)
aggregates the systematic components of
CVA risk, while the second term under
the square root in the formula ((1¥ρ2)
· SC(SCVAC2)) aggregates the
idiosyncratic components of CVA risk.
The purpose of the Kunhedged formula is
intended to reflect the potential losses
arising from unhedged CVA risk.
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I. Regulatory Correlation Parameter
One of the basic assumptions
underlying the BA–CVA is that a single
risk factor drives systematic credit
spread risk. This assumption is
important because it simplifies the
credit spread correlation structure. The
proposed regulatory correlation
parameter ρ of 0.5 approximates the
correlation between the credit spread of
437 Suppose, for example, that a banking
organization perfectly offsets the counterparty
credit spread component of CVA risk, so that Khedged
= 0. Allowing the banking organization to set the
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method of calculating risk weights for
credit indices.
Under the proposal, the risk-based
capital requirement under the BA–CVA
would be calculated according to the
following formula, as provided under
§ ll.222(a) of the proposed rule:
Kbasic = 0.65 · (β · Kunhedged + (1¥β) ·
Khedged)
Where:
Kbasic is the risk-based capital requirement
under the BA–CVA;
Kunhedged is the risk-based capital requirement
for CVA positions before recognizing the
risk mitigating effect of eligible CVA
hedges;
Khedged is the risk-based capital requirement
after recognizing such hedges; and
β is a regulatory parameter set to 0.25.
reducing the effectiveness of eligible
CVA hedges to 75 percent (preventing a
banking organization’s eligible CVA
hedges from fully offsetting the CVA
risk of its CVA risk covered
positions).437 Thus, even if a banking
organization perfectly hedges the
counterparty credit spread component
of CVA risk, the BA–CVA capital
requirement would be equal to 0.65 ·
(0.25 · Kunhedged) For a banking
organization that does not hedge CVA
risk, eliminating the recognition of
eligible CVA hedges would result in
Khedged = Kunhedged, so that the BA–CVA
calculation would become:
Kbasic = 0.65 · (Kunhedged)
i. Calculation of Kunhedged
The formula sets the capital
requirement under the BA–CVA equal
to the weighted average of Kunhedged and
Khedged scaled by a factor of 0.65 in order
to ensure that the simpler and less risksensitive BA–CVA method is calibrated
appropriately relative to the SA–CVA.
Applying the weighted average in the
BA–CVA capital requirement formula is
a conservative measure that implicitly
recognizes the presence of the expected
exposure component of CVA risk by
Under BA–CVA, the proposal would
first require a banking organization to
calculate the risk-based capital
requirements for CVA risk covered
positions without recognizing the risk
mitigating effect of eligible CVA hedges,
Kunhedged, for each counterparty on a
stand-alone basis (SCVAC) and then
aggregate the respective standalone
counterparty capital requirements
across counterparties, as expressed by
the following formula:
a counterparty and the systematic risk
factor. The square of the regulatory
correlation parameter (0.25)
approximates the correlation between
credit spreads of any two
counterparties. The proposed value of
the regulatory correlation parameter is
consistent with historically observed
correlations between credit spreads and
would appropriately recognize the
diversification of CVA risk by ensuring
that a banking organization’s exposure
would be less than the sum of the CVA
risks for each counterparty.
SCVAC represents the capital
requirement a banking organization
would be subject to under the BA–CVA
if a single counterparty were the only
counterparty with which the banking
organization has CVA risk covered
positions (that is ignoring the existence
of the other counterparties), and there
are no eligible CVA hedges to consider.
For purposes of calculating SCVAC, the
proposal first would require a banking
organization to calculate for each
netting set the product of the effective
maturity MNS, the exposure at default
amount EADNS, and the regulatory
discount factor DFNS, and sum the
resulting products across all netting sets
with the same counterparty. The
banking organization would multiply
the resulting quantity for each
counterparty by the supervisory risk
weight of the counterparty RWC from
Table 1 to § ll.222 and divide by
alpha (a), discussed below, as expressed
by the following formula: 438
BA–CVA to zero in this case would not be prudent
because there is also the exposure component of
CVA risk, which is not explicitly captured by the
BA–CVA.
438 The above formula for SCVA is a simplified
c
representation of how the expected shortfall of the
counterparty credit spread component of CVA risk
of a single counterparty can be calculated.
II. Standalone CVA Capital Requirement
for Each Counterparty (SCVAC)
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requirement for CVA risk under the BA–
CVA would be calculated according to
a formula, described below, that
approximates CVA expected shortfall,
which replaces value-at-risk in the
simple CVA approach, assuming fixed
expected exposure profiles and based on
a set of simplifying assumptions. The
assumptions provide that: (1) all credit
spreads have a flat term structure; (2) all
credit spreads at the time horizon have
a lognormal distribution; (3) each single
name credit spread is driven by the
combination of a single systematic risk
factor and an idiosyncratic risk factor;
(4) the correlation between any single
name credit spread and the systematic
risk factor is 0.5, and (5) the single
systematic risk factor drives all credit
indices without any idiosyncratic risk
component.
The BA–CVA would improve upon
the simple CVA approach in the capital
rule by: (1) providing limited
recognition for the risk-mitigating
benefit of eligible single-name credit
instruments that do not reference a
counterparty directly; (2) putting a
restriction on hedge effectiveness; (3)
relying on risk weights derived from the
SA–CVA; and (4) introducing a new
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The proposal would set the exposure
at default amount, EADNS, for the
netting set, NS, equal to the exposure
amount calculated by the banking
organization for the same netting set for
counterparty credit risk capital
requirements according to § ll.113 of
the proposal, which captures the
potential losses in the event of the
counterparty’s default. The effective
maturity of the netting set, MNS, would
equal the weighted-average remaining
maturity, measured in whole or
fractional years, of the individual CVA
risk covered positions in the netting set,
NS, with the weight of each individual
position set equal to the ratio of the
notional amount of the position to the
aggregate notional amount of all CVA
risk covered positions in the netting
set.439 As the proposal would define the
effective maturity of a netting set as an
average of the actual CVA risk covered
position maturities, the regulatory
discount factor, DFNS, would scale down
the potential losses projected over the
Table 1 to § ll.222 of the proposed
rule provides the proposed supervisory
risk weights for each counterparty, RWc,
which reflect the potential variability of
credit spreads based on a combination
of the sector and credit quality of the
counterparty or of the eligible hedge
reference entity. With the exception of
sovereigns and MDBs, each sector
would have two risk weights, one for
counterparties that are investment
grade, as defined in the current rule,440
and one for counterparties that are
speculative grade or sub-speculative
grade, each as defined in the
proposal.441 Sovereigns and MDBs
would have separate risk weights for
counterparties that are speculative grade
and counterparties that are subspeculative grade. The proposed
supervisory risk weights match the risk
weights set out in the SA–CVA for
counterparty credit spread risk class.
The proposal would provide
counterparty sectors similar to those
contained in the Basel III reforms and a
treatment for certain U.S.-specific
counterparties (for example, GSEs and
public sector entities). Specifically, the
proposal would include GSE debt and
public sector entities for governmentbacked non-financials, education, and
public administration to appropriately
reflect the potential variability in the
credit spreads of such counterparties.
Question 164: The agencies seek
comments on the appropriateness of the
proposed risk weights of Table 1 to
§ ll.222 for financials, including
government-backed financials. What, if
any, alternative risk weights should the
agencies consider? Please provide
specific details and supporting evidence
on the alternative risk weights.
Question 165: The agencies seek
comments on the appropriateness of
treating the counterparty credit risks of
public-sector entities and the GSEs in
the same way as those of governmentbacked non-financials, education, and
public administration. What, if any,
alternatives should the agencies
consider to more appropriately capture
439 For a netting set consisting of a single
transaction (for example, a derivative contract that
is not subject to a QMNA), the effective maturity
would equal the remaining contractual maturity of
the derivative contract.
440 See the definition of Investment Grade in the
capital rule. 12 CFR 3.2 (OCC); 12 CFR 217.2
(Board); 12 CFR 324.2 (FDIC).
441 See the definitions of Speculative Grade and
Sub-Speculative Grade in § ll.2 of the proposed
rule.
442 Under § ll.2 of the current capital rule,
public sector entity (PSE) means a state, local
authority, or other governmental subdivision below
the sovereign level.
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effective maturity of the netting set to
their net present value, using a 5
percent interest rate. The proposed
interest rate would be a reasonable
discount factor and consistent with the
long-term historically observed average
of long-term interest rates. The proposal
would define components of the SCVAc
calculation at a netting set level, thus
clarifying the use of counterparty-level
exposure at default and effective
maturity calculated in the same way as
the banking organization calculates it
for minimum capital requirements for
counterparty credit risk.
A. Supervisory Risk Weights (RWc)
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As previously discussed, when
calculating a standalone CVA
counterparty-level capital requirement,
the proposal would require a banking
organization to use the exposure amount
that it uses in the counterparty credit
risk framework. The exposure amount
determined in the counterparty credit
risk framework would be the sum of
replacement cost and potential future
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ii. Calculation of Khedged
The second component of the BA–
CVA calculation, Khedged, represents the
risk-based capital requirements for CVA
risk after recognizing the risk mitigation
benefits of eligible counterparty credit
spread hedges, as expressed by the
following formula:
Under the proposal, to calculate the
capital reduction for a single-name
hedging instrument, a banking
organization would multiply the
supervisory prescribed correlation (rhc)
between the credit spread of the
counterparty and the hedging
instrument, the supervisory risk weight
of the reference name of the hedging
instrument (RWh), the remaining
maturity of the hedging instrument in
years (MhSN), the notional amount of the
hedging instrument (BhSN) 446 and the
supervisory discount factor (DFhSN). The
offsetting benefit of all single-name
hedges of credit spread risk on the CVA
risk of each counterparty (SNHc) would
equal the simple sum of the capital
reduction for each eligible CVA hedge
that a banking organization uses to
hedge the counterparty credit spread
component of CVA risk of a given
counterparty as expressed by the
following formula:
Risk weights (RWh) would be based on
a combination of the sector and the
credit quality of the reference name of
the hedging instrument as prescribed in
Table 1 to § ll.222 included above.
Parameter rhc is the regulatory value of
the correlation between the credit
spread of the counterparty and the
credit spread of the reference name of
an eligible single-name hedge as
prescribed in Table 2 to § ll.222
below.
443 Wrong-way risk reflects the situation where
exposure is positively correlated with the
counterparty’s probability of default—that is, the
exposure amount of the derivative contract
increases as the counterparty’s probability of
default increases.
444 See 85 FR 4362 (January 24, 2020). Under SA–
CCR, the alpha factor generally is set at 1.4.
However, for a derivative contract with a
commercial end-user counterparty, the alpha factor
is removed from the exposure amount formula. This
is equivalent to applying an alpha factor of 1 to
these contracts.
445 The standalone CVA capital, SCVA , and
c
regulatory correlation parameter, ρ, are defined in
exactly the same way as in the formula for CVA risk
covered positions Kunhedged. See section III.I.5.a.i. of
this SUPPLEMENTARY INFORMATION.
446 Under the proposal, the notional amount for
single-name contingent CDS would be determined
by the current market value of the reference
portfolio or instrument.
In general, the calculation of Khedged
follows that of Kunhedged, but introduces
new terms to reflect the risk-mitigating
effect of eligible CVA hedges.445 The
first term, ((ρ ·
SC(SCVAc¥SNHc)¥IH)2), recognizes
the risk mitigating effect of single-name
hedges (SNHc) and index hedges (IH) on
the systematic component of a banking
organization’s aggregate CVA risk. The
second term, ((1¥ρ2) ·
Sc(SCVAc¥SNHc)2), recognizes the risk
mitigating effect of single-name hedges
on the aggregate idiosyncratic
component of aggregate CVA risk. The
third term, ScHMAc, aggregates the
components of indirect single-name
hedges that are not aligned with
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counterparty credit spreads and is
designed to limit the regulatory capital
reduction a banking organization may
realize from indirect hedges given that
such hedges will not fully offset
movements in a counterparty’s credit
spread (that is, indirect hedges cannot
reduce Khedged to zero).
at 1 for derivative contracts with
commercial end-users.
Question 167: The agencies seek
comment on using the counterparty
credit risk framework to calculate the
exposure amount for the standalone
CVA counterparty-level capital
requirement. Does the CVA capital
requirement pose particular issues in
the case of nonfinancial counterparties?
If so, what modifications should the
agencies consider to mitigate such
issues?
I. Single-Name Hedges of Credit Spread
Risk (SNHc)
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B. Alpha Factor (α)
exposure multiplied by a multiplication
factor (the alpha factor) to capture
certain risks (for example, wrong-way
risk 443 and risks resulting from nonperfect granularity).444 CVA calculations
are based on expected exposure, which
in SA–CCR is proxied by the sum of
replacement cost and potential future
exposure. Accordingly, the proposal
would remove the effect of this
multiplication factor from the risk-based
capital requirement for CVA risk by
dividing the exposure at default amount
used in the SCVAc formula by the alpha
factor. Specifically, the proposal would
require such banking organization to use
the same alpha factor in calculating the
risk-based capital required under the
BA–CVA as required in exposure
amount calculations under SA–CCR by
setting the alpha factor at 1.4 for
derivative contracts with counterparties
that are not commercial end-users and
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the counterparty credit risk for such
entities?
Question 166: The agencies seek
comments on the appropriateness of
applying a 0.65 calibration factor in the
formula setting the capital requirement
under the BA–CVA to ensure that CVA
risk capital requirements appropriately
reflect CVA risk. What other level of the
calibration should the agencies consider
and why?
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adjustment, HMAc, as expressed by the
following formula:
While the summation would cover all
single-name hedges assigned to
counterparty c, only indirect hedges for
which correlation with the counterparty
spread is non-perfect (that is, the
regulatory prescribed correlation (rhc) is
less than one) would contribute to
HMAc
III. Index Hedges of Credit Spread Risk
(IH)
amounts for eligible CVA hedges that
are index hedges, which would be
calculated for each such hedge as the
product of the supervisory risk weight
(RWi), the remaining maturity in years
(Miind), notional amount (Biind), and the
supervisory discount factor (DFiind)—as
expressed by the following formula:
Each term in the summation in the
formula for IH above is a simplified
representation of how the expected
shortfall for the market value of a given
index hedge can be calculated. Because
of the BA–CVA’s underlying
assumption that each credit index is
driven by the same systematic factor
without any idiosyncratic risk
component, the expected shortfall of
each individual index hedge would be
aggregated via simple summation across
all such hedges, and the result of this
aggregation (IH) would appear only in
the systematic risk component in the
formula for Khedged above.
To determine the appropriate
supervisory risk weight (RWi) for each
index hedge, the proposal would require
a banking organization to adjust the
supervisory risk weights in Table 1 to
§ ll.222. Specifically, for index
hedges where all the underlying
constituents belong to the same sector
and are of the same credit quality, a
banking organization would assign the
index hedge to the corresponding
bucket used for single-name positions
and multiply the supervisory risk
weight by 0.7. For index hedges where
the underlying constituents span
multiple sectors or are not of the same
credit quality, the banking organization
would calculate the notional-weighted
average of the risk weights assigned to
each underlying constituent in the
index based on the risk weights
provided in Table 1 to § ll.222 and
multiply the result by 0.7.
Multiplication by a factor of 0.7 is
intended to recognize diversification of
idiosyncratic risk of individual index
constituents.
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Under the proposal, the portion of the
indirect hedges that are not recognized
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Under the proposal, the total amount
by which index hedges of credit spread
risk reduce the systematic component of
the aggregate CVA risk across all
counterparties, IH, would equal the
simple sum of the capital reduction
b. Standardized Approach for CVA Risk
The SA–CVA is an adaptation of the
sensitivities-based method used in the
standardized measure for market risk as
described in section III.H.7.a of this
SUPPLEMENTARY INFORMATION. The inputs
to the SA–CVA calculations are
sensitivities of the aggregate regulatory
CVA (discussed in the following
subsection) and of the market value of
all eligible CVA hedges under SA–CVA
(discussed below in this section) to
delta and vega risk factors specified in
the proposal. In general, the proposed
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SA–CVA would closely follow the
sensitivities-based method for market
risk with some exceptions. Broadly, the
SA–CVA calculation would reflect
capital requirements for only delta and
vega (but not curvature), apply slightly
different steps in the calculation of the
risk-weighted net sensitivity, use less
granular risk factors and risk buckets,
and include a capital multiplier to
account for model risk.
There are other specific differences
between the SA–CVA and the
sensitivities-based method for market
risk. Unlike the market risk of trading
instruments, CVA risk always depends
on two types of risk factors: the term
structure of credit spreads of the
counterparty and a set of market risk
factors that drives the expected
exposure of the banking organization to
the counterparty. For this reason, the
SA–CVA would have six distinct risk
classes for the CVA delta capital
requirement: counterparty credit spread
and the five risk classes for exposurerelated market risk factors which are the
interest rate, foreign exchange, reference
credit spread, equity, and commodity
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in SNHc due to the imperfect regulatory
prescribed correlation would be
reflected in the hedge mismatch
II. Hedge Mismatch Adjustment for
Indirect Single-Name Hedges (HMAc)
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risk classes. Regulatory CVA is
approximately linear in counterparty
credit spreads and does not depend on
their volatilities. Accordingly,
calculation of the CVA vega capital
requirement would not be required in
the counterparty credit spread risk class.
Expected exposure, on the other hand,
is always sensitive to volatilities of
market risk factors that drive market
values of CVA risk covered positions.
Because of this, a banking organization
would be required to calculate the CVA
vega capital requirements for the five
exposure-related risk classes regardless
of the presence of options in CVA risk
covered positions.
Regulatory CVA would require
simulating future exposure that depends
on multiple market risk factors over
long time horizons. Calculation of each
CVA sensitivity to an exposure-related
market risk factor would involve a
separate regulatory CVA calculation,
which could limit the number of CVA
sensitivities to market risk factors that a
banking organization could realistically
calculate. Accordingly, the agencies
would reduce the granularity of both
delta and vega risk factors in the five
exposure-related risk classes in the SA–
CVA compared to the sensitivities-based
method for market risk. Curvature
calculations would not be required. For
the five exposure-related risk classes,
the SA–CVA would use the same risk
buckets, regulatory risk weight
calibrations, and correlation parameters
as are used in the sensitivities-based
method for market risk, with necessary
adjustments for the SA–CVA’s reduced
granularity of market risk factors.
In contrast to market risk factors that
drive exposure, CVA sensitivities to
counterparty credit spreads can be
calculated based on a single regulatory
CVA calculation. In the counterparty
credit spread risk class, the SA–CVA
would use the same granularity of risk
factors as are used in the sensitivitiesbased method for market risk. Vega and
curvature calculations would not be
required in the counterparty credit
spread risk class because regulatory
CVA would be approximately linear
with respect to counterparty credit
spreads. For counterparty credit
spreads, the SA–CVA would adjust risk
buckets and correlations based on the
role that counterparty credit spreads
play in CVA calculations.
i. Regulatory CVA
Under the proposal, the aggregate
regulatory CVA would equal the simple
sum of counterparty-level regulatory
CVAs. Counterparty-level regulatory
CVA is intended to reflect an estimate
of the market expectation of future loss
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that a banking organization would incur
on its portfolio of derivatives with a
counterparty in the event of the
counterparty’s default, assuming that
the banking organization survives until
the maturity of the longest instrument in
the portfolio. For consistency in the
calculation of risk-based capital across
banking organizations, the proposal
would require a banking organization to
apply a positive sign to non-zero losses,
so that regulatory CVA is always a
positive quantity. The proposal would
require a banking organization to base
the calculation of regulatory CVA for
each counterparty on at least three sets
of inputs: the term structure of marketimplied probability of default (marketimplied PD) of the counterparty, the
market-consensus expected loss-givendefault (ELGD), and the simulated paths
of discounted future exposure. In
addition to the three specified inputs,
the proposal would also allow a banking
organization to use models that
incorporate additional inputs for
purposes of calculating regulatory CVA.
I. Term Structure of Market-Implied PD
The proposal would require a banking
organization to use credit spreads
observed in the markets, if available, to
estimate the term structure of the
market-implied PD based on market
expectations of the likelihood that the
counterparty will default by a certain
point in the future. Relative to historical
default probabilities, market-implied
PDs are typically substantially higher as
they reflect the premium that investors
demand for accepting default risk.
As many counterparties’ credit is not
actively traded, the proposal would
allow a banking organization to use
proxies to estimate the term structure of
market-implied PD. For these illiquid
counterparties, a banking organization
would be required to estimate proxy
credit spreads from credit spreads
observed in the market for the
counterparty’s liquid peers, determined
using, at a minimum, credit quality,
industry, and region. Alternatively, the
proposal would permit a banking
organization to map an illiquid
counterparty to a single liquid reference
name if a banking organization provides
a justification to its primary Federal
supervisor for the appropriateness of
such mapping.447 In addition, for
illiquid counterparties for which there
are no available credit spreads of liquid
peers, the proposal would permit a
447 For example, a banking organization may be
permitted to use the credit spread curve of the
home country as a proxy for that of a municipality
in the home country (that is, setting the
municipality credit spread equal to the sovereign
credit spread plus a premium).
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banking organization to use an estimate
of credit risk to proxy the credit spread
of an illiquid counterparty (for example,
to use a more fundamental analysis of
credit risk based on balance sheet
information or other approaches). To be
able to use the fundamental analysis of
credit risk or similar approaches, a
banking organization would need the
prior approval of its primary Federal
supervisor and be subject to supervisory
review of its policies and procedures
that reasonably demonstrate that the
analysis of credit risk produces a
credible proxy of the credit spread of
the counterparty. While historical
default probabilities may form part of
this analysis, the resulting spread would
have to relate to credit markets as well.
This requirement would ensure the
estimated term structure of marketimplied PD reflects the market risk
premium for counterparty credit risk.
II. Market-Consensus ELGD
In general, the proposal would require
a banking organization to use the
market-consensus ELGD value that is
used to calculate the market-implied
PDs from the counterparty’s credit
spreads. The fraction of exposure that a
banking organization would lose in the
event of a counterparty default (that is,
loss given default) depends on the
seniority of the derivative contracts that
the banking organization has with the
counterparty at the time of default. Most
CDS contracts, which are used to
calculate the market-implied PD, allow
for delivery of senior unsecured bonds
and thus have the same seniority as
senior unsecured bonds in bankruptcy.
By generally requiring a banking
organization to use the same marketconsensus ELGD as the one used in
calculations of the market-implied PD
from the credit spreads, the proposal
would require a banking organization to
generally assume that derivative
contracts’ seniority is the same as the
seniority of senior unsecured bonds. If
a banking organization’s derivative
contracts with the counterparty are
more or less senior to senior unsecured
bonds, the proposal would allow a
banking organization to adjust the
market-consensus ELGD to
appropriately reflect the lower or higher
losses arising from such exposures.
However, the proposal would not allow
a banking organization to use collateral
provided by the counterparty as the
justification for changing the marketconsensus ELGD as the banking
organization would already have
considered collateral in determining its
exposure to the counterparty.
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III. Simulated Paths of Discounted
Future Exposure
To align regulatory CVA with
industry practices, the regulatory CVA
calculation in the SA–CVA would
generally be based on the exposure
models that a banking organization uses
to calculate CVA for purposes of
financial reporting. Specifically, a
banking organization would obtain the
simulated paths of discounted future
exposure by using the exposure models
the banking organization uses for
calculating CVA for financial reporting,
adjusted, if needed, to meet the
requirements imposed for regulatory
CVA calculation, as described below.
The proposal would require that these
exposure models be subject to the same
model calibration processes (with the
exception of the margin period of risk,
which would have to meet the
regulatory floors), and use the same
market and transaction data as the
exposure models that the banking
organization uses for calculating CVA
for financial reporting purposes.
To produce the simulated paths of
discounted future exposure, a banking
organization would price all
standardized CVA risk covered
positions with the counterparty along
simulated paths of relevant market risk
factors and discount the prices to today
using risk-free interest rates along the
path. The banking organization would
be required to simulate all market risk
factors material to the transactions as
stochastic processes for an appropriate
number of paths defined on an
appropriate set of future time points
extending to the maturity of the longest
transaction. The proposal would require
drifts of risk factors to be consistent
with a risk-neutral probability measure
and would not permit historical
calibration of drifts. The banking
organization would be required to
calibrate volatilities and correlations of
market risk factors to current market
data whenever sufficient data exist in a
given market, although the proposal
would permit a banking organization to
use historical calibration of volatilities
and correlations if sufficient current
market data are not available. A banking
organization’s assumed distributions for
modelled risk factors would be required
to account for the possible nonnormality of the distribution of
exposures, including the existence of
leptokurtosis (that is, ‘‘fat tails’’), where
appropriate. The banking organization
would be required to use the same
netting recognition as in its CVA
calculations for financial reporting.
Where a transaction has a significant
level of dependence between exposure
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and the counterparty’s credit quality,
the banking organization would be
required to take this dependence into
account.
The proposal would permit a banking
organization to recognize financial
collateral as a risk mitigant for margined
counterparties if the financial collateral
would be included in the net
independent collateral amount or
variation margin amount and the
collateral management requirements in
the SA–CCR are satisfied.
The proposal would require that (1)
simulated paths of discounted future
exposure capture the effects of
margining collateral that is recognized
as a risk mitigant along each exposure
path; and (2) the exposure model
appropriately captures all the relevant
contractual features such as the nature
of the margin agreement (that is,
unilateral versus bilateral), the
frequency of margin calls, the type of
collateral, thresholds, independent
amounts, initial margins, and minimum
transfer amounts.448 To determine
collateral available to a banking
organization at a given exposure
measurement time, the proposal would
require a banking organization’s
exposure model to assume that the
counterparty will not post or return any
collateral within a certain time period
immediately prior to that time, known
as the margin period of risk (MPoR). The
proposal specifies a minimum length of
time for the MPoR.
For client-facing derivative
transactions, the minimum MPoR would
be equal to 4 + N business days, where
N is the re-margining period specified in
the margin agreement. In particular, for
margin agreements with daily or intradaily exchange of margin, the minimum
MPoR would be 5 business days. For all
other CVA risk covered positions, the
minimum MPoR is equal to 9 + N
business days, or 10 business days for
margin agreements with daily or intradaily exchange of margin.
ii. Calculation of the SA–CVA Approach
Conceptually, the proposed SA–CVA
approach is similar to the proposed
sensitivities-based method under the
market risk framework, as described in
section III.H.7.a of this SUPPLEMENTARY
INFORMATION, in that a banking
organization would estimate the
changes in regulatory CVA arising from
CVA risk covered positions and, if
applicable, eligible CVA hedges
resulting from applying standardized
448 Minimum transfer amount means the smallest
amount of variation margin that may be transferred
between counterparties to a netting set pursuant to
the variation margin agreement.
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shocks to the relevant risk factors. As in
the case of the proposed sensitivitiesbased method, to help ensure
consistency in the application of riskbased capital requirements across
banking organizations, the proposal
would establish the applicable risk
factors, the method to calculate the
sensitivity of regulatory CVA and CVA
hedges to each of the prescribed risk
factors, the shock applied to each risk
factor, and the process for aggregating
the net weighted sensitivities within
each risk class and across risk classes to
arrive at the total CVA risk-based capital
requirement for the portfolio under the
SA–CVA. First, under the proposal, a
banking organization would identify
one or more of the specified risk classes
that, in addition to counterparty credit
spread risk class, would be applicable to
its CVA risk covered positions and its
CVA hedges. Based on standard
industry classifications, the proposed
exposure-related risk classes represent
the common, yet distinct market
variables that impact the value of CVA
risk covered positions and CVA hedges.
The proposed sensitivity calculations
for delta and vega risk factors would
estimate how much the aggregate
regulatory CVA arising from CVA risk
covered positions and separately the
market value of all standardized CVA
hedges would change as a result of a
small change in a given risk factor,
while all other relevant risk factors
remain constant. For the sensitivity
calculation, a banking organization
would be able to use either the standard
risk factor shifts or smaller values of risk
factor changes, if such smaller values
are consistent with those used by the
banking organization for internal risk
management.
Second, for each delta (and,
separately, vega) risk factor, the banking
organization would multiply the
measured sensitivity of the aggregate
CVA arising from CVA risk covered
positions to that risk factor and,
separately, that of the market value of
the aggregate eligible CVA hedges to
that risk factor by the standardized risk
weight proposed for that risk factor. A
banking organization would then
subtract the resulting weighted
sensitivity for the eligible CVA hedges
from the weighted sensitivity for the
aggregate CVA arising from the CVA risk
covered positions to obtain the net
weighted sensitivity to a given risk
factor. The agencies intend the proposed
risk weights to capture the amount that
a risk factor would be expected to move
during the liquidity horizon of the risk
factor in stress conditions and generally
would be consistent with the risk
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weights in the proposed sensitivitiesbased method for market risk outlined
in section III.H.7.a.ii of the
SUPPLEMENTARY INFORMATION.
Third, to aggregate CVA risk
contributions of individual risk factors,
the proposal would provide aggregation
formulas for calculating the total delta
and vega capital requirements for the
entire CVA portfolio. Within each risk
class, the proposal would group similar
risk factors into risk buckets. Similar to
the sensitivities-based method for
market risk, a banking organization
would aggregate the net risk-weighted
sensitivities for delta (and, separately,
for vega) risk factors first within each
risk bucket and then across risk buckets
within each risk class using the
prescribed aggregation formulas to
produce the respective delta and vega
risk-based capital requirements. The
agencies’ intention is that the
aggregation formulas limit offsetting and
diversification benefits via the
prescribed correlation parameters.
Under the proposal, the correlation
parameters specified for each risk factor
pair would limit the risk-mitigating
benefit of hedges and diversification,
given that the hedge relationship
between the underlying position and the
hedge as well as the relationship
between different types of positions
could decrease or become less effective
in a time of stress.
Fourth, a banking organization would
aggregate the resulting delta and vega
risk-class-level capital requirements as
the simple sum across risk classes with
no recognition of any diversification
benefits because in stress diversification
across different risk classes may become
less effective.
Finally, the overall risk-based capital
requirement for CVA risk would be the
simple sum of the separately calculated
delta and vega capital requirements
without recognition of any
diversification benefits as these
measures are intended to capture
different types of risk and because in
stress diversification may become less
effective.
I. Delta and Vega
To appropriately capture linear CVA
risks, the proposal would require a
banking organization to separately
calculate the risk-based capital
requirements for delta and vega using
the above steps. As the sensitivity to
vega risk is always material for CVA (as
discussed further below), the proposal
would require a banking organization to
always measure the sensitivity of
regulatory CVA to vega risk factors,
regardless of whether the CVA risk
covered positions include positions
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with optionality. When a banking
organization calculates a sensitivity of
regulatory CVA to a vega risk factor, it
would apply the appropriate volatility
shift to both types of volatilities that
appear in exposure models: volatilities
used for generating risk factor paths and
volatilities used for pricing options.
II. Risk Classes
Under the proposal, a banking
organization would be required to
identify all of the relevant risk factors
for which it would calculate
sensitivities for delta risk and vega risk.
Based on the identified risk factors, a
banking organization would be required
to identify the corresponding risk
buckets within relevant risk classes.
CVA of a single counterparty can be
represented as the product of
counterparty credit spread and expected
exposure for various future time points,
aggregated across these time points.
Because of this structure, counterparty
credit spread risk naturally presents
itself as a separate delta risk class that
is always present in CVA risk regardless
of the type of CVA risk covered
positions in the portfolio.449 The risk
classes specified for delta and vega risk
factors related to expected exposure
under SA–CVA are generally consistent
with those under the sensitivities-based
method for market risk and include
interest rate, foreign exchange, credit
spread, equity, and commodity.
For credit spread risk, the proposal
would specify two distinct risk classes
that may share the same risk factors but
would need to be treated separately: (i)
counterparty credit spread risk; and (ii)
reference credit spread risk. Reference
credit spread risk would be defined as
the risk of loss that could arise from
changes in the underlying credit spread
risk factors that drive the exposure
component of CVA risk. For example, a
banking organization could have a
portfolio of derivatives with Firm X as
a counterparty and, at the same time,
have a CDS referencing credit of Firm X
in a portfolio of derivatives with Firm
Y. In such cases, under the SA–CVA,
the same credit spreads of Firm X would
be treated as distinct risk factors in two
sets of sensitivity calculations: one
within the counterparty credit spread
risk class calculations, and the other
within the reference credit spread risk
class calculations. To incorporate credit
spread hedges of CVA risk properly,
each such hedge would be designated as
either a counterparty credit spread
449 This is a fundamental distinction between
CVA risk and market risk, which, in the latter case,
is entirely determined by market risk covered
positions.
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hedge or a reference credit spread hedge
and included only in one calculation
according to the designation.
Each risk class used for delta would
also apply to vega, except for
counterparty credit spread risk. The
regulatory CVA is approximately linear
in counterparty credit spreads and does
not depend on their volatilities.
Accordingly, calculation of the CVA
vega capital requirement would not be
required in the counterparty credit
spread risk class. On the other hand,
expected exposure is always sensitive to
volatilities of market risk factors that
drive market values of CVA risk covered
positions.450 Accordingly, for each of
the five exposure-related risk classes, a
banking organization would be required
to compute vega risk factor sensitivities
of the aggregate regulatory CVA, in
addition to delta risk factor sensitivities,
regardless of whether the portfolio
includes options.
III. Risk Factors
Under the proposal, a banking
organization would be required to
identify all of the relevant risk factors
for which it would calculate
sensitivities for delta risk and vega risk.
The proposed risk factors differ for each
risk class to appropriately reflect the
specific market risk variables relevant
for each risk class.
To measure the impact of a small
change in each of the risk factors on the
aggregate regulatory CVA and the
market value of eligible CVA hedges, the
proposal would specify the sensitivity
calculations that a banking organization
may use to calculate the CVA sensitivity
to small changes in each of the specified
delta or vega risk factors, as
applicable.451 Specifically, for the
equity, commodity, and foreign
exchange delta risk factors, the
sensitivity would equal the change in
the aggregate regulatory CVA arising
from CVA risk covered positions and
separately the market value of all
eligible CVA hedges due to a one
450 CVA expected exposure profile can be
characterized as today’s price of a call option on the
portfolio market value at that time point (or on the
increment of the portfolio market value over the
MPoR for a margined portfolio). Since the price of
an option depends both on the price and volatility
of the underlying asset, both delta and vega risk
factor sensitivities materially contribute to expected
exposure variability, even when the portfolio of
CVA risk covered positions with a counterparty
does not include options.
451 As previously noted, for the sensitivity
calculation, a banking organization would be able
to use either the standard risk factor shifts or
smaller values of risk factor changes, if such smaller
values are consistent with those used by the
banking organization for internal risk management
(for example, using infinitesimal values of risk
factor shifts in combination with algorithmic
differentiation techniques).
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percentage point increase in the delta
risk factor divided by one percentage
point. For the interest rate, counterparty
credit spread, and reference credit
spread delta risk factors, the sensitivity
would equal the change in the aggregate
regulatory CVA arising from CVA risk
covered positions and separately the
market value of all eligible CVA hedges
due to a one basis point increase in the
risk factor divided by one basis point.
The sensitivity to a vega risk factor
would equal the change in the aggregate
regulatory CVA arising from CVA risk
covered positions and separately the
market value of all eligible CVA hedges
due to a one percentage point increase
in the volatility risk factor divided by
one percentage point. When a banking
organization calculates the sensitivity of
regulatory CVA arising from CVA risk
covered positions and separately of the
market value of all eligible CVA hedges
to a vega risk factor, the banking
organization would apply the shift to
the relevant volatility used for
generating risk factor simulation paths
for regulatory CVA calculations. If there
are options in the portfolio with the
counterparty, the shift would also be
applied to the relevant volatility used to
price options along the simulation
paths.
In cases where a CVA risk covered
position or an eligible CVA hedge
references an index, the proposal would
require a banking organization to
calculate the sensitivities of the
aggregate regulatory CVA arising from
the CVA risk covered positions or the
market value of the eligible CVA hedges
to all risk factors upon which the value
of the index depends. The sensitivity of
the aggregate regulatory CVA or the
market value of the eligible CVA hedges
to a risk factor would be calculated by
applying the shift of the risk factor to all
index constituents that depend on this
risk factor and recalculating the
aggregate regulatory CVA or the market
value of the eligible CVA hedges.
For the risk classes of counterparty
credit spread risk, reference credit
spread risk, and equity risk, the SA–
CVA would allow a banking
organization to introduce a set of
additional risk factors that directly
correspond to qualified credit and
equity indices.452 For a CVA risk
covered position or an eligible CVA
452 For delta risk, a credit or equity index would
be qualified if it is listed and well-diversified; for
vega risk, any credit or equity index would be
qualified. If a banking organization chooses to
introduce such additional risk factors, the banking
organization would be required to calculate CVA
sensitivities to the qualified index risk factors in
addition to sensitivities to the non-index risk
factors.
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hedge whose underlying is a qualified
index, its contribution to sensitivities to
the index constituents would be
replaced with its contribution to a single
sensitivity to the underlying index,
provided that (1) for listed and welldiversified indices that are not sector
specific where 75 percent of notional
value for credit indices or market value
for equity indices of the qualified
index’s constituents on a weighted basis
are mapped to the same sector, the
entire index would have to be mapped
to that sector and treated as a singlename sensitivity in that bucket, and (2)
in all other cases, the sensitivity would
have to be mapped to the applicable
index bucket. The proposal would
provide this option because some
popular credit and equity indices
involve a large number of
constituents 453 and calculating
sensitivities to each constituent may be
impractical for such indices.
A. Counterparty Credit Spread Risk
The proposal would define the
counterparty credit spread delta risk
factors as the absolute shifts of credit
spreads of individual entities
(counterparties and reference names for
counterparty credit spread hedges) and
qualified indices (under the optional
treatment of qualified indices) for the
following tenors: 0.5 years, 1 year, 3
years, 5 years, and 10 years.
In addition to single-name CVA
counterparty credit spread hedges,
banking organizations use index hedges
to hedge the systematic component of
counterparty credit spread risk. If an
eligible CVA counterparty credit spread
risk hedge references a credit index, a
banking organization would be required
to calculate delta sensitivities of the
market value of all eligible CVA hedges
of counterparty credit spread risk to the
credit spread of each constituent entity
included in the index. In these
calculations, a banking organization
would be required to shift the credit
spread of each of the underlying
constituents of the index while holding
the credit spreads of all others constant.
The SA–CVA would offer an
alternative, optional approach that
introduces additional index risk factors
for qualified indices. Specifically, for
each qualified index referenced by
eligible CVA counterparty credit spread
risk hedges, delta risk factors would be
absolute shifts of the qualified index for
the following tenor points: 0.5 years, 1
year, 3 years, 5 years, and 10 years.
Under this optional approach, when a
453 For example, the credit index CDX has 125
constituents, equity index S&P 500 has 500
constituents.
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banking organization calculates
sensitivities to single-name credit
spread risk factors, the qualified indices
would remain unchanged. For each
distinct qualified credit index
referenced by an eligible CVA
counterparty credit spread risk hedge,
the banking organization would perform
a separate delta sensitivity calculation
where the entire credit index is shifted.
The qualified index sensitivity
calculations would only affect eligible
CVA hedges of counterparty credit
spread risk that reference the qualified
indices. This alternative is designed to
reduce the complexity of constituent-byconstituent calculations, as many
popular credit indices have more than a
hundred constituents of sensitivities.
B. Risk Factors for Market Risk Classes
As noted above, given the
computational intensity of calculating
the sensitivity of CVA to market risk
factors and the less material impact of
such risk factors on the volatility of
CVA, the proposal would define the
delta and vega risk factors for all five
market risk classes (interest rate risk,
foreign exchange risk, reference credit
spread risk, equity risk, and commodity
risk) in a much less granular way than
under the sensitivity-based method for
market risk.
1. Interest Rate Risk
For both delta and vega risk factors in
the interest rate risk class, the proposal
would define individual buckets by
currency, which would consist of
interest rate risk factors and inflation
rate risk factors. For specified currencies
(USD, EUR, GBP, AUD, CAD, SEK, or
JPY), the delta interest rate risk factors
would be defined as the simultaneous
absolute change in all risk-free yields in
a given currency at each specified tenor
point (1 year, 2 years, 5 years, 10 years,
and 30 years) and the absolute change
in the inflation rate of a given currency.
For all other currencies, the delta risk
factors for interest rate risk would be
defined along two dimensions: the
simultaneous parallel shift in all riskfree yields in a given currency and the
absolute change in the inflation rate of
a given currency.
As the specified currencies are
intended to capture the set of liquid
currencies that would likely dominate a
banking organization’s portfolios, the
proposal would require a banking
organization to identify and apply more
granular delta risk factors for such
exposures relative to those for all other
currencies. Of the ten tenors used under
the sensitivities-based method in market
risk, the proposed five tenors are
intended to capture the most commonly
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used tenors based on the liquidity in
interest rate OTC derivative markets.
For all currencies, the interest rate
vega risk factors for each currency
would be defined along two
dimensions: the simultaneous relative
change of all interest rate volatilities for
a given currency and the simultaneous
relative change of all inflation rate
volatilities for a given currency. For
vega risk factors, the proposal would
reduce the granularity in the tenor
dimension in the same manner for all
currencies given the computational
intensity of calculating the vega risk
sensitivity and the less material impact
of such risk factors on the volatility of
CVA.
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2. Foreign Exchange Risk
The proposal would specify delta and
vega risk buckets for foreign exchange
risk as individual foreign currencies.
For each foreign exchange risk bucket,
the proposal would define one delta risk
factor and one vega risk factor.
Specifically, the proposal would define
(1) the foreign exchange delta risk factor
as the relative change in the foreign
exchange spot rate 454 between a given
foreign currency and the reporting
currency (or base currency); and (2) the
foreign exchange vega risk factor as the
simultaneous, relative change of all
volatilities for an exchange rate between
a banking organization’s reporting
currency (or base currency) and another
given currency. For transactions that
reference an exchange rate between a
pair of non-reporting currencies, the
sensitivities to the foreign exchange spot
rates between the bank’s reporting
currency and each of the referenced
non-reporting currencies must be
measured.
3. Reference Credit Spread Risk
The proposal would define risk
buckets for the delta and vega risk
factors by sector and credit quality
which is consistent with the definitions
of risk buckets for non-securitization
credit spread risk that are used in the
proposed sensitivities-based method for
market risk. The proposal would define
one reference credit spread risk factor
per delta or vega risk bucket under the
SA–CVA. Specifically, the proposal
would define (1) the delta risk factor as
the simultaneous absolute shift of all
credit spreads of all tenors for all
reference entities in the bucket; and (2)
the vega risk factor as the simultaneous
relative shift of the volatilities of all
454 Under the proposal, the foreign exchange spot
rate would be defined for purposes of CVA risk as
the current market price of one unit of another
currency expressed in the units of the banking
organization’s reporting (or base) currency.
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credit spreads of all tenors for all
reference entities in the bucket. In
addition, similar to the counterparty
credit spread risk as described above in
section III.I.5.b.ii.III.A of the
Supplementary Information, the SA–
CVA would offer an alternative,
optional approach that introduces
additional index risk factors for
qualified indices and allows a banking
organization to calculate delta and vega
sensitivities of aggregate regulatory CVA
and eligible CVA hedges with respect to
the qualified indices instead of each
constituent of the indices.
4. Equity Risk
The proposal would set the risk
buckets for delta and vega risk factors
generally matching the risk buckets for
equity risk in the proposed sensitivitiesbased method for market risk. The
proposal would define one equity risk
factor per delta or vega risk bucket to
reduce the complexity of calculating
CVA sensitivities to equity risk factors.
The proposal would define (1) the delta
risk factor as the simultaneous relative
change of all equity spot prices for all
entities in the bucket and (2) the vega
risk factor as the simultaneous relative
change of all equity price volatilities for
all entities in the bucket. In addition,
similarly to the counterparty credit
spread risk and reference credit spread
risk as described in sections III.I.5.b.ii.III
and III.I.5.b.ii.III.B.3 of the
Supplementary Information, the SA–
CVA would offer an alternative,
optional approach that introduces
additional index risk factors for
qualified indices and allows a banking
organization to calculate delta and vega
sensitivities of aggregate regulatory CVA
and eligible CVA hedges with respect to
the qualified indices instead of each
constituent of the indices.
5. Commodity Risk
The proposal would set the risk
buckets for delta and vega risk factors
matching the risk buckets for
commodity risk in the proposed
sensitivities-based method for market
risk. The proposal would define one
commodity risk factor per delta or vega
risk bucket under the SA–CVA.
Specifically, the proposal would define
(1) the delta risk factor as the
simultaneous relative shift of all
commodity spot prices for all
commodities in the bucket and (2) the
vega risk factor as the simultaneous
relative shift of all commodity price
volatilities for all commodities in the
bucket.
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IV. Risk Buckets, Risk Weights, and
Correlations
As noted above, there are six risk
classes for delta risk factors in the SA–
CVA: the counterparty credit spread risk
class and the five risk classes for market
risk factors that drive expected exposure
(interest rate, foreign exchange,
reference credit spread, equity, and
commodity). In addition, there are five
exposure-related risk classes for vega
risk factors. The granularity of risk
factors in the counterparty credit spread
risk class matches the one in the nonsecuritization credit spread risk class in
the sensitivities-based method for
market risk, while the granularity of
both delta and vega risk factors in the
exposure-related risk classes is greatly
reduced.
A. Exposure-Related Risk Classes
The exposure component of
regulatory CVA of a portfolio of CVA
risk covered positions is affected by
delta and vega market risk factors in a
similar way as a portfolio of options on
future market values (or their
increments). Therefore, there is no
compelling reason for the exposurerelated risk classes in the SA–CVA to
deviate from the bucket structure, risk
weights, and correlations used in the
corresponding risk classes in the
sensitivities-based method for market
risk, except for accommodating the
reduced granularity of exposure-related
risk factors in the SA–CVA.
Accordingly, for both delta and vega
risk factors in the exposure-related risk
classes, the SA–CVA would use the
bucket structure that matches the bucket
structure of the corresponding risk
classes in the sensitivities-based method
for market risk. Furthermore, the
proposal would set the values of all
cross-bucket correlations, gbc, used for
aggregation of bucket-level capital
requirements across risk buckets within
each exposure-related risk class equal to
the corresponding values used in the
sensitivities-based method for market
risk.
For the foreign exchange, reference
credit spread, equity, and commodity
risk classes, the SA–CVA would assign
one delta (and, separately, one vega) risk
factor per risk bucket. Therefore, in
contrast to the sensitivities-based
method for market risk, the SA–CVA
does not need to provide intra-bucket
correlations, rkl, for these risk classes.
Furthermore, because the sensitivitiesbased method for market risk provides
no more than one risk weight per risk
bucket for the corresponding risk classes
(foreign exchange, non-securitization
credit spread, equity, and commodity),
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the SA–CVA would generally match the
values of these risk weights for both
delta and vega risk factors.455
For the interest rate risk class, similar
to the market risk, the SA–CVA would
have two groups of risk buckets/
currencies: the ‘‘specified’’ currencies
(USD, EUR, GBP, AUD, CAD, SEK, and
JPY) and the other currencies. However,
while in the sensitivities-based method
for market risk the two groups only
differ in the values of the risk weights
(the general risk weights can be divided
by √2 when applied to the specified
currencies), in the SA–CVA they would
differ both in the value of risk weights
and in the level of granularity for delta
risk factors. As mentioned above, the
SA–CVA would specify delta risk
factors for the specified currencies as
the absolute changes of the inflation rate
and of the risk-free yields for the
following five tenors: 1 year, 2 years, 5
years, 10 years, and 30 years. Risk
weights for these risk factors would be
set approximately equal to the general
risk weights for the inflation rate and for
the corresponding tenors of risk-free
yields in the sensitivities-based method
for market risk divided by √2. The intrabucket correlations, rkl, for the specified
currencies in the SA–CVA would
approximately match the ones between
the corresponding tenors and the
inflation rate in the sensitivities-based
method for market risk. For each of the
non-specified currencies, the SA–CVA
would provide two delta risk factors per
bucket/currency: the absolute change of
the inflation rate and the parallel shift
of the entire risk-free yield curve for a
given currency. The risk weights for
these risk factors would approximately
match the ones for the inflation rate and
for the 1-year risk free yield in the
sensitivities-based method for market
risk. The intra-bucket correlation
between the two risk factors for the nonspecified currencies would be set equal
to the value of the correlation between
the inflation rate and any tenor of the
risk-free yield specified in the
sensitivities-based method for market
risk. As stated above, the SA–CVA
would specify two vega risk factors for
the interest rate risk class for each
bucket/currency: a simultaneous
relative change of all inflation rate
volatilities and a simultaneous relative
change of all interest rate volatilities for
a given currency. The SA–CVA would
set the vega risk weights for both risk
455 The only exception would be foreign exchange
delta risk: the sensitivities-based method for market
risk would use two values for the delta risk weight
(depending on the currencies), while the SA–CVA
would use a single delta risk weight (set
approximately equal to the lower of the two)
regardless of the currency.
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factors equal to the single value of the
vega risk weight used for all interest rate
vega risk factors in the sensitivitiesbased method for market risk. The SA–
CVA would set the only intra-bucket
interest rate vega correlation equal to
the value of the SA–CVA intra-bucket
interest rate delta correlation for the
non-specified currencies.
Question 168: The agencies seek
comment on the appropriateness of the
proposed risk buckets, risk weights and
correlations for the exposure-related
risk classes. What, if any, alternative
risk bucketing structures, risk weights,
or correlations should the agencies
consider and why?
B. Counterparty Credit Spread Risk
Class
Fundamentally, counterparty credit
spreads are no different from reference
credit spreads and, therefore, should
follow the same dynamics. Accordingly,
the risk weights for counterparty credit
spread risk factors under the SA–CVA
would exactly match those for reference
credit spread delta risk factors (and,
thus, match the ones for nonsecuritization credit spread delta risk
factors in the sensitivities-based method
for market risk). While the common
dynamics might suggest using the same
set of buckets for counterparty credit
spread risk class and the reference
credit spread risk class, the proposal
would modify risk bucket definitions for
non-securitization credit spread delta
risk factors in the sensitivities-based
method for market risk in their
application to the counterparty credit
spread risk class based on the different
role counterparty credit spreads play in
CVA risk management.
The counterparty credit spread
component of CVA risk is usually
substantially greater than the exposure
component, and, therefore, is the
primary focus of CVA risk management
by banking organizations. Banking
organizations often use single-name
credit instruments to hedge the
counterparty credit spread component
of CVA risk of individual counterparties
with large CVA and use index credit
instruments to hedge the systematic part
of the counterparty credit spread
component of the aggregate (across
counterparties) CVA risk. In order to
improve recognition of both single-name
and index hedges of the counterparty
credit spread component of CVA risk
and thus promote prudential CVA risk
management, the agencies propose, for
the application in the counterparty
credit spread risk class, to modify the
bucket structure that is used for the nonsecuritization credit spread risk class in
the sensitivities-based method for
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market risk, as described below. These
modifications do not affect the risk
weights in the counterparty credit
spread risk class that match exactly the
corresponding risk weights in the
sensitivities-based method for market
risk.
In the non-securitization credit spread
risk class in the sensitivities-based
method for market risk, (1) investment
grade entities and (2) speculative and
sub-speculative grade entities from the
same sector generally form two separate
risk buckets based on credit quality.
This, however, could undermine the
efficiency of hedges of the counterparty
credit spread component of CVA risk. In
order to prevent this, the proposal
would merge the investment grade
bucket and speculative and subspeculative grade bucket of each sector
into a single bucket.
Furthermore, banking organizations
often use single-name sovereign CDS as
indirect single-name counterparty credit
spread hedges of CVA risk of illiquid
counterparties such as GSEs and local
governments. However, in the nonsecuritization credit spread risk class in
the sensitivities-based method for
market risk, such entities would belong
to the PSE, government-backed nonfinancials, GSE debt, education, and
public administration sector, which
form a risk bucket separate from
sovereign exposures and MDBs. Thus,
following the non-securitization credit
spread risk bucket structure of the
sensitivities-based method for market
risk would result in a situation where
the counterparty and the reference
entity of the hedge reside in different
risk buckets, thus substantially reducing
the effectiveness of the hedge. In order
to prevent a such scenario, the proposal
would merge the sovereign exposures
and MDBs sector and the PSE,
government-backed non-financials, GSE
debt, education, and public
administration sector into a single risk
bucket. To preserve hedging efficiency,
the proposal would move governmentbacked financials from the ‘‘financials’’
bucket to the combined bucket that
includes sovereign exposures.
The agencies propose to set the crossbucket correlations, gbc, equal to the
corresponding correlations that would
be applicable under the assumption of
the same credit quality in the nonsecuritization credit spread risk class as
in the sensitivities-based method for
market risk. The agencies propose to
change both the structure and the values
of the intra-bucket correlations used in
the sensitivities-based method to better
recognize indirect single-name hedges
where the reference name is in the same
risk bucket as the counterparty. Similar
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to the non-securitization credit spread
risk class in the sensitivities-based
method for market risk, the intra-bucket
correlations, rkl, proposed for the
counterparty credit spread risk class
would be equal to the product of three
correlation parameters. Two of the SA–
CVA parameters—for tenor difference
and name difference—are the same as in
the sensitivities-based method if risk
factors are identical but have higher
values for non-identical risk factors for
better hedge recognition. The third SA–
CVA parameter—for credit quality
difference—would replace the basis
correlation parameter of the
sensitivities-based method. This
parameter would equal 100 percent if
the credit quality of the two names is
the same (treating speculative and sub-
speculative grade as one credit quality
category) and 80 percent otherwise. The
basis correlation parameter is not
needed in the SA–CVA because the SA–
CVA does not make a distinction
between different credit curves
referencing the same entity. On the
other hand, reference entities of the
same sector, but different credit quality
would be in different risk buckets under
the sensitivities-based method, so the
sensitivities-based method does not
need the credit quality difference
correlation parameter.
Question 169: To what extent are the
proposed risk buckets, risk weights, and
correlations for counterparty credit
spread risk class appropriate? What, if
any, alternative risk bucketing
structures, risk weights, or correlations
should the agencies consider and why?
where WSk is the net weighted
sensitivity to risk factor k, WSkHdg, is the
weighted sensitivity of the market value
of all standardized CVA hedges to risk
factor k, rkl is the regulatory correlation
parameter between risk factors k and l
within risk bucket b, and R is the
hedging disallowance parameter set at
0.01. While this formula is similar to the
intra-bucket aggregation formula in the
sensitivities-based method for market
risk, it differs by the presence of an
additional term under the square root,
proportional to the hedging
disallowance parameter R. The purpose
of this term is to prevent extremely
small levels of Kb when most of the risk
factors k are perfectly hedged. For the
case of perfect hedging (WSk = 0 for all
k), the term provides a floor equal to 10
percent of weighted sensitivities of the
standardized CVA hedges, aggregated as
idiosyncratic risks.
Second, a banking organization would
aggregate bucket-level capital
requirements across risk buckets within
the same risk class according to the
following formula:
where gbc is the regulatory correlation
parameter between bucket b and bucket
c; Sb is the sum of the net weighted
sensitivities WSk over all risk factors k
in bucket b, floored by ¥Kb and capped
by Kb; and Sc is the sum of the net
weighted sensitivities WSk over all risk
factors k in bucket c, floored by ¥Kc
and capped by Kc as given by the
following formulas: 456
456 Note that this definition of S differs from the
b
one used in the sensitivities-based method for
market risk, where the floor and the cap apply only
when the quantity under the square root in the
aggregation formula is negative.
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V. Intra- and Inter-Bucket Aggregation
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EP18SE23.050</GPH>
Consistent with the sensitivities-based
method for market risk, the proposal
would require a banking organization
first to separately aggregate the riskweighted net sensitivities for CVA delta
and CVA vega within their respective
risk buckets and then across risk
buckets within each risk class using the
prescribed aggregation formulas to
produce respective delta and vega risk
capital requirements for CVA risk.
First, for each risk bucket b, a banking
organization would aggregate all net
weighted sensitivities for all risk factors
within this risk bucket according to the
following formula:
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delta and vega capital requirements
across risk classes without any
recognition of any diversification
benefits given that delta and vega are
intended to separately capture different
risks.
Question 170: To what extent are the
proposed intra- and inter-bucket
aggregation methodologies appropriate?
What, if any, alternative methodologies
should the agencies consider and why?
Question 171: What, if any,
alternative methods should the agencies
consider for recognizing diversification
across risk classes in the calculation of
the SA–CVA, and why?
Question 172: To what extent is the
default value of one for the multiplier
appropriate or should the agencies
consider a higher or lower default value
for the multiplier and why?
subject to Category III or IV capital
standards, the AOCI regulatory capital
adjustments described in section III.B of
this SUPPLEMENTARY INFORMATION. The
main goal of the transition provisions is
to provide applicable banking
organizations sufficient time to adjust to
the proposal while minimizing the
potential impact that implementation
could have on their ability to lend.458
A. Transitions for Expanded Total RiskWeighted Assets
The agencies are proposing a threeyear transition period for two provisions
of the proposal: the expanded risk-based
approach and, for banking organizations
As described in Table 9 below, a
banking organization’s expanded total
risk-weighted assets would be phased-in
starting July 1, 2025, until June 30,
2028. Specifically, a banking
organization would multiply expanded
total risk-weighted assets as defined in
the proposal by the phase-in amount for
each transition period provided in Table
9 and use that amount as the
denominator of its risk-based capital
ratios in place of expanded total riskweighted assets during the transition
period.
B. AOCI Regulatory Capital Adjustments defined benefit pension obligations, and
From July 1, 2025 until June 30, 2028, accumulated net gains or losses on cash
flow hedges related to items that are
for a banking organization subject to
reported on the balance sheet at fair
Category III or IV capital standards, the
value included in AOCI (AOCI
aggregate amount of net unrealized
adjustment amount) would be
gains or losses on AFS debt securities
transitioned as set forth in Table 10
and HTM securities included in AOCI,
below. Therefore, if a banking
accumulated adjustments related to
organization’s AOCI adjustment amount
is positive, it would multiply its AOCI
adjustment amount by the percentage of
the transition provided in Table 10
below and subtract the resulting amount
from its common equity tier 1 capital.459
If a banking organization’s AOCI
adjustment amount is negative, it would
457 For example, the SA–CVA calculation does
not fully account for the dependence between the
banking organization’s exposure to a counterparty
and the counterparty’s credit quality.
458 Any banking organization not subject to
Category I, II, III, or IV standards that becomes
subject to Category I, II, III, or IV standards during
the proposed transition period, would be eligible
equity tier 1 capital elements before applying the
deductions for investments in capital instruments,
covered debt instruments, MSAs and temporary
difference DTAs, if applicable. See 12 CFR 3.22(c)
and (d) (OCC); 12 CFR 217.22(c) and (d) (Board); 12
CFR 324.22(c) and (d) (FDIC).
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IV. Transition Provisions
for the remaining time that the transition provisions
provide. Beginning July 1, 2028, no transitions
under this proposal would be provided to banking
organizations that become subject to Category I, II,
III, or IV standards.
459 The proposal would require a banking
organization to subtract the percentage of the AOCI
adjustment amount from the sum of its common
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This aggregation formula differs from
the one used in the sensitivities-based
method for market risk. In order to
compensate for a higher level of model
risk in the calculation of sensitivities for
the aggregate regulatory CVA arising
from the CVA risk covered positions
relative to that for market risk covered
positions, the proposed inter-bucket
aggregation formula includes a
multiplication factor (mcva) with a
default value equal to one but would
allow the primary Federal supervisor to
increase the multiplier and scale up
risk-based capital required for each risk
class (K), if the supervisor determines
that the banking organization’s CVA
model risk warrants such an increase.457
The primary Federal supervisor would
notify the banking organization in
writing that a different value must be
used.
Finally, as with the sensitivities-based
method for market risk, the overall riskbased capital requirement for CVA risk
would be the simple sum of the
separately calculated risk-class level
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perform the same calculation and
subtract the resulting amount from its
common equity tier 1 capital. All other
elements of the calculation of regulatory
capital would apply upon the effective
date of the rule.
Question 173: What are the
advantages and disadvantages of the
proposed transition provisions? What
alternatives to the proposed
implementation should the agencies
consider and why, including to the
length and amounts of the proposed
transitions? What, if any, additional
transitions should the agencies consider
in connection with the proposal, such as
for aspects of the calculation of
regulatory capital other than related to
AOCI? For example, if warranted, how
could the transitions be applied relative
to the standardized approach?
Question 174: What are the
advantages and disadvantages of
providing a transition for any increase
in market risk capital requirements, as
described in the proposal? How should
the transitional amount be determined
and what would be the appropriate time
frame for a transition and why? How
should the transitional provision be
designed to ensure banking
organizations do not have lower market
risk capital requirements during the
transition period relative to the current
rule, while accounting for operational
burden?
of the credit risk and operational risk
frameworks. This would have the effect
of modestly increasing capital
requirements for lending activity.
Although a slight reduction in bank
lending could result from the increase
in capital requirements, the economic
cost of this reduction would be more
than offset by the expected economic
benefits associated with the increased
resiliency of the financial system.
Additionally, the relative capital
requirements associated with different
types of bank lending would change
slightly, which could lead to small
changes in loan portfolio allocations.
Capital requirements for trading
activities would be determined by the
market risk, CVA risk, and operational
risk frameworks, and are estimated to
increase substantially, though the
specific outcome will depend on
banking organizations’ implementation
of internal models. The proposed
market risk framework would capture a
larger range of risks and improve the
resiliency of banking organizations
relative to the current capital rule,
although it could also increase banking
organizations’ costs of engaging in
market making activities.
The remainder of this section reviews
the agencies’ analyses, starting with a
description of the banking-organization
scope of the proposal and the data used,
followed by the resulting estimates of
the impact the proposed rule would
have on the risk-weighted assets and
capital requirements of affected banking
organizations. It then discusses the
economic impact of the proposal—cost
and benefits—on lending activity and
trading activity respectively. This
section concludes with a discussion of
the impact of the proposal on other
connected rules and regulations.
III, or IV capital standards, and to
banking organizations with significant
trading activity, while retaining the
current U.S. standardized approach for
all banking organizations. As of
December 31, 2022, there were 37 toptier U.S. depository institution holding
companies and 62 U.S.-based depository
institutions that report risk-based
capital figures and are subject to
Category I, II, III, or IV standards. The
37 top-tier depository institution
holding companies include 25 U.S.domiciled holding companies (8 in
Category I, 1 in Category II, 5 in
Category III, and 11 in Category IV) and
12 U.S. intermediate holding companies
of foreign banking organizations (6 in
Category III and 6 in Category IV).
To estimate the impact of the proposal
on these large banking organizations,
the agencies utilized data collected in
Quantitative Impact Study (QIS) reports
from the Basel III monitoring exercises
as well as regulatory financial reports
(Call Report, FR Y–9C, FR Y–14, and
FFIEC 101). The year-end 2021 reports
are used for estimating the impact of the
proposal on risk-weighted assets
calculation and its consequence on
capital requirements and potential
capital shortfalls.460 Data over a longer
time period—2015 to 2022—are used to
estimate the effect of AOCI recognition
and the threshold deductions.
V. Impact and Economic Analysis
The agencies assessed the impact of
the proposal on banking organization
capital requirements and its likely effect
on economic activity and resilience. The
proposal is expected to strengthen riskbased capital requirements for large
banking organizations by improving
their comprehensiveness and risk
sensitivity. Better alignment between
capital requirements and risk-taking
helps to ensure that banks internalize
the risk of their operations. The agencies
expect that the benefits of strengthening
risk-based capital requirements for large
banking organizations outweigh the
costs.
Under the proposal, capital
requirements for lending activities
would be determined by a combination
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A. Scope and Data
The proposal would apply revised
capital requirements to banking
organizations subject to Category I, II,
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B. Impact on Risk-Weighted Assets and
Capital Requirements
To improve the risk sensitivity and
robustness of risk-based capital
requirements, the proposal would revise
calculations of risk-weighted assets for
large banking organizations.
Consequently, a large banking
organization’s risk-based capital
requirements would change even
460 The number of entities considered for the
purpose of impact estimates, based on year-end
2021 reports, may differ from the number of entities
reported above as in-scope, based on year-end 2022
reports.
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though the minimum capital ratios
would not. The impact of the proposal
depends on each banking organization’s
exposures. The current binding riskbased capital requirement serves as the
baseline relative to which impacts are
measured in the following analysis.
The impact estimates come with
several caveats. First, these estimates
heavily rely on banking organizations’
Basel III QIS submissions. The Basel III
QIS was conducted before the
introduction of a U.S. notice of
proposed rulemaking, and therefore is
based on banking organizations’
assumptions on how the Basel III
reforms would be implemented in the
United States. For market risk, the
impact of the proposal further depends
on banking organizations’ assumptions
on the degree to which they will pursue
the internal models versus the
standardized approach and their success
in obtaining approval for modeling.
Second, for banking organizations that
do not participate in Basel III
monitoring exercises, the agencies’
estimates are primarily based on
banking organizations’ regulatory
filings, which do not include sufficient
granularity for precise estimates.461 In
cases where the proposed capital
requirements are difficult to calculate
because there is no formula to apply (in
particular, the proposed market risk rule
revisions), impact estimates are based
on projections of the other banking
organizations that submitted QIS
reports. Third, estimates are based on
banking organizations’ balance sheets as
of year-end 2021, and do not account for
potential changes in banking structure,
banking organization behavior, or
market conditions since that point.
In aggregate across holding companies
subject to Category I, II, III or IV
standards, the agencies estimate that the
proposal would increase total riskweighted assets by 20 percent relative to
the currently binding measure of riskweighted assets. Across depository
institutions subject to Category I, II, III
or IV standards, the agencies estimate
that the proposal would increase risk-
weighted assets by 9 percent. Estimated
impacts vary meaningfully across
banking organizations, depending on
each banking organization’s activities
and risk profile.462
As described previously, the proposal
would replace the current advanced
approaches with the new expanded riskbased approach, consisting of the new
standardized approaches for credit,
operational, and CVA risk, and the new
market risk framework. At the same
time, the proposal would not change the
current U.S. standardized approach,
other than through the revisions to
market risk. Table 11 provides riskweighted assets aggregated across
holding companies, for both the current
U.S. standardized and advanced
approaches as well as estimated values
under this proposal. Because banking
organizations subject to Category III or
IV capital standards are not currently
subject to the advanced approaches, the
table separates those banking
organizations from the ones subject to
Category I or II capital standards.463
In general, the expanded risk-based
framework would produce greater
overall risk-weighted assets than either
of the current approaches. The overall
increase would lead to the expanded
risk-based framework becoming the
binding risk-based approach for most
large banking organizations. As a result,
the most commonly binding capital
requirement would shift from the
current standardized approach to the
expanded risk-based approach. For a
number of reasons, this would result in
capital requirements becoming more
sensitive to the specific risks of large
banking organizations. The risk weights
applicable to credit risk exposures
would be more granular under the
expanded risk-based approach than
under the current standardized
approach. Additionally, the inclusion of
461 For credit risk revisions, almost all banking
organizations subject to Category I or II capital
standards, as well as two banking organizations
subject to Category III capital standards, report their
estimated impacts. For market risk revisions, only
the top trading firms report their estimated impacts.
462 The estimated increase in risk-weighted assets
is 25 percent for holding companies subject to
Category I or II standards, 6 percent for domestic
holding companies subject to Category III or IV
standards, and 25 percent for intermediate holding
companies of foreign banking organizations subject
to Category III and IV standards.
463 For brevity, the decomposition at the
depository institution level is omitted here. The
comparison of risk-weighted assets by risk category
would look similar at the depository institution
level except that CVA risk and market risk riskweighted assets are considerably smaller because
trading assets are largely outside of the depository
institutions.
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an operational and CVA risk component
in the binding requirement ensures that
large banking organizations are more
attuned to managing these risks. Finally,
the new market risk rule would be
applicable under both the U.S.
standardized and expanded risk-based
approaches, improving capture of tail
risks and other features that are difficult
to model.
While the proposal would not
generally change the minimum required
capital ratios, the amount of required
capital would change due to changes to
the calculation of risk-weighted assets.
As a result of the increases in riskweighted assets, the agencies estimate
that the proposal would increase the
binding common equity tier 1 capital
requirement, including minimums and
buffers, of large holding companies by
around 16 percent.464 The aggregate
percentage increase is smaller for capital
than for risk-weighted assets because for
some banking organizations in the
sample, the stress capital buffer
requirement is determined by the dollar
amount of the stress losses from the
supervisory stress tests and therefore
does not increase with the change in
risk-weighted assets.465 Across
depository institutions subject to
Category I, II, III or IV standards, the
agencies estimate that the proposal
would increase the binding common
equity tier 1 capital requirement by an
estimated 9 percent, consistent with the
increase in risk-weighted assets for the
depository institutions. The percentage
impact of the proposal on binding tier
1 capital requirements would be smaller
than for common equity tier 1 because
the supplementary leverage ratio, which
is calculated as tier 1 capital divided by
total leverage exposure, binds in some
large banking organizations.
At year-end 2021, five holding
companies that were subject to Category
I or II capital standards had less
common equity tier 1 capital than what
the agencies estimate would have been
required under the proposal. To meet
464 Further breakdown by category shows that the
proposal would increase binding common equity
tier 1 capital requirements by an estimated 19
percent for holding companies subject to Category
I or II capital standards, by an estimated 6 percent
for Category III and IV domestic holding companies,
and by an estimated 14 percent for Category III and
IV intermediate holding companies of foreign
banking organizations. The impact assessment
focuses on common equity tier 1 capital because it
is the highest quality of regulatory capital and its
minimum regulatory requirements are risk-based.
465 This analysis assumes that the stress test
losses projected under the supervisory stress tests
are unchanged by the proposal, although the stress
capital buffer requirement for each banking
organization is floored by 2.5 percent of riskweighted assets which would be generally higher
due to the proposal.
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the proposed capital requirement, these
five holding companies would have
needed to increase capital ratios
between 16 and 105 basis points relative
to their risk-weighted assets prior to
Basel III reforms. For comparison, the
largest U.S. bank holding companies
annually earned an average of 180 basis
points of capital ratio between 2015 and
2022.466 All of the depository
institutions, as well as all holding
companies that were subject to Category
III or IV capital standards, would have
met the common equity tier 1 capital
requirements under the proposal.
While most large banking
organizations already have enough
capital to meet the proposed
requirements, the proposal would likely
result in an increase in equity capital
funding maintained by these banking
organizations. There is extensive
academic literature on the impact of
bank capital on economic activity which
typically focuses on the tradeoff of safer
individual banks and improved
macroeconomic stability against
reduced credit supply and
investment.467 Some studies further
consider the financial stability
implications of potential migration of
banking activities to nonbanks.468 While
quantification of the economic costs and
benefits of changes in bank capital is
difficult and highly contingent on the
assumptions made, current capital
requirements in the United States are
toward the low end of the range of
optimal capital levels described in the
existing literature.469 On balance, this
466 Earned capital is computed as net income
relative to risk-weighted assets.
467 See Basel Committee on Banking Supervision,
2010, ‘‘An assessment of the long-term economic
impact of stronger capital and liquidity
requirements;’’ (BCBS, 2010) Slovik, Patrick and
Boris Courne`de, 2011, ‘‘Macroeconomic Impact of
Basel III’’, OECD Economics Department Working
Papers 844; Booke, Martin et al., 2015, ‘‘Measuring
the macroeconomic costs and benefits of higher UK
bank capital requirements,’’ Bank of England
Financial Stability Paper 35; Dagher, Jihad,
Giovanni Dell’Ariccia, Luc Laeven, Lev Ratnovski,
and Hui Tong, 2016, ‘‘Benefits and Costs of Bank
Capital,’’ IMF Staff Discussion Note 16/04 (Dagher
et al., 2016); Firestone, Simon, Amy Lorenc, and
Ben Ranish, 2019, ‘‘An Empirical Economic
Assessment of the Costs and Benefits of Bank
Capital in the US,’’ St. Louis Review Vol. 101 (3)
(Firestone, Lorenc, and Ranish, 2019).
468 See Begenau, Juliane and Tim Landvoigt,
2022, ‘‘Financial Regulation in a Quantitative
Model of the Modern Banking System,’’ The Review
of Economic Studies 89(4): 1748–1784 (Begenau
and Landvoigt, 2022). See also Irani, Rustom M.,
Rajkamal Iyer, Ralf R. Meisenzahl, and Jose-Luis
Peydro, 2021, ‘‘The Rise of Shadow Banking:
Evidence from Capital Regulation.’’ The Review of
Financial Studies 34: 2181–2235.
469 Studies suggesting generally higher optimal
capital requirements include Miles, David, Jing
Yang, and Gilberto Marcheggiano, 2013, ‘‘Optimal
Bank Capital,’’ The Economic Journal 123: 1–37;
Dagher et al. (2016); Firestone, Lorenc, and Ranish
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literature concludes that there is room
to increase capital requirements from
their current levels while still yielding
positive net benefits.
C. Economic Impact on Lending Activity
This subsection discusses the
proposal’s potential impact on lending.
Lending activity creates credit riskweighted assets and increases banking
organizations’ net interest income,
which is a significant driver of
operational risk-weighted assets under
the expanded risk-based approach.
Therefore, the agencies quantified how
the proposal would impact riskweighted assets associated with lending
activity by adding changes to credit riskweighted assets and the interest incomerelated part of operational risk-weighted
assets.
The agencies estimate that riskweighted assets (RWA) associated with
banking organizations’ lending activities
would increase by $380 billion for
holding companies subject to Category I,
II, III, or IV capital standards due to the
proposal. This increase is roughly
equivalent to an increase of 30 basis
points in required risk-based capital
ratios across large banking
organizations. While this increase in
requirements could lead to a modest
reduction in bank lending, with possible
implications for economic growth, the
benefits of making the financial system
more resilient to stresses that could
otherwise impair growth are greater.470
Historical experience has demonstrated
the severe impact that distress or failure
at individual banking organizations can
have on the stability of the U.S. banking
system, in particular banking
organizations that would have been
subject to the proposal. The banking
organizations that experience an
increase in their capital requirements
under the proposal would be better able
to absorb losses and continue to serve
households and businesses through
times of stress. Enhanced resilience of
the banking sector supports more stable
(2019); Begenau and Landvoigt (2022); and Van den
Heuvel, Skander, 2022, ‘‘The Welfare Effects of
Bank Liquidity and Capital Requirements,’’ FEDS
Working Paper. Some studies suggest somewhat
lower optimal capital requirements, for example,
BCBS (2010) and Elenev, Vadim, Tim Landvoight,
Stijn van Nieuwerburgh, 2021, ‘‘A Macroeconomic
Model with Financially Constrained Producers and
Intermediaries,’’ Econometrica 89(3): 1361–1418.
470 See Macroeconomic Assessment Group, 2010,
‘‘Assessing the macroeconomic impact of the
transition to stronger capital and liquidity
requirements,’’ Final Report; Brooke, Martin et al.,
2015, ‘‘Measuring the macroeconomic costs and
benefits of higher UK bank capital requirements,’’
Bank of England Financial Stability Paper 35;
Slovik, Patrick and Boris Courne`de, 2011,
‘‘Macroeconomic Impact of Basel III’’, OECD
Economics Department Working Papers 844;
Firestone, Lorenc, and Ranish (2019).
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lending through the economic cycle and
diminishes the likelihood of financial
crises and their associated costs.
Similarly, while increases in market
risk capital requirements could have
some spillover impact on lending,
increases in capital requirements in
general should also enhance the
resilience of the banking system,
supporting lending and economic
activity in downturns.
The agencies further analyzed asset
class-level funding costs and incentives
for reallocation within banking
organizations’ lending activities. The
agencies estimate that the proposal
would slightly decrease marginal riskweighted assets attributable to retail and
commercial real estate exposures and
slightly increase marginal risk-weighted
assets attributable to corporate,
residential real estate and securitization
exposures.471 From the marginal riskweighted assets, the agencies derive the
marginal required capital for each asset
class under the proposal. The changes
in required capital drive the cost of
funding for each asset class, which may
in turn influence banking organizations’
portfolio allocation decisions. Based on
the estimated sensitivity of lending
volumes to capital requirements found
in the existing literature,472 the agencies
estimate that changes in asset classspecific risk weights would change
banking organizations’ portfolio
471 The agencies estimate the marginal RWA
under the expanded risk-based approach and
compare it to the marginal RWA under the current
U.S. standardized approach. Marginal RWA for
each asset class are defined as the incremental riskweighted assets resulting from an incremental
dollar of exposure invested pro rata within the asset
class. This analysis considers the contribution of
risk exposures to risk-weighted assets holistically,
accounting both for their credit risk RWA as well
as the incremental operational risk RWA resulting
from the exposures. The estimates derive from the
aggregate balance sheet of all holding companies
subject to Category I, II, III, or IV capital standards
and, therefore, represent the average exposure
within each asset class at such banking
organizations.
472 See Aiyar, Shekhar, Charles W. Calomiris, and
Tomasz Wieladek, 2014, ‘‘Does Macro-prudential
Regulation Leak? Evidence from a UK Policy
Experiment,’’ Journal of Money, Credit and Banking
46 (s1), 181–214; Behn, Markus, Rainer Haselmann,
and Paul Wachtel, 2016, ‘‘Procyclical Capital
Regulation and Lending.’’ Journal of Finance 71 (2),
919–956; Bridges, Jonathan, David Gregory, Mette
Nielsen, Silvia Pezzini, Amar Radia, and Marco
Spaltro, 2014, ‘‘The Impact of Capital Requirements
on Bank Lending,’’ Bank of England Working Paper
486; Fraisse, Henri, Mathias Le´, and David
Thesmar, 2020, ‘‘The Real Effects of Bank Capital
Requirements,’’ Management Science 66 (1), 5–23;
Gropp, Reint, Thomas Mosk, Steven Ongena, and
Carlo Wix, 2020, ‘‘Banks Response to Higher Capital
Requirements: Evidence from a Quasi-natural
Experiment,’’ Review of Financial Studies 32 (1),
266–299; Plosser, Matthew C. and Joa˜o A. C. Santos,
2018, ‘‘The Cost of Bank Regulatory Capital,’’ FRB
of New York Staff Report 853.
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allocations only by a few percentage
points.
The proposal may have second-order
effects on other banking organizations,
as a result of potential changes in large
banking organizations’ lending
decisions. Large banking organizations
may shift asset allocation toward assets
that are assigned lower risk weights
under the proposal relative to current
capital rule, which would affect other
lenders that compete in the same
lending markets. The proposal mitigates
potential competitive benefits for large
banking organizations first by requiring
that they continue to be subject to the
current standardized approach. This
requirement guarantees that a large
banking organization covered by the
proposal would maintain equity capital
funding at a level at least as high as that
required by the U.S. standardized
approach for a banking organization not
covered by the proposal.
In addition, the proposal attempts to
mitigate potential competitive effects
between U.S. banking organizations by
adjusting the U.S. implementation of the
Basel III reforms, specifically by raising
the risk weights for residential real
estate and retail credit exposures.
Without the adjustment relative to Basel
III risk weights in this proposal,
marginal funding costs on residential
real estate and retail credit exposures for
many large banking organizations could
have been substantially lower than for
smaller organizations not subject to the
proposal. Though the larger
organizations would have still been
subject to higher overall capital
requirements, the lower marginal
funding costs could have created a
competitive disadvantage for smaller
firms.
D. Economic Impact on Trading Activity
The agencies estimate that capital
requirements primarily affecting trading
activities would increase substantially,
though the actual outcome will depend
on banking organizations’ particular
exposures and implementation of
internal models. Based on the year-end
of 2021 data and QIS reports of large
banking organizations, the agencies
estimate that the increase in RWA
associated with trading activity (market
risk RWA, CVA risk RWA, and
attributable operational risk RWA)
would be around $880 billion for large
holding companies. Consequently, the
increase in RWA associated with trading
activity would raise required capital
ratios by as much as roughly 67 basis
points across large holding companies
subject to Category I, II, III, or IV capital
standards.
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The academic literature documents
important roles that financial
intermediaries play in lowering
transaction costs and improving market
efficiency.473 Several banking
organizations subject to the proposal are
major market makers in securities
trading and important liquidity
providers in over-the-counter markets.
Higher capital requirements for trading
activity could enhance the resilience of
bank-affiliated broker dealers and,
therefore, benefit the provision of
market liquidity, especially during
stress periods. Higher capital
requirements in normal times could also
discourage the type of excessive risktaking that resulted in large losses
during the 2007–09 financial crisis.
Over the long run, risk-weighted assets
calibrated to better capture risks could
support a larger role for bank-affiliated
dealers in market making and enhance
financial stability.
On the other hand, higher capital
requirements on trading activity may
also reduce banking organizations’
incentives to engage in certain market
making activities and may impair
market liquidity. The identification of
causal effects of tighter capital
requirements on market liquidity is
challenging, partly because historical
changes in capital regulations have
often happened at the same time as
changes in other factors affecting market
liquidity, such as other regulatory
changes, liquidity demand shocks, or
the development of electronic trading
platforms. The observable effects of
changes in capital requirements can also
vary depending on the measurements of
market liquidity.474 Therefore, existing
empirical studies on the relationship
between capital requirements and
market liquidity are limited and
empirical evidence on causal effects of
higher capital requirements on liquidity
is mixed.475 The overall effect of higher
473 See, e.g., Grossman, Sanford and Merton
Miller, 1988, ‘‘Liquidity and Market Structure,’’
Journal of Finance 43: 617–633; Duffie, Darrell,
Nicolae Gaˆrleanu, and Lasse Pedersen, 2005, ‘‘Overthe-Counter Markets,’’ Econometrica 73: 1815–
1847; and Duffie, Darrell and Bruno Strulovici,
2012, ‘‘Capital Mobility and Asset Pricing,’’
Econometrica 80: 2469–2509.
474 For a discussion on difficulties in detangling
impacts of capital regulation on market liquidity,
see Adrian, Tobias, Michael Fleming, Or Shachar,
and Erik Vogt, 2017, ‘‘Market Liquidity after the
Financial Crisis,’’ Annual Review of Financial
Economics, Vol. 9 (1): 43–83. For time-varying bond
market liquidity and mixed evidence on the
liquidity changes post the 2007–09 financial crisis,
see Anderson, Mike and Rene´ M. Stulz, 2017, ‘‘Is
Post-crisis Bond Liquidity Lower?’’ National
Bureau of Economic Research, Working Paper, No.
23317.
475 Empirical research on causal effects of banking
regulation generally compares liquidity provision
between bank-affiliated dealers and non-bank
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capital requirements on market making
activity and market liquidity remains a
research question needing further study.
E. Additional Impact Considerations
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In addition to the impact on riskweighted assets examined in previous
subsections, the proposal would also
affect large banking organizations
through changes in the calculation of
regulatory capital, total loss-absorbing
capacity (TLAC) and long-term debt
(LTD) requirements, single counterparty
credit limits, as well as the calculation
of method 2 GSIB scores.
First, the proposal would revise the
regulatory capital calculation of banking
organizations subject to Category III or
IV capital standards through the
recognition of AOCI and the application
of lower deduction thresholds. Under
the current capital framework, most
banking organizations subject to
Category III or IV capital standards have
opted to exclude AOCI from their
regulatory capital. The proposal would
withdraw this option and require AOCI
to be included in regulatory capital.
Notably, for holding companies
subject to Category III or IV capital
standards that opted out of the AOCI
inclusion, the majority (at the end of
2022, more than 80 percent) of AOCI is
attributable to substantial unrealized
losses on current or former available-forsale securities. Capital market and yield
curve developments can at times lead to
substantial AOCI fluctuation. In recent
years, the aggregate AOCI related to the
security holdings of holding companies
subject to Category III or IV capital
standards fluctuated between an
unrealized gain of $25 billion and an
unrealized loss of $108 billion.
Therefore, the agencies assessed the
impact of AOCI inclusion and threshold
deduction changes from a long-run
perspective, which provides a more
representative measure of the risk and
portfolio management practices of
banking organizations over time.
dealers. For evidence that bank dealers commit less
capital to market-making activities, see
Bessembinder, H., S. Jacobsen, W. Maxwell, and K.
Venkataraman, 2018, ‘‘Capital Commitment and
Illiquidity in Corporate Bonds,’’ Journal of Finance
73(4): 1615–1661, although this paper confirms that
postcrisis transaction costs have not increased
materially. For evidence that bank dealers did not
differentially decrease intermediation activity
relative to non-bank dealers, see Boyarchenko,
Nina, Anna Kovner, and Or Shachar, 2022, ‘‘It’s
What You Say and What You Buy: A Holistic
Evaluation of the Corporate Credit Facilities,’’
Journal of Financial Economics, Vol. 144(3): 695–
731. For evidence based on German bank data that
largely confirms findings in Bessembinder (2018),
see Haselmann, Rainer, Thomas Kick, Shikhar
Singla, and Vikrant Vig, 2022, ‘‘Capital Regulation,
Market-Making, and Liquidity,’’ Goethe University
LawFin Working Paper No. 44.
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The agencies used quarterly FR Y–9C
data from 2015 Q1 to 2022 Q4 to
estimate the effect of AOCI recognition
and quarterly FR Y–14Q data from 2020
Q3 to 2022 Q4 for the estimation of the
threshold deduction effect. The impact
of the proposal would generally be
driven by the AOCI recognition, albeit
threshold deduction changes would
dominate for the U.S. intermediate
holding companies of foreign banking
organizations subject to Category III
capital standards. The differential
impact holds for both risk-based capital
and leverage ratios. The agencies
estimate that the average long-run effect
of both proposed changes on domestic
holding companies subject to Category
III standards would be equivalent to a
4.6-percent and 3.8-percent relative
increase in the common equity tier 1
and leverage capital requirements,
respectively. For the U.S. intermediate
holding companies of foreign banking
organizations subject to Category III
capital standards, the average long-run
effect of both proposed changes would
be equivalent to a 13.2-percent and 9.7percent relative increase in the
respective requirements. For the holding
companies of banking organizations
subject to Category IV capital standards,
the average long-run effect of both
proposed changes would be equivalent
to a 2.6-percent and 2.5-percent relative
increase in the respective capital
requirements. Finally, if affected
banking organizations do not adjust
their AOCI management, for example by
adjusting the relative size, fair value
hedging, or interest rate sensitivity of
their available-for-sale security
portfolios, AOCI recognition could
increase variation in regulatory capital
ratios over time and make them more
correlated with market cycles.
Second, the RWA changes under the
proposal would affect the risk-based
TLAC and LTD requirements applicable
to Category I bank holding companies.
While the leverage-based TLAC
requirement was binding for half of the
bank holding companies subject to
Category I capital standards at the end
of 2021, the RWA increases under this
proposal would make the risk-based
TLAC requirement binding for all these
companies. The Board estimates 476 that
the average TLAC requirement for bank
holding companies subject to Category I
capital standards would increase by
15.2 percent as a result of the proposed
RWA changes, which would have
476 In these paragraphs, the term ‘‘Board
estimates’’ is used instead of the term ‘‘agencies
estimate’’ to reflect that the impact assessment is
related to Board rules, such as the TLAC, LTD, and
GSIB capital surcharge requirements.
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created a moderate shortfall in TLAC for
three of these companies at the end of
2021. Similarly, while the leveragebased LTD requirement was binding for
all bank holding companies subject to
Category I capital standards at the end
of 2021 Q4, the proposal would make
the risk-based LTD requirement binding
for some of these companies. The Board
estimates that the average LTD
requirement for bank holding
companies subject to Category I capital
standards would increase by 2.0 percent
as a result of the RWA changes, which
would not have created a shortfall in
LTD for any of these companies at the
end of 2021. Lastly, the RWA changes
under the proposal could also increase
the TLAC and LTD requirements for the
U.S. intermediate holding companies of
some globally systemically important
foreign banking organizations.
Third, the proposed elimination of the
internal models method for calculating
derivatives exposures would require all
large banking organizations to use the
standardized approach for counterparty
credit risk to calculate their singlecounterparty credit limits. The agencies
estimate that the standardized approach
for counterparty credit risk would
generally result in higher derivative
exposures than the internal models
method. Therefore, credit limits for
counterparties to which a banking
organization has derivatives exposure
are likely to become more stringent
under the proposal.
Fourth, the proposed RWA changes
would affect the method 2 scores of U.S.
GSIBs through the Short-Term
Wholesale Funding component score,
which is based on the ratio of average
weighted short-term wholesale funding
to average RWA. The Board estimates
that the proposal would decrease the
method 2 scores by 32 points on average
across U.S. GSIBs, which would reduce
their GSIB capital surcharges by about
16 basis points. This effect would
reduce the overall impact of the
proposal on the binding capital
requirements of banking organizations
subject to Category I capital standards.
VI. Technical Amendments to the
Capital Rule
The proposal would make certain
technical corrections and clarifications
to several provisions of the capital rule,
as described below. Most of these
proposed corrections or technical
changes are self-explanatory, such as
updates to terminology to align with the
proposal, and would apply only to
banking organizations that would be
subject to subpart E. In addition, there
are several transition provisions and
temporary provisions that have expired
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or no longer apply that the proposal
would remove from the capital rule. The
proposal would also make technical
updates to various aspects of the capital
rule to account for the proposed changes
to subparts E and F of the capital rule
related to the removal and replacement
of the current internal model-based
approaches for credit risk, operational
risk, and market risk. Also, the proposal
would make certain technical
corrections to the rule to address errors,
such updating the numbering of
footnotes in certain sections and
correcting the definition of qualifying
master netting agreement to include
criteria that were originally included
and inadvertently deleted. These
revisions are not all applicable to each
agency and would only apply to a given
agency as appropriate.
In § ll.2, the proposal would
remove references to subpart E for
purposes of the internal models
approach in the definition of residential
mortgage exposure and the treatment of
residential mortgages managed as part of
a segment of exposures with
homogenous risk characteristics.
In § ll.2 of the Board’s and the
OCC’s capital rule, the proposal would
correct the definition of qualifying
master netting agreement to put back
certain paragraphs related to a
walkaway clause. Under the 2013
capital rule,477 the definition of QMNA
required that the agreement not contain
a walkaway clause and that a banking
organization must comply with certain
operational requirements with respect to
the agreement. When the Board and
OCC finalized the restrictions in the
qualified financial contracts stay rule 478
and made conforming amendments to
the capital rule, certain paragraphs
related to a walkaway clause in the
definition of QMNA were removed in
error. The Board and OCC propose to
correct the error by inserting back the
two sub-paragraphs for the definition of
QMNA.
In § ll.10(c)(2)(i) of the capital rule,
the proposal would clarify in the
definition of total leverage exposure that
total leverage exposure amount could be
reduced by any AACL for on-balance
sheet assets. The capital rule defines
total leverage exposure to include the
carrying value of on-balance sheet assets
without any adjustment for AACL. The
definition of carrying value does not
allow for the reduction in the onbalance sheet amount by any credit loss
allowances, except for allowances
related to AFS securities and purchased
credit deteriorated assets. In the
477 See
478 See
78 FR 62018 (October 11, 2013).
82 FR 42882 (September 12, 2017).
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numerator of the supplementary
leverage ratio, the AACL flows through
earnings and is reflected in Tier 1
capital. To align the numerator and the
denominator of the SLR, the proposed
change would allow banking
organizations to net the AACL from the
denominator of the SLR.
The proposal would require banking
organizations subject to Category III or
IV standards to use SA–CCR, including
for purposes of calculating total leverage
exposure for derivatives under the
supplementary leverage ratio. In
§ ll.10(c) of the capital rule, banking
organizations subject to Category III or
IV capital standards are allowed to use
the current exposure method when
calculating the total leverage exposure.
The proposal would remove
§ ll.10(c)(2)(ii)(A) and (iii)(A), which
describe how total leverage exposure is
calculated when a banking organization
uses the current exposure method, since
under the proposal only SA–CCR would
be permitted under the proposal.
The proposal would make a technical
correction to § ll.10(c)(2)(ix) of the
capital rule to clarify the treatment of a
guarantee by a clearing member banking
organization of the performance of a
clearing member client on repo-style
transaction that the clearing member
client has with a central counterparty.
Consistent with the treatment of such
exposures under the risk-based
framework, the proposal would require
the clearing member banking
organization to treat the guarantee of
client performance on a repo-style
transaction as a repo-style style
transaction, just as it must treat such a
guarantee of client performance on a
derivative contract as a derivative
contract.
Under the capital rule, § ll.300(a)
covers the 2016 to 2018 transition for
the capital conservation buffer and
countercyclical capital buffer.
§ ll.300(c) covers the transition for
non-qualifying capital instruments that
expired in calendar year 2022.
§ ll.300(e) covers the transition for
prompt corrective action. § ll.300(f)
covers simplifications early adoption
and has expired by its terms.479
§ ll.300(g) of the capital rule covers
SA–CCR transition and § ll.300(h)
covers the default fund contribution
transition, both of which expired on
January 1, 2022. The proposal would
update the terminology in § ll.300(a)
and (c) of the capital rule and would
remove § ll.300(f) to (h).
§ ll.303 of the capital rule covers a
temporary exclusion from total leverage
exposure that ended March 31, 2021.
479 See
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§ ll.304 of the capital rule covers
temporary changes to the community
bank leverage ratio framework that
applied until December 31, 2021. The
proposal would remove § ll.303 and
§ ll.304 of the capital rule. Similarly,
§ ll.12(a)(4) of the capital rule covers
temporary relief for the community
bank leverage ratio that applied until
December 31, 2021, and would therefore
be removed from the capital rule.
A. Additional OCC Technical
Amendments
Enhanced Supplementary Leverage
Ratio
In addition to the technical
amendments described above, the OCC
is proposing to revise the methodology
it uses to identify which national banks
and Federal savings associations are
subject to the enhanced supplementary
leverage ratio (eSLR) standard to ensure
that the standard applies only to those
national banks and Federal savings
associations that are subsidiaries of a
Board-identified U.S. GSIB.
In 2014, the agencies adopted a final
rule that established the eSLR standard
for the largest, most interconnected U.S.
banking organizations (eSLR rule) in
order to strengthen the overall
regulatory capital framework in the
United States.480 The eSLR rule, as
adopted in 2014, applied to U.S. top-tier
bank holding companies with
consolidated assets over $700 billion or
more than $10 trillion in assets under
custody, or that are insured depository
institution (IDI) subsidiaries of holding
companies that meet those thresholds.
The eSLR rule also provides that any
subsidiary depository institutions of
those bank holding companies must
maintain a 6 percent supplementary
leverage ratio to be deemed ‘‘well
capitalized’’ under the prompt
corrective action (PCA) framework of
each agency.481
Subsequently, in 2015, the Board
adopted a final rule establishing a
methodology for identifying a bank
holding company as a U.S. GSIB and
applying a risk-based capital surcharge
on such an institution (GSIB surcharge
rule).482 Under the GSIB surcharge rule,
a U.S. top-tier bank holding company
that is not a subsidiary of a foreign
banking organization and that is an
advanced approaches banking
organization must determine whether it
is a U.S. GSIB by applying a multifactor
methodology based on size,
480 See
79 FR 24528 (May 1, 2014).
12 CFR part 6 (national banks) and 12 CFR
part 165 (Federal savings associations) (OCC).
482 12 CFR 217.402; 80 FR 49082 (August 14,
2015).
481 See
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interconnectedness, substitutability,
complexity, and cross-jurisdictional
activity.483 As part of the GSIB
surcharge rule, the Board revised the
application of the eSLR standard to
apply to any bank holding company
identified as a U.S. GSIB and to each
Board-regulated subsidiary depository
institution of a U.S. GSIB.484
The OCC’s current eSLR rule applies
to national banks and Federal savings
associations that are subsidiaries of U.S.
top-tier bank holding companies with
more than $700 billion in total
consolidated assets or more than $10
trillion total in assets under custody. In
order to align with the Board’s
regulations for identifying U.S. GSIBs
and measuring the eSLR standard for
holding companies and their subsidiary
depository institutions, the OCC is
proposing to revise its eSLR rule to
ensure that the eSLR standard will
apply to only those national banks and
Federal savings associations that are
subsidiaries of holding companies
identified as U.S. GSIBs under the GSIB
surcharge rule.
Definition of Financial Collateral
In § ll.2 of the OCC’s capital rule,
the proposed rule would correct an error
in the definition of financial collateral
by changing the word ‘‘and’’ in
paragraph (2) ‘‘in which the national
bank and Federal Savings association
has a perfected . . . [emphasis added]’’
to ‘‘or.’’ The proposed correction would
clarify that this requirement in the
definition of financial collateral applies
to national banks or Federal Savings
associations, as relevant.
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B. Additional FDIC Technical
Amendments
In addition to the joint technical
amendments described above, the FDIC
is proposing technical amendments to
certain provisions of the capital rule in
part 324 of the FDIC’s regulations.
Specifically, the FDIC proposes to
correct a spelling error in the definition
of ‘‘financial institution’’ in § 324.2.
Additionally, the FDIC proposes to
correct the footnote numbering in part
324 so that each section with any
footnote would begin with footnote 1.
This would affect the footnotes in
§§ 324.2, 324.4, 324.11, 324.20, and
324.22.
483 12 CFR part 217, subpart H. The methodology
provides a tool for identifying as GSIBs those
banking organizations that pose elevated risks.
484 The eSLR rule does not apply to intermediate
holding companies of foreign banking organizations
as such banking organizations are outside the scope
of the GSIB surcharge rule and cannot be identified
as U.S. GSIBs.
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The FDIC also proposes removing
expired or obsolete provisions from
various sections in part 324, including
section 324.1(f), footnote 10 in § 324.4,
§ 324.10(b)(5), and § 324.10(d)(4).
Finally, the FDIC proposes amending
§§ 324.401 and 324.403 of the prompt
corrective action provisions of subpart
H to remove outdated transitions and
obsolete references to part 325, and to
replace references to the advanced
approaches consistent with the
proposal.
VII. Proposed Amendments to Related
Rules and Related Proposals
A. OCC Amendments
Lending Limits Rule
The OCC’s lending limit rule 485
includes a definition of eligible credit
derivative, which references the
definition of eligible guarantee in the
capital rule.486 This proposed rule
would revise the definition of eligible
guarantee in 12 CFR part 3 to add a
requirement that an eligible guarantee
must be provided by an eligible
guarantor, also as defined in 12 CFR
part 3. To avoid imposing this
additional requirement of an eligible
guarantor for eligible credit derivatives,
as defined for lending limit purposes,
the OCC is proposing to revise the
definition of eligible credit derivative in
12 CFR part 32 to scope out the new
proposed requirement of an eligible
guarantor.
B. Board Amendments
In connection with this proposal, the
Board is proposing amendments to
various regulations that reference the
capital rule in order to make appropriate
conforming amendments to reflect this
proposal. For example, references to
advanced approaches risk-weighted
assets would be removed and replaced
with expanded total risk-weighted
assets, consistent with the proposal.
Such conforming changes would be
made to Regulation H (12 CFR part 208),
Regulation Y (12 CFR part 225),
Regulation LL (12 CFR part 238), and
Regulation YY (12 CFR part 252). To the
extent that other Board rules rely on
items determined under the capital rule,
changes to the capital rule could impact
the effective requirements of such other
Board rules. In addition to these
proposed amendments, as discussed
elsewhere in this document, the
proposal would amend Regulation Y,
Regulation LL, and Regulation YY as
appropriate to reflect the proposed
stress capital buffer framework.
485 12
CFR part 32.
12 CFR 32.2(m)(1).
486 See
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Question 175: What modifications, if
any, should the Board consider to this
proposal or to other Board rules
indirectly affected by this proposal?
C. Related Proposals
The Board is separately issuing a
proposal (the GSIB surcharge proposal)
that would amend the Board’s
framework under the capital rule for
identifying and establishing risk-based
surcharges for global systemically
important bank holding companies
(GSIBs). The GSIB surcharge proposal
would also amend the FR Y–15, which
is the source of inputs to the
implementation of the GSIB framework
under the capital rule. The changes set
forth in the GSIB surcharge proposal
would improve the sensitivity of the
GSIB surcharge to changes in a GSIB’s
systemic footprint and better measure
systemic risk under the framework.
As discussed in section II of this
SUPPLEMENTARY INFORMATION, the
current proposal would broaden the
scope of application of the
supplementary leverage ratio
requirement. To account for this aspect
of the proposal, the GSIB surcharge
proposal would require all banking
organizations that file the FR Y–15 to
report data for the total exposures
systemic indicator as the average of
daily values for on-balance sheet items
and the average of month-end values for
off-balance sheet items, to align with the
calculation of total leverage exposure for
purposes of the supplementary leverage
ratio requirement.
Question 176: What modifications, if
any, should the Board consider to this
proposal due to the Board’s separate
GSIB proposal and why?
VIII. Administrative Law Matters
A. Paperwork Reduction Act
Certain provisions of the proposed
rule contain ‘‘collections of
information’’ within the meaning of the
Paperwork Reduction Act of 1995
(PRA).487 In accordance with the
requirements of the PRA, the agencies
may not conduct or sponsor, and a
respondent is not required to respond
to, an information collection unless it
displays a currently valid Office of
Management and Budget (OMB) control
number. The information collection
requirements contained in this joint
notice of proposed rulemaking have
been submitted to OMB for review and
approval by the OCC and FDIC under
section 3507(d) of the PRA (44 U.S.C.
3507(d)) and § 1320.11 of OMB’s
implementing regulations (5 CFR part
487 44
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1320). The Board reviewed the proposed
rule under the authority delegated to the
Board by OMB.
The proposed rule contains revisions
to current information collections
subject to the PRA. To implement these
requirements, the agencies would revise
and extend for three years the (1)
Reporting, Recordkeeping, and
Disclosure Requirements Associated
with Regulatory Capital Rules (OMB
Nos. 1557–0318, 3064–0153, and 7100–
0313) and (2) Reporting, Recordkeeping,
and Disclosure Requirements
Associated with Market Risk Capital
Rules (OMB Nos. 1557–0247, 3064–
0178, and 7100–0314). The Board would
also revise and extend for three years
the (1) Financial Statements for Holding
Companies (FR Y–9; OMB No. 7100–
0128), (2) the Capital Assessments and
Stress Testing (FR Y–14A/Q/M; OMB
No. 7100–0341), and (3) the Systemic
Risk Report (FR Y–15; OMB No. 7100–
0352).
The agencies, under the auspices of
the FFIEC, would also propose related
revisions to (1) all versions of the
Consolidated Reports of Condition and
Income (Call Reports) (FFIEC 031,
FFIEC 041, and FFIEC 051; OMB Nos.
1557–0081; 3064–0052, and 7100–
0036), (2) the Regulatory Capital
Reporting for Institutions Subject to the
Advanced Capital Adequacy Framework
(FFIEC 101; OMB Nos. 1557–0239,
3064–0159, and 7100–0319), and (3) the
Market Risk Regulatory Report for
Institutions Subject to the Market Risk
Capital Rule (FFIEC 102; OMB Nos.
1557–0325, 3064–0199, and 7100–
0365), including by adding a new sub
report, the FFIEC 102a. The proposed
revisions to these FFIEC reports will be
addressed in one or more separate
Federal Register notices.
Comments are invited on the
following:
(a) Whether the collections of
information are necessary for the proper
performance of the agencies’ functions,
including whether the information has
practical utility;
(b) the accuracy of the agencies
estimates of the burden of the
information collections, including the
validity of the methodology and
assumptions used;
(c) ways to enhance the quality,
utility, and clarity of the information to
be collected;
(d) ways to minimize the burden of
the information collections on
respondents, including through the use
of automated collection techniques or
other forms of information technology;
and
(e) estimates of capital or start-up
costs and costs of operation,
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maintenance, and purchase of services
to provide information.
Comments on aspects of this
document that may affect reporting,
recordkeeping, or disclosure
requirements and burden estimates
should be sent to the addresses listed in
the ADDRESSES section of the
SUPPLEMENTARY INFORMATION. A copy of
the comments may also be submitted to
the OMB desk officer for the Agencies:
By mail to U.S. Office of Management
and Budget, 725 17th Street NW,
#10235, Washington, DC 20503 or by
facsimile to (202) 395–5806, Attention,
Federal Banking Agency Desk Officer.
1. Proposed Revisions, With Extension,
of the Following Information
Collections
a. (1) Collection Title: Reporting,
Recordkeeping, and Disclosure
Requirements Associated With
Regulatory Capital Rules
OCC
OMB control number: 1557–0318.
Frequency: Quarterly, annually,
event-generated.
Affected Public: Businesses or other
for-profit.
Respondents: National banks and
Federal savings associations.
Estimated number of respondents: 48
(48 expanded risk based approach).
Estimated average hours per response:
One-Time
Standardized Approach
Recordkeeping
Section 3.35(b)(3)(i)(A)—2.
Section 3.37(c)(4)(i)(E)—80.
Sections 3.41(b)(3) and 3.41(c)(2)(i)—
40.
Recordkeeping
Section 3.3(d)—8.
Standardized Approach
Reporting
Section 3.34(a)(1)(ii)—2.
Section 3.37(c)(4)(i)(E)—1.
Recordkeeping
Section 3.35(b)(3)(i)(A)—2.
Section 3.37(c)(4)(i)(E)—16.
Section 3.41(c)(2)(ii)—2.
Disclosure
Section 3.42(e)(2)—20.
Sections 3.62(a) through (c), 3.63(a)
and (b), and 3.63 tables—111.25.
Expanded Risk Based Approach
Reporting
Section 3.113(i)(3)(ii)(C)—2.
Section 3.114(d)(6)(vi)—2.
Section 3.150(d)(5)—20.
Sections 3.150(e)(3)(i) and (ii)—40.
Recordkeeping
Section 3.114(b)(3)(i)(A)—1.
Section 3.120(e)(1)—1.
Section 3.121(d)(2)(ii)(C)—1.
Section 3.130(b)(3)—39.
Section 3.130(c)(2)(ii)—2.
Sections 3.150(f)(1) and (2)—22.
Section 3.161(b)—1.
Disclosure
Sections 3.20(c)(1)(xiv) and
3.20(d)(1)(xi)—2.
Sections 3.162 and 3.162 Tables 1–
14—90.
Estimated annual burden hours:
20,535 (11,818 initial setup and 8,717
ongoing).
Board
Sections 3.162 and 3.162 Tables 1–
14—328.
Collection identifier: FR Q.
OMB control number: 7100–0313.
Frequency: Quarterly, annually,
event-generated.
Affected Public: Businesses or other
for-profit.
Respondents: State member banks,
certain bank holding companies, U.S.
intermediate holding companies, certain
covered savings and loan holding
companies.
Estimated number of respondents:
1,004 (48 expanded risk based
approach).
Estimated average hours per response:
Ongoing
One-Time
Minimum Capital Ratios
Standardized Approach
Reporting
Recordkeeping
Sections 3.22(b)(2)(iv), 3.22(c)(4),
3.22(c)(5)(i), 3.22(c)(6), 3.22(d)(2)(i)(C),
and 3.22(d)(2)(iii)—6.
Section 3.22(h)(2)(iii)(A)—2.
Section 217.35(b)(3)(i)(A)—2.
Section 217.37(c)(4)(i)(E)—80.
Sections 217.41(b)(3) and
217.41(c)(2)(i)—40.
Disclosure
Sections 3.42(e)(2), 3.62(a) through
(c), 3.63(a) and (b), and 3.63 tables—
226.25.
Expanded Risk Based Approach
Recordkeeping
Section 3.120(e)(1)—40.
Sections 3.130(c)(2)(i) and (ii)—81.
Sections 3.150(f)(1) and (2)—70.
Disclosure
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Disclosure
Sections 217.42(e)(2), 217.62(a)
through (c), 217.63(a) and (b), and
217.63 tables—226.25.
FDIC
Expanded Risk Based Approach
Recordkeeping
Section 217.120(e)(1)—40.
Sections 217.130(c)(2)(i) and (ii)—81.
Sections 217.150(f)(1) and (2)—70.
Disclosure
Sections 217.162, 217.162 Tables 1–
14—328, 217.162 Table 15 (Board
only)—30.
One-Time
Standardized Approach
Ongoing
Recordkeeping
Minimum Capital Ratios
Section 324.35(b)(3)(i)(A)—2.
Section 324.37(c)(4)(i)(E)—80.
Sections 324.41(b)(3) and
324.41(c)(2)(i)—40.
Reporting
Section 217.22(b)(2)(iv), (c)(4),
(c)(5)(i), (c)(6), (d)(2)(i)(C), and
(d)(2)(iii)—6.
Section 217.22(h)(2)(iii)(A)—2.
Disclosure
Sections 324.42(e)(2), 324.62(a)
through (c), 324.63(a) and (b), and
324.63 tables—226.25.
Recordkeeping
Section 217.3(d)—8.
Expanded Risk Based Approach
Standardized Approach
Recordkeeping
Reporting
Section 217.34(a)(1)(ii)—2.
Section 217.37(c)(4)(i)(E)—1.
Section 324.120(e)(1)—40.
Sections 324.130(c)(2)(i) and (ii)—81.
Sections 324.150(f)(1) and (2)—70.
Recordkeeping
Section 217.35(b)(3)(i)(A)—2.
Section 217.37(c)(4)(i)(E)—16.
Section 217.41(c)(2)(ii)—2.
Disclosure
Sections 324.162 and 324.162 Tables
1–14—328,
Ongoing
Disclosure
Section 217.42(e)(2)—20.
Sections 217.62(a) through (c),
217.63(a) and (b), and
217.63 tables—111.25.
Minimum Capital Ratios
Reporting
Expanded Risk Based Approach
Reporting
Section 217.113(i)(3)(ii)(C)—2.
Section 217.114(d)(6)(vi)—2.
Section 217.150(d)(5)—20.
Sections 217.150(e)(3)(i) and (ii)—40.
Recordkeeping
Section 217.114(b)(3)(i)(A)—1.
Section 217.120(e)(1)—1.
Section 217.121(d)(2)(ii)(C)—1.
Section 217.130(b)(3)—39.
Section 217.130(c)(2)(ii)—2.
Sections 217.150(f)(1) and (2)—22.
Section 217.161(b)—1.
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OMB control number: 3064–0153.
Frequency: Quarterly, annually,
event-generated.
Affected Public: Businesses or other
for-profit.
Respondents: State nonmember
banks, state savings associations, and
certain subsidiaries of those entities.
Estimated number of respondents:
3,038 (9 expanded risk based approach).
Estimated average hours per response:
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Recordkeeping
Section 324.3(d)—8.
Standardized Approach
Reporting
Section 324.34(a)(1)(ii)—2.
Section 324.37(c)(4)(i)(E)—1.
Recordkeeping
Section 324.35(b)(3)(i)(A)—2.
Section 324.37(c)(4)(i)(E)—16.
Section 324.41(c)(2)(ii)—2.
Disclosure
Sections 217.20(c)(1)(xiv) and
217.20(d)(1)(xi)—2.
Sections 217.162 and 217.162 Tables
1–14—90.
Section 217.162 Table 15 (Board
only)—30.
Estimated annual burden hours:
77,001 (17,956 initial setup and 59,045
ongoing).
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Sections 324.22(b)(2)(iv), 324.22(c)(4),
324.22(c)(5)(i), 324.22(c)(6),
324.22(d)(2)(i)(C), and 324.22(d)(2)(iii)—
6.
Section 324.22(h)(2)(iii)(A)—2.
Disclosure
Section 324.42(e)(2)—20.
Sections 324.62(a) through (c),
324.63(a) and (b), and 324.63 tables—
111.25.
Expanded Risk Based Approach
Reporting
Section 324.113(i)(3)(ii)(C)—2.
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Section 324.114(d)(6)(vi)—2.
Section 324.150(d)(5)—20.
Sections 324.150(e)(3)(i) and (ii)—40.
Recordkeeping
Section 324.114(b)(3)(i)(A)—1.
Section 324.120(e)(1)—1.
Section 324.121(d)(2)(ii)(C)—1.
Section 324.130(b)(3)—39.
Section 324.130(c)(2)(ii)—2.
Sections 324.150(f)(1) and (2)—22.
Section 324.161(b)—1.
Disclosure
Sections 324.20(c)(1)(xiv) and
324.20(d)(1)(xi)—2.
Sections 324.162 and 324.162 Tables
1–14—90.
Estimated annual burden hours:
118,392 (4,371 initial setup and 114,021
ongoing).
Current Actions: The proposal would
modify the reporting, recordkeeping,
and disclosure requirements of the
regulatory capital rules by adding new
requirements and revising existing
reporting, recordkeeping, and disclosure
requirements. The citations for the
requirements retained from the current
rule have been revised in keeping with
the broader proposal.
The proposed revisions would
include new recordkeeping
requirements related to the legal status
in bankruptcy of collateral posted to a
QCCP; the management of hedged
exposures during bankruptcy,
reorganization, or restructuring; and the
monitoring of operational risk. The
proposal would include new reporting
requirements related to the exclusion of
certain operational loss data from a
banking organization’s operational risk
calculation. The proposal would also
revise existing disclosure requirements
and add new disclosure requirements.
The disclosure requirements are laid out
in 15 tables, and the overall number of
disclosure requirements has dropped by
54 line items, including all quantitative
disclosures, which are now included in
regulatory reporting. Please see the
disclosure section III.G of this
SUPPLEMENTARY INFORMATION for a
detailed description of the proposed
revisions.
b. (2) Collection Title: Reporting,
Recordkeeping, and Disclosure
Requirements Associated With Market
Risk Capital Rules
OCC
OMB control number: 1557–0247.
Frequency: Quarterly, annually,
weekly, event-generated.
Affected Public: Businesses or other
for-profit.
Respondents: National banks and
Federal savings associations.
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Estimated number of respondents: 49.
Estimated average hours per response:
Reporting
Sections 3.201(b)(5)(i) and (ii), 3.202
Market risk covered position
(1)(ii)(A)(2), 3.204(d)(1), 3.204(d)(3)(i),
3.204(e)(1), 3.204(e)(2)(v), 3.204(e)(3),
3.204(g)(2), 3.204(g)(4), 3.205(f)(1)(ii),
3.205(h)(1)(ii)(B), 3.205(h)(1)(ii)(A)(3),
3.207(a)(3), (4), and (5), 3.207(a)(8),
3.208(b)(4), 3.208(h)(3)(ii), 3.212(a)(2),
3.212(b)(1)(iii)(C), 3.212(b)(3),
3.215(c)(1), 3.215(d)(1)(i), 3.221(a),
3.221(c)(2)(iii), 3.221(3), 3.223(a)(1), and
3.224(d)(3)(iii)—1,200.
Sections 3.204(g)(1)(iii), 3.212(b)(2),
and 3.212(c)—300.
Section 3.224(d)(3)(ii)—2.
Recordkeeping
Section 3.203(a)(1)—96.
Section 3.203(a)(2)—16.
Section 3.203(b)(2)—16.
Sections 3.203(c), 3.203(h),
3.208(h)(1)(ii)(B), and
3.214(b)(7)(iv),(vi), and (vii)—96.
Section 3.203(e)(1)—12.
Section 3.203(e)(3)—12.
Section 3.203(f)—12.
Section 3.203(g)—12.
Sections 3.203(h)(2)(i)—80.
Section 3.203(h)(2)(ii)—12.
Sections 3.203(i) and 3.205(h)—48.
Sections 3.213—128.
Section 3.214(b)(7)(v)—12.
Section 3.217(c)—40.
Section 3.220(b)—40.
Sections 3.223(b)(4), 3.223(b)(7), and
3.223(b)(9),—40.
Section 3.223(b)(10)—12.
Disclosure
Section 3.217(d)—12.
Section 3.217(e)—12.
Sections 3.217(f)(1) and 3.217(f)(3)—
16.
Section 3.217(f)(2)—8.
Estimated annual burden hours:
127,254.
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Board
Collection identifier: FR 4201.
OMB control number: 7100–0314.
Frequency: Quarterly, annually,
weekly, event-generated.
Affected Public: Businesses or other
for-profit.
Respondents: Bank holding
companies, savings and loan holding
companies, intermediate holding
companies, and state member banks that
meet certain risk thresholds.
Estimated number of respondents: 33.
Estimated average hours per response:
Reporting
Sections 217.201(b)(5)(i) and (ii),
217.202 Market risk covered position
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(1)(ii)(A)(2), 217.204(d)(1),
217.204(d)(3)(i), 217.204(e)(1),
217.204(e)(2)(v), 217.204(e)(3),
217.204(g)(2), 217.204(g)(4),
217.205(f)(1)(ii), 217.205(h)(1)(ii)(B),
217.205(h)(1)(ii)(A)(3), 217.207(a)(3),
(4), and (5), 217.207(a)(8), 217.208(b)(4),
217.208(h)(3)(ii), 217.212(a)(2),
217.212(b)(1)(iii)(C), 217.212(b)(3),
217.215(c)(1), 217.215(d)(1)(i),
217.221(a), 217.221(c)(2)(iii), 217.221(3),
217.223(a)(1), and 217.224(d)(3)(iii)—
1,200.
Sections 217.204(g)(1)(iii),
217.212(b)(2), and 217.212(c)—300.
Section 217.224(d)(3)(ii)—2.
Recordkeeping
Section 217.203(a)(1)—96.
Section 217.203(a)(2)—16.
Section 217.203(b)(2)—16.
Sections 217.203(c), 217.203(h),
217.208(h)(1)(ii)(B), and
217.214(b)(7)(iv), (vi), and (vii)—96.
Section 217.203(e)(1)—12.
Section 217.203(e)(3)—12.
Section 217.203(f)—12.
Section 217.203(g)—12.
Section 217.203(h)(2)(i)—80.
Section 217.203(h)(2)(ii)—12.
Sections 217.203(i) and 217.205(h)—
48.
Sections 217.213—128.
Section 217.214(b)(7)(v)—12.
Section 217.217(c)—40.
Section 217.220(b)—40.
Sections 217.223(b)(4), 217.223(b)(7),
and 217.223(b)(9)—40.
Section 217.223(b)(10)—12.
Disclosure
Section 217.217(d)—12.
Section 217.217(e)—12.
Sections 217.217(f)(1) and
217.217(f)(3)—16.
Section 217.217(f)(2)—8.
Estimated annual burden hours:
89,622.
FDIC
OMB control number: 3064–0178.
Frequency: Quarterly, annually,
weekly, event-generated.
Affected Public: Businesses or other
for-profit.
Respondents: State nonmember
banks, state savings associations, and
certain subsidiaries of those entities.
Estimated number of respondents: 9.
Estimated average hours per response:
Reporting
Sections 324.201(b)(5)(i) and (ii),
324.202 Market risk covered position
(1)(ii)(A)(2).
Sections 324.204(d)(1),
324.204(d)(3)(i), 324.204(e)(1),
324.204(e)(2)(v), 324.204(e)(3),
324.204(g)(2), 324.204(g)(4),
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324.205(f)(1)(ii), 324.205(h)(1)(ii)(B),
324.205(h)(1)(ii)(A)(3), 324.207(a)(3),
(4), and (5),
Sections 324.207(a)(8), 324.208(b)(4),
324.208(h)(3)(ii), 324.212(a)(2),
324.212(b)(1)(iii)(C), 324.212(b)(3),
324.215(c)(1), 324.215(d)(1)(i),
324.221(a), 324.221(c)(2)(iii), 324.221(3),
324.223(a)(1), and 324.224(d)(3)(iii)—
1,200.
Sections 324.204(g)(1)(iii),
324.212(b)(2), and 324.212(c)—300.
Section 324.224(d)(3)(ii)—2.
Recordkeeping
Section 324.203(a)(1)—96.
Section 324.203(a)(2)—16.
Section 324.203(b)(2)—16.
Sections 324.203(c), 324.203(h),
324.208(h)(1)(ii)(B), and
324.214(b)(7)(iv), (vi), and (vii)—96.
Section 324.203(e)(1)—12.
Section 324.203(e)(3)—12.
Section 324.203(f)—12.
Section 324.203(g)—12.
Sections 324.203(h)(2)(i)—80.
Section 324.203(h)(2)(ii)—12.
Sections 324.203(i) and 324.205(h)—
48.
Sections 324.213—128.
Section 324.214(b)(7)(v)—12.
Section 324.217(c)—40.
Section 324.220(b)—40.
Sections 324.223(b)(4), 324.223(b)(7),
and 324.223(b)(9)—40.
Section 324.223(b)(10)—12.
Disclosure
Section 324.217(d)—12.
Section 324.217(e)—12.
Sections 324.217(f)(1) and
324.217(f)(3)—16.
Section 324.217(f)(2)—8.
Estimated annual burden hours:
22,370.
Current Actions: The agencies are
proposing to amend their market risk
information collections to reflect the
proposed recordkeeping, disclosure, and
reporting requirements associated with
the proposed market risk capital
requirements. In addition, the agencies
are proposing to add recordkeeping
requirements to this information
collection associated with the proposed
credit valuation adjustment.
Under the proposal, a banking
organization that is subject to the
proposed market risk capital
requirements would have to provide
public regulatory reports in the manner
and form prescribed by its primary
Federal supervisor, including any
additional information and reports that
the supervisor may require. A banking
organization would have to receive a
prior written approval of its primary
Federal supervisor for calculating
market risk capital requirements using
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Federal Register / Vol. 88, No. 179 / Monday, September 18, 2023 / Proposed Rules
internal models. Section
ll.212(b)(2)(i) of the market risk rule
requires a banking organization that is
subject to the market risk capital
requirements to obtain the prior written
approval of the primary Federal
supervisor before using any internal
model to calculate its risk-based capital
requirements.
Any such banking organization that
received a prior written approval from
its primary Federal supervisor to
calculate market risk capital
requirements under the models-based
measure would have to provide
confidential supervisory reports to its
primary Federal supervisor in a manner
and form prescribed by that supervisor.
Specifically, under the proposal, a
banking organization using the modelsbased measure to calculate market risk
capital requirements would be required
to submit, via confidential regulatory
reporting in the manner and form
prescribed by the primary Federal
supervisor, data pertaining to a trading
desk’s backtesting and PLA testing
results. To reflect the proposed changes
to the market risk framework, the
proposal would require a banking
organization to submit backtesting
information at both the aggregate level
for model-eligible trading desks as well
as for each trading desk and profit and
loss attribution (PLA) testing
information for model-eligible trading
desks at the trading desk level on a
quarterly basis. Section ll.203(h)(1) of
the market risk rule requires that a
subject banking organization
demonstrate to the satisfaction of the
primary Federal supervisor a
comprehensive understanding of the
features of a securitization position that
would materially affect the performance
of the position by conducting and
documenting the analysis set forth in
§ ll.203(h)(2).
The proposal would also include
recordkeeping requirements for banking
organizations subject to the credit
valuation adjustment. Those include
that a banking organization must (1)
have a clear documented hedging policy
for credit valuation adjustment (CVA)
risk, (2) document identification and
management of CVA risk covered
positions and eligible CVA hedges, (3)
document the initial and ongoing
validation of models used for
calculating regulatory CVA, and (4)
maintain current and historical data
inputs to exposure models.
Disclosure requirements related to the
proposed CVA are included in section
ll.162, which would be part of
subpart E of Regulation Q. Therefore,
those requirements are included in the
Reporting, Recordkeeping, and
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Disclosure Requirements Associated
with Regulatory Capital Rules
information collections.
2. Proposed Revisions, With Extension,
of the Following Information
Collections (Board Only)
a. (1) Collection Title: Financial
Statements for Holding Companies
Collection identifier: FR Y–9C, FR Y–
9LP, FR Y–9SP, FR Y–9ES, and FR Y–
9CS.
OMB control number: 7100–0128.
General description of report: The FR
Y–9 family of reporting forms continues
to be the primary source of financial
data on holding companies (HCs) on
which examiners rely between on-site
inspections. Financial data from these
reporting forms is used to detect
emerging financial problems, review
performance, conduct pre-inspection
analysis, monitor and evaluate capital
adequacy, evaluate HC mergers and
acquisitions, and analyze an HC’s
overall financial condition to ensure the
safety and soundness of its operations.
The FR Y–9C, FR Y–9LP, and FR Y–9SP
serve as standardized financial
statements for the consolidated HC. The
Board requires HCs to provide
standardized financial statements to
fulfill the Board’s statutory obligation to
supervise these organizations. The FR
Y–9ES is a financial statement for HCs
that are Employee Stock Ownership
Plans. The Board uses the FR Y–9CS (a
free-form supplement) to collect
additional information deemed to be
critical and needed in an expedited
manner. HCs file the FR Y–9C on a
quarterly basis, the FR Y–9LP quarterly,
the FR Y–9SP semiannually, the FR Y–
9ES annually, and the FR Y–9CS on a
schedule that is determined when this
supplement is used.
Frequency: Quarterly, semiannually,
and annually.
Affected Public: Businesses or other
for-profit.
Respondents: Bank holding
companies (BHCs), savings and loan
holding companies (SLHCs), securities
holding companies (SHCs), and U.S.
Intermediate Holding Companies (IHCs)
(collectively, holding companies (HCs)).
Total estimated number of
respondents:
Reporting
FR Y–9C (non-advanced approaches
holding companies with less than $5
billion in total assets): 107; FR Y–9C
(non-advanced approaches with $5
billion or more in total assets) 236; FR
Y–9C (advanced approached holding
companies): 9; FR Y–9LP: 411; FR Y–
9SP: 3,596; FR Y–9ES: 73; FR Y–9CS:
236.
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Recordkeeping
FR Y–9C: 352; FR Y–9LP: 411; FR Y–
9SP: 3,596; FR Y–9ES: 73; FR Y–9CS:
236.
Total estimated average hours per
response:
Reporting
FR Y–9C (non-advanced approaches
holding companies with less than $5
billion in total assets): 35.34; FR Y–9C
(non-advanced approaches holding
companies with $5 billion or more in
total assets): 44.59, FR Y–9C (advanced
approached holding companies): 49.81;
FR Y–9LP: 5.27; FR Y–9SP: 5.45; FR Y–
9ES: 0.50; FR Y–9CS: 0.50.
Recordkeeping
FR Y–9C: 1; FR Y–9LP: 1; FR Y–9SP:
0.50; FR Y–9ES: 0.50; FR Y–9CS: 0.50.
Total estimated change in burden: 49.
Total estimated annual burden hours:
114,538.
Current Actions: The Board is
proposing to amend the FR Y–9C report
form and instructions to align with the
proposal. The Board proposes to revise
Schedule HC–R, Part I, Regulatory
Capital Components and Ratios, to
align, subject to certain transition
provisions, the calculation of regulatory
capital for HCs subject to Category III
and IV standards with the calculation
for HCs subject to Category I and II
standards. The Board proposes to make
updates to Schedule HC–R, Part I, Line
item 60, a, b and c to apply the stress
capital buffer requirement to the riskbased capital ratios derived from the
expanded risk-based approach, in
addition to the standardized approach,
as described in the proposal.
Additionally, the Board proposes to add
one new memorandum item to Schedule
HC–D, Trading Assets and Liabilities, to
capture information about customer and
proprietary reserve balances of brokerdealers for purposes of determining the
market-risk rule applicability and revise
Schedule HC–R, Part II, line item 27 to
conform to changes under the Board’s
market risk rule proposal. The Board
would also apply other minor
conforming edits to the FR Y–9C report.
The revisions are proposed to be
effective for the September 30, 2025, as
of date.
The Board estimates that revisions to
the FR Y–9C would increase the
estimated annual burden by 49 hours.
The respondent count for the FR Y–9C
would not change because of these
changes. The draft reporting forms and
instructions are available on the Board’s
public website at https://
www.federalreserve.gov/apps/
reportingforms.
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b. (2) Collection Title: Capital
Assessments and Stress Test Reports
Collection identifier: FR Y–14A/Q/M.
OMB control number: 7100–0341.
General description of report: This
family of information collections is
composed of the following three reports:
• The annual FR Y–14A collects
quantitative projections of balance
sheet, income, losses, and capital across
a range of macroeconomic scenarios and
qualitative information on
methodologies used to develop internal
projections of capital across
scenarios.488
• The quarterly FR Y–14Q collects
granular data on various asset classes,
including loans, securities, trading
assets, and pre-provision net revenue
(PPNR) for the reporting period.
• The monthly FR Y–14M is
comprised of three retail portfolio- and
loan-level schedules, and one detailed
address-matching schedule to
supplement two of the portfolio- and
loan-level schedules.
The data collected through the FR Y–
14A/Q/M reports (FR Y–14 reports)
provide the Board with the information
needed to help ensure that large firms
have strong, firm-wide risk
measurement and management
processes supporting their internal
assessments of capital adequacy and
that their capital resources are
sufficient, given their business focus,
activities, and resulting risk exposures.
The data within the reports are used to
set firms’ stress capital buffer
requirements. The data are also used to
support other Board supervisory efforts
aimed at enhancing the continued
viability of large firms, including
continuous monitoring of firms’
planning and management of liquidity
and funding resources, as well as
regular assessments of credit risk,
market risk, and operational risk, and
associated risk management practices.
Information gathered in this data
collection is also used in the
supervision and regulation of
respondent financial institutions.
Respondent firms are currently required
to complete and submit up to 17 filings
each year: one annual FR Y–14A filing,
four quarterly FR Y–14Q filings, and 12
monthly FR Y–14M filings. Compliance
with the information collection is
mandatory.
Frequency: Annually, quarterly, and
monthly.
488 In certain circumstances, a firm may be
required to re-submit its capital plan. See 12 CFR
225.8(e)(4); 12 CFR 238.170(e)(4). Firms that must
re-submit their capital plan generally also must
provide a revised FR Y–14A in connection with
their resubmission.
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Affected Public: Businesses or other
for-profit.
Respondents: These collections of
information are applicable to bank
holding companies (BHCs), U.S.
intermediate holding companies (IHCs),
and covered savings and loan holding
companies (SLHCs) with $100 billion or
more in total consolidated assets, as
based on: (i) the average of the firm’s
total consolidated assets in the four
most recent quarters as reported
quarterly on the firm’s Consolidated
Financial Statements for Holding
Companies (FR Y–9C); or (ii) if the firm
has not filed an FR Y–9C for each of the
most recent four quarters, then the
average of the firm’s total consolidated
assets in the most recent consecutive
quarters as reported quarterly on the
firm’s FR Y–9C. Reporting is required as
of the first day of the quarter
immediately following the quarter in
which the respondent meets this asset
threshold, unless otherwise directed by
the Board.
Estimated number of respondents: FR
Y–14A/Q: 36; FR Y–14M: 34; 489 FR Y–
14 On-going Automation Revisions: 36;
FR Y–14 Attestation On-going: 8.
Estimated average hours per response:
FR Y–14A: 1,341; FR Y–14Q: 2,002; FR
Y–14M: 1,071; FR Y–14 On-going
Automation Revisions: 480; FR Y–14
Attestation On-going: 2,560.
Estimated annual burden hours: FR
Y–14A: 48,276; FR Y–14Q: 288,288;
FRY–14M: 436,968; FR Y–14 On-going
Automation Revisions: 17,280; FR Y–14
Attestation On-going: 20,480.
Current actions: The Board proposes
several conforming revisions to the FR
Y–14A/Q/M reports based on the
proposed rule. Specifically, the Board
proposes revisions related to capital,
operational risk, and credit risk
mitigation. All revisions are proposed to
be effective for the July 31, 2025, as of
date for the FR Y–14M, the September
30, 2025, as of date for the FR Y–14Q,
and the December 31, 2025, as of date
for the FR Y–14A.
Capital
Capital Ratios and Buffers
Banking organizations subject to
Category I, II, or III standards are
required to project capital ratios and
capital buffer requirements assuming
various scenarios under the generally
applicable standardized approach on FR
489 The estimated number of respondents for the
FR Y–14M is lower than for the FR Y–14Q and FR
Y–14A because, in recent years, certain respondents
to the FR Y–14A and FR Y–14Q have not met the
materiality thresholds to report the FR Y–14M due
to their lack of mortgage and credit activities. The
Board expects this situation to continue for the
foreseeable future.
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Y–14A, Schedule A (Summary). Under
the proposed rule, a banking
organization subject to Category I, II, III
or IV standards would be required to
calculate its risk-based capital ratios
under both the new expanded riskbased approach and the current,
generally applicable standardized
approach, and the lower of the two for
each ratio would be binding. In
addition, all capital buffer requirements,
including the stress capital buffer,
would apply regardless of whether the
expanded risk-based approach or the
existing standardized approach
produces the binding ratio.
Since the binding capital ratios could
be based on either the standardized
approach or the expanded risk-based
approach, banking organizations would
be required to calculate both version of
capital ratios and capital buffers under
the proposed rule. To allow banking
organizations to report values using
either calculation method, the Board
proposes to revise FR Y–14A, Schedule
A.1.d (Capital) to require banking
organizations subject to Category I, II, or
III standards to report certain items
depending on which common equity
tier 1 ratio is binding as of the report
date. Specifically, banking organizations
subject to Category I, II, or III standards
that are also subject to the expanded
risk-based approach would be required
to report the following items if the
common equity tier 1 ratio for a banking
organization under the expanded riskbased approach is binding as of the
report date:
• Item 55 (Adjusted allowance for
credit losses includable in tier 2
capital);
Æ As described in the preamble, the
concept of eligible credit reserves
includable in tier 2 capital would be
replaced by adjusted allowance for
credit losses includable in tier 2 capital
for banking organizations subject to the
expanded risk-based approach.
Therefore, the Board proposes to revise
item 55 to capture the adjusted
allowance for credit losses includable in
tier 2 capital.
• Item 58 (Expanded risk-based
approach: Tier 2 capital before
deductions);
• Item 59.b (Expanded risk-based
approach: Tier 2 capital deductions);
• Item 61 (Expanded risk-based
approach: Tier 2 capital);
• Item 63 (Expanded risk-based
approach: Total capital (sum of items 50
and 61));
• Item 95 (Expanded risk-based
approach: Total Capital);
• Item 97 (Total risk-weighted assets
using expanded risk-based approach);
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• Item 101 (Expanded risk-based
approach: Common Equity Tier 1 Ratio
(%));
• Item 103 (Expanded risk-based
approach: Tier 1 Capital Ratio (%)); and
• Item 105 (Expanded risk-based
approach: Total risk-based capital ratio
(%)).
The items listed above are currently
on the reporting form but are not
required to be submitted since banking
organizations are not required to project
values calculated under the advanced
approaches framework. The Board is
proposing to activate these items and
remove references to advanced
approaches firms that exit parallel run
from the descriptions of the items, as
well as to any other items that may refer
to the advanced approaches framework.
Banking organizations would not report
these items if the common equity tier 1
ratio under the standardized approach is
binding as of the report date.
If a banking organization reports the
items listed above, then it would not be
required to report the following items,
which would only be required if the
common equity tier 1 ratio for a banking
organization under the standardized
approach is binding as of the report
date:
• Item 54 (Allowance for loan and
lease losses includable in tier 2 capital);
• Item 57 (Tier 2 capital before
deductions);
• Item 59.a (Tier 2 capital
deductions);
• Item 60 (Tier 2 capital);
• Item 62 (Total capital);
• Item 94 (Total capital);
• Item 96 (Total risk-weighted assets
using standardized approach);
• Item 100 (Common Equity Tier 1
Ratio (%));
• Item 102 (Tier 1 Capital Ratio (%));
and
• Item 104 (Total risk-based capital
ratio (%)).
The Board also proposes to remove
language from the instructions for
Schedule A.1.d stating the banking
organizations are not required to project
values calculated under the advanced
approaches framework.
In addition, the Board proposes to
allow the three items listed below on
Schedule A.1.d to be reported using the
expanded risk-based approach or the
standardized approach, instead of only
the standardized approach, as currently
required:
• Item 134 (Maximum Payout Ratio);
• Item 135 (Minimum Payout
Amount); and
• Item 146(a) (TLAC risk-weighted
asset buffer).
The Board proposes to specify that
these items be reported in the same
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manner (i.e., using either the expanded
risk-based approach or the standardized
approach) as the corresponding item on
FR Y–9C, Schedule HC–R (Regulatory
Capital), Part I (Regulatory Capital
Components and Ratios).
Further, to ensure that applicable
banking organizations remain in
compliance with distribution
limitations, the Board is also proposing
to require banking organizations subject
to the expanded risk-based approach,
which would include firms subject to
Category IV standards, to report the
expanded risk-based approach versions
of the common equity tier 1 capital
ratio, tier 1 capital ratio, and total
capital ratio, on FR Y–14A, Schedule C
(Regulatory Capital Instruments) if the
expanded risk-based approach is
binding for the common equity tier 1
capital ratio as of the report date.
Banking organizations subject to the
expanded risk-based approach would
continue to report the standardized
approach versions of these ratios if the
standardized approach is binding for the
common equity tier 1 capital ratio as of
the report date.
Accumulated Other Comprehensive
Income (AOCI)
Under the Board’s regulatory capital
rule, a banking organization that is not
subject to Category I or II standards was
provided an opportunity to make a onetime election to opt out of recognizing
most elements of AOCI and related
deferred tax assets (DTAs) and deferred
tax liabilities (DTLs) in regulatory
capital. Applicable banking
organizations are required to report the
result of this decision on FR Y–14A,
Schedule A.1.d, item 18 (‘‘AOCI opt-out
election’’). As described in the proposed
rule, banking organizations subject to
Category III and IV standards would be
required to include all AOCI
components in common equity tier 1
capital elements, except gains and
losses on cash-flow hedges where the
hedged item is not recognized on a
banking organization’s balance sheet at
fair value. As a result, the Board is
proposing to revise the instructions for
item 18 to eliminate the opt-out option
for banking organizations subject to the
proposed expanded risk-based
standards.
Regulatory Capital Deductions
Currently, a banking organization
subject to Category I or II standards has
different regulatory capital deduction
thresholds than a banking organization
subject to Category III or IV standards.
Deducted amounts are reported across
various items on FR Y–14A, Schedule
A.1.d and FR Y–14Q, Schedule D
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(Regulatory Capital). As described in the
proposed rule, a banking organization
subject to Category III and Category IV
standards would have the same
deduction thresholds as banking
organization subject to Category I and II
standards. For alignment purposes, the
Board proposes to revise applicable
items on Schedule A.1.d and Schedule
D to specify which deduction thresholds
apply to banking organizations subject
to expanded risk-based standards.
General RWAs
Banking organizations subject to the
advanced approaches framework are
required to report the RWA amount
based on the internal ratings-based (IRB)
capital formula in Schedule A.1
(International Auto Loan) and Schedule
A.2 (US Auto Loan) of the FR Y–14Q.
Since the Board is proposing to remove
the IRB approach from the capital rule,
the Board is also proposing to replace
the reference to IRB on Schedules A.1
and A.2, and to specify that banking
organizations subject to expanded riskbased standards should calculate RWAs
as specified in the capital rule on
Schedules A.1 and A2.
Market Risk RWAs
As described in the preamble, the
Board is proposing to introduce two
methodologies for calculating market
risk RWAs: the standardized measure
and the models-based measure. A firm
must receive approval from its primary
Federal supervisor to calculate the
market risk capital requirements under
the models-based measure. If a firm has
certain trading desks that do not meet
eligibility requirements for the internal
models approach, then the proposal
would impose the standardized measure
for the ineligible trading desks.
The Board is proposing several
revisions to market risk RWAs in the
proposed rule. To align with the
proposed rule, the Board proposes to
replace the existing market risk RWA
items (items 24 through 40) on FR Y–
14A, Schedule A.1.c.1 (Standardized
RWA) with thirty-five items that cover
six categories under the standardized
measure. These categories would be:
• Delta Capital Requirements;
• Vega Capital Requirements;
• Curvature Capital Requirements;
• Default Risk Capital Requirements;
• Residual Risk Add-on Components;
and
• Capital Add-ons.
The granularity of the proposed items
would align with the revisions
described in the proposed rule and
would provide the Board with insight
into the drivers of market risk RWAs,
facilitating understanding of how
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changes in the projections of distinct
exposure types contribute to overall
changes in market risk RWAs over the
projection horizon. In addition, to
further increase insight into a banking
organization’s market risk RWAs for
those banking organizations that
received approval to calculate market
risk capital requirements under the
models-based measure, the Board
proposes to add items to capture total
standardized RWAs for model-ineligible
trading desks and total RWAs under the
models-based measure for modeleligible trading desks that are approved.
All proposed market risk RWA items
would only be reported by firms subject
to the market risk rule.
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Operational Risk
The Board proposes several revisions
to FR Y–14Q, Schedule E (Operational
Risk) to align with the changes
described in the proposed rule.
Although the revisions described only
apply to banking organizations subject
to expanded risk-based standards, for
data consistency and comparability
purposes, the Board is proposing that
the operational risk revisions apply to
all banking organizations that file
Schedule E.
Loss Events
The Board would make several
revisions to the definition of
‘‘operational loss’’ and ‘‘operational loss
event’’ in the proposed rule. The
instructions for Schedule E define an
operational loss as a financial loss
resulting from an operational loss event,
which is defined as an event that is
associated with any of the seven
operational loss event type categories:
• Internal Fraud;
• External Fraud;
• Employment Practices and
Workplace Safety;
• Clients, Products, and Business
Practices;
• Damage to Physical Assets;
• Business Disruption and System
Failures; and
• Execution, Delivery, and Process
Management.
The seven event type categories are
further defined in Table E.1.a (Level 1
and Level 2 Event-Types). For
congruency, the Board proposes to align
the definitions of ‘‘operational loss’’,
‘‘operational loss event,’’ and the seven
operational loss event type categories in
Schedule E.1 with the proposed
definitions specified in the rule.
Banking organizations can currently
report their operational loss events on
FR Y–14Q, Schedule E.1 (Operational
Loss History) at the event level (i.e., one
single row for each operational loss
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event) or at the impact level (i.e., across
several rows, with each row
corresponding to a unique expense
incurred at a certain point in time). As
described in the proposed rule, the
calculation of annual net operational
losses would be based on a ten-year
average. To ensure that the Board can
adequately capture losses over this
timespan, the Board proposes to require
banking organizations to report loss
events at the impact level when a loss
event involves more than one expense
that occurs over time. The Board
proposes to further clarify that the
reported accounting date for loss events
should be specific to each impact and
reflect the date the financial loss
associated with the impact was recorded
on the banking organization’s financial
statements.
Timing Losses
Banking organizations are required to
exclude timing losses from Schedule
E.1. Timing losses are operational risk
events that cause a temporary distortion
of a banking organization’s financial
statements in a particular financial
reporting period but that can be fully
corrected when later discovered (e.g.,
revenue overstatement, accounting, and
mark-to-market errors). Since the Board
is proposing to have timing losses be
considered operational losses, the Board
also proposes to revise the instructions
for Schedule E.1. to require that timing
losses be reported. To clearly identify
timing losses, the Board proposes to add
the ‘‘Timing event flag’’ item to
Schedule E.1.
Loss Threshold
The instructions for Schedules E.1
and E.4 (Threshold Information) do not
require that banking organizations
provide an explicit dollar threshold for
collecting and reporting operational loss
events. Rather, banking organizations
are required to submit a complete
history of operational losses at and
above the institution’s established
collection threshold(s). As described in
the proposed rule, a banking
organization would be required to
include a loss event of $20,000 or more
on a net basis in its capital calculation.
Given this, the Board also proposes to
specify that each banking organization’s
collection and reporting threshold on
Schedules E.1 and E.4 should be no
greater than $20,000 on a nominal and
net loss basis (inclusive of noninsurance recoveries).
Insurance Recoveries
Banking organizations are required to
exclude insurance recoveries from the
‘‘Recovery Amount ($USD))’’ item in
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Schedule E.1. Since the Board is
proposing to include insurance
recoveries as part of the internal loss
multiplier calculation, the Board is also
proposing to add the ‘‘Insurance
Recovery Amount ($USD))’’ item to
Schedule E.1. To avoid double counting
of insurance recoveries, the Board
proposes to rename the ‘‘Recovery
Amount ($USD))’’ item as ‘‘NonInsurance Recovery Amount ($USD)),’’
and to specify that only non-insurance
recoveries are reported in this item.
Credit Risk Mitigation
Banking organizations subject to the
advanced approaches framework report
probability of default (PD), loss given
default (LGD), expected loss given
default (ELGD), and exposure at default
(EAD) values on FR Y–14Q, Schedule A
(Retail) and Schedule H (Wholesale), as
well as FR Y–14M, Schedule A (First
Lien), Schedule B (Home Equity), and
Schedule D (Credit Card), calculated as
specified in the Board’s capital rule. On
Schedule H, these banking organizations
report the advanced internal ratingsbased (IRB) parameter estimates for PD,
LGD, and EAD. Since the Board is
proposing to revise the calculation of
these values in the capital rule as
described in the proposal, the Board
proposes to revise FR Y–14Q, Schedules
A and H, as well as FR Y–14M,
Schedules A, B, and D, to specify that
banking organizations subject to
expanded risk-based standards should
report PD, LGD, ELGD, and EAD items
as specified in the Board’s capital rule,
calculated as proposed. The Board is
also proposing to remove references to
the IRB approach in Schedule H, and to
instead require banking organizations
subject to expanded risk-based
standards to calculate PD, LGD, and
EAD as described in the Board’s capital
rule.
c. (3) Collection Title: Systemic Risk
Report
Collection identifier: FR Y–15.
OMB control number: 7100–0352.
General description of report: The FR
Y–15 quarterly report collects systemic
risk data from U.S. bank holding
companies and covered savings and
loan holding companies with total
consolidated assets of $100 billion or
more, any U.S.-based bank holding
company designated as a GSIB that does
not meet the consolidated assets
threshold, and foreign banking
organizations with $100 billion or more
in combined U.S. assets. The Board uses
the FR Y–15 data to monitor, on an
ongoing basis, the systemic risk profile
of subject institutions. In addition, the
FR Y–15 is used to (1) facilitate the
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implementation of the GSIB capital
surcharge under the capital rule, (2)
identify other institutions that may
present significant systemic risk, and (3)
analyze the systemic risk implications
of proposed mergers and acquisitions.
Frequency: Quarterly.
Affected Public: Businesses or other
for-profit.
Respondents: Top tier U.S. bank
holding companies and covered savings
and loan holding companies with $100
billion or more in total consolidated
assets, any U.S.-based bank holding
company designated as a GSIB that does
not meet that consolidated assets
threshold, and foreign banking
organizations with combined U.S. assets
of $100 billion or more.
Estimated number of respondents: 53.
Estimated average hours per response:
Reporting—49.8 hours;
Recordkeeping—0.25 hours.
Estimated annual burden hours:
Reporting—10,558 hours; 490
Recordkeeping—53 hours.
Current Actions: The Board is
proposing to amend the FR Y–15 form
and instructions to align with the
proposed capital rule. As discussed in
section III.C.3.b of this SUPPLEMENTARY
INFORMATION section, under the
proposal, a 40 percent credit conversion
factor would apply to commitments that
are not unconditionally cancelable
commitments for purposes of
calculating total leverage exposure for
the supplementary leverage ratio. The
Board is proposing to make a
conforming revision to the FR Y–15 to
align the reporting of data for the total
exposures systemic indicator with this
change. The revisions are proposed to
be effective for the September 30, 2025,
as of date.
The Board estimates that revisions to
the FR Y–15 would increase the
estimated annual burden by 56 hours.
The respondent count for the FR Y–15
would not change because of these
changes. The draft reporting forms and
instructions are available on the Board’s
public website at https://
www.federalreserve.gov/apps/
reportingforms.
B. Regulatory Flexibility Act
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OCC
The Regulatory Flexibility Act (RFA),
5 U.S.C. 601 et seq., requires an agency,
in connection with a proposed rule, to
prepare an Initial Regulatory Flexibility
Analysis describing the impact of the
490 This estimated total annual burden reflects
adjustments that have been made to the Board’s
burden methodology for the FR Y–15 that provide
a more consistent estimate of respondent burden
across different regulatory reports.
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rule on small entities (defined by the
Small Business Administration (SBA)
for purposes of the RFA to include
commercial banks and savings
institutions with total assets of $850
million or less and trust companies with
total assets of $47 million or less) or to
certify that the proposed rule would not
have a significant economic impact on
a substantial number of small entities.
The OCC currently supervises
approximately 661 small entities.491
The OCC estimates that the proposed
rule would impact none of these small
entities, as the scope of the rule only
applies to banking organizations with
total assets of at least $100 billion or
banking organizations with significant
trading activity. Therefore, the OCC
certifies that the proposed rule would
not have a significant economic impact
on a substantial number of small
entities.
Board
The Board is providing an initial
regulatory flexibility analysis with
respect to this proposed rule. The
Regulatory Flexibility Act 492 (‘‘RFA’’),
requires an agency to consider whether
the rule it proposes will have a
significant economic impact on a
substantial number of small entities.493
In connection with a proposed rule, the
RFA requires an agency to prepare and
invite public comment on an initial
regulatory flexibility analysis describing
the impact of the rule on small entities,
unless the agency certifies that the
proposed rule, if promulgated, will not
have a significant economic impact on
a substantial number of small entities.
491 The OCC bases its estimate of the number of
small entities on the Small Business
Administration’s size standards for commercial
banks and savings associations, and trust
companies, which are $850 million and $47
million, respectively. Consistent with the General
Principles of Affiliation 13 CFR 121.103(a), the OCC
counts the assets of affiliated banks when
determining whether to classify an OCC-supervised
bank as a small entity. The OCC used December 31,
2022, to determine size because a ‘‘financial
institution’s assets are determined by averaging the
assets reported on its four quarterly financial
statements for the preceding year.’’ See, FN 8 of the
U.S. Small Business Administration’s Table of Size
Standards.
492 5 U.S.C. 601 et seq.
493 Under regulations issued by the Small
Business Administration (‘‘SBA’’), a small entity
includes a depository institution, bank holding
company, or savings and loan holding company
with total assets of $850 million or less. See 13 CFR
121.201. Consistent with the SBA’s General
Principles of Affiliation, the Board includes the
assets of all domestic and foreign affiliates toward
the applicable size threshold when determining
whether to classify a particular entity as a small
entity. See 13 CFR 121.103. As of December 31,
2022, there were approximately 2081 small bank
holding companies, approximately 88 small savings
and loan holding companies, and approximately
427 small state member banks.
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An initial regulatory flexibility analysis
must contain (1) a description of the
reasons why action by the agency is
being considered; (2) a succinct
statement of the objectives of, and legal
basis for, the proposed rule; (3) a
description of, and, where feasible, an
estimate of the number of small entities
to which the proposed rule will apply;
(4) a description of the projected
reporting, recordkeeping, and other
compliance requirements of the
proposed rule, including an estimate of
the classes of small entities that will be
subject to the requirement and the type
of professional skills necessary for
preparation of the report or record; (5)
an identification, to the extent
practicable, of all relevant Federal rules
which may duplicate, overlap with, or
conflict with the proposed rule; and (6)
a description of any significant
alternatives to the proposed rule which
accomplish the stated objectives of
applicable statutes and minimize any
significant economic impact of the
proposed rule on small entities.494
The Board has considered the
potential impact of the proposed rule on
small entities in accordance with the
RFA. Based on its analysis and for the
reasons stated below, the Board believes
that this proposed rule will not have a
significant economic impact on a
substantial number of small entities.
Nevertheless, the Board is publishing
and inviting comment on this initial
regulatory flexibility analysis. The
proposal would also make
corresponding changes to the Board’s
reporting forms.
As discussed in detail in sections I
through VII of this SUPPLEMENTARY
INFORMATION, the proposed rule would
substantially revise the capital
requirements applicable to large
banking organizations and to banking
organizations with significant trading
activity. The revisions set forth in the
proposal would improve the calculation
of risk-based capital requirements to
better reflect the risks of these banking
organizations’ exposures, reduce the
complexity of the framework, enhance
the consistency of requirements across
these banking organizations, and
facilitate more effective supervisory and
market assessments of capital adequacy.
The revisions would include replacing
current requirements that include the
use of banking organizations’ internal
models for credit risk and operational
risk with standardized approaches and
replacing the current market risk and
credit valuation adjustment risk
requirements with revised approaches.
The proposed revisions are being
494 5
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considered due to, and would be
generally consistent with, recent
changes to international capital
standards issued by the Basel
Committee on Banking Supervision.
The Board has broad authority under
the International Lending Supervision
Act (‘‘ILSA’’) 495 and the prompt
corrective action (‘‘PCA’’) provisions of
the Federal Deposit Insurance Act 496 to
establish regulatory capital
requirements for the institutions it
regulates. For example, ILSA directs
each Federal banking agency to cause
banking institutions to achieve and
maintain adequate capital by
establishing minimum capital
requirements as well as by other means
that the agency deems appropriate.497
The PCA provisions of the Federal
Deposit Insurance Act direct each
Federal banking agency to specify, for
each relevant capital measure, the level
at which an insured depository
institution subsidiary is well
capitalized, adequately capitalized,
undercapitalized, and significantly
undercapitalized.498 In addition, the
Board has broad authority to establish
regulatory capital standards for bank
holding companies, savings and loan
holding companies, and U.S.
intermediate holding companies of
foreign banking organizations under the
Bank Holding Company Act, the Home
Owners’ Loan Act, and the Dodd-Frank
Reform and Consumer Protection Act
(‘‘Dodd-Frank Act’’).499
As discussed in more detail in section
II of the SUPPLEMENTARY INFORMATION,
the proposed rule would apply to
banking organizations with total assets
of $100 billion or more and their
subsidiary depository institutions, as
well as to banking organizations with
significant trading activity. Under the
proposed rule, a banking organization
with significant trading activity would
include any banking organization with
average aggregate trading assets and
trading liabilities, excluding customer
and proprietary broker-dealer reserve
bank accounts, over the previous four
calendar quarters equal to $5 billion or
more, or equal to 10 percent or more of
total consolidated assets at quarter end
as reported on the most recent quarterly
regulatory report. Accordingly,
essentially all banking organizations to
which the proposed rule would apply
exceed the SBA’s $850 million total
asset threshold.
495 12
U.S.C. 3901–3911.
U.S.C. 1831o.
497 12 U.S.C. 3907(a)(1).
498 12 U.S.C. 1831o(c)(2).
499 See 12 U.S.C. 1467a, 1844, 5365, 5371.
496 12
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As discussed in more detail in the
Paperwork Reduction Act section, the
proposed rule, once final, would require
changes to the Consolidated Financial
Statements for Holding Companies
report (FR Y–9C) and the Capital
Assessments and Stress Testing reports
(FR Y–14A and FR Y–14Q).
The Board is aware of no other
Federal rules that duplicate, overlap, or
conflict with the proposed changes to
the capital rule. The Board also is aware
of no significant alternatives to the
proposed rule that would accomplish
the stated objectives of applicable
statutes. Because the proposed rule
generally would not apply to any small
entities supervised by the Board, there
are no alternatives that could minimize
the impact of the proposed rule on small
entities.
Therefore, the Board believes that the
proposed rule would not have a
significant economic impact on a
substantial number of small entities
supervised by the Board.
The Board welcomes comment on all
aspects of its analysis. In particular, the
Board requests that commenters
describe the nature of any impact on
small entities and provide empirical
data to illustrate and support the extent
of the impact.
FDIC
The Regulatory Flexibility Act (RFA)
generally requires an agency, in
connection with a proposed rulemaking,
to prepare and make available for public
comment an initial regulatory flexibility
analysis that describes the impact of the
proposed rule on small entities.500
However, an initial regulatory flexibility
analysis is not required if the agency
certifies that the proposed rule will not,
if promulgated, have a significant
economic impact on a substantial
number of small entities. The Small
Business Administration (SBA) has
defined ‘‘small entities’’ to include
banking organizations with total assets
of less than or equal to $850 million.501
Generally, the FDIC considers a
significant economic impact to be a
quantified effect in excess of 5 percent
500 5
U.S.C. 601 et seq.
501 The SBA defines a small banking organization
as having $850 million or less in assets, where an
organization’s ‘‘assets are determined by averaging
the assets reported on its four quarterly financial
statements for the preceding year.’’ See 86 FR 69118
which amends 13 CFR 121.201, (effective December
19, 2022.). In its determination, the ‘‘SBA counts
the receipts, employees, or other measure of size of
the concern whose size is at issue and all of its
domestic and foreign affiliates.’’ See 13 CFR
121.103. Following these regulations, the FDIC uses
a covered entity’s affiliated and acquired assets,
averaged over the preceding four quarters, to
determine whether the covered entity is ‘‘small’’ for
the purposes of RFA.
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of total annual salaries and benefits or
2.5 percent of total noninterest
expenses. The FDIC believes that effects
in excess of one or more of these
thresholds typically represent
significant economic impacts for FDICsupervised institutions. For the reasons
described below, the FDIC certifies that
the proposed rule will not have a
significant economic impact on a
substantial number of small entities.
According to recent Call Reports,
there are 3,038 FDIC-supervised IDIs.502
Of these, approximately 2,325 would be
considered small entities for the
purposes of RFA.503 As of December 31,
2022, there were 37 top-tier U.S.
depository institution holding
companies and 62 U.S.-based depository
institutions that report risk-based
capital figures and are subject to
Category I, II, III, or IV standards.504 As
of December 31, 2022, the FDIC
supervises one institution that is a
subsidiary of a holding company subject
to the Category I capital standards, three
institutions that are subsidiaries of
holding companies subject to the
Category III capital standards, and five
that are subsidiaries of holding
companies subject to the Category IV
standards.505 These nine FDICsupervised institutions that would be
subject to this proposed rule should it
be implemented are not considered
small entities for the purposes of the
RFA since they are owned by holding
companies with over $850 million in
total assets.
As all FDIC-supervised small entities
are outside the scope of the proposed
rule none would experience any direct
effects, therefore, the FDIC certifies that
the proposed rule, if adopted, would not
have a significant economic effect on a
substantial number of small entities.
The FDIC invites comments on all
aspects of the supporting information
provided in this RFA section. In
particular, would this proposed rule
have any significant effects on small
entities that the FDIC has not identified?
502 Call
Reports data, December 31, 2022.
503 Id.
504 On November 1, 2019, the banking agencies
established four risk-based categories in order to
tailor requirements under the agencies’ regulatory
capital and liquidity rules to banking organizations
with assets of $100 billion or more (84 FR 59230).
These Tailored Categories are defined in 12 CFR
part 252 (84 FR 59032). The tailored holding
company and depository institutions counts are
based on December 2022 Call Reports, FR Y–9C
data, and FR Y–15 data.
505 Counts are based on December 31, 2022 Call
Reports, FR Y–9C data, and FR Y–15 data. Note
these counts of FDIC-supervised institutions
include three that are no longer within FDIC’s
supervisory scope due to one merger and two
failures in 2023. The counts will be updated for the
final rule to account for these changes.
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C. Plain Language
Section 722 of the Gramm-Leach
Bliley Act 506 requires the Federal
banking agencies to use plain language
in all proposed and final rules
published after January 1, 2000. The
agencies invite comments on how to
make these notices of proposed
rulemaking easier to understand. For
example:
• Have the agencies presented the
material in an organized manner that
meets your needs? If not, how could this
material be better organized?
• Are the requirements in the notice
of proposed rulemaking clearly stated?
If not, how could the proposed rule be
more clearly stated?
• Does the proposed rule contain
language that is not clear? If so, which
language requires clarification?
• Would a different format (grouping
and order of sections, use of headings,
paragraphing) make the proposed rule
easier to understand? If so, what
changes to the format would make the
proposed rule easier to understand?
• What else could the agencies do to
make the proposed rule easier to
understand?
D. Riegle Community Development and
Regulatory Improvement Act of 1994
Pursuant to section 302(a) of the
Riegle Community Development and
Regulatory Improvement Act
(RCDRIA),507 in determining the
effective date and administrative
compliance requirements for new
regulations that impose additional
reporting, disclosure, or other
requirements on IDIs, each Federal
banking agency must consider,
consistent with the principle of safety
and soundness and the public interest,
any administrative burdens that such
regulations would place on depository
institutions, including small depository
institutions, and customers of
depository institutions, as well as the
benefits of such regulations. In addition,
section 302(b) of RCDRIA requires new
regulations and amendments to
regulations that impose additional
reporting, disclosures, or other new
requirements on IDIs generally to take
effect on the first day of a calendar
quarter that begins on or after the date
on which the regulations are published
in final form, with certain exceptions,
including for good cause.508
The agencies note that comment on
these matters has been solicited in other
sections of this SUPPLEMENTARY
506 Public Law 106–102, section 722, 113 Stat.
1338, 1471 (1999).
507 12 U.S.C. 4802(a).
508 12 U.S.C. 4802.
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INFORMATION section, and that the
requirements of RCDRIA will be
considered as part of the overall
rulemaking process. In addition, the
agencies also invite any other comments
that further will inform the agencies’
consideration of RCDRIA.
E. OCC Unfunded Mandates Reform Act
of 1995 Determination
The OCC has analyzed the proposed
rule under the factors in the Unfunded
Mandates Reform Act of 1995 (UMRA)
(2 U.S.C. 1532). Under this analysis, the
OCC considered whether the proposed
rule includes a Federal mandate that
may result in the expenditure by State,
local, and tribal governments, in the
aggregate, or by the private sector, of
$100 million or more in any one year
(adjusted annually for inflation).
The OCC has determined this
proposed rule is likely to result in the
expenditure by the private sector of
$100 million or more in any one year
(adjusted annually for inflation). The
OCC has prepared an impact analysis
and identified and considered
alternative approaches. When the
proposed rule is published in the
Federal Register, the full text of the
OCC’s analysis will be available at:
https://www.regulations.gov, Docket ID
OCC–2023–0008.
F. Providing Accountability Through
Transparency Act of 2023
The Providing Accountability
Through Transparency Act of 2023 (12
U.S.C. 553(b)(4)) requires that a notice
of proposed rulemaking include the
internet address of a summary of not
more than 100 words in length of the
proposed rule, in plain language, that
shall be posted on the internet website
under section 206(d) of the EGovernment Act of 2002 (44 U.S.C. 3501
note).
In summary, in the proposal the bank
regulatory agencies request comment on
a proposal to increase the strength and
resilience of the banking system. The
proposal would modify large bank
capital requirements to better reflect
underlying risks and increase the
consistency of how banks measure their
risks.
The proposal and such a summary
can be found at https://
www.regulations.gov, https://
www.federalreserve.gov/supervisionreg/
reglisting.htm, https://www.fdic.gov/
resources/regulations/federal-registerpublications/, and https://occ.gov/
topics/laws-and-regulations/occregulations/proposed-issuances/indexproposed-issuances.html.
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Text of Common Rule
Subpart E—Risk-Weighted Assets—
Expanded Risk-Based Approach
§ ll.100
Purpose and applicability.
(a) Purpose. This subpart sets forth
methodologies for determining
expanded total risk-weighted assets for
purposes of the expanded capital ratio
calculations.
(b) Applicability.
(1) This subpart applies to any
[BANKING ORGANIZATION] that is a
global systemically important BHC, a
subsidiary of a global systemically
important BHC, a Category II [BANKING
ORGANIZATION], a Category III
[BANKING ORGANIZATION], or a
Category IV [BANKING
ORGANIZATION], as defined in
§ ll.2.
(2) The [AGENCY] may apply this
subpart to any [BANKING
ORGANIZATION] if the [AGENCY]
deems it necessary or appropriate to
ensure safe and sound banking
practices.
(c) Notwithstanding any other
provision of this section, a market risk
[BANKING ORGANIZATION] must
exclude from its calculation of riskweighted assets under this subpart the
risk-weighted asset amounts of all
market risk covered positions, as
defined in subpart F of this part (except
foreign exchange positions that are not
trading positions, OTC derivative
positions, cleared transactions, and
unsettled transactions).
§ ll.101
Definitions.
(a) Terms that are set forth in § ll.2
and used in this subpart have the
definitions assigned thereto in § ll.2
unless otherwise defined in paragraph
(b) of this section.
(b) For purposes of this subpart, the
following terms are defined as follows:
Acquisition, development, or
construction exposure (ADC) exposure
means a loan secured by real estate for
the purpose of acquiring, developing, or
constructing residential or commercial
real estate properties, as well as all land
development loans, and all other land
loans.
Bank exposure means an exposure to
a depository institution, foreign bank, or
credit union.
Collateral upgrade transaction means
a transaction in which a [BANKING
ORGANIZATION] lends to a
counterparty one or more securities that,
on average, are subject to a lower
haircut floor, as set forth in Table 2 to
§ ll.121, than the securities received
in exchange.
Credit obligation means an exposure
where the lender but not the obligor is
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exposed to credit risk. The following
exposures are not credit obligations:
derivative contracts, cleared
transactions, default fund contributions,
repo-style transactions, eligible margin
loans, equity exposures, or
securitization exposures.
Defaulted exposure means an
exposure that is a credit obligation, that
is not an exposure to a sovereign entity,
a real estate exposure, or a policy loan,
and where:
(1) For a retail exposure:
(i) The exposure is 90 days or more
past due or in nonaccrual status;
(ii) The [BANKING ORGANIZATION]
has taken a partial charge-off, writedown of principal, or negative fair value
adjustment on the exposure for creditrelated reasons, until the [BANKING
ORGANIZATION] has reasonable
assurance of repayment and
performance for all contractual
principal and interest payments on the
exposure; or
(iii) A distressed restructuring of the
exposure was agreed to by the
[BANKING ORGANIZATION], until the
[BANKING ORGANIZATION] has
reasonable assurance of repayment and
performance for all contractual
principal and interest payments on the
exposure as demonstrated by a
sustained period of repayment
performance, provided that a distressed
restructuring includes the following
made for credit-related reasons:
forgiveness or postponement of
principal, interest, or fees, term
extension or an interest rate reduction;
and
(2) For an exposure that is not a retail
exposure:
(i) The obligor has a credit obligation
to the [BANKING ORGANIZATION]
that is 90 days or more past due or in
nonaccrual status; or
(ii) The [BANKING ORGANIZATION]
has determined that, based on ongoing
credit monitoring, the obligor is
unlikely to pay its credit obligations to
the [BANKING ORGANIZATION] in
full, without recourse by the [BANKING
ORGANIZATION]. For the purposes of
this definition, a [BANKING
ORGANIZATION] must consider an
obligor unlikely to pay its credit
obligations if:
(A) The obligor has any credit
obligation that is 90 days or more past
due or in nonaccrual status with any
creditor;
(B) Any credit obligation of the
obligor has been sold at a credit-related
loss;
(C) A distressed restructuring of any
credit obligation of the obligor was
agreed to by any creditor, provided that
a distressed restructuring includes the
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following made for credit-related
reasons: forgiveness or postponement of
principal, interest, or fees, term
extension, or an interest rate reduction;
(D) The obligor is subject to a pending
or active bankruptcy proceeding; or
(E) Any creditor has taken a full or
partial charge-off, write-down of
principal, or negative fair value
adjustment on a credit obligation of the
obligor for credit-related reasons.
(3) For an exposure that is not a retail
exposure, a [BANKING
ORGANIZATION] may consider an
obligor no longer unlikely to pay its
credit obligations to the [BANKING
ORGANIZATION] in full if the
[BANKING ORGANIZATION]
determines the obligor is speculative
grade or investment grade.
(4) For purposes of this definition,
overdrafts are past due once the obligor
has breached an advised limit or been
advised of a limit smaller than the
current outstanding balance.
Defaulted real estate exposure means
a real estate exposure where:
(1) For a residential mortgage
exposure,
(i) The exposure is 90 days or more
past due or in nonaccrual status;
(ii) The [BANKING ORGANIZATION]
has taken a partial charge-off, writedown of principal, or negative fair value
adjustment on the exposure for creditrelated reasons, until the [BANKING
ORGANIZATION] has reasonable
assurance of repayment and
performance for all contractual
principal and interest payments on the
exposure; or
(iii) A distressed restructuring of the
exposure was agreed to by the
[BANKING ORGANIZATION], provided
that a distressed restructuring includes
the following made for credit-related
reasons: forgiveness or postponement of
principal, interest, or fees, term
extension, or an interest rate reduction
but does not include a loan modified or
restructured solely pursuant to the U.S.
Treasury’s Home Affordable Mortgage
Program.
(2) For a real estate exposure that is
not a residential mortgage exposure,
(i) The obligor has a credit obligation
to the [BANKING ORGANIZATION]
that is 90 days or more past due or in
nonaccrual status; or
(ii) The [BANKING ORGANIZATION]
has determined that, based on ongoing
credit monitoring, the obligor is
unlikely to pay its credit obligations to
the [BANKING ORGANIZATION] in
full, without recourse by the [BANKING
ORGANIZATION]. For the purposes of
this definition, a [BANKING
ORGANIZATION] must consider an
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obligor unlikely to pay its credit
obligations if:
(A) The obligor has any credit
obligation that is 90 days or more past
due or in nonaccrual status with any
creditor;
(B) Any credit obligation of the
obligor has been sold at a credit-related
loss;
(C) A distressed restructuring of any
credit obligation of the obligor was
agreed to by any creditor, provided that
a distressed restructuring includes the
following made for credit-related
reasons: forgiveness or postponement of
principal, interest, or fees, term
extension, or an interest rate reduction;
(D) The obligor is subject to a pending
or active bankruptcy proceeding; or
(E) Any creditor has taken a full or
partial charge-off, write-down of
principal, or negative fair value
adjustment on a credit obligation for
credit-related reasons.
(3) For an exposure that is not a
residential mortgage exposure, a
[BANKING ORGANIZATION] may
consider an obligor no longer unlikely
to pay its credit obligations to the
[BANKING ORGANIZATION] in full if
the [BANKING ORGANIZATION]
determines the obligor is speculative
grade or investment grade.
Dependent on the cash flows
generated by the real estate means, for
a real estate exposure, for which the
underwriting, at the time of origination,
includes the cash flows generated by
lease, rental, or sale of the real estate
securing the loan as a source of
repayment. For purposes of this
definition, a residential mortgage
exposure that is secured by the
borrower’s principal residence is
deemed not dependent on the cash
flows generated by the real estate.
Dividend income means all dividends
received on securities not consolidated
in the [BANKING ORGANIZATION]’s
financial statements.
Fee and commission expense means
expenses paid for advisory and financial
services received.
Fee and commission income means
income received from providing
advisory and financial services,
including insurance income.
Grade A bank exposure means:
(1) A bank exposure for which the
depository institution, foreign bank, or
credit union is investment grade and
whose most recent capital ratios meet or
exceed the higher of:
(i) The minimum capital requirements
and any additional amounts necessary
to not be subject to limitations on
distributions and discretionary bonus
payments under capital rules
established by the prudential supervisor
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of the depository institution, foreign
bank, or credit union, and;
(ii) If applicable, the capital ratio
requirements for the well capitalized
capital category under the regulations of
the appropriate Federal banking agency
implementing 12 U.S.C. 1831o or under
similar regulations of the National
Credit Union Administration.
(2) Notwithstanding paragraph (1) of
this definition, an exposure is not a
Grade A bank exposure if:
(i) The capital ratios for the
depository institution, foreign bank, or
credit union have not been publicly
disclosed within the previous 6 months;
(ii) The external auditor of the
depository institution, foreign bank, or
credit union has issued an adverse audit
opinion or has expressed substantial
doubt about the ability of the depository
institution, foreign bank, or credit union
to continue as a going concern within
the previous 12 months; or
(iii) For a foreign bank, the capital
standards imposed by the home country
supervisor on the foreign bank are not
consistent with the Capital Accord of
the Basel Committee on Banking
Supervision.
Grade B bank exposure means:
(1) A bank exposure that is not a
Grade A bank exposure and for which
the depository institution, foreign bank,
or credit union is speculative grade or
investment grade and whose most
recent capital ratios meet or exceed the
higher of:
(i) The minimum capital requirements
under capital rules established by the
prudential supervisor of the depository
institution, foreign bank, or credit
union; and
(ii) If applicable, the capital ratio
requirements for the adequatelycapitalized category under the
regulations of the appropriate Federal
banking agency implementing 12 U.S.C.
1831o or under similar regulations of
the National Credit Union
Administration.
(2) Notwithstanding paragraph (1) of
this definition, an exposure to a
depository institution, foreign bank, or
credit union is not a Grade B bank
exposure if:
(i) The capital ratios for the
depository institution, foreign bank, or
credit union have not been publicly
disclosed within the previous 6 months;
(ii) The external auditor of the
depository institution, foreign bank, or
credit union has issued an adverse audit
opinion or has expressed substantial
doubt about the ability of the depository
institution, foreign bank, or credit union
to continue as a going concern within
the previous 12 months; or
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(iii) For a foreign bank, the capital
standards imposed by the home country
supervisor on the foreign bank are not
consistent with the Capital Accord of
the Basel Committee on Banking
Supervision.
Grade C bank exposure means a bank
exposure for which the depository
institution, foreign bank, or credit union
does not qualify as a Grade A bank
exposure or a Grade B bank exposure.
Interest-earning assets means the sum
of all gross outstanding loans and leases,
securities that pay interest, interestbearing balances, Federal funds sold,
and securities purchased under
agreement to resell.
Net profit or loss on assets and
liabilities not held for trading means the
sum of realized gains (losses) on heldto-maturity securities, realized gains
(losses) on available-for-sale securities,
net gains (losses) on sales of loans and
leases, net gains (losses) on sales of
other real estate owned, net gains
(losses) on sales of other assets, venture
capital revenue, net securitization
income, and mark-to-market profit or
loss on bank liabilities.
Non-performing loan securitization
(NPL securitization) means a traditional
securitization, or a synthetic
securitization, that is not a
resecuritization, where parameter W (as
defined in § ll.133(b)(1)) for the
underlying pool is greater than or equal
to 90 percent at the origination cut-off
date and at any subsequent date on
which assets are added to or removed
from the pool due to replenishment or
restructuring.
Nonrefundable purchase price
discount (NRPPD) means the difference
between the initial outstanding balance
of the exposures in the underlying pool
and the price at which these exposures
are sold by the originator to the
securitization SPE, when neither
originator nor the original lender are
reimbursed for this difference. In cases
where the originator underwrites
tranches of a NPL securitization for
subsequent sale, the NRPPD may
include the differences between the
notional amount of the tranches and the
price at which these tranches are first
sold to unrelated third parties. For any
given piece of a securitization tranche,
only its initial sale from the originator
to investors is taken into account in the
determination of NRPPD. The purchase
prices of subsequent re-sales are not
considered.
Operational loss means all losses
(excluding insurance or tax effects)
resulting from an operational loss event,
including any reduction in previously
reported capital levels attributable to
restatements or corrections of financial
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statements. Operational loss includes all
expenses associated with an operational
loss event except for opportunity costs,
forgone revenue, and costs related to
risk management and control
enhancements implemented to prevent
future operational losses. Operational
loss does not include losses that are also
credit losses and are related to
exposures within the scope of the credit
risk-weighted assets framework (except
for retail credit card losses arising from
non-contractual, third-party-initiated
fraud, which are operational losses).
Operational loss event means an event
that results in loss due to inadequate or
failed internal processes, people, and
systems or from external events. This
includes legal loss events and
restatements or corrections of financial
statements that result in a reduction of
capital relative to amounts previously
reported. Losses with a common
underlying trigger must be grouped into
a single operational loss event.
Operational loss events are classified
according to the following seven
operational loss event types:
(1) Internal fraud, which means the
operational loss event type that
comprises operational losses resulting
from an act involving at least one
internal party of a type intended to
defraud, misappropriate property, or
circumvent regulations, the law, or
company policy excluding diversity and
discrimination noncompliance events.
(2) External fraud, which means the
operational loss event type that
comprises operational losses resulting
from an act by a third party of a type
intended to defraud, misappropriate
property, or circumvent the law. Retail
credit card losses arising from noncontractual, third-party-initiated fraud
(for example, identity theft) are external
fraud operational losses.
(3) Employment practices and
workplace safety, which means the
operational loss event type that
comprises operational losses resulting
from an act inconsistent with
employment, health, or safety laws or
agreements, payment of personal injury
claims, or payment arising from
diversity and discrimination
noncompliance events.
(4) Clients, products, and business
practices, which means the operational
loss event type that comprises
operational losses resulting from the
nature or design of a product or from an
unintentional or negligent failure to
meet a professional obligation to
specific clients (including fiduciary and
suitability requirements).
(5) Damage to physical assets, which
means the operational loss event type
that comprises operational losses
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resulting from the loss of or damage to
physical assets from natural disaster or
other events.
(6) Business disruption and system
failures, which means the operational
loss event type that comprises
operational losses resulting from
disruption of business or system
failures, including hardware, software,
telecommunications, utility outage or
disruptions.
(7) Execution, delivery, and process
management, which means the
operational loss event type that
comprises operational losses resulting
from failed transaction processing or
process management or losses arising
from relations with trade counterparties
and vendors.
Operational risk means the risk of loss
resulting from inadequate or failed
internal processes, people, and systems
or from external events (including legal
risk but excluding strategic and
reputational risk).
Other operating expense means
expenses associated with financial
services not included in other elements
of the Business Indicator, as defined in
§ ll.150(d), and all expenses
associated with operational loss events.
Other operating expense does not
include expenses excluded from the
Business Indicator.
Other operating income means
income not included in other elements
of the Business Indicator, as defined in
§ ll.150(d), and not excluded from the
Business Indicator.
Other real estate exposure means a
real estate exposure that is not a
defaulted real estate exposure, a
regulatory commercial real estate
exposure, a regulatory residential real
estate exposure, a pre-sold construction
loan, a statutory multifamily mortgage,
an HVCRE exposure, or an ADC
exposure.
Project finance exposure means a
corporate exposure:
(1) For which the [BANKING
ORGANIZATION] relies on the
revenues generated by a single project,
both as the source of repayment and as
security for the loan;
(2) The exposure is to an entity that
was created specifically to finance,
operate the physical assets of the
project, or do both; and
(3) The borrowing entity has an
immaterial amount of assets, activities,
or sources of income apart from the
revenues from the activities of the
project being financed.
Project finance operational phase
exposure means a project finance
exposure where the project has positive
net cash flow that is sufficient to
support the debt service and expenses of
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the project and any other remaining
contractual obligation, in accordance
with the [BANKING ORGANIZATION]’s
applicable loan underwriting criteria for
permanent financings, and where the
outstanding long-term debt on the
project is declining.
Real estate exposure means an
exposure that is neither a sovereign
exposure nor an exposure to a PSE and
that is:
(1) A residential mortgage exposure;
(2) Secured by collateral in the form
of real estate;
(3) A pre-sold construction loan;
(4) A statutory multifamily mortgage;
(5) An HVCRE exposure; or
(6) An ADC exposure.
Recovery means an inflow of funds or
economic benefits received from a third
party in relation to an operational loss
event. Recoveries do not include
receivables.
Regulatory commercial real estate
exposure means a real estate exposure
that is not a regulatory residential real
estate exposure, a defaulted real estate
exposure, an ADC exposure, a pre-sold
construction loan, a statutory
multifamily mortgage, or an HVCRE
exposure, and that meets the following
criteria:
(1) The exposure must be primarily
secured by fully completed real estate;
(2) The [BANKING ORGANIZATION]
holds a first priority security interest in
the property that is legally enforceable
in all relevant jurisdictions; provided
that when the [BANKING
ORGANIZATION] also holds a junior
security interest in the same property
and no other party holds an intervening
security interest, the [BANKING
ORGANIZATION] must treat the
exposures as a single regulatory
commercial real estate exposure;
(3) The exposure is made in
accordance with prudent underwriting
standards, including standards relating
to the loan amount as a percent of the
value of the property;
(4) During underwriting of the loan,
the [BANKING ORGANIZATION] must
have applied underwriting policies that
took into account the ability of the
borrower to repay in a timely manner
based on clear and measurable
underwriting standards that enable the
[BANKING ORGANIZATION] to
evaluate relevant credit factors; and
(5) The property must be valued in
accordance with § ll.103.
Regulatory residential real estate
exposure means a first-lien residential
mortgage exposure that is not a
defaulted real estate exposure, an ADC
exposure, a pre-sold construction loan,
a statutory multifamily mortgage, or an
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HVCRE exposure, and that meets the
following criteria:
(1) The exposure:
(i) Is secured by a property that is
either owner-occupied or rented;
(ii) Is made in accordance with
prudent underwriting standards,
including standards relating to the loan
amount as a percent of the value of the
property;
(iii) During underwriting of the loan,
the [BANKING ORGANIZATION] must
have applied underwriting policies that
took into account the ability of the
borrower to repay in a timely manner
based on clear and measurable
underwriting standards that enable the
[BANKING ORGANIZATION] to
evaluate these credit factors; and
(iv) The property must be valued in
accordance with § ll.103.
(2) When a [BANKING
ORGANIZATION] holds the first-lien
and junior-lien(s) residential mortgage
exposure, and no other party holds an
intervening lien, the [BANKING
ORGANIZATION] must treat the
exposures as a single regulatory
residential real estate exposure.
Regulatory retail exposure means a
retail exposure that meets all of the
following criteria:
(1) Product criterion. The exposure is
a revolving credit or line of credit, or a
term loan or lease;
(2) Aggregate limit. The sum of the
exposure amount and the amounts of all
other retail exposures to the obligor and
to its affiliates does not exceed $1
million; and
(3) Granularity limit. Notwithstanding
paragraphs (1) and (2) of this definition,
if a retail exposure exceeds 0.2 percent
of the [BANKING ORGANIZATION]’s
total retail exposures that meet criteria
(1) and (2) of this definition, only the
portion up to 0.2 percent of the
[BANKING ORGANIZATION]’s total
retail exposures may be considered a
regulatory retail exposure. Any excess
portion is a retail exposure that is not
a regulatory retail exposure. For
purposes of this paragraph (3), offbalance sheet exposures are measured
by applying the appropriate credit
conversion factor in § ll.112, and
defaulted exposures are excluded.
Retail exposure means an exposure
that is not a real estate exposure and
that meets the following criteria:
(1) The exposure is to a natural person
or persons, or
(2) The exposure is to an SME and
satisfies the criteria in paragraphs (1)
through (3) of the definition of
regulatory retail exposure.
Senior securitization exposure means
a securitization exposure that has a firstpriority claim on the cash flows from
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the underlying exposures. When
determining whether a securitization
exposure has a first-priority claim on
the cash flows from the underlying
exposures, a [BANKING
ORGANIZATION] is not required to
consider amounts due under interest
rate derivative, currency derivative, and
servicer cash advance facility contracts;
fees due; and other similar payments.
Both the most senior commercial paper
issued by an ABCP program and a
liquidity facility that supports the ABCP
program may be senior securitization
exposures if the liquidity facility
provider’s right to reimbursement of the
drawn amounts is senior to all claims on
the cash flows from the underlying
exposures except amounts due under
interest rate derivative, currency
derivative, and servicer cash advance
facility contracts; fees due; and other
similar payments.
Small or medium-sized entity (SME)
means an entity in which the reported
annual revenues or sales for the
consolidated group of which the entity
is a part are less than or equal to $50
million for the most recent fiscal year.
Subordinated debt instrument means
a debt security that is a corporate
exposure, a bank exposure or an
exposure to a GSE, including a note,
bond, debenture, similar instrument, or
other debt instrument as determined by
the [AGENCY], that is subordinated by
its terms, or separate intercreditor
agreement, to any creditor of the obligor,
or preferred stock that is not an equity
exposure.
Synthetic excess spread means any
contractual provisions in a synthetic
securitization that are designed to
absorb losses prior to any of the
tranches of the securitization structure.
Transactor exposure means a
regulatory retail exposure that is a credit
facility where the balance has been
repaid in full at each scheduled
repayment date for the previous 12
months or an overdraft facility where
there has been no drawdown over the
previous 12 months.
Total interest expense means interest
expenses related to all financial
liabilities and other interest expenses.
Total interest income means interest
income from all financial assets and
other interest income.
Trading revenue means the net gain or
loss from trading cash instruments and
derivative contracts (including
commodity contracts).
§ ll.103 Calculation of loan-to-value
(LTV) ratio.
(a) Loan-to-Value ratio. The loan-tovalue (LTV) ratio must be calculated as
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the extension of credit divided by the
value of the property.
(b) Extension of credit. For purposes
of a LTV ratio calculated under this
section, the extension of credit is equal
to the total outstanding amount of the
loan including any undrawn committed
amount of the loan.
(c) Value of the property. (1) For
purposes of a LTV ratio calculated
under this section, the value of the
property is the market value of all real
estate properties securing or being
improved by the extension of credit plus
the amount of any readily marketable
collateral and other acceptable
collateral, as defined in [REAL ESTATE
LENDING GUIDELINES], that secures
the extension of credit, subject to the
following:
(i) For exposures subject to
[APPRAISAL RULE], the market value
of property is a valuation that meets all
requirements of that rule.
(ii) For exposures not subject to
[APPRAISAL RULE]:
(A) The market value of real estate
must be obtained from an independent
valuation of the property using
prudently conservative valuation
criteria;
(B) The valuation must be done
independently from the [BANKING
ORGANIZATION]’s origination and
underwriting process, and
(C) To ensure that the market value of
the real estate is determined in a
prudently conservative manner, the
valuation must exclude expectations of
price increases and must be adjusted
downward to take into account the
potential for the current market price to
be significantly above the value that
would be sustainable over the life of the
loan.
(2) In the case where the exposure
finances the purchase of the property,
the value of the property is the lower of
the market value obtained under
paragraph (c)(1)(i) or (ii), as applicable,
and the actual acquisition cost.
(3) The value of the property must be
measured at the time of origination,
except in the following circumstances:
(i) The [AGENCY] requires a
[BANKING ORGANIZATION] to revise
the value of the property downward;
(ii) The value of the property must be
adjusted downward due to an
extraordinary event that results in a
permanent reduction of the property
value; or
(iii) The value of the property may be
increased to reflect modifications made
to the property that increase the market
value, as determined according to the
requirements in paragraphs (c)(1)(i) or
(ii) of this section.
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(4) Readily marketable collateral and
other acceptable collateral, as defined in
[REAL ESTATE LENDING
GUIDELINES], must be appropriately
discounted by the [BANKING
ORGANIZATION] consistent with the
[BANKING ORGANIZATION]’s usual
practices for making loans secured by
such collateral.
Risk-Weighted Assets for Credit Risk
§ ll.110 Calculation of total riskweighted assets for general credit risk.
(a) General risk-weighting
requirements. A [BANKING
ORGANIZATION] must apply risk
weights to its exposures as follows:
(1) A [BANKING ORGANIZATION]
must determine the exposure amount of
each on-balance sheet exposure, each
OTC derivative contract, and each offbalance sheet commitment, trade and
transaction-related contingency,
guarantee, repo-style transaction,
financial standby letter of credit,
forward agreement, or other similar
transaction that is not:
(i) An unsettled transaction subject to
§ ll.115;
(ii) A cleared transaction subject to
§ ll.114;
(iii) A default fund contribution
subject to § ll.114;
(iv) A securitization exposure subject
to §§ ll.130 through ll.134;
(v) An equity exposure (other than an
equity OTC derivative contract) subject
to §§ ll.140 through ll.142.
(2) The [BANKING ORGANIZATION]
must multiply each exposure amount by
the risk weight appropriate to the
exposure based on the exposure type or
counterparty, eligible guarantor, or
financial collateral to determine the
risk-weighted asset amount for each
exposure.
(b) Total risk-weighted assets for
general credit risk. Total credit riskweighted assets equals the sum of the
risk-weighted asset amounts calculated
under this section.
§ ll.111
General risk weights.
(a) Sovereign exposures—(1)
Exposures to the U.S. government. (i)
Notwithstanding any other requirement
in this subpart, a [BANKING
ORGANIZATION] must assign a zero
percent risk weight to:
(A) An exposure to the U.S.
government, its central bank, or a U.S.
government agency; and
(B) The portion of an exposure that is
directly and unconditionally guaranteed
by the U.S. government, its central bank,
or a U.S. government agency. This
includes a deposit or other exposure, or
the portion of a deposit or other
exposure, that is insured or otherwise
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unconditionally guaranteed by the FDIC
or the National Credit Union
Administration.
(ii) A [BANKING ORGANIZATION]
must assign a 20 percent risk weight to
the portion of an exposure that is
conditionally guaranteed by the U.S.
government, its central bank, or a U.S.
government agency. This includes an
exposure, or the portion of an exposure,
that is conditionally guaranteed by the
FDIC or the National Credit Union
Administration.
(iii) A [BANKING ORGANIZATION]
must assign a zero percent risk weight
to a Paycheck Protection Program
covered loan as defined in section
7(a)(36) of the Small Business Act (15
U.S.C. 636(a)(36)).
(2) Other sovereign exposures. In
accordance with Table 1 to § ll.111,
a [BANKING ORGANIZATION] must
assign a risk weight to a sovereign
exposure based on the CRC applicable
to the sovereign or the sovereign’s OECD
membership status if there is no CRC
applicable to the sovereign.
(3) Certain sovereign exposures.
Notwithstanding paragraph (a)(2) of this
section, a [BANKING ORGANIZATION]
may assign to a sovereign exposure a
risk weight that is lower than the
applicable risk weight in Table 1 to
§ ll.111 if:
(i) The exposure is denominated in
the sovereign’s currency;
(ii) The [BANKING ORGANIZATION]
has at least an equivalent amount of
liabilities in that currency; and
(iii) The risk weight is not lower than
the risk weight that the home country
supervisor allows an organization
engaged in the business of banking
under its jurisdiction to assign to the
same exposures to the sovereign.
(4) Exposures to a non-OECD member
sovereign with no CRC. Except as
provided in paragraphs (a)(3), (5) and (6)
of this section, a [BANKING
ORGANIZATION] must assign a 100
percent risk weight to an exposure to a
sovereign if the sovereign does not have
a CRC.
(5) Exposures to an OECD member
sovereign with no CRC. Except as
provided in paragraph (a)(6) of this
section, a [BANKING ORGANIZATION]
must assign a 0 percent risk weight to
an exposure to a sovereign that is a
member of the OECD if the sovereign
does not have a CRC.
(6) Sovereign default. A [BANKING
ORGANIZATION] must assign a 150
percent risk weight to a sovereign
exposure immediately upon
determining that an event of sovereign
default has occurred, or if an event of
sovereign default has occurred during
the previous five years.
(b) Certain supranational entities and
multilateral development banks (MDBs).
A [BANKING ORGANIZATION] must
assign a zero percent risk weight to
exposures to the Bank for International
Settlements, the European Central Bank,
the European Commission, the
International Monetary Fund, the
European Stability Mechanism, the
European Financial Stability Facility, or
an MDB.
(c) Exposures to GSEs. (1) A
[BANKING ORGANIZATION] must
assign a 20 percent risk weight to an
exposure to a GSE that is not:
(i) An equity exposure; or
(ii) An exposure to a subordinated
debt instrument issued by a GSE.
(2) A [BANKING ORGANIZATION]
must assign a 150 percent risk weight to
an exposure to a subordinated debt
instrument issued by a GSE, unless a
different risk weight is provided under
paragraph (c)(3) of this section.
(3) Notwithstanding paragraphs (c)(1)
and (2) of this section, a [BANKING
ORGANIZATION] must assign a 20
percent risk weight to an exposure to a
subordinated debt instrument issued by
a Federal Home Loan Bank or the
Federal Agricultural Mortgage
Corporation (Farmer Mac) that is not a
defaulted exposure.
(d) Exposures to a depository
institution, a foreign bank, or a credit
union. (1) A [BANKING
ORGANIZATION] must assign a risk
weight to a bank exposure in accordance
with Table 2 of this section, unless
otherwise provided under paragraph
(d)(2) or (d)(3) of this section.
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PSE’s home country if there is no CRC
applicable to the PSE’s home country.
(ii) Except as provided in paragraphs
(e)(1) and (e)(3) of this section, a
[BANKING ORGANIZATION] must
assign a risk weight to a revenue
obligation exposure of a PSE, in
accordance with Table 4 to § ll.111,
based on the CRC that corresponds to
the PSE’s home country; or the OECD
membership status of the PSE’s home
country if there is no CRC applicable to
the PSE’s home country.
(3) A [BANKING ORGANIZATION]
may assign a lower risk weight than
would otherwise apply under Tables 3
or 4 to § ll.111 to an exposure to a
foreign PSE if:
(i) The PSE’s home country supervisor
allows banks under its jurisdiction to
assign a lower risk weight to such
exposures; and
(ii) The risk weight is not lower than
the risk weight that corresponds to the
PSE’s home country in accordance with
Table 1 to § ll.111.
BILLING CODE 6210–01–P; 6714–01–P; 4810–33–P
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(ii) A 150 percent risk weight to a
bank exposure that is an exposure to a
subordinated debt instrument or an
exposure to a covered debt instrument.
(e) Exposures to public sector entities
(PSEs)—(1) Exposures to U.S. PSEs. (i)
A [BANKING ORGANIZATION] must
assign a 20 percent risk weight to a
general obligation exposure of a PSE
that is organized under the laws of the
United States or any state or political
subdivision thereof.
(ii) A [BANKING ORGANIZATION]
must assign a 50 percent risk weight to
a revenue obligation exposure of a PSE
that is organized under the laws of the
United States or any state or political
subdivision thereof.
(2) Exposures to foreign PSEs. (i)
Except as provided in paragraphs (e)(1)
and (3) of this section, a [BANKING
ORGANIZATION] must assign a risk
weight to a general obligation exposure
to a PSE, in accordance with Table 3 to
§ ll.111, based on the CRC that
corresponds to the PSE’s home country
or the OECD membership status of the
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(2) Notwithstanding paragraph (d)(1)
of this section, a [BANKING
ORGANIZATION] must not assign a risk
weight to an exposure to a foreign bank
lower than the risk weight applicable to
a sovereign exposure of the home
country of the foreign bank unless:
(i) The exposure is in the local
currency of the home country of the
foreign bank;
(ii) For an exposure to a branch of the
foreign bank in a foreign jurisdiction
that is not the home country of the
foreign bank, the exposure is in the local
currency of the jurisdiction in which the
foreign branch operates; or
(iii) The exposure is a self-liquidating,
trade-related contingent item that arises
from the movement of goods and that
has a maturity of three months or less.
(3) Notwithstanding paragraph (d)(1)
or (d)(2) of this section, a [BANKING
ORGANIZATION] must assign:
(i) A risk weight under § ll.141 to
a bank exposure that is an equity
exposure; and
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BILLING CODE 6210–01–C; 6714–01–C; 4810–33–C
(4) ADC exposures that are not
HVCRE exposures. A [BANKING
ORGANIZATION] must assign a 100
percent risk weight to an ADC exposure
that is not an HVCRE exposure or a
defaulted real estate exposure.
(5) Regulatory residential real estate
exposure. (i) A [BANKING
ORGANIZATION] must assign a risk
weight to a regulatory residential real
estate exposure that is not dependent on
the cash flows generated by the real
estate based on the exposure’s LTV ratio
in accordance with Table 5 to
§ ll.111.
(ii) A [BANKING ORGANIZATION]
must assign a risk weight to a regulatory
residential real estate exposure that is
dependent on the cash flows generated
by the real estate based on the
exposure’s LTV ratio in accordance with
Table 6 to § ll.111.
BILLING CODE 6210–01–P; 6714–01–P; 4810–33–P
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default has occurred in a PSE’s home
country or if an event of sovereign
default has occurred in the PSE’s home
country during the previous five years.
(f) Real estate exposures—(1)
Statutory multifamily mortgages. A
[BANKING ORGANIZATION] must
assign a 50 percent risk weight to a
statutory multifamily mortgage that is
not a defaulted real estate exposure.
(2) Pre-sold construction loans. A
[BANKING ORGANIZATION] must
assign a 50 percent risk weight to a presold construction loan that is not a
defaulted real estate exposure, unless
the purchase contract is cancelled, in
which case a [BANKING
ORGANIZATION] must assign a 100
percent risk weight.
(3) High-volatility commercial real
estate (HVCRE) exposures. A [BANKING
ORGANIZATION] must assign a 150
percent risk weight to an HVCRE
exposure that is not a defaulted real
estate exposure.
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(4) Exposures to PSEs from an OECD
member sovereign with no CRC. (i) A
[BANKING ORGANIZATION] must
assign a 20 percent risk weight to a
general obligation exposure to a PSE
whose home country is an OECD
member sovereign with no CRC.
(ii) A [BANKING ORGANIZATION]
must assign a 50 percent risk weight to
a revenue obligation exposure to a PSE
whose home country is an OECD
member sovereign with no CRC.
(5) Exposures to PSEs whose home
country is not an OECD member
sovereign with no CRC. A [BANKING
ORGANIZATION] must assign a 100
percent risk weight to an exposure to a
PSE whose home country is not a
member of the OECD and does not have
a CRC.
(6) A [BANKING ORGANIZATION]
must assign a 150 percent risk weight to
a PSE exposure immediately upon
determining that an event of sovereign
accordance with Table 7 to § ll.111,
provided that if the [BANKING
ORGANIZATION] cannot determine the
risk weight applicable to the borrower
under this section, the [BANKING
ORGANIZATION] must consider the
risk weight of the borrower to be 100
percent.
(ii) A [BANKING ORGANIZATION]
must assign a risk weight to a regulatory
commercial real estate exposure that is
dependent on the cash flows generated
by the real estate based on the
exposure’s LTV in accordance with
Table 8 to § ll.111.
BILLING CODE 6210–01–C; 6714–01–C; 4810–33–C
ORGANIZATION] must apply a 1.5
multiplier to the applicable risk weight,
subject to a maximum risk weight of 150
percent, to a residential mortgage
exposure to a borrower that does not
have a source of repayment in the
currency of the loan equal to at least 90
percent of the annual payment from
either income generated through
ordinary business activities or from a
contract with a financial institution that
provides funds denominated in the
currency of the loan.
(g) Retail exposures. A [BANKING
ORGANIZATION] must assign a risk
weight to a retail exposure according to
the following:
(1) Regulatory retail exposures—(i)
Regulatory retail exposures that are not
transactor exposures. A [BANKING
ORGANIZATION] must assign a 85
percent risk weight to a regulatory retail
exposure that is not a transactor
exposure.
(ii) Transactor exposures. A
[BANKING ORGANIZATION] must
assign a 55 percent risk weight to a
transactor exposure.
(2) Other retail exposures. A
[BANKING ORGANIZATION] must
assign a 110 percent risk weight to retail
exposures that are not regulatory retail
exposures.
(3) Risk weight multiplier to certain
exposures with currency mismatch.
Notwithstanding any other provision of
paragraphs (g)(1) and (2) of this section,
a [BANKING ORGANIZATION] must
apply a 1.5 multiplier to the applicable
risk weight, subject to a maximum risk
weight of 150 percent, to any retail
exposure in a foreign currency to a
(7) Other real estate exposures. A
[BANKING ORGANIZATION] must
assign another real estate exposure a 150
percent risk weight, unless the exposure
is a residential mortgage exposure that
is not dependent on the cash flows
generated by the real estate, which must
be assigned a 100 percent risk weight.
(8) Defaulted real estate exposures. A
[BANKING ORGANIZATION] must
assign a defaulted real estate exposure a
150 percent risk weight, unless the
exposure is a residential mortgage
exposure that is not dependent on the
cash flows generated by the real estate,
which must be assigned a 100 percent
risk weight.
(9) Risk weight multiplier to certain
exposures with currency mismatch.
Notwithstanding any other provision of
this paragraph (f), a [BANKING
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(6) Regulatory commercial real estate
exposure. (i) A [BANKING
ORGANIZATION] must assign a risk
weight to a regulatory commercial real
estate exposure that is not dependent on
the cash flows generated by the real
estate based on the exposure’s LTV and
the risk weight applicable to the
borrower under this section, in
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borrower that does not have a source of
repayment in the foreign currency equal
to at least 90 percent of the annual
payment amount from either income
generated through ordinary business
activities or from a contract with a
financial institution that provides funds
denominated in the foreign currency.
(h) Corporate exposures. A
[BANKING ORGANIZATION] must
assign a 100 percent risk weight to a
corporate exposure unless the corporate
exposure qualifies for a different risk
weight under paragraphs (h)(1) through
(4).
(1) A [BANKING ORGANIZATION]
must assign a 65 percent risk weight to
a corporate exposure that is an exposure
to a company that is investment grade
and that has a publicly traded security
outstanding or that is controlled by a
company that has a publicly traded
security outstanding.
(2) A [BANKING ORGANIZATION]
must assign a 130 percent risk weight to
a project finance exposure that is not a
project finance operational phase
exposure.
(3) A [BANKING ORGANIZATION]
must assign risk weights to certain
exposures to a QCCP as follows:
(i) A [BANKING ORGANIZATION]
must assign a 2 percent risk weight to
an exposure to a QCCP arising from the
[BANKING ORGANIZATION] posting
cash collateral to the QCCP in
connection with a cleared transaction
that meets the requirements of
§ ll.114(b)(3)(i)(A) and a 4 percent
risk weight to an exposure to a QCCP
arising from the [BANKING
ORGANIZATION] posting cash
collateral to the QCCP in connection
with a cleared transaction that meets the
requirements of § ll.114(b)(3)(i)(B).
(ii) A [BANKING ORGANIZATION]
must assign a 2 percent risk weight to
an exposure to a QCCP arising from the
[BANKING ORGANIZATION] posting
cash collateral to the QCCP in
connection with a cleared transaction
that meets the requirements of
§ ll.114(c)(3)(i).
(4) A [BANKING ORGANIZATION]
must assign a 150 percent risk weight to
a corporate exposure that is an exposure
to a subordinated debt instrument or an
exposure to a covered debt instrument.
(5) Notwithstanding any other
provision of this paragraph (h), a
[BANKING ORGANIZATION] must
assign a 100 percent risk weight to:
(i) A corporate exposure that is for the
purpose of acquiring or financing
equipment or physical commodities
where repayment of the exposure is
dependent on the physical assets being
financed or acquired; or
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(ii) A project finance operational
phase exposure.
(i) Defaulted exposures.
Notwithstanding any other provision of
this subpart, a [BANKING
ORGANIZATION] must assign a 150
percent risk weight to any exposure that
is a defaulted exposure.
(j) Other assets. (1)(i) A bank holding
company or savings and loan holding
company must assign a zero percent risk
weight to cash owned and held in all
offices of subsidiary depository
institutions or in transit, and to gold
bullion held in a subsidiary depository
institution’s own vaults, or held in
another depository institution’s vaults
on an allocated basis, to the extent the
gold bullion assets are offset by gold
bullion liabilities.
(ii) A [BANKING ORGANIZATION]
must assign a zero percent risk weight
to cash owned and held in all offices of
the [BANKING ORGANIZATION] or in
transit; to gold bullion held in the
[BANKING ORGANIZATION]’s own
vaults or held in another depository
institution’s vaults on an allocated
basis, to the extent the gold bullion
assets are offset by gold bullion
liabilities; and to exposures that arise
from the settlement of cash transactions
(such as equities, fixed income, spot
foreign exchange and spot commodities)
with a central counterparty where there
is no assumption of ongoing
counterparty credit risk by the central
counterparty after settlement of the
trade and associated default fund
contributions.
(2) A [BANKING ORGANIZATION]
must assign a 20 percent risk weight to
cash items in the process of collection.
(3) A [BANKING ORGANIZATION]
must assign a 100 percent risk weight to
DTAs arising from temporary
differences that the [BANKING
ORGANIZATION] could realize through
net operating loss carrybacks.
(4) A [BANKING ORGANIZATION]
must assign a 250 percent risk weight to
the portion of each of the following
items to the extent it is not deducted
from common equity tier 1 capital
pursuant to § ll.22(d):
(i) MSAs; and
(ii) DTAs arising from temporary
differences that the [BANKING
ORGANIZATION] could not realize
through net operating loss carrybacks.
(5) A [BANKING ORGANIZATION]
must assign a 100 percent risk weight to
all assets not specifically assigned a
different risk weight under this subpart
and that are not deducted from tier 1 or
tier 2 capital pursuant to § ll.22.
(6) Notwithstanding the requirements
of this section, a [BANKING
ORGANIZATION] may assign an asset
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that is not included in one of the
categories provided in this section to the
risk weight category applicable under
the capital rules applicable to bank
holding companies and savings and
loan holding companies at 12 CFR part
217, provided that all of the following
conditions apply:
(i) The [BANKING ORGANIZATION]
is not authorized to hold the asset under
applicable law other than debt
previously contracted or similar
authority; and
(ii) The risks associated with the asset
are substantially similar to the risks of
assets that are otherwise assigned to a
risk weight category of less than 100
percent under this subpart.
(k) Insurance assets—(1) Assets held
in a separate account. (i) A bank
holding company or savings and loan
holding company must risk-weight the
individual assets held in a separate
account that does not qualify as a nonguaranteed separate account as if the
individual assets were held directly by
the bank holding company or savings
and loan holding company.
(ii) A bank holding company or
savings and loan holding company must
assign a zero percent risk weight to an
asset that is held in a non-guaranteed
separate account.
(2) Policy loans. A bank holding
company or savings and loan holding
company must assign a 20 percent risk
weight to a policy loan.
§ ll.112
Off-balance sheet exposures.
(a) General. (1) A [BANKING
ORGANIZATION] must calculate the
exposure amount of an off-balance sheet
exposure using the credit conversion
factors (CCFs) in paragraph (b) of this
section. In the case of commitments, a
[BANKING ORGANIZATION] must
multiply the committed but undrawn
amount of the exposure by the
applicable CCF.
(2) Where a [BANKING
ORGANIZATION] commits to provide a
commitment, the [BANKING
ORGANIZATION] may apply the lower
of the two applicable CCFs.
(3) Where a [BANKING
ORGANIZATION] provides a
commitment structured as a syndication
or participation, the [BANKING
ORGANIZATION] is only required to
calculate the exposure amount for its
pro rata share of the commitment.
(4) Where a [BANKING
ORGANIZATION] provides a
commitment, enters into a repurchase
agreement, or provides a creditenhancing representation and warranty,
and such commitment, repurchase
agreement, or credit-enhancing
representation and warranty is not a
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securitization exposure, the exposure
amount shall be no greater than the
maximum contractual amount of the
commitment, repurchase agreement, or
credit-enhancing representation and
warranty, as applicable.
(5) For purposes of this section, if a
commitment does not have an express
contractual maximum amount that can
be drawn, the committed but undrawn
amount of the commitment is equal to
the average total drawn amount over the
period since the commitment was
created or the prior eight quarters,
whichever period is shorter, multiplied
by ten, minus the current drawn
amount.
(6) For purposes of this subpart, with
respect to a repurchase or reverse
repurchase transaction, or a securities
borrowing or securities lending
transaction, a [BANKING
ORGANIZATION] must include in
expanded total risk-weighted assets the
risk-weighted asset amount for
counterparty credit risk according to
§ ll.121 and the risk-weighted asset
amount for securities or posted
collateral, where the credit risk of the
securities lent or posted as collateral
remains with the [BANKING
ORGANIZATION].
(b) Credit Conversion Factors—(1) 10
percent CCF. A [BANKING
ORGANIZATION] must apply a 10
percent CCF to the unused portion of a
commitment that is unconditionally
cancellable by the [BANKING
ORGANIZATION].
(2) 20 percent CCF. A [BANKING
ORGANIZATION] must apply a 20
percent CCF to the amount of selfliquidating trade-related contingent
items that arise from the movement of
goods, with an original maturity of one
year or less.
(3) 40 percent CCF. A [BANKING
ORGANIZATION] must apply a 40
percent CCF to commitments, regardless
of the maturity of the facility, unless
they qualify for a lower or higher CCF.
(4) 50 percent CCF. A [BANKING
ORGANIZATION] must apply a 50
percent CCF to the amount of:
(i) Transaction-related contingent
items, including performance bonds, bid
bonds, warranties, and performance
standby letters of credit; and
(ii) Note issuance facilities and
revolving underwriting facilities.
(5) 100 percent CCF. A [BANKING
ORGANIZATION] must apply a 100
percent CCF to the amount of the
following off-balance-sheet items and
other similar transactions:
(i) Guarantees;
(ii) Repurchase agreements (the offbalance sheet component of which
equals the sum of the current fair values
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of all positions the [BANKING
ORGANIZATION] has sold subject to
repurchase);
(iii) Credit-enhancing representations
and warranties that are not
securitization exposures;
(iv) Off-balance sheet securities
lending transactions (the off-balance
sheet component of which equals the
sum of the current fair values of all
positions the [BANKING
ORGANIZATION] has lent under the
transaction);
(v) Off-balance sheet securities
borrowing transactions (the off-balance
sheet component of which equals the
sum of the current fair values of all noncash positions the [BANKING
ORGANIZATION] has posted as
collateral under the transaction);
(vi) Financial standby letters of credit;
and
(vii) Forward agreements.
§ ll.113
Derivative contracts.
(a) Exposure amount for derivative
contracts. A [BANKING
ORGANIZATION] must determine the
exposure amount for a derivative
contract using the standardized
approach for counterparty credit risk
(SA–CCR) under this section. A
[BANKING ORGANIZATION] may
reduce the exposure amount calculated
according to this section by the credit
valuation adjustment that the
[BANKING ORGANIZATION] has
recognized in its balance sheet valuation
of any derivative contracts in the netting
set. For purposes of this paragraph (a),
the credit valuation adjustment does not
include any adjustments to common
equity tier 1 capital attributable to
changes in the fair value of the
[BANKING ORGANIZATION]’s
liabilities that are due to changes in its
own credit risk since the inception of
the transaction with the counterparty.
(b) Definitions. For purposes of this
section, the following definitions apply:
(1) End date means the last date of the
period referenced by an interest rate or
credit derivative contract or, if the
derivative contract references another
instrument, by the underlying
instrument, except as otherwise
provided in this section.
(2) Start date means the first date of
the period referenced by an interest rate
or credit derivative contract or, if the
derivative contract references the value
of another instrument, by underlying
instrument, except as otherwise
provided in this section.
(3) Hedging set means:
(i) With respect to interest rate
derivative contracts, all such contracts
within a netting set that reference the
same reference currency;
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(ii) With respect to exchange rate
derivative contracts, all such contracts
within a netting set that reference the
same currency pair;
(iii) With respect to credit derivative
contract, all such contracts within a
netting set;
(iv) With respect to equity derivative
contracts, all such contracts within a
netting set;
(v) With respect to a commodity
derivative contract, all such contracts
within a netting set that reference one
of the following commodity categories:
Energy, metal, agricultural, or other
commodities;
(vi) With respect to basis derivative
contracts, all such contracts within a
netting set that reference the same pair
of risk factors and are denominated in
the same currency; or
(vii) With respect to volatility
derivative contracts, all such contracts
within a netting set that reference one
of interest rate, exchange rate, credit,
equity, or commodity risk factors,
separated according to the requirements
under paragraphs (b)(3)(i) through (v) of
this section.
(viii) If the risk of a derivative
contract materially depends on more
than one of interest rate, exchange rate,
credit, equity, or commodity risk
factors, the [AGENCY] may require a
[BANKING ORGANIZATION] to
include the derivative contract in each
appropriate hedging set under
paragraphs (b)(3)(i) through (v) of this
section.
(c) Credit derivatives.
Notwithstanding paragraphs (a) and (b)
of this section:
(1) A [BANKING ORGANIZATION]
that purchases a credit derivative that is
recognized under § ll.120 as a credit
risk mitigant for an exposure that is not
a market risk covered position under
subpart F of this part is not required to
calculate a separate counterparty credit
risk capital requirement under this
section so long as the [BANKING
ORGANIZATION] does so consistently
for all such credit derivatives and either
includes all or excludes all such credit
derivatives that are subject to a master
netting agreement from any measure
used to determine counterparty credit
risk exposure to all relevant
counterparties for risk-based capital
purposes.
(2) A [BANKING ORGANIZATION]
that is the protection provider in a
credit derivative must treat the credit
derivative as an exposure to the
reference obligor and is not required to
calculate a counterparty credit risk
capital requirement for the credit
derivative under this section, so long as
it does so consistently for all such credit
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derivatives and either includes all or
excludes all such credit derivatives that
are subject to a master netting agreement
from any measure used to determine
counterparty credit risk exposure to all
relevant counterparties for risk-based
capital purposes (unless the [BANKING
ORGANIZATION] is treating the credit
derivative as a market risk covered
position under subpart F of this part, in
which case the [BANKING
ORGANIZATION] must calculate a
counterparty credit risk capital
requirement under this section).
(d) Equity derivatives. A [BANKING
ORGANIZATION] must treat an equity
derivative contract as an equity
exposure and compute a risk-weighted
asset amount for the equity derivative
contract under § ll.140–ll.142
(unless the [BANKING
ORGANIZATION] is treating the
contract as a market risk covered
position under subpart F of this part). In
addition, if the [BANKING
ORGANIZATION] is treating the
contract as a market risk covered
position under subpart F of this part, the
[BANKING ORGANIZATION] must also
calculate a risk-based capital
requirement for the counterparty credit
risk of an equity derivative contract
under this section. If the [BANKING
ORGANIZATION] risk weights an
equity derivative contract under
§ ll.140–ll.142, the [BANKING
ORGANIZATION] may choose not to
hold risk-based capital against the
counterparty credit risk of the equity
derivative contract, as long as it does so
for all such contracts. Where an equity
derivative contract is subject to a
qualified master netting agreement, a
[BANKING ORGANIZATION] using
§ ll.140–ll.142 must either include
all or exclude all of the contracts from
any measure used to determine
counterparty credit risk exposure.
(e) Exposure amount. (1) The
exposure amount of a netting set, as
calculated under this section, is equal to
1.4 multiplied by the sum of the
replacement cost of the netting set, as
calculated under paragraph (f) of this
section, and the potential future
exposure of the netting set, as calculated
under paragraph (g) of this section.
(2) Notwithstanding the requirements
of paragraph (e)(1) of this section, the
exposure amount of a netting set subject
to a variation margin agreement,
excluding a netting set that is subject to
a variation margin agreement under
which the counterparty to the variation
margin agreement is not required to post
variation margin, is equal to the lesser
of the exposure amount of the netting
set calculated under paragraph (e)(1) of
this section and the exposure amount of
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the netting set calculated under
paragraph (e)(1) of this section as if the
netting set were not subject to a
variation margin agreement.
(3) Notwithstanding the requirements
of paragraph (e)(1) of this section, the
exposure amount of a netting set that
consists of only sold options in which
the premiums have been fully paid by
the counterparty to the options and
where the options are not subject to a
variation margin agreement is zero.
(4) Notwithstanding the requirements
of paragraph (e)(1) of this section, the
exposure amount of a netting set in
which the counterparty is a commercial
end-user is equal to the sum of
replacement cost, as calculated under
paragraph (f) of this section, and the
potential future exposure of the netting
set, as calculated under paragraph (g) of
this section.
(5) For purposes of the exposure
amount calculated under paragraph
(e)(1) of this section and all calculations
that are part of that exposure amount, a
[BANKING ORGANIZATION] may elect
to treat a derivative contract that is a
cleared transaction that is not subject to
a variation margin agreement as one that
is subject to a variation margin
agreement, if the derivative contract is
subject to a requirement that the
counterparties make daily cash
payments to each other to account for
changes in the fair value of the
derivative contract and to reduce the net
position of the contract to zero. If a
[BANKING ORGANIZATION] makes an
election under this paragraph (e)(5) for
one derivative contract, it must treat all
other derivative contracts within the
same netting set that are eligible for an
election under this paragraph (e)(5) as
derivative contracts that are subject to a
variation margin agreement.
(6) For purposes of the exposure
amount calculated under paragraph
(e)(1) of this section and all calculations
that are part of that exposure amount, a
[BANKING ORGANIZATION] may elect
to treat a credit derivative contract,
equity derivative contract, or
commodity derivative contract that
references an index as if it were
multiple derivative contracts each
referencing one component of the index,
provided that the derivative contract is
not an option or a CDO tranche.
(7) For purposes of the exposure
amount calculated under paragraph
(e)(1) of this section and all calculations
that are part of that exposure amount,
with respect to a client-facing derivative
transaction or netting set of client-facing
derivative transactions, a clearing
member [BANKING ORGANIZATION]
may multiply the standard supervisory
haircuts applied for purposes of the net
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independent collateral amount and
variation margin amount by the scaling
factor of the square root of 1⁄2 (which
equals 0.707107). If the [BANKING
ORGANIZATION] determines that a
longer period is appropriate, the
[BANKING ORGANIZATION] must use
a larger scaling factor to adjust for a
longer holding period as provided
below by the formula in this paragraph.
In addition, the [AGENCY] may require
the [BANKING ORGANIZATION] to set
a longer holding period if the [AGENCY]
determines that a longer period is
appropriate due to the nature, structure,
or characteristics of the transaction or is
commensurate with the risks associated
with the transaction.
Where H = the holding period greater than
or equal to five days
(f) Replacement cost of a netting set—
(1) Netting set subject to a variation
margin agreement under which the
counterparty must post variation
margin. The replacement cost of a
netting set subject to a variation margin
agreement, excluding a netting set that
is subject to a variation margin
agreement under which the
counterparty is not required to post
variation margin, is the greater of:
(i) The sum of the fair values (after
excluding any valuation adjustments) of
the derivative contracts within the
netting set less the sum of the net
independent collateral amount and the
variation margin amount applicable to
such derivative contracts;
(ii) The sum of the variation margin
threshold and the minimum transfer
amount applicable to the derivative
contracts within the netting set less the
net independent collateral amount
applicable to such derivative contracts;
or
(iii) Zero.
(2) Netting sets not subject to a
variation margin agreement under
which the counterparty must post
variation margin. The replacement cost
of a netting set that is not subject to a
variation margin agreement under
which the counterparty must post
variation margin to the [BANKING
ORGANIZATION] is the greater of:
(i) The sum of the fair values (after
excluding any valuation adjustments) of
the derivative contracts within the
netting set less the sum of the net
independent collateral amount and
variation margin amount applicable to
such derivative contracts; or
(ii) Zero.
(3) Multiple netting sets subject to a
single variation margin agreement.
Notwithstanding paragraphs (f)(1) and
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(2) of this section, the replacement cost
for multiple netting sets subject to a
single variation margin agreement must
be calculated according to paragraph
(j)(1) of this section.
(4) Netting set subject to multiple
variation margin agreements or a hybrid
netting set. Notwithstanding paragraphs
(f)(1) and (2) of this section, the
replacement cost for a netting set subject
to multiple variation margin agreements
or a hybrid netting set must be
calculated according to paragraph (k)(1)
of this section.
(g) Potential future exposure of a
netting set. The potential future
exposure of a netting set is the product
of the PFE multiplier and the aggregated
amount.
(1) PFE multiplier. The PFE multiplier
is calculated according to the following
formula:
Where:
V is the sum of the fair values (after
excluding any valuation adjustments) of
the derivative contracts within the
netting set;
C is the sum of the net independent collateral
amount and the variation margin amount
applicable to the derivative contracts
within the netting set; and
A is the aggregated amount of the netting set.
calculating the potential future exposure
for purposes of total leverage exposure
under § ll.10(c)(2)(ii), the potential
future exposure for a netting set subject
to multiple variation margin agreements
or a hybrid netting set must be
calculated according to paragraph (k)(2)
of this section.
(h) Hedging set amount—(1) Interest
rate derivative contracts. To calculate
the hedging set amount of an interest
rate derivative contract hedging set, a
[BANKING ORGANIZATION] may use
either of the formulas provided in
paragraphs (h)(1)(i) and (ii) of this
section:
(i) Formula 1 is as follows:
Hedging set amount = [(AddOnTB1IR)2 +
(AddOnTB2IR)2 + (Add OnTB3IR)2 +
1.4 * Add OnTB1IR * Add OnTB2IR +
1.4 * Add OnTB2IR * Add OnTB3IR +
0.6 * Add OnTB1IR * Add OnTB3IR)]1/2
(ii) Formula 2 is as follows:
Hedging set amount = |Add OnTB1IR| +
|Add OnTB2IR| + |Add OnTB3IR|
calculated under paragraph (i) of this
section, within the hedging set with an
end date of less than one year from the
present date;
AddOnTB2IR is the sum of the adjusted
derivative contract amounts, as
calculated under paragraph (i) of this
section, within the hedging set with an
end date of one to five years from the
present date; and
AddOnTB3IR is the sum of the adjusted
derivative contract amounts, as
calculated under paragraph (i) of this
section, within the hedging set with an
end date of more than five years from the
present date.
Where:
k is each reference entity within the hedging
set.
K is the number of reference entities within
the hedging set.
AddOn (Refk) equals the sum of the adjusted
derivative contract amounts, as
determined under paragraph (i) of this
section, for all derivative contracts
within the hedging set that reference
entity k.
ρk equals the applicable supervisory
correlation factor, as provided in Table 2
to this section.
(4) Commodity derivative contracts.
The hedging set amount of a commodity
derivative contract hedging set within a
netting set is calculated according to the
following formula:
EP18SE23.066</GPH>
Where in paragraphs (h)(1)(i) and (ii) of this
section:
AddOnTB1IR is the sum of the adjusted
derivative contract amounts, as
(2) Exchange rate derivative contracts.
For an exchange rate derivative contract
hedging set, the hedging set amount
equals the absolute value of the sum of
the adjusted derivative contract
amounts, as calculated under paragraph
(i) of this section, within the hedging
set.
(3) Credit derivative contracts and
equity derivative contracts. The hedging
set amount of a credit derivative
contract hedging set or equity derivative
contract hedging set within a netting set
is calculated according to the following
formula:
EP18SE23.065</GPH>
(2) Aggregated amount. The
aggregated amount is the sum of all
hedging set amounts, as calculated
under paragraph (h) of this section,
within a netting set.
(3) Multiple netting sets subject to a
single variation margin agreement.
Notwithstanding paragraphs (g)(1) and
(2) of this section and when calculating
the potential future exposure for
purposes of total leverage exposure
under § ll.10(c)(2)(ii), the potential
future exposure for multiple netting sets
subject to a single variation margin
agreement must be calculated according
to paragraph (j)(2) of this section.
(4) Netting set subject to multiple
variation margin agreements or a hybrid
netting set. Notwithstanding paragraphs
(g)(1) and (2) of this section and when
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Where:
k is each commodity type within the hedging
set.
K is the number of commodity types within
the hedging set.
AddOn (Typek) equals the sum of the
adjusted derivative contract amounts, as
determined under paragraph (i) of this
section, for all derivative contracts
within the hedging set that reference
commodity type.
ρ equals the applicable supervisory
correlation factor, as provided in table 2
to this section.
(5) Basis derivative contracts and
volatility derivative contracts.
Notwithstanding paragraphs (h)(1)
through (4) of this section, a [BANKING
ORGANIZATION] must calculate a
Where:
S is the number of business days from the
present day until the start date of the
derivative contract, or zero if the start
date has already passed; and
E is the number of business days from the
present day until the end date of the
derivative contract.
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(B) For purposes of paragraph
(i)(2)(i)(A) of this section:
(1) For an interest rate derivative
contract or credit derivative contract
that is a variable notional swap, the
notional amount is equal to the timeweighted average of the contractual
notional amounts of such a swap over
the remaining life of the swap; and
(2) For an interest rate derivative
contract or a credit derivative contract
that is a leveraged swap, in which the
notional amount of all legs of the
derivative contract are divided by a
factor and all rates of the derivative
contract are multiplied by the same
factor, the notional amount is equal to
the notional amount of an equivalent
unleveraged swap.
(ii)(A) For an exchange rate derivative
contract, the adjusted notional amount
is the notional amount of the non-U.S.
denominated currency leg of the
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separate hedging set amount for each
basis derivative contract hedging set and
each volatility derivative contract
hedging set. A [BANKING
ORGANIZATION] must calculate such
hedging set amounts using one of the
formulas under paragraphs (h)(1)
through (4) that corresponds to the
primary risk factor of the hedging set
being calculated.
(i) Adjusted derivative contract
amount—(1) Summary. To calculate the
adjusted derivative contract amount of a
derivative contract, a [BANKING
ORGANIZATION] must determine the
adjusted notional amount of the
derivative contract, pursuant to
paragraph (i)(2) of this section, and
multiply the adjusted notional amount
by each of the supervisory delta
adjustment, pursuant to paragraph (i)(3)
of this section, the maturity factor,
pursuant to paragraph (i)(4) of this
section, and the applicable supervisory
factor, as provided in Table 2 to this
section.
(2) Adjusted notional amount. (i)(A)
For an interest rate derivative contract
or a credit derivative contract, the
adjusted notional amount equals the
product of the notional amount of the
derivative contract, as measured in U.S.
dollars using the exchange rate on the
date of the calculation, and the
supervisory duration, as calculated by
the following formula:
derivative contract, as measured in U.S.
dollars using the exchange rate on the
date of the calculation. If both legs of
the exchange rate derivative contract are
denominated in currencies other than
U.S. dollars, the adjusted notional
amount of the derivative contract is the
largest leg of the derivative contract, as
measured in U.S. dollars using the
exchange rate on the date of the
calculation.
(B) Notwithstanding paragraph
(i)(2)(ii)(A) of this section, for an
exchange rate derivative contract with
multiple exchanges of principal, the
[BANKING ORGANIZATION] must set
the adjusted notional amount of the
derivative contract equal to the notional
amount of the derivative contract
multiplied by the number of exchanges
of principal under the derivative
contract.
(iii)(A) For an equity derivative
contract or a commodity derivative
contract, the adjusted notional amount
is the product of the fair value of one
unit of the reference instrument
underlying the derivative contract and
the number of such units referenced by
the derivative contract.
(B) Notwithstanding paragraph
(i)(2)(iii)(A) of this section, when
calculating the adjusted notional
amount for an equity derivative contract
or a commodity derivative contract that
is a volatility derivative contract, the
[BANKING ORGANIZATION] must
replace the unit price with the
underlying volatility referenced by the
volatility derivative contract and replace
the number of units with the notional
amount of the volatility derivative
contract.
(3) Supervisory delta adjustment. (i)
For a derivative contract that is not an
option contract or collateralized debt
obligation tranche, the supervisory delta
adjustment is 1 if the fair value of the
derivative contract increases when the
value of the primary risk factor
increases and ¥1 if the fair value of the
derivative contract decreases when the
value of the primary risk factor
increases.
(ii)(A) For a derivative contract that is
an option contract, the supervisory delta
adjustment is determined by the
formulas in Table 1 to this section, as
applicable:
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have negative values, to determine the
value of λ for a given risk factor or
instrument, a [BANKING
ORGANIZATION] must find the lowest
value, L, of Ρ and Κ of all option
contracts that reference this risk factor
or instrument or, in the case of interest
rate option contracts, the lowest value,
L, of Ρ and Κ of all interest rate option
contracts in a given currency, that the
[BANKING ORGANIZATION] has with
all counterparties. Then, λ is set as
follows: when the underlying risk factor
is an interest rate, λ=max{¥L+0.1%,0};
otherwise, λ=max{¥1.1·L,0}; and
(6) σ equals the supervisory option
volatility, as provided in Table 2 to this
section.
(C) Notwithstanding paragraph
(i)(3)(ii)(B)(5) of this section, a
[BANKING ORGANIZATION] may, with
the prior approval of the [AGENCY],
specify a value for λ in accordance with
this paragraph for an option contract,
other than an interest rate option
contract described in paragraph
(i)(3)(ii)(B)(5) of this section, if a
different value for λ would be
appropriate considering the range of
values for the instrument or risk factor,
as appropriate, underlying the option
contract. A [BANKING
ORGANIZATION] that specifies a value
for λ in accordance with this paragraph
for an option contract must assign the
same value for λ to all option contracts
with the same instrument or risk factor,
as applicable, underlying the option that
the [BANKING ORGANIZATION] has
with all counterparties.
(iii)(A) For a derivative contract that
is a collateralized debt obligation
tranche, the supervisory delta
adjustment is determined by the
following formula:
(B) As used in the formula in
paragraph (i)(3)(iii)(A) of this section:
(1) A is the attachment point, which
equals the ratio of the notional amounts
of all underlying exposures that are
subordinated to the [BANKING
ORGANIZATION]’s exposure to the
total notional amount of all underlying
exposures, expressed as a decimal value
between zero and one; 30
(2) D is the detachment point, which
equals one minus the ratio of the
notional amounts of all underlying
exposures that are senior to the
[BANKING ORGANIZATION]’s
exposure to the total notional amount of
all underlying exposures, expressed as a
decimal value between zero and one;
and
(3) The resulting amount is designated
with a positive sign if the collateralized
debt obligation tranche was used to
purchase credit protection by the
[BANKING ORGANIZATION] and is
designated with a negative sign if the
collateralized debt obligation tranche
was used to sell credit protection by the
[BANKING ORGANIZATION].
(4) Maturity factor. (i)(A) The maturity
factor of a derivative contract that is
subject to a variation margin agreement,
excluding derivative contracts that are
subject to a variation margin agreement
under which the counterparty is not
required to post variation margin, is
determined by the following formula:
the case of a first-to-default credit
derivative, there are no underlying exposures
that are subordinated to the [BANKING
ORGANIZATION]’s exposure. In the case of
a second-or-subsequent-to-default credit
derivative, the smallest (n¥1) notional
amounts of the underlying exposures are
subordinated to the [BANKING
ORGANIZATION]’s exposure.
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Where MPOR refers to the period from
the most recent exchange of collateral
covering a netting set of derivative
contracts with a defaulting counterparty
until the derivative contracts are closed
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(B) As used in the formulas in Table
1 to this section:
(1) Φ is the standard normal
cumulative distribution function;
(2) Ρ equals the current fair value of
the instrument or risk factor, as
applicable, underlying the option;
(3) Κ equals the strike price of the
option;
(4) Τ equals the number of business
days until the latest contractual exercise
date of the option;
(5) The same value of λ must be used
for all option contracts that reference
the same underlying risk factor or
instrument or, in the case of interest rate
option contracts, all interest rate option
contracts that are denominated in the
same currency. λ equals zero for all
derivative contracts except those option
contracts where it is possible for Ρ to
have negative values. For option
contracts where it is possible for Ρ to
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out and the resulting market risk is rehedged.
(B) Notwithstanding paragraph
(i)(4)(i)(A) of this section:
(1) For a derivative contract that is not
a client-facing derivative transaction,
MPOR cannot be less than ten business
days plus the periodicity of remargining expressed in business days
minus one business day;
(2) For a derivative contract that is a
client-facing derivative transaction,
MPOR cannot be less than five business
days plus the periodicity of re-
margining expressed in business days
minus one business day; and
(3) For a derivative contract that is
within a netting set that is composed of
more than 5,000 derivative contracts
that are not cleared transactions, or a
netting set that contains one or more
trades involving illiquid collateral or a
derivative contract that cannot be easily
replaced, MPOR cannot be less than
twenty business days.
(4) Notwithstanding paragraphs
(i)(4)(i)(A) and (B) of this section, for a
netting set subject to more than two
outstanding disputes over margin that
lasted longer than the MPOR over the
previous two quarters, the applicable
floor is twice the amount provided in
paragraphs (i)(4)(i)(A) and (B) of this
section.
(ii) The maturity factor of a derivative
contract that is not subject to a variation
margin agreement, or derivative
contracts under which the counterparty
is not required to post variation margin,
is determined by the following formula:
Where M equals the greater of 10
business days and the remaining
maturity of the contract, as measured in
business days.
(iii) For purposes of paragraph (i)(4) of
this section, if a [BANKING
ORGANIZATION] has elected pursuant
to paragraph (e)(5) of this section to treat
a derivative contract that is a cleared
transaction that is not subject to a
variation margin agreement as one that
is subject to a variation margin
agreement, the [BANKING
ORGANIZATION] must treat the
derivative contract as subject to a
variation margin agreement with
maturity factor as determined according
to paragraph (i)(4)(i) of this section, and
daily settlement does not change the
end date of the period referenced by the
derivative contract.
(5) Derivative contract as multiple
effective derivative contracts. A
[BANKING ORGANIZATION] must
separate a derivative contract into
separate derivative contracts, according
to the following rules:
(i) For an option where the
counterparty pays a predetermined
amount if the value of the underlying
asset is above or below the strike price
and nothing otherwise (binary option),
the option must be treated as two
separate options. For purposes of
paragraph (i)(3)(ii) of this section, a
binary option with strike price K must
be represented as the combination of
one bought European option and one
sold European option of the same type
as the original option (put or call) with
the strike prices set equal to 0.95 * K
and 1.05 * K so that the payoff of the
binary option is reproduced exactly
outside the region between the two
strike prices. The absolute value of the
sum of the adjusted derivative contract
amounts of the bought and sold options
is capped at the payoff amount of the
binary option.
(ii) For a derivative contract that can
be represented as a combination of
standard option payoffs (such as collar,
butterfly spread, calendar spread,
straddle, and strangle), a [BANKING
ORGANIZATION] must treat each
standard option component as a
separate derivative contract.
(iii) For a derivative contract that
includes multiple-payment options,
(such as interest rate caps and floors), a
[BANKING ORGANIZATION] may
represent each payment option as a
combination of effective single-payment
options (such as interest rate caplets and
floorlets).
(iv) A [BANKING ORGANIZATION]
may not decompose linear derivative
contracts (such as swaps) into
components.
(j) Multiple netting sets subject to a
single variation margin agreement—(1)
Calculating replacement cost.
Notwithstanding paragraph (f) of this
section, a [BANKING ORGANIZATION]
must assign a single replacement cost to
multiple netting sets that are subject to
a single variation margin agreement
under which the counterparty must post
variation margin, calculated according
to the following formula:
Where:
NS is each netting set subject to the variation
margin agreement MA;
VNS is the sum of the fair values (after
excluding any valuation adjustments) of
the derivative contracts within the
netting set NS; and
CMA is the sum of the net independent
collateral amount and the variation
margin amount applicable to the
derivative contracts within the netting
sets subject to the single variation margin
agreement.
(g) of this section, a [BANKING
ORGANIZATION] must assign a single
potential future exposure to multiple
netting sets that are subject to a single
variation margin agreement under
which the counterparty must post
variation margin equal to the sum of the
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(2) Calculating potential future
exposure. Notwithstanding paragraph
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potential future exposure of each such
netting set, each calculated according to
paragraph (g) of this section as if such
nettings sets were not subject to a
variation margin agreement.
(k) Netting set subject to multiple
variation margin agreements or a hybrid
netting set—(1) Calculating replacement
cost. To calculate replacement cost for
either a netting set subject to multiple
variation margin agreements under
which the counterparty to each
variation margin agreement must post
variation margin, or a netting set
composed of at least one derivative
contract subject to variation margin
agreement under which the
counterparty must post variation margin
and at least one derivative contract that
is not subject to such a variation margin
agreement, the calculation for
replacement cost is provided under
paragraph (f)(1) of this section, except
that the variation margin threshold
equals the sum of the variation margin
thresholds of all variation margin
agreements within the netting set and
the minimum transfer amount equals
the sum of the minimum transfer
amounts of all the variation margin
agreements within the netting set.
(2) Calculating potential future
exposure. (i) To calculate potential
future exposure for a netting set subject
to multiple variation margin agreements
under which the counterparty to each
variation margin agreement must post
variation margin, or a netting set
composed of at least one derivative
contract subject to a variation margin
agreement under which the
counterparty to the derivative contract
must post variation margin and at least
one derivative contract that is not
subject to such a variation margin
agreement, a [BANKING
ORGANIZATION] must divide the
netting set into sub-netting sets (as
described in paragraph (k)(2)(ii) of this
section) and calculate the aggregated
amount for each sub-netting set. The
aggregated amount for the netting set is
calculated as the sum of the aggregated
amounts for the sub-netting sets. The
multiplier is calculated for the entire
netting set.
(ii) For purposes of paragraph (k)(2)(i)
of this section, the netting set must be
divided into sub-netting sets as follows:
(A) All derivative contracts within the
netting set that are not subject to a
variation margin agreement or that are
subject to a variation margin agreement
under which the counterparty is not
required to post variation margin form
a single sub-netting set. The aggregated
amount for this sub-netting set is
calculated as if the netting set is not
subject to a variation margin agreement.
(B) All derivative contracts within the
netting set that are subject to variation
margin agreements in which the
counterparty must post variation margin
and that share the same value of the
MPOR form a single sub-netting set. The
aggregated amount for this sub-netting
set is calculated as if the netting set is
subject to a variation margin agreement,
using the MPOR value shared by the
derivative contracts within the netting
set.
§ ll.114
ORGANIZATION] that is a clearing
member client must use the
methodologies described in paragraph
(b) of this section to calculate riskweighted assets for a cleared
transaction.
Cleared Transactions.
(a) General requirements—(1)
Clearing member clients. A [BANKING
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(2) Clearing members. A [BANKING
ORGANIZATION] that is a clearing
member must use the methodologies
described in paragraph (c) of this
section to calculate its risk-weighted
assets for a cleared transaction and
paragraph (d) of this section to calculate
its risk-weighted assets for its default
fund contribution to a CCP.
(b) Clearing member client [BANKING
ORGANIZATIONS]—(1) Risk-weighted
assets for cleared transactions. (i) To
determine the risk-weighted asset
amount for a cleared transaction, a
[BANKING ORGANIZATION] that is a
clearing member client must multiply
the trade exposure amount for the
cleared transaction, calculated in
accordance with paragraph (b)(2) of this
section, by the risk weight appropriate
for the cleared transaction, determined
in accordance with paragraph (b)(3) of
this section.
(ii) A clearing member client
[BANKING ORGANIZATION]’s total
risk-weighted assets for cleared
transactions is the sum of the riskweighted asset amounts for all of its
cleared transactions.
(2) Trade exposure amount. (i) For a
cleared transaction that is a derivative
contract or a netting set of derivative
contracts, trade exposure amount equals
the exposure amount for the derivative
contract or netting set of derivative
contracts calculated using § ll.113,
plus the fair value of the collateral
posted by the clearing member client
[BANKING ORGANIZATION] and held
by the CCP, clearing member, or
custodian in a manner that is not
bankruptcy remote.
(ii) For a cleared transaction that is a
repo-style transaction or netting set of
repo-style transactions, trade exposure
amount equals the exposure amount for
the repo-style transaction calculated
using the methodology set forth in
§ ll.121, plus the fair value of the
collateral posted by the clearing member
client [BANKING ORGANIZATION] and
held by the CCP, clearing member, or
custodian in a manner that is not
bankruptcy remote.
(3) Cleared transaction risk weights.
(i) For a cleared transaction with a
QCCP, a clearing member client
[BANKING ORGANIZATION] must
apply a risk weight of:
(A) 2 percent if the collateral posted
by the [BANKING ORGANIZATION] to
the QCCP or clearing member is subject
to an arrangement that prevents any loss
to the clearing member client
[BANKING ORGANIZATION] due to the
joint default or a concurrent insolvency,
liquidation, or receivership proceeding
of the clearing member and any other
clearing member clients of the clearing
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member; and the clearing member client
[BANKING ORGANIZATION] has
conducted sufficient legal review to
conclude with a well-founded basis
(and maintains sufficient written
documentation of that legal review) that
in the event of a legal challenge
(including one resulting from an event
of default or from liquidation,
insolvency, or receivership proceedings)
the relevant court and administrative
authorities would find the arrangements
to be legal, valid, binding, and
enforceable under the law of the
relevant jurisdictions; or
(B) 4 percent, if the requirements of
paragraph (b)(3)(i)(A) of this section are
not met.
(ii) For a cleared transaction with a
CCP that is not a QCCP, a clearing
member client [BANKING
ORGANIZATION] must apply the risk
weight applicable to the CCP under
§ ll.111.
(4) Collateral. (i) Notwithstanding any
other requirement of this section,
collateral posted by a clearing member
client [BANKING ORGANIZATION]
that is held by a custodian (in its
capacity as a custodian) in a manner
that is bankruptcy remote from the CCP,
clearing member, and other clearing
member clients of the clearing member,
is not subject to a capital requirement
under this section.
(ii) A clearing member client
[BANKING ORGANIZATION] must
calculate a risk-weighted asset amount
for any collateral provided to a CCP,
clearing member or a custodian in
connection with a cleared transaction in
accordance with requirements under
subpart E or F of this part, as applicable.
(c) Clearing member [BANKING
ORGANIZATION]—(1) Risk-weighted
assets for cleared transactions. (i) To
determine the risk-weighted asset
amount for a cleared transaction, a
clearing member [BANKING
ORGANIZATION] must multiply the
trade exposure amount for the cleared
transaction, calculated in accordance
with paragraph (c)(2) of this section by
the risk weight appropriate for the
cleared transaction, determined in
accordance with paragraph (c)(3) of this
section.
(ii) A clearing member [BANKING
ORGANIZATION]’s total risk-weighted
assets for cleared transactions is the sum
of the risk-weighted asset amounts for
all of its cleared transactions.
(2) Trade exposure amount. A
clearing member [BANKING
ORGANIZATION] must calculate its
trade exposure amount for a cleared
transaction as follows:
(i) For a cleared transaction that is a
derivative contract or a netting set of
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derivative contracts, trade exposure
amount equals the exposure amount for
the derivative contract or netting set of
derivative contracts calculated using
§ ll.113, plus the fair value of the
collateral posted by the clearing member
[BANKING ORGANIZATION] and held
by the CCP in a manner that is not
bankruptcy remote.
(ii) For a cleared transaction that is a
repo-style transaction or netting set of
repo-style transactions, trade exposure
amount equals the exposure amount for
the repo-style transaction calculated
using the methodology set forth in
§ ll.121, plus the fair value of the
collateral posted by the clearing member
[BANKING ORGANIZATION] and held
by the CCP in a manner that is not
bankruptcy remote.
(3) Cleared transaction risk weights.
(i) A clearing member [BANKING
ORGANIZATION] must apply a risk
weight of 2 percent to the trade
exposure amount for a cleared
transaction with a QCCP.
(ii) For a cleared transaction with a
CCP that is not a QCCP, a clearing
member [BANKING ORGANIZATION]
must apply the risk weight applicable to
the CCP according to § ll.111.
(iii) Notwithstanding paragraphs
(c)(3)(i) and (ii) of this section, a
clearing member [BANKING
ORGANIZATION] may apply a risk
weight of zero percent to the trade
exposure amount for a cleared
transaction with a QCCP where the
clearing member [BANKING
ORGANIZATION] is acting as a
financial intermediary on behalf of a
clearing member client, the transaction
offsets another transaction that satisfies
the requirements set forth in § ll.3(a),
and the clearing member [BANKING
ORGANIZATION] is not obligated to
reimburse the clearing member client in
the event of the QCCP default.
(4) Collateral. (i) Notwithstanding any
other requirement of this section,
collateral posted by a clearing member
[BANKING ORGANIZATION] that is
held by a custodian in a manner that is
bankruptcy remote from the CCP is not
subject to a capital requirement under
this section.
(ii) A clearing member [BANKING
ORGANIZATION] must calculate a riskweighted asset amount for any collateral
provided to a CCP, clearing member or
a custodian in connection with a cleared
transaction in accordance with
requirements under subparts E or F of
this part, as applicable.
(d) Default fund contributions—(1)
General requirement. A clearing
member [BANKING ORGANIZATION]
must determine the risk-weighted asset
amount for a default fund contribution
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to a CCP at least quarterly, or more
frequently if, in the opinion of the
[BANKING ORGANIZATION] or the
[AGENCY], there is a material change in
the financial condition of the CCP. The
total risk-weighted assets for default
fund contributions of a clearing member
[BANKING ORGANIZATION] is the
sum of the [BANKING
ORGANIZATION]’s risk-weighted assets
for all of its default fund contributions
to all CCPs of which the [BANKING
ORGANIZATION] is a clearing member.
(2) Risk-weighted asset amount for
default fund contributions to
nonqualifying CCPs. A clearing member
[BANKING ORGANIZATION]’s riskweighted asset amount for default fund
contributions to CCPs that are not
QCCPs equals the sum of such default
fund contributions multiplied by 1,250
percent, or an amount determined by
the [AGENCY], based on factors such as
size, structure, and membership
characteristics of the CCP and riskiness
of its transactions, in cases where such
default fund contributions may be
unlimited.
(3) Risk-weighted asset amount for
default fund contributions to QCCPs. A
clearing member [BANKING
ORGANIZATION]’s risk-weighted asset
amount for default fund contributions to
QCCPs equals the sum of its capital
requirement, KCM for each QCCP, as
calculated under the methodology set
forth in paragraph (d)(4) of this section,
multiplied by 12.5.
(4) Capital requirement for default
fund contributions to a QCCP. A
clearing member [BANKING
ORGANIZATION]’s capital requirement
for its default fund contribution to a
QCCP (KCM) is equal to:
Where:
KCCP is the hypothetical capital requirement
of the QCCP, as determined under
paragraph (d)(5) of this section;
DFpref is the prefunded default fund
contribution of the clearing member
[BANKING ORGANIZATION] to the
QCCP;
DFCCP is the QCCP’s own prefunded amounts
that are contributed to the default
waterfall and are junior or pari passu
with prefunded default fund
contributions of clearing members of the
CCP; and
DFCCPCMpref is the total prefunded default
fund contributions from clearing
members of the QCCP to the QCCP.
instead of calculating KCCP under this
paragraph (d)(5), unless the [BANKING
ORGANIZATION] determines that a
more conservative figure is appropriate
based on the nature, structure, or
characteristics of the QCCP. The
hypothetical capital requirement of a
QCCP (KCCP), as determined by the
[BANKING ORGANIZATION], is equal
to:
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outside the United States, under a
substantially identical methodology in
effect in the jurisdiction) using a value
of 10 business days for purposes of
§ ll.113(i)(4), provided that for this
calculation, in place of the net
independent collateral amount, the
calculation must include the fair value
amount of the independent collateral, as
adjusted by the market price volatility
haircut under Table 1 to § ll.121, as
applicable, posted to the QCCP by the
clearing member, including collateral
posted on behalf of a client of the
clearing member in connection with a
derivative contract for which the
clearing member has provided
guarantees to the QCCP, plus the
amount of the prefunded default fund
contribution, as adjusted by the market
price volatility haircut under Table 1 to
§ ll.121, as applicable, plus the
amount of the prefunded default fund
contribution of the clearing member to
the QCCP.
(iii) With respect to any repo-style
transactions between the clearing
member and the QCCP that are cleared
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transactions, exposure amount (EA) is
equal to:
EA = max {EBRMi¥ IMi ¥ DFi; 0}
Where:
EBRMi is the exposure amount of the QCCP
to each clearing member for all repostyle transactions between the QCCP and
the clearing member, as determined
under § ll.121 and without
recognition of the initial margin
collateral posted by the clearing member
to the QCCP with respect to the repostyle transactions or the prefunded
default fund contribution of the clearing
member institution to the QCCP;
IMi is the initial margin collateral posted by
each clearing member to the QCCP with
respect to the repo-style transactions;
and
DFi is the prefunded default fund
contribution of each clearing member to
the QCCP that is not already deducted in
paragraph (d)(6)(ii) of this section.
(iv) Exposure amount must be
calculated separately for each clearing
member’s sub-client accounts and subhouse account (i.e., for the clearing
member’s proprietary activities). If the
clearing member’s collateral and its
client’s collateral are held in the same
default fund contribution account, then
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(6) Exposure amount of a QCCP to a
clearing member. (i) The exposure
amount of a QCCP to a clearing member
is equal to the sum of the exposure
amount for derivative contracts
determined under paragraph (d)(6)(ii) of
this section and the exposure amount
for repo-style transactions determined
under paragraph (d)(6)(iii) of this
section.
(ii) With respect to any derivative
contracts between the QCCP and the
clearing member and any guarantees
that the clearing member has provided
to the QCCP with respect to
performance of a clearing member client
on a derivative contract, the exposure
amount is equal to the exposure amount
of the QCCP to the clearing member for
all such derivative contracts and
guaranteed derivative contracts
calculated under SA–CCR in § ll.113
(or, with respect to a QCCP located
(5) Hypothetical capital requirement
of a QCCP. Where a QCCP has provided
its KCCP, a [BANKING ORGANIZATION]
must rely on such disclosed figure
EP18SE23.074</GPH>
Where:
CMi is each clearing member of the QCCP;
and
EAi is the exposure amount of the QCCP to
each clearing member of the QCCP to the
QCCP, as determined under paragraph
(d)(6) of this section.
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the exposure amount of that account is
the sum of the exposure amount for the
client-related transactions within the
account and the exposure amount of the
house-related transactions within the
account. For purposes of determining
such exposure amounts, the
independent collateral of the clearing
member and its client must be allocated
in proportion to the respective total
amount of independent collateral posted
by the clearing member to the QCCP.
(v) If any account or sub-account
contains both derivative contracts and
repo-style transactions, the exposure
amount of that account is the sum of the
exposure amount for the derivative
contracts within the account and the
exposure amount of the repo-style
transactions within the account. If
independent collateral is held for an
account containing both derivative
contracts and repo-style transactions,
then such collateral must be allocated to
the derivative contracts and repo-style
transactions in proportion to the
respective product specific exposure
amounts, calculated, excluding the
effects of collateral, according to
§ ll.121 for repo-style transactions
and to § ll.113 for derivative
contracts.
(vi) Notwithstanding any other
provision of paragraph (d) of this
section, with the prior approval of the
[AGENCY], a [BANKING
ORGANIZATION] may determine the
risk-weighted asset amount for a default
fund contribution to a QCCP according
to § ll.35(d)(3)(i) through (iii).
§ ll.115
(a) Definitions. For purposes of this
section:
(1) Delivery-versus-payment (DvP)
transaction means a securities or
commodities transaction in which the
buyer is obligated to make payment only
if the seller has made delivery of the
securities or commodities and the seller
is obligated to deliver the securities or
commodities only if the buyer has made
payment.
(2) Payment-versus-payment (PvP)
transaction means a foreign exchange
transaction in which each counterparty
is obligated to make a final transfer of
one or more currencies only if the other
counterparty has made a final transfer of
one or more currencies.
(3) A transaction has a normal
settlement period if the contractual
settlement period for the transaction is
equal to or less than the market standard
for the instrument underlying the
transaction and equal to or less than five
business days.
(4) Positive current exposure of a
[BANKING ORGANIZATION] for a
transaction is the difference between the
transaction value at the agreed
settlement price and the current market
price of the transaction, if the difference
results in a credit exposure of the
[BANKING ORGANIZATION] to the
counterparty.
(b) Scope. This section applies to all
transactions involving securities, foreign
exchange instruments, and commodities
that have a risk of delayed settlement or
delivery. This section does not apply to:
(1) Cleared transactions that are
marked-to-market daily and subject to
daily receipt and payment of variation
margin;
(2) Repo-style transactions, including
unsettled repo-style transactions;
(3) One-way cash payments on OTC
derivative contracts; or
(4) Transactions with a contractual
settlement period that is longer than the
normal settlement period (which are
treated as OTC derivative contracts as
provided in § ll.113).
(c) System-wide failures. In the case of
a system-wide failure of a settlement,
clearing system or central counterparty,
the [AGENCY] may waive risk-based
capital requirements for unsettled and
failed transactions until the situation is
rectified.
(d) Delivery-versus-payment (DvP)
and payment-versus-payment (PvP)
transactions. A [BANKING
ORGANIZATION] must hold risk-based
capital against any DvP or PvP
transaction with a normal settlement
period if the [BANKING
ORGANIZATION]’s counterparty has
not made delivery or payment within
five business days after the settlement
date. The [BANKING ORGANIZATION]
must determine its risk-weighted asset
amount for such a transaction by
multiplying the positive current
exposure of the transaction for the
[BANKING ORGANIZATION] by the
appropriate risk weight in Table 1 to
§ ll.115.
(e) Non-DvP/non-PvP (non-deliveryversus-payment/non-payment-versuspayment) transactions. (1) A [BANKING
ORGANIZATION] must hold risk-based
capital against any non-DvP/non-PvP
transaction with a normal settlement
period if the [BANKING
ORGANIZATION] has delivered cash,
securities, commodities, or currencies to
its counterparty but has not received its
corresponding deliverables by the end
of the same business day. The
[BANKING ORGANIZATION] must
continue to hold risk-based capital
against the transaction until the
[BANKING ORGANIZATION] has
received its corresponding deliverables.
(2) From the business day after the
[BANKING ORGANIZATION] has made
its delivery until five business days after
the counterparty delivery is due, the
[BANKING ORGANIZATION] must
calculate the risk-weighted asset amount
for the transaction by treating the
current fair value of the deliverables
owed to the [BANKING
ORGANIZATION] as an exposure to the
counterparty and using the applicable
counterparty risk weight under this
subpart.
(3) If the [BANKING
ORGANIZATION] has not received its
deliverables by the fifth business day
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after counterparty delivery was due, the
[BANKING ORGANIZATION] must
assign a 1,250 percent risk weight to the
current fair value of the deliverables
owed to the [BANKING
ORGANIZATION].
(f) Total risk-weighted assets for
unsettled transactions. Total riskweighted assets for unsettled
transactions is the sum of the riskweighted asset amounts of all DvP, PvP,
and non-DvP/non-PvP transactions.
Credit Risk Mitigation
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§ ll.120 Guarantees and credit
derivatives: Substitution approach.
(a) Scope—(1) A [BANKING
ORGANIZATION] may recognize the
credit risk mitigation benefits of an
eligible guarantee or eligible credit
derivative that is not an nth-to-default
credit derivative by substituting the risk
weight associated with the protection
provider for the risk weight assigned to
an exposure, as provided under this
section.
(2) This section applies to exposures
for which:
(i) Credit risk is fully covered by an
eligible guarantee or eligible credit
derivative; or
(ii) Credit risk is covered on a pro rata
basis (that is, on a basis in which the
[BANKING ORGANIZATION] and the
protection provider share losses
proportionately) by an eligible guarantee
or eligible credit derivative.
(3) Exposures on which there is a
tranching of credit risk (reflecting at
least two different levels of seniority)
generally are securitization exposures
subject to § ll.130 through ll.134.
(4) If multiple eligible guarantees or
eligible credit derivatives cover a single
exposure described in this section, a
[BANKING ORGANIZATION] may treat
the hedged exposure as multiple
separate exposures each covered by a
single eligible guarantee or eligible
credit derivative and may calculate a
separate risk-weighted asset amount for
each separate exposure as described in
paragraph (c) of this section.
(5) If a single eligible guarantee or
eligible credit derivative covers multiple
hedged exposures described in
paragraph (a)(2) of this section, a
[BANKING ORGANIZATION] must treat
each hedged exposure as covered by a
separate eligible guarantee or eligible
credit derivative and must calculate a
separate risk-weighted asset amount for
each exposure as described in paragraph
(c) of this section.
(b) Rules of recognition. (1) A
[BANKING ORGANIZATION] may only
recognize the credit risk mitigation
benefits of eligible guarantees and
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eligible credit derivatives that are not
nth-to-default credit derivatives.
(2) A [BANKING ORGANIZATION]
may only recognize the credit risk
mitigation benefits of an eligible credit
derivative to hedge an exposure that is
different from the credit derivative’s
reference exposure used for determining
the derivative’s cash settlement value,
deliverable obligation, or occurrence of
a credit event if:
(i) The reference exposure ranks pari
passu with, or is subordinated to, the
hedged exposure;
(ii) The reference exposure and the
hedged exposure are to the same legal
entity, and
(iii) Legally enforceable cross-default
or cross-acceleration clauses are in place
to ensure payments under the credit
derivative are triggered when the
obligated party of the hedged exposure
fails to pay under the terms of the
hedged exposure.
(c) Substitution approach—(1) Full
coverage. If an eligible guarantee or
eligible credit derivative meets the
conditions in paragraphs (a) and (b) of
this section and the protection amount
(P) of the guarantee or credit derivative
is greater than or equal to the exposure
amount of the hedged exposure, a
[BANKING ORGANIZATION] may
recognize the guarantee or credit
derivative in determining the riskweighted asset amount for the hedged
exposure by substituting the risk weight
applicable to the guarantor or credit
derivative protection provider under
this subpart for the risk weight assigned
to the exposure.
(2) Partial coverage. If an eligible
guarantee or eligible credit derivative
meets the conditions in paragraphs (a)
and (b) of this section and the protection
amount (P) of the guarantee or credit
derivative is less than the exposure
amount of the hedged exposure, the
[BANKING ORGANIZATION] must treat
the hedged exposure as two separate
exposures (protected and unprotected)
in order to recognize the credit risk
mitigation benefit of the guarantee or
credit derivative.
(i) The [BANKING ORGANIZATION]
may calculate the risk-weighted asset
amount for the protected exposure
under this subpart E, where the
applicable risk weight is the risk weight
applicable to the guarantor or credit
derivative protection provider.
(ii) The [BANKING ORGANIZATION]
must calculate the risk-weighted asset
amount for the unprotected exposure
under this subpart E, where the
applicable risk weight is that of the
unprotected portion of the hedged
exposure.
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(iii) The treatment provided in this
section is applicable when the credit
risk of an exposure is covered on a
partial pro rata basis and may be
applicable when an adjustment is made
to the effective notional amount of the
guarantee or credit derivative under
paragraph (d), (e), or (f) of this section.
(d) Maturity mismatch adjustment. (1)
A [BANKING ORGANIZATION] that
recognizes an eligible guarantee or
eligible credit derivative in determining
the risk-weighted asset amount for a
hedged exposure must adjust the
effective notional amount of the credit
risk mitigant to reflect any maturity
mismatch between the hedged exposure
and the credit risk mitigant.
(2) A maturity mismatch occurs when
the residual maturity of a credit risk
mitigant is less than that of the hedged
exposure(s).
(3) The residual maturity of a hedged
exposure is the longest possible
remaining time before the obligated
party of the hedged exposure is
scheduled to fulfil its obligation on the
hedged exposure. If a credit risk
mitigant has embedded options that
may reduce its term, the [BANKING
ORGANIZATION] (protection
purchaser) must adjust the residual
maturity of the credit risk mitigant. If a
call is at the discretion of the protection
provider, the residual maturity of the
credit risk mitigant is at the first call
date. If the call is at the discretion of the
[BANKING ORGANIZATION]
(protection purchaser), but the terms of
the arrangement at origination of the
credit risk mitigant contain a positive
incentive for the [BANKING
ORGANIZATION] to call the transaction
before contractual maturity, the
remaining time to the first call date is
the residual maturity of the credit risk
mitigant.
(4) A credit risk mitigant with a
maturity mismatch may be recognized
only if its original maturity is greater
than or equal to one year and its
residual maturity is greater than three
months.
(5) When a maturity mismatch exists,
the [BANKING ORGANIZATION] must
apply the following adjustment to
reduce the effective notional amount of
the credit risk mitigant:
Where:
Pm = E × (t¥0.25)/(T¥0.25),
(i) Pm = effective notional amount of the
credit risk mitigant, adjusted for maturity
mismatch;
(ii) E = effective notional amount of the credit
risk mitigant;
(iii) t = the lesser of T or the residual
maturity of the credit risk mitigant,
expressed in years; and
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(iv) T = the lesser of five or the residual
maturity of the hedged exposure,
expressed in years.
(e) Adjustment for credit derivatives
without restructuring as a credit event.
(1) If a [BANKING ORGANIZATION]
recognizes an eligible credit derivative
that does not include as a credit event
a restructuring of the hedged exposure
involving forgiveness or postponement
of principal, interest, or fees that results
in a credit loss event (that is, a chargeoff, specific provision, or other similar
debit to the profit and loss account), the
[BANKING ORGANIZATION] must
apply the adjustment in paragraph (e)(2)
of this section to reduce the effective
notional amount of the credit derivative
unless: the terms of the hedged
exposure and the reference exposure, if
different from the hedged exposure,
allow the maturity, principal, coupon,
currency, or seniority status of the
exposure to be amended outside of
receivership, insolvency, liquidation, or
similar proceeding only by unanimous
consent of all parties, and the
[BANKING ORGANIZATION] has
conducted sufficient legal review to
conclude with a well-founded basis
(and maintains sufficient written
documentation of that legal review) that
the hedged exposure is subject to the
U.S. Bankruptcy Code, the Federal
Deposit Insurance Act, or a domestic or
foreign insolvency regime with similar
features that allow for a company to
liquidate, reorganize, or restructure and
provides for an orderly settlement of
creditor claims.
(2) The [BANKING ORGANIZATION]
must apply the following adjustment to
reduce the effective notional amount of
any eligible credit derivative that is
subject to adjustment under paragraph
(e)(1) of this section:
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Where:
Pr = Pm × 0.60,
(i) Pr = effective notional amount of the
credit risk mitigant, adjusted for lack of
restructuring event (and maturity
mismatch, if applicable); and
(ii) Pm = effective notional amount of the
credit risk mitigant (adjusted for
maturity mismatch, if applicable).
(f) Currency mismatch adjustment. (1)
If a [BANKING ORGANIZATION]
recognizes an eligible guarantee or
eligible credit derivative that is
denominated in a currency different
from that in which the hedged exposure
is denominated, the [BANKING
ORGANIZATION] must apply the
following formula to the effective
notional amount of the guarantee or
credit derivative:
Where:
Pc = Pr × (1¥HFX),
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(i) Pc = effective notional amount of the
credit risk mitigant, adjusted for
currency mismatch (and maturity
mismatch and lack of restructuring
event, if applicable);
(ii) Pr = effective notional amount of the
credit risk mitigant (adjusted for
maturity mismatch and lack of
restructuring event, if applicable); and
(iii) HFX = haircut appropriate for the
currency mismatch between the credit
risk mitigant and the hedged exposure,
as determined under paragraphs (f)(2)
through (3) of this section.
(2) Subject to paragraph (f)(3) of this
section, a [BANKING ORGANIZATION]
must set HFX equal to eight percent.
(3) A [BANKING ORGANIZATION]
must increase HFX as determined under
paragraph (f)(2) of this section if the
[BANKING ORGANIZATION] revalues
the guarantee or credit derivative less
frequently than once every 10 business
days using the following formula:
Where:
HFX = 8% × (TM/10)1⁄2, where TM equals the
greater of 10 or the number of business
days between revaluations.
§ ll.121
Collateralized transactions.
(a) General. (1) To recognize the riskmitigating effects of financial collateral,
a [BANKING ORGANIZATION] may
use:
(i) The simple approach in paragraph
(b) of this section for any exposure that
is not a derivative contract or a netting
set of derivative contracts; or
(ii) The collateral haircut approach in
paragraph (c) of this section for a repostyle transaction, eligible margin loan,
or a netting set of such transactions.
(2) A [BANKING ORGANIZATION]
may use any approach described in this
section that is valid for a particular type
of exposure or transaction; however, it
must use the same approach for similar
exposures or transactions.
(3) For purposes of this section, a
[BANKING ORGANIZATION] may only
recognize the risk-mitigating effects of a
corporate debt security that meets the
definition of financial collateral if the
corporate issuer of the debt security has
a publicly traded security outstanding
or is controlled by a company that has
a publicly traded security outstanding.
(b) The simple approach—(1) General
requirements. (i) A [BANKING
ORGANIZATION] may recognize the
credit risk mitigation benefits of
financial collateral that secures any
exposure that is not a derivative
contract or netting set of derivative
contracts.
(ii) To qualify for the simple
approach, the financial collateral must
meet the following requirements:
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(A) The collateral must be subject to
a collateral agreement for at least the life
of the exposure;
(B) The collateral must be revalued at
least every six months; and
(C) The collateral (other than gold)
and the exposure must be denominated
in the same currency.
(2) Risk weight substitution. (i) A
[BANKING ORGANIZATION] may
apply a risk weight to the portion of an
exposure that is secured by the fair
value of financial collateral (that meets
the requirements of paragraph (b)(1) of
this section) based on the risk weight
assigned to the collateral under this
subpart. For repurchase agreements,
reverse repurchase agreements, and
securities lending and borrowing
transactions, the collateral is the
instruments, gold, and cash the
[BANKING ORGANIZATION] has
borrowed, purchased subject to resale,
or taken as collateral from the
counterparty under the transaction.
Except as provided in paragraph (b)(3)
of this section, the risk weight assigned
to the collateralized portion of the
exposure may not be less than 20
percent.
(ii) A [BANKING ORGANIZATION]
must apply a risk weight to the
unsecured portion of the exposure based
on the risk weight applicable to the
exposure under this subpart.
(3) Exceptions to the 20 percent risk
weight floor and other requirements.
Notwithstanding paragraph (b)(2)(i) of
this section, a [BANKING
ORGANIZATION] may assign a zero
percent risk weight to the collateralized
portion of an exposure where:
(i) The financial collateral is cash on
deposit; or
(ii) The financial collateral is an
exposure to a sovereign that qualifies for
a zero percent risk weight under
§ ll.111, and the [BANKING
ORGANIZATION] has discounted the
fair value of the collateral by 20 percent.
(c) Collateral haircut approach—
Exposure amount for eligible margin
loans and repo-style transactions—(1)
General. A [BANKING
ORGANIZATION] may recognize the
credit risk mitigation benefits of
financial collateral that secures an
eligible margin loan, repo-style
transaction, or netting set of such
transactions, and of any collateral that
secures a repo-style transaction that is
included in the [BANKING
ORGANIZATION]’s measure for market
risk under subpart F of this part, by
using the collateral haircut approach
covered in paragraph (c)(2) of this
section.
(2) Collateral haircut approach—(i)
Netting set amount calculation. For
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purposes of the collateral haircut
approach, except as provided in
paragraph (c)(2)(ii) of this section, a
[BANKING ORGANIZATION] must
determine the exposure amount for a
netting set of eligible margin loans or
repo-style transactions according to the
following formula:
Where:
(A) E* is the exposure amount of the netting
set after credit risk mitigation;
(B) Ei is the current fair value of the
instrument, cash, or gold the [BANKING
ORGANIZATION] has lent, sold subject
to repurchase, or posted as collateral to
the counterparty;
(C) Ci is the current fair value of the
instrument, cash, or gold the banking
organization has borrowed, purchased
subject to resale, or taken as collateral
from the counterparty;
(D) netexposure = |SsEsHs||;
(E) grossexposure = SsEs|Hs|;
(F) Es is the absolute value of the net position
in a given instrument or in gold, where
the net position in a given instrument or
gold equals the sum of the current fair
values of the instrument or gold the
[BANKING ORGANIZATION] has lent,
sold subject to repurchase, or posted as
collateral to the counterparty, minus the
sum of the current fair values of that
same instrument or gold the [BANKING
ORGANIZATION] has borrowed,
purchased subject to resale, or taken as
collateral from the counterparty;
(G) Hs is the haircut appropriate to Es as
described in Table 1 of this section, as
applicable. Hs has a positive sign if the
instrument or gold is net lent, sold
subject to repurchase, or posted as
collateral to the counterparty; Hs has a
negative sign if the instrument or gold is
net borrowed, purchased subject to
resale, or taken as collateral from the
counterparty;
(H) N is the number of instruments with a
unique Committee on Uniform Securities
Identification Procedures (CUSIP)
designation or foreign equivalent that the
[BANKING ORGANIZATION] lends,
sells subject to repurchase, posts as
collateral, borrows, purchases subject to
resale, or takes as collateral in the netting
set, including all collateral that the
[BANKING ORGANIZATION] elects to
include within the credit risk mitigation
framework, except that instruments
where the value Es is less than one tenth
of the value of the largest Es in the
netting set are not included in the count
or gold, with any amount of gold given
a value of one;
(I) Efx is the absolute value of the net position
in each currency fx different from the
settlement currency;
(J) Hfx is the haircut appropriate for currency
mismatch of currency fx.
E* = max{0; E × (1 + He)¥C ×
(1¥Hc¥Hfx)}
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(ii) Single transaction exposure
amount calculation. For purposes of the
collateral haircut approach, a
[BANKING ORGANIZATION] must use
the following formula to calculate the
exposure amount for an individual
eligible margin loan or repo-style
transaction that is not a part of a netting
set:
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Where:
(A) E* is the exposure amount of the
transaction after credit risk mitigation.
(B) E is the current fair value of the specific
instrument, cash, or gold the banking
organization has lent, sold subject to
repurchase, or posted as collateral to the
counterparty;
(C) He is the haircut appropriate to E as
described in Table 1 of this section, as
applicable.
(D) C is the current fair value of the specific
instrument, cash, or gold the banking
organization has borrowed, purchased
subject to resale, or taken as collateral
from the counterparty.
(E) Hc is the haircut appropriate to C as
described in Table 1 to this section, as
applicable.
(F) H(fx) is the haircut appropriate for
currency mismatch between the
collateral and exposure.
(iii) Market price volatility and
currency mismatch haircuts. (A) A
[BANKING ORGANIZATION] must use
the haircuts for market price volatility
(Hs) in Table 1 to this section, as
adjusted in certain circumstances as
provided in paragraphs (c)(2)(iii)(C)
through (E) of this section.
BILLING CODE 6210–01–P; 6714–01–P; 4810–33–P
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Federal Register / Vol. 88, No. 179 / Monday, September 18, 2023 / Proposed Rules
BILLING CODE 6210–01–C; 6714–01–C; 4810–33–C
(B) For currency mismatches, a
[BANKING ORGANIZATION] must use
a haircut for foreign exchange rate
volatility (Hfx) of 8 percent, as adjusted
in certain circumstances under
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paragraphs (c)(2)(iii)(C) and (D) of this
section.
(C) For repo-style transactions, a
[BANKING ORGANIZATION] may
multiply the haircuts provided in
paragraphs (c)(2)(iii)(A) and (B) of this
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section by the square root of 1⁄2 (which
equals 0.707107).
(D) A [BANKING ORGANIZATION]
must adjust the haircuts provided in
paragraphs (c)(2)(iii)(A) and (B) of this
section upward on the basis of a holding
period longer than ten business days for
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eligible margin loans or a holding
period longer than five business days for
repo-style transactions that are not
cleared transactions under the following
conditions. If the number of trades in a
netting set exceeds 5,000 at any time
during a quarter, a [BANKING
ORGANIZATION] must adjust the
haircuts provided in paragraphs
(c)(2)(iii)(A) and (B) of this section
upward on the basis of a holding period
of twenty business days for the
following quarter except in the
calculation of exposure amount for
purposes of § ll.114. If a netting set
contains one or more trades involving
illiquid collateral, a [BANKING
ORGANIZATION] must adjust the
haircuts provided in paragraphs
(c)(2)(iii)(A) and (B) of this section
upward on the basis of a holding period
of twenty business days. If over the two
previous quarters more than two margin
disputes on a netting set have occurred
that lasted longer than the holding
period, then the [BANKING
ORGANIZATION] must adjust the
haircuts provided in paragraphs
(c)(2)(iii)(A) and (B) of this section
upward for that netting set on the basis
of a holding period that is at least two
times the minimum holding period for
that netting set. The [BANKING
ORGANIZATION] must adjust the
haircuts upward using the following
formula:
Where:
(1) Tm equals a holding period of longer than
10 business days for eligible margin
loans or longer than 5 business days for
repo-style transactions;
(2) Hs equals the market price volatility
haircut provided in Table 1 of this
section or to the foreign exchange rate
volatility haircut provided in paragraph
(c)(3)(iii)(B) of this section; and
(3) Ts equals 10 business days for eligible
margin loans or 5 business days for repostyle transactions.
the risk-mitigating benefits of financial
collateral that secures such
transaction(s) unless the requirements
set forth in paragraphs (d)(3)(ii) or
(d)(3)(iii) of this section, as applicable,
are satisfied.
(2) Transactions subject to the
minimum haircut floors. (i) The
minimum haircut floors must be applied
to any of the following transactions with
an unregulated financial institution that
are not cleared transactions:
(A) An eligible margin loan or repostyle transaction in which a [BANKING
ORGANIZATION] lends cash to an
unregulated financial institution in
exchange for securities, unless all of the
securities are nondefaulted sovereign
exposures; and
(B) A repo-style transaction that is a
collateral upgrade transaction.
(ii) Notwithstanding paragraph
(d)(2)(i) of this section, the following
eligible margin loans and repo-style
transactions with an unregulated
financial institution are exempted from
the minimum haircut floors:
(A) A transaction in which an
unregulated financial institution lends,
sells subject to repurchase, or posts as
collateral securities to a [BANKING
ORGANIZATION] in exchange for cash
and the unregulated financial institution
uses the cash to fund one or more
transactions with the same or shorter
maturity than the original transaction
with the [BANKING ORGANIZATION].
(B) A collateral upgrade transaction in
which the unregulated financial
institution is unable to re-hypothecate,
or contractually agrees that it will not
re-hypothecate, the securities it receives
as collateral against the securities lent.
(C) A transaction in which a
[BANKING ORGANIZATION] borrows
securities for the purpose of meeting a
current or anticipated demand,
including for delivery obligations,
customer demand, or segregation
requirements, and not to provide
financing to the unregulated financial
institution. The [BANKING
ORGANIZATION] must maintain
sufficient written documentation that
such transaction is for the purpose of
meeting a current or anticipated
demand.
(3) Minimum haircut floors. (i) The
minimum haircut floors, expressed as
percentages, are provided in tTable 2 to
this section.
(E) If the instruments a [BANKING
ORGANIZATION] has lent, sold subject
to repurchase, or posted as collateral do
not meet the definition of financial
collateral, the [BANKING
ORGANIZATION] must use a 30 percent
haircut for market price volatility (Hs).
(d) Minimum haircut floors for certain
eligible margin loans and repo-style
transactions—(1) General. To recognize
the risk mitigation benefit of financial
collateral that secures an eligible margin
loan or repo-style transaction with an
unregulated financial institution or
netting set of such transactions with an
unregulated financial institution, a
[BANKING ORGANIZATION] must
apply this paragraph (d). A [BANKING
ORGANIZATION] may not recognize
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collateral that secures the exposure
under this section.
(A) The haircut H equals to the ratio
of the fair value of financial collateral
borrowed, purchased subject to resale,
or taken as collateral from the
unregulated financial institution (CB) to
the fair value of financial collateral lent,
sold subject to repurchase, or posted as
collateral (CL) expressed as a percent,
minus 100 percent.
(B) The haircut floor f is calculated as:
(1) For a single cash-lent-for-security
transaction, f is given in Table 2 to this
section.
(2) For a single security-for-security
repo-style transaction, f is calculated
using the following formula, in which
security L (haircut floor fL given in
Table 2 to this section) is lent, sold
subject to repurchase, or posted as
collateral in exchange for borrowing,
purchasing subject to resale, or taking as
collateral security B (haircut floor fB
given in Table 2 to this section):
(iii) Portfolio haircut floors. For a
netting set of eligible margin loans or
repo-style transactions with an
unregulated financial institution, a
[BANKING ORGANIZATION] must
compare the portfolio haircut to the
portfolio haircut floor. If the portfolio
haircut H is less than the portfolio
haircut floor the [BANKING
ORGANIZATION] may not recognize
the risk-mitigating effects of financial
collateral that secures the exposures.
The portfolio haircut H and the portfolio
haircut floor f are calculated as:
Where:
(A) CL equals the fair value of the net
position in a given security (or cash) the
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[BANKING ORGANIZATION] has lent,
sold subject to repurchase, or posted as
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institution;
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(ii) Single-transaction haircut floors.
For a single eligible margin loan or repostyle transaction with an unregulated
financial institution that is not included
in a netting set, a [BANKING
ORGANIZATION] must compare the
haircut of the transaction with the
respective single-transaction haircut
floor. If the haircut for the transaction H
is smaller than the single transaction
haircut floor f, the [BANKING
ORGANIZATION] may not recognize
the risk-mitigating effects of financial
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(B) CB equals the fair value of the net position
in a given security the [BANKING
ORGANIZATION] has borrowed,
purchased subject to resale, or taken as
collateral from the unregulated financial
institution; and
(C) fL and fB are the respective haircut floors
given in Table 2 to this section for each
security net lent (L) and net borrowed (B)
by the [BANKING ORGANIZATION].
Risk-Weighted Assets for Securitization
Exposures
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§ ll.130 Operational criteria for
recognizing the transfer of risk.
(a) Operational criteria for traditional
securitizations. A [BANKING
ORGANIZATION] that transfers
exposures it has originated or purchased
to a securitization SPE or other third
party in connection with a traditional
securitization may exclude the
exposures from the calculation of its
risk-weighted assets only if each
condition in this section is satisfied. A
[BANKING ORGANIZATION] that
meets these conditions must hold riskbased capital against any credit risk it
retains in connection with the
securitization. A [BANKING
ORGANIZATION] that fails to meet
these conditions must hold risk-based
capital against the transferred exposures
as if they had not been securitized and
must deduct from common equity tier 1
capital any after-tax gain-on-sale
resulting from the transaction and any
portion of a CEIO strip that does not
constitute after-tax gain-on-sale. If the
transferred exposures are in connection
with a resecuritization and all of the
conditions in this paragraph (a) are
satisfied, the [BANKING
ORGANIZATION] must exclude the
exposures from the calculation of its
risk-weighted assets and must hold riskbased capital against any credit risk it
retains in connection with the
resecuritization. The conditions are:
(1) The exposures are not reported on
the [BANKING ORGANIZATION]’s
consolidated balance sheet under
GAAP;
(2) The [BANKING ORGANIZATION]
has transferred to one or more third
parties credit risk associated with the
underlying exposures;
(3) Any clean-up calls relating to the
securitization are eligible clean-up calls;
and
(4) The securitization does not:
(i) Include one or more underlying
exposures in which the borrower is
permitted to vary the drawn amount
within an agreed limit under a line of
credit; and
(ii) Contain an early amortization
provision.
(b) Operational criteria for synthetic
securitizations. For synthetic
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securitizations, a [BANKING
ORGANIZATION] may recognize for
risk-based capital purposes the use of a
credit risk mitigant to hedge underlying
exposures only if each condition in this
paragraph (b) is satisfied. A [BANKING
ORGANIZATION] that meets these
conditions must hold risk-based capital
against any credit risk of the exposures
it retains in connection with the
synthetic securitization. A [BANKING
ORGANIZATION] that fails to meet
these conditions or chooses not to
recognize the credit risk mitigant for
purposes of this section must instead
hold risk-based capital against the
underlying exposures as if they had not
been synthetically securitized. If the
synthetic securitization is a
resecuritization and all of the conditions
in this paragraph (b) are satisfied, the
[BANKING ORGANIZATION] must
exclude the underlying from the
calculation of its risk-weighted assets
and must hold risk-based capital against
any credit risk it retains in connection
with the resecuritization. The
conditions are:
(1) The credit risk mitigant is:
(i) Financial collateral;
(ii) A guarantee that meets all criteria
as set forth in the definition of ‘‘eligible
guarantee’’ in § ll.2, except for the
criteria in paragraph (3) of that
definition; or
(iii) A credit derivative that is not an
nth-to-default credit derivative and that
meets all criteria as set forth in the
definition of ‘‘eligible credit derivative’’
in § ll.2, except for the criteria in
paragraph (3) of the definition of
‘‘eligible guarantee’’ in § ll.2.
(2) The [BANKING ORGANIZATION]
transfers credit risk associated with the
underlying exposures to one or more
third parties, and the terms and
conditions in the credit risk mitigants
employed do not include provisions
that:
(i) Allow for the termination of the
credit protection due to deterioration in
the credit quality of the underlying
exposures;
(ii) Require the [BANKING
ORGANIZATION] to alter or replace the
underlying exposures to improve the
credit quality of the underlying
exposures;
(iii) Increase the [BANKING
ORGANIZATION]’s cost of credit
protection in response to deterioration
in the credit quality of the underlying
exposures;
(iv) Increase the yield payable to
parties other than the [BANKING
ORGANIZATION] in response to a
deterioration in the credit quality of the
underlying exposures; or
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(v) Provide for increases in a retained
first loss position or credit enhancement
provided by the [BANKING
ORGANIZATION] after the inception of
the securitization;
(3) The [BANKING ORGANIZATION]
obtains a well-reasoned opinion from
legal counsel that confirms the
enforceability of the credit risk mitigant
in all relevant jurisdictions;
(4) Any clean-up calls relating to the
securitization are eligible clean-up calls;
(5) No synthetic excess spread is
permitted within the synthetic
securitization;
(6) Any applicable minimum payment
threshold for the credit risk mitigant is
consistent with standard market
practice; and
(7) The securitization does not:
(i) Include one or more underlying
exposures in which the borrower is
permitted to vary the drawn amount
within an agreed limit under a line of
credit; and
(ii) Contain an early amortization
provision.
(c) Due diligence requirements for
securitization exposures. (1) Except for
exposures that are deducted from
common equity tier 1 capital and
exposures subject to § ll.132(h), if a
[BANKING ORGANIZATION] is unable
to demonstrate to the satisfaction of the
[AGENCY] a comprehensive
understanding of the features of a
securitization exposure that would
materially affect the performance of the
exposure, the [BANKING
ORGANIZATION] must assign the
securitization exposure a risk weight of
1,250 percent. The [BANKING
ORGANIZATION]’s analysis must be
commensurate with the complexity of
the securitization exposure and the
materiality of the exposure in relation to
its capital.
(2) A [BANKING ORGANIZATION]
must demonstrate its comprehensive
understanding of a securitization
exposure under paragraph (c)(1) of this
section, for each securitization exposure
by:
(i) Conducting an analysis of the risk
characteristics of a securitization
exposure prior to acquiring the exposure
and documenting such analysis within
3 business days after acquiring the
exposure, considering:
(A) Structural features of the
securitization that would materially
impact the performance of the exposure,
for example, the contractual cash flow
waterfall, waterfall-related triggers,
credit enhancements, liquidity
enhancements, fair value triggers, the
performance of organizations that
service the exposure, and deal-specific
definitions of default;
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(B) Relevant information regarding—
(1) The performance the underlying
credit exposure(s), for example, the
percentage of loans 30, 60, and 90 days
past due; default rates; prepayment
rates; loans in foreclosure; property
types; occupancy; average credit score
or other measures of creditworthiness;
average LTV ratio; and industry and
geographic diversification data on the
underlying exposure(s); and
(2) For resecuritization exposures, in
addition to the information described in
paragraph (c)(2)(i)(B)(1) of this section,
performance information on the
underlying securitization exposures,
which may include the issuer name and
credit quality, and the characteristics
and performance of the exposures
underlying the securitization exposures;
and
(C) Relevant market data of the
securitization, for example, bid-ask
spread, most recent sales price and
historic price volatility, trading volume,
implied market rating, and size, depth
and concentration level of the market
for the securitization; and
(ii) On an on-going basis (no less
frequently than quarterly), evaluating,
reviewing, and updating as appropriate
the analysis required under paragraph
(c)(1) of this section for each
securitization exposure.
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§ ll.131 Exposure amount of a
securitization exposure.
(a) On-balance sheet securitization
exposure. The exposure amount of an
on-balance sheet securitization exposure
(excluding a repo-style transaction,
eligible margin loan, OTC derivative
contract that is not a credit derivative,
or cleared transaction that is not a credit
derivative) is equal to the [BANKING
ORGANIZATION]’s carrying value of
the exposure. For a credit derivative, a
[BANKING ORGANIZATION] must
apply § ll.132(i) or (j), as applicable.
(b) Off-balance sheet securitization
exposure. Except as provided in
§ ll.132(h), the exposure amount of
an off-balance sheet securitization
exposure that is not a repo-style
transaction, eligible margin loan, OTC
derivative contract (other than a credit
derivative), or cleared transaction (other
than a credit derivative) is the notional
amount of the exposure. For an offbalance sheet securitization exposure to
an ABCP program, such as an eligible
ABCP liquidity facility, the notional
amount may be reduced to the
maximum potential amount that the
[BANKING ORGANIZATION] could be
required to fund given the ABCP
program’s current underlying assets
(calculated without regard to the current
credit quality of those assets).
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(c) Repo-style transaction, eligible
margin loan, OTC derivative contract
that is not a credit derivative, or cleared
transaction that is not a credit
derivative. The exposure amount of a
securitization exposure that is a repostyle transaction, eligible margin loan,
or OTC derivative contract (other than a
credit derivative) is the exposure
amount as calculated in § ll.113 or
§ ll.121, as applicable, and the
exposure amount of a securitization
exposure that is a cleared transaction
that is not a credit derivative is the
exposure amount as calculated in
§ ll.114.
§ ll.132 Risk-weighted assets for
securitization exposures.
(a) General approach. Except as
provided elsewhere in this section and
in § ll.130:
(1) A [BANKING ORGANIZATION]
may, subject to the limitation under
paragraph (e) of this section, apply the
securitization standardized approach
(SEC–SA) in § ll.133 to the exposure
if the exposure meets the following
requirements:
(i) The [BANKING ORGANIZATION]
has accurate information on A, D, W,
and KG (as defined in § ll.133) for the
exposure. Data used to assign the
parameters described in this paragraph
(a)(1)(i) must be the most currently
available data. If the contracts governing
the underlying exposures of the
securitization require payments on a
monthly or quarterly basis, the data
used to assign the parameters described
in this paragraph (a)(1)(i) must be no
more than 91 calendar days old.
(ii) The [BANKING ORGANIZATION]
has accurate information regarding
whether the exposure is a
resecuritization exposure.
(2) If the securitization exposure is an
interest rate derivative contract, an
exchange rate derivative contract, or a
cash collateral account related to an
interest rate or exchange rate derivative
contract, the [BANKING
ORGANIZATION] must assign a risk
weight to the exposure equal to the risk
weight of a securitization exposure that
is pari passu to the interest rate
derivative contract or exchange rate
derivative contract or, if such an
exposure does not exist, the risk weight
of any subordinate securitization
exposure.
(3) If the [BANKING
ORGANIZATION] cannot apply, or
chooses not to apply, the securitization
standardized approach in § ll.133, the
[BANKING ORGANIZATION] must
apply a 1,250 percent risk weight to the
exposure.
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(b) Total risk-weighted assets for
securitization exposures. A [BANKING
ORGANIZATION]’s total risk-weighted
assets for securitization exposures
equals the sum of the risk-weighted
asset amount for securitization
exposures that the [BANKING
ORGANIZATION] risk weights under
§ ll.132 through ll.134, as
applicable.
(c) After-tax gain-on-sale resulting
from a securitization. Notwithstanding
any other provision of this subpart, a
[BANKING ORGANIZATION] must
deduct from common equity tier 1
capital any after-tax gain-on-sale
resulting from a securitization as well as
the portion of a CEIO that does not
constitute an after-tax gain-on sale.
(d) Overlapping exposures. (1) If a
[BANKING ORGANIZATION] has
multiple securitization exposures that
provide duplicative coverage of the
underlying exposures of a
securitization, the [BANKING
ORGANIZATION] is not required to
hold duplicative risk-based capital
against the overlapping position.
Instead, the [BANKING
ORGANIZATION] may assign to the
overlapping securitization exposure the
applicable risk-based capital treatment
under this subpart that results in the
highest risk-based capital requirement.
(2) If a [BANKING ORGANIZATION]
has a securitization exposure that
partially overlaps with another
exposure, the [BANKING
ORGANIZATION] may assign to the
overlapping portion of the securitization
exposure the applicable risk-based
capital treatment under this subpart that
results in the highest risk-based capital
requirement. A [BANKING
ORGANIZATION] may treat two nonoverlapping securitization exposures as
overlapping if the [BANKING
ORGANIZATION] assumes that
obligations with respect to one of the
exposures are larger than those
established contractually. In such an
instance, the [BANKING
ORGANIZATION] may calculate its
risk-weighted assets as if the exposures
were overlapping as long as the
[BANKING ORGANIZATION] also
assumes for capital purposes that the
obligations of the relevant exposure are
larger than those established
contractually.
(3) If a [BANKING ORGANIZATION]
has a securitization exposure under this
subpart that partially overlaps with a
securitization exposure that is a market
risk covered position under subpart F of
this part, the [BANKING
ORGANIZATION] may assign to the
overlapping portion of the securitization
exposure the applicable risk-based
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capital treatment under either this
subpart or subpart F, whichever results
in the highest risk-based capital
requirement.
(e) Implicit support. If a [BANKING
ORGANIZATION] provides support to a
securitization in excess of the
[BANKING ORGANIZATION]’s
contractual obligation to provide credit
support to the securitization:
(1) The [BANKING ORGANIZATION]
must calculate a risk-weighted asset
amount for underlying exposures
associated with the securitization as if
the exposures had not been securitized
and must deduct from common equity
tier 1 capital any after-tax gain-on-sale
resulting from the securitization and
any portion of a CEIO strip that does not
constitute after-tax gain-on-sale; and
(2) The [BANKING ORGANIZATION]
must disclose publicly:
(i) That it has provided implicit
support to the securitization; and
(ii) The risk-based capital impact to
the [BANKING ORGANIZATION] of
providing such implicit support.
(f) Undrawn portion of a servicer cash
advance facility. (1) Notwithstanding
any other provision of this subpart, a
[BANKING ORGANIZATION] that is a
servicer under an eligible servicer cash
advance facility is not required to hold
risk-based capital against potential
future cash advance payments that it
may be required to provide under the
contract governing the facility.
(2) For a [BANKING
ORGANIZATION] that acts as a servicer,
the exposure amount for a servicer cash
advance facility that is a not an eligible
servicer cash advance facility is equal to
the amount of all potential future cash
advance payments that the [BANKING
ORGANIZATION] may be contractually
required to provide during the
subsequent 12-month period under the
contract governing the facility.
(g) Interest-only mortgage-backed
securities. Notwithstanding any other
provision of this subpart, the risk weight
for a non-credit-enhancing interest-only
mortgage-backed security may not be
less than 100 percent.
(h) Small-business loans and leases
on personal property transferred with
retained contractual exposure. (1)
Regardless of any other provision of this
subpart, a [BANKING ORGANIZATION]
that has transferred small-business loans
and leases on personal property (smallbusiness obligations) with recourse
must include in risk-weighted assets
only its contractual exposure to the
small-business obligations if all the
following conditions are met:
(i) The transaction must be treated as
a sale under GAAP;
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(ii) The [BANKING ORGANIZATION]
establishes and maintains, pursuant to
GAAP, a non-capital reserve sufficient
to meet the [BANKING
ORGANIZATION]’s reasonably
estimated liability under the contractual
obligation;
(iii) The small-business obligations
are to businesses that meet the criteria
for a small-business concern established
by the Small Business Administration
under section 3(a) of the Small Business
Act (15 U.S.C. 632 et seq.); and
(iv) The [BANKING ORGANIZATION]
is well capitalized for purposes of the
Prompt Corrective Action framework
(12 U.S.C. 1831o). For purposes of
determining whether a [BANKING
ORGANIZATION] is well capitalized for
purposes of this paragraph (h), the
[BANKING ORGANIZATION]’s capital
ratios must be calculated without regard
to the capital treatment for transfers of
small-business obligations with recourse
specified in paragraph (h)(1) of this
section.
(2) The total outstanding amount of
contractual exposure retained by a
[BANKING ORGANIZATION] on
transfers of small-business obligations
receiving the capital treatment specified
in paragraph (h)(1) of this section
cannot exceed 15 percent of the
[BANKING ORGANIZATION]’s total
capital.
(3) If a [BANKING ORGANIZATION]
ceases to be well capitalized, or exceeds
the 15 percent capital limitation
provided in paragraph (h)(2) of this
section, the capital treatment specified
in paragraph (h)(1) of this section will
continue to apply to any transfers of
small-business obligations with retained
contractual exposure that occurred
during the time that the [BANKING
ORGANIZATION] was well capitalized
and did not exceed the capital limit.
(4) The risk-based capital ratios of the
[BANKING ORGANIZATION] must be
calculated without regard to the capital
treatment for transfers of small-business
obligations specified in paragraph (h)(1)
of this section for purposes of:
(i) Determining whether a [BANKING
ORGANIZATION] is adequately
capitalized, undercapitalized,
significantly undercapitalized, or
critically undercapitalized under the
[AGENCY]’s prompt corrective action
regulations; and
(ii) Reclassifying a well-capitalized
[BANKING ORGANIZATION] to
adequately capitalized and requiring an
adequately capitalized [BANKING
ORGANIZATION] to comply with
certain mandatory or discretionary
supervisory actions as if the [BANKING
ORGANIZATION] were in the next
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lower prompt-corrective-action
category.
(i) Nth-to-default credit derivatives—
(1) Protection provider. A [BANKING
ORGANIZATION] providing protection
through a first-to-default or second-todefault derivative is subject to capital
requirements on such instruments
under this paragraph (i)(1).
(i) First-to-default. For first-to-default
derivatives, a [BANKING
ORGANIZATION] must aggregate by
simple summation the risk weights of
the assets covered up to a maximum of
1,250 percent and multiply by the
nominal amount of the protection
provided by the credit derivative to
obtain the risk-weighted asset amount.
(ii) Nth-to-default. For second-todefault derivatives, in aggregating the
risk weights, a [BANKING
ORGANIZATION] may exclude the
asset with the lowest risk-weighted
amount from the risk-weighted capital
calculation. This risk-based capital
treatment applies for nth-to-default
derivatives for which the n-1 assets with
the lowest risk-weighted amounts can
be excluded from the risk-weighted
capital calculation.
(2) Protection purchaser. A
[BANKING ORGANIZATION] is not
permitted to recognize a purchased nthto-default credit derivative as a credit
risk mitigant. A [BANKING
ORGANIZATION] must calculate the
counterparty credit risk of a purchased
nth-to-default credit derivative under
§ ll.113.
(j) Guarantees and credit derivatives
other than nth-to-default credit
derivatives—(1) Protection provider. For
a guarantee or credit derivative (other
than an nth-to-default credit derivative)
provided by a [BANKING
ORGANIZATION] that covers the full
amount or a pro rata share of a
securitization exposure’s principal and
interest, the [BANKING
ORGANIZATION] must risk-weight the
guarantee or credit derivative under
paragraph (a) of this section as if it held
the portion of the reference exposure
covered by the guarantee or credit
derivative.
(2) Protection purchaser. (i) A
[BANKING ORGANIZATION] that
purchases a credit derivative (other than
an nth-to-default credit derivative) that
is recognized under § ll.134 as a
credit risk mitigant (including via
recognized collateral) is not required to
compute a separate counterparty credit
risk capital requirement under
§ ll.110.
(ii) If a [BANKING ORGANIZATION]
cannot, or chooses not to, recognize a
purchased credit derivative as a credit
risk mitigant under § ll.134, the
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[BANKING ORGANIZATION] must
determine the exposure amount of the
credit derivative under § ll.113.
(A) If the [BANKING
ORGANIZATION] purchases credit
protection from a counterparty that is
not a securitization SPE, the [BANKING
ORGANIZATION] must determine the
risk weight for the exposure according
to § ll.111.
(B) If the [BANKING
ORGANIZATION] purchases credit
protection from a counterparty that is a
securitization SPE, the [BANKING
ORGANIZATION] must determine the
risk weight for the exposure according
to this section.
(k) Look-through approach. (1)
Subject to paragraph (k)(2) of this
section, a [BANKING ORGANIZATION]
may assign a risk weight to a senior
securitization exposure that is not a
resecuritization exposure equal to the
greater of:
(i) The weighted-average risk weight
of all the underlying exposures where
the weight for each exposure in the
weighted-average calculation is
determined by the unpaid principal
amount of the exposure; and
(ii) 15 percent.
(2) A [BANKING ORGANIZATION]
may assign a risk weight under this
paragraph (k) only if the [BANKING
ORGANIZATION] has knowledge of the
composition of all of the underlying
exposures.
(l) NPL securitization.
Notwithstanding any other provision of
this subpart except for paragraph (e) of
this section:
(1) If the NPL securitization is a
traditional securitization and the
nonrefundable purchase price discount
is greater than or equal to 50 percent of
the outstanding balance of the pool of
exposures, the risk weight for a senior
securitization exposure to an NPL
securitization is 100 percent.
(2) If the [BANKING
ORGANIZATION] is an originating
[BANKING ORGANIZATION] with
respect to the NPL securitization, the
[BANKING ORGANIZATION] may hold
risk-based capital against the transferred
exposures as if they had not been
securitized and must deduct from
common equity tier 1 capital any aftertax gain-on-sale resulting from the
transaction and any portion of a CEIO
that does not constitute an after-tax
gain-on-sale.
Where:
(1) KA is calculated under paragraph (b) of
this section;
(2) A (attachment point) equals the greater of
zero and the ratio, expressed as a
decimal value between zero and one, of
the outstanding balance of all underlying
assets in the securitization minus the
outstanding balance of all tranches that
rank senior or pari passu to the tranche
that contains the securitization exposure
of the [BANKING ORGANIZATION]
(including the exposure itself) to the
outstanding balance of all underlying
assets in the securitization, as adjusted
in accordance with paragraph (a)(6) of
this section;
(3) D (detachment point) equals the greater of
zero and the ratio, expressed as a
decimal value between zero and one, of
the outstanding balance of all underlying
assets in the securitization minus the
outstanding balance of all tranches that
rank senior to the tranche that contains
the securitization exposure of the
[BANKING ORGANIZATION] to the
outstanding balance of all underlying
assets in the securitization, as adjusted
in accordance with paragraph (a)(6) of
this section;
(4) RWFLOOR equals 100 percent for
resecuritization exposures and NPL
securitization exposures and 15 percent
for all other securitization exposures;
and
(5) KSEC–SA is calculated according to the
following formula:
Where:
(i) a equals ¥1/(p*KA) (as KA is defined in
this paragraph (a)), where p equals 1.5
for a resecuritization exposure and 1 for
all other securitization exposures;
(ii) u equals D¥KA (as D and KA are defined
in this paragraph (a));
(iii) l equals max(A¥KA, 0) (as A and KA are
defined in this paragraph (a)); and
(iv) e equals the base of the natural logarithm.
account funded by the accumulated
cash flows from the underlying
exposures that is subordinated to the
[BANKING ORGANIZATION]’s
securitization exposure. Interest rate
derivative contracts, exchange rate
derivative contracts, and cash collateral
accounts related to these contracts must
not be included in the calculation of A
and D. If the securitization exposure
includes a nonrefundable purchase
price discount, the nonrefundable
purchase price discount must be
included in the numerator and
denominator of A and D.
(b) Calculation of KA. KA is calculated
under this paragraph (b) according to
the following formula:
KA = (1¥W) · KG + (W · 0.5)
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(a) In general. The risk weight
RWSEC–SA assigned to a securitization
exposure, or portion of a securitization
exposure, is calculated according to the
following formula:
Where:
(1) W equals the ratio, expressed as a
decimal value between zero and one, of
the sum of the outstanding balance of
any underlying exposures of the
securitization that are not securitization
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(6) A [BANKING ORGANIZATION]
must include in the calculation of A and
D the funded portion of any reserve
§ ll.133 Securitization standardized
approach (SEC–SA).
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exposures and that meet any of the
criteria in paragraphs (b)(1)(i) through
(vi) of this section to the outstanding
balance of all underlying exposures:
(i) Ninety days or more past due;
(ii) Subject to a bankruptcy or
insolvency proceeding;
(iii) In the process of foreclosure;
(iv) Held as real estate owned;
(v) Has contractually deferred
payments for 90 days or more, other
than principal or interest payments
deferred on:
(A) Federally guaranteed student
loans, in accordance with the terms of
those guarantee programs; or
(B) Consumer loans, including nonfederally-guaranteed student loans,
provided that such payments are
deferred pursuant to provisions
included in the contract at the time
funds are disbursed that provide for
period(s) of deferral that are not
initiated based on changes in the
creditworthiness of the borrower; or
(vi) Is in default; and
(2) KG equals the weighted average
(with the outstanding balance used as
the weight for each exposure) total
capital requirement, expressed as a
decimal value between zero and one, of
the underlying exposures calculated
using this subpart E (that is, an average
risk weight of 100 percent represents a
value of KG equal to 0.08), as adjusted
in accordance with paragraphs (b)(2)(i)
and (ii) of this section.
(i) For interest rate derivative
contracts and exchange rate derivative
contracts, the positive current exposure
times the risk weight of the counterparty
multiplied by 0.08 must be included in
the numerator of KG but must be
excluded from the denominator of KG.
(ii) If a [BANKING ORGANIZATION]
transfers credit risk via a synthetic
securitization to a securitization SPE
and if the securitization SPE issues
funded obligations to investors, the
[BANKING ORGANIZATION] must
include the total capital requirement
(exposure amount multiplied by risk
weight multiplied by 0.08) of any
collateral held by the securitization SPE
in the numerator of KG. The
denominator of KG is calculated without
recognition of the collateral.
lotter on DSK11XQN23PROD with PROPOSALS2
§ ll.134 Recognition of credit risk
mitigants for securitization exposures.
(a) General. (1) An originating
[BANKING ORGANIZATION] that has
obtained a credit risk mitigant to hedge
its exposure to a synthetic or traditional
securitization that satisfies the
operational criteria provided in
§ ll.130 may recognize the credit risk
mitigant under § ll.120 or § ll.121,
but only as provided in this section.
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(2) An investing [BANKING
ORGANIZATION] that has obtained a
credit risk mitigant to hedge a
securitization exposure may recognize
the credit risk mitigant under § ll.120
or § ll.121, but only as provided in
this section.
(3) If the recognized credit risk
mitigant hedges a portion of the
[BANKING ORGANIZATION]’s
securitization exposure, the [BANKING
ORGANIZATION] must calculate its
capital requirements for the hedged and
unhedged portions of the exposure
separately. For each unhedged portion,
the [BANKING ORGANIZATION] must
calculate capital requirements according
to § ll.131 and § ll.132. For each
hedged portion, the [BANKING
ORGANIZATION] may recognize the
credit risk mitigant under § ll.120 or
§ ll.121, but only as provided in this
section.
(4) When a [BANKING
ORGANIZATION] purchases or sells
credit protection on a portion of a senior
tranche, the lower-priority portion,
whether hedged or unhedged, must be
considered a non-senior securitization
exposure.
(b) Mismatches. A [BANKING
ORGANIZATION] must make any
applicable adjustment to the protection
amount as required in § ll.120 for any
hedged securitization exposure. In the
context of a synthetic securitization,
when an eligible guarantee, eligible
credit derivative, or a credit risk
mitigant described in § ll.130(b)(1)(ii)
or (iii) covers multiple hedged
exposures that have different residual
maturities, the [BANKING
ORGANIZATION] must use the longest
residual maturity of any of the hedged
exposures as the residual maturity of all
hedged exposures.
Risk-Weighted Assets for Equity
Exposures
§ ll.140 Introduction and exposure
measurement.
(a) General. (1) To calculate its riskweighted asset amounts for equity
exposures that are not equity exposures
in investment funds, a [BANKING
ORGANIZATION] must use the
approach provided in § ll.141. A
[BANKING ORGANIZATION] must use
the approaches provided in § ll.142
to calculate its risk-weighted asset
amounts for other equity exposures as
provided in § ll.142.
(2) A [BANKING ORGANIZATION]
must treat an investment in a separate
account (as defined in § ll.2) as if it
were an equity exposure subject to
§ ll.142.
(3) Stable value protection—(i) Stable
value protection means a contract where
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the provider of the contract is obligated
to pay:
(A) The policy owner of a separate
account an amount equal to the shortfall
between the fair value and cost basis of
the separate account when the policy
owner of the separate account
surrenders the policy; or
(B) The beneficiary of the contract an
amount equal to the shortfall between
the fair value and book value of a
specified portfolio of assets.
(ii) A [BANKING ORGANIZATION]
that purchases stable value protection
on its investment in a separate account
must treat the portion of the carrying
value of its investment in the separate
account attributable to the stable value
protection as an exposure to the
provider of the protection and the
remaining portion of the carrying value
of its separate account as an equity
exposure subject to § ll.142.
(iii) A [BANKING ORGANIZATION]
that provides stable value protection
must treat the exposure as an equity
derivative with an adjusted carrying
value determined as the sum of
paragraphs (b)(1) and (2) of this section.
(b) Adjusted carrying value. For
purposes of § ll.140 through ll.142,
the adjusted carrying value of an equity
exposure is:
(1) For the on-balance sheet
component of an equity exposure, the
[BANKING ORGANIZATION]’s carrying
value of the exposure;
(2) For the off-balance sheet
component of an equity exposure that is
not an equity commitment, the effective
notional principal amount of the
exposure, the size of which is
equivalent to a hypothetical on-balance
sheet position in the underlying equity
instrument that would evidence the
same change in fair value (measured in
dollars) given a small change in the
price of the underlying equity
instrument, minus the adjusted carrying
value of the on-balance sheet
component of the exposure as
calculated in paragraph (b)(1) of this
section; and
(3) For a commitment to acquire an
equity exposure (an equity
commitment), the effective notional
principal amount of the exposure is
multiplied by the following conversion
factors (CFs):
(i) Conditional equity commitments
receive a 40 percent conversion factor.
(ii) Unconditional equity
commitments receive a 100 percent
conversion factor.
§ ll.141 Expanded simple risk-weight
approach (ESRWA).
(a) General. A [BANKING
ORGANIZATION]’s total risk-weighted
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assets for equity exposures equals the
sum of the risk-weighted asset amounts
for each of the [BANKING
ORGANIZATION]’s equity exposures
that are not equity exposures subject to
§ ll.142, as determined under this
section, and the risk-weighted asset
amounts for each of the [BANKING
ORGANIZATION]’s equity exposures
subject to § ll.142, as determined
under § ll.142.
(b) Computation for individual equity
exposures. A [BANKING
ORGANIZATION] must determine the
risk-weighted asset amount for an equity
exposure that is not an equity exposure
subject to § ll.142 by multiplying the
adjusted carrying value of the exposure
by the lowest applicable risk weight in
this paragraph (b).
(1) Zero percent risk weight equity
exposures. An equity exposure to a
sovereign, the Bank for International
Settlements, the European Central Bank,
the European Commission, the
International Monetary Fund, the
European Stability Mechanism, the
European Financial Stability Facility, an
MDB, and any other entity whose credit
exposures receive a zero percent risk
weight under § ll.111 may be
assigned a zero percent risk weight.
(2) 20 percent risk weight equity
exposures. An equity exposure to a PSE,
Federal Home Loan Bank, or the Federal
Agricultural Mortgage Corporation
(Farmer Mac) must be assigned a 20
percent risk weight.
(3) 100 percent risk weight. The equity
exposures set forth in this paragraph
(b)(3) must be assigned a 100 percent
risk weight:
(i) An equity exposure that qualifies
as a community development
investment under section 24 (Eleventh)
of the National Bank Act; and
(ii) An equity exposure to an
unconsolidated small business
investment company or held through a
consolidated small business investment
company described in section 302 of the
Small Business Investment Act.
(4) 250 percent risk weight. The equity
exposures set forth in this paragraph
Where:
(1) RWAon is the aggregate riskweighted asset amount of the on-balance
sheet exposures of the investment fund
determined under this subpart E as if
each exposure were held directly on
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(b)(4) must be assigned a 250 percent
risk weight:
(i) An equity exposure that is publicly
traded;
(ii) Significant investments in the
capital of unconsolidated financial
institutions in the form of common
stock that are not deducted from capital
pursuant to § ll.22(d)(2); and
(iii) Exposures that hedge equity
exposures described in paragraph
(b)(4)(ii) of this section.
(5) 400 percent risk weight. An equity
exposure that is not publicly traded and
is not described in paragraph (b)(6) of
this section, must be assigned a 400
percent risk weight.
(6) 1250 percent risk weight. An
equity exposure to an investment firm
must be assigned a 1250 percent risk
weight, provided that the investment
firm:
(i) Would meet the definition of a
traditional securitization were it not for
the application of paragraph (8) of that
definition; and
(ii) Has greater than immaterial
leverage.
§ ll.142
funds.
Equity exposures to investment
(a) Available approaches. A
[BANKING ORGANIZATION] must
determine the risk-weighted asset
amount of an equity exposure to an
investment fund as described in this
paragraph (a).
(1) If a [BANKING ORGANIZATION]
has information from the investment
fund regarding the underlying
exposures held by the investment fund
that is verified by an independent third
party at least quarterly and that is
sufficient to calculate the risk-weighted
asset amount for each underlying
exposure as calculated under this
subpart as if each exposure were held
directly by the [BANKING
ORGANIZATION], the [BANKING
ORGANIZATION] must use the full
look-through approach described in
paragraph (b) of this section.
(2) If a [BANKING ORGANIZATION]
does not have information sufficient to
balance sheet by the [BANKING
ORGANIZATION];
(2) RWAoff is the aggregate riskweighted asset amount of the offbalance sheet exposures of the
investment fund, determined as the sum
of the exposure amount determined
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use the full look-through approach
under paragraph (b) of this section but
does have information sufficient to use
the alternative modified look-through
approach described in paragraph (c) of
this section, the [BANKING
ORGANIZATION] must use the
alternative modified look-through
approach described in paragraph (c) of
this section.
(3) If a [BANKING ORGANIZATION]
does not have sufficient information to
use either the full look-through
approach described in paragraph (b) of
this section or the alternative modified
look-through approach described in
paragraph (c) of this section, the
[BANKING ORGANIZATION] must
assign a risk-weighted asset amount
equal to the adjusted carrying value of
the equity exposure multiplied by a
1,250 percent risk weight.
(4) In order to determine a riskweighted asset amount for a
securitization exposure held by an
investment fund, for purposes of either
the full look-through approach
described in paragraph (b) of this
section or the alternative modified lookthrough approach described in
paragraph (c) of this section, the
[BANKING ORGANIZATION] must use
the approach described in paragraph (d)
of this section.
(5) In order to determine a riskweighted asset amount for an equity
investment in an investment fund held
by another investment fund, for
purposes of either the full look-through
approach described in paragraph (b) of
this section or the alternative modified
look-through approach described in
paragraph (c) of this section, the
[BANKING ORGANIZATION] must use
the approach described in paragraph (e)
of this section.
(b) Full look-through approach. Under
the full look-through approach, the riskweighted asset amount for an equity
exposure to an investment fund is equal
to the adjusted carrying value
multiplied by the risk weight (RWIF),
which equals:
under § ll.112 multiplied by the
applicable risk weight under this
subpart E, for each exposure, as if each
exposure were held off-balance sheet
under the same terms by the [BANKING
ORGANIZATION];
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(3) RWAderivatives is the aggregate riskweighted asset amount of the derivative
contracts held by the investment fund,
determined as the sum of the exposure
amount determined under § ll.113
multiplied by the risk weight applicable
to the counterparty under § ll.111 of
this subpart for each netting set, as if
each derivative contract were held
directly by the [BANKING
ORGANIZATION], subject to the
following conditions:
(i) If the [BANKING
ORGANIZATION] cannot determine
which netting set a derivative contract
is part of, the [BANKING
ORGANIZATION] must treat the
derivative contract as constituting its
own netting set;
(ii) If the [BANKING
ORGANIZATION] cannot determine
replacement cost under § ll.113, the
[BANKING ORGANIZATION] must
assume that replacement cost is equal to
the notional amount of each derivative
contract and use a PFE multiplier under
§ ll.113 equal to one;
(iii) If the [BANKING
ORGANIZATION] cannot determine
potential future exposure under
§ ll.113, the [BANKING
ORGANIZATION] must assume that
potential future exposure is equal to 15
percent of the notional amount of each
derivative contract;
(iv) If the [BANKING
ORGANIZATION] cannot determine
whether the counterparty is a
commercial end-user, the [BANKING
ORGANIZATION] must assume that the
counterparty is not a commercial enduser;
(v) If the derivative contract is a CVA
risk covered position or the [BANKING
ORGANIZATION] cannot determine
that a derivative contract is not a CVA
risk covered position as defined in
§ ll.201, the [BANKING
ORGANIZATION] must multiply the
exposure amount by 1.5; and
(vi) If the [BANKING
ORGANIZATION] cannot determine the
risk-weight of the counterparty under
§ ll.111, the [BANKING
ORGANIZATION] must apply a riskweight of 100 percent;
(4) Total AssetsIF is the balance sheet
total assets of the investment fund; and
(5) Total EquityIF is the balance sheet
total equity of the investment fund.
(c) Alternative modified look-through
approach. Under the alternative
modified look-through approach, the
risk-weighted asset amount for an equity
exposure is determined in the same way
as under the full look-through approach
specified in paragraph (b) of this
section, with the following exceptions:
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(1) To calculate RWAon, a [BANKING
ORGANIZATION] must assign the total
assets of the investment fund on a pro
rata basis to different risk weight
categories under this subpart based on
the investment limits in the investment
fund’s prospectus, partnership
agreement, or similar contract that
defines the investment fund investment
fund’s permissible investments, other
than for derivatives. The risk-weighted
asset amount for the [BANKING
ORGANIZATION]’s equity exposure to
the investment fund equals the sum of
each portion of the total assets of the
investment fund assigned to an
exposure type multiplied by the
applicable risk weight under this
subpart. If the sum of the investment
limits for all exposure types within the
investment fund exceeds 100 percent,
the [BANKING ORGANIZATION] must
assume that the investment fund invests
to the maximum extent permitted under
its investment limits in the exposure
type with the highest applicable risk
weight under this subpart and continues
to make investments in descending
order of the exposure type with the next
highest applicable risk weight under
this subpart until the maximum total
investment level is reached. If more
than one exposure type applies to an
exposure, the [BANKING
ORGANIZATION] must use the highest
applicable risk weight.
(2) To calculate RWAoff, the
[BANKING ORGANIZATION] must
assume that the investment fund invests
to the maximum extent permitted under
its investment limits in the transactions
with the highest applicable credit
conversion factor under § ll.112 and
with the highest applicable risk weight
under this subpart.
(3) To calculate RWAderivatives, the
[BANKING ORGANIZATION] must
assume that the investment fund has the
maximum volume of derivative
contracts permitted under its
investment limits and must assume,
notwithstanding paragraphs (b)(3)(ii)
and (iii), that the replacement cost plus
potential future exposure under
§ ll.113 equals 115 percent of the
notional amount.
(d) Equity exposures to investment
funds with underlying securitizations.
To determine the risk-weighted asset
amount for a securitization exposure
held by an investment fund, a
[BANKING ORGANIZATION] must:
(1) If applying the full look-through
approach under paragraph (b) of this
section, apply a risk weight determined
under § ll.133 or a risk weight of
1,250 percent; and
(2) If applying the alternative
modified look-through approach under
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paragraph (c) of this section, apply a
1,250 percent risk weight.
(e) Equity exposures to an investment
fund held by another investment fund.
To determine the risk-weighted asset
amount for an equity exposure to an
investment fund held by another
investment fund, a [BANKING
ORGANIZATION] must:
(1) For an equity exposure to an
investment fund held directly by the
investment fund to which the
[BANKING ORGANIZATION] has a
direct equity exposure, use the full lookthrough approach described in
paragraph (b) of this section, the
alternative modified look-through
approach described in paragraph (c) of
this section, or multiply the exposure
amount by a 1,250 percent risk weight;
and
(2) For an equity exposure to an
investment fund held indirectly,
through one or more additional
investment funds, by the investment
fund to which the [BANKING
ORGANIZATION] has a direct equity
exposure, multiply the exposure amount
of the equity exposure to an investment
fund held indirectly by a 1,250 percent
risk-weight, unless the [BANKING
ORGANIZATION] uses the full lookthrough approach described in
paragraph (b) of this section to calculate
the risk-weighted asset amount for the
equity exposure to the investment fund
that holds the equity exposure, in which
case the [BANKING ORGANIZATION]
may use either the full look-through
approach described in paragraph (b) of
this section or multiply the exposure
amount by a 1,250 percent risk weight.
Risk-Weighted Assets for Operational
Risk
§ ll.150
Operational Risk Capital
(a) Risk-Weighted Assets for
Operational Risk. Risk-weighted assets
for operational risk equals the
operational risk capital requirement
multiplied by 12.5.
(b) Operational Risk Capital
Requirement. A [BANKING
ORGANIZATION]’s operational risk
capital requirement equals the Business
Indicator Component, as calculated
pursuant to paragraph (c) of this section,
multiplied by the Internal Loss
Multiplier, as calculated pursuant to
paragraph (e) of this section.
(c) Business Indicator Component.
The Business Indicator Component is
calculated as follows:
(1) If the [BANKING
ORGANIZATION]’s Business Indicator
is less than or equal to $1 billion,
Business Indicator Component = 0.12 ×
Business Indicator.
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(2) If the [BANKING
ORGANIZATION]’s Business Indicator
is greater than $1 billion and less than
or equal to $30 billion, Business
Indicator Component = $120 million +
0.15 × (Business Indicator¥$1 billion).
(3) If the [BANKING
ORGANIZATION]’s Business Indicator
is greater than $30 billion, Business
Indicator Component = $4.47 billion +
0.18 × (Business Indicator¥$30 billion).
(d) Business Indicator. (1) A
[BANKING ORGANIZATION]’s
Business Indicator equals the sum of
three components: the interest, lease,
and dividend component; the services
component; and the financial
component.
(i) The interest, lease, and dividend
component is calculated using the
following formula:
Interest, lease, and divided component
= min (Avg3y(Abs(total interest income
¥total interest expense)), 0.0225
· Avg3y(interest earning assets))
+ Avg3y(dividend income)
where Avg3y refers to the three-year
average of the expression in parenthesis;
Abs refers to the absolute value of the
expression in parenthesis; and total
interest income, total interest expense,
interest earning assets, and dividend
income are the amounts determined in
accordance with paragraph (d)(2) of this
section.
(ii) The services component is
calculated using the following formula:
Services component
= max (Avg3y(fee and commission
income), Avg3y(fee and commission
expense))
+ max (Avg3y(other operating income),
Avg3y(other operating expense))
where Avg3y refers to the three-year
average of the expression in parenthesis;
and fee and commission income, fee
where Avg3y refers to the three-year
average of the expression in parenthesis;
Abs refers to the absolute value of the
expression in parenthesis; and trading
revenue and net profit or loss on assets
and liabilities not held for trading are
determined in accordance with
paragraph (d)(2) of this section.
(2) For purposes of paragraph (d)(1) of
this section, to calculate the three-year
average of the Abs(total interest
income¥total interest expense),
dividend income, fee and commission
income, fee and commission expense,
other operating income, other operating
expense, Abs(trading revenue), and
Abs(net profit or loss on assets and
liabilities not held for trading), a
[BANKING ORGANIZATION] must
calculate the average of the values of
each of these items for each of the three
most recent preceding four-calendarquarter periods. To calculate the threeyear average of interest-earning assets, a
[BANKING ORGANIZATION] must
divide by 12 the sum of the quarterly
values of interest-earning assets over
each of the previous 12 quarters. For
purposes of the calculations in this
paragraph, the amounts used must be
based on the consolidated financial
statements of the [BANKING
ORGANIZATION].
(3) For purposes of paragraph (d)(1) of
this section, a [BANKING
ORGANIZATION] must exclude the
following items from the calculation of
the Business Indicator:
(i) Expenses that are not related to
financial services received by the
[BANKING ORGANIZATION], except
when they relate to operational loss
events;
(ii) Loss provisions and reversals of
provisions, except for those relating to
operational loss events;
(iii) Changes in goodwill; and
(iv) Applicable income taxes.
(4) For purpose of paragraph (d)(1) of
this section, a [BANKING
ORGANIZATION] must reflect three full
years of data for entities that were
acquired by or merged with the
[BANKING ORGANIZATION],
including for any period prior to the
acquisition or merger, in the [BANKING
ORGANIZATION]’s Business Indicator.
(5) With the prior approval of the
[AGENCY], a [BANKING
ORGANIZATION] may exclude from the
calculation of its Business Indicator any
interest income, interest expense,
dividend income, interest-earning
assets, fee and commission income, fee
and commission expense, other
operating income, other operating
expense, trading revenue, and net profit
or loss on assets and liabilities not held
for trading associated with an activity if
the [BANKING ORGANIZATION] has
ceased to directly or indirectly conduct
the activity. Approval by the [AGENCY]
requires a demonstration that the
activity does not carry legacy legal
exposure.
(e) Internal Loss Multiplier. (1) A
[BANKING ORGANIZATION]’s Internal
Loss Multiplier is calculated using the
following formula:
where average annual total net
operational losses are calculated
according to paragraph (e)(2) of this
section; the Business Indicator
Component is calculated pursuant to
paragraph (c) of this section; exp(1) is
Euler’s number, which is approximately
equal to 2.7183; and ln is the natural
logarithm.
(2) The calculation of average annual
total net operational losses is as follows:
(i) Average annual total net
operational losses are the average of
annual total net operational losses over
the previous ten years. For purposes of
this calculation, the previous ten years
correspond to the previous 40 quarters
as of the reporting date.
(ii) The annual total net operational
losses of a year equals the sum of the
total net operational losses of the
quarters that compose the year for
purposes of the calculation in paragraph
(e)(2)(i) of this section.
(iii) The total net operational losses of
a quarter equal the sum of any portions
of losses or recoveries of any material
operational losses allocated to the
quarter.
(iv) A material operational loss is an
operational loss incurred by the
[BANKING ORGANIZATION] that
resulted in a net loss greater than or
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and commission expense, other
operating income, and other operating
expense are the amounts determined in
accordance with paragraph (d)(2) of this
section.
(iii) The financial component is
calculated using the following formula:
Financial Component
= Avg3y(Abs(trading revenue))
+ Avg3y(Abs(net profit or loss on
assets and liabilities not held for
trading))
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equal to $20,000 after taking into
account all subsequent recoveries
related to the operational loss.
(v) For purposes of this paragraph
(e)(2), operational losses and recoveries
must be based on the date of accounting,
including for legal loss events.
Reductions in the legal reserves
associated with an ongoing legal event
are to be treated as recoveries for the
calculation of total net operational
losses. Losses and recoveries related to
a common operational loss event, but
with accounting impacts across several
quarters, must be allocated to the
quarters in which the accounting
impacts occur.
(vi) If a [BANKING ORGANIZATION]
does not have complete operational loss
event data meeting the requirements of
paragraph (f)(2)(i) of this section due to
a lack of appropriate operational loss
event data from a merged or acquired
business, the [BANKING
ORGANIZATION] must calculate the
annual total net operational loss
contribution for each year of missing
loss data of a merged or acquired
business as follows:
(A) Annual total net operational loss
for a merged or acquired business that
lacks loss data = Business Indicator
contribution of merged or acquired
business that lacks loss data * Average
annual total net operational loss of the
[BANKING ORGANIZATION] excluding
amounts attributable to the merged or
acquired business/Business Indicator of
the [BANKING ORGANIZATION]
excluding amounts attributable to the
merged or acquired business.
(B) Where ‘‘Business Indicator
contribution of merged or acquired
business that lacks loss data’’ is the
Business Indicator of the [BANKING
ORGANIZATION] including the merged
or acquired business that lacks loss data
minus the Business Indicator of the
[BANKING ORGANIZATION] excluding
amounts attributable to the merged or
acquired business.
(vii) Notwithstanding any other
provision of paragraph (e)(2) of this
section, if a [BANKING
ORGANIZATION] does not have
operational loss event data that meets
the requirements of paragraph (f)(2)(i) of
this section for the entire ten-year
period described in paragraph (e)(2)(i) of
this section after taking into account
paragraph (e)(2)(vi), the [BANKING
ORGANIZATION] must adjust the
calculations under this paragraph (e) as
follows:
(A) If the [BANKING
ORGANIZATION] has five or more
years of operational loss event data that
meets the requirements of paragraph
(f)(2)(i) of this section, the [BANKING
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ORGANIZATION] must calculate
average annual total net operational
losses using only the data that meets the
requirements of paragraph (f)(2)(i) of
this section.
(B) If the [BANKING
ORGANIZATION] has less than five
years of operational loss event data that
meets the requirements in paragraph
(f)(2)(i) of this section, the [BANKING
ORGANIZATION] must set the Internal
Loss Multiplier to one.
(3) Notwithstanding paragraph (e)(2)
of this section:
(i) A [BANKING ORGANIZATION]
may request approval from the
[AGENCY] to exclude from the
[BANKING ORGANIZATION]’s
operational loss events associated with
an activity that the [BANKING
ORGANIZATION] has ceased to directly
or indirectly conduct from the
calculation of annual total net
operational losses. Approval by the
[AGENCY] of the exclusion of
operational loss events relating to legal
risk requires a demonstration that the
activity does not carry legacy legal
exposure.
(ii) A [BANKING ORGANIZATION]
may request the [AGENCY] to exclude
operational loss events that are no
longer relevant to the [BANKING
ORGANIZATION]’s risk profile from the
calculation of annual total operational
losses. To justify such exclusion, the
[BANKING ORGANIZATION] must
provide adequate justification for why
the operational loss events are no longer
relevant to its risk profile. In order to be
eligible for exclusion under this
paragraph, an operational loss event
must have been included in the
calculation of the [BANKING
ORGANIZATION]’s average annual total
net operational losses for at least the
prior 12 quarters.
(iii) A [BANKING ORGANIZATION]
may not request exclusion of
operational loss events under paragraph
(e)(3)(i) or (ii) of this section unless the
operational loss events represent a total
net operational loss amount equal to
five percent or more of average annual
total net operational losses prior to the
requested exclusion.
(f) Operational Risk Management and
Operational Loss Event Data Collection
Processes. (1) A [BANKING
ORGANIZATION] must:
(i) Have an operational risk
management function that:
(A) Is independent of business line
management; and
(B) Is responsible for designing,
implementing, and overseeing the
[BANKING ORGANIZATION]’s internal
loss event data collection processes as
specified in paragraph (f)(2) and for
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overseeing the processes that implement
paragraphs (f)(1)(ii) and (f)(1)(iii) of this
section;
(ii) Have and document a process to
identify, measure, monitor, and control
operational risk in the [BANKING
ORGANIZATION]’s products, activities,
processes, and systems; and
(iii) Report operational loss events
and other relevant operational risk
information to business unit
management, senior management, and
the board of directors (or a designated
committee of the board).
(2) A [BANKING ORGANIZATION]
must have operational loss event data
collection processes that meet the
following requirements:
(i) The processes must produce
operational loss event data that satisfies
the following criteria:
(A) Operational loss event data must
be comprehensive and capture all
operational loss events that resulted in
operational losses equal to or higher
than $20,000 (before any recoveries are
taken into account) from all activities
and exposures of the [BANKING
ORGANIZATION];
(B) Operational loss event data must
include operational loss event data
relative to entities that have been
acquired by or merged with the
[BANKING ORGANIZATION] for ten
full years, including for any period prior
to the acquisition or merger during the
ten-year period; and
(C) Operational loss event data must
include gross operational loss amounts,
recovery amounts, the date when the
event occurred or began (‘‘occurrence
date’’), the date when the [BANKING
ORGANIZATION] became aware of the
event (‘‘discovery date’’), and the date
(or dates) when losses or recoveries
related to the event were recognized in
the [BANKING ORGANIZATION]’s
profit and loss accounts (‘‘accounting
date’’). The [BANKING
ORGANIZATION] must be able to map
its operational loss event data into the
seven operational loss event type
categories. In addition, the [BANKING
ORGANIZATION] must collect
descriptive information about the
drivers of operational loss events.
(ii) Procedures for the identification
and collection of internal loss event data
must be documented.
(iii) The [BANKING
ORGANIZATION] must have processes
to independently review the
comprehensiveness and accuracy of
operational loss event data.
(iv) The [BANKING ORGANIZATION]
must subject the procedures in
paragraph (f)(2)(ii) of this section and
the processes in (f)(2)(iii) of this section
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to regular independent reviews by
internal or external audit functions.
Disclosures
§ ll.160
Purpose and scope.
Sections ll.160 through ll.162 of
this part establish public disclosure
requirements related to the capital
requirements for a [BANKING
ORGANIZATION] subject to subpart E
of this part, unless the [BANKING
ORGANIZATION] is a consolidated
subsidiary of a bank holding company,
savings and loan holding company, or
depository institution that is subject to
these disclosure requirements, or a
subsidiary of a non-U.S. banking
organization that is subject to
comparable public disclosure
requirements in its home jurisdiction.
§ ll.161
Disclosure requirements.
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(a) A [BANKING ORGANIZATION]
described in § ll.160 must provide
timely public disclosures each calendar
quarter of the information in the
applicable tables in § ll.162. If a
significant change occurs to the
information required to be reported in
the applicable tables in § ll.162 or to
the [BANKING ORGANIZATION]’s
financial condition as reported on the
Call Report, for a [bank]; FR Y–9C, for
a bank holding company or savings and
loan holding company; or FFIEC 101, as
applicable, then a brief discussion of
this change and its likely impact must
be disclosed as soon as practicable
thereafter. Qualitative disclosures that
typically do not change each quarter (for
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example, a general summary of the
[BANKING ORGANIZATION]’s risk
management objectives and policies,
reporting system, and definitions) may
be disclosed annually after the end of
the fourth calendar quarter, provided
that any significant changes are
disclosed in the interim. The [BANKING
ORGANIZATION]’s management may
provide all of the disclosures required
by § ll.162 in one place on the
[BANKING ORGANIZATION]’s public
website or may provide the disclosures
in more than one public financial report
or other regulatory report. If the
[BANKING ORGANIZATION] does not
provide all of the disclosures as
required by § ll.162 in one place on
the [BANKING ORGANIZATION]’s
public website, the [BANKING
ORGANIZATION] must provide a
summary table specifically indicating
the location(s) of all such disclosures on
the [BANKING ORGANIZATION]’s
public website.
(b) A [BANKING ORGANIZATION]
described in § ll.160 must have a
formal disclosure policy approved by
the board of directors that addresses its
approach for determining the
disclosures it makes. The policy must
address the associated internal controls
and disclosure controls and procedures.
The board of directors and senior
management are responsible for
establishing and maintaining an
effective internal control structure over
financial reporting, including the
disclosures required by this subpart,
and must ensure that appropriate review
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of the disclosures takes place. One or
more senior officers of the [BANKING
ORGANIZATION] must attest that the
disclosures meet the requirements of
this subpart.
(c) If a [BANKING ORGANIZATION]
described in § ll.160 reasonably
concludes that specific commercial or
financial information that it would
otherwise be required to disclose under
this section would be exempt from
disclosure by the [AGENCY] under the
Freedom of Information Act (5 U.S.C.
552), then the [BANKING
ORGANIZATION] is not required to
disclose that specific information
pursuant to this section. However, the
[BANKING ORGANIZATION] must
disclose more general information about
the subject matter of the requirement,
together with the fact that, and the
reason why, the specific items of
information have not been disclosed.
§ ll.162 Disclosures by [BANKING
ORGANIZATION] described in § ll.160.
(a) General disclosures. Except as
provided in § ll.161, a [BANKING
ORGANIZATION] described in
§ ll.160 must make the disclosures
described in tables 1 through 15 of this
section. The [BANKING
ORGANIZATION] must make these
disclosures publicly available for each
of the last twelve quarters, or such
shorter period beginning in the quarter
in which the [BANKING
ORGANIZATION] becomes subject to
subpart E of this part.
BILLING CODE 6210–01–P; 6714–01–P; 4810–33–P
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directors, executive management,
separate risk committee, risk
management structure, compliance
function, internal audit function);
(iii) Channels to communicate, define,
and enforce the risk culture within the
[BANKING ORGANIZATION] (e.g., code
of conduct; manuals containing
operating limits or procedures to treat
violations or breaches of risk thresholds;
procedures to raise and share risk issues
EP18SE23.089</GPH>
how the risk profile of the [BANKING
ORGANIZATION] interacts with the
risk tolerance approved by the board;
(ii) The risk governance structure,
including: responsibilities attributed
throughout the [BANKING
ORGANIZATION] (e.g., oversight and
delegation of authority; breakdown of
responsibilities by type of risk, business
unit, etc.); and relationships between
the structures involved in risk
management processes (e.g., board of
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(b) Risk management-related
disclosure requirements. (1) The
[BANKING ORGANIZATION] must
describe its risk management objectives
and policies for the organization overall,
in particular:
(i) How the business model
determines and interacts with the
overall risk profile (e.g., the key risks
related to the business model and how
each of these risks is reflected and
described in the risk disclosures) and
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between business lines and risk
functions);
(iv) The scope and nature of risk
reporting and/or measurement systems;
(v) Description of the process of risk
information reporting provided to the
board and senior management, in
particular the scope and main content of
reporting on risk exposure;
(vi) Qualitative information on stress
testing (e.g., portfolios subject to stress
testing, scenarios adopted and
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methodologies used, and use of stress
testing in risk management); and
(vii) The strategies and processes to
manage, hedge, and mitigate risks that
arise from the [BANKING
ORGANIZATION]’s business model,
and the processes for monitoring the
continuing effectiveness of hedges and
mitigants.
(2) For each separate risk area that is
the subject of Tables 5 through 14 of
§ ll.162, the [BANKING
ORGANIZATION] must describe its risk
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management objectives and policies,
including:
(i) The strategies and processes;
(ii) The structure and organization of
the relevant risk management function;
(iii) The scope and nature of risk
reporting and/or measurement systems;
and
(iv) Policies for hedging and/or
mitigating risk and strategies and
processes for monitoring the continuing
effectiveness of hedges/mitigants.
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(c) Regulatory capital instrument and
other instruments eligible for total loss
absorbing capacity (TLAC) disclosures.
(1) A [BANKING ORGANIZATION]
described in § ll.160 must provide a
description of the main features of its
regulatory capital instruments, in
accordance with Table 15 of this
section. If the [BANKING
ORGANIZATION] issues or repays a
capital instrument, or in the event of a
redemption, conversion, write down, or
other material change in the nature of an
existing instrument, but in no event less
frequently than semiannually, the
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[BANKING ORGANIZATION] must
update the disclosures provided in
accordance with Table 15 of this
section. A [BANKING ORGANIZATION]
also must disclose the full terms and
conditions of all instruments included
in regulatory capital.
(2) In addition to the disclosure
requirement in § ll.162(c)(1), a
[BANKING ORGANIZATION] that is a
global systemically important BHC also
must provide a description of the main
features of each eligible debt security, as
defined in 12 CFR 252.61, that the
[BANKING ORGANIZATION] has
issued and outstanding, in accordance
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with Table 15 of this section. If the
global systemically important BHC
issues or repays an eligible debt
security, or in the event of a
redemption, conversion, write down, or
other material change in the nature of an
existing instrument, but in no event less
frequently than semiannually, the global
systemically important BHC must
update the disclosures provided in
accordance with Table 15 of this
section. A global systemically important
BHC also must disclose the full terms
and conditions of all eligible debt
securities.
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BILLING CODE 6210–01–C; 6714–01–C; 4810–33–C
Subpart F—Risk-Weighted Assets—
Market Risk and Credit Valuation
Adjustment (CVA)
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§ ll.201 Purpose, applicability, and
reservations of authority.
(a) Purpose. This subpart establishes
risk-based capital requirements in a
manner that:
(1) For [BANKING
ORGANIZATIONS] with significant
exposure to market risk, provides
methods for these [BANKING
ORGANIZATIONS] to calculate their
standardized measure for market risk
and, if applicable, their models-based
measure for market risk, and establishes
public disclosure requirements; and
(2) For [BANKING
ORGANIZATIONS] with significant
exposure to CVA risk, provides methods
for these [BANKING ORGANIZATIONS]
to calculate their basic measure for CVA
risk and, if applicable, their
standardized measure for CVA risk.
(b) Applicability—(1) Market Risk.
The market risk capital requirements
and related public disclosure
requirements specified in § ll.203
through § ll.217 apply to a
[BANKING ORGANIZATION] that
meets one or more of the standards in
this paragraph (b)(1):
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(i) The [BANKING ORGANIZATION]
is:
(A) A depository institution holding
company that is a global systemically
important BHC, Category II Boardregulated institution, Category III Boardregulated institution, or Category IV
Board-regulated institution;
(B) A subsidiary of a holding
company that is listed under paragraph
(b)(1)(i)(A) of this section, provided that
the subsidiary has engaged in trading
activity over any of the four most recent
quarters; or
(ii) The [BANKING ORGANIZATION]
has aggregate trading assets and trading
liabilities, excluding customer and
proprietary broker-dealer reserve bank
accounts, equal to:
(A) 10 percent or more of quarter-end
total assets as reported on the most
recent quarterly [REGULATORY
REPORT]; or
(B) $5 billion or more, on average for
the four most recent quarters as reported
in the [BANKING ORGANIZATION]’s
[REGULATORY REPORT]s.
(2) CVA Risk. The CVA risk-based
capital requirements specified in
§ ll.220 through § ll.225 apply to
any [BANKING ORGANIZATION] that
is a global systemically important BHC,
a subsidiary of a global systemically
important BHC, Category II [BANKING
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ORGANIZATION], Category III
[BANKING ORGANIZATION], or
Category IV [BANKING
ORGANIZATION].
(3) Initial Applicability. A [BANKING
ORGANIZATION] must meet the
requirements of this subpart beginning
the quarter after a [BANKING
ORGANIZATION] meets the criteria of
paragraph (b)(1) or (b)(2) of this section,
as applicable.
(4) Monitoring of Trading Assets and
Liabilities. A [BANKING
ORGANIZATION] must monitor its
aggregate trading assets and trading
liabilities to determine the applicability
of this subpart F in accordance with
paragraph (b)(1) of this section.
(5) Ongoing applicability. (i) A
[BANKING ORGANIZATION] that
meets at least one of the standards in
paragraph (b)(1) of this section shall
remain subject to the relevant
requirements of this subpart F unless
and until it does not meet any of the
standards in paragraph (b)(1)(ii) of this
section for each of four consecutive
quarters as reported in the [BANKING
ORGANIZATION]’s [REGULATORY
REPORT]s, or it is no longer a
depository institution holding company
that is a global systemically important
BHC, a Category II Board-regulated
institution, a Category III Board-
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regulated institution, or Category IV
Board-regulated institution; or it is no
longer a U.S. intermediate holding
company that is a Category II Boardregulated institution, a Category III
Board-regulated institution, or Category
IV Board-regulated institution, as
applicable, and the [BANKING
ORGANIZATION] provides notice to the
[AGENCY].
(ii) A [BANKING ORGANIZATION]
that meets the standard in paragraph
(b)(2) of this section shall remain subject
to the relevant requirements of this
subpart F unless and until it no longer
meets the standard in paragraph (b)(2) of
this section for each of four consecutive
quarters as reported in the [BANKING
ORGANIZATION]’s [REGULATORY
REPORT]s and the [BANKING
ORGANIZATION] provides notice to the
[AGENCY].
(6) Exclusions. The [AGENCY] may
exclude a [BANKING ORGANIZATION]
that meets one or more of the standards
of paragraph (b)(1) of this section or the
standard in paragraph (b)(2) of this
section from application of § ll.203
through § ll.217 or § ll.220 through
§ ll.225 if the [AGENCY] determines
that the exclusion is appropriate based
on the level of market risk or level of
CVA risk, respectively, of the
[BANKING ORGANIZATION] and is
consistent with safe and sound banking
practices.
(7) Data Availability. A [BANKING
ORGANIZATION] that does not have
four quarters of aggregate data on
trading assets and trading liabilities
(excluding customer and proprietary
broker-dealer reserve bank accounts)
must calculate the average in paragraph
(b)(1)(ii)(B) of this section by averaging
as much data as the [BANKING
ORGANIZATION] has available, unless
the [AGENCY] notifies the [BANKING
ORGANIZATION] in writing to use an
alternative method.
(c) Reservations of authority. (1) The
[AGENCY] may apply § ll.203
through § ll.217 or § ll.220 through
§ ll.225 to any [BANKING
ORGANIZATION] if the [AGENCY]
deems it necessary or appropriate
because of the level of market risk or
CVA risk, respectively, of the
[BANKING ORGANIZATION] or to
ensure safe and sound banking
practices.
(2) The [AGENCY] may require a
[BANKING ORGANIZATION] to hold
an amount of capital greater than
otherwise required under this subpart F
if the [AGENCY] determines that the
[BANKING ORGANIZATION]’s capital
requirement for market risk or CVA risk
as calculated under this subpart F is not
commensurate with the market risk or
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the CVA risk of the [BANKING
ORGANIZATION]’s market risk covered
positions or CVA risk covered positions,
respectively.
(3) If the [AGENCY] determines that
the risk-based capital requirement
calculated under this subpart F by the
[BANKING ORGANIZATION] for one or
more market risk covered positions or
CVA risk covered positions or categories
of such positions is not commensurate
with the risks associated with those
market risk covered positions or CVA
risk covered positions or categories of
such positions, the [AGENCY] may
require the [BANKING
ORGANIZATION] to assign a different
risk-based capital requirement to the
market risk covered positions or CVA
risk covered positions or categories of
such positions that more accurately
reflects the risk of the market risk
covered positions or CVA risk covered
positions or categories of such positions.
(4) The [AGENCY] may also require a
[BANKING ORGANIZATION] to
calculate market risk capital
requirements for specific positions or
categories of positions under this
subpart F instead of risk-based capital
requirements under subpart D or
subpart E of this part, as applicable; or
to calculate risk-based capital
requirements for specific exposures or
categories of exposures under subpart D
or subpart E of this part, as applicable,
instead of market risk capital
requirements under this subpart F, as
appropriate, to more accurately reflect
the risks of the positions or exposures.
In such cases, the [AGENCY] may
alternatively require a [BANKING
ORGANIZATION] to apply the capital
add-ons for re-designations as described
in § ll.204(e).
(5) The [AGENCY] may require a
[BANKING ORGANIZATION] that
calculates the models-based measure for
market risk to modify the methodology
or observation period used to measure
market risk.
(6) In making determinations under
paragraphs (c)(1) through (5) of this
section, the [AGENCY] will apply notice
and response procedures generally in
the same manner as the notice and
response procedures set forth in 12 CFR
3.404, 263.202, and 324.5(c).
(7) Nothing in this subpart F limits
the authority of the [AGENCY] under
any other provision of law or regulation
to take supervisory or enforcement
action, including action to address
unsafe or unsound practices or
conditions, deficient capital levels, or
violations of law.
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§ ll.202
64229
Definitions
(a) Terms set forth in § ll.2 and
used in this subpart F have the
definitions assigned thereto in § ll.2.
(b) For the purposes of this subpart F,
the following terms are defined as
follows:
Actual profit and loss means the
actual profit and loss derived from the
daily trading activity for market risk
covered positions. Intraday trading, net
interest income, and time effects must
be included; valuation adjustments for
which separate regulatory capital
requirements have been otherwise
specified, fees, reserves, and
commissions must be excluded.
Backtesting means the comparison of
a [BANKING ORGANIZATION]’s daily
actual profit and loss and hypothetical
profit and loss with the VaR-based
measure as described in § ll.204(g)
and § ll.213(b).
Basic CVA hedge means an eligible
CVA hedge that is included in the basic
CVA approach capital requirement
under the standardized measure for
CVA risk, pursuant to § ll.221(c)(3).
Basic CVA risk covered position
means a CVA risk covered position that
is included in the basic CVA approach
capital requirement, pursuant to
§ ll.221(c)(2).
Cash equity position means an equity
position that is not a derivative contract.
Committed quote means a price from
an arm’s-length provider at which the
provider of the quote must buy or sell
the instrument.
Commodity position means a market
risk covered position for which price
risk arises from changes in the price of
one or more commodities.
Commodity risk means the risk of loss
that could arise from changes in
underlying commodity risk factors.
Corporate position means a market
risk covered position that is a corporate
exposure.
Correlation trading position means:
(1) Except as provided in paragraph
(2) of this definition:
(i) A securitization position for which
all or substantially all of the value of the
underlying exposures reference the
credit exposures to single name
companies for which a two-way market
exists, or on commonly traded indices
based on such exposures, for which a
two-way market exists; or
(ii) A position that is not a
securitization position and that hedges
a position described in paragraph (1)(i)
of this definition.
(2) Notwithstanding paragraph (1) of
this definition, a correlation trading
position does not include:
(i) A resecuritization position;
(ii) A derivative of a securitization
position that does not provide a pro rata
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share in the proceeds of a securitization
tranche; or
(iii) A securitization position for
which the underlying assets or reference
exposures are retail exposures,
residential mortgage exposures, or
commercial mortgage exposures.
Counterparty credit spread risk means
the risk of loss resulting from a change
in the credit spread of a counterparty
that results in an increase in CVA.
Covered bond means a bond issued by
a financial institution that satisfies all of
the criteria in paragraphs (1) through (6)
of this definition from inception
through its remaining maturity:
(1) The bond is subject to a specific
regulatory regime under the law of the
jurisdiction governing the bond that is
designed to protect bond holders;
(2) The bond has a pool of underlying
assets consisting exclusively of:
(i) Claims on, or guaranteed by,
sovereigns, their central banks, PSEs, or
MDBs;
(ii) Claims secured by first lien
residential mortgages that would qualify
for a 55 percent or lower risk weight
under subpart E of this part; or
(iii) Claims secured by commercial
real estate that would qualify for a 100
percent or lower risk weight under
subpart E of this part and have a loanto-value ratio of 60 percent or lower;
and
(3) If the pool of underlying assets has
any claims described in paragraphs
(2)(ii) or (iii) of this definition, then, for
purposes of calculating the loan-tovalue ratios for these assets:
(i) The collateral is valued at or less
than the current fair market value under
which the property could be sold under
private contract between a willing seller
and an arm’s-length buyer on the date
of valuation;
(ii) The issuing financial institution
monitors the value of the collateral
regularly and at least once per year; and
(iii) A qualified professional evaluates
the property when information indicates
that the value of the collateral may have
declined materially relative to general
market prices or when a credit event,
such as a default, occurs;
(4) The nominal value of the pool of
assets assigned to the bond exceeds the
bond’s nominal outstanding value by at
least 10 percent;
(5) If the law governing the bond does
not provide for the requirement in
paragraph (4) of this definition, then the
issuing financial institution discloses
publicly on a regular basis that the
issuing financial institution in practice
meets the requirement in paragraph (4)
of this definition; and
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(6) The proceeds deriving from the
bond are invested by law in assets that,
during the entire duration of the bond—
(i) Are capable of covering claims
attached to the bond; and
(ii) In the event of the failure of the
issuer, would be used on a priority basis
for the payment of principal and
accrued interest.
Credit spread risk means the risk of
loss that could arise from changes in
underlying credit spread risk factors.
Credit valuation adjustment (CVA)
means the fair value adjustment to
reflect counterparty credit risk in the
valuation of derivative contracts.
Cross-currency basis means the basis
spread added to the associated reference
rate of the non-USD leg or non-EUR leg
of a cross-currency basis swap.
Currency union means an agreement
by treaty among countries or territorial
entities, under which the members agree
to use a single currency, where the
currency used is described in
§ ll.209(b)(1)(iv).
Curvature risk means the incremental
risk of loss of a market risk covered
position that is not captured by the delta
capital requirement arising from
changes in the value of an option or
embedded option and is measured
based on two stress scenarios (curvature
scenarios) involving an upward shock
and a downward shock to each
prescribed curvature risk factor.
Customer and proprietary brokerdealer reserve bank accounts means
segregated accounts established by a
subsidiary of a [BANKING
ORGANIZATION] that fulfill the
requirements of 17 CFR 240.15c3–3 or
17 CFR 1.20.
CVA hedge means a transaction that a
[BANKING ORGANIZATION] enters
into with a third party or an internal
trading desk and manages for the
purpose of mitigating CVA risk.
CVA risk means the risk of loss due
to an increase in CVA resulting from the
deterioration in the creditworthiness of
a counterparty perceived by the market
or changes in the exposure of CVA risk
covered positions.
CVA risk covered position means a
position that is a derivative contract that
is not a cleared transaction, provided
that a position that is an eligible credit
derivative the credit risk mitigation
benefits of which are recognized under
§ ll.36 or § ll.120, as applicable,
may be excluded from being a CVA risk
covered position.
Default risk means the risk of loss on
a non-securitization debt or equity
position or a securitization position that
could result from the failure of an
obligor to make timely payments of
principal or interest on its debt
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obligations, and the risk of loss that
could result from bankruptcy,
insolvency, or similar proceeding.
Delta risk means the risk of loss that
could result from changes in the value
of a position due to small changes in
underlying risk factors. Delta risk is
measured based on the sensitivities of a
position to prescribed delta risk factors,
which are specified in § ll.207 and
§ ll.208 for purposes of calculating
the sensitivities-based capital
requirement and § ll.224 and
§ ll.225 for purposes of calculating
the standardized CVA approach capital
requirement.
Eligible CVA hedge. (1) Except as
provided in paragraph (2) of this
definition, eligible CVA hedge means a
CVA hedge with an external party or a
CVA hedge that is the CVA segment of
an internal risk transfer:
(i) For purposes of calculating the
basic CVA approach capital
requirement, a CVA hedge of
counterparty credit spread risk,
specifically:
(A) An index credit default swap
(CDS); or
(B) A single-name CDS or a singlename contingent CDS that:
(1) References the counterparty
directly; or
(2) References an affiliate of the
counterparty; or
(3) References an entity that belongs
to the same sector and region as the
counterparty.
(ii) For purposes of calculating the
standardized CVA approach capital
requirement, eligible hedges can
include:
(A) Instruments that hedge variability
of the counterparty credit spread
component of CVA risk; and
(B) Instruments that hedge the
exposure component of CVA risk.
(2) Notwithstanding paragraph (1) of
this definition, an eligible CVA hedge
does not include:
(i) A CVA hedge that is not a whole
transaction;
(ii) A securitization position; or
(iii) A correlation trading position.
Emerging market economy means a
country or territorial entity that is not a
liquid market economy.
Equity position means a market risk
covered position that is not a
securitization position or a correlation
trading position and that has a value
that reacts primarily to changes in
equity prices.
Equity risk means the risk of loss that
could arise from changes in underlying
equity risk factors.
Equity repo rate means the equity
repurchase agreement rate.
Exotic exposure means an underlying
exposure that is not in scope of any of
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the risk classes under the sensitivitiesbased capital requirement or is not
captured by the standardized default
risk capital requirement, which
includes, but is not limited to, longevity
risk, weather risk, and natural disaster
risk.
Expected shortfall (ES) means a
measure of the average of all potential
losses exceeding the VaR at a given
confidence level and over a specified
horizon.
Exposure model means a CVA
exposure model used by the [BANKING
ORGANIZATION] for financial
reporting purposes or such a CVA
exposure model that has been adjusted
to satisfy the requirements of this
subpart F.
Foreign exchange risk means the risk
of loss that could arise from changes in
underlying foreign exchange risk
factors.
Foreign exchange position means a
position for which price risk arises from
changes in foreign exchange rates.
GSE debt means an exposure to a GSE
that is not an equity exposure or
exposure to a subordinated debt
instrument issued by a GSE.
Hedge means a position or positions
that offset all, or substantially all, of the
price risk of another position or
positions.
Hybrid instrument means an
instrument that has characteristics in
common with both debt and equity
instruments, including traditional
convertible bonds.
Hypothetical profit and loss means
the change in the value of the market
risk covered positions that would have
occurred due to changes in the market
data at end of current day if the end-ofprevious-day market risk covered
positions remained unchanged.
Valuation adjustments that are updated
daily must be included, unless the
[BANKING ORGANIZATION] has
received approval from the [AGENCY]
to exclude them. Valuation adjustments
for which separate regulatory capital
requirements have been otherwise
specified, commissions, fees, reserves,
net interest income, intraday trading,
and time effects must be excluded.
Idiosyncratic risk means the risk of
loss in the value of a position that arises
from changes in risk factors unique to
the issuer.
Idiosyncratic risk factor means
categories of risk factors that present
idiosyncratic risk.
Interest rate risk means the risk of loss
that could arise from changes in
underlying interest rate risk factors.
Internal risk management model
means a valuation model that the
independent risk control unit within the
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[BANKING ORGANIZATION] uses to
report market risks and risk-theoretical
profits and losses to senior management.
Internal risk transfer means a transfer,
executed through internal derivatives
trades:
(1) Of credit risk or interest rate risk
arising from an exposure capitalized
under subpart D or subpart E of this part
to a trading desk under this subpart F;
or
(2) Of CVA risk from a CVA desk (or
the functional equivalent if a [BANKING
ORGANIZATION] does not have any
CVA desks) to a trading desk under this
subpart F.
Large market cap means a market
capitalization equal to or greater than $2
billion.
Liquid market economy means:
(1) A country or territorial entity that,
based on an annual review, the
[BANKING ORGANIZATION] has
determined meets all of the following
criteria:
(i) The country or territorial entity has
at least $10,000 in gross domestic
product per capita in current prices;
(ii) The country or territorial entity
has at least $95 billion in total market
capitalization of all domestic stock
markets;
(iii) The country or territorial entity
has export diversification such that no
single sector or commodity comprises
more than 50 percent of the country or
territorial entity’s total annual exports;
(iv) The country or territorial entity
does not impose material controls on
liquidation of direct investment; and
(v) The country or territorial entity
does not have sovereign entities, public
sector entities, or sovereign-controlled
enterprises subject to sanctions by the
U.S. Office of Foreign Assets Control.
(2) A country or territorial entity that
is in a currency union with at least one
country or territorial entity that meets
the criteria in paragraph (1) of this
definition.
Liquidity horizon means the time
required to exit or hedge a market risk
covered position without materially
affecting market prices in stressed
market conditions.
Look-through approach means an
approach in which a [BANKING
ORGANIZATION] treats a market risk
covered position that has multiple
underlying exposures (such as an index
instrument, multi-underlying option, an
equity position in an investment fund,
or a correlation trading position) as if
the underlying exposures were held
directly by the [BANKING
ORGANIZATION].
Market capitalization means the
aggregate value of all outstanding
publicly traded shares issued by a
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64231
company and its affiliates as determined
by multiplying each share price by the
number of outstanding shares.
Market risk means the risk of loss that
could result from market movements,
such as changes in the level of interest
rates, credit spreads, equity prices,
foreign exchange rates, or commodity
prices.
Market risk covered position. (1)
Except as provided in paragraph (2) of
this definition, market risk covered
position means the following positions:
(i) A trading asset or trading liability
(whether on- or off-balance sheet),509 as
reported on [REGULATORY REPORT],
that is a trading position, a position that
is held for the purpose of regular
dealing or making a market in securities
or in other instruments, or hedges
another market risk covered position
and that is free of any restrictive
covenants on its tradability or where the
[BANKING ORGANIZATION] is able to
hedge the material risk elements of the
position in a two-way market; 510 and
(ii) The following positions,
regardless of whether the position is a
trading asset or trading liability, and
hedges of such positions:
(A) A foreign exchange position or
commodity position, excluding:
(1) An eligible CVA hedge that
mitigates the exposure component of
CVA risk; and
(2) Any structural position in a
foreign currency that the [BANKING
ORGANIZATION] chooses to exclude
with prior approval from the [AGENCY];
(B) A publicly traded equity position
that is not excluded from being a market
risk covered position by paragraph
(2)(iv) of this definition;
(C) An equity position in an
investment fund that is not excluded
from being a market risk covered
position by paragraph (2)(vi) of this
definition;
(D) A net short risk position of $20
million or more;
(E) An embedded derivative on
instruments that the [BANKING
ORGANIZATION] issued that relates to
credit or equity risk that it bifurcates for
accounting purposes;
(F) The trading desk segment of an
eligible internal risk transfer of credit
risk as described in § ll.205(h)(1)(i);
(G) The trading desk segment of an
eligible internal risk transfer of interest
rate risk as described in
§ ll.205(h)(1)(ii);
509 Securities subject to repurchase and lending
agreements are included as if they are still owned
by the lender.
510 A position that hedges a trading position must
be within the scope of the [BANKING
ORGANIZATION]’s hedging strategy as described
in § ll.203(a)(2).
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(H) A position arising from a
transaction between a trading desk and
an external party conducted as part of
an internal risk transfer described in
§ ll.205(h);
(I) The trading desk segment of an
internal risk transfer of CVA risk;
(J) The CVA segment of an internal
risk transfer that is not an eligible CVA
hedge; and
(K) A CVA hedge with an external
party that is not an eligible CVA hedge.
(2) Notwithstanding paragraph (1) of
this definition, a market risk covered
position does not include:
(i) An intangible asset, including a
servicing asset;
(ii) A hedge of a trading position that
the [AGENCY] determines to be outside
the scope of the [BANKING
ORGANIZATION]’s trading and hedging
strategy required in § ll.203(a)(2);
(iii) An instrument that, in form or
substance, acts as a liquidity facility that
provides support to asset-backed
commercial paper;
(iv) A publicly traded equity position
with restrictions on tradability;
(v) A non-publicly traded equity
position that is not an equity position in
an investment fund;
(vi) An equity position in an
investment fund that does not meet at
least one of the two following criteria:
(A) The [BANKING ORGANIZATION]
has access to the investment fund’s
prospectus, partnership agreement, or
similar contract that defines the fund’s
permissible investments and investment
limits and is able to use the lookthrough approach to calculate a market
risk capital requirement for its
proportional ownership share of each
exposure held by the investment fund;
or
(B) The [BANKING ORGANIZATION]
has access to the investment fund’s
prospectus, partnership agreement, or
similar contract that defines the fund’s
permissible investments and investment
limits and obtains daily price quotes for
the investment fund;
(vii) Any position a [BANKING
ORGANIZATION] holds with the intent
to securitize;
(viii) A direct real estate holding;
(ix) A derivative instrument or an
exposure to a fund that has material
exposure to the instrument types
described in paragraphs (2)(i) through
(viii) of this definition as underlying
assets;
(x) A debt security, for which the
[BANKING ORGANIZATION] elects the
fair value option for purposes of asset
and liability management;
(xi) A significant investment in the
capital of unconsolidated financial
institutions in the form of common
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stock that is not deducted from capital
pursuant to § ll.22(c)(6);
(xii) An instrument held for the
purpose of hedging a particular risk of
a position in the types of instruments
described in paragraphs (2)(i) through
(x) of this definition;
(xiii) An eligible CVA hedge with an
external party;
(xiv) The CVA segment of an internal
risk transfer that is an eligible CVA
hedge; and
(xv) An equity position arising from
deferred compensation plans, employee
stock ownership plans, and retirement
plans.
Mid-prime RMBS means a security
that references underlying exposures
that consist primarily of residential
mortgages that is not a prime RMBS or
a sub-prime RMBS.
Model-eligible trading desk means a
trading desk (including a notional
trading desk) that received approval of
the [AGENCY] to be a model-eligible
trading desk pursuant to § ll.212(b)(2)
and continues to remain a modeleligible trading desk.
Model-ineligible trading desk means a
trading desk that is not a model-eligible
trading desk.
Modellable risk factor means a risk
factor that satisfies the risk factor
eligibility test as defined in
§ ll.214(b)(1) and has data that
satisfies the requirements specified in
§ ll.214(b)(7).
Net short risk position means a
position that is calculated by comparing
the notional amounts of a [BANKING
ORGANIZATION]’s long and short
positions for a given exposure, provided
that the notional amounts of the short
position exceed the notional amounts of
the long position and that the position
is: 511
(1) From a credit derivative that the
[BANKING ORGANIZATION]
recognizes as a guarantee for riskweighted asset amount calculation
purposes under subpart D or subpart E
of this part and other exposures
recognized under subpart D or subpart
E of this part;
(2) Arises under subpart D or subpart
E of this part from the credit risk
segment of an internal risk transfer
described in § ll.205(h)(1)(i) that the
[BANKING ORGANIZATION]
recognizes as a guarantee for riskweighted asset amount calculation
purposes under subpart D or subpart E
of this part; and
511 For equity derivatives, the notional long and
short positions are based on the adjusted notional
amount, which is the product of the current price
of one unit of the stock (for example, a share of
equity) and the number of units referenced by the
trade.
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(3) An equity position or a credit
position that arises under subpart D or
subpart E of this part that is not
referenced in paragraph (1) or (2) of this
definition provided that:
(i) For a [BANKING ORGANIZATION]
that hedges at the single name level, the
notional amounts of the positions are
compared at the name or obligor level;
and
(ii) For a [BANKING
ORGANIZATION] that hedges at the
portfolio level using indices, the
notional amounts of the positions are
compared at the portfolio level.
Non-modellable risk factor means a
risk factor that does not satisfy the risk
factor eligibility test as defined in
§ ll.214(b)(1) or does not have data
that satisfies the requirements specified
in § ll.214(b)(7).
Non-securitization position means a
market risk covered position that is not
a securitization position or a correlation
trading position and that has a value
that reacts primarily to changes in
interest rates or credit spreads.
Non-securitization debt or equity
position means a non-securitization
position or an equity position that is
subject to default risk.
Notional trading desk means a trading
desk created for regulatory capital
purposes to account for market risk
covered positions arising under subpart
D or subpart E of this part such as net
short risk positions, embedded
derivatives on instruments that the
[BANKING ORGANIZATION] issued
that relate to credit or equity risk that it
bifurcates for accounting purposes, and
foreign exchange positions and
commodity positions. Notional trading
desks are not required to fulfill the
requirements set forth in
§ ll.203(b)(2) and (c).
Pricing model means:
(1) A valuation model used for
financial reporting such as models used
in reporting actual profits and losses; or
(2) A valuation model used for
internal risk management.
Prime RMBS means a security that
references underlying exposures that
consist primarily of qualified residential
mortgages as defined under 12 CFR
244.13(a).
Profit and loss attribution (PLA)
means a method for assessing the
robustness of a [BANKING
ORGANIZATION]’s internal models
used to calculate the ES-based measure
in § ll.215(b) by comparing the risktheoretical profit and loss predicted by
the internal models with the
hypothetical profit and loss.
PSE position means a market risk
covered position that is an exposure to
a public sector entity (PSE).
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p-value means the probability, when
using the VaR-based measure for
purposes of backtesting, of observing a
profit that is less than, or a loss that is
greater than, the profit or loss that
actually occurred on a given date.
Real price means:
(1) A price at which the [BANKING
ORGANIZATION] has executed a
transaction;
(2) A verifiable price for an actual
transaction between other arm’s-length
parties;
(3) A price obtained from a committed
quote made by the [BANKING
ORGANIZATION] itself or a third-party
provider, provided that, for any price
obtained from a third-party provider:
(i) The transaction or committed
quote has been processed through a
third-party provider; or
(ii) The third-party provider agrees to
provide evidence of the transaction or
committed quote to the [BANKING
ORGANIZATION] upon request.
Reference credit spread risk means
the risk of loss that could arise from
changes in the underlying credit spread
risk factors that drive the exposure
component of CVA risk.
Resecuritization position means a
market risk covered position that is a
resecuritization exposure.
Risk class means categories of risk
that are used as the basis for calculating
the sensitivities-based capital
requirement as specified in § ll.206
and the standardized CVA approach
capital requirement as specified in
§ ll.224.
Risk factor means underlying
variables, such as market rates and
prices that affect the value of a market
risk covered position or a CVA risk
covered position. For purposes of
calculating the sensitivities-based
capital requirement, the risk factors are
specified in § ll.208. For purposes of
calculating the standardized CVA
approach capital requirement, the risk
factors are specified in § ll.225.
Risk factor classes means, for
purposes of calculating the non-default
risk capital measure, interest rate risk,
equity risk, foreign exchange risk,
commodity risk, and credit risk,
including related options volatilities in
each risk factor category set forth in
Table 2 to § ll.215.
Risk-theoretical profit and loss means
the daily trading desk-level profit and
loss on the end-of-previous-day market
risk covered positions generated by the
[BANKING ORGANIZATION]’s internal
risk management models. The risktheoretical profit and loss must take into
account all risk factors, including nonmodellable risk factors, in the
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[BANKING ORGANIZATION]’s internal
risk management models.
Residential mortgage-backed security
(RMBS) means a prime RMBS, midprime RMBS, or sub-prime RMBS.
Securitization position means a
market risk covered position that is a
securitization exposure.
Securitization position non-CTP
means a securitization position other
than a correlation trading position.
Small market cap means a market
capitalization of less than $2 billion.
Sovereign position means a market
risk covered position that is a sovereign
exposure.
Standardized CVA hedge means a
CVA hedge that is an eligible CVA
hedge that (1) is not a basic CVA hedge
and (2) is included in the standardized
CVA approach capital requirement.
Standardized CVA risk covered
position means a CVA risk covered
position that is not a basic CVA risk
covered position.
Structural position in a foreign
currency means a position that is not a
trading position and that is:
(1) Subordinated debt, equity, or
minority interest in a consolidated
subsidiary that is denominated in a
foreign currency;
(2) Capital assigned to foreign
branches that is denominated in a
foreign currency;
(3) A position related to an
unconsolidated subsidiary or another
item that is denominated in a foreign
currency and that is deducted from the
[BANKING ORGANIZATION]’s tier 1 or
tier 2 capital; or
(4) A position designed to hedge a
[BANKING ORGANIZATION]’s capital
ratios or earnings against the effect on
paragraph (1), (2), or (3) of this
definition of adverse exchange rate
movements.
Sub-prime RMBS means a security
that references underlying exposures
consisting primarily of higher-priced
mortgage loans as defined in 12 CFR
1026.35, high-cost mortgages as defined
in 12 CFR 1026.32, or both.
Systematic risk means the risk of loss
that could arise from changes in risk
factors that represent broad market
movements and that are not specific to
an issue or issuer.
Systematic risk factors means
categories of risk factors that present
systematic risk, such as economy,
region, and sector.
Term repo-style transaction means a
repo-style transaction that has an
original maturity in excess of one
business day.
Trading desk means a unit of
organization of a [BANKING
ORGANIZATION] that purchases or
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sells market risk covered positions that
is:
(1) Structured by the [BANKING
ORGANIZATION] to implement a welldefined business strategy;
(2) Organized to ensure appropriate
setting, monitoring, and management
review of the desk’s trading and hedging
limits and strategies; and
(3) Characterized by a clearly defined
unit of organization that:
(i) Engages in coordinated trading
activity with a unified approach to the
key elements described in
§ ll.203(b)(2) and (c);
(ii) Operates subject to a common and
calibrated set of risk metrics, risk levels,
and joint trading limits;
(iii) Submits compliance reports and
other information as a unit for
monitoring by management; and
(iv) Books its trades together.
Trading position means a position
that is held by a [BANKING
ORGANIZATION] for the purpose of
short-term resale or with the intent of
benefiting from actual or expected shortterm price movements, or to lock in
arbitrage profits.
Two-way market means a market
where there are independent bona fide
offers to buy and sell so that a price
reasonably related to the last sales price
or current bona fide competitive bid and
offer quotations can be determined
within one day and settled at that price
within a relatively short time frame
conforming to trade custom.
Value-at-Risk (VaR) means the
estimate of the maximum amount that
the value of one or more market risk
covered positions could decline due to
market price or rate movements during
a fixed holding period within a stated
confidence interval.
Vega risk means the risk of loss that
could arise from changes in the value of
a position due to changes in the
volatility of the underlying exposure.
Vega risk is measured based on the
sensitivities of a position to prescribed
vega risk factors as specified in
§ ll.207 and § ll.208 for purposes
of calculating the sensitivities-based
capital requirement and § ll.224 and
§ ll.225 for purposes of calculating
the standardized CVA approach capital
requirement.
§ ll.203 General requirements for
market risk.
(a) Market risk covered positions—(1)
Identification of market risk covered
positions. A [BANKING
ORGANIZATION] must have clearly
defined policies and procedures for
determining its market risk covered
positions, which the [BANKING
ORGANIZATION] must update at least
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annually. These policies and procedures
must include:
(i) Identification of trading assets and
trading liabilities that are trading
positions and of trading positions that
are correlation trading positions;
(ii) Identification of trading assets and
trading liabilities that are positions held
for the purpose of regular dealing or
making a market in securities or other
instruments;
(iii) Identification of equity positions
in an investment fund that are market
risk covered positions;
(iv) Identification of positions that are
market risk covered positions,
regardless of whether the position is a
trading asset or trading liability,
including net short risk positions (and
the calculation of such positions),
eligible internal risk transfer positions
as described in § ll.205(h), and
embedded derivatives on instruments
that the [BANKING ORGANIZATION]
issued that relate to credit or equity risk
that it must bifurcate for accounting
purposes;
(v) Consideration of the extent to
which a position, or a hedge of its
material risks, can be marked-to-market
daily by reference to a two-way market;
(vi) Consideration of possible
impairments to the liquidity of a
position or its hedge;
(vii) Identification of positions that
must be excluded from market risk
covered positions; and
(viii) A process for determining
whether a position needs to be redesignated after its initial identification
as a market risk covered position or
otherwise, which must include redesignation restrictions and a
description of the events or
circumstances under which a
[BANKING ORGANIZATION] would
consider a re-designation, a process for
identifying such events or
circumstances, and a process for
obtaining senior management approval
and for notifying the [AGENCY] of
material re-designations.
(2) Market risk trading and hedging
strategies. A [BANKING
ORGANIZATION] must have clearly
defined trading and hedging strategies
for its market risk covered positions that
are approved by senior management of
the [BANKING ORGANIZATION].
(i) The trading strategy must articulate
the expected holding period of, and the
market risk associated with, each
portfolio of market risk covered
positions.
(ii) The hedging strategy must
articulate for each portfolio of market
risk covered positions the level of
market risk that the [BANKING
ORGANIZATION] is willing to accept
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and must detail the instruments,
techniques, and strategies that the
[BANKING ORGANIZATION] will use
to hedge the risk of the portfolio.
(b) Trading Desks—(1) Trading desk
structure. A [BANKING
ORGANIZATION] must define its
trading desk structure. That structure
must include:
(i) Definition of each trading desk;
(ii) Identification of model-eligible
trading desks, consistent with
§ ll.212(b);
(iii) Identification of model-ineligible
trading desks used in both the
standardized measure for market risk
and the models-based measure for
market risk (as applicable);
(iv) Identification of trading desks that
are used for internal risk transfers (as
applicable); and
(v) Identification of notional trading
desks (as applicable).
(2) Trading desk policies. For each
trading desk that is not a notional
trading desk, a [BANKING
ORGANIZATION] must have a clearly
defined policy that is approved by
senior management of the [BANKING
ORGANIZATION] and describes the
general strategy of the trading desk, the
risk and position limits established for
the trading desk, and the internal
controls and governance structure
established to oversee the risk-taking
activities of the trading desk, and that
includes, at a minimum:
(i) A written description of the general
strategy of the trading desk that
addresses the economics of the business
strategy, the primary activities, and the
trading and hedging strategies of the
trading desk;
(ii) A clearly defined trading strategy
for the trading desk’s market risk
covered positions, approved by senior
management of the [BANKING
ORGANIZATION], which details the
types of market risk covered positions
purchased and sold by the trading desk;
indicates which of these are the main
types of market risk covered positions
purchased and sold by the trading desk;
and articulates the expected holding
period of, and the market risk associated
with, each portfolio of market risk
covered positions held by the trading
desk;
(iii) A clearly defined hedging strategy
for the trading desk’s market risk
covered positions, approved by senior
management of the [BANKING
ORGANIZATION], which articulates for
each trading desk the level of market
risk the [BANKING ORGANIZATION] is
willing to accept and details the
instruments, techniques, and strategies
that the trading desk will use to hedge
the risk of the portfolio;
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(iv) A business strategy that includes
regular reports on the revenue, costs,
and market risk capital requirements of
the trading desk; and
(v) A clearly defined risk scope that
is consistent with the trading desk’s preestablished business strategy and
objectives that specify the trading desk’s
overall risk classes and permitted risk
factors.
(c) Active management of market risk
covered positions. A [BANKING
ORGANIZATION] must have clearly
defined policies and procedures
describing the internal controls, ongoing
monitoring, management, and
authorization procedures, including
escalation procedures, for actively
managing all market risk covered
positions. At a minimum, these policies
and procedures must identify the key
groups and personnel responsible for
overseeing the activities of the
[BANKING ORGANIZATION]’s trading
desks that are not notional trading desks
and require:
(1) Determining the fair value of the
market risk covered positions on a daily
basis;
(2) Ongoing assessment of the ability
of trading desks to hedge market risk
covered positions and portfolio risks
and of the extent of market liquidity;
(3) Establishment by each trading
desk of clear trading limits, including
limits on intraday exposures, with welldefined trader mandates and
articulation of why the risk factors used
to establish the limits appropriately
reflect the general strategy of the trading
desk;
(4) Establishment and daily
monitoring by trading desks of the
following risk-management
measurements:
(i) Trading limits, including limits on
intraday exposures; usage; and
remediation of breaches;
(ii) Sensitivities to risk factors;
(iii) VaR and expected shortfall (as
applicable);
(iv) Backtesting and p-values at the
trading desk level and at the aggregate
level for all model-eligible trading desks
(as applicable);
(v) Comprehensive profit and loss
attribution (as applicable); and
(vi) Market risk covered positions and
transaction volumes;
(5) Establishment and daily
monitoring by a risk control unit
independent of the trading business unit
of the risk-management measurements
listed in paragraph (c)(4) of this section;
(6) Strategy to appropriately mitigate
risks when stress tests reveal particular
vulnerabilities to a given set of
circumstances;
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(7) Daily monitoring by senior
management of information described in
paragraphs (c)(1) through (4) of this
section;
(8) Reassessment of established limits
on market risk covered positions,
performed by senior management
annually or more frequently; and
(9) Assessments of the quality of
market inputs to the valuation process,
the soundness of key assumptions, the
reliability of parameter estimation in
pricing models, and the stability and
accuracy of model calibration under
alternative market scenarios, performed
by qualified personnel annually or more
frequently.
(d) Stress testing. (1) A [BANKING
ORGANIZATION] must stress test the
market risk of its market risk covered
positions at the aggregate level and on
each trading desk at a frequency
appropriate to manage risk, but in no
case less frequently than quarterly. The
stress tests must take into account
concentration risk (including but not
limited to concentrations in single
issuers, industries, sectors, or markets),
illiquidity under stressed market
conditions, and risks arising from the
[BANKING ORGANIZATION]’s trading
activities that may not be adequately
captured in the standardized measure
for market risk or in the models-based
measure for market risk, as applicable.
(2) The results of the stress testing
must be reviewed by the [BANKING
ORGANIZATION]’s senior management
when available; and reflected in the
policies and limits set by the [BANKING
ORGANIZATION]’s management and its
board of directors (or a committee
thereof).
(e) Control and oversight. (1) A
[BANKING ORGANIZATION] must
have in place internal market risk
management systems and processes for
identifying, measuring, monitoring, and
managing market risk that are
conceptually sound.
(2) A [BANKING ORGANIZATION]
must have a risk control unit that is
responsible for the design and
implementation of the [BANKING
ORGANIZATION]’s market risk
management system and that reports
directly to senior management and is
independent from the business trading
units.
(3) A [BANKING ORGANIZATION]
must have an internal audit function
independent of business line
management that at least annually
assesses the effectiveness of the controls
supporting the [BANKING
ORGANIZATION]’s market risk
measurement systems, including the
activities of the business trading units
and independent risk control unit, the
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initial designation of positions as
market risk covered positions and any
re-designations of positions, compliance
with policies and procedures, and the
calculation of the [BANKING
ORGANIZATION]’s measures for market
risk under this subpart F, including the
mapping of risk factors to liquidity
horizons, as applicable. At least
annually, the internal audit function
must report its findings to the
[BANKING ORGANIZATION]’s board of
directors (or a committee thereof).
(f) Valuation of market risk covered
positions. A [BANKING
ORGANIZATION] must have a process
for the prudent valuation of its market
risk covered positions that includes
policies and procedures on the
valuation of its market risk covered
positions, determining the fair value of
its market risk covered positions,
independent price verification, and
independent validation of the valuation
models and valuation adjustments or
reserves.
(g) Internal assessment of capital
adequacy. A [BANKING
ORGANIZATION] must have a rigorous
process for assessing its overall capital
adequacy in relation to its market risk.
The assessment must take into account
risks that may not be captured fully by
the standardized measure for market
risk or in the models-based measure for
market risk, including concentration
and liquidity risk under stressed market
conditions.
(h) Due diligence requirements for
securitization positions. (1) A
[BANKING ORGANIZATION] must
demonstrate to the satisfaction of the
[AGENCY] a comprehensive
understanding of the features of a
securitization position that would
materially affect the performance of the
position. The [BANKING
ORGANIZATION]’s analysis must be
commensurate with the complexity of
the securitization position and the
materiality of the position in relation to
its regulatory capital under this part.
(2) A [BANKING ORGANIZATION]
must demonstrate its comprehensive
understanding of a securitization
position under this paragraph (h), for
each securitization position by:
(i) Conducting an analysis of the risk
characteristics of a securitization
position prior to acquiring the exposure
and documenting such analysis
promptly after acquiring the exposure,
considering:
(A) Structural features of the
securitization that would materially
impact the performance of the exposure,
which may include the contractual cash
flow waterfall, waterfall-related triggers,
credit enhancements, liquidity
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64235
enhancements, fair value triggers, the
performance of organizations that
service the exposure, and deal-specific
definitions of default;
(B) Relevant information regarding—
(1) The performance of the underlying
credit exposure(s) by exposure amount,
which may include the percentage of
loans 30, 60, and 90 days past due;
default rates; prepayment rates; loans in
foreclosure; property types; occupancy;
average credit score or other measures of
creditworthiness; average loan-to-value
ratio; and industry and geographic
diversification data on the underlying
exposure(s); and
(2) For resecuritization positions,
performance information on the
underlying securitization exposures by
exposure amount, which may include
the issuer name and credit quality, and
the characteristics and performance of
the exposures underlying the
securitization exposures, in addition to
the information described in paragraph
(h)(2)(i)(B)(1) of this section; and
(C) Relevant market data of the
securitization, which may include bidask spreads, most recent sales price and
historical price volatility, trading
volume, implied market rating, and size,
depth and concentration level of the
market for the securitization; and
(ii) On an ongoing basis (not less
frequently than quarterly), evaluating
and updating as appropriate the analysis
required under this section for each
securitization position.
(i) Documentation. (1) A [BANKING
ORGANIZATION] must adequately
document all material aspects of its
identification, management, and
valuation of market risk covered
positions, including internal risk
transfers and any re-designations of its
positions, including market risk covered
positions; its control, oversight and
review processes; and its internal
assessment of capital adequacy.
(2) A [BANKING ORGANIZATION]
must adequately document its trading
desk structure and must document
policies describing how each trading
desk satisfies the applicable
requirements in this section.
(3) A [BANKING ORGANIZATION]
that calculates the models-based
measure for market risk must adequately
document all material aspects of its
internal models, including validation
and review processes and results and an
explanation of the empirical techniques
used to measure market risk.
(4) A [BANKING ORGANIZATION]
that calculates the models-based
measure for market risk must document
policies and procedures around
processes related to:
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(i) The risk factor eligibility test,
including the description of the
mapping of real price observations to
risk factors as described in
§ ll.214(b)(1) and (b)(3);
(ii) Data alignment of hypothetical
profit and loss and risk-theoretical profit
and loss time series used in PLA testing
as described in § ll.213(c)(1); and
(iii) The assignment of risk factors to
liquidity horizons as described in
§ ll.215(b)(11) and any empirical
correlations recognized with respect to
risk factor classes.
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§ ll.204
Measure for market risk.
(a) General requirements. A
[BANKING ORGANIZATION] must
calculate its measure for market risk as
the standardized measure for market
risk in accordance with paragraph (b) of
this section, unless the [BANKING
ORGANIZATION] has one or more
model-eligible trading desks, in which
case the [BANKING ORGANIZATION]
must calculate its measure for market
risk as the models-based measure for
market risk in accordance with
paragraph (c) of this section. A
[BANKING ORGANIZATION] must
calculate the standardized measure for
market risk at least weekly and must
calculate the models-based measure for
market risk daily.
(b) Standardized Measure for Market
Risk. The standardized measure for
market risk equals the sum of the
standardized approach capital
requirement as defined in this
paragraph (b), the fallback capital
requirement as defined in paragraphs
(d)(1) and (2) of this section, the capital
add-ons for re-designations of market
risk covered positions as defined in
paragraph (e) of this section, and any
additional capital requirement
established by the [AGENCY] pursuant
to § ll.201(c). The standardized
approach capital requirement equals the
sum of the sensitivities-based capital
requirement, the standardized default
risk capital requirement, and the
residual risk add-on as defined under
this paragraph (b).
(1) Sensitivities-based capital
requirement. A [BANKING
ORGANIZATION]’s sensitivities-based
capital requirement equals the
sensitivities-based capital requirement,
as calculated in accordance with
§ ll.206 through § ll.209 for market
risk covered positions and for term
repo-style transactions that the
[BANKING ORGANIZATION] elects to
include in the calculation of its market
risk capital requirement.
(2) Standardized default risk capital
requirement. A [BANKING
ORGANIZATION]’s standardized
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default risk capital requirement equals
the sum of the standardized default risk
capital requirements for nonsecuritization debt or equity positions,
correlation trading positions, and
securitization positions non-CTP, as
calculated in accordance with
§ ll.210 for market risk covered
positions and for term repo-style
transactions that the [BANKING
ORGANIZATION] elects to include in
the calculation of its market risk capital
requirement.
(3) Residual risk add-on. A
[BANKING ORGANIZATION]’s residual
risk add-on equals any residual risk
add-on that is required under
§ ll.211(a) and calculated in
accordance with § ll.211(b) for
market risk covered positions.
(c) Models-based Measure for Market
Risk. The models-based measure for
market risk, IMATotal, equals:
IMATotal = min ((IMAG,A + PLA add-on
+ SAU), SAall desks) + max
((IMAG,A¥SAG,A), 0) + fallback
capital requirement + capital addons
Where,
(1) IMAG,A is calculated for market
risk covered positions and term repostyle transactions the [BANKING
ORGANIZATION] elects to include in
market risk on model-eligible trading
desks and equals the sum of the nondefault risk capital requirement, CA, as
defined in paragraph (c)(1)(i) of this
section, and the default risk capital
requirement. The default risk capital
requirement for model-eligible trading
desks is the standardized default risk
capital requirement as defined in
paragraph (b)(2) of this section.
(i) The non-default risk capital
requirement. A [BANKING
ORGANIZATION]’s non-default risk
capital requirement, CA, is calculated as
follows:
CA = max ((IMCCt¥1 + SESt¥1), ((mc ×
IMCCaverage) + SESaverage))
where,
(A) IMCC is the internally modelled
capital calculation, which is the
aggregate capital measure for modellable
risk factors based on the weighted
average of the constrained and
unconstrained ES-based measures and
calculated in accordance with
§ ll.215(c) for the most recent
outcome, denoted as t¥1, and for the
average of the previous 60 business
days, denoted as average;
(B) SES is the stressed expected
shortfall, which is the aggregate capital
measure for non-modellable risk factors
that is required under § ll.214(b) and
calculated in accordance with
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§ ll.215(d) for the most recent
outcome, denoted as t¥1, and for the
average of the previous 60 business
days, denoted as average; and
(C) The capital multiplier, mC, equals
1.5 unless otherwise specified in
paragraph (g) of this section.
(ii) [Reserved]
(2) PLA add-on equals any PLA addon that is required under
§ ll.212(b)(2)(ii)(D), § ll.212(b)(4),
or § ll.213(c)(3)(iii) and is calculated
in accordance with § ll.213(c)(4);
(3) SAU equals the standardized
approach capital requirement as defined
in paragraph (b) of this section for
market risk covered positions and term
repo-style transactions the [BANKING
ORGANIZATION] elects to include in
market risk on model-ineligible trading
desks, unless otherwise required under
§ ll.213(b)(3) and § ll.213(c)(3)(iv).
(4) SAall desks equals the standardized
approach capital requirement as defined
in paragraph (b) of this section for
market risk covered positions and term
repo-style transactions the [BANKING
ORGANIZATION] elects to include in
market risk on all trading desks;
(5) SAG,A equals the standardized
approach capital requirement as defined
in paragraph (b) of this section for
market risk covered positions and term
repo-style transactions the [BANKING
ORGANIZATION] elects to include in
market risk on model-eligible trading
desks;
(6) Fallback capital requirement
equals any fallback capital requirement
as defined in paragraph (d) of this
section; and
(7) Capital add-ons equal any capital
add-ons for re-designations as defined
in paragraph (e) of this section, any
capital add-on for ineligible positions
on model-eligible trading desks as
defined in paragraph (f) of this section,
and any additional capital requirement
established by the [AGENCY] pursuant
to § ll.201(c).
(d) Fallback capital requirement—(1)
Calculation of the fallback capital
requirement. Unless the [BANKING
ORGANIZATION] receives prior written
approval of the [AGENCY] to use
alternative techniques that
appropriately measure the market risk
associated with those market risk
covered positions, a [BANKING
ORGANIZATION]’s fallback capital
requirement equals the sum of:
(i) The standardized approach capital
requirement for any market risk covered
positions described by paragraph
(d)(3)(ii)(A) for which the [BANKING
ORGANIZATION] is able to calculate all
parts of the standardized approach
capital requirement; and
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(ii) The sum of the absolute value of
the fair values of all other market risk
covered positions that must be included
in the fallback capital requirement in
accordance with paragraphs (d)(2)(ii)
and (d)(3)(ii) of this section,
respectively.
(2) Standardized measure for market
risk—(i) Market risk covered positions
excluded from certain calculations.
Notwithstanding paragraph (b) of this
section, for a [BANKING
ORGANIZATION] that calculates the
standardized measure for market risk, if
for any reason, a [BANKING
ORGANIZATION] is unable to calculate
the sensitivities-based capital
requirement or the standardized default
risk capital requirement for a market
risk covered position, that position must
be excluded from the calculation of the
standardized approach capital
requirement.
(ii) Market risk covered positions
included in the fallback capital
requirement. A [BANKING
ORGANIZATION] that calculates the
standardized measure for market risk
must include all market risk covered
positions excluded from the calculation
of the standardized approach capital
requirement under paragraph (d)(2)(i) of
this section in the calculation of the
fallback capital requirement.
(3) Models-based measure for market
risk—(i) Market risk covered positions
excluded from certain calculations.
Unless the [BANKING
ORGANIZATION] receives prior written
approval from the [AGENCY], for a
[BANKING ORGANIZATION] that
calculates the models-based measure for
market risk:
(A) Notwithstanding paragraph (c) of
this section, in cases where, for any
reason, a [BANKING ORGANIZATION]
is unable to calculate any portion of
IMAG,A, SAU, SAall desks, SAG,A, or SAi as
part of the calculation of the PLA addon for a market risk covered position,
that market risk covered position must
be excluded from the calculation of
IMAG,A, SAU, SAall desks, SAG,A, or SAi,
respectively; and
(B) Notwithstanding paragraph (f) of
this section, for a [BANKING
ORGANIZATION] that has any
securitization positions or correlation
trading positions or equity positions in
an investment fund, where a [BANKING
ORGANIZATION] is not able to identify
the underlying positions held by an
investment fund on a quarterly basis, on
model-eligible trading desks, in cases
where, for any reason, a [BANKING
ORGANIZATION] is unable to calculate
any portion of the standardized
approach capital requirement for such
position, that market risk covered
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position must be excluded from the
calculation of the capital add-on for
ineligible positions on model-eligible
trading desks.
(ii) Market risk covered positions
included in the fallback capital
requirement. A [BANKING
ORGANIZATION] that calculates the
models-based measure for market risk
must include the following market risk
covered positions in the calculation of
the fallback capital requirement:
(A) All market risk covered positions
on model-eligible trading desks
excluded from the calculation of IMAG,A
under paragraph (d)(3)(i)(A) of this
section;
(B) All market risk covered positions
on model-ineligible trading desks
excluded from the calculation of SAU
under paragraph (d)(3)(i)(A) of this
section; and
(C) All securitization positions and
correlation trading positions excluded
from the calculation of the capital addon for securitization and correlation
trading positions on model-eligible
trading desks under paragraph
(d)(3)(i)(B) of this section.
(e) Capital add-ons for redesignations. (1) After the initial
designation of an exposure to be
capitalized under subpart D or subpart
E of this part or a position to be
capitalized as a market risk covered
position under this subpart F, a
[BANKING ORGANIZATION] may
make a re-designation if:
(i) The [BANKING ORGANIZATION]
receives prior approval of senior
management and documents the redesignation; and
(ii) The [BANKING ORGANIZATION]
sends notification within 30 days of any
material re-designation to the
[AGENCY].
(2) For each re-designation, a
[BANKING ORGANIZATION] must
calculate its capital add-on for redesignation following the approach
below:
(i) For the calculation of Expanded
Total Risk-Weighted Assets, the capital
add-on for re-designation is the higher
of zero and the total capital requirement
under subpart E of this part and under
this subpart before the re-designation
minus the total capital requirement
under subpart E of this part and under
this subpart after the re-designation.
(ii) For the calculation of
Standardized Total Risk-Weighted
Assets, the capital add-on for redesignation is the higher of zero and the
total capital requirement under subpart
D of this part and under this subpart F
before the re-designation minus the total
capital requirement under subpart D of
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this part and under this subpart after the
re-designation.
(iii) The capital add-on for redesignation must initially be calculated
at the time of the re-designation.
(iv) The capital add-on for redesignation is permitted to run off as the
exposure or position matures or expires.
(v) Notwithstanding paragraphs
(e)(2)(i) through (iv) of this section, with
prior written approval from the
[AGENCY], no capital add-on for redesignation is required if the redesignation is due to circumstances that
are outside of the [BANKING
ORGANIZATION]’s control, including
any re-designation required for
accounting purposes or a change in the
characteristics of the exposure or
position that would change its
qualification as a market risk covered
position.
(3) Any re-designation is irrevocable
unless the [BANKING
ORGANIZATION] receives written
approval of the [AGENCY].
(f) Capital add-on for ineligible
positions on model-eligible trading
desks. A [BANKING ORGANIZATION]
must calculate its capital add-on for
ineligible positions on model-eligible
trading desks for (1) securitization
positions or correlation trading
positions on model-eligible trading
desks or (2) equity positions in an
investment fund on model-eligible
trading desks, where a [BANKING
ORGANIZATION] is not able to identify
the underlying positions held by an
investment fund on a quarterly basis,
provided such positions are not
included in paragraph (d) of this
section. The capital add-on for ineligible
positions on model-eligible trading
desks is equal to the standardized
approach capital requirement as defined
in paragraph (b) of this section for such
positions.
(g) Aggregate trading portfolio
backtesting and capital multiplier. (1)
Beginning on the business day a
[BANKING ORGANIZATION] begins
calculating the models-based measure
for market risk, the [BANKING
ORGANIZATION] must generate
backtesting data by separately
comparing each business day’s aggregate
actual profit and loss for transactions on
model-eligible trading desks and
aggregate hypothetical profit and loss
for transactions on model-eligible
trading desks with the corresponding
aggregate VaR-based measures for that
business day calibrated to a one-day
holding period and at a one-tail, 99.0th
percent confidence level for market risk
covered positions on all model-eligible
trading desks.
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(i) An exception for actual profit and
loss occurs when the aggregate actual
loss exceeds the corresponding
aggregate VaR-based measure. An
exception for hypothetical profit and
loss occurs when the aggregate
hypothetical loss exceeds the
corresponding VaR-based measure.
(ii) If either the business day’s actual
or hypothetical profit and loss is not
available or impossible to compute for
a particular day, an exception for actual
profit and loss or for hypothetical profit
and loss, respectively, occurs. If the
VaR-based measure for a business day is
not available or impossible to compute
for a particular day, exceptions for
actual profit and loss and for
hypothetical profit and loss occur. No
exception occurs if the unavailability or
impossibility is related to an official
holiday.
(iii) With approval of the [AGENCY],
a [BANKING ORGANIZATION] may
consider an exception not to have
occurred if:
(A) The [BANKING ORGANIZATION]
can demonstrate that the exception is
due to technical issues that are
unrelated to the [BANKING
ORGANIZATION]’s internal models; or
(B) The [BANKING ORGANIZATION]
can demonstrate that one or more non-
modellable risk factors caused the
relevant loss, and the properly scaled
capital requirement for these nonmodellable risk factors exceeds the
difference between the [BANKING
ORGANIZATION]’s VaR-based measure
and the actual or hypothetical loss for
that business day.
(2) A [BANKING ORGANIZATION]
must specify the scope of its modeleligible trading desks for the purposes of
this paragraph (g) by determining which
trading desks are model-eligible trading
desks, and taking into consideration any
changes to the model eligibility status of
trading desks as soon as practicable. A
[BANKING ORGANIZATION] must use
this scope of model-eligible trading
desks for the purposes of this paragraph
(g) unless the [AGENCY] notifies the
[BANKING ORGANIZATION] in writing
that a different scope of model-eligible
trading desks must be used.
(3) A [BANKING ORGANIZATION]
that calculates the models-based
measure for market risk must conduct
aggregate trading portfolio backtesting
on a quarterly basis. In order to conduct
aggregate trading portfolio backtesting, a
[BANKING ORGANIZATION] must
count the number of exceptions that
have occurred over the most recent 250
business days, provided that in the first
year that the [BANKING
ORGANIZATION] begins backtesting,
the [BANKING ORGANIZATION] must
count the number of exceptions that
have occurred since the date that the
[BANKING ORGANIZATION] began
backtesting. A [BANKING
ORGANIZATION] must count
exceptions for aggregate actual profit
and loss separately from exceptions for
aggregate hypothetical profit and loss.
The overall number of exceptions is the
greater of the number of exceptions for
aggregate actual profit and loss and the
number of exceptions for aggregate
hypothetical profit and loss.
(4) A [BANKING ORGANIZATION]
must use the multiplication factor in
Table 1 of this section that corresponds
to the overall number of exceptions
identified in paragraph (g)(3) of this
section to determine the multiplication
factor for the non-default risk capital
requirement under paragraph (c)(1)(i)(C)
of this section until the [BANKING
ORGANIZATION] conducts aggregate
trading portfolio backtesting for the next
quarter, unless the [AGENCY] notifies
the [BANKING ORGANIZATION] in
writing that a different adjustment or
other action is appropriate.
§ ll.205 The treatment of certain market
risk covered positions and term repo-style
transactions the [BANKING
ORGANIZATION] elects to include in market
risk: net short risk positions; securitization
positions and defaulted and distressed
positions; hybrid instruments; index
instruments and multi-underlying options;
and equity positions in an investment fund.
calculate its net short risk positions on
a quarterly basis.
(b) Treatment of securitization
positions and defaulted and distressed
market risk covered positions. (1) A
[BANKING ORGANIZATION] may cap
the market risk capital requirement of
securitization positions and defaulted or
distressed market risk covered positions
at the maximum loss of the market risk
covered position.
(2) For purposes of calculating the
standardized default risk capital
requirement, a [BANKING
ORGANIZATION] must include
defaulted market risk covered positions.
A [BANKING ORGANIZATION] does
not need to include defaulted market
risk covered positions in the
sensitivities-based capital requirement,
the residual risk add-on, or the nondefault risk capital requirement.
(a) Net short risk positions. A
[BANKING ORGANIZATION] must
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(c) Treatment of hybrid instruments in
the standardized approach capital
requirement. For purposes of calculating
the standardized approach capital
requirement, a [BANKING
ORGANIZATION] must assign risk
sensitivities of hybrid instruments into
the applicable risk classes such as
interest rate, credit spread, and equity
risk for calculating the delta, vega, and
curvature capital requirements. For the
standardized default risk capital
requirement, a [BANKING
ORGANIZATION] must decompose a
hybrid instrument into a nonsecuritization position and an equity
position and calculate the standardized
default risk capital requirement for each
position respectively.
(d) Treatment of index instruments
and multi-underlying options in the
standardized approach capital
requirement. (1) For purposes of
calculating the delta capital requirement
under § ll.206(b) and the curvature
capital requirement under § ll.206(d):
(i) A [BANKING ORGANIZATION]
must apply the look-through approach
for any market risk covered position that
is an index instrument or a multiunderlying option. Where the lookthrough approach is adopted:
(A) The curvature scenarios and delta
sensitivities to constituent risk factors
from those index instruments and multiunderlying options are allowed to net
with the curvature scenarios and delta
sensitivities of single-name positions
without restriction; and
(B) A [BANKING ORGANIZATION]
must apply the look-through approach
consistently through time and must use
the approach consistently for all market
risk covered positions that reference the
same index.
(ii) Notwithstanding paragraph
(d)(1)(i) of this section, for market risk
covered positions of listed and welldiversified indices, a [BANKING
ORGANIZATION] may choose not to
apply the look-through approach, in
which case a single sensitivity shall be
calculated to the index and assigned to
the relevant sector or index bucket as
provided in § ll.209 and in
accordance with the below:
(A) Where at least 75 percent of the
notional value of the underlying
constituents relate to the same sector
(sector specific), taking into account the
weightings of such index, the sensitivity
must be assigned to the corresponding
sector bucket, otherwise the sensitivity
must be mapped to an index bucket;
(B) For listed and well-diversified
equity indices that are not sector
specific, where at least 75 percent of the
market value of the constituents in the
index, taking into account the
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weightings of such index, are both large
market cap and liquid market economy,
the sensitivity must be assigned to
bucket 12, otherwise the sensitivity
must be assigned to bucket 13 in Table
8 to § ll.209;
(C) For listed and well-diversified
credit indices that are not sector
specific, where at least 75 percent of the
notional value of the constituents in the
index, taking into account the
weightings of such index, are
investment grade, the sensitivity must
be assigned to bucket 18, otherwise the
sensitivity must be assigned to bucket
19 in Table 3 to § ll.209; and
(D) Where an index spans multiple
risk classes, a [BANKING
ORGANIZATION] must allocate the
index proportionately to the relevant
risk classes following the methodology
in paragraphs (d)(1)(ii)(A) through (C) of
this section.
(2) For purposes of calculating the
vega capital requirement under
§ ll.206(c):
(i) A [BANKING ORGANIZATION]
may, for a multi-underlying option
(including an index option), calculate
the vega capital requirement based
either on the implied volatility of the
option or the implied volatility of
options on the underlying constituents;
and
(ii) For indices, a [BANKING
ORGANIZATION] must calculate the
vega capital requirement with respect to
the implied volatility of the multiunderlying options based on the same
sector specific bucket or index bucket
used to calculate the delta capital
requirement and the curvature capital
requirement in paragraph (d)(1)(ii) of
this section.
(3) For purposes of calculating the
standardized default risk capital
requirement under § ll.204(b)(2), a
[BANKING ORGANIZATION] may
apply the look-through approach for
multi-underlying options that are nonsecuritization debt or equity positions.
(e) Treatment of equity positions in an
investment fund in the standardized
approach capital requirement. (1) For
an equity position in an investment
fund that is a market risk covered
position, and for which a [BANKING
ORGANIZATION] is able to use the
look-through approach to calculate a
market risk capital requirement for its
proportional ownership share of each
exposure held by the investment fund,
the [BANKING ORGANIZATION] must
apply the look-through approach for the
purposes of calculating the standardized
measure for market risk for any equity
position in an investment fund, and
treat the underlying positions of the
fund as if such positions were held
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64239
directly by the [BANKING
ORGANIZATION].
(2) Notwithstanding paragraph (e)(1)
of this section, for an equity position in
an investment fund that is a market risk
covered position, a [BANKING
ORGANIZATION] may calculate the
standardized measure for market risk by
applying the treatment in paragraphs
(d)(1)(ii), (d)(2)(ii), and (d)(3) of this
section to:
(i) An index that is listed and welldiversified held by an investment fund,
in which the [BANKING
ORGANIZATION] holds an equity
position; and
(ii) An investment fund, in which the
[BANKING ORGANIZATION] holds an
equity position, that closely tracks an
index benchmark, provided that the
[BANKING ORGANIZATION] must treat
the investment fund as if it were the
tracked index.
(3) For any equity position in an
investment fund that is a market risk
covered position, but for which the
[BANKING ORGANIZATION] is not
able to use the look-through approach to
calculate a market risk capital
requirement for its proportional
ownership share of each exposure held
by the investment fund, the [BANKING
ORGANIZATION] must calculate the
standardized measure for market risk for
equity position in the investment fund
using one of the following methods in
this paragraph (e)(3). If multiple
methods could apply, the [BANKING
ORGANIZATION] may choose from the
applicable methods:
(i) Tracked index method. If the
investment fund closely tracks an index
benchmark, the [BANKING
ORGANIZATION] may treat the
investment fund as the tracked index
and calculate the standardized measure
for market risk by applying the
treatment in paragraphs (d)(1)(ii),
(d)(2)(ii), and (d)(3) of this section;
(ii) Hypothetical portfolio approach.
The [BANKING ORGANIZATION] may
treat the investment fund as a
hypothetical portfolio, provided that:
(A) Market risk capital requirements
for the decomposed positions in the
hypothetical portfolio are calculated on
a stand-alone basis, separate from other
market risk covered positions;
(B) Weighting the constituents of the
investment fund based on the
hypothetical portfolio; and
(C) The hypothetical portfolio is
determined using one of the following
approaches, at the [BANKING
ORGANIZATION]’s discretion:
(1) A hypothetical portfolio invested
to the maximum extent permitted under
the fund’s investment limits in the
exposure type(s) with the highest
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applicable risk weight. If more than one
risk weight can be applied to a given
exposure under the sensitivities-based
capital requirement, the maximum risk
weight applicable must be used; or
(2) A hypothetical portfolio based on
the most recent quarterly disclosure of
the investment fund’s historical
holdings of underlying positions.
(iii) Fall back method. A [BANKING
ORGANIZATION] may allocate its
equity positions in an investment fund
to the other sector bucket 11 in Table 8
to § ll.209.
(A) In applying this treatment, a
[BANKING ORGANIZATION] must
determine whether, given the mandate
of the investment fund, the risk weight
under the standardized default risk
capital requirement is sufficiently
prudent and whether the residual risk
add-on should apply. In the case where
the [BANKING ORGANIZATION]
determines that the residual risk add-on
applies, a [BANKING ORGANIZATION]
must assume that the investment fund
contains exposure types as described in
§ ll.211(a) to the maximum extent
permitted under the investment fund’s
mandate for purposes of calculating the
residual risk add-on.
(B) In applying this treatment, a
[BANKING ORGANIZATION] must
calculate the standardized default risk
capital requirement under
§ ll.204(b)(2) for non-securitization
debt or equity positions held by an
investment fund based on a
hypothetical portfolio, assuming the
investment fund is invested to the
maximum extent permitted under the
fund’s investment limits in the exposure
type(s) with the highest applicable risk
weight(s), in the same manner as
described in paragraph (e)(3)(ii)(C)(1) of
this section.
(f) Treatment of equity positions in an
investment fund in the models-based
measure for market risk. (1) For equity
positions in an investment fund, where
a [BANKING ORGANIZATION] is able
to identify the underlying positions held
by an investment fund on a quarterly
basis, the [BANKING ORGANIZATION]
must calculate IMAG,A, using one of the
following approaches:
(i) The look-through approach for that
position or based on the hypothetical
portfolio of the investment fund,
consistent with paragraph (e)(3)(ii)(C)(2)
of this section; or
(ii) After receiving prior approval of
the [AGENCY], an alternative modelling
approach.
(2) For equity positions in an
investment fund, where a [BANKING
ORGANIZATION] is not able to identify
the underlying positions held by an
investment fund on a quarterly basis,
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the [BANKING ORGANIZATION] must
not include such equity positions in the
calculation of IMAG,A.
(g) Term repo-style transactions the
[BANKING ORGANIZATION] elects to
include in market risk. (1) A [BANKING
ORGANIZATION] may elect to include
a term repo-style transaction in market
risk provided that:
(i) The transaction is marked to
market;
(ii) The [BANKING ORGANIZATION]
captures the market price risk and the
issuer-default risk of the transaction by:
(A) Including the risk factor
sensitivity to each applicable risk factor
pursuant to § ll.208; and
(B) Calculating the standardized
default risk capital requirement under
§ ll.210 using:
(1) For the calculation of Expanded
Total Risk-Weighted Assets, the
collateral haircut approach that would
apply to the transaction under
§ ll.121(c) multiplied by 8 percent; or
(2) For the calculation of
Standardized Total Risk-Weighted
Assets, the collateral haircut approach
that would apply to the transaction
under § ll.37(c) multiplied by 8
percent.
(iii) The [BANKING
ORGANIZATION] elects to include all
of its term repo-style transactions in
market risk and does so consistently
over time; and
(iv) The [BANKING ORGANIZATION]
recognizes:
(A) For the calculation of Expanded
Total Risk-Weighted Assets, the credit
risk mitigation benefits of collateral
pursuant to § ll.121(c); or
(B) For the calculation of
Standardized Total Risk-Weighted
Assets, the credit risk mitigation
benefits of collateral pursuant to
§ ll.37(c).
(2) Term repo-style transactions the
[BANKING ORGANIZATION] elects to
include in market risk must be treated
as market risk covered positions for the
purposes of calculations under this part.
(h) Internal risk transfers. (1) A
[BANKING ORGANIZATION] that is
subject to the market risk capital
requirements in this subpart F may
recognize the risk mitigation benefits of
an external hedge under subpart D or
subpart E of this part if the internal risk
transfer meets the applicable criteria in
this paragraph (h).
(i) Credit risk. A [BANKING
ORGANIZATION] may capitalize under
subpart D or subpart E of this part the
leg of an eligible internal risk transfer to
hedge credit risk transferred by the
trading desk to another unit within the
[BANKING ORGANIZATION].
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(A) For credit risk, an eligible internal
risk transfer means an internal risk
transfer for which:
(1) The documentation of the internal
risk transfer identifies the exposure
under subpart D or subpart E of this part
that is being hedged and its source(s) of
credit risk;
(2) The terms of the internal risk
transfer, aside from amount, are
identical to the terms of the external
hedge of credit risk; and
(3) The external hedge meets the
requirements of § ll.36 or § ll.120,
as applicable.
(B) If the amount of the internal risk
transfer exceeds the exposure being
hedged under subpart D or subpart E of
this part, the [BANKING
ORGANIZATION] must treat the
amount equal to the exposure being
hedged under subpart D or subpart E of
this part as an eligible internal risk
transfer, and the excess amount as a
separate internal risk transfer that is not
an eligible internal risk transfer, which
must be capitalized as a net short credit
position.
(ii) Interest rate risk. A [BANKING
ORGANIZATION] may capitalize the
trading desk segment of an eligible
internal risk transfer as a market risk
covered position.
(A) For interest rate risk, an eligible
internal risk transfer means an internal
risk transfer:
(1) For which the documentation of
the internal risk transfer identifies the
exposure being hedged and its source(s)
of interest rate risk;
(2) That is capitalized on the trading
desk on a stand-alone basis, without
regard to other market risks generated
by activities in the trading unit; and
(3) Is executed on a trading desk that
the [BANKING ORGANIZATION] has
established for conducting internal risk
transfers to hedge interest rate risk and
that has received approval from the
[AGENCY] to execute such internal risk
transfers to hedge interest rate risk.
(B) The [BANKING ORGANIZATION]
may request approval from the
[AGENCY] for a single dedicated
notional trading desk to conduct
internal risk transfers to hedge interest
rate risk.
(2) CVA Risk. A [BANKING
ORGANIZATION] that is subject to the
market risk capital requirements and
CVA risk-based capital requirements in
this subpart F may hedge CVA risk
arising from a derivative contract
through internal CVA hedges executed
with the [BANKING ORGANIZATION]’s
trading desk, using an eligible internal
risk transfer.
(i) The [BANKING ORGANIZATION]
may consider the internal risk transfer
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§ ll.206 Sensitivities-based capital
requirement.
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(a) Overview of the calculation. A
[BANKING ORGANIZATION] must
follow the steps below to calculate the
sensitivities-based capital requirement:
(1) The [BANKING ORGANIZATION]
must identify the market risks in each
of its portfolios of market risk covered
positions and include the relevant risk
classes in its calculation of the
sensitivities-based capital requirement.
The risk classes are:
(i) Interest rate risk;
(ii) Credit spread risk for nonsecuritization positions;
(iii) Credit spread risk for correlation
trading positions;
(iv) Credit spread risk for
securitization positions non-CTP;
(v) Equity risk;
(vi) Commodity risk; and
(vii) Foreign exchange risk.
(2) For each market risk covered
position, a [BANKING
ORGANIZATION] must identify all of
the relevant risk factors as described in
§ ll.208 for which it will calculate
sensitivities for delta risk and vega risk
as described in § ll.207 and curvature
scenarios for curvature risk as described
in both paragraph (d) of this section and
in § ll.207. A [BANKING
ORGANIZATION] must also identify the
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corresponding buckets related to these
risk factors as described in § ll.209.
(3) To calculate risk-weighted
sensitivities a [BANKING
ORGANIZATION] must aggregate the
delta sensitivities and vega sensitivities,
respectively, for each risk factor across
all market risk covered positions and
apply the corresponding risk weights as
described in § ll.209(b) and (c). To
calculate the net curvature risk position,
a [BANKING ORGANIZATION] must
aggregate the incremental loss beyond
the delta capital requirement by
applying an upward and downward
shock to each risk factor in accordance
with paragraph (d)(1) of this section.
(4) For each bucket, a [BANKING
ORGANIZATION] must calculate a
bucket-level risk position separately for
delta risk and vega risk by aggregating
the risk-weighted sensitivities across
risk factors with common characteristics
as described in paragraphs (b)(2) and
(c)(2) of this section. Similarly, for
curvature risk, a [BANKING
ORGANIZATION] must calculate a
bucket-level risk position for each
bucket by aggregating the net curvature
risk positions within each bucket as
described in paragraph (d)(2) of this
section.
(5) To calculate the risk class-level
capital requirement a [BANKING
ORGANIZATION] must aggregate the
bucket-level risk positions for each risk
class for delta risk, vega risk, and
curvature risk (separately) under three
correlation scenarios in accordance with
paragraphs (b)(3), (c)(3), and (d)(3) of
this section. For each risk class, the risk
class-level capital requirement is the
sum of the delta capital requirement, the
vega capital requirement and the
curvature capital requirement for the
respective correlation scenario.
(i) The delta capital requirement is
described in paragraph (b) of this
section.
(ii) The vega capital requirement is
described in paragraph (c) of this
section.
(iii) The curvature capital requirement
is described in paragraph (d) of this
section.
(iv) The correlation scenarios are
provided in paragraph (e) of this section
and § ll.209.
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(6) To calculate the sensitivities-based
capital requirement, a [BANKING
ORGANIZATION] must sum the risk
class-level capital requirements for each
risk class under each correlation
scenario. The sensitivities-based capital
requirement equals the largest capital
requirement produced under the three
correlation scenarios.
(b) Delta capital requirement. For
each risk class, a [BANKING
ORGANIZATION] must calculate the
delta capital requirement for all of its
market risk covered positions, except for
market risk covered positions whose
value at any point in time exclusively
depends on an exotic exposure. To
calculate the delta capital requirement,
for each risk class, a [BANKING
ORGANIZATION] must calculate its
market risk covered positions’ delta
sensitivities in accordance with
§ ll.207 to the relevant risk factors
specified in § ll.208, multiply the
sensitivities by the corresponding risk
weights specified in § ll.209(b), and
aggregate the resulting risk-weighted
delta sensitivities in accordance with
the following:
(1) Weighted sensitivity calculation.
For each risk factor, a [BANKING
ORGANIZATION] must calculate the
delta sensitivity as described in
§ ll.207. A [BANKING
ORGANIZATION] must net the delta
sensitivities of a risk factor k,
irrespective of the market risk covered
positions from which they derive, to
produce a net delta sensitivity, sk, across
all market risk covered positions. The
risk-weighted delta sensitivity, WSk,
equals the product of the net sensitivity,
sk, and the corresponding risk weight
specified in § ll.209(b).
(2) Within bucket aggregation. Unless
otherwise specified in § ll.209(b), for
each bucket, b, specified § ll.209(b), a
[BANKING ORGANIZATION] must
calculate the delta bucket-level risk
position, Kb, by aggregating the riskweighted delta sensitivities of all risk
factors that are within the same bucket,
using the correlation parameter rkl as
specified in § ll.206(e) and
§ ll.209(b), as follows:
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of CVA risk to be an eligible internal
risk transfer, if the following
requirements are satisfied:
(A) The CVA segment of the
transaction is an eligible CVA hedge;
(B) The documentation of the internal
risk transfer of CVA risk identifies the
CVA risk being hedged and the source(s)
of such risk.
(C) If the internal risk transfer of CVA
risk is subject to curvature risk, default
risk, or the residual risk add-on under
the market risk capital requirement,
then the trading desk must execute an
external transaction with a third-party
provider, identical in its terms to the
internal risk transfer of CVA risk.
(ii) The [BANKING ORGANIZATION]
must designate a CVA desk or the
functional equivalent to manage internal
risk transfers of CVA risk to the
[BANKING ORGANIZATION]’s trading
desks.
64241
delta bucket-level risk positions across
all of the buckets within the risk class,
using the cross-bucket correlation
parameter gbc as specified in
§ ll.206(e) and § ll.209(b), as
follows:
Where,
(i) Sb = SkWSk for all risk factors in
bucket b and Sc = SkWSk for all risk
factors in bucket c; and
(ii) If Sb and Sc produce a negative
number for the overall sum of Sb(Kb2) +
Sb(Sc≠b gbcSbSc), the [BANKING
ORGANIZATION] must calculate the
delta capital requirement using an
alternative specification, whereby:
(A) Sb = max(min(SkWSk, Kb), ¥Kb) for
all risk factors in bucket b; and
(B) Sc = max(min(SkWSk, Kc), ¥Kc) for
all risk factors in bucket c.
(c) Vega capital requirement. For each
risk class, a [BANKING
ORGANIZATION] must calculate the
vega capital requirement for market risk
covered positions that are options or are
positions with embedded optionality,
including positions with material
prepayment risk. Callable and puttable
bonds that are priced based on yield to
maturity are not required to estimate
vega capital requirement. To calculate
the vega capital requirement, for each
risk class, a [BANKING
ORGANIZATION] must calculate its
market risk covered positions’ vega
sensitivities in accordance with
§ ll.207 to the relevant risk factors
specified in § ll.208, multiply the
sensitivities by the corresponding risk
weights specified in § ll.209(c), and
aggregate the resulting risk-weighted
sensitivities for vega risk in accordance
with the following:
(1) Weighted sensitivity calculation.
For each risk factor, a [BANKING
ORGANIZATION] must calculate the
vega sensitivity as described in
§ ll.207(c). A [BANKING
ORGANIZATION] must net the vega
sensitivities of a risk factor k,
irrespective of the market risk covered
positions from which they derive, to
produce a net vega sensitivity, sk, across
all market risk covered positions. The
risk-weighted vega sensitivity, WSk,
equals the product of the net sensitivity,
sk, and the corresponding risk weight
specified in § ll.209(c).
(2) Within bucket aggregation. Unless
otherwise specified in § ll.209(c), for
each bucket, b, specified in
§ ll.209(c), a [BANKING
ORGANIZATION] must calculate the
vega bucket-level risk position, Kb, by
aggregating the risk-weighted vega
sensitivities of all risk factors that are
within the same bucket, using the
correlation parameter, rkl, as specified
in § ll.206(e) and § ll.209(c), as
follows:
(3) Across bucket aggregation. A
[BANKING ORGANIZATION] must
calculate the vega capital requirement
for each risk class by aggregating the
vega bucket-level risk positions across
all of the buckets within the risk class,
using the cross-bucket correlation
parameter, gbc, specified in § ll.206(e)
and § ll.209(c), as follows:
Where,
(i) Sb = SkWSk for all risk factors in
bucket b and Sc = Sk WSk for all risk
factors in bucket c; and
(ii) If Sb and Sc produce a negative
number for the overall sum of Sb(Kb2) +
Sb(Sc≠b gbcSbSc), the [BANKING
ORGANIZATION] must calculate the
vega capital requirement using an
alternative specification, whereby:
(A) Sb = max(min(SkWSk, Kb), ¥Kb) for
all risk factors in bucket b; and
(B) Sc = max(min(SkWSk, Kc), ¥Kc) for
all risk factors in bucket c.
(d) Curvature capital requirement. For
each risk class, a [BANKING
ORGANIZATION] must calculate the
curvature capital requirement by
applying an upward shock and a
downward shock to each risk factor and
calculate the incremental loss in excess
of that already captured by the delta
capital requirement for all market risk
covered positions that are options or
positions with embedded optionality,
including positions with material
prepayment risk, using the approach in
paragraph (d)(1) of this section and in
accordance with § ll.207 and
§ ll.209(d). A [BANKING
ORGANIZATION] may, on a trading
desk by trading desk basis, choose to
include market risk covered positions
without optionality in the calculation of
its curvature capital requirement,
provided that the [BANKING
ORGANIZATION] does so consistently
through time.
(1) Curvature risk position
calculation. For each market risk
covered position for which the
curvature capital requirement is
calculated, an upward shock and a
downward shock must be applied to
risk factor, k. The size of the shock, i.e.,
the risk weight, is specified in
§ ll.209(d). The net curvature risk
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(3) Across bucket aggregation. A
[BANKING ORGANIZATION] must
calculate the delta capital requirement
for each risk class by aggregating the
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64243
(vi) sik is the delta sensitivity of
market risk covered position i with
respect to curvature risk factor k, such
that:
(A) For the following risk classes, sik
is the delta sensitivity of market risk
covered position i:
(1) Foreign exchange risk; and
(2) Equity risk;
(B) For the following risk classes, sik
is the sum of the delta sensitivities to all
tenors of the relevant curve of market
risk covered position i with respect to
curvature risk factor k:
(1) Interest rate risk;
(2) Credit spread risk for nonsecuritization positions;
(3) Credit spread risk for correlation
trading positions;
(4) Credit spread risk for
securitization positions non-CTP; and
(5) Commodity risk; and
(C) The delta sensitivity sik must be
the delta sensitivity described in
§ ll.207 used in calculating the delta
capital requirement.
(2) Within bucket aggregation. Unless
otherwise specified in § ll.209(d), for
each bucket specified in § ll.209(d), a
[BANKING ORGANIZATION] must
calculate a curvature bucket-level risk
position by aggregating the net
curvature risk positions within the
bucket using the correlation parameter,
rkl, as specified in §§ ll.206(e) and
ll.209(d) as follows:
and
(i) The bucket-level capital
requirement, Kb, is calculated as the
greater of the capital requirement under
the upward scenario, Kb+, or the capital
requirement under the downward
scenario, Kb¥;
(ii) In the specific case where Kb+ =
Kb¥, if Sk(CVRk+) > Sk(CVRk¥) the
upward scenario is selected, otherwise
the downward scenario is selected; and
(iii) y(CVRk, CVRl) = 0 if CVRk and
CVRl both have negative signs; and
y(CVRk, CVRl) = 1 otherwise.
(3) Across bucket aggregation. A
[BANKING ORGANIZATION] must
calculate the curvature capital
requirement for each risk class by
aggregating the curvature bucket-level
risk positions across buckets within
each risk class, using the prescribed
cross-bucket correlation parameter, gbc,
as specified in §§ ll.206(e) and
ll.209(d), as follows:
EP18SE23.110</GPH>
EP18SE23.111</GPH>
where,
(i) i is a market risk covered position
subject to curvature risk for risk factor
k;
(ii) xk is the current level of risk factor
k;
(iii) Vi(xk) is the value of market risk
covered position i at the current level of
risk factor k;
(iv) Vi(xk(RW(curvature)∂)) and
Vi(xk(RW(curvature)¥)) denote the value of
market risk covered position i after xk is
shifted (i.e., ‘‘shocked’’) upward and
downward, respectively;
(v) RWk(curvature) is the risk weight for
curvature risk for factor k and market
risk covered position i; and
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position for the portfolio is calculated
as,
Federal Register / Vol. 88, No. 179 / Monday, September 18, 2023 / Proposed Rules
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§ ll.207 Sensitivities-based capital
requirement: calculation of delta
sensitivities, vega sensitivities and
curvature scenarios.
(a) General requirements. For
purposes of calculating the delta capital
requirement, the vega capital
requirement, and the curvature capital
requirement, a [BANKING
ORGANIZATION] must calculate the
delta sensitivities, vega sensitivities,
and curvature scenarios in accordance
with the requirements set forth below.
(1) To calculate delta sensitivities, a
[BANKING ORGANIZATION] must use
the sensitivity definitions for delta risk
as provided in paragraph (b) of this
section.
(2) To calculate its vega sensitivities,
a [BANKING ORGANIZATION] must
use the sensitivity definitions for vega
risk as provided in paragraph (c) of this
section.
(3) A [BANKING ORGANIZATION]
must calculate delta sensitivities, vega
sensitivities, and curvature scenarios
based on the valuation models used for
financial reporting, except that, with
prior written approval from the
[AGENCY], a [BANKING
ORGANIZATION] may calculate delta
sensitivities, vega sensitivities, and
curvature scenarios based on the
internal risk management models.
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(4) For each risk factor as provided in
§ ll.208, a [BANKING
ORGANIZATION] must calculate the
delta sensitivities, vega sensitivities,
and curvature scenarios as the change in
the value of a market risk covered
position as a result of applying a
specified shift to each risk factor,
assuming all other relevant risk factors
are held at the current level. In cases
where applying this assumption is
ambiguous, a [BANKING
ORGANIZATION] must perform the
calculation consistently with paragraph
(a)(3) of this section. With prior written
approval from the [AGENCY], a
[BANKING ORGANIZATION] may
calculate delta sensitivities, vega
sensitivities, and curvature scenarios
using an alternative basis.
(5) When calculating delta
sensitivities for market risk covered
positions that are options or positions
with embedded options, a [BANKING
ORGANIZATION] must use one of the
following assumptions:
(i) The dynamics of the implied
volatility are such that when the price
of the underlying changes, the implied
volatility of an option or a market risk
covered position with an embedded
option will remain unchanged for any
given moneyness (sticky delta rule); or
(ii) When the price of the underlying
changes, the implied volatility of an
option or a market risk covered position
with an embedded option will remain
unchanged for any given strike price
(sticky strike rule); or
(iii) With prior written approval from
the [AGENCY], another assumption.
(6) The curvature scenarios and
sensitivities to the delta risk factors for
credit spread risk for securitization
positions non-CTP (as specified in
§ ll.208(d)) must be calculated with
respect to the spread of the tranche
rather than the spread of the underlying
position.
(7) The curvature scenarios and
sensitivities to the delta risk factors for
credit spread risk for correlation trading
positions (as specified in § ll.208(e))
must be computed with respect to the
underlying names of the securitization
position or nth-to-default position.
(8) A [BANKING ORGANIZATION]
must calculate the delta sensitivities,
vega sensitivities, and curvature
scenarios for each risk class in the
reporting currency of the [BANKING
ORGANIZATION], except for the
foreign exchange risk class where, with
prior written approval of the [AGENCY],
the [BANKING ORGANIZATION] may
calculate sensitivities and curvature
scenarios relative to a base currency
instead of the reporting currency as
specified in § ll.208(h).
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(9) A [BANKING ORGANIZATION]
must calculate all sensitivities ignoring
the impact of CVA on fair values.
(b) Sensitivity definitions for delta
risk—(1) Interest rate risk. The delta
sensitivity for interest rate risk is
calculated by changing the interest rate
at tenor t of the relevant interest rate
curve in a given currency by one basis
point (0.0001 in absolute terms) and
dividing the resulting change in the
value of the market risk covered
position, Vi, by 0.0001 as follows:
where,
(i) k is a given risk factor;
(ii) i is a given market risk covered
position;
(iii) rt is the interest rate curve at tenor
t;
(iv) cst is the credit spread curve at
tenor t; and
(v) Vi is the value of the market risk
covered position i as a function of the
interest rate curve and credit spread
curve.
(2) Credit spread risk. The delta
sensitivity for credit spread risk for nonsecuritization positions, credit spread
risk for securitization positions nonCTP, and credit spread risk for
correlation trading positions is
calculated by changing the relevant
credit spread at tenor t by one basis
point (0.0001 in absolute terms) and
dividing the resulting change in the
value of the market risk covered
position, Vi, by 0.0001 as follows:
where,
(i) k is a given risk factor;
(ii) i is a given market risk covered
position;
(iii) rt is the interest rate curve at tenor
t;
(iv) cst is the credit spread curve at
tenor t; and
(v) Vi is the value of the market risk
covered position i as a function of the
interest rate curve and credit spread
curve.
(3) Equity risk. A [BANKING
ORGANIZATION] must calculate the
delta sensitivity for equity risk using the
equity spot price and the equity repo
rate as follows:
(i) A [BANKING ORGANIZATION]
must calculate the delta sensitivity for
equity spot price by changing the
relevant equity spot price by one
percentage point (0.01 in relative terms)
and dividing the resulting change in the
value of the market risk covered
position, Vi, by 0.01 as follows:
E:\FR\FM\18SEP2.SGM
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EP18SE23.113</GPH>
where,
(i) Sb = Sk(CVRk+) for all risk factors
in bucket b when the upward scenario
has been selected for bucket b, and Sb
= Sk(CVRk¥) otherwise; and
(ii) y(Sb, Sc) = 0 if Sb and Sc both have
negative signs, and y(Sb, Sc) = 1
otherwise.
(e) Correlation scenarios. A
[BANKING ORGANIZATION] must
repeat the aggregation of the bucketlevel risk positions and risk class-level
capital requirements for delta risk, vega
risk, and curvature risk for three
different values of the correlation
parameters rkl (correlation between risk
factors within a bucket) and gbc
(correlation across buckets within a risk
class) as specified below:
(1) For the medium correlation
scenario, the correlation parameters rkl
and gbc specified in § ll.209 apply;
(2) For the high correlation scenario,
the specified correlation parameters rkl
and gbc are uniformly multiplied by
1.25, with rkl and gbc subject to a cap at
100 percent; and
(3) For the low correlation scenario,
the specified correlation parameters rkl
and gbc are replaced by,
rkllow = max((2 × rkl) ¥ 100%, 75% ×
rkl), and
gbclow = max((2 × gbc) ¥ 100%, 75% ×
gbc).
EP18SE23.112</GPH>
64244
(C) Vi is the value of market risk
covered position i as a function of the
repo term structure of equity k.
(4) Commodity risk. A [BANKING
ORGANIZATION] must calculate the
delta sensitivity for commodity risk by
changing the relevant commodity spot
price by one percentage point (0.01 in
relative terms) and dividing the
resulting change in the value of the
market risk covered position (Vi) by 0.01
as follows:
where,
(i) k is a given commodity;
(ii) CTYk is the value of commodity k;
and
(iii) Vi is the value of market risk
covered position i as a function of the
spot price of commodity k:
(5) Foreign exchange risk. A
[BANKING ORGANIZATION] must
calculate the delta sensitivity for foreign
exchange risk by changing the relevant
exchange rate by one percentage point
(0.01 in relative terms) and dividing the
resulting change in the value of the
market risk covered position, Vi, by 0.01
as follows:
where,
(i) k is a given currency;
(ii) FXk is the exchange rate between
a given currency and a [BANKING
ORGANIZATION]’s reporting currency
or base currency, as applicable, where
the foreign exchange spot rate is the
current market price of one unit of
another currency expressed in the units
of the [BANKING ORGANIZATION]’s
reporting currency or base currency, as
applicable; and
(iii) Vi is the value of market risk
covered position i as a function of the
exchange rate k.
(c) Sensitivity definitions for vega risk.
(1) A [BANKING ORGANIZATION]
must calculate the vega sensitivity to a
given risk factor (provided in § ll.208)
by multiplying vega by the volatility of
the option as follows:
sk = vega × volatility
volatility of the option, depending on
which is used by the models used to
calculate vega sensitivity to determine
the intrinsic value of volatility in the
price of the option.
(2) For interest rate risk, a [BANKING
ORGANIZATION] must map the
implied volatility of the option to one or
more tenors specified in the risk factors
definitions in § ll.208(b)(2).
(3) A [BANKING ORGANIZATION]
must assign market risk covered
positions that are options or positions
with embedded options that do not have
a maturity to the longest prescribed
maturity tenor.
(4) A [BANKING ORGANIZATION]
must map market risk covered positions
that are options or positions with
embedded options that do not have a
strike price, that have multiple strike
prices, or are barrier options, to the
strike prices and maturities used for
models used to calculate vega
sensitivity to value these positions.
identify all of the relevant risk factors in
accordance with the requirements in
this section for its market risk covered
positions. Where specified, a [BANKING
ORGANIZATION] must use the tenors
or maturities specified in this section
and assign risk factors and
corresponding sensitivities to specified
tenors or maturities by linear
interpolation or a method that is most
consistent with the pricing functions
used by the internal risk management
models.
(b) Risk factors for interest rate risk—
(1) Delta risk factors for interest rate
risk. The delta risk factors for interest
rate risk are defined for each currency
and consist of interest rate risk factors
as well as inflation rate risk factors and
cross-currency basis risk factors, as
applicable.
(i) For each currency, the delta risk
factors for interest rate risk are defined
along two dimensions:
(A) An interest rate curve, for the
currency, in which interest ratesensitive market risk covered positions
are denominated; and
(B) Tenor: 0.25 years, 0.5 years, 1
year, 2 years, 3 years, 5 years, 10 years,
15 years, 20 years and 30 years.
where,
(i) vega is defined as the change in the
value of the option, Vi, as a result of a
small amount of change to the volatility,
si, which can be represented as (∂Vi/
∂si); and
(ii) volatility is defined as either the
implied volatility or at-the-money
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§ ll.208 Sensitivities-based capital
requirement: risk factor definitions.
(a) For purposes of calculating the
sensitivities-based capital requirement,
a [BANKING ORGANIZATION] must
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EP18SE23.117</GPH>
where,
(A) k is a given equity;
(B) RTSk is the repo term structure of
equity k; and
EP18SE23.116</GPH>
shift to the equity repo rate term
structure by one basis point (0.0001 in
absolute terms) and dividing the
resulting change in the value of the
market risk covered position, Vi, by
0.0001 as follows:
EP18SE23.115</GPH>
(C) EQk is the value of equity k; and
(D) Vi is the value of market risk
covered position i as a function of the
price of equity k.
(ii) A [BANKING ORGANIZATION]
must calculate the delta sensitivity for
equity repo rate by applying a parallel
where,
(A) k is a given equity;
(B) i is a given market risk covered
position;
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(ii) For each currency (each interest
rate risk bucket), a [BANKING
ORGANIZATION] must calculate, in
addition to paragraph (b)(1)(i) of this
section, separate delta sensitivities for
each of the following delta risk factors,
as applicable:
(A) Inflation rate risk factors. Inflation
rate risk factors apply to any market risk
covered position whose cash flows are
functionally dependent on a measure of
inflation (inflation positions). Inflation
rate risk factors must be based on the
market-implied inflation rates for each
currency where term structure is not
recognized. All inflation rate risk for a
given currency must be aggregated as
the sum of the delta sensitivities to the
inflation rate risk factors of all inflation
positions.
(B) Cross-currency basis risk factors.
The delta risk factors for interest rate
risk include one of two possible crosscurrency basis risk factors for each
currency where term structure is not
recognized. The two cross-currency
basis risk factors are basis of each
currency over USD or basis of each
currency over EUR. Cross-currency
bases that do not relate to either basis
over USD or basis over EUR must be
computed either on ‘‘basis over USD’’ or
‘‘basis over EUR,’’ but not both.
(2) Vega risk factors for interest rate
risk. The vega risk factors for interest
rate risk are defined for each currency
and consist of:
(i) The implied volatilities of inflation
rate risk-sensitive options as defined
along (b)(2)(iii)(A) of this section;
(ii) The implied volatilities of crosscurrency basis risk-sensitive options as
defined along (b)(2)(iii)(A) of this
section; and
(iii) The implied volatilities of interest
rate risk-sensitive options as defined
along (b)(2)(iii)(A) and (B) of this
section.
(A) The maturity of the option: 0.5
years, 1 year, 3 years, 5 years and 10
years; and
(B) The residual maturity of the
underlying instrument at the expiry date
of the option: 0.5 years, 1 year, 3 years,
5 years and 10 years.
(3) Curvature risk factors for interest
rate risk. The curvature risk factors for
interest rate risk are defined along one
dimension, the relevant interest rate
curve, per currency, where term
structure is not recognized. To calculate
curvature scenarios, a [BANKING
ORGANIZATION] must shift all tenors
provided in paragraph (b)(1)(i)(B) of this
section, in parallel. There is no
curvature capital requirement for
inflation risk and cross-currency basis
risks.
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(4) On-shore and offshore variants of
a currency must be treated as separate
currencies, unless a [BANKING
ORGANIZATION] has received prior
approval of the [AGENCY] to treat onshore and offshore variants as a single
currency.
(c) Risk factors for credit spread risk
for non-securitization positions—(1)
Delta risk factors for credit spread risk
for non-securitization positions. The
delta risk factors for credit spread risk
for non-securitization positions are
defined along two dimensions:
(i) The issuer credit spread curve; and
(ii) Tenor: 0.5 years, 1 year, 3 years,
5 years and 10 years.
(2) Vega risk factors for credit spread
risk for non-securitization positions. For
each credit spread curve, the vega risk
factors for credit spread risk for nonsecuritization positions are the implied
volatilities of options as defined along
one dimension for the maturity of the
option: 0.5 years, 1 year, 3 years, 5 years
and 10 years.
(3) Curvature risk factors for credit
spread risk for non-securitization
positions. The curvature risk factors for
credit spread risk for non-securitization
positions are defined along the relevant
issuer credit spread curves. For
purposes of calculating curvature
scenarios, a [BANKING
ORGANIZATION] must ignore the
bond-CDS basis and treat the bondinferred spread curve of an issuer and
the CDS-inferred spread curve of that
same issuer as a single spread curve. To
calculate curvature scenarios, a
[BANKING ORGANIZATION] must shift
all tenors provided in paragraph
(c)(1)(ii) of this section, in parallel.
(d) Risk factors for credit spread risk
for securitization positions non-CTP—
(1) Delta risk factors for credit spread
risk for securitization positions nonCTP. The delta risk factors for credit
spread risk for securitization positions
non-CTP are defined along two
dimensions:
(i) The tranche credit spread curve;
and
(ii) Tenor of the tranche: 0.5 years, 1
year, 3 years, 5 years and 10 years.
(2) Vega risk factors for credit spread
risk for securitization positions nonCTP. For each tranche credit spread
curve, the vega risk factors for credit
spread risk for securitization positions
non-CTP are the implied volatilities of
options as defined along one dimension
for the maturity of the option: 0.5 years,
1 year, 3 years, 5 years and 10 years.
(3) Curvature risk factors for credit
spread risk for securitization positions
non-CTP. The curvature risk factors for
credit spread risk for securitization
positions non-CTP are defined along
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one dimension, the relevant tranche
credit spread curves. For purposes of
calculating curvature scenarios, a
[BANKING ORGANIZATION] must
ignore the bond-CDS basis and treat the
bond-inferred spread curve of a tranche
and the CDS-inferred spread curve of
that same tranche as a single spread
curve. To calculate curvature scenarios,
a [BANKING ORGANIZATION] must
shift all tenors provided in paragraph
(d)(1)(ii) of this section in parallel.
(e) Risk factors for credit spread risk
for correlation trading positions—(1)
Delta risk factors for credit spread risk
for correlation trading positions. The
delta risk factors for credit spread risk
for correlation trading positions are
defined along two dimensions:
(i) The underlying credit spread
curve; and
(ii) Tenor of the underlying name: 0.5
years, 1 year, 3 years, 5 years and 10
years.
(2) Vega risk factors for credit spread
risk for correlation trading positions.
For each underlying credit spread curve,
the vega risk factors for the credit spread
risk for correlation trading positions are
the implied volatilities of options as
defined along one dimension for the
maturity of the option: 0.5 years, 1 year,
3 years, 5 years and 10 years.
(3) Curvature risk factors for credit
spread risk for correlation trading
positions. The curvature risk factors for
credit spread risk for correlation trading
positions are defined along one
dimension, the relevant underlying
credit spread curves. For purposes of
calculating curvature scenarios, a
[BANKING ORGANIZATION] must
disregard the bond-CDS basis and treat
the bond-inferred spread curve of a
given name in an index and the CDSinferred spread curve of that same
underlying name as a single spread
curve. To calculate curvature scenarios,
a [BANKING ORGANIZATION] must
shift all tenors provided in paragraph
(e)(1)(ii) of this section in parallel.
(f) Risk factors for equity risk—(1)
Delta risk factors for equity risk. The
delta risk factors for equity risk are
defined for each issuer and consist of
equity spot prices and equity repo rates,
as appropriate.
(2) Vega risk factors for equity risk.
The vega risk factors for equity risk are
defined for each issuer and consist of
the implied volatilities of the spot prices
of equity risk-sensitive options as
defined along the maturity of the option:
0.5 years, 1 year, 3 years, 5 years and
10 years.
(3) Curvature risk factors for equity
risk. The curvature risk factors for
equity risk are defined for each issuer
and consist of all equity spot prices.
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There are no curvature risk factors for
equity repo rates.
(g) Risk factors for commodity risk—
(1) Delta risk factors for commodity risk.
The delta risk factors for commodity
risk are all commodity spot prices or
forward prices and are defined along
two dimensions for each commodity:
(i) The contracted delivery location of
the commodity; and
(ii) Remaining maturity of the
contract: 0 years, 0.25 years, 0.5 years,
1 year, 2 years, 3 years, 5 years, 10
years, 15 years, 20 years and 30 years.
(2) Vega risk factors for commodity
risk. The vega risk factors for
commodity risk are the implied
volatilities of commodity-sensitive
options as defined along one dimension
for each commodity, the maturity of the
option: 0.5 years, 1 year, 3 years, 5 years
and 10 years.
(3) Curvature risk factors for
commodity risk. The curvature risk
factors for commodity risk are defined
along one dimension per commodity,
the constructed curve per commodity
spot prices or forward prices, consistent
with the delta risk factor, where term
structure is not recognized. For the
calculation of sensitivities, all tenors
provided in paragraph (g)(1)(ii) of this
section, are to be shifted in parallel.
(h) Risk factors for foreign exchange
risk—(1) Delta risk factors for foreign
exchange risk. The delta risk factors for
foreign exchange risk are all the
exchange rates between the currency in
which a market risk covered position is
denominated and the reporting
currency.
(i) For market risk covered positions
that reference an exchange rate between
a pair of non-reporting currencies, the
delta risk factors for foreign exchange
risk are all the exchange rates between:
(A) The reporting currency; and
(B) The currency in which a market
risk covered position is denominated
and any other currencies referenced by
the market risk covered position.
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(ii) Alternatively, a [BANKING
ORGANIZATION] may calculate delta
risk factors for foreign exchange risk
relative to a base currency instead of the
reporting currency if approved by the
[AGENCY]. In such case a [BANKING
ORGANIZATION] must account for the
foreign exchange risk against the base
currency and the foreign exchange risk
between the reporting currency and the
base currency (i.e., translation risk). The
resulting foreign exchange risk
calculated relative to the base currency
must be converted to the capital
requirements in the reporting currency
using the spot reporting/base exchange
rate reflecting the foreign exchange risk
between the base currency and the
reporting currency.
(A) To use this alternative, a
[BANKING ORGANIZATION] may only
consider a single currency as its base
currency; and
(B) A [BANKING ORGANIZATION]
must demonstrate to the [AGENCY] that
calculating foreign exchange risk
relative to its base currency provides an
appropriate risk representation of the
[BANKING ORGANIZATION]’s market
risk covered positions and that the
translation risk between the base
currency and the reporting currency is
addressed.
(2) Vega risk factors for foreign
exchange risk. The vega risk factors for
foreign exchange risk-sensitive options
are the implied volatility of options that
reference exchange rates between
currency pairs defined along the
maturity of the option: 0.5 years, 1 year,
3 years, 5 years and 10 years.
(3) Curvature risk factors for foreign
exchange risk. The curvature risk factors
for foreign exchange risk are all the
exchange rates between the currency in
which a market risk covered position is
denominated and the reporting
currency.
(i) For market risk covered positions
that reference an exchange rate between
a pair of non-reporting currencies, the
curvature risk factors for foreign
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64247
exchange risk are all the exchange rates
between:
(A) The reporting currency; and
(B) The currency in which a market
risk covered position is denominated
and any other currencies referenced by
the market risk covered position.
(ii) If the [BANKING
ORGANIZATION] has received prior
approval of the [AGENCY] to use the
base currency approach in paragraph
(h)(1)(ii) of this section, curvature risk
factors for foreign exchange risk must be
calculated relative to the base currency
instead of the reporting currency, and
then converted to the capital
requirements in the reporting currency
using the spot reporting/base exchange
rate.
(4) For all risk factors for foreign
exchange risk, a [BANKING
ORGANIZATION] may distinguish
between onshore and offshore variants
of a currency.
§ ll.209 Sensitivities-based method:
definitions of buckets, risk weights and
correlation parameters.
(a) For the purpose of calculating the
sensitivities-based capital requirement,
a [BANKING ORGANIZATION] must
identify all of the relevant buckets,
corresponding risk weights and
correlation parameters for each risk
class as provided in paragraph (b) of this
section (delta capital requirement),
paragraph (c) of this section (vega
capital requirement), and paragraph (d)
of this section (curvature capital
requirement), for its market risk covered
positions.
(b) Delta capital requirement—(1)
Delta buckets, risk weights, and
correlations for interest rate risk. (i) A
[BANKING ORGANIZATION] must
establish a separate interest rate risk
bucket for each currency.
(ii) For calculating risk-weighted delta
sensitivities, the risk weights for each
tenor of an interest rate curve are set out
in Table 1 of this section.
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onshore and offshore curves, a
[BANKING ORGANIZATION] may
choose to take the sum of the riskweighted delta sensitivities.
(B) The correlation parameter ρkl
between risk-weighted delta
sensitivities WSk and WSl within the
same bucket, with different tenors and
the same interest rate curve are set out
in table 2 of this section.
BILLING CODE 6210–01–P; 6714–01–P; 4810–33–P
EP18SE23.119</GPH>
(v) For purposes of aggregating riskweighted delta sensitivities of interest
rate risk within a bucket as specified in
§ ll.206(b)(2), a [BANKING
ORGANIZATION] must use the
following correlation parameters:
(A) The correlation parameter ρkl
between risk-weighted delta
sensitivities WSk and WSl within the
same bucket, with the same tenor but
different interest rate curves equals 99.9
percent. For cross-currency basis risk for
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(iii) The risk weight for inflation rate
risk factors and cross-currency basis risk
factors equals 1.6 percent.
(iv) For United States Dollar,
Australian Dollar, Canadian Dollar,
Euro, Japanese Yen, Swedish Krona, and
United Kingdom Pound, and any other
currencies specified by the [AGENCY],
a [BANKING ORGANIZATION] may
divide the risk weights in paragraphs
(b)(1)(ii) and (iii) of this section by √2.
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(C) The correlation parameter ρkl
between risk-weighted delta
sensitivities WSk and WSl within the
same bucket, with different tenors and
different interest rate curves equals the
correlation parameter ρkl specified in
Table 2 of this section multiplied by
99.9 percent.
(D) The correlation parameter ρkl
between risk-weighted delta
sensitivities WSk and WSl to different
inflation curves within the same bucket
equals 99.9 percent.
(E) The correlation parameter ρkl
between a risk-weighted delta
sensitivity WSk to the inflation curve
and a risk weighted delta sensitivity WSl
to a given tenor of the relevant interest
rate curve equals 40 percent.
(F) The correlation parameter ρkl
equals zero percent between risk-
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weighted delta sensitivity WSk to a
cross-currency basis curve and a risk
weighted delta sensitivity WSl to each of
the following curves:
(1) A given tenor of the relevant
interest rate curve;
(2) The inflation curve; and
(3) Any other cross-currency basis
curve.
(vi) For purposes of aggregating delta
bucket-level risk positions across
buckets within the interest rate risk
class as specified in § ll.206(b)(3), the
cross-bucket correlation parameter γbc
equals 50 percent.
(2) Delta buckets, risk weights, and
correlations for credit spread risk for
non-securitizations. (i) For credit spread
risk for non-securitizations, a
[BANKING ORGANIZATION] must
establish buckets along two dimensions,
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64249
credit quality and sector, as set out in
Table 3 of this section. In assigning a
delta sensitivity to a sector, a
[BANKING ORGANIZATION] must
follow market convention. A [BANKING
ORGANIZATION] must assign each
delta sensitivity to one and only one of
the sector buckets in Table 3 of this
section. Delta sensitivities that a
[BANKING ORGANIZATION] cannot
assign to a sector must be assigned to
the other sector, bucket 17 in Table 3 of
this section.
(ii) For calculating risk weighted delta
sensitivities for credit spread risk for
non-securitizations, a [BANKING
ORGANIZATION] must use the risk
weights in Table 3 of this section. The
risk weights are the same for all tenors
within a bucket.
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BILLING CODE 6210–01–C; 6714–01–C; 4810–33–C
(iii) For purposes of aggregating risk
weighted delta sensitivities of credit
spread risk for non-securitizations
within a bucket as specified in
§ ll.206(b)(2), a [BANKING
ORGANIZATION] must use the
following correlation parameters:
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(A) For buckets 1 to 16, the
correlation parameter rkl between risk
weighted delta sensitivities WSk and
WSl equals:
ρkl = ρkl(name) × ρkl(tenor) × ρkl(basis)
where,
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(1)ρkl(name) equals 100 percent if the
two names of the delta sensitivities to
risk factors k and l are identical, and 35
percent otherwise;
(2) ρkl(tenor) equals 100 percent if the
two tenors of the delta sensitivities to
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64250
64251
risk factors k and l are identical, and 65
percent otherwise; and
(3) rkl(basis) equals 100 percent if the
two delta sensitivities are related to the
same curve, and 99.9 percent otherwise.
(B) For bucket 17, the risk delta
bucket level risk position equals the
sum of the absolute values of the risk
weighted delta sensitivities allocated to
this bucket,
(C) For buckets 18 and 19, the
correlation parameter rkl between risk
weighted delta sensitivities WSk and
WSl equals:
rkl(name) × rkl(tenor) × rkl(basis)
where,
(1) rkl(name) equals 100 percent if the
two names of the delta sensitivities to
risk factors k and l are identical, and 80
percent otherwise;
(2) rkl(tenor) equals 100 percent if the
two tenors of the delta sensitivities to
risk factors k and l are identical, and 65
percent otherwise; and
(3)rkl(basis) equals 100 percent if the
two delta sensitivities are related to the
same curves, and 99.9 percent
otherwise.
(iv) For purposes of aggregating delta
bucket-level risk positions across
buckets within the credit spread risk for
non-securitizations risk class as
specified in § ll.206(b)(3), a
[BANKING ORGANIZATION] must
calculate the cross-bucket correlation
parameter gbc as follows with respect to
buckets 1 to 19:
where,
BILLING CODE 6210–01–P; 6714–01–P; 4810–33–P
EP18SE23.122</GPH>
gbc(credit quality) × gbc(sector)
(A) gbc(credit quality) equals 50 percent
where the two buckets b and c are both
in the set of buckets 1 to 16, 18 and 19
and have a different credit quality
category, where speculative and subspeculative grade is treated as one credit
quality category; gbc(credit quality) equals
100 percent otherwise; and
(B) gbc(sector) equals 100 percent if the
two buckets belong to the same sector,
and the specified values set out in Table
4 of this section otherwise.
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(3) Delta buckets, risk weights, and
correlations for credit spread risk for
correlation trading positions. (i) For
credit spread risk for correlation trading
positions, a [BANKING
ORGANIZATION] must establish
buckets along two dimensions, credit
quality and sector as set out in Table 5
of this section. In assigning a delta
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sensitivity to a sector, a [BANKING
ORGANIZATION] must follow market
convention. A [BANKING
ORGANIZATION] must assign each
delta sensitivity to one and only one of
the sector buckets in Table 5 of this
section. Delta sensitivities that a
[BANKING ORGANIZATION] cannot
assign to a sector must be assigned to
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the other sector, bucket 17 in Table 5 of
this section.
(ii) For calculating risk weighted delta
sensitivities for credit spread risk for
correlation trading positions, a
[BANKING ORGANIZATION] must use
the risk weights in Table 5 of this
section. The risk weights are the same
for all tenors within a bucket.
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(iii) For purposes of aggregating risk
weighted delta sensitivities of credit
spread risk for correlation trading
positions within a bucket as specified in
§ ll.206(b)(2), a [BANKING
ORGANIZATION] must use the
following correlation parameters:
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(A) For buckets 1 to 16, the
correlation parameter rkl between risk
weighted delta sensitivities WSk and
WSl equals:
rkl = rkl(name) × rkl(tenor) × rkl(basis)
where,
(1) rkl(name) equals 100 percent if the
two names of delta sensitivities to risk
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factors k and l are identical, and 35
percent otherwise;
(2) rkl(tenor) equals 100 percent if the
two tenors of the delta sensitivities to
risk factors k and l are identical, and 65
percent otherwise; and
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(3) rkl(basis) equals 100 percent if the
two delta sensitivities are related to
same curve, and 99 percent otherwise.
(B) For bucket 17, the delta bucketlevel risk position equals the sum of the
absolute values of the risk weighted
delta sensitivities allocated to this
bucket,
(C) For purposes of aggregating delta
bucket-level risk positions across
buckets within the credit spread risk for
correlation trading positions risk class
as specified in § ll.206(b)(3), a
[BANKING ORGANIZATION] must
calculate the cross-bucket correlation
parameter γbc as follows:
gbc = gbc(credit quality) × gbc(sector)
treated as one credit quality category;
gbc(credit quality) equals 100 percent
otherwise; and
(2) gbc(sector) equals 100 percent if the
two buckets belong to the same sector,
and the specified values set out in Table
6 of this section otherwise.
(1) gbc(credit quality) equals 50 percent
where the two buckets b and c are both
in buckets 1 to 16 and have a different
credit quality category, where
speculative and sub-speculative grade is
assign to a sector must be assigned to
the other sector bucket.
(ii) For calculating risk weighted delta
sensitivities for credit spread risk for
securitization positions non-CTP, a
[BANKING ORGANIZATION] must use
the risk weights in Table 7 of this
section.
EP18SE23.125</GPH>
sensitivity to a credit quality, a
[BANKING ORGANIZATION] must take
into account the structural features of
the securitization position non-CTP. In
assigning a delta sensitivity to a sector,
a [BANKING ORGANIZATION] must
follow market convention. Delta
sensitivities of any tranche that a
[BANKING ORGANIZATION] cannot
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(4) Delta buckets, risk weights, and
correlations for credit spread risk for
securitization positions non-CTP. (i) For
credit spread risk for securitization
positions non-CTP, a [BANKING
ORGANIZATION] must establish
buckets along two dimensions, credit
quality and sector, as set out in Table 7
of this section. In assigning a delta
where,
BILLING CODE 6210–01–C; 6714–01–C; 4810–33–C
(iii) For purposes of aggregating risk
weighted delta sensitivities of credit
spread risk for securitization positions
non-CTP within a bucket as specified in
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§ ll.206(b)(2), a [BANKING
ORGANIZATION] must use the
following correlation parameters:
(A) For buckets 1 through 24, the
correlation parameter ρkl between risk
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64255
weighted delta sensitivities WSk and
WSl, equals:
ρkl = ρkl(tranche) × ρkl(tenor) × ρkl(basis)
where,
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(1) ρkl(tranche) equals 100 percent where
the two delta sensitivities to risk factors
k and l are within the same bucket and
related to the same tranche, with more
than 80 percent overlap in notional
terms and 40 percent otherwise;
(2) ρkl(tenor) equals 100 percent if the
two tenors of the delta sensitivities to
risk factors k and l are identical, and 80
percent otherwise; and
(3) ρkl(basis) equals 100 percent if the
two delta sensitivities reference the
same curve, and 99.9 percent otherwise.
(B) For bucket 25, the delta bucketlevel risk position equals the sum of the
absolute values of the risk weighted
delta sensitivities allocated to this
bucket,
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(iv) For purposes of aggregating delta
bucket-level risk positions across
buckets within the credit spread risk for
securitization positions non-CTP risk
class as specified in § ll.206(b)(3), the
cross-bucket correlation parameter γbc
equals zero percent.
(5) Delta buckets, risk weights, and
correlations for equity risk. (i) For equity
risk, a [BANKING ORGANIZATION]
must establish buckets along three
dimensions, market capitalization,
economy and sector as set out in Table
8 of this section. To assign a delta
sensitivity to an economy, a [BANKING
ORGANIZATION], at least annually,
must review and update the countries
and territorial entities that satisfy the
requirements of a liquid market
economy using the most recent
economic data available. To assign a
delta sensitivity to a sector, a
[BANKING ORGANIZATION] must
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follow market convention by using
classifications that are commonly used
in the market for grouping issuers by
industry sector. A [BANKING
ORGANIZATION] must assign each
issuer to one of the sector buckets and
must assign all issuers from the same
industry to the same sector. Delta
sensitivities of any equity issuer that a
[BANKING ORGANIZATION] cannot
assign to a sector must be assigned to
the other sector. For multinational,
multi-sector equity issuers, the
allocation to a particular bucket must be
done according to the most material
economy and sector in which the issuer
operates.
(ii) For calculating risk weighted delta
sensitivities for equity risk, a [BANKING
ORGANIZATION] must use the risk
weights in Table 8 of this section.
BILLING CODE 6210–01–P; 6714–01–P; 4810–33–P
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(iii) For purposes of aggregating risk
weighted delta sensitivities of equity
risk within a bucket as specified in
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§ ll.206(b)(2), a [BANKING
ORGANIZATION] must use the
following correlation parameters:
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(A) For buckets 1 through 10 and 12
through 13, the correlation parameter ρkl
between two risk weighted delta
sensitivities WSk and WSl is as follows:
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(1) ρkl equals 99.9 percent, where one
delta sensitivity is to an equity spot
price and the other delta sensitivity is
to an equity repo rate, and both are
related to the same equity issuer;
(2) Where both delta sensitivities are
to equity spot prices, or both delta
sensitivities are to equity repo rates, ρkl
equals:
(i) 15 percent between delta
sensitivities assigned to buckets 1, 2, 3,
and 4 of Table 8 of this section (large
market cap, emerging market economy);
(ii) 25 percent between delta
sensitivities assigned to buckets 5, 6, 7
or 8 of Table 8 of this section (large
market cap, liquid market economy);
(iii) 7.5 percent between delta
sensitivities assigned to bucket 9 of
Table 8 of this section (small market
cap, emerging market economy);
(iv) 12.5 percent between delta
sensitivities assigned to bucket 10 of
Table 8 of this section (small market
cap, liquid market economy); and
(v) 80 percent between delta
sensitivities assigned to buckets 12 or 13
of Table 8 of this section (either index
bucket); and
(3) Where one delta sensitivity is to an
equity spot price and the other delta
sensitivity is to an equity repo rate, and
each delta sensitivity is related to a
different equity issuer, the applicable
correlation parameter equals ρkl, as
defined in paragraph (b)(5)(iii)(A)(2) of
this section, multiplied by 99.9 percent;
and
(B) For bucket 11, the delta bucketlevel risk position equals the sum of the
absolute values of the risk weighted
delta sensitivities allocated to this
bucket,
(iv) For purposes of aggregating delta
bucket-level risk positions across
buckets within the equity risk class as
specified in § ll.206(b)(3), the crossbucket correlation parameter γbc equals:
(A) 15 percent if bucket b and bucket
c fall within buckets 1 to 10 of Table 8
of this section;
(B) Zero percent if either of bucket b
and bucket c is bucket 11 of Table 8 of
this section;
(C) 75 percent if bucket b and bucket
c are buckets 12 and 13 of Table 8 of
this section (i.e., one is bucket 12 and
one is bucket 13); and
(D) 45 percent otherwise.
(6) Delta buckets, risk weights, and
correlations for commodity risk.
(i) For commodity risk, a [BANKING
ORGANIZATION] must establish
buckets for each commodity type as set
out in Table 9 of this section. A
[BANKING ORGANIZATION] must
assign each contract to one of the
commodity buckets and must assign all
contracts with the same underlying
commodity to the same bucket. Delta
sensitivities of any contract that a
[BANKING ORGANIZATION] cannot
assign to a commodity type must be
assigned to the other commodity bucket.
(ii) For calculating risk weighted delta
sensitivities for commodity risk, a
[BANKING ORGANIZATION] must use
the risk weights in Table 9 of this
section.
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(iii) For purposes of aggregating risk
weighted delta sensitivities of
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commodity risk within a bucket as
specified in § ll.206(b)(2), a
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[BANKING ORGANIZATION] must use
the following correlation parameters:
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(A) For buckets 1 through 11, the
correlation parameter rkl between two
risk weighted delta sensitivities WSk
and WSl equals:
rkl = rkl(cty) × rkl(tenor) × rkl(basis)
where,
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(iv) For purposes of aggregating delta
bucket-level risk positions across
buckets within the commodity risk class
as specified in § ll.206(b)(3), the
cross-bucket correlation parameter gbc
equals:
(A) 20 percent if bucket b and c fall
within buckets 1 to 10 of Table 10 of
this section; and
(B) Zero percent if either bucket b and
c is bucket number 11 of Table 10 of this
section.
(7) Delta buckets, risk weights, and
correlations for foreign exchange risk. (i)
For foreign exchange risk, a [BANKING
ORGANIZATION] must establish
buckets for each exchange rate between
the currency in which a market risk
covered position is denominated and
the reporting currency (or alternative
base currency).
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(1) rkl(cty) equals 100 percent where
the two delta sensitivities to risk factors
k and l are identical, and the intrabucket correlation parameters set out in
Table 10 of this section otherwise;
(2) rkl(tenor) equals 100 percent if the
two tenors of the delta sensitivities to
risk factors k and l are identical, and 99
percent otherwise; and
(3) rkl(basis) equals 100 percent if the
two delta sensitivities are identical in
the delivery location of a commodity,
and 99.9 percent otherwise.
(ii) For calculating risk weighted delta
sensitivities for foreign exchange risk, a
[BANKING ORGANIZATION] must
apply a risk weight equal to 15 percent,
except for any currency pair formed by
the following list of currencies, a
[BANKING ORGANIZATION] may
divide the above risk weight by √2:
United States Dollar, Australian Dollar,
Brazilian Real, Canadian Dollar, Chinese
Yuan, Euro, Hong Kong Dollar, Indian
Rupee, Japanese Yen, Mexican Peso,
New Zealand Dollar, Norwegian Krone,
Singapore Dollar, South African Rand,
South Korean Won, Swedish Krona,
Swiss Franc, Turkish Lira, United
Kingdom Pound, and any additional
currencies specified by the [AGENCY].
(iii) For purposes of aggregating delta
bucket-level risk positions across
buckets within the foreign exchange risk
class, the cross-bucket correlation
parameter gbc equals 60 percent.
(c) Vega capital requirement—(1)
Vega buckets. For each risk class, a
[BANKING ORGANIZATION] must use
the same buckets as specified in
paragraph (b) of this section for the
calculation of the vega capital
requirement.
(2) Vega risk weights. For calculating
risk weighted sensitivities for vega risk
as described in § ll.206(c)(1), a
[BANKING ORGANIZATION] must use
the corresponding risk weight for each
risk class specified in Table 11 of this
section.
(i) Equity risk (large market cap and
indices) applies to vega risk factors that
correspond to buckets 1 to 8, 12 and 13
of Table 8 of this section.
(ii) Equity risk (small market cap and
other sector) applies to vega risk factors
that correspond to buckets 9 to 11 of
Table 8 of this section.
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with a set at 1 percent and TkU
(respectively TlU) denoting the maturity
of the underlying of the option from
which the sensitivity VRk (VRl) is
derived, expressed as a number of years
after the maturity of the option.
(ii) Except as noted in paragraph
(c)(3)(iii) of this section, for purposes of
aggregating risk weighted vega
sensitivities within a bucket of:
(A) Interest rate risk, where term
structure is not recognized (inflation
rate risk factors and cross-currency basis
risk factors); and
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with a set at 1 percent and Tk
(respectively Tl) denoting the maturity
of the option from which the vega
sensitivity VRk (VRl) is derived,
expressed as a number of years; and
(2) rkl(delta) equals the correlation
between the delta risk factors that
correspond to vega risk factors k and l.
For instance, if k is the vega risk factor
from equity option X and l is the vega
risk factor from equity option Y then
rkl(delta) is the delta correlation
applicable between X and Y.
Specifically:
(i) For the risk classes of credit spread
risk for non-securitization positions and
credit spread risk for correlation trading
positions, the vega risk correlation
parameter, rkl(delta), equals the
corresponding delta correlation
parameter, rkl(name), as specified in
paragraphs (b)(2)(iii)(A)(1) and
(b)(3)(iii)(A)(1) of this section,
respectively;
(ii) For the risk class of credit spread
risk for securitization positions nonCTP, the vega risk correlation
parameter, rkl(delta), equals the
corresponding delta correlation
parameter, kl(tranche), as specified in
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with a set at 1 percent and Tk
(respectively Tl) denoting the maturity
of the option from which the vega
sensitivity VRk (VRl) is derived,
expressed as a number of years; and
(B) rkl(underlying maturity) equals:
where,
(A) rkl(option maturity) equals:
paragraph (b)(4)(iii)(A)(1) of this section;
and
(iii) For the risk class of commodity
risk, the vega risk correlation parameter,
rkl(delta), equals the corresponding delta
correlation parameter, rkl(cty), as
specified in paragraph (b)(6)(iii)(A)(1) of
this section.
(iii) For purposes of aggregating risk
weighted vega sensitivities within the
other sector buckets (for credit spread
risk for non-securitizations, bucket 17 in
table 3 to Table 3 of this section, for
credit spread risk for correlation trading
positions, bucket 17 in Table 5 of this
section, for credit spread risk for
securitization positions non-CTP,
bucket 25 in Table 7 of this section, and
for equity risk, bucket 11 in Table 8 of
this section), the vega bucket-level risk
position equals the sum of the absolute
values of the risk weighted vega
sensitivities allocated to this bucket.
(iv) For purposes of aggregating vega
bucket-level risk positions across
different buckets within a risk class as
specified in § ll.206(c)(3), a
[BANKING ORGANIZATION] must use
the same cross-bucket correlation
parameters gbc as specified for delta risk
in paragraph (b) of this section.
(d) The curvature capital
requirement—(1) Curvature buckets. For
each risk class, a [BANKING
ORGANIZATION] must use the same
buckets as specified in paragraph (b) of
this section for the calculation of the
curvature capital requirement.
(2) Curvature risk weights. (i) For
calculating the net curvature risk
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where,
(A) rkl(option maturity) equals
(B) The other risk classes (numbered
2 through 8 in Table 11 of this section),
the correlation parameter rkl equals:
rkl = min((rkl(delta) × rkl(option maturity), 1)
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(3) Vega correlation parameters. For
purposes of aggregating risk weighted
vega sensitivities within a bucket as
specified in § ll.206(c)(2) a
[BANKING ORGANIZATION] must use
the following correlation parameters:
(i) For interest rate risk, where tenor
is a dimension of the risk factor,
correlation parameter rkl equals:
rkl = min((rkl(option maturity) × rkl(underlying
maturity)), 1)
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position CVRk, as described in
§ ll.206(d)(1), for the risk classes of
foreign exchange risk and equity risk,
the curvature risk weight that represents
a shock to risk factor k is a relative shift
equal to the delta risk weight
corresponding to risk factor k.
(A) For options that do not reference
a [BANKING ORGANIZATION]’s
reporting currency or base currency as
an underlying exposure, a [BANKING
ORGANIZATION] may divide the net
curvature risk positions CVRk+ and
CVRk¥ for foreign exchange risk by a
scalar of 1.5.
(B) A [BANKING ORGANIZATION]
may apply the scalar of 1.5 consistently
to all market risk covered positions
subject to foreign exchange risk,
provided curvature scenarios are
calculated for all currencies, including
curvature scenarios calculated by
shocking the reporting currency (or base
currency where used) relative to all
other currencies.
(ii) For calculating the net curvature
risk position CVRk, as described in
§ ll.206(d)(1), for the risk classes
below, the curvature risk weight
corresponding to risk factor k is the
parallel shift of all the tenors for each
curve based on the highest prescribed
delta risk weight for each bucket:
(A) Interest rate risk;
(B) Credit spread risk for nonsecuritization positions;
(C) Credit spread risk for correlation
trading positions;
(D) Credit spread risk for
securitization positions non-CTP; and
(E) Commodity risk.
(iii) A [BANKING ORGANIZATION]
may floor credit spreads at zero in cases
where applying the delta risk weight
described in paragraph (d)(2)(ii) of this
section results in negative credit spreads
for the credit spread risk classes
referenced in paragraphs (d)(2)(ii)(B)
through (D) of this section.
(3) Curvature correlation parameters.
For purposes of aggregating the net
curvature risk positions within a bucket
as described in § ll.206(d)(2), a
[BANKING ORGANIZATION] must use
the following correlation parameters:
(i) Except as noted in paragraph
(d)(3)(vi) of this section, for the risk
class of interest rate risk, the curvature
risk correlation parameter, rkl, equals
99.8 percent where risk factors k and l
relate to different interest rate curves
and 100 percent otherwise;
(ii) Except as noted in paragraph
(d)(3)(vi) of this section, for the risk
classes of credit spread risk for nonsecuritization positions and credit
spread risk for correlation trading
positions, the curvature risk correlation
parameter, rkl, equals the corresponding
delta correlation parameter, rkl(name), as
specified in paragraphs (b)(2)(iii)(A)(1)
and (b)(3)(iii)(A)(1) of this section,
respectively, squared.
(iii) Except as noted in paragraph
(d)(3)(vi) of this section, for the risk
class of credit spread risk for
securitization positions non-CTP, the
curvature risk correlation parameter, rkl,
equals the corresponding delta
correlation parameter, rkl(tranche), as
specified in paragraph (b)(4)(iii)(A) of
this section, squared;
(iv) Except as noted in paragraph
(d)(3)(vi) of this section, for the risk
class of commodity risk, the curvature
risk correlation parameter, rkl, equals
the corresponding delta correlation
parameter, rkl(cty), as specified in
paragraph (b)(6)(iii)(A)(1) of this section,
squared;
(v) Except as noted in paragraph
(d)(3)(vi) of this section, for the risk
class of equity risk, the curvature risk
correlation parameter, rkl, equals the
corresponding delta correlation
parameters, rkl, as specified in
paragraph (b)(5)(iii)(A)(2) of this section,
squared;
(vi) For purposes of aggregating the
net curvature risk positions within the
other sector buckets (for credit spread
risk for non-securitizations, bucket 17 in
Table 3 of this section, for credit spread
risk for correlation trading positions,
bucket 17 in Table 5 of this section, for
credit spread risk for securitization
positions non-CTP, bucket 25 in Table
7 of this section, and for equity risk,
bucket 11 in Table 8 of this section), the
curvature bucket-level risk position
equals:
(4) For purposes of aggregating
curvature bucket-level risk positions
across buckets within each risk class as
specified in § ll.206(d)(3), a
[BANKING ORGANIZATION] must
calculate the cross-bucket correlation
parameters gbc for curvature risk by
squaring the corresponding delta
correlation parameters gbc.
(5) In applying the high and low
correlations scenarios in § ll.206(e), a
[BANKING ORGANIZATION] must
calculate the curvature capital
requirements by applying the
correlation parameters, rkl, as calculated
in paragraph (d)(3) of this section and
the cross-bucket correlation parameter
gbc as calculated in paragraph (d)(4) of
this section.
[BANKING ORGANIZATION] must
calculate default risk capital
requirements for its market risk covered
positions, including defaulted market
risk covered positions, that are subject
to default risk (default risk positions)
across the following default risk
categories:
(i) Non-securitization debt or equity
positions, other than U.S. sovereign
positions or MDBs;
(ii) Securitization positions non-CTP;
and
(iii) Correlation trading positions.
(2) For each default risk category, the
standardized default risk capital
requirement must be calculated as
follows:
(i) Assign each default risk position to
one of the prescribed buckets.
(ii) Calculate the gross default
exposure for each default risk position.
(iii) Calculate obligor-level net default
exposure by offsetting, where
permissible, the gross default exposure
amounts of long and short default risk
positions.
(A) To account for defaults within the
one-year capital horizon, a [BANKING
ORGANIZATION] must scale the gross
default exposures for default risk
positions of maturity less than one year,
and their hedges, by the corresponding
fraction of a year. The maturity
weighting applied to the gross default
exposure for any default risk position
with a maturity of less than three
months (such as short-term lending)
must be floored at three months. No
scaling is applied to the gross default
exposures for default risk positions with
maturities of one year or greater.
(1) A [BANKING ORGANIZATION]
may assign unhedged cash equity
positions to a maturity of either three
months or one year. For cash equity
positions that hedge derivative
contracts, a [BANKING
§ ll.210 Standardized default risk capital
requirement.
(a) Overview of the standardized
default risk capital requirements. (1) A
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ORGANIZATION] may assign the same
maturity to the cash equity position as
the maturity of the derivative contract it
hedges.
(2) For derivative transactions,
eligibility for offsetting treatment is
determined by the maturity of the
derivative contract, not the maturity of
the underlying. In the case where a
default risk position can be delivered
into a derivative contract that it hedges
in fulfillment of the contract, a
[BANKING ORGANIZATION] may align
the maturity of the default risk position
with the derivative contract it hedges to
permit full offsetting.
(B) A [BANKING ORGANIZATION]
may offset gross default exposures of
different maturities that meet the
offsetting criterion specified for the
default risk category as follows:
(1) Gross default exposures with
maturities longer than the one-year
capital horizon may be fully offset;
(2) Gross default exposures with a mix
of long and short exposures where some
maturities are less than the one-year
capital horizon must be weighted by the
ratio of each gross default exposure’s
maturity relative to the one-year capital
horizon. In the case where long and
short gross default exposures both have
maturities under the one-year capital
horizon, scaling must be applied to both
the long and short gross default
exposure.
(iv) Within a bucket, a [BANKING
ORGANIZATION] must:
(A) Calculate a hedge benefit ratio
(HBR) to recognize hedging between
long and short net default exposures
within a bucket as follows:
where,
(1) Net defulat exposure(long) equals
the aggregate net long default exposure,
calculated as the simple sum of the net
long default exposures across obligors;
(2) Net defulat exposure(short) equals
the aggregate net short default exposure,
calculated as the simple sum of the net
short default exposures across obligors.
(B) Assign risk weights to the obligorlevel net default exposures using the
corresponding risk weights specified for
the default risk category; and
(C) Generate bucket-level default risk
capital requirements by aggregating risk
weighted obligor-level net default
exposures according to the specified
aggregation formulas in paragraphs
(b)(3)(ii), (c)(3)(iii) and (d)(3)(iv) of this
section.
(v) The standardized default risk
capital requirement for nonsecuritization debt and equity positions
or securitization positions non-CTP
equals the sum of the bucket-level
default risk capital requirements. The
standardized default risk capital
requirement for correlation trading
positions must be calculated in
accordance with the aggregation formula
in paragraph (d)(3)(v) of this section.
(3) A [BANKING ORGANIZATION]
may not recognize any diversification
benefits across default risk categories.
The overall standardized default risk
capital requirement is the sum of the
default risk capital requirement for each
default risk category.
(4) For purposes of calculating the
standardized default risk capital
requirement, a [BANKING
ORGANIZATION] may apply the lookthrough approach to credit and equity
indices that are non-securitization debt
or equity positions.
(b) Standardized default risk capital
requirement for non-securitization debt
or equity positions—(1) Gross default
exposure. (i) A [BANKING
ORGANIZATION] must calculate the
gross default exposure for each nonsecuritization debt or equity position.
(ii) A [BANKING ORGANIZATION]
must determine the long and short
direction of a gross default exposure
with respect to whether there would be
a loss (long) or a gain (short) in the
event of a default.
(iii) A [BANKING ORGANIZATION]
must calculate the gross default
exposure based on the loss given default
(LGD) rate, notional amount (or face
value) and the cumulative profit and
loss (P&L) already realized on the nonsecuritization position, as follows:
Gross default exposure(long) = max((LGD
rate × notional amount + P&L), 0)
Gross default exposure(short) = min((LGD
rate × notional amount + P&L), 0)
(iv) When applying the look-through
approach to multi-underlying exposures
or index options, a [BANKING
ORGANIZATION] must set the gross
default exposure assigned to a single
name, referenced by the instrument,
equal to the difference between the
value of the instrument assuming only
the single name defaults (with zero
recovery) and the value of the
instrument assuming none of the single
names referenced by the instrument
default.
(v) A [BANKING ORGANIZATION]
must assign LGD rates to nonsecuritization debt or equity positions as
follows:
(A) 100 percent for equity and nonsenior debt and defaulted positions;
(B) 75 percent for senior debt;
(C) 75 percent for GSE debt issued,
but not guaranteed, by GSEs;
(D) 25 percent for GSE debt
guaranteed by GSEs;
(E) 25 percent for covered bonds; and
(F) Zero percent if the value of the
non-securitization debt or equity
position is not linked to the recovery
rate of the defaulter.
(vi) For credit derivatives, a
[BANKING ORGANIZATION] must use
the LGD rate of the reference exposure.
(vii) A [BANKING ORGANIZATION]
must reflect the notional amount of a
non-securitization debt or equity
position that gives rise to a long (short)
gross default exposure as a positive
(negative) value and the loss (gain) as a
negative (positive) value. If the
contractual or legal terms of the
derivative contract allow for the
unwinding of the instrument, with no
exposure to default risk, the gross
default exposure equals zero.
(viii) For all non-securitization debt or
equity positions, the notional amount
equals the amount of the nonsecuritization debt or equity position
relative to which the loss of principal is
calculated. For a call option on a nonsecuritization position, the notional
amount to be used in the gross default
exposure calculation is zero.
(2) Net default exposures. To
calculate the net default exposure to an
obligor, a [BANKING ORGANIZATION]
must sum the maturity-weighted default
exposures to the issuer and in doing so,
may offset long and short gross default
exposures to the same obligor, provided
the short gross default exposures have
the same or lower seniority relative to
the long gross default exposures. In
determining whether a market risk
covered position that has an eligible
guarantee is an exposure to the
underlying obligor or an exposure to the
eligible guarantor, the credit risk
mitigation requirements set out in
§ ll.36 and § ll.120 and § ll.121
apply. For purposes of this section,
GSEs may be considered eligible
guarantors and each GSE must be
considered a separate obligor, provided
that a [BANKING ORGANIZATION]
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(i) To calculate the standardized default
risk capital requirement for nonsecuritization debt or equity positions, a
[BANKING ORGANIZATION] must
assign each non-securitization debt or
equity position to one of four buckets:
(A) Non-U.S. sovereign positions;
(B) PSE and GSE debt positions;
where i refers to a non-securitization
debt or equity position belonging to
bucket b and the corresponding risk
weights, RWi, are set out in Table 1 of
this section:
(iii) The standardized default risk
capital requirement for nonsecuritization debt or equity positions
equals the sum of the four bucket-level
default risk capital requirements.
(c) Standardized default risk capital
requirement for securitization positions
non-CTP— (1) Gross default exposure.
(i) A [BANKING ORGANIZATION] must
determine the gross default exposure for
each securitization position non-CTP
using the approach for nonsecuritization debt or equity positions in
paragraphs (b)(1)(i), (ii), and (vi) of this
section, treating each securitization
position non-CTP as a nonsecuritization debt or equity position.
The gross default exposure for a
securitization position non-CTP equals
the position’s market value.
(2) Net default exposure. (i) A
[BANKING ORGANIZATION] may
offset long and short securitization
positions non-CTP if the positions have
the same underlying asset pools and
belong to the same tranche.
(ii) A [BANKING ORGANIZATION]
may offset long and short securitization
positions non-CTP with one or more
long and short non-securitization
positions by decomposing the exposures
of the non-tranched index instruments.
To recognize offsetting for securitization
positions non-CTP, a [BANKING
ORGANIZATION] must sum the
equivalent underlying assets of the
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(C) Corporate positions; and
(D) Defaulted positions.
(ii) A [BANKING ORGANIZATION]
must calculate the bucket-level default
risk capital requirement, DRCb, for each
bucket, b, for non-securitization debt or
equity positions as follows:
decomposed non-tranche index
instruments to the equivalent
replicating tranches that span the entire
capital structure of the securitized
instrument. Non-securitization positions
that are recognized as offsetting in this
way must be excluded from the
calculation of the standardized default
risk capital requirement for nonsecuritization debt or equity positions
under paragraph (b) of this section.
(iii) Securitization positions non-CTP
that can be replicated through
decomposition may offset. Specifically,
if a collection of long securitization
positions non-CTP can be replicated by
a collection of short securitization
positions non-CTP, then the long and
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may fully offset long and short gross
default exposures to Uniform MortgageBacked Securities that are issued by two
different obligors.
(3) Calculation of the standardized
default risk capital requirement for nonsecuritization debt or equity positions.
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short securitization positions non-CTP
may offset.
(3) Calculation of the standardized
default risk capital requirement for
securitization positions non-CTP. (i) To
calculate the standardized default risk
capital requirement for securitization
positions non-CTP, a [BANKING
ORGANIZATION] must assign each
securitization position non-CTP to one
of the following buckets:
(A) Corporate positions;
(B) Asset class buckets defined along
two dimensions:
(1) Asset class: asset-backed
commercial paper, auto loans/leases,
RMBS, credit cards, commercial
mortgage-backed securities,
collateralized loan obligations,
collateralized debt obligations squared,
small and medium enterprises, student
loans, other retail, and other wholesale;
and
(2) Region: Asia, Europe, North
America, and other.
(ii) When assigning securitization
positions non-CTP to a bucket, a
[BANKING ORGANIZATION] must rely
on market convention for classifying
securitization positions non-CTP by
asset class and region of the underlying
assets. In addition, a [BANKING
ORGANIZATION] must assign:
(A) Each securitization position nonCTP to exactly one bucket and must
assign all securitization positions nonCTP with underlying exposures in the
same asset class and region to the same
bucket;
(B) Any securitization position nonCTP that is not a corporate position and
that a [BANKING ORGANIZATION]
cannot assign to a specific asset class or
region, must be assigned to one of the
‘‘other’’ buckets.
(iii) A [BANKING ORGANIZATION]
must calculate the bucket-level default
risk capital requirement, DRCb, for each
bucket, b, for securitization positions
non-CTP as follows:
where,
(A) i refers to a securitization position
non-CTP belonging to bucket b;
(B) HBR equals the hedge benefit ratio
specified in paragraph (a)(2)(iv)(A) of
this section; and
(C) RWi equals:
(1) For the calculation of Expanded
Total Risk-Weighted Assets, the
corresponding risk weight that would
apply to the securitization exposure
under § ll.132 or § ll.133
multiplied by 8 percent; or
(2) For the calculation of
Standardized Total Risk-Weighted
Assets, the corresponding risk weight
that would apply to the securitization
exposure under § ll. 42, § ll.43, or
§ ll.44 multiplied by 8 percent.
(3) Provided that a [BANKING
ORGANIZATION] may cap the
standardized default risk capital
requirement for an individual cash
securitization position non-CTP at its
fair value.
(iv) The standardized default risk
capital requirement for securitization
positions non-CTP equals the sum of the
bucket-level default risk capital
requirements.
(d) Standardized default risk capital
requirement for correlation trading
positions—(1) Gross default exposure.
(i) A [BANKING ORGANIZATION] must
determine the gross default exposure for
each correlation trading position using
the approach for non-securitization debt
or equity positions in paragraphs
(b)(1)(i), (ii), and (vi) of this section,
including the determination of the
direction (long or short) of the
correlation trading position, provided
that the gross default exposure for a
correlation trading position is its market
value.
(ii) A [BANKING ORGANIZATION]
must treat a Nth-to-default position as a
tranched position with attachment and
detachment points calculated as:
where ‘‘total names’’ is the total number
of single names in the underlying basket
or pool.
(2) Net default exposure. (i) A
[BANKING ORGANIZATION] may
recognize offsetting for correlation
trading positions that are otherwise
identical, except for maturity, including
index tranches of the same series.
(ii) A [BANKING ORGANIZATION]
may offset combinations of long gross
default exposures and combinations of
short gross default exposures of tranches
that are perfect replications of nontranched correlation trading positions.
(iii) A [BANKING ORGANIZATION]
may offset long and short gross default
exposures of the types of exposures
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listed in paragraphs (d)(2)(i) and (ii)
through decomposition, provided that
the long and short gross default
exposures are otherwise equivalent
except for a residual component and
that a [BANKING ORGANIZATION]
must account for the residual exposure
in the calculation of the net default
exposure.
(iv) A [BANKING ORGANIZATION]
may offset long and short gross default
exposures of different tranches of the
same index and series through
replication and decomposition, if the
residual component has the attachment
and detachment point nested with the
original tranche or the combination of
tranches. A [BANKING
ORGANIZATION] must account for the
residual component of the unhedged
tranche.
(3) Calculation of the standardized
default risk capital requirement for
correlation trading positions. (i) To
calculate the default risk capital
requirement for a correlation trading
position, a [BANKING
ORGANIZATION] must assign each
index to a bucket of its own.
(ii) A [BANKING ORGANIZATION]
must assign a bespoke correlation
trading position that is substantially
similar to an index to the bucket
corresponding to the index. A
[BANKING ORGANIZATION] must
assign each bespoke correlation trading
position that is not substantially similar
to an index to a bucket of its own.
(iii) For a non-securitization position
that hedges a correlation trading
position, a [BANKING
ORGANIZATION] must assign such
position and the related correlation
trading position to the same bucket.
(iv) A [BANKING ORGANIZATION]
must calculate the bucket-level default
risk capital requirement, DRCb, for each
bucket, b, for correlation trading
positions as follows:
where,
(A) i refers to a correlation trading
position belonging to bucket b.
(B) HBRCTP equals the hedge benefit
ratio specified in paragraph (a)(2)(iv)(A)
of this section, but calculated using the
combined long and short net default
exposures across all indices in the
correlation trading position default risk
category.
(C) The summation of risk-weighted
net default exposures in the formula
spans all exposures relating to the
index.
(D) RWi equals:
(1) For tranched correlation trading
positions:
(i) For the calculation of Expanded
Total Risk-Weighted Assets, the
corresponding risk weight that would
apply to the securitization exposure
under § ll.132 or § ll.133
multiplied by 8 percent; or
(ii) For the calculation of
Standardized Total Risk-Weighted
Assets, the corresponding risk weight
that would apply to the securitization
exposure under § ll. 42, § ll.43, or
§ ll.44 multiplied by 8 percent.
(2) For non-tranched hedges of
correlation trading positions, the same
risk weights as for non-securitization
debt or equity positions, provided that
such hedges must be excluded from the
calculation of the standardized default
risk capital requirement for nonsecuritization debt or equity positions.
(v) A [BANKING ORGANIZATION]
must calculate the standardized default
risk capital requirement for correlation
trading positions by aggregating the
bucket-level capital requirements as
follows:
§ ll.211
covered positions without optionality
that a [BANKING ORGANIZATION]
chooses to include in the calculation of
its curvature capital requirement as
described under § ll.206(d)) or the
vega capital requirements and have payoffs that cannot be replicated as a finite
linear combination of vanilla options or
the underlying instrument;
(iii) Options or positions with
embedded options that do not have a
maturity; and
(iv) Options or positions with
embedded options that do not have a
strike price or barrier, or that have
multiple strike prices or barriers.
(3) Any other market risk covered
positions that the [AGENCY] determines
must be subject to the residual risk addon in order to capture the material risks
of the position.
(4) Notwithstanding paragraph (a)(2)
of this section, a [BANKING
ORGANIZATION] may exclude the
following market risk covered positions
from the residual risk add-on:
(i) Market risk covered position that
are listed;
(ii) Market risk covered position that
are eligible to be cleared by a CCP or
QCCP; and
Residual risk add-on.
(a) A [BANKING ORGANIZATION]
must calculate the residual risk add-on
for all market risk covered positions
identified as follows:
(1) Market risk covered positions that
have an exotic exposure.
(2) Market risk covered positions that
are:
(i) Correlation trading positions with
three or more underlying exposures,
except for market risk covered positions
that are hedges of correlation trading
positions;
(ii) Subject to the curvature capital
requirement (excluding any market risk
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(iii) Market risk covered position that
are options without path dependent
pay-offs or with two or fewer
underlyings.
(5) Notwithstanding paragraphs (a)(1)
and (2) of this section, a [BANKING
ORGANIZATION] may exclude the
following market risk covered positions
from the residual risk add-on:
(i) In the case where a market risk
covered position is a transaction that
exactly matches that with a third-party
transaction (back-to-back transactions),
both transactions;
(ii) In the case where a market risk
covered position can be delivered into
a derivative contract that it hedges in
fulfillment of the contract, both the
market risk covered position and the
derivative contract;
(iii) Securities issued or guaranteed by
the U.S. government or GSE debt;
(iv) Any market risk covered position
that is subject to the fallback capital
requirement;
(v) Internal transactions between two
trading desks, if only one trading desk
is a model-eligible trading desk; and
(vi) Any other market risk covered
positions that the [AGENCY] determines
are not required to be subject to the
residual risk add-on because the
material risks are sufficiently
capitalized under this subpart F.
(b) Calculation of the residual risk
add-on. (1) The residual risk add-on
equals the sum of the gross effective
notional amounts of market risk covered
positions identified in paragraph (a) of
this section, multiplied by the
prescribed risk weight as set out as
follows:
(i) The risk weight for market risk
covered positions identified in
paragraph (a)(1) of this section is 1.0
percent.
(ii) The risk weight for market risk
covered positions identified in
paragraph (a)(2) of this section is 0.1
percent.
(2) For purposes of calculating the
residual risk add-on, the gross effective
notional amount means the notional
amount as a [BANKING
ORGANIZATION] reports in the most
recent Call Report or FR Y–9C.
Internal Models Approach
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§ ll.212 Operational requirements for
the models-based measure for market risk.
(a) General requirements. In order to
calculate the models-based measure for
market risk, a [BANKING
ORGANIZATION] must:
(1) Have at least one model-eligible
trading desk; and
(2) Receive prior written approval
from the [AGENCY] of the [BANKING
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ORGANIZATION]’s trading desk
structure.
(b) Trading desk identification and
approval process—(1) Identification of
trading desks. A [BANKING
ORGANIZATION] must identify a
trading desk for which the [BANKING
ORGANIZATION] will seek approval to
be a model-eligible trading desk and in
making this identification must:
(i) Consider whether having the
trading desk be a model-eligible trading
desk would better reflect the market risk
of the market risk covered positions on
the trading desk;
(ii) Exclude any trading desk that
includes more than de minimis amounts
of securitization positions or correlation
trading positions; and
(iii) For any trading desk that includes
de minimis amounts of securitization
positions or correlation trading
positions:
(A) Subject securitization positions
and correlation trading positions to the
capital add-ons for ineligible positions
on model-eligible trading desks under
§ ll.204(f);
(B) Not consider securitization
positions and correlation trading
positions on model-eligible trading
desks to be market risk covered
positions on a model-eligible trading
desk; and
(C) Exclude securitization positions
and correlation trading positions on
model-eligible trading desks from
aggregate trading portfolio backtesting,
under § ll.204(g), and the relevant
trading desks’ backtesting and PLAtesting, under § ll.213, unless the
[BANKING ORGANIZATION] receives
approval from the [AGENCY] to include
such positions for backtesting and PLAtesting purposes.
(2) Approval process for trading
desks. A [BANKING ORGANIZATION]
must receive prior written approval of
the [AGENCY] for a trading desk to be
a model-eligible trading desk. To receive
such approval, a [BANKING
ORGANIZATION] must:
(i) Receive approval by [AGENCY] of
the internal models to be used by the
trading desk pursuant to § ll.212(c);
and
(ii) Comply with one of the following:
(A) Provide at least 250 business days
of trading desk level backtesting and
PLA test results for the trading desk to
the [AGENCY];
(B) Provide at least 125 business days
of trading desk level backtesting and
PLA test results for the trading desk to
the [AGENCY] and demonstrate to the
satisfaction of the [AGENCY] that the
internal models will be able to meet the
backtesting and PLA testing on an
ongoing basis;
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(C) Demonstrate that the trading desk
consists of similar market risk covered
positions to another trading desk of the
[BANKING ORGANIZATION], which
has been approved by the [AGENCY]
and has provided at least 250 business
days of trading desk level backtesting
and PLA test results to the [AGENCY];
or
(D) Subject the trading desk to the
PLA add-on until the trading desk
provides at least 250 business days of
trading desk-level backtesting and PLA
test results, produces results in the PLA
test green zone, and passes trading desklevel backtesting.
(3) Changes to trading desk structure.
(i) A [BANKING ORGANIZATION] must
receive prior written approval from the
[AGENCY] before the [BANKING
ORGANIZATION] implements any
change to its trading desk structure that
would result in a material change in the
[BANKING ORGANIZATION]’s market
risk capital requirement for a portfolio
of market risk covered positions.
(ii) A [BANKING ORGANIZATION]
must promptly notify the [AGENCY]
when the [BANKING ORGANIZATION]
makes any change to its trading desk
structure that would result in a nonmaterial change in the [BANKING
ORGANIZATION]’s market risk capital
requirement for a portfolio of market
risk covered positions.
(4) The [AGENCY] may rescind its
approval of a model-eligible trading
desk or subject such trading desk to the
PLA add-on if the [AGENCY]
determines that the trading desk no
longer complies with any of the
applicable requirements of this subpart
F, provided that the trading desk may
not be subjected to the PLA add-on if
the approval for a stressed expected
shortfall methodology used by the
trading desk was rescinded. A modeleligible trading desk that becomes
subject to the PLA add-on under this
paragraph (b)(4) shall remain subject to
the PLA add-on until the [AGENCY]
determines that the trading desk is no
longer subject to the PLA add-on under
this paragraph (b)(4).
(c) Approval of internal models and
stressed expected shortfall
methodologies—(1) Initial approval. A
[BANKING ORGANIZATION] must
receive prior written approval of the
[AGENCY] to use an internal model for
the ES-based measure in § ll.215(b),
and the stressed expected shortfall
methodologies. To receive [AGENCY]
approval of an internal model or
methodology, a [BANKING
ORGANIZATION] must demonstrate:
(i) The internal model properly
measures all the material risks of the
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market risk covered positions to which
it is applied;
(ii) The internal model has been
properly validated, consistent with
paragraph (d)(3) of this section;
(iii) The level of sophistication of the
internal model or methodology is
commensurate with the complexity and
amount of its market risk covered
positions; and
(iv) The internal model or
methodology meets the applicable
requirements of this subpart F.
(2) Changes to internal models. (i) A
[BANKING ORGANIZATION] must
receive prior written approval from the
[AGENCY] before the [BANKING
ORGANIZATION] implements any
change to an approved model, including
any change to its modelling
assumptions, that would result in a
material change in the [BANKING
ORGANIZATION]’s IMCC for a trading
desk.
(ii) A [BANKING ORGANIZATION]
must promptly notify the [AGENCY]
when the [BANKING ORGANIZATION]
makes any change to an approved
model, including any change to its
modelling assumptions, that would
result in a non-material change in the
[BANKING ORGANIZATION]’s IMCC
for a trading desk.
(3) If the [AGENCY] determines that
the [BANKING ORGANIZATION] no
longer complies with this subpart F or
that the [BANKING ORGANIZATION]’s
internal models or methodologies fail to
accurately reflect the risks of any of the
[BANKING ORGANIZATION]’s market
risk covered positions, the [AGENCY]
may rescind its approval of an internal
model or methodology previously
approved under paragraph (c)(1) of this
section, or impose the PLA add-on on
the trading desk using the internal
model for the ES-based measure
pursuant to paragraph (b)(4) of this
section. When approval for an internal
model or methodology is rescinded, any
trading desk that had used that internal
model or methodology must be a modelineligible trading desk.
(d) Review, risk management, and
validation. (1) A [BANKING
ORGANIZATION] must, no less
frequently than annually, review its
internal models in light of
developments in financial markets and
modeling technologies, and enhance
those internal models as appropriate to
ensure that they continue to meet the
[AGENCY]’s standards for model
approval and employ risk measurement
methodologies that are the most
appropriate for the [BANKING
ORGANIZATION]’s market risk covered
positions.
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(2) A [BANKING ORGANIZATION]
must integrate the internal models used
for calculating the ES-based measure in
§ ll.215(b) into its daily risk
management process.
(3) A [BANKING ORGANIZATION]
must validate its internal models
initially and on an ongoing basis. A
[BANKING ORGANIZATION] must
revalidate its internal models when it
makes any material changes to the
models or when there have been
significant structural changes in the
market or changes in the composition of
the [BANKING ORGANIZATION]’s
market risk covered positions that might
lead to the [BANKING
ORGANIZATION]’s internal models to
be no longer adequate. The [BANKING
ORGANIZATION]’s validation process
must be independent of the internal
models’ development, implementation,
and operation, or the validation process
must be subjected to an independent
review of its adequacy and
effectiveness. Validation must include:
(i) An evaluation of the conceptual
soundness of the internal models;
(ii) An evaluation that the internal
models adequately reflect all material
risks and that assumptions are
appropriate and do not underestimate
risk;
(iii) An ongoing monitoring process
that includes verification of processes
and the comparison of the [BANKING
ORGANIZATION]’s model outputs with
relevant internal and external data
sources or estimation techniques;
(iv) An outcomes analysis process that
includes backtesting and PLA testing at
the trading desk level; and
(v) Backtesting conducted at the
aggregate level for all model-eligible
trading desks.
(e) Supervisory action for modeleligible trading desks. If required by the
[AGENCY], a [BANKING
ORGANIZATION] that has one or more
model-eligible trading desks must
calculate the standardized measure for
market risk for each model-eligible
trading desk as if that trading desk were
a standalone regulatory portfolio. For
each such model-eligible trading desk,
the [BANKING ORGANIZATION] must
sum the risk class-level capital
requirements for each risk class under
each correlation scenario as described in
§ ll.206. For each such model-eligible
trading desk, the sensitivities-based
capital requirement equals the largest
capital requirement produced under the
three correlation scenarios for the
trading desk.
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§ ll.213 Trading desk level backtesting
and PLA testing.
(a) A model-eligible trading desk must
conduct backtesting as described in
paragraph (b) of this section and PLA
testing as described in paragraph (c) of
this section at the trading desk level on
a quarterly basis.
(b) Trading desk level backtesting
requirements. (1) Beginning on the
business day a trading desk becomes a
model-eligible trading desk, the
[BANKING ORGANIZATION] must
generate backtesting data by separately
comparing each business day’s actual
profit and loss and hypothetical profit
and loss with the corresponding VaRbased measure calculated by the
[BANKING ORGANIZATION]’s internal
models for that business day, at both the
97.5th percentile and the 99.0th
percentile one-tail confidence levels at
the trading desk level.
(i) An exception for actual profit and
loss at either percentile occurs when the
actual loss of the model-eligible trading
desk exceeds the corresponding VaRbased measure calculated at that
percentile. An exception for
hypothetical profit and loss at either
percentile occurs when the hypothetical
loss of the model-eligible trading desk
exceeds the corresponding VaR-based
measure calculated at that percentile.
(ii) If either the business day’s actual
or hypothetical profit and loss is not
available or the [BANKING
ORGANIZATION] is unable to compute
the business day’s actual or hypothetical
profit and loss, an exception for actual
profit and loss or for hypothetical profit
and loss, respectively, at each percentile
occurs. If the VaR-based measure for a
business day is not available or the
[BANKING ORGANIZATION] is unable
to compute the VaR-based measure for
a particular business day, exceptions for
actual profit and loss and for
hypothetical profit and loss at each
percentile occur. No exception will
occur if the unavailability or inability is
related to an official holiday.
(iii) With approval of the [AGENCY],
a [BANKING ORGANIZATION] may
consider an exception not to have
occurred if:
(A) The [BANKING ORGANIZATION]
can demonstrate that the exception is
due to technical issues that are
unrelated to the [BANKING
ORGANIZATION]’s internal models; or
(B) The [BANKING ORGANIZATION]
can demonstrate that one or more nonmodellable risk factors caused the
relevant loss, and the capital
requirement for these non-modellable
risk factors exceeds the difference
between the [BANKING
ORGANIZATION]’s VaR-based measure
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and the actual or hypothetical loss for
that business day.
(2) In order to conduct backtesting, a
[BANKING ORGANIZATION] must
count the number of exceptions over the
most recent 250 business days. A
[BANKING ORGANIZATION] must
count exceptions for actual profit and
loss at each percentile separately from
exceptions for hypothetical profit and
loss.
(3) If any given model-eligible trading
desk experiences either more than 12
exceptions for actual profit and loss or
12 exceptions for hypothetical profit
and loss at the 99.0th percentile or 30
exceptions for actual profit and loss or
30 exceptions for hypothetical profit
and loss at the 97.5th percentile in the
most recent 250 business day period,
then the trading desk becomes, upon the
completion of the [AGENCY]’s quarterly
review of the relevant backtesting data,
a model-ineligible trading desk.
(4) Notwithstanding paragraphs (b)(2)
and (3) of this section, in cases where
a model-eligible trading desk is
approved pursuant to
§ ll.212(b)(2)(ii)(B), (C) or (D):
(i) The model-eligible trading desk
that has fewer than 250 business days of
backtesting data available must use all
available backtesting data; and
(ii) The [BANKING ORGANIZATION]
must prorate the number of allowable
exceptions under paragraph (b)(3) of
this section by the number of business
days for which backtesting data are
available for the model-eligible trading
desk.
(5) A trading desk that becomes a
model-ineligible trading desk under
paragraph (b)(3) of this section becomes
a model-eligible trading desk when:
(i) The trading desk produces results
in the PLA test green zone or PLA test
amber zone and the trading desk
experiences less than or equal to 12
exceptions for actual profit and loss and
12 exceptions for hypothetical profit
and loss at the 99.0th percentile and 30
exceptions for actual profit and loss and
30 exceptions for hypothetical profit
and loss at the 97.5th percentile in the
most recent 250 business day period; or
(ii) The [BANKING ORGANIZATION]
receives approval of the [AGENCY].
(c) Trading desk level PLA test
requirements—(1) General
requirements. At the trading desk level,
the [BANKING ORGANIZATION] must
compare each of its most recent 250
business days’ hypothetical profit and
loss with the corresponding daily risktheoretical profit and loss. Time effects
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must be treated in a consistent manner
in the hypothetical profit and loss and
the risk-theoretical profit and loss.
(i) For the purpose of PLA testing, the
[BANKING ORGANIZATION] may align
risk-theoretical profit and loss input
data for its risk factors with the data
used in hypothetical profit and loss,
where the [BANKING ORGANIZATION]
is able to demonstrate that hypothetical
profit and loss input data can be used
appropriately for risk-theoretical profit
and loss purposes.
(ii) The [BANKING ORGANIZATION]
may adjust risk-theoretical profit and
loss input data when the input data for
a given risk factor that is included in
both the risk-theoretical profit and loss
and the hypothetical profit and loss
differs due to different market data
sources, time fixing of market data
sources, or transformations of market
data into input data suitable for the risk
factors of the underlying valuation
engines. When transforming input data
into a format that can be applied to the
risk factors used in internal risk
management models, the [BANKING
ORGANIZATION] must demonstrate
that no differences in the risk factors or
in the valuation models have been
omitted.
(iii) The [BANKING
ORGANIZATION] must be able to assess
the effect that input data alignments
would have on the risk-theoretical profit
and loss. The [BANKING
ORGANIZATION] must be able to
compare the risk-theoretical profit and
loss based on the hypothetical profit
and loss aligned market data with the
risk-theoretical profit and loss based on
market data without alignment. This
comparison must be performed when
designing or changing the input data
alignment process or at the request of
the [AGENCY].
(2) PLA test metrics. (i) A [BANKING
ORGANIZATION] must calculate each
metric in this paragraph (c)(2) at the
trading desk level, using the most recent
250 business days of the risk-theoretical
profit and loss and the hypothetical
profit and loss.
(ii) Spearman correlation metric. The
Spearman correlation metric assesses
the correlation between the risktheoretical profit and loss and the
hypothetical profit and loss.
(A) For a time series of hypothetical
profit and loss, a [BANKING
ORGANIZATION] must compute the
rank order, RHPL, of the hypothetical
profit and loss based on the size, where
the lowest value in the hypothetical
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profit and loss time series receives a
rank of 1, and the next lowest value
receives a rank of 2 and so on.
(B) Similarly, a [BANKING
ORGANIZATION] must compute the
rank order, RRTPL, of the time series of
the risk-theoretical profit and loss.
(C) A [BANKING ORGANIZATION]
must calculate the Spearman correlation
metric for the two rank orders, RHPL and
RRTPL, as follows:
Where cov(RHPL, RRTPL) is the covariance
between RHPL and RRTPL and σRHPL and
σRTPL are the standard deviations of rank
orders RHPL and RRTPL, respectively.
(iii) Kolmogorov-Smirnov metric. The
Kolmogorov-Smirnov metric assesses
the similarity of the distributions of the
risk-theoretical profit and loss and the
hypothetical profit and loss.
(A) A [BANKING ORGANIZATION]
must calculate the empirical cumulative
distribution function of the risktheoretical profit and loss where, for any
value of risk-theoretical profit and loss,
the empirical cumulative distribution is
the product of 0.004 and the number of
risk-theoretical profit and loss
observations that are less than or equal
to the specified risk-theoretical profit
and loss.
(B) A [BANKING ORGANIZATION]
must calculate the empirical cumulative
distribution function of hypothetical
profit and loss where, for any value of
hypothetical profit and loss, the
empirical cumulative distribution is the
product of 0.004 and the number of
hypothetical profit and loss
observations that are less than or equal
to the specified hypothetical profit and
loss.
(C) A [BANKING ORGANIZATION]
must calculate the Kolmogorov-Smirnov
metric as the largest absolute difference
observed between these two empirical
cumulative distribution functions at any
profit and loss value.
(3) PLA test metrics evaluation. (i) A
[BANKING ORGANIZATION] must
identify the PLA test zone of the trading
desk’s PLA test results as set out in
Table 1 of this section, provided that if
either metric is in the red zone, the PLA
test zone must be identified as red, and
if one metric is in the amber zone and
one in the green zone, the PLA test zone
must be identified as amber.
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(ii) Notwithstanding paragraph
(c)(3)(i) of this section, the [AGENCY]
may determine that a [BANKING
ORGANIZATION] must identify the
PLA test zone of a trading desk’s PLA
test results as a different PLA test zone.
(iii) Upon the completion of the
quarterly review of the relevant PLA test
data, a trading desk that produces
results in the PLA test amber zone,
pursuant to paragraph (c)(3)(i) or
(c)(3)(ii) of this section, is subject to the
PLA add-on.
(iv) Upon the completion of the
quarterly review of the relevant PLA test
data, a trading desk that produces
results in the PLA test red zone,
pursuant to paragraph (c)(3)(i) or
(c)(3)(ii) of this section, is a modelineligible trading desk.
(v) A trading desk that becomes a
model-ineligible trading desk under
paragraph (c)(3)(iv) of this section will
become a model-eligible trading desk
when:
(A) The trading desk produces results
in the PLA test green zone or PLA test
amber zone; and in the most recent 250
business day period, the trading desk
experiences less than or equal to 12
backtesting exceptions for actual profit
and loss and 12 exceptions for
hypothetical profit and loss at the 99.0th
percentile or less than or equal to 30
backtesting exceptions for actual profit
and loss and 30 backtesting exceptions
for hypothetical profit and loss at the
97.5th percentile; or
(B) The [BANKING ORGANIZATION]
receives approval of the [AGENCY].
(4) PLA add-on. The PLA add-on, if
required under paragraph (c)(3)(iii) of
this section, § ll.212(b)(2)(ii)(D), or
§ ll.212(b)(4), equals:
PLA add-on = k × max ((SAG,A¥IMAG,A),
0)
where,
(A) SAi denotes the standardized
approach capital requirement for market
risk covered positions on trading desk,
i;
(B) Si∈ASAi equals the sum of the
standardized approach capital
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requirement, calculated separately, for
each trading desk i that is subject to the
PLA add-on; and
(C) Si∈G,ASAi equals the sum of the
standardized approach capital
requirement, calculated separately, for
each model-eligible trading desk i
(including trading desks subject to the
PLA add-on).
§ ll.214 Risk factor identification and
model eligibility.
(a) Identification of risk factors. A
[BANKING ORGANIZATION] must
identify an appropriate set of risk factors
to be used for purposes of calculating
the aggregate capital measure for
modellable risk factors, IMCC, and the
aggregate capital measure for nonmodellable risk factors, SES, subject to
the requirements below:
(1) The set of risk factors must be
sufficient to represent the risks inherent
in the market risk covered positions
held by model-eligible trading desks;
(2) The [BANKING ORGANIZATION]
must include all risk factors included in
the [BANKING ORGANIZATION]’s
internal risk management models or
models used in reporting actual profits
and losses; and
(3) The [BANKING ORGANIZATION]
must include all risk factors that are
specified in § ll.208 for each
corresponding risk class. In the event
the [BANKING ORGANIZATION] does
not incorporate all such risk factors, the
[BANKING ORGANIZATION] must be
able to support this omission to the
satisfaction of the [AGENCY].
(b) Model eligibility of risk factors. A
[BANKING ORGANIZATION] that
calculates the models-based measure for
market risk must determine which risk
factors are modellable using the risk
factor eligibility test described in
paragraph (b)(1) of this section. If the
[AGENCY] determines that a risk factor
is non-modellable, then a [BANKING
ORGANIZATION] must not consider
that risk factor as modellable. The
[BANKING ORGANIZATION] must
calculate its market risk capital
requirements for modellable risk factors
using the ES-based measure in
§ ll.215(b) and must calculate its
market risk capital requirements for
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non-modellable risk factors using
stressed expected shortfall
methodologies in accordance with
§ ll.215(d).
(1) Risk factor eligibility test. For a
risk factor to be classified as modellable,
a [BANKING ORGANIZATION] must
identify a sufficient number of real
prices, as specified in this paragraph
(b)(1), that are representative of the risk
factor. A real price is representative of
a risk factor provided it can be used by
the [BANKING ORGANIZATION] to
inform the value of the risk factor. For
contracts that reference new reference
rates to replace discontinued reference
rates, [BANKING ORGANIZATIONS]
are permitted to use discontinued
reference rate quotes to pass the risk
factor eligibility test until new reference
rate liquidity improves. For any market
risk covered position, the [BANKING
ORGANIZATION] must not count more
than one real price observation in a
single day and the real price that the
[BANKING ORGANIZATION] observes
must be counted as an observation for
all of the risk factors for which it is
representative. In addition, for new
issuances, the observation period for the
risk factor eligibility test may begin on
the issuance date and the number of real
price observations required to pass the
risk factor eligibility test may be
prorated until 12 months after the
issuance date. To pass the risk factor
eligibility test, a risk factor must meet
either of the following criteria, on a
quarterly basis.
(i) The [BANKING ORGANIZATION]
must identify at least 24 real price
observations in the previous 12-month
period for the risk factor, and there must
be no 90-day period in the previous 12month period in which fewer than four
real price observations are identified for
the risk factor; or
(ii) The [BANKING ORGANIZATION]
must identify at least 100 real price
observations for the risk factor over the
previous 12-month period.
(2) When one or more actual
transactions between arm’s-length
parties occurred on a specific date, only
one real price may be counted.
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(3) When a [BANKING
ORGANIZATION] uses real prices from
a third-party provider:
(i) The third-party provider must
provide a minimum necessary set of
identifier information to enable the
[BANKING ORGANIZATION] to map
real prices observed to risk factors;
(ii) The third-party provider must be
subject to an audit regarding the validity
of its pricing information and the results
and reports of this audit must be made
public or available on request to the
[BANKING ORGANIZATION], provided
that if the audit of a third-party provider
is not satisfactory to the [AGENCY], the
data from the third-party provider may
not be used for purposes of the risk
factor eligibility test; and
(iii) When the real price observations
are provided with a time lag, the period
used for the risk factor eligibility test
may differ from the period used to
calibrate the [BANKING
ORGANIZATION]’s ES-based measure,
provided that the difference is no
greater than one month.
(4) When a [BANKING
ORGANIZATION] uses real prices from
internal sources, the period used for the
risk factor eligibility test may also differ
from the period used to calibrate the
[BANKING ORGANIZATION]’s ESbased measure, as long as the period
used for internal data is exactly the
same as the period used for external
data.
(5) Bucketing approaches. For the risk
factor eligibility test, a [BANKING
ORGANIZATION] must allocate each
real price observation into one bucket
for a risk factor and must count all real
price observations allocated to a bucket
in order to establish whether the risk
factors in the bucket pass the risk factor
eligibility test. To allocate real price
observations into buckets, the
[BANKING ORGANIZATION] must
group risk factors on a curve or surface
level. Each bucket may be defined by
using either of the bucketing approaches
specified in this paragraph (b)(5).
(i) Own bucketing approach. Under
this approach, each bucket must include
only one risk factor. Each risk factor
must correspond to a risk factor
included in the risk-theoretical profit
and loss of the [BANKING
ORGANIZATION]. Real price
observations may be mapped to more
than one risk factor.
(ii) Standard bucketing approach.
Under this approach, the [BANKING
ORGANIZATION] must use the
standard buckets as set out as follows:
(A) For interest rate, foreign exchange
and commodity risk factors with a
single maturity dimension (excluding
implied volatilities), (t, where t is
measured in years), the buckets
corresponding to the t values in row (A)
of Table 1 of this section must be used.
(B) For interest rate, foreign exchange
and commodity risk factors with several
maturity dimensions (excluding implied
volatilities) (t, where t is measured in
years), the buckets corresponding to the
t values in row (B) of Table 1 of this
section must be used.
(C) Credit spread and equity risk
factors with one or several maturity
dimensions (excluding implied
volatilities) (t, where t is measured in
years), the buckets corresponding to the
t values in row (C) of Table 1 of this
section must be used.
(D) For any risk factors with one or
several strike dimensions (the
probability that an option is ‘‘in the
money’’ at maturity, δ), the buckets
corresponding to the δ values in row (D)
of Table 1 of this section must be used.
(E) For expiry and strike dimensions
of implied volatility risk factors
(excluding those of interest rate
swaptions), only the buckets
corresponding to the t or δ values in
rows (C) and (D), respectively, of Table
1 of this section must be used.
(F) For maturity, expiry and strike
dimensions of implied volatility risk
factors from options on swaps, only the
buckets corresponding to the t or δ
values in row (B), (C) and (D),
respectively, of Table 1 of this section
must be used.
(G) For options markets where
alternative definitions of moneyness are
customary, a [BANKING
ORGANIZATION] must convert the
standard buckets to the market-standard
convention using the [BANKING
ORGANIZATION]’s own pricing
models.
(iii) For purposes of the risk factor
eligibility test, a real price observation
must be counted in a single bucket
based on the maturity or based on the
probability that an option is ‘‘in the
money’’ at maturity associated with the
position. Real price observations that
have been identified within the prior 12
months may be counted in the maturity
bucket to which they were initially
allocated. Alternatively, a [BANKING
ORGANIZATION] may re-allocate these
real price observations to the shorter
maturity bucket that reflects the market
risk covered position’s remaining
maturity.
(iv) A [BANKING ORGANIZATION]
may decompose risks associated with
credit or equity indices into systematic
risk factors within its internal models
designed to capture market-wide
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movements for a given economy, region
or sector. A [BANKING
ORGANIZATION] may include
idiosyncratic risk factors of specific
issuers provided there are a sufficient
number of real price observations to
pass the risk factor eligibility test.
(6) Calibration. The [BANKING
ORGANIZATION] must choose the most
appropriate data for modellable risk
factors to calibrate the ES-based
measure. For the calibration, the
[BANKING ORGANIZATION] may use
different data than the data used to pass
the risk factor eligibility test.
(7) Data for modellable risk factors. In
order to determine the data used to
calibrate the ES-based measure, a
[BANKING ORGANIZATION] must
comply with this paragraph (b)(7). In
cases where a risk factor has passed the
risk factor eligibility test, but the related
data does not comply with this
paragraph (b)(7), such risk factor must
be treated as a non-modellable risk
factor.
(i) The data used may include
combinations of modellable risk factors.
(ii) The data must allow the internal
models used to calculate the ES-based
measure to capture both idiosyncratic
risk and systematic risk, if applicable.
(iii) The data must allow the internal
models used to calculate the ES-based
measure to reflect volatility and
correlation of risk factors of market risk
covered positions.
(iv) The data must be reflective of
prices observed or quoted in the market.
Where data used are not derived from
real price observations, the [BANKING
ORGANIZATION] must be able to
demonstrate that the data used are
reasonably representative of real price
observations.
(v) The data must be updated at a
sufficient frequency, and at a minimum
on a weekly basis. Where the
[BANKING ORGANIZATION] uses
regressions to estimate risk factor
parameters, these must be re-estimated
on a regular basis. The [BANKING
ORGANIZATION] must have clear
policies and procedures for backfilling
and gap-filling missing data.
(vi) The data to determine the
liquidity horizon-adjusted ES-based
measure must be reflective of market
prices observed or quoted in the period
of stress. The data should be sourced
directly from the historical period
whenever possible. The [BANKING
ORGANIZATION] must empirically
justify any instances where the market
prices used in the period of stress are
different from the market prices actually
observed during that period. In cases
where market risk covered positions
that are currently traded did not exist
during a period of significant financial
stress, the [BANKING ORGANIZATION]
must demonstrate that the prices used
match changes in prices or spreads of
similar instruments during the stress
period.
(vii) The data may include proxies
provided the [BANKING
ORGANIZATION] can demonstrate to
the satisfaction of the [AGENCY] that
the proxies are appropriate and that the
following standards are satisfied:
(A) There is sufficient evidence
demonstrating the appropriateness of
the proxies, such as an appropriate track
record for their representation of a
market risk covered position;
(B) Proxies must have sufficiently
similar characteristics to the
transactions they represent in terms of
volatility level and correlations;
where,
(i) ES is the regulatory liquidity
horizon-adjusted ES;
(ii) T is the length of the base liquidity
horizon, 10 days;
(iii) EST(P) is the ES at base liquidity
horizon T of a portfolio with market risk
covered positions P;
(iv) EST(P,j) is the ES at base liquidity
horizon T of a portfolio with market risk
covered positions P for all risk factors
whose liquidity horizon LHj is at least
as long as j;
(v) LHj is the liquidity horizon
corresponding to the index value, j,
specified in Table 1 of this section:
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(C) Proxies must be appropriate for
the region, credit spread, quality and
type of instrument they are intended to
represent; and
(D) Proxying of new risk-free
reference rates, during the stressed
period, must appropriately capture the
risk-free rate as well as credit spread, if
applicable.
(viii) The [AGENCY] may determine
that the data for modellable risk factors
is unsuitable to calibrate the [BANKING
ORGANIZATION]’s ES-based measure.
§ ll.215
measure.
The non-default risk capital
(a) A [BANKING ORGANIZATION]
that calculates the non-default risk
capital measure must calculate the ESbased measure, the aggregate capital
measure for modellable risk factors,
IMCC, and the aggregate capital measure
for non-modellable risk factors, SES, in
accordance with this section.
(b) ES-based measure. Any internal
model used by a [BANKING
ORGANIZATION] to calculate the ESbased measure must meet the following
minimum requirements:
(1) The ES-based measure must be
computed for each business day at the
trading desk level, at the aggregate level,
and on the aggregate for each risk class
for all model-eligible trading desks;
(2) The ES-based measure must be
calculated using a one-tail, 97.5th
percentile confidence level; and
(3) A liquidity horizon-adjusted ESbased measure must be calculated from
an ES-based measure at a base liquidity
horizon of 10 days, with scaling applied
to this base horizon result as specified
below:
(4) The time series of changes in risk
factors over the base liquidity horizon T
may be calculated using observations of
price differentials from overlapping 10day periods, provided, a [BANKING
ORGANIZATION] must not scale up
from a shorter horizon; and
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either the full set of risk factors or a
reduced set of risk factors;
(ii) Any [BANKING ORGANIZATION]
using a reduced set of risk factors to
identify the period of stress must:
(A) Specify a reduced set of risk
factors for which there is a sufficiently
long history of observations;
(B) Update the reduced set of risk
factors whenever the [BANKING
ORGANIZATION] updates its 12-month
period of stress; and
(C) Ensure that the variation of the
full ES-based measure explained by the
ES-based measure for the reduced set of
risk factors over the previous 60
business days is at least 75 percent,
where the variation explained equals
where,
(1) ESF,C is the liquidity horizonadjusted ES-based measure based on the
most recent 12-month observation
period (the current ES-based measure)
using the full set of risk factors;
(2) ESR,C is the lesser of (i) the current
liquidity horizon-adjusted ES-based
measure using the reduced set of factors
or (ii) ESF,C; and
(3) Mean(ESF,C) is the mean of ESF,C
over the previous 60 business days.
(iii) The observation horizon for
determining the most stressful 12-month
period, at a minimum, must span back
to 2007;
(iv) Observations within this period
must be equally weighted; and
(v) A [BANKING ORGANIZATION]
must update, as appropriate, its 12month stressed period at least quarterly,
or whenever there are material changes
in the risk factors in the portfolio.
(6) Liquidity horizon-adjusted ESbased measure. A [BANKING
ORGANIZATION] must calibrate the
liquidity horizon-adjusted ES-based
measure to a period of stress for its
entire portfolio of market risk covered
positions (on model-eligible trading
desks) using one of the two approaches
set forth in this paragraph (b)(6).
(i) Direct approach. A [BANKING
ORGANIZATION] using the direct
approach must use the full set of risk
factors to calculate the liquidity
horizon-adjusted ES-based measure,
provided a [BANKING
ORGANIZATION] may use proxies to
fill in data on missing risk factors in
accordance with § ll.214(b)(7)(vii).
(ii) Indirect approach. A [BANKING
ORGANIZATION] using the indirect
approach must follow the steps below to
calculate the liquidity horizon-adjusted
ES-based measure:
(A) Calculate a liquidity horizonadjusted ES-based measure in
accordance with paragraph (b)(3) of this
section;
(B) Convert the three types of
liquidity horizon-adjusted ES-based
measures defined below into one
liquidity horizon-adjusted ES-based
measure, as follows:
where,
period (the current ES-based measure)
using the full set of risk factors; and
(3) ESR,C is the lesser of:
(i) the current liquidity horizonadjusted ES-based measure using the
reduced set of factors; or
(ii) ESF,C.
(7) Input data. A [BANKING
ORGANIZATION] must update its input
data for internal models used to
calculate the ES-based measure no less
frequently than quarterly and reassess
its input data whenever market prices
are subject to material changes. This
updating process must be flexible
enough to allow for updates when
warranted by material changes in
market prices.
(8) Risk capture. Internal models used
to calculate the ES-based measure must
address non-linearities, as well as
correlation and relevant basis risks,
such as basis risk between credit default
swaps and bonds.
(1) ESR,S is the liquidity horizonadjusted ES-based measure for the
[BANKING ORGANIZATION]’s market
risk covered positions (on modeleligible trading desks) using the reduced
set of risk factors, calculated based on
the 12-month period of stress;
(2) ESF,C is the liquidity horizonadjusted ES-based measure based on the
most recent 12-month observation
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(5) Stress period. A [BANKING
ORGANIZATION] must identify a 12month period of stress over the
observation horizon in which the
[BANKING ORGANIZATION]’s market
risk covered positions on model-eligible
trading desks would experience the
largest loss, provided that:
(i) To identify the period of stress, a
[BANKING ORGANIZATION] must use
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(9) Empirical correlations. A
[BANKING ORGANIZATION] may
recognize empirical correlations within
risk factor classes. Empirical
correlations across risk factor classes are
constrained by the aggregation scheme
as described in paragraph (c) of this
section.
(10) Options. With respect to options,
a [BANKING ORGANIZATION]’s
internal models used to calculate the
ES-based measure must:
(i) Capture the risks associated with
options, including non-linear price
characteristics, within each of the risk
factor classes;
(ii) Have a set of risk factors that
captures the volatilities of the
underlying rates and prices of options;
and
(iii) Model the volatility surface
across both strike price and maturity.
(11) Assignment of liquidity horizons.
At a minimum on a quarterly basis, a
[BANKING ORGANIZATION] must
consistently assign a liquidity horizon
of 10, 20, 40, 60, or 120 days to each of
its risk factors, and must consistently
map each of its risk factors to one of the
risk factor categories and corresponding
liquidity horizons, n, in Table 2 of this
section in accordance with the
requirements of this paragraph (b)(11).
(i) On a trading desk level basis, the
minimum liquidity horizon is the
corresponding value, n, for the risk
factor category in tTable 2 of this
section, unless otherwise specified in
paragraphs (b)(11)(ii) and (iii) of this
section.
(ii) If the maturity of a market risk
covered position is shorter than the
respective liquidity horizon, n, of the
risk factor category as set forth in Table
2 of this section, the minimum liquidity
BILLING CODE 6210–01–C; 6714–01–C; 4810–33–C
calculate an aggregate capital measure
(c) Modellable risk factors. A
[BANKING ORGANIZATION] must
1 Any currency pair formed by the following list
of currencies: United States Dollar, Australian
Dollar, Brazilian Real, Canadian Dollar, Chinese
Yuan, Euro, Hong Kong Dollar, Indian Rupee,
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Japanese Yen, Mexican Peso, New Zealand Dollar,
Norwegian Krone, Singapore Dollar, South African
Rand, South Korean Won, Swedish Krona, Swiss
Franc, Turkish Lira, United Kingdom Pound, and
any additional currencies specificed by the
[AGENCY] under § __.209(b)(7)(ii).
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horizon is the next longer liquidity
horizon, n, from the maturity of the
market risk covered position.
(iii) The minimum liquidity horizon
for credit and equity indices and other
similar multi-underlying instruments
must be the shortest liquidity horizon,
n, that is equal to or longer than the
weighted average of the liquidity
horizons of the underlyings, calculated
by multiplying the respective liquidity
horizon, n, of the risk factor category as
set forth in Table 2 of this section of
each individual underlying by its
weight in the index and summing the
weighted liquidity horizons across all
underlyings.
(iv) Inflation risk factors must be
mapped consistently with the liquidity
horizon for the interest rate risk factor
category for a given currency.
BILLING CODE 6210–01–P; 6714–01–P; 4810–33–P
for modellable risk factors, IMCC, on
each business day in accordance with
the below:
(1) For all model-eligible trading
desks, a [BANKING ORGANIZATION]
must include all modellable risk factors
in its internal models used to calculate
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the aggregate liquidity horizon-adjusted
ES-based measure. With prior written
approval of [AGENCY], a [BANKING
ORGANIZATION] also may include
non-modellable risk factors in its
internal models used to calculate the
aggregate liquidity horizon-adjusted ESbased measure.
(2) The [BANKING ORGANIZATION]
must calculate its aggregate liquidity
horizon-adjusted ES-based measure,
IMCC(C), using the liquidity horizon-
adjusted ES-based measure specified in
paragraph (b) of this section, with no
supervisory constraints on cross-risk
class correlations.
(3) The [BANKING ORGANIZATION]
must also calculate a series of partial
liquidity horizon-adjusted ES-based
measures (with risk factors of all other
risk factor classes held constant) for
each risk factor class using the liquidity
horizon-adjusted ES-based measure
specified in paragraph (b) of this
section. These partial, non-diversifiable
liquidity horizon-adjusted ES-based
measures, IMCC(Ci), must be summed to
provide an aggregated risk factor class
ES-based measure. The stress period
used to calculate IMCC(C) and IMCC(Ci)
must be the same.
(4) The aggregate capital measure for
modellable risk factors, IMCC, must be
calculated as the weighted average of
the constrained and unconstrained ESbased measures as follows:
Where,
(i) r equals 0.5;
(ii) i indexes the following risk
classes: interest rate risk, credit spread
risk, equity risk, commodity risk and
foreign exchange risk;
(iii) IMCC(C) equals the aggregate
liquidity horizon-adjusted ES-based
measure specified in paragraph (c)(2) of
this section; and
(iv) IMCC(Ci) equals the partial
liquidity horizon-adjusted ES-based
measure specified in paragraph (c)(3) of
this section for risk class i.
(d) Non-modellable risk factors. (1)
General. A [BANKING
ORGANIZATION] must calculate an
aggregate capital measure for nonmodellable risk factors, SES, using
stressed expected shortfall
methodologies that meet the following
requirements:
(i) The [BANKING ORGANIZATION]
must calculate a capital measure for
each non-modellable risk factor using a
stress scenario that is calibrated to be at
least as prudent as the ES-based
measure used for modellable risk factors
as described in paragraph (b) of this
section, provided that to determine the
applicable stress scenario, the
[BANKING ORGANIZATION] must
select a common 12-month period of
stress for all non-modellable risk factors
in the same risk factor class, that in
determining the stress scenario, a
[BANKING ORGANIZATION] may use
proxies, provided the proxies meet the
standards in § ll.214(b)(7)(vii), that,
with approval of the [AGENCY], a
[BANKING ORGANIZATION] also may
use an alternative approach to
determine the stress scenario, and that:
(A) Methodologies used to calculate
any stressed expected shortfall for nonmodellable risk factors must address
non-linearities, as well as correlation
and relevant basis risks, such as basis
risk between credit default swaps and
bonds;
(B) For each non-modellable risk
factor, the liquidity horizon of the stress
scenario must be the greater of (1) the
risk factor’s liquidity horizon assigned
pursuant to paragraph (b)(11) of this
section and (2) 20 days; and
(C) For non-modellable risk factors
arising from idiosyncratic credit spread
risk or from idiosyncratic equity risk
due to spot, futures and forward prices,
equity repo rates, dividends and
volatilities, the [BANKING
ORGANIZATION] may apply a common
12-month period of stress; and
(ii) When the [BANKING
ORGANIZATION] cannot determine a
stress scenario for a risk factor class, or
a smaller set of non-modellable risk
factors under paragraph (d)(1)(i) of this
section, that is acceptable to the
[AGENCY], the [BANKING
ORGANIZATION] must use the scenario
that produces the maximum possible
loss as the stress scenario.
(2) Stressed expected shortfall
calculation. A [BANKING
ORGANIZATION] must calculate the
aggregate capital measure, SES, for nonmodellable idiosyncratic credit spread
risk factors, i, non-modellable
idiosyncratic equity risk factors, j, and
the remaining non-modellable risk
factors, k, as follows:
where,
(i) ISESNM,i is the stress scenario
capital measure for non-modellable
idiosyncratic credit spread risk, i,
aggregated with zero correlation;
(ii) I is a non-modellable idiosyncratic
credit spread risk factor;
(iii) ISESNM,j is the stress scenario
capital measure for non-modellable
idiosyncratic equity risk, j, aggregated
with zero correlation;
(iv) J is a non-modellable
idiosyncratic equity risk factor;
(v) SESNM,k is the stress scenario
capital measure for the remaining nonmodellable risk factors, k;
(vi) K is the remaining nonmodellable risk factors in a modeleligible trading desk; and
(vii) r equals 0.6.
§ ll.216
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[RESERVED]
(a) Scope. This section applies to
[BANKING ORGANIZATIONS] subject
to the market risk capital requirements
as described in § ll.201(b)(1),
provided that a [BANKING
ORGANIZATION] that is a consolidated
subsidiary of a bank holding company,
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§ ll.217 Market risk reporting and
disclosures.
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covered savings and loan holding
company that is a banking organization
as defined in 12 CFR 238.2, or a
depository institution that is subject to
these requirements or of a non-U.S.
banking organization that is subject to
comparable public disclosure
requirements in its home jurisdiction is
not required to make the disclosures
required by paragraph (f) of this section.
(b) Timing. A [BANKING
ORGANIZATION] must make the
reports and disclosures described herein
beginning on [THE FIRST DATE OF
THE QUARTER THE RULE TAKES
EFFECT]. A [BANKING
ORGANIZATION] must make timely
public reports and disclosures each
calendar quarter. If a significant change
occurs, such that the most recent
reporting amounts are no longer
reflective of the [BANKING
ORGANIZATION]’s capital adequacy
and risk profile, then a brief discussion
of this change and its likely impact must
be provided in a public disclosure as
soon as practicable thereafter.
Qualitative disclosures that typically do
not change each quarter may be
disclosed annually, provided any
significant changes are disclosed in the
interim.
(c) Reporting and disclosure policy.
The [BANKING ORGANIZATION] must
have a formal reporting and disclosure
policy approved by the board of
directors that addresses the [BANKING
ORGANIZATION]’s approach for
determining its market risk reports and
disclosures. The policy must address
the associated internal controls and
reporting and disclosure controls and
procedures. The board of directors and
senior management must ensure that
appropriate verification of the reports
and disclosures takes place and that
effective internal controls and reporting
and disclosure controls and procedures
are maintained. One or more senior
officers of the [BANKING
ORGANIZATION] must attest that the
reports and disclosures meet the
requirements of this subpart F, and the
board of directors and senior
management are responsible for
establishing and maintaining an
effective internal control structure over
financial reporting, including the
reports and disclosures required by this
section.
(d) Proprietary and confidential
information. If a [BANKING
ORGANIZATION] reasonably believes
that reporting or disclosure of specific
commercial or financial information
would materially prejudice its position
by making public certain information
that is either proprietary or confidential
in nature, the [BANKING
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ORGANIZATION] is not required to
publicly report or disclose these specific
items, but must report or disclose more
general information about the subject
matter of the requirement, together with
the fact that, and the reason why, the
specific items of information have not
been disclosed.
(e) Location. The [BANKING
ORGANIZATION] must either provide
all of the public reports and disclosures
required by this section in one place on
the [BANKING ORGANIZATION]’s
public website or provide the reporting
and disclosures in more than one public
financial report or other public
regulatory reports, provided that the
[BANKING ORGANIZATION] publicly
provides a summary table specifically
indicating the location(s) of all such
reporting and disclosures.
(f) Disclosures and reports—(1)
Quarterly public disclosures. A
[BANKING ORGANIZATION] must
disclose publicly the following
information at least quarterly:
(i) The aggregate amount of onbalance sheet and off-balance sheet
securitization positions by exposure
type;
(ii) The soundness criteria on which
the [BANKING ORGANIZATION]’s
internal capital adequacy assessment is
based and a description of each
methodology used to achieve a capital
adequacy assessment that is consistent
with the required soundness criteria,
including, for a [BANKING
ORGANIZATION] that calculates the
models-based measure for market risk,
for categories of non-modellable risk
factors;
(iii) The aggregate amount of
correlation trading positions; and
(iv) For a [BANKING
ORGANIZATION] that calculates the
models-based measure for market risk, a
comparison of VaR-based estimates with
actual gains or losses experienced by the
[BANKING ORGANIZATION] for each
material portfolio of market risk covered
positions, including an analysis of
important outliers.
(2) Annual public disclosures. A
[BANKING ORGANIZATION] must
provide timely public disclosures of the
following information at least annually:
(i) A description of the structure and
organization of the market risk
management system, including a
description of the market risk
governance structure established to
implement the strategies and processes
of the [BANKING ORGANIZATION]
described in this paragraph (f);
(ii) A description of the policies and
processes for determining whether a
position is designated as a market risk
covered position and the risk
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management policies for monitoring
market risk covered positions;
(iii) The composition of material
portfolios of market risk covered
positions;
(iv) A description of the scope and
nature of risk reporting and/or
measurement systems and the strategies
and processes implemented by the
[BANKING ORGANIZATION] to
identify, measure, monitor and control
the [BANKING ORGANIZATION]’s
market risks, including policies for
hedging;
(v) A description of the trading desk
structure and the types of market risk
covered positions included on the
trading desks or in trading desk
categories, which must include:
(A) A description of the modeleligible trading desks for which a
[BANKING ORGANIZATION] calculates
the non-default risk capital requirement;
and
(B) Any changes in the scope of
model-ineligible trading desks and the
market risk covered positions on those
trading desks.
(vi) The [BANKING
ORGANIZATION]’s valuation policies,
procedures, and methodologies for each
material portfolio of market risk covered
positions including, for securitization
positions, the methods and key
assumptions used for valuing such
securitization positions, any significant
changes since the last reporting period,
and the impact of such change;
(vii) The characteristics of the internal
models used for purposes of calculating
the models-based measure for market
risk and the specific approaches used in
the validation of these models. For the
non-default risk capital requirement,
this must include a general description
of the model(s) used to calculate the ESbased measure in § ll.215(b), the
frequency by which data is updated,
and a description of the calculation
based on current and stressed
observations.
(viii) A description of the approaches
used for validating and evaluating the
accuracy of internal models and
modeling processes for purposes of this
subpart F;
(ix) For each market risk category
(that is, interest rate risk, credit spread
risk, equity risk, foreign exchange risk,
and commodity risk), a description of
the stress tests applied to the market
risk covered positions subject to the
factor;
(x) The results of the comparison of
the [BANKING ORGANIZATION]’s
internal estimates for purposes of this
subpart F with actual outcomes during
a sample period not used in model
development;
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(xi) A description of the [BANKING
ORGANIZATION]’s processes for
monitoring changes in the credit and
market risk of securitization positions,
including how those processes differ for
resecuritization positions; and
(xii) A description of the [BANKING
ORGANIZATION]’s policy governing
the use of credit risk mitigation to
mitigate the risks of securitization
positions and resecuritization positions.
(3) Public reports. A [BANKING
ORGANIZATION] subject to the market
risk capital requirements as described in
§ ll.201(b)(1) must provide, in the
manner and form prescribed by the
[AGENCY], a public report of its
measure for market risk, on a quarterly
basis. A [BANKING ORGANIZATION]
must report additional information and
reports as the [AGENCY] may require.
(4) Confidential supervisory reports.
(i) A [BANKING ORGANIZATION] that
calculates the models-based measure for
market risk must provide to the
[AGENCY], in the manner and form
prescribed by the [AGENCY], a
confidential supervisory report of
backtesting and PLA testing
information, on a quarterly basis.
(ii) A [BANKING ORGANIZATION]
must report to the [AGENCY] the
following information at the aggregate
level for all model-eligible trading desks
for each business day over the previous
500 business days, or all available
business days, if 500 business days are
not available, with no more than a 20day lag:
(A) Daily VaR-based measures
calibrated to the 99.0th percentile as
described in § ll.204(g)(1);
(B) Daily ES-based measure calculated
in accordance with § ll.215(b)
calibrated at the 97.5th percentile;
(C) The actual profit and loss;
(D) The hypothetical profit and loss;
and
(E) The p-value of the profit or loss on
each day, which is the probability of
observing a profit that is less than, or a
loss that is greater than, the amount
reported for purposes of paragraph
(f)(4)(ii)(C) of this section based on the
model used to calculate the VaR-based
measure described in paragraph
(f)(4)(ii)(A) of this section.
(iii) A [BANKING ORGANIZATION]
must report to the [AGENCY] the
following information for each trading
desk for each business day over the
previous 500 business days, or all
available business days, if 500 business
days are not available, with no more
than a 20-day lag:
(A) Daily VaR-based measures for the
trading desk calibrated at both the
97.5th percentile and the 99.0th
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percentile as described in
§ ll.213(b)(1);
(B) Daily ES-based measure calculated
in accordance with § ll.215(b)
calibrated at the 97.5th percentile;
(C) The actual profit and loss;
(D) The hypothetical profit and loss;
(E) Risk-theoretical profit and loss;
and
(F) The p-values of the profit or loss
on each day (that is, the probability of
observing a profit that is less than, or a
loss that is greater than, the amount
reported for purposes of paragraph
(f)(4)(iii)(C) of this section based on the
model used to calculate the VaR-based
measure described in paragraph
(f)(4)(iii)(A) of this section).
§ ll.220
risk.
General requirements for CVA
(a) Identification of CVA risk covered
positions and eligible CVA hedges. A
[BANKING ORGANIZATION] must:
(1) Identify all CVA risk covered
positions and all transactions that hedge
or are intended to hedge CVA risk;
(2) Identify all eligible CVA hedges;
and
(3) For a [BANKING
ORGANIZATION] that has approval to
use the standardized measure for CVA
risk, identify all eligible CVA hedges for
the purposes of calculating the basic
CVA approach capital requirement and
all eligible CVA hedges for the purpose
of calculating the standardized CVA
approach capital requirement.
(b) CVA hedging policy. A [BANKING
ORGANIZATION] that hedges its CVA
risk must have a clearly defined hedging
policy for CVA risk that is reviewed and
approved by senior management at least
annually. The hedging policy must
quantify the level of CVA risk that the
[BANKING ORGANIZATION] is willing
to accept and must detail the
instruments, techniques, and strategies
that the [BANKING ORGANIZATION]
will use to hedge CVA risk.
(c) Documentation. A [BANKING
ORGANIZATION] must have policies
and procedures for determining its CVA
risk-based capital requirement. A
[BANKING ORGANIZATION] must
adequately document all material
aspects of its identification and
management of CVA risk covered
positions and eligible CVA hedges, and
control, oversight, and review processes.
A [BANKING ORGANIZATION] that
calculates the standardized measure for
CVA risk must adequately document:
(1) Policies and procedures of the
CVA desk, or similar dedicated
function, and the independent risk
control unit;
(2) The internal auditing process;
(3) The internal policies, controls, and
procedures concerning the [BANKING
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64277
ORGANIZATION]’s CVA calculations
for financial reporting purposes;
(4) The initial and ongoing validation
of the [BANKING ORGANIZATION]’s
models used for calculating regulatory
CVA under § ll.224(d), including
exposure models; and
(5) The [BANKING
ORGANIZATION]’s process to assess
the performance of models used for
calculating regulatory CVA under
§ ll.224(d), including exposure
models, and implement remedies.
§ ll.221
Measure for CVA risk.
(a) General requirements. A
[BANKING ORGANIZATION] must
calculate its measure for CVA risk as the
basic measure for CVA risk in
accordance with paragraph (b) of this
section, unless the [BANKING
ORGANIZATION] has prior written
approval of the [AGENCY] and chooses
to calculate its measure for CVA risk as
the standardized measure for CVA risk
in accordance with paragraph (c) of this
section.
(b) Basic measure for CVA risk. The
basic measure for CVA risk equals the
basic CVA approach capital requirement
as provided in § ll.222 for all CVA
risk covered positions and eligible CVA
hedges, plus any additional capital
requirement for CVA risk established by
the [AGENCY] pursuant to § ll.201(c).
(c) Standardized measure for CVA
risk. The standardized measure for CVA
risk equals the sum of the standardized
CVA approach capital requirement as
provided in paragraph (c)(1) of this
section for all standardized CVA risk
covered positions and standardized
CVA hedges, the basic CVA approach
capital requirement as provided in
§ ll.222 for all basic CVA risk covered
positions and basic CVA hedges, and
any additional capital requirement for
CVA risk established by the [AGENCY]
pursuant to § ll.201(c).
(1) The standardized CVA approach
capital requirement equals the sum of
the CVA delta capital requirement and
the CVA vega capital requirement as
calculated in accordance with
§ ll.224.
(2) A [BANKING ORGANIZATION]
that has received approval from the
[AGENCY] to use the standardized
measure for CVA risk must include the
following CVA risk covered positions as
basic CVA risk covered positions to be
included in the calculation of the basic
CVA approach capital requirement:
(i) Any CVA risk covered position that
the [AGENCY] specifies must be
included in the basic CVA approach
capital requirement pursuant to
§ ll.223(a)(1);
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measure for CVA risk must include the
following eligible CVA hedges as basic
CVA hedges to be included in the
calculation of the basic CVA approach
capital requirement:
(i) Any eligible CVA hedge that the
[AGENCY] specifies must be included
in the basic CVA approach capital
requirement pursuant to
§ ll.223(a)(1); and
(ii) Any CVA hedge that is an eligible
CVA hedge for purposes of calculating
the basic CVA approach capital
requirement that the [BANKING
ORGANIZATION] chooses to include in
Where,
(i) The correlation parameter, r,
equals 50 percent;
(ii) Sc(. . .) refers to a summation
across all counterparties, c, of CVA risk
covered positions;
Where,
(A) a equals:
(1) 1 for counterparties for which the
[BANKING ORGANIZATION] calculates
exposure amount under § ll.113(e)(4);
and
(2) 1.4 for all other counterparties.
(B) SN(. . .) refers to a summation
across all netting sets with the
counterparty;
(C) MNS is the effective maturity for
the netting set, NS, measured in years,
calculated as the weighted-average
remaining maturity of the individual
CVA risk covered positions within the
netting set, with the weight of each
individual position equal to the notional
amount of the position divided by the
aggregate notional amount of all
positions in the netting set;
(D) EADNS is the EAD of the netting
set, NS, provided that a [BANKING
ORGANZATION] must determine the
the basic CVA approach capital
requirement.
§ ll.222
Basic CVA approach.
(a) Basic CVA approach capital
requirement. The basic CVA approach
capital requirement equals Kbasic, which
is calculated as follows:
Kbasic = 0.65 · (b · Kunhedged + (1¥b) ·
Khedged)
Where,
(1) The parameter, b, equals 0.25;
(2) Kunhedged is calculated as follows:
(iii) SCVAc is equal to:
EAD for a netting set, NS, using the
same methodology it uses to calculate
the exposure amount for counterparty
credit risk for its OTC derivative
contracts under § ll.113;
(E) DFNS is a discount factor equal to
(1¥e∧(¥0.05*MNS))/(0.05*MNS); and
(F) RWc is the risk weight for
counterparty c, based on the sector and
credit quality of the counterparty, as
specified in Table 1 of this section.
EP18SE23.156</GPH>
(ii) Any CVA risk covered position in
a netting set that the [BANKING
ORGANIZATION] chooses to exclude
from the calculation of the standardized
CVA approach capital requirement; and
(iii) Any CVA risk covered position in
a partial netting set designated for
inclusion in the basic CVA approach
that the [BANKING ORGANIZATION]
has prior written approval from the
[AGENCY] to create from splitting a
netting set into two netting sets.
(3) A [BANKING ORGANIZATION]
that has received approval from the
[AGENCY] to use the standardized
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covered positions, SCVAc, as defined in
paragraph (a)(2)(iii) of this section;
(iii) SNHc is calculated as follows:
Where,
(A) The summation in the formula
refers to a summation across all singlename eligible CVA hedges, h, that the
[BANKING ORGANIZATION] uses to
hedge the CVA risk of counterparty, c;
(B) rhc is the correlation between the
credit spread of counterparty, c, and the
credit spread of a single-name hedge, h,
of counterparty, c, as specified in Table
2 of this section;
(C) RWh is the risk weight of singlename hedge, h, as prescribed in Table 1
of this section, for the sector and credit
quality of the reference name of the
hedge;
(D) MhSN is the remaining maturity of
single-name hedge, h, measured in
years;
(E) BhSN is the notional amount of
single-name hedge, h, provided that, for
single-name contingent CDS, the
notional amount is determined by the
current market value of the reference
portfolio or instrument; and
(F) DFhSN is the discount factor and is
calculated as:
EP18SE23.160</GPH>
(ii) Sc(. . .) refers to a summation
across all counterparties, c, of CVA risk
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Where,
(i) The correlation parameter, r, is
defined in paragraph (a)(2)(i) of this
section;
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§ ll.223 Requirements for the
standardized measure for CVA risk.
(a) Eligibility requirements. (1) A
[BANKING ORGANIZATION] must
receive written approval of the
[AGENCY] prior to using the
standardized measure for CVA risk for
calculating CVA capital requirements.
Such approval may specify certain CVA
risk covered positions and eligible CVA
hedges that must be included in the
calculation of the basic CVA approach
capital requirement. In order to be
eligible to use the standardized measure
for CVA risk, a [BANKING
ORGANIZATION] must meet the
following requirements:
(i) A [BANKING ORGANIZATION]
must be able to calculate, on at least a
monthly basis, regulatory CVA and CVA
sensitivities to market risk factors and
counterparty credit spreads specified in
§ ll.224 and § ll.225.
(ii) A [BANKING ORGANIZATION]
must have a CVA desk, or a similar
dedicated function, responsible for CVA
risk management and hedging
consistent with the [BANKING
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(C) Miind is the remaining maturity of
the index hedge, i, measured in years;
(D) Biind is the notional amount of the
index hedge, i; and
(E) DFiind is the discount factor and is
calculated as (1¥e∧(¥0.05*MNS))/
(0.05*MNS); and
(v) HMAc is calculated as follows
where all terms have the same
definitions as set out in paragraph
(a)(3)(iii) of this section:
ORGANIZATION]’s policies and
procedures.
(iii) A [BANKING ORGANIZATION]
must meet all of the requirements listed
in paragraph (b) of this section and the
requirements in § ll.220(c) on an
ongoing basis. The [AGENCY] may
rescind its approval of the use of the
standardized measure for CVA risk (in
whole or in part), if the [AGENCY]
determines that the model no longer
complies with this subpart or fails to
reflect accurately the CVA risk of the
[BANKING ORGANIZATION]’s CVA
risk covered positions.
(2) The [AGENCY] may specify that
one or more CVA risk covered positions
or one or more eligible CVA hedges
must be included in the basic CVA
approach capital requirement or
prescribe an alternative capital
requirement, if the [AGENCY]
determines that the [BANKING
ORGANIZATION]’s implementation of
the standardized CVA approach capital
requirement no longer complies with
this subpart F or fails to reflect
accurately the CVA risk.
(b) Ongoing requirements. (1)
Exposure models used in the calculation
of regulatory CVA under § ll.224(d)
must be part of a CVA risk management
framework that includes the
identification, measurement,
management, approval, and internal
reporting of CVA risk.
(2) Senior management must have
oversight of the risk control process.
(3) A [BANKING ORGANIZATION]
must have an independent risk control
unit that is responsible for the effective
initial and ongoing validation (no less
than annual) of the models used for
calculating regulatory CVA under
§ ll.224(d), including exposure
models. This unit must be independent
from the business unit that evaluates
counterparties and sets limits, a
[BANKING ORGANIZATION]’s trading
desks, and the CVA desk, or similar
dedicated function, and must report
directly to senior management of the
[BANKING ORGANIZATION].
(4) A [BANKING ORGANIZATION]
must document the process for initial
and ongoing validation of its models
used for calculating regulatory CVA
under § ll.224(d), including exposure
models, which must recreate the
analysis, to a level of detail that would
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(b) [Reserved]
the value in Table 1 of this section
corresponding to that sector and credit
quality, multiplied by 0.7; or
(2) For an index spanning multiple
sectors or with a mixture of investment
grade constituents and other grade
constituents, the notional-weighted
average of the risk weights from Table
1 of this section corresponding to the
sectors and credit qualities of the
constituents, multiplied by 0.7;
EP18SE23.161</GPH>
Where,
(A) Si(. . .) refers to a summation
across all eligible CVA hedges that are
index hedges, i, that the [BANKING
ORGANIZATION] uses to hedge CVA
risk;
(B) RWi is the risk weight of the index
hedge, i, as follows:
(1) For an index hedge where all
index constituents belong to the same
sector and are of the same credit quality,
EP18SE23.163</GPH>
(iv) IH is calculated as follows:
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less than annually. The transmission of
transaction terms and specifications
data to the exposure model must also be
subject to internal audit, and formal
reconciliation processes must be in
place between the internal model and
source data systems to verify on an
ongoing basis that transaction terms and
specifications are being reflected
correctly or at least conservatively.
(10) A [BANKING ORGANIZATION]
must acquire current and historical
market data that are either independent
of the lines of business or validated
independently from the lines of
business and be compliant with
applicable accounting standards. The
data must be input into the exposure
models in a timely and complete
fashion, and maintained in a secure
database subject to formal and periodic
audit. A [BANKING ORGANIZATION]
must also have a well-developed data
integrity process to handle the data of
erroneous and anomalous observations.
In the case where an exposure model
relies on proxy market data, a
[BANKING ORGANIZATION] must set
internal policies to identify suitable
proxies and the [BANKING
ORGANIZATION] must demonstrate
empirically on an ongoing basis that the
proxy provides a conservative
representation of the underlying risk
under adverse market conditions.
§ ll.224 Calculation of the standardized
CVA approach.
(a) General. A [BANKING
ORGANIZATION] must calculate the
CVA delta capital requirement pursuant
to paragraph (b) of this section and the
CVA vega capital requirement pursuant
to paragraph (c) of this section, in both
cases for all standardized CVA risk
covered positions and for the market
value of all standardized CVA hedges,
in accordance with the requirements set
forth below.
(1) For each standardized CVA risk
covered position and standardized CVA
hedge, a [BANKING ORGANIZATION]
must identify all of the relevant risk
factors as described in § ll.225 for
which it will calculate sensitivities for
delta risk and vega risk as described in
paragraphs (b) and (c) of this section. A
[BANKING ORGANIZATION] must also
identify the corresponding buckets
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related to these risk factors as described
in § ll.225.
(2) A [BANKING ORGANIZATION]
must assign a standardized CVA hedge
that mitigates credit spread delta risk
either to the counterparty credit spread
risk class or to the reference credit
spread risk class.
(b) CVA delta capital requirement. (1)
General. The CVA delta capital
requirement equals the sum of the risk
class-level CVA delta capital
requirements calculated pursuant to
paragraph (b)(4) of this section for each
of the following six risk classes:
(i) Interest rate risk;
(ii) Foreign exchange risk;
(iii) Counterparty credit spread risk;
(iv) Reference credit spread risk;
(v) Equity risk; and
(vi) Commodity risk.
(2) Net weighted sensitivity
calculation. For each risk factor, k,
specified in § ll.225(a), a [BANKING
ORGANIZATION] must:
(i) Calculate the CVA delta sensitivity
of aggregate regulatory CVA to the risk
factor, SkCVA, and the CVA delta
sensitivity of the aggregate market value
of standardized CVA hedges to the risk
factor, SkHdg, pursuant to paragraph (e)
of this section.
(ii) Calculate the weighted CVA delta
sensitivity to the risk factor, WSkCVA,
and the weighted hedge delta sensitivity
to the risk factor, WSkHdg, by multiplying
SkCVA and SkHdg, respectively, by the
corresponding risk weight, RWk,
specified in § ll.225(a):
WSkCVA = RWk · SkCVA
WSkHdg = RWk · SkHdg
(iii) Calculate the net weighted delta
sensitivity, WSk, by subtracting the
weighted hedge delta sensitivity,
WSkHdg, from the weighted CVA delta
sensitivity, WSkCVA:
WSk = WSkCVA ¥ WSkHdg
(3) Within bucket aggregation. For
each bucket, b, as provided in
§ ll.225(a), a [BANKING
ORGANIZATION] must calculate the
bucket-level CVA delta capital
requirement, Kb, by aggregating the net
weighted delta sensitivities for each risk
factor in a bucket, b, using the buckets
and correlation parameters, rkl,
applicable to each risk class as specified
in § ll.225(a), as follows:
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enable a third party to understand how
the models operate, their limitations,
and their key assumptions. This
documentation must set out the
minimum frequency (no less than
annual) with which ongoing validation
will be conducted as well as other
circumstances (such as a sudden change
in market behavior) under which
additional validation must be conducted
more frequently. In addition, the
documentation must sufficiently
describe how the validation is
conducted with respect to data flows
and portfolios, what analyses are used,
and how representative counterparty
portfolios are constructed.
(5) A [BANKING ORGANIZATION]
must test the pricing models used to
calculate exposure for given paths of
market risk factors against appropriate
independent benchmarks for a wide
range of market states as part of the
initial and ongoing model validation
process. A [BANKING
ORGANIZATION]’s pricing models for
options must account for the nonlinearity of option value with respect to
market risk factors.
(6) An independent review of the
overall CVA risk management process
must be conducted as part of the
[BANKING ORGANIZATION]’s own
regular internal auditing process. This
review must include both the activities
of the CVA desk, or similar dedicated
function, and of the independent risk
control unit.
(7) A [BANKING ORGANIZATION]
must define criteria on which to assess
the exposure models and their inputs
and have a written policy in place to
describe the process to assess the
performance of exposure models and
remedy unacceptable performance.
(8) A [BANKING ORGANIZATION]’s
exposure models must capture
transaction-specific information in order
to aggregate exposures at the level of the
netting set. A [BANKING
ORGANIZATION] must verify that
transactions are assigned to the
appropriate netting set within the
model.
(9) A [BANKING ORGANIZATION]’s
exposure models must reflect
transaction terms and specifications
accurately. The terms and specifications
must reside in a secure database that is
subject to formal and periodic audit no
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where R is the hedging disallowance
parameter equal to 0.01.
(4) Across bucket aggregation. A
[BANKING ORGANIZATION] must
calculate the risk class-level CVA delta
capital requirement, K, by aggregating
the bucket-level CVA delta capital
requirements, Kb, for each bucket in the
where,
risk class using the correlation
parameters, gbc, applicable to each risk
class as specified in § ll.225(a), as
follows:
(i) Sb is defined for bucket, b, as:
where R is the hedging disallowance
parameter equal to 0.01.
(4) Across bucket aggregation. A
[BANKING ORGANIZATION] must
calculate the risk class-level CVA vega
capital requirement, K, by aggregating
the bucket-level CVA vega capital
requirements, Kb, far each bucket in the
risk class using the correlation
parameters, gbc, applicable to each risk
class as specified in § ll.225(b), as
follows:
EP18SE23.169</GPH>
WSkCVA = RWk · SkCVA
WSkHdg = RWk · SkHdg
(iii) Calculate the net weighted vega
sensitivity, WSk, by subtracting the
weighted hedge vega sensitivity, WSkHdg,
from the weighted CVA vega sensitivity,
WSkCVA:
WSk = WSkCVA¥WSkHdg
(3) Within bucket aggregation. For
each bucket, b, as provided in
§ ll.225(b), a [BANKING
ORGANIZATION] must calculate the
bucket-level CVA vega capital
requirement, Kb, by aggregating the net
weighted vega sensitivities for each risk
factor in a bucket, b, using the buckets
and correlation parameters, rkl,
applicable to each risk class as specified
in § ll.225(b), as follows:
EP18SE23.168</GPH>
(v) Commodity risk.
(2) Net weighted sensitivity
calculation. For each risk factor, k,
specified in § ll.225(b), a [BANKING
ORGANIZATION] must:
(i) Calculate the CVA vega sensitivity
of aggregate regulatory CVA to the risk
factor, SkCVA, and the CVA vega
sensitivity of the aggregate market value
of standardized CVA hedges to the risk
factor, SkHdg, pursuant to paragraph (e)
of this section.
(ii) Calculate the weighted CVA vega
sensitivity to the risk factor, WSkCVA,
and the weighted hedge vega sensitivity
to the risk factor, WSkHdg, by multiplying
SkCVA and SkHdg, respectively, by the
corresponding risk weight, RWk,
specified in § ll.225(b):
where,
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(iii) The multiplier, mCVA, equals 1,
unless the [AGENCY] notifies the
[BANKING ORGANIZATION] in writing
that a different value must be used. The
[AGENCY] may increase a [BANKING
ORGANIZATION]’s multiplier if it
determines that the [BANKING
ORGANIZATION]’s CVA model risk
warrants it.
(c) CVA vega capital requirement. (1)
General. The CVA vega capital
requirement equals the sum of the risk
class-level CVA vega capital
requirements calculated pursuant to
paragraph (c)(4) of this section for each
of the following five risk classes:
(i) Interest rate risk;
(ii) Foreign exchange risk;
(iii) Reference credit spread risk;
(iv) Equity risk; and
(i) Sb is defined for bucket b as:
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(ii) Sc is defined for bucket c as:
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demonstrates to the [AGENCY] that
such mapping is appropriate; and
(iii) When no credit spread of any of
the counterparty’s peers is available due
to the counterparty’s specific type, a
[BANKING ORGANIZATION] may, with
the approval of the [AGENCY], use an
estimate of credit risk to proxy the
spread of an illiquid counterparty;
provided that where a [BANKING
ORGANIZATION] uses historical
probabilities of default as part of this
assessment, the resulting spread must
relate to credit markets and cannot be
based on historical probabilities of
default alone.
(4) The market-consensus expected
loss-given-default value must be the
same as the one used to calculate the
market-implied probability of default
from credit spreads unless the seniority
of the exposure resulting from CVA risk
covered positions differs from the
seniority of senior unsecured bonds.
(5) The simulated paths of discounted
future exposure are produced by pricing
all standardized CVA risk covered
positions with the counterparty along
simulated paths of relevant market risk
factors and discounting the prices to
today using risk-free interest rates along
the path.
(6) All market risk factors material for
the transactions with a counterparty
must be simulated as stochastic
processes for an appropriate number of
paths defined on an appropriate set of
future time points extending to the
maturity of the longest transaction.
(7) For transactions with a significant
level of dependence between exposure
and the counterparty’s credit quality, a
[BANKING ORGANIZATION] must
account for this dependence in
regulatory CVA calculations.
(8) For margined counterparties, only
financial collateral that qualifies for
inclusion in the net independent
collateral amount or variation margin
amount under § ll.113 may be
recognized as a risk mitigant.
(9) For margined counterparties, the
simulated paths of discounted future
exposure must capture the effects of
margining collateral that is recognized
as a risk mitigant along each exposure
path. All of the relevant contractual
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features such as the nature of the margin
agreement (unilateral vs bilateral), the
frequency of margin calls, the type of
collateral, thresholds, independent
amounts, initial margins, and minimum
transfer amounts must be appropriately
captured by the exposure model. To
determine collateral available to a
[BANKING ORGANIZATION] at a given
exposure measurement time point, the
exposure model must assume that the
counterparty will not post or return any
collateral within a certain time period
immediately prior to that time point, the
margin period of risk (MPoR). For a
client-facing derivative transaction that
is a standardized CVA risk covered
position, the MPoR must not be less
than 4 + N business days. For all other
standardized CVA risk covered
positions, the MPoR must not be less
than 9 + N business days. For purposes
of this paragraph (d)(9), N is the remargining period specified in the
margin agreement.
(10) A [BANKING ORGANIZATION]
must obtain the simulated paths of
discounted future exposure using the
same CVA exposure models used by the
[BANKING ORGANIZATION] for
financial reporting purposes, adjusted to
meet the requirements of this section.
For purposes of this section, a
[BANKING ORGANIZATION] must use
the same model calibration process,
market data, and transaction data as the
[BANKING ORGANIZATION] uses in its
CVA calculations for financial reporting
purposes, adjusted to meet the
requirements of this calculation.
(11) A [BANKING ORGANIZATION]’s
generation of market risk factor paths
underlying the exposure models must
satisfy the following requirements:
(i) Drifts of risk factors must be
consistent with a risk-neutral
probability measure and a [BANKING
ORGANIZATION] may not calibrate
drifts of risk factors on a historical basis;
(ii) A [BANKING ORGANIZATION]
must calibrate the volatilities and
correlations of market risk factors to
market data; provided that, where
sufficient data from a liquid derivatives
market does not exist, a [BANKING
ORGANIZATION] may calibrate
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EP18SE23.171</GPH>
(iii) The multiplier, mCVA, equals 1,
unless the [AGENCY] notifies the
[BANKING ORGANIZATION] in writing
that a different value must be used. The
[AGENCY] may increase a [BANKING
ORGANIZATION]’s multiplier if it
determines that the [BANKING
ORGANIZATION]’s CVA model risk
warrants it.
(d) Calculation of regulatory CVA. A
[BANKING ORGANIZATION] must
calculate aggregate regulatory CVA as
the sum of regulatory CVA for each
counterparty.
(1) A [BANKING ORGANIZATION]
must calculate regulatory CVA at the
counterparty level as the expected loss
resulting from default of the
counterparty and assuming non-default
of the [BANKING ORGANIZATION]. In
expressing the regulatory CVA, non-zero
losses must have a positive sign.
(2) The calculation of regulatory CVA
must be based, at a minimum, on the
following inputs, consistent with the
requirements of this paragraph (d) of
this section:
(i) Term structure of market-implied
probability of default;
(ii) Market-consensus expected lossgiven-default; and
(iii) Simulated paths of discounted
future exposure.
(3) The term structure of marketimplied probability of default must be
estimated from credit spreads observed
in the markets. For counterparties
whose credit is not actively traded
(illiquid counterparties), the marketimplied probability of default must be
estimated from proxy credit spreads,
estimated for such counterparties
according to the following requirements:
(i) A [BANKING ORGANIZATION]
must estimate the credit spread curves
of illiquid counterparties from credit
spreads observed in the markets of the
counterparty’s liquid peers via an
algorithm that is based, at a minimum,
on the following inputs:
(A) A measure of credit quality;
(B) Industry; and
(C) Region;
(ii) A [BANKING ORGANIZATION]
may map an illiquid counterparty to a
single liquid reference name if the
[BANKING ORGANIZATION]
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(ii) Sc is defined for bucket c as:
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volatilities and correlations of market
risk factors on a historical basis; and
(iii) The distribution of modelled risk
factors must adequately account for the
possible non-normality of the
distribution of exposures.
(12) For purposes of the calculation of
the regulatory CVA, a [BANKING
ORGANIZATION] must recognize
netting in the same manner as used by
the [BANKING ORGANIZATION] for
financial reporting purposes.
(e) CVA Sensitivities. For purposes of
calculating the CVA delta capital
requirement and the CVA vega capital
requirement, a [BANKING
ORGANIZATION] must calculate the
CVA delta sensitivities and CVA vega
sensitivities in accordance with the
requirements set forth below.
(1) Reference value. For purposes of
calculating the CVA delta sensitivity or
CVA vega sensitivity of aggregate
regulatory CVA to a risk factor, SkCVA,
the reference value is the aggregate
regulatory CVA of all standardized CVA
risk covered positions. For purposes of
calculating the CVA delta sensitivity or
CVA vega sensitivity of aggregate market
value of standardized CVA hedges to a
risk factor, SkHdg, the reference value is
the aggregate market value of all
standardized CVA hedges.
(2) CVA delta sensitivities
definitions—(i) Interest rate risk. (A) For
currencies specified in
§ ll.225(a)(1)(ii), a [BANKING
ORGANIZATION] must calculate the
CVA delta sensitivity to each delta risk
factor by changing the risk-free yield for
a given tenor for all curves in a given
currency by 0.0001 and dividing the
resulting change in the reference value
by 0.0001. A [BANKING
ORGANIZATION] must measure the
delta sensitivity to the inflation rate by
changing the inflation rate by 0.0001
and dividing the resulting change in the
reference value by 0.0001.
(B) For currencies not specified in
§ ll.225(a)(1)(ii), a [BANKING
ORGANIZATION] must measure the
CVA delta sensitivity to each delta risk
factor by applying a parallel shift to all
risk-free yield curves in a given
currency by 0.0001 and dividing the
resulting change in the reference value
by 0.0001. A [BANKING
ORGANIZATION] must measure the
delta sensitivity to the inflation rate by
changing the inflation rate by 0.0001
and dividing the resulting change in the
reference value by 0.0001.
(ii) Foreign exchange risk. A
[BANKING ORGANIZATION] must
measure the CVA delta sensitivity to
each delta risk factor by multiplying the
current value of the exchange rate
between the [BANKING
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ORGANIZATION]’s reporting currency
and the other currency (i.e., the value of
one unit of another currency expressed
in units of the reporting currency) by
1.01 and dividing the resulting change
in the reference value by 0.01. For
transactions that reference an exchange
rate between a pair of non-reporting
currencies, a [BANKING
ORGANIZATION] must measure the
CVA delta sensitivities to the foreign
exchange spot rate between the
[BANKING ORGANIZATION]’s
reporting currency and each of the
referenced non-reporting currencies.
(iii) Counterparty credit spread risk.
For each entity and each tenor point, a
[BANKING ORGANIZATION] must
measure the CVA delta sensitivity to
each delta risk factor for counterparty
credit risk by shifting the relevant credit
spread by 0.0001 and dividing the
resulting change in the reference value
by 0.0001.
(iv) Reference credit spread risk. A
[BANKING ORGANIZATION] must
measure the CVA delta sensitivity to
each delta risk factor for reference credit
spread risk by simultaneously shifting
all of the credit spreads for all tenors of
all reference names in the bucket by
0.0001 and dividing the resulting
change in the reference value by 0.0001.
(v) Equity risk. A [BANKING
ORGANIZATION] must measure the
CVA delta sensitivity to each delta risk
factor for equity risk by multiplying the
current values of all of the equity spot
prices for all reference names in the
bucket by 1.01 and dividing the
resulting change in the reference value
by 0.01.
(vi) Commodity risk. A [BANKING
ORGANIZATION] must measure the
CVA delta sensitivities to each delta risk
factor for commodity risk by
multiplying the current values of all of
the spot prices of all commodities in the
bucket by 1.01 and dividing the
resulting change in the reference value
by 0.01.
(3) CVA vega sensitivities
definitions—(i) Interest rate risk. A
[BANKING ORGANIZATION] must
measure the CVA vega sensitivity to
each vega risk factor by multiplying the
current values of all interest rate or
inflation rate volatilities, respectively,
by 1.01 and dividing the resulting
change in the reference value by 0.01.
(ii) Foreign exchange risk. A
[BANKING ORGANIZATION] must
measure the CVA vega sensitivity to
each vega risk factor for foreign
exchange risk by multiplying the
current values of all volatilities for a
given exchange rate between the
[BANKING ORGANIZATION]’s
reporting currency and another currency
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by 1.01 and dividing the resulting
change in the reference value by 0.01.
For transactions that reference an
exchange rate between a pair of nonreporting currencies, a [BANKING
ORGANIZATION] must measure the
volatilities of the foreign exchange spot
rates between the [BANKING
ORGANIZATION]’s reporting currency
and each of the referenced nonreporting currencies.
(iii) Reference credit spread risk. A
[BANKING ORGANIZATION] must
measure the CVA vega sensitivity to
each vega risk factor for reference credit
spread risk by multiplying the current
values of the volatilities of all credit
spreads of all tenors for all reference
names in the bucket by 1.01 and
dividing the resulting change in the
reference values by 0.01.
(iv) Equity risk. A [BANKING
ORGANIZATION] must measure the
CVA vega sensitivity to each risk factor
for equity risk by multiplying the
current values of the volatilities for all
reference names in the bucket by 1.01
and dividing the resulting change in the
reference value by 0.01.
(v) Commodity risk. A [BANKING
ORGANIZATION] must measure the
CVA vega sensitivity to each vega risk
factor for commodity risk by
multiplying the current values of the
volatilities for all commodities in the
bucket by 1.01 and dividing the
resulting change in the reference value
by 0.01.
(4) Notwithstanding paragraphs (e)(2)
and (3) of this section, a [BANKING
ORGANIZATION] may use smaller
values of risk factor changes than what
is specified in paragraphs (e)(2) and (3)
of this section if doing so is consistent
with internal risk management
calculations.
(5) When CVA vega sensitivities are
calculated, the volatility shift must
apply to both types of volatilities that
appear in exposure models:
(i) Volatilities used for generating risk
factor paths; and
(ii) Volatilities used for pricing
options.
(6) In cases where a standardized CVA
risk covered position or a standardized
CVA hedge references an index, the
sensitivities of the aggregate regulatory
CVA or the market value of the eligible
CVA hedge to all risk factors upon
which the value of the index depends
must be calculated. The sensitivity of
the aggregate regulatory CVA or the
market value of the standardized CVA
hedge to risk factor, k, must be
calculated by applying the shift of risk
factor, k, to all index constituents that
depend on this risk factor and
recalculating the aggregate regulatory
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(A) For listed and well-diversified
equity indices that are not sector
specific, where 75 percent of market
value of the constituents of the index,
taking into account the weightings of
the constituents, are mapped to the
same sector, the entire index must be
mapped to that sector and treated as a
single-name sensitivity in that bucket;
(B) For listed and well-diversified
credit indices that are not sector
specific, where 75 percent of notional
value of the constituents of the index,
taking into account the weightings of
the constituents, are mapped to the
same sector, the entire index must be
mapped to that sector and treated as a
single-name sensitivity in that bucket;
and
(C) In all other cases, the sensitivity
must be mapped to the applicable index
bucket.
§ ll.225 Standardized CVA approach:
definitions of buckets, risk factors, risk
weights, and correlation parameters.
ORGANIZATION] must establish a
separate interest rate risk bucket for
each currency.
(ii) For the purposes of this section,
specified currencies mean United States
Dollar, Australian Dollar, Canadian
Dollar, Euro, Japanese Yen, Swedish
Krona, and United Kingdom Pound, and
any additional currencies specified by
the [AGENCY].
(A) Delta risk factors for interest rate
risk, specified currencies. The delta risk
factors for interest rate risk for the
specified currencies are the absolute
changes of the inflation rate and of the
risk-free yields for the following five
tenors: 1 year, 2 years, 5 years, 10 years,
and 30 years.
(B) Delta risk weights for interest rate
risk, specified currencies. The delta risk
weights, RWk, for interest rate risk for
the specified currencies are set out in
Table 1 of this section.
(C) Delta within-bucket correlation
parameter for interest rate risk,
specified currencies. The correlation
parameters, rkl, related to the specified
currencies are set out in Table 2 of this
section.
(iii) For currencies not specified in
paragraph (a)(2)(ii) of this section:
(A) Delta risk factors for interest rate
risk, other currencies. The delta risk
factors for interest rate risk equal the
absolute change of the inflation rate and
the parallel shift of the entire risk-free
yield curve for a given currency;
(B) Delta risk weights for interest rate
risk, other currencies. The delta risk
weights, RWk, for both the risk-free yield
curve and the inflation rate equal 1.58
percent; and
(C) Delta within-bucket correlation
parameter for interest rate risk, other
currencies. The correlation parameter,
rkl, between the risk-free yield curve
and the inflation rate equals 40 percent.
(iv) Delta cross-bucket correlation
parameter for interest rate risk. The
delta cross-bucket correlation
parameter, gbc, for interest rate risk
equals 50 percent for all currency pairs.
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(a) CVA delta capital requirement—
(1) Interest rate risk—(i) Delta buckets
for interest rate risk. A [BANKING
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CVA or the market value of the
standardized CVA hedge.
(7) Notwithstanding paragraph (e)(6)
of this section:
(i) For the risk classes of counterparty
credit spread risk, reference credit
spread risk, and equity risk, a
[BANKING ORGANIZATION] may
choose to introduce a set of additional
risk factors that directly correspond to
qualified credit and equity indices;
(ii) For delta risk, a credit or equity
index is qualified if it is listed and welldiversified; for vega risk, any credit or
equity index is qualified. If a [BANKING
ORGANIZATION] chooses to introduce
such additional risk factors, a
[BANKING ORGANIZATION] must
calculate CVA sensitivities to the
qualified index risk factors in addition
to sensitivities to the non-index risk
factors; and
(iii) For a standardized CVA risk
covered position or a standardized CVA
hedge whose underlying is a qualified
index, its contribution to sensitivities to
the index constituents is replaced with
its contribution to a single sensitivity to
the underlying index, provided that:
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or base currency and another currency
equal 11 percent.
(iv) Delta cross-bucket correlation
parameter for foreign exchange risk. The
delta cross-bucket correlation
parameter, gbc, for foreign exchange risk
equals 60 percent for all currency pairs.
(3) Counterparty credit spread risk—
(i) Delta buckets for counterparty credit
spread risk. Delta buckets for
counterparty credit spread risk are set
out in Table 3 of this section. Delta
buckets 1 to 7 represent the non-index
risk factors and bucket 8 is available for
the optional treatment of qualified
indices. Under the optional treatment of
qualified indices, only standardized
CVA hedges of counterparty credit
spread risk and reference qualified
indices can be assigned to bucket 8,
whereas buckets 1 to 7 must be used for
calculations of CVA delta sensitivities
for standardized CVA risk covered
positions and all single-name and all
non-qualified index hedges. For any
CVA index hedge assigned to buckets 1
to 7, the sensitivity of the hedge to each
index constituent must be calculated as
described in § ll.224(e)(6).
(ii) Delta risk factors for counterparty
credit spread risk. The delta risk factors
for counterparty credit spread risk equal
the absolute shifts of credit spreads of
individual entities (counterparties and
reference names for counterparty credit
spread hedges) and qualified indices
(under the optional treatment of
qualified indices) for the following
tenors: 0.5 years, 1 year, 3 years, 5 years,
and 10 years.
(iii) Delta risk weights for
counterparty credit spread risk. The
delta risk weights, RWk, for counterparty
credit spread risk are set out in Table 3
of this section. The same risk weight for
a given bucket and given credit quality
applies to all tenors.
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BILLING CODE 6210–01–C; 6714–01–C; 4810–33–C
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(2) Foreign exchange risk—(i) Delta
buckets for foreign exchange risk. A
[BANKING ORGANIZATION] must
establish a separate delta foreign
exchange risk bucket for each currency,
except for a [BANKING
ORGANIZATION]’s own reporting
currency.
(ii) Delta risk factors for foreign
exchange risk. The delta risk factors for
foreign exchange risk equal the relative
change of the foreign exchange spot rate
between a given currency and a
[BANKING ORGANIZATION]’s
reporting currency or base currency,
where the foreign exchange spot rate is
the current market price of one unit of
another currency expressed in the units
of the [BANKING ORGANIZATION]’s
reporting currency or base currency.
(iii) Delta risk weights for foreign
exchange risk. The delta risk weights,
RWk, for foreign exchange risk for all
exchange rates between the [BANKING
ORGANIZATION]’s reporting currency
Federal Register / Vol. 88, No. 179 / Monday, September 18, 2023 / Proposed Rules
where,
(1) rkl(tenor) equals 100 percent if the
two tenors are the same, and 90 percent
otherwise;
(2) rkl(name) equals 100 percent if the
two names are the same, 90 percent if
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(4) Reference credit spread risk—(i)
Delta buckets for reference credit spread
risk. Delta buckets for reference credit
spread risk are set out in Table 5 of this
section.
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the two names are distinct but are
affiliates, and 50 percent otherwise; and
(3) rkl(quality) equals 100 percent if the
credit quality of the two names is the
same (where speculative and subspeculative grade is treated as one credit
quality category), and 80 percent
otherwise.
(B) For bucket 8, a [BANKING
ORGANIZATION] must calculate the
correlation parameter, rkl, between two
weighted sensitivities WSk and WSl as
follows:
rkl = rkl(tenor) · rkl(name) · rkl(quality)
where,
(1) rkl(tenor) equals 100 percent if the
two tenors are the same, and 90 percent
otherwise;
(2) rkl(name) equals 100 percent if the
two indices are the same and of the
same series, 90 percent if the two
indices are the same but of distinct
series, and 80 percent otherwise; and
(3) rkl(quality) equals 100 percent if the
credit quality of the two indices is the
same (where speculative and subspeculative grade is treated as one credit
quality category), and 80 percent
otherwise.
(v) Delta cross-bucket correlation
parameters for counterparty credit
spread risk. The delta cross-bucket
correlation parameters, gbc, for
counterparty credit spread risk are set
out in Table 4 of this section.
(ii) Delta risk factors for reference
credit spread risk. The delta risk factor
for reference credit spread risk equals
the simultaneous absolute shift of all
credit spreads for all tenors of all
reference names in the bucket.
(iii) Delta risk weights for reference
credit spread risk. The delta risk
weights, RWk, for reference credit spread
risk are set out in Table 5 of this section.
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(iv) Delta within-bucket correlation
parameters, rkl, for counterparty credit
spread risk. The delta correlation
parameters, rkl, for counterpart credit
spread risk must be defined as follows:
(A) For buckets 1 through 7, a
[BANKING ORGANIZATION] must
calculate the correlation parameter, rkl,
between two weighted sensitivities WSk
and WSl as follows:
rkl = rkl(tenor) · rkl(name) · rkl(quality)
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(iv) Delta cross-bucket correlation
parameters for reference credit spread
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risk. The delta cross-bucket correlation
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parameter, gbc, for reference credit
spread risk equals:
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64288
(A) The cross-bucket correlation
parameters, gbc, between buckets of the
same credit quality (where speculative
and sub-speculative grade is treated as
one credit quality category) are set out
in Table 6 of this section.
(B) The cross-bucket correlation
parameters, gbc, between buckets 1 to 14
of different credit quality (where
speculative and sub-speculative grade is
treated as one credit quality category),
are set out in Table 7 of this section.
(5) Equity risk—(i) Delta buckets for
equity risk. For equity risk, a [BANKING
ORGANIZATION] must establish
buckets along three dimensions: the
reference entity’s market capitalization,
economy and sector as set out in Table
8 of this section. To assign a delta
sensitivity to an economy, a [BANKING
ORGANIZATION], at least annually,
must review and update the countries
and territorial entities that satisfy the
requirements of a liquid market
economy using the most recent
economic data available. To assign a
delta sensitivity to a sector, a
[BANKING ORGANIZATION] must
follow market convention by using
classifications that are commonly used
in the market for grouping issuers by
industry sector. A [BANKING
ORGANIZATION] must assign each
issuer to one of the sector buckets and
must assign all issuers from the same
industry to the same sector. Delta
sensitivities of any equity issuer that a
[BANKING ORGANIZATION] cannot
assign to a sector must be assigned to
the other sector. For multinational,
multi-sector equity issuers, the
allocation to a particular bucket must be
done according to the most material
economy and sector in which the issuer
operates.
(ii) Delta risk factors for equity risk.
The delta risk factor for equity risk
equals the simultaneous relative shift of
all equity spot prices for all reference
entities in the bucket.
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(iv) Delta cross-bucket correlation
parameters for equity risk. The delta
cross-bucket correlation parameter, gbc,
for equity risk equals 15 percent for all
cross-bucket pairs that assigned to
bucket numbers 1 to 10 and zero percent
for all cross-bucket pairs that include
bucket 11. The cross-bucket correlation
between buckets 12 and 13 equals 75
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percent and the cross-bucket correlation
between buckets 12 or 13 and any of the
buckets 1 through 10 equals 45 percent.
(6) Commodity risk—(i) Delta buckets
for commodity risk. Delta buckets for
commodity risk are set out in Table 9 of
this section.
(ii) Delta risk factors for commodity
risk. The delta risk factor for commodity
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risk equals the simultaneous relative
shift of all of the commodity spot prices
for all commodities in the bucket.
(iii) Delta risk weights for commodity
risk. The delta risk weights, RWk, for
commodity risk are set out in Table 9 of
this section.
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(iii) Delta risk weights for equity risk.
The delta risk weights, RWk, for equity
risk are set out in Table 8 of this section.
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(iv) Delta cross-bucket correlation
parameters for commodity risk. The
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delta cross-bucket correlation, gbc, for
commodity risk equals 20 percent for all
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cross-bucket pairs assigned to bucket
numbers 1 to 10 and zero percent for all
cross-bucket pairs that include bucket
11.
(b) CVA vega capital requirement—(1)
Interest rate risk.
(i) Vega buckets for interest rate risk.
A [BANKING ORGANIZATION] must
establish a separate vega interest rate
risk bucket for each currency.
(ii) Vega risk factors for interest rate
risk. The vega risk factors for interest
rate risk for all currencies equal a
simultaneous relative change of all
inflation rate volatilities for each
currency and a simultaneous relative
change of all interest rate volatilities for
each currency.
(iii) Vega risk weights for interest rate
risk. The vega risk weights, RWk, for
interest rate risk equal 100 percent.
(iv) Vega within-bucket correlation
parameters for interest rate risk. The
vega within-bucket correlation
parameter, rkl, for interest rate risk
equals 40 percent.
(v) Vega cross-bucket correlation
parameter for interest rate risk. The vega
cross-bucket correlation parameter, gbc,
for interest rate risk equals 50 percent
for all currency pairs.
(2) Foreign exchange risk—(i) Vega
buckets for foreign exchange risk. A
[BANKING ORGANIZATION] must
establish a separate vega foreign
exchange risk bucket for each currency,
except for a [BANKING
ORGANIZATION]’s own reporting
currency.
(ii) Vega risk factors for foreign
exchange risk. The vega risk factors for
foreign exchange risk equal the
simultaneous, relative change of all
volatilities for the exchange rate
between a [BANKING
ORGANIZATION]’s reporting currency
or base currency and each other
currency.
(iii) Vega risk weights for foreign
exchange risk. The vega risk weights,
RWk, for foreign exchange risk equal 100
percent.
(iv) Vega cross-bucket correlation
parameter for foreign exchange risk. The
vega cross-bucket correlation parameter,
gbc, for foreign exchange risk equals 60
percent for all currency pairs.
(3) Reference credit spread risk—(i)
Vega buckets for reference credit spread
risk. Vega buckets for reference credit
spread risk are set out in Table 5 of this
section.
(ii) Vega risk factors for reference
credit spread risk. The vega risk factors
for reference credit spread risk equal the
simultaneous relative shift of the
volatilities of all credit spreads of all
tenors for all reference names in the
bucket.
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(iii) Vega risk weights for reference
credit spread risk. The vega risk
weights, RWk, for reference credit spread
risk equal 100 percent.
(iv) Vega cross-bucket correlation
parameters for reference credit spread
risk. The vega cross-bucket correlation
parameter, gbc, for reference credit
spread risk is defined in the same
manner as the delta cross-bucket
correlation parameter for reference
credit spread risk, pursuant to
paragraph (a)(4)(iv) of this section.
(4) Equity risk—(i) Vega buckets for
equity risk. The vega buckets for equity
risk are defined in the same manner as
the delta buckets for equity risk,
pursuant to paragraph (a)(5)(i) of this
section.
(ii) Vega risk factors for equity risk.
The vega risk factor for equity risk
equals the simultaneous relative shift of
the volatilities for all reference entities
in the bucket.
(iii) Vega risk weights for equity risk.
The vega risk weights, RWk, for equity
risk equal 78 percent for large market
cap buckets and 100 percent otherwise.
(iv) Vega cross-bucket correlation
parameters for equity risk. The vega
cross-bucket correlation parameter, gbc,
for equity risk equals 15 percent for all
cross-bucket pairs that fall within
bucket numbers 1 to 10 and zero percent
for all cross-bucket pairs that include
bucket 11. The cross-bucket correlation
between buckets 12 and 13 is set at 75
percent and the cross-bucket correlation
between buckets 12 or 13 and any of the
buckets 1 to 10 is 45 percent.
(5) Commodity risk—(i) Vega buckets
for commodity risk. The vega buckets
for commodity risk are defined in the
same manner as the delta buckets for
commodity risk, pursuant to paragraph
(a)(6)(i) of this section.
(ii) Vega risk factors for commodity
risk. The vega risk factor for commodity
risk equals the simultaneous relative
shift of the volatilities for all
commodities in the bucket.
(iii) Vega risk weights for commodity
risk. The vega risk weights for
commodity risk RWk are 100 percent.
(iv) Vega cross-bucket correlation
parameters for commodity risk. The
vega cross-bucket correlation parameter,
gbc, for commodity risk equals 20
percent for all cross-bucket pairs that
fall within bucket numbers 1 to 10 and
zero percent for all cross-bucket pairs
that include bucket 11.
End of Common Rule.
Fmt 4701
Federal Reserve System, National
banks, Penalties.
12 CFR Part 32
National banks, Reporting and
recordkeeping requirements, Savings
Associations.
12 CFR Part 208
Confidential business information,
Crime, Currency, Federal Reserve
System, Mortgages, Reporting and
recordkeeping requirements, Securities.
12 CFR Part 217
Administrative practice and
procedure, Banks, Banking, Capital,
Federal Reserve System, Holding
companies.
12 CFR Part 225
Administrative practice and
procedure, Banks, banking, Federal
Reserve System, Holding companies,
Reporting and recordkeeping
requirements, Securities.
12 CFR Part 238
Administrative practice and
procedure, Banks, banking, Federal
Reserve System, Holding companies,
Reporting and recordkeeping
requirements, Securities.
12 CFR Part 252
Administrative practice and
procedure, Banks, banking, Credit,
Federal Reserve System, Holding
companies, Investments, Qualified
financial contracts, Reporting and
recordkeeping requirements, Securities.
12 CFR Part 324
Administrative practice and
procedure, Banks, banking, Capital
adequacy, Reporting and recordkeeping
requirements, Savings associations,
State non-member banks.
Adoption of Common Rule
The proposed adoption of the
common rule by the agencies, as
modified by the agency-specific text, is
set forth below:
DEPARTMENT OF THE TREASURY
Office of the Comptroller of the
Currency
Authority and Issuance
12 CFR Part 3
Administrative practice and
procedure, Banks, banking, Federal
Frm 00266
12 CFR Part 6
12 CFR Chapter I
List of Subjects
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banks, Reporting and recordkeeping
requirements, Savings associations.
Sfmt 4702
For the reasons set forth in the
common preamble, the OCC proposes to
amend parts 3, 6, and 32 of chapter I of
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Federal Register / Vol. 88, No. 179 / Monday, September 18, 2023 / Proposed Rules
title 12 of the Code of Federal
Regulations as follows:
PART 3—CAPITAL ADEQUACY
STANDARDS
1. The authority citation for part 3
continues to read as follows:
■
Authority: 12 U.S.C. 93a, 161, 1462,
1462a, 1463, 1464, 1818, 1828(n), 1828 note,
1831n note, 1835, 3907, 3909, 5412(b)(2)(B),
and Pub. L. 116–136, 134 Stat. 281.
2. In § 3.1, revise paragraphs (c)(3)(ii),
(c)(4)(i) and (iii), and (f) to read as
follows:
■
§ 3.1 Purpose, applicability, reservations
of authority, and timing.
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*
*
*
*
*
(c) * * *
(3) * * *
(ii) Each national bank or Federal
savings association subject to subpart E
of this part must use the methodologies
in subpart E (and subpart F of this part
for a market risk national bank or
Federal savings association) to calculate
expanded total risk-weighted assets.
(4) * * *
(i) Except for a national bank or
Federal savings association subject to
subpart E of this part, each national
bank or Federal savings association with
total consolidated assets of $50 billion
or more must make the public
disclosures described in subpart D of
this part.
*
*
*
*
*
(iii) Each national bank or Federal
savings association subject to subpart E
of this part must make the public
disclosures described in subpart E of
this part.
*
*
*
*
*
(f) Transitions and timing— (1)
Transitions. Notwithstanding any other
provision of this part, a national bank or
Federal savings association must make
any adjustments provided in subpart G
of this part for purposes of
implementing this part.
(2) Timing. A national bank or Federal
savings association that changes from
one category to another category, or that
changes from having no category to
having a category, must comply with the
requirements of its category in this part,
including applicable transition
provisions of the requirements in this
part, no later than on the first day of the
second quarter following the change in
the national bank’s or Federal savings
association’s category.
■ 3. In § 3.2:
■ a. Redesignate footnotes 3 through 9
as footnotes 1 through 7.
■ b. Remove the definitions for
‘‘Advanced approaches national bank or
Federal savings association’’,
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‘‘Advanced approaches total riskweighted assets’’, and ‘‘Advanced
market risk-weighted assets’’;
■ c. Revise the definitions for ‘‘Category
II national bank or Federal savings
association’’ and ‘‘Category III national
bank or Federal savings association’’;
■ d. Add, in alphabetical order, the
definition for ‘‘Category IV national
bank or Federal savings association’’;
■ e. Revise newly redesignated footnote
1 to paragraph (2) of the definition for
‘‘Cleared transaction’’ and the definition
for ‘‘Corporate exposure’’;
■ f. Remove the definition for ‘‘Creditrisk-weighted assets’’;
■ g. Add, in alphabetical order, the
definition for ‘‘CVA risk-weighted
assets’’;
■ h. Revise the definition for ‘‘Effective
notional amount’’;
■ i. Remove the definition for ‘‘Eligible
credit reserves’’;
■ j. Revise paragraph (10) of the
definition for ‘‘Eligible guarantee’’;
■ k. Add, in alphabetical order, the
definition for ‘‘Expanded total riskweighted assets’’;
■ l. Remove the definition for ‘‘Expected
credit loss (ECL)’’;
■ m. Revise paragraphs (1) and (4)
through (8) of the definition for
‘‘Exposure amount’’, paragraph (2) of
the definition for ‘‘Financial collateral’’,
paragraph (5)(i) of the definition for
‘‘Financial institution’’, and the
definitions for ‘‘Indirect exposure’’ and
‘‘Market risk national bank or Federal
savings association’’;
■ n. Add, in alphabetical order, the
definition for ‘‘Market risk-weighted
assets’’;
■ o. Revise the definitions for ‘‘Net
independent collateral amount’’,
‘‘Netting set’’, ‘‘Non-significant
investment in the capital of an
unconsolidated financial institution’’,
‘‘Protection amount (P)’’, paragraph (2)
of the definition for ‘‘Qualifying central
counterparty (QCCP)’’, and paragraphs
(3) and (4) of the definition for
‘‘Qualifying master netting agreement’’;
■ p. In the definition of ‘‘Residential
mortgage exposure’’:
■ i. Remove paragraph (2);
■ ii. Redesignate paragraphs (1)(i) and
(ii) as paragraphs (1) and (2),
respectively; and
■ iii. In newly redesignated paragraph
(2), remove the words ‘‘family; and’’ and
add in their place the word ‘‘family.’’;
■ q. Revise the definition for
‘‘Significant investment in the capital of
an unconsolidated financial
institution’’;
■ r. Remove the definition for ‘‘Specific
wrong-way risk’’;
■ s. Revise the definitions for
‘‘Speculative grade’’ and ‘‘Standardized
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64293
market risk-weighted assets’’,
paragraphs (1)(vi) and (2) of the
definition for ‘‘Standardized total riskweighted assets’’, and the definitions for
‘‘Sub-speculative grade’’, ‘‘Synthetic
exposure’’, and ‘‘Unregulated financial
institution’’;
■ t. Add, in alphabetical order, the
definition for ‘‘Total credit riskweighted assets’’;
■ u. Remove the definition for ‘‘Valueat-risk (VaR)’’;
■ v. Revise the definition for ‘‘Variation
margin amount’’;
■ w. Remove the definition for ‘‘Wrongway risk’’; and
The additions and revisions read as
follows:
§ 3.2
Definitions
*
*
*
*
*
Category II national bank or Federal
savings association means a national
bank or Federal savings association that
is not a subsidiary of a global
systemically important BHC, as defined
pursuant to 12 CFR 252.5, and that:
(1) Is a subsidiary of a Category II
banking organization, as defined
pursuant to 12 CFR 252.5 or 12 CFR
238.10, as applicable; or
(2)(i) Has total consolidated assets,
calculated based on the average of the
national bank’s or Federal savings
association’s total consolidated assets
for the four most recent calendar
quarters as reported on the Call Report,
equal to $700 billion or more. If the
national bank or Federal savings
association has not filed the Call Report
for each of the four most recent calendar
quarters, total consolidated assets is
calculated based on its total
consolidated assets, as reported on the
Call Report, for the most recent quarter
or the average of the most recent
quarters, as applicable; or
(ii)(A) Has total consolidated assets,
calculated based on the average of the
national bank’s or Federal savings
association’s total consolidated assets
for the four most recent calendar
quarters as reported on the Call Report,
of $100 billion or more but less than
$700 billion. If the national bank or
Federal savings association has not filed
the Call Report for each of the four most
recent quarters, total consolidated assets
is based on its total consolidated assets,
as reported on the Call Report, for the
most recent quarter or average of the
most recent quarters, as applicable; and
(B) Has cross-jurisdictional activity,
calculated based on the average of its
cross-jurisdictional activity for the four
most recent calendar quarters, of $75
billion or more. Cross-jurisdictional
activity is the sum of crossjurisdictional claims and cross-
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jurisdictional liabilities, calculated in
accordance with the instructions to the
FR Y–15 or equivalent reporting form.
(3) After meeting the criteria in
paragraph (2) of this definition, a
national bank or Federal savings
association continues to be a Category II
national bank or Federal savings
association until the national bank or
Federal savings association has:
(i) Less than $700 billion in total
consolidated assets, as reported on the
Call Report, for each of the four most
recent calendar quarters; and
(ii)(A) Less than $75 billion in crossjurisdictional activity for each of the
four most recent calendar quarters.
Cross-jurisdictional activity is the sum
of cross-jurisdictional claims and crossjurisdictional liabilities, calculated in
accordance with the instructions to the
FR Y–15 or equivalent reporting form;
or
(B) Less than $100 billion in total
consolidated assets, as reported on the
Call Report, for each of the four most
recent calendar quarters.
Category III national bank or Federal
savings association means a national
bank or Federal savings association that
is not a subsidiary of a global
systemically important banking
organization or a Category II national
bank or Federal savings association and
that:
(1) Is a subsidiary of a Category III
banking organization, as defined
pursuant to 12 CFR 252.5 or 12 CFR
238.10, as applicable; or
(2)(i) Has total consolidated assets,
calculated based on the average of total
consolidated assets for the four most
recent calendar quarters as reported on
the Call Report, equal to $250 billion or
more. If the national bank or Federal
savings association has not filed the Call
Report for each of the four most recent
calendar quarters, total consolidated
assets is calculated based on its total
consolidated assets, as reported on the
Call Report, for the most recent quarter
or average of the most recent quarters,
as applicable; or
(ii)(A) Has total consolidated assets,
calculated based on the average of total
consolidated assets for the four most
recent calendar quarters as reported on
the Call Report, of $100 billion or more
but less than $250 billion. If the national
bank or Federal savings association has
not filed the Call Report for each of the
four most recent calendar quarters, total
consolidated assets is calculated based
on its total consolidated assets, as
reported on the Call Report, for the most
recent quarter or average of the most
recent quarters, as applicable; and
(B) Has at least one of the following
in paragraphs (2)(ii)(B)(1) through (3) of
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this definition, each calculated as the
average of the four most recent calendar
quarters, or if the national bank or
Federal savings association has not filed
each applicable reporting form for each
of the four most recent calendar
quarters, for the most recent quarter or
quarters, as applicable:
(1) Total nonbank assets, calculated in
accordance with the instructions to the
FR Y–9LP or equivalent reporting form,
equal to $75 billion or more;
(2) Off-balance sheet exposure equal
to $75 billion or more. Off-balance sheet
exposure is a national bank’s or Federal
savings association’s total exposure,
calculated in accordance with the
instructions to the FR Y–15 or
equivalent reporting form, minus the
total consolidated assets, as reported on
the Call Report; or
(3) Weighted short-term wholesale
funding, calculated in accordance with
the instructions to the FR Y–15 or
equivalent reporting form, equal to $75
billion or more.
(iii) After meeting the criteria in
paragraph (2)(ii) of this definition, a
national bank or Federal savings
association continues to be a Category
III national bank or Federal savings
association until the national bank or
Federal savings association:
(A) Has:
(1) Less than $250 billion in total
consolidated assets, as reported on the
Call Report, for each of the four most
recent calendar quarters;
(2) Less than $75 billion in total
nonbank assets, calculated in
accordance with the instructions to the
FR Y–9LP or equivalent reporting form,
for each of the four most recent calendar
quarters;
(3) Less than $75 billion in weighted
short-term wholesale funding,
calculated in accordance with the
instructions to the FR Y–15 or
equivalent reporting form, for each of
the four most recent calendar quarters;
and
(4) Less than $75 billion in off-balance
sheet exposure for each of the four most
recent calendar quarters. Off-balance
sheet exposure is a national bank’s or
Federal savings association’s total
exposure, calculated in accordance with
the instructions to the FR Y–15 or
equivalent reporting form, minus the
total consolidated assets of the national
bank or Federal savings association, as
reported on the Call Report; or
(B) Has less than $100 billion in total
consolidated assets, as reported on the
Call Report, for each of the four most
recent calendar quarters; or
(C) Is a Category II national bank or
Federal savings association.
*
*
*
*
*
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Category IV national bank or Federal
savings association means a national
bank or Federal savings association that
is not a Category II national bank or
Federal savings association or Category
III national bank or Federal savings
association and that:
(1) Is a subsidiary of a Category IV
banking organization, as defined
pursuant to 12 CFR 252.5 or 12 CFR
238.10, as applicable; or
(2) Has total consolidated assets,
calculated based on the average of total
consolidated assets for the four most
recent calendar quarters as reported on
the Call Report, of $100 billion or more.
If the national bank or Federal savings
association has not filed the Call Report
for each of the four most recent calendar
quarters, total consolidated assets is
calculated based on the average of its
total consolidated assets, as reported on
the Call Report, for the most recent
quarter(s) available.
(3) After meeting the criterion in
paragraph (2) of this definition, a
national bank or Federal savings
association continues to be a Category
IV national bank or Federal savings
association until it:
(i) Has less than $100 billion in total
consolidated assets, as reported on the
Call Report, for each of the four most
recent calendar quarters; or
(ii) Is a Category II national bank or
Federal savings association or Category
III national bank or Federal savings
association.
*
*
*
*
*
Cleared transaction * * *
(2) * * * 1
*
*
*
*
*
Corporate exposure means an
exposure to a company that is not:
(1) An exposure to a sovereign, the
Bank for International Settlements, the
European Central Bank, the European
Commission, the International Monetary
Fund, the European Stability
Mechanism, the European Financial
Stability Facility, a multi-lateral
development bank (MDB), a depository
institution, a foreign bank, or a credit
union, a public sector entity (PSE);
(2) An exposure to a GovernmentSponsored Enterprises (GSE);
(3) For purposes of subpart D of this
part, a residential mortgage exposure;
(4) A pre-sold construction loan;
(5) A statutory multifamily mortgage;
(6) A high volatility commercial real
estate (HVCRE) exposure;
(7) A cleared transaction;
(8) A default fund contribution;
(9) A securitization exposure;
(10) An equity exposure;
(11) An unsettled transaction;
(12) A policy loan;
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(13) A separate account;
(14) A Paycheck Protection Program
covered loan as defined in section
7(a)(36) or (37) of the Small Business
Act (15 U.S.C. 636(a)(36)–(37));
(15) For purposes of subpart E of this
part, a real estate exposure, as defined
in § 3.101 of this part; or
(16) For purposes of subpart E of this
part, a retail exposure as defined in
§ 3.101 of this part.
*
*
*
*
*
CVA risk-weighted assets means the
measure for CVA risk calculated under
§ 3.221(a) multiplied by 12.5.
*
*
*
*
*
Effective notional amount means for
an eligible guarantee or eligible credit
derivative, the lesser of the contractual
notional amount of the credit risk
mitigant and the exposures amount of
the hedged exposure, multiplied by the
percentage coverage of the credit risk
mitigant.
*
*
*
*
*
Eligible guarantee * * *
(10) Is provided by an eligible
guarantor.
*
*
*
*
*
Expanded total risk-weighted assets
means the greater of:
(1) The sum of:
(i) Total credit risk-weighted assets;
(ii) Total risk-weighted assets for
equity exposures as calculated under
§§ 3.141 and 3.142;
(iii) Risk-weighted assets for
operational risk as calculated under
§ 3.150;
(iv) Market risk-weighted assets; and
(v) CVA risk-weighted assets; minus
(vi) Any amount of the national
bank’s or Federal savings association’s
adjusted allowance for credit losses that
is not included in tier 2 capital and any
amount of allocated transfer risk
reserves; or
(2)(i) 72.5 percent of the sum of:
(A) Total credit risk-weighted assets;
(B) Total risk-weighted assets for
equity exposures as calculated under
§§ 3.141 and 3.142;
(C) Risk-weighted assets for
operational risk as calculated under
§ 3.150;
(D) Standardized market riskweighted assets; and
(E) CVA risk-weighted assets; minus
(ii) Any amount of the national bank’s
or Federal savings association’s adjusted
allowance for credit losses that is not
included in tier 2 capital and any
amount of allocated transfer risk
reserves.
*
*
*
*
*
Exposure amount means:
(1) For the on-balance sheet
component of an exposure (other than
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an available-for-sale or held-to-maturity
security, if the national bank or Federal
savings association has made an AOCI
opt-out election (as defined in
§ 3.22(b)(2)); an OTC derivative contract;
a repo-style transaction or an eligible
margin loan for which the national bank
or Federal savings association
determines the exposure amount under
§ 3.37 or § 3.121, as applicable; a cleared
transaction; a default fund contribution;
or a securitization exposure), the
national bank’s or Federal savings
association’s carrying value of the
exposure.
*
*
*
*
*
(4) For the off-balance sheet
component of an exposure (other than
an OTC derivative contract; a repo-style
transaction or an eligible margin loan
for which the national bank or Federal
savings association calculates the
exposure amount under § 3.37 or
§ 3.121, as applicable; a cleared
transaction; a default fund contribution;
or a securitization exposure), the
notional amount of the off-balance sheet
component multiplied by the
appropriate credit conversion factor
(CCF) in § 3.33 or § 3.112, as applicable.
(5) For an exposure that is an OTC
derivative contract, the exposure
amount determined under § 3.34 or
§ 3.113, as applicable.
(6) For an exposure that is a cleared
transaction, the exposure amount
determined under § 3.35 or § 3.114, as
applicable.
(7) For an exposure that is an eligible
margin loan or repo-style transaction for
which the national bank or Federal
savings association calculates the
exposure amount as provided in § 3.37
or § 3.121, as applicable, the exposure
amount determined under § 3.37 or
§ 3.121, as applicable.
(8) For an exposure that is a
securitization exposure, the exposure
amount determined under § 3.42 or
§ 3.131, as applicable.
*
*
*
*
*
Financial collateral * * *
(2) In which the national bank or
Federal savings association has a
perfected, first-priority security interest
or, outside of the United States, the legal
equivalent thereof (with the exception
of cash on deposit; and notwithstanding
the prior security interest of any
custodial agent or any priority security
interest granted to a CCP in connection
with collateral posted to that CCP).
Financial institution * * *
(5) * * *
(i) 85 percent or more of the total
consolidated annual gross revenues (as
determined in accordance with
applicable accounting standards) of the
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64295
company in either of the two most
recent calendar years were derived,
directly or indirectly, by the company
on a consolidated basis from the
activities; or
*
*
*
*
*
Indirect Exposure means an exposure
that arises from the national bank’s or
Federal savings association’s investment
in an investment fund which holds an
investment in the national bank’s or
Federal savings association’s own
capital instrument, or an investment in
the capital of an unconsolidated
financial institution. For a national bank
or Federal savings association subject to
subpart E of this part, indirect exposure
also includes an investment in an
investment fund that holds a covered
debt instrument.
*
*
*
*
*
Market risk national bank or Federal
savings association means a national
bank or Federal savings association that
is described in § 3.201(b)(1).
Market risk-weighted assets means the
measure for market risk calculated
pursuant to § 3.204(a) multiplied by
12.5.
*
*
*
*
*
Net independent collateral amount
means the fair value amount of the
independent collateral, as adjusted by
the haircuts under § 3.121(c)(2)(iii), as
applicable, that a counterparty to a
netting set has posted to a national bank
or Federal savings association less the
fair value amount of the independent
collateral, as adjusted by the haircuts
under § 3.121(c)(2)(iii), as applicable,
posted by the national bank or Federal
savings association to the counterparty,
excluding such amounts held in a
bankruptcy-remote manner or posted to
a QCCP and held in conformance with
the operational requirements in § 3.3.
Netting set means:
(1) A group of transactions with a
single counterparty that are subject to a
qualifying master netting agreement and
that consist only of:
(i) Derivative contracts;
(ii) Repo-style transactions; or
(iii) Eligible margin loans.
(2) For derivative contracts, netting
set also includes a single derivative
contract between a national bank or
Federal savings association and a single
counterparty.
Non-significant investment in the
capital of an unconsolidated financial
institution means an investment by a
national bank or Federal savings
association subject to subpart E of this
part in the capital of an unconsolidated
financial institution where the national
bank or Federal savings association
owns 10 percent or less of the issued
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and outstanding common stock of the
unconsolidated financial institution.
*
*
*
*
*
Protection amount (P) means, with
respect to an exposure hedged by an
eligible guarantee or eligible credit
derivative, the effective notional amount
of the guarantee or credit derivative,
reduced to reflect any currency
mismatch, maturity mismatch, or lack of
restructuring coverage (as provided in
§ 3.36 or § 3.120, as appropriate).
*
*
*
*
*
Qualifying central counterparty
(QCCP) * * *
(2) (i) Provides the national bank or
Federal savings association with the
central counterparty’s hypothetical
capital requirement or the information
necessary to calculate such hypothetical
capital requirement, and other
information the national bank or Federal
savings association is required to obtain
under §§ 3.35(d)(3) and 3.113(d)(3);
(ii) Makes available to the OCC and
the CCP’s regulator the information
described in paragraph (2)(i) of this
definition; and
(iii) Has not otherwise been
determined by the OCC to not be a
QCCP due to its financial condition, risk
profile, failure to meet supervisory risk
management standards, or other
weaknesses or supervisory concerns that
are inconsistent with the risk weight
assigned to qualifying central
counterparties under §§ 3.35 and 3.113.
Qualifying master netting agreement
* * *
(3) The agreement does not contain a
walkaway clause (that is, a provision
that permits a non-defaulting
counterparty to make a lower payment
than it otherwise would make under the
agreement, or no payment at all, to a
defaulter or the estate of a defaulter,
even if the defaulter or the estate of the
defaulter is a net creditor under the
agreement); and
(4) In order to recognize an agreement
as a qualifying master netting agreement
for purposes of this subpart, a national
bank or Federal savings association
must comply with the requirements of
§ 3.3(d) with respect to that agreement.
*
*
*
*
*
Significant investment in the capital
of an unconsolidated financial
institution means an investment by a
national bank or Federal savings
association subject to subpart E of this
part in the capital of an unconsolidated
financial institution where the national
bank or Federal savings association
owns more than 10 percent of the issued
and outstanding common stock of the
unconsolidated financial institution.
*
*
*
*
*
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Speculative grade means that the
entity to which the national bank or
Federal savings association is exposed
through a loan or security, or the
reference entity with respect to a credit
derivative, has adequate capacity to
meet financial commitments in the near
term, but is vulnerable to adverse
economic conditions, such that should
economic conditions deteriorate, the
issuer or the reference entity would
present an elevated default risk.
Standardized market risk-weighted
assets means the standardized measure
for market risk calculated under
§ 3.204(b) multiplied by 12.5.
Standardized total risk-weighted
assets means:
(1) * * *
(vi) For a market risk national bank or
Federal savings association only, market
risk-weighted assets; minus
(2) Any amount of the national bank’s
or Federal savings association’s
allowance for loan and lease losses or
adjusted allowance for credit losses, as
applicable, that is not included in tier
2 capital and any amount of allocated
transfer risk reserves.
*
*
*
*
*
Sub-speculative grade means that the
entity to which the national bank or
Federal savings association is exposed
through a loan or security, or the
reference entity with respect to a credit
derivative, depends on favorable
economic conditions to meet its
financial commitments, such that
should such economic conditions
deteriorate the issuer or the reference
entity likely would default on its
financial commitments.
*
*
*
*
*
Synthetic exposure means an
exposure whose value is linked to the
value of an investment in the national
bank or Federal savings association’s
own capital instrument or to the value
of an investment in the capital of an
unconsolidated financial institution. For
a national bank or Federal savings
association subject to subpart E of this
part, synthetic exposure includes an
exposure whose value is linked to the
value of an investment in a covered debt
instrument.
*
*
*
*
*
Total credit risk-weighted assets
means the sum of:
(1) Total risk-weighted assets for
general credit risk as calculated under
§ 3.110;
(2) Total risk-weighted assets for
cleared transactions and default fund
contributions as calculated under
§ 3.114;
(3) Total risk-weighted assets for
unsettled transactions as calculated
under § 3.115; and
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(4) Total risk-weighted assets for
securitization exposures as calculated
under § 3.132.
*
*
*
*
*
Unregulated financial institution
means a financial institution that is not
a regulated financial institution,
including any financial institution that
would meet the definition of ‘‘Financial
institution’’ under this section but for
the ownership interest thresholds set
forth in paragraph (4)(i) of that
definition.
*
*
*
*
*
Variation margin amount means the
fair value amount of the variation
margin, as adjusted by the standard
supervisory haircuts under
§ 3.121(c)(2)(iii), as applicable, that a
counterparty to a netting set has posted
to a national bank or Federal savings
association less the fair value amount of
the variation margin, as adjusted by the
standard supervisory haircuts under
§ 3.121(c)(2)(iii), as applicable, posted
by the national bank or Federal savings
association to the counterparty.
*
*
*
*
*
1 For the standardized approach treatment
of these exposures, see § 3.34(e) (OTC
derivative contracts) or § 3.37(c) (repo-style
transactions). For the expanded risk-based
approach treatment of these exposures, see
§ 3.113 (OTC derivative contracts) or § 3.121
(repo-style transactions).
*
*
*
§ 3.3
[Amended]
*
*
4. In § 3.3, remove and reserve
paragraph (c).
■ 5. In § 3.10:
■ a. Revise paragraph (a)(1)(v);
■ b. In paragraph (b) introductory text,
remove the words ‘‘paragraph (c)’’ and
add in their the words ‘‘paragraph (d)’’;
■ c. Revise paragraph (c);
■ d. In paragraph (d):
■ i. Revise the introductory text;
■ ii. Remove the words ‘‘advanced
approaches’’ from paragraphs (d)(1)(ii)
and (d)(2)(ii) and and add in their place
the word ‘‘expanded’’; and
■ iii. Revise paragraph (d)(3)(ii); and
■ f. In paragraph (e)(1), remove the
phrase ‘‘(national banks), 12 CFR
167.3(c) (Federal savings associations)’’.
The revisions read as follows:
■
§ 3.10
Minimum capital requirements.
(a) * * *
(1) * * *
(v) For a national bank or Federal
savings association subject to subpart E
of this part, a supplementary leverage
ratio of 3 percent.
*
*
*
*
*
(c) Supplementary leverage ratio. (1)
The supplementary leverage ratio of a
national bank or Federal savings
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association subject to subpart E of this
part is the ratio of its tier 1 capital to
total leverage exposure. Total leverage
exposure is calculated as the sum of:
(i) The mean of the on-balance sheet
assets calculated as of each day of the
reporting quarter; and
(ii) The mean of the off-balance sheet
exposures calculated as of the last day
of each of the most recent three months,
minus the applicable deductions under
§ 3.22(a), (c), and (d).
(2) For purposes of this part, total
leverage exposure means the sum of the
items described in paragraphs (c)(2)(i)
through (viii) of this section, as adjusted
pursuant to paragraph (c)(2)(ix) of this
section for a clearing member national
bank or Federal savings association and
paragraph (c)(2)(x) of this section for a
custodial banking organization:
(i) The balance sheet carrying value of
all of the national bank’s or Federal
savings association’s on-balance sheet
assets, net of adjusted allowances for
credit losses, plus the value of securities
sold under a repurchase transaction or
a securities lending transaction that
qualifies for sales treatment under
GAAP, less amounts deducted from tier
1 capital under § 3.22(a), (c), and (d),
less the value of securities received in
security-for-security repo-style
transactions, where the national bank or
Federal savings association acts as a
securities lender and includes the
securities received in its on-balance
sheet assets but has not sold or rehypothecated the securities received,
and less the fair value of any derivative
contracts;
(ii) (A) The potential future credit
exposure (PFE) for each netting set to
which the national bank or Federal
savings association is a counterparty
(including cleared transactions except
as provided in paragraph (c)(2)(viii) of
this section and, at the discretion of the
national bank or Federal savings
association, excluding a forward
agreement treated as a derivative
contract that is part of a repurchase or
reverse repurchase or a securities
borrowing or lending transaction that
qualifies for sales treatment under
GAAP), as determined under § 3.113(g),
in which the term C in § 3.113(g)(1)
equals zero, and, for any counterparty
that is not a commercial end-user,
multiplied by 1.4. For purposes of this
paragraph (c)(2)(ii)(A), a national bank
or Federal savings association may set
the value of the term C in § 3.113(g)(1)
equal to the amount of collateral posted
by a clearing member client of the
national bank or Federal savings
association in connection with the
client-facing derivative transactions
within the netting set; and
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(B) A national bank or Federal savings
association may choose to exclude the
PFE of all credit derivatives or other
similar instruments through which it
provides credit protection when
calculating the PFE under § 3.113,
provided that it does so consistently
over time for the calculation of the PFE
for all such instruments;
(iii)(A) The replacement cost of each
derivative contract or single product
netting set of derivative contracts to
which the national bank or Federal
savings association is a counterparty,
calculated according to the following
formula, and, for any counterparty that
is not a commercial end-user,
multiplied by 1.4:
Replacement Cost = max{V¥CVMr + CVMp;
0}
Where:
V equals the fair value for each derivative
contract or each netting set of derivative
contracts (including a cleared transaction
except as provided in paragraph (c)(2)(viii) of
this section and, at the discretion of the
national bank or Federal savings association,
excluding a forward agreement treated as a
derivative contract that is part of a
repurchase or reverse repurchase or a
securities borrowing or lending transaction
that qualifies for sales treatment under
GAAP);
CVMr equals the amount of cash collateral
received from a counterparty to a derivative
contract and that satisfies the conditions in
paragraphs (c)(2)(iii)(B) through (H) of this
section, or, in the case of a client-facing
derivative transaction, the amount of
collateral received from the clearing member
client; and
CVMp equals the amount of cash collateral
that is posted to a counterparty to a
derivative contract and that has not offset the
fair value of the derivative contract and that
satisfies the conditions in paragraphs
(c)(2)(iii)(B) through (H) of this section, or, in
the case of a client-facing derivative
transaction, the amount of collateral posted
to the clearing member client;
(B) Notwithstanding paragraph
(c)(2)(iii)(A) of this section, where
multiple netting sets are subject to a
single variation margin agreement, a
national bank or Federal savings
association must apply the formula for
replacement cost provided in
§ 3.113(j)(1), in which the term CMA
may only include cash collateral that
satisfies the conditions in paragraphs
(c)(2)(iii)(B) through (H) of this section;
and
(C) For purposes of paragraph
(c)(2)(iii)(A) of this section a national
bank or Federal savings association
must treat a derivative contract that
references an index as if it were
multiple derivative contracts each
referencing one component of the index
if the national bank or Federal savings
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64297
association elected to treat the
derivative contract as multiple
derivative contracts under § 3.113(e)(6);
(D) For derivative contracts that are
not cleared through a QCCP, the cash
collateral received by the recipient
counterparty is not segregated (by law,
regulation, or an agreement with the
counterparty);
(E) Variation margin is calculated and
transferred on a daily basis based on the
mark-to-fair value of the derivative
contract;
(F) The variation margin transferred
under the derivative contract or the
governing rules of the CCP or QCCP for
a cleared transaction is the full amount
that is necessary to fully extinguish the
net current credit exposure to the
counterparty of the derivative contracts,
subject to the threshold and minimum
transfer amounts applicable to the
counterparty under the terms of the
derivative contract or the governing
rules for a cleared transaction;
(G) The variation margin is in the
form of cash in the same currency as the
currency of settlement set forth in the
derivative contract, provided that for the
purposes of paragraph (c)(2)(iii)(E) of
this section, currency of settlement
means any currency for settlement
specified in the governing qualifying
master netting agreement and the credit
support annex to the qualifying master
netting agreement, or in the governing
rules for a cleared transaction; and
(H) The derivative contract and the
variation margin are governed by a
qualifying master netting agreement
between the legal entities that are the
counterparties to the derivative contract
or by the governing rules for a cleared
transaction, and the qualifying master
netting agreement or the governing rules
for a cleared transaction must explicitly
stipulate that the counterparties agree to
settle any payment obligations on a net
basis, taking into account any variation
margin received or provided under the
contract if a credit event involving
either counterparty occurs;
(iv) The effective notional principal
amount (that is, the apparent or stated
notional principal amount multiplied by
any multiplier in the derivative
contract) of a credit derivative, or other
similar instrument, through which the
national bank or Federal savings
association provides credit protection,
provided that:
(A) The national bank or Federal
savings association may reduce the
effective notional principal amount of
the credit derivative by the amount of
any reduction in the mark-to-fair value
of the credit derivative if the reduction
is recognized in common equity tier 1
capital;
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(B) The national bank or Federal
savings association may reduce the
effective notional principal amount of
the credit derivative by the effective
notional principal amount of a
purchased credit derivative or other
similar instrument, provided that the
remaining maturity of the purchased
credit derivative is equal to or greater
than the remaining maturity of the
credit derivative through which the
national bank or Federal savings
association provides credit protection
and that:
(1) With respect to a credit derivative
that references a single exposure, the
reference exposure of the purchased
credit derivative is to the same legal
entity and ranks pari passu with, or is
junior to, the reference exposure of the
credit derivative through which the
national bank or Federal savings
association provides credit protection;
or
(2) With respect to a credit derivative
that references multiple exposures, the
reference exposures of the purchased
credit derivative are to the same legal
entities and rank pari passu with the
reference exposures of the credit
derivative through which the national
bank or Federal savings association
provides credit protection, and the level
of seniority of the purchased credit
derivative ranks pari passu to the level
of seniority of the credit derivative
through which the national bank or
Federal savings association provides
credit protection;
(3) Where a national bank or Federal
savings association has reduced the
effective notional principal amount of a
credit derivative through which the
national bank or Federal savings
association provides credit protection in
accordance with paragraph (c)(2)(iv)(A)
of this section, the national bank or
Federal savings association must also
reduce the effective notional principal
amount of a purchased credit derivative
used to offset the credit derivative
through which the national bank or
Federal savings association provides
credit protection, by the amount of any
increase in the mark-to-fair value of the
purchased credit derivative that is
recognized in common equity tier 1
capital; and
(4) Where the national bank or
Federal savings association purchases
credit protection through a total return
swap and records the net payments
received on a credit derivative through
which the national bank or Federal
savings association provides credit
protection in net income, but does not
record offsetting deterioration in the
mark-to-fair value of the credit
derivative through which the national
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bank or Federal savings association
provides credit protection in net income
(either through reductions in fair value
or by additions to reserves), the national
bank or Federal savings association may
not use the purchased credit protection
to offset the effective notional principal
amount of the related credit derivative
through which the national bank or
Federal savings association provides
credit protection;
(v) Where a national bank or Federal
savings association acting as a principal
has more than one repo-style transaction
with the same counterparty and has
offset the gross value of receivables due
from a counterparty under reverse
repurchase transactions by the gross
value of payables under repurchase
transactions due to the same
counterparty, the gross value of
receivables associated with the repostyle transactions less any on-balance
sheet receivables amount associated
with these repo-style transactions
included under paragraph (c)(2)(i) of
this section, unless the following
criteria are met:
(A) The offsetting transactions have
the same explicit final settlement date
under their governing agreements;
(B) The right to offset the amount
owed to the counterparty with the
amount owed by the counterparty is
legally enforceable in the normal course
of business and in the event of
receivership, insolvency, liquidation, or
similar proceeding; and
(C) Under the governing agreements,
the counterparties intend to settle net,
settle simultaneously, or settle
according to a process that is the
functional equivalent of net settlement,
(that is, the cash flows of the
transactions are equivalent, in effect, to
a single net amount on the settlement
date), where both transactions are
settled through the same settlement
system, the settlement arrangements are
supported by cash or intraday credit
facilities intended to ensure that
settlement of both transactions will
occur by the end of the business day,
and the settlement of the underlying
securities does not interfere with the net
cash settlement;
(vi) The counterparty credit risk of a
repo-style transaction, including where
the national bank or Federal savings
association acts as an agent for a repostyle transaction and indemnifies the
customer with respect to the
performance of the customer’s
counterparty in an amount limited to
the difference between the fair value of
the security or cash its customer has
lent and the fair value of the collateral
the borrower has provided, calculated as
follows:
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(A) If the transaction is not subject to
a qualifying master netting agreement,
the counterparty credit risk (E*) for
transactions with a counterparty must
be calculated on a transaction by
transaction basis, such that each
transaction i is treated as its own netting
set, in accordance with the following
formula, where Ei is the fair value of the
instruments, gold, or cash that the
national bank or Federal savings
association has lent, sold subject to
repurchase, or provided as collateral to
the counterparty, and Ci is the fair value
of the instruments, gold, or cash that the
national bank or Federal savings
association has borrowed, purchased
subject to resale, or received as
collateral from the counterparty:
Ei* = max {0, [Ei¥Ci]}; and
(B) If the transaction is subject to a
qualifying master netting agreement, the
counterparty credit risk (E*) must be
calculated as the greater of zero and the
total fair value of the instruments, gold,
or cash that the national bank or Federal
savings association has lent, sold subject
to repurchase or provided as collateral
to a counterparty for all transactions
included in the qualifying master
netting agreement (SEi), less the total
fair value of the instruments, gold, or
cash that the national bank or Federal
savings association borrowed,
purchased subject to resale or received
as collateral from the counterparty for
those transactions (SCi), in accordance
with the following formula:
E* = max {0, [SEi¥ SCi]}
(vii) If a national bank or Federal
savings association acting as an agent
for a repo-style transaction provides a
guarantee to a customer of the security
or cash its customer has lent or
borrowed with respect to the
performance of the customer’s
counterparty and the guarantee is not
limited to the difference between the
fair value of the security or cash its
customer has lent and the fair value of
the collateral the borrower has
provided, the amount of the guarantee
that is greater than the difference
between the fair value of the security or
cash its customer has lent and the value
of the collateral the borrower has
provided;
(viii) The credit equivalent amount of
all off-balance sheet exposures of the
national bank or Federal savings
association, excluding repo-style
transactions, repurchase or reverse
repurchase or securities borrowing or
lending transactions that qualify for
sales treatment under GAAP, and
derivative transactions, determined
using the applicable credit conversion
factor under § 3.112(b), provided,
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however, that the minimum credit
conversion factor that may be assigned
to an off-balance sheet exposure under
this paragraph is 10 percent; and
(ix) For a national bank or Federal
savings association that is a clearing
member:
(A) A clearing member national bank
or Federal savings association that
guarantees the performance of a clearing
member client with respect to a cleared
transaction must treat its exposure to
the clearing member client as a
derivative contract or repo-style
transaction, as applicable, for purposes
of determining its total leverage
exposure;
(B) A clearing member national bank
or Federal savings association that
guarantees the performance of a CCP
with respect to a transaction cleared on
behalf of a clearing member client must
treat its exposure to the CCP as a
derivative contract or repo-style
transaction, as applicable, for purposes
of determining its total leverage
exposure;
(C) A clearing member national bank
or Federal savings association that does
not guarantee the performance of a CCP
with respect to a transaction cleared on
behalf of a clearing member client may
exclude its exposure to the CCP for
purposes of determining its total
leverage exposure;
(D) Notwithstanding paragraphs
(c)(2)(ix)(A) through (C) of this section,
a national bank or Federal savings
association that is a clearing member
may exclude from its total leverage
exposure the effective notional principal
amount of credit protection sold
through a credit derivative contract, or
other similar instrument, that it clears
on behalf of a clearing member client
through a CCP as calculated in
accordance with paragraph (c)(2)(iv) of
this section; and
(E) A national bank or Federal savings
association may exclude from its total
leverage exposure a clearing member’s
exposure to a clearing member client for
a derivative contract if the clearing
member client and the clearing member
are affiliates and consolidated for
financial reporting purposes on the
national bank’s or Federal savings
association’s balance sheet.
(x) A custodial banking organization
shall exclude from its total leverage
exposure the lesser of:
(A) The amount of funds that the
custodial banking organization has on
deposit at a qualifying central bank; and
(B) The amount of funds in deposit
accounts at the custodial banking
organization that are linked to fiduciary
or custodial and safekeeping accounts at
the custodial banking organization. For
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purposes of this paragraph (c)(2)(x), a
deposit account is linked to a fiduciary
or custodial and safekeeping account if
the deposit account is provided to a
client that maintains a fiduciary or
custodial and safekeeping account with
the custodial banking organization and
the deposit account is used to facilitate
the administration of the fiduciary or
custodial and safekeeping account.
(d) Expanded capital ratio
calculations. A national bank or Federal
savings association subject to subpart E
of this part must determine its
regulatory capital ratios as described in
paragraphs (d)(1) through (3) of this
section.
*
*
*
*
*
(3) * * *
(ii) The ratio of the national bank’s or
Federal savings association’s expanded
risk-based approach-adjusted total
capital to expanded total risk-weighted
assets. A national bank’s or Federal
savings association’s expanded riskbased approach-adjusted total capital is
the national bank’s or Federal savings
association’s total capital after being
adjusted as follows:
(A) A national bank or Federal savings
association subject to subpart E must
deduct from its total capital any
adjusted allowance for credit losses
included in its tier 2 capital in
accordance with § 3.20(d)(3); and
(B) A national bank or Federal savings
association subject to subpart E must
add to its total capital any adjusted
allowance for credit losses up to 1.25
percent of the sum of the national
bank’s or Federal savings association’s
total credit risk-weighted assets.
*
*
*
*
*
■ 6. In § 3.11, revise paragraphs (b)(1)
introductory text, and (b)(1)(ii) and (iii)
to read as follows:
national bank’s or Federal savings
association’s private sector credit
exposures are located, as specified in
paragraphs (b)(2) and (3) of this section.
(iii) Weighting. The weight assigned to
a jurisdiction’s countercyclical capital
buffer amount is calculated by dividing
the total risk-weighted assets for the
national bank’s or Federal savings
association’s private sector credit
exposures located in the jurisdiction by
the total risk-weighted assets for all of
the national bank’s or Federal savings
association’s private sector credit
exposures. The methodology a national
bank or Federal savings association uses
for determining risk-weighted assets for
purposes of this paragraph (b) must be
the methodology that determines its
risk-based capital ratios under § 3.10.
Notwithstanding the previous sentence,
the risk-weighted asset amount for a
private sector credit exposure that is a
covered position under subpart F of this
part is its standardized default risk
capital requirement as determined
under § 3.210 multiplied by 12.5.
*
*
*
*
*
■ 7. In § 3.12, revise paragraph (a)(2)
and remove paragraph (a)(4) to read as
follows:
§ 3.11 Capital conservation buffer and
countercyclical capital buffer amount.
§ 3.20 Capital components and eligibility
criteria for regulatory capital instruments.
*
*
*
*
*
*
(b) * * *
(1) General. A national bank or
Federal savings association subject to
subpart E of this part must calculate a
countercyclical capital buffer amount in
accordance with this paragraph (b) for
purposes of determining its maximum
payout ratio under table 1 to this
section.
*
*
*
*
*
(ii) Amount. A national bank or
Federal savings association subject to
subpart E of this part has a
countercyclical capital buffer amount
determined by calculating the weighted
average of the countercyclical capital
buffer amounts established for the
national jurisdictions where the
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§ 3.12 Community bank leverage ratio
framework.
(a) * * *
(2) For purposes of this section, a
qualifying community banking
organization means a national bank or
Federal savings association that is not a
national bank or Federal savings
association subject to subpart E of this
part and that satisfies all of the
following criteria:
*
*
*
*
*
■ 8. In § 3.20, revise paragraphs
(c)(1)(xiv), (d)(1)(xi), and (d)(3) to read
as follows:
*
*
*
*
(c) * * *
(1) * * *
(xiv) For a national bank or Federal
savings association subject to subpart E
of this part, the governing agreement,
offering circular, or prospectus of an
instrument issued after the date upon
which the national bank or Federal
savings association becomes subject to
subpart E must disclose that the holders
of the instrument may be fully
subordinated to interests held by the
U.S. government in the event that the
national bank or Federal savings
association enters into a receivership,
insolvency, liquidation, or similar
proceeding.
*
*
*
*
*
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(d) * * *
(1) * * *
(xi) For a national bank or Federal
savings association subject to subpart E
of this part, the governing agreement,
offering circular, or prospectus of an
instrument issued after the date on
which the national bank or Federal
savings association becomes subject to
subpart E must disclose that the holders
of the instrument may be fully
subordinated to interests held by the
U.S. government in the event that the
national bank or Federal savings
association enters into a receivership,
insolvency, liquidation, or similar
proceeding.
*
*
*
*
*
(3) ALLL or AACL, as applicable, up
to 1.25 percent of the national bank’s or
Federal savings association’s
standardized total risk-weighted assets,
not including any amount of the ALLL
or AACL, as applicable (and for a
market risk national bank or Federal
savings association institution,
excluding its market risk weighted
assets).
*
*
*
*
*
■ 9. In § 3.21:
■ a. In paragraph (a)(1), remove the
words ‘‘an advanced approaches
national bank or Federal savings
association’’ and add in their place the
words ‘‘subject to subpart E of this
part’’;
■ b. In paragraph (b):
■ i. Revise paragraph (b)(1) introductory
text;
■ ii. Remove the words ‘‘advanced
approaches’’ wherever they appear in
paragraphs (b)(1)(i) and (b)(2);
■ iii. In paragraph (b)(3) introductory
text, remove the words ‘‘an advanced
approaches’’ and add in their place the
word ‘‘a’’ and remove the words ‘‘the
advanced approaches’’; and
■ iv. Remove the words ‘‘advanced
approaches’’ wherever they appear in
paragraphs (b)(3)(ii), and (b)(4) and (5).
The revision read as follows:
§ 3.21
Minority interest.
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*
*
*
*
*
(b) (1) Applicability. For purposes of
§ 3.20, a national bank or Federal
savings association subject to subpart E
of this part is subject to the minority
interest limitations in this paragraph (b)
if:
*
*
*
*
*
■ 10. In § 3.22:
■ a. Redesignate footnotes 21 through 31
as footnotes 1 through 11.
■ b. Revise paragraphs (a)(1)(ii) and
(a)(4);
■ c. Remove and reserve paragraph
(a)(6);
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d. Revise paragraphs (a)(7), (b)(1)(ii)
and (iii), (b)(2)(i) through (iii), (b)(2)(iv)
introductory text, newly designated
footnote 3 to paragraph (c) introductory
text, and paragraph (c)(1) introductory
text;
■ e. Add paragraph (c)(1)(iv);
■ f. Revise paragraph (c)(2) introductory
text, paragraphs (c)(2)(ii)(D), (c)(3)(ii),
(c)(4), (c)(5)(i) through (iii), (c)(6),
paragraph (d)(1) introductory text, and
paragraphs (d)(2), (f), and (g); and
The revisions and addition read as
follows:
■
§ 3.22 Regulatory capital adjustments and
deductions.
(a) * * *
(1) * * *
(ii) For a national bank or Federal
savings association subject to subpart E
of this part, goodwill that is embedded
in the valuation of a significant
investment in the capital of an
unconsolidated financial institution in
the form of common stock (and that is
reflected in the consolidated financial
statements of the national bank or
Federal savings association), in
accordance with paragraph (d) of this
section;
*
*
*
*
*
(4)(i) For a national bank or Federal
savings association that is not subject to
subpart E of this part, any gain-on-sale
in connection with a securitization
exposure;
(ii) For a national bank or Federal
savings association subject to subpart E
of this part, any gain-on-sale in
connection with a securitization
exposure and the portion of any CEIO
that does not constitute an after-tax
gain-on-sale;
*
*
*
*
*
(7) With respect to a financial
subsidiary, the aggregate amount of the
national bank’s or Federal savings
association’s outstanding equity
investment, including retained earnings,
in its financial subsidiaries (as defined
in 12 CFR 5.39). A national bank or
Federal savings association must not
consolidate the assets and liabilities of
a financial subsidiary with those of the
parent bank, and no other deduction is
required under paragraph (c) of this
section for investments in the capital
instruments of financial subsidiaries.
*
*
*
*
*
(b) * * *
(1) * * *
(ii) A national bank or Federal savings
association that is subject to subpart E
of this part, and a national bank or
Federal savings association that has not
made an AOCI opt-out election (as
defined in paragraph (b)(2) of this
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section), must deduct any accumulated
net gains and add any accumulated net
losses on cash flow hedges included in
AOCI that relate to the hedging of items
that are not recognized at fair value on
the balance sheet.
(iii) A national bank or Federal
savings association must deduct any net
gain and add any net loss related to
changes in the fair value of liabilities
that are due to changes in the national
bank’s or Federal savings association’s
own credit risk. A national bank or
Federal savings association subject to
subpart E of this part must deduct the
difference between its credit spread
premium and the risk-free rate for
derivatives that are liabilities as part of
this adjustment.
(2) * * *
(i) A national bank or Federal savings
association that is not subject to subpart
E of this part may make a one-time
election to opt out of the requirement to
include all components of AOCI (with
the exception of accumulated net gains
and losses on cash flow hedges related
to items that are not fair-valued on the
balance sheet) in common equity tier 1
capital (AOCI opt-out election). A
national bank or Federal savings
association that makes an AOCI opt-out
election in accordance with this
paragraph (b)(2) must adjust common
equity tier 1 capital as follows:
(A) Subtract any net unrealized gains
and add any net unrealized losses on
available-for-sale debt securities;
(B) Subtract any accumulated net
gains and add any accumulated net
losses on cash flow hedges;
(C) Subtract any amounts recorded in
AOCI attributed to defined benefit
postretirement plans resulting from the
initial and subsequent application of the
relevant GAAP standards that pertain to
such plans (excluding, at the national
bank’s or Federal savings association’s
option, the portion relating to pension
assets deducted under paragraph (a)(5)
of this section); and
(D) Subtract any net unrealized gains
and add any net unrealized losses on
held-to-maturity securities that are
included in AOCI.
(ii) A national bank or Federal savings
association that is not subject to subpart
E of this part must make its AOCI optout election in the Call Report during
the first reporting period after the
national bank or Federal savings
association is required to comply with
subpart A of this part. If the national
bank or Federal savings association was
previously subject to subpart E of this
part, the national bank or Federal
savings association must make its AOCI
opt-out election in the Call Report
during the first reporting period after
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the national bank or Federal savings
association is not subject to subpart E of
this part.
(iii) With respect to a national bank or
Federal savings association that is not
subject to subpart E, each of its
subsidiary banking organizations that is
subject to regulatory capital
requirements issued by the Board of
Governors of the Federal Reserve, the
Federal Deposit Insurance Corporation,
or the Office of the Comptroller of the
Currency1 must elect the same option as
the national bank or Federal savings
association pursuant to this paragraph
(b)(2).
(iv) With prior notice to the OCC, a
national bank or Federal savings
association resulting from a merger,
acquisition, or purchase transaction and
that is not subject to subpart E of this
part may change its AOCI opt-out
election in its Call Report filed for the
first reporting period after the date
required for such national bank or
Federal savings association to comply
with subpart A of this part if:
*
*
*
*
*
(c) * * * 3
(1) Investment in the national bank’s
or Federal savings association’s own
capital or covered debt instruments. A
national bank or Federal savings
association must deduct an investment
in the national bank’s or Federal savings
association’s own capital instruments,
and a national bank or Federal savings
association subject to subpart E of this
part also must deduct an investment in
the national bank’s or Federal savings
association’s own covered debt
instruments, as follows:
*
*
*
*
*
(iv) A national bank or Federal
savings association subject to subpart E
of this part must deduct an investment
in the institution’s own covered debt
instruments from its tier 2 capital
elements, as applicable. If the national
bank or Federal savings association does
not have a sufficient amount of tier 2
capital to effect this deduction, the
institution must deduct the shortfall
amount from the next higher (that is,
more subordinated) component of
regulatory capital.
*
*
*
*
*
(2) Corresponding deduction
approach. For purposes of subpart C of
this part, the corresponding deduction
approach is the methodology used for
the deductions from regulatory capital
related to reciprocal cross holdings (as
described in paragraph (c)(3) of this
section), investments in the capital of
unconsolidated financial institutions for
a national bank or Federal savings
association that is not subject to subpart
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E of this part (as described in paragraph
(c)(4) of this section), non-significant
investments in the capital of
unconsolidated financial institutions for
a national bank or Federal savings
association subject to subpart E of this
part (as described in paragraph (c)(5) of
this section), and non-common stock
significant investments in the capital of
unconsolidated financial institutions for
a national bank or Federal savings
association subject to subpart E of this
part (as described in paragraph (c)(6) of
this section). Under the corresponding
deduction approach, a national bank or
Federal savings association must make
deductions from the component of
capital for which the underlying
instrument would qualify if it were
issued by the national bank or Federal
savings association itself, as described
in paragraphs (c)(2)(i) through (iii) of
this section. If the national bank or
Federal savings association does not
have a sufficient amount of a specific
component of capital to effect the
required deduction, the shortfall must
be deducted according to paragraph (f)
of this section.
*
*
*
*
*
(ii) * * *
(D) For a national bank or Federal
savings association subject to subpart E
of this part, a tier 2 capital instrument
if it is a covered debt instrument.
*
*
*
*
*
(3) * * *
(ii) A national bank or Federal savings
association subject to subpart E of this
part must deduct an investment in any
covered debt instrument that the
institution holds reciprocally with
another financial institution, where
such reciprocal cross holdings result
from a formal or informal arrangement
to swap, exchange, or otherwise intend
to hold each other’s capital or covered
debt instruments, by applying the
corresponding deduction approach in
paragraph (c)(2) of this section.
(4) Investments in the capital of
unconsolidated financial institutions. A
national bank or Federal savings
association that is not subject to subpart
E of this part must deduct its
investments in the capital of
unconsolidated financial institutions (as
defined in § 3.2) that exceed 25 percent
of the sum of the national bank or
Federal savings association’s common
equity tier 1 capital elements minus all
deductions from and adjustments to
common equity tier 1 capital elements
required under paragraphs (a) through
(c)(3) of this section by applying the
corresponding deduction approach in
paragraph (c)(2) of this section.4 The
deductions described in this section are
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64301
net of associated DTLs in accordance
with paragraph (e) of this section. In
addition, with the prior written
approval of the OCC, a national bank or
Federal savings association that
underwrites a failed underwriting, for
the period of time stipulated by the
OCC, is not required to deduct an
Investment in the capital of an
unconsolidated financial institution
pursuant to this paragraph (c) to the
extent the investment is related to the
failed underwriting.5
(5) * * *
(i) A national bank or Federal savings
association subject to subpart E of this
part must deduct its non-significant
investments in the capital of
unconsolidated financial institutions (as
defined in § 3.2) that, in the aggregate
and together with any investment in a
covered debt instrument (as defined in
§ 3.2) issued by a financial institution in
which the national bank or Federal
savings association does not have a
significant investment in the capital of
the unconsolidated financial institution
(as defined in § 3.2), exceeds 10 percent
of the sum of the national bank’s or
Federal savings association’s common
equity tier 1 capital elements minus all
deductions from and adjustments to
common equity tier 1 capital elements
required under paragraphs (a) through
(c)(3) of this section (the 10 percent
threshold for non-significant
investments) by applying the
corresponding deduction approach in
paragraph (c)(2) of this section.6 The
deductions described in this paragraph
are net of associated DTLs in accordance
with paragraph (e) of this section. In
addition, with the prior written
approval of the OCC, a national bank or
Federal savings association subject to
subpart E of this part that underwrites
a failed underwriting, for the period of
time stipulated by the OCC, is not
required to deduct from capital a nonsignificant investment in the capital of
an unconsolidated financial institution
or an investment in a covered debt
instrument pursuant to this paragraph
(c)(5) to the extent the investment is
related to the failed underwriting.7 For
any calculation under this paragraph
(c)(5)(i), a national bank or Federal
savings association subject to subpart E
of this part may exclude the amount of
an investment in a covered debt
instrument under paragraph (c)(5)(iii) or
(iv) of this section, as applicable.
(ii) For a national bank or Federal
savings association subject to subpart E
of this part, the amount to be deducted
under this paragraph (c)(5) from a
specific capital component is equal to:
(A) The national bank’s or Federal
savings association’s aggregate non-
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significant investments in the capital of
an unconsolidated financial institution
and, if applicable, any investments in a
covered debt instrument subject to
deduction under this paragraph (c)(5),
exceeding the 10 percent threshold for
non-significant investments, multiplied
by
(B) The ratio of the national bank’s or
Federal savings association’s aggregate
non-significant investments in the
capital of an unconsolidated financial
institution (in the form of such capital
component) to the national bank’s or
Federal savings association’s total nonsignificant investments in
unconsolidated financial institutions,
with an investment in a covered debt
instrument being treated as tier 2 capital
for this purpose.
(iii) For purposes of applying the
deduction under paragraph (c)(5)(i) of
this section, a national bank or Federal
savings association subject to subpart E
of this part that is not a subsidiary of a
global systemically important banking
organization, as defined in 12 CFR
252.2, may exclude from the deduction
the amount of the national bank’s or
Federal savings association’s gross long
position, in accordance with
§ 3.22(h)(2), in investments in covered
debt instruments issued by financial
institutions in which the national bank
or Federal savings association does not
have a significant investment in the
capital of the unconsolidated financial
institutions up to an amount equal to 5
percent of the sum of the national
bank’s or Federal savings association’s
common equity tier 1 capital elements
minus all deductions from and
adjustments to common equity tier 1
capital elements required under
paragraphs (a) through (c)(3) of this
section, net of associated DTLs in
accordance with paragraph (e) of this
section.
*
*
*
*
*
(6) Significant investments in the
capital of unconsolidated financial
institutions that are not in the form of
common stock. If a national bank or
Federal savings association subject to
subpart E of this part has a significant
investment in the capital of an
unconsolidated financial institution, the
national bank or Federal savings
association must deduct from capital
any such investment issued by the
unconsolidated financial institution that
is held by the national bank or Federal
savings association other than an
investment in the form of common
stock, as well as any investment in a
covered debt instrument issued by the
unconsolidated financial institution, by
applying the corresponding deduction
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approach in paragraph (c)(2) of this
section.8 The deductions described in
this section are net of associated DTLs
in accordance with paragraph (e) of this
section. In addition, with the prior
written approval of the OCC, for the
period of time stipulated by the OCC, a
national bank or Federal savings
association subject to subpart E of this
part that underwrites a failed
underwriting is not required to deduct
the significant investment in the capital
of an unconsolidated financial
institution or an investment in a
covered debt instrument pursuant to
this paragraph (c)(6) if such investment
is related to such failed underwriting.
(d) * * *
(1) A national bank or Federal savings
association that is not subject to subpart
E of this part must make deductions
from regulatory capital as described in
this paragraph (d)(1).
*
*
*
*
*
(2) A national bank or Federal savings
association subject to subpart E of this
part must make deductions from
regulatory capital as described in this
paragraph (d)(2).
(i) A national bank or Federal savings
association subject to subpart E of this
part must deduct from common equity
tier 1 capital elements the amount of
each of the items set forth in this
paragraph (d)(2) that, individually,
exceeds 10 percent of the sum of the
national bank’s or Federal savings
association’s common equity tier 1
capital elements, less adjustments to
and deductions from common equity
tier 1 capital required under paragraphs
(a) through (c) of this section (the 10
percent common equity tier 1 capital
deduction threshold).
(A) DTAs arising from temporary
differences that the national bank or
Federal savings association could not
realize through net operating loss
carrybacks, net of any related valuation
allowances and net of DTLs, in
accordance with paragraph (e) of this
section. A national bank or Federal
savings association subject to subpart E
of this part is not required to deduct
from the sum of its common equity tier
1 capital elements DTAs (net of any
related valuation allowances and net of
DTLs, in accordance with § 3.22(e))
arising from timing differences that the
national bank or Federal savings
association could realize through net
operating loss carrybacks. The national
bank or Federal savings association
must risk weight these assets at 100
percent. For a national bank or Federal
savings association that is a member of
a consolidated group for tax purposes,
the amount of DTAs that could be
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realized through net operating loss
carrybacks may not exceed the amount
that the national bank or Federal savings
association could reasonably expect to
have refunded by its parent holding
company.
(B) MSAs net of associated DTLs, in
accordance with paragraph (e) of this
section.
(C) Significant investments in the
capital of unconsolidated financial
institutions in the form of common
stock, net of associated DTLs in
accordance with paragraph (e) of this
section.10 Significant investments in the
capital of unconsolidated financial
institutions in the form of common
stock subject to the 10 percent common
equity tier 1 capital deduction threshold
may be reduced by any goodwill
embedded in the valuation of such
investments deducted by the national
bank or Federal savings association
pursuant to paragraph (a)(1) of this
section. In addition, with the prior
written approval of the OCC, for the
period of time stipulated by the OCC, a
national bank or Federal savings
association subject to subpart E of this
part that underwrites a failed
underwriting is not required to deduct
a significant investment in the capital of
an unconsolidated financial institution
in the form of common stock pursuant
to this paragraph (d)(2) if such
investment is related to such failed
underwriting.
(ii) A national bank or Federal savings
association subject to subpart E of this
part must deduct from common equity
tier 1 capital elements the items listed
in paragraph (d)(2)(i) of this section that
are not deducted as a result of the
application of the 10 percent common
equity tier 1 capital deduction
threshold, and that, in aggregate, exceed
17.65 percent of the sum of the national
bank’s or Federal savings association’s
common equity tier 1 capital elements,
minus adjustments to and deductions
from common equity tier 1 capital
required under paragraphs (a) through
(c) of this section, minus the items listed
in paragraph (d)(2)(i) of this section (the
15 percent common equity tier 1 capital
deduction threshold). Any goodwill that
has been deducted under paragraph
(a)(1) of this section can be excluded
from the significant investments in the
capital of unconsolidated financial
institutions in the form of common
stock.11
(iii) For purposes of calculating the
amount of DTAs subject to the 10 and
15 percent common equity tier 1 capital
deduction thresholds, a national bank or
Federal savings association subject to
subpart E of this part may exclude DTAs
and DTLs relating to adjustments made
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to common equity tier 1 capital under
paragraph (b) of this section. A national
bank or Federal savings association
subject to subpart E of this part that
elects to exclude DTAs relating to
adjustments under paragraph (b) of this
section also must exclude DTLs and
must do so consistently in all future
calculations. A national bank or Federal
savings association subject to subpart E
of this part may change its exclusion
preference only after obtaining the prior
approval of the OCC.
*
*
*
*
*
(f) Insufficient amounts of a specific
regulatory capital component to effect
deductions. Under the corresponding
deduction approach, if a national bank
or Federal savings association does not
have a sufficient amount of a specific
component of capital to effect the full
amount of any deduction from capital
required under paragraph (d) of this
section, the national bank or Federal
savings association must deduct the
shortfall amount from the next higher
(that is, more subordinated) component
of regulatory capital. Any investment by
a national bank or Federal savings
association subject to subpart E of this
part in a covered debt instrument must
be treated as an investment in the tier
2 capital for purposes of this paragraph
(f). Notwithstanding any other provision
of this section, a qualifying community
banking organization (as defined in
§ 3.12) that has elected to use the
community bank leverage ratio
framework pursuant to § 3.12 is not
required to deduct any shortfall of tier
2 capital from its additional tier 1
capital or common equity tier 1 capital.
(g) Treatment of assets that are
deducted. A national bank or Federal
savings association must exclude from
standardized total risk-weighted assets
and, as applicable, expanded total riskweighted assets any item that is
required to be deducted from regulatory
capital.
*
*
*
*
*
1 These rules include the regulatory capital
requirements set forth at 12 CFR part 3
(OCC); 12 CFR part 225 (Board); 12 CFR part
325, and 12 CFR part 390 (FDIC).
*
*
*
*
*
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3 The
national bank or Federal savings
association must calculate amounts deducted
under paragraphs (c) through (f) of this
section after it calculates the amount of
AACL includable in tier 2 capital under
§ 3.20(d)(3).
4 With the prior written approval of the
OCC, for the period of time stipulated by the
OCC, a national bank or Federal savings
association is not required to deduct a nonsignificant investment in the capital
instrument of an unconsolidated financial
institution or an investment in a covered debt
instrument pursuant to this paragraph if the
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financial institution is in distress and if such
investment is made for the purpose of
providing financial support to the financial
institution, as determined by the OCC.
5 Any non-significant investments in the
capital of an unconsolidated financial
institution that is not required to be deducted
under this paragraph (c)(4) or otherwise
under this section must be assigned the
appropriate risk weight under subparts D, E,
or F of this part, as applicable.
6 With the prior written approval of the
OCC, for the period of time stipulated by the
OCC, a national bank or Federal savings
association subject to subpart E of this part
is not required to deduct a non-significant
investment in the capital of an
unconsolidated financial institution or an
investment in a covered debt instrument
pursuant to this paragraph if the financial
institution is in distress and if such
investment is made for the purpose of
providing financial support to the financial
institution, as determined by the OCC.
7 Any non-significant investment in the
capital of an unconsolidated financial
institution or any investment in a covered
debt instrument that is not required to be
deducted under this paragraph (c)(5) or
otherwise under this section must be
assigned the appropriate risk weight under
subparts D, E, or F of this part, as applicable.
8 With prior written approval of the OCC,
for the period of time stipulated by the OCC,
a national bank or Federal savings
association subject to subpart E of this part
is not required to deduct a significant
investment in the capital of an
unconsolidated financial institution,
including an investment in a covered debt
instrument, under this paragraph (c)(6) or
otherwise under this section if such
investment is made for the purpose of
providing financial support to the financial
institution as determined by the OCC.
*
*
*
*
*
10 With
the prior written approval of the
OCC, for the period of time stipulated by the
OCC, a national bank or Federal savings
association subject to subpart E of this part
is not required to deduct a significant
investment in the capital instrument of an
unconsolidated financial institution in
distress in the form of common stock
pursuant to this section if such investment is
made for the purpose of providing financial
support to the financial institution as
determined by the OCC.
11 The amount of the items in paragraph
(d)(2) of this section that is not deducted
from common equity tier 1 capital pursuant
to this section must be included in the riskweighted assets of the national bank or
Federal savings association subject to subpart
E of this part and assigned a 250 percent risk
weight for purposes of standardized total
risk-weighted assets and assigned the
appropriate risk weight for the investment
under subpart E of this part for purposes of
expanded total risk-weighted assets.
§ 3.30
[Amended]
11. In § 3.30, in paragraph (b), remove
the words ‘‘covered positions’’ and add
in their place the words ‘‘market risk
covered positions’’.
■
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64303
12. In § 3.34, revise paragraph (a) to
read as follows:
■
§ 3.34
Derivative contracts.
(a) Exposure amount for derivative
contracts—(1) National bank or Federal
savings association not subject to
subpart E of this part.
(i) A national bank or Federal savings
association that is not subject to subpart
E of this part must use the current
exposure methodology (CEM) described
in paragraph (b) of this section to
calculate the exposure amount for all its
OTC derivative contracts, unless the
national bank or Federal savings
association makes the election provided
in paragraph (a)(1)(ii) of this section.
(ii) A national bank or Federal savings
association that is not subject to subpart
E of this part may elect to calculate the
exposure amount for all its OTC
derivative contracts under the
standardized approach for counterparty
credit risk (SA–CCR) in § 3.113 by
notifying the OCC, rather than
calculating the exposure amount for all
its derivative contracts using CEM. A
national bank or Federal savings
association that elects under this
paragraph (a)(1)(ii) to calculate the
exposure amount for its OTC derivative
contracts under SA–CCR must apply the
treatment of cleared transactions under
§ 3.114 to its derivative contracts that
are cleared transactions and to all
default fund contributions associated
with such derivative contracts, rather
than applying § 3.35. A national bank or
Federal savings association that is not
subject to subpart E of this part must use
the same methodology to calculate the
exposure amount for all its derivative
contracts and, if a national bank or
Federal savings association has elected
to use SA–CCR under this paragraph
(a)(1)(ii), the national bank or Federal
savings association may change its
election only with prior approval of the
OCC.
(2) National bank or Federal savings
association subject to subpart E of this
part. A national bank or Federal savings
association that is subject to subpart E
of this part must calculate the exposure
amount for all its derivative contracts
using SA–CCR in § 3.113 for purposes of
standardized total risk-weighted assets.
A national bank or Federal savings
association subject to subpart E of this
part must apply the treatment of cleared
transactions under § 3.114 to its
derivative contracts that are cleared
transactions and to all default fund
contributions associated with such
derivative contracts for purposes of
standardized total risk-weighted assets.
*
*
*
*
*
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For purposes of this section, total
consolidated assets are determined
based on the average of the national
bank’s or Federal savings association’s
total consolidated assets in the four
most recent quarters as reported on the
Call Report or the average of the
national bank or Federal savings
association’s total consolidated assets in
the most recent consecutive quarters as
reported quarterly on the national
bank’s or Federal savings association’s
Call Report if the national bank or
Federal savings association has not filed
such a report for each of the most recent
four quarters.
■ 16. In § 3.63:
■ a. In table 3, revise entry (c); and
■ b. Remove paragraphs (d) and (e).
The revision reads as follows:
Sections 3.61 through 3.63 of this
subpart establish public disclosure
requirements related to the capital
requirements described in subpart B of
this part for a national bank or Federal
savings association with total
consolidated assets of $50 billion or
more as reported on the national bank’s
or Federal savings association’s most
recent year-end Call Report that is not
making public disclosures pursuant to
§§ 3.160 and 3.161 of this part. A
national bank or Federal savings
association with total consolidated
assets of $50 billion or more as reported
on the national bank’s or Federal
savings association’s most recent yearend Call Report that is not making
public disclosures pursuant to §§ 3.160
and 3.161 of this part must comply with
§ 3.62 unless it is a consolidated
subsidiary of a bank holding company,
savings and loan holding company, or
depository institution that is subject to
the disclosure requirements of § 3.62 or
a subsidiary of a non-U.S. banking
organization that is subject to
comparable public disclosure
requirements in its home jurisdiction.
Subparts E and F [Amended]
■
h. Remove ‘‘ll.’’ and add ‘‘3.’’ in its
place wherever it appears.
■ 18. In § 3.100, revise paragraph (b)(1)
introductory text to read as follows:
■
§ 3.100
*
13. In § 3.35, revise paragraph (a)(3) to
read as follows:
■
§ 3.35
Cleared transactions.
(a) * * *
(3) Alternate requirements.
Notwithstanding any other provision of
this section, a national bank or Federal
savings association that is subject to
subpart E of this part or a national bank
or Federal savings association that is not
subject to subpart E of this part and that
has elected to use SA–CCR under
§ 3.34(a)(1) must apply § 3.114 to its
derivative contracts that are cleared
transactions rather than this section.
*
*
*
*
*
§ 3.37
[Amended]
14. In § 3.37, in paragraph (c)(1),
remove the words ‘‘VaR-based measure’’
and add in their place the words
‘‘measure for market risk’’.
■ 15. Revise § 3.61 to read as follows:
■
§ 3.61
Purpose and scope.
17. Subparts E and F are amended as
follows:
■ a. Revise subparts E and F as set forth
at the end of the common preamble;
■ b. Remove ‘‘[AGENCY]’’ and add
‘‘OCC’’ in its place wherever it appears;
■ c. Remove ‘‘[BANKING
ORGANIZATION]’’ and add ‘‘national
bank or Federal savings association’’ in
its place wherever it appears;
■ d. Remove ‘‘[BANKING
ORGANIZATION]’s’’ and add ‘‘national
bank’s or Federal savings association’s’’
in its place, wherever it appears;
■ e. Remove ‘‘[REAL ESTATE LENDING
GUIDELINES]’’ and add ‘‘12 CFR part
34, appendix A to subpart D’’ in its
place wherever it appears;
■ f. Remove ‘‘[APPRAISAL RULE]’’ and
add ‘‘12 CFR part 34, subpart C’’ in its
place wherever it appears;
■ g. Remove ‘‘[REGULATORY
REPORT]’’ and add ‘‘Call Report’’ in its
place wherever it appears; and
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■
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Purpose and applicability.
*
*
*
*
*
(b) * * *
(1) This subpart applies to any
national bank or Federal savings
association that is a subsidiary of a
global systemically important BHC, a
Category II national bank or Federal
savings association, a Category III
national bank or Federal savings
association, or a Category IV national
bank or Federal savings association, as
defined in § 3.2.
*
*
*
*
*
§ 3.111
[Amended]
19. In § 3.111:
a. Remove paragraph (j)(1)(i);
b. Redesignate paragraph (j)(1)(ii) as
paragraph (j)(1); and
■ c. Remove paragraphs (k).
■
■
■
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§ 3.63 Disclosures by national banks or
Federal savings associations described in
§ 3.61.
*
*
*
*
*
Table 3 to § 3.63—Capital Adequacy
*
*
*
*
*
20. In § 3.132, revise paragraphs
(h)(1)(iv) and (h)(4)(i) to read as follows.
§ 3.132 Risk-weighted assets for
securitization exposures.
*
*
*
*
(h) * * *
(1) * * *
(iv) The national bank or Federal
savings association is well capitalized,
as defined in part 6 of this chapter. For
purposes of determining whether a
national bank or Federal savings
association is well capitalized for
purposes of this paragraph (h), the
national bank’s or Federal savings
association’s capital ratios must be
calculated without regard to the capital
treatment for transfers of small-business
obligations with recourse specified in
paragraph (h)(1) of this section.
*
*
*
*
*
(4) * * *
(i) Determining whether a national
bank or Federal savings association is
adequately capitalized,
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§ 3.162 Disclosures by a national bank or
Federal savings association described in
§ 3.160.
*
*
*
*
*
(c) Regulatory capital instrument and
other instruments eligible for total loss
absorbing capacity (TLAC) disclosures.
A national bank or Federal savings
association described in § 3.160 must
provide a description of the main
features of its regulatory capital
instruments, in accordance with table
15 to paragraph (c). If the national bank
or Federal savings association issues or
repays a capital instrument, or in the
event of a redemption, conversion, write
down, or other material change in the
nature of an existing instrument, but in
no event less frequently than
semiannually, the national bank or
Federal savings association must update
the disclosures provided in accordance
with table 15 to paragraph (c). A
national bank or Federal savings
association also must disclose the full
terms and conditions of all instruments
included in regulatory capital.
■ 22. In § 3.201, revise paragraphs
(b)(1)(i), (b)(2), (b)(4)(i), (b)(5)(i), and
(c)(6) to read as follows:
§ 3.201 Purpose, applicability, and
reservations of authority.
*
*
*
*
(b) * * *
(1) * * *
(i) The national bank or Federal
savings association is:
(A) A Category II national bank or
Federal savings association, a Category
III national bank or Federal savings
association, or a Category IV national
bank or Federal savings association;
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*
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(B) A subsidiary of a global
systemically important BHC; or
*
*
*
*
*
(2) CVA Risk. The CVA risk-based
capital requirements specified in
§§ 3.220 through 3.225 apply to any
national bank or Federal savings
association that is a subsidiary of a
global systemically important BHC, a
Category II national bank or Federal
savings association, a Category III
national bank or Federal savings
association, or a Category IV national
bank or Federal savings association.
*
*
*
*
*
(4) * * *
(i) A national bank or Federal savings
association that meets at least one of the
standards in paragraph (b)(1) of this
section shall remain subject to the
relevant requirements of this subpart F
unless and until it does not meet any of
the standards in paragraph (b)(1)(ii) of
this section for each of four consecutive
quarters as reported in the national
bank’s or Federal savings association’s
Call Report, it is no longer a subsidiary
of a depository institution holding
company, Category II national bank or
Federal savings association, or a
Category III national bank or Federal
savings association and the national
bank or Federal savings association
provides notice to the OCC.
*
*
*
*
*
(5) * * *
(i) A national bank or Federal savings
association that meets at least one of the
standards in paragraph (b)(1) of this
section shall remain subject to the
relevant requirements of this subpart F
unless and until it does not meet any of
the standards in paragraph (b)(1)(ii) of
this section for each of four consecutive
quarters as reported in the national
bank’s or Federal savings association’s
Call Report, and it is not a subsidiary of
a global systemically important BHC, a
Category II national bank or Federal
savings association, a Category III
national bank or Federal savings
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association, or Category IV national
bank or Federal savings association, and
the national bank or Federal savings
association provides notice to the OCC.
*
*
*
*
*
(c) * * *
(6) In making determinations under
paragraphs (c)(1) through (5) of this
section, the OCC will apply notice and
response procedures generally in the
same manner as the notice and response
procedures set forth in 12 CFR 3.404.
*
*
*
*
*
■ 23. In § 3.300:
■ a. Revise paragraph (a);
■ b. Add paragraph (b);
■ c. Remove paragraphs (c) and (d);
■ d. Redesignate paragraph (e) as new
paragraph (c); and
■ e. Remove paragraphs (f) through (h).
The revision and addition read as
follows:
§ 3.300
Transitions.
(a) Transition adjustments for AOCI.
Beginning July 1, 2025, a Category III
national bank or Federal savings
association or a Category IV national
bank or Federal savings association
must subtract from the sum of its
common equity tier 1 elements, before
making deductions required under
§ 3.22(c) or (d), the AOCI adjustment
amount multiplied by the percentage
provided in Table 1 to § 3.300. The
transition AOCI adjustment amount is
the sum of:
(1) Net unrealized gains or losses on
available-for-sale debt securities, plus
(2) Accumulated net gains or losses
on cash flow hedges, plus
(3) Any amounts recorded in AOCI
attributed to defined benefit
postretirement plans resulting from the
initial and subsequent application of the
relevant GAAP standards that pertain to
such plans, plus
(4) Net unrealized holding gains or
losses on held-to-maturity securities
that are included in AOCI.
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undercapitalized, significantly
undercapitalized, or critically
undercapitalized under part 6 of this
chapter; and
*
*
*
*
*
■ 21. In § 3.162, revise paragraph (c) as
follows:
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(b) Expanded total risk-weighted
assets. Beginning July 1, 2025, a
national bank or Federal savings
association subject to subpart E of this
part must comply with the requirements
of subpart B of this part using transition
expanded total risk-weighted assets as
calculated under this paragraph in place
of expanded total risk-weighted assets.
Transition expanded total risk-weighted
assets is a national bank or Federal
savings association’s expanded total
risk-weighted assets multiplied by the
percentage provided in Table 2 to
§ 3.300.
*
supplementary leverage ratio by one
hundred percent of its modified CECL
transitional amount during the second
year of the transition period, increase
total leverage exposure for purposes of
the supplementary leverage ratio by
seventy-five percent of its modified
CECL transitional amount during the
third year of the transition period,
increase total leverage exposure for
purposes of the supplementary leverage
ratio by fifty percent of its modified
CECL transitional amount during the
fourth year of the transition period, and
increase total leverage exposure for
purposes of the supplementary leverage
ratio by twenty-five percent of its
modified CECL transitional amount
during the fifth year of the transition
period.
*
*
*
*
*
Authority: 12 U.S.C. 93a, 1831o,
5412(b)(2)(B).
■
■
■
■
■
*
*
*
*
24. In § 3.301:
a. Remove paragraph (b)(5);
b. Revise paragraph (c)(2);
c. Revise paragraph (d)(2)(ii); and
d. Remove and reserve paragraph (e).
The revisions read as follows:
§ 3.301 Current expected credit losses
(CECL) transition.
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*
*
*
*
*
(c) * * *
(2) For purposes of the election
described in paragraph (a)(1) of this
section, a national bank or Federal
savings association subject to subpart E
of this part must increase total leverage
exposure for purposes of the
supplementary leverage ratio by
seventy-five percent of its CECL
transitional amount during the first year
of the transition period, increase total
leverage exposure for purposes of the
supplementary leverage ratio by fifty
percent of its CECL transitional amount
during the second year of the transition
period, and increase total leverage
exposure for purposes of the
supplementary leverage ratio by twentyfive percent of its CECL transitional
amount during the third year of the
transition period.
(d) * * *
(2) * * *
(ii) A national bank or Federal savings
association subject to subpart E of this
part that has elected the 2020 CECL
transition provision described in this
paragraph (d) may increase total
leverage exposure for purposes of the
supplementary leverage ratio by onehundred percent of its modified CECL
transitional amount during the first year
of the transition period, increase total
leverage exposure for purposes of the
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§ 3.302
[Amended]
25. In § 3.302, remove the words
‘‘advanced approaches total riskweighted assets’’ and add in their place
the words ‘‘expanded total riskweighted assets’’.
■
§ § 3.303 and 3.304
Reserved]
[Removed and
26. Remove and reserve §§ 3.303 and
3.304.
■
§ 3.305
[Amended]
27. In § 3.305, remove the words
‘‘advanced approaches total riskweighted assets’’ and add in their place
the words ‘‘expanded total riskweighted assets’’.
■
PART 6—PROMPT CORRECTIVE
ACTION
28. The authority citation for part 6
continues to read as follows:
■
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29. In § 6.2:
a. Remove the definition for
‘‘Advanced approaches national bank or
advanced approaches Federal savings
association’’;
■ b. Add, in alphabetical order, the
definition for ‘‘National bank or Federal
savings association subject to part 3,
subpart E of this chapter’’; and
■ c. Revise the definition for ‘‘Total riskweighted assets’’.
The addition and revision read as
follows:
■
■
§ 6.2
Definitions.
*
*
*
*
*
National bank or Federal savings
association subject to part 3, subpart E
of this chapter means a bank that is
subject to part 3, subpart E of this
chapter.
*
*
*
*
*
Total risk-weighted assets means
standardized total risk-weighted assets,
and for a national bank or Federal
savings association subject to part 3,
subpart E of this chapter, also includes
expanded risk-weighted assets, as
defined in § 3.2 of this chapter.
■ 30. In § 6.4, revise paragraphs
(a)(1)(iv)(B), (b)(1)(i)(D)(2), (b)(2)(iv)(B),
and (b)(3)(iv)(B) to read as follows:
§ 6.4 Capital measures and capital
categories.
(a) * * *
(1) * * *
(iv) * * *
(B) With respect to a national bank or
Federal savings association subject to
subpart E of part 3 of this chapter, the
supplementary leverage ratio; and
*
*
*
*
*
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(b) * * *
(1) * * *
(i) * * *
(D) * * *
(2) With respect to a national bank or
Federal savings association that is
controlled by a bank holding company
designated as a global systemically
important bank holding company
pursuant to § 252.82 of this title, the
national bank or Federal savings
association has a supplementary
leverage ratio of 6.0 percent or greater;
and
*
*
*
*
*
(2) * * *
(iv) * * *
(B) With respect to national bank or
Federal savings association subject to
subpart E of part 3 of this chapter, the
national bank or Federal savings
association has a supplementary
leverage ratio of 3.0 percent or greater;
*
*
*
*
*
(3) * * *
(iv) * * *
(B) With respect to national bank
Federal savings association subject to
subpart E of part 3 of this chapter, the
national bank or Federal savings
association has a supplementary
leverage ratio of less than 3.0 percent.
*
*
*
*
*
PART 32—LENDING LIMITS
31. The authority citation for part 32
continues to read as follows:
■
Authority: 12 U.S.C. 1 et seq., 12 U.S.C.
84, 93a, 1462a, 1463, 1464(u), 5412(b)(2)(B),
and 15 U.S.C. 1639h.
32. In § 32.2, revise paragraph (m)(1)
to read as follows:
■
§ 32.2
Definitions.
*
*
*
*
*
(m) Eligible credit derivative * * *
(1) The derivative contract meets the
requirements of paragraphs (1) through
(9) of an eligible guarantee, as defined
in § 3.2 of this chapter, and has been
confirmed by the protection purchaser
and the protection provider;
*
*
*
*
*
■ 33. In § 32.9, revise paragraphs
(b)(1)(i)(C), (b)(1)(iv), and (c)(1)(i) and
(iii) to read as follows:
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§ 32.9 Credit exposure arising from
derivative and securities financing
transactions.
*
*
*
*
*
(b) * * *
(1) * * *
(i) * * *
(C) Calculation of potential future
credit exposure. A bank or savings
association shall calculate its potential
future credit exposure by using any
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appropriate model the use of which has
been approved in writing for purposes
of this section by the appropriate
Federal banking agency. Any
substantive revisions to a model made
after the appropriate Federal banking
agency has approved the use of the
model must be approved by the agency
before a bank or savings association may
use the revised model for purposes of
this part.
*
*
*
*
*
(iv) Standardized Approach for
Counterparty Credit Risk Method. The
credit exposure arising from a derivative
transaction (other than a credit
derivative transaction) under the
Standardized Approach for
Counterparty Credit Risk Method shall
be calculated pursuant to 12 CFR
3.113(c)(5) or 324.113(c)(5), as
appropriate.
*
*
*
*
*
(c) * * *
(1) * * *
(i) Model method. A bank or savings
association may calculate the credit
exposure of a securities financing
transaction by using any appropriate
model the use of which has been
approved in writing for purposes of this
section by the appropriate Federal
banking agency. Any substantive
revisions to a model made after the
appropriate Federal banking agency has
approved the use of the model must be
approved by the agency before a bank or
savings association may use the revised
model for purposes of this part.
*
*
*
*
*
(iii) Basel collateral haircut method.
A bank or savings association may
calculate the credit exposure of a
securities financing transaction
pursuant to 12 CFR 3.113(b)(2)(i) and
(ii) or 324.113(b)(2)(i) and (ii), as
appropriate.
*
*
*
*
*
Board of Governors of the Federal
Reserve System
12 CFR Chapter II
Authority and Issuance
For the reasons set forth in the
common preamble, the Board of
Governors of the Federal Reserve
System proposes to amend chapter II of
title 12 of the Code of Federal
Regulations as follows:
PART 208—MEMBERSHIP OF STATE
BANKING INSTITUTIONS IN THE
FEDERAL RESERVE SYSTEM
(REGULATION H)
34. The authority citation for part 208
continues to read as follows:
■
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Authority: 12 U.S.C. 24, 36, 92a, 93a,
248(a), 248(c), 321–338a, 371d, 461, 481–486,
601, 611, 1814, 1816, 1817(a)(3), 1817(a)(12),
1818, 1820(d)(9), 1833(j), 1828(o), 1831,
1831o, 1831p–1, 1831r–1, 1831w, 1831x,
1835a, 1882, 2901–2907, 3105, 3310, 3331–
3351, 3905–3909, 5371, and 5371 note; 15
U.S.C. 78b, 78I(b), 78l(i), 78o–4(c)(5), 78q,
78q–1, 78w, 1681s, 1681w, 6801, and 6805;
31 U.S.C. 5318; 42 U.S.C. 4012a, 4104a,
4104b, 4106, and 4128.
Subpart D—Prompt Corrective Action
■
35. Revise § 208.41 to read as follows:
§ 208.41 Definitions for purposes of this
subpart.
For purposes of this subpart, except as
modified in this section or unless the
context otherwise requires, the terms
used have the same meanings as set
forth in section 38 and section 3 of the
FDI Act. As used in this subpart:
Bank means an insured depository
institution as defined in section 3 of the
FDI Act (12 U.S.C. 1813).
Bank subject to subpart E of 12 CFR
part 217 means a bank that is subject to
part 217, subpart E of this chapter.
Common equity tier 1 capital means
the amount of capital as defined in
§ 217.2 of this chapter.
Common equity tier 1 risk-based
capital ratio means the ratio of common
equity tier 1 capital to total riskweighted assets, as calculated in
accordance with § 217.10(b)(1) or
§ 217.10(d)(1) of this chapter, as
applicable.
Control—(1) Control has the same
meaning assigned to it in section 2 of
the Bank Holding Company Act (12
U.S.C. 1841), and the term controlled
shall be construed consistently with the
term control.
(2) Exclusion for fiduciary ownership.
No insured depository institution or
company controls another insured
depository institution or company by
virtue of its ownership or control of
shares in a fiduciary capacity. Shares
shall not be deemed to have been
acquired in a fiduciary capacity if the
acquiring insured depository institution
or company has sole discretionary
authority to exercise voting rights with
respect to the shares.
(3) Exclusion for debts previously
contracted. No insured depository
institution or company controls another
insured depository institution or
company by virtue of its ownership or
control of shares acquired in securing or
collecting a debt previously contracted
in good faith, until two years after the
date of acquisition. The two-year period
may be extended at the discretion of the
appropriate Federal banking agency for
up to three one-year periods.
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Controlling person means any person
having control of an insured depository
institution and any company controlled
by that person.
Global systemically important BHC
has the same meaning as in § 217.2 of
this chapter.
Leverage ratio means the ratio of tier
1 capital to average total consolidated
assets, as calculated in accordance with
§ 217.10 of this chapter.
Management fee means any payment
of money or provision of any other thing
of value to a company or individual for
the provision of management services or
advice to the bank, or related overhead
expenses, including payments related to
supervisory, executive, managerial, or
policy making functions, other than
compensation to an individual in the
individual’s capacity as an officer or
employee of the bank.
Supplementary leverage ratio means
the ratio of tier 1 capital to total leverage
exposure, as calculated in accordance
with § 217.10 of this chapter.
Tangible equity means the amount of
tier 1 capital, plus the amount of
outstanding perpetual preferred stock
(including related surplus) not included
in tier 1 capital.
Tier 1 capital means the amount of
capital as defined in § 217.20 of this
chapter.
Tier 1 risk-based capital ratio means
the ratio of tier 1 capital to total riskweighted assets, as calculated in
accordance with § 217.10(b)(2) or
§ 217.10(d)(2) of this chapter, as
applicable.
Total assets means quarterly average
total assets as reported in a bank’s Call
Report, minus items deducted from tier
1 capital. At its discretion the Federal
Reserve may calculate total assets using
a bank’s period-end assets rather than
quarterly average assets.
Total leverage exposure means the
total leverage exposure as defined in
§ 217.10(c)(2) of this chapter.
Total risk-based capital ratio means
the ratio of total capital to total riskweighted assets, as calculated in
accordance with § 217.10(b)(3) or
§ 217.10(d)(3) of this chapter, as
applicable.
Total risk-weighted assets means
standardized total risk-weighted assets,
and for an expanded risk-based bank
also includes expanded total riskweighted assets, as defined in § 217.2 of
this chapter.
Subpart D [Amended]
36. In subpart D:
a. Remove the words ‘‘advanced
approaches bank’’ and ‘‘advanced
approaches banks’’ wherever they
■
■
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appear and add in their place the words
‘‘bank subject to subpart E of 12 CFR
part 217’’ and ‘‘banks subject to subpart
E of 12 CFR part 217’’, respectively; and
■ b. Remove the words ‘‘bank or bank
that is a Category III Board-regulated
institution (as defined in § 217.2 of this
chapter),’’ wherever they appear and
add in their place the word ‘‘bank,’’.
Subpart G—Financial Subsidiaries of
State Member Banks
37. In § 208.73:
a. Revise paragraph (a) introductory
text;
■ b. Remove paragraph (b); and
■ c. Redesignate paragraphs (c) through
(f) as (b) through (e), respectively.
The revision reads as follows:
■
■
§ 208.73 What additional provisions are
applicable to state member banks with
financial subsidiaries?
(a) Capital requirements. A state
member bank that controls or holds an
interest in a financial subsidiary must
comply with the rules set forth in
§ 217.22(a)(7) of Regulation Q (12 CFR
217.22(a)(7)) in determining its
compliance with applicable regulatory
capital standards (including the well
capitalized standard of § 208.71(a)(1)).
*
*
*
*
*
■ 38. In Appendix C, revise footnote 2
to read as follows:
Appendix C to Part 208—Interagency
Guidelines for Real Estate Lending
Policies
*
*
*
*
*
2 The
term ‘‘total capital’’ refers to that
term as defined in 12 CFR part 3, 12 CFR part
217, or 12 CFR part 324, as applicable.
PART 217—CAPITAL ADEQUACY OF
BANK HOLDING COMPANIES,
SAVINGS AND LOAN HOLDING
COMPANIES, AND STATE MEMBER
BANKS (REGULATION Q)
39. The authority citation for part 217
reads as follows:
■
Authority: 12 U.S.C. 248(a), 321–338a,
481–486, 1462a, 1467a, 1818, 1828, 1831n,
1831o, 1831p–1, 1831w, 1835, 1844(b), 1851,
3904, 3906–3909, 4808, 5365, 5368, 5371,
and 5371 note, and sec. 4012, Pub. L. 116–
136, 134 Stat. 281.
40. Revise subparts E and F of part
217 as set forth at the end of the
common preamble.
■ 41. In part 217, subparts E and F:
■ a. Remove ‘‘[AGENCY]’’ and add
‘‘Board’’ in its place wherever it
appears;
■ b. Remove ‘‘[BANKING
ORGANIZATION]’’ and add ‘‘Boardregulated institution’’ in its place
wherever it appears;
■
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c. Remove ‘‘[BANKING
ORGANIZATION]’s’’ and add ‘‘Boardregulated institution’s’’ in its place
wherever it appears;
■ d. Remove ‘‘[REAL ESTATE LENDING
GUIDELINES]’’ and add ‘‘12 CFR part
208, appendix C’’ in its place wherever
it appears;
■ e. Remove ‘‘[APPRAISAL RULE]’’ and
add ‘‘12 CFR part 208, subpart E, or 12
CFR part 225, subpart G, as applicable’’
in its place wherever it appears; and
■ f. Remove ‘‘ll.’’ and add ‘‘217.’’ in
its place wherever it appears.
■
Subpart A—General Provisions
42. In § 217.1:
a. Add paragraph (c)(6); and
b. Revise paragraph (f).
The addition and revision read as
follows:
■
■
■
§ 217.1 Purpose, applicability,
reservations of authority, and timing.
*
*
*
*
*
(c) * * *
(6) Transitions. Notwithstanding any
other provision of this part, a Boardregulated institution must make any
adjustments provided in subpart G of
this part for purposes of implementing
this part.
*
*
*
*
*
(f) Timing. A Board-regulated
institution that changes from one
category of Board-regulated institution
to another of such categories, or that
changes from having no category of
Board-regulated institution to having a
such category, must comply with the
requirements of its category in this part,
including applicable transition
provisions of the requirements in this
part, no later than on the first day of the
second quarter following the change in
the company’s category.
■ 43. In § 217.2:
■ a. Remove the definitions for
‘‘Advanced approaches Board-regulated
institution’’, ‘‘Advanced approaches
total risk-weighted assets’’, and
‘‘Advanced market risk-weighted
assets’’;
■ b. In the definition for ‘‘Category II
Board-regulated institution’’:
■ i. Remove paragraph (3);
■ ii. Redesignate paragraph (4) as
paragraph (3);
■ iii. Revise newly redesignated
paragraph (3)(i);
■ iv. In newly redesiganted paragraph
(3)(iii) introductory text, remove the
words ‘‘paragraph (4)(i) of this section’’
and add, in their place, the words
‘‘paragraph (3)(ii) of this definition’’;
■ c. In the definition of ‘‘Category III
Board-regulated institution’’:
■ i. Remove paragraph (3);
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ii. Redesignate paragraph (4) as
paragraph (3);
■ iii. Revise newly redesignated
paragraph (3) introductory text;
■ iv. Revise newly redesignated
paragraph (3)(i); and
■ vi. In newly redesignated paragraph
(3)(iv) introductory text, remove the
words ‘‘paragraph (4)(ii) of this
definition’’ and add, in their place, the
words ‘‘paragraph (3)(ii) of this
definition’’;
■ d. Add, in alphabetical order, the
definition for ‘‘Category IV Boardregulated institution’’; e. Revise footnote
3 to paragraph (2) of the definition for
‘‘Cleared transaction.’’
■ f. Revise the definition for ‘‘Corporate
exposure’’;
■ g. Remove the definition for ‘‘Creditrisk-weighted assets’’;
■ h. Add, in alphabetical order, the
definition for ‘‘CVA risk-weighted
assets’’;
■ i. Revise the definition for ‘‘Effective
notional amount’’;
■ j. Remove the definition for ‘‘Eligible
credit reserves’’;
■ k. Revise the definition for ‘‘Eligible
guarantee’’;
■ l. Add, in alphabetical order,
‘‘Expanded total risk-weighted assets’’;
■ m. Remove the definition for
‘‘Expected credit loss (ECL)’’;
■ n. Revise the definitions for
‘‘Exposure amount’’, ‘‘Market risk
Board-regulated institution’’, ‘‘Net
independent collateral amount’’, Netting
set’’, ‘‘Protection amount (P)’’, and
paragraphs (3) and (4) of the definition
for ‘‘Qualifying master netting
agreement’’;
■ o. In the definition of ‘‘Residential
mortgage exposure’’:
■ i. Remove paragraph (2);
■ ii. Redesignate paragraphs (1)(i) and
(1)(ii) as paragraphs (1) and (2),
respectively; and
■ iii. In newly redesignated paragraph
(2), remove the words ‘‘family; and’’ and
add, in their place, the word ‘‘family.’’;
■ p. Remove the definition for ‘‘Specific
wrong-way risk’’;
■ q. Revise the definitions for
‘‘Speculative grade’’, ‘‘Standardized
market risk-weighted assets’’,
‘‘Standardized total risk-weighted
assets’’, ‘‘Sub-speculative grade’’;
■ r. Add, in alphabetical order, the
definition for ‘‘Total credit riskweighted assets’’;
■ s. Revise the definition for
‘‘Unregulated financial institution’’;
■ r. Remove the definition for ‘‘Value-atrisk (VaR)’’; and
■ s. Revise the definition for ‘‘Variation
margin amount’’.
The additions and revisions read as
follows:
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§ 217.2
Definitions.
*
*
*
*
*
Category II Board-regulated
institution means:
*
*
*
*
*
(3) * * *
(i) Is a subsidiary of a Category II
banking organization, as defined
pursuant to § 252.5 of this chapter or
§ 238.10 of this chapter, as applicable;
or
*
*
*
*
*
Category III Board-regulated
institution means:
*
*
*
*
*
(3) A state member bank that is not a
Category II Board-regulated institution
and that:
(i) Is a subsidiary of a Category III
banking organization, as defined
pursuant to § 252.5 of this chapter or
§ 238.10 of this chapter, as applicable;
or
*
*
*
*
*
Category IV Board-regulated
institution means:
(1) A depository institution holding
company that is identified as a Category
IV banking organization pursuant to
§ 252.5 of this chapter or § 238.10 of this
chapter, as applicable;
(2) A U.S. intermediate holding
company that is identified as a Category
IV banking organization pursuant to
§ 252.5 of this chapter;
(3) A state member bank that is not a
Category II Board-regulated institution
or Category III Board-regulated
institution and that:
(i) Is a subsidiary of a Category IV
banking organization, as defined
pursuant to § 252.5 of this chapter or
§ 238.10 of this chapter, as applicable;
or
(ii) Has total consolidated assets,
calculated based on the average of the
depository institution’s total
consolidated assets for the four most
recent calendar quarters as reported on
the Call Report of $100 billion or more.
If the depository institution has not filed
the Call Report for each of the four most
recent calendar quarters, total
consolidated assets is calculated based
on its total consolidated assets, as
reported on the Call Report, for the most
recent quarter or the average of the four
most recent quarters, as applicable.
(iii) After meeting the criterion in
paragraph (3)(ii) of this definition, a
state member bank continues to be a
Category IV Board-regulated institution
until the state member bank:
(A) Has less than $100 billion in total
consolidated assets, as reported on the
Call Report, for each of the four most
recent calendar quarters; or
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(B) Is a Category II or Category III
Board-regulated institution.
*
*
*
*
*
Cleared transaction * * *
(2) * * * 3
3 For the standardized approach treatment
of these exposures, see § 217.34(e) (OTC
derivative contracts) or § 217.37(c) (repo-style
transactions). For the expanded risk-based
treatment of these exposures, see § 217.113
(OTC derivative contracts) or § 217.121 (repostyle transactions).
*
*
*
*
*
Corporate exposure means an
exposure to a company that is not:
(1) An exposure to a sovereign, the
Bank for International Settlements, the
European Central Bank, the European
Commission, the International Monetary
Fund, the European Stability
Mechanism, the European Financial
Stability Facility, a multi-lateral
development bank (MDB), a depository
institution, a foreign bank, or a credit
union, a public sector entity (PSE);
(2) An exposure to a governmentsponsored enterprise (GSE);
(3) For purposes of subpart D of this
part, a residential mortgage exposure;
(4) A pre-sold construction loan;
(5) A statutory multifamily mortgage;
(6) A high volatility commercial real
estate (HVCRE) exposure;
(7) A cleared transaction;
(8) A default fund contribution;
(9) A securitization exposure;
(10) An equity exposure;
(11) An unsettled transaction;
(12) A policy loan;
(13) A separate account;
(14) A Paycheck Protection Program
covered loan as defined in section
7(a)(36) or (37) of the Small Business
Act (15 U.S.C. 636(a)(36)–(37));
(15) For purposes of subpart E of this
part, a real estate exposure, as defined
in § 217.101; or
(16) For purposes of subpart E of this
part, a retail exposure as defined in
§ 217.101.
*
*
*
*
*
CVA risk-weighted assets means the
measure for CVA risk calculated under
§ 217.221(a) multiplied by 12.5.
*
*
*
*
*
Effective notional amount means for
an eligible guarantee or eligible credit
derivative, the lesser of the contractual
notional amount of the credit risk
mitigant and the exposures amount of
the hedged exposure, multiplied by the
percentage coverage of the credit risk
mitigant.
*
*
*
*
*
Eligible guarantee means a guarantee
that:
(1) Is written;
(2) Is either:
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(i) Unconditional, or
(ii) A contingent obligation of the U.S.
government or its agencies, the
enforceability of which is dependent
upon some affirmative action on the
part of the beneficiary of the guarantee
or a third party (for example, meeting
servicing requirements);
(3) Covers all or a pro rata portion of
all contractual payments of the
obligated party on the reference
exposure;
(4) Gives the beneficiary a direct
claim against the protection provider;
(5) Is not unilaterally cancelable by
the protection provider for reasons other
than the breach of the contract by the
beneficiary;
(6) Except for a guarantee by a
sovereign, is legally enforceable against
the protection provider in a jurisdiction
where the protection provider has
sufficient assets against which a
judgment may be attached and enforced;
(7) Requires the protection provider to
make payment to the beneficiary on the
occurrence of a default (as defined in
the guarantee) of the obligated party on
the reference exposure in a timely
manner without the beneficiary first
having to take legal actions to pursue
the obligor for payment;
(8) Does not increase the beneficiary’s
cost of credit protection on the
guarantee in response to deterioration in
the credit quality of the reference
exposure;
(9) Is not provided by an affiliate of
the Board-regulated institution, unless
the affiliate is an insured depository
institution, foreign bank, securities
broker or dealer, or insurance company
that:
(i) Does not control the Boardregulated institution; and
(ii) Is subject to consolidated
supervision and regulation comparable
to that imposed on depository
institutions, U.S. securities brokerdealers, or U.S. insurance companies (as
the case may be); and
(10) Is provided by an eligible
guarantor.
*
*
*
*
*
Expanded total risk-weighted assets
means the greater of:
(1) The sum of:
(i) Total credit risk-weighted assets;
(ii) Total risk-weighted assets for
equity exposures as calculated under
§ 217.141 and 217.142;
(iii) Risk-weighted assets for
operational risk as calculated under
§ 217.150;
(iv) Market risk-weighted assets; and
(v) CVA risk-weighted assets; minus
(vi) Any amount of the Boardregulated institution’s adjusted
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allowance for credit losses that is not
included in tier 2 capital and any
amount of allocated transfer risk
reserves; or
(2) (i) 72.5 percent of the sum of:
(A) Total credit risk-weighted assets;
(B) Total risk-weighted assets for
equity exposures as calculated under
§ 217.141 and 217.142;
(C) Risk-weighted assets for
operational risk as calculated under
§ 217.150;
(D) Standardized market riskweighted assets; and
(E) CVA risk-weighted assets; minus
(ii) Any amount of the Boardregulated institution’s adjusted
allowance for credit losses that is not
included in tier 2 capital and any
amount of allocated transfer risk
reserves.
*
*
*
*
*
Exposure amount means:
(1) For the on-balance sheet
component of an exposure (other than
an available-for-sale or held-to-maturity
security, if the Board-regulated
institution has made an AOCI opt-out
election (as defined in § 217.22(b)(2));
an OTC derivative contract; a repo-style
transaction or an eligible margin loan
for which the Board-regulated
institution determines the exposure
amount under § 217.37 or § 217.121, as
applicable; a cleared transaction; a
default fund contribution; or a
securitization exposure), the Boardregulated institution’s carrying value of
the exposure.
(2) For a security (that is not a
securitization exposure, equity
exposure, or preferred stock classified as
an equity security under GAAP)
classified as available-for-sale or heldto-maturity if the Board-regulated
institution has made an AOCI opt-out
election (as defined in § 217.22(b)(2)),
the Board-regulated institution’s
carrying value (including net accrued
but unpaid interest and fees) for the
exposure less any net unrealized gains
on the exposure and plus any net
unrealized losses on the exposure.
(3) For available-for-sale preferred
stock classified as an equity security
under GAAP if the Board-regulated
institution has made an AOCI opt-out
election (as defined in § 217.22(b)(2)),
the Board-regulated institution’s
carrying value of the exposure less any
net unrealized gains on the exposure
that are reflected in such carrying value
but excluded from the Board-regulated
institution’s regulatory capital
components.
(4) For the off-balance sheet
component of an exposure (other than
an OTC derivative contract; a repo-style
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transaction or an eligible margin loan
for which the Board-regulated
institution calculates the exposure
amount under § 217.37 or § 217.121, as
applicable; a cleared transaction; a
default fund contribution; or a
securitization exposure), the notional
amount of the off-balance sheet
component multiplied by the
appropriate credit conversion factor
(CCF) in § 217.33 or § 217.112, as
applicable.
(5) For an exposure that is an OTC
derivative contract, the exposure
amount determined under § 217.34 or
§ 217.113, as applicable.
(6) For an exposure that is a cleared
transaction, the exposure amount
determined under § 217.35 or § 217.114,
as applicable.
(7) For an exposure that is an eligible
margin loan or repo-style transaction for
which the bank calculates the exposure
amount as provided in § 217.37 or
§ 217.131, as applicable, the exposure
amount determined under § 217.37 or
§ 217.121, as applicable.
(8) For an exposure that is a
securitization exposure, the exposure
amount determined under § 217.42 or
§ 217.131, as applicable.
*
*
*
*
*
Market risk Board-regulated
institution means a Board-regulated
institution that is described in
§ 217.201(b)(1).
Market risk-weighted assets means the
measure for market risk calculated
pursuant to § 217.204(a) multiplied by
12.5.
*
*
*
*
*
Net independent collateral amount
means the fair value amount of the
independent collateral, as adjusted by
the haircuts under § 217.121(c)(2)(iii), as
applicable, that a counterparty to a
netting set has posted to a Boardregulated institution less the fair value
amount of the independent collateral, as
adjusted by the haircuts under
§ 217.121(c)(2)(iii), as applicable, posted
by the Board-regulated institution to the
counterparty, excluding such amounts
held in a bankruptcy-remote manner or
posted to a QCCP and held in
conformance with the operational
requirements in § 217.3
Netting set means:
(1) A group of transactions with a
single counterparty that are subject to a
qualifying master netting agreement and
that consist only of:
(i) Derivative contracts;
(ii) Repo-style transactions; or
(iii) Eligible margin loans.
(2) For derivative contracts, netting
set also includes a single derivative
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contract between a Board-regulated
institution and a single counterparty.
*
*
*
*
*
Protection amount (P) means, with
respect to an exposure hedged by an
eligible guarantee or eligible credit
derivative, the effective notional amount
of the guarantee or credit derivative,
reduced to reflect any currency
mismatch, maturity mismatch, or lack of
restructuring coverage (as provided in
§ 217.36 or 217.120, as appropriate).
*
*
*
*
*
Qualifying master netting agreement
means a written, legally enforceable
agreement provided that:
*
*
*
*
*
(3) The agreement does not contain a
walkaway clause (that is, a provision
that permits a non-defaulting
counterparty to make a lower payment
than it otherwise would make under the
agreement, or no payment at all, to a
defaulter or the estate of a defaulter,
even if the defaulter or the estate of the
defaulter is a net creditor under the
agreement); and
(4) In order to recognize an agreement
as a qualifying master netting agreement
for purposes of this subpart, a Boardregulated institution must comply with
the requirements of § 217.3(d) with
respect to that agreement.
*
*
*
*
*
Speculative grade means that the
entity to which the Board-regulated
institution is exposed through a loan or
security, or the reference entity with
respect to a credit derivative, has
adequate capacity to meet financial
commitments in the near term, but is
vulnerable to adverse economic
conditions, such that should economic
conditions deteriorate, the issuer or the
reference entity would present an
elevated default risk.
Standardized market risk-weighted
assets means the standardized measure
for market risk calculated under
§ 217.204(b) multiplied by 12.5.
Standardized total risk-weighted
assets means:
(1) The sum of:
(i) Total risk-weighted assets for
general credit risk as calculated under
§ 217.31;
(ii) Total risk-weighted assets for
cleared transactions and default fund
contributions as calculated under
§ 217.35;
(iii) Total risk-weighted assets for
unsettled transactions as calculated
under § 217.38;
(iv) Total risk-weighted assets for
securitization exposures as calculated
under § 217.42;
(v) Total risk-weighted assets for
equity exposures as calculated under
§ 217.52 and § 217.53; and
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(vi) For a market risk Board-regulated
institution only, market risk-weighted
assets; less
(2) Any amount of the Boardregulated institution’s allowance for
loan and lease losses or adjusted
allowance for credit losses, as
applicable, that is not included in tier
2 capital and any amount of ‘‘allocated
transfer risk reserves.’’
*
*
*
*
*
Sub-speculative grade means that the
entity to which the Board-regulated
institution is exposed through a loan or
security, or the reference entity with
respect to a credit derivative, depends
on favorable economic conditions to
meet its financial commitments, such
that should such economic conditions
deteriorate the issuer or the reference
entity likely would default on its
financial commitments.
*
*
*
*
*
Total credit risk-weighted assets
means the sum of:
(1) Total risk-weighted assets for
general credit risk as calculated under
§ 217.110;
(2) Total risk-weighted assets for
cleared transactions and default fund
contributions as calculated under
§ 217.114;
(3) Total risk-weighted assets for
unsettled transactions as calculated
under § 217.115; and
(4) Total risk-weighted assets for
securitization exposures as calculated
under § 217.132.
*
*
*
*
*
Unregulated financial institution
means a financial institution that is not
a regulated financial institution,
including any financial institution that
would meet the definition of ‘‘financial
institution’’ under this section but for
the ownership interest thresholds set
forth in paragraph (4)(i) of that
definition.
*
*
*
*
*
Variation margin amount means the
fair value amount of the variation
margin, as adjusted by the standard
supervisory haircuts under
§ 217.121(c)(2)(iii), as applicable, that a
counterparty to a netting set has posted
to a Board-regulated institution less the
fair value amount of the variation
margin, as adjusted by the standard
supervisory haircuts under
§ 217.121(c)(2)(iii), as applicable, posted
by the Board-regulated institution to the
counterparty.
*
*
*
*
*
§ 217.3
[Amended]
44. In § 217.3, remove and reserve
paragraph (c).
■
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Subpart B—Capital Ratio
Requirements and Buffers
45. In § 217.10:
a. Revise paragraph (a)(1)(v);
b. Revise paragraph (b) introductory
text;
■ c. Revise paragraph (c);
■ d. Revise paragraph (d) introductory
text; and
■ e. Revise paragraph (d)(3)(ii).
The revisions read as follows:
■
■
■
§ 217.10
Minimum capital requirements.
(a) * * *
(1) * * *
(v) For a Board-regulated institution
subject to subpart E of this part, a
supplementary leverage ratio of 3
percent.
*
*
*
*
*
(b) Standardized capital ratio
calculations. Other than as provided in
paragraph (d) of this section:
*
*
*
*
*
(c) Supplementary leverage ratio. (1)
The supplementary leverage ratio of a
Board-regulated institution subject to
subpart E of this part is the ratio of its
tier 1 capital to total leverage exposure.
Total leverage exposure is calculated as
the sum of:
(i) The mean of the on-balance sheet
assets calculated as of each day of the
reporting quarter; and
(ii) The mean of the off-balance sheet
exposures calculated as of the last day
of each of the most recent three months,
minus the applicable deductions under
§ 217.22(a), (c), and (d).
(2) For purposes of this part, total
leverage exposure means the sum of the
items described in paragraphs (c)(2)(i)
through (viii) of this section, as adjusted
pursuant to paragraph (c)(2)(ix) of this
section for a clearing member Boardregulated institution and paragraph
(c)(2)(x) of this section for a custodial
banking organization:
(i) The balance sheet carrying value of
all of the Board-regulated institution’s
on-balance sheet assets, net of adjusted
allowances for credit losses, plus the
value of securities sold under a
repurchase transaction or a securities
lending transaction that qualifies for
sales treatment under GAAP, less
amounts deducted from tier 1 capital
under § 217.22(a), (c), and (d), less the
value of securities received in securityfor-security repo-style transactions,
where the Board-regulated institution
acts as a securities lender and includes
the securities received in its on-balance
sheet assets but has not sold or rehypothecated the securities received,
and less the fair value of any derivative
contracts;
(ii)(A) The PFE for each netting set to
which the Board-regulated institution is
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a counterparty (including cleared
transactions except as provided in
paragraph (c)(2)(ix) of this section and,
at the discretion of the Board-regulated
institution, excluding a forward
agreement treated as a derivative
contract that is part of a repurchase or
reverse repurchase or a securities
borrowing or lending transaction that
qualifies for sales treatment under
GAAP), as determined under
§ 217.113(g), in which the term C in
§ 217.113(g)(1) equals zero, and, for any
counterparty that is not a commercial
end-user, multiplied by 1.4. For
purposes of this paragraph (c)(2)(ii)(A),
a Board-regulated institution may set
the value of the term C in § 217.113(g)(1)
equal to the amount of collateral posted
by a clearing member client of the
Board-regulated institution in
connection with the client-facing
derivative transactions within the
netting set; and
(B) A Board-regulated institution may
choose to exclude the PFE of all credit
derivatives or other similar instruments
through which it provides credit
protection when calculating the PFE
under § 217.113, provided that it does
so consistently over time for the
calculation of the PFE for all such
instruments;
(iii)(A)(1) The replacement cost of
each derivative contract or single
product netting set of derivative
contracts to which the Board-regulated
institution is a counterparty, calculated
according to the following formula, and,
for any counterparty that is not a
commercial end-user, multiplied by 1.4:
Replacement Cost = max{V¥CVMr +
CVMp; 0}
Where:
V equals the fair value for each derivative
contract or each netting set of derivative
contracts (including a cleared transaction
except as provided in paragraph (c)(2)(ix)
of this section and, at the discretion of
the Board-regulated institution,
excluding a forward agreement treated as
a derivative contract that is part of a
repurchase or reverse repurchase or a
securities borrowing or lending
transaction that qualifies for sales
treatment under GAAP);
CVMr equals the amount of cash collateral
received from a counterparty to a
derivative contract and that satisfies the
conditions in paragraphs (c)(2)(iii)(B)
through (F) of this section, or, in the case
of a client-facing derivative transaction,
the amount of collateral received from
the clearing member client; and
CVMp equals the amount of cash collateral
that is posted to a counterparty to a
derivative contract and that has not
offset the fair value of the derivative
contract and that satisfies the conditions
in paragraphs (c)(2)(iii)(B) through (F) of
this section, or, in the case of a client-
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facing derivative transaction, the amount
of collateral posted to the clearing
member client;
(2) Notwithstanding paragraph
(c)(2)(iii)(A)(1) of this section, where
multiple netting sets are subject to a
single variation margin agreement, a
Board-regulated institution must apply
the formula for replacement cost
provided in § 217.113(j)(1), in which the
term CMA may only include cash
collateral that satisfies the conditions in
paragraphs (c)(2)(iii)(B) through (F) of
this section; and
(3) For purposes of paragraph
(c)(2)(iii)(A)(1) of this section, a Boardregulated institution must treat a
derivative contract that references an
index as if it were multiple derivative
contracts each referencing one
component of the index if the Boardregulated institution elected to treat the
derivative contract as multiple
derivative contracts under
§ 217.113(e)(6);
(B) For derivative contracts that are
not cleared through a QCCP, the cash
collateral received by the recipient
counterparty is not segregated (by law,
regulation, or an agreement with the
counterparty);
(C) Variation margin is calculated and
transferred on a daily basis based on the
mark-to-fair value of the derivative
contract;
(D) The variation margin transferred
under the derivative contract or the
governing rules of the CCP or QCCP for
a cleared transaction is the full amount
that is necessary to fully extinguish the
net current credit exposure to the
counterparty of the derivative contracts,
subject to the threshold and minimum
transfer amounts applicable to the
counterparty under the terms of the
derivative contract or the governing
rules for a cleared transaction;
(E) The variation margin is in the form
of cash in the same currency as the
currency of settlement set forth in the
derivative contract, provided that for the
purposes of this paragraph (c)(2)(iii)(E),
currency of settlement means any
currency for settlement specified in the
governing qualifying master netting
agreement and the credit support annex
to the qualifying master netting
agreement, or in the governing rules for
a cleared transaction; and
(F) The derivative contract and the
variation margin are governed by a
qualifying master netting agreement
between the legal entities that are the
counterparties to the derivative contract
or by the governing rules for a cleared
transaction, and the qualifying master
netting agreement or the governing rules
for a cleared transaction must explicitly
stipulate that the counterparties agree to
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settle any payment obligations on a net
basis, taking into account any variation
margin received or provided under the
contract if a credit event involving
either counterparty occurs;
(iv) The effective notional principal
amount (that is, the apparent or stated
notional principal amount multiplied by
any multiplier in the derivative
contract) of a credit derivative, or other
similar instrument, through which the
Board-regulated institution provides
credit protection, provided that:
(A) The Board-regulated institution
may reduce the effective notional
principal amount of the credit
derivative by the amount of any
reduction in the mark-to-fair value of
the credit derivative if the reduction is
recognized in common equity tier 1
capital;
(B) The Board-regulated institution
may reduce the effective notional
principal amount of the credit
derivative by the effective notional
principal amount of a purchased credit
derivative or other similar instrument,
provided that the remaining maturity of
the purchased credit derivative is equal
to or greater than the remaining
maturity of the credit derivative through
which the Board-regulated institution
provides credit protection and that:
(1) With respect to a credit derivative
that references a single exposure, the
reference exposure of the purchased
credit derivative is to the same legal
entity and ranks pari passu with, or is
junior to, the reference exposure of the
credit derivative through which the
Board-regulated institution provides
credit protection; or
(2) With respect to a credit derivative
that references multiple exposures, the
reference exposures of the purchased
credit derivative are to the same legal
entities and rank pari passu with the
reference exposures of the credit
derivative through which the Boardregulated institution provides credit
protection, and the level of seniority of
the purchased credit derivative ranks
pari passu to the level of seniority of the
credit derivative through which the
Board-regulated institution provides
credit protection;
(3) Where a Board-regulated
institution has reduced the effective
notional principal amount of a credit
derivative through which the Boardregulated institution provides credit
protection in accordance with paragraph
(c)(2)(iv)(A) of this section, the Boardregulated institution must also reduce
the effective notional principal amount
of a purchased credit derivative used to
offset the credit derivative through
which the Board-regulated institution
provides credit protection, by the
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amount of any increase in the mark-tofair value of the purchased credit
derivative that is recognized in common
equity tier 1 capital; and
(4) Where the Board-regulated
institution purchases credit protection
through a total return swap and records
the net payments received on a credit
derivative through which the Boardregulated institution provides credit
protection in net income, but does not
record offsetting deterioration in the
mark-to-fair value of the credit
derivative through which the Boardregulated institution provides credit
protection in net income (either through
reductions in fair value or by additions
to reserves), the Board-regulated
institution may not use the purchased
credit protection to offset the effective
notional principal amount of the related
credit derivative through which the
Board-regulated institution provides
credit protection;
(v) Where a Board-regulated
institution acting as a principal has
more than one repo-style transaction
with the same counterparty and has
offset the gross value of receivables due
from a counterparty under reverse
repurchase transactions by the gross
value of payables under repurchase
transactions due to the same
counterparty, the gross value of
receivables associated with the repostyle transactions less any on-balance
sheet receivables amount associated
with these repo-style transactions
included under paragraph (c)(2)(i) of
this section, unless the following
criteria are met:
(A) The offsetting transactions have
the same explicit final settlement date
under their governing agreements;
(B) The right to offset the amount
owed to the counterparty with the
amount owed by the counterparty is
legally enforceable in the normal course
of business and in the event of
receivership, insolvency, liquidation, or
similar proceeding; and
(C) Under the governing agreements,
the counterparties intend to settle net,
settle simultaneously, or settle
according to a process that is the
functional equivalent of net settlement,
(that is, the cash flows of the
transactions are equivalent, in effect, to
a single net amount on the settlement
date), where both transactions are
settled through the same settlement
system, the settlement arrangements are
supported by cash or intraday credit
facilities intended to ensure that
settlement of both transactions will
occur by the end of the business day,
and the settlement of the underlying
securities does not interfere with the net
cash settlement;
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(vi) The counterparty credit risk of a
repo-style transaction, including where
the Board-regulated institution acts as
an agent for a repo-style transaction and
indemnifies the customer with respect
to the performance of the customer’s
counterparty in an amount limited to
the difference between the fair value of
the security or cash its customer has
lent and the fair value of the collateral
the borrower has provided, calculated as
follows:
(A) If the transaction is not subject to
a qualifying master netting agreement,
the counterparty credit risk (E*) for
transactions with a counterparty must
be calculated on a transaction by
transaction basis, such that each
transaction i is treated as its own netting
set, in accordance with the following
formula, where Ei is the fair value of the
instruments, gold, or cash that the
Board-regulated institution has lent,
sold subject to repurchase, or provided
as collateral to the counterparty, and Ci
is the fair value of the instruments, gold,
or cash that the Board-regulated
institution has borrowed, purchased
subject to resale, or received as
collateral from the counterparty:
Ei* = max {0, [Ei—Ci]}; and
(B) If the transaction is subject to a
qualifying master netting agreement, the
counterparty credit risk (E*) must be
calculated as the greater of zero and the
total fair value of the instruments, gold,
or cash that the Board-regulated
institution has lent, sold subject to
repurchase or provided as collateral to
a counterparty for all transactions
included in the qualifying master
netting agreement (SEi), less the total
fair value of the instruments, gold, or
cash that the Board-regulated institution
borrowed, purchased subject to resale or
received as collateral from the
counterparty for those transactions
(SCi), in accordance with the following
formula:
E* = max {0, [Sei¥ Sci]}
(vii) If a Board-regulated institution
acting as an agent for a repo-style
transaction provides a guarantee to a
customer of the security or cash its
customer has lent or borrowed with
respect to the performance of the
customer’s counterparty and the
guarantee is not limited to the difference
between the fair value of the security or
cash its customer has lent and the fair
value of the collateral the borrower has
provided, the amount of the guarantee
that is greater than the difference
between the fair value of the security or
cash its customer has lent and the value
of the collateral the borrower has
provided;
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(viii) The credit equivalent amount of
all off-balance sheet exposures of the
Board-regulated institution, excluding
repo-style transactions, repurchase or
reverse repurchase or securities
borrowing or lending transactions that
qualify for sales treatment under GAAP,
and derivative transactions, determined
using the applicable credit conversion
factor under § 217.112(b), provided,
however, that the minimum credit
conversion factor that may be assigned
to an off-balance sheet exposure under
this paragraph is 10 percent; and
(ix) For a Board-regulated institution
that is a clearing member:
(A) A clearing member Boardregulated institution that guarantees the
performance of a clearing member client
with respect to a cleared transaction
must treat its exposure to the clearing
member client as a derivative contract
or repo-style transaction, as applicable,
for purposes of determining its total
leverage exposure;
(B) A clearing member Boardregulated institution that guarantees the
performance of a CCP with respect to a
transaction cleared on behalf of a
clearing member client must treat its
exposure to the CCP as a derivative
contract or repo-style transaction, as
applicable, for purposes of determining
its total leverage exposure;
(C) A clearing member Boardregulated institution that does not
guarantee the performance of a CCP
with respect to a transaction cleared on
behalf of a clearing member client may
exclude its exposure to the CCP for
purposes of determining its total
leverage exposure;
(D) A Board-regulated institution that
is a clearing member may exclude from
its total leverage exposure the effective
notional principal amount of credit
protection sold through a credit
derivative contract, or other similar
instrument, that it clears on behalf of a
clearing member client through a CCP as
calculated in accordance with paragraph
(c)(2)(iv) of this section; and
(E) Notwithstanding paragraphs
(c)(2)(ix)(A) through (C) of this section,
a Board-regulated institution may
exclude from its total leverage exposure
a clearing member’s exposure to a
clearing member client for a derivative
contract if the clearing member client
and the clearing member are affiliates
and consolidated for financial reporting
purposes on the Board-regulated
institution’s balance sheet.
(x) A custodial banking organization
shall exclude from its total leverage
exposure the lesser of:
(A) The amount of funds that the
custodial banking organization has on
deposit at a qualifying central bank; and
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(B) The amount of funds in deposit
accounts at the custodial banking
organization that are linked to fiduciary
or custodial and safekeeping accounts at
the custodial banking organization. For
purposes of this paragraph (c)(2)(x), a
deposit account is linked to a fiduciary
or custodial and safekeeping account if
the deposit account is provided to a
client that maintains a fiduciary or
custodial and safekeeping account with
the custodial banking organization and
the deposit account is used to facilitate
the administration of the fiduciary or
custodial and safekeeping account.
(d) Expanded capital ratio
calculations. A Board-regulated
institution subject to subpart E of this
part must determine its regulatory
capital ratios as described in paragraphs
(d)(1) through (3) of this section.
*
*
*
*
*
(3) * * *
(ii) The ratio of the Board-regulated
institution’s expanded risk-based
approach-adjusted total capital to
expanded total risk-weighted assets. A
Board-regulated institution’s expanded
risk-based approach-adjusted total
capital is the Board-regulated
institution’s total capital after being
adjusted as follows:
(A) A Board-regulated institution
subject to subpart E of this part must
deduct from its total capital any AACL
included in its tier 2 capital in
accordance with § 217.20(d)(3); and
(B) A Board-regulated institution
subject to subpart E of this part must
add to its total capital any AACL up to
1.25 percent of the Board-regulated
institution’s total credit risk-weighted
assets.
*
*
*
*
*
■ 46. Revise § 217.11 to read as follows:
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§ 217.11 Capital conservation buffer,
countercyclical capital buffer amount, and
GSIB surcharge.
(a) Capital conservation buffer—(1)
Composition of the capital conservation
buffer. The capital conservation buffer is
composed solely of common equity tier
1 capital.
(2) Definitions. For purposes of this
section, the following definitions apply:
(i) Eligible retained income. The
eligible retained income of a Boardregulated institution is the greater of:
(A) The Board-regulated institution’s
net income, calculated in accordance
with the instructions to the FR Y–9C or
Call Report, as applicable, for the four
calendar quarters preceding the current
calendar quarter, net of any
distributions and associated tax effects
not already reflected in net income; and
(B) The average of the Board-regulated
institution’s net income, calculated in
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accordance with the instructions to the
FR Y–9C or Call Report, as applicable,
for the four calendar quarters preceding
the current calendar quarter.
(ii) Maximum payout amount. A
Board-regulated institution’s maximum
payout amount for the current calendar
quarter is equal to the Board-regulated
institution’s eligible retained income,
multiplied by its maximum payout
ratio.
(iii) Maximum payout ratio. The
maximum payout ratio is the percentage
of eligible retained income that a Boardregulated institution can pay out in the
form of distributions and discretionary
bonus payments during the current
calendar quarter. For a Board-regulated
institution that is not subject to 12 CFR
225.8 or 238.170, the maximum payout
ratio is determined by the Boardregulated institution’s capital
conservation buffer, calculated as of the
last day of the previous calendar
quarter, as set forth in table 1 to
§ 217.11(a)(4)(iv) of this section. For a
Board-regulated institution that is
subject to 12 CFR 225.8 or 238.170, the
maximum payout ratio is determined
under paragraph (c)(1)(ii) of this section.
(iv) Private sector credit exposure.
Private sector credit exposure means an
exposure to a company or an individual
that is not an exposure to a sovereign,
the Bank for International Settlements,
the European Central Bank, the
European Commission, the European
Stability Mechanism, the European
Financial Stability Facility, the
International Monetary Fund, a MDB, a
PSE, or a GSE.
(v) Leverage buffer requirement. A
bank holding company’s leverage buffer
requirement is 2.0 percent.
(vi) Stress capital buffer requirement.
(A) The stress capital buffer requirement
for a Board-regulated institution subject
to 12 CFR 225.8 or 238.170 is the stress
capital buffer requirement determined
under 12 CFR 225.8 or 238.170 except
as provided in paragraph (a)(2)(vi)(B) of
this section.
(B) If a Board-regulated institution
subject to 12 CFR 225.8 or 238.170 has
not yet received a stress capital buffer
requirement, its stress capital buffer
requirement for purposes of this part is
2.5 percent.
(3) Calculation of capital conservation
buffer. (i) A Board-regulated institution
that is not subject to 12 CFR 225.8 or
238.170 has a capital conservation
buffer equal to the lowest of the
following ratios, calculated as of the last
day of the previous calendar quarter:
(A) The Board-regulated institution’s
common equity tier 1 capital ratio
minus the Board-regulated institution’s
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minimum common equity tier 1 capital
ratio requirement under § 217.10;
(B) The Board-regulated institution’s
tier 1 capital ratio minus the Boardregulated institution’s minimum tier 1
capital ratio requirement under
§ 217.10; and
(C) The Board-regulated institution’s
total capital ratio minus the Boardregulated institution’s minimum total
capital ratio requirement under
§ 217.10; or
(ii) Notwithstanding paragraphs
(a)(3)(i)(A) through (C) of this section, if
a Board-regulated institution’s common
equity tier 1, tier 1, or total capital ratio
is less than or equal to the Boardregulated institution’s minimum
common equity tier 1, tier 1, or total
capital ratio requirement under
§ 217.10, respectively, the Boardregulated institution’s capital
conservation buffer is zero.
(4) Limits on distributions and
discretionary bonus payments. (i) A
Board-regulated institution that is not
subject to 12 CFR 225.8 or 238.170 shall
not make distributions or discretionary
bonus payments or create an obligation
to make such distributions or payments
during the current calendar quarter that,
in the aggregate, exceed its maximum
payout amount.
(ii) A Board-regulated institution that
is not subject to 12 CFR 225.8 or
238.170 and that has a capital
conservation buffer that is greater than
2.5 percent plus 100 percent of its
applicable countercyclical capital buffer
amount in accordance with paragraph
(b) of this section is not subject to a
maximum payout amount under
paragraph (a)(2)(ii) of this section.
(iii) Except as provided in paragraph
(a)(4)(iv) of this section, a Boardregulated institution that is not subject
to 12 CFR 225.8 or 238.170 may not
make distributions or discretionary
bonus payments during the current
calendar quarter if the Board-regulated
institution’s:
(A) Eligible retained income is
negative; and
(B) Capital conservation buffer was
less than 2.5 percent as of the end of the
previous calendar quarter.
(iv) Notwithstanding the limitations
in paragraphs (a)(4)(i) through (iii) of
this section, the Board may permit a
Board-regulated institution that is not
subject to 12 CFR 225.8 or 238.170 to
make a distribution or discretionary
bonus payment upon a request of the
Board-regulated institution, if the Board
determines that the distribution or
discretionary bonus payment would not
be contrary to the purposes of this
section, or to the safety and soundness
of the Board-regulated institution. In
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making such a determination, the Board
will consider the nature and extent of
the request and the particular
circumstances giving rise to the request.
(v) Additional limitations on
distributions may apply under 12 CFR
225.4 and 263.202 to a Board-regulated
institution that is not subject to 12 CFR
225.8 or 238.170.
(b) Countercyclical capital buffer
amount—(1) General. A Board-regulated
institution subject to subpart E of this
part must calculate a countercyclical
capital buffer amount in accordance
with this paragraph (b) for purposes of
determining its maximum payout ratio
under Table 1 to § 217.11(a)(4)(iv) of
this section and, if applicable, Table 2
to § 217.11(c)(4)(iii) of this section.
(i) Extension of capital conservation
buffer. The countercyclical capital
buffer amount is an extension of the
capital conservation buffer as described
in paragraph (a) or (c) of this section, as
applicable.
(ii) Amount. A Board-regulated
institution subject to subpart E of this
part has a countercyclical capital buffer
amount determined by calculating the
weighted average of the countercyclical
capital buffer amounts established for
the national jurisdictions where the
Board-regulated institution’s private
sector credit exposures are located, as
specified in paragraphs (b)(2) and (3) of
this section.
(iii) Weighting. The weight assigned to
a jurisdiction’s countercyclical capital
buffer amount is calculated by dividing
the total risk-weighted assets for the
Board-regulated institution’s private
sector credit exposures located in the
jurisdiction by the total risk-weighted
assets for all of the Board-regulated
institution’s private sector credit
exposures. The methodology a Boardregulated institution uses for
determining risk-weighted assets for
purposes of this paragraph (b) must be
the methodology that determines its
risk-based capital ratios under § 217.10.
Notwithstanding the previous sentence,
the risk-weighted asset amount for a
private sector credit exposure that is a
covered position under subpart F of this
part is its standardized default risk
capital requirement as determined
under § 217.210 multiplied by 12.5.
(iv) Location. (A) Except as provided
in paragraphs (b)(1)(iv)(B) and (C) of this
section, the location of a private sector
credit exposure is the national
jurisdiction where the borrower is
located (that is, where it is incorporated,
chartered, or similarly established or, if
the borrower is an individual, where the
borrower resides).
(B) If, in accordance with subpart D or
E of this part, the Board-regulated
institution has assigned to a private
sector credit exposure a risk weight
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64315
associated with a protection provider on
a guarantee or credit derivative, the
location of the exposure is the national
jurisdiction where the protection
provider is located.
(C) The location of a securitization
exposure is the location of the
underlying exposures, or, if the
underlying exposures are located in
more than one national jurisdiction, the
national jurisdiction where the
underlying exposures with the largest
aggregate unpaid principal balance are
located. For purposes of this paragraph
(b), the location of an underlying
exposure shall be the location of the
borrower, determined consistent with
paragraph (b)(1)(iv)(A) of this section.
(2) Countercyclical capital buffer
amount for credit exposures in the
United States—(i) Initial countercyclical
capital buffer amount with respect to
credit exposures in the United States.
The initial countercyclical capital buffer
amount in the United States is zero.
(ii) Adjustment of the countercyclical
capital buffer amount. The Board will
adjust the countercyclical capital buffer
amount for credit exposures in the
United States in accordance with
applicable law.1
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1 The Board expects that any adjustment
will be based on a determination made
jointly by the Board, OCC, and FDIC.
(iii) Range of countercyclical capital
buffer amount. The Board will adjust
the countercyclical capital buffer
amount for credit exposures in the
United States between zero percent and
2.5 percent of risk-weighted assets.
(iv) Adjustment determination. The
Board will base its decision to adjust the
countercyclical capital buffer amount
under this section on a range of
macroeconomic, financial, and
supervisory information indicating an
increase in systemic risk including, but
not limited to, the ratio of credit to gross
domestic product, a variety of asset
prices, other factors indicative of
relative credit and liquidity expansion
or contraction, funding spreads, credit
condition surveys, indices based on
credit default swap spreads, options
implied volatility, and measures of
systemic risk.
(v) Effective date of adjusted
countercyclical capital buffer amount—
(A) Increase adjustment. A
determination by the Board under
paragraph (b)(2)(ii) of this section to
increase the countercyclical capital
buffer amount will be effective 12
months from the date of announcement,
unless the Board establishes an earlier
effective date and includes a statement
articulating the reasons for the earlier
effective date.
(B) Decrease adjustment. A
determination by the Board to decrease
the established countercyclical capital
buffer amount under paragraph (b)(2)(ii)
of this section will be effective on the
day following announcement of the
final determination or the earliest date
permissible under applicable law or
regulation, whichever is later.
(vi) Twelve-month sunset. The
countercyclical capital buffer amount
will return to zero percent 12 months
after the effective date that the adjusted
countercyclical capital buffer amount is
announced, unless the Board announces
a decision to maintain the adjusted
countercyclical capital buffer amount or
adjust it again before the expiration of
the 12-month period.
(3) Countercyclical capital buffer
amount for foreign jurisdictions. The
Board will adjust the countercyclical
capital buffer amount for private sector
credit exposures to reflect decisions
made by foreign jurisdictions consistent
with due process requirements
described in paragraph (b)(2) of this
section.
(c) Calculation of buffers for Boardregulated institutions subject to 12 CFR
225.8 or 238.170—(1) Limits on
distributions and discretionary bonus
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payments. (i) General. A Boardregulated institution that is subject to 12
CFR 225.8 or 238.170 shall not make
distributions or discretionary bonus
payments or create an obligation to
make such distributions or payments
during the current calendar quarter that,
in the aggregate, exceed its maximum
payout amount.
(ii) Maximum payout ratio. The
maximum payout ratio of a Boardregulated institution that is subject to 12
CFR 225.8 or 238.170 is the lowest of
the payout ratios determined by its
capital conservation buffer; and, if
applicable, leverage buffer; as set forth
in table 2 to § 217.11(c)(3)(iii).
(iii) Capital conservation buffer
requirement. A Board-regulated
institution that is subject to 12 CFR
225.8 or 238.170 has a capital
conservation buffer requirement equal
to its stress capital buffer requirement
plus its applicable countercyclical
capital buffer amount in accordance
with paragraph (b) of this section plus
its applicable GSIB surcharge in
accordance with paragraph (d) of this
section.
(iv) No maximum payout amount
limitation. A Board-regulated institution
that is subject to 12 CFR 225.8 or
238.170 is not subject to a maximum
payout amount under paragraph
(a)(2)(ii) of this section if it has:
(A) A capital conservation buffer,
calculated under paragraph (c)(2) of this
section, that is greater than its capital
conservation buffer requirement
calculated under paragraph (c)(1)(iii) of
this section; and
(B) If applicable, a leverage buffer,
calculated under paragraph (c)(3) of this
section, that is greater than its leverage
buffer requirement as set forth in
paragraph (a)(2)(v) of this section.
(v) Negative eligible retained income.
Except as provided in paragraph
(c)(1)(vi) of this section, a Boardregulated institution that is subject to 12
CFR 225.8 or 238.170 may not make
distributions or discretionary bonus
payments during the current calendar
quarter if, as of the end of the previous
calendar quarter, the Board-regulated
institution’s:
(A) Eligible retained income is
negative; and
(B) (1) Capital conservation buffer was
less than its capital conservation buffer
requirement; or
(2) If applicable, leverage buffer was
less than its leverage buffer requirement.
(vi) Prior approval. Notwithstanding
the limitations in paragraphs (c)(1)(i)
through (v) of this section, the Board
may permit a Board-regulated
institution that is subject to 12 CFR
225.8 or 238.170 to make a distribution
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or discretionary bonus payment upon a
request of the Board-regulated
institution, if the Board determines that
the distribution or discretionary bonus
payment would not be contrary to the
purposes of this section, or to the safety
and soundness of the Board-regulated
institution. In making such a
determination, the Board will consider
the nature and extent of the request and
the particular circumstances giving rise
to the request.
(vii) Other limitations on
distributions. Additional limitations on
distributions may apply under 12 CFR
225.4, 225.8, 238.170, 252.63, 252.165,
and 263.202 to a Board-regulated
institution that is subject to 12 CFR
225.8 or 238.170.
(2) Capital conservation buffer. (i) The
capital conservation buffer for Boardregulated institutions subject to 12 CFR
225.8 or 238.170 is composed solely of
common equity tier 1 capital.
(ii) A Board-regulated institution that
is subject to 12 CFR 225.8 or 238.170
has a capital conservation buffer that is
equal to the lowest of the following
ratios, calculated as of the last day of the
previous calendar quarter:
(A) The Board-regulated institution’s
common equity tier 1 capital ratio
minus the Board-regulated institution’s
minimum common equity tier 1 capital
ratio requirement under § 217.10;
(B) The Board-regulated institution’s
tier 1 capital ratio minus the Boardregulated institution’s minimum tier 1
capital ratio requirement under
§ 217.10; and
(C) The Board-regulated institution’s
total capital ratio minus the Boardregulated institution’s minimum total
capital ratio requirement under
§ 217.10; or
(iii) Notwithstanding paragraph
(c)(2)(ii) of this section, if a Boardregulated institution’s common equity
tier 1, tier 1, or total capital ratio is less
than or equal to the Board-regulated
institution’s minimum common equity
tier 1, tier 1, or total capital ratio
requirement under § 217.10,
respectively, the Board-regulated
institution’s capital conservation buffer
is zero.
(3) Leverage buffer. (i) The leverage
buffer is composed solely of tier 1
capital.
(ii) A global systemically important
BHC has a leverage buffer that is equal
to the global systemically important
BHC’s supplementary leverage ratio
minus 3 percent, calculated as of the
last day of the previous calendar
quarter.
(iii) Notwithstanding paragraph
(c)(3)(ii) of this section, if the global
systemically important BHC’s
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systemically important BHC’s leverage
buffer is zero.
(d) GSIB surcharge. A global
systemically important BHC must use
its GSIB surcharge calculated in
accordance with subpart H of this part
for purposes of determining its
maximum payout ratio under Table 2 to
§ 217.11(c)(3)(iii).
(1) * * *
(xi) For a Board-regulated institution
subject to subpart E of this part, the
governing agreement, offering circular,
or prospectus of an instrument issued
after the date on which the Boardregulated institution becomes subject to
subpart E must disclose that the holders
of the instrument may be fully
subordinated to interests held by the
U.S. government in the event that the
Board-regulated institution enters into a
receivership, insolvency, liquidation, or
similar proceeding.
*
*
*
*
*
(3) ALLL or AACL, as applicable, up
to 1.25 percent of the Board-regulated
institution’s standardized total riskweighted assets not including any
amount of the ALLL or AACL, as
applicable (and excluding the case of a
market risk Board-regulated institution,
its market risk weighted assets).
*
*
*
*
*
■ 48. In § 217.21:
■ a. In paragraph (a)(1), remove the
words ‘‘an advanced approaches Boardregulated institution’’ and add in their
place the words ‘‘subject to subpart E of
this part’’; and
■ b. Revise paragraph (b).
The revision reads as follows:
Subpart C—Definition of Capital
47. In § 217.20, revise paragraphs
(c)(1)(xiv), (d)(1)(xi) and (d)(3) to read as
follows:
■
§ 217.20 Capital components and eligibility
criteria for regulatory capital instruments.
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*
*
*
*
*
(c) * * *
(1) * * *
(xiv) For a Board-regulated institution
subject to subpart E of this part, the
governing agreement, offering circular,
or prospectus of an instrument issued
after the date upon which the Boardregulated institution becomes subject to
subpart E must disclose that the holders
of the instrument may be fully
subordinated to interests held by the
U.S. government in the event that the
Board-regulated institution enters into a
receivership, insolvency, liquidation, or
similar proceeding.
*
*
*
*
*
(d) * * *
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§ 217.21
Minority interest.
*
*
*
*
*
(b) (1) Applicability. For purposes of
§ 217.20, a Board-regulated institution
that is subject to subpart E of this part
is subject to the minority interest
limitations in this paragraph (b) if:
(i) A consolidated subsidiary of the
Board-regulated institution has issued
regulatory capital that is not owned by
the Board-regulated institution; and
(ii) For each relevant regulatory
capital ratio of the consolidated
subsidiary, the ratio exceeds the sum of
the subsidiary’s minimum regulatory
capital requirements plus its capital
conservation buffer.
(2) Difference in capital adequacy
standards at the subsidiary level. For
purposes of the minority interest
calculations in this section, if the
consolidated subsidiary issuing the
capital is not subject to capital adequacy
standards similar to those of the Boardregulated institution, the Boardregulated institution must assume that
the capital adequacy standards of the
Board-regulated institution apply to the
subsidiary.
(3) Common equity tier 1 minority
interest includable in the common
equity tier 1 capital of the Boardregulated institution. For each
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supplementary leverage ratio is less
than or equal to 3 percent, the global
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consolidated subsidiary of a Boardregulated institution, the amount of
common equity tier 1 minority interest
the Board-regulated institution may
include in common equity tier 1 capital
is equal to:
(i) The common equity tier 1 minority
interest of the subsidiary; minus
(ii) The percentage of the subsidiary’s
common equity tier 1 capital that is not
owned by the Board-regulated
institution, multiplied by the difference
between the common equity tier 1
capital of the subsidiary and the lower
of:
(A) The amount of common equity
tier 1 capital the subsidiary must hold,
or would be required to hold pursuant
to this paragraph (b), to avoid
restrictions on distributions and
discretionary bonus payments under
§ 217.11 or equivalent standards
established by the subsidiary’s home
country supervisor; or
(B) (1) The standardized total riskweighted assets of the Board-regulated
institution that relate to the subsidiary
multiplied by
(2) The common equity tier 1 capital
ratio the subsidiary must maintain to
avoid restrictions on distributions and
discretionary bonus payments under
§ 217.11 or equivalent standards
established by the subsidiary’s home
country supervisor.
(4) Tier 1 minority interest includable
in the tier 1 capital of the Boardregulated institution. For each
consolidated subsidiary of the Boardregulated institution, the amount of tier
1 minority interest the Board-regulated
institution may include in tier 1 capital
is equal to:
(i) The tier 1 minority interest of the
subsidiary; minus
(ii) The percentage of the subsidiary’s
tier 1 capital that is not owned by the
Board-regulated institution multiplied
by the difference between the tier 1
capital of the subsidiary and the lower
of:
(A) The amount of tier 1 capital the
subsidiary must hold, or would be
required to hold pursuant to this
paragraph (b), to avoid restrictions on
distributions and discretionary bonus
payments under § 217.11 or equivalent
standards established by the
subsidiary’s home country supervisor,
or
(B) (1) The standardized total riskweighted assets of the Board-regulated
institution that relate to the subsidiary
multiplied by
(2) The tier 1 capital ratio the
subsidiary must maintain to avoid
restrictions on distributions and
discretionary bonus payments under
§ 217.11 or equivalent standards
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established by the subsidiary’s home
country supervisor.
(5) Total capital minority interest
includable in the total capital of the
Board-regulated institution. For each
consolidated subsidiary of the Boardregulated institution, the amount of total
capital minority interest the Boardregulated institution may include in
total capital is equal to:
(i) The total capital minority interest
of the subsidiary; minus
(ii) The percentage of the subsidiary’s
total capital that is not owned by the
Board-regulated institution multiplied
by the difference between the total
capital of the subsidiary and the lower
of:
(A) The amount of total capital the
subsidiary must hold, or would be
required to hold pursuant to this
paragraph (b), to avoid restrictions on
distributions and discretionary bonus
payments under § 217.11 or equivalent
standards established by the
subsidiary’s home country supervisor,
or
(B) (1) The standardized total riskweighted assets of the Board-regulated
institution that relate to the subsidiary
multiplied by
(2) The total capital ratio the
subsidiary must maintain to avoid
restrictions on distributions and
discretionary bonus payments under
§ 217.11 or equivalent standards
established by the subsidiary’s home
country supervisor.
■ 49. In § 217.22:
■ a. Revise paragraphs (a)(1) and (4);
and
■ b. Remove paragraph (a)(6); and
■ c. Redesignate paragraph (a)(7) as new
paragraph (a)(6); and
■ d. In paragraph (b)(2)(i), remove the
words ‘‘an advanced approaches Boardregulated institution’’ and add in their
place the words ‘‘subject to subpart E of
this part’’;
■ e. Revise paragraph (b)(2)(ii);
■ f. In paragraph (b)(2)(iii), remove the
words ‘‘an advanced approaches Boardregulated institution’’ and add in their
place the words ‘‘subject to subpart E of
this part’’;
■ g. In paragraph (b)(2)(iv), remove the
words ‘‘or FR Y–9SP’’;
■ h. In footnote 22, in paragraph
(b)(2)(iv)(A), remove the words ‘‘12 CFR
part 225 (Board)’’, and add in its place
‘‘12 CFR part 217 (Board)’’;
■ i. Revise paragraph (c)(2);
■ j. In paragraph (c)(4), remove the
words ‘‘an advanced approaches Boardregulated institution’’ and add in their
place the words ‘‘subject to subpart E of
this part’’; and
■ k. Revise paragraphs (c)(5)(i) and (ii),
(c)(6), and (d)(2).
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The revisions read as follows:
§ 217.22 Regulatory capital adjustments
and deductions.
(a) * * *
(1)(i) Goodwill, net of associated
deferred tax liabilities (DTLs) in
accordance with paragraph (e) of this
section; and
(ii) For a Board-regulated institution
subject to subpart E of this part,
goodwill that is embedded in the
valuation of a significant investment in
the capital of an unconsolidated
financial institution in the form of
common stock (and that is reflected in
the consolidated financial statements of
the Board-regulated institution), in
accordance with paragraph (d) of this
section;
*
*
*
*
*
(4) (i) For a Board-regulated
institution that is not subject to subpart
E of this part, any gain-on-sale in
connection with a securitization
exposure;
(ii) For a Board-regulated institution
subject to subpart E of this part, any
gain-on-sale in connection with a
securitization exposure and the portion
of any CEIO that does not constitute an
after-tax gain-on-sale;
(b) * * *
(2) * * *
(ii) A Board-regulated institution that
is not subject to subpart E of this part
must make its AOCI opt-out election in
the Call Report during the first reporting
period after the Board-regulated
institution is required to comply with
subpart A of this part. If the Boardregulated institution was previously
subject to subpart E of this part, the
Board-regulated institution must make
its AOCI opt-out election in the Call
Report during the first reporting period
after the Board-regulated institution is
not subject to subpart E of this part.
*
*
*
*
*
(c) * * *
(2) Corresponding deduction
approach. For purposes of subpart C of
this part, the corresponding deduction
approach is the methodology used for
the deductions from regulatory capital
related to reciprocal cross holdings (as
described in paragraph (c)(3) of this
section), investments in the capital of
unconsolidated financial institutions for
a Board-regulated institution that is not
subject to subpart E of this part (as
described in paragraph (c)(4) of this
section), non-significant investments in
the capital of unconsolidated financial
institutions for a Board-regulated
institution subject to subpart E of this
part (as described in paragraph (c)(5) of
this section), and non-common stock
significant investments in the capital of
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unconsolidated financial institutions for
a Board-regulated institution subject to
subpart E of this part (as described in
paragraph (c)(6) of this section). Under
the corresponding deduction approach,
a Board-regulated institution must make
deductions from the component of
capital for which the underlying
instrument would qualify if it were
issued by the Board-regulated
institution itself, as described in
paragraphs (c)(2)(i) through (iii) of this
section. If the Board-regulated
institution does not have a sufficient
amount of a specific component of
capital to effect the required deduction,
the shortfall must be deducted
according to paragraph (f) of this
section.
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(5) * * *
(i) A Board-regulated institution
subject to subpart E of this part must
deduct its non-significant investments
in the capital of unconsolidated
financial institutions (as defined in
§ 217.2) that, in the aggregate and
together with any investment in a
covered debt instrument (as defined in
§ 217.2) issued by a financial institution
in which the Board-regulated institution
does not have a significant investment
in the capital of the unconsolidated
financial institution (as defined in
§ 217.2), exceeds 10 percent of the sum
of the Board-regulated institution’s
common equity tier 1 capital elements
minus all deductions from and
adjustments to common equity tier 1
capital elements required under
paragraphs (a) through (c)(3) of this
section (the 10 percent threshold for
non-significant investments) by
applying the corresponding deduction
approach in paragraph (c)(2) of this
section.26 The deductions described in
this paragraph are net of associated
DTLs in accordance with paragraph (e)
of this section. In addition, with the
prior written approval of the Board, a
Board-regulated institution subject to
subpart E of this part that underwrites
a failed underwriting, for the period of
time stipulated by the Board, is not
required to deduct from capital a nonsignificant investment in the capital of
an unconsolidated financial institution
or an investment in a covered debt
instrument pursuant to this paragraph
(c)(5) to the extent the investment is
related to the failed underwriting.27 For
any calculation under this paragraph
(c)(5)(i), a Board-regulated institution
subject to subpart E of this part may
exclude the amount of an investment in
a covered debt instrument under
paragraph (c)(5)(iii) or (iv) of this
section, as applicable.
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(ii) For a Board-regulated institution
subject to subpart E of this part, the
amount to be deducted under this
paragraph (c)(5) from a specific capital
component is equal to:
(A) The Board-regulated institution’s
aggregate non-significant investments in
the capital of an unconsolidated
financial institution and, if applicable,
any investments in a covered debt
instrument subject to deduction under
this paragraph (c)(5), exceeding the 10
percent threshold for non-significant
investments, multiplied by
(B) The ratio of the Board-regulated
institution’s aggregate non-significant
investments in the capital of an
unconsolidated financial institution (in
the form of such capital component) to
the Board-regulated institution’s total
non-significant investments in
unconsolidated financial institutions,
with an investment in a covered debt
instrument being treated as tier 2 capital
for this purpose.
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*
(6) Significant investments in the
capital of unconsolidated financial
institutions that are not in the form of
common stock. If a Board-regulated
institution subject to subpart E of this
part has a significant investment in the
capital of an unconsolidated financial
institution, the Board-regulated
institution must deduct from capital any
such investment issued by the
unconsolidated financial institution that
is held by the Board-regulated
institution other than an investment in
the form of common stock, as well as
any investment in a covered debt
instrument issued by the
unconsolidated financial institution, by
applying the corresponding deduction
approach in paragraph (c)(2) of this
section.28 The deductions described in
this section are net of associated DTLs
in accordance with paragraph (e) of this
section. In addition, with the prior
written approval of the Board, for the
period of time stipulated by the Board,
a Board-regulated institution subject to
subpart E of this part that underwrites
a failed underwriting is not required to
deduct the significant investment in the
capital of an unconsolidated financial
institution or an investment in a
covered debt instrument pursuant to
this paragraph (c)(6) if such investment
is related to such failed underwriting.
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(d) * * *
(2) A Board-regulated institution
subject to subpart E of this part must
make deductions from regulatory capital
as described in this paragraph (d)(2).
(i) A Board-regulated institution
subject to subpart E of this part must
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deduct from common equity tier 1
capital elements the amount of each of
the items set forth in this paragraph
(d)(2) that, individually, exceeds 10
percent of the sum of the Boardregulated institution’s common equity
tier 1 capital elements, less adjustments
to and deductions from common equity
tier 1 capital required under paragraphs
(a) through (c) of this section (the 10
percent common equity tier 1 capital
deduction threshold).
(A) DTAs arising from temporary
differences that the Board-regulated
institution could not realize through net
operating loss carrybacks, net of any
related valuation allowances and net of
DTLs, in accordance with paragraph (e)
of this section. A Board-regulated
institution subject to subpart E of this
part is not required to deduct from the
sum of its common equity tier 1 capital
elements DTAs (net of any related
valuation allowances and net of DTLs,
in accordance with § 217.22(e)) arising
from timing differences that the Boardregulated institution could realize
through net operating loss carrybacks.
The Board-regulated institution must
risk weight these assets at 100 percent.
For a state member bank that is a
member of a consolidated group for tax
purposes, the amount of DTAs that
could be realized through net operating
loss carrybacks may not exceed the
amount that the state member bank
could reasonably expect to have
refunded by its parent holding
company.
(B) MSAs net of associated DTLs, in
accordance with paragraph (e) of this
section.
(C) Significant investments in the
capital of unconsolidated financial
institutions in the form of common
stock, net of associated DTLs in
accordance with paragraph (e) of this
section.30 Significant investments in the
capital of unconsolidated financial
institutions in the form of common
stock subject to the 10 percent common
equity tier 1 capital deduction threshold
may be reduced by any goodwill
embedded in the valuation of such
investments deducted by the Boardregulated institution pursuant to
paragraph (a)(1) of this section. In
addition, with the prior written
approval of the Board, for the period of
time stipulated by the Board, a Boardregulated institution subject to subpart E
of this part that underwrites a failed
underwriting is not required to deduct
a significant investment in the capital of
an unconsolidated financial institution
in the form of common stock pursuant
to this paragraph (d)(2) if such
investment is related to such failed
underwriting.
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(ii) A Board-regulated institution
subject to subpart E of this part must
deduct from common equity tier 1
capital elements the items listed in
paragraph (d)(2)(i) of this section that
are not deducted as a result of the
application of the 10 percent common
equity tier 1 capital deduction
threshold, and that, in aggregate, exceed
17.65 percent of the sum of the Boardregulated institution’s common equity
tier 1 capital elements, minus
adjustments to and deductions from
common equity tier 1 capital required
under paragraphs (a) through (c) of this
section, minus the items listed in
paragraph (d)(2)(i) of this section (the 15
percent common equity tier 1 capital
deduction threshold). Any goodwill that
has been deducted under paragraph
(a)(1) of this section can be excluded
from the significant investments in the
capital of unconsolidated financial
institutions in the form of common
stock.31
(iii) For purposes of calculating the
amount of DTAs subject to the 10 and
15 percent common equity tier 1 capital
deduction thresholds, a Board-regulated
institution subject to subpart E of this
part may exclude DTAs and DTLs
relating to adjustments made to
common equity tier 1 capital under
paragraph (b) of this section. A Boardregulated institution subject to subpart E
of this part that elects to exclude DTAs
relating to adjustments under paragraph
(b) of this section also must exclude
DTLs and must do so consistently in all
future calculations. A Board-regulated
institution subject to subpart E of this
part may change its exclusion
preference only after obtaining the prior
approval of the Board.
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26 With the prior written approval of the
Board, for the period of time stipulated by
the Board, a Board-regulated institution
subject to subpart E of this part is not
required to deduct a non-significant
investment in the capital of an
unconsolidated financial institution or an
investment in a covered debt instrument
pursuant to this paragraph if the financial
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institution is in distress and if such
investment is made for the purpose of
providing financial support to the financial
institution, as determined by the Board.
27 Any non-significant investment in the
capital of an unconsolidated financial
institution or any investment in a covered
debt instrument that is not required to be
deducted under this paragraph (c)(5) or
otherwise under this section must be
assigned the appropriate risk weight under
subparts D, E, or F of this part, as applicable.
28 With prior written approval of the Board,
for the period of time stipulated by the
Board, a Board-regulated institution subject
to subpart E of this part is not required to
deduct a significant investment in the capital
of an unconsolidated financial institution,
including an investment in a covered debt
instrument, under this paragraph (c)(6) or
otherwise under this section if such
investment is made for the purpose of
providing financial support to the financial
institution as determined by the Board.
*
*
*
*
*
With the prior written approval of the
Board, for the period of time stipulated by
the Board, a Board-regulated institution
subject to subpart E of this part is not
required to deduct a significant investment in
the capital instrument of an unconsolidated
financial institution in distress in the form of
common stock pursuant to this section if
such investment is made for the purpose of
providing financial support to the financial
institution as determined by the Board.
31 The amount of the items in paragraph
(d)(2) of this section that is not deducted
from common equity tier 1 capital pursuant
to this section must be included in the riskweighted assets of the Board-regulated
institution subject to subpart E of this part
and assigned a 250 percent risk weight for
purposes of standardized total risk-weighted
assets and assigned the appropriate risk
weight for the investment under subpart E of
this part for purposes of expanded total riskweighted assets.
30
Subpart D—Risk-Weighted Assets—
Standardized Approach
§ 217.30
[Amended]
50. In § 217.30, in paragraph (b),
remove the words ‘‘covered positions’’
and add in their place the words
‘‘market risk covered positions’’.
■
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§ 217.34
[Amended]
51. In § 217.34, in paragraph (a),
remove the citation ‘‘§ 217.132(c)’’
wherever it appears, and add in its place
the citation ‘‘§ 217.113’’.
■ 52. In § 217.37, revise paragraph (c)(1)
to read as follows:
■
§ 217. 37
Collateralized transactions.
*
*
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*
*
(c) Collateral haircut approach—(1)
General. A Board-regulated institution
may recognize the credit risk mitigation
benefits of financial collateral that
secures an eligible margin loan, repostyle transaction, collateralized
derivative contract, or single-product
netting set of such transactions, and of
any collateral that secures a repo-style
transaction that is included in the
Board-regulated institution’s measure
for market risk under subpart F of this
part by using the collateral haircut
approach in this section. A Boardregulated institution may use the
standard supervisory haircuts in
paragraph (c)(3) of this section or, with
prior written approval of the Board, its
own estimates of haircuts according to
paragraph (c)(4) of this section.
*
*
*
*
*
§ 217.61
[Amended]
53. In § 217.61:
a. Remove the citation ‘‘§ 217.172’’
wherever it appears, and add in its place
the citations ‘‘§§ 217.160 and 217.161’’;
and
■ b. Remove the sentence ‘‘An advanced
approaches Board-regulated institution
that has not received approval from the
Board to exit parallel run pursuant to
§ 217.121(d) is subject to the disclosure
requirements described in §§ 217.62 and
217.63.’’.
■ 54. In § 217.63:
■ a. In table 3, revise entry (c); and
■ b. Remove paragraphs (d) and (e).
The revision reads as follows:
■
■
§ 217.63 Disclosures by Board-regulated
institutions described in § 217.61.
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§ 217.300
*
Subpart G—Transition Provisions
55. In § 217.300:
a. Revise paragraph (a);
■ b. Add paragraph (b); and
■ c. Remove and reserve paragraphs (f)
through (i).
The revision and addition read as
follows:
■
■
using transition expanded total riskweighted assets as calculated under this
paragraph (b) in place of expanded total
risk-weighted assets. Transition
expanded total risk-weighted assets is a
(1) Net unrealized gains or losses on
available-for-sale debt securities, plus
(2) Accumulated net gains or losses
on cash flow hedges, plus
(3) Any amounts recorded in AOCI
attributed to defined benefit
postretirement plans resulting from the
initial and subsequent application of the
relevant GAAP standards that pertain to
such plans, plus
(4) Net unrealized holding gains or
losses on held-to-maturity securities
that are included in AOCI.
Board-regulated institution’s expanded
total risk-weighted assets multiplied by
the percentage provided in Table 2 to
§ 217.300.
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(b) Expanded total risk-weighted
assets. Beginning July 1, 2025, a Boardregulated institution subject to subpart E
of this part must comply with the
requirements of subpart B of this part
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Transitions.
(a) Transition adjustments for AOCI.
Beginning July 1, 2025, a Category III
Board-regulated institution or a
Category IV Board-regulated institution
must subtract from the sum of its
common equity tier 1 elements, before
making deductions required under
§ 217.22(c) or (d), the AOCI adjustment
amount multiplied by the percentage
provided in Table 1 to § 217.300.
The transition AOCI adjustment
amount is the sum of:
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56. In § 217.301:
a. Remove paragraph (b)(5);
b. Revise paragraph (c)(2);
c. Revise paragraph (d)(2)(ii); and
d. Remove and reserve paragraph (e).
The revisions read as follows:
§ 217.301 Current expected credit losses
(CECL) transition.
*
*
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*
(c) * * *
(2) For purposes of the election
described in paragraph (a)(1) of this
section, a Board-regulated institution
subject to subpart E of this part must
increase total leverage exposure for
purposes of the supplementary leverage
ratio by seventy-five percent of its CECL
transitional amount during the first year
of the transition period, increase total
leverage exposure for purposes of the
supplementary leverage ratio by fifty
percent of its CECL transitional amount
during the second year of the transition
period, and increase total leverage
exposure for purposes of the
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*
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supplementary leverage ratio by twentyfive percent of its CECL transitional
amount during the third year of the
transition period.
(d) * * *
(2) * * *
(ii) A Board-regulated institution
subject to subpart E of this part that has
elected the 2020 CECL transition
provision described in this paragraph
(d) may increase total leverage exposure
for purposes of the supplementary
leverage ratio by one-hundred percent of
its modified CECL transitional amount
during the first year of the transition
period, increase total leverage exposure
for purposes of the supplementary
leverage ratio by one hundred percent of
its modified CECL transitional amount
during the second year of the transition
period, increase total leverage exposure
for purposes of the supplementary
leverage ratio by seventy-five percent of
its modified CECL transitional amount
during the third year of the transition
period, increase total leverage exposure
for purposes of the supplementary
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leverage ratio by fifty percent of its
modified CECL transitional amount
during the fourth year of the transition
period, and increase total leverage
exposure for purposes of the
supplementary leverage ratio by twentyfive percent of its modified CECL
transitional amount during the fifth year
of the transition period.
*
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*
*
§ 217.303
■
57. Remove and reserve § 217.303.
§ 217.304
■
[Removed and Reserved]
[Removed and Reserved]
58. Remove and reserve § 217.304.
§§ 217.1, 217.2, 217.10, 217.12, 217.22,
217.34, 217.35, 217.61, 217.300, Appendix A
to Part 217 [Amended]
59. In the table below, for each section
indicated in the left column, remove the
words indicated in the middle column
from wherever it appears in the section,
and add the words indicated in the right
column:
■
BILLING CODE 6210–01–P; 6714–01–P; 4810–33–P
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Appendix A to Part 217—The Federal
Reserve Board’s Framework for
Implementing the Countercyclical
Capital Buffer
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2 12 CFR 217.11(b). The CCyB applies only
to banking organizations subject to subpart E
of the Federal banking agencies’ capital rule,
which generally applies to those banking
organizations with greater than $250 billion
in average total consolidated assets and those
banking organizations with greater than $100
billion in average total consolidated assets
and at least $75 billion in average total
nonbank assets, average weighted short-term
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wholesale funding, or average off-balancesheet exposure. See, e.g., 12 CFR 217.100(b).
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4 The
CcyB was subject to a phase-in
arrangement between 2016 and 2019.
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61. Redesignate the footnotes in part
217, as follows:
■
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60. In Appendix A to part 217, revise
footnotes 2 and 4 to read as follows:
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BILLING CODE 6210–01–C; 6714–01–C; 4810–33–C
PART 225—BANK HOLDING
COMPANIES AND CHANGE IN BANK
CONTROL (REGULATION Y)
62. 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, 3906,
3907, and 3909; 15 U.S.C. 1681s, 1681w,
6801, and 6805.
Subpart A—General Provisions
63. In § 225.8:
a. Remove paragraph (d)(1);
b. Redesignate paragraphs (d)(2)
through (21) as (d)(1) through (20),
respectively;
■ c. Revise newly redesignated
paragraphs (d)(9) and (16);
■ d. Add paragraph (e)(1)(iv); and
■ e. Revise paragraph (f)(2).
The revisions and addition read as
follows:
■
■
■
§ 225.8 Capital planning and stress capital
buffer requirement.
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(d) * * *
(9) Effective capital distribution
limitations means any limitations on
capital distributions established by the
Board by order or regulation, including
pursuant to 12 CFR 217.11, 225.4,
252.63, 252.165, and 263.202.
*
*
*
*
*
(16) Regulatory capital ratio means a
capital ratio for which the Board has
established minimum requirements for
the bank holding company by regulation
or order, including, as applicable, any
regulatory capital ratios calculated
under 12 CFR part 217 and the
deductions required under 12 CFR
248.12.
*
*
*
*
*
(e) * * *
(1) * * *
(iv) For purposes of paragraph (e) of
this section, a bank holding company
must calculate its regulatory capital
ratios using either 12 CFR part 217,
subpart D, or 12 CFR part 217, subpart
E, whichever subpart resulted in the
higher amount of total risk-weighted
assets as of the last day of the previous
capital plan cycle.
*
*
*
*
*
(f) * * *
(2) Stress capital buffer requirement
calculation. A bank holding company’s
stress capital buffer requirement is equal
to the greater of:
(i) The following calculation:
(A) The bank holding company’s
common equity tier 1 capital ratio as of
the last day of the previous capital plan
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cycle, unless otherwise determined by
the Board; minus
(B) The bank holding company’s
lowest projected common equity tier 1
capital ratio in any quarter of the
planning horizon under a supervisory
stress test; plus
(C) The ratio of:
(1) The sum of the bank holding
company’s planned common stock
dividends (expressed as a dollar
amount) for each of the fourth through
seventh quarters of the planning
horizon; to
(2) The risk-weighted assets of the
bank holding company in the quarter in
which the bank holding company had
its lowest projected common equity tier
1 capital ratio in any quarter of the
planning horizon under a supervisory
stress test; and
(ii) 2.5 percent.
*
*
*
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*
PART 238—SAVINGS AND LOAN
HOLDING COMPANIES (REGULATION
LL)
64. The authority citation for part 238
continues to read as follows:
■
Authority: 5 U.S.C. 552, 559; 12 U.S.C.
1462, 1462a, 1463, 1464, 1467, 1467a, 1468,
5365; 1813, 1817, 1829e, 1831i, 1972; 15
U.S.C. 78l.
Subpart O—Supervisory Stress Test
Requirements for Covered Savings
and Loan Holding Companies
65. In § 238.130:
a. Remove the definition of
‘‘Advanced approaches’’; and
■ b. Revise the definition of ‘‘Regulatory
capital ratio’’.
The revision reads as follows:
■
■
§ 238.130
Definitions.
*
*
*
*
*
Regulatory capital ratio means a
capital ratio for which the Board has
established minimum requirements for
the company by regulation or order,
including, as applicable, any regulatory
capital ratios calculated under 12 CFR
part 217 and the deductions required
under 12 CFR 248.12; for purposes of
this section, regulatory capital ratios
may be calculated using each of 12 CFR
part 217, subpart D, and 12 CFR part
217, subpart E.
*
*
*
*
*
Subpart P—Company-Run Stress Test
Requirements for Savings and Loan
Holding Companies
66. In § 238.141:
a. Remove the definition of
‘‘Advanced approaches’’; and
■ b. Revise the definition of ‘‘Regulatory
capital ratio’’.
■
■
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The revision reads as follows:
§ 238.141
Definitions.
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*
Regulatory capital ratio means a
capital ratio for which the Board has
established minimum requirements for
the company by regulation or order,
including, as applicable, any regulatory
capital ratios calculated under 12 CFR
part 217 and the deductions required
under 12 CFR 248.12; except that a
savings and loan holding company must
calculate its regulatory capital ratios
using either 12 CFR part 217, subpart D,
or 12 CFR part 217, subpart E,
whichever subpart resulted in the
higher amount of total risk-weighted
assets as of the last day of the previous
stress test cycle.
*
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*
Subpart Q—Single Counterparty Credit
Limits for Covered Savings and Loan
Holding Companies
§ 238.151
[Amended]
67. In § 238.151, remove the words
‘‘in table 1 to § 217.132 of this chapter’’
wherever they appear and add in their
place the words ‘‘in table 1 to § 217.121
of this chapter’’.
■
§ 238.153
[Amended]
68. In § 238.153, remove the words
‘‘any of the methods that the covered
company is authorized to use under 12
CFR part 217, subparts D and E’’
wherever they appear and add in their
place the words ‘‘the method specified
in 12 CFR part 217 subpart E’’.
■
Subpart S—Capital Planning and
Stress Capital Buffer Requirement
69. In § 238.170:
a. Remove paragraph (d)(1);
b. Redesignate paragraphs (d)(2)
through (18) as (d)(1) through (17),
respectively;
■ c. Revise newly redesignated
paragraphs (d)(9) and (14);
■ d. Add paragraph (e)(1)(iv); and
■ e. Revise paragraph (f)(2).
The revisions and addition read as
follows:
■
■
■
§ 238.170 Capital planning and stress
capital buffer requirement.
*
*
*
*
*
(d) * * *
(9) Effective capital distribution
limitations means any limitations on
capital distributions established by the
Board by order or regulation, including
pursuant to 12 CFR 217.11.
*
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*
(14) Regulatory capital ratio means a
capital ratio for which the Board has
established minimum requirements for
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the covered savings and loan holding
company by regulation or order,
including, as applicable, any regulatory
capital ratios calculated under 12 CFR
part 217 and the deductions required
under 12 CFR 248.12.
*
*
*
*
*
(e) * * *
(1) * * *
(iv) For purposes of this paragraph (e),
a savings and loan holding company
must calculate its regulatory capital
ratios using either 12 CFR part 217,
subpart D, or 12 CFR part 217, subpart
E, whichever subpart resulted in the
higher amount of total risk-weighted
assets as of the last day of the previous
capital plan cycle.
*
*
*
*
*
(f) * * *
(2) Stress capital buffer requirement
calculation. A covered savings and loan
holding company’s stress capital buffer
requirement is equal to the greater of:
(i) The following calculation:
(A) The covered savings and loan
holding company’s common equity tier
1 capital ratio as of the last day of the
previous capital plan cycle, unless
otherwise determined by the Board;
minus
(B) The covered savings and loan
holding company’s lowest projected
common equity tier 1 capital ratio in
any quarter of the planning horizon
under a supervisory stress test; plus
(C) The ratio of:
(1) The sum of the covered savings
and loan holding company’s planned
common stock dividends (expressed as
a dollar amount) for each of the fourth
through seventh quarters of the
planning horizon; to
(2) The risk-weighted assets of the
covered savings and loan holding
company in the quarter in which the
covered savings and loan holding
company had its lowest projected
common equity tier 1 capital ratio in
any quarter of the planning horizon
under a supervisory stress test; and
(ii) 2.5 percent.
*
*
*
*
*
lotter on DSK11XQN23PROD with PROPOSALS2
PART 252—ENHANCED PRUDENTIAL
STANDARDS (REGULATION YY)
70. The authority citation for part 252
continues to read as follows:
■
Authority: 12 U.S.C. 321–338a, 481–486,
1467a, 1818, 1828, 1831n, 1831o, 1831p–1,
1831w, 1835, 1844(b), 1844(c), 3101 et seq.,
3101 note, 3904, 3906–3909, 4808, 5361,
5362, 5365, 5366, 5367, 5368, 5371.
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Subpart B—Company-Run Stress Test
Requirements for State Member Banks
With Total Consolidated Assets Over
$250 Billion
71. In § 252.12:
a. Remove the definition of
‘‘Advanced approaches’’; and
■ b. Revise the definition of ‘‘Regulatory
capital ratio’’.
The revision reads as follows:
■
■
§ 252.12
Definitions.
*
*
*
*
*
Regulatory capital ratio means a
capital ratio for which the Board has
established minimum requirements for
the state member bank by regulation or
order, including, as applicable, any
regulatory capital ratios calculated
under 12 CFR part 217 and the
deductions required under 12 CFR
248.12; except that the state member
bank must calculate its regulatory
capital ratios using either 12 CFR part
217, subpart D, or 12 CFR part 217,
subpart E, whichever subpart resulted in
the higher amount of total risk-weighted
assets as of the last day of the previous
stress test cycle.
*
*
*
*
*
Subpart E—Supervisory Stress Test
Requirements for Certain U.S. Banking
Organizations With $100 Billion or
More in Total Consolidated Assets and
Nonbank Financial Companies
Supervised by the Board
72. In § 252.42:
a. Remove the definition of
‘‘Advanced approaches’’; and
■ b. Revise the definition of ‘‘Regulatory
capital ratio’’.
The revision reads as follows:
■
■
§ 252.42
Definitions.
*
*
*
*
*
Regulatory capital ratio means a
capital ratio for which the Board has
established minimum requirements for
the company by regulation or order,
including, as applicable, any regulatory
capital ratios calculated under 12 CFR
part 217 and the deductions required
under 12 CFR 248.12; for purposes of
this section regulatory capital ratios may
be calculated using each of 12 CFR part
217, subpart D, and 12 CFR part 217,
subpart E.
*
*
*
*
*
Subpart F—Company-Run Stress Test
Requirements for Certain U.S. Bank
Holding Companies and Nonbank
Financial Companies Supervised by
the Board
73. In § 252.52:
a. Remove the definition of
‘‘Advanced approaches’’; and
■
■
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b. Revise the definition of ‘‘Regulatory
capital ratio’’.
The revision reads as follows:
■
§ 252.52
Definitions.
*
*
*
*
*
Regulatory capital ratio means a
capital ratio for which the Board has
established minimum requirements for
the company by regulation or order,
including, as applicable, any regulatory
capital ratios calculated under 12 CFR
part 217 and the deductions required
under 12 CFR 248.12; except that the
covered company must calculate its
regulatory capital ratios using either 12
CFR part 217, subpart D, or 12 CFR part
217, subpart E, whichever subpart
resulted in the higher amount of total
risk-weighted assets as of the last day of
the previous stress test cycle.
*
*
*
*
*
Subpart G—External Long-term Debt
Requirement, External Total Lossabsorbing Capacity Requirement and
Buffer, and Restrictions on Corporate
Practices for U.S. Global Systemically
Important Banking Organizations
74. In § 252.61, revise the definition of
‘‘Total risk-weighted assets’’ to read as
follows:
■
§ 252.61
Definitions.
*
*
*
*
*
Total risk-weighted assets means the
greater of standardized total riskweighted assets and expanded total riskweighted assets, each as calculated
under part 217 of this chapter.
Subpart H—Single-Counterparty Credit
Limits
§ 252.71
[Amended]
75. In § 252.71, remove the words ‘‘in
Table 1 to § 217.132 of the Board’s
Regulation Q (12 CFR 217.132)’’
wherever they appear and add in their
place the words ‘‘in Table 1 to § 217.121
of the Board’s Regulation Q (12 CFR
217.121)’’.
■
§ 252.73
[Amended]
76. In § 252.73, remove the words
‘‘any of the methods that the covered
company is authorized to use under the
Board’s Regulation Q (12 CFR part 217,
subparts D and E)’’ wherever they
appear and add, in their place, the
words ‘‘the method specified in 12 CFR
part 217 subpart E’’.
■
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Federal Register / Vol. 88, No. 179 / Monday, September 18, 2023 / Proposed Rules
Subpart N—Enhanced Prudential
Standards for Foreign Banking
Organizations With Total Consolidated
Assets of $100 Billion or More and
Combined U.S. Assets of Less Than
$100 Billion
77. In § 252.147, revise paragraph
(e)(1)(i) to read as follows:
■
§ 252.147 U.S. intermediate holding
company requirement for foreign banking
organizations with combined U.S. assets of
less than $100 billion and U.S. non-branch
assets of $50 billion or more.
*
*
*
*
*
(e) * * *
(1) * * *
(i) A U.S. intermediate holding
company must comply with 12 CFR part
217 in the same manner as a bank
holding company.
*
*
*
*
*
Subpart O—Enhanced Prudential
Standards for Foreign Banking
Organizations With Total Consolidated
Assets of $100 Billion or More and
Combined U.S. Assets of $100 Billion
or More
78. In § 252.153, revise paragraph
(e)(1)(i) to read as follows:
■
§ 252.153 U.S. intermediate holding
company requirement for foreign banking
organizations with combined U.S. assets of
$100 billion or more and U.S. non-branch
assets of $50 billion or more.
*
*
*
*
*
(e) * * *
(1) * * *
(i) A U.S. intermediate holding
company must comply with 12 CFR part
217 in the same manner as a bank
holding company.
*
*
*
*
*
Subpart Q—Single Counterparty Credit
Limits
§ 252.171
[Amended]
79. In § 252.171, remove the words
‘‘in Table 1 to § 217.132 of the Board’s
Regulation Q (12 CFR 217.132)’’
wherever they appear and add in their
place the words ‘‘in Table 1 to § 217.121
of the Board’s Regulation Q (12 CFR
217.121)’’.
■
lotter on DSK11XQN23PROD with PROPOSALS2
§ 252.173
[Amended]
80. In § 252.173, remove the words
‘‘any of the methods that the covered
company is authorized to use under the
Board’s Regulation Q (12 CFR part 217,
subparts D and E)’’ wherever they
appear and add, in their place, the
words ‘‘the method specified in 12 CFR
part 217 subpart E’’.
■
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Federal Deposit Insurance Corporation
12 CFR Chapter III
For the reasons stated in the common
preamble, the Federal Deposit Insurance
Corporation proposes to amend 12 CFR
part 324 as follows:
PART 324—CAPITAL ADEQUACY OF
FDIC-SUPERVISED INSTITUTIONS
81. The authority citation for part 324
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; 5371; 5412; Pub. L. 102–233, 105 Stat.
1761, 1789, 1790 (12 U.S.C. 1831n note); Pub.
L. 102–242, 105 Stat. 2236, 2355, as amended
by Pub. L. 103–325, 108 Stat. 2160, 2233 (12
U.S.C. 1828 note); Pub. L. 102–242, 105 Stat.
2236, 2386, as amended by Pub. L. 102–550,
106 Stat. 3672, 4089 (12 U.S.C. 1828 note);
Pub. L. 111–203, 124 Stat. 1376, 1887 (15
U.S.C. 78o–7 note), Pub. L. 115–174; section
4014 § 201, Pub. L. 116–136, 134 Stat. 281
(15 U.S.C. 9052).
82. Revise subpart E and subpart F of
part 324 as set forth at the end of the
common preamble.
■ 83. For purposes of part 324, Subpart
E and subpart F of the common rule are
amended as follows:
■ a. Remove ‘‘[AGENCY]’’ and add
‘‘FDIC’’ in its place wherever it appears;
■ b. Remove ‘‘[BANKING
ORGANIZATION]’’ and add ‘‘FDICsupervised institution’’ in its place
wherever it appears;
■ c. Remove ‘‘[BANKING
ORGANIZATIONS]’’ and add ‘‘FDICsupervised institutions’’ in its place
wherever it appears;
■ d. Remove ‘‘[BANKING
ORGANIZATION]’s’’ and add ‘‘FDICsupervised institution’s’’ in its place,
wherever it appears;
■ e. Remove ‘‘[bank]’’ and add ‘‘FDICsupervised institution’’ in its place,
wherever it appears;
■ f. Remove ‘‘[REAL ESTATE LENDING
GUIDELINES]’’ and add ‘‘12 CFR part
365, Subpart A, Appendix A’’ in its
place wherever it appears;
■ g. Remove ‘‘[APPRAISAL RULE]’’ and
add ‘‘12 CFR part 323, Subpart A’’ in its
place wherever it appears;
■ h. Remove ‘‘ll.’’ And add ‘‘324.’’ In
its place wherever it appears;
■ i. Remove ‘‘[REGULATORY
REPORT]’’ and add ‘‘Call Report’’ in its
place wherever it appears.
■
Subpart A—General Provisions
84. In § 324.1, revise paragraph (f) to
read as follows.
■
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§ 324.1 Purpose, applicability,
reservations of authority, and timing.
*
Authority and Issuance
64327
*
*
*
*
(f) Transitions and timing—(1)
Transitions. Notwithstanding any other
provision of this part, an FDICsupervised institution must make any
adjustments provided in subpart G of
this part for purposes of implementing
this part.
(2) Timing. An FDIC-supervised
institution that changes from one
category to another category, or that
changes from having no category to
having a category, must comply with the
requirements of its category in this part,
including applicable transition
provisions of the requirements in this
part, no later than on the first day of the
second quarter following the change in
the FDIC-supervised institution’s
category.
*
*
*
*
*
■ 85. Amend § 324.2 as follows:
■ a. Redesignate footnotes 3 through 9
as footnotes 1 through 7, respectively.
■ b. Remove the definitions for
‘‘Advanced approaches FDIC-supervised
institution’’, ‘‘Advanced approaches
total risk-weighted assets’’, and
‘‘Advanced market risk-weighted
assets’’;
■ c. Revise the definitions for ‘‘Category
II FDIC-supervised institution’’ and
‘‘Category III FDIC-supervised
institution’’;
■ d. Add the definition for ‘‘Category IV
FDIC-supervised institution’’ in
alphabetical order;
■ e. Revise newly redesignated footnote
1 to paragraph (2) of the definition for
‘‘Cleared transaction’’;
■ f. Revise the definition for ‘‘Corporate
exposure’’;
■ g. Remove the definition for ‘‘Creditrisk-weighted assets;
■ h. Add the definition for ‘‘CVA riskweighted assets’’ in alphabetical order;
■ i. Revise the definition for ‘‘Effective
notional amount’’;
■ j. Remove the definition for ‘‘Eligible
credit reserves’’;
■ k. Revise the definition for ‘‘Eligible
guarantee’’;
■ l. Add the definition for ‘‘Expanded
total risk-weighted assets’’ in
alphabetical order;
■ m. Remove the definition for
‘‘Expected credit loss (ECL)’’;
■ n. Revise the definitions for
‘‘Exposure amount’’, paragraph (5)(i) of
the definition for ‘‘Financial
institution’’, and the definition for
‘‘Market risk FDIC-supervised
institution’’;
■ o. Add the definition for ‘‘Market riskweighted assets’’ in alphabetical order;
■ p. Revise the definitions for ‘‘Net
independent collateral amount’’,
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‘‘Netting set’’, and ‘‘Protection amount
(P)’’;
■ q. In the definition for ‘‘Residential
mortgage exposure’’:
■ i. Remove paragraph (2);
■ ii. Redesignate paragraphs (1)(i) and
(ii) as paragraphs (1) and (2),
respectively; and
■ iii. In newly redesiganted paragraph
(2), remove the words ‘‘family; and’’ and
add, in their place, the word ‘‘family.’’;
■ r. Remove the definition for ‘‘Specific
wrong-way risk’’;
■ s. Revise the definitions for
‘‘Speculative grade’’, ‘‘Standardized
market risk-weighted assets’’,
‘‘Standardized total risk-weighted
assets’’, and ‘‘Sub-speculative grade’’;
■ t. Add the definition for ‘‘Total credit
risk-weighted assets’’ in alphabetical
order;
■ u. Revise the definition for
‘‘Unregulated financial institution’’;u.
Remove the definition for ‘‘Value-atRisk (VaR)’’;
■ v. Revise the definition for ‘‘Variation
margin amount’’;
The additions and revisions read as
follows:
§ 324.2
Definitions.
lotter on DSK11XQN23PROD with PROPOSALS2
*
*
*
*
*
Category II FDIC-supervised
institution means an FDIC-supervised
institution that is not a subsidiary of a
global systemically important BHC, as
defined pursuant to 12 CFR 252.5, and
that:
(1) Is a subsidiary of a Category II
banking organization, as defined
pursuant to 12 CFR 252.5 or 12 CFR
238.10, as applicable; or
(2)(i) Has total consolidated assets,
calculated based on the average of the
FDIC-supervised institution’s total
consolidated assets for the four most
recent calendar quarters as reported on
the Call Report, equal to $700 billion or
more. If the FDIC-supervised institution
has not filed the Call Report for each of
the four most recent calendar quarters,
total consolidated assets is calculated
based on its total consolidated assets, as
reported on the Call Report, for the most
recent quarter or the average of the most
recent quarters, as applicable; or
(ii)(A) Has total consolidated assets,
calculated based on the average of the
FDIC-supervised institution’s total
consolidated assets for the four most
recent calendar quarters as reported on
the Call Report, of $100 billion or more
but less than $700 billion. If the FDICsupervised institution has not filed the
Call Report for each of the four most
recent quarters, total consolidated assets
is based on its total consolidated assets,
as reported on the Call Report, for the
most recent quarter or average of the
most recent quarters, as applicable; and
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(B) Has cross-jurisdictional activity,
calculated based on the average of its
cross-jurisdictional activity for the four
most recent calendar quarters, of $75
billion or more. Cross-jurisdictional
activity is the sum of crossjurisdictional claims and crossjurisdictional liabilities, calculated in
accordance with the instructions to the
FR Y–15 or equivalent reporting form.
(3) After meeting the criteria in
paragraph (2) of this definition, an FDIC
supervised-institution continues to be a
Category II FDIC-supervised institution
until the FDIC-supervised institution
has:
(i) Less than $700 billion in total
consolidated assets, as reported on the
Call Report, for each of the four most
recent calendar quarters; and
(ii) (A) Less than $75 billion in crossjurisdictional activity for each of the
four most recent calendar quarters.
Cross-jurisdictional activity is the sum
of cross-jurisdictional claims and crossjurisdictional liabilities, calculated in
accordance with the instructions to the
FR Y–15 or equivalent reporting form;
or
(B) Less than $100 billion in total
consolidated assets, as reported on the
Call Report, for each of the four most
recent calendar quarters.
Category III FDIC-supervised
institution means an FDIC-supervised
institution that is not a subsidiary of a
global systemically important banking
organization or a Category II FDICsupervised institution and that:
(1) Is a subsidiary of a Category III
banking organization, as defined
pursuant to 12 CFR 252.5 or 12 CFR
238.10, as applicable; or
(2)(i) Has total consolidated assets,
calculated based on the average of the
FDIC-supervised institution’s total
consolidated assets for the four most
recent calendar quarters as reported on
the Call Report, equal to $250 billion or
more. If the FDIC-supervised institution
has not filed the Call Report for each of
the four most recent calendar quarters,
total consolidated assets is calculated
based on its total consolidated assets, as
reported on the Call Report, for the most
recent quarter or average of the most
recent quarters, as applicable; or
(ii)(A) Has total consolidated assets,
calculated based on the average of the
FDIC-supervised institution’s total
consolidated assets for the four most
recent calendar quarters as reported on
the Call Report, of $100 billion or more
but less than $250 billion. If the FDICsupervised institution has not filed the
Call Report for each of the four most
recent calendar quarters, total
consolidated assets is calculated based
on its total consolidated assets, as
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reported on the Call Report, for the most
recent quarter or average of the most
recent quarters, as applicable; and
(B) Has at least one of the following
in paragraphs (2)(ii)(B)(1) through (3) of
this definition, each calculated as the
average of the four most recent calendar
quarters, or if the FDIC-supervised
institution has not filed each applicable
reporting form for each of the four most
recent calendar quarters, for the most
recent quarter or quarters, as applicable:
(1) Total nonbank assets, calculated in
accordance with the instructions to the
FR Y–9LP or equivalent reporting form,
equal to $75 billion or more;
(2) Off-balance sheet exposure equal
to $75 billion or more. Off-balance sheet
exposure is a FDIC-supervised
institution’s total exposure, calculated
in accordance with the instructions to
the FR Y–15 or equivalent reporting
form, minus the total consolidated
assets of the FDIC-supervised
institution, as reported on the Call
Report; or
(3) Weighted short-term wholesale
funding, calculated in accordance with
the instructions to the FR Y–15 or
equivalent reporting form, equal to $75
billion or more.
(iii) After meeting the criteria in
paragraph (2)(ii) of this definition, an
FDIC-supervised institution continues
to be a Category III FDIC-supervised
institution until the FDIC-supervised
institution:
(A) Has:
(1) Less than $250 billion in total
consolidated assets, as reported on the
Call Report, for each of the four most
recent calendar quarters;
(2) Less than $75 billion in total
nonbank assets, calculated in
accordance with the instructions to the
FR Y–9LP or equivalent reporting form,
for each of the four most recent calendar
quarters;
(3) Less than $75 billion in weighted
short-term wholesale funding,
calculated in accordance with the
instructions to the FR Y–15 or
equivalent reporting form, for each of
the four most recent calendar quarters;
and
(4) Less than $75 billion in off-balance
sheet exposure for each of the four most
recent calendar quarters. Off-balance
sheet exposure is an FDIC-supervised
institution’s total exposure, calculated
in accordance with the instructions to
the FR Y–15 or equivalent reporting
form, minus the total consolidated
assets of the FDIC-supervised
institution, as reported on the Call
Report; or
(B) Has less than $100 billion in total
consolidated assets, as reported on the
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Call Report, for each of the four most
recent calendar quarters; or
(C) Is a Category II FDIC-supervised
institution.
Category IV FDIC-supervised
institution means an FDIC-supervised
institution that is not a subsidiary of a
global systemically important banking
organization, a Category II FDICsupervised institution, or a Category III
FDIC-supervised institution and that:
(1) Is a subsidiary of a Category IV
banking organization, as defined
pursuant to 12 CFR 252.5 or 12 CFR
238.10, as applicable; or:
(2) Has total consolidated assets,
calculated based on the average of the
FDIC-supervised institution’s total
consolidated assets for the four most
recent calendar quarters as reported on
the Call Report, of $100 billion or more.
If the FDIC-supervised institution has
not filed the Call Report for each of the
four most recent calendar quarters, total
consolidated assets is calculated based
on the average of its total consolidated
assets, as reported on the Call Report,
for the most recent quarter(s) available.
(3) After meeting the criterion in
paragraph (2) of this definition, an
FDIC-supervised institution continues
to be a Category IV FDIC-supervised
institution until it:
(i) Has less than $100 billion in total
consolidated assets, as reported on the
Call Report, for each of the four most
recent calendar quarters; or
(ii) Is a Category II FDIC-supervised
institution or Category III FDICsupervised institution.
*
*
*
*
*
Cleared transaction * * *
(2) * * *
1 For the standardized approach treatment
of these exposures, see § 324.34(e) (OTC
derivative contracts) or § 324.37(c) (repo-style
transactions). For the expanded risk-based
approach treatment of these exposures, see
§ 324.113 (OTC derivative contracts) or
§ 324.121 (repo-style transactions).
lotter on DSK11XQN23PROD with PROPOSALS2
*
*
*
*
*
Corporate exposure means an
exposure to a company that is not:
(1) An exposure to a sovereign, the
Bank for International Settlements, the
European Central Bank, the European
Commission, the International Monetary
Fund, the European Stability
Mechanism, the European Financial
Stability Facility, a multi-lateral
development bank (MDB), a depository
institution, a foreign bank, or a credit
union, a public sector entity (PSE);
(2) An exposure to a governmentsponsored enterprises (GSE);
(3) For purposes of subpart D of this
part, a residential mortgage exposure;
(4) A pre-sold construction loan;
(5) A statutory multifamily mortgage;
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(6) A high volatility commercial real
estate (HVCRE) exposure;
(7) A cleared transaction;
(8) A default fund contribution;
(9) A securitization exposure;
(10) An equity exposure;
(11) An unsettled transaction;
(12) A policy loan;
(13) A separate account;
(14) A Paycheck Protection Program
covered loan as defined in section
7(a)(36) or (37) of the Small Business
Act (15 U.S.C. 636(a)(36)–(37));
(15) For purposes of subpart E of this
part, a real estate exposure, as defined
in § 324.101; or
(16) For purposes of subpart E of this
part, a retail exposure as defined in
§ 324.101.
*
*
*
*
*
CVA risk-weighted assets means the
measure for CVA risk calculated under
§ 324.221(a) multiplied by 12.5.
*
*
*
*
*
Effective notional amount means for
an eligible guarantee or eligible credit
derivative, the lesser of the contractual
notional amount of the credit risk
mitigant and the exposures amount of
the hedged exposure, multiplied by the
percentage coverage of the credit risk
mitigant.
*
*
*
*
*
Eligible guarantee means a guarantee
that:
(1) Is written;
(2) Is either:
(i) Unconditional, or
(ii) A contingent obligation of the U.S.
government or its agencies, the
enforceability of which is dependent
upon some affirmative action on the
part of the beneficiary of the guarantee
or a third party (for example, meeting
servicing requirements);
(3) Covers all or a pro rata portion of
all contractual payments of the
obligated party on the reference
exposure;
(4) Gives the beneficiary a direct
claim against the protection provider;
(5) Is not unilaterally cancelable by
the protection provider for reasons other
than the breach of the contract by the
beneficiary;
(6) Except for a guarantee by a
sovereign, is legally enforceable against
the protection provider in a jurisdiction
where the protection provider has
sufficient assets against which a
judgment may be attached and enforced;
(7) Requires the protection provider to
make payment to the beneficiary on the
occurrence of a default (as defined in
the guarantee) of the obligated party on
the reference exposure in a timely
manner without the beneficiary first
having to take legal actions to pursue
the obligor for payment;
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64329
(8) Does not increase the beneficiary’s
cost of credit protection on the
guarantee in response to deterioration in
the credit quality of the reference
exposure;
(9) Is not provided by an affiliate of
the FDIC-supervised institution, unless
the affiliate is an insured depository
institution, foreign bank, securities
broker or dealer, or insurance company
that:
(i) Does not control the FDICsupervised institution; and
(ii) Is subject to consolidated
supervision and regulation comparable
to that imposed on depository
institutions, U.S. securities brokerdealers, or U.S. insurance companies (as
the case may be); and
(10) Is provided by an eligible
guarantor.
*
*
*
*
*
Expanded total risk-weighted assets
means the greater of:
(1) The sum of:
(i) Total credit risk-weighted assets;
(ii) Total risk-weighted assets for
equity exposures as calculated under
§§ 324.141 and 324.142;
(iii) Risk-weighted assets for
operational risk as calculated under
§ 324.150;
(iv) Market risk-weighted assets; and
(v) CVA risk-weighted assets; minus
(vi) Any amount of the FDICsupervised institution’s adjusted
allowance for credit losses that is not
included in tier 2 capital and any
amount of allocated transfer risk
reserves; or
(2)(i) 72.5 percent of the sum of:
(A) Total credit risk-weighted assets;
(B) Total risk-weighted assets for
equity exposures as calculated under
§ 324.141 and 324.142;
(C) Risk-weighted assets for
operational risk as calculated under
§ 324.150;
(D) Standardized market riskweighted assets; and
(E) CVA risk-weighted assets; minus
(ii) Any amount of the FDICsupervised institution’s adjusted
allowance for credit losses that is not
included in tier 2 capital and any
amount of allocated transfer risk
reserves.
*
*
*
*
*
Exposure amount means:
(1) For the on-balance sheet
component of an exposure (other than
an available-for-sale or held-to-maturity
security, if the FDIC-supervised
institution has made an AOCI opt-out
election (as defined in § 324.22(b)(2));
an OTC derivative contract; a repo-style
transaction or an eligible margin loan
for which the FDIC-supervised
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institution determines the exposure
amount under § 324.37 or § 324.121, as
applicable; a cleared transaction; a
default fund contribution; or a
securitization exposure), the FDICsupervised institution’s carrying value
of the exposure.
(2) For a security (that is not a
securitization exposure, equity
exposure, or preferred stock classified as
an equity security under GAAP)
classified as available-for-sale or heldto-maturity if the FDIC-supervised
institution has made an AOCI opt-out
election (as defined in § 324.22(b)(2)),
the FDIC-supervised institution’s
carrying value (including net accrued
but unpaid interest and fees) for the
exposure less any net unrealized gains
on the exposure and plus any net
unrealized losses on the exposure.
(3) For available-for-sale preferred
stock classified as an equity security
under GAAP if the FDIC-supervised
institution has made an AOCI opt-out
election (as defined in § 324.22(b)(2)),
the FDIC-supervised institution’s
carrying value of the exposure less any
net unrealized gains on the exposure
that are reflected in such carrying value
but excluded from the FDIC-supervised
institution’s regulatory capital
components.
(4) For the off-balance sheet
component of an exposure (other than
an OTC derivative contract; a repo-style
transaction or an eligible margin loan
for which the FDIC-supervised
institution calculates the exposure
amount under § 324.37 or § 324.121, as
applicable; a cleared transaction; a
default fund contribution; or a
securitization exposure), the notional
amount of the off-balance sheet
component multiplied by the
appropriate credit conversion factor
(CCF) in § 324.33 or § 324.112, as
applicable.
(5) For an exposure that is an OTC
derivative contract, the exposure
amount determined under § 324.34 or
§ 324.113, as applicable.
(6) For an exposure that is a cleared
transaction, the exposure amount
determined under § 324.35 or § 324.114,
as applicable.
(7) For an exposure that is an eligible
margin loan or repo-style transaction for
which the FDIC-supervised institution
calculates the exposure amount as
provided in § 324.37 or § 324.121, as
applicable, the exposure amount
determined under § 324.37 or § 324.121,
as applicable.
(8) For an exposure that is a
securitization exposure, the exposure
amount determined under § 324.42 or
§ 324.131, as applicable.
*
*
*
*
*
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Financial institution * * *
(5) * * *
(i) 85 percent or more of the total
consolidated annual gross revenues (as
determined in accordance with
applicable accounting standards) of the
company in either of the two most
recent calendar years were derived,
directly or indirectly, by the company
on a consolidated basis from the
activities; or
*
*
*
*
*
Market risk FDIC-supervised
institution means a FDIC-supervised
institution that is described in
§ 324.201(b)(1).
Market risk-weighted assets means the
measure for market risk calculated
pursuant to § 324.204(a) multiplied by
12.5.
*
*
*
*
*
Net independent collateral amount
means the fair value amount of the
independent collateral, as adjusted by
the haircuts under § 324.121(c)(2)(iii), as
applicable, that a counterparty to a
netting set has posted to an FDICsupervised institution less the fair value
amount of the independent collateral, as
adjusted by the haircuts under
§ 324.121(c)(2)(iii), as applicable, posted
by the FDIC-supervised institution to
the counterparty, excluding such
amounts held in a bankruptcy-remote
manner or posted to a QCCP and held
in conformance with the operational
requirements in § 324.3.
Netting set means:
(1) A group of transactions with a
single counterparty that are subject to a
qualifying master netting agreement and
that consist only of:
(i) Derivative contracts;
(ii) Repo-style transactions; or
(iii) Eligible margin loans.
(2) For derivative contracts, netting
set also includes a single derivative
contract between an FDIC-supervised
institution and a single counterparty.
*
*
*
*
*
Protection amount (P) means, with
respect to an exposure hedged by an
eligible guarantee or eligible credit
derivative, the effective notional amount
of the guarantee or credit derivative,
reduced to reflect any currency
mismatch, maturity mismatch, or lack of
restructuring coverage (as provided in
§ 324.36 or § 324.120, as appropriate).
*
*
*
*
*
Speculative grade means that the
entity to which the FDIC-supervised
institution is exposed through a loan or
security, or the reference entity with
respect to a credit derivative, has
adequate capacity to meet financial
commitments in the near term, but is
vulnerable to adverse economic
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conditions, such that should economic
conditions deteriorate, the entity would
present an elevated default risk.
Standardized market risk-weighted
assets means the standardized measure
for market risk calculated under
§ 324.204(b) multiplied by 12.5.
Standardized total risk-weighted
assets means:
(1) The sum of:
(i) Total risk-weighted assets for
general credit risk as calculated under
§ 324.31;
(ii) Total risk-weighted assets for
cleared transactions and default fund
contributions as calculated under
§ 324.35;
(iii) Total risk-weighted assets for
unsettled transactions as calculated
under § 324.38;
(iv) Total risk-weighted assets for
securitization exposures as calculated
under § 324.42;
(v) Total risk-weighted assets for
equity exposures as calculated under
§ 324.52 and § 324.53; and
(vi) For a market risk FDIC-supervised
institution only, market risk-weighted
assets; less
(2) Any amount of the FDICsupervised institution’s allowance for
loan and lease losses or adjusted
allowance for credit losses, as
applicable, that is not included in tier
2 capital and any amount of ‘‘allocated
transfer risk reserves.’’
*
*
*
*
*
Sub-speculative grade means that the
entity to which the FDIC-supervised
institution is exposed through a loan or
security, or the reference entity with
respect to a credit derivative, depends
on favorable economic conditions to
meet its financial commitments, such
that should such economic conditions
deteriorate the entity likely would
default on its financial commitments.
*
*
*
*
*
Total credit risk-weighted assets
means the sum of:
(1) Total risk-weighted assets for
general credit risk as calculated under
§ 324.110;
(2) Total risk-weighted assets for
cleared transactions and default fund
contributions as calculated under
§ 324.114;
(3) Total risk-weighted assets for
unsettled transactions as calculated
under § 324.115; and
(4) Total risk-weighted assets for
securitization exposures as calculated
under § 324.132.
*
*
*
*
*
Unregulated financial institution
means a financial institution that is not
a regulated financial institution,
including any financial institution that
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would meet the definition of ‘‘Financial
institution’’ under this section but for
the ownership interest thresholds set
forth in paragraph (4)(i) of that
definition.
*
*
*
*
*
Variation margin amount means the
fair value amount of the variation
margin, as adjusted by the standard
supervisory haircuts under
§ 324.121(c)(2)(iii), as applicable, that a
counterparty to a netting set has posted
to an FDIC-supervised institution less
the fair value amount of the variation
margin, as adjusted by the standard
supervisory haircuts under
§ 324.121(c)(2)(iii), as applicable, posted
by the FDIC-supervised institution to
the counterparty.
*
*
*
*
*
§ 324.3
[Amended]
86. In § 324.3, remove and reserve
paragraph (c).
■ 87. In § 324.4:
■ a. Redesignate footnote 10 as footnote
1; and
■ b. Revise newly redesignated footnote
1.
The revision reads as follows:
■
§ 324.4 Inadequate capital as an unsafe or
unsound practice or condition.
*
*
*
*
*
1 The
term total assets shall have the same
meaning as provided in 12 CFR 324.401(g).
Subpart B—Capital Ratio
Requirements and Buffers
88. In § 324.10, revise paragraphs
(a)(1)(v), (b) introductory text, (b)(5), (c),
(d) introductory text, (d)(3)(ii), and
(d)(4) to read as follows.
■
§ 324.10
Minimum capital requirements.
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*
*
*
*
*
(a) * * *
(1) * * *
(v) For an FDIC-supervised institution
subject to subpart E of this part, a
supplementary leverage ratio of 3
percent.
*
*
*
*
*
(b) Standardized capital ratio
calculations. Other than as provided in
paragraph (d) of this section:
*
*
*
*
*
(5) State savings association tangible
capital ratio. A state savings
association’s tangible capital ratio is the
ratio of the state savings association’s
core capital (tier 1 capital) to total
assets. For purposes of this paragraph
(b)(5), the term total assets shall have
the meaning provided in § 324.401(g).
*
*
*
*
*
(c) Supplementary leverage ratio. (1)
The supplementary leverage ratio of an
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FDIC-supervised institution subject to
subpart E of this part is the ratio of its
tier 1 capital to total leverage exposure.
Total leverage exposure is calculated as
the sum of:
(i) The mean of the on-balance sheet
assets calculated as of each day of the
reporting quarter; and
(ii) The mean of the off-balance sheet
exposures calculated as of the last day
of each of the most recent three months,
minus the applicable deductions under
§ 324.22(a), (c), and (d).
(2) For purposes of this part, total
leverage exposure means the sum of the
items described in paragraphs (c)(2)(i)
through (viii) of this section, as adjusted
pursuant to paragraph (c)(2)(ix) of this
section for a clearing member FDICsupervised institution and paragraph
(c)(2)(x) of this section for a custody
bank:
(i) The balance sheet carrying value of
all of the FDIC-supervised institution’s
on-balance sheet assets, net of adjusted
allowances for credit losses, plus the
value of securities sold under a
repurchase transaction or a securities
lending transaction that qualifies for
sales treatment under GAAP, less
amounts deducted from tier 1 capital
under § 324.22(a), (c), and (d), less the
value of securities received in securityfor-security repo-style transactions,
where the FDIC-supervised institution
acts as a securities lender and includes
the securities received in its on-balance
sheet assets but has not sold or rehypothecated the securities received,
and less the fair value of any derivative
contracts;
(ii)(A) The potential future exposure
(PFE) for each netting set to which the
FDIC-supervised institution is a
counterparty (including cleared
transactions except as provided in
paragraph (c)(2)(ix) of this section and,
at the discretion of the FDIC-supervised
institution, excluding a forward
agreement treated as a derivative
contract that is part of a repurchase or
reverse repurchase or a securities
borrowing or lending transaction that
qualifies for sales treatment under
GAAP), as determined under
§ 324.113(g), in which the term C in
§ 324.113(g)(1) equals zero, and, for any
counterparty that is not a commercial
end-user, multiplied by 1.4. For
purposes of this paragraph (c)(2)(ii)(A),
an FDIC-supervised institution may set
the value of the term C in § 324.113(g)(1)
equal to the amount of collateral posted
by a clearing member client of the FDICsupervised institution in connection
with the client-facing derivative
transactions within the netting set; and
(B) An FDIC-supervised institution
may choose to exclude the PFE of all
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64331
credit derivatives or other similar
instruments through which it provides
credit protection when calculating the
PFE under § 324.113, provided that it
does so consistently over time for the
calculation of the PFE for all such
instruments;
(iii)(A)(1) The replacement cost of
each derivative contract or single
product netting set of derivative
contracts to which the FDIC-supervised
institution is a counterparty, calculated
according to the following formula, and,
for any counterparty that is not a
commercial end-user, multiplied by 1.4:
Replacement Cost = max{V¥CVMr +
CVMp; 0}
Where:
V equals the fair value for each derivative
contract or each netting set of derivative
contracts (including a cleared transaction
except as provided in paragraph (c)(2)(ix)
of this section and, at the discretion of
the FDIC-supervised institution,
excluding a forward agreement treated as
a derivative contract that is part of a
repurchase or reverse repurchase or a
securities borrowing or lending
transaction that qualifies for sales
treatment under GAAP);
CVMr equals the amount of cash collateral
received from a counterparty to a
derivative contract and that satisfies the
conditions in paragraphs (c)(2)(iii)(B)
through (F) of this section, or, in the case
of a client-facing derivative transaction,
the amount of collateral received from
the clearing member client; and
CVMp equals the amount of cash collateral
that is posted to a counterparty to a
derivative contract and that has not
offset the fair value of the derivative
contract and that satisfies the conditions
in paragraphs (c)(2)(iii)(B) through (F) of
this section, or, in the case of a clientfacing derivative transaction, the amount
of collateral posted to the clearing
member client;
(2) Notwithstanding paragraph
(c)(2)(iii)(A)(1) of this section, where
multiple netting sets are subject to a
single variation margin agreement, a
FDIC-supervised institution must apply
the formula for replacement cost
provided in § 324.113(j)(1), in which the
term CMA may only include cash
collateral that satisfies the conditions in
paragraphs (c)(2)(iii)(B) through (F) of
this section; and
(3) For purposes of paragraph
(c)(2)(iii)(A) of this section, a FDICsupervised institution must treat a
derivative contract that references an
index as if it were multiple derivative
contracts each referencing one
component of the index if the FDICsupervised institution elected to treat
the derivative contract as multiple
derivative contracts under
§ 324.113(e)(6);
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(B) For derivative contracts that are
not cleared through a QCCP, the cash
collateral received by the recipient
counterparty is not segregated (by law,
regulation, or an agreement with the
counterparty);
(C) Variation margin is calculated and
transferred on a daily basis based on the
mark-to-fair value of the derivative
contract;
(D) The variation margin transferred
under the derivative contract or the
governing rules of the CCP or QCCP for
a cleared transaction is the full amount
that is necessary to fully extinguish the
net current credit exposure to the
counterparty of the derivative contracts,
subject to the threshold and minimum
transfer amounts applicable to the
counterparty under the terms of the
derivative contract or the governing
rules for a cleared transaction;
(E) The variation margin is in the form
of cash in the same currency as the
currency of settlement set forth in the
derivative contract, provided that for the
purposes of this paragraph (c)(2)(iii)(E),
currency of settlement means any
currency for settlement specified in the
governing qualifying master netting
agreement and the credit support annex
to the qualifying master netting
agreement, or in the governing rules for
a cleared transaction; and
(F) The derivative contract and the
variation margin are governed by a
qualifying master netting agreement
between the legal entities that are the
counterparties to the derivative contract
or by the governing rules for a cleared
transaction, and the qualifying master
netting agreement or the governing rules
for a cleared transaction must explicitly
stipulate that the counterparties agree to
settle any payment obligations on a net
basis, taking into account any variation
margin received or provided under the
contract if a credit event involving
either counterparty occurs;
(iv) The effective notional principal
amount (that is, the apparent or stated
notional principal amount multiplied by
any multiplier in the derivative
contract) of a credit derivative, or other
similar instrument, through which the
FDIC-supervised institution provides
credit protection, provided that:
(A) The FDIC-supervised institution
may reduce the effective notional
principal amount of the credit
derivative by the amount of any
reduction in the mark-to-fair value of
the credit derivative if the reduction is
recognized in common equity tier 1
capital;
(B) The FDIC-supervised institution
may reduce the effective notional
principal amount of the credit
derivative by the effective notional
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principal amount of a purchased credit
derivative or other similar instrument,
provided that the remaining maturity of
the purchased credit derivative is equal
to or greater than the remaining
maturity of the credit derivative through
which the FDIC-supervised institution
provides credit protection and that:
(1) With respect to a credit derivative
that references a single exposure, the
reference exposure of the purchased
credit derivative is to the same legal
entity and ranks pari passu with, or is
junior to, the reference exposure of the
credit derivative through which the
FDIC-supervised institution provides
credit protection; or
(2) With respect to a credit derivative
that references multiple exposures, the
reference exposures of the purchased
credit derivative are to the same legal
entities and rank pari passu with the
reference exposures of the credit
derivative through which the FDICsupervised institution provides credit
protection, and the level of seniority of
the purchased credit derivative ranks
pari passu to the level of seniority of the
credit derivative through which the
FDIC-supervised institution provides
credit protection;
(3) Where an FDIC-supervised
institution has reduced the effective
notional principal amount of a credit
derivative through which the FDICsupervised institution provides credit
protection in accordance with paragraph
(c)(2)(iv)(A) of this section, the FDICsupervised institution must also reduce
the effective notional principal amount
of a purchased credit derivative used to
offset the credit derivative through
which the FDIC-supervised institution
provides credit protection, by the
amount of any increase in the mark-tofair value of the purchased credit
derivative that is recognized in common
equity tier 1 capital; and
(4) Where the FDIC-supervised
institution purchases credit protection
through a total return swap and records
the net payments received on a credit
derivative through which the FDICsupervised institution provides credit
protection in net income, but does not
record offsetting deterioration in the
mark-to-fair value of the credit
derivative through which the FDICsupervised institution provides credit
protection in net income (either through
reductions in fair value or by additions
to reserves), the FDIC-supervised
institution may not use the purchased
credit protection to offset the effective
notional principal amount of the related
credit derivative through which the
FDIC-supervised institution provides
credit protection;
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(v) Where an FDIC-supervised
institution acting as a principal has
more than one repo-style transaction
with the same counterparty and has
offset the gross value of receivables due
from a counterparty under reverse
repurchase transactions by the gross
value of payables under repurchase
transactions due to the same
counterparty, the gross value of
receivables associated with the repostyle transactions less any on-balance
sheet receivables amount associated
with these repo-style transactions
included under paragraph (c)(2)(i) of
this section, unless the following
criteria are met:
(A) The offsetting transactions have
the same explicit final settlement date
under their governing agreements;
(B) The right to offset the amount
owed to the counterparty with the
amount owed by the counterparty is
legally enforceable in the normal course
of business and in the event of
receivership, insolvency, liquidation, or
similar proceeding; and
(C) Under the governing agreements,
the counterparties intend to settle net,
settle simultaneously, or settle
according to a process that is the
functional equivalent of net settlement,
(that is, the cash flows of the
transactions are equivalent, in effect, to
a single net amount on the settlement
date), where both transactions are
settled through the same settlement
system, the settlement arrangements are
supported by cash or intraday credit
facilities intended to ensure that
settlement of both transactions will
occur by the end of the business day,
and the settlement of the underlying
securities does not interfere with the net
cash settlement;
(vi) The counterparty credit risk of a
repo-style transaction, including where
the FDIC-supervised institution acts as
an agent for a repo-style transaction and
indemnifies the customer with respect
to the performance of the customer’s
counterparty in an amount limited to
the difference between the fair value of
the security or cash its customer has
lent and the fair value of the collateral
the borrower has provided, calculated as
follows:
(A) If the transaction is not subject to
a qualifying master netting agreement,
the counterparty credit risk (E*) for
transactions with a counterparty must
be calculated on a transaction by
transaction basis, such that each
transaction i is treated as its own netting
set, in accordance with the following
formula, where Ei is the fair value of the
instruments, gold, or cash that the FDICsupervised institution has lent, sold
subject to repurchase, or provided as
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collateral to the counterparty, and Ci is
the fair value of the instruments, gold,
or cash that the FDIC-supervised
institution has borrowed, purchased
subject to resale, or received as
collateral from the counterparty:
Ei* = max {0, [Ei¥Ci]}; and
(B) If the transaction is subject to a
qualifying master netting agreement, the
counterparty credit risk (E*) must be
calculated as the greater of zero and the
total fair value of the instruments, gold,
or cash that the FDIC-supervised
institution has lent, sold subject to
repurchase or provided as collateral to
a counterparty for all transactions
included in the qualifying master
netting agreement (SEi), less the total
fair value of the instruments, gold, or
cash that the FDIC-supervised
institution borrowed, purchased subject
to resale or received as collateral from
the counterparty for those transactions
(SCi), in accordance with the following
formula:
E* = max {0, [Sei¥ Sci]}
(vii) If an FDIC-supervised institution
acting as an agent for a repo-style
transaction provides a guarantee to a
customer of the security or cash its
customer has lent or borrowed with
respect to the performance of the
customer’s counterparty and the
guarantee is not limited to the difference
between the fair value of the security or
cash its customer has lent and the fair
value of the collateral the borrower has
provided, the amount of the guarantee
that is greater than the difference
between the fair value of the security or
cash its customer has lent and the value
of the collateral the borrower has
provided;
(viii) The credit equivalent amount of
all off-balance sheet exposures of the
FDIC-supervised institution, excluding
repo-style transactions, repurchase or
reverse repurchase or securities
borrowing or lending transactions that
qualify for sales treatment under GAAP,
and derivative transactions, determined
using the applicable credit conversion
factor under § 324.112(b), provided,
however, that the minimum credit
conversion factor that may be assigned
to an off-balance sheet exposure under
this paragraph (c)(2)(viii) is 10 percent;
and
(ix) For an FDIC-supervised
institution that is a clearing member:
(A) A clearing member FDICsupervised institution that guarantees
the performance of a clearing member
client with respect to a cleared
transaction must treat its exposure to
the clearing member client as a
derivative contract or repo-style
transaction, as applicable, for purposes
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of determining its total leverage
exposure;
(B) A clearing member FDICsupervised institution that guarantees
the performance of a CCP with respect
to a transaction cleared on behalf of a
clearing member client must treat its
exposure to the CCP as a derivative
contract or repo-style transaction, as
applicable, for purposes of determining
its total leverage exposure;
(C) A clearing member FDICsupervised institution that does not
guarantee the performance of a CCP
with respect to a transaction cleared on
behalf of a clearing member client may
exclude its exposure to the CCP for
purposes of determining its total
leverage exposure;
(D) An FDIC-supervised institution
that is a clearing member may exclude
from its total leverage exposure the
effective notional principal amount of
credit protection sold through a credit
derivative contract, or other similar
instrument, that it clears on behalf of a
clearing member client through a CCP as
calculated in accordance with paragraph
(c)(2)(iv) of this section; and
(E) Notwithstanding paragraphs
(c)(2)(ix)(A) through (C) of this section,
an FDIC-supervised institution may
exclude from its total leverage exposure
a clearing member’s exposure to a
clearing member client for a derivative
contract if the clearing member client
and the clearing member are affiliates
and consolidated for financial reporting
purposes on the FDIC-supervised
institution’s balance sheet.
(x) A custody bank shall exclude from
its total leverage exposure the lesser of:
(A) The amount of funds that the
custody bank has on deposit at a
qualifying central bank; and
(B) The amount of funds in deposit
accounts at the custody bank that are
linked to fiduciary or custodial and
safekeeping accounts at the custody
bank. For purposes of this paragraph
(c)(2)(x), a deposit account is linked to
a fiduciary or custodial and safekeeping
account if the deposit account is
provided to a client that maintains a
fiduciary or custodial and safekeeping
account with the custody bank and the
deposit account is used to facilitate the
administration of the fiduciary or
custodial and safekeeping account.
*
*
*
*
*
(d) Expanded capital ratio
calculations. An FDIC-supervised
institution subject to subpart E of this
part must determine its regulatory
capital ratios as described in paragraphs
(d)(1) through (3) of this section.
*
*
*
*
*
(3) * * *
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(ii) The ratio of the FDIC-supervised
institution’s expanded risk-based
approach-adjusted total capital to
expanded total risk-weighted assets. An
FDIC-supervised institution’s expanded
risk-based approach-adjusted total
capital is the FDIC-supervised
institution’s total capital after being
adjusted as follows:
(A) A FDIC-supervised institution
subject to subpart E of this part must
deduct from its total capital any AACL
included in its tier 2 capital in
accordance with § 324.20(d)(3); and
(B) An FDIC-supervised institution
subject to subpart E of this part must
add to its total capital any AACL up to
1.25 percent of the FDIC-supervised
institution’s total credit risk-weighted
assets.
(4) State savings association tangible
capital ratio. A state savings
association’s tangible capital ratio is the
ratio of the state savings association’s
core capital (tier 1 capital) to total
assets. For purposes of this paragraph,
the term total assets shall have the
meaning provided in 12 CFR 324.401(g).
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■ 89. In § 324.11:
■ a. In paragraph (b)(1), remove the
words ‘‘advanced approaches FDICsupervised institution or a Category III
FDIC-supervised institution’’ and add in
their place the words ‘‘FDIC-supervised
institution subject to subpart E of this
part’’;
■ b. Revise paragraph (b)(1)(iii).
■ c. In paragraph (b)(2)(ii), redesignate
footnote 11 as footnote 1; and
The revision reads as follows:
§ 324.11 Capital conservation buffer and
countercyclical capital buffer amount.
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(b) * * *
(1) * * *
(iii) Weighting. The weight assigned to
a jurisdiction’s countercyclical capital
buffer amount is calculated by dividing
the total risk-weighted assets for the
FDIC-supervised institution’s private
sector credit exposures located in the
jurisdiction by the total risk-weighted
assets for all of the FDIC-supervised
institution’s private sector credit
exposures. The methodology an FDICsupervised institution uses for
determining risk-weighted assets for
purposes of this paragraph (b) must be
the methodology that determines its
risk-based capital ratios under § 324.10.
Notwithstanding the previous sentence,
the risk-weighted asset amount for a
private sector credit exposure that is a
covered position under subpart F of this
part is its standardized default risk
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The revision reads as follows:
capital requirement as determined
under § 324.210 multiplied by 12.5.
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§ 324.12
§ 324.21
[Amended]
90. In § 324.12, remove paragraph
(a)(4).
■
Subpart C—Definition of Capital
91. In § 324.20:
a. Revise paragraphs (c)(1)(xiv),
(d)(1)(xi), and (d)(3); and
■ b. Redesignate footnotes 12 through
23 as footnotes 1 through 12,
respectively;
The revisions read as follows:
■
■
§ 324.20 Capital components and eligibility
criteria for regulatory capital instruments.
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(c) * * *
(1) * * *
(xiv) For an FDIC-supervised
institution subject to subpart E of this
part, the governing agreement, offering
circular, or prospectus of an instrument
issued after the date upon which the
FDIC-supervised institution becomes
subject to subpart E must disclose that
the holders of the instrument may be
fully subordinated to interests held by
the U.S. government in the event that
the FDIC-supervised institution enters
into a receivership, insolvency,
liquidation, or similar proceeding.
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(d) * * *
(1) * * *
(xi) For an FDIC-supervised
institution subject to subpart E of this
part, the governing agreement, offering
circular, or prospectus of an instrument
issued after the date on which the FDICsupervised institution becomes subject
to subpart E must disclose that the
holders of the instrument may be fully
subordinated to interests held by the
U.S. government in the event that the
FDIC-supervised institution enters into
a receivership, insolvency, liquidation,
or similar proceeding.
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(3) ALLL or AACL, as applicable, up
to 1.25 percent of the FDIC-supervised
institution’s standardized total riskweighted assets not including any
amount of the ALLL or AACL, as
applicable (and excluding the case of a
market risk FDIC-supervised institution,
its market risk weighted assets).
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■ 92. In § 324.21:
■ a. In paragraph (a)(1), remove the
words ‘‘an advanced approaches FDICsupervised institution’’ and add in their
place the words ‘‘subject to subpart E of
this part’’; and
■ b. Revise paragraph (b).
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Minority interest.
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(b) (1) Applicability. For purposes of
§ 324.20, an FDIC-supervised institution
that is subject to subpart E of this part
is subject to the minority interest
limitations in this paragraph (b) if:
(i) A consolidated subsidiary of the
FDIC-supervised institution has issued
regulatory capital that is not owned by
the FDIC-supervised institution; and
(ii) For each relevant regulatory
capital ratio of the consolidated
subsidiary, the ratio exceeds the sum of
the subsidiary’s minimum regulatory
capital requirements plus its capital
conservation buffer.
(2) Difference in capital adequacy
standards at the subsidiary level. For
purposes of the minority interest
calculations in this section, if the
consolidated subsidiary issuing the
capital is not subject to capital adequacy
standards similar to those of the FDICsupervised institution subject to subpart
E of this part, the FDIC-supervised
institution subject to subpart E of this
part must assume that the capital
adequacy standards of the FDICsupervised institution apply to the
subsidiary.
(3) Common equity tier 1 minority
interest includable in the common
equity tier 1 capital of the FDICsupervised institution. For each
consolidated subsidiary of an FDICsupervised institution subject to subpart
E of this part, the amount of common
equity tier 1 minority interest the FDICsupervised institution may include in
common equity tier 1 capital is equal to:
(i) The common equity tier 1 minority
interest of the subsidiary; minus
(ii) The percentage of the subsidiary’s
common equity tier 1 capital that is not
owned by the FDIC-supervised
institution, multiplied by the difference
between the common equity tier 1
capital of the subsidiary and the lower
of:
(A) The amount of common equity
tier 1 capital the subsidiary must hold,
or would be required to hold pursuant
to this paragraph (b), to avoid
restrictions on distributions and
discretionary bonus payments under
§ 324.11 or equivalent standards
established by the subsidiary’s home
country supervisor; or
(B) (1) The standardized total riskweighted assets of the FDIC-supervised
institution that relate to the subsidiary
multiplied by
(2) The common equity tier 1 capital
ratio the subsidiary must maintain to
avoid restrictions on distributions and
discretionary bonus payments under
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§ 324.11 or equivalent standards
established by the subsidiary’s home
country supervisor.
(4) Tier 1 minority interest includable
in the tier 1 capital of the FDICsupervised institution subject to subpart
E of this part. For each consolidated
subsidiary of the FDIC-supervised
institution subject to subpart E of this
part, the amount of tier 1 minority
interest the FDIC-supervised institution
may include in tier 1 capital is equal to:
(i) The tier 1 minority interest of the
subsidiary; minus
(ii) The percentage of the subsidiary’s
tier 1 capital that is not owned by the
FDIC-supervised institution multiplied
by the difference between the tier 1
capital of the subsidiary and the lower
of:
(A) The amount of tier 1 capital the
subsidiary must hold, or would be
required to hold pursuant to this
paragraph (b), to avoid restrictions on
distributions and discretionary bonus
payments under § 324.11 or equivalent
standards established by the
subsidiary’s home country supervisor,
or
(B) (1) The standardized total riskweighted assets of the FDIC-supervised
institution that relate to the subsidiary
multiplied by
(2) The tier 1 capital ratio the
subsidiary must maintain to avoid
restrictions on distributions and
discretionary bonus payments under
§ 324.11 or equivalent standards
established by the subsidiary’s home
country supervisor.
(5) Total capital minority interest
includable in the total capital of the
FDIC-supervised institution. For each
consolidated subsidiary of the FDICsupervised institution subject to subpart
E of this part, the amount of total capital
minority interest the FDIC-supervised
institution may include in total capital
is equal to:
(i) The total capital minority interest
of the subsidiary; minus
(ii) The percentage of the subsidiary’s
total capital that is not owned by the
FDIC-supervised institution multiplied
by the difference between the total
capital of the subsidiary and the lower
of:
(A) The amount of total capital the
subsidiary must hold, or would be
required to hold pursuant to this
paragraph (b), to avoid restrictions on
distributions and discretionary bonus
payments under § 324.11 or equivalent
standards established by the
subsidiary’s home country supervisor,
or
(B) (1) The standardized total riskweighted assets of the FDIC-supervised
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institution that relate to the subsidiary
multiplied by
(2) The total capital ratio the
subsidiary must maintain to avoid
restrictions on distributions and
discretionary bonus payments under
§ 324.11 or equivalent standards
established by the subsidiary’s home
country supervisor.
■ 93. In § 324.22:
■ a. Redesignate footnotes 22 through 31
as footnotes 1 through 10, respectively;
■ b. Revise paragraph (a)(4), and remove
and reserve paragraph (a)(6);
■ c. Revise paragraph (b)(1)(ii);
■ d. In paragraph (b)(2)(i), remove the
words ‘‘an advanced approaches FDICsupervised institution’’ and add, in their
place, the words ‘‘subject to subpart E
of this part’’;
■ e. Revise paragraphs (b)(2)(ii),
(b)(2)(iii), and (b)(2)(iv) introductory
text, and (c)(2) introductory text;
■ f. In paragraph (c)(4), remove the
words ‘‘an advanced approaches FDICsupervised institution’’ and add in their
place the words ‘‘subject to subpart E of
this part’’; and
■ e. Revise paragraphs (c)(5)(i) and (ii),
(c)(6), (d)(1) introductory text, (d)(2),
and (f),
The revisions read as follows:
§ 324.22 Regulatory capital adjustments
and deductions.
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(a) * * *
(4) (i) For an FDIC-supervised
institution that is not subject to subpart
E of this part, any gain-on-sale in
connection with a securitization
exposure;
(ii) For an FDIC-supervised institution
subject to subpart E of this part, any
gain-on-sale in connection with a
securitization exposure and the portion
of any CEIO that does not constitute an
after-tax gain-on-sale;
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(b) * * *
(1) * * *
(ii) An FDIC-supervised institution
that is subject to subpart E of this part,
and a FDIC-supervised institution that
has not made an AOCI opt-out election
(as defined in paragraph (b)(2) of this
section), must deduct any accumulated
net gains and add any accumulated net
losses on cash flow hedges included in
AOCI that relate to the hedging of items
that are not recognized at fair value on
the balance sheet.
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(2) * * *
(i) An FDIC-supervised institution
that is not subject to subpart E of this
part may make a one-time election to
opt out of the requirement to include all
components of AOCI (with the
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exception of accumulated net gains and
losses on cash flow hedges related to
items that are not fair-valued on the
balance sheet) in common equity tier 1
capital (AOCI opt-out election). An
FDIC-supervised institution that makes
an AOCI opt-out election in accordance
with this paragraph (b)(2) must adjust
common equity tier 1 capital as follows:
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(ii) An FDIC-supervised institution
that is not subject to subpart E of this
part must make its AOCI opt-out
election in the Call Report during the
first reporting period after the FDICsupervised institution is required to
comply with subpart A of this part. If
the FDIC-supervised institution was
previously subject to subpart E of this
part, the FDIC-supervised institution
must make its AOCI opt-out election in
the Call Report during the first reporting
period after the FDIC-supervised
institution is not subject to subpart E of
this part.
(iii) With respect to an FDICsupervised institution that is not subject
to subpart E of this part, each of its
subsidiary banking organizations that is
subject to regulatory capital
requirements issued by the Federal
Reserve, the FDIC, or the OCC 1 must
elect the same option as the FDICsupervised institution pursuant to this
paragraph (b)(2).
(iv) With prior notice to the FDIC, an
FDIC-supervised institution resulting
from a merger, acquisition, or purchase
transaction that is not subject to subpart
E of this part may change its AOCI optout election in its Call Report filed for
the first reporting period after the date
required for such FDIC-supervised
institution to comply with subpart A of
this part as set forth in § 324.1(f) if:
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(c) * * *
(2) Corresponding deduction
approach. For purposes of subpart C of
this part, the corresponding deduction
approach is the methodology used for
the deductions from regulatory capital
related to reciprocal cross holdings (as
described in paragraph (c)(3) of this
section), investments in the capital of
unconsolidated financial institutions for
an FDIC-supervised institution that is
not subject to subpart E of this part (as
described in paragraph (c)(4) of this
section), non-significant investments in
the capital of unconsolidated financial
institutions for an FDIC-supervised
institution subject to subpart E of this
part (as described in paragraph (c)(5) of
this section), and non-common stock
significant investments in the capital of
unconsolidated financial institutions for
an FDIC-supervised institution subject
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to subpart E of this part (as described in
paragraph (c)(6) of this section). Under
the corresponding deduction approach,
an FDIC-supervised institution must
make deductions from the component of
capital for which the underlying
instrument would qualify if it were
issued by the FDIC-supervised
institution itself, as described in
paragraphs (c)(2)(i) through (iii) of this
section. If the FDIC-supervised
institution does not have a sufficient
amount of a specific component of
capital to effect the required deduction,
the shortfall must be deducted
according to paragraph (f) of this
section.
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(5) * * *
(i) An FDIC-supervised institution
subject to subpart E of this part must
deduct its non-significant investments
in the capital of unconsolidated
financial institutions (as defined in
§ 324.2) that, in the aggregate and
together with any investment in a
covered debt instrument (as defined in
§ 324.2) issued by a financial institution
in which the FDIC-supervised
institution does not have a significant
investment in the capital of the
unconsolidated financial institution (as
defined in § 324.2), exceeds 10 percent
of the sum of the FDIC-supervised
institution’s common equity tier 1
capital elements minus all deductions
from and adjustments to common equity
tier 1 capital elements required under
paragraphs (a) through (c)(3) of this
section (the 10 percent threshold for
non-significant investments) by
applying the corresponding deduction
approach in paragraph (c)(2) of this
section.5 The deductions described in
this paragraph are net of associated
DTLs in accordance with paragraph (e)
of this section. In addition, with the
prior written approval of the FDIC, an
FDIC-supervised institution subject to
subpart E of this part that underwrites
a failed underwriting, for the period of
time stipulated by the FDIC, is not
required to deduct from capital a nonsignificant investment in the capital of
an unconsolidated financial institution
or an investment in a covered debt
instrument pursuant to this paragraph
(c)(5) to the extent the investment is
related to the failed underwriting.6 For
any calculation under this paragraph
(c)(5)(i), an FDIC-supervised institution
subject to subpart E of this part may
exclude the amount of an investment in
a covered debt instrument under
paragraph (c)(5)(iii) or (iv) of this
section, as applicable.
(ii) For an FDIC-supervised institution
subject to subpart E of this part, the
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amount to be deducted under this
paragraph (c)(5) from a specific capital
component is equal to:
(A) The FDIC-supervised institution’s
aggregate non-significant investments in
the capital of an unconsolidated
financial institution and, if applicable,
any investments in a covered debt
instrument subject to deduction under
this paragraph (c)(5), exceeding the 10
percent threshold for non-significant
investments, multiplied by
(B) The ratio of the FDIC-supervised
institution’s aggregate non-significant
investments in the capital of an
unconsolidated financial institution (in
the form of such capital component) to
the FDIC-supervised institution’s total
non-significant investments in
unconsolidated financial institutions,
with an investment in a covered debt
instrument being treated as tier 2 capital
for this purpose.
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(6) Significant investments in the
capital of unconsolidated financial
institutions that are not in the form of
common stock. If an FDIC-supervised
institution subject to subpart E of this
part has a significant investment in the
capital of an unconsolidated financial
institution, the FDIC-supervised
institution must deduct from capital any
such investment issued by the
unconsolidated financial institution that
is held by the FDIC-supervised
institution other than an investment in
the form of common stock, as well as
any investment in a covered debt
instrument issued by the
unconsolidated financial institution, by
applying the corresponding deduction
approach in paragraph (c)(2) of this
section.7 The deductions described in
this section are net of associated DTLs
in accordance with paragraph (e) of this
section. In addition, with the prior
written approval of the FDIC, for the
period of time stipulated by the FDIC,
an FDIC-supervised institution subject
to subpart E of this part that underwrites
a failed underwriting is not required to
deduct the significant investment in the
capital of an unconsolidated financial
institution or an investment in a
covered debt instrument pursuant to
this paragraph (c)(6) if such investment
is related to such failed underwriting.
(d) * * *
(1) An FDIC-supervised institution
that is not subject to subpart E of this
part must make deductions from
regulatory capital as described in this
paragraph (d)(1).
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(2) An FDIC-supervised institution
subject to subpart E of this part must
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make deductions from regulatory capital
as described in this paragraph (d)(2).
(i) An FDIC-supervised institution
subject to subpart E of this part must
deduct from common equity tier 1
capital elements the amount of each of
the items set forth in this paragraph
(d)(2) that, individually, exceeds 10
percent of the sum of the FDICsupervised institution’s common equity
tier 1 capital elements, less adjustments
to and deductions from common equity
tier 1 capital required under paragraphs
(a) through (c) of this section (the 10
percent common equity tier 1 capital
deduction threshold).
(A) DTAs arising from temporary
differences that the FDIC-supervised
institution could not realize through net
operating loss carrybacks, net of any
related valuation allowances and net of
DTLs, in accordance with paragraph (e)
of this section. An FDIC-supervised
institution subject to subpart E of this
part is not required to deduct from the
sum of its common equity tier 1 capital
elements DTAs (net of any related
valuation allowances and net of DTLs,
in accordance with § 324.22(e)) arising
from timing differences that the FDICsupervised institution could realize
through net operating loss carrybacks.
The FDIC-supervised institution must
risk weight these assets at 100 percent.
For an FDIC-supervised institution that
is a member of a consolidated group for
tax purposes, the amount of DTAs that
could be realized through net operating
loss carrybacks may not exceed the
amount that the FDIC-supervised
institution could reasonably expect to
have refunded by its parent holding
company.
(B) MSAs net of associated DTLs, in
accordance with paragraph (e) of this
section.
(C) Significant investments in the
capital of unconsolidated financial
institutions in the form of common
stock, net of associated DTLs in
accordance with paragraph (e) of this
section.9 Significant investments in the
capital of unconsolidated financial
institutions in the form of common
stock subject to the 10 percent common
equity tier 1 capital deduction threshold
may be reduced by any goodwill
embedded in the valuation of such
investments deducted by the FDICsupervised institution pursuant to
paragraph (a)(1) of this section. In
addition, with the prior written
approval of the FDIC, for the period of
time stipulated by the FDIC, an FDICsupervised institution subject to subpart
E of this part that underwrites a failed
underwriting is not required to deduct
a significant investment in the capital of
an unconsolidated financial institution
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in the form of common stock pursuant
to this paragraph (d)(2) if such
investment is related to such failed
underwriting.
(ii) A FDIC-supervised institution
subject to subpart E of this part must
deduct from common equity tier 1
capital elements the items listed in
paragraph (d)(2)(i) of this section that
are not deducted as a result of the
application of the 10 percent common
equity tier 1 capital deduction
threshold, and that, in aggregate, exceed
17.65 percent of the sum of the FDICsupervised institution’s common equity
tier 1 capital elements, minus
adjustments to and deductions from
common equity tier 1 capital required
under paragraphs (a) through (c) of this
section, minus the items listed in
paragraph (d)(2)(i) of this section (the 15
percent common equity tier 1 capital
deduction threshold). Any goodwill that
has been deducted under paragraph
(a)(1) of this section can be excluded
from the significant investments in the
capital of unconsolidated financial
institutions in the form of common
stock.10
(iii) For purposes of calculating the
amount of DTAs subject to the 10 and
15 percent common equity tier 1 capital
deduction thresholds, a FDICsupervised institution subject to subpart
E of this part may exclude DTAs and
DTLs relating to adjustments made to
common equity tier 1 capital under
paragraph (b) of this section. A FDICsupervised institution subject to subpart
E of this part that elects to exclude
DTAs relating to adjustments under
paragraph (b) of this section also must
exclude DTLs and must do so
consistently in all future calculations. A
FDIC-supervised institution subject to
subpart E of this part may change its
exclusion preference only after
obtaining the prior approval of the
FDIC.
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(f) Insufficient amounts of a specific
regulatory capital component to effect
deductions. Under the corresponding
deduction approach, if a FDICsupervised institution does not have a
sufficient amount of a specific
component of capital to effect the full
amount of any deduction from capital
required under paragraph (d) of this
section, the FDIC-supervised institution
must deduct the shortfall amount from
the next higher (that is, more
subordinated) component of regulatory
capital. Any investment by a FDICsupervised institution subject to subpart
E of this part in a covered debt
instrument must be treated as an
investment in the tier 2 capital for
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purposes of this paragraph (f).
Notwithstanding any other provision of
this section, a qualifying community
banking organization (as defined in
§ 324.12) that has elected to use the
community bank leverage ratio
framework pursuant to § 324.12 is not
required to deduct any shortfall of tier
2 capital from its additional tier 1
capital or common equity tier 1 capital.
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These rules include the regulatory
capital requirements set forth at 12 CFR part
3 (OCC); 12 CFR part 217 (Board); 12 CFR
part 324 (FDIC).
1
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5 With
the prior written approval of the
FDIC, for the period of time stipulated by the
FDIC, an FDIC-supervised institution subject
to subpart E of this part is not required to
deduct a non-significant investment in the
capital of an unconsolidated financial
institution or an investment in a covered debt
instrument pursuant to this paragraph if the
financial institution is in distress and if such
investment is made for the purpose of
providing financial support to the financial
institution, as determined by the FDIC.
6 Any non-significant investment in the
capital of an unconsolidated financial
institution or any investment in a covered
debt instrument that is not required to be
deducted under this paragraph (c)(5) or
otherwise under this section must be
assigned the appropriate risk weight under
subparts D, E, or F of this part, as applicable.
7 With prior written approval of the FDIC,
for the period of time stipulated by the FDIC,
an FDIC-supervised institution subject to
subpart E of this part is not required to
deduct a significant investment in the capital
of an unconsolidated financial institution,
including an investment in a covered debt
instrument, under this paragraph (c)(6) or
otherwise under this section if such
investment is made for the purpose of
providing financial support to the financial
institution as determined by the FDIC.
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9 With
the prior written approval of the
FDIC, for the period of time stipulated by the
FDIC, an FDIC-supervised institution subject
to subpart E of this part is not required to
deduct a significant investment in the capital
instrument of an unconsolidated financial
institution in distress in the form of common
stock pursuant to this section if such
investment is made for the purpose of
providing financial support to the financial
institution as determined by the FDIC.
10 The amount of the items in paragraph
(d)(2) of this section that is not deducted
from common equity tier 1 capital pursuant
to this section must be included in the riskweighted assets of the FDIC-supervised
institution subject to subpart E of this part
and assigned a 250 percent risk weight for
purposes of standardized total risk-weighted
assets and assigned the appropriate risk
weight for the investment under subpart E of
this part for purposes of expanded total riskweighted assets.
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Subpart D—Risk-Weighted Assets—
Standardized Approach
§ 324.30
[Amended]
94. In § 324.30, in paragraph (b),
remove the words ‘‘covered positions’’
and add in their place the words
‘‘market risk covered positions’’.
■ 95. In § 324.34, revise paragraph (a) to
read as follows:
■
§ 324.34
Derivative contracts.
(a) Exposure amount for derivative
contracts—(1) An FDIC-supervised
institution not subject to subpart E of
this part. (i) An FDIC-supervised
institution that is not subject to subpart
E of this part must use the current
exposure methodology (CEM) described
in paragraph (b) of this section to
calculate the exposure amount for all its
OTC derivative contracts, unless the
FDIC-supervised institution makes the
election provided in paragraph (a)(1)(ii)
of this section.
(ii) An FDIC-supervised institution
that is not subject to subpart E of this
part may elect to calculate the exposure
amount for all its OTC derivative
contracts under the standardized
approach for counterparty credit risk
(SA–CCR) in § 324.113 by notifying the
FDIC, rather than calculating the
exposure amount for all its derivative
contracts using CEM. An FDICsupervised institution that elects under
this paragraph (a)(1)(ii) to calculate the
exposure amount for its OTC derivative
contracts under SA–CCR must apply the
treatment of cleared transactions under
§ 324.114 to its derivative contracts that
are cleared transactions and to all
default fund contributions associated
with such derivative contracts, rather
than applying § 324.35. An FDICsupervised institution that is not subject
to subpart E of this part must use the
same methodology to calculate the
exposure amount for all its derivative
contracts and, if an FDIC-supervised
institution has elected to use SA–CCR
under this paragraph (a)(1)(ii), the FDICsupervised institution may change its
election only with prior approval of the
FDIC.
(2) An FDIC-supervised institution
subject to subpart E of this part. An
FDIC-supervised institution that is
subject to subpart E of this part must
calculate the exposure amount for all its
derivative contracts using SA–CCR in
§ 324.113 for purposes of standardized
total risk-weighted assets. An FDICsupervised institution subject to subpart
E of this part must apply the treatment
of cleared transactions under § 324.114
to its derivative contracts that are
cleared transactions and to all default
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fund contributions associated with such
derivative contracts for purposes of
standardized total risk-weighted assets.
*
*
*
*
*
■ 96. In § 324.35, revise paragraph (a)(3)
to read as follows:
§ 324.35
Cleared transactions.
(a) * * *
(3) Alternate requirements.
Notwithstanding any other provision of
this section, an FDIC-supervised
institution that is subject to subpart E of
this part or an FDIC-supervised
institution that is not subject to subpart
E of this part and that has elected to use
SA–CCR under § 324.34(a)(1) must
apply § 324.114 to its derivative
contracts that are cleared transactions
rather than this section.
■ 97. In § 324.37, revise paragraph (c)(1)
to read as follows:
§ 324.37
Collateralized transactions.
*
*
*
*
*
(c) Collateral haircut approach—(1)
General. An FDIC-supervised institution
may recognize the credit risk mitigation
benefits of financial collateral that
secures an eligible margin loan, repostyle transaction, collateralized
derivative contract, or single-product
netting set of such transactions, and of
any collateral that secures a repo-style
transaction that is included in the FDICsupervised institution’s measure for
market risk under subpart F of this part
by using the collateral haircut approach
in this section. An FDIC-supervised
institution may use the standard
supervisory haircuts in paragraph (c)(3)
of this section or, with prior written
approval of the FDIC, its own estimates
of haircuts according to paragraph (c)(4)
of this section.
*
*
*
*
*
§ 324.61
[Amended]
98. In § 324.61:
a. Remove the citation ‘‘§ 324.172’’
wherever it appears, and add in its place
the citations ‘‘§§ 324.160 and 324.161’’;
and
■ b. Remove the sentence ‘‘An advanced
approaches FDIC-supervised institution
that has not received approval from the
FDIC to exit parallel run pursuant to
§ 324.121(d) is subject to the disclosure
requirements described in §§ 324.62 and
324.63.’’.
■ 99. In § 324.63:
■ a. In table 3, revise entry (c); and
■ b. Remove paragraphs (d) and (e).
The revision reads as follows:
■
■
§ 324.63 Disclosures by FDIC-supervised
institutions described in § 324.61.
*
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Subpart E—Risk-Weighted Assets—
Expanded Risk-Based Approach
100. In § 324.100, revise paragraph
(b)(1) to read as follows:
■
§ 324.100
Purpose and applicability.
*
*
*
*
*
(b) * * *
(1) This subpart applies to any FDICsupervised institution that is a
subsidiary of a global systemically
important BHC or a Category II FDICsupervised institution, a Category III
FDIC-supervised institution, or a
Category IV FDIC-supervised institution,
as defined in § 324.2.
*
*
*
*
*
§ 324.111
[Amended]
101. In § 324.111:
a. Remove paragraph (j)(1)(i) and
redesignate paragraph (j)(1)(ii) as
paragraph (j)(1); and
■ b. Remove paragraphs (k).
■ 102. In § 324.132, revise paragraphs
(h)(1)(iv) and (h)(4)(i) to read as follows:
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■
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§ 324.132 Risk-weighted assets for
securitization exposures.
§ 324.162 Mechanics of risk-weighted
asset calculation.
*
*
*
*
*
*
(h) * * *
(1) * * *
(iv) The FDIC-supervised institution
is well capitalized, as defined in subpart
H of this part. For purposes of
determining whether a FDIC-supervised
institution is well capitalized for
purposes of this paragraph (h), the
FDIC-supervised institution’s capital
ratios must be calculated without regard
to the capital treatment for transfers of
small-business obligations with recourse
specified in paragraph (h)(1) of this
section.
*
*
*
*
*
(4) * * *
(i) Determining whether a FDICsupervised institution is adequately
capitalized, undercapitalized,
significantly undercapitalized, or
critically undercapitalized under
subpart H of this part; and
*
*
*
*
*
■ 103. In § 324.162, revise paragraph (c)
as follows:
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*
*
*
*
(c) Regulatory capital instrument and
other instruments eligible for total loss
absorbing capacity (TLAC) disclosures.
A FDIC-supersvied institution described
in § 324.160 must provide a description
of the main features of its regulatory
capital instruments, in accordance with
table 15 to paragraph (c). If the FDICsupervised institution issues or repays a
capital instrument, or in the event of a
redemption, conversion, write down, or
other material change in the nature of an
existing instrument, but in no event less
frequently than semiannually, the FDICsupervised institution must update the
disclosures provided in accordance with
table 15 to paragraph (c). A FDICsupervised institution also must
disclose the full terms and conditions of
all instruments included in regulatory
capital.
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BILLING CODE 6210–01–C; 6714–01–C; 4810–33–C
Subpart F—Risk-Weighted Assets—
Market Risk and Credit Valuation
Adjustment (CVA)
104. In § 324.201:
a. Revise paragraphs (b)(1)(i), (b)(2),
and (b)(5)(i); and
■ b. In paragraph (c)(6), remove the
citations ‘‘12 CFR 3.404, 12 CFR
263.202,’’.
The revisions are as follows:
■
■
§ 324.201 Purpose, applicability, and
reservation of authority.
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*
*
*
*
(b) * * *
(1) * * *
(i) The FDIC-supervised institution is:
(A) A Category II FDIC-supervised
institution, a Category III FDICsupervised institution or a Category IV
FDIC-supervised institution;
(B) A subsidiary of a global
systemically important BHC; or
*
*
*
*
*
(2) CVA Risk. The CVA risk-based
capital requirements specified in
§ 324.220 through § 324.225 apply to
any FDIC-supervised institution that is
a subsidiary of a global systemically
important BHC, a Category II FDICsupervised institution, a Category III
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FDIC-supervised institution, or a
Category IV FDIC-supervised institution.
*
*
*
*
*
(5) * * *
(i) An FDIC-supervised institution
that meets at least one of the standards
in paragraph (b)(1) of this section shall
remain subject to the relevant
requirements of this subpart F unless
and until it does not meet any of the
standards in paragraph (b)(1)(ii) of this
section for each of four consecutive
quarters as reported in the FDICsupervised institution’s Call Report, and
it is not a subsidiary of a global
systemically important BHC, a Category
II FDIC-supervised institution, a
Category III FDIC-supervised institution,
or Category IV FDIC-supervised
institution, and the FDIC-supervised
institution provides notice to the FDIC.
*
*
*
*
*
■ 105. In § 324.202, revise the definition
for ‘‘Prime RMBS’’ to read as follows:
§ 324.202
Definitions.
*
*
*
*
*
Prime RMBS means a security that
references underlying exposures that
consist primarily of qualified residential
mortgages as defined under § 373.13(a)
of this subchapter.
*
*
*
*
*
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Subpart G—Transition Provisions
106. In § 324.300:
a. Revise paragraph (a);
b. Add paragraph (b);
c. Remove paragraphs (c) and (d);
d. Redesignate paragraph (e) as new
paragraph (c); and
■ e. Remove paragraphs (f) through (h).
The revision and addition read as
follows:
■
■
■
■
■
§ 324.300
Transitions.
(a) Transition adjustments for AOCI.
Beginning July 1, 2025, a Category III
FDIC-supervised institution or a
Category IV FDIC-supervised institution
must subtract from the sum of its
common equity tier 1 elements, before
making deductions required under
§ 324.22(c) or (d), the AOCI adjustment
amount multiplied by the percentage
provided in Table 1 to § 324.300.
The transition AOCI adjustment
amount is the sum of:
(1) Net unrealized gains or losses on
available-for-sale debt securities, plus
(2) Accumulated net gains or losses
on cash flow hedges, plus
(3) Any amounts recorded in AOCI
attributed to defined benefit
postretirement plans resulting from the
initial and subsequent application of the
relevant GAAP standards that pertain to
such plans, plus
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(4) Net unrealized holding gains or
losses on held-to-maturity securities
that are included in AOCI.
(b) Expanded total risk-weighted
assets. Beginning July 1, 2025, an FDICsupervised institution subject to subpart
E of this part must comply with the
requirements of subpart B of this part
using transition expanded total riskweighted assets as calculated under this
paragraph in place of expanded total
risk-weighted assets. Transition
expanded total risk-weighted assets is
an FDIC-supervised institution’s
expanded total risk-weighted assets
multiplied by the percentage provided
in Table 2 to § 324.300.
*
period, and increase total leverage
exposure for purposes of the
supplementary leverage ratio by twentyfive percent of its CECL transitional
amount during the third year of the
transition period.
(d) * * *
(2) * * *
(ii) An FDIC-supervised institution
subject to subpart E of this part that has
elected the 2020 CECL transition
provision described in this paragraph
(d) may increase total leverage exposure
for purposes of the supplementary
leverage ratio by one-hundred percent of
its modified CECL transitional amount
during the first year of the transition
period, increase total leverage exposure
for purposes of the supplementary
leverage ratio by one hundred percent of
its modified CECL transitional amount
during the second year of the transition
period, increase total leverage exposure
for purposes of the supplementary
leverage ratio by seventy-five percent of
its modified CECL transitional amount
during the third year of the transition
period, increase total leverage exposure
for purposes of the supplementary
leverage ratio by fifty percent of its
modified CECL transitional amount
during the fourth year of the transition
period, and increase total leverage
exposure for purposes of the
supplementary leverage ratio by twentyfive percent of its modified CECL
transitional amount during the fifth year
of the transition period.
*
*
*
*
*
§ 324.301 Current expected credit losses
(CECL) transition.
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*
*
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*
(c) * * *
(2) For purposes of the election
described in paragraph (a)(1) of this
section, an FDIC-supervised institution
subject to subpart E of this part must
increase total leverage exposure for
purposes of the supplementary leverage
ratio by seventy-five percent of its CECL
transitional amount during the first year
of the transition period, increase total
leverage exposure for purposes of the
supplementary leverage ratio by fifty
percent of its CECL transitional amount
during the second year of the transition
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§ 324.303
■
§ 324.304
■
[Removed and Reserved]
108. Remove and reserve § 324.303.
[Removed and Reserved]
109. Remove and reserve § 324.304.
Subpart H—Prompt Corrective Action
■
110. In § 324.401:
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*
*
*
107. In § 324.301:
a. Remove paragraph (b)(5);
b. Revise paragraph (c)(2);
c. Revise paragraph (d)(2)(ii); and
d. Remove and reserve paragraph (e).
The revisions read as follows:
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■
■
■
■
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Federal Register / Vol. 88, No. 179 / Monday, September 18, 2023 / Proposed Rules
a. Revise paragraph (c);
b. Remove and reserve paragraph (f);
and
■ c. Revise paragraph (g).
The revisions read as follows:
■
■
§ 324.401 Authority, purpose, scope, other
supervisory authority, disclosure of capital
categories, and transition procedures.
*
*
*
*
(c) Scope. This subpart H implements
the provisions of section 38 of the FDI
Act as they apply to FDIC-supervised
institutions and insured branches of
foreign banks for which the FDIC is the
appropriate Federal banking agency.
Certain of these provisions also apply to
officers, directors and employees of
those insured institutions. In addition,
certain provisions of this subpart apply
to all insured depository institutions
that are deemed critically
undercapitalized.
*
*
*
*
*
(g) For purposes of subpart H, total
assets means quarterly average total
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assets as reported in an FDIC-supervised
institution’s Call Report, minus amounts
deducted from tier 1 capital under
§ 324.22(a), (c), and (d). At its
discretion, the FDIC may calculate total
assets using an FDIC-supervised
institution’s period-end assets rather
than quarterly average assets.
■ 111. Amend § 324.403, by revising
paragraphs (a)(1)(iv)(B), (b)(2)(vi), and
(b)(3)(v) to read as follows:
§ 324.403 Capital measures and capital
category definitions.
(a) * * *
(1) * * *
(iv) * * *
(B) With respect to an FDICsupervised institution subject to subpart
E of this part, the supplementary
leverage ratio.
*
*
*
*
*
(b) * * *
(2) * * *
(vi) An FDIC-supervised institution
subject to subpart E of this part will be
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deemed to be ‘‘adequately capitalized’’
if it satisfies paragraphs (b)(2)(i) through
(v) of this section and has a
supplementary leverage ratio of 3.0
percent or greater, as calculated in
accordance with § 324.10.
(3) * * *
(v) An FDIC-supervised institution
subject to subpart E of this part will be
deemed to be ‘‘undercapitalized’’ if it
has a supplementary leverage ratio of
less than 3.0 percent, as calculated in
accordance with § 324.10.
*
*
*
*
*
§ § 324.1, 324.2, 324.10, 324.12, 324.22,
324.61, 324.302, 324.305 [Amended]
112. In the table below, for each
section indicated in the left column,
remove the words indicated in the
middle column from wherever it
appears in the section, and add the
words indicated in the right column:
■
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Federal Register / Vol. 88, No. 179 / Monday, September 18, 2023 / Proposed Rules
Michael J. Hsu,
Acting Comptroller of the Currency.
By order of the Board of Governors of the
Federal Reserve System.
Ann E. Misback,
Secretary of the Board.
64343
By order of the Board of Directors.
Dated at Washington, DC, on July 27, 2023.
James P. Sheesley,
Assistant Executive Secretary.
[FR Doc. 2023–19200 Filed 9–1–23; 8:45 am]
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Federal Deposit Insurance Corporation.
]]>Agencies
[Federal Register Volume 88, Number 179 (Monday, September 18, 2023)]
[Proposed Rules]
[Pages 64028-64343]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2023-19200]
[[Page 64027]]
Vol. 88
Monday,
No. 179
September 18, 2023
Part II
Department of the Treasury
-----------------------------------------------------------------------
Office of the Comptroller of the Currency
12 CFR Parts 3, 6, 32, et al.
Federal Reserve System
-----------------------------------------------------------------------
Federal Deposit Insurance Corporation
-----------------------------------------------------------------------
Regulatory Capital Rule: Large Banking Organizations and Banking
Organizations With Significant Trading Activity; Proposed Rule
Federal Register / Vol. 88, No. 179 / Monday, September 18, 2023 /
Proposed Rules
[[Page 64028]]
DEPARTMENT OF THE TREASURY
Office of the Comptroller of the Currency
12 CFR Parts 3, 6, 32
[Docket ID OCC-2023-0008]
RIN 1557-AE78
FEDERAL RESERVE SYSTEM
12 CFR Parts 208, 217, 225, 238, 252
[Docket No. R-1813]
RIN 7100-AG64
FEDERAL DEPOSIT INSURANCE CORPORATION
12 CFR Part 324
RIN 3064-AF29
Regulatory Capital Rule: Large Banking Organizations and Banking
Organizations With Significant Trading Activity
AGENCY: Office of the Comptroller of the Currency, Treasury; the Board
of Governors of the Federal Reserve System; and the Federal Deposit
Insurance Corporation.
ACTION: Notice of proposed rulemaking.
-----------------------------------------------------------------------
SUMMARY: The Office of the Comptroller of the Currency, the Board of
Governors of the Federal Reserve System, and the Federal Deposit
Insurance Corporation are inviting public comment on a notice of
proposed rulemaking (proposal) that would substantially revise the
capital requirements applicable to large banking organizations and to
banking organizations with significant trading activity. The revisions
set forth in the proposal would improve the calculation of risk-based
capital requirements to better reflect the risks of these banking
organizations' exposures, reduce the complexity of the framework,
enhance the consistency of requirements across these banking
organizations, and facilitate more effective supervisory and market
assessments of capital adequacy. The revisions would include replacing
current requirements that include the use of banking organizations'
internal models for credit risk and operational risk with standardized
approaches and replacing the current market risk and credit valuation
adjustment risk requirements with revised approaches. The proposed
revisions would be generally consistent with recent changes to
international capital standards issued by the Basel Committee on
Banking Supervision. The proposal would not amend the capital
requirements applicable to smaller, less complex banking organizations.
DATES: Comments must be received by November 30, 2023.
ADDRESSES: Comments should be directed to:
OCC: Commenters are encouraged to submit comments through the
Federal eRulemaking Portal, if possible. Please use the title
``Regulatory capital rule: Amendments applicable to large banking
organizations and to banking organizations with significant trading
activity'' to facilitate the organization and distribution of the
comments. You may submit comments by any of the following methods:
Federal eRulemaking Portal--Regulations.gov:
Go to https://regulations.gov/. Enter ``Docket ID OCC-2023-0008''
in the Search Box and click ``Search.'' Public comments can be
submitted via the ``Comment'' box below the displayed document
information or by clicking on the document title and then clicking the
``Comment'' box on the top-left side of the screen. For help with
submitting effective comments, please click on ``Commenter's
Checklist.'' For assistance with the Regulations.gov site, please call
1-866-498-2945 (toll free) Monday-Friday, 9 a.m.-5 p.m. ET, or email
[email protected].
Mail: Chief Counsel's Office, Attention: Comment
Processing, Office of the Comptroller of the Currency, 400 7th Street
SW, Suite 3E-218, Washington, DC 20219.
Hand Delivery/Courier: 400 7th Street SW, Suite 3E-218,
Washington, DC 20219.
Instructions: You must include ``OCC'' as the agency name and
``Docket ID OCC-2023-0008'' in your comment. In general, the OCC will
enter all comments received into the docket and publish the comments on
the Regulations.gov website without change, including any business or
personal information provided such as name and address information,
email addresses, or phone numbers. Comments received, including
attachments and other supporting materials, are part of the public
record and subject to public disclosure. Do not include any information
in your comment or supporting materials that you consider confidential
or inappropriate for public disclosure.
You may review comments and other related materials that pertain to
this action by the following method:
Viewing Comments Electronically--Regulations.gov:
Go to https://regulations.gov/. Enter ``Docket ID OCC-2023-0008''
in the Search Box and click ``Search.'' Click on the ``Dockets'' tab
and then the document's title. After clicking the document's title,
click the ``Browse All Comments'' tab. Comments can be viewed and
filtered by clicking on the ``Sort By'' drop-down on the right side of
the screen or the ``Refine Comments Results'' options on the left side
of the screen. Supporting materials can be viewed by clicking on the
``Browse Documents'' tab. Click on the ``Sort By'' drop-down on the
right side of the screen or the ``Refine Results'' options on the left
side of the screen checking the ``Supporting & Related Material''
checkbox. For assistance with the Regulations.gov site, please call 1-
866-498-2945 (toll free) Monday-Friday, 9 a.m.-5 p.m. ET, or email
[email protected].
The docket may be viewed after the close of the comment period in
the same manner as during the comment period.
Board: You may submit comments, identified by Docket No. R-1813,
RIN 7100-AG64 by any of the following methods:
Agency Website: https://www.federalreserve.gov. Follow the
instructions for submitting comments at https://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm.
Federal eRulemaking Portal: https://www.regulations.gov. Follow the
instructions for submitting comments.
Email: [email protected]. Include the docket number
and RIN in the subject line of the message.
Fax: (202) 452-3819 or (202) 452-3102.
Mail: Ann E. Misback, Secretary, Board of Governors of the Federal
Reserve System, 20th Street and Constitution Avenue NW, Washington, DC
20551.
In general, all public comments will be made available on the
Board's website at www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm as submitted, and will not be modified to remove
confidential, contact or any identifiable information. Public comments
may also be viewed electronically or in paper in Room M-4365A, 2001 C
St. NW, Washington, DC 20551, between 9 a.m. and 5 p.m. during Federal
business weekdays.
FDIC: The FDIC encourages interested parties to submit written
comments. Please include your name, affiliation, address, email
address, and telephone number(s) in your comment. You may submit
comments to the FDIC, identified by RIN 3064-AF29 by any of the
following methods:
Agency Website: https://www.fdic.gov/resources/regulations/
[[Page 64029]]
federal-register-publications. Follow instructions for submitting
comments on the FDIC's website.
Mail: James P. Sheesley, Assistant Executive Secretary, Attention:
Comments/Legal OES (RIN 3064-AF29), Federal Deposit Insurance
Corporation, 550 17th Street NW, Washington, DC 20429.
Hand Delivered/Courier: Comments may be hand-delivered to the guard
station at the rear of the 550 17th Street NW, building (located on F
Street NW) on business days between 7 a.m. and 5 p.m.
Email: [email protected]. Include the RIN 3064-AF29 on the subject
line of the message.
Public Inspection: Comments received, including any personal
information provided, may be posted without change to https://www.fdic.gov/resources/regulations/federal-register-publications.
Commenters should submit only information that the commenter wishes to
make available publicly. The FDIC may review, redact, or refrain from
posting all or any portion of any comment that it may deem to be
inappropriate for publication, such as irrelevant or obscene material.
The FDIC may post only a single representative example of identical or
substantially identical comments, and in such cases will generally
identify the number of identical or substantially identical comments
represented by the posted example. All comments that have been
redacted, as well as those that have not been posted, that contain
comments on the merits of this document will be retained in the public
comment file and will be considered as required under all applicable
laws. All comments may be accessible under the Freedom of Information
Act.
FOR FURTHER INFORMATION CONTACT:
OCC: Venus Fan, Risk Expert, Benjamin Pegg, Analyst, Andrew
Tschirhart, Risk Expert, or Diana Wei, Risk Expert, Capital Policy,
(202) 649-6370; Carl Kaminski, Assistant Director, Kevin Korzeniewski,
Counsel, Rima Kundnani, Counsel, Daniel Perez, Counsel, or Daniel
Sufranski, Senior Attorney, Chief Counsel's Office, (202) 649-5490,
Office of the Comptroller of the Currency, 400 7th Street SW,
Washington, DC 20219. If you are deaf, hard of hearing, or have a
speech disability, please dial 7-1-1 to access telecommunications relay
services.
Board: Anna Lee Hewko, Associate Director, (202) 530-6260; Brian
Chernoff, Manager, (202) 452-2952; Andrew Willis, Manager, (202) 912-
4323; Cecily Boggs, Lead Financial Institution Policy Analyst, (202)
530-6209; Marco Migueis, Principal Economist, (202) 452-6447; Diana
Iercosan, Principal Economist, (202) 912-4648; Nadya Zeltser, Senior
Financial Institution Policy Analyst, (202) 452-3164; Division of
Supervision and Regulation; or Jay Schwarz, Assistant General Counsel,
(202) 452-2970; Mark Buresh, Special Counsel, (202) 452-5270; Andrew
Hartlage, Special Counsel, (202) 452-6483; Gillian Burgess, Senior
Counsel, (202) 736-5564; Jonah Kind, Senior Counsel, (202) 452-2045,
Legal Division, Board of Governors of the Federal Reserve System, 20th
Street and Constitution Avenue NW, Washington, DC 20551. For users of
TTY-TRS, please call 711 from any telephone, anywhere in the United
States.
FDIC: Benedetto Bosco, Chief Capital Policy Section; Bob Charurat,
Corporate Expert; Irina Leonova, Corporate Expert; Andrew Carayiannis,
Chief, Policy and Risk Analytics Section; Brian Cox, Chief, Capital
Markets Strategies Section; Noah Cuttler, Senior Policy Analyst; David
Riley, Senior Policy Analyst; Michael Maloney, Senior Policy Analyst;
Richard Smith, Capital Markets Policy Analyst; Olga Lionakis, Capital
Markets Policy Analyst; Kyle McCormick, Senior Policy Analyst; Keith
Bergstresser, Senior Policy Analyst, Capital Markets and Accounting
Policy Branch, Division of Risk Management Supervision; Catherine Wood,
Counsel; Benjamin Klein, Counsel; Anjoly David, Honors Attorney, Legal
Division; [email protected], (202) 898-6888; Federal Deposit
Insurance Corporation, 550 17th Street NW, Washington, DC 20429.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Introduction
A. Overview of the Proposal
B. Use of Internal Models Under the Proposed Framework
II. Scope of Application
III. Proposed Changes to the Capital Rule
A. Calculation of Capital Ratios and Application of Buffer
Requirements
1. Standardized Output Floor
2. Stress Capital Buffer Requirement
B. Definition of Capital
1. Accumulated Other Comprehensive Income
2. Regulatory Capital Deductions
3. Additional Definition of Capital Adjustments
4. Changes to the Definition of Tier 2 Capital Applicable to
Large Banking Organizations
C. Credit Risk
1. Due Diligence
2. Proposed Risk Weights for Credit Risk
3. Off-Balance Sheet Exposures
4. Derivatives
5. Credit Risk Mitigation
D. Securitization Framework
1. Operational Requirements
2. Securitization Standardized Approach (SEC-SA)
3. Exceptions to the SEC-SA Risk-Based Capital Treatment for
Securitization Exposures
4. Credit Risk Mitigation for Securitization Exposures
E. Equity Exposures
1. Risk-Weighted Asset Amount
F. Operational Risk
1. Business Indicator
2. Business Indicator Component
3. Internal Loss Multiplier
4. Operational Risk Management and Data Collection Requirements
G. Disclosure Requirements
1. Proposed Disclosure Requirements
2. Specific Public Disclosure Requirements
H. Market Risk
1. Background
2. Scope and Application of the Proposed Rule
3. Market Risk Covered Position
4. Internal Risk Transfers
5. General Requirements for Market Risk
6. Measure for Market Risk
7. Standardized Measure for Market Risk
8. Models-Based Measure for Market Risk
9. Treatment of Certain Market Risk Covered Positions
10. Reporting and Disclosure Requirements
11. Technical Amendments
I. Credit Valuation Adjustment Risk
1. Background
2. Scope of Application
3. CVA Risk Covered Positions and CVA Hedges
4. General Risk Management Requirements
5. Measure for CVA Risk
IV. Transition Provisions
A. Transitions for Expanded Total Risk-Weighted Assets
B. AOCI Regulatory Capital Adjustments
V. Impact and Economic Analysis
A. Scope and Data
B. Impact on Risk-Weighted Assets and Capital Requirements
C. Economic Impact on Lending Activity
D. Economic Impact on Trading Activity
E. Additional Impact Considerations
VI. Technical Amendments to the Capital Rule
A. Additional OCC Technical Amendments
B. Additional FDIC Technical Amendments
VII. Proposed Amendments to Related Rules and Related Proposals
A. OCC Amendments
B. Board Amendments
C. Related Proposals
VIII. Administrative Law Matters
A. Paperwork Reduction Act
B. Regulatory Flexibility Act
C. Plain Language
D. Riegle Community Development and Regulatory Improvement Act
of 1994
E. OCC Unfunded Mandates Reform Act of 1995 Determination
F. Providing Accountability Through Transparency Act of 2023
I. Introduction
The Office of the Comptroller of the Currency (OCC), the Board of
Governors
[[Page 64030]]
of the Federal Reserve System (Board), and the Federal Deposit
Insurance Corporation (FDIC) (collectively, the agencies) are proposing
to modify the capital requirements applicable to banking organizations
\1\ with total assets of $100 billion or more and their subsidiary
depository institutions (large banking organizations) and to banking
organizations with significant trading activity. The revisions set
forth in the proposal would strengthen the calculation of risk-based
capital requirements to better reflect the risks of these banking
organizations' exposures. In addition, the proposed revisions would
enhance the consistency of requirements across large banking
organizations and facilitate more effective supervisory and market
assessments of capital adequacy.
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\1\ The term ``banking organizations'' includes national banks,
state member banks, state nonmember banks, Federal savings
associations, state savings associations, top-tier bank holding
companies domiciled in the United States not subject to the Board's
Small Bank Holding Company and Savings and Loan Holding Company
Policy Statement (12 CFR part 225, appendix C), U.S. intermediate
holding companies of foreign banking organizations, and top-tier
savings and loan holding companies domiciled in the United States,
except for certain savings and loan holding companies that are
substantially engaged in insurance underwriting or commercial
activities and savings and loan holding companies that are subject
to the Small Bank Holding Company and Savings and Loan Holding
Company Policy Statement.
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Following the 2007-09 financial crisis, the agencies adopted an
initial set of reforms to improve the effectiveness of and address
weaknesses in the regulatory capital framework. For example, in 2013,
the agencies adopted a final rule that increased the quantity and
quality of regulatory capital banking organizations must maintain.\2\
These changes were broadly consistent with an initial set of reforms
published by the Basel Committee on Banking Supervision (Basel
Committee) following the financial crisis.\3\ The Board also
implemented capital planning and stress testing requirements for large
bank holding companies and savings and loan holding companies \4\ and
an additional capital buffer requirement to mitigate the financial
stability risks posed by U.S. global systemically important banking
organizations (GSIBs),\5\ as well as other enhanced prudential
standards, consistent with the Dodd-Frank Wall Street Reform and
Consumer Protection Act of 2010 (Dodd-Frank Act).\6\
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\2\ The Board and the OCC issued a joint final rule on October
11, 2013 (78 FR 62018) and the FDIC issued a substantially identical
interim final rule on September 10, 2013 (78 FR 55340). In April
2014, the FDIC adopted the interim final rule as a final rule with
no substantive changes. 79 FR 20754 (April 14, 2014).
\3\ The Basel Committee is a committee composed of central banks
and banking supervisory authorities, which was established by the
central bank governors of the G-10 countries in 1975.
\4\ See 12 CFR 225.8; 12 CFR part 238, subparts N, O, P, R, S;
12 CFR part 252, subparts D, E, F, N, O.
\5\ 12 CFR part 217, subpart H.
\6\ See 12 CFR part 252; 12 U.S.C. 5365.
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The proposal would build on these initial reforms by making
additional changes developed in response to the 2007-09 financial
crisis and informed by experience since the crisis. Requirements under
the proposal would generally be consistent with international capital
standards issued by the Basel Committee, commonly known as the Basel
III reforms.\7\ Where appropriate, the proposal differs from the Basel
III reforms to reflect, for example, specific characteristics of U.S.
markets, requirements under U.S. generally accepted accounting
principles (GAAP),\8\ practices of U.S. banking organizations, and U.S.
legal requirements and policy objectives.
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\7\ See the consolidated Basel Framework at https://www.bis.org/basel_framework/.
\8\ GAAP often serve as a foundational measurement component for
U.S. capital requirements.
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The proposal would strengthen risk-based capital requirements for
large banking organizations by improving their comprehensiveness and
risk sensitivity. These proposed revisions, including removal of
certain internal models, would increase capital requirements in the
aggregate, in particular for those banking organizations with
heightened risk profiles. Increased capital requirements can produce
both economic costs and benefits. The agencies assessed the likely
effect of the proposal on economic activity and resilience, and expect
that the benefits of strengthening capital requirements for large
banking organizations outweigh the costs.\9\
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\9\ See the impact and economic analysis presented in section V
of this SUPPLEMENTARY INFORMATION.
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Historical experience has demonstrated the impact individual
banking organizations can have on the stability of the U.S. banking
system, in particular banking organizations that would have been
subject to the proposal. Large banking organizations that experience an
increase in their capital requirements resulting from the proposal
would be expected to be able to absorb losses with reduced disruption
to financial intermediation in the U.S. economy. Enhanced resilience of
the banking sector supports more stable lending through the economic
cycle and diminishes the likelihood of financial crises and their
associated costs.
The agencies seek comment on all aspects of the proposal.
A. Overview of the Proposal
The proposal would improve the risk capture and consistency of
capital requirements across large banking organizations and reduce
complexity and operational costs through changes across multiple areas
of the agencies' risk-based capital framework. For most parts of the
framework, the proposal would eliminate the use of banking
organizations' internal models to set regulatory capital requirements
and in their place apply a simpler and more consistent standardized
framework. For market risk, the proposal would retain banking
organizations' ability to use internal models, with an improved models-
based measure for market risk that better accounts for potential
losses. The use of internal models would be subject to enhanced
requirements for model approval and performance and a new ``output
floor'' to limit the extent to which a banking organization's internal
models may reduce its overall capital requirement. The proposal would
also adopt new standardized approaches for market risk and credit
valuation adjustment (CVA) risk that better reflect the risks of
banking organizations' exposures.
This new framework for calculating risk-weighted assets (the
expanded risk-based approach) would apply to banking organizations with
total assets of $100 billion or more and their subsidiary depository
institutions. The revised requirements for market risk would also apply
to other banking organizations with $5 billion or more in trading
assets plus trading liabilities or for which trading assets plus
trading liabilities exceed 10 percent of total assets.
The expanded risk-based approach would be more risk-sensitive than
the current U.S. standardized approach by incorporating more credit-
risk drivers (for example, borrower and loan characteristics) and
explicitly differentiating between more types of risk (for example,
operational risk, credit valuation adjustment risk). In this manner,
the expanded risk-based approach would better account for key risks
faced by large banking organizations. The proposed changes would also
enhance the alignment of capital requirements to the risks of banking
organizations' exposures and increase incentives for prudent risk
management.
To ensure that large banking organizations would not have lower
capital requirements than smaller, less complex banking organizations,
the
[[Page 64031]]
proposal would maintain the capital rule's dual-requirement structure.
Under this structure, a large banking organization would be required to
calculate its risk-based capital ratios under both the new expanded
risk-based approach and the standardized approach (including market
risk, as applicable), and use the lower of the two for each risk-based
capital ratio.\10\ All capital buffer requirements, including the
stress capital buffer requirement, would apply regardless of whether
the expanded risk-based approach or the existing standardized approach
produces the lower ratio.
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\10\ Banking organizations' risk-based capital ratios are the
common equity tier 1 capital ratio, tier 1 capital ratio, and total
capital ratio. See 12 CFR 3.10 (OCC), 12 CFR 217.10 (Board), and 12
CFR 324.10 (FDIC).
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For banking organizations subject to Category III or IV capital
standards,\11\ the proposal would align the calculation of regulatory
capital--the numerator of the regulatory capital ratios--with the
calculation for banking organizations subject to Category I or II
capital standards, providing the same approach for all large banking
organizations. Banking organizations subject to Category III or IV
capital standards would be subject to the same treatment of accumulated
other comprehensive income (AOCI), capital deductions, and rules for
minority interest as banking organizations subject to Category I or II
capital standards. This change would help ensure that the regulatory
capital ratios of these banking organizations better reflect their
capacity to absorb losses, including by taking into account unrealized
losses or gains on securities positions reflected in AOCI.
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\11\ In 2019, the agencies adopted rules establishing four
categories of capital standards for U.S. banking organizations with
$100 billion or more in total assets and foreign banking
organizations with $100 billion or more in combined U.S. assets.
Under this framework, Category I capital standards apply to U.S.
global systemically important bank holding companies and their
depository institution subsidiaries. Category II capital standards
apply to banking organizations with at least $700 billion in total
consolidated assets or at least $75 billion in cross-jurisdictional
activity and their depository institution subsidiaries. Category III
capital standards apply to banking organizations with total
consolidated assets of at least $250 billion or at least $75 billion
in weighted short-term wholesale funding, nonbank assets, or off-
balance sheet exposure and their depository institution
subsidiaries. Category IV capital standards apply to banking
organizations with total consolidated assets of at least $100
billion that do not meet the thresholds for a higher category and
their depository institution subsidiaries. See 12 CFR 3.2 (OCC), 12
CFR 252.5, 12 CFR 238.10 (Board), 12 CFR 324.2 (FDIC); ``Prudential
Standards for Large Bank Holding Companies, Savings and Loan Holding
Companies, and Foreign Banking Organizations,'' 84 FR 59032
(November 1, 2019); and ``Changes to Applicability Thresholds for
Regulatory Capital and Liquidity Requirements,'' 84 FR 59230
(November 1, 2019).
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The proposal would expand application of the supplementary leverage
ratio and the countercyclical capital buffer to banking organizations
subject to Category IV capital standards. This change would bring
further alignment of capital requirements across large banking
organizations and is consistent with the proposal's goal of
strengthening the resilience of large banking organizations.
The proposal would also introduce enhanced disclosure requirements
to facilitate market participants' understanding of a banking
organization's financial condition and risk management practices. Also,
the proposal would align Federal Reserve's regulatory reporting
requirements with the changes to capital requirements. The agencies
anticipate that revisions to the reporting forms of the Federal
Financial Institutions Examination Council (FFIEC) applicable to large
banking organizations and to banking organizations with significant
trading activity will be proposed in the near future, which would align
with the proposed revisions to the capital rule.
The proposed changes would take effect subject to the transition
provisions described in section IV of this SUPPLEMENTARY INFORMATION.
The revisions introduced by the proposal would interact with
several Board rules, including by modifying the risk-weighted assets
used to calculate total loss-absorbing capacity requirements, long-term
debt requirements, and the short-term wholesale funding score included
in the GSIB surcharge method 2 score. Also, the proposal would revise
the calculation of single-counterparty credit limits by removing the
option of using a banking organization's internal models to calculate
derivatives exposure amounts and requiring the use of the standardized
approach for counterparty credit risk for this purpose. The proposal
would also remove the exemption from calculating risk-weighted assets
under subpart E of the capital rule currently available to U.S.
intermediate holding companies of foreign banking organizations under
the Board's enhanced prudential standards.
In parallel, the Board is issuing a notice of proposed rulemaking
revising the GSIB surcharge calculation applicable to GSIBs and the
systemic risk report applicable to large banking organizations.\12\
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\12\ On October 24, 2019, the Board published in the Federal
Register a notice of proposed rulemaking inviting comment on a
proposal to establish risk-based capital requirements for depository
institution holding companies significantly engaged in insurance
activities. See 84 FR 57240 (October 24, 2019). The Board
anticipates that any final rule based on the proposal in this
Supplementary Information would include appropriate adjustments as
necessary to take into account any final insurance capital rule.
---------------------------------------------------------------------------
Question 1: The Board invites comment on the interaction of the
revisions under the proposal with other existing rules and with the
other notice of proposed rulemaking. In particular, comment is invited
on the impact of the proposal on the single-counterparty credit limit
framework. What are the advantages and disadvantages of the proposed
approach? Which alternatives, if any, should the Board consider and
why?
B. Use of Internal Models Under the Proposed Framework
The proposal would remove the use of internal models to set credit
risk and operational risk capital requirements (the so-called advanced
approaches) for banking organizations subject to Category I or II
capital standards. These internal models rely on a banking
organization's choice of modeling assumptions and supporting data. Such
model assumptions include a degree of subjectivity, which can result in
varying risk-based capital requirements for similar exposures.
Moreover, empirical verification of modeling choices can require many
years of historical experience because severe credit risk and
operational risk losses can occur infrequently. In the agencies'
previous observations, the advanced approaches have produced
unwarranted variability across banking organizations in requirements
for exposures with similar risks.\13\ This unwarranted variability,
combined with the complexity of these models-based approaches, can
reduce confidence in the validity of the modeled outputs, lessen the
transparency of the risk-based capital ratios, and challenge
comparisons of capital adequacy across banking organizations.
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\13\ The Basel Committee has published analysis illustrating the
variability of credit-risk-weighted assets across banking
organizations. See https://www.bis.org/publ/bcbs256.pdf and https://www.bis.org/bcbs/publ/d363.pdf.
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Standardization of credit and operational risk capital requirements
would improve the consistency of requirements. Standardized
requirements, together with robust public disclosure and reporting
requirements, would enhance the transparency of capital requirements
and the ability of supervisors and market participants to make
independent assessments of a banking
[[Page 64032]]
organization's capital adequacy, individually and relative to its
peers.
The use of robust, risk-sensitive standardized approaches for
credit and operational risk would also improve the efficiency of the
capital framework by reducing operational costs. Under the advanced
approaches, banking organizations subject to Category I or II capital
standards must develop and maintain internal modeling systems to
determine capital requirements, which may differ from the risk
measurement approaches they use to monitor risk for internal
assessments. Further, any material changes to a banking organization's
internal models must be fully documented and presented to the banking
organization's primary Federal supervisor for review.\14\ Replacing the
use of internal models with standardized approaches would reduce costs
associated with maintaining such modeling systems and eliminate the
associated submissions to the agencies.
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\14\ See 12 CFR 3.123(a) (OCC); 12 CFR 217.123(a) (Board); 12
CFR 324.123(a) (FDIC).
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Eliminating the use of internal models to set credit and
operational risk capital requirements would not reduce the overall risk
capture of the regulatory framework. In addition to the calculation of
expanded risk-based approach and standardized approach capital
requirements, a large banking organization would continue to be
required to maintain capital commensurate with the level and nature of
all risks to which the banking organization is exposed,\15\ to have a
process for assessing its overall capital adequacy in relation to its
risk profile and a comprehensive strategy for maintaining an
appropriate level of capital,\16\ and, where applicable, to conduct
internal stress tests.\17\ Also, holding companies subject to the
Board's capital plan rule would continue to be subject to a stress
capital buffer requirement that is based on a supervisory stress test
of the holding company's exposures.\18\ Although the proposal would
remove use of internal models for calculating capital requirements for
credit and operational risk, internal models can provide valuable
information to a banking organization's internal stress testing,
capital planning, and risk management functions. Large banking
organizations should employ internal modeling capabilities as
appropriate for the complexity of their activities.
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\15\ See 12 CFR 3.10(e)(1) (OCC); 12 CFR 217.10(e)(1) (Board);
12 CFR 324.10(e)(1) (FDIC).
\16\ See 12 CFR 3.10(e)(2) (OCC); 12 CFR 217.10(e)(2) (Board);
12 CFR 324.10(e)(2) (FDIC).
\17\ See 12 CFR 46 (OCC); 12 CFR 252 subpart B and F (Board); 12
CFR 325 (FDIC).
\18\ See 12 CFR 225.8 and 12 CFR 238.170.
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The proposal would continue to allow use of internal models to set
market risk capital requirements for portfolios where modeling can be
demonstrated to be appropriate. In addition, the proposal would provide
for conservative but risk-sensitive standardized alternatives where
modeling is not supported. In contrast to credit and operational risk,
market risk data allows for daily feedback on model performance to
support empirical verification. The proposal would limit the use of
models to only those trading desks for which a banking organization has
received approval from its primary Federal supervisor. Ongoing use of
such models would depend upon a banking organization's ability to
demonstrate through robust testing that the models are sufficiently
conservative and accurate for purposes of calculating market risk
capital requirements. In cases where a banking organization cannot
demonstrate acceptable performance of its internal models for a given
trading desk, the banking organization would be required to use the
standardized measure for market risk which acts as a risk-sensitive
alternative.
II. Scope of Application
The proposal's expanded risk-based approach would apply to banking
organizations with total assets of $100 billion or more and their
subsidiary depository institutions.\19\ These banking organizations are
large and exhibit heightened complexity. Application of the expanded
risk-based approach to large banking organizations would provide
granular, generally standardized requirements that result in robust
risk capture and appropriate risk sensitivity. By strengthening the
requirements that apply to large banking organizations, the proposal
would enhance their resilience and reduce risks to U.S. financial
stability and costs they may pose to the Federal Deposit Insurance Fund
in case of material distress or failure. Relative to smaller, less
complex banking organizations, these banking organizations have greater
operational capacity to apply more sophisticated requirements.
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\19\ The proposal would also apply to depository institutions
with total assets of $100 billion or more that are not consolidated
subsidiaries of depository institution holding companies, and to
depository institutions with total assets of $100 billion or more
that are subsidiaries of depository institution holding companies
that are not assigned a category under the capital rule.
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Previously, the agencies determined that the advanced approaches
requirements should not apply to banking organizations subject to
Category III or IV capital standards, as the agencies considered such
requirements to be overly complex and burdensome relative to the safety
and soundness benefits that they would provide for these banking
organizations.\20\ The expanded risk-based approach generally is based
on standardized requirements, which would be less complex and costly.
In addition, recent events demonstrate the impact banking organizations
subject to Category III or IV capital standards can have on financial
stability. While the recent failure of banking organizations subject to
Category IV capital standards may be attributed to a variety of
factors, the effect of these failures on financial stability supports
further alignment of the regulatory capital framework across large
banking organizations.
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\20\ See ``Prudential Standards for Large Bank Holding
Companies, Savings and Loan Holding Companies, and Foreign Banking
Organizations,'' 84 FR 59032 (November 1, 2019).
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Banking organizations with significant trading activities are
subject to substantial market risk and, therefore, would be subject to
market risk capital requirements. Recognizing that the dollar-based
threshold for the application of market risk requirements was
established in 1996, the proposal would increase this dollar-based
threshold from $1 billion to $5 billion of trading assets plus trading
liabilities. Banking organizations would also continue to be subject to
market risk requirements if their trading assets plus trading
liabilities represent 10 percent or more of total assets. The proposal
would revise the calculation of the dollar-based threshold amount to be
based on four-quarter averages of trading assets and trading
liabilities instead of point-in-time amounts. Banking organizations
that would no longer meet these minimum thresholds for being subject to
market risk capital requirements would calculate risk-weighted assets
for trading exposures under the standardized approach. Additionally,
under the proposal, large banking organizations would be subject to
market risk capital requirements regardless of trading activities.
The proposal would expand application of the countercyclical
capital buffer to banking organizations subject to Category IV capital
standards. The countercyclical capital buffer is a macroprudential tool
that can be used to increase the resilience of the financial system by
increasing capital requirements for large banking organizations during
a period of
[[Page 64033]]
elevated risk of above-normal losses. Failure or distress of a banking
organization with assets of $100 billion or more during a time of
elevated risk or stress can have significant destabilizing effects for
other banking organizations and the broader financial system--even if
the banking organization does not meet the criteria for being subject
to Category II or III capital standards. Applying the countercyclical
capital buffer to banking organizations subject to Category IV capital
standards would increase the resilience of these banking organizations
and, in turn, improve the resilience of the broader financial system.
The proposed approach also has the potential to moderate fluctuations
in the supply of credit over time. The proposal would also modify how
the countercyclical capital buffer amount is determined to reflect the
proposed changes to market risk capital requirements. Specifically, the
risk-weighted asset amount for private sector credit exposures that are
market risk covered positions under the proposal would be determined
using the standardized default risk capital requirement for such
positions rather than using the specific risk add-on of the current
rule.
The proposal also would expand application of the supplementary
leverage ratio requirement to banking organizations subject to Category
IV capital standards. In contrast to the risk-based capital
requirements, a leverage ratio does not differentiate the amount of
capital required by exposure type. Rather, a leverage ratio puts a
simple and transparent limit on banking organization leverage. Leverage
requirements protect against underestimation of risk both by banking
organizations and by risk-based capital requirements and serve as a
complement to risk-based capital requirements. The supplementary
leverage ratio measures tier 1 capital relative to total leverage
exposure, which includes on-balance sheet assets and certain off-
balance sheet exposures. The proposed change would ensure that all
large banking organizations are subject to a consistent and robust
leverage requirement that serves as a complement to risk-based capital
requirements and takes into account on- and off-balance sheet
exposures.
Question 2: What are the advantages and disadvantages of applying
the expanded risk-based approach to banking organizations subject to
Category III or IV capital standards? To what extent is the expanded
risk-based approach appropriate for banking organizations with
different risk profiles, including from a cost and operational burden
perspective? Are there specific areas, such as the market risk capital
framework, for which the agencies should consider a materiality
threshold to better balance cost and operational burden and risk
sensitivity, and if so what should that threshold be and why? What
would the appropriate exposure treatment be for banking organizations
with such exposures beneath any materiality threshold, and how would
that treatment be consistent with the overall calibration of the
expanded risk-based approach? What alternatives, if any, should the
agencies consider to help ensure that the risks of large banking
organizations are appropriately captured under minimum risk-based
capital requirements and why?
Question 3: What are the advantages and disadvantages of
harmonizing the calculation of regulatory capital across large banking
organizations? What are any unintended consequences of the proposal and
what steps should the agencies consider to mitigate those consequences?
What are the advantages and disadvantages of harmonizing the
calculation of regulatory capital across large banking organizations
and using different approaches (for example, the expanded risk-based
approach and the U.S. standardized approach) for the calculation of
risk-weighted assets?
Question 4: What are the advantages and disadvantages of applying
the countercyclical capital buffer and supplementary leverage ratio to
banking organizations subject to Category IV capital standards?
III. Proposed Changes to the Capital Rule
A. Calculation of Capital Ratios and Application of Buffer Requirements
Under the proposal, large banking organizations would be required
to calculate total risk-weighted assets under two approaches: (1) the
expanded risk-based approach, and (2) the standardized approach. Total
risk-weighted assets under the expanded risk-based approach (expanded
total risk-weighted assets) would equal the sum of risk-weighted assets
for credit risk, equity risk, operational risk, market risk, and CVA
risk, as described in this proposal, minus any amount of the banking
organization's adjusted allowance for credit losses that is not
included in tier 2 capital and any amount of allocated transfer risk
reserves. For calculating standardized total risk-weighted assets, the
proposal would revise the methodology for determining market risk-
weighted assets and would require banking organizations subject to
Category III or IV capital standards to use the standardized approach
for counterparty credit risk (SA-CCR) for derivative exposures.\21\
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\21\ The proposed methodology for determining market risk-
weighted assets, in certain instances, would require a banking
organization that is subject to subpart E to apply risk weights from
subpart D for purposes of determining its standardized total risk-
weighted assets and from subpart E for purposes of determining its
expanded total risk-weighted assets. This approach would apply in
the case of: (i) capital add-ons for re-designations, (ii) term
repo-style transactions the banking organization elects to include
in market risk, (iii) the standardized default risk capital
requirement for securitization positions non-CTP, and (iv) the
standardized default risk capital requirement for correlation
trading positions, each as discussed further below.
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To determine its applicable risk-based capital ratios, a large
banking organization would calculate two sets of risk-based capital
ratios (common equity tier 1 capital ratio, tier 1 capital ratio, and
total capital ratio), one using expanded total risk-weighted assets and
one using standardized total risk-weighted assets. A banking
organization's common equity tier 1 capital ratio, tier 1 capital
ratio, and total capital ratio would be the lower of each ratio of the
two approaches.
The proposal would not change the minimum risk-based capital ratios
under the capital rule. Also, the capital conservation buffer would
continue to apply to risk-based capital ratios as under the capital
rule, except that the stress capital buffer requirement--a component of
the capital conservation buffer that is applicable to banking
organizations subject to the Board's capital plan rule--would apply to
a banking organization's risk-based capital ratios regardless of
whether the ratios result from the expanded risk-based approach or the
standardized approach.
Question 5: What are the advantages and disadvantages of banking
organizations being required to calculate risk-based capital ratios in
two different ways and what alternatives, such as a single calculation,
should the agencies consider and why? What modifications, if any, to
the proposed structure of the risk-based capital calculation should the
agencies consider?
1. Standardized Output Floor
To enhance the consistency of capital requirements and ensure that
the use of internal models for market risk does not result in
unwarranted reductions in capital requirements, the proposal would
introduce an ``output floor'' to the calculation of expanded total
risk-
[[Page 64034]]
weighted assets. This output floor would correspond to 72.5 percent of
the sum of a banking organization's credit risk-weighted assets, equity
risk-weighted assets, operational risk-weighted assets, and CVA risk-
weighted assets under the expanded risk-based approach and risk-
weighted assets calculated using the standardized measure for market
risk, minus any amount of the banking organization's adjusted allowance
for credit losses that is not included in tier 2 capital and any amount
of allocated transfer risk reserves.
The output floor would serve as a lower bound on the risk-weighted
assets under the expanded risk-based approach. In other words, if the
risk-weighted assets under the expanded risk-based approach were less
than the output floor, the output floor would have to be used as the
risk-weighted asset amount to determine the expanded risk-based
approach capital ratios.
The proposed calibration of the output floor aims to strike a
balance between allowing internal models to enhance the risk
sensitivity of market risk capital requirements and ensuring that these
models would not result in unwarranted reductions in capital
requirements. The output floor would be consistent with the Basel III
reforms, which would promote consistency in capital requirements for
large, complex, and internationally active banking organizations across
jurisdictions.
[GRAPHIC] [TIFF OMITTED] TP18SE23.000
Question 6: What are the advantages and disadvantages of the
proposed output floor?
2. Stress Capital Buffer Requirement
Under the current capital rule, each banking organization is
subject to one or more buffer requirements, and must maintain capital
ratios above the sum of its minimum requirements and buffer
requirements to avoid restrictions on capital distributions and certain
discretionary bonus payments.\22\ Banking organizations that are
subject to the Board's capital plan rule \23\ (bank holding companies,
U.S. intermediate holding companies, and savings and loan holding
companies that have over $100 billion or more in total consolidated
assets) are currently subject to a standardized approach capital
conservation buffer requirement, which is calculated as the sum of the
banking organization's stress capital buffer requirement, applicable
countercyclical capital buffer requirement, and applicable GSIB
surcharge. The standardized approach capital conservation buffer
requirement applies to a banking organization's standardized approach
risk-based capital ratios. In addition, banking organizations that are
subject to the capital plan rule and the advanced approaches
requirements are subject to an advanced approaches capital conservation
buffer requirement, which applies to their advanced approaches risk-
based capital ratios, and which is calculated in the same manner as the
standardized approach capital conservation buffer requirement, except
that the banking organization's stress capital buffer requirement is
replaced with a 2.5 percent buffer requirement.\24\
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\22\ 12 CFR 3.11 (OCC); 12 CFR 217.11 (Board); 12 CFR 324.11
(FDIC).
\23\ 12 CFR 225.8 (bank holding companies and U.S. intermediate
holding companies of foreign banking organizations); 12 CFR 238.170
(savings and loan holding companies).
\24\ See 12 CFR 217.11(c).
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The stress capital buffer requirement integrates the results of the
Board's supervisory stress tests with the risk-based requirements of
the capital rule to determine capital distribution limitations. As a
result, required capital levels for each banking organization more
closely align with the banking organization's risk profile and
projected losses as measured by the Board's stress test.\25\ The stress
capital buffer requirement is generally calculated as (1) the
difference between the banking organization's starting and minimum
projected common equity tier 1 capital ratios under the severely
adverse scenario in the supervisory stress test (stress test losses)
plus (2) the sum of the dollar amount of the banking organization's
planned common stock dividends for each of the fourth through seventh
quarters of the planning horizon as a percentage of risk-weighted
assets (dividend add-on).\26\ A banking organization's stress capital
buffer requirement cannot be less than 2.5 percent of standardized
total risk-weighted assets.
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\25\ See 85 FR 15576 (March 18, 2020).
\26\ 12 CFR 225.8(f)(2); 12 CFR 238.170(f)(2).
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Currently, the stress test losses and dividend add-on portion of
the stress capital buffer requirement are calculated using only the
standardized approach common equity tier 1 capital ratio. This is
consistent with the exclusion of the stress capital buffer requirement
from the advanced approaches capital conservation buffer requirement,
and with the Board's stress testing and capital plan rules, under which
banking organizations are not required to project capital ratios using
the advanced approaches.
The Board is proposing to amend its capital plan rule, stress
testing rule, and the buffer framework in its capital rule to take into
account capital ratios calculated under the expanded risk-based
approach, in addition to the standardized approach. Under the proposal,
banking organizations subject to the capital plan rule would be subject
to a single capital conservation buffer requirement, which would
include the stress capital buffer requirement, applicable
countercyclical capital buffer requirement, and applicable GSIB
surcharge, and would apply to the banking organization's risk-based
capital ratios, regardless of whether the ratios result from the
expanded risk-based approach or the standardized approach. In this
manner, the proposal would ensure that the stress capital buffer
requirement contributes to the robustness and risk-sensitivity of the
[[Page 64035]]
risk-based capital requirements of these banking organizations.
Application of the stress capital buffer requirement to the risk-based
capital ratios derived from the expanded risk-based approach would not
introduce complexity given the fixed balance sheet assumption currently
used in the Board stress tests and because the expanded risk-based
approach is based in mostly standardized requirements.\27\
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\27\ Initially, the Board did not incorporate the stress capital
buffer requirement into the advanced approaches capital conservation
buffer requirement owing to the complexity involved in doing so.
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Additionally, the proposal would revise the calculation of the
stress capital buffer requirement for large banking organizations.
Under the proposal, both the stress test losses and dividend add-on
components of the stress capital buffer requirement would be calculated
using the binding common equity tier 1 capital ratio, as of the final
quarter of the previous capital plan cycle, regardless of whether it
results from the expanded risk-based approach or the standardized
approach.\28\ The proposed calculation methodology would limit
complexity relative to potential alternatives, such as introducing two
stress capital buffer requirements for each banking organization (one
for each approach to calculating total risk-weighted assets). In
addition, the proposed approach recognizes that the binding approach
for a banking organization is unlikely to change within the period in
which a given stress capital buffer requirement is applicable.
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\28\ The Board's Stress Testing Policy Statement includes an
assumption that the magnitude of a banking organization's balance
sheet will be fixed throughout the projection horizon under the
supervisory stress test. 12 CFR part 252, appendix B. Under this
assumption, because the denominators of the common equity tier 1
capital ratios as calculated under the standardized approach and the
expanded risk-based approach would remain the same throughout the
stress test, the approach under which the binding common equity tier
1 capital ratio is calculated would remain the same throughout the
final quarter of the previous capital plan cycle and the projection
horizon.
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As part of the capital buffer framework, the stress capital buffer
requirement helps ensure that a banking organization can withstand
losses from a severely adverse scenario, while still meeting its
minimum regulatory capital requirements and thereby continuing to serve
as a viable financial intermediary. Because this proposal aims to
better reflect the risk of banking organizations' exposures in the
calculation of risk-weighted assets, without changing the targeted
level of conservatism of the minimum capital requirements, the Board is
not proposing associated changes to the targeted severity of the stress
capital buffer requirement. The Board evaluates the minimum risk-based
capital requirements, which are largely determined by risk-weighted
assets, and the stress capital buffer requirement individually for
their specific intended purposes in the capital framework, and
holistically as they determine the aggregate capital banking
organizations hold in the normal course of business.
In addition to revising the stress capital buffer requirement, the
proposal would amend the Board's stress testing and capital plan rules
to require banking organizations subject to Category I, II, or III
standards to project their risk-based capital ratios in their company-
run stress tests and capital plans using the calculation approach that
results in the binding ratios as of the start of the projection horizon
(generally, as of December 31 of a given year). Also, the proposal
would require banking organizations subject to Category IV standards to
project their risk-based capital ratios under baseline conditions in
their capital plans and FR Y-14A submissions using the risk-weighted
assets calculation approach that results in the binding ratios as of
the start of the projection horizon. The use of the binding approach to
calculating risk-based capital ratios aims to conform company-run
stress tests and capital plans with the binding risk-based capital
ratios in the proposed capital rule and promote simplicity relative to
possible alternatives (such as requiring that firms project ratios
under both the expanded risk-based approach and the standardized
approach).
Question 7: The Board invites comment on the appropriate level of
risk capture for the risk-weighted assets framework and the stress
capital buffer requirement, both for their respective roles in the
capital framework and for their joint determination of overall capital
requirements. How should the Board balance considerations of overall
capital requirements with the distinct roles of minimum requirements
and buffer requirements? What adjustments, if any, to either piece of
the framework should the Board consider? Which, if any, specific
portfolios or exposure classes merit particular attention and why?
Question 8: What are the advantages and disadvantages of applying
the same stress capital buffer requirement to a banking organization's
risk-based capital ratios regardless of whether they are determined
using the standardized or expanded risk-based approach? What would be
the advantages and disadvantages of applying different stress capital
buffer requirements for each set of risk-based capital ratios?
Question 9: What, if any, adjustments should the Board consider
with respect to the buffer requirements to account for the transitions
in this proposal, particularly related to expanded total risk-weighted
assets? For example, what would be the advantages and disadvantages of
the Board determining stress capital buffer requirements using fully
phased-in expanded total risk-weighted assets versus transitional
expanded total risk-weighted assets? What, if any, additional
adjustments to stress capital buffer requirements should the Board
consider during the expanded total risk-weighted assets transition?
B. Definition of Capital
The agencies regularly review their capital framework to help
ensure it is functioning as intended. Consistent with this ongoing
assessment, the agencies believe it is appropriate to align the
definition of capital for banking organizations subject to Category III
or IV capital standards with the definition currently applicable to
banking organizations subject to Category I or II capital standards.
The current definition of capital applicable to banking organizations
subject to Category I or II capital standards provides for risk
sensitivity and transparency that is commensurate with the size,
complexity, and risk profile of banking organizations subject to
Category III or IV capital standards. The proposed alignment of the
numerator and denominator of regulatory capital ratios of large banking
organizations would support the transparency of the capital rule as it
facilitates market participants' assessment of loss absorbency and
would promote consistency of requirements across large banking
organizations.
As described in more detail below, under the proposal, banking
organizations subject to Category III or IV capital standards would be
required to recognize most elements of AOCI in regulatory capital
consistent with the treatment for banking organizations subject to
Category I or II capital standards. Banking organizations subject to
Category III or IV capital standards would also apply the capital
deductions and minority interest treatments that are currently
applicable to banking organizations subject to Category I or II capital
standards. The proposal would also apply total loss absorbing capacity
(TLAC) holdings deduction treatments to banking organizations subject
to Category III or IV capital standards. The proposal
[[Page 64036]]
includes a three-year transition period for AOCI.
1. Accumulated Other Comprehensive Income
Under the current capital rule, banking organizations subject to
Category I or II capital standards are required to include most
elements of AOCI in regulatory capital; whereas all other banking
organizations including those subject to Category III or IV capital
standards were provided an opportunity to make a one-time election to
opt-out of recognizing most elements of AOCI and related deferred tax
assets (DTAs) and deferred tax liabilities within regulatory capital
(AOCI opt-out banking organizations).\29\ Under the proposal,
consistent with the treatment applicable to banking organizations
subject to Category I or II capital standards, banking organizations
subject to Category III or IV capital standards would be required to
include all AOCI components in common equity tier 1 capital, except
gains and losses on cash-flow hedges where the hedged item is not
recognized on a banking organization's balance sheet at fair value.
This would require all net unrealized holding gains and losses on
available-for-sale (AFS) debt securities \30\ from changes in fair
value to flow through to common equity tier 1 capital, including those
that result primarily from fluctuations in benchmark interest rates.
This treatment would better reflect the point in time loss-absorbing
capacity of banking organizations subject to Category III or IV capital
standards and would align with banking organizations subject to
Category I or II capital standards.
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\29\ See 12 CFR 3.22(b) (OCC); 12 CFR 217.22(b) (Board); 12 CFR
324.22(b) (FDIC). A banking organization that made an opt-out
election is currently required to adjust common equity tier 1
capital as follows: subtract any net unrealized holding gains and
add any net unrealized holding losses on available-for-sale
securities; subtract any accumulated net gains and add any
accumulated net losses on cash flow hedges; subtract any amounts
recorded in AOCI attributed to defined benefit postretirement plans
resulting from the initial and subsequent application of the
relevant GAAP standards that pertain to such plans (excluding, at
the banking organization's option, the portion relating to pension
assets deducted under Sec. __.22(a)(5) of the current capital
rule); and, subtract any net unrealized holding gains and add any
net unrealized holding losses on held-to-maturity securities that
are included in AOCI.
\30\ AFS securities refers to debt securities. ASC Subtopic 321-
10 eliminated the classification of equity securities with readily
determinable fair values not held for trading as available-for-sale
and generally requires investments in equity securities to be
measured at fair value with changes in fair value recognized in net
income. Changes in the fair value of (i.e., the unrealized gains and
losses on) a banking organization's equity securities are recognized
through net income rather than other comprehensive income.
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The agencies have previously observed that the requirement to
recognize elements of AOCI in regulatory capital has helped improve the
transparency of regulatory capital ratios, as it better reflects
banking organizations' actual loss-absorbing capacity at a specific
point in time, notwithstanding the potential volatility that such
recognition may pose for their regulatory capital ratios. The agencies
have also previously observed that AOCI is an important indicator used
by market participants to evaluate the capital strength of a banking
organization.\31\ More recently, the agencies have observed generally
higher levels of securities classified as held-to-maturity (HTM) among
banking organizations that recognize AOCI in regulatory capital.\32\
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\31\ 84 FR 59230, 59249 (November 1, 2019).
\32\ GAAP set forth restrictions on the classification of a debt
security as HTM, circumstances not consistent with the HTM
classification, and situations that call into question or taint a
banking organization's intent to hold securities in the HTM
category.
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Changes in interest rates have led to net unrealized losses for
banking organizations' investment portfolios and brought into focus the
importance of regulatory capital measures reflecting the loss absorbing
capacity of a banking organization. The agencies have observed that
adverse trends in a banking organization's GAAP equity can have
negative market perception and liquidity implications.\33\
Specifically, net unrealized losses on AFS securities included in AOCI
have reduced banking organizations' tangible book value and liquidity
buffers,\34\ which can adversely affect market participants'
assessments of capital adequacy and liquidity. Banking organizations
are often reluctant to sell these AFS securities as the unrealized
losses would become realized losses upon sale, thus reducing regulatory
capital. However, banking organizations may need to take such steps in
order to meet liquidity needs. Recognizing elements of AOCI in
regulatory capital thus achieves a better alignment of regulatory
capital with market participants' assessment of loss-absorbing
capacity.
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\33\ See Board of Governors of the Federal Reserve System,
Supervision and Regulation Report, at 11 (November 2022); Office of
the Comptroller of the Currency, Semiannual Risk Perspective, at 22
(Fall 2022); Federal Deposit Insurance Corporation, Fourth Quarter
2022 Quarterly Banking Profile, at 5, 22 (February 2023), Managing
Sensitivity to Market Risk in a Challenging Interest Rate
Environment (FIL-46-2013, October 8, 2013).
\34\ See 12 CFR part 50 (OCC); 12 CFR part 249 (Board); 12 CFR
part 329 (FDIC).
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Question 10: What complementary measures should the banking
agencies consider regarding the regulatory capital treatment for
securities held as HTM rather than AFS?
2. Regulatory Capital Deductions
The agencies have long limited the amount of intangible and higher-
risk assets, such as mortgage servicing assets (MSAs) and certain
temporary difference DTAs, included in regulatory capital and required
deduction of the amounts above the limits. This is due to the
relatively high level of uncertainty regarding the ability of banking
organizations to both accurately value and realize value from these
assets, especially under adverse financial conditions. The current
capital rule also limits the amount of investments in the capital
instruments of other banking organizations that can be reflected in
regulatory capital. Furthermore, the current capital rule limits the
inclusion of minority interest \35\ in regulatory capital in
recognition that minority interest is generally not available to absorb
losses at the banking organization's consolidated level and to prevent
highly capitalized subsidiaries from overstating the amount of capital
available to absorb losses at the consolidated organization.
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\35\ Minority interest, also referred to as non-controlling
interest, reflects investments in the capital instruments of
subsidiaries of banking organizations that are held by third
parties.
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Under the current capital rule, banking organizations subject to
Category I or II capital standards must deduct from common equity tier
1 capital amounts of MSAs, temporary difference DTAs that the banking
organization could not realize through net operating loss carrybacks,
and significant investments in the capital of unconsolidated financial
institutions in the form of common stock \36\ (collectively, threshold
items) that individually exceed 10 percent of the banking
organization's common equity tier 1 capital minus certain deductions
and adjustments.\37\ Banking organizations subject to Category I or II
capital standards must also deduct from common equity tier 1 capital
the aggregate amount of threshold items not deducted under the 10
percent
[[Page 64037]]
threshold deduction but that nevertheless exceeds 15 percent of the
banking organization's common equity tier 1 capital minus certain
deductions and adjustments. Under the current capital rule, banking
organizations subject to Category III or IV capital standards are
required to deduct from common equity tier 1 capital any amount of
MSAs, temporary difference DTAs that the banking organization could not
realize through net operating loss carrybacks, and investments in the
capital of unconsolidated financial institutions \38\ that individually
exceed 25 percent of common equity tier 1 capital of the banking
organization minus certain deductions and adjustments.
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\36\ A significant investment in the capital of an
unconsolidated financial institution is defined as an investment in
the capital of an unconsolidated financial institution where a
banking organization subject to Category I or II capital standards
owns more than 10 percent of the issued and outstanding common stock
of the unconsolidated financial institution. 12 CFR 3.2 (OCC); 12
CFR 217.2 (Board); 12 CFR 324.2 (FDIC).
\37\ See 12 CFR 3.22(c)(6), (d)(2) (OCC); 12 CFR 217.22(c)(6),
(d)(2) (Board); 12 CFR 324.22(c)(6), (d)(2) (FDIC).
\38\ For banking organizations that are not subject to Category
I or II capital standards, the current capital rule does not have
distinct treatments for significant and nonsignificant investments
in the capital of unconsolidated financial institutions. Rather, the
regulatory capital treatment for an investment in the capital of
unconsolidated financial institutions would be based on the type of
instrument underlying the investment.
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Under the proposal, banking organizations subject to Category III
or IV capital standards would be required to deduct threshold items
from common equity tier 1 capital and apply other capital deductions
that are currently applicable to banking organizations subject to
Category I or II capital standards instead of the deductions applicable
to all other banking organizations, thereby creating alignment across
all banking organizations subject to the proposal.
In addition to deductions for the threshold items, the current
capital rule requires that a banking organization subject to Category I
or II capital standards deduct from regulatory capital any amount of
the banking organization's nonsignificant investments \39\ in the
capital of unconsolidated financial institutions that exceeds 10
percent of the banking organization's common equity tier 1 capital
minus certain deductions and adjustments.\40\ Further, significant
investments in the capital of unconsolidated financial institutions not
in the form of common stock must be deducted from regulatory capital in
their entirety.\41\ Under the proposal, banking organizations subject
to Category III or IV capital standards would be required to make these
deductions.
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\39\ A non-significant investment in the capital of an
unconsolidated financial institution is defined as an investment in
the capital of an unconsolidated financial institution where a
banking organization subject to Category I or II capital standards
owns 10 percent or less of the issued and outstanding common stock
of the unconsolidated financial institution. 12 CFR 3.2 (OCC); 12
CFR 217.2 (Board); 12 CFR 324.2 (FDIC).
\40\ 12 CFR 3.22(c)(5) (OCC); 12 CFR 217.22(c)(5) (Board); 12
CFR 324.22(c)(5) (FDIC).
\41\ 12 CFR 3.22(c)(6) (OCC); 12 CFR 217.22(c)(6) (Board); 12
CFR 324.22(c)(6) (FDIC).
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Similar to the deductions for investments in the capital of
unconsolidated financial institutions, the current capital rule
requires banking organizations subject to Category I or II capital
standards to deduct covered debt instruments from regulatory
capital.\42\ Under the proposal, banking organizations subject to
Category III or IV capital standards would be required to apply the
deduction requirements for certain investments in unsecured debt
instruments issued by U.S. or foreign GSIBs (covered debt instruments)
that currently apply to banking organizations subject to Category I or
II capital standards.\43\ The current capital rule generally treats
investments in unsecured debt instruments issued by U.S. or foreign
GSIBs as tier 2 capital instruments for purposes of applying deduction
requirements.
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\42\ See 12 CFR 3.22(c) (OCC); 12 CFR 217.22(c) (Board); 12 CFR
324.22(c) (FDIC).
\43\ Similar to banking organizations subject to Category II
capital standards, the definition of excluded covered debt and the
applicable capital treatment, would not apply to banking
organizations subject to Category III and IV capital standards. See
12 CFR 3.2 (OCC); 12 CFR 217.2) (Board); 12 CFR 324.2 (FDIC).
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The current capital rule also limits the amount of minority
interest that banking organizations subject to Category I or II capital
standards may include in regulatory capital based on the amount of
capital held by a consolidated subsidiary, relative to the amount of
capital the subsidiary would have had to maintain to avoid any
restrictions on capital distributions and discretionary bonus payments
under capital conservation buffer requirements.\44\ Under the current
capital rule, banking organizations subject to Category III or IV
capital standards are allowed to include: (i) common equity tier 1
minority interest comprising up to 10 percent of the parent banking
organization's common equity tier 1 capital; (ii) tier 1 minority
interest comprising up to 10 percent of the parent banking
organization's tier 1 capital; and (iii) total capital minority
interest comprising up to 10 percent of the parent banking
organization's total capital.\45\ Under the proposal, the limitations
on minority interests that apply to banking organizations subject to
Category I or II capital standards would also apply to banking
organizations subject to Category III or IV capital standards.
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\44\ See 12 CFR 3.21(b) (OCC); 12 CFR 217.21(b) (Board); 12 CFR
324.21(b) (FDIC).
\45\ See 12 CFR 3.21(a) (OCC); 12 CFR 217.21(a) (Board); 12 CFR
324.21(a) (FDIC).
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3. Additional Definition of Capital Adjustments
The current capital rule applies an additional capital eligibility
criterion to banking organizations subject to Category I or II capital
standards for their additional tier 1 and tier 2 capital instruments.
The criterion requires that the governing agreement, offering circular
or prospectus for the instrument must disclose that the holders of the
instrument may be fully subordinated to interests held by the U.S.
government in the event the banking organization enters into a
receivership, insolvency, liquidation, or similar proceeding. Under the
proposal, this eligibility criterion would also apply to instruments
issued after the date on which the issuer becomes subject to the
proposed rule, which generally would be the effective date of a final
rule for banking organizations subject to Category III or IV capital
standards. Instruments issued by banking organizations subject to
Category III or IV capital standards prior to the effective date of a
final rule that currently count as regulatory capital would continue to
count as regulatory capital as long as those instruments remain
outstanding.
4. Changes to the Definition of Tier 2 Capital Applicable to Large
Banking Organizations
The current capital rule defines an element of tier 2 capital to
include the allowance for loan and lease losses (ALLL) or the adjusted
allowance for credit losses (AACL), as applicable, up to 1.25 percent
of standardized total risk-weighted assets not including any amount of
the ALLL or AACL, as applicable (and excluding in the case of a banking
organization subject to market risk requirements, its standardized
market risk-weighted assets). Further, as part of its calculations for
determining its total capital ratio, a banking organization subject to
Category I or II standards must determine its advanced-approaches-
adjusted total capital by (1) deducting from its total capital any ALLL
or AACL, as applicable, included in its tier 2 capital and; (2) adding
to its total capital any eligible credit reserves that exceed the
banking organization's total expected credit losses to the extent that
the excess reserve amount does not exceed 0.6 percent of credit-risk-
weighted assets. Due to changes in GAAP, all large banking
organizations are no longer using ALLL and must use AACL. In addition,
the concept of eligible credit reserves is related to use
[[Page 64038]]
of the internal ratings-based approach, which the proposal would
eliminate. Therefore, under the proposal, a large banking organization
would determine its expanded risk-based approach-adjusted total capital
by (1) deducting from its total capital AACL included in its tier 2
capital and; (2) adding to its total capital any AACL up to 1.25
percent of total credit risk-weighted assets. The proposal would define
total credit risk-weighted assets as the sum of total risk-weighted
assets for: (1) general credit risk as calculated under Sec. __.110;
(2) cleared transactions and default fund contributions as calculated
under Sec. __.114; (3) unsettled transactions as calculated under
Sec. __.115; and (4) securitization exposures as calculated under
Sec. __.132.
Question 11: The agencies seek comment on the proposed definition
of total credit risk-weighted assets in connection with determining a
banking organization's total capital ratio. What, if any, modifications
should the agencies consider making to this definition and why?
C. Credit Risk
Credit risk arises from the possibility that an obligor, including
a borrower or counterparty, will fail to perform on an obligation.
While loans are a significant source of credit risk, other products,
activities, and services also expose banking organizations to credit
risk, including investments in debt securities and other credit
instruments, credit derivatives, and cash management services. Off-
balance sheet activities, such as letters of credit, unfunded loan
commitments, and the undrawn portion of lines of credit, also expose
banking organizations to credit risk.
In this section of the Supplementary Information, subsection
III.C.1. describes expectations for completing due diligence on a
banking organization's credit risk portfolio; subsection III.C.2.
describes the risk-weight treatment for on-balance sheet exposures
under the proposal; subsection III.C.3. describes the proposed approach
to determine the exposure amount for off-balance sheet exposures; and
subsections III.C.4.-5 provide the available approaches for recognizing
the benefits of credit risk mitigants including certain guarantees,
certain credit derivatives and financial collateral.
1. Due Diligence
Banking organizations must maintain capital commensurate with the
level and nature of the risks to which they are exposed.\46\ The
agencies' safety and soundness guidelines establish standards for
banking organizations to have an adequate understanding of the impact
of their lending decisions on the banking organization's credit
risk.\47\ A banking organization's performance of due diligence on
their credit portfolios is central to meeting both of these
obligations. For example, under the safety and soundness guidelines, a
banking organization is expected to have established effective internal
policies, processes, systems, and controls to ensure that the banking
organization's regulatory reporting is accurate and reflects
appropriate risk weights assigned to credit exposures.\48\
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\46\ See 12 CFR 3.10(e) (OCC); 12 CFR 217.10(e) (Board); 12 CFR
324.10(e) (FDIC).
\47\ See 12 CFR part 30, appendix A (OCC); 12 CFR, appendix D-1
to part 208 (Board); 12 CFR, appendix A to part 364 (FDIC).
\48\ When performing due diligence, banking organizations must
adhere to the operational and managerial standards for loan
documentation and credit underwriting as set forth in the
Interagency Guidelines Establishing Standards for Safety and
Soundness (safety and soundness guidelines).
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When properly performed, due diligence may lead a banking
organization to conclude that the minimum regulatory capital
requirements for certain exposures do not sufficiently account for
their potential credit risk. In such instances, the banking
organization should take appropriate risk mitigating measures such as
allocating additional capital, establishing larger credit loss
allowances, or requiring additional collateral. Adherence to due
diligence standards, as established through the agencies' safety and
soundness guidelines, directly supports and facilitates requirements
for banking organizations to maintain capital commensurate with the
level and nature of the risks to which they are exposed.
Question 12: The agencies seek comment on whether due diligence
requirements should be directly integrated into the text of the final
rule. What would be the advantages and disadvantages of specifying
increases in risk weights that would be required to the extent that due
diligence requirements are not met, similar to the proposed risk-weight
treatment for securitization exposures as described in section III.D of
this Supplementary Information?
2. Proposed Risk Weights for Credit Risk
The proposal would replace the use of internal models to set
regulatory capital requirements for credit risk as set out in subpart E
of the current capital rule with a new expanded risk-based approach for
credit risk applicable to large banking organizations. The proposed
expanded risk-based approach for credit risk would retain many of the
same definitions Sec. __.2 of the current capital rule including among
others a sovereign, a sovereign exposure, certain supranational
entities, a multilateral development bank, a public sector entity
(PSE), a government-sponsored enterprise (GSE), other assets, and a
commitment. Some elements of the proposed expanded risk-based approach
for credit risk would apply the same risk-weight treatment provided in
subpart D of the current capital rule (current standardized approach)
for on-balance sheet exposures, including exposures to sovereigns,
certain supranational entities and multilateral development banks,
government sponsored entities (GSEs) in the form of senior debt and
guaranteed exposures, Federal Home Loan Bank (FHLB) and Federal
Agricultural Mortgage Corporation (Farmer Mac) equity exposures,\49\
public sector entities (PSEs), and other assets. The proposal would
also apply the same risk-weight treatment provided in the current
standardized approach to the following real estate exposures: pre-sold
construction loans, statutory multifamily mortgages, and high-
volatility commercial real estate (HVCRE) exposures.
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\49\ For treatment of other exposures to GSEs, see discussion
related to equity exposures in section III.E. and exposures to
subordinated debt instruments in section III.C.2.d. of this
Supplementary Information.
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Relative to the internal models-based approaches in the advanced
approaches under the current capital rule, the proposed expanded risk-
based approach would result in more transparent capital requirements
for credit risk exposures across banking organizations. The proposal
would also facilitate comparisons of capital adequacy across banking
organizations by reducing excessive, unwarranted variability in risk-
weighted assets for similar exposures. Relative to the current
standardized approach, the proposal would incorporate more granular
risk factors to allow for a broader range of risk weights.
Specifically, the proposal would introduce the expanded risk-based
approach for exposures to depository institutions, foreign banks, and
credit unions; exposures to subordinated debt instruments, including
those to GSEs; and real estate, retail, and corporate exposures. The
proposal would also increase risk capture for certain off-balance sheet
exposures through a new exposure methodology for commitments without
pre-set limits and would
[[Page 64039]]
modify the credit conversion factors applicable to commitments.
Additionally, the proposal would introduce new definitions for
defaulted exposures and defaulted real estate exposures.
Under the proposal, a banking organization would determine the
risk-weighted asset amount for an on-balance sheet exposure by
multiplying the exposure amount by the applicable risk weight,
consistent with the method used under the current standardized
approach. The on-balance sheet exposure amount would generally be the
banking organization's carrying value \50\ of the exposure, consistent
with the value of the asset on the balance sheet as determined in
accordance with GAAP, which is the same as under the current capital
rule. For all assets other than AFS securities and purchased credit-
deteriorated assets, the carrying value is not reduced by any
associated credit loss allowance that is determined in accordance with
GAAP. Using the value of an asset under GAAP to determine a banking
organization's exposure amount would reduce burden and provide a
consistent framework that can be easily applied across all banking
organizations of the proposal because, in most cases, GAAP serve as the
basis for the information presented in financial statements and
regulatory reports.\51\
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\50\ Carrying value under Sec. __. 2 of the current capital
rule means, with respect to an asset, the value of the asset on the
balance sheet of the banking organization as determined in
accordance with GAAP. For all assets other than available-for-sale
debt securities or purchased credit deteriorated assets, the
carrying value is not reduced by any associated credit loss
allowance that is determined in accordance with GAAP. See 12 CFR 3.2
(OCC); 12 CFR 217.2 (Board); 12 CFR 324.2 (FDIC). The exposure
amount arising from an OTC derivative contract; a repo-style
transaction or an eligible margin loan; a cleared transaction; a
default fund contribution; or a securitization exposure would be
calculated in accordance with Sec. Sec. __.113, 121, or 131 of the
proposal, respectively, as described in sections III.C.4, II.C.5.b.,
and III.D. of this Supplementary Information.
\51\ See 12 U.S.C. 1831n.
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The proposal would group credit risk exposures into the following
categories: sovereign exposures; exposures to certain supranational
entities and multilateral development banks; exposures to GSEs;
exposures to depository institutions, foreign banks, and credit unions;
exposures to PSEs; real estate exposures; retail exposures; corporate
exposures; defaulted exposures; exposures to subordinated debt
instruments; and off-balance sheet exposures.
The proposed categories with amended risk-weight treatments
relative to the current standardized approach include equity exposures
to GSEs and exposures to subordinated debt instruments issued by GSEs;
exposures to depository institutions, foreign banks, and credit unions;
exposures to subordinated debt instruments; real estate exposures;
retail exposures; corporate exposures; defaulted exposures; and some
off-balance sheet exposures such as commitments. The proposed risk
weight treatments for each of these categories are described in the
following sections of this Supplementary Information.
a. Defaulted Exposures
The proposal would introduce an enhanced definition of a defaulted
exposure that would be broader than the current capital rule's
definition of a defaulted exposure under subpart E. The proposed scope
and criteria of the defaulted exposure category is intended to
appropriately capture the elevated credit risk of exposures where the
banking organization's reasonable expectation of repayment has been
reduced, including exposures where the obligor is in default on an
unrelated obligation. Under the proposal, a defaulted exposure would be
any exposure that is a credit obligation and that meets the proposed
criteria related to reduced expectation of repayment, and that is not
an exposure to a sovereign entity,\52\ a real estate exposure,\53\ or a
policy loan.\54\ The proposal would define a credit obligation as any
exposure where the lender but not the obligor is exposed to credit
risk. In other words, for these exposures, the lender would have a
claim on the obligor that does not give rise to counterparty credit
risk \55\ and would exclude derivative contracts, cleared transactions,
default fund contributions, repo-style transactions, eligible margin
loans, equity exposures, and securitization exposures.
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\52\ Under the proposal, the expanded risk-based approach would
rely on the treatment of sovereign default in the current
standardized approach in the capital rule. See 12 CFR 3.32(a)(6)
(OCC); 12 CFR 217.32(a)(6) (Board); 12 CFR 324.32 (a)(6) (FDIC).
\53\ For the treatment of defaulted real estate exposures, see
section III.C.2.e.vii of this Supplementary Information.
\54\ A policy loan is defined under Sec. __.2 of the current
capital rule to mean means a loan by an insurance company to a
policy holder pursuant to the provisions of an insurance contract
that is secured by the cash surrender value or collateral assignment
of the related policy or contract. A policy loan includes: (1) A
cash loan, including a loan resulting from early payment benefits or
accelerated payment benefits, on an insurance contract when the
terms of contract specify that the payment is a policy loan secured
by the policy; and (2) An automatic premium loan, which is a loan
that is made in accordance with policy provisions which provide that
delinquent premium payments are automatically paid from the cash
value at the end of the established grace period for premium
payments. See 12 CFR 3.2 (OCC); 12 CFR 217.2 (Board); 12 CFR 324.2
(FDIC).
\55\ Counterparty credit risk is the risk that the counterparty
to a transaction could default before the final settlement of the
transaction where there is a bilateral risk of loss.
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For all other exposure categories (excluding an exposure to a
sovereign entity, real estate exposure, a retail exposure, or a policy
loan), the proposed definition of defaulted exposure would look to the
performance of the borrower with respect to credit obligations to any
creditor. Specifically, if the banking organization determines that an
obligor meets any of the of the defaulted criteria for exposures that
are not retail exposures, described further below, the proposal would
require the banking organization to treat all exposures that are credit
obligations of that obligor as defaulted exposures. Additionally, the
proposal would differentiate the criteria for determining whether an
exposure is a defaulted exposure between exposures that are retail
exposures and those that are not.
Retail exposures are originated to individuals or small- and
medium-sized businesses. Evaluating whether a retail borrower has other
exposures that are in default as defined by the proposal may be
difficult to operationalize for banking organizations given many unique
obligors. For other types of exposures that are not retail exposures,
evaluating default at the obligor level is appropriate because those
obligors are more likely to have additional credit obligations that are
large and held by multiple banking organizations. Default on one of
those credit obligations would be indicative of increased riskiness of
the exposure held by a banking organization, and hence a banking
organization should account for this in evaluating the risk profile of
the borrower.
Under the proposal, for a retail exposure, a credit obligation
would be considered a defaulted exposure if any of the following has
occurred: (1) the exposure is 90 days past due or in nonaccrual status;
(2) the banking organization has taken a partial charge-off, write-down
of principal, or negative fair value adjustment on the exposure for
credit-related reasons, until the banking organization has reasonable
assurance of repayment and performance for all contractual principal
and interest payments on the exposure; or (3) a distressed
restructuring of the exposure was agreed to by the banking
organization, until the banking organization has reasonable assurance
of repayment and performance for all contractual principal and interest
payments on the exposure as demonstrated by a
[[Page 64040]]
sustained period of repayment performance, provided that a distressed
restructuring includes the following made for credit-related reasons:
forgiveness or postponement of principal, interest, or fees, term
extension, or an interest rate reduction. A sustained period of
repayment performance by the borrower is generally a minimum of six
months in accordance with the contractual terms of the restructured
exposure.
For exposures that are not retail exposures (excluding an exposure
to a sovereign entity, a real estate exposure, or a policy loan), a
credit obligation would be considered a defaulted exposure if either of
the following has occurred: (1) the obligor has a credit obligation to
the banking organization that is 90 days or more past due \56\ or in
nonaccrual status; or (2) the banking organization determines that,
based on ongoing credit monitoring, the obligor is unlikely to pay its
credit obligations to the banking organization in full, without
recourse by the banking organization. If a banking organization
determines that an obligor meets these proposed criteria, the proposal
would require the banking organization to treat all exposures that are
credit obligations of that obligor as defaulted exposures.
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\56\ Overdrafts are past due and are considered defaulted
exposures once the obligor has breached an advised limit or been
advised of a limit smaller than the current outstanding balance.
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For purposes of the second criterion, the proposal would require a
banking organization to consider an obligor as unlikely to pay its
credit obligations if any of the following criteria apply: (1) the
obligor has any credit obligation that is 90 days or more past due or
in nonaccrual status with any creditor; (2) any credit obligation of
the obligor has been sold at a credit-related loss; (3) a distressed
restructuring of any credit obligation of the obligor was agreed to by
any creditor, provided that a distressed restructuring includes the
following made for credit-related reasons: forgiveness or postponement
of principal, interest, or fees, term extension or an interest rate
reduction; (4) the obligor is subject to a pending or active bankruptcy
proceeding; or (5) any creditor has taken a full or partial charge-off,
write-down of principal, or negative fair value adjustment on a credit
obligation of the obligor for credit-related reasons. Under the
proposal, banking organizations are expected to conduct ongoing credit
monitoring regarding relevant obligors. The proposal would require
banking organizations to continue to treat an exposure as a defaulted
exposure until the exposure no longer meets the definition or until the
banking organization determines that the obligor meets the definition
of investment grade \57\ or the proposed definition of speculative
grade.\58\ The proposal would revise the definition of speculative
grade, consistent with the current definition of investment grade, to
allow the definition to apply to entities to which the banking
organization is exposed through a loan or security. In addition, the
proposal would make the same revision to the definition of sub-
speculative grade.
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\57\ Under Sec. __.2 of the current capital rule, investment
grade means that the entity to which the banking organization is
exposed through a loan or security, or the reference entity with
respect to a credit derivative, has adequate capacity to meet
financial commitments for the projected life of the asset or
exposure. Such an entity or reference entity has adequate capacity
to meet financial commitments if the risk of its default is low and
the full and timely repayment of principal and interest is expected.
See 12 CFR 3.2 (OCC); 12 CFR 217.2 (Board); 12 CFR 324.2 (FDIC).
\58\ The proposal would revise the definition of speculative
grade to mean that the entity to which a banking organization is
exposed through a loan or security, or the reference entity with
respect to a credit derivative, has adequate capacity to meet
financial commitments in the near term, but is vulnerable to adverse
economic conditions, such that should economic conditions
deteriorate, the issuer or the reference entity would present an
elevated default risk.
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A banking organization would assign a 150 percent risk weight to a
defaulted exposure including any exposure amount remaining on the
balance sheet following a charge-off, and any other non-retail exposure
to the same obligor, to reflect the increased uncertainty as to the
recovery of the remaining carrying value. The proposed risk weight is
intended to reflect the impaired credit quality of defaulted exposures
and to help ensure that banking organizations maintain sufficient
regulatory capital for the increased probability of losses on these
exposures. A banking organization may apply a risk weight to the
guaranteed or secured portion of a defaulted exposure based on (1) the
risk weight under Sec. __.120 of the proposal if the guarantee or
credit derivative meets the applicable requirements or (2) the risk
weight under Sec. __.121 of the proposal if the collateral meets the
applicable requirements.
Question 13: How does the defaulted exposure definition compare
with banking organizations' existing policies relating to the
determination of the credit risk of a defaulted exposure and the
creditworthiness of a defaulted obligor? What additional clarifications
are necessary to determine the point at which retail and non-retail
exposures should no longer be treated as defaulted exposures?
Question 14: What operational challenges, if any, would a banking
organization face in identifying which exposures meet the proposed
definition of defaulted exposure? In particular, the agencies seek
comment on the ability of a banking organization to obtain the
necessary information to assess whether the credit obligations of a
borrower to creditors other than the banking organization would meet
the proposed criteria? What operational challenges, if any, would a
banking organization face in identifying whether obligors on non-retail
credit obligations are subject to a pending or active bankruptcy
proceeding?
Question 15: For the purposes of retail credit obligations, the
agencies invite comment on the appropriateness of including a
borrower's bankruptcy as a criterion for a defaulted exposure. What
operational challenges, if any, would a banking organization face in
identifying whether obligors on retail credit obligations are subject
to a pending or active bankruptcy proceeding? To what extent would
criteria (1) through (3) in the proposed defaulted exposure definition
for retail exposures sufficiently capture the risk of a borrower
involved in a bankruptcy proceeding?
Question 16: What alternatives to the proposed treatment should the
agencies consider while maintaining a risk-sensitive treatment for
credit risk of a defaulted borrower? For example, what would be the
advantages and disadvantages of limiting the defaulted borrower scope
to obligations of the borrower with the banking organization?
b. Exposures to Government-Sponsored Enterprises
The proposal would assign a 20 percent risk weight to GSE \59\
exposures that are not equity exposures, securitization exposures or
exposures to a subordinated debt instrument issued by a GSE, consistent
with the current standardized approach.\60\ Under the proposal, an
exposure to the common stock issued by a GSE would be an
[[Page 64041]]
equity exposure. An exposure to the preferred stock issued by a GSE
would be an equity exposure or an exposure to a subordinated debt
instrument, depending on the contractual terms of the preferred stock
instrument. Equity exposures to a GSE must be assigned a risk-weighted
asset amount as calculated under Sec. Sec. __.140 through __.142 of
subpart E. An exposure to a subordinated debt instrument issued by a
GSE must be assigned a 150 percent risk weight, unless issued by a FHLB
or Farmer Mac. As discussed later in sections III.E. and III.C.2.d. of
this Supplementary Information, equity exposures and exposures to
subordinated debt instruments would generally be subject to an
increased risk-based capital requirement to reflect their heightened
risk relative to exposures to senior debt.
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\59\ Government-sponsored enterprise (GSE) under Sec. __. 2 of
the current capital rule means an entity established or chartered by
the U.S. government to serve public purposes specified by the U.S.
Congress but whose debt obligations are not explicitly guaranteed by
the full faith and credit of the U.S. government. See 12 CFR 3.2
(OCC); 12 CFR 217.2 (Board); 12 CFR 324.2 (FDIC).
\60\ Similar to the treatment of senior debt exposures to GSEs
and GSE exposures that are not equity exposures or exposures to a
subordinated debt instrument issued by a GSE, the proposal would
apply the same 20 percent risk weight to all exposures to FHLB or
Farmer Mac, including equity exposures and exposures to subordinated
debt instruments, which continues the treatment under the current
standardized approach.
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c. Exposures to Depository Institutions, Foreign Banks, and Credit
Unions
The proposal would define the scope of exposures to depository
institutions, foreign banks, and credit unions in a manner that is
consistent with the definitions and scope of exposures covered under
the current capital rule. Under the proposal, a bank exposure would
mean an exposure (such as a receivable, guarantee, letter of credit,
loan, OTC derivative contract, or senior debt instrument) to any
depository institution, foreign bank, or credit union.\61\
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\61\ Under Sec. __.2 of the current capital rule, a depository
institution means a depository institution as defined in section 3
of the Federal Deposit Insurance Act, a foreign bank means a foreign
bank as defined in section 211.2 of the Federal Reserve Board's
Regulation K (12 CFR 211.2) (other than a depository institution),
and a credit union means an insured credit union as defined under
the Federal Credit Union Act (12 U.S.C. 1751 et seq.). See 12 CFR
3.2 (OCC); 12 CFR 217.2 (Board); 12 CFR 324.2 (FDIC). Exposures to
other financial institutions, such as bank holding companies,
savings and loans holding companies, and securities firms, generally
would be considered corporate exposures. See 78 FR 62087 (October
11, 2013).
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The proposed treatment for bank exposures supports the simplicity,
transparency, and consistency objectives of the proposal in a manner
that is appropriately risk sensitive. The proposal would provide three
categories for bank exposures that are ranked from the highest to the
lowest in terms of creditworthiness: Grade A, Grade B, and Grade C. The
assignment of the bank exposure category would be based on the obligor
depository institution, foreign bank, or credit union. As outlined
below, the proposal would rely on the current capital rule's definition
of investment grade and the proposed definition of speculative grade
for differentiating the credit risk of bank exposures. In addition, the
proposal would incorporate publicly disclosed capital levels to
differentiate the financial strength of a depository institution,
foreign bank, or credit union in a manner that is both objective and
transparent to supervisors and the public.
More specifically, a Grade A bank exposure would mean a bank
exposure for which the obligor depository institution, foreign bank, or
credit union (1) is investment grade, and (2) whose most recent
publicly disclosed capital ratios meet or exceed the higher of: (a) the
minimum capital requirements and any additional amounts necessary to
not be subject to limitations on distributions and discretionary bonus
payments under the capital rules established by the prudential
supervisor of the depository institution, foreign bank, or credit
union, and (b) if applicable, the capital ratio requirements for the
well-capitalized category under the agencies' prompt corrective action
framework,\62\ or under similar rules of the National Credit Union
Administration.\63\ For example, an exposure to an investment grade
depository institution could qualify as a Grade A bank exposure if the
depository institution was not subject to limitations on distributions
and discretionary bonus payments under the capital rules and had risk-
based capital ratios that met the well capitalized thresholds under the
agencies' prompt corrective action framework. Further, a bank exposure
to a depository institution that had opted into the community bank
leverage ratio (CBLR) framework and is investment grade would be
considered to be a Grade A bank exposure, even if the obligor
depository institution were in the grace period under the CBLR
framework.\64\ Under the proposal, a depository institution that uses
the CBLR framework would not be required to calculate or disclose risk-
based capital ratios for purposes of qualifying as a Grade A bank
exposure.
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\62\ The capital ratios used for this determination are the
ratios on the depository institution's most recent quarterly
Consolidated Report of Condition and Income (Call Report).
\63\ See 12 CFR part 702 (National Credit Union Administration).
\64\ See 12 CFR 3.12(a)(1) (OCC); 12 CFR 217.12(a)(1) (Board);
12 CFR 324.12(a)(1) (FDIC).
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A Grade B bank exposure would mean a bank exposure that is not a
Grade A bank exposure and for which the obligor depository institution,
foreign bank, or credit union (1) is speculative grade or investment
grade, and (2) whose most recent publicly disclosed capital ratios meet
or exceed the higher of: (a) the applicable minimum capital
requirements under capital rules established by the prudential
supervisor of the depository institution, foreign bank, or credit
union, and (b) if applicable, the capital ratio requirements for the
adequately-capitalized category \65\ under the agencies' prompt
corrective action framework,\66\ or under similar rules of the National
Credit Union Administration.\67\
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\65\ See 12 CFR 6.4(b)(2) (OCC); 12 CFR 208.43(b)(2) (Board); 12
CFR 324.403(b)(2) (FDIC).
\66\ The capital ratios used for this determination are the
ratios on the depository institution's most recent quarterly Call
Report.
\67\ See 12 CFR part 702 (National Credit Union Administration).
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For a foreign bank to qualify as a Grade A or Grade B bank
exposure, the proposal would require the applicable capital standards
imposed by the home country supervisor to be consistent with
international capital standards issued by the Basel Committee.
A Grade C bank exposure would mean a bank exposure that does not
qualify as a Grade A or Grade B bank exposure. For example, a bank
exposure would be a Grade C bank exposure if the obligor depository
institution, foreign bank, or credit union has not publicly disclosed
its capital ratios within the last six months. In addition, an exposure
would be a Grade C bank exposure if the external auditor of the
depository institution, foreign bank, or credit union has issued an
adverse audit opinion or has expressed substantial doubt about the
ability of the depository institution, foreign bank, or credit union to
continue as a going concern within the previous 12 months.
Under the proposal, a foreign bank exposure that is a Grade A or
Grade B bank exposure and is a self-liquidating, trade-related
contingent item that arises from the movement of goods and that has a
maturity of three months or less may be assigned a risk weight that is
lower than the risk weight applicable to other exposures to the same
foreign bank. The proposed approach to providing a preferential risk
weight for short-term self-liquidating, trade-related contingent items
would be consistent with the current standardized approach.
The proposal would also address the risk that capital and foreign
exchange controls imposed by a sovereign entity in which a foreign bank
is located could prevent or materially impede the ability of the
foreign bank to convert its currency to meet its obligations or
transfer funds. The proposal would, therefore, provide a risk weight
floor for foreign bank exposures based on the risk weight applicable to
a sovereign
[[Page 64042]]
exposure for the jurisdiction where the foreign bank is incorporated
when (1) the exposure is not in the local currency of the jurisdiction
where the foreign bank is incorporated; or (2) the exposure to a
foreign bank branch that is not in the local currency of the
jurisdiction in which the foreign branch operates (sovereign risk-
weight floor).\68\ The risk weight floor would not apply to short-term
self-liquidating, trade-related contingent items that arise from the
movement of goods.
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\68\ See Sec. __.111 for the proposed sovereign risk-weight
table, which is identical to Table 1 to Sec. __.32 in the current
capital rule.
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As provided in Table 1, the proposed risk weights for bank
exposures generally would range from 40 percent to 150 percent.
[GRAPHIC] [TIFF OMITTED] TP18SE23.001
Question 17: What are the advantages and disadvantages of assigning
a range of risk weights based on the bank's creditworthiness? What
alternatives, if any, should the agencies consider, including to
address potential concerns around procyclicality?
Question 18: What are the advantages and disadvantages of
incorporating specific capital levels in the determination of each of
the three categories of bank exposures? What, if any, other risk
factors should the banking agencies consider to differentiate the
credit risk of bank exposures? What concerns, if any, could limitations
on available information about foreign banks raise in the context of
determining the appropriate risk weights for exposures to such banks
and how should the agencies consider addressing such concerns?
Question 19: What is the impact of limiting the lower risk weight
for self-liquidating, trade-related contingent items that arise from
the movement of goods to those with a maturity of three months or less?
What would be the advantages and disadvantages of expanding this risk
weight treatment to include such exposures with a maturity of six
months or less? What would be the advantages and disadvantages of
limiting this reduced risk weight treatment to only foreign banks whose
home country has an Organization for Economic Cooperation and
Development (OECD) Country Risk Classification (CRC) \69\ of 0, 1, 2,
or 3, or is an OECD member with no CRC, consistent with the current
standardized approach? \70\
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\69\ Under Sec. __. 2 of the current capital rule, a Country
Risk Classification (CRC) for a sovereign means the most recent
consensus CRC published by the Organization for Economic Cooperation
and Development (OECD) as of December 31st of the prior calendar
year that provides a view of the likelihood that the sovereign will
service its external debt. See 12 CFR 3.2 (OCC); 12 CFR 217.2
(Board); 12 CFR 324.2 (FDIC). For more information on the OECD
country risk classification methodology, see OECD, ``Country Risk
Classification,'' available at https://www.oecd.org/trade/topics/export-credits/arrangement-and-sector-understandings/financing-terms-and-conditions/country-risk-classification/.
\70\ The CRCs reflect an assessment of country risk, used to set
interest rate charges for transactions covered by the OECD
arrangement on export credits. The CRC methodology classifies
countries into one of eight risk categories (0-7), with countries
assigned to the zero category having the lowest possible risk
assessment and countries assigned to the 7 category having the
highest possible risk assessment. See 78 FR 62088 (October 11,
2018).
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d. Subordinated Debt Instruments
The proposal would introduce a definition and an explicit risk
weight treatment for exposures in the form of subordinated debt
instruments. The proposed definition of a subordinated debt instrument
would capture exposures that are financial instruments and present
heightened credit risk but are not equity exposures, including: (1) any
preferred stock that does not meet the definition of an equity
exposure, (2) any covered debt instrument, including a TLAC debt
instrument, that is not deducted from regulatory capital, and (3) any
debt instrument that qualifies as tier 2 capital under the current
capital rule or that would otherwise be treated as regulatory capital
by the primary Federal supervisor of the issuer and that is not
deducted from regulatory capital.
The proposal would define a subordinated debt instrument as (1) a
debt security that is a corporate exposure, a bank exposure, or an
exposure to a GSE, including a note, bond, debenture, similar
instrument, or other debt instrument as determined by the primary
Federal supervisor, that is subordinated by its terms, or separate
intercreditor agreement, to any creditor of the obligor, or (2)
preferred stock that is not an equity exposure. For these purposes, a
debt security would be subordinated if the documentation creating or
evidencing such indebtedness (or a separate intercreditor agreement)
provides for any of the issuer's other creditors to rank senior to the
payment of such indebtedness in the event the issuer becomes the
subject of a bankruptcy or other insolvency proceeding, with the scope
of applicable bankruptcy or other insolvency proceedings being defined
in the applicable documentation. The scope of the definition of a
subordinated debt instrument is meant to capture the types of entities
that issue subordinated debt instruments and for which the level of
subordination is a meaningful determinant of the credit risk of the
instrument.
[[Page 64043]]
In addition, even though the provision of collateral typically
reduces the risk of loss on indebtedness, the proposal includes secured
as well as unsecured subordinated debt securities in the scope of
subordinated debt instruments, since the effect of subordination may
result in the collateral providing little or no real value to the
subordinated debt holder in the event the issuer becomes to subject of
a bankruptcy or other insolvency proceeding. A subordinated debt
instrument would not include any loan, including a syndicated loan, a
debt security issued by a sovereign, public sector entity, multilateral
development bank, or supranational entity, or a security that would be
captured under the securitization framework. Due to the contractual
obligations and structures associated with subordinated debt
instruments, such exposures generally pose increased risk relative to a
senior loan, including a syndicated loan, or a senior debt security to
the same entity because investments in subordinated debt instruments
are usually considered junior creditors and subordinate to obligations
specified in the definition of senior debt in the document governing
the junior creditors' obligations.
The proposal generally would apply a 150 percent risk weight for
exposures that meet the definition of a subordinated debt instrument,
including any preferred stock that is not an equity exposure, and any
tier 2 instrument or covered debt instrument that is not deducted from
regulatory capital, including TLAC debt instruments, and any debt
instrument that would otherwise be treated as regulatory capital by the
primary Federal supervisor of the issuer and that is not deducted from
regulatory capital.\71\
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\71\ Covered debt instruments are subject to deduction by
banking organizations subject to Category I or II capital standards
similar to the deduction framework for exposures to capital
instruments. See 12 CFR 3.22(c) (OCC); 12 CFR 217.22(c) (Board); 12
CFR 324.22(c) (FDIC). As noted in section III.B.3. of this
Supplementary Information, under the proposal, this deduction
framework will be expanded to banking organizations subject to
Category III or IV capital standards. As discussed in section
III.C.2.b. above, exposures to subordinated debt instruments issued
by an FHLB or by Farmer Mac would be assigned a 20 percent risk
weight.
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The instruments included in the scope of subordinated debt
instruments present a greater risk of loss to an investing banking
organization relative to more senior debt exposures to the same issuer
because subordinated debt instruments have a lower priority of
repayment in the event of default. As a result, the proposal would
apply an increased risk weight to recognize this increase in loss given
default. Since a covered debt instrument that qualifies as a TLAC debt
instrument shares similar risk characteristics with a subordinated debt
instrument, the proposal would require banking organizations to apply
the same 150 percent risk weight to any such exposures that are not
otherwise deducted from regulatory capital.
Question 20: The agencies seek comment on the scope of the proposed
definition of a subordinated debt instrument. What, if any, operational
challenges might the proposed definition pose for banking
organizations, such as identifying the level of subordination in debt
securities or similar instruments, and how should the agencies consider
addressing such challenges?
Question 21: Would expanding the definition of a subordinated debt
instrument to include loans that are not securities more appropriately
capture the types of exposures that pose elevated risk and, if so, why?
Question 22: The agencies seek comment on applying a heightened 150
percent risk weight to exposures to subordinated debt instruments
issued by GSEs. What would be the advantages and disadvantages of this
proposed regulatory capital requirement? Would there be any challenges
for banking organizations to be able to identify which GSE exposures
would be subject to the 150 percent risk weight? Please provide
specific examples of any challenges and supporting data.
e. Real Estate Exposures
The proposal would define a real estate exposure as an exposure
that is neither a sovereign exposure nor an exposure to a PSE and that
is (1) a residential mortgage exposure, (2) secured by collateral in
the form of real estate,\72\ (3) a pre-sold construction loan,\73\ (4)
a statutory multifamily mortgage,\74\ (5) a high volatility commercial
real estate (HVCRE) exposure,\75\ or (6) an acquisition, development,
or construction (ADC) exposure. A pre-sold construction loan, a
statutory multifamily mortgage, and an HVCRE exposure are collectively
referred to as statutory real estate exposures for purposes of this
Supplementary Information. Under the proposal, the risk weight
treatment for statutory real estate exposures that are not defaulted
real estate exposures would be consistent with the current standardized
approach.
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\72\ For purposes of the proposal, ``secured by collateral in
the form of real estate'' should be interpreted in a manner that is
consistent with the current definition for ``a loan secured by real
estate'' in the Call Report and Consolidated Financial Statements
for Holding Companies (FR Y-9C) instructions.
\73\ The Resolution Trust Corporation Refinancing,
Restructuring, and Improvement Act of 1991 (RTCRRI Act) mandates
that each agency provide in its capital regulations (i) a 50 percent
risk weight for certain one-to-four-family residential pre-sold
construction loans that meet specific statutory criteria in the
RTCRRI Act and any other underwriting criteria imposed by the
agencies, and (ii) a 100 percent risk weight for one-to-four-family
residential pre-sold construction loans for residences for which the
purchase contract is cancelled. See 12 U.S.C. 1831n, note.
\74\ The RTCRRI Act mandates that each agency provide in its
capital regulations a 50 percent risk weight for certain multifamily
residential loans that meet specific statutory criteria in the
RTCRRI Act and any other underwriting criteria imposed by the
agencies. See 12 U.S.C. 1831n, note.
\75\ Section 214 of the Economic Growth, Regulatory Relief, and
Consumer Protection Act imposes certain requirements on high
volatility commercial real estate acquisition, development, or
construction loans. Section 214 of Public Law 115-174, 132 Stat.
1296 (2018). See 12 U.S.C. 1831bb.
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The proposal would differentiate the credit risk of real estate
exposures that are not statutory real estate exposures by introducing
the following categories: regulatory residential real estate exposures,
regulatory commercial real estate exposures, ADC exposures, and other
real estate exposures. The applicable risk weight for these non-
statutory real estate exposures would depend on (1) whether the real
estate exposure meets the definitions of regulatory residential real
estate exposure, regulatory commercial real estate exposure, ADC
exposure, or other real estate exposure, described below; (2) whether
the repayment of such exposures is dependent on the cash flows
generated by the underlying real estate (such as rental properties,
leased properties, hotels); and (3) in the case of regulatory
residential or regulatory commercial real estate exposures, the loan-
to-value (LTV) ratio of the exposure.
These proposed criteria for differentiating the credit risk of real
estate exposures would be based on information already collected and
maintained by a banking organization as part of its mortgage lending
activities and underwriting practices. Under the proposal, regulatory
residential and regulatory commercial real estate exposures would be
required to meet prudential criteria that are intended to reduce the
likelihood of default relative to other real estate exposures. The
criteria in these definitions generally align with existing Interagency
Guidelines for Real Estate Lending Policies (real estate lending
[[Page 64044]]
guidelines).\76\ Real estate loans in which repayment is dependent on
the cash flows generated by the real estate can expose a banking
organization to elevated credit risk relative to comparable exposures
\77\ as the borrower may be unable to meet its financial commitments
when cash flows from the property decrease, such as when tenants
default or properties are unexpectedly vacant.\78\ In addition, LTV
ratios can be a useful risk indicator because the amount of a
borrower's equity in a real estate property correlates inversely with
default risk and provides banking organizations with a degree of
protection against losses.\79\ Therefore, exposures with lower LTV
ratios generally would receive a lower risk weight than comparable real
estate exposures with higher LTV ratios under the proposal.\80\ The
following chart illustrates how the proposal would require a banking
organization to assign risk weights to various real estate exposures,
as described in more detail below:
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\76\ See 12 CFR part 34, appendix A to subpart D (OCC); 12 CFR
part 208, appendix C (Board); 12 CFR part 365, appendix A (FDIC).
\77\ Comparable exposures include loans secured by real estate
where the repayment of the loan depends on non-real estate cash
flows such as owner-occupied properties, revenue from manufacturing
or retail sales.
\78\ See Board of Governors of the Federal Reserve System,
Financial Stability Report (November 2020), https://www.federalreserve.gov/publications/files/financial-stability-report-20201109.pdf.
\79\ Id., at 30.
\80\ The proposed LTV criterion measures the borrower's use of
debt (leverage) to finance a real estate purchase, with higher LTV
reflecting greater leverage and thus higher credit risk.
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BILLING CODE 6210-01-P; 6714-01-P; 4810-33-P
[[Page 64045]]
[GRAPHIC] [TIFF OMITTED] TP18SE23.002
BILLING CODE 6210-01-C; 6714-01-C; 4810-33-C
i. Regulatory Residential Real Estate Exposures
Under the proposal, a regulatory residential real estate exposure
would be defined as a first-lien residential mortgage exposure (as
defined in Sec. __.2) that is not a defaulted real estate exposure (as
defined in Sec. __. 101), an ADC exposure, a pre-sold construction
loan, a statutory multifamily mortgage, or an HVCRE exposure, provided
the exposure meets certain prudential criteria.\81\ First, the loan
would be required to be secured by a property that is either owner-
occupied or rented. Second, the exposure would be required to be made
in accordance with prudent underwriting standards, including standards
relating to the loan amount as a percent of the value of the
[[Page 64046]]
property.\82\ Third, during the underwriting process, the banking
organization would be required to apply underwriting policies that
account for the ability of the borrower to repay based on clear and
measurable underwriting standards that enable the banking organization
to evaluate these credit factors. The agencies would expect these
underwriting standards to be consistent with the agencies' safety and
soundness and real estate lending guidelines.\83\ Fourth, the property
must be valued in accordance with the proposed requirements included in
the proposed LTV ratio calculation, as discussed below.
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\81\ Consistent with the standardized approach in the capital
rule, under the proposal, when a banking organization holds the
first-lien and junior-lien(s) residential mortgage exposures and no
other party holds an intervening lien, the banking organization must
combine the exposures and treat them as a single first-lien
regulatory residential real estate exposure, if the first-lien meets
all of the criteria for a regulatory residential real estate
exposure.
\82\ For more information on value of the property, see section
III.C.2.e.iv of this Supplementary Information.
\83\ See 12 CFR part 30, appendix A (OCC); 12 CFR part 208,
appendix C (Board); 12 CFR parts 364 and 365 (FDIC).
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ii. Regulatory Commercial Real Estate Exposures
The proposal would define a regulatory commercial real estate
exposure as a real estate exposure that is not a regulatory residential
real estate exposure, a defaulted real estate exposure, an ADC
exposure, a pre-sold construction loan, a statutory multifamily
mortgage, or an HVCRE exposure, provided the exposure meets several
prudential criteria. First, the exposure must be primarily secured by
fully completed real estate. Second, the banking organization must hold
a first priority security interest in the property that is legally
enforceable in all relevant jurisdictions.\84\ Third, the exposure must
be made in accordance with prudent underwriting standards, including
standards relating to the loan amount as a percent of the value of the
property. Fourth, during the underwriting process, the banking
organization must apply underwriting policies that account for the
ability of the borrower to repay in a timely manner based on clear and
measurable underwriting standards that enable the banking organization
to evaluate these credit factors. The agencies would expect that these
underwriting standards would be consistent with the agencies' safety
and soundness and real estate lending guidelines. Finally, the property
must be valued in accordance with the proposed requirements included in
the proposed LTV ratio calculation, as discussed below.
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\84\ When the banking organization also holds a junior security
interest in the same property and no other party holds an
intervening security interest, the banking organization must treat
the exposures as a single first-lien regulatory commercial real
estate exposure, if the first-lien meets all of the criteria for a
regulatory commercial real estate exposure.
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Question 23: The agencies seek comment on the application of
prudent underwriting standards in the proposed definitions of
regulatory residential and regulatory commercial real estate exposures,
including standards relating to the loan amount as a percent of the
value of the property. What, if any, further clarity is needed and why?
iii. Exposures That Are Dependent on the Cash Flows Generated by the
Real Estate
As noted above, the proposal would differentiate the risk weight of
regulatory residential, regulatory commercial, and other real estate
exposures based on whether the borrower's ability to service the loan
is dependent on cash flows generated by the real estate. Exposures that
are dependent on the cash flows generated by real estate to repay the
loan can be affected by local market conditions and present elevated
credit risk relative to exposures that are serviceable by the income,
cash, or other assets of the borrower. For example, an increase in the
supply of competitive rental property can lower demand and suppress
cash flows needed to support repayment of the loan.
If the underwriting process at origination of the real estate
exposure considers any cash flows generated by the real estate securing
the loan, such as from lease or rental payments or from the sale of the
real estate as a source of repayment, then the exposure would meet the
proposal's definition of dependent on the cash flows generated by the
real estate. Evaluating whether repayment of the exposure is dependent
on cash flows generated from the real estate is a conservative and
straightforward approach for differentiating the credit risk of real
estate exposures. Given their increased credit risk, the proposal would
assign relatively higher risk weights to exposures that are dependent
on any proceeds or income generated from the real estate itself to
service the debt.
Under the proposal, additional loan characteristics can affect
whether an exposure would be considered dependent on cash flows from
the real estate. The proposal's definition of dependence on the cash
flows generated by the real estate would exclude any residential
mortgage exposure that is secured by the borrower's principal residence
as such mortgage exposures present reduced credit risk relative to real
estate exposures that are secured by the borrower's non-principal
residence.\85\ For residential properties that are not the borrower's
principal residence, including vacation homes and other second homes,
such properties would be considered dependent on the cash flows
generated by the real estate unless the banking organization has relied
solely on the borrower's personal income and resources, rather than
rental income (or resale or refinance of the property), to repay the
loan.
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\85\ For example, if (1) a borrower purchases a two-unit
property with the intention of making one unit their principal
residence, (2) the borrower intends to rent out the second unit to a
third party, and (3) the banking organization considered the cash
flows from the rental unit as a source of repayment, the exposure
would not meet the proposal's definition of dependent on the cash
flows generated by the real estate because the property securing the
exposure is the borrower's principal residence.
---------------------------------------------------------------------------
For regulatory commercial real estate exposures, the applicable
risk weights similarly would be determined based on whether repayment
is dependent on the cash flows generated by the real estate. For
example, the agencies would expect that rental office buildings,
hotels, and shopping centers leased to tenants are dependent on the
cash flows generated by the real estate for repayment of the loan. In
the case of a loan to a borrower to purchase or refinance real estate
where the borrower will operate a business such as a retail store or
factory and rely solely on the revenues from the business or resources
of the borrower other than rental, resale, or other income from the
real estate for repayment, the exposure would not be considered
dependent on the cash flows generated by the real estate under the
proposal. Similarly, a loan to the owner-operator of a farm would not
be considered dependent on the cash flows generated by the real estate
under the proposal if the borrower will rely solely on the sale of
products from the farm or other resources of the borrower other than
rental, resale, or other income from the real estate for repayment.
Question 24: What, if any, alternative quantitative threshold
should the agencies consider in determining whether a real estate
exposure is dependent on cash flows from the real estate (for example,
a threshold between 5 and 50 percent of the income)? Further, if the
agencies decide to adopt an alternative quantitative threshold, either
for regulatory residential or regulatory commercial real estate
exposures, how should it be calibrated for regulatory residential and
separately for regulatory commercial real estate exposures and what
would be the appropriate calibration levels for each? Please provide
specific examples of any
[[Page 64047]]
alternatives, including calculations and supporting data.
Question 25: The agencies seek feedback on the proposed treatment
of exposures secured by second homes, including vacation homes where
repayment of the loan is not dependent on cash flows. What are the
advantages and disadvantages of treating such exposures as regulatory
residential real estate exposures? Would a different category be more
appropriate for these exposures given their risk profile, and if so,
describe which other category(s) of real estate exposures would be most
similar and why. Please provide supporting data in your responses.\86\
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\86\ See Garcia, Daniel (2019). ``Second Home Buyers and the
Housing Boom and Bust,'' Finance and Economics Discussion Series
2019-029. Washington: Board of Governors of the Federal Reserve
System, https://www.federalreserve.gov/econres/feds/files/2019029pap.pdf.
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Question 26: The agencies seek comment on the treatment of
residential mortgage exposures where repayment is dependent on cash
flows from overnight or short-term rentals, as such cash flows may not
be as reliable as a source of repayment as cash flows from long-term
rental contracts or the borrower's other income sources. What would be
the advantages or disadvantages of treating residential real estate
exposures dependent on cash flows from short-term rentals similar to
commercial real estate exposures dependent on cash flows?
iv. Calculating the Loan-To-Value Ratio
The proposal would require a banking organization also to use LTV
ratios to assign a risk weight to a regulatory residential or
regulatory commercial real estate exposure. Under the proposal, LTV
ratio would be calculated as the extension of credit divided by the
value of the property. The proposed calculation of LTV ratio would be
generally consistent with the real estate lending guidelines except
with respect to the recognition of private mortgage insurance, as
described below.
The extension of credit would mean the total outstanding amount of
the loan including any undrawn committed amount of the loan. The total
outstanding amount of the loan would reflect the current amortized
balance as the loan pays down, which may allow a banking organization
to assign a lower risk weight during the life of the loan. Similarly,
if a loan balance increases, a banking organization would need to
increase the risk weight if the increased LTV would result in a higher
risk weight. For purposes of the LTV ratio calculation, a banking
organization would calculate the loan amount without making any
adjustments for credit loss provisions or private mortgage insurance.
Not recognizing private mortgage insurance would be consistent with the
current capital rule's definition of eligible guarantor, which does not
recognize an insurance company engaged predominately in the business of
providing credit protection (such as a monoline bond insurer or re-
insurer) and also reflects the performance of private mortgage
insurance during times of stress in the housing market. The agencies do
not intend the proposed risk weights to be applied to LTVs that include
private mortgage insurance.
The value of the property would mean the value at the time of
origination of all real estate properties securing or being improved by
the extension of credit, plus the fair value of any readily marketable
collateral and other acceptable collateral, as defined in the real
estate lending guidelines, that secures the extension of credit.
For exposures subject to the Real Estate Lending, Appraisal
Standards, and Minimum Requirements for Appraisal Management Companies
or Appraisal Standards for Federally Related Transactions (combined,
the appraisal rule),\87\ the market value of real estate would be a
valuation that meets all requirements of that rule. For exposures not
subject to the appraisal rule, the proposal would require that (1) the
market value of real estate be obtained from an independent valuation
of the property using prudently conservative valuation criteria and (2)
the valuation be done independently from the banking organization's
origination and underwriting process. Most real estate exposures held
by insured depository institutions are subject to the agencies'
appraisal rule, which also provides for evaluations in some cases, and
provides for certain exceptions, such as where a lien on real estate is
taken as an abundance of caution. To help ensure that the value of the
real estate is determined in a prudently conservative manner, the
proposal would also provide that, for exposures not subject to the
appraisal rule, the valuations of the real estate properties would need
to exclude expectations of price increases and be adjusted downward to
take into account the potential for the current market prices to be
significantly above the values that would be sustainable over the life
of the loan.
---------------------------------------------------------------------------
\87\ See 12 CFR part 34, subpart C or subpart G (OCC); 12 CFR
part 208, subpart E or 12 CFR part 225, subpart G (Board); 12 CFR
part 323 (FDIC).
---------------------------------------------------------------------------
In addition, when the real estate exposure finances the purchase of
the property, the value would be the lower of (1) the actual
acquisition cost of the property and (2) the market value obtained from
either (i) the valuation requirements under the appraisal rule (if
applicable) or (ii) as described above, an independent valuation using
prudently conservative valuation criteria that is separate from the
banking organization's origination and underwriting process.
Supervisory experience has shown that market values of real estate
properties can be temporarily impacted by local market forces and using
a value figure including such volatility would not reflect the long-
term value of the real estate. Therefore, the proposal would require
that the value used for the LTV calculation be an amount that is more
conservative than the market value of the property.
Using the value of the property at origination when calculating the
LTV ratio protects against volatility risk or short-term market price
inflation. For purposes of the LTV ratio calculation, the proposal
would require banking organizations to use the value of the property at
the time of origination, except under the following circumstances: (1)
the banking organization's primary Federal supervisor requires the
banking organization to revise the property value downward; (2) an
extraordinary event occurs resulting in a permanent reduction of the
property value (for example, a natural disaster); or (3) modifications
are made to the property that increase its market value and are
supported by an appraisal or independent evaluation using prudently
conservative criteria. These proposed exceptions are intended to
constrain the use of values other than the value of the property at
loan origination only to exceptional circumstances that are
sufficiently material to warrant use of a revised valuation.
For purposes of determining the value of the property, the proposal
would use the definition of readily marketable collateral and other
acceptable collateral consistent with the real estate lending
guidelines. Therefore, readily marketable collateral would mean insured
deposits, financial instruments, and bullion in which the banking
organization has a perfected security interest. Financial instruments
and bullion would need to be salable under ordinary circumstances with
reasonable promptness at a fair market value determined by quotations
based on actual transactions, on an auction or similarly available
daily bid and ask price market. Readily marketable
[[Page 64048]]
collateral should be appropriately discounted by the banking
organization consistent with the banking organization's usual practices
for making loans secured by such collateral. Other acceptable
collateral would mean any collateral in which the banking organization
has a perfected security interest that has a quantifiable value and is
accepted by the banking organization in accordance with safe and sound
lending practices. Other acceptable collateral should be appropriately
discounted by the banking organization consistent with the banking
organization's usual practices for making loans secured by such
collateral. Under the proposal, other acceptable collateral would
include, among other items, unconditional irrevocable standby letters
of credit for the benefit of the banking organization. The
reasonableness of a banking organization's underwriting criteria would
be reviewed through the examination and supervisory process to help
ensure its real estate lending policies are consistent with safe and
sound banking practices.
Question 27: What are the benefits and drawbacks of allowing
readily marketable collateral and other acceptable collateral to be
included in the value for purposes of calculating the LTV ratio? What
are the advantages and disadvantages of providing specific discount
factors to the value of acceptable collateral for purposes of
calculating the LTV ratio such as the standard supervisory market price
volatility haircuts contained in Sec. __.121 of the proposed rule?
What alternatives should the agencies consider? Please provide specific
examples and supporting data.
v. Risk Weights for Regulatory Residential Real Estate Exposures
Under the proposal, a banking organization would assign a risk
weight to a regulatory residential real estate exposure based on the
exposure's LTV ratio and whether the exposure is dependent on the cash
flows generated by the real estate, as reflected in Tables 2 and 3
below. LTV ratios and dependence on cash flows generated by the real
estate would factor into the risk-weight treatment for real estate
exposures under the proposal because these risk factors can be
determinants of credit risk for real estate exposures. The proposed
corresponding risk weights in each LTV ratio category are intended to
appropriately reflect differences in the credit risk of these
exposures. The risk weights that would apply under the proposal are
provided below.\88\
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\88\ The risk weight assigned to loans does not impact the
appropriate treatment of loans under the agencies' other regulations
and guidance, such as the supervisory LTV limits under the real
estate lending guidelines.
[GRAPHIC] [TIFF OMITTED] TP18SE23.003
[GRAPHIC] [TIFF OMITTED] TP18SE23.004
While LTV ratios and dependency upon cash flows of the real estate
are useful risk indicators, the agencies recognize that banking
organizations consider a variety of factors when underwriting a
residential real estate exposure and assessing a borrower's ability to
repay. For example, a banking organization may consider a borrower's
current and expected income, current and expected cash flows, net
worth, other relevant financial resources, current financial
obligations, employment status, credit history, or other relevant
factors during the underwriting process. The agencies are supportive of
home ownership and do not intend the proposal to diminish home
affordability or homeownership opportunities, including for low- and
moderate-income (LMI) home buyers or other historically underserved
markets. The agencies are particularly interested in whether the
proposed framework for regulatory residential real estate exposures
should be modified in any way to avoid unintended impacts on the
ability of otherwise credit-worthy borrowers who make a smaller down
payment to purchase a home. For example, the agencies are considering
whether a 50 percent risk weight would be appropriate for these loans,
to the extent they are originated in accordance with prudent
underwriting standards and originated through a home ownership program
that the primary Federal regulatory agency determines provides a public
benefit and includes risk mitigation features such as credit counseling
and consideration of repayment ability.
Question 28: The agencies seek comment on how the proposed
treatment of regulatory residential real estate exposures will impact
home affordability and home ownership opportunities, particularly for
LMI borrowers or other historically underserved markets. What are the
advantages and disadvantages of an alternative treatment that would
assign a 50 percent risk weight to mortgage loans originated in
accordance with
[[Page 64049]]
prudent underwriting standards and originated through a home ownership
program that the primary Federal regulatory agency determines provides
a public benefit and includes risk mitigation features such as credit
counseling and consideration of repayment ability? What, if any,
additional or alternative risk indicators should the agencies consider,
besides loan-to-value or dependency upon cash flow for risk-weighting
regulatory residential real estate exposures? Please provide specific
examples of mortgage lending programs where such factors were the basis
for underwriting the loans and the historical repayment performance of
the loans in such programs. Please comment on whether these risk
indicators are already collected and maintained by banking
organizations as part of their mortgage lending activities and
underwriting practices.
In addition, the agencies considered adopting an alternative risk-
based capital treatment in subpart E that does not rely on loan-to-
value ratios or dependency upon cash flow generated by the real estate.
One such alternative would be to incorporate the same treatment for
residential mortgage exposures as found in the current U.S.
standardized risk-based capital framework. Under this alternative, the
risk-based capital treatment for residential mortgage exposures in
subpart D of the capital rule would be incorporated into the proposed
subpart E. First-lien residential mortgage exposures that are prudently
underwritten would receive a 50 percent risk weight consistent with the
treatment contained in the U.S. standardized risk-based capital
framework. Such an approach would allow banking organizations to
continue to offer prudently underwritten products through lending
programs with the flexibility to meet the needs of their communities
without additional regulatory capital implications. The agencies note
that current mortgage rules promulgated since the global financial
crisis require lenders to consider each borrower's ability to
repay.\89\
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\89\ See 12 CFR part 1026.
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As in subpart D, residential mortgage exposures that do not meet
the requirements necessary to receive a 50 percent risk weight would
receive a 100 percent risk weight. While such an approach would not use
loan-to-value or dependency upon cash flow generated by the real estate
to assign a risk-weight, it would provide for a simpler framework where
all prudently underwritten first-lien residential mortgage exposures
would receive the same risk-based capital treatment. Lastly and
consistent with the treatment in subpart D, if a banking organization
holds the first and junior lien(s) on a regulatory residential real
estate exposure and no other party holds an intervening lien, the
banking organization would be required to treat the combined exposure
as a single loan secured by a first lien for purposes of assigning a
risk weight.
Question 29: The agencies seek comment on assigning risk weights to
residential mortgage exposures, consistent with the current U.S.
standardized risk-based capital framework. What are the pros and cons
of this alternative treatment?
vi. Risk Weights for Regulatory Commercial Real Estate Exposures
In a manner similar to regulatory residential real estate exposure,
the proposal would require a banking organization to assign a risk
weight to a regulatory commercial real estate exposure based on the
exposure's LTV ratio and whether the exposure is dependent on the cash
flows generated by the real estate, as reflected in Tables 4 and 5
below. For regulatory commercial real estate exposures that are not
dependent on cash flows for repayment, the main driver of risk to the
banking organization is whether the commercial borrower would generate
sufficient revenue through its non-real estate business activities to
repay the loan to the banking organization. For this reason, under
Table 4 the proposed risk weight for the exposure would be dependent on
the risk weight assigned to the borrower. For the purposes of Table 4,
if the LTV ratio of the exposures is greater than 60 percent, and the
banking organization does not have sufficient information about the
exposure to determine what the risk weight applicable to the borrower
would be, the banking organization would be required to assign a 100
percent risk weight to the exposure.
[GRAPHIC] [TIFF OMITTED] TP18SE23.005
[GRAPHIC] [TIFF OMITTED] TP18SE23.006
Question 30: What, if any, market effects could the proposed
treatment have on residential and commercial real estate mortgage
lending and why? What alternatives to the proposed treatment or
calibration should the agencies consider? Please provide supporting
data.
vii. Defaulted Real Estate Exposures
The proposal would require banking organizations to apply an
elevated risk weight to defaulted real estate
[[Page 64050]]
exposures, consistent with the approach to defaulted exposures
described in section III.C.2.a. of this Supplementary Information. The
proposal would introduce a definition of defaulted real estate exposure
that would provide new criteria for determining whether a residential
mortgage exposure or a non-residential mortgage exposure is in default.
These new criteria are indicative of a credit-related default for such
exposures. For residential mortgage exposures, the definition of
defaulted real estate exposure would require the banking organization
to evaluate default at the exposure level. For other real estate
exposures that are not residential mortgage exposures, the definition
of defaulted real estate exposure would require the banking
organization to evaluate default at the obligor level, consistent with
the approach describe above for non-retail defaulted exposures.
Since residential mortgage exposures are primarily originated to
individuals for the purchase or refinancing of their primary residence,
most obligors of residential real estate exposures do not have
additional real estate exposures. Therefore, determining default at the
exposure level would account for the material default risk of most
residential mortgage exposures. Additionally, evaluating defaulted
residential mortgage exposures at the obligor level may be difficult
for banking organizations to operationalize, for example, if there are
challenges collecting information on the payment status of other
obligations of individual borrowers.
In contrast, for other types of real estate exposures, such as
regulatory commercial real estate and ADC exposures, evaluating default
at the obligor level would be more appropriate and less challenging as
those obligors frequently have other credit obligations that are large
in value and potentially held by multiple banking organizations.
Default by an obligor on other credit obligations, which a banking
organization should account for when evaluating the risk profile of the
borrower, would indicate increased credit risk of the exposure held by
a banking organization.
A defaulted real estate exposure that is a residential mortgage
exposure would include an exposure (1) that is 90 days or more past due
or in nonaccrual status; (2) where the banking organization has taken a
partial charge-off, write-down of principal, or negative fair value
adjustment on the exposure for credit-related reasons, until the
banking organization has reasonable assurance of repayment and
performance for all contractual principal and interest payments on the
exposure; or (3) where the banking organization agreed to a distressed
restructuring that includes the following credit-related reasons:
forgiveness or postponement of principal, interest, or fees; term
extension; or an interest rate reduction. Distressed restructuring
would not include a loan modified or restructured solely pursuant to
the U.S. Treasury's Home Affordable Mortgage Program.\90\
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\90\ The U.S. Treasury's Home Affordable Mortgage Program was
created under the Troubled Asset Relief Program in response to the
subprime mortgage crisis of 2008. See Emergency Economic
Stabilization Act, Public Law 110-343, 122 Stat. 3765 (2008).
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To determine if a non-residential mortgage exposure would be a
defaulted real estate exposure, banking organizations would apply the
same criteria as described above in section III.C.2.a. of this
Supplementary Information that are used to determine if a non-retail
exposure is a defaulted exposure. Banking organizations are expected to
conduct ongoing credit reviews of relevant obligors. The proposal would
require banking organizations to continue to treat non-residential real
estate exposures that meet this definition as defaulted real estate
exposures until the non-residential real estate exposure no longer
meets the definition or until the banking organization determines that
the obligor meets the definition of investment grade or speculative
grade.
Under the proposal, a defaulted real estate exposure that is a
residential mortgage exposure not dependent on the cash flows generated
by the real estate would receive a risk weight of 100 percent,
regardless of whether the exposure qualifies as a regulatory real
estate exposure, unless a portion of the real estate exposure is
guaranteed under Sec. __.120 of the proposal. This treatment is
consistent with the risk weight for past due residential mortgage
exposures under the current standardized approach. Additionally, a
residential mortgage guaranteed by the Federal Government through the
Federal Housing Administration (FHA) or the Department of Veterans
Affairs (VA) generally will be risk-weighted at 20 percent under the
proposal, including a residential mortgage guaranteed by FHA or VA that
meets the defaulted real estate exposure definition.
Any other defaulted real estate exposure would receive a risk
weight of 150 percent, including any other non-residential real estate
exposure to the same obligor, consistent with the proposed risk weight
of other defaulted exposures described in section II.C.2.a. of this
Supplementary Information. A banking organization may apply a risk
weight to the guaranteed portion of defaulted real estate exposures
based on the risk weight that applies under Sec. __.120 of the
proposal if the guarantee or credit derivative meets the applicable
requirements.
Question 31: How does the defaulted real estate exposure definition
compare with banking organizations' existing policies relating to the
determination of the credit risk of defaulted real estate exposures and
the creditworthiness of defaulted real estate obligors? What, if any,
additional clarifications are necessary to determine the point at which
residential and non-residential mortgages should no longer be treated
as defaulted exposures? Please provide specific examples and supporting
data.
Question 32: For purposes of commercial real estate exposures, the
agencies invite comment on the extent to which obligors have
outstanding other exposures with multiple banking organizations and
other creditors. What would be the advantages and disadvantages of
considering both the obligor and the parent company or other entity or
individual that owns or controls the obligor when determining if the
exposure meets the criteria for ``defaulted real estate exposure''?
Question 33: For purposes of residential mortgage exposures, the
agencies invite comment on the appropriateness of including a
borrower's bankruptcy as a criterion for defaulted real estate
exposure. Would criteria (1)(i) through (1)(iii) in the proposed
defaulted real estate definition for residential mortgages sufficiently
capture the risk of a borrower involved in a bankruptcy proceeding?
viii. ADC Exposures That Are Not HVCRE Exposures
Under the proposal, the agencies would define an ADC exposure as an
exposure secured by real estate for the purpose of acquiring,
developing, or constructing residential or commercial real estate
properties, as well as all land development loans, and all other land
loans. Some ADC exposures meet the definition of HVCRE exposure in
Sec. __.2 of the capital rule and would be assigned a 150 percent risk
weight.\91\ Real estate exposures that meet the
[[Page 64051]]
definition of ADC exposure but do not meet the criteria of an HVCRE
exposure or a defaulted real estate exposure would be assigned a 100
percent risk weight under the proposal. The proposed regulatory
treatment for ADC exposures would not take into consideration cash flow
dependency or LTV ratio criteria. ADC exposures are mostly short-term
or bridge loans to cover construction or development, or lease up or
sales phases of a real estate project, rather than an amortizing
permanent loan for completed residential or commercial real estate.
Supervisory experience has shown that ADC exposures have heightened
risk compared to permanent commercial real estate exposures, and these
exposures generally have been subject to a risk weight of 100 percent
or more under the current standardized approach. Repayment of ADC loans
is often based on the expected completion of the construction or
development of the property, which can be delayed or interrupted by
many factors such as changes in market condition or financial
difficulty of the obligor.
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\91\ Section 214 of the Economic Growth, Regulatory Relief, and
Consumer Protection Act (EGRRCPA) imposes certain requirements on
high volatility commercial real estate acquisition, development, or
construction loans. Section 214 of Public Law 115-174, 132 Stat.
1296 (2018); 12 U.S.C. 1831bb.
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ix. Other Real Estate Exposures
The proposal would define other real estate exposures as real
estate exposures that are not defaulted real estate exposures,
regulatory commercial real estate exposures, regulatory residential
real estate exposures, ADC exposures, or any of the statutory real
estate exposures.
An exposure meeting the proposed definition of other real estate
exposure poses heightened credit risk as a result of not meeting the
proposed prudential underwriting criteria included in the definitions
of regulatory residential and regulatory commercial real estate,
respectively, and accordingly would be assigned a higher risk weight.
Specifically, the proposal would require a banking organization to
assign a 150 percent risk weight to an other real estate exposure,
unless the exposure is a residential mortgage exposure that is not
dependent on the cash flows generated by the real estate, which must be
assigned a 100 percent risk weight.
For example, a banking organization would assign a 150 percent risk
weight to real estate exposures that are dependent on the cash flows
generated by the underlying real estate, such as a rental property, and
that do not meet the regulatory residential or regulatory commercial
real estate exposure definitions. Loans for the purpose of acquiring
real estate and reselling it at higher value that do not qualify as ADC
loans and do not meet the definition of regulatory residential real
estate exposures would be assigned a 150 percent risk weight as other
real estate exposures. The proposed 150 percent risk weight also would
provide a regulatory capital incentive for banking organizations to
originate real estate exposures in accordance with the prudential
qualification requirements for regulatory residential and commercial
real estate exposures, respectively.
In other cases, if a banking organization does not adequately
evaluate the creditworthiness of a borrower for an owner-occupied
residential mortgage exposure, or if the borrower has inadequate
creditworthiness or capacity to repay the loan, the exposure would not
be considered prudently underwritten and would be assigned a 100
percent risk weight instead of the lower risk weights included in Table
2 for regulatory residential mortgage exposures not dependent on the
cash flows generated by the real estate. The 100 percent risk weight
would also apply to junior lien home equity lines of credit and other
second mortgages given the elevated risk of these loans when compared
to similar senior lien loans.
f. Retail Exposures
Relative to the current standardized approach, and as described in
more detail below, the proposal would increase the credit risk-
sensitivity of the capital requirements applicable to retail exposures
by assigning risk weights that would vary depending on product type and
the degree of portfolio diversification. The proposal would introduce a
new definition of retail exposure, which would include an exposure to a
natural person or persons, or an exposure to a small or medium-sized
entity (SME) \92\ that meets the proposed definition of a regulatory
retail exposure described below. Including an exposure to an SME in the
definition of a retail exposure provides a benefit for small companies,
such as smaller limited liability companies, which may have
characteristics more similar to those of a natural person than of a
larger corporation. The proposed definition of a retail exposure would
be narrower in scope than the current capital rule's existing
definition of a retail exposure under subpart E, which includes a
broader range of exposures, including real estate-related exposures.
Because the proposal would include separate risk-weight treatments for
real estate exposures that account for the underlying collateral, the
proposed definition of a retail exposure would only apply to a retail
exposure that would not otherwise be a real estate exposure.\93\
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\92\ An SME would mean an entity in which the reported annual
revenues or sales for the consolidated group of which the entity is
a part are less than or equal to $50 million for the most recent
fiscal year. This scope is generally consistent with the definition
of an SME under the Basel III reforms and also corresponds with the
maximum receipts-based size standard for small businesses set by the
Small Business Administration, which varies by industry and does not
exceed $47 million per year. See 13 CFR part 121.
\93\ For an exposure that qualifies as a real estate exposure
and also meets conditions (1) and (2) of the definition of a retail
exposure, the proposal would require a banking organization to treat
the exposure as a real estate exposure and calculate risk-based
requirements for the exposure as described in section III.C.2.e of
this Supplementary Information.
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The proposal would differentiate the risk-weight treatment for
retail exposures based on whether (1) the exposure qualifies as a
regulatory retail exposure, (2) further qualifies as a transactor
exposure; or (3) does not qualify for either of the previous categories
and is treated as an other retail exposure. The proposed definitions of
a regulatory retail exposure and a transactor exposure outlined below
include key criteria for broadly categorizing the relative credit risk
of retail exposures.
To qualify as a regulatory retail exposure, the proposal would
require the exposure to be in the form of any of the following credit
products: a revolving credit or line of credit (such as a credit card,
charge card, or overdraft) or a term loan or lease (such as an
installment loan, auto loan or lease, or student or educational loan)
(collectively, eligible products). In addition, under the proposal, the
amount of retail exposures that a banking organization could treat as
regulatory retail exposures would be limited on an aggregate and
granular basis. A banking organization would include all outstanding
and committed but unfunded regulatory retail exposures accounting for
any applicable credit conversion factor when aggregating the retail
exposures. Specifically, the regulatory retail exposure category would
exclude any retail exposure to a single obligor and its affiliates
that, in the aggregate with any other retail exposures to that obligor
or its affiliates, including both on- and off-balance sheet exposures,
exceeds a combined total of $1 million (aggregate limit).
In addition, for any single retail exposure, only the portion up to
0.2 percent of the banking organization's total retail exposures that
are eligible products (granularity limit) would be considered a
regulatory retail exposure.
[[Page 64052]]
The portion of any single retail exposure that exceeds the granularity
limit would not qualify as a regulatory retail exposure. For purposes
of calculating the 0.2 percent granularity limit for a regulatory
retail exposure, off-balance sheet exposures would be subject to the
applicable credit conversion factors, as discussed in Sec. __.112(b),
and defaulted exposures, as discussed in Sec. __.101(b) of the
proposal, would be excluded. Under the proposal, if an exposure to an
SME does not meet criteria (1) through (3) of the definition of a
regulatory retail exposure, then none of the exposures to that SME
would qualify as retail exposures and all of the exposures to that SME
would be treated as corporate exposures.
The proposal would define a transactor exposure as a regulatory
retail exposure that is a credit facility where the balance has been
repaid in full at each scheduled repayment date for the previous twelve
months or an overdraft facility where there has been no drawdown over
the previous twelve months. If a single obligor had both a credit
facility and an overdraft facility from the same banking organization,
the banking organization would separately evaluate each facility to
determine whether each facility would meet the definition of a
transactor exposure to be categorized as a transactor exposure.
Under the proposal, a banking organization would assign a risk
weight of 55 percent to a regulatory retail exposure that is a
transactor exposure and an 85 percent risk weight to a regulatory
retail exposure that is not a transactor exposure. All other retail
exposures would be assigned a 110 percent risk weight. The proposed 55
percent risk weight for a transactor exposure is appropriate because
obligors that demonstrate a historical repayment capacity generally
exhibit less credit risk relative to other retail obligors. A
regulatory retail exposure that is not a transactor exposure warrants
the proposed 85 percent risk weight, which would be lower than the
proposed 110 percent risk weight for all other retail exposures, due to
mitigating factors related to size or concentration risk. The aggregate
limit and granularity limit are intended to ensure that the regulatory
retail portfolio consists of a set of small exposures to a diversified
group of obligors, which would reduce credit risk to the banking
organization. Conversely, banking organizations with a high aggregate
amount of retail exposures to a single obligor, or exposures exceeding
the granularity limit, have a heightened concentration of retail
exposures. This concentration of retail exposures increases the level
of credit risk the banking organization has to a single obligor, and
the likelihood that the banking organization could face material losses
if the obligor misses a payment or defaults. Therefore, any retail
exposure that would not qualify as a regulatory retail or a transactor
exposure warrants a risk weight of 110 percent.
The following example describes how a banking organization would
identify the amount of retail exposures that could be treated as
regulatory retail exposures. First, a banking organization would
identify the amount of credit exposures that meet the eligible products
criterion within the definition of a regulatory retail exposure. Assume
a banking organization has $100 million in total retail exposures that
meet the eligible regulatory retail product criterion described above.
Next, for this set of exposures, the banking organization would
identify any amounts to a single obligor and its affiliates that exceed
$1 million. The banking organization in this example determines that a
single obligor and its affiliates account for an aggregate of $20
million of the banking organization's total retail exposures. Because
this $20 million exceeds the $1 million threshold for amounts to a
single obligor and its affiliates, this $20 million would be retail
exposures that are not regulatory retail exposures and subject to a 110
percent risk weight, leaving $80 million that could be categorized as
regulatory retail exposures.
Also, assume that of the $80 million, $1 million of the exposures
are considered defaulted exposures. This $1 million in defaulted
exposures would be subtracted from the $80 million. The banking
organization would multiply the remaining $79 million by the 0.2
percent granularity limit, with the resulting $158,000 representing the
dollar amount equivalent of the granularity limit for this banking
organization's retail portfolio. Therefore, of the remaining $79
million, the portion of those retail exposures to a single obligor and
its affiliates that do not exceed $158,000 would be considered
regulatory retail exposures. Of the regulatory retail exposures, the
portion of the exposure that would qualify as a transactor exposure
would receive a 55 percent risk weight and the remaining portion would
receive an 85 percent risk weight. Under the proposal, a banking
organization would assign a 110 percent risk weight to the portion of a
retail exposure that exceeds the granularity limit. Thus, the total
amount of retail exposures to a single obligor exceeding $158,000 in
this example would receive a 110 percent risk weight as other retail
exposures. This example is also illustrated in the following decision
tree.
[[Page 64053]]
[GRAPHIC] [TIFF OMITTED] TP18SE23.007
Question 34: What, if any, additional criteria or alternatives
should the agencies consider to help ensure that the regulatory retail
treatment is limited to a group of diversified retail obligors? What
alternative thresholds or calibrations should the agencies consider for
purposes of retail exposures? Please provide supporting data in your
response.
Question 35: What simplifications, if any, to the calculation
described above for a regulatory retail exposure should the agencies
consider to reduce operational complexity for banking organizations?
For example, what operational challenges would arise from assigning
differing risk weights to portions of retail exposures based on the
regulatory retail eligibility criteria?
Question 36: Is the requirement for repayment of a credit facility
in full at each scheduled repayment date for the previous twelve months
or lack of overdraft history an appropriate criterion to distinguish
the credit risk of a transactor exposure from other retail exposures,
and if not, what would be more appropriate and why? Is twelve months of
full repayment history a sufficient amount of time to demonstrate a
consistent repayment history of the credit or overdraft facility to
meet the definition of a transactor and if not, what would be an
appropriate amount of time?
g. Risk-Weight Multiplier for Certain Retail and Residential Mortgage
Exposures With Currency Mismatch
The proposal would introduce a new requirement for banking
organizations to apply a multiplier to the applicable risk weight
assigned to certain exposures that contain currency mismatches between
the banking organization's lending currency and the borrower's source
of repayment. The multiplier would reflect the borrower's increased
risk of default due to the borrower's exposure to foreign exchange
risk. The multiplier would apply to exposure types where the borrower
generally does not manage or hedge its foreign exchange risk. Exposures
with such currency mismatches pose increased credit risk to the banking
organization as the borrower's repayment ability could be affected by
exchange rate fluctuations.
To capture this increased risk, the proposal would require banking
organizations to apply a 1.5 multiplier to the applicable risk weight,
subject to a maximum risk weight of 150 percent, for retail and
residential mortgage exposures to a borrower that does not have a
source of repayment in the currency of the loan equal to at least 90
percent of the annual payment from either income generated through
ordinary business activities or from a contract with a financial
institution that provides funds denominated in the currency of the
loan, such as a forward exchange contract. Other types of exposures
generally account for foreign exchange risk through hedging or other
risk mitigants and would not be subject to the proposed multiplier. The
proposed risk weight ceiling of 150 percent aligns with the maximum
risk weight for credit exposures under the proposal.
Question 37: What, if any, additional or alternative criteria of
the proposed multiplier should the agencies consider and why?
h. Corporate Exposures
A corporate exposure under the proposal would be an exposure to a
company that does not fall under any other exposure category under the
proposal. This scope would be consistent with the definition found in
Sec. __.2 of the current capital rule. For example, an exposure to a
corporation that also meets the proposed definition of a real estate
exposure would be a real estate exposure rather than a corporate
exposure for purposes of the proposal.
As described in more detail below, the proposal would differentiate
the risk weights of corporate exposures based on credit risk by
considering such factors as a corporate exposure's investment quality
and the general creditworthiness of the borrower, level of
subordination, as well as the nature and substance of the lending
arrangement, and the degree of reliance on the borrower's independent
capacity for repayment of the obligation, or reliance on the income
that the borrowing entity is expected to generate from the asset(s) or
a project being financed. First, a banking organization would assign a
65 percent risk weight to a corporate exposure that is an exposure to a
company that is investment grade, and that has a publicly traded
security outstanding or that is controlled by a company that has
[[Page 64054]]
a publicly traded security outstanding.\94\ Second, consistent with the
current standardized approach, a banking organization would assign risk
weights of 2 percent or 4 percent to certain exposures to a qualifying
central counterparty.\95\ Third, as discussed further below, a banking
organization would assign a 130 percent risk weight to a project
finance exposure that is not a project finance operational phase
exposure. Fourth, a banking organization would assign a 150 percent
risk weight to a corporate exposure that is an exposure to a
subordinated debt instrument or an exposure to a covered debt
instrument unless a deduction treatment is provided as described in
section III.C.2.d. of this Supplementary Information.
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\94\ Under Sec. __.2 of the current capital rule, a person or
company controls a company if it: (1) owns, controls, or holds with
power to vote 25 percent or more of a class of voting securities of
the company; or (2) consolidates the company for financial reporting
purposes. See 12 CFR 3.2 (OCC); 12 CFR 217.2 (Board); 12 CFR 324.2
(FDIC).
\95\ See 12 CFR 3.32(f)(2) and (3) (OCC); 12 CFR 217.32(f)(2)
and (3) (Board); 12 CFR 324.32(f)(2) and (3) (FDIC).
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Finally, a banking organization would assign a 100 percent risk
weight to all other corporate exposures. Assigning a 100 percent risk
weight to all other corporate exposures appropriately reflects the
relative risk of such corporate exposures, as the repayment methods for
these exposures pose greater risks than those of publicly-traded
corporate exposures that are deemed investment grade. A banking
organization would also assign a 100 percent risk weight to corporate
exposures that finance income-producing assets or projects that engage
in non-real estate activities where the obligor has no independent
capacity to repay the loan. For example, corporate exposures subject to
the 100 percent risk weight would include exposures (i) for the purpose
of acquiring or financing equipment where repayment of the exposure is
dependent on the cash flows generated by either the equipment being
financed or acquired, (ii) for the purpose of acquiring or financing
physical commodities where repayment of the exposure is dependent on
the proceeds from the sale of the physical commodities, and (iii)
project finance operational phase exposures, as further discussed
below.
i. Investment Grade Companies With Publicly Traded Securities
Outstanding
Under the proposal, a banking organization would assign a 65
percent risk weight to a corporate exposure that is both (1) an
exposure to a company that is investment grade, and (2) where that
company, or a parent that controls that company, has publicly traded
securities outstanding.\96\ This two-pronged test would serve as a
reasonable basis for banking organizations to identify exposures to
obligors of sufficient creditworthiness to be eligible for a reduced
risk weight. The definition of investment grade directly addresses the
credit quality of the exposure by requiring that the entity or
reference entity have adequate capacity to meet financial commitments,
which means that the risk of its default is low and the full and timely
repayment of principal and interest is expected. A banking
organization's investment grade analysis is dependent upon the banking
organization's underwriting criteria, judgment, and assumptions.
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\96\ Under Sec. __.2 of the current capital rule, publicly-
traded means traded on: (1) any exchange registered with the SEC as
a national securities exchange under section 6 of the Securities
Exchange Act; or (2) any non-U.S.-based securities exchange that:
(i) is registered with, or approved by, a national securities
regulatory authority; and (ii) provides a liquid, two-way market for
the instrument in question. See 12 CFR 3.2 (OCC); 12 CFR 217.2
(Board); 12 CFR 324.2 (FDIC).
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The proposed requirement that the company or its parent company
have securities outstanding that are publicly traded, in contrast,
would be a simple, objective criterion that would provide a degree of
consistency across banking organizations. Further, publicly-traded
corporate entities are subject to enhanced transparency and market
discipline as a result of being listed publicly on an exchange. A
banking organization would use these simple criteria, which complement
a banking organization's due diligence and internal credit analysis, to
determine whether a corporate exposure qualifies as an investment grade
exposure.
Question 38: What, if any, alternative criteria should the agencies
consider to identify corporate exposures that would warrant a risk
weight of 65 percent or a risk weight between 65 percent and 100
percent?
Question 39: For what reasons, if any, should the agencies consider
applying a lower risk weight than 100 percent to exposures to companies
that are not publicly traded but are companies that are ``highly
regulated?'' What, if any, criteria should the agencies consider to
identify companies that are ``highly regulated?'' Alternatively, what
are the advantages and disadvantages of assigning lower risk weights to
highly regulated entities (such as open-ended mutual funds, mutual
insurance companies, pension funds, or registered investment
companies)?
Question 40: What are the advantages and disadvantages of applying
a lower risk weight (such as between 85 and 100 percent), to entities
based on size, such as companies with reported annual sales of less
than or equal to $50 million for the most recent financial year? What
alternative criteria, if any, should the agencies consider to identify
small or medium-sized entities that present lower credit risk? For
example, should the agencies consider asset size or number of employees
to identify small or medium-sized entities? Please provide supporting
data.
Question 41: What criteria, if any, should the agencies consider to
further differentiate corporate exposures according to their risk
profiles and what implications would such criteria have for the risk
weighting of these exposures and why?
ii. Project Finance Exposures
The proposal would define a project finance exposure as a corporate
exposure for which the banking organization relies on the revenues
generated by a single project (typically a large and complex
installation, such as power plants, manufacturing plants,
transportation infrastructure, telecommunications, or other similar
installations), both as the source of repayment and as security for the
loan. For example, a project finance exposure could take the form of
financing the construction of a new installation, or a refinancing of
an existing installation, with or without improvements. The primary
determinant of credit risk for a project finance exposure is the
variability of the cash flows expected to be generated by the project
being financed rather than the general creditworthiness of the obligor
or the market value or sale of the project or the real estate on which
the project sits.\97\ A project finance exposure also would be required
to meet the following criteria: (1) the exposure would need to be to a
borrowing entity that was created specifically to finance the project,
operate the physical assets of the project, or do both, and (2) the
borrowing entity would need to have an immaterial amount of assets,
activities, or sources of income apart from revenues from the
activities of the project being financed. Under the proposal, an
exposure that is deemed secured by real estate,\98\ would not be
[[Page 64055]]
considered a project finance exposure and would be assigned a risk
weight as described in section III.C.2.e. of this Supplementary
Information.
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\97\ Exposures that are guaranteed by the government or
considered a general obligation or revenue obligation exposure to a
PSE would not qualify as a project finance exposure.
\98\ Although it is common for the banking organization to take
a mortgage over the real property and a lien against other assets of
the project for security and lender control purposes, a project
finance exposure would not be considered a real estate exposure
because the banking organization does not rely on real estate
collateral to grant credit. As noted in section III.C.2.e of this
Supplementary Information, for purposes of the proposal, ``secured
by collateral in the form of real estate'' in the context of the
proposed real estate exposure definition should be interpreted in a
manner that is consistent with the current definition for ``a loan
secured by real estate'' in the Call Report and FR Y-9C
instructions.
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Under the proposal, a project finance exposure would receive a 130
percent risk weight during the pre-operational phase and a 100 percent
risk weight during the operational phase. The proposal would define a
project finance operational phase exposure as a project finance
exposure where the project has a positive net cash flow that is
sufficient to support the debt service and expenses of the project and
any other remaining contractual obligation, in accordance with the
banking organization's applicable loan underwriting criteria for
permanent financings, and where the outstanding long-term debt of the
project is declining. Prior to the operational phase classification, a
banking organization would be required to treat a project finance
exposure as being in the pre-operational phase and assign a 130 percent
risk weight to the exposure. The pre-operational phase would be the
period between the origination of the loan and the time at which the
banking organization determines that the project has entered the
operational phase. Relative to the operational phase, the pre-
operational phase presents increased uncertainty that the project will
be completed in a timely and cost-effective manner, which warrants the
application of a higher risk weight. For example, market conditions
could change significantly between commencement and completion of the
project. In addition, unanticipated supply shortages could disrupt
timely completion of the project and the expected timing of the
transition to the operational phase. These unanticipated changes could
disrupt the completion of the project and delay it becoming
operational, and thus impact the ability of the project to generate
cash flows as projected and to repay creditors.
Question 42: What additional exposures, if any, should be captured
by the proposed definition of a project finance exposure? What
exposures, if any, captured by the proposed definition of a project
finance exposure should be excluded from the definition?
Question 43: What clarifications or changes, if any, should the
agencies consider to differentiate project finance exposures from
exposures secured by real estate? What, if any, capital market effects
would the proposed treatment of project finance exposures have and why
and what, if any, modifications should the agencies consider to address
such effects? How material for banking organizations are project
finance exposures that are not based on the creditworthiness of a
Federal, state or local government?
3. Off-Balance Sheet Exposures
In addition to on-balance sheet exposures, banking organizations
are exposed to credit risk associated with off-balance sheet exposures.
Banking organizations often enter into contractual arrangements with
borrowers or counterparties to provide credit or other support. Such
arrangements generally are not recorded on-balance sheet under GAAP.
These off-balance sheet exposures often include commitments, contingent
items, guarantees, certain repo-style transactions, financial standby
letters of credit, and forward agreements.
The proposal would introduce a few updated credit conversion
factors that a banking organization would apply to an off-balance sheet
item's notional amount (typically, the contractual amount) in order to
calculate the exposure amount for an off-balance sheet exposure. Under
the proposal, the credit conversion factors, which would range from 10
percent to 100 percent, would reflect the expected proportion of the
off-balance sheet item that would become an on-balance sheet credit
exposure to the borrower, taking into account the contractual features
of the off-balance sheet item. For example, a guarantee provided by a
banking organization would be subject to a 100 percent credit
conversion factor because there generally is a high probability of the
full amount of the guarantee becoming an on-balance sheet credit
exposure. In contrast, under the terms of most commitments, banking
organizations generally are not expected to extend the full amount of
credit agreed to in the contract. After determining the off-balance
sheet exposure amount, the banking organization would then multiply it
by the appropriate risk weight, as provided under section III.C.2. of
the Supplementary Information, to arrive at the risk-weighted asset
amount for the off-balance sheet exposure, consistent with the
calculation method under the current standardized approach.
a. Commitments
The proposal would maintain the existing definition of commitment
under the current capital rule. The current capital rule defines a
commitment as any legally binding arrangement that obligates a banking
organization to extend credit or to purchase assets.\99\ A commitment
can exist even when the banking organization has the unilateral right
to not extend credit at any time.
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\99\ See 12 CFR 3.2 (OCC); 12 CFR 217.2 (Board); 12 CFR 324.2
(FDIC).
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Off-balance sheet exposures such as credit cards allow obligors to
borrow up to a specified amount. However, some off-balance sheet
exposures such as charge cards do not have an explicit contractual pre-
set credit limit and generally require obligors to pay their balance in
full each month. For commitments with no express contractual maximum
amount or pre-set limit, the proposal would include an approach to
calculate a proxy for the committed but undrawn amount of the
commitment (off-balance sheet notional amount), based on an averaging
formula over the previous two years (averaging methodology). A banking
organization would first calculate the average total drawn amount of
the commitment over the prior eight quarters or, if the banking
organization has offered such products to the obligor for fewer than
eight quarters, the average total drawn amount since the commitment
with no pre-set limit was first issued. The banking organization would
then multiply the average total drawn amount by 10 to determine the
off-balance sheet notional amount. Next, the banking organization would
determine the applicable off-balance sheet exposure amount by first
subtracting the current drawn amount from the calculated off-balance
sheet notional amount and then multiplying this difference by the
applicable credit conversion factor (10 percent for an unconditionally
cancelable commitment, as described in more detail in the following
section). The risk-weighted asset amount would be the off-balance sheet
exposure amount multiplied by the applicable risk weight (e.g., 55
percent for a transactor retail exposure).
For example, assume an obligor's charge card had an average drawn
amount of $4,000 over the prior eight quarters, and a drawn amount of
$3,000 during the most recent reporting quarter. To determine the off-
balance sheet exposure amount of the charge card, a banking
organization would (1) multiply the average of $4,000 by 10
[[Page 64056]]
($40,000), (2) subtract the current drawn amount of $3,000 from $40,000
($37,000), and (3) multiply $37,000 by the 10 percent credit conversion
factor for unconditionally cancellable commitments ($3,700). For
purposes of this example, assume the obligor's charge card would
qualify as a regulatory retail exposure \100\ that is a transactor
exposure. Applying the 55 percent risk weight for transactor exposures
to the exposure amount of $3,700. would result in a risk-weighted asset
amount of $2,035.
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\100\ As discussed in section III.C.2.f of this Supplementary
Information, a retail exposure would need to meet certain criteria
and be evaluated against the aggregate and granularity limits to
qualify as a regulatory retail exposure.
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The proposed averaging methodology would apply a multiplier of 10
to the average total drawn amount because supervisory experience
suggests that obligors similar to those with charge cards have average
credit utilization rates equal to approximately 10 percent. This
approach uses an eight-quarter average balance, as opposed to a shorter
period, to better reflect a borrower's credit usage, notably by
mitigating the impact of seasonality and of short-term trends in drawn
balances from the total credit exposure estimate.
Question 44: What are the advantages and disadvantages of the
averaging methodology to calculate a proxy for the undrawn credit
exposure amount for commitments with no pre-set limits? What, if any,
adjustments should the agencies consider to better reflect a borrower's
credit usage when calculating the undrawn portion of the credit
exposures for commitments that have less than eight quarters of data,
particularly those with less than a full quarter of data? What, if any,
alternative approaches should the agencies consider and why?
Question 45: What adjustments, if any, should the agencies make to
the proposed multiplier of 10 for calculating the total off-balance
sheet notional amount of the obligor under the proposed methodology and
why?
b. Credit Conversion Factors
The proposal would provide the same credit conversion factors in
the current capital rule except with respect to commitments. The
proposal would modify the credit conversion factors applicable to
commitments and simplify the treatment relative to the current
standardized approach by no longer differentiating such factors by
maturity. Under the proposal, a commitment, regardless of the maturity
of the facility, would be subject to a credit conversion factor of 40
percent, except for the unused portion of a commitment that is
unconditionally cancelable \101\ (to the extent permitted under
applicable law) by the banking organization, which would be subject to
a credit conversion factor of 10 percent.\102\ Although unconditionally
cancellable commitments allow banking organizations to cancel such
commitments at any time without prior notice, in practice, banking
organizations often extend credit or provide funding for reputational
reasons or to support the viability of borrowers to which the banking
organization has significant ongoing exposure, even when borrowers are
under economic stress. For example, banking organizations may have
incentives to preserve substantial or core customer relationships when
there is a deterioration in creditworthiness that may, for less
substantial customer relationships, cause the banking organization to
cancel a commitment. Relative to the current standardized approach, the
proposal would simplify the applicable credit conversion factor for all
other commitments given the 10 percent applicable credit conversion
factor for unconditionally cancellable commitments. A 40 percent credit
conversion factor for other commitments is appropriate because such
commitments do not provide the banking organization the same
flexibility to exit the commitment compared with unconditionally
cancellable commitments.
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\101\ Under Sec. __. 2 of the current capital rule,
unconditionally cancelable means a commitment that a banking
organization may, at any time, with or without cause, refuse to
extend credit (to the extent permitted under applicable law). See 12
CFR 3.2 (OCC); 12 CFR 217.2 (Board); 12 CFR 324.2 (FDIC).
\102\ Under the proposal, a 40 percent CCF would also apply to
commitments that are not unconditionally cancelable commitments for
purposes of calculating total leverage exposure for the
supplementary leverage ratio.
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Question 46: What additional factors, if any, should the agencies
consider for determining the applicable credit conversion factors for
commitments?
4. Derivatives
The current capital rule requires banking organizations to
calculate risk-weighted assets based on the exposure amount of their
derivative contracts and prescribes different approaches for measuring
the exposure amount of derivative contracts based on the size and risk
profile of the banking organization. The proposal would expand the
scope of banking organizations that would be required to use one of the
approaches, SA-CCR, which was adopted in January 2020 (the SA-CCR final
rule),\103\ and make certain technical revisions to that approach. The
current capital rule requires banking organizations subject to Category
I or II capital standards to utilize SA-CCR or the internal models
methodology to calculate their advanced approaches total risk-weighted
assets and to utilize SA-CCR to calculate standardized total risk-
weighted assets.\104\ The current capital rule permits banking
organizations subject to Category III or IV capital standards to
utilize the current exposure methodology or SA-CCR to calculate
standardized total risk-weighted assets.\105\
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\103\ 85 FR 4362 (January 24, 2020).
\104\ 12 CFR 3.34 (OCC); 12 CFR 217.34 (Board); 12 CFR 324.34
(FDIC).
\105\ Id.
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As discussed in section II of this Supplementary Information, the
proposal would require institutions subject to Category III or IV
capital standards to use the expanded risk-based approach, which
includes the requirement to use SA-CCR, and would eliminate the
internal models methodology as an available approach to calculate the
exposure amount of derivative contracts. Therefore, under the proposal,
large banking organizations would be required to use SA-CCR to
calculate regulatory capital ratios under the standardized approach,
expanded risk-based approach, and supplementary leverage ratio.
The agencies are also proposing technical revisions to SA-CCR to
assist banking organizations in implementing SA-CCR in a consistent
manner and with an exposure measurement that more appropriately
reflects the counterparty credit risks posed by derivative
transactions.
a. Proposed Technical Revisions
i. Treatment of Collateral Held by a Qualifying Central Counterparty
(QCCP)
Under the current capital rule, a clearing member banking
organization using SA-CCR must determine its capital requirement for a
default fund contribution to a QCCP based on the hypothetical capital
requirement for the QCCP (KCCP) using SA-CCR.\106\ The
calculation of KCCP requires calculating the exposure amount
of the QCCP to each of its clearing members. In the calculation of the
exposure amount, the SA-CCR final rule allows the exposure amount of
the QCCP to each clearing member to be reduced by all collateral held
by the QCCP posted by the clearing member and by the amount of
[[Page 64057]]
prefunded default fund contributions provided by the clearing member to
the QCCP. However, this treatment is inconsistent with the calculation
of the exposure amount for a netting set, in which collateral is not
subtracted from the exposure amount but is instead a component of the
calculations of both the replacement cost (RC) and potential future
exposure (PFE).
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\106\ See 12 CFR 3.133(d) (OCC); 12 CFR 217.133(d) (Board); 12
CFR 324.133(d) (FDIC).
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The proposal would change how collateral posted to a QCCP by
clearing members and the amount of clearing members' prefunded default
fund contributions factor into the calculation of KCCP. This
treatment, which is more sensitive to the risk-reducing benefits of
collateral, would allow the proper recognition of collateral in
calculating the exposure amount of a QCCP to its clearing members and
would be consistent with the calculation of the exposure amount for a
netting set. Specifically, for the purpose of calculating the exposure
amount of a QCCP to a clearing member, the net independent collateral
amount that appears in the RC and PFE calculations would be replaced by
the sum of:
(1) the fair value amount of the independent collateral posted to a
QCCP by a clearing member;
(2) the fair value amount of the independent collateral posted to a
QCCP by a clearing member on behalf of a client, in connection with
derivative contracts for which the clearing member has provided a
guarantee to the QCCP; and
(3) the amount of the prefunded default fund contribution of the
clearing member to the QCCP.
Both the amount of independent collateral and the prefunded default
fund contribution would be adjusted by the standard supervisory
haircuts under Table 1 to Sec. __.121 of the proposal, as applicable.
ii. Treatment of Collateral Held in a Bankruptcy-Remote Manner
Both the standardized approach and the advanced approaches under
the current capital rule require a banking organization to determine
the trade exposure amount for derivative contracts transacted through a
central counterparty (CCP).
When calculating its trade exposure amount for a cleared
transaction, a banking organization under both the standardized and
advanced approaches under the capital rule may exclude collateral
posted to the CCP that is held in a bankruptcy-remote manner by the CCP
or a custodian. In the SA-CCR final rule, the agencies inadvertently
imposed heightened requirements for the exclusion of collateral from
the trade exposure amount posted by a clearing member banking
organizations to a CCP under the advanced approaches.\107\ The expanded
risk-based approach does not include these heightened requirements and
would align the requirements for the exclusion of collateral from the
trade exposure amount of banking organizations under both the
standardized and expanded risk-based approach.
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\107\ 12 CFR 3.133(c)(4)(i) (OCC); 12 CFR 217.133(c)(4)(i)
(Board); 12 CFR 324.133(c)(4)(i) (FDIC).
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iii. Supervisory Delta for Collateralized Debt Obligation (CDO)
Tranches
Under the SA-CCR final rule, a banking organization must apply a
supervisory delta adjustment to account for the sensitivity of a
derivative contract (scaled to unit size) to the underlying primary
risk factor, including the correct sign (positive or negative) to
account for the direction of the derivative contract amount relative to
the primary risk factor.\108\
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\108\ For the supervisory delta adjustment, a banking
organization applies a positive sign to the derivative contract
amount if the derivative contract is long the risk factor and a
negative sign if the derivative contract is short the risk factor. A
derivative contract is long the primary risk factor if the fair
value of the instrument increases when the value of the primary risk
factor increases. A derivative contract is short the primary risk
factor if the fair value of the instrument decreases when the value
of the primary risk factor increases.
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For a derivative contract that is a CDO tranche, the supervisory
delta adjustment is calculated using the formula below:
[GRAPHIC] [TIFF OMITTED] TP18SE23.008
where A is the attachment point and D is the detachment point.
The SA-CCR final rule applies a positive sign to the resulting
amount if the banking organization purchased the CDO tranche and
applies a negative sign if the banking organization sold the CDO
tranche. However, the appropriate sign to account for the purchasing or
selling of CDO tranches can be ambiguous: purchasing a CDO tranche can
be interpreted as selling credit protection, while selling a CDO
tranche can be interpreted as purchasing credit protection. In order to
ensure the correct sign of the supervisory delta adjustment for CDO
tranches that would result in a proper aggregation of CDO tranches with
linear credit derivative contracts in PFE calculations, the proposal
would revise the sign specification for the supervisory delta
adjustment for CDO tranches as follows: positive if the CDO tranches
were used to purchase credit protection by the banking organization and
negative if the CDO tranches were used to sell credit protection by the
banking organization.
iv. Supervisory Delta for Options Contracts
Under the SA-CCR final rule, the supervisory delta adjustment for
option contracts is calculated based on the Black-Scholes formulas for
delta sensitivity of European call and put option contracts. The
original Black-Scholes formula for a European option contract's delta
sensitivity assumes a lognormal probability distribution for the value
of the instrument or risk factor underlying the option contract, thus
precluding negative values for both the current value of the underlying
instrument or risk factor and the strike price of the option contract.
The SA-CCR final rule uses modified Black-Scholes formulas that are
based on a shifted lognormal probability distribution, which allows
negative values of the underlying instrument or risk factor with the
magnitude not exceeding the value of a shift parameter [lambda]
(lambda). The SA-CCR final rule sets [lambda] to zero (thus precluding
negative values) for all asset classes except the interest rate asset
class, which has exhibited negative values in some currencies in recent
years. For the interest rate asset class, a banking organization must
set the value of [lambda] for a given currency equal to the greater of
(i) the negative of the lowest value of the strike prices and the
current values of the interest rate underlying all interest rate
options in a given currency that the banking organization has with all
counterparties plus 0.1 percent; and (ii) zero.
However, negative values of the instrument or risk factor
underlying an option contract can occur in other asset classes as well.
For example, whenever
[[Page 64058]]
an option contract references the difference between the values of two
instruments or risk factors, the underlying spread of this option
contract can be negative. Such option contracts are commonly traded in
the OTC derivatives market, including option contracts on the spread
between two commodity prices and on the difference in performance
across two equity indices. Under the current capital rule, banking
organizations cannot calculate the supervisory delta adjustment for any
option contract other than an interest rate derivative contract if the
strike price or the current value of the underlying instrument or risk
factor is negative because the SA-CCR final rule only allows a non-zero
value for [lambda] for interest rate derivative contracts. To ensure
that a banking organization is able to calculate the supervisory delta
adjustment for option contracts when the underlying instrument or risk
factor has a negative value, the proposal would extend the use of the
shift parameter [lambda] to all asset classes. More specifically, for
non-interest-rate asset classes, the proposal would require a banking
organization to use the same value of [lambda] for all option contracts
that reference the same underlying instrument or risk factor. If the
value of the underlying instrument or risk factor cannot be negative,
the value of [lambda] would be set to zero. Otherwise, to determine the
value of [lambda] for a given risk factor or instrument, the proposal
would require a banking organization to find the lowest value L of the
strike price and the current value of the underlying instrument or risk
factor of all option contracts that reference this instrument or risk
factor with all counterparties. The proposal would require a banking
organization to set [lambda] for this instrument or risk factor
according to the formula [lambda]=max{-1.1[middot]L,0{time} . The
purpose of multiplying negative L by 1.1 (thus, resulting in -
1.1[middot]L) is the same as that for adding 0.1 percent in the case of
interest rate derivative contracts under the SA-CCR final rule: to set
the lowest possible value of the underlying instrument or risk factor
slightly below the lowest observed value. Because it is challenging to
determine a universal additive offset value for all values of non-
interest-rate instruments and risk factors, the offset would be
performed via multiplication for asset classes other than the interest
rate asset class.
The proposal would also permit a banking organization, with the
approval of its primary Federal supervisor, to specify a different
value for [lambda] for purposes of the supervisory delta adjustment for
option contracts other than interest rate option contracts, if a
different value for [lambda] would be appropriate, considering the
range of values for the instrument or risk factor underlying option
contracts. This flexibility would allow a banking organization to use a
specific value for [lambda], rather than the value resulting from the
proposed formula described above, in the event that a different value
for [lambda] is more appropriate than the value resulting from the
formula. A banking organization that specifies a different value for
[lambda] would be required to assign the same value for [lambda] to all
option contracts with the same underlying instrument or risk factor, as
applicable, with all counterparties. This proposed provision is
intended to permit a banking organization, with approval from its
primary Federal supervisor, to account for unanticipated outcomes in
the supervisory delta adjustment of certain asset classes while
avoiding arbitrage between assets in that class.
Question 47: What other approaches should the agencies consider to
calibrate the lambda parameter for non-interest-rate asset classes,
such as a formula that is different from the proposed formula of
[lambda]=max{-1.1[middot]L,0{time} , and why? What values besides 1.1,
if any, should the agencies consider for the value of the multiplier in
the proposed formula? Why?
v. Decomposition of Credit, Equity, and Commodity Indices
Under the capital rule, banking organizations are permitted to
decompose indices within credit, equity, and commodity asset classes,
such that a banking organization would treat each component of the
index as a separate single-name derivative contract.\109\ The capital
rule requires that if a banking organization elects to decompose
indices within the credit, equity, and commodity asset classes, the
banking organization must perform all calculations in determining the
exposure amount based on the underlying instrument rather than the
index. While this is possible for linear indices, for non-linear index
contracts (e.g., those with optionality and CDS index tranches) it is
not mathematically possible to calculate the supervisory delta for an
underlying component, as the delta associated with the non-linear index
applies at the instrument level. In recognition of this fact, the
agencies are clarifying that the option to decompose a non-linear index
is not available under SA-CCR. Additionally, the agencies are
clarifying that if electing to decompose a linear index, banking
organizations must apply the weights used by the index when determining
the exposure amounts for the underlying instrument.
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\109\ See 12 CFR 3.132(c)(5)(vi) (OCC); 12 CFR 217.132(c)(5)(vi)
(Board); 12 CFR 324.132(c)(5)(vi) (FDIC).
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5. Credit Risk Mitigation
The current capital rule permits banking organizations to recognize
certain types of credit risk mitigants, such as guarantees, credit
derivatives, and collateral, for risk-based capital purposes provided
the credit risk mitigants satisfy the qualification standards under the
rule.\110\ Credit derivatives and guarantees can reduce the credit risk
of an exposure by placing a legal obligation on a third-party
protection provider to compensate the banking organization for losses
in the event of a borrower default.\111\ Similarly, the use of
collateral can reduce the credit risk of an exposure by creating the
right of a banking organization to take ownership of and liquidate the
collateral in the event of a default by the counterparty. Prudent use
of such mitigants can help a banking organization reduce the credit
risk of an exposure and thereby reduce the risk-based capital
requirement associated with that exposure.
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\110\ Consistent with the current capital rule, the proposal
would not require banking organizations to recognize any instrument
as a credit risk mitigant. Credit derivatives that a banking
organization cannot or chooses not to recognize as a credit risk
mitigant would be subject to a separate counterparty credit risk
capital requirement.
\111\ Credit events are defined in the documents governing the
credit risk mitigant and often include events such as failure to pay
principal and interest and entry into insolvency or similar
proceedings.
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Credit risk mitigants recognized for risk-based capital purposes
must be of sufficiently high quality to effectively reduce credit risk.
For guarantees and credit derivatives, the current capital rule
primarily looks to the creditworthiness of the guarantor and the
features of the underlying contract to determine whether these forms of
credit risk mitigation may be recognized for risk-based capital
purposes (eligible guarantee or eligible credit derivative). With
respect to collateralized transactions, the current capital rule
primarily looks to the liquidity profile and quality of the collateral
received and the nature of the banking organization's security interest
to determine whether the collateral qualifies as financial collateral
that may be recognized for purposes of risk-based capital.\112\
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\112\ See 12 CFR 3.2, 217.2, and 324.2 for the definition of
financial collateral.
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As stated earlier, the proposal would eliminate the use of models
for credit risk under the current capital rule.
[[Page 64059]]
Therefore, the proposal would replace certain methodologies for
recognizing the risk-reducing benefits of financial collateral and
eligible guarantees and credit derivatives--namely, the internal models
methodology, simple VaR approach, PD substitution approach, LGD
adjustment approach, and double default treatment--with the
standardized approaches described below. For eligible guarantees and
eligible credit derivatives, the proposal would permit banking
organizations to use the substitution approach from subpart D of the
current capital rule with a modification for eligible credit
derivatives that do not include restructuring as a credit event.
Further, the proposal would no longer permit the recognition of credit
protection from nth-to-default credit derivatives.\113\ For all
collateralized transactions, the corporate issuer of any financial
collateral in the form of a corporate debt security must have an
outstanding publicly traded security or the corporate issuer must be
controlled by a company that has an outstanding publicly traded
security in order to be recognized. For collateralized transactions
where financial collateral secures exposures that are not derivative
contracts or netting sets of derivative contracts, the proposal would
permit banking organizations to use the simple approach from subpart D
without any modification. For eligible margin loans and repo-style
transactions, the proposal would also permit banking organizations to
use the collateral haircut approach with standard supervisory market
price volatility haircuts \114\ from subpart D with two proposed
modifications to increase risk sensitivity: (1) adjustments to the
market price volatility haircuts and (2) a modified formula for netting
sets of eligible margin loans or repo-style transactions that reflects
netting and diversification benefits within netting sets. Finally, the
proposal would introduce minimum haircut floors for certain eligible
margin loan and repo-style transactions with unregulated financial
institutions that banking organizations must meet in order to recognize
the risk-mitigation benefits of financial collateral.
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\113\ See section III.D.3.a of this Supplementary Information.
\114\ Under subpart D, banking organizations also are permitted
to use their own estimates of market price volatility haircuts, with
prior written approval from the primary Federal supervisors. The
proposal would not include this option in subpart E as the agencies
have found it to introduce unwarranted variability in banking
organizations' risk-weighted assets.
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In connection with the removal of the internal models methodology,
the proposal would make corresponding revisions to reflect this change
in the definition of a netting set. Compared to the current capital
rule, the proposal would exclude cross-product netting sets from the
definition of a netting set, as none of the proposed approaches under
the revised framework would recognize cross-product netting. This would
be consistent with the current capital rule, which also does not
recognize cross-product netting. Therefore, the proposal would define a
netting set as a group of single-product transactions with a single
counterparty that are subject to a qualifying master netting agreement
(QMNA) \115\ and that consist only of one of the following: derivative
contracts, repo-style transactions, or eligible margin loans. For
purposes of the proposed netting set definition, the netting set must
include the same product (i.e., all derivative contracts or all repo-
style transactions or all eligible margin loans). Consistent with the
current capital rule, for derivative contracts, the proposed definition
of netting set would also include a single derivative contract between
a banking organization and a single counterparty.
---------------------------------------------------------------------------
\115\ See 12 CFR 3.2, 217.2, and 324.2 for the definition of
qualifying master netting agreement.
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Question 48: What would be the impact of requiring that certain
debt securities must be issued by a publicly-traded company, or issued
by a company controlled by a publicly-traded company, in order to
qualify as financial collateral and what, if any, alternatives should
the agencies consider to this requirement?
a. Guarantees and Credit Derivatives
i. Substitution Approach
As under subpart D in the current capital rule, under the proposal
a banking organization would be permitted to recognize the credit-risk-
mitigation benefits of eligible guarantees and eligible credit
derivatives by substituting the risk weight applicable to the eligible
guarantor or protection provider for the risk weight applicable to the
hedged exposure.\116\
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\116\ Under subpart E in the current capital rule, an eligible
guarantee need not be issued by an eligible guarantor unless the
exposure is a securitization exposure. The proposal would require
all eligible guarantees to be issued by an eligible guarantor.
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ii. Adjustment for Credit Derivatives Without Restructuring as a Credit
Event
Credit derivative contracts in certain jurisdictions include debt
restructuring as a credit event that triggers a payment obligation by
the protection provider to the protection purchaser. Such
restructurings of the hedged exposure may involve forgiveness or
postponement of principal, interest, or fees that result in a loss to
investors. Consistent with the current capital rule, the proposal would
generally require a banking organization that seeks to recognize the
credit risk-mitigation benefits of an eligible credit derivative that
does not include a restructuring of the reference exposure as a credit
event to reduce the effective notional amount of the credit derivative
by 40 percent to account for any unmitigated losses that could occur as
a result of a restructuring of the hedged exposure.
Under the proposal, however, the 40 percent adjustment would not
apply to eligible credit derivatives without restructuring as a credit
event if both of the following requirements are satisfied: (1) the
terms of the hedged exposure (and the reference exposure, if different
from the hedged exposure) allow the maturity, principal, coupon,
currency, or seniority status to be amended outside of receivership,
insolvency, liquidation, or similar proceeding only by unanimous
consent of all parties; and (2) the banking organization has conducted
sufficient legal review to conclude with a well-founded basis (and
maintains sufficient written documentation of that legal review) that
the hedged exposure is subject to the U.S. Bankruptcy Code or a
domestic or foreign insolvency regime with similar features that allows
for a company to reorganize or restructure and provides for an orderly
settlement of creditor claims.
The unanimous consent requirement would mean that, for
restructurings occurring outside of an insolvency proceeding, all
holders of the hedged exposure (and the reference exposure, if
different from the hedged exposure) must agree to any restructuring for
the restructuring to occur, and no holder can vote against the
restructuring or abstain. This unanimous consent requirement would
reduce the risk that a banking organization would suffer a credit loss
on the hedged exposure that would not be offset by a payment under the
eligible credit derivative. Banking organizations generally would only
be incentivized to vote for a restructuring if the terms of the
restructuring would provide a more beneficial outcome to the banking
organization relative to insolvency proceedings that would trigger
payment under the eligible credit derivative. Additionally, the
unanimous consent requirement for the reference exposure, if different
from the hedged exposure, would add an additional layer of security by
significantly reducing the
[[Page 64060]]
probability of reaching a restructuring agreement that results in a
loss of principal or interest for creditors without triggering payment
under the eligible credit derivative. The unanimous consent requirement
would need to be satisfied through the terms of the hedged exposure
(and the reference exposure, if different from the hedged exposure),
which could be accomplished through a contractual provision of the
exposure or the application of law.
The requirement that the hedged exposure be subject to the U.S.
Bankruptcy Code or a similar domestic or foreign insolvency regime
would help to ensure that any restructuring is done in an orderly,
predictable, and regulated process. In the event that the obligor of
the hedged exposure defaults and the default is not cured, the obligor
would either be required to enter insolvency proceedings, which would
trigger payment under the credit derivative, or the obligor would be
required to pursue restructuring outside of insolvency, which could not
occur without the banking organization's consent. Together, the
proposed requirements would ensure that credit derivatives that do not
include restructuring as a credit event but provide similarly effective
protection as those that do contain such provisions, are afforded
similar recognition under the capital framework.
Question 49: The agencies seek comment on the appropriateness of
allowing banking organizations to recognize in full the effective
notional amount of credit derivatives that do not include restructuring
as a credit event, if certain conditions are met. Is the exemption from
the 40 percent haircut overly broad? If so, why, and how might the
exemption be narrowed to only capture the types of credit derivatives
that provide protection similar to credit derivatives that include
restructuring as a credit event?
Question 50: To what extent is the proposed treatment of eligible
credit derivatives that do not include restructuring of the reference
exposure as a credit event relevant outside of the United States?
b. Collateralized Transactions
The proposal would only allow a banking organization to recognize
the risk-mitigating benefits of a corporate debt security that meets
the definition of financial collateral in expanded risk-weighted assets
if the corporate issuer of the debt security has a publicly traded
security outstanding or is controlled by a company that has a publicly
traded security outstanding. Corporations with publicly traded
securities typically are subject to mandatory regulatory and public
reporting and disclosure requirements, and therefore debt securities
issued by such corporations may be a more stable and liquid form of
collateral.
i. Simple Approach
Subpart D of the current capital rule includes the simple approach,
which allows a banking organization to recognize the risk-mitigating
benefits of financial collateral received by substituting the risk
weight applicable to an exposure with the risk weight applicable to the
financial collateral securing the exposure, generally subject to a 20
percent floor. The proposal generally would maintain the simple
approach of the current capital rule, including restrictions on
collateral eligibility and the risk-weight floor, except for the
proposed requirement for certain corporate debt securities.
ii. Collateral Haircut Approach
Under the current capital rule, a banking organization may
recognize the credit risk-mitigation benefits of repo-style
transactions, eligible margin loans, and netting sets of such
transactions by adjusting its exposure amount to its counterparty to
recognize any financial collateral received and any collateral posted
to the counterparty. Subpart E of the current capital rule includes
several approaches that a banking organization may use and some of
those approaches include the use of models that contribute to
variability in risk-weighted assets. For this reason, under the
proposal a banking organization would no longer be allowed to use the
simple VaR approach or the internal models methodology to calculate the
exposure amount, nor would a banking organization be permitted to use
its own internal estimates for calculating haircuts. The proposal would
broadly retain the collateral haircut approach with standard
supervisory market volatility haircuts with some modifications. This
approach would require a banking organization to adjust the fair value
of the collateral received and posted to account for any potential
market price volatility in the value of the collateral during the
margin period of risk, as well as to address any differences in
currency. To increase the risk-sensitivity of the collateral haircut
approach, the proposal would modify certain market price volatility
haircuts. The proposal would also introduce a new method to calculate
the exposure amount of eligible transactions in a netting set and
simplify the existing exposure calculation method for individual
transactions that are not part of a netting set.
I. Exposure Amount
The proposal would provide two methods for calculating the exposure
amount under the collateral haircut approach for eligible margin loans
and repo-style transactions. One method would apply to individual
eligible margin loans and repo-style transactions, the other to single-
product netting sets of such transactions, as described below. The new
formula for netting sets would allow for the recognition of the risk-
mitigating benefits of netting and portfolio diversification and is
intended to provide for increased risk-sensitivity of the capital
requirement for such transactions relative to the current capital rule.
A. Exposure Amount for Transactions Not in a Netting Set
Under the collateral haircut approach, the proposed exposure amount
for an individual eligible margin loan or repo-style transaction that
is not part of a netting set would yield the same result as the
exposure amount equation in the current capital rule. However, the
proposal would change the variables and structure to provide a
simplified calculation for an individual eligible margin loan or repo-
style transaction in comparison with transactions that are part of a
netting set. Specifically, the proposal would require a banking
organization to calculate the exposure amount as the greater of zero
and the difference of the following two quantities: (1) the value of
the exposure, adjusted by the market price volatility haircut
applicable to the exposure for a potential increase in the exposure
amount; and (2) the value of the collateral, adjusted by the market
price volatility haircut applicable to the collateral for a potential
decrease in the collateral value and the currency mismatch haircut
applicable where the currency of the collateral is different from the
settlement currency. The banking organization would use the market
price volatility haircuts and a standard 8 percent currency mismatch
haircut, subject to adjustments, as described in the following section.
Specifically, the exposure amount for an individual eligible margin
loan or repo-style transaction that is not in a netting set would be
based on the following formula:
E* = max{0; E x (1 + He)-C x (1-Hc-Hfx){time}
Where:
[[Page 64061]]
E* is the exposure amount of the transaction after credit
risk mitigation.
E is the current fair value of the specific instrument,
cash, or gold the banking organization has lent, sold subject to
repurchase, or posted as collateral to the counterparty.
He is the haircut appropriate to E as described in Table 1
to Sec. __.121, as applicable.
C is the current fair value of the specific instrument,
cash, or gold the banking organization has borrowed, purchased
subject to resale, or taken as collateral from the counterparty.
Hc is the haircut appropriate to C as described in Table 1
to Sec. __.121, as applicable.
Hfx is the haircut appropriate for currency mismatch
between the collateral and exposure.
The first component in the above formula, E x (1 + He), would
capture the current value of the specific instrument, cash, or gold the
banking organization has lent, sold subject to repurchase, or posted as
collateral to the counterparty by the banking organization in the
eligible margin loan or repo-style transaction, while accounting for
the market price volatility of the instrument type. The second
component in the above formula, C x (1-Hc-Hfx), would capture the
current value of the specific instrument, cash, or gold the banking
organization has borrowed, purchased subject to resale, or taken as
collateral from the counterparty in the eligible margin loan or repo-
style transaction, while accounting for the market price volatility of
the specific instrument as well as any adjustment to reflect currency
mismatch, if applicable.
B. Exposure Amount for Transactions in a Netting Set
Under the collateral haircut approach, the proposal would provide a
new, more risk-sensitive equation that recognizes diversification
benefits by taking into consideration the number of securities included
in a netting set of eligible margin loans or repo-style transactions.
Under this approach, the exposure amount for a netting set of eligible
margin loans or repo-style transactions would equal:
[GRAPHIC] [TIFF OMITTED] TP18SE23.009
Where:
E* is the exposure amount of the netting set after credit
risk mitigation.
Ei is the current fair value of the instrument, cash, or
gold the banking organization has lent, sold subject to repurchase,
or posted as collateral to the counterparty.
Ci is the current fair value of the instrument, cash, or
gold the banking organization has borrowed, purchased subject to
resale, or taken as collateral from the counterparty.
netexposure = [verbar][Sigma]s Es Hs[verbar].
grossexposure = [Sigma]s Es [verbar]Hs[verbar].
Es is the absolute value of the net position in a given
instrument or in gold (where the net position in a given instrument
or gold equals the sum of the current fair values of the instrument
or gold the banking organization has lent, sold subject to
repurchase, or posted as collateral to the counterparty, minus the
sum of the current fair values of that same instrument or gold the
banking organization has borrowed, purchased subject to resale, or
taken as collateral from the counterparty).
Hs is the haircut appropriate to Es as described in Table 1
to Sec. __.121, as applicable. Hs has a positive sign if the
instrument or gold is net lent, sold subject to repurchase, or
posted as collateral to the counterparty; Hs has a negative sign if
the instrument or gold is net borrowed, purchased subject to resale,
or taken as collateral from the counterparty.
N is the number of instruments in the netting set with a
unique Committee on Uniform Securities Identification Procedures
(CUSIP) designation or foreign equivalent, with certain exceptions.
N would include any instrument with a unique CUSIP that the banking
organization lends, sells subject to repurchase, or posts as
collateral, as well as any instrument with a unique CUSIP that the
banking organization borrows, purchases subject to resale, or takes
as collateral. However, N would not include collateral instruments
that the banking organization is not permitted to include within the
credit risk mitigation framework (such as nonfinancial collateral
that is not part of a repo-style transaction included in the banking
organization's market risk weighted assets) or elects not to include
within the credit risk mitigation framework. The number of
instruments for N would also not include any instrument (or gold)
for which the value Es is less than one-tenth of the value of the
largest Es in the netting set. Any amount of gold would be given a
value of one.
Efx is the absolute value of the net position in each
currency fx different from the settlement currency.
Hfx is the haircut appropriate for currency mismatch of
currency fx.
The first component in the above formula, ([Sigma]i Ei-[Sigma]iCi)
would capture the baseline exposure of a netting set of eligible margin
loans or repo-style transactions after accounting for the value of any
collateral. The second, (0.4 x netexposure), and third, (0.6
x (\grossexposure\/[radic]N)) components in the above
formula would reflect the systematic risk (based on the net exposure)
and the idiosyncratic risk \117\ (based on the gross exposure) of the
netting set of eligible margin loans or repo-style transactions covered
by a QMNA. Under the proposal, the net exposure component would allow
the formula to recognize netting at the level of the netting set and
correlations in the movement of market prices for instruments lent and
received. Additionally, because the contribution from the gross
exposure component to the exposure amount would decrease proportionally
with an increase in the number of unique instruments by CUSIP
designations or foreign equivalent, the gross exposure would capture
the impact of portfolio diversification. The fourth component,
([Sigma]fx (Efx x Hfx)) would capture any adjustment to reflect
currency mismatch, if applicable.
---------------------------------------------------------------------------
\117\ Systematic risk represents risks that are impacted by
broad market variables (such as economy, region, and sector).
Idiosyncratic risk represents risks that are endemic to a specific
asset, borrower, or counterparty.
---------------------------------------------------------------------------
When determining the market price volatility and currency mismatch
haircuts, the banking organization would use the market price
volatility haircuts described in the following section and a standard 8
percent currency mismatch haircut, subject to certain adjustments.
Question 51: What are the advantages and disadvantages of the
proposed
[[Page 64062]]
methodology for calculating the exposure amount for eligible margin
loans and repo-style transactions covered by a QMNA?
Question 52: What would be the advantages and disadvantages of an
alternative method to calculate the number of instruments N based on
the number of legal entities that issued or guaranteed the instruments?
II. Market Price Volatility Haircuts
Under the proposal, a banking organization would apply the market
price volatility haircut appropriate for the type of collateral, as
provided in Table 1 to Sec. __.121 below, in the exposure amount
calculation for repo-style transactions, eligible margin loans, and
netting sets thereof using the collateral haircut approach and in the
calculation of the net independent collateral amount and the variation
margin amount for collateralized derivative transactions using SA-CCR.
Consistent with the current capital rule, the proposal would require
banking organizations to apply an 8 percent supervisory haircut,
subject to adjustments, to the absolute value of the net position in
each currency that is different from the settlement
currency.118 119
---------------------------------------------------------------------------
\118\ This category also would include public sector entities
that are treated as sovereigns by the national supervisor.
\119\ Includes senior securitization exposures with a risk
weight greater than or equal to 100 percent and sovereign exposures
with a risk weight greater than 100 percent.
---------------------------------------------------------------------------
BILLING CODE 6210-01-P; 6714-01-P; 4810-33-P
[GRAPHIC] [TIFF OMITTED] TP18SE23.010
BILLING CODE 6210-01-C; 6714-01-C; 4810-33-C
The proposed haircuts would strike a balance between simplicity and
risk sensitivity relative to the supervisory haircuts in the current
capital rule by introducing additional granularity with respect to
residual maturity, which is a meaningful driver for distinguishing
between the market price volatility of different instruments, and by
streamlining other aspects of the collateral haircut approach where the
exposure's risk weight figures less
[[Page 64063]]
prominently in the instrument's market price volatility, as described
below.
The proposal would apply haircuts based solely on residual
maturity, rather than a combination of residual maturity and underlying
risk weight as under the current capital rule for investment grade debt
securities other than sovereign debt securities. These haircuts are
derived from observed stress volatilities during 10-business day
periods during the 2008 financial crisis. Debt securities with longer
maturities are subject to higher price volatility from future changes
in both interest rates and the creditworthiness of the issuer.
Because securitization exposures tend to be more volatile than
corporate debt,\120\ the proposal would provide a distinct category of
market price volatility haircuts for certain securitization exposures
consistent with the current capital rule. The proposal would
distinguish between non-senior and senior securitization exposures to
enhance risk sensitivity. Since senior securitization exposures absorb
losses only after more junior securitization exposures, these exposures
have an added layer of security and different market price volatility.
Therefore, the proposal would only specify term-based haircuts for
investment grade senior securitization exposures that receive a risk
weight of less than 100 percent under the securitization framework.
Other securitization exposures would receive the 30 percent market
price volatility haircut applicable to ``other'' exposure types.
---------------------------------------------------------------------------
\120\ See Basel Committee, ``Strengthening the resilience of the
banking sector--consultative document,'' December 2009; https://www.bis.org/publ/bcbs164.pdf.
---------------------------------------------------------------------------
The proposal would require a banking organization to apply market
price volatility haircuts of 20 percent for main index equities
(including convertible bonds) and gold, 30 percent for other publicly
traded equities and convertible bonds, and 30 percent for other
exposure types. Equities in a main index typically are more liquid than
those that are not included in a main index, as investors may seek to
replicate the index by purchasing the referenced equities or engaging
in derivative transactions involving the index or equities within the
index. The lower haircuts for equities included in a main index under
the proposal would reflect the higher liquidity of those securities
compared to other publicly traded equities or exposure types, which
would generally help to reduce losses to banking organizations when
liquidating those securities during stress conditions.
For collateral in the form of mutual fund shares, the proposal
would be consistent with the collateral haircut approach provided in
the current capital rule in which a banking organization would apply
the highest haircut applicable to any security in which the fund can
invest. The proposal also would include an alternative method available
to a banking organization if the mutual fund qualifies for the full
look-through approach described in section III.E.1.c.ii. of this
Supplementary Information. This alternative method would provide a more
risk-sensitive calculation of the haircut on mutual fund shares
collateral by using the weighted average of haircuts applicable to the
instruments held by the mutual fund.\121\ This aspect of the proposal
reflects the agencies' observation that, while certain mutual funds may
be authorized to hold a wide range of investments, the actual holdings
of mutual funds are often more limited.
---------------------------------------------------------------------------
\121\ If the mutual fund qualifies for the full look-through
approach described in section III.E.1.c.ii of this Supplementary
Information but would be treated as a market risk covered position
as described in section III.H.3 of this Supplementary Information if
the banking organization held the mutual fund directly, the banking
organization is permitted to apply the alternative method to
calculate the haircut.
---------------------------------------------------------------------------
In addition, the proposal would maintain the requirement for a
banking organization to apply a market price volatility haircut of 30
percent to address the potential market price volatility for any
instruments that the banking organization has lent, sold subject to
repurchase, or posted as collateral that is not of a type otherwise
specified in Table 1 to Sec. __.121.
Question 53: What are the advantages and disadvantages of allowing
banking organizations to apply the full look-through approach for
certain collateral in the form of mutual fund shares? What alternative
approaches should the agencies consider for banking organizations to
determine the market price volatility haircuts for collateral in the
form of mutual fund shares?
III. Minimum Haircut Floors for Certain Eligible Margin Loans and Repo-
Style Transactions
The proposed framework for minimum haircuts on non-centrally
cleared securities financing transactions would reflect the risk
exposure of banking organizations to non-bank financial entities that
employ leverage and engage in maturity transformation but that are not
subject to prudential regulation.
The absence of prudential regulation makes such entities more
vulnerable to runs, leading to an increase in the credit risk of these
entities in the form of a greater risk of default in stress
periods.\122\ Episodes of non-bank financial entities' distress, such
as the 2008 financial crisis, have highlighted banking organizations'
exposure to non-bank financial entities through securities financing
transactions, which may give rise to credit and liquidity risks.
---------------------------------------------------------------------------
\122\ See ``Strengthening Oversight and Regulation of Shadow
Banking,'' Financial Stability Board, August 2013 https://www.fsb.org/wp-content/uploads/r_130829b.pdf.
---------------------------------------------------------------------------
Securities financing transactions may include repo-style
transactions and eligible margin loans. The motivation behind a
specific securities financing transaction can be either to lend or
borrow cash, or to lend or borrow a security. Securities financing
transactions can be used by a counterparty to achieve significant
leverage--for example, through transactions where the primary purpose
is to finance a counterparty through the lending of cash--and result in
elevated counterparty credit risk.
The proposal would require a banking organization to receive a
minimum amount of collateral when undertaking certain repo-style
transactions and eligible margin loans (in-scope transactions) with
such entities (unregulated financial institutions). The application of
haircut floors would determine the minimum amount of collateral
exchanged. A banking organization would treat in-scope transactions
with unregulated financial institutions that do not meet the proposed
haircut floors as repo-style transactions or eligible margin loans
where the banking organization did not receive any collateral from its
counterparty.\123\ The proposed treatment is intended to limit the
build-up of excessive leverage outside the banking system and reduce
the cyclicality of such leverage, thereby limiting risk to the lending
banking organization and the banking system.
---------------------------------------------------------------------------
\123\ In this example, the banking organization would be
permitted to calculate the exposure amount using the collateral
haircut approach but would be required to exclude any collateral
received from the calculation. Alternatively, the banking
organization could choose not to use the collateral haircut approach
but to risk weight any on-balance sheet or off-balance sheet
portions of the exposure as demonstrated in the example below.
---------------------------------------------------------------------------
A. Unregulated Financial Institutions
Consistent with the definition in Sec. __. 2 of the current
capital rule, the proposal would define unregulated financial
institution as a financial institution that is not a regulated
financial institution, including any
[[Page 64064]]
financial institution that would meet the definition of ``financial
institution'' under Sec. __.2 of the current capital rule but for the
ownership interest thresholds set forth in paragraph (4)(i) of that
definition. Unregulated financial institutions would include hedge
funds and private equity firms. This definition would capture non-bank
financial entities that employ leverage and engage in maturity
transformation but that are not subject to prudential regulation.
Question 54: What entities should be included or excluded from the
scope of entities subject to the minimum haircut floors and why? For
example, what would be the advantages and disadvantages of expanding
the definition of entities that are scoped-in to include all
counterparties, or all counterparties other than QCCPs? What impact
would expanding the scope of entities subject to the minimum haircut
floors have on banking organizations' business models, competitiveness,
or ability to intermediate in funding markets and in U.S. Treasury
securities markets?
B. In-Scope Transactions
Under the proposal, an in-scope transaction generally would include
the following non-centrally cleared transactions: (1) an eligible
margin loan or a repo-style transaction in which a banking organization
lends cash to an unregulated financial institution in exchange for
securities, unless all of the securities are non-defaulted sovereign
exposures, and (2) certain security-for-security repo-style
transactions that are collateral upgrade transactions with an
unregulated financial institution. Under the proposal, a collateral
upgrade transaction would include a transaction in which the banking
organization lends one or more securities that, in aggregate, are
subject to a lower haircut floor in Table 2 to Sec. __.121 than the
securities received from the unregulated financial institution.
The proposal would exempt the following types of transactions and
netting sets of such transactions with unregulated financial
institutions from the minimum haircut floor requirements: (1)
transactions in which an unregulated financial institution lends, sells
subject to repurchase, or posts as collateral securities to a banking
organization in exchange for cash and the unregulated financial
institution reinvests the cash at the same or a shorter maturity than
the original transaction with the banking organization; (2) collateral
upgrade transactions in which the unregulated financial institution is
unable to re-hypothecate, or contractually agrees that it will not re-
hypothecate, the securities it receives as collateral; or (3)
transactions in which a banking organization borrows securities from an
unregulated financial institution for the purpose of meeting current or
anticipated demand, such as for delivery obligations, customer demand,
or segregation requirements, and not to provide financing to the
unregulated financial institution. For transactions that are cash-
collateralized in which an unregulated financial institution lends
securities to the banking organization, banking organizations could
rely on representations made by the unregulated financial institution
as to whether the unregulated financial institution reinvests the cash
at the same or a shorter maturity than the maturity of the transaction.
For transactions in which a banking organization is seeking to borrow
securities from an unregulated financial institution to meet a current
or anticipated demand, banking organizations must maintain sufficient
written documentation that such transactions are for the purpose of
meeting a current or anticipated demand and not for providing financing
to an unregulated financial institution. The proposal would exclude
these in-scope transactions from the minimum haircut floors as these
transactions do not pose the same credit and liquidity risks as other
in-scope transactions and serve as important liquidity and
intermediation services provided by banking organizations.
Question 55: What alternative definitions of ``in-scope
transactions'' should the agencies consider? For example, what would be
the pros and cons of an expanded definition of ``in-scope
transactions'' to include all eligible margin loan or repo-style
transactions in which a banking organization lends cash, including
those involving sovereign exposures as collateral? How would the
inclusion of sovereign exposures affect the market for those
securities? What, if any, additional factors should the agencies
consider concerning this alternative definition?
Question 56: What, if any, difficulties would banking organizations
have in identifying transactions that would be exempt from the minimum
haircut floor?
Question 57: What, if any, operational burdens would be imposed by
the proposal to require banking organizations to maintain sufficient
written documentation to exempt transactions with an unregulated
financial institution where the banking organization is seeking to
borrow securities from an unregulated financial institution to meet a
current or anticipated demand?
C. Application of the Minimum Haircut Floors
For in-scope transactions, the proposal would establish minimum
haircut floors that would be applied on a single-transaction or a
portfolio basis depending on whether the in-scope transaction is part
of a netting set. The proposed haircut floors are derived from observed
historical price volatilities as well as existing market and central
bank haircut conventions. If the in-scope transaction is a single
transaction, then the banking organization would apply the
corresponding single-transaction haircut floor. If the in-scope
transaction is part of a netting set, the banking organization would
apply a portfolio-based floor to the entire netting set.\124\ In-scope
transactions that do not meet the applicable minimum haircut floor
would be treated as uncollateralized exposures.
---------------------------------------------------------------------------
\124\ If a netting set contains both in-scope and out-of-scope
transactions, the banking organization would apply a portfolio-based
floor for the entire netting set.
---------------------------------------------------------------------------
The minimum haircut floors are intended to reflect the minimum
amount of collateral banking organizations should receive when
undertaking in-scope transactions with unregulated financial
institutions. Banking organizations should require an appropriate
amount of collateral to be provided to account for the risks of the
transaction and counterparty. Figure 1 provides a summary of the
process for determining whether an in-scope transaction meets the
applicable minimum haircut floor.
BILLING CODE 6210-01-P; 6714-01-P; 4810-33-P
[[Page 64065]]
[GRAPHIC] [TIFF OMITTED] TP18SE23.011
[GRAPHIC] [TIFF OMITTED] TP18SE23.012
BILLING CODE 6210-01-C; 6714-01-C; 4810-33-C
The proposal would require a banking organization to compare the
haircut (H) and a single-transaction or portfolio haircut floor
([fnof]), as calculated below, to determine whether an in-scope
transaction or a netting set of in-scope transactions meets the
relevant floor. If H is less than f, then the banking organization may
not recognize the risk-mitigating effects of any financial collateral
that secures the exposure.
For a single cash-lent-for-security in-scope transaction, H would
be defined as the ratio of the fair value of financial collateral
borrowed, purchased subject to resale, or taken as collateral from the
counterparty to the fair value of cash lent, minus one, and [fnof]
would be the corresponding haircut applicable to the collateral in
Table 2 to Sec. __.121. For example, for an in-scope transaction in
which a banking organization lends $100 in cash to an unregulated
financial institution and receives $102 in investment-grade corporate
bonds with a residual maturity of 10 years as collateral, the haircut
would be calculated as H = (102/100)-1 = 2 percent. The single-
transaction haircut floor for an investment grade corporate bond with a
residual maturity of 10 years or less under Table 2 to Sec. __.121
would be [fnof]= 3 percent Since the haircut is less than the single-
transaction haircut floor (H = 2 percent < 3 percent = [fnof]), the
proposal would not allow the banking organization to recognize the
risk-mitigating benefits of the collateral and would require the
banking organization to calculate the exposure amount of its repo-style
transaction or eligible margin loan as if it had not received any
collateral from its counterparty.
For a single security-for-security repo-style transaction, H would
be defined as the ratio of the fair value of financial collateral
borrowed, purchased subject to resale, or taken as collateral from the
counterparty (B) relative to the fair value of the financial collateral
the banking organization has lent, sold subject to repurchase, or
posted as
[[Page 64066]]
collateral to the counterparty (L), minus one. The single-transaction
haircut floor (f) of the transaction would incorporate the
corresponding haircut applicable to the collateral received (fB) and
collateral lent ([fnof]L) in Table 2 to Sec. __.121. The single-
transaction haircut floor for the two types of collateral would be
computed as follows:
[GRAPHIC] [TIFF OMITTED] TP18SE23.013
The single transaction floor then would be compared to the haircut
of the transaction, determined as follows:
[GRAPHIC] [TIFF OMITTED] TP18SE23.014
where CB denotes the fair value of collateral received and CL the fair
value of collateral lent. For example, for a securities lending
transaction in which a banking organization lends $100 in investment
grade corporate bonds with a residual maturity of 10 years (which
correspond to a haircut floor of 3 percent) and receives $102 in main
index equity securities (which correspond to a haircut floor of 6
percent) as collateral, the haircut would be:
[GRAPHIC] [TIFF OMITTED] TP18SE23.015
The single-transaction haircut floor would be:
[GRAPHIC] [TIFF OMITTED] TP18SE23.016
Since the haircut is less than the single-transaction haircut floor
(H = 2 percent < 2.9126 percent = [fnof]), the banking organization
would not be able to recognize the risk-mitigating benefits of the
collateral received and would be required to calculate the exposure
amount of its repo-style transaction or eligible margin loan as if it
had not received any collateral from its counterparty.
For a netting set of in-scope transactions, the haircut floor of
the netting set would be computed as follows:
[GRAPHIC] [TIFF OMITTED] TP18SE23.017
In the above formula, (CL) would be the fair value of the net
position in each security or in cash that is net lent, sold subject to
repurchase, or posted as collateral to the counterparty; [Scy]B is the
fair value of the net position that is net borrowed, purchased subject
to resale, or taken as collateral from the counterparty; and [fnof]L
and [fnof]B would be the haircut floors for the securities or cash, as
applicable, that are net lent and net borrowed, respectively.\125\ This
calculation would be the weighted average haircut floor of the
portfolio. The portfolio haircut H would be calculated as:
---------------------------------------------------------------------------
\125\ For a given security or cash, a banking organization may
collect the security or cash in one transaction and post it in
another. Thus, at the portfolio level, the banking organization may,
after netting across all transactions in the same portfolio, be
either collecting the security or cash (that is, net borrowed) or
posting the security or cash (that is, net lent).
[GRAPHIC] [TIFF OMITTED] TP18SE23.018
The portfolio would satisfy the minimum haircut floor requirement
where the following condition is satisfied: H >= fPortfolio.
If the portfolio does not satisfy the minimum haircut floor, the
banking organization would not be able to recognize the risk-mitigating
benefits of the collateral received.
In the following example, there are two in-scope repo-style
transactions that are in the same netting set: (1) a reverse repo
transaction in which a banking organization lends $100 in cash to an
unregulated financial institution and receives $102 in investment grade
corporate bonds with a residual maturity of 10 years (which correspond
to a haircut floor of 3 percent) as collateral; and (2) a securities
lending transaction in which a banking organization lends $100 of
different investment grade corporate bonds also with a residual
maturity of 10 years and receives $104 in main index equity securities
(which correspond to a haircut floor of 6 percent) as collateral. For
this set of in-scope repo-style transactions, the portfolio haircut
would be:
[GRAPHIC] [TIFF OMITTED] TP18SE23.019
The portfolio haircut floor would be:
[GRAPHIC] [TIFF OMITTED] TP18SE23.020
The banking organization would be able to recognize the risk-
mitigating benefits of the collateral received, because the portfolio
haircut is higher than the portfolio haircut floor:
H = 3 percent > 2.971 percent = fPortfolio)
To calculate the exposure amount for this transaction, the banking
organization would use the collateral haircut approach formula in Sec.
__.121(c) and the standard market price volatility haircuts in Table 1
to Sec. __.121 and set N to 3:
[[Page 64067]]
[GRAPHIC] [TIFF OMITTED] TP18SE23.021
Where:
exposurenet = [verbar](100 x 0%) + (100 x 12%) + (102 x (- 12%)) +
(104 x (-20%))[verbar] = 21.04
and
exposuregross = (100 x [verbar]0%[verbar]) + (100 x
[verbar]12%[verbar] + (102 x [verbar]- 12% [verbar]) + (104 x
[verbar]- 20%[verbar]) = 45.04
In a similar example, there are also two in-scope repo-style
transactions that are in the same netting set: (1) a reverse repo
transaction in which a banking organization lends $100 in cash to an
unregulated financial institution and receives $101 in investment grade
corporate bonds with a residual maturity of 10 years (which correspond
to a haircut floor of 3 percent) as collateral; and (2) a securities
lending transaction in which a banking organization lends $100 of
different investment grade corporate bonds and receives $102 in main
index equity securities (which correspond to a haircut floor of 6
percent) as collateral. For this set of in-scope repo-style
transactions, the portfolio haircut would be:
[GRAPHIC] [TIFF OMITTED] TP18SE23.022
and the portfolio haircut floor would be:
[GRAPHIC] [TIFF OMITTED] TP18SE23.023
Since the portfolio haircut is less than the portfolio haircut
floor (H= 1.5 percent < 2.9642 percent = [fnof]Portfolio), the banking
organization would not be able to recognize the risk-mitigating
benefits of the collateral received.
Instead, the banking organization would be required to separately
risk-weight the on-balance sheet and off-balance sheet portion of each
individual transaction. In this example, assuming that both individual
transactions are treated as secured borrowings instead of sales under
GAAP, the first transaction in which a banking organization lends $100
in cash to an unregulated financial institution and receives $101 in
investment grade corporate bonds would result in an on-balance sheet
receivable of $100.\126\ If the second transaction is a securities
lending transaction from the perspective of the banking organization
and the banking organization is permitted to sell or repledge the
equity securities, the transaction results in an increase in the
banking organization's balance sheet of $102 for the equity securities
received from the counterparty. The banking organization would be
required to apply a 100 percent credit conversion factor (CCF) to the
off-balance sheet exposure to its counterparty for the return of the
investment grade corporate bonds. In this case, the off-balance sheet
exposure to the counterparty would be the $100 of lent investment grade
corporate bonds.\127\ The total exposure amount for the two
transactions would be ($100 receivable + $102 equity exposure + $100
off-balance sheet exposure) = $302. If the banking organization is not
permitted to sell or repledge the equity securities in the second
transaction, or if that transaction is a securities borrowing
transaction from the perspective of the banking organization, the
equity securities received by the banking organization would not be
recognized on the banking organization's balance sheet.\128\ The
banking organization would still be required to apply a 100 percent CCF
to the off-balance sheet exposure to its counterparty,\129\ so the
total exposure amount would be ($100 receivable + $100 off-balance
sheet exposure) = $200.\130\
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\126\ The transaction would also result in credit (reduction) of
$100 cash, but this would have no impact on the banking
organization's risk-weighted assets as cash is assigned a 0 percent
risk weight under Sec. __.111.
\127\ See proposed Sec. __.112(b)(5)(iv).
\128\ If the transaction is a securities borrowing transaction
from the perspective of the banking organization, and if the equity
securities received are sold or if the counterparty defaults, the
banking organization would be required to record an obligation to
return the securities.
\129\ See proposed Sec. __.112(b)(5)(v)
\130\ In all cases, the $100 of investment grade corporate bonds
the banking organization has lent would continue to remain on the
banking organization's balance sheet and the banking organization
would continue to maintain risk-based capital against these bonds.
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Question 58: What alternative minimum haircut floors should the
agencies consider and why? What would be the advantages and
disadvantages of setting the minimum haircuts at a higher level, such
as at the proposed market price volatility haircuts used for
recognition of collateral for eligible margin loans and repo-style
transactions, or at levels between the proposed minimum haircut floors
and the proposed market price volatility haircuts?
Question 59: Where a banking organization has exchanged multiple
securities for multiple other securities under a QMNA with an
unregulated financial institution, what would be the costs and benefits
of providing banking organizations the flexibility to apply a single-
transaction haircut floor on a transaction-by-transaction basis for in-
scope transactions within the netting set, rather than applying a
portfolio-based floor? Under this approach, each in-scope transaction
within a netting set would be evaluated separately. Banking
organizations would be permitted to recognize the risk-mitigation
benefits of collateral for individual transactions that meet the
single-transaction haircut floor, even if the netting set did not meet
the portfolio-based floor.
Question 60: How can the proposed formulas used for determining
whether an in-scope transaction or in-scope set of transactions
breaches the minimum haircut floors be improved or further clarified?
Question 61: What are the advantages and disadvantages of the
proposed approach to minimum collateral haircuts for in-scope
transactions with unregulated financial institutions? How might the
proposal change the behavior of banking organizations and their
counterparties, including changes in funding practices and potential
migration of funding transactions to other counterparties? Commenters
are encouraged to provide data and supporting analysis.
D. Securitization Framework
The securitization framework is designed to provide the capital
requirement for exposures that involve the tranching of credit risk of
one or more underlying financial exposures. The risk and complexity
posed by securitizations differ relative to direct exposure to the
underlying assets in the securitization because the credit risk of
those assets is divided into different levels of loss prioritization
using a wide
[[Page 64068]]
range of structural mechanisms.\131\ The performance of a
securitization depends not only on the structure, but also on the
performance of the underlying assets and certain parties to the
securitization structure, including the asset servicer and any
liquidity facility provider. The involvement of these parties makes
securitization exposures susceptible to additional risks as compared to
direct credit exposures.
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\131\ To segment a reference portfolio into different levels of
risks for different investors, the securitization process divides
the reference portfolio into different slices, called tranches,
which receive cash flows or absorb losses based on a predetermined
order of priority. This payment structure is known as the ``cash
flow waterfall,'' or simply the ``waterfall.'' The waterfall
schedule prioritizes the manner in which interest or principal
payments from the reference portfolio must be allocated, creating
different risk-return profiles for each tranche.
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The proposed securitization framework would draw on many features
of the framework in subpart E of the current capital rule with the
following modifications: (1) additional operational requirements for
synthetic securitizations; (2) a modified treatment for
resecuritizations that meet the operational requirements; (3) a new
securitization standardized approach (SEC-SA), as a replacement to the
supervisory formula approach and standardized supervisory formula
approach (SSFA), which includes, relative to the SSFA, modified
definitions of attachment point and detachment point, a modified
definition of the W parameter, modifications to the definition of
KG, a higher p-factor, a lower risk-weight floor for
securitization exposures that are not resecuritization exposures, and a
higher risk-weight floor for resecuritization exposures; (4) a
prohibition on using the securitization framework for nth-to-default
credit derivatives; (5) a new treatment for derivative contracts that
do not provide credit enhancement; (6) a modified treatment for
overlapping exposures; (7) new maximum capital requirements and
eligibility criteria for certain senior securitization exposures (the
``look-through approach''); (8) a modification to the treatment for
credit-enhancing interest only strips (CEIOs); and (9) a new framework
for non-performing loan (NPL) securitizations.\132\
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\132\ The proposal generally would use the same approaches to
determine the exposure amount of securitization exposures.
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1. Operational Requirements
The proposed operational requirements would be consistent with the
operational requirements in subpart E of the current capital rule, with
three exceptions as described below. In addition, for resecuritization
exposures that meet the operational requirements, the proposal would
eliminate the option for banking organizations to treat the exposures
as if they had not been securitized.
a. Early Amortization Provisions
Early amortization provisions cause investors in securitization
exposures to be repaid before the original stated maturity when certain
conditions are triggered. For example, many securitizations of
revolving credit facilities, most commonly credit-card receivable
securitizations, contain provisions that require the securitization to
be wound down and investors repaid on an accelerated basis if excess
spread falls below a certain threshold. This decrease in excess spread
would typically be caused by credit deterioration in the underlying
exposures. Such provisions can expose the originating banking
organization to increased credit and liquidity risk and potentially
increased capital requirements after the early amortization is
triggered as the banking organization could be obligated to fund the
borrowers' future draws on the revolving lines of credit. In such an
instance, the originating banking organization may have to either find
a new funding source, whether internal or external, to cover the new
draws or reduce borrowers' credit line availability.
The proposal would expand the applicability of the operational
requirements regarding early amortization provisions to synthetic
securitizations, similar to their application to traditional
securitizations under subpart D of the current capital rule. Under
Sec. __. 2 of the current capital rule, an early amortization
provision means a provision in the documentation governing a
securitization that, when triggered, causes investors in the
securitization exposure to be repaid before the original stated
maturity of the securitization exposure, with certain exceptions.\133\
Under the proposal, if a synthetic securitization includes an early
amortization provision and references one or more underlying exposures
in which the borrower is permitted to vary the drawn amount within an
agreed limit under a line of credit, the banking organization would be
required to hold risk-based capital against the underlying exposures as
if they had not been synthetically securitized.
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\133\ The exceptions to the current definition of early
amortization provision are a provision that: (1) is triggered solely
by events not directly related to the performance of the underlying
exposures or the originating banking organization (such as material
changes in tax laws or regulations); or (2) leaves investors fully
exposed to future draws by borrowers on the underlying exposures
even after the provision is triggered.
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Question 62: What, if any, additional exceptions to the early
amortization provision definition should the agencies consider and why,
provided such exceptions would not incentivize a banking organization
to provide implicit support to a securitization exposure?
b. Synthetic Excess Spread
The proposal would prohibit an originating banking organization
from recognizing the risk-mitigating benefits of a synthetic
securitization that includes synthetic excess spread. Synthetic excess
spread would be defined in the proposal as any contractual provision in
a synthetic securitization that is designed to absorb losses prior to
any of the tranches of the securitization structure. Synthetic excess
spread is a form of credit enhancement provided by the originating
banking organization to the investors in the synthetic securitization;
therefore, the originating banking organization should maintain capital
against the credit exposure represented by the synthetic excess spread.
However, a risk-based capital requirement for synthetic excess spread
may not be determinable with sufficient precision to promote
comparability across banking organizations because the amount of
synthetic excess spread made available to investors in the synthetic
securitization would depend upon the maturity of the underlying assets,
which itself depends on whether any of the underlying exposures have
defaulted or prepaid. In particular, the total amount of synthetic
excess spread made available at inception to investors over the life of
the transaction may not be known ex ante, as the outstanding balance of
the securitization in future years is unknown. Therefore, if a
synthetic securitization structure includes synthetic excess spread,
the banking organization would be required under the proposal to
maintain capital against all the underlying exposures as if they had
not been synthetically securitized.
Question 63: What clarifications or modifications should the
agencies consider for the above proposed definition of synthetic excess
spread and why?
Question 64: What are the advantages and disadvantages of the
proposed treatment of synthetic securitizations with synthetic excess
spread? If the agencies were to permit originating banking
organizations to recognize the credit risk-mitigation benefits of
[[Page 64069]]
securitizations with synthetic excess spread, how should the exposure
amount of the synthetic excess spread be calculated, and what would be
the appropriate capital requirement for synthetic excess spread?
c. Minimum Payment Threshold
Under the proposal, the operational requirements for synthetic
securitizations would include a new requirement that any applicable
minimum payment threshold for the credit risk mitigant be consistent
with standard market practice. A minimum payment threshold is a
contractual minimum amount that must be delinquent before a credit
event is deemed to have occurred. The proposed minimum payment
threshold criterion is intended to prohibit an originating banking
organization from recognizing the capital reducing benefits of a
synthetic securitization whose minimum payment threshold is so large
that it allows for material losses to occur without triggering the
credit protection acquired by the protection purchaser, as such
provisions would interfere with an effective transfer of credit risk.
Question 65: What are the benefits and drawbacks of the proposed
minimum payment threshold criterion? What, if any, additional criteria
or clarifications should the agencies consider and why?
d. Resecuritization Exposures
For a resecuritization that is a traditional securitization, if the
operational requirements have been met, an originating banking
organization would be required to exclude the transferred exposures
from the calculation of its risk-weighted assets and maintain risk-
based capital against any credit risk it retains in connection with the
resecuritization. Unlike in the case of a securitization exposure that
is not a resecuritization, the proposal would not allow a banking
organization the option to elect to treat a resecuritization as if the
underlying exposures had not been re-securitized. While a
securitization of non-securitized assets can be used to diversify or
transfer credit risk of those exposures, a resecuritization might not
offer similar risk reduction or diversification benefits, particularly
if the underlying exposures reflect similar high-risk tranches of other
securitizations. Therefore, these resecuritization exposures warrant a
higher regulatory capital requirement than that applicable to the
underlying exposures.
Similarly, for a resecuritization that is a synthetic
securitization, if the operational requirements have been met, an
originating banking organization would be required to recognize for
risk-based capital purposes the use of a credit risk mitigant to hedge
the underlying exposures and must hold capital against any credit risk
of the exposures it retains in connection with the synthetic
securitization.
2. Securitization Standardized Approach (SEC-SA)
Under the proposal, a banking organization would determine the
capital requirements for most securitization exposures under the SEC-
SA, which is substantively similar to the SSFA in the current capital
rule except for certain changes as discussed below. Under the SEC-SA, a
banking organization would determine the risk weight for a
securitization exposure based on the risk weight of the underlying
assets, with adjustments to reflect (1) delinquencies in such assets,
(2) the securitization exposure's subordination level in the allocation
of losses, and (3) the heightened correlation and additional risks
inherent in securitizations relative to direct credit exposures.
To calculate the risk weight for a securitization exposure using
the SEC-SA, a banking organization must have accurate information on
the parameters used in the SEC-SA calculation. If the banking
organization cannot, or chooses not to, apply the SEC-SA, the banking
organization would be required to apply a 1,250 percent risk weight to
the exposure.
a. Definition of Attachment Point and Detachment Point
Under the current capital rule, the attachment point (parameter A)
of a securitization exposure equals the ratio of the current dollar
amount of underlying exposures that are subordinated to the exposure of
the banking organization to the current dollar amount of underlying
exposures. Any reserve account funded by the accumulated cash flows
from the underlying exposures that is subordinated to the banking
organization's securitization exposure may be included in the
calculation of parameter A to the extent that cash is present in the
account. The calculation in the current capital rule does not permit a
banking organization to recognize noncash assets in a reserve account
in the calculation of parameter A. In contrast, the proposal would
permit a banking organization to recognize all assets, cash or noncash,
that are included in a reserve account in the calculation of parameter
A. However, a banking organization would not be allowed to include
interest rate derivative contracts and exchange rate derivative
contracts, or the cash collateral accounts related to these
instruments, in the calculation of parameters A and D. The agencies are
proposing this treatment because assets held in a funded reserve
account, whether cash or noncash, can provide credit enhancement to a
securitization exposure, whereas interest rate and foreign exchange
derivatives (and any cash collateral held against these derivatives) do
not.\134\
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\134\ For example, if a securitization SPE has assets
denominated in U.S. Dollars and liabilities denominated in Euros,
and if the securitization SPE executes a USD-EUR foreign exchange
swap, the swap hedges the foreign exchange risk between the SPE's
assets and liabilities but does not provide credit enhancement to
any of the tranches of the securitization.
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The proposal would modify the definition of attachment point so
that it refers to the outstanding balance of the underlying assets in
the pool rather than the current dollar value of the underlying
exposures. By referencing the outstanding balance of the underlying
assets instead of the current dollar amount of the underlying
exposures, the revised definition would clarify that a banking
organization may recognize a nonrefundable purchase price discount
\135\ when calculating the attachment point of a securitization
exposure. A similar modification would be made to the definition of
detachment point.\136\
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\135\ The proposal would define nonrefundable purchase price
discount to mean the difference between the initial outstanding
balance of the exposures in the underlying pool and the price at
which these exposures are sold by the originator to the
securitization SPE, when neither originator nor the original lender
are reimbursed for this difference. In cases where the originator
underwrites tranches of a NPL securitization for subsequent sale,
the NRPPD may include the differences between the notional amount of
the tranches and the price at which these tranches are first sold to
unrelated third parties. For any given piece of a securitization
tranche, only its initial sale from the originator to investors is
taken into account in the determination of NRPPD. The purchase
prices of subsequent re-sales are not considered. See proposed
definition in Sec. __.101.
\136\ For the sake of consistency, the proposal would also use
the term ``outstanding balance'' in the calculation of W and
KG.
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b. Definition of W Parameter
Under the current capital rule, parameter W, which is expressed as
a decimal value between zero and one, reflects the proportion of
underlying exposures that are not performing or are delinquent,
according to criteria outlined in the rule. The proposal would apply a
similar definition of parameter W for subpart E, but clarify that for
resecuritization exposures, any
[[Page 64070]]
underlying exposure that is a securitization exposure would only be
included in the denominator of the ratio and would be excluded from the
numerator of the ratio. That is, for resecuritization exposures,
parameter W would be the ratio of the sum of the outstanding balance of
any underlying exposures of the securitization that meet any of the
criteria in paragraphs __.133(b)(1)(i) through (vi) of the proposal
that are not securitization exposures to the outstanding balance of all
underlying exposures. Underlying securitization exposures need not be
included in the numerator of parameter W because the risk weight of the
underlying securitization exposure as calculated by the SEC-SA already
reflects the impact of any delinquent or otherwise nonperforming loans
within the underlying securitization exposure. For example, if a
resecuritization with a notional amount of $10 million includes
underlying securitization exposures with a notional amount of $5
million and underlying non-securitization exposures with a notional
amount of $5 million, and if $500,000 of the non-securitization
exposures are delinquent, the numerator for the W parameter would be
$500,000 while the denominator for the W parameter would be $10
million. This would be true regardless of the delinquency status of any
of the securitization exposures.
c. Delinquency-Adjusted (KA) and Non-Adjusted
(KG) Weighted-Average Capital Requirement of the Underlying
Exposures
Under the proposal, KA would reflect the delinquency-
adjusted, weighted-average capital requirement of the underlying
exposures and would be a function of KG and W. Under this
approach, in order to calculate parameter W, and thus KA,
the banking organization must know the delinquency status of all
underlying exposures in the securitization. KG would equal
the weighted average total capital requirement of the underlying
exposures (with the outstanding balance used as the weight for each
exposure), calculated using the risk weights according to subpart E of
the proposed rule.
The agencies are proposing two modifications to the definition of
KG for SEC-SA compared to the current KG as used
in the SSFA. First, for interest rate derivative contracts and exchange
rate derivative contracts, the positive current exposure times the risk
weight of the counterparty multiplied by 0.08 would be included in the
numerator of KG but excluded from the denominator of
KG. If amounts related to interest rate and exchange rate
derivative contracts were included in both the numerator and
denominator of KG, these contracts could reduce the capital
requirement of securitization exposures even though interest rate and
exchange rate derivative contracts do not provide any credit
enhancement to a securitization. Second, if a banking organization
transfers credit risk via a synthetic securitization to a
securitization SPE and if the securitization SPE issues funded
obligations to investors, the banking organization would include the
total capital requirement (exposure amount multiplied by risk weight
multiplied by 0.08) of any collateral held by the securitization SPE in
the numerator of KG. The denominator of KG is
calculated without recognition of the collateral. This ensures that if
collateral held at the SPE is invested in credit-sensitive assets, the
credit risk associated with those assets will be included in the
banking organization's capital calculation. Consistent with subpart D
of the current capital rule, under the proposal, the value of
KG for a resecuritization exposure would equal the weighted
average of two distinct KG values, one for the underlying
securitization (which equals the capital requirement calculated using
the SEC-SA), the other for the underlying exposures (which equals the
weighted average capital requirement of the underlying exposures).
Question 66: Recognizing that banking organizations may not always
know the delinquency status of all underlying exposures, what would be
the benefits and drawbacks of allowing a banking organization to use
the SEC-SA if the banking organization knows the delinquency status for
most, but not all, of the underlying exposures? For example, if the
banking organization knew the delinquency status of 95 percent of the
exposures, it could (1) split the underlying exposures into two
subpools, (2) calculate a weighted average of the KA of the subpool
comprising the underlying exposures for which the delinquency status is
known, (3) assign a value of 1 for KA of the other subpool comprising
exposures for which the delinquency status is unknown, and (4) assign a
KA for the entire pool equal to the weighted average of the KA for each
subpool. What other approaches should the agencies consider and why?
d. Supervisory Calibration Parameter (Supervisory Parameter p)
Under the proposal, a banking organization would apply a
supervisory parameter p of 1.0 to securitization exposures that are not
resecuritization exposures and a supervisory parameter p of 1.5 to
resecuritization exposures. The proposed increase to the supervisory
parameter p for securitizations that are not resecuritization exposures
from 0.5 to 1.0 would help to ensure that the framework produces
appropriately conservative risk-based capital requirements when
combined with the reduced risk weights applicable to certain underlying
assets under the proposal that would be reflected in lower values of
KG and the proposed reduction in the risk-weight floor under
SEC-SA for securitization exposures that are not resecuritization
exposures.\137\
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\137\ See sections III.C.2 and III.D.2.d of this Supplementary
Information for a more detailed discussion of the reduced risk
weights applicable to certain underlying assets and the risk-weight
floor, respectively.
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e. Supervisory Risk-Weight Floors
The SEC-SA would require banking organizations to apply a risk
weight floor to all securitization exposures. The SEC-SA is based on
assumptions and the risk weight floor ensures a minimum level of
capital is held to account for modelling risks and correlation
risks.\138\ The proposal would apply a risk weight floor of 15 percent
for securitization exposures that are not resecuritization exposures.
The 15 percent risk weight floor is most relevant for more senior
securitization exposures. While junior tranches can absorb a
significant amount of credit risk, senior tranches are still exposed to
some amount of credit risk on the underlying exposures. Therefore, a
minimum prudential capital requirement continues to be appropriate in
the securitization context.
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\138\ Default correlation is the likelihood that two or more
exposures will default at the same time.
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For resecuritization exposures, the proposed SEC-SA approach would
require banking organizations to apply a risk-weight floor of at least
100 percent. The proposed 100 percent supervisory risk-weight floor for
resecuritization exposures is intended to capture the greater
complexity of such exposures and heightened correlation risks inherent
in the underlying securitization exposures.\139\
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\139\ In a typical securitization exposure that is not a
resecuritization, each underlying exposure is subject to
idiosyncratic default risks (for example, the employment status of
each obligor) which may exhibit lower relative default correlation.
In a resecuritization exposure, the underlying exposures, which are
typically tranches of securitizations, usually have credit
enhancement from more junior tranches that protects against many
idiosyncratic risks. Systematic risks are more likely to generate
defaults in the underlying exposures of resecuritizations than
idiosyncratic risks, but systematic risks are also much more
correlated; therefore, resecuritizations typically have higher
default correlations than other types of securitizations.
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[[Page 64071]]
The proposal would also apply a minimum risk weight of 100 percent
to NPL securitization exposures. Compared to other securitizations, the
performance of NPL securitizations depends more heavily on the
servicer's ability to generate cashflows from the workout of the
underlying exposures, typically through renegotiation of the defaulted
loans with the borrower or enforcement against the collateral. These
idiosyncratic risks associated with NPL securitizations merit a higher
minimum risk weight.
3. Exceptions to the SEC-SA Risk-Based Capital Treatment for
Securitization Exposures
Securitization exposures sometimes contain unique features that, if
not accounted for, could produce inconsistent outcomes under the SEC-SA
or in some cases make the calculation of the risk weight inoperable.
Thus, notwithstanding the general application of SEC-SA, the proposal
would include additional approaches to account for certain types of
securitization exposures, which would more appropriately align the
capital requirement with the risk of the exposure.
a. Nth-to-Default Credit Derivatives
Under the current capital rule, a banking organization that has
purchased credit protection in the form of an nth-to-default credit
derivative is permitted to recognize the risk mitigating benefits of
that derivative. The proposal would not permit banking organizations to
recognize any risk-mitigating benefit for nth-to-default credit
derivatives in which the banking organization is the protection
purchaser under either the proposed credit risk mitigation framework or
under the proposed securitization framework. Purchased credit
protection through nth-to-default derivatives often does not correlate
with the hedged exposure which inhibits the risk mitigating benefits of
the instrument.
For nth-to-default credit derivatives in which the banking
organization is the protection provider, the proposal would prohibit
use of the securitization framework and instead would require banking
organizations to calculate the risk-weighted asset amount by
multiplying the aggregate risk weights of the assets included in the
basket up to a maximum of 1,250 percent by the notional amount of the
protection provided by the credit derivative. In aggregating the risk
weights, the (n-1) assets with the lowest risk weight may be excluded
from the calculation. This approach would require banking organizations
to maintain capital based on the risk characteristics of all the
underlying assets in the basket on which it is providing protection,
while accounting for the fact that the banking organization is not
required to make a payment unless ``n'' names in the basket default.
b. Derivative Contracts That Do Not Provide Credit Enhancements
The proposal would provide a new treatment for certain interest
rate or foreign exchange derivative contracts that qualify as
securitization exposures. Some securitizations either make payments to
investors in a different currency from the underlying exposures or make
fixed payments to investors when the cash flows received on the
securitized assets are linked to a floating interest rate. To
neutralize these foreign exchange or interest rate risks, the
securitization SPE may enter into a derivative contract that mirrors
the currency or interest rate mismatch between the exposures and the
tranches. Cash flows required to be made to the derivative counterparty
tend to have a senior claim to the principal and interest payment of
the collateral, and therefore tend not to provide credit enhancement.
The proposal would require a banking organization that acts as a
counterparty to these types of interest rate and foreign exchange
derivatives to set the risk weight on such derivatives equal to the
risk weight calculated under the SEC-SA for a securitization exposure
that is pari passu to the derivative contract or, if such an exposure
does not exist, the risk weight of the next subordinated tranche of the
securitization exposure. A banking organization may otherwise not be
able to calculate a risk weight for these derivative contracts using
the SEC-SA because the attachment and detachment points under the
proposed formula could equal one another, rendering the formula
inoperable. The proposed treatment is intended to appropriately reflect
how the credit risk associated with these derivative contracts would be
commensurate with or less than the credit risk associated with a pari
passu tranche or the next subordinated tranche of a securitization
exposure.
The current capital rule permits banking organizations to assign a
risk-weighted asset amount for certain derivative contracts that are
securitization exposures equal to the exposure amount of the derivative
contract (i.e., a risk weight of 100 percent). The proposal would
eliminate this option. The approaches for derivative contracts
described in sections III.C.4. of this Supplementary Information
(including the treatment for derivative contracts that do not provide
credit enhancement described above) are more risk-sensitive and
reflective of the risks than a flat 100 percent risk weight.
i. Overlapping Exposures
The proposal would introduce new provisions for overlapping
exposures.\140\ First, the proposal would allow a banking organization
to treat two non-overlapping securitization exposures as overlapping to
the degree that the banking organization assumes that obligations with
respect to one of the exposures covers obligations with respect to the
other exposure. For example, if a banking organization provides a full
liquidity facility to an ABCP program that is not contractually
required to fund defaulted assets and the banking organization also
holds commercial paper issued by the ABCP program, a banking
organization would be permitted to calculate risk-weighted assets only
for the liquidity facility if the banking organization assumes, for
purposes of calculating risk-based capital requirements, that the
liquidity facility would be required to fund the defaulted assets. In
this case, the banking organization would be maintaining capital to
cover losses on the commercial paper when calculating capital
requirements for the liquidity facility, so there is no need to assign
a separate capital requirement for the commercial paper held by the
banking organization.
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\140\ An overlapping exposure occurs when a banking organization
is exposed to the same risk to the same obligor through multiple
direct or indirect exposures to that obligor.
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Second, the proposal would also allow a banking organization to
recognize an overlap between relevant risk-based requirements for
securitization exposures under subpart E and market risk covered
positions under subpart F, provided the banking organization is able to
calculate and compare the capital requirements for the relevant
exposures. For example, a banking organization could hold a correlation
trading position that would be subject to the proposed requirements
under subpart F but would preclude losses in all circumstances on a
separate securitization exposure held by the banking organization that
would be subject to requirements under subpart E under the proposal. In
such cases, the
[[Page 64072]]
proposal would allow the banking organization to calculate the risk-
based requirement for the overlapping portion of the exposures based on
the greater of the requirement under subpart E or under subpart F.
Question 67: What challenges, if any, would the option to recognize
an overlap between market risk covered and noncovered positions
introduce? To what degree do banking organizations anticipate
recognizing overlaps between market risk covered and noncovered
positions?
ii. Look-Through Approach for Senior Securitization Exposures
The proposal would introduce a provision that would allow a banking
organization to cap the risk weight applied to a senior securitization
exposure that is not a resecuritization exposure at the weighted-
average risk weight of the underlying exposures, provided that the
banking organization has knowledge of the composition of all of the
underlying exposures (also referred to as the ``look-through
approach''). For purposes of calculating the weighted-average risk
weight, the unpaid principal balance would be used as the weight for
each exposure. The proposal would define a senior securitization
exposure as an exposure that has a first priority claim on the cash
flows from the underlying exposures. When determining whether a
securitization exposure has a first priority claim on the cash flows
from the underlying exposures, a banking organization would not be
required to consider amounts due under interest rate derivative
contracts, exchange rate derivative contracts, and servicer cash
advance facility contracts,\141\ or any fees and other similar payments
to be made by the securitization SPE to other parties. Both the most
senior commercial paper issued by an ABCP program and a liquidity
facility that supports the ABCP program may be senior securitization
exposures if the liquidity facility provider's right to reimbursement
of the drawn amounts is senior to all claims on the cash flows from the
underlying exposures, except amounts due under interest rate derivative
contracts, exchange rate derivative contracts, and servicer cash
advance facility contracts, fees due, and other similar payments.
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\141\ A servicer cash advance facility means a facility under
which the servicer of the underlying exposures of a securitization
may advance cash to ensure an uninterrupted flow of payments to
investors in the securitization, including advances made to cover
foreclosure costs or other expenses to facilitate the timely
collection of the underlying exposures.
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Accordingly, under the proposed look-through approach, if a senior
securitization exposure's underlying pool of assets consists solely of
loans with a weighted average risk weight of 100 percent, the risk
weight for the senior securitization exposure would be the lower of the
risk weight calculated under the SEC-SA and 100 percent. The proposed
risk-weight cap is intended to recognize that the credit risk
associated with each dollar of a senior securitization exposure
generally will not be greater than the credit risk associated with each
dollar of the underlying assets, because the non-senior tranches of a
securitization provide credit enhancement to the senior tranche.
Notwithstanding the proposed risk weight cap, the proposal would
require banking organizations to floor the total risk-based capital
requirement under the look-through approach at 15 percent, consistent
with the proposed 15 percent floor under the SEC-SA. The proposed 15
percent floor, even if it results in a risk weight amount greater than
the risk weight cap, is intended to appropriately reflect the minimum
amount of risk-based capital that a banking organization should
maintain for such exposures given that the process of securitization
can introduce additional risks that are not present in the underlying
exposures such as modelling risks and correlation risks.
iii. Credit-Enhancing Interest Only Strips
The proposal would require a banking organization to deduct from
common equity tier 1 capital any portion of a CEIO strip \142\ that
does not constitute an after-tax-gain-on sale, regardless of whether
the securitization exposure meets the proposed operational
requirements. The proposed treatment for CEIOs would be different than
under subpart D of the current capital rule, which requires a risk
weight of 1,250 percent for these items. The agencies are proposing to
require deduction from common equity tier 1 capital because valuations
of CEIOs can include a high degree of subjectivity and, just like
assets subject to deduction under the current capital rule such as
goodwill and other intangible assets, banking organizations may not be
able to fully realize value from CEIOs based on their balance sheet
carrying amounts. While a deduction is generally equivalent to a 1,250
percent risk weight when the banking organization maintains an 8
percent capital ratio, given the various capital ratios, buffers, and
add-ons applicable to banking organizations subject to subpart E,
applying a deduction provides a more consistent treatment across ratios
and banking organizations.
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\142\ See Sec. __.2 for the definition of credit-enhancing
interest-only strip.
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iv. NPL Securitizations
The proposal would define an NPL securitization as a securitization
whose underlying exposures consist solely of loans where parameter W
for the underlying pool is greater than or equal to 90 percent at the
origination cut-off date \143\ and at any subsequent date on which
assets are added to or removed from the pool due to replenishment or
restructuring. A securitization exposure that meets the definition of a
resecuritization exposure would be excluded from the definition of an
NPL securitization.
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\143\ Cut-off date is the date on which the composition of the
asset pool collateralizing a securitization transaction is
established. This means that all assets to be included in a
securitization must already be in existence and meet the NPL
criteria as of that date.
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In a typical NPL securitization, the originating banking
organization sells the non-performing loans to a securitization SPE at
a significant discount to the outstanding loan balances (reflecting the
nonperforming nature of the underlying exposures) and this discount
acts as a credit enhancement to investors. Unlike the performance of
securitizations of performing loans, which principally depend on the
cash flows of the underlying loans, the performance of NPL
securitizations depends in part on the performance of workouts on
defaulted loans, which are uncertain and could be volatile, and on the
liquidation of underlying collateral for those loans which are unable
to be cured.
The proposal would introduce a specific approach for NPL
securitization exposures as the proposed SEC-SA may be inappropriate
for the unique risks of such exposures. The proposal would require a
banking organization to assign a risk weight of 100 percent to a
securitization exposure to an NPL securitization if the following
conditions are satisfied: (1) the transaction structure meets the
definition of a traditional securitization; (2) the securitization has
a credit enhancement in the form of a nonrefundable purchase price
discount greater than or equal to 50 percent of the outstanding balance
of the pool of exposures; and (3) the banking organization's exposure
is a senior
[[Page 64073]]
securitization exposure as described in section III.D.3.b.ii. of this
Supplementary Information.\144\ Using the SEC-SA for senior
securitizations of NPLs that meet these criteria would result in
capital requirements that do not reflect the nonrefundable purchase
price discount associated with these transactions. The SEC-SA is
calibrated on the basis that the loans in the pool at origination are
generally performing and is therefore inappropriate for senior
exposures to securitizations of NPLs that meet these criteria.
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\144\ If the banking organization is an originating banking
organization with respect to the NPL securitization, the banking
organization may maintain risk-based capital against the transferred
exposures as if they had not been securitized and must deduct from
common equity tier 1 capital any after-tax gain-on-sale resulting
from the transaction and any portion of a CEIO strip that does not
constitute an after-tax gain-on-sale.
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If the NPL securitization exposure is not a senior securitization
exposure or the purchase price discount is less than 50 percent, the
banking organization would be required to use the SEC-SA to calculate
the risk weight (subject to a risk weight floor of 100 percent and
reflecting all delinquent exposures in calculating parameter W). If the
exposure does not meet the requirements of the SEC-SA, the banking
organization must assign a risk weight of 1,250 to the exposure.
I. Attachment and Detachment Points for NPL Securitizations
Under the proposal, the nonrefundable purchase price discount would
equal the difference between the outstanding balance of the underlying
exposures and the price at which these exposures are sold by the
originator \145\ to investors on a final basis without recourse through
the securitization SPE, when neither the originator nor the original
lender are eligible for future reimbursement for this difference (that
is, that the purchase price discount is ``non-refundable''). In cases
where the originator underwrites tranches of the NPL securitization for
subsequent sale, a banking organization may include in the calculation
of the nonrefundable purchase price discount the differences between
the outstanding balance of the underlying nonperforming loans and the
price at which the tranches are first sold to third parties unrelated
to the originator. For any given piece of a securitization tranche, a
banking organization may only take into account the initial sale from
the originator to investors in the determination of the nonrefundable
purchase price discount and may not account for any subsequent
secondary re-sales.
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\145\ While originator typically refers to the party originating
the underlying loans, in the NPL context it refers to the party
arranging the NPL securitization (i.e., the securitizer).
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Since the calculation of parameters A and D both depend on the
outstanding balance of the assets in the underlying pool, any
nonrefundable purchase price discount associated with a securitization
would be included in both the numerator and denominator of parameters A
and D. For example, assume an originating banking organization
transfers a pool of mortgage loans with an outstanding balance of $100
million to a securitization SPE at a price of $60 million. The
nonrefundable purchase price discount would be the difference between
the unpaid principal balances on the underlying mortgages at the time
of sale to the securitization SPE and the price at which the
originating banking organization sold these mortgages to the
securitization SPE (that is, $40 million). Assume that the
securitization SPE issues $60 million in securitization tranches of
which the banking organization retains the senior $50 million tranche
and an investing banking organization purchases the $10 million first-
loss tranche. Parameter A for the investing banking organization's
exposure would equal 40 percent (that is, the ratio of $40 million to
$100 million). Thus, the discount paid for the underlying assets is
effectively the ``first loss'' position in the securitization.
Likewise, the originating banking organization would treat both the
nonrefundable purchase price discount and the investing banking
organization's tranche as subordinate and would set Parameter A at 50
percent.
If, in the example above, the originating bank sells both tranches
and each tranche is sold at a 20 percent discount (that is, the $10
million first loss tranche is sold for a price of $8 million and the
$50 million senior tranche is sold for a price of $40 million), the
investing banking organization that purchases the first-loss tranche
would be permitted to assign an attachment point of 52 percent to its
exposure, because the nonrefundable purchase price discount would be
the difference between the original outstanding amount of the exposures
($100 million) and the total notional value of all the securitization
tranches ($48 million). The investing banking organization that
purchases the senior tranche would be permitted to assign an attachment
point of 60 percent to the exposure.
4. Credit Risk Mitigation for Securitization Exposures
The proposal would replace the existing credit risk mitigation
framework under subpart E with a framework that is consistent with the
credit risk mitigation framework under subpart D of the current capital
rule,\146\ with one exception. A banking organization that purchases or
sells tranched credit protection, whether hedged or unhedged,
referencing part of a senior tranche would not be allowed to treat the
lower-priority portion that the credit protection does not reference as
a senior securitization exposure. For example, if a banking
organization holds a securitization exposure with an attachment point
of 20 percent and a detachment point of 100 percent and the banking
organization purchases an eligible guarantee with an attachment point
of 50 percent and a detachment point of 100 percent, the banking
organization's residual exposure, which attaches at 20 percent and
detaches at 50 percent, would be considered a non-senior securitization
exposure, and the banking organization would not be permitted to apply
the look-through approach to this exposure. A banking organization that
purchases a mezzanine tranche that attaches at 20 percent and detaches
at 50 percent has a similar economic exposure to a banking organization
that purchases a senior tranche that attaches at 20 percent and
detaches at 100 percent and then purchases credit protection that
attaches at 50 percent and detaches at 100 percent. Since the former
transaction would not be considered a senior securitization exposure
eligible for the look-through approach, the agencies believe that the
latter transaction likewise should not be eligible for the look-through
approach. Alternatively, the banking organization may choose not to
recognize the tranched credit protection, in which case, the banking
organization may treat the securitization exposure (which attaches at
20 percent and detaches at 100 percent) as a senior securitization
exposure.
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\146\ In particular, the proposal would eliminate references to
model-based approaches that are currently contained in subpart E.
The proposal would also eliminate the formula for collateral
recognition under subpart E, which includes standard supervisory
haircuts calibrated to a 65-day holding period and permits banking
organizations to calculate their own estimates of haircuts with
prior supervisory approval.
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E. Equity Exposures
Equity exposures present a greater risk of loss relative to credit
exposures as equity exposures represent an ownership interest in the
issuer of an
[[Page 64074]]
equity instrument and have a lower priority of payment or reimbursement
in the event that the issuing entity fails to meet its credit
obligations. For example, an equity exposure entitles a banking
organization to no more than the pro-rata residual value of a company
after all other creditors, including subordinated debt holders, are
repaid. As a result, consistent with the current capital rule, the
proposal would generally assign higher risk weights to equity exposures
than exposures subject to the proposed credit risk framework.
The current capital rule's advanced approaches equity framework
permits use of an internal models approach for publicly traded and non-
publicly traded equity exposures and equity derivative contracts. The
proposal would not include an internal models approach because of the
types of equity exposures that would likely be subject to the equity
framework. Under the proposal, material publicly traded equity
exposures would generally be subject to the proposed market risk
framework described in section III.H of this Supplementary Information,
unless there are restrictions on the tradability of such
exposures.\147\ Similarly, equity exposures to investment funds for
which the banking organization has access to the investment fund's
prospectus, partnership agreement, or similar contract that defines the
fund's permissible investments and investment limits, and is either
able to (1) calculate a market risk capital requirement for its
proportional ownership share of each exposure held by the investment
fund, or (2) obtain daily price quotes--would generally be subject to
the proposed market risk framework.\148\ As the proposed equity
framework would primarily cover illiquid or infrequently traded equity
exposures, the proposal would require banking organizations to use a
standardized approach to determine capital requirements for such equity
exposures. This is intended to increase the transparency of the capital
framework and facilitate comparisons of capital adequacy across banking
organizations.
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\147\ While the proposal would require banking organizations
that are not subject to the proposed market risk capital framework
to calculate risk-weighted assets for all publicly traded equity
exposures under the proposed equity framework, such entities
typically do not have material equity exposures.
\148\ See Sec. __.202 for the proposed definition of market
risk covered position.
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The proposed framework would largely maintain those sections of the
current capital rule's equity framework that do not rely on models,
including the definition of equity exposure,\149\ the definition of
investment fund, the treatment of stable value protection, and the
methods for measuring the exposure amount for equity exposures. The
proposal would make certain modifications to improve the risk
sensitivity and robustness of the risk-based capital requirements for
equity exposures relative to the current capital rule. Specifically,
the proposal would: (1) eliminate the 100 percent risk weight threshold
category under the simple risk-weight approach for non-significant
equity exposures; (2) eliminate the effective and ineffective hedge
pair treatment under the simple risk-weight approach; (3) align the
conversion factors for conditional commitments to acquire an equity
exposure, consistent with the proposed off-balance sheet treatment for
exposures subject to the proposed credit risk framework, and (4)
increase the risk weight applicable to equity exposures to investment
firms with greater than immaterial leverage that the primary Federal
supervisor has determined do not qualify as a traditional
securitization. Additionally, the proposal would enhance the risk-
sensitivity of the current capital rule's look-through approaches for
equity exposures to investment funds by (1) specifying a hierarchy of
approaches that a banking organization would be required to use based
on the nature and quality of the information available to the banking
organization concerning the investment fund's underlying assets and
liabilities; (2) modifying the full look-through and the alternative
look-through approaches to explicitly capture off-balance sheet
exposures held by an investment fund, the counterparty credit risk and
CVA risk of any underlying derivatives held by the investment fund, and
the leverage of the investment fund; (3) replacing the simple modified
look-through approach with a flat 1,250 percent risk weight, and (4)
flooring the risk weight applicable to an equity exposure to an
investment fund at 20 percent, consistent with the standardized
approach in the current capital rule.
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\149\ See 12 CFR 3.2 (OCC); 12 CFR 217.2 (Board); 12 CFR 324.2
(FDIC).
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1. Risk-Weighted Asset Amount
The proposal would retain the risk-weighted asset amount
calculation under the current capital rule. Consistent with the current
capital rule, the proposal would require a banking organization to
determine the risk-weighted asset amount for each equity exposure,
except for equity exposures to investment funds, by multiplying the
adjusted carrying value of the exposure by the lowest applicable risk
weight, as described below in section III.E.1.b. of this Supplementary
Information. A banking organization would determine the risk-weighted
asset amount for an equity exposure to an investment fund by
multiplying the adjusted carrying value of the exposure by either the
risk weight calculated under one of the look-through approaches or by a
risk weight of 1,250 percent, as described below in section III.E.1.c.
of this Supplementary Information. A banking organization would
calculate its aggregate risk-weighted asset amount for equity exposures
as the sum of the risk-weighted asset amount calculated for each equity
exposure.\150\
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\150\ The proposal would exclude from the proposed equity
framework equity exposures that a banking organization would be
required to deduct from regulatory capital under Sec.
__.22(d)(2)(i)(C) of the proposal. The proposal would require a
banking organization to assign a 250 percent risk weight to the
amount of the significant investments in the common stock of
unconsolidated financial institutions that is not deducted from
common equity tier 1 capital.
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a. Adjusted Carrying Value
Under the proposal, the adjusted carrying value of an equity
exposure, including equity exposures to investment funds, would be
based on the type of exposure, as described in Table 6 below.
BILLING CODE 6210-01-P; 6714-01-P; 4810-33-P
[[Page 64075]]
[GRAPHIC] [TIFF OMITTED] TP18SE23.024
The proposal would maintain the current capital rule's methods for
calculating the adjusted carrying value for equity exposures, with one
exception. The proposal would simplify the treatment of conditional
commitments to acquire an equity exposure to remove the differentiation
of conversion factors by maturity. The proposal would require a banking
organization to multiply the effective notional principal amount of a
conditional commitment by a 40 percent conversion factor to calculate
its adjusted carrying value. The 40 percent conversion factor is meant
to appropriately account for the risk of conditional equity
commitments, which provide the banking organization more flexibility to
exit the commitment relative to unconditional equity commitments.
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\151\ Consistent with the current capital rule, the proposal
would allow a banking organization to choose not to hold risk-based
capital against the counterparty credit risk of equity derivative
contracts, as long as it does so for all such contracts. Where the
equity derivative contracts are subject to a qualified master
netting agreement, the proposal would require the banking
organization to either include all or exclude all of the contracts
from any measure used to determine counterparty credit risk
exposure. See Sec. __.113(d) of the proposal.
\152\ Consistent with the current capital rule, the proposal
includes the concept of the effective notional principal amount of
the off-balance sheet portion of an equity exposure to provide a
uniform method for banking organizations to measure the on-balance
sheet equivalent of an off-balance sheet exposure. For example, if
the value of a derivative contract referencing the common stock of
company X changes the same amount as the value of 150 shares of
common stock of company X, for a small change (for example, 1.0
percent) in the value of the common stock of company X, the
effective notional principal amount of the derivative contract is
the current value of 150 shares of common stock of company X,
regardless of the number of shares the derivative contract
references. The adjusted carrying value of the off-balance sheet
component of the derivative is the current value of 150 shares of
common stock of company X minus the adjusted carrying value of any
on-balance sheet amount associated with the derivative.
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b. Expanded Simple Risk-Weight Approach (ESRWA)
Under the proposal, the risk-weighted asset amount for an equity
exposure, except for equity exposures to investment funds, would be the
product of the adjusted carrying value of the equity exposure
multiplied by the lowest applicable risk weight in Table 7.
[[Page 64076]]
[GRAPHIC] [TIFF OMITTED] TP18SE23.025
BILLING CODE 6210-01-C; 6714-01-C; 4810-33-C
Except for the proposed zero, 20, and 400 percent risk-weight
buckets and the 250 percent risk weight for significant investments in
the capital of an unconsolidated financial institution in the form of
common stock that are not deducted from regulatory capital, the
proposal would revise the risk weights applicable to other types of
equity exposures relative to those in the current capital rule's simple
risk-weight approach. Specifically, to enhance risk sensitivity and
simplify the equity framework, the proposal would eliminate the
following risk weights within the current capital rule's simple risk-
weight approach: (1) the 100 percent risk weight for non-significant
equity exposures whose aggregate adjusted carrying value does not
exceed 10 percent of the banking organization's total capital, and (2)
the 100 and 300 percent risk weights for the effective and ineffective
portion of hedge pairs, respectively. Given the removal of the 100
percent risk weight threshold category for non-significant equity
exposures and the revised scope of equity exposures subject to the
proposed equity framework, the proposal would (1) assign a 100 percent
risk weight to equity exposures to Small Business Investment Companies
and (2) generally assign a 250 percent risk weight to publicly traded
equity exposures with restrictions on tradability,\155\ as described in
more
[[Page 64077]]
detail below. Finally, the proposal would introduce a 1,250 percent
risk weight to replace the 600 percent risk weight in the simple risk-
weight approach under subpart E of the current capital rule for equity
exposures to investment firms that have greater than immaterial
leverage and that the primary Federal supervisor has determined do not
qualify as a traditional securitization exposure, as described in more
detail below.
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\153\ The proposal would rely on the existing definition of
publicly traded under the current capital rule. See 12 CFR 3.2
(OCC); 12 CFR 217.2 (Board); 12 CFR 324.2 (FDIC).
\154\ Consistent with the current capital rule, the proposal
would require banking organizations to apply the 250 percent risk
weight to the net long position, as calculated under Sec. __.22(h),
that is not deducted from capital pursuant to Sec.
__.22(d)(2)(i)(C).
\155\ Banking organizations that would be subject to the
proposed enhanced risk-based capital framework but not the proposed
market risk capital requirements would be required to assign a 250
percent risk weight to all publicly traded equity positions that are
not equity exposures to investment funds.
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Removing the 100 percent risk weight for non-significant equity
exposures is intended to increase the risk sensitivity of the equity
framework by requiring banking organizations to apply a risk weight
based on the characteristics of each equity exposure, rather than only
for those in excess of 10 percent of the banking organization's total
capital. Given that primarily illiquid or infrequently traded equity
positions would be subject to the proposed equity framework, the
proposal would remove the 100 and 300 percent risk weights under the
current capital rule for the effective and ineffective portions of
hedge pairs. The hedge pair treatment under the current capital rule is
only available if each of the equity exposures is publicly traded or
has a return that is primarily based on a publicly traded equity
exposure. As such positions would generally be subject to the proposed
market risk capital framework under the proposal, the agencies are
proposing to eliminate the hedge pair treatment to simplify the risk-
weighting framework under the proposal.
i. Community Development Investments and Small Business Investment
Companies
The current capital rule assigns a 100 percent risk weight to
equity exposures that either (1) qualify as a community development
investment under section 24 (Eleventh) of the National Bank Act, or (2)
represent non-significant equity exposures to the extent that the
aggregate adjusted carrying value of the exposures does not exceed 10
percent of the banking organization's total capital. Under the current
capital rule, when determining which equity exposures are ``non-
significant'' and thus eligible for a 100 percent risk weight, a
banking organization first must include equity exposures to an
unconsolidated small business investment company or held through a
consolidated small business investment company described in section 302
of the Small Business Investment Act of 1958 (15 U.S.C. 682).\156\ As
depository institutions are limited by statute to only invest up to 5
percent of total capital in the equity exposures and debt instruments
of small business investment companies, the current capital rule
effectively assigns a 100 percent risk weight to all equity exposures
to such programs.
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\156\ See 12 CFR 3.152(b)(3)(iii)(B) (OCC); 12 CFR
217.152(b)(3)(iii)(B) (Board); 12 CFR 324.152(b)(3)(iii)(B) (FDIC).
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Equity exposures to community development investments and small
business investment companies generally receive favorable tax treatment
and/or investment subsidies that make their risk and return
characteristics different than equity investments in general.
Recognizing this more favorable risk-return structure and the
importance of these investments to promoting important public welfare
goals, the proposal would effectively retain the treatment of equity
exposures that qualify as community development investments and equity
exposures to small business investment companies under the current
capital rule and assign such exposures a 100 percent risk weight.
ii. Publicly Traded Equity With Tradability Restrictions \157\
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\157\ The proposal would require banking organizations that are
not subject to the proposed market risk capital framework to
calculate risk-weighted assets for all publicly traded equity
exposures under the proposed equity framework.
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To appropriately capture the risk of publicly traded equity
exposures with restrictions on tradability, the proposal would (1)
eliminate the 100 percent risk weight for non-significant equity
exposures up to 10 percent of total capital under the current capital
rule; and (2) introduce a 250 percent risk weight to replace the
current capital rule's 300 percent risk weight applicable to publicly
traded exposures.\158\ The revised calibration of the risk-weight for
publicly traded equity exposures with restrictions on tradability is
intended to take into account the removal of the non-significant equity
exposures treatment. Under the proposal, banking organizations would no
longer assign separate risk weights (100 percent and 300 percent) to
publicly traded equity exposures based on factors that are unrelated to
the underlying risk of the exposure. Instead, the proposal would assign
an identical 250 percent risk weight to all publicly traded equity
exposures with restrictions on tradability, improving the consistency
and risk-sensitivity of the framework.
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\158\ Equity exposures, including preferred stock exposures, to
the FHLBs and Farmer Mac would continue to receive a 20 percent risk
weight.
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iii. Equity Exposures to Investment Firms With Greater Than Immaterial
Leverage and That Would Meet the Definition of a Traditional
Securitization Were It Not for the Application of Paragraph (8) of That
Definition
Consistent with the current capital rule, the proposed
securitization framework generally would apply to exposures to
investment firms with material liabilities that are not operating
companies,\159\ unless the primary Federal supervisor determines the
exposure is not a traditional securitization based on its leverage,
risk profile or economic substance.160 161 For an equity
exposure to an investment firm that has greater than immaterial
leverage and that the primary Federal supervisor has determined does
not qualify as a traditional securitization exposure, the proposal
would increase the 600 percent risk weight in the simple risk-weight
approach under subpart E of the current capital rule to 1,250 percent
under the proposed expanded simple risk-weight approach.
[[Page 64078]]
As under the current capital rule, the applicable risk weight for
equity exposures to such investment firms with greater than immaterial
liabilities under the proposed securitization framework would depend on
the size of the first loss tranche.\162\ For investment firms that have
greater than immaterial leverage, their capital structure may result in
a large first loss tranche that understates the risk of the exposure to
the investment firm. Unlike most traditional securitization structures,
investment firms that can easily change the size and composition of
their capital structure (as well as the size and composition of their
assets and off-balance sheet exposures) may pose additional risks not
covered by the securitization framework. For example, the performance
of an equity exposure to an investment firm with greater than
immaterial liabilities may depend in part on management discretion
regarding asset composition and capital structure. To appropriately
capture the additional risks posed by equity exposures to investment
firms with greater than immaterial liabilities that may not be
reflected within the proposed securitization framework, the proposal
would permit the primary Federal supervisor to determine that the
exposure is not a traditional securitization and require the banking
organization to apply a 1,250 percent risk weight to the adjusted
carrying value of equity exposures to such investment firms.\163\
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\159\ Operating companies generally refer to companies that are
established to conduct business with clients with the intention of
earning a profit in their own right and generally produce goods or
provide services beyond the business of investing, reinvesting,
holding, or trading in financial assets. Accordingly, an equity
investment in an operating company generally would be an equity
exposure under the proposal and subject to the proposed enhanced
simple risk-weight approach. Consistent with the current capital
rule, under the proposal, banking organizations would be operating
companies and would not fall under the definition of a traditional
securitization. However, investment firms that generally do not
produce goods or provide services beyond the business of investing,
reinvesting, holding, or trading in financial assets, would not be
operating companies, and would not qualify for the general exclusion
from the definition of traditional securitization.
\160\ In general, such entities qualify as ``traditional
securitizations'' unless explicitly scoped out by criterion (10) of
that definition (for example collective investment funds, as defined
in 12 CFR 208.34, as well as entities registered with the SEC under
the Investment Company Act of 1940, 15 U.S.C. 80a-1, or foreign
equivalents thereof). As the definition of ``traditional
securitization'' does not include exposures to entities where all or
substantially all of the underlying exposures are not financial
exposures, equity exposures to Real Estate Investment Trusts (REITs)
generally would be treated in a similar manner to equity exposures
to operating companies and, unless they qualify as market risk
covered positions, would be subject to the proposed expanded simple
risk-weight approach of the equity framework.
\161\ For example, for an equity security issued by a qualifying
venture capital fund, as defined under Sec. __.10(c)(16) of each
agency's regulations implementing section 13 of the BHC Act, that
also has outstanding debt securities, the proposal would generally
require a banking organization to treat the exposure as a
traditional securitization exposure if the exposure would meet all
of the criteria of the definition of traditional securitization
under Sec. __.2 of the current capital rule unless the primary
Federal supervisor determines the exposure is not a traditional
securitization.
\162\ Consistent with the current capital rule, under the
proposal, an equity exposure to an investment firm that is treated
as a traditional securitization would be subject to due diligence
requirements. If a banking organization is unable to demonstrate to
the satisfaction of the primary Federal supervisor a comprehensive
understanding of the features of an equity exposure that would
materially affect the performance of the exposure, the proposal
would require the banking organization to assign a risk weight of
1,250 percent to the equity exposure to the investment firm.
\163\ Consistent with the current capital rule, the agencies
will consider the economic substance, leverage, and risk profile of
a transaction to ensure that an appropriate risk-based capital
treatment is applied. The agencies will consider a number of factors
when assessing the economic substance of a transaction including,
for example, the amount of equity in the structure, overall leverage
(whether on or off-balance sheet), whether redemption rights attach
to the equity investor, and the ability of the junior tranches to
absorb losses without interrupting contractual payments to more
senior tranches.
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Question 68: The agencies request comment on the proposed
application of a 1,250 percent risk weight to equity exposures to
investment firms with greater than immaterial leverage and that would
meet the definition of a traditional securitization were it not for the
application of paragraph (8) of that definition. For what, if any,
types of exposures would requiring banking organizations to apply a
1,250 percent risk weight be inappropriate and why? What are the
advantages and disadvantages of the proposed 1,250 percent risk weight
relative to expanding the proposed look-through approaches for
investment funds to include such exposures?
Question 69: The agencies seek comment on the advantages and
disadvantages of requiring banking organizations to calculate risk-
based capital requirements for equity exposures to investment firms
with greater than immaterial leverage under the proposed securitization
framework relative to the proposed look-through approaches under the
equity framework. What, if any, types of equity exposures to investment
firms with greater than immaterial leverage may not be appropriately
captured by the securitization framework--such as equity exposures to
investment firms where all the exposures of the investment firm are
pari passu in the event of a bankruptcy or other insolvency proceeding?
Between the proposed securitization framework and the proposed look-
through approaches under the equity framework, which approach would be
more operationally burdensome or challenging and why? Which approach
would produce a more appropriate capital requirement and why? Provide
supporting data and examples.
c. Risk Weights for Equity Exposures to Investment Funds
The separate risk-based capital treatment for equity exposures to
investment funds under the current capital rule reflects that the risk
of equity exposures to investment fund structures depends primarily on
the nature of the underlying assets held by the fund and the degree of
leverage employed by the fund. Consistent with the current capital
rule, the proposal would require banking organizations to determine the
risk weight applicable to the adjusted carrying value of each equity
exposure to an investment fund using a look-through approach in the
equity framework. When more detailed information is available about the
investment fund's characteristics, a banking organization is in a
better position to evaluate the risk profile of its equity exposure to
the fund and calculate a risk weight commensurate with that risk.
Conversely, equity exposures to investment funds that provide less
transparency or are not subject to regular independent verification
could present elevated risk to banking organizations. Accordingly, the
proposal would specify a hierarchy that banking organizations would be
required to use to identify the applicable look-through approach for
each equity exposure to an investment fund based on the nature and
quality of the information available to the banking organization.
The proposal would also enhance the risk sensitivity of the current
capital rule's look-through approaches under subpart E by modifying the
full look-through and the alternative look-through approaches to
explicitly capture off-balance sheet exposures held by an investment
fund, the counterparty credit risk and CVA risk of any underlying
derivatives held by the investment fund, and the leverage of an
investment fund. The proposal would also replace the simple modified
look-through approach under subpart E with a flat 1,250 percent risk-
weight.
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\164\ The proposal would require banking organizations subject
to the market risk capital requirements to apply the proposed market
risk capital framework to determine the risk-weighted asset amount
for equity exposures to investment funds that would otherwise be
subject to the full look-through approach under the proposed equity
framework. See Sec. __.202 for the proposed definition of market
risk covered position.
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i. Hierarchy of Look-Through Approaches
The proposal would require a banking organization that is not
subject to the proposed market risk capital framework to use the full
look-through approach if the banking organization has sufficient
verified information about the underlying exposures of the investment
fund to calculate a risk-weighted asset amount for each of the
exposures held by the investment fund.\164\ If a banking organization
is unable to meet the criteria to use the full look-through approach,
the proposal would require the banking organization to apply the
alternative modified look-through approach and determine a risk-
weighted asset amount for the exposures of the investment fund based on
the information contained in the investment fund's prospectus,
partnership agreement, or similar contract that defines the investment
fund's permissible investments. If the banking organization is unable
to apply either the full look-through approach or the alternative
modified look-through approach, the proposal would require the banking
organization to assign a 1,250 percent risk weight to the adjusted
carrying value of the equity exposure to the investment fund. Banking
organizations generally would not be permitted to apply a combination
of the
[[Page 64079]]
above approaches to determine the risk-weighted asset amount applicable
to the adjusted carrying value of an equity exposure to an investment
fund, except for equity exposures to investment funds with underlying
securitizations, or equity exposures to other investment funds, as
described in section III.E.1.c.v. of this Supplementary Information.
ii. Full Look-Through Approach
Since the full look-through approach is the most granular and risk-
sensitive approach, the proposal would require banking organizations
that are not subject to the proposed market risk capital framework to
use the full look-through approach when verified, detailed information
about the underlying exposures of the investment fund is available to
enhance risk-sensitivity of the risk-based capital requirements. Under
the proposed hierarchy, such banking organizations would be required to
use the full look-through approach if the banking organization is able
to calculate a risk-weighted asset amount for each of the underlying
exposures of the investment fund as if the exposures were held directly
by the banking organization, with the exception of securitization
exposures, derivative exposures, and equity exposures to other
investment funds, as described in section III.E.1.c.v. of this
Supplementary Information.
Specifically, the proposal would require banking organizations that
are not subject to the proposed market risk capital framework to apply
the full look-through approach when there is sufficient and frequent
information provided to the banking organization regarding the
underlying exposures of the investment fund. To satisfy this criterion,
the frequency of financial reporting of the investment fund must be at
least quarterly, and the financial information must be sufficient for
the banking organization to calculate the risk-weighted asset amount
for each exposure held by the investment fund as if each exposure were
held directly by the banking organization (except for securitization
exposures, derivatives exposures, and equity exposures to other
investment funds). In addition, such information would be required to
be verified on at least a quarterly basis by an independent third
party, such as a custodian bank or management fund.\165\
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\165\ As externally licensed auditors typically express their
opinions on investment funds' accounts rather than on the accuracy
of the data used for the purposes of applying the full look-through
approach, an external audit would not be required.
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The proposal would largely maintain the same risk-weight treatment
as provided under the full look-through approach in the advanced
approaches of the current capital rule, with five exceptions. First, to
facilitate application of the full look-through approach, the proposal
would allow banking organizations the option to use conservative
alternative methods to those provided under the proposed expanded risk-
weighted asset approach to calculate the risk-weighted asset amount
attributable to any underlying exposures that are securitizations,
derivatives, or equity exposures to another investment fund, as
described in section III.E.1.c.v. of this Supplementary Information.
Second, to increase comparability across banking organizations, the
proposal would clarify that the total risk-weighted asset amount for
the investment fund under the full look-through approach must include
any off-balance sheet exposures of the investment fund and the
counterparty credit risk and, where applicable, the CVA risk of any
underlying derivative exposures held by the investment fund.
Accordingly, under the proposal, the total risk-weighted asset amount
for the investment fund under the full look-through approach would
equal the sum of the risk-weighted asset amount for (1) the on-balance
sheet exposures, including any equity exposures to other investment
funds and securitization exposures; (2) the off-balance sheet
exposures; and (3) the counterparty credit risk and CVA risk, if
applicable, of any underlying derivative exposures held by the
investment fund, as described in section III.E.1.c.v. of this
Supplementary Information. A banking organization would calculate the
average risk weight for an equity exposure to the investment fund by
dividing the total risk-weighted asset amount for the investment fund
by the total assets of the investment fund.
Third, to capture the risk of equity exposures to investment funds
with leverage, the full look-through approach under the proposal would
explicitly require banking organizations to adjust the average risk
weight for its equity exposure to the investment fund upwards to
reflect the leverage of the investment fund.\166\ Specifically, the
proposal would require banking organizations to multiply the average
risk weight for its equity exposure to the investment fund by the ratio
of the total assets of the investment fund to the total equity of the
investment fund.
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\166\ While not done explicitly, the full look-through approach
under the current capital rule does capture the leverage of an
investment fund.
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Fourth, to avoid disincentivizing banking organizations from
obtaining the necessary information to apply the full-look through
approach, the proposal would cap the risk weight for an equity exposure
to an investment fund under the full look-through approach at no more
than 1,250 percent.
Fifth, consistent with the standardized approach under the current
capital rule, to reflect the agencies' and banking organizations'
experience with money market fund investments and similar investment
funds during the 2008 financial crisis and the 2020 coronavirus
response, the proposal would floor the minimum risk weight that may be
assigned to the adjusted carrying value of any equity exposure to an
investment fund under the proposed look-through approaches at 20
percent. Accordingly, under the proposal, a banking organization would
be required to calculate the total risk-weighted asset amount for an
equity exposure to an investment fund under the full look-through
approach by multiplying the adjusted carrying value of the equity
exposure by the applicable risk weight, as calculated according to the
following formula provided under Sec. __.142(b) of the proposed rule:
[GRAPHIC] [TIFF OMITTED] TP18SE23.026
Where:
RWAon is the aggregate risk-weighted asset
amount of the on-balance sheet exposures of the investment fund,
including any equity exposures to other investment funds and
securitization exposures, calculated as if each exposure were held
directly on balance sheet by the banking organization;
RWAoff is the aggregate risk-weighted asset
amount of the off-balance sheet exposures of the investment fund,
calculated for each exposure as if it were
[[Page 64080]]
held under the same terms by the banking organization;
RWAderivatives is the aggregate risk-weighted
asset amount for the counterparty credit risk and CVA risk, if
applicable, of the derivative contracts held by the investment fund,
calculated as if each derivative contract were held directly by the
banking organization, unless the banking organization applies the
alternative approach described in section III.E.1.c.v. of this
Supplementary Information; \167\
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\167\ Under the proposal, a banking organization may exclude
equity derivative contracts held by the investment fund for purposes
of calculating the RWAderivatives component of the full
and alternative modified look-through approaches, if the banking
organization has elected to exclude equity derivative contracts for
purposes of Sec. __.113(d) of the proposal.
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Total AssetsIF is the balance sheet total assets of the
investment fund; and
Total EquityIF is the balance sheet total equity of the
investment fund.
Question 70: What would be the advantages and disadvantages of
allowing a banking organization that does not have adequate data or
information to determine the risk weight associated with its equity
exposure to an investment fund to rely on information from a source
other than the investment fund itself, if the risk weight would be
increased (for example by a factor of 1.2)? For what types of
investment funds would a banking organization rely on a source other
than the investment fund itself to obtain this information and what
types of entities would it rely on to obtain this information?
iii. Alternative Modified Look-Through Approach
If a banking organization is unable to meet the criteria to use the
full look-through approach, the proposal would require the banking
organization to use the alternative modified look-through approach,
provided that the information contained in the investment fund's
prospectus, partnership agreement, or similar contract is sufficient to
determine the risk weight applicable to each exposure type in which the
investment fund is permitted to invest.\168\ To account for the
uncertain accuracy of risk assessments when banking organizations have
limited information about the underlying exposures of an investment
fund or such information is not verified on at least a quarterly basis
by an independent third party, the alternative modified look-through
approach in the current capital rule requires banking organizations to
use conservative assumptions when calculating total risk-weighted
assets for equity exposures to investment funds.
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\168\ Under the proposal, banking organizations subject to the
proposed market risk capital requirements would only apply the
alternative modified look-through approach to such equity exposures
to investment funds if the banking organization is unable to obtain
daily quotes for the equity exposure to the investment fund. See
Sec. __.202 for the proposed definition of market risk covered
position.
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The proposal would largely maintain the same risk-weight treatment
as provided under the alternative modified look-through approach in the
advanced approaches of the current capital rule, with five exceptions.
First, to increase comparability of the risk-based capital requirements
applicable to equity exposures to investment funds with investment
policies that permit the investment fund to hold equity exposures to
other investment funds or securitization exposures, the proposed
alternative modified look-through approach would specify the methods
that banking organizations would be required to use to calculate risk-
weighted assets for such underlying exposures, as described in section
III.E.1.c.v. of this Supplementary Information.
Second, to capture the risk of equity exposures to investment funds
with investment policies that permit the use of off-balance sheet
transactions or derivative contracts, the proposal would require
banking organizations to include the off-balance sheet transactions as
well as the counterparty credit risk and CVA risk, if applicable, of
the derivative contracts, when calculating the total risk-weighted
asset amount for the investment fund. Specifically, the proposal would
require banking organizations to assume that the investment fund
invests to the maximum extent permitted under its investment limits in
off-balance sheet transactions with the highest applicable credit
conversion factor and risk weight.\169\ The proposal would also require
banking organizations to assume that the investment fund has the
maximum volume of derivative contracts permitted under its investment
limits. Under the proposal, the total risk-weighted asset amount for
the investment fund under the alternative modified look-through
approach would equal the sum of the following risk-weighted asset
amounts: (1) the on-balance sheet exposures, including any equity
exposures to other investment funds and securitization exposures; (2)
the off-balance sheet exposures, and (3) the counterparty credit risk
and CVA risk, if applicable, for derivative exposures, as described in
section III.E.1.c.v. of this Supplementary Information. A banking
organization would calculate the average risk weight for an equity
exposure to the investment fund by dividing the total risk-weighted
asset amount for the investment fund by the total assets of the
investment fund.
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\169\ For example, if the mandate of an investment entity
permits the use of unconditional equity commitments, the proposal
would require the banking organization to multiply the notional
amount of the commitment by a 100 percent credit conversion factor
and the risk weight applicable to the underlying reference exposure
of the commitment. If the banking organization does not know the
type of equity underlying the commitment, the banking organization
would be required to use the highest applicable risk-weight to
equity exposures.
---------------------------------------------------------------------------
Third, to capture the risk of equity exposures to investment funds
with leverage, the alternative modified look-through approach under the
proposal would require a banking organization to adjust the average
risk weight for its equity exposure to the investment fund upwards by
the ratio of the total assets of the investment fund to the total
equity of the investment fund.
Fourth, to avoid disincentivizing banking organizations from
obtaining the necessary information to apply the alternative modified
look-through approach, the proposal would cap the risk weight
applicable to an equity exposure to an investment fund under the
alternative modified look-through approach at no more than 1,250
percent.
Fifth, consistent with the standardized approach under the current
capital rule, to reflect the agencies' and banking organizations'
experience with money market fund investments and similar investment
funds during the 2008 financial crisis and the 2020 coronavirus
response, the proposal would floor the minimum risk weight that may be
assigned to the adjusted carrying value of any equity exposure to an
investment fund under the proposed look-through approaches at 20
percent.
Accordingly, under the proposal, a banking organization's risk-
weighted asset amount for an equity exposure to an investment fund
under the alternative modified look-through approach would be equal to
the adjusted carrying value of the equity exposure multiplied by the
lesser of 1,250 percent or the greater of either (1) the product of the
average risk weight of the investment fund multiplied by the leverage
of the investment fund or (2) 20 percent.
iv. 1,250 Percent Risk Weight
When banking organizations have limited information on the
underlying exposures or the leverage of the investment fund, they have
limited ability to appropriately capture and manage the risk and price
volatility of such equity exposures. Accordingly, if a
[[Page 64081]]
banking organization does not have the necessary information to apply
the full look-through approach or the alternative modified look-through
approach, the proposal would require the banking organization to assign
a 1,250 percent risk weight to the adjusted carrying value of its
equity exposure to the investment fund.
v. Risk Weights for Equity Exposures to Investment Funds With
Underlying Securitizations, Derivatives, or Equity Exposures to Other
Investment Funds
Banking organizations may not always be able to obtain the
necessary information to calculate risk-weighted asset amounts under
the full look-though approach or the alternative modified look-through
approach for certain types of underlying exposures held by an
investment fund. For example, even if an investment fund provides
detailed quarterly disclosures on all its underlying assets and
liabilities, such disclosures may not identify the actual counterparty
to each underlying derivative exposure of the investment fund or which
of the underlying derivative exposures of the investment fund are
subject to the same qualified master netting agreement. Furthermore,
the information contained in an investment fund's prospectus,
partnership agreement, or similar contract may not always allow banking
organizations to calculate risk-weighted asset amounts for such
underlying exposures under the alternative modified look-through
approach.
To facilitate application of the look-through approaches, the
proposal would allow banking organizations to use conservative
assumptions to calculate risk-weighted asset amounts under the full
look-through approach for underlying exposures that are securitization
exposures, derivative exposures, or equity exposures to another
investment fund. For purposes of the alternative modified look-through
approach, the proposal would require banking organizations to use these
alternative assumptions for such underlying exposures.
I. Securitization Exposures
For any securitization exposures held by an investment fund, the
proposal would allow a banking organization using the full look-through
approach to apply a 1,250 percent risk weight to the exposure, if it
cannot or chooses not to calculate the applicable risk weight under the
securitization standardized approach (SEC-SA), as described in section
III.D. of this Supplementary Information. The proposal would require a
banking organization applying the alternative modified look-through
approach to apply a 1,250 percent risk weight to any securitization
exposures held by an investment fund.
II. Derivative Exposures
For derivative exposures held by an investment fund, the proposal
would require a banking organization to calculate the risk-weighted
asset amount for each derivative netting set by multiplying the
exposure amount of the netting set by the risk weight applicable to the
derivative counterparty under the proposed credit risk framework. To
the extent a banking organization cannot determine the counterparty,
the proposal would require the banking organization to multiply the
resulting exposure amount by a 100 percent risk weight, as a
conservative approach to reflect the highest risk-weight that would be
likely to apply to a counterparty to such transactions.\170\
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\170\ Relatedly, to the extent a banking organization is unable
to determine the netting sets of the underlying derivative
exposures, the proposal would require each single derivative to be
its own netting set.
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For banking organizations using the full look-through approach, the
proposal would require a banking organization to use the replacement
cost and the potential future exposure as calculated under SA-CCR to
determine the exposure amount for each netting set of underlying
derivative exposures (including single derivative contracts) \171\ held
by the investment fund, where possible.\172\ If a banking organization
using the full look-through approach does not have sufficient
information to calculate the replacement cost or the potential future
exposure for each derivative netting set using SA-CCR or is using the
alternative modified look-through approach, the proposal would require
the banking organization to use the notional amount of each netting set
and 15 percent of the notional amount of each netting set for the
replacement cost and potential future exposure, respectively. The
proposal would require banking organizations using the alternative
modified look-through approach to use the notional amount of each
netting set and 15 percent of the notional amount of each netting set
to determine the replacement cost and potential future exposure,
respectively. A banking organization would multiply the resulting
exposure amount by a factor of 1.4 if the banking organization
determines that the counterparty is not a commercial end-user or cannot
determine whether the counterparty is a commercial end-user.\173\
Additionally, the proposal would require a banking organization to
further multiply the exposure amount by a factor of 1.5 for each
derivative netting set that either qualifies (or for which the banking
organization cannot determine whether the exposure qualifies) as a CVA
risk covered position, as defined in section III.I.3 of this
Supplementary Information. Accordingly, the proposal would require
banking organizations to calculate the exposure amount for derivative
exposures held by an investment fund as described in the following
formula:
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\171\ The proposal would rely on the existing definition of
netting set under the current capital rule, which is defined to
include a single derivative contract between a banking organization
and a single counterparty. See 12 CFR 3.2 (OCC); 12 CFR 217.2
(Board); 12 CFR 324.2 (FDIC).
\172\ Under the proposal, a banking organization may exclude
equity derivative contracts held by the investment fund for purposes
of calculating the RWAderivatives component of the full
and alternative modified look-through approaches, if the banking
organization has elected to exclude equity derivative contracts for
purposes of Sec. __.113(d) of the proposal.
\173\ The proposal would rely on the existing definition of
commercial end-user under the current capital rule. See 12 CFR 3.2
(OCC); 12 CFR 217.2 (Board); 12 CFR 324.2 (FDIC).
Exposure Amount = C * [alpha] (Replacement Cost + Potential Future
---------------------------------------------------------------------------
Exposure)
Where:
C would equal 1.5 if at least one of the derivative
contracts in the netting set is a CVA risk covered position or if the
banking organization cannot determine whether one or more of the
derivative contracts within the netting set is a CVA risk covered
position; C would equal 1 if all of the derivative contracts within the
netting set are not CVA risk covered positions;
[alpha] would equal 1.4 if the banking organization
determines that the counterparty is not a commercial end-user or cannot
determine whether the counterparty is a commercial end-user, or 1
otherwise;
Replacement Cost would equal:
[rtarr8] The replacement cost as calculated under SA-CCR for
purposes of the full look-through approach, where possible; or
[rtarr8] The notional amount of the derivative contract if the
banking organization cannot determine replacement cost under SA-CCR or
is using the alternative modified look-through approach;
Potential Future Exposure would equal:
[rtarr8] The potential future exposure as calculated under SA-CCR
\174\ for
[[Page 64082]]
purposes of the full look-through approach, where possible; or
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\174\ If the banking organization is not able to calculate the
replacement cost of the netting set under SA-CCR but is able to
calculate the PFE aggregated amount, the banking organization must
set the PFE multiplier equal to 1.
---------------------------------------------------------------------------
[rtarr8] 15 percent of the notional amount of the derivative
contract if the banking organization cannot determine the potential
future exposure under SA-CCR or is using the alternative modified look-
through approach.
The proposal is intended to provide a conservative approach for
banking organizations to calculate risk-weighted asset amounts for the
underlying derivative exposures held by an investment fund in a manner
that appropriately captures the risk of such positions. For example,
using 100 percent of the notional amount of the derivative contract as
a proxy for the replacement cost is intended to provide a standardized
and simple input to the exposure amount calculation when the necessary
information about the replacement cost is not available. The notional
amount of the derivative contract is typically larger than the fair
value or replacement cost of the contract and thus providing a
conservative estimate of the maximum exposure that could arise for a
derivative contract. Similarly, setting potential future exposure equal
to 15 percent of the notional amount of the derivative contract is
intended to provide a conservative estimate of the potential losses
that could arise from a counterparty credit risk exposure when the
likelihood of significant changes in the value of the exposure
increases over the longer term.
III. Equity Exposures to Other Investment Funds
For an equity exposure to an investment fund (e.g., Investment Fund
A) that itself has a direct equity exposure to another investment fund
(e.g., Investment Fund B), the proposal would require a banking
organization to determine the proportional amount of risk-weighted
assets of Investment Fund A attributable to the underlying equity
exposure to Investment Fund B using the hierarchy of approaches
described in section III.E.1.c.i. of this Supplementary Information.
That is, the banking organization may be required to apply the same or
another approach to determine the risk-weighted asset amount for
Investment Fund A's equity exposure to Investment Fund B than was used
for the banking organization's equity exposure to Investment Fund A,
based on the nature and quality of the information available to the
banking organization regarding the underlying assets and liabilities of
Investment Fund B.
For all subsequent indirect equity exposure layers (e.g.,
Investment Fund B's equity exposure to Investment Fund C and so forth),
the proposal would generally require the banking organization to assign
a 1,250 percent risk weight, with one exception. If the banking
organization applied the full look-through approach to calculate risk-
weighted assets for the equity exposure to the investment fund at the
previous layer, the banking organization would be required to apply the
full look-through approach to any subsequent layer when there is
sufficient and frequent information provided to the banking
organization regarding the underlying exposures of that particular
investment fund. If there is not sufficient and frequent information to
apply the full look-through approach to the subsequent layer, then the
banking organization would be required to assign a 1,250 percent risk
weight to the subsequent layer.
Question 71: The agencies invite comment on the impact of the
proposed expanded risk-based framework for equity exposures. What are
the pros and cons of the proposal and what, if any, unintended
consequences might the proposed treatment pose with respect to a
banking organization's equity exposures? Provide data to support the
response.
Question 72: The agencies solicit comment on all aspects of the
proposed treatment of equity exposures to investment funds. What, if
any, challenges could implementing the full look-through approach, the
alternative modified look-through approach, or the 1,250 percent risk
weight pose for banking organizations? What, if any, clarifications or
modifications should the agencies consider making to the proposed look-
through approaches and why? To what extent would equity exposures to
investment funds be captured under the proposed look-through approaches
in equity exposure framework as opposed to the market risk framework?
Which type(s) of investment funds would present challenges under the
proposed methods? What other methods should the agencies consider to
more accurately capture such exposures' risk that would still help
promote simplicity and transparency of risk-based capital requirements?
Question 73: What, if any, modifications should the agencies
consider to more appropriately capture the risk of underlying
derivatives exposures held by an investment fund and why? The agencies
seek comment on the appropriateness of the proposed alternative method
for banking organizations to calculate risk-weighted asset amounts for
derivative exposures held by an investment fund if the banking
organization does not have sufficient information to use SA-CCR. What
would be the benefits and drawbacks of excluding derivative contracts
that are used for hedging rather than speculative purposes and that do
not constitute a material portion of the investment entity's exposures?
F. Operational Risk
The proposal would introduce a capital requirement for operational
risk based on a standardized approach (standardized approach for
operational risk). The current capital rule defines operational risk as
the risk of loss resulting from inadequate or failed internal
processes, people, and systems, or from external events. Operational
risk includes legal risk but excludes strategic and reputational
risk.\175\ Experience shows that operational risk is inherent in all
banking products, activities, processes, and systems.
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\175\ See 12 CFR 3.101 (OCC), 217.101 (Board), and 12 CFR
324.101 (FDIC).
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Under the current capital rule, banking organizations subject to
Category I or II capital standards are required to calculate risk-
weighted assets for operational risk using the advanced measurement
approaches (AMA),\176\ which are based on a banking organization's
internal models. The AMA results in significant challenges for banking
organizations, market participants, and the supervisory process. AMA
exposure estimates can present substantial uncertainty and volatility,
which introduces challenges to capital planning processes.\177\ In
addition, the AMA's reliance on internal models has resulted in a lack
of transparency and comparability across banking organizations. As a
result, supervisors and market participants experience challenges in
assessing the relative magnitude of operational risk across banking
organizations, evaluating the adequacy of operational risk capital, and
determining the effectiveness of operational risk management practices.
To address these concerns, the proposal would remove the AMA and
introduce a standardized approach for operational
[[Page 64083]]
risk that seeks to address the operational risks currently covered by
the AMA.
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\176\ The agencies adopted the AMA for operational risk as part
of the advanced approaches capital framework in 2007. See 72 FR
69288 (December 7, 2007).
\177\ See, e.g., Cope, E., G. Mignola, G. Antonini, and R.
Ugoccioni. 2009. Challenges and Pitfalls in Measuring Operational
Risk from Loss Data. Journal of Operational Risk 4(4): 3-27; and
Opdyke, J., and A. Cavallo. 2012. Estimating Operational Risk
Capital: The Challenges of Truncation, the Hazards of Maximum
Likelihood Estimation, and the Promise of Robust Statistics. Journal
of Operational Risk 7(3): 3-90.
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The operational risk capital requirements under the standardized
approach for operational risk would be a function of a banking
organization's business indicator component and internal loss
multiplier. The business indicator component would provide a measure of
the operational risk exposure of the banking organization and would be
calculated based on its business indicator multiplied by scaling
factors that increase with the business indicator. The business
indicator would serve as a proxy for a banking organization's business
volume and would be based on inputs compiled from a banking
organization's financial statements. The internal loss multiplier would
be based on the ratio of a banking organization's historical
operational losses to its business indicator component and would
increase the operational risk capital requirement as historical
operational losses increase. To help ensure the robustness of the
operational risk capital requirement, the proposal would require that
the internal loss multiplier be no less than one.
A banking organization's operational risk capital requirement would
be equal to its business indicator component multiplied by its internal
loss multiplier. Similar to the current capital rule, risk-weighted
assets for operational risk would be equal to 12.5 times the
operational risk capital requirement.
1. Business Indicator
Under the proposal, the business indicator would be based on the
sum of the following three components: an interest, lease, and dividend
component; a services component; and a financial component. Each
component would serve as a measure of a broad category of activities in
which banking organizations typically engage. Given that operational
risk is inherent in all banking products, activities, processes, and
systems, these components aim to capture comprehensively the volume of
a banking organization's financial activities and thus serve as a proxy
for a banking organization's business volume. The interest, lease, and
dividend component aims to capture lending and investment activities
through measures of interest income, interest expense, interest-earning
assets, and dividends. The services component aims to capture fee and
commission-based activities as well as other banking activities, such
as those resulting in other operating income and other operating
expense. Lastly, the financial component aims to capture trading
activity and other activities that are associated with a banking
organization's assets and liabilities.
Banking organizations with higher overall business volume are
larger and more complex, which likely results in exposure to higher
operational risk.\178\ Higher business volumes present more
opportunities for operational risk to manifest. In addition, the
complexities associated with a higher business volume can give rise to
gaps or other deficiencies in internal controls that result in
operational losses. Therefore, higher overall business volume would
correlate with higher operational risk capital requirements under the
proposal.
---------------------------------------------------------------------------
\178\ Recent research connecting operational risk to higher
business volume includes Frame, McLemore, and Mihov (2020), Haste
Makes Waste: Banking Organization Growth and Operational Risk,
Federal Reserve Bank of Dallas, https://www.dallasfed.org/research/papers/2020/wp2023; Curti, Frame, and Mihov (2019), Are the Largest
Banking Organizations Operationally More Risky?, Journal of Money,
Credit and Banking Vol. 54, Issue 5, 1223-1259, https://doi.org/10.1111/jmcb.12933; and Abdymomunov and Curti (2020), Quantifying
and Stress Testing Operational Risk with Peer Banks' Data, Journal
of Financial Services Research Vol. 57, 287-313, https://link.springer.com/article/10.1007/s10693-019-00320-w.
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Under the proposal, all inputs to the business indicator would be
based on three-year rolling averages. For example, when calculating the
three-year average for a business indicator input reported at the end
of the third calendar quarter of 2023, the values of the item for the
fourth quarter of 2020 through the third quarter of 2021, the fourth
quarter of 2021 through the third quarter of 2022, and the fourth
quarter of 2022 through the third quarter of 2023 would be averaged.
The one exception is interest-earning assets, which would be calculated
as the average of the quarterly values of interest-earning assets for
the previous 12 quarters.\179\
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\179\ Unlike the other inputs used to calculate the business
indicator, interest-earning assets are balance-sheet items, rather
than income statement items, and thus their use in the business
indicator does not represent a flow over a one-year period, but
rather a point-in-time value. The use of average interest-earning
assets for the previous 12 quarters instead of, for example, the
average interest-earning assets for the ending quarter of the last
three years aims to increase the robustness of the average used in
the calculation.
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The use of three-year averages would capture a banking
organization's activities over time and help reduce the impact of
temporary fluctuations. Basing the business indicator on a shorter time
period, such as a single year of data, would likely result in a more
volatile capital requirement, which could make it more difficult for
banking organizations to incorporate the operational risk capital
requirement into capital planning processes and could result in unduly
low or high operational risk capital requirements given temporary
changes in a banking organization's activities. Alternatively, basing
the business indicator on too many years of data could reduce its
responsiveness to changes in a banking organization's activities, which
could in turn weaken the relationship between the capital requirements
and the banking organization's risk profile. Based on these
considerations, the use of three-year averages aims to balance the
stability and responsiveness of a banking organization's operational
risk capital requirement.
As described below, the inputs used in each component of the
business indicator would, in most cases, use information contained in
line items from schedules RI and RC of the Call Report and schedules HI
and HC of the FR Y-9C report, as applicable. The agencies are planning
to separately propose modifications to the FFIEC 101 report so that all
inputs to the business indicator (described below) as well as total net
operational losses (described further below) would be publicly reported
as separate inputs to the applicable calculations.
The inputs to each component of the business indicator would not be
meant to overlap. Income and expenses would not be counted in more than
one component of the business indicator, consistent with instructions
to the regulatory reports and the principles of accounting. The inputs
used to calculate the business indicator would include data relative to
entities that have been acquired by, or merged with, the banking
organization over the period prior to the acquisition or merger that is
relevant to the calculation of the business indicator.
a. The Interest, Lease, and Dividend Component
Under the proposal, the interest, lease, and dividend component
would account for activities that produce interest, lease, and dividend
income and would be calculated as follows:
Interest, Lease, and Dividend Component = min (Avg3y (Abs(total
interest income - total interest expense)), 0.0225 * Avg3y (interest
earning assets)) + Avg3y (dividend income)
The proposal includes the following definitions:
Total interest income would mean interest income from all
financial assets and other interest income; \180\
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\180\ Total interest income would correspond to total interest
income in the FR Y-9C (holding companies) and Call Report, excluding
dividend income as defined in the proposal.
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[[Page 64084]]
Total interest expense would mean interest expenses
related to all financial liabilities and other interest expenses; \181\
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\181\ Total interest expense would correspond to total interest
expense in the FR Y-9C (holding companies) and Call Report.
---------------------------------------------------------------------------
Dividend income would mean all dividends received on
securities not consolidated in the banking organization's financial
statements; \182\ and
---------------------------------------------------------------------------
\182\ Dividend income is currently included in total interest
income in the FR Y-9C (holding companies) and Call Report.
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Interest-earning assets would mean the sum of all gross
outstanding loans and leases, securities that pay interest, interest-
bearing balances, Federal funds sold, and securities purchased under
agreements to resell.\183\
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\183\ Interest-earning assets would equal the sum of interest-
bearing balances in U.S. offices, interest-bearing balances in
foreign offices, Edge and agreement subsidiaries, and IBFs, Federal
funds sold in domestic offices, securities purchased under
agreements to resell, loans and leases held for sale, loans and
leases, held for investment, total held-to-maturity securities at
amortized cost (only including securities that pay interest), total
available-for-sale securities at fair value (only including
securities that pay interest), and total trading assets (only
including trading assets that pay interest) in the FR Y-9C (holding
companies) and Call Report.
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The interest, lease, and dividend component aims to capture a
banking organization's interest income and expenses from financial
assets and liabilities, as well as dividend income from investments in
stocks and mutual funds.
The interest income and expenses portion is calculated as the
absolute value of the difference between total interest income and
total interest expense (which constitutes net interest income) and is
subject to a ceiling equal to 2.25 percent of the banking
organization's total interest-earning assets. Net interest income is a
useful indicator of a banking organization's operational risk because a
higher volume of business is associated with higher operational risk.
Because operational risk does not necessarily increase proportionally
to increases in net interest income, the net interest income input
would be capped at 2.25 percent of interest-earning assets.
The proposal would add dividend income to the net interest income
input to capture investment activities that do not produce interest
income (for example, investment in equities and mutual funds).
b. The Services Component
Under the proposal, the services component would account for
activities that result in fees and commissions and other financial
activities not captured by the other components of the business
indicator. The services component would be calculated as follows:
Services component = max (Avg3y (fee and commission income),
Avg3y(fee and commission expense)) + max (Avg3y
(other operating income), Avg3y(other operating expense))
The proposal includes the following definitions:
Fee and commission income would mean income received from
providing advisory and financial services, including insurance income;
\184\
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\184\ Fee and commission income would include the sum of income
from fiduciary activities, service charges on deposit accounts in
domestic offices; fees and commissions from securities brokerage;
investment banking, advisory, and underwriting fees and commissions;
fees and commissions from annuity sales; income and fees from
printing and sale of checks; income and fees from automated teller
machines; safe deposit box rent; bank card and credit card
interchange fees; income and fees from wire transfers; underwriting
income from insurance and reinsurance activities; and income from
other insurance activities in the FR Y-9C (holding companies) and
Call Report. Fee and commission income would also include servicing
fees on a gross basis, which would correspond to net servicing fees
in the FR Y-9C (holding companies) and Call Report, with the
modification that expenses should not be netted, because fee and
commission expenses should not be netted in the calculation of fee
and commission income. In addition, fee and commission income would
include other income received from providing advice and financial
services that is not currently itemized in the regulatory reports.
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Fee and commission expense would mean expenses paid by the
banking organization for advisory and financial services received;
\185\
---------------------------------------------------------------------------
\185\ Fee and commission expense would include consulting and
advisory expenses and automated teller machine and interchange
expenses in the FR Y-9C (holding companies) and Call Report. Fee and
commission expense would also include any other expenses paid for
advice and financial services received that are not currently
itemized in the regulatory reports.
Note that fee and commission expense would include fees paid by
the banking organization as a result of outsourcing financial
services, but not fees paid for outsourced non-financial services
(e.g., logistical, information technology, human resources).
---------------------------------------------------------------------------
Other operating income would mean income not included in
other elements of the business indicator and not excluded from the
business indicator; \186\ and
---------------------------------------------------------------------------
\186\ Other operating income would include rent and other income
from other real estate owned in the FR Y-9C (holding companies) and
Call Report. Other operating income would also include all other
income items not currently itemized in the regulatory reports, which
are not included in other business indicator items and are not
specifically excluded from the business indicator.
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Other operating expense would mean expenses associated
with financial services not included in other elements of the business
indicator and all expenses associated with operational loss events
(expenses associated with operational loss events would not be included
in other business indicator items).\187\ Other operating expense would
not include expenses excluded from the business indicator.
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\187\ Note that expenses with operational loss events in ``other
operating expense'' would not exclude expenses associated with
operational loss events that result in less than $20,000 in net loss
amount.
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The services component would reflect a banking organization's
income and expenses from fees and commissions as well as its other
operating income and expenses.
The fee and commission elements and the other operating elements of
the services component would be calculated as gross amounts, reflecting
the larger of either income or expense. This approach would account for
the different business models of banking organizations better than a
netting approach, which may lead to variances in the services component
that exaggerate differences in operational risk. For example, using
income net of expense as the indicator would result in the services
component for banking organizations that only distribute products
bought from third parties, for which expenses would be netted from
income, being substantially lower than the services component of
banking organizations that originate products to distribute, which
would generally not have many financial expenses to net from income.
Therefore, a netting approach would likely exaggerate the difference in
operational risk between these two business models.
The proposal would include in the services component the income and
expense of a banking organization's insurance activities. The agencies
intend for the operational risk capital requirement to reflect all
operational risks to which a banking organization is exposed,
regardless of the activity or legal entity in which the operational
risk resides.
Question 74: What are the advantages and disadvantages of the
proposed approach to calculating the services component, including any
impacts on specific business models? Which alternatives, if any, should
the agencies consider and why? Similarly, should the agencies consider
any adjustments or limits related to specific business lines, such as
underwriting, wealth management, or custody, or to specific fee types,
such as interchange fees, and if so what adjustment or limits should
they consider? For example, should the agencies consider adjusting or
limiting how the services component contributes
[[Page 64085]]
to the business indicator and, if so, how? What would be the advantages
and disadvantages of any alternative approach and what impact would
such an alternative approach have on operational risk capital
requirements? For example, under the proposal, fee income and expenses
of charge cards are included under the services component. Would it be
more appropriate for fee income and expenses of charge cards to be
included in net interest income of the interest, lease, and dividend
component (and excluded from the services component) and for charge
card exposures to be included in interest earning assets of the
interest, lease, and dividend component and why? Please provide
supporting data with your response.
c. The Financial Component
Under the proposal, the financial component would capture trading
activities and other activities associated with a banking
organization's assets and liabilities. The financial component would be
calculated as follows:
Financial Component = Avg3y (Abs (trading revenue)) +
Avg3y (Abs (net profit or loss on assets and liabilities not
held for trading))
The proposal includes the following definitions:
Trading revenue would mean the net gain or loss from
trading cash instruments and derivative contracts (including commodity
contracts); \188\ and
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\188\ Trading revenue would correspond to trading revenue in the
FR Y-9C (holding companies) and Call Report.
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Net profit or loss on assets and liabilities not held for
trading would mean the sum of realized gains (losses) on held-to-
maturity securities, realized gains (losses) on available-for-sale
securities, net gains (losses) on sales of loans and leases, net gains
(losses) on sales of other real estate owned, net gains (losses) on
sales of other assets, venture capital revenue, net securitization
income, and mark-to-market profit or loss on bank liabilities.\189\
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\189\ Realized gains (losses) on held-to-maturity securities,
realized gains (losses) on available-for-sale securities, net gains
(losses) on sales of loans and leases, net gains (losses) on sales
of other real estate owned, net gains (losses) on sales of other
assets, venture capital revenue, and net securitization income
correspond to their current definitions in the FR Y-9C (holding
companies) and Call Report.
---------------------------------------------------------------------------
The financial component aims to capture trading activities and
other activities that are associated with a banking organization's
assets and liabilities. Trading revenue, which reflects net income or
loss from trading activities, would be a proxy for the business volume
associated with trading and related activities. Net profit or loss on
assets and liabilities not held for trading would reflect the profit or
loss of activities associated with assets and liabilities that are not
included by other components of the business indicator and therefore
ensures that the business indicator comprehensively captures these
activities. The use of net values for these inputs would align with
current regulatory reporting, thereby reducing data gathering and
calculation burden. Both of these inputs would be measured in terms of
their absolute value to better capture business volume (for example,
negative trading revenue would not imply that a banking organization's
trading activities are small in volume), which is associated with
higher operational risk.
d. Exclusions From the Business Indicator
Under the proposal, the business indicator would reflect the volume
of financial activities of a banking organization; therefore, the
business indicator would exclude expenses that do not relate to
financial services received by the banking organization. Excluded
expenses would include staff expenses, expenses to outsource non-
financial services (such as logistical, human resources, and
information technology), administrative expenses (such as utilities,
telecommunications, travel, office supplies, and postage), expenses
relating to premises and fixed assets, and depreciation of tangible and
intangible assets. Still, the proposal would include expenses related
to operational loss events in the services component even when they
relate to these otherwise-excluded categories of expenses because the
objective of the operational risk capital requirement is to support a
banking organization's resilience to operational risk, and observed
operational loss expenses are a meaningful indicator of a banking
organization's exposure to operational risk.
The proposal also would not include loss provisions and reversal of
provisions (except for those related to operational loss events) or
changes in goodwill in the business indicator, as these items do not
reflect business volume of the banking organization. In addition, the
business indicator would not include applicable income taxes as an
expense, as they reflect obligations to the government for which the
operational risk capital framework should be neutral.
With prior supervisory approval, the proposal would allow banking
organizations to exclude activities that they have ceased to conduct,
whether directly or indirectly, from the calculation of the business
indicator, provided that the banking organization demonstrates that
such activities do not carry legacy legal exposure. Supervisory
approval would not be granted when, for example, legacy business
activities are subject to potential or pending legal or regulatory
enforcement action. The supervisory approval requirement would help
ensure that a banking organization's operational risk capital
requirement aligns with its existing operational risk exposure.
2. Business Indicator Component
Under the proposal, the business indicator component would be a
function of the business indicator, with three linear segments. The
business indicator component would increase at a rate of: (a) 12
percent per unit of business indicator for levels of business indicator
up to $1 billion; (b) 15 percent per unit of business indicator for
levels of business indicator above $1 billion and up to $30 billion;
and (c) 18 percent per unit of business indicator for levels of
business indicator above $30 billion. Table 8 below presents the
formulas that can be used to calculate the business indicator component
given a banking organization's business indicator.
[[Page 64086]]
[GRAPHIC] [TIFF OMITTED] TP18SE23.027
The higher rate of increase of the business indicator component as
a banking organization's business indicator rises above $1 billion and
$30 billion would reflect exposure to operational risk generally
increasing more than proportionally with a banking organization's
overall business volume, in part due to the increased complexity of
large banking organizations. This approach is supported by analysis
undertaken by the Basel Committee.\191\ Similarly, academic studies
have found that larger U.S. bank holding companies have higher
operational losses per dollar of total assets.\192\
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\190\ $120 million is equal to 0.12 * $1 billion. $4.47 billion
is equal to 0.12 * $1 billion + 0.15 * ($30 billion-$1 billion).
\191\ See Basel Committee (2014), ``Operational risk--Revisions
to the simpler approaches,'' https://www.bis.org/publ/bcbs291.htm
and Basel Committee (2016), ``Standardized Measurement Approach for
operational risk,'' https://www.bis.org/bcbs/publ/d355.htm.
\192\ See Curti, Mih, and Mihov (2022), ``Are the Largest
Banking Organizations Operationally More Risky?, Journal of Money,
Credit and Banking,'' DOI: 10.111/jmcb.12933; and Frame, McLemore,
and Mihov (2020), ``Haste Makes Waste: Banking Organization Growth
and Operational Risk,'' Federal Reserve Bank of Dallas, https://www.dallasfed.org/research/papers/2020/wp2023.
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3. Internal Loss Multiplier
Higher historical operational losses are associated with higher
future operational risk exposure.\193\ Supervisory experience also
suggests that operational risk management deficiencies can be
persistent, which can often result in operational losses. Accordingly,
under the proposal, the operational risk capital requirement would be
higher for banking organizations that experienced larger operational
losses in the past. To this effect, the proposal would include a
scalar, the internal loss multiplier, that increases operational risk
capital requirements based on a banking organization's historical
operational loss experience. This multiplier would depend on the ratio
of a banking organization's average annual total net operational losses
to its business indicator component.
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\193\ See Curti and Migueis (2023), ``The Information Value of
Past Losses in Operational Risk, Finance and Economics Discussion
Series,'' Board of Governors of the Federal Reserve System, https://doi.org/10.17016/FEDS.2023.003.
---------------------------------------------------------------------------
The proposal would require the internal loss multiplier to be no
less than one. This floor would ensure that the operational risk
capital requirement provides a robust minimum amount of coverage to the
potential future operational risks a banking organization may be
exposed to, as reflected by its overall business volume through the
business indicator component, even in situations where historical
operational losses have been low in relative terms.
The internal loss multiplier would be calculated as follows:
[GRAPHIC] [TIFF OMITTED] TP18SE23.028
Where:
Average annual total net operational losses would
correspond to the average of annual total net operational losses
over the previous ten years (on a rolling quarter basis).\194\ In
this calculation, the total net operational losses of a quarter
would equal the sum of any portions of losses or recoveries of any
material operational losses allocated to the quarter. Material
operational loss would mean an operational loss incurred by the
banking organization that resulted in a net loss greater than or
equal to $20,000 after taking into account all subsequent recoveries
related to the operational loss.
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\194\ For example, when calculating average annual total net
operational losses for the second calendar quarter of 2023, total
net operational losses from the third calendar quarter of 2013
through the second calendar quarter of 2023 would be included.
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exp(1) is the Euler's number, which is approximately equal
to 2.7183.
ln is the natural logarithm.
Average annual total net operational losses would be multiplied by
15 in the internal loss multiplier formula. This multiplication
extrapolates from average annual total net operational losses the
potential for unusually large losses and, therefore, aims to ensure
that a banking organization maintains sufficient capital given its
operational loss history and risk profile. The constant used is
consistent with the Basel III reforms.
[[Page 64087]]
The natural log function (ln) combined with an exponent of 0.8
would limit the effect that large operational losses have on a banking
organization's operational risk capital requirement. This feature of
the internal loss multiplier formula is intended to constrain the
volatility of the operational risk capital requirement. As a result,
increases in average annual total net operational losses would increase
the operational risk capital requirement at a decreasing rate.\195\
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\195\ The internal loss multiplier variation depends on the
ratio of the product of 15 and the average annual total operational
losses to the business indicator component. The 0.8 exponent applied
to this ratio reduces the effect of the variation of this ratio on
the internal loss multiplier. For example, a ratio of 2 becomes
approximately 1.74 after application of the exponent, and a ratio of
0.5 becomes approximately 0.57 after application of the exponent.
Similarly, the application of a logarithmic function further reduces
the variability of the internal loss multiplier for values above 1.
Taken together, these two transformations mitigate the reaction of
the operational risk capital requirement to large historical
operational losses.
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The calculation of average annual total net operational losses
would be based on an average of ten years of data. The use of a ten-
year average for annual total net operational losses would balance
recognition that a banking organization's operational risk exposure
changes over time with limiting the volatility that would result from
using a shorter time horizon and the importance of the calculation
window providing sufficient information regarding the banking
organization's operational risk profile.
The proposal would define an ``operational loss'' as all losses
(excluding insurance or tax effects) resulting from an operational loss
event, including any reduction in previously reported capital levels
attributable to restatements or corrections of financial statements. An
operational loss includes all expenses associated with an operational
loss event except for opportunity costs, forgone revenue, and costs
related to risk management and control enhancements implemented to
prevent future operational losses. Operational loss would not include
losses that are also credit losses and are related to exposures within
the scope of the credit risk risk-weighted assets framework (except for
retail credit card losses arising from non-contractual, third-party-
initiated fraud, which are operational losses).
``Operational loss event'' would be defined as an event that
results in loss due to inadequate or failed internal processes, people,
or systems or from external events. This definition includes legal loss
events and restatements or corrections of financial statements that
result in a reduction of capital relative to amounts previously
reported. The proposal would retain the current classification of
operational loss events according to seven event types:
1--Internal fraud, which means the operational loss event type that
comprises operational losses resulting from an act involving at least
one internal party of a type intended to defraud, misappropriate
property, or circumvent regulations, the law, or company policy
excluding diversity and discrimination noncompliance events.
2--External fraud, which means the operational loss event type that
comprises operational losses resulting from an act by a third party of
a type intended to defraud, misappropriate property, or circumvent the
law. Retail credit card losses arising from non-contractual, third-
party-initiated fraud (for example, identity theft) are external fraud
operational losses.
3--Employment practices and workplace safety, which means the
operational loss event type that comprises operational losses resulting
from an act inconsistent with employment, health, or safety laws or
agreements, payment of personal injury claims, or payment arising from
diversity and discrimination noncompliance events.
4--Clients, products, and business practices, which means the
operational loss event type that comprises operational losses resulting
from the nature or design of a product or from an unintentional or
negligent failure to meet a professional obligation to specific clients
(including fiduciary and suitability requirements).
5--Damage to physical assets, which means the operational loss
event type that comprises operational losses resulting from the loss of
or damage to physical assets from natural disasters or other events.
6--Business disruption and system failures, which means the
operational loss event type that comprises operational losses resulting
from disruption of business or system failures, including hardware,
software, telecommunications, or utility outage or disruptions.
7--Execution, delivery, and process management, which means the
operational loss event type that comprises operational losses resulting
from failed transaction processing or process management or losses
arising from relations with trade counterparties and vendors.
By ensuring consistency, the classification of operational loss
events according to these event types would continue to assist banking
organizations and the agencies in understanding the causal factors
driving operational losses.
The proposal would include a $20,000 net loss threshold (that is,
$20,000 after taking into account all subsequent recoveries related to
the operational loss) for inclusion of an operational loss in the
calculation of average annual total net operational losses. This
threshold aims to balance comprehensiveness against the materiality of
the operational losses.
The proposal would require a banking organization to group losses
with a common underlying trigger into the same operational loss event.
For example, losses that occur in multiple locations or over a period
of time resulting from the same natural disaster would be grouped into
a single operational loss event. This grouping requirement aims to
ensure comprehensive inclusion of operational loss events that result
in $20,000 or more of net loss in the calculation of the internal loss
multiplier and to facilitate understanding of operational risk exposure
by banking organizations and supervisors.
There are two main differences in how the proposal would treat
operational losses relative to typical practice under the AMA. First,
total net operational losses would include operational losses in the
quarter in which their accounting impacts were recorded, rather than
aggregated into a single event date.\196\ Second, operational losses
would enter the internal loss multiplier calculation net of related
recoveries, including insurance recoveries.\197\ Recoveries would be
included in the quarter in which they are paid to the banking
organization. Insurance receivables would not be accounted for in the
calculation as recoveries. Reductions in the legal reserves associated
with an ongoing legal event would be treated as recoveries for the
calculation of total net operational losses. Also, a recovery would
only offset a loss arising from a related operational loss event. This
proposed treatment would ensure that only applicable recoveries are
recognized.
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\196\ For example, if an operation loss event results in a loss
impact of $500,000 in the first quarter of 2020 and a loss impact of
$400,000 in the second quarter of 2021, the banking organization
would add $500,000 to the total gross operational losses of first
quarter of 2020 and add $400,000 to the total gross operational
losses of the second quarter of 2021.
\197\ A recovery is an inflow of funds or economic benefits
received from a third party in relation to an operational loss
event.
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Under the proposal, a negative financial impact that a banking
organization books in its financial
[[Page 64088]]
statement due to having incorrectly booked a positive financial impact
in a previous financial statement would constitute an operational loss
(these losses are generally known as ``timing losses''). Examples of an
incorrectly booked positive financial impact would include revenue
overstatement, overbilling, accounting errors, and mark-to-market
errors. Corrections that would constitute operational losses include
refunds and restatements that result in a reduction in equity capital.
If the initial overstatement and its correction occur in the same
financial statement period, there would be no operational loss under
the proposal.
The proposal's definition of operational loss includes a
clarification regarding the boundary between operational risk and
credit risk, which aims to ensure that all losses experienced by a
banking organization in its financial statements are within the scope
of the credit risk, market risk, or operational risk frameworks. Losses
resulting from events that meet the definition of an operational loss
event which are also credit losses and are related to exposures within
the scope of the credit risk risk-weighted assets framework would
continue to be excluded from total operational losses for purposes of
the operational risk capital requirement. In keeping with the current
framework and prevailing industry practice, retail credit card losses
arising from non-contractual, third-party-initiated fraud would
continue to be operational losses under the proposal. In addition,
operational losses related to products that are outside of the scope of
the credit risk-weighted asset framework (for example, losses due to
representations and warranties unrelated to credit risk that require
the banking organization to repurchase an asset) would be operational
losses even if they are associated with obligor default events.
Operational losses that result from boundary events with market risk
(for example, losses that are the result of failed or inadequate model
validation processes) would also continue to be treated as operational
losses in the proposal.
The proposal includes revisions to the FR Y-14Q report, which is
applicable to large banking organizations subject to the Board's
capital plan rule, to conform with the revisions to the definitions of
operational loss and operational loss event introduced by the proposal.
Under the proposal, a banking organization would include in its
calculation of total net operational losses any operational loss events
incurred by an entity that has been acquired by or merged with the
banking organization. In cases where historical loss data meeting the
collection requirements is not available for a merged or acquired
entity for certain years in the calculation window of the internal loss
multiplier, the proposal would provide a formula for calculating annual
total net operational losses for this merged or acquired entity for
these missing years. Annual total net operational losses of the merged
or acquired entity for the missing years would be such that the ratio
of average annual total net operational losses to the business
indicator contribution of this merged or acquired entity \198\ is the
same as the ratio of the average annual total net operational losses to
business indicator of the remainder of the banking organization:
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\198\ The business indicator contribution of a merged or
acquired entity would be the business indicator of the banking
organization inclusive of the merged or acquired entity minus the
business indicator of the banking organization when the merged or
acquired entity is excluded.
Annual total net operational losses for a merged or acquired business
that lacks loss data = Business indicator contribution of merged or
acquired business that lacks loss data * Average annual total net
operational losses of the banking organization excluding amounts
attributable to the merged or acquired business/Business indicator of
the banking organization excluding amounts attributable to the merged
---------------------------------------------------------------------------
or acquired business.
This approach would recognize that historical data for operational
losses may be difficult to obtain in certain circumstances,
particularly if an acquired or merged entity had not previously been
required to track operational losses.\199\
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\199\ In contrast, the business indicator includes only three
years of financial statement data, which should be readily
available.
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Banking organizations that only have five to nine years of loss
data meeting the operational loss event data collection requirements in
Sec. __.150(f)(2) of the proposal (for example, when transitioning
into the standardized approach for operational risk) would be expected
to use as many years of loss data meeting the internal loss event data
collection requirements as are available in the calculation of average
annual total net operational losses. In cases where a banking
organization's loss collection practices are deficient, its primary
Federal supervisor may require higher capital requirements under the
capital rule's reservation of authority.
Under the proposal, the internal loss multiplier would equal one in
cases where the number of years of loss data meeting the internal loss
event data collection requirements is less than five years. In cases
where the banking organization's primary Federal supervisor determines
that an internal loss multiplier of one results in insufficient
operational risk capital, the primary Federal supervisor may require
higher capital requirements under the capital rule's reservation of
authority.
Under the proposal, a banking organization would be able to request
supervisory approval to exclude operational loss events that are no
longer relevant to their risk profile from the internal loss multiplier
calculation. The agencies expect the exclusion of operational loss
events would generally be rare, and a banking organization would be
required to provide adequate justification for why operational loss
events are no longer relevant to its risk profile when requesting
supervisory approval for exclusion. In evaluating the relevance of
operational loss events to the banking organization's risk profile, the
primary Federal supervisor would consider various factors, including
whether the cause or causes of the loss events could occur in other
areas of the banking organization's operations. The banking
organization would need to demonstrate, for example, that there is no
similar or residual legal exposure and that the excluded operational
loss events have no relevance to other continuing activities or
products.
In the case of divestitures, a banking organization would be able
to request supervisory approval to remove historical operational loss
events associated with an activity that the banking organization has
ceased to directly or indirectly conduct--either through full sale of
the business or closing of the business--from the calculation of the
internal loss multiplier. Given that divestiture has occurred,
exclusion of operational losses relating to legal events would
generally depend on whether the divested activities carry legacy legal
exposure, as would be the case, for example, where such activities are
the subject of a potential or pending legal or regulatory enforcement
action.
Except in the case of divestitures, the agencies would only
consider providing supervisory approval for exclusions after
operational losses have been included in a banking organization's total
net operational losses for at least three years. This retention period
would aim to ensure prudence in the calculation of operational risk
capital requirements, as operational risk
[[Page 64089]]
exposure is unlikely to be fully eliminated over a short time frame.
Finally, to ensure that requests for operational loss exclusions
are of a substantive nature, the agencies would only consider a request
for exclusion when the total net operational losses to be excluded are
equal to five percent or more of the banking organization's average
annual total net operational losses.
Question 75: What are the advantages and disadvantages of flooring
the internal loss multiplier at one? Which alternatives, if any, should
the agencies consider and why?
Question 76: What are the advantages and disadvantages of including
the internal loss multiplier as opposed to setting it equal to one?
Question 77: What are the advantages and disadvantages of the
treatment proposed for losses of merged or acquired businesses? Which
alternatives, if any, should the agencies consider and why? What impact
would any alternatives have on the conservatism of the proposal?
Question 78: What are the advantages and disadvantages of an
alternative threshold for the operational losses for which banking
organizations may request supervisory approval to exclude?
4. Operational Risk Management and Data Collection Requirements
Under the proposal, banking organizations would continue to be
required to collect operational loss event data. As discussed above, a
banking organization would be required to include operational losses,
net of recoveries, of $20,000 or more in the calculation of the
internal loss multiplier. To assist the identification of operational
loss events that result in an operational loss, net of recoveries, of
$20,000 or more, the proposal would require banking organizations to
collect operational loss event data for all operational loss events
that result in $20,000 or more of gross operational loss.
Operational loss event data would include the gross loss amount,
recovery amounts, the date when the event occurred or began (date of
occurrence), the date when the banking organization became aware of the
event (date of discovery), and the date when the loss event resulted in
a loss, provision, or recovery being recognized in the banking
organization's profit and loss accounts (date of accounting). These
loss data collection requirements are similar to the loss reporting
requirements currently in place for banking organizations subject to
the FR Y-14 reporting and are similar to the data that banking
organizations subject to the AMA have typically collected.
To ensure the validity of its operational loss event data, a
banking organization would be required to document the procedures used
for the identification and collection of operational loss event data.
Additionally, the banking organization would be required to have
processes to independently review the comprehensiveness and accuracy of
operational loss data, and the banking organization would be required
to subject the aforementioned procedures and processes to regular
independent reviews by internal or external audit functions.
The proposal would introduce a requirement that banking
organizations collect descriptive information about the drivers or
causes of operational loss events that result in a gross operational
loss of $20,000 or more. This requirement would facilitate the efforts
of banking organizations and the agencies to understand the sources of
operational risk and the drivers of operational loss events. The
agencies would expect that the level of detail of any descriptive
information be commensurate with the size of the gross loss amount of
the operational loss event.
The proposal would not include certain data requirements included
in the AMA. Specifically, banking organizations would not be required
to estimate their operational risk exposure or to collect external
operational loss event data, scenario analysis, and business,
environment, and internal control factors.
The agencies consider effective operational risk management to be
critical to ensuring the financial and operational resilience of
banking organizations, particularly for large banking
organizations.\200\ Thus, consistent with the current advanced
approaches qualification requirements applicable to banking
organizations subject to Category I or II capital standards, the
proposal would include the requirement that large banking organizations
have an operational risk management function that is independent of
business line management. This independent operational risk management
function would be expected to design, implement, and oversee the
comprehensiveness and accuracy of operational loss event data and
operational loss event data collection processes, and oversee other
aspects of the banking organization's operational risk management.
Large banking organizations would also be required to have and document
processes to identify, measure, monitor, and control operational risk
in their products, activities, processes, and systems. In addition,
large banking organizations would be required to report operational
loss events and other relevant operational risk information to business
unit management, senior management, and the board of directors (or a
designated committee of the board).
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\200\ The interagency paper titled ``Sound Practices to
Strengthen Operational Resilience'' (November 2, 2020) notes that
operational resilience ``is the outcome of effective operational
risk management combined with sufficient financial and operational
resources to prepare, adapt, withstand, and recover from
disruptions.''
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Question 79: The proposal would require a banking organization to
collect information on the drivers of operational loss events, with the
level of detail of any descriptive information commensurate with the
size of the gross loss amount. What are the advantages and
disadvantages of this requirement? Which alternatives should the
agencies consider--for example, introducing a higher dollar threshold
for such a requirement--and why?
G. Disclosure Requirements
1. Proposed Disclosure Requirements
Meaningful public disclosures of a banking organization's
activities and the features of its risk profile, including risk
appetite, work in tandem with the regulatory and supervisory frameworks
applicable to banking organizations by helping to support robust market
discipline. In this way, meaningful public disclosures help to support
the safety and soundness of banking organizations and the financial
system more broadly.
The proposal would revise certain existing qualitative disclosure
requirements and introduce new and enhanced qualitative disclosure
requirements related to the proposed revisions described in this
Supplementary Information. The proposal would also remove from the
disclosure tables most of the existing quantitative disclosures, which
would instead be included in regulatory reporting forms. Therefore, the
agencies anticipate separately proposing revisions to the Consolidated
Reports of Condition and Income, the Regulatory Capital Reporting for
Institutions Subject to the Advanced Capital Adequacy Framework (FFIEC
101), and the Market Risk Regulatory Report for Institutions Subject to
the Market Risk Capital Rule (FFIEC 102). The Board similarly
anticipates proposing
[[Page 64090]]
corresponding revisions to the Consolidated Financial Statements for
Holding Companies (FR Y-9C), the Capital Assessments and Stress Testing
(FR Y-14A and FR Y-14Q), and the Systemic Risk Report (FR Y-15) to
reflect the changes to the capital rule that would be required under
this proposal. The proposal would also remove disclosures related to
internal ratings-based systems and internal models, consistent with the
broader objectives of this proposal.
Under the current capital rule, banking organizations subject to
Category I or II capital standards are subject to enhanced public
disclosure and reporting requirements in comparison to the disclosure
and reporting requirements applicable to banking organizations subject
to Category III or IV capital standards. Under the proposal, the
enhanced public disclosure requirements would apply to all large
banking organizations. Applying enhanced disclosure and reporting
requirements to banking organizations subject to Category III or IV
capital standards would bring consistency across large banking
organizations and promote transparency for market participants.
Consistent with the current capital rule, the top-tier entity
(including a depository institution, if applicable), would be subject
to both the qualitative and quantitative enhanced disclosure and
reporting requirements.\201\
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\201\ In the case of a depository institution that is not a
consolidated subsidiary of a depository institution holding company
that is assigned a category under the capital rule, the depository
institution would be considered the top-tier entity for purposes of
the qualitative and quantitative enhanced disclosure and reporting
requirements.
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The current capital rule does not subject a banking organization
that is a consolidated subsidiary of a bank holding company, a covered
savings and loan holding company that is a banking organization as
defined in 12 CFR 238.2, or depository institution that is subject to
public disclosure requirements, or a subsidiary of a non-U.S. banking
organization that is subject to comparable public disclosure
requirements in its home jurisdiction to the qualitative disclosure
requirements described in the current capital rule. The proposal would
not change the current capital rule's requirements regarding public
disclosure policy and attestation, the frequency of required
disclosures, the location of disclosures, or the treatment of
proprietary information.
2. Specific Public Disclosure Requirements
The proposed changes to disclosure requirements pertaining to the
risk-based capital framework are described below.\202\ Disclosure
tables 1,\203\ 2,\204\ 3,\205\ 4,\206\ 11 \207\ (table 9 to Sec.
__.162 in the proposal), and 12 \208\ (table 10 to Sec. __.162 in the
proposal) in Sec. __.173 of the current capital rule have been
retained without material modification, although the table numbers
would change.
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\202\ The table numbers refer to the table numbers included in
the proposed rule.
\203\ See Table 1 to Sec. 3.173 (OCC); Sec. 217.173 (Board);
Sec. 324.173 (FDIC)--Scope of Application.
\204\ See Table 2 to Sec. 3.173 (OCC); Sec. 217.173 (Board);
Sec. 324.173 (FDIC)--Capital Structure.
\205\ See Table 3 to Sec. 3.173 (OCC); Sec. 217.173 (Board);
Sec. 324.173 (FDIC)--Capital Adequacy.
\206\ See Table 4 to Sec. 3.173 (OCC); Sec. 217.173 (Board);
Sec. 324.173 (FDIC)--Capital Conservation and Countercyclical
Capital Buffers.
\207\ See Table 11 to Sec. 3.173 (OCC); Sec. 217.173 (Board);
Sec. 324.173 (FDIC)--Equities Not Subject to Subpart F of This
Part.
\208\ See Table 12 to 3.173 (OCC); Sec. 217.173 (Board); Sec.
324.173 (FDIC)--Interest Rate Risk for Non-Trading Activities.
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The proposal would retain the requirement that a banking
organization disclose its risk management objectives as they relate to
specific risk areas (e.g., credit risk). The proposal would revise the
risk areas to which these disclosure requirements apply to help ensure
consistency with the broader proposal. In addition, the proposal would
require a banking organization to describe its risk management
objectives as they relate to the organization overall. The required
disclosures would include information regarding how the banking
organization's business model determines and interacts with the overall
risk profile; how this risk profile interacts with the risk tolerance
approved by its board; the banking organization's risk governance
structure; channels to communicate, define, and enforce the risk
culture within the banking organization; scope and features of risk
measurement systems; risk information reporting; qualitative
information on stress testing; and the strategies and processes to
manage, hedge, and mitigate risks. These disclosures are intended to
allow market participants to evaluate the adequacy of a banking
organization's approach to risk management.
Table 5 to Sec. __.162, ``Credit Risk: General Disclosures,''
would include the disclosures a banking organization is required to
make under the current capital rule regarding its approach to general
credit risk.\209\ In addition, the proposal would require a banking
organization to disclose certain additional information regarding its
risk management policies and objectives for credit risk. Specifically,
the proposal would require a banking organization to enhance its
existing disclosures by describing how its business model translates
into the components of the banking organization's credit risk profile
and how it defines credit risk management policy and sets credit
limits. Additionally, a banking organization would be required to
disclose the organizational structure of its credit risk management and
control function as well as interactions with other functions. A
banking organization would also be required to disclose information on
its policies related to reporting of credit risk exposure and the
credit risk management function that are provided to the banking
organization's leadership.
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\209\ See Table 5 to Sec. 3.173 (OCC); Sec. 217.173 (Board);
Sec. 324.173 (FDIC)--Credit Risk--General Disclosures.
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Table 6 to Sec. __.162, ``General Disclosure for Counterparty
Credit Risk-Related Exposures,'' would include the disclosures a
banking organization is required to make under the current capital rule
regarding its approach to managing counterparty credit risk.\210\ The
proposal would also include new disclosure requirements regarding a
banking organization's methodology for assigning economic capital for
counterparty credit risk exposures as well as its policies regarding
wrong-way risk exposures. Additionally, the proposal would further
require a banking organization to disclose its risk management
objectives and policies related to counterparty credit risk, including
the method used to assign the operating limits defined in terms of
internal capital for counterparty credit risk exposures and for CCP
exposures, policies relating to guarantees and other risk mitigants and
assessments concerning counterparty credit risk (including exposures to
CCPs), and the increase in the amount of collateral that the banking
organization would be required to provide in the event of a credit
rating downgrade.
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\210\ See Table 7 to Sec. 3.173 (OCC); Sec. 217.173 (Board);
Sec. 324.173 (FDIC)--General Disclosure for Counterparty Credit
Risk of OTC Derivative Contracts, Repo-Style Transactions, and
Eligible Margin Loans.
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Table 7 to Sec. __.162, ``Credit Risk Mitigation,'' would include
the disclosures a banking organization is required to make under the
current rule regarding its approach to credit risk mitigation.\211\ In
addition, the proposal would specify that a banking organization must
provide a meaningful
[[Page 64091]]
breakdown of its credit derivative providers, including a breakdown by
rating class or by type of counterparty (e.g., banking organizations,
other financial institutions, and non-financial institutions). These
disclosures would apply to eligible credit risk mitigants under the
proposal,\212\ although a banking organization would be encouraged to
also disclose information about other mitigants. The credit risk
mitigation disclosures in Table 7 to Sec. __.162 of the proposal would
not apply to synthetic securitization exposures, which would be
included in Table 8 to Sec. __.162 as part of the banking
organization's disclosures related to securitization exposures.
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\211\ See Table 8 to Sec. 3.173 (OCC); Sec. 217.173 (Board);
Sec. 324.173 (FDIC)--Credit Risk Mitigation.
\212\ See section III.C.5 of this Supplementary Information for
a more detailed discussion on the types of credit risk mitigants
that a banking organization would be allowed to recognize for
purposes of calculating risk-based capital requirements.
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Table 8 to Sec. __.162, ``Securitization,'' would include the
disclosures a banking organization is required to make under the
current capital rule regarding its approach to securitization.\213\ In
addition to the existing qualitative disclosures related to
securitization, the proposal would require disclosure of whether the
banking organization provides implicit support to a securitization and
the risk-based capital impact of such support.
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\213\ See Table 9 to Sec. 3.173 (OCC); Sec. 217.173 (Board);
Sec. 324.173 (FDIC)--Securitization.
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Table 11 to Sec. __.162, ``Additional Disclosure Related to the
Credit Quality of Assets,'' is a new disclosure table that would
require banking organizations to provide further information on the
scope of ``past due'' exposures used for accounting purposes, including
the differences, if any, between the banking organization's scope of
exposures treated as past due for accounting purposes and those treated
as past due for regulatory capital purposes. Table 11 to Sec. __.162
would also describe the scope of exposures that qualify as ``defaulted
exposures'' or ``defaulted real estate exposures'' that are not
exposures for which credit losses are measured under ASC \214\ Topic
326 and for which the banking organization has recorded a partial
write-off or write-down. Additionally, a banking organization would be
required to disclose the scope of exposures that qualify as a ``loan
modification to borrowers experiencing financial difficulty'' for
accounting purposes under ASC Topic 310 \215\ and the difference, if
any, between the scope of exposures treated as ``defaulted exposures''
or ``defaulted real estate exposures.''
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\214\ The Accounting Standards Codification is promulgated by
the Financial Accounting Standards Board for GAAP.
\215\ See ASC 310-10-50-36.
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Table 12 to Sec. __.162, ``General Qualitative Disclosure
Requirements Related to CVA'' is a new disclosure table that would
require a banking organization to disclose certain information
pertaining to CVA risk, including its risk management objectives and
policies for CVA risk and information related to a banking
organization's CVA risk management framework, including processes
implemented to identify, measure, monitor, and control CVA risks and
effectiveness of CVA hedges. Table 13 to Sec. __.162, ``Qualitative
Disclosures for Banks Using the SA-CVA'' is a new disclosure table that
would require a banking organization that has approval to use the
standardized CVA approach (SA-CVA) to make disclosures related to the
banking organization's risk management framework, including a
description of the banking organization's risk management framework, a
description of how senior management is involved in the CVA risk
management framework, and an overview of the governance of the CVA risk
management framework such as documentation, independent risk control
unit, independent review, and independence of data acquisition from
lines of business.
Table 14 to Sec. __.162, ``General Qualitative Information on a
Banking Organization's Operational Risk Framework,'' is a new
disclosure table that would require a banking organization to disclose
information regarding its operational risk management processes,
including its policies, frameworks, and guidelines for operational risk
management; the structure and organization of its operational risk
management and control function; its operational risk measurement
system (the systems and data used to measure operational risk in order
to estimate the operational risk capital requirement); the scope and
context of its reporting framework on operational risk to executive
management and to the board of directors; and the risk mitigation and
risk transfer used in the management of operational risk.
Table 15 to Sec. __.162, ``Main Features of Regulatory Capital
Instruments and of other TLAC-Eligible Instruments,'' is a new
disclosure table that would require a banking organization to disclose
information regarding the terms and features of its regulatory capital
instruments and other instruments eligible for TLAC.\216\ In addition,
the proposal would require a banking organization to describe the main
features of its regulatory capital instruments and provide disclosures
of the full terms and conditions of all instruments included in
regulatory capital. A banking organization that is also a GSIB would
also be required to describe the main features of its covered debt
positions and provide disclosures of the full terms and conditions of
all covered debt positions.
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\216\ For purposes of Table 15, unique identifiers associated
with regulatory capital instruments and other instruments eligible
for TLAC may include Committee on Uniform Security Identification
Procedures number, Bloomberg identifier for private placement,
International Securities Identification Number, or others.
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H. Market Risk
1. Background
a. Description of Market Risk
Market risk for a banking organization results from exposure to
price movements caused by changes in market conditions, market events,
and issuer events that affect asset prices. Losses resulting from
market risk can affect a banking organization's capital strength,
liquidity, and profitability. To help ensure that a banking
organization maintains a sufficient amount of capital to withstand
adverse market risks and consistent with amendments to the Basel
Capital Accord, the agencies adopted risk-based capital standards for
market risk in 1996 (1996 rule).\217\ Although adoption of the 1996
rule was a constructive step in capturing market risk, the 1996 rule
did not sufficiently capture the risks associated with financial
instruments that became prevalent in the years following its adoption.
This became evident during the 2007-2009 financial crisis, when the
1996 rule did not fully capture banking organizations' increased
exposures to traded credit and other structured products, such as
collateralized debt obligations (CDO), credit default swaps (CDS),
mortgage-related securitizations, and exposures to other less liquid
products.
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\217\ 61 FR 47358 (September 6, 1996). The agencies' market risk
capital rules were located at 12 CFR part 3, appendix B (OCC), 12
CFR part 208, appendix E and 12 CFR part 225, appendix E (Board),
and 12 CFR part 325, appendix C (FDIC).
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In August 2012, the agencies issued a final rule that modified the
1996 rule to address these deficiencies.\218\ Specifically, the rule
added a stressed value-at-risk (VaR) measure, a capital requirement for
default and migration risk (the incremental risk capital
[[Page 64092]]
requirement), a comprehensive risk measurement for correlation trading
portfolio, a modified definition of covered position, a definition of
trading position, an expanded set of requirements for internal models
to reflect advances in risk management, and revised requirements for
regulatory backtesting. These changes enhanced the calibration of
market risk capital requirements by incorporating stressed conditions
into VaR and by increasing the comprehensiveness and quality of the
standards for internal models used to calculate market risk capital
requirements.\219\
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\218\ Risk-Based Capital Guidelines: Market Risk, 77 FR 53059
(August 30, 2012).
\219\ The rule was subsequently modified in 2013 with changes
that included moving the market risk requirements from the agencies'
respective appendices to subpart F of the capital rule; making
savings associations and savings and loan holding companies with
material exposure to market risk subject to the market risk rule, 78
FR 62018 (October 11, 2013); addressing changes to the country risk
classifications, clarifying the treatment of certain traded
securitization positions; revising the definition of covered
position, and clarifying the timing of the market risk disclosure
requirements, 78 FR 76521 (December 18, 2013).
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While these updates to the rule addressed certain pressing
deficiencies in the calculation of market risk capital requirements, a
number of structural shortcomings that came to light during the crisis
remained unaddressed (such as an inability of a VaR metric to capture
tail risks). To address these shortcomings, the Basel Committee
conducted a fundamental review of the market risk capital
framework.\220\ Following this review, the Basel Committee in January
2016 published a new, more robust framework, which established minimum
capital requirements for market risk.\221\ The new framework also
included enhanced templates and qualitative disclosure requirements to
increase the transparency of banking organizations' market-risk-
weighted assets. In January 2019, the Basel Committee published an
amended framework for market risk capital requirements that revised the
calibration of certain risk weights to more appropriately capture the
potential losses for certain types of risks.\222\ The proposal would
modify subpart F of the capital rule to increase risk sensitivity,
transparency, and consistency of the market risk capital requirements
in a manner generally consistent with the revised framework of the
Basel Committee.
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\220\ The Basel Committee has published three consultative
documents on the review and to address the structural shortcomings
identified. ``Fundamental review of the trading book,'' May 2012,
www.bis.org/publ/bcbs219.pdf; ``Fundamental review of the trading
book: A revised market risk framework,'' October 2013, www.bis.org/publ/bcbs265.pdf; and, ``Fundamental review of the trading book:
Outstanding issues,'' December 2014, www.bis.org/bcbs/publ/d305.pdf.
\221\ Basel Committee, ``Minimum capital requirements for market
risk,'' January 2016, www.bis.org/bcbs/publ/d352.pdf.
\222\ Basel Committee, Explanatory note on the minimum capital
requirements for market risk, January 2019, www.bis.org/bcbs/publ/d457.pdf.
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b. Overview of the Proposal
The proposal would improve the risk-sensitivity and calibration of
market risk capital requirements relative to the current capital rule.
The proposal would introduce a risk-sensitive standardized methodology
for calculating risk-weighted assets for market risk (standardized
measure for market risk) and a new models-based methodology (models-
based measure for market risk) to replace the framework in subpart F of
the current capital rule. The standardized measure for market risk
would be the default methodology for calculating market risk capital
requirements for all banking organizations subject to market risk
requirements. A banking organization would be required to obtain prior
approval from its primary Federal supervisor to use the models-based
measure for market risk to determine its market risk capital
requirements.\223\
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\223\ A banking organization that has regulatory approval to use
internal models to measure market risk would be required to obtain
new approvals to use the models-based measure for market risk under
the proposed framework.
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In contrast to the current framework which, subject to approval,
allows the use of internal models at the banking organization level,
the proposal would provide for enhanced risk-sensitivity by introducing
the concept of a trading desk and restricting application of the
proposed models-based approach to the trading desk level. The trading
desk-level approach would limit use of the internal models approach to
only those trading desks that can appropriately capture the risk of
market risk covered positions in banking organizations' internal
models. Notably, the proposal would also improve the current capital
rule's models-based measure for market risk. Specifically, the proposal
would replace the VaR-based measure of market risk with an expected
shortfall-based measure that better accounts for extreme losses.\224\
In addition, the proposal would replace the fixed ten-business-day
liquidity horizon in the current capital rule with liquidity horizons
that vary based on the underlying risk factors to adequately capture
the market risk of less liquid positions.\225\
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\224\ The proposal would define expected shortfall as a measure
of the average of all potential losses exceeding the VaR at a given
confidence level and over a specified horizon.
\225\ The proposal would define liquidity horizon as the time
required to exit or hedge a market risk covered position without
materially affecting market prices in stressed market conditions.
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If after receiving approval from the primary Federal supervisor to
use the models-based measure for market risk, a banking organization's
trading desk fails to satisfy either the proposed desk-level
backtesting requirements \226\ or the proposed desk-level profit and
loss attribution testing requirements,\227\ the proposal would require
the banking organization to use the standardized measure for market
risk to calculate market risk capital requirements for the trading
desk. This requirement would limit the use of internal models to only
those trading desks for which the models are sufficiently conservative
and accurate for purposes of calculating market risk capital
requirements for the trading desk.
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\226\ The proposed desk-level backtesting requirements are
intended to measure the conservatism of the forecasting assumptions
and valuation methods used in the desk's expected shortfall models.
\227\ The proposed desk-level profit and loss attribution (PLA)
testing requirements are intended to measure the accuracy of the
potential future profits or losses estimated by the expected
shortfall models relative to those produced by the front office
models. For purposes of this Supplementary Information, the term
``front office model'' refers to the valuation methods used to
report actual profits and losses for financial reporting purposes.
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The proposed standardized measure for market risk (as illustrated
in Figure 2 below) would consist of three main components: (1) a
sensitivities-based capital requirement that would capture non-default
market risk based on the estimated losses produced by risk factor
sensitivities \228\ under regulatorily determined stress conditions;
\229\ (2) a standardized default risk capital requirement that would
capture losses on credit and equity positions in the event of issuer
default; and (3) a residual risk capital requirement (a residual risk
add-on) that would address in a simple, conservative manner any other
known risks that are not already captured by the first two components,
such as gap risk, correlation risk, and behavioral risks. The proposed
[[Page 64093]]
standardized measure for market risk would also include three
additional components that would apply in limited instances to specific
positions: (1) a fallback capital requirement for instances where a
banking organization is unable to calculate market risk capital
requirements under the sensitivities-based method or the standardized
default risk capital requirement; (2) a capital add-on for re-
designations for instances where a banking organization re-classifies
an instrument after initial designation as being subject either to the
market risk capital requirements under subpart F or to the capital
requirements under either subpart D or E of the capital rule,
respectively, and (3) any additional capital requirement established by
the primary Federal supervisor. Specifically, as part of the proposal's
reservation of authority provisions, the primary Federal supervisor may
require a banking organization to maintain an overall amount of capital
that differs from the amount otherwise required under the proposal, if
the primary Federal supervisor determines that the banking
organization's market risk capital requirements under the proposal are
not commensurate with the risk of the banking organization's market
risk covered positions, a specific market risk covered position, or
categories of positions, as applicable. The standardized measure for
market risk would equal the simple sum of the above components as shown
in Figure 2.
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\228\ A risk factor sensitivity is the change in value of an
instrument given a small movement in a risk factor that affects the
instrument's value.
\229\ Under the proposal, the market risk capital requirement
for the sensitivities-based method would equal the sum of the
capital requirements for a given risk factor for delta (a measure of
impact on a market risk covered position's value from small changes
in underlying risk factors), vega (a measure of the impact on a
market risk covered position's value from small changes in
volatility) and curvature (a measure of the additional change in the
positions' value not captured by delta arising from changes in the
value of an option or an embedded option).
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BILLING CODE 6210-01-P; 6714-01-P; 4810-33-P
[GRAPHIC] [TIFF OMITTED] TP18SE23.029
BILLING CODE 6210-01-C; 6714-01-C; 4810-33-C
The core components of the models-based measure for market risk
would consist of (1) the internal models approach capital requirements
for model-eligible trading desks; \230\ (2) the standardized approach
capital requirements for model-ineligible trading desks; and (3) the
additional capital requirement applied to model-eligible trading desks
with shortcomings in the internal models used for determining risk-
based capital requirements in the form of a PLA add-on,\231\ if
applicable. To limit the increase in capital requirements arising due
to differences in calculating risk-based capital requirements
separately \232\ between market risk covered positions held by trading
desks subject to the internal models approach and those held by trading
desks subject to the standardized approach, the models-based measure
for market risk would cap the sum of these three
[[Page 64094]]
components at the capital required for all trading desks under the
standardized approach.
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\230\ The internal models approach capital requirements for
model-eligible trading desks would itself consist of four
components: (1) the internally modelled capital requirement for
modellable risk factors, (2) the stressed expected shortfall for
non-modellable risk factors, (3) the standardized default risk
capital requirement, and (4) the aggregate trading portfolio
backtesting capital multiplier. See section III.H.8.a of this
Supplementary Information.
\231\ The PLA add-on would be an additional capital requirement
for model deficiencies in model-eligible trading desks based on the
profit and loss attribution test results. See section III.H.8.b of
this Supplementary Information.
\232\ Separate capital calculations could unnecessarily increase
capital requirement because they ignore the offsetting benefits
between market risk covered positions held by trading desks subject
to the internal models approach and those held by trading desks
subject to the standardized approach.
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There are four other components of the models-based measure for
market risk; however, these would only apply in limited circumstances.
These components include: (1) the capital requirement for instances
where the capital requirements for model-eligible desks under the
internal models approach exceed those under the standardized approach;
\233\ (2) the fallback capital requirement for instances where a
banking organization is not able to apply the standardized approach to
market risk covered positions on model-ineligible trading desks or the
internal models approach to market risk covered positions on model-
eligible trading desks, as well as all securitization positions and
correlation trading positions that are excluded from the capital add-on
for ineligible positions on model-eligible trading desks; (3) the
capital add-on for re-designations for instances where a banking
organization re-classifies an instrument after initial designation as
being subject either to the market risk capital requirements under
subpart F or to the capital requirements under either subpart D or
subpart E of the capital rule, respectively, or from including
securitization positions, correlation trading positions, or certain
equity positions in investment funds \234\ on a model-eligible trading
desk, provided such positions are not included in the fallback capital
requirement; and (4) any additional capital requirement established by
the primary Federal supervisor. Specifically, as part of the proposal's
reservation of authority provisions, and similar to the standardize
measure for market risk, the primary Federal supervisor may require the
banking organization to maintain an overall amount of capital that
differs from the amount otherwise required under the proposal.
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\233\ As the standardized approach is less risk-sensitive than
the internal models approach, to the extent that the capital
requirement under the internal models approach exceeds that under
the standardized approach for model-eligible desks, the proposal
would require this difference to be reflected in the aggregate
capital requirement under the models-based measure for market risk.
\234\ Specifically, the capital add-on would apply to equity
positions in an investment fund on model-eligible trading desks
where the banking organization cannot identify the underlying
positions held by the investment fund on a quarterly basis or there
is no daily price of the fund available.
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Under the proposal, the market risk capital requirements for a
banking organization under the models-based measure for market risk
would equal the sum of the following components as shown in Figure 3.
[GRAPHIC] [TIFF OMITTED] TP18SE23.030
The proposal would also revise the criteria for determining whether
a banking organization is subject to the market risk-based capital
requirements to (1) reflect the significant growth in capital markets
since adoption of the 1996 rule; (2) provide a more reliable and stable
measure of banking organizations' trading activity by introducing a
four-quarter average requirement, and (3) incorporate measures of risk
identified as part of the agencies' 2019 regulatory tiering rule.\235\
In general, the revised criteria would take into account the prudential
benefits of the proposed market risk capital requirements and the
potential costs, including compliance costs.
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\235\ See 84 FR 59230, 59249 (November 1, 2019).
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In addition, the proposal would help promote consistency and
comparability in market risk capital requirements across banking
organizations by strengthening the criteria for identifying positions
subject to the proposed market risk capital requirement and by
proposing a risk-based capital treatment of transfers of risk between a
trading
[[Page 64095]]
desk and another unit within the same banking organization (internal
risk transfers). The proposal would also improve the transparency of
market risk capital requirements through enhanced disclosures.
2. Scope and Application of the Proposed Rule
a. Scope of the Proposed Rule
Currently, any banking organization with aggregate trading assets
and trading liabilities that, as of the most recent calendar quarter,
equal to $1 billion or more, or 10 percent or more of the banking
organization's total consolidated assets, is required to calculate
market risk capital requirements under subpart F of the current capital
rule.
The proposal would revise the criteria for determining whether a
banking organization is subject to subpart F of the capital rule. Under
the proposal, large banking organizations, as well as those with
significant trading activity, would be required to calculate market
risk capital requirements under subpart F of the capital rule.
Specifically, a banking organization with significant trading activity
would be any banking organization with average aggregate trading assets
and trading liabilities, excluding customer and proprietary broker-
dealer reserve bank accounts,\236\ over the previous four calendar
quarters equal to $5 billion or more, or equal to 10 percent or more of
total consolidated assets at quarter end as reported on the most recent
quarterly regulatory report. Under the proposal, any holding company
subject to Category I, II, III, or IV standards or any subsidiary
thereof, if the subsidiary engaged in any trading activity over any of
the four most recent quarters, would be subject to subpart F of the
capital rule.
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\236\ The proposal would define customer and proprietary broker-
dealer reserve bank accounts as segregated accounts established by a
subsidiary of a banking organization that fulfill the requirements
of 17 CFR 240.15c3-3 (SEC Rule 15c3-3) or 17 CFR 1.20 (CFTC
Regulation 1.20).
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The proposed scope is designed to apply market risk capital
requirements to all large banking organizations. As the agencies noted
in the preamble to the final regulatory tiering rule, due to their
operational scale or global presence, banking organizations subject to
Category I or II capital standards pose heightened risks to U.S.
financial stability which would benefit from more stringent capital
requirements being applied to such banking organizations.\237\ As
banking organizations subject to Category I or II capital standards are
generally subject to rules based on the standards published by the
Basel Committee, the proposed scope would help promote competitive
equity among U.S. banking organizations and their foreign peers and
competitors, and reduce opportunities for regulatory arbitrage across
jurisdictions. In addition, given the increasing size and complexity of
activities of banking organizations subject to Category III and IV
capital standards and the risks such banking organizations pose to U.S.
financial stability, it would be appropriate to require such banking
organizations to be subject to the proposed market risk capital
requirements, which provide for enhanced risk sensitivity.
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\237\ See 84 FR 59230, 59249 (November 1, 2019).
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In addition to applying subpart F of the capital rule to large
banking organizations, the proposed rule would retain a trading
activity threshold. To reflect inflation since 1996 and growth in the
capital markets, the agencies are proposing to increase the trading
activity dollar threshold from $1 billion to $5 billion. A banking
organization whose trading assets and trading liabilities are equal to
10 percent or more of its total assets would continue to be subject to
subpart F of the capital rule under the proposal. This means that a
banking organization that is not subject to Category I, II, III, or IV
capital standards may still be subject to subpart F if it exceeds
either of these quantitative thresholds. The proposed trading activity
dollar threshold would be measured using the average aggregate trading
assets and trading liabilities of a banking organization, calculated in
accordance with the instructions to the FR Y-9C or Call Report, as
applicable, over the prior four consecutive quarters, rather than using
only the single most recent quarter.\238\ This approach would provide a
more reliable and stable measure of the banking organization's trading
activities than the current capital rule's quarter-end measure.\239\
Furthermore, for purposes of determining applicability of subpart F of
the capital rule, a banking organization would exclude from its
calculation of aggregate trading assets and trading liabilities
securities related to certain segregated accounts established by a
subsidiary of a banking organization pursuant to SEC Rule 15c3-3 and
CFTC Regulation 1.20 (customer and proprietary broker-dealer reserve
bank accounts). To protect customers against losses arising from a
broker-dealer's use of customer assets and cash, the SEC's and CFTC's
requirements for customer and proprietary broker-dealer reserve bank
accounts limit the ability of a banking organization to benefit from
short-term price movements on the assets held in such accounts. When
such accounts constitute the vast majority of a banking organization's
trading activities, the prudential benefit of requiring the banking
organization to measure risk-weighted assets for market risk would be
limited. The proposal would only allow a banking organization to
exclude these amounts from proposed trading activity thresholds for the
purpose of determining whether the banking organization is subject to
market risk capital requirements. If a banking organization exceeds
either of the proposed trading threshold criteria after excluding such
accounts, the proposal would require the banking organization to
include such accounts when calculating market risk capital
requirements.
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\238\ For purposes of the proposed scoping criteria, aggregate
average trading assets and trading liabilities would mean the sum of
the amount of trading assets and the amount of trading liabilities
as reported by the banking organization on the Consolidated
Financial Statements for Holding Companies (sum of line items 5 and
15 on schedule HC of the Y-9C) or on the Consolidated Reports of
Condition and Income (i.e., the sum of line items 5 and 15 on
schedule RC of the FFIEC 031, the FFIEC 041, or the FFIEC 051), as
applicable.
\239\ If the banking organization has not reported trading
assets and trading liabilities for each of the preceding four
calendar quarters, the threshold would be based on the average
amount of trading assets and trading liabilities over the quarters
that the banking organization has reported, unless the primary
Federal supervisor notifies the banking organization in writing to
use an alternative method.
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b. Application of Proposed Rule
The proposal would require a banking organization to comply with
the market risk capital requirements beginning the quarter after the
banking organization meets any of the proposed scoping criteria. To
avoid volatility in requirements, a banking organization would remain
subject to market risk capital requirements unless and until (1) it
falls below the trading activity threshold criteria for each of four
consecutive quarters or is no longer a banking organization subject to
Category I, II, III, or IV capital standards, as applicable, and (2)
has provided notice to its primary Federal supervisor.
Implementing the proposed market risk capital requirements would
require significant operational preparation. Therefore, the agencies
expect that that a banking organization would monitor its aggregate
trading assets and trading liabilities on an ongoing basis and work
with its primary Federal supervisor as it approaches any of the
proposed scoping criteria to prepare for compliance. To facilitate
supervisory oversight, the proposal would require a banking
[[Page 64096]]
organization to notify its primary Federal supervisor after falling
below the relevant scope thresholds.
While the proposed threshold criteria for application of market
risk capital requirements would help reasonably identify a banking
organization with significant levels of trading activity given the
current risk profile of the banking organization, there may be unique
instances where a banking organization either should or should not be
required to reflect market risk in its risk-based capital requirements.
To continue to allow the agencies to address such instances on a case-
by-case basis, the proposal would retain, without modification, the
authority under subpart F of the capital rule for the primary Federal
supervisor to either: (1) require a banking organization that does not
meet the proposed threshold criteria to calculate the proposed market
risk capital requirements, or (2) exclude a banking organization that
meets the proposed threshold criteria from such calculation, as
appropriate. To allow the agencies to address such instances on a case-
by-case basis, the proposal would retain such existing authority under
subpart F of the capital rule.
Question 80: The agencies seek comment on the appropriateness of
the proposed scope of application thresholds. Given the compliance
costs associated with the proposal, what, if any, alternative
thresholds should the agencies consider and why?
Question 81: What are the advantages or disadvantages of using a
four-quarter rolling average for the $5 billion aggregate trading
assets and trading liabilities scope of application threshold? What
different methodologies and time periods should the agencies consider
for purposes of this threshold?
3. Market Risk Covered Position
Subpart F of the capital rule applies to a banking organization's
covered positions, which are defined to include, subject to certain
restrictions: (i) any trading asset or trading liability as reported on
a banking organization's regulatory reports that is a trading position
\240\ or that hedges another covered position and is free of any
restrictive covenants on its tradability or for which the material risk
elements may be hedged by the banking organization in a two-way market,
and (ii) any foreign exchange \241\ or commodity position regardless of
whether such position is a trading asset or trading liability. The
definition of a covered position also explicitly excludes certain
positions. Thus, the definition is structured into three broad
categories, each subject to certain conditions: trading assets or
liabilities that are covered positions, positions that are covered
positions regardless of whether they are trading assets or trading
liabilities, and exclusions.
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\240\ The current capital rule defines a trading position as one
that is held by a banking organization for the purpose of short-term
resale or with the intent of benefiting from actual or expected
short-term price movements or to lock-in arbitrage profits.
\241\ With prior approval from its primary Federal supervisor, a
banking organization may exclude from its market risk covered
positions any structural position in a foreign currency, which is
defined as a position that is not a trading position and that is (i)
a subordinated debt, equity or minority interest in a consolidated
subsidiary that is denominated in a foreign currency; (ii) capital
assigned to foreign branches that is denominated in a foreign
currency; (iii) a position related to an unconsolidated subsidiary
or another item that is denominated in a foreign currency and that
is deducted from the banking organization's tier 1 or tier 2
capital, or (iv) a position designed to hedge a banking
organization's capital ratios or earnings against the effect of
adverse exchange rate movements on (i), (ii), or (iii).
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The proposal would retain the structure and major elements of the
existing definition of covered position (re-designated as ``market risk
covered position'') with several modifications intended to better align
the definition of market risk covered position with those positions the
agencies believe should be subject to the market risk capital
requirements as well as to reflect other proposed changes to the
framework (for example, to incorporate the proposed treatment of
internal risk transfers). The proposed revisions would also help
promote consistency and comparability in the risk-based capital
treatment of positions across banking organizations.
a. Trading Assets and Trading Liabilities That Would Be Market Risk
Covered Positions Under the Proposal
The proposed definition of market risk covered position would
expand to explicitly include any trading asset or trading liability
that is held for the purpose of regular dealing or making a market in
securities or other instruments.242 243 In general, such
positions are held to facilitate sales to customers or otherwise to
support the banking organization's trading activities, for example by
hedging its trading positions, and therefore expose a banking
organization to significant market risk.
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\242\ The proposal also would require such a position to be free
of any restrictive covenants on its tradability or for the banking
organization to be able to hedge the material risk elements of such
a position in a two-way market.
\243\ The proposed definition of market risk covered position
would include correlation trading positions and instruments
resulting from securities underwriting commitments where the
securities are purchased by the banking organization on the
settlement date, excluding purchases that are held to maturity or
available for sale purposes.
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b. Positions That Would Be Market Risk Covered Positions Under the
Proposal Regardless of Whether They Are Trading Assets or Trading
Liabilities
The proposal would include as market risk covered positions certain
positions or hedges of such positions \244\ regardless of whether the
position is a trading asset or trading liability.\245\ Consistent with
subpart F of the current capital rule, such positions would continue to
include foreign exchange and commodity positions with certain
exclusions. In particular, the proposal would continue to allow a
banking organization to exclude structural positions in a foreign
currency from market risk covered positions with prior approval from
its primary Federal supervisor. In addition, the proposal would exclude
from market risk covered positions foreign exchange and commodity
positions that are eligible CVA hedges that mitigate the exposure
component of CVA risk.\246\
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\244\ A position that hedges a trading position must be within
the scope of the banking organization's hedging strategy as
described in Sec. __.203(a)(2) of the proposed rule.
\245\ Extending market risk covered positions to also include
such hedges is intended to encourage sound risk management by
allowing a banking organization to capture both the underlying
market risk covered position and any associated hedge(s) when
calculating its market risk capital requirements. Consistent with
current practice, the agencies would review a banking organization's
hedging strategies to ensure the appropriate designation of
positions subject to subpart F of the capital rule.
\246\ An eligible CVA hedge generally would include an external
CVA hedge or a CVA hedge that is the CVA segment of an internal risk
transfer. See section III.I.3.b. of this Supplementary Information
for more detail on the treatment and recognition of CVA hedges
either under the proposed CVA risk framework or the market risk
framework.
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The proposal would also expand the types of positions that would be
market risk covered positions, even if not categorized as trading
assets or trading liabilities, to include the following, each discussed
further below: (i) certain equity positions in an investment fund; (ii)
net short risk positions; (iii) certain publicly traded equity
positions; \247\ (iv) embedded derivatives on instruments issued by the
banking organization that relate to credit or equity risk and that the
banking organization bifurcates for accounting purposes; \248\ and (v)
certain
[[Page 64097]]
positions associated with internal risk transfer under the
proposal.\249\
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\247\ Equity positions arising from deferred compensation plans,
employee stock ownership plans, and retirement plans would not be
included in the scope of market risk covered position.
\248\ This would apply to hybrid contracts containing an
embedded derivative that must be separated from the host contract
and accounted for as a derivative instrument under ASC Topic 815,
Derivatives and Hedging (formerly FASB Statement No. 133
``Accounting for Derivative Instruments and Hedging Activities,'' as
amended).
\249\ See section III.H.4 of this Supplementary Information for
further detail on eligible internal risk transfer positions.
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First, the proposal would include as a market risk covered position
an equity position in an investment fund for which the banking
organization has access to the fund's prospectus, partnership
agreement, or similar contract that defines the fund's permissible
investments and investment limits, and which meets one of two
conditions. Specifically, the banking organization would either need to
(i) be able to use the look-through approach to calculate a market risk
capital requirement for its proportional ownership share of each
exposure held by the investment fund, or (ii) obtain daily price quotes
for the investment fund.
In contrast to the current covered position definition, which in
part relies on the legal form of the investment fund by referencing the
Investment Company Act to determine whether an equity position in such
a fund is a covered position, the proposed criteria would capture
equity positions for which there is sufficient transparency to be
reliably valued on a daily basis, either from an observable market
price for the equity position in the investment fund itself or from the
banking organization's ability to identify the underlying positions
held by the investment fund.
Second, the proposal would introduce a new term, net short risk
positions, to describe over-hedges of credit and equity exposures that
are not market risk covered positions. As the hedged exposures from
which such positions originate are not traded, net short risk positions
would not meet the definition of trading position even though they
expose the banking organization to market risk.\250\ The agencies
propose to include net short risk positions in market risk covered
positions in order to help ensure that such exposures are appropriately
reflected in banking organizations' risk-based capital requirements.
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\250\ The proposal would retain, without modification, the
existing definition of trading position in subpart F of the current
capital rule. See 12 CFR 3.202 (OCC); 12 CFR 217.202 (Board); 12 CFR
324.202 (FDIC).
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For example, assume a banking organization purchases an eligible
credit derivative (for example, a credit default swap) to mitigate the
credit risk arising from a loan that is not a market risk covered
position and the notional amount of protection provided by the credit
default swap exceeds the loan exposure amount. The banking organization
is exposed to additional market risk on the exposure arising from the
difference between the amount of protection purchased and the amount of
protected exposure because the value of the protection would fall if
the credit spread of the credit default swap narrows. Neither subpart D
nor E \251\ of the capital rule would require the banking organization
to reflect this risk in risk-weighted assets. To capture the market
risk arising from net short risk positions, the proposal would require
the banking organization to treat such positions as market risk covered
positions.
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\251\ Under the proposal, subpart D would cover a Standardized
Approach and subpart E would cover an Expanded Risk-Based Approach
for Risk-Weighted Assets.
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To calculate the exposure amount of a net short risk position, the
proposal would require a banking organization to compare the notional
amounts of its long and short credit positions and the adjusted
notional amounts of its long and short equity positions that are not
market risk covered positions.\252\ For purposes of this calculation,
the notional amounts would include the total funded and unfunded
commitments for loans that are not market risk covered positions.
Additionally, as a banking organization may hedge exposures at either
the single-name level or the portfolio level, the proposal would
require a banking organization to identify separately net short risk
positions for single name exposures and for index hedges. For single-
name exposures, the proposal would require a banking organization to
evaluate its long and short equity and credit exposures for all
positions referencing a single exposure to determine if it has a net
short risk position in a single-name exposure. For index hedges, the
proposal would require a banking organization to evaluate its long and
short equity and credit exposures for all positions in the portfolio
(aggregating across all relevant individual exposures) to determine if
it has a net short risk position for any given portfolio.
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\252\ For equity derivatives, the adjusted notional amount would
be the product of the current price of one unit of the stock (for
example, a share of equity) and the number of units referenced by
the trade.
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The proposal would limit the application of the proposed market
risk capital requirements to positions arising from exposures for which
the notional amount of a short position exceeds the notional amount of
a long position by $20 million or more at either the single-name or
index hedge level. Exposures arising from net short risk positions are
a potential area where a banking organization may maintain insufficient
capital relative to the market risk and should be monitored at the
single name or portfolio level rather than in the aggregate. The
agencies nonetheless recognize that it could be burdensome to require a
banking organization to capture every net short exposure that may
arise, regardless of size or duration, when calculating their market
risk capital requirements. Accordingly, the proposed $20 million
threshold is intended to help ensure that individual net short risk
exposures that could materially impact the risk-based capital
requirements of a banking organization would be appropriately reflected
in the proposed market risk capital requirements. Additionally, the
proposed $20 million threshold is intended to strike a balance between
over-hedging concerns and aligning incentives for banking organizations
to prudently hedge and manage risk while capturing positions for which
a market risk capital requirement would be appropriate. For example, if
a loan amortizes more quickly than expected, due to a borrower making
additional payments to pay down principal, the amount of notional
protection would only constitute a net short risk position if it
exceeds the amount of the total committed loan balance by $20 million
or more. The operational burden of requiring a banking organization to
capture temporary or small differences due to accelerated amortization
within its market risk capital requirements could inhibit the banking
organization from engaging in prudential hedging and sound risk
management. The proposal would require a banking organization to
calculate net short risk positions on a spot, quarter-end basis,
consistent with regulatory reporting, in order to reduce the
operational burden of identifying such positions subject to the
proposed market risk capital requirements.
Third, the proposal generally would include as market risk covered
positions all publicly traded equity positions \253\
[[Page 64098]]
regardless of whether they are trading assets or trading liabilities
and provided that there are no restrictions on the tradability of such
positions.
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\253\ The proposal would not change the current capital rule's
definition of publicly traded as traded on: (1) any exchange
registered with the SEC as a national securities exchange under
section 6 of the Securities Exchange Act of 1934 (15 U.S.C. 78f); or
(2) any non-U.S.-based securities exchange that is registered with,
or approved by, a national securities regulatory authority and that
provides a liquid, two-way market for the instrument in question.
Consistent with the current capital rule, the proposal would define
a two-way market as a market where there are independent bona fide
offers to buy and sell so that a price reasonably related to the
last sales price or current bona fide competitive bid and offer
quotations can be determined within one day and settled at that
price within a relatively short time frame conforming to trade
custom.
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Fourth, a banking organization may issue hybrid instruments that
contain an embedded derivative related to credit or equity risk and a
host contract and bifurcate the derivative and the host contract for
accounting purposes under GAAP. Under such circumstances, the proposal
would include the embedded derivative in the definition of market risk
covered position regardless of whether GAAP treats the derivative as a
trading asset or a trading liability. If the banking organization
elected to report the entire hybrid instrument at fair value under the
fair value option rather than bifurcating the accounting, it would be a
market risk covered position only if it otherwise met the proposed
definition, such as held with trading intent or to hedge another market
risk covered position.\254\ This approach would capture the market risk
of embedded derivatives a banking organization faces when it issues
such hybrid instruments while being sensitive to the operational
challenges of requiring banking organizations to calculate the fair
value such derivatives on a daily basis, and also appropriately
excluding conventional instruments with an embedded derivative for
which the capital requirements under subpart D or E of the capital rule
would be appropriate.\255\
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\254\ For purposes of regulatory reporting, the instructions to
the Y-9C and Call Report require a banking organization to classify
as trading securities all debt securities that a banking
organization has elected to report at fair value under a fair value
option with changes in fair value reported in current earnings,
regardless of whether such positions are held with trading intent.
ASC 815-15-25-4 permits both issuers of and investors in hybrid
financial instruments that would otherwise require bifurcation of an
embedded derivative to elect at acquisition, issuance or a new basis
event to carry such instrument at fair value with all changes in
fair value reported in earnings.
\255\ For example, a conventional mortgage loan contains an
embedded prepayment or call option.
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Fifth, the proposed definition of market risk covered position
would include certain transactions of internal risk transfers, as
described in section III.H.4 of this Supplementary Information, based
in certain cases on the eligibility of the internal risk transfers. The
market risk covered position would explicitly include (1) the trading
desk segment of an eligible internal risk transfer of credit risk or
interest rate risk and the trading desk segment of an internal risk
transfer of CVA risk; (2) certain external transactions based on
eligibility of the risk transfers, executed by a trading desk related
to an internal risk transfer of CVA, credit, or interest rate risk, and
(3) both external and internal ineligible CVA hedges (an internal CVA
hedge is the CVA segment of an internal transfer of CVA risk). This
aspect of the proposal is intended to help promote consistency and
comparability in the risk-based capital treatment of such positions
across banking organizations and ensure the appropriate capitalization
of such positions under subparts D, E, or F of the capital rule.
c. Exclusions From the Proposed Definition of Market Risk Covered
Position
The definition of a covered position under subpart F of the current
capital rule explicitly excludes certain positions.\256\ These excluded
instruments and positions generally reflect the fact that they are
either deducted from regulatory capital, explicitly addressed under
subpart D or E of the current capital rule, have significant
constraints in terms of a banking organization's ability to liquidate
them readily and value them reliably on a daily basis, or are not held
with trading intent.
---------------------------------------------------------------------------
\256\ See 77 FR 53060, 53064-53065 (August 30, 2012) for a more
detailed discussion on these exclusions under the market risk
capital rule.
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Consistent with subpart F of the current capital rule, the proposal
would continue to exclude from the definition of market risk covered
positions any intangible asset, including any servicing asset; any
hedge of a trading position that the banking organization's primary
Federal supervisor determines to be outside the scope of the banking
organization's trading and hedging strategy; any instrument that, in
form or substance, acts as a liquidity facility that provides support
to asset-backed commercial paper, and any position a banking
organization holds with the intent to securitize.
The proposed definition would also continue to exclude from market
risk covered positions any direct real estate holdings.\257\ Consistent
with past guidance from the agencies, indirect investments in real
estate, such as through REITs or special purpose vehicles, would not be
direct real estate holdings and could be market risk covered positions
if they meet the proposed definition.\258\
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\257\ Direct real estate holdings include real estate for which
the banking organization holds title, such as ``other real estate
owned'' held from foreclosure activities, and bank premises used by
the bank as part of its ongoing business activities.
\258\ See 77 FR 53060, 53065 (August 30, 2012) for the agencies'
interpretive guidance on the treatment of such indirect holdings
under subpart F of the capital rule.
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The proposed definition would also exclude from market risk covered
positions any non-publicly traded equity positions, other than certain
equity positions in investment funds, and would additionally exclude:
(1) a publicly traded equity position that has restrictions on
tradability; (2) a publicly traded equity position that is a
significant investment in the capital of an unconsolidated financial
institution in the form of common stock not deducted from regulatory
capital, and (3) any equity position in an investment fund that is not
a trading asset or trading liability or that otherwise does not meet
the requirements to be a market risk covered position. The proposed
definition would add an exclusion for any derivative instrument or
exposure to an investment fund that has material exposures to any of
the preceding excluded instruments or positions discussed in this
section.
To provide additional clarity, the proposal would also exclude from
market risk covered positions debt securities for which the banking
organization elects the fair value option for purposes of asset and
liability management, as such positions are not reflective of a banking
organization's trading activity. The proposal would also add an
exclusion for instruments held for the purpose of hedging a particular
risk of a position in any of the preceding excluded types of
instruments discussed in this section.
With respect to internal risk transfers of CVA risks, the proposed
definition would exclude from market risk covered positions the CVA
segment of an internal risk transfer that is an eligible CVA hedge. In
addition, consistent with the Basel III reforms, only positions
recognized as eligible external CVA hedges under either the basic or
standardized capital requirements for CVA risk would be excluded from
the market risk capital requirements.\259\ To the extent a banking
organization enters into one or more external hedges that hedge CVA
variability but do not qualify as eligible hedges under the revised CVA
capital standards, the banking organization would need to capture such
hedges in its market risk capital
[[Page 64099]]
requirements and would not be able to recognize the benefit of the
external hedge when calculating risk-based capital requirements for CVA
risk.
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\259\ External transactions executed by a trading desk as
matching transactions to all internal transfers of CVA risk would be
market risk covered positions under the proposal. See section
III.H.3.b of this Supplementary Information for a more detailed
discussion on the treatment of eligible and ineligible internal risk
transfers of CVA risk.
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Question 82: The agencies seek comment on the appropriateness of
the proposed definition of market risk covered position. What, if any,
practical challenges might the proposed definition pose for banking
organizations, such as the ability to fair value daily any of the
proposed instruments that would be captured by the definition? \260\
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\260\ For banking organizations subject to subpart F of the
capital rule, the Volcker Rule defines the scope of instruments
subject to the proprietary trading prohibition (trading account)
based on two prongs: market risk capital rule covered positions that
are trading positions, and instruments purchased or sold in
connection with the business of a dealer, swap dealer, or
securities-based swap dealer that require it to be licensed or
registered as such. The proposed revisions to the definition of
covered positions under subpart F of the capital rule could alter
the scope of financial instruments deemed to be in the trading
account under the Volcker Rule, but only to the extent that a market
risk covered position is also a trading position and the position is
not otherwise excluded from the Volcker rule definition of trading
account.
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Question 83: The agencies seek comment on the extent to which
limiting the proposed definition of market risk covered position to
include equity positions in investment funds only for which a banking
organization has access to the fund's investments limits (as specified
in the fund's prospectus, partnership agreement, or similar contract
that define the fund's permissible investments) appropriately captures
the types of positions that should be subject to regulatory capital
requirements under the proposed market risk framework. What types of
investment funds, if any, would a banking organization have the ability
to value reliably on a daily basis that do not meet this condition?
Question 84: The agencies seek comment on whether the agencies
should consider allowing a banking organization to exclude from the
definition of market risk covered position investments in capital
instruments or covered debt instruments of financial institutions that
have been deducted from tier 1 capital, including investments in
publicly-traded common stock of financial institutions, and hedges of
these investments that meet the requirements to offset such positions
for purposes of determining deductions. What would the benefits and
drawbacks be of not providing such an optionality?
Question 85: For the purposes of determining whether certain
positions are within the definition of market risk covered position, is
the proposed definition of net short risk position appropriate, and
why? What, if any, alternative measures should the agencies consider to
identify net short risk positions and why would these be more
appropriate?
Question 86: The agencies seek comment on whether the proposed $20
million threshold is an appropriate measure for identifying significant
net short risk exposures that warrant capitalization under the market
risk framework. What alternative thresholds or methods should the
agencies consider for identifying significant net short risk positions,
and why would these alternatives be more appropriate than the proposed
$20 million threshold?
Question 87: What, if any, challenges might banking organizations
face in calculating the market risk capital requirement for net short
risk positions? In particular, what, if any, alternatives to the total
commitment for loans should the agencies consider using to calculate
notional amount--for example, delta notional values rather than
notional amount, present value, sensitivities--and why would any such
alternatives be a better metric? Please provide specific details on the
mechanics of and rationale for any suggested methodology. In addition,
which, if any, of the items to be included in a banking organization's
net short credit or equity risk position may present operational
difficulties and what is the nature of such difficulties? How could
such concerns be mitigated?
Question 88: The agencies seek comment on whether to modify the
exclusion for debt instruments for which a banking organization has
elected to apply the fair value option that are used for asset and
liability management purposes. Would such an exclusion be overly
restrictive, and, if so, why and how should the exclusion be expanded?
Please specify the types and amounts of debt instruments for which
banking organizations apply the fair value option that should be
covered under this exclusion, and the capital implications of expanding
the exclusion relative to the proposal.
Question 89: The agencies seek comment on whether to modify the
criteria for including external CVA hedges in the scope of market risk
covered position. What are the benefits and drawbacks of requiring a
banking organization to include ineligible external CVA hedges in the
market risk capital requirements, provided a banking organization has
effective risk management and an effective hedging program?
4. Internal Risk Transfers
A banking organization may choose to hedge the risks of certain
positions \261\ held by a banking unit or a CVA desk by having one of
its trading desks obtain the hedge and subsequently transfer the hedge
position through an internal transaction to the banking unit or the CVA
desk. The current capital rule does not address the transfers of risk
from a banking unit or a CVA desk (or a functional equivalent thereof)
to a trading desk within the same banking organization \262\ (internal
risk transfers), for example between a mortgage banking unit and a
rates trading desk. Thus, market risk-weighted assets do not reflect
the market risk of such internal transactions and capture only the
external portion of the hedge, potentially misrepresenting the risk
position of the banking organization.
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\261\ Such risks can include credit, interest rate, or CVA risk
arising from exposures that are subject to risk-based requirements
under subpart D or E of the capital rule.
\262\ For example, if the banking organization is a depository
institution within a holding company structure, transactions
conducted between the depository institution and an affiliated
broker-dealer entity would not qualify as transactions within the
same banking organization for the depository institution. Such
transactions would qualify as transactions within the same banking
organization for the consolidated holding company.
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Accordingly, the proposal would define internal risk transfers and
establish a set of requirements including documentation and other
conditions for a banking organization to recognize certain types of
internal risk transfers in risk-based capital requirements. The
proposal would define internal risk transfers as a transfer executed
through internal derivatives trades of credit risk or interest rate
risk arising from an exposure capitalized under subparts D or E of the
capital rule to a trading desk, or a transfer of CVA risk arising from
a CVA desk (or the functional equivalent if the banking organization
does not have any CVA desks) to a trading desk.\263\ The proposed
definition of internal risk transfer would not include transfers of
risk from a trading desk to a banking unit or between trading desks
because such transactions present the types of risks appropriately
captured in market risk-weighted assets.\264\
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\263\ An internal risk transfer transaction would comprise two
perfectly offsetting segments--one segment for each of two parties
to the transaction.
\264\ As described in section III.H.7.c.ii of this Supplementary
Information, for transfers of risk between a trading desk that uses
the standardized measure and a trading desk that uses the internal
models approach, a banking organization may exclude the leg of the
transaction acquired by the trading desk using the standardized
approach from the residual risk add-on.
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In practice, for internal risk management purposes, most banking
[[Page 64100]]
organizations already document the source of risk being hedged and the
trading desk providing the hedge. As a result, the agencies do not
expect the proposed documentation requirements for such transactions to
qualify as eligible internal risk transfers, as described in more
detail below, to pose a significant compliance burden on banking
organizations. The agencies encourage prudent risk management and
believe this aspect of the proposal will help promote consistency and
comparability in the risk-based capital treatment of such internal
transactions across banking organizations and ensure the appropriate
capitalization of such positions.
a. Internal Risk Transfers of Credit Risk
The Basel III reforms introduce risk-based capital treatment of
internal transfers of credit risk executed from a banking unit to a
trading desk to hedge the credit risk arising from exposures in the
banking unit. The proposal is generally consistent with the Basel III
reforms by specifying the criteria for internal risk transfer
eligibility and clarifying the scope of exposures subject to market
risk capital requirements. Specifically, the banking organization would
be required to maintain documentation identifying the underlying
exposure under subpart D or E of the capital rule being hedged and its
sources of credit risk. In addition, a trading desk would be required
to enter into an external hedge that meets the requirements of Sec.
__.36 of the current capital rule or Sec. __.120 of the proposed rule
and matches the terms, other than amount, of the internal credit risk
transfer.
When these requirements are met, the transaction would qualify as
an eligible internal risk transfer, for which the banking unit would be
allowed to recognize the amount of the hedge position received from the
trading desk as a credit risk mitigant when calculating the risk-based
capital requirements for the underlying exposure under subpart D or E
of the capital rule. Since the trading desk enters into external hedges
to manage credit risk arising from banking unit exposures, such
external hedges would be included in the scope of market risk covered
positions along with the internal risk transfer (the trading desk
segment), where they would cancel each other provided the amounts and
terms of both transactions match. Nevertheless, if the internal risk
transfer results in a net short credit position for the banking unit,
the trading desk would be required to calculate risk-based capital
requirements for such positions under subpart F of the capital rule. A
net short risk credit position results when the external hedge exceeds
the amount required by the banking unit to hedge the underlying
exposure under subpart D or E of the capital rule.
For transactions that do not meet these requirements, the proposal
would require a banking organization to disregard the internal risk
transfer (the trading desk segment) from the market risk covered
positions. The proposal would subject the entire amount of the external
hedge acquired by the trading desk to the proposed market risk capital
requirements and disallow any recognition of risk mitigation benefits
of the internal credit risk transfer under subpart D or E of the
capital rule.
b. Internal Risk Transfers of Interest Rate Risk
The proposal would specify the risk-based capital treatment of
internal transfers of interest rate risk from a banking unit to the
trading desk to hedge the interest rate risk arising from the banking
unit. When a banking organization executes an internal interest rate
risk transfer between a banking unit and a trading desk, the
transferred interest rate risk exposure would be considered an eligible
risk transfer that the banking organization may treat as a market risk
covered position only if such internal risk transfer meets a set of
requirements. Specifically, the banking organization would be required
to maintain documentation of the underlying exposure being hedged and
its sources of interest rate risk. In addition, given the complexity of
tracking the direction of internal transfers of interest rate risk, the
proposal would allow a banking organization to establish a dedicated
notional trading desk for conducting internal risk transfers to hedge
interest rate risk. The proposal would require such a desk to receive
approval from its primary Federal supervisor to execute such internal
risk transfers.\265\ The proposal would require the capitalization of
trading desks that engage in such transactions on a standalone basis,
without regard to other market risks generated by activities on the
trading desk.
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\265\ The proposal would not require banking organizations to
purchase the hedge from a third party for such transactions to
qualify as an internal risk transfer.
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When these requirements are met, the transaction would qualify as
an eligible internal interest rate risk transfer, for which the banking
organization may recognize the hedge benefit of an internal derivative
transaction. A trading desk that conducts internal risk transfers of
interest rate risk may enter into external hedges to mitigate the risk
but would not be required to do so under the proposal. As the amount
transferred to the trading desk from the banking unit to hedge the
underlying exposure under subpart D or E of the capital rule would be a
market risk covered position, any such external hedges would also be
market risk covered positions and thus also subject to the proposed
market risk capital requirements.\266\
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\266\ As the trading desk segments of eligible internal risk
transfers of interest rate risk would be market risk covered
positions, to the extent a trading desk enters into external hedges
to mitigate the risk of such positions, the external hedge would
also be subject to the market risk capital rule and could in whole
or in part offset the market risk of the eligible internal risk
transfer.
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For transactions that do not meet these requirements, a banking
organization would be required to exclude the internal interest rate
risk transfer (the trading desk segment) from its market risk covered
positions. The entire amount of any external hedge of an ineligible
internal risk transfer would be a market risk covered position.
c. Internal Risk Transfers of CVA Risk
The proposal would specify the capital treatment of internal CVA
risk transfers executed between a CVA desk (or the functional
equivalent thereof) and a trading desk to hedge CVA risk arising from
exposures that are subject to the proposed capital requirements for CVA
risk.
Under the proposal, an internal CVA risk transfer would involve two
perfectly offsetting positions of a derivative transaction executed
between a CVA desk and a trading desk. For the CVA desk to recognize
the risk mitigation benefits of the internal risk transfer under the
risk-based capital requirements for CVA risk, the proposal would
require the banking organization to have a dedicated CVA desk or the
functional equivalent thereof that, along with other functions
performed by the desk, manages internal risk transfers of CVA risk. In
either case, such a desk would not need to satisfy the proposed trading
desk definition, given the proposed risk-based capital requirements for
CVA risk are not calibrated at the trading desk level. Additionally,
the proposal would require a banking organization to maintain an
internal written record of each internal derivative transaction
executed between the CVA desk and the trading desk, including
identifying the underlying exposure being hedged by the CVA desk and
the sources of such
[[Page 64101]]
risk. Furthermore, if the internal risk transfer from the CVA desk to
the trading desk is subject to curvature risk, default risk, or the
residual risk add-on under the proposed market risk capital rule, as
described in sections III.H.7.a.ii.III., III.H.7.b., and III.H.7.c of
this Supplementary Information, respectively, the trading desk would
have to execute an external transaction with a third party that is
identical in its terms to the risk transferred by the CVA desk to the
trading desk. This external transaction would be included in market
risk covered positions; therefore, there would be no impact to the
market risk capital required for the trading desk as the external
transaction would perfectly offset the risk from the internal risk
transfer. Given the difference in recognizing the curvature risk, the
default risk, or the residual risk add-on under the proposed market
risk capital requirements and the CVA risk capital requirements, as
well as complexity of tracking and ensuring the appropriateness of
internal transfers of CVA risk, the external matching transaction
requirement is intended to ensure the complete offsetting of the above
mentioned risks at the time the trades are originated, facilitate the
identification by the primary Federal supervisor of the underlying
position or sources of risk being hedged by the internal risk transfer,
and thus the determination of whether the transfer is an eligible
internal CVA risk transfer.
In addition to the above-mentioned requirements for the internal
transaction and the related external matching transaction to qualify as
an eligible internal risk transfer of CVA risk, the proposal sets forth
general requirements for the recognition of CVA hedges that would be
applicable to both internal transfers of CVA risk and external CVA
hedges. The proposal specifies these requirements for both the basic
approach for CVA risk and standardized approach for CVA risk, as
described in section III.I.3 of this Supplementary Information.\267\
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\267\ While the basic approach for CVA applies certain
restrictions on eligible instrument types for hedges to be
recognized as eligible, the standardized approach for CVA risk
allows for a broader set of hedging instruments. Moreover, the
standardized approach for CVA risk would also recognize as eligible
hedges instruments that are used to hedge the exposure component of
CVA risk.
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For eligible internal risk transfers of CVA risk, the banking
organization would be required to treat the transfers of risk from the
CVA desk or the functional equivalent to the trading desk as market
risk covered positions. In this way, the proposal would allow the CVA
desk to recognize the risk-mitigating benefit of the hedge position
received from the trading desk when calculating risk-based capital
requirements for CVA risk. As the overall risk profile of the banking
organization would not have changed, the proposed treatment would
require the trading desk to reflect the impact of the risk transferred
from the CVA desk as part of the transaction in the proposed market
risk capital requirements.
For transactions that do not meet these requirements or the general
hedge eligibility requirements under the basic approach for CVA risk or
the standardized approach for CVA risk, a banking organization would be
required to include both the trading desk segment and the CVA segment
of the internal transfer of CVA risk in market risk-weighted assets.
This is equivalent to disregarding the internal CVA risk transfer. The
entire amount of the external matching transaction executed by the non-
CVA trading desk in the context of an internal CVA risk transfer would
be deemed a market risk covered position. In addition, the CVA desk
would not be able to recognize any risk mitigation or offsetting
benefit from the ineligible internal risk transfer in its capital
requirements for CVA risk.
d. Internal Risk Transfers of Equity Risk
The agencies are not proposing to allow a banking organization to
recognize any risk mitigation benefits for internal equity risk
transfers executed between a trading desk and a banking unit to hedge
exposures that are subject to either subpart D or E of the capital
rule. The proposed definition of market risk covered position would
include equity positions that are publicly traded with no restrictions
on tradability. Given the expanded scope of equity positions that would
be subject to the proposed market risk capital requirements as
discussed above, the agencies believe that primarily illiquid or
irregularly traded equity positions would remain subject to subparts D
or E of the capital rule. As a banking organization would not be able
to hedge the material risk elements of such equity positions in a
liquid, two-way market, consistent with the current framework, the
proposal would not allow a banking organization to recognize internal
transfers of equity risk of such positions for risk-based capital
purposes.
Question 90: The agencies seek comment on any operational
challenges of the proposed internal risk transfer framework, in
particular any potential difficulties related to internal risk
transfers executed before implementation of the proposed market risk
capital rule. What is the nature of such difficulties and how could
they be mitigated?
Question 91: The agencies seek comment on the extent to which the
proposed internal risk transfer framework would incentivize hedging and
prudent risk management and/or provide opportunity to misrepresent the
risk profile of a banking organization. What, if any, additional
requirements or other modifications should the agencies consider?
Question 92: The agencies seek comment on the appropriateness of
the proposed eligibility requirements for a banking unit to recognize
the risk mitigation benefit of an eligible internal risk transfer of
credit risk. What, if any, additional requirements or other
modifications should the agencies consider, and why?
Question 93: What, if any, operational burden might the proposed
exclusion for the credit risk segment of internal risk transfers pose
for banking organizations? What, if any, alternatives should the
agencies consider to appropriately exclude the types of positions that
should be captured under subpart D or E of the capital rule, but would
impose less operational burden relative to the proposal?
Question 94: The agencies seek comment on subjecting the internal
risk transfers of interest rate risk to the market risk capital
requirements on a standalone basis. What are the benefits and costs
associated with this requirement?
Question 95: The agencies seek comment on the matching external
transaction requirements for internal transfer of CVA risk. Should such
external matching transactions be subject to additional requirements,
such as those applicable to external hedges of credit risk, and if so,
why?
Question 96: The agencies seek comment on limiting an eligible
internal risk transfer of CVA risk to only internal transactions for
which the external transaction perfectly offsets the internal risk
transfer. What, if any, challenges might this requirement pose and what
should the agencies consider to mitigate such challenges?
Question 97: The agencies seek comment on the proposed requirement
that a banking organization's trading desk execute a matching
transaction with a third party if the internal risk transfer of CVA
risk is subject to curvature risk, default risk, or the residual risk
add-on? What other risk mitigation techniques would the banking
organization implement?
Question 98: The agencies seek comment on the proposed
documentation requirements for an
[[Page 64102]]
internal risk transfer of credit risk, interest rate risk, and CVA risk
to qualify as an eligible internal risk transfer. What, if any,
alternatives should the agencies consider that would appropriately
capture the types of positions that should be recognized under subpart
D or E of the capital rule?
5. General Requirements for Market Risk
Subpart F of the current capital rule requires a banking
organization to satisfy certain general risk management requirements
related to the identification of trading positions, active management
of covered positions, stress testing, control and oversight, and
documentation. The proposal would maintain these requirements, as well
as introduce additional requirements. The additional requirements are
designed to further strengthen a banking organization's risk management
of market risk covered positions and to appropriately reflect other
changes under the proposal such as the definition of market risk
covered position and the introduction of the trading desk concept, as
described in sections III.H.3 and III.H.5.b of this Supplementary
Information. The proposal would also make certain related technical
corrections to the requirements around valuation of market risk covered
positions.\268\
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\268\ Specifically, to align with the GAAP considerations for
valuation of market risk covered positions, the proposal would
eliminate the market risk capital rule requirement that a banking
organization's process for valuing covered positions must consider,
as appropriate, unearned credit spreads, close-out costs, early
termination costs, investing and funding costs, liquidity, and model
risk. See 12 CFR 3.203(b)(2) (OCC); 12 CFR 217.203(b)(2) (Board); 12
CFR 324.203(b)(2) (FDIC).
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a. Identification of Market Risk Covered Positions
Subpart F of the current capital rule requires a banking
organization to have clearly defined policies and procedures for
determining which trading assets and trading liabilities are trading
positions and which trading positions are correlation trading
positions, as well as for actively managing all positions subject to
the rule.
The proposal would expand these requirements to reflect the
proposed scope and definition of market risk covered position as
described in section III.H.3 of this Supplementary Information. A
banking organization also would be required to update its policies and
procedures for identifying market risk covered positions at least
annually and to identify positions that must be excluded from market
risk covered positions. In addition, the proposal would introduce a new
requirement for a banking organization to establish a formal framework
for re-designating a position after its initial designation as being
subject to subpart F or to subparts D and, as applicable, E of the
capital rule. Specifically, the proposal would require a banking
organization to establish policies and procedures that describe the
events or circumstances under which a re-designation would be
considered, a process for identifying such events or circumstances, any
restrictions on re-designations, and the process for obtaining senior
management approval as well as for notifying the primary Federal
supervisor of material re-designations. These proposed requirements are
intended to complement the proposed capital requirement for re-
designations described in section III.H.6.d of this Supplementary
Information by ensuring re-designations would occur in only those
circumstances identified by the banking organization's senior
management as appropriate to merit re-designation.\269\
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\269\ As described in further detail in section III.H.6.d of
this Supplementary Information, the proposal would introduce a
capital requirement (the capital add-on for re-designations) to
offset any potential capital benefit that a banking organization
otherwise might have received from re-classifying an instrument
previously treated under subparts D or E of the capital rule as a
market risk covered position.
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In addition to the requirements for identifying market risk covered
positions, the proposal would require a banking organization to have
clearly defined trading and hedging strategies for its market risk
covered positions that are approved by the banking organization's
senior management. Consistent with the capital rule, the trading
strategy would need to specify the expected holding period and the
market risk of each portfolio of market risk covered positions, and the
hedging strategy would need to specify the level of market risk that
the banking organization would be willing to accept for each portfolio
of market risk covered positions, along with the instruments,
techniques, and strategies for hedging such risk.
b. Trading Desk
i. Trading Desk Definition
To limit overreliance on internal models, support more prudent
market risk management practices, and better align operational
requirements with the level at which trading activity is conducted, the
proposal would introduce the concept of a trading desk and apply the
proposed internal models approach at the trading desk level. Regardless
of whether a banking organization uses the standardized or the models-
based measure for market risk, the proposal would require the banking
organization to satisfy certain general operational requirements for
each trading desk, as described below in section III.H.5.c of this
Supplementary Information. The proposal would require the banking
organization to satisfy certain additional operational requirements, as
described below in section III.H.5.d of this Supplementary Information,
in order for the banking organization to calculate the market risk
capital requirements for trading desks under the internal models
approach.
The proposal would define trading desk as a unit of organization of
a banking organization that purchases or sells market risk covered
positions and satisfies three requirements. First, the proposal would
require a banking organization to structure a trading desk pursuant to
a well-defined business strategy. In general, a well-defined business
strategy would include a written description of the trading desk's
general strategy, including the economics behind the business strategy,
the trading and hedging strategies and a list of the types of
instruments and activities that the desk will use to accomplish its
objectives. The proposal would require a trading desk to be organized
to ensure the appropriate setting, monitoring, and management review of
the desk's trading and hedging limits and strategies. Third, the
proposal would require that a trading desk be characterized by a
clearly-defined unit of organization that: (1) engages in coordinated
trading activity with a unified approach to the key elements of the
proposed rule's requirements for trading desk policies and active
management of market risk covered positions; (2) operates subject to a
common and calibrated set of risk metrics, risk levels, and joint
trading limits; (3) submits compliance reports and other information as
a unit for monitoring by management; and (4) books its trades together.
The proposed trading desk definition is intended to help ensure
that a banking organization structures its trading desks to capture the
level at which trading activities are managed and operated and at which
the profit and loss of the trading strategy is attributed.\270\ This
approach would recognize the different strategies and objectives of
discrete units in a banking
[[Page 64103]]
organization's trading operations. The proposed parameters provide
sufficient specificity to enable more precise measures of market risk
for the purpose of determining risk-based capital requirements, while
taking into account the potential variation in trading practices across
banking organizations. In this regard, the proposal aims to reduce the
regulatory compliance burden for banking organizations by providing
flexibility to align the proposed trading desk definition with the
organizational structure that banking organizations may already have in
place to carry out their trading activities.
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\270\ The proposal would define trading desk in a manner
generally consistent with the Volcker Rule. See 12 CFR 44.3(e)(14)
(OCC); 12 CFR 248.3(e)(14) (Board); 12 CFR 351.3(e)(14) (FDIC).
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Question 99: What, if any, changes should the agencies consider
making to the definition of a trading desk and why? Are there any other
key factors that banking organizations typically use to define trading
desks for business purposes that the agencies should consider including
in the trading desk definition to clarify the designation of trading
desks for purposes of the market risk capital framework?
Question 100: The agencies seek comment on any implementation
challenges banking organizations with cross-border operations could
face in applying the proposed trading desk definition. What are the
advantages and disadvantages of permitting a U.S. subsidiary of a
foreign banking organization to apply trading desk designations
consistent with its home country's regulatory requirements, provided
those requirements are consistent with the Basel III reforms?
ii. Notional Trading Desk Definition
The proposed definition of market risk covered position would
include certain types of instruments and positions that may not arise
from, and may be unrelated to, a banking organization's trading
activities, such as net short risk positions, certain embedded
derivatives that are bifurcated for accounting purposes, as well as
foreign exchange and commodity exposures that are not trading assets or
trading liabilities.\271\ When a banking organization enters into such
positions, it may do so in a manner that causes these positions to
appear not to originate from a banking organization's existing trading
desks.
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\271\ As noted in section III.H.3.c of this Supplementary
Information, identifying these positions for treatment under the
proposed rule is necessary to enhance the rule's sensitivity to
risks that might not otherwise be captured or adequately captured by
subparts D or E of the capital rule.
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To address the issue that certain trading desk-level requirements
are not applicable to these types of activities and positions, the
proposal would introduce the concept of a notional trading desk \272\
to which such positions would be allocated. Under the proposal,
notional trading desks would be subject to only a subset of the general
risk management requirements applicable to trading desks. Specifically,
the proposal would require a banking organization to identify any such
positions and activities allocated to notional trading desks, as
described in section III.H.5.b.iii of this Supplementary Information,
but would not require a banking organization to establish policies and
procedures describing the trading strategy or risk management for the
notional trading desks or require a notional trading desk to satisfy
the requirements for active management of market risk covered
positions. Nevertheless, to qualify for use of the internal models
approach, the proposal would require a notional trading desk to satisfy
all of the general requirements for trading desks, as well as those
applicable for the models-based measure.\273\
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\272\ The proposal would define a notional trading desk as a
trading desk created for regulatory capital purposes to account for
market risk covered positions arising under subpart D or subpart E
such as net short risk positions, embedded derivatives on
instruments that the banking organization issued that relate to
credit or equity risk that it bifurcates for accounting purposes,
and foreign exchange positions and commodity positions. Notional
trading desks would be exempt from certain requirements applicable
to other trading desks, as discussed in this section III.H.5.b.iv.
\273\ See section III.H.5.d of this Supplementary Information
for further discussion on the requirements applicable to model-
eligible trading desks.
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The agencies are proposing to require a banking organization to
identify any notional trading desks as part of the trading desk
structure requirement, described in section III.H.5.b.iii of this
Supplementary Information, to help ensure that a banking organization
appropriately treats all market risk covered positions under the
capital rule. The agencies would review a banking organization's
trading desk structure, including notional trading desks and trading
desks used for internal risk transfers, to help ensure that they have
been appropriately identified.
Question 101: What, if any, additional requirements should apply to
notional trading desks to clarify the level at which market risk
capital requirements must be calculated? What, if any, additional types
of positions should be assigned to the notional trading desk and why?
iii. Trading Desk Structure
The proposal would require a banking organization to define its
trading desk structure, subject to the requirement that the structure
must define each constituent trading desk and identify: (1) model-
eligible trading desks that are used in the models-based measure for
market risk, (2) model-ineligible trading desks used in both the
standardized measure and model-based measure for market risk,\274\ (3)
trading desks that are used for internal risk transfers (as
applicable), and (4) notional trading desks (as applicable).\275\
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\274\ The list of model-eligible trading desks should include
both those for which the banking organization has elected to
calculate market risk capital requirements under the standardized
approach as well as any trading desks that previously received
approval to use the internal models approach but subsequently
reported one or both PLA test metrics in the red zone, as described
in more detail in section III.H.8.b.ii of this Supplementary
Information. A banking organization should maintain a list of all
trading desks and make it available for the primary Federal
supervisor for review upon request.
\275\ A banking organization could also seek approval for a
notional trading desk to be a model-eligible trading desk. Any such
desk that is approved would be subject to backtesting and profit and
loss attribution testing at the trading desk level.
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Additionally, before calculating market risk capital requirements
under the models-based measure for market risk, the proposal would
require a banking organization to receive prior written approval from
the primary Federal supervisor of its trading desk structure. As part
of the model approval process described in section III.H.5.d.iv of this
Supplementary Information, the agencies would consider whether the
level at which a banking organization is proposing to establish its
trading desks is consistent with the level at which trading activities
are actively managed and operated. The agencies would also consider
whether the level at which the banking organization defines each
trading desk is sufficiently granular to allow the banking organization
and the primary Federal supervisor to assess the adequacy of the
internal models used by the trading desk. For example, a banking
organization's proposed trading desk structure may be considered
insufficiently detailed if it reflects risk limits, internal controls,
and ongoing management at one or more organizational levels above the
routine management of the trading desk (for example, at the division-
wide or entity level).
iv. Trading Desk Policies
Subpart F of the current capital rule requires a banking
organization to have clearly defined trading and hedging strategies for
their trading positions that are approved by senior management. In
addition to applying these requirements at the trading desk level for
trading desks that are not notional trading
[[Page 64104]]
desks, the proposal would require policies and procedures for each
trading desk to describe the strategy and risk management framework
established for overseeing the risk-taking activities of the trading
desk.
For each trading desk that is not a notional trading desk, the
proposal would require a banking organization to have a clearly defined
policy, approved by senior management, that describes the general
strategy of the trading desk, the risk and position limits established
for the trading desk, and the internal controls and governance
structure established to oversee the risk-taking activities of the
trading desk.\276\ At a minimum, this would include the business
strategy for each trading desk; \277\ the clearly defined trading
strategy that details the market risk covered positions in which the
trading desk is permitted to trade, identifies the main types of market
risk covered positions purchased and sold by the trading desk, and
articulates the expected holding period of, and market risk associated
with, each portfolio of market risk covered positions held by the
trading desk; the clearly defined hedging strategy that articulates the
acceptable level of market risk and details the instruments,
techniques, and strategies that the trading desk will use to hedge the
risks of the portfolio; a brief description of the general strategy of
the trading desk that addresses the economics of its business strategy,
primary activities, and trading and hedging strategies; and the risk
scope applicable to the trading desk that is consistent with its
business strategy, including the overall risk classes and permitted
risk factors.\278\
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\276\ Under the proposal, these requirements would generally not
apply to any notional trading desk, except those with prior approval
from the primary Federal supervisor to use the internal models
approach.
\277\ Under the proposal, the business strategy must include
regular reports on the revenue, costs and market risk capital
requirements of the trading desk.
\278\ See section III.H.7.a.i of this Supplementary Information
for further discussion on risk factors.
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Together, the proposed requirements are intended to help ensure
that each trading desk engages only in those activities that are
permitted by senior management and that any exceptions would be
elevated to the appropriate organizational level. For example, the
proposed requirement for a banking organization to document trading,
hedging, and business strategies, including the internal controls
established to manage the risks arising from the trading strategy, at
the level of the organization responsible for implementing the general
business strategy, is intended to help ensure appropriate monitoring of
the risk limits set by senior management. Additionally, the proposed
requirements would help to assist the primary Federal supervisor in
monitoring compliance, particularly when assessing whether the trading
activities conducted by a trading desk are consistent with the general
strategy of the desk and the appropriateness of the limits established
for the desk. For example, the requirement for a trading desk to list
the types of instruments traded by the desk to hedge risks arising from
its business strategy would help to assist the primary Federal
supervisor in providing effective supervisory oversight of the trading
desk's activities.
c. Operational Requirements
Subpart F of the current capital rule requires a banking
organization to satisfy certain operational requirements for active
management of market risk covered positions, stress testing, control
and oversight, and documentation. The proposal would maintain these
requirements and introduce revisions designed to complement changes
under the proposed standardized and models-based measures for market
risk (including the application of calculations at the trading desk
level in the case of the models-based measure for market risk), and to
support the proposed requirements described in section III.H.5.a of
this Supplementary Information that would help ensure a banking
organization maintains robust risk management processes for identifying
and appropriately managing its market risk covered positions.
A key assumption of the proposed market risk framework is that the
internal risk management models \279\ used by banking organizations
provide an adequate basis for determining risk-based capital
requirements for market risk covered positions.\280\ To help ensure
such adequacy, the proposal also would strengthen a banking
organization's prudent valuation practices by incorporating
requirements that build on the agencies' overall regulatory framework
for market risk management, including the regulatory guidance set forth
in the Board's Supervision and Regulation (SR) Letter 11-7 and OCC's
Bulletin 2011-12, Regulatory Guidance on Model Risk Management. In
addition to facilitating the regulatory review process, the proposed
revisions are intended to assist a banking organization's independent
risk control unit and audit functions in providing appropriate review
of and challenge to model risk management, thereby promoting effective
model risk management.
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\279\ The proposal would define internal risk management model
as a valuation model that the independent risk control unit within
the banking organization uses to report market risks and risk-
theoretical profits and losses to senior management. See Sec.
__.202 of the proposed rule.
\280\ Additionally, as described in more detail in section
III.H.7.a.ii of this Supplementary Information, the proposal also
assumes that the valuation models used to report actual profits and
losses for purposes of financial reporting would provide an adequate
basis for purposes of calculating regulatory capital requirements.
As such models are already subject to additional requirements to
enhance the accuracy of the financial data produced, the proposed
requirements would only apply to those internal risk management
models that the primary Federal supervisor has approved the banking
organization to use in calculating regulatory capital requirements.
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The general risk management requirements described in this section
would apply to all banking organizations subject to the proposed market
risk capital framework regardless of whether they use the standardized
measure for market risk or models-based measure for market risk.
i. Active Management of Market Risk Covered Positions
Subpart F of the current capital rule requires a banking
organization to have clearly defined policies and procedures for
actively managing all positions subject to the market risk capital
rule, including establishing and conducting daily monitoring of
position limits.\281\ These requirements are appropriate to support
active management and monitoring under the current framework; the
proposal adds enhancements to support active management and monitoring
at the trading desk level.
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\281\ The proposal would retain certain other requirements with
modifications such as policies and procedures for active management
of trading positions subject to the market risk requirements which
include, but are not limited to, ongoing assessment of the ability
to hedge market risk covered positions and portfolio risks. See 12
CFR 3.203(b)(1) or 12 CFR 217.203(b)(1).
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Accordingly, the proposal would require a banking organization to
have clearly defined policies and procedures that describe its internal
controls, as well as its ongoing monitoring, management, and
authorization procedures, including escalation procedures, for the
active management of all market risk covered positions. At a minimum,
these policies and procedures must identify key groups and personnel
responsible for overseeing the activities of the banking organization's
trading desks that are not notional trading desks.
Further, the proposal would specify a broader set of risk metrics
for the monitoring requirement, which would
[[Page 64105]]
apply at the trading desk level. Specifically, at a minimum, the
proposal would require that a banking organization establish and
conduct daily monitoring by trading desks of: (1) trading limits,
including intraday trading limits, limit usage, and remedial actions
taken in response to limit breaches; (2) sensitivities to risk factors;
and (3) market risk covered positions and transaction volumes; and, as
applicable, (4) VaR and expected shortfall; (5) backtesting and p-
values \282\ at the trading desk level and at the aggregate level for
all model-eligible trading desks; and (6) comprehensive profit-and-loss
attribution (each as described in sections III.H.7 and III.H.8 of this
Supplementary Information). These risk metrics are the minimum elements
necessary to support adequate daily monitoring of market risk covered
positions at the trading desk level.
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\282\ P-value is the probability, when using the VaR-based
measure for purposes of backtesting, of observing a profit that is
less than, or a loss that is greater than, the profit or loss that
actually occurred on a given date.
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Consistent with subpart F of the capital rule, for a banking
organization that has approval for at least one model-eligible trading
desk, the proposal would require the banking organization's policies
and procedures to describe the establishment and monitoring of
backtesting and p-values at the trading desk level and at the aggregate
level for all model-eligible trading desks. Daily information on the
probability of observing a loss greater than that which occurred on any
given day is a useful metric for a banking organization and supervisors
to assess the quality of a banking organization's VaR model. For
example, if a banking organization that used a historical simulation
VaR model using the most recent 500 business days experienced a loss
equal to the second worst day of the 500, it would assign a probability
of 0.004 (2/500) to that loss based on its VaR model. Applying this
process many times over a long interval provides information about the
adequacy of the VaR model's ability to characterize the entire
distribution of losses, including information on the size and number of
backtesting exceptions. The requirement to create and retain this
information at the entity-wide and trading desk level may help identify
particular products or business lines for which a model does not
adequately measure risk. The agencies view active management of model
risk at the trading desk level as the best mechanism to address
potential risks of reliance on models, such as the possible adverse
consequences (including financial loss) of decisions based on models
that are incorrect or misused.
ii. Stress Testing and Internal Assessment of Capital Adequacy
Subpart F of the capital rule requires a banking organization to
have a rigorous process for assessing its overall capital adequacy in
relation to its market risk. The process must take into account market
concentration and liquidity risks under stressed market conditions as
well as other risks arising from the banking organization's trading
activities that may not be fully captured by a banking organization's
internal models. At least quarterly, a banking organization must
conduct stress tests at the entity-wide level of the market risk of its
covered positions.
The proposal would enhance the stress testing and internal
assessment of capital adequacy requirements in subpart F of the capital
rule to reflect both the entity-wide and the trading-desk level
elements within the proposed market risk capital requirement
calculation. Specifically, the proposal would require a banking
organization to stress-test the market risk of its market risk covered
positions at both the entity-wide and trading-desk level on at least a
quarterly basis. The proposal also would require that results of such
stress testing be reviewed by senior management of the banking
organization and reflected in the policies and limits set by the
banking organization's management and the board of directors, or a
committee thereof. In addition to concentration and liquidity risks,
the proposal would require stress tests to take into account risks
arising from a banking organization's trading activities that may not
be adequately captured in the standardized measure for market risk or
in the models-based measure for market risk, as applicable.
The proposed requirements are intended to help ensure that each
trading desk only engages in those activities that are permitted by the
banking organization's senior management, and that any weaknesses
revealed by the stress testing results would be elevated to the
appropriate management levels of the banking organization and addressed
in a timely manner.
iii. Control and Oversight
Subpart F of the capital rule requires a banking organization to
maintain a risk control unit that reports directly to senior management
and is independent of the business trading units. The internal audit
function is responsible for assessing, at least annually, the
effectiveness of the controls supporting the banking organization's
market risk measurement systems (including the activities of the
business trading units and independent risk control unit), compliance
with the banking organization's policies and procedures, and the
calculation of the banking organization's market risk capital
requirements. At least annually, the internal audit function must
report its findings to the banking organization's board of directors
(or a committee thereof).
The proposal largely would retain the control, oversight, and
validation requirements in subpart F of the capital rule, including the
requirement that a banking organization maintain an independent risk
control unit. The proposal would expand the required oversight
responsibilities of the independent risk control unit to include the
design and implementation of market risk management systems that are
used for identifying, measuring, monitoring, and managing market risk.
The proposed change is intended to complement other changes under the
proposal, in particular allowing a banking organization to calculate
risk-based requirements using standardized and models-based measures
for market risk (for example, the inclusion of more rigorous model
eligibility tests that apply at the trading desk level), as well as the
introduction of a capital add-on requirement for re-designations.
Further, the proposal would enhance the internal review and
challenge responsibilities of a banking organization by requiring it to
maintain conceptually sound systems and processes for identifying,
measuring, monitoring, and managing market risk. In addition to its
current requirements under subpart F of the capital rule, the banking
organization's internal audit function would have to assess at least
annually the effectiveness of the designations and re-designations of
market risk covered positions, and its assessment of the calculation of
the banking organization's measures for market risk under subpart F,
including the mapping of risk factors to liquidity horizons, as
applicable. The proposal would enhance the validation requirements by
requiring a banking organization to maintain independent validation of
its valuation models and valuation adjustments or reserves.
The agencies intend for these elements of the proposal to enhance
the accountability of the banking organization's independent risk
control unit and internal audit function and provide banking
organizations with sufficient flexibility to incorporate the
[[Page 64106]]
risk management processes required for regulatory capital purposes
within those daily risk management processes used by the banking
organization, such that managing market risk would be more consistent
with the banking organization's overall risk profile and business
model. A banking organization's primary Federal supervisor would
evaluate the robustness and appropriateness of the banking
organization's internal stress-testing methods, risk management
processes, and capital adequacy.
iv. Documentation
Similar to the enhancements to policies and procedures described
above, the proposal would enhance the documentation requirements under
subpart F of the capital rule to reflect the proposed market risk
capital framework. Specifically, a banking organization would be
required to adequately document all material aspects of its
identification, management, and valuation of its market risk covered
positions, including internal risk transfers and any re-designations of
positions between subpart F and subparts D and E of the capital rule.
Consistent with subpart of F of the current capital rule, the proposal
would require a banking organization to adequately document all
material aspects of its internal models, and its control, oversight,
validation, and review processes and results, as well as its internal
assessment of capital adequacy. The proposal also would require a
banking organization to document an explanation of the empirical
techniques used to measure market risk. Further, a banking organization
would be required to establish and document its trading desk structure,
including identifying which trading desks are model-eligible, model-
ineligible, used for internal risk transfers, or constitute notional
trading desks, as well as document policies describing how each trading
desk satisfies applicable requirements. These enhancements would
support the banking organization's ability to distinguish between
positions subject to subpart F of the capital rule and those that are
not.
d. Additional Operational Requirements for the Models-Based Measure for
Market Risk
Under subpart F of the capital rule, a banking organization must
use an internal VaR based model to calculate risk-based capital
requirements for its covered positions. The proposal would not require
a banking organization to use an internal model but would allow a
banking organization that has approval from its primary Federal
supervisor for at least one model-eligible trading desk to use the
internal models approach to calculate market risk capital requirements.
As a condition for use of the internal models approach, the
proposal would require a trading desk to satisfy certain additional
operational requirements, which are intended to help ensure that a
banking organization has allocated sufficient resources for the desk to
develop and rely on internal models that appropriately capture the
market risk of its market risk covered positions. Specifically, the
additional operational requirements, as well as the proposed profit and
loss attribution and backtesting requirements, as described in sections
III.H.8.b and III.H.8.c of this Supplementary Information, would help
ensure that the losses estimated by the internal models used to
calculate a trading desk's risk-based capital requirements are
sufficiently accurate and sufficiently conservative relative to the
profits and losses that are reported in the general ledger. These
general ledger reported profits and losses are produced by front-office
models.\283\ In this way, the additional operational requirements are
intended to help ensure that the internal models of a trading desk
properly measure all material risks of the market risk covered
positions to which they are applied, and the sophistication of the
internal models is commensurate with the complexity and extent of
trading activity conducted by the trading desk.
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\283\ The proposed backtesting requirements are intended to
measure the conservatism of the forecasting assumptions and
valuation methods in the expected shortfall models used for
determining risk-based capital requirements while the proposed PLA
testing requirements are intended to measure the accuracy of the
potential future profits or losses estimated by the expected
shortfall models relative to those produced by the front office
models. If a trading desk fails to satisfy either the proposed PLA
or backtesting requirements, it would no longer be able to calculate
risk-based capital requirements using the internal models approach.
In this way, the proposal would only allow trading desks for which
the internal models are sufficiently conservative and accurate to
use the internal models approach to calculate its market risk
capital requirements.
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As described above, the proposal would require eligibility for use
of the internal models approach to be determined at the trading desk
level, rather than for the entire banking organization. By aligning the
level at which a banking organization may be permitted to model market
risk capital requirements with the level at which the banking
organization applies its front office controls, the proposed
requirements would enhance prudent capital management for banking
organizations that use the models-based measure for market risk.
Additionally, the proposed trading desk-level framework would provide a
prudential backstop to the internal models approach by requiring the
use of the standardized approach for trading desks with risks that are
not adequately captured by a banking organization's internal models.
This avoids the risk of an abrupt or severe change in a banking
organization's overall market risk capital requirement in the event
that a particular trading desk ceases to be eligible to use the
internal models approach.
i. Trading Desk Identification
As part of the model approval process, the proposal would require a
banking organization to identify all trading desks within its trading
desk structure that it would designate as model-eligible and for which
it would seek approval to use internal models from the primary Federal
supervisor. When identifying which trading desks to designate as model-
eligible, the banking organization would be required to consider
whether the standardized or internal models approach would more
appropriately reflect the market risk of the desk's market risk covered
positions.
Additionally, the proposal generally would prohibit a banking
organization from seeking model approval for trading desks that hold
securitization positions or correlation trading positions, with one
exception. Given the operational difficulties of requiring a banking
organization to bifurcate trading desks that hold an insignificant
amount of securitization or correlation trading positions pursuant to
their trading or hedging strategy, the proposal would allow the banking
organization to designate such desks as model-eligible. If the primary
Federal supervisor were to approve the use of internal models for such
desks, the proposal would require the banking organization to
separately calculate market risk capital requirements for such
securitization or correlation trading positions held by a model-
eligible trading desk under either the standardized approach or the
fallback capital requirement, and otherwise treat such positions as if
they were not held by the desk.\284\
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\284\ Specifically, the proposal would require a banking
organization to exclude any insignificant amount of securitization
positions and/or correlation trading positions held by the model-
eligible trading desk from (1) the aggregate trading portfolio
backtesting; and (2) from the relevant desk-level backtesting and
profit and loss attribution metrics, except with the approval of the
banking organization's primary Federal supervisor.
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Question 102: The agencies seek comment on the benefits and
drawbacks
[[Page 64107]]
of requiring trading desks that hold an insignificant amount of
securitization positions and correlation trading positions to exclude
from the internal models approach such positions and any related
hedges, if applicable, in order for such desks to request approval to
calculate market risk capital requirements under the models-based for
market risk. Commenters are encouraged to provide data to support their
responses.
ii. Review, Risk Management, and Validation
To help ensure that the internal models appropriately capture a
model-eligible trading desk's market risk exposure on an ongoing basis,
the proposal would require a banking organization to satisfy additional
model review and validation standards for model-eligible trading desks
in order to calculate market risk capital requirements under the
models-based measure for market risk.
Specifically, a banking organization that uses the models-based
measure for market risk would be required to (1) review its internal
models at least annually and enhance them, as appropriate, to help
ensure the models continue to satisfy the initial approval requirements
and employ risk measurement methodologies that are the most appropriate
for the banking organization's market risk covered positions, (2)
integrate its internal models used for calculating the expected
shortfall-based measure for market risk into its daily risk management
process, and (3) independently \285\ validate its internal models both
initially and on an ongoing basis, and revalidate them when there is a
material change to a model, a significant structural change in the
market, or changes in the composition of its market risk covered
positions that might result in the internal models no longer adequately
capturing the market risk of the market risk covered positions held by
the model-eligible trading desk.
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\285\ Either the validation process itself would have to be
independent, or the validation process would have to be subjected to
independent review of its adequacy and effectiveness. The
independence of the banking organization's validation process would
be characterized by separateness from and impartiality to the
development, implementation, and operation of the banking
organization's internal models, or otherwise by independent review
of its adequacy and effectiveness, though the personnel conducting
the validation would not necessarily be required to be external to
the banking organization.
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The proposal also would require banking organizations to establish
a validation process that at a minimum includes an evaluation of the
internal models' (1) conceptual soundness \286\ and (2) adequacy in
appropriately capturing and reflecting all material risks, including
that the assumptions are appropriate and do not underestimate risks.
Additionally, the proposal would require a banking organization to
perform ongoing monitoring to review and verify processes, including by
comparing the outputs of the internal models with relevant internal and
external data sources or estimation techniques. The results of this
comparison provide a valuable diagnostic tool for identifying potential
weaknesses in a banking organization's models. As part of this
comparison, a banking organization would be expected to investigate the
source of differences between the model estimates and the relevant
internal or external data or estimation techniques and whether the
extent of the differences is appropriate.
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\286\ The process should include evaluation of empirical
evidence supporting the methodologies used and evidence of a model's
strengths and weaknesses.
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In addition, the proposal would expand on the outcomes analysis
requirements in subpart F of the capital rule by requiring validation
to include not only any outcomes analysis that includes backtesting at
the aggregated level of all model-eligible trading desks, but also
backtesting and profit and loss attribution testing at the trading desk
level for each model-eligible trading desk. The agencies recognize that
financial markets and modeling technologies undergo continual
development. Accordingly, a banking organization needs to continually
ensure that its models are appropriate. The ongoing review, risk
management, and validation requirements in the proposal are intended to
help ensure that the internal models used accurately reflect the risks
of market risk covered positions in evolving markets.
iii. Documentation
In addition to the general documentation requirements applicable to
all banking organizations as described in section III.H.5.c.iv of this
Supplementary Information, the proposal would require a banking
organization that uses the models-based measure for market risk to
document policies and procedures regarding the determination of which
risk factors are modellable and which are not modellable (risk factor
eligibility test), including a description of how the banking
organization maps real price observations to risk factors; the data
alignment of the profit and loss systems used by front office and by
the internal risk management models; the assignment of risk factors to
liquidity horizons, and any empirical correlations recognized with
respect to risk factor classes.
As with the other enhanced operational requirements applicable to a
banking organization that uses the models-based measure for market
risk, these requirements are designed to help ensure the use of the
internal models approach under the models-based measure for market risk
only applies to those trading desks for which the banking organization
is able to demonstrate that the internal models appropriately capture
the market risk of the market risk covered positions held by the desk.
iv. Model Eligibility
For the banking organization to use the models-based measure for
market risk, the proposal would require a banking organization to
receive the prior written approval from its primary Federal supervisor
for at least one trading desk to apply the internal models approach.
Accordingly, the proposal would establish a framework for such
approval.
I. Initial Approval
Under the proposal, the approval for a banking organization to use
internal models would be granted at the individual trading desk
level.\287\ For the primary Federal supervisor to approve an internal
model, the proposal would require a banking organization to demonstrate
that (1) the internal model properly measures all the material risks of
the market risk covered positions to which it would be applied; (2) the
internal model has been properly validated in accordance with the
validation process and requirements; (3) the level of sophistication of
the internal model is commensurate with the complexity and amount of
the market risk covered positions to which it would be applied; and (4)
the internal model meets all applicable requirements.
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\287\ The proposal would require a banking organization to
receive written approval from the primary Federal supervisor for
both the expected shortfall internal model and the stressed expected
shortfall methodology used by the trading desk. As the initial
approval process for each would be the same, for simplicity, the
term ``internal models'' used throughout this section is intended to
refer to both.
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To receive approval as a model-eligible trading desk, the proposal
would require a trading desk to satisfy one of the following criteria.
The banking organization could provide to the primary Federal
supervisor at least 250 business days of backtesting and PLA test
results for the trading desk.
[[Page 64108]]
Alternatively, the banking organization could either (1) provide at
least 125 business days of backtesting and PLA test results for the
trading desk and demonstrate to the satisfaction of the primary Federal
supervisor that the internal models would be able to satisfy the
backtesting and PLA requirements on an ongoing basis; (2) demonstrate
that the trading desk consists of market risk covered positions similar
to those of another trading desk that has received approval from the
primary Federal supervisor and such other trading desk has provided at
least 250 business days of backtesting and PLA results, or (3) subject
the trading desk to the PLA add-on until the desk provides at least 250
business days of backtesting and PLA test results that pass the
trading-desk level backtesting requirements and produce PLA metrics in
the green zone, as further described in sections III.H.8.b and
III.H.8.c of this Supplementary Information.
The proposed criteria would hold trading desks to robust modeling
requirements, while providing a banking organization sufficient
flexibility to satisfy the standard over time and as the banking
organization adapts its business structure. The agencies recognize that
when initially requesting approval and in subsequent requests (for
example, after a reorganization or upon entering into a new business),
a banking organization may not always be able to provide a full year of
backtesting and PLA results for each trading desk, even if the internal
models used by the desk provide an adequate basis for determining risk-
based capital requirements. The proposed criteria would allow a banking
organization to seek model approval for trading desks with at least a
six-month track record demonstrating the accuracy and conservatism of
the internal models used by the desk (PLA and backtesting results) as
well as for trading desks that consist of similar market risk covered
positions to another trading desk, for which the banking organization
has provided at least 250 business days of trading desk level profit
and loss attribution test and backtesting results and has received
approval from its primary Federal supervisor. Given the difficulty in
evaluating the appropriateness of the internal models used by trading
desks that provide less than six months of profit and loss attribution
test and backtesting results and that do not consist of market risk
covered positions similar to those of another trading desk that has
received approval, the agencies are proposing to allow a banking
organization to designate such desks as model-eligible, but to subject
any such trading desk approved by the primary Federal supervisor to the
PLA add-on until the desk produces one year of satisfactory profit and
loss attribution test and backtesting results in the green zone. Thus,
the trading desk would remain subject to an additional capital
requirement until it provides sufficient evidence demonstrating the
appropriateness of the internal models, at which time application of
the PLA add-on would automatically cease.
II. Ongoing Eligibility and Changes to Trading Desk Structure or
Internal Models
Subpart F of the current capital rule requires a banking
organization to promptly notify the primary Federal supervisor when (1)
extending the use of a model that the primary Federal supervisor has
approved to an additional business line or product type, (2) making any
change to an internal model that would result in a material change in
the banking organization's total risk-weighted asset amount for market
risk for a portfolio of covered positions, or (3) making any material
change to its modelling assumptions.
The proposal would expand on these requirements to require a
banking organization to receive prior written approval from its primary
Federal supervisor before implementing any change to its trading desk
structure or internal models (including any material change to its
modelling assumptions) that would (1) in the case of trading desk
structure, materially impact the risk-weighted asset amount for a
portfolio of market risk covered positions; or (2) in the case of
internal models, result in a material change in the banking
organization's internally modelled capital calculation for a trading
desk under the internal models approach. Additionally, the proposal
would require a banking organization to promptly notify its primary
Federal supervisor of any change, including non-material changes, to
its internal models, modelling assumptions, or trading desk
structure.\288\ Whether a banking organization would be required to
receive prior written approval or promptly notify the primary Federal
supervisor before extending the use of an approved model to an
additional business line or product type would depend on the nature of
and impact of such a change.
---------------------------------------------------------------------------
\288\ In such cases, a banking organization should notify the
primary Federal supervisor in writing, in a manner acceptable to the
supervisor (such as through email, where appropriate).
---------------------------------------------------------------------------
The proposal also would require a model-eligible trading desk to
perform and successfully pass quarterly backtesting and the PLA testing
requirements on an ongoing basis in order to maintain its approval
status.\289\ As banking organizations' quarterly review of backtesting
and PLA results would take place after a quarter is over, the proposal
would permit a banking organization to rely on the internal models
approach for model-eligible trading desks that previously received
approval from the primary Federal supervisor during the 20-day period
following quarter end while updating its use of internal models based
on the results of the quarterly review.
---------------------------------------------------------------------------
\289\ See sections III.H.8.b and III.H.8.c of this Supplementary
Information.
---------------------------------------------------------------------------
Even if a model-eligible trading desk were to satisfy the above
requirements, a banking organization's primary Federal supervisor could
determine that the desk no longer complies with any of the proposed
applicable requirements for use of the models-based measure for market
risk or that the banking organization's internal model for the trading
desk fails to either comply with any of the applicable requirements or
to accurately reflect the risks of the desk's market risk covered
positions. In such cases, the primary Federal supervisor could (1)
rescind the desk's model approval and require the desk to calculate
market risk capital requirements under the standardized approach, or
(2) subject the desk to a PLA add-on capital requirement until it
restores the desk's full approval, in the case of trading desk
noncompliance.
The agencies recognize that even if a banking organization's
expected shortfall model for a trading desk satisfies the proposed
backtesting, PLA testing, and operational requirements, the model may
not appropriately capture the risk of the market risk covered positions
held by the desk (for example, if the model develops specific
shortcomings in risk identification, risk aggregation and
representation, or validation). Thus, as an alternative to requiring a
trading desk to use the standardized approach, the proposal would allow
the primary Federal supervisor to subject the trading desk to the PLA
add-on if the desk were to continue to satisfy all of the proposed
backtesting, PLA testing, and operational requirements for use of the
models-based measure for market risk. In this way, the proposal would
help to ensure that the market risk capital requirements for the
trading desk appropriately reflect the materiality of the shortcomings
of the expected
[[Page 64109]]
shortfall model, as the PLA add-on would apply until such time that the
banking organization enhances the accuracy and conservatism of the
trading desk's expected shortfall model to the satisfaction of its
primary Federal supervisor.
Similarly, after approving a banking organization's stressed
expected shortfall methodology to capture non-modellable risk factors
for use by one or more trading desks, as described in section
III.H.8.a.i of this Supplementary Information, the primary Federal
supervisor may subsequently determine that the methodology no longer
complies with the operational requirements for use of the models-based
measure for market risk or that the methodology fails to accurately
reflect the risks of the market risk covered positions held by the
trading desk. In such cases, the proposal would allow the primary
Federal supervisor to rescind its approval of the banking
organization's methodology and require the affected trading desk(s) to
calculate market risk capital requirements for the trading desk under
the standardized approach. As the methodologies used to capture the
market risk of non-modellable risk factors would not be subject to the
proposed PLA testing requirements, which inform the calibration of the
PLA add-on as described in section III.H.8.b of this Supplementary
Information, the PLA add-on would not be an alternative if the primary
Federal supervisor rescinds its approval of such a methodology.
6. Measure for Market Risk
Under subpart F of the current capital rule, a banking organization
must use one or more internal models to calculate market risk capital
requirements for its covered positions.\290\ A banking organization's
market risk-weighted assets equal the sum of the VaR-based capital
requirement, the stressed VaR-based capital requirement, specific risk
add-ons, the incremental risk capital requirement, the comprehensive
risk capital requirement, and the capital requirement for de minimis
exposures, plus any additional capital requirement established by the
primary Federal supervisor, multiplied by 12.5. The primary Federal
supervisor may require the banking organization to maintain an overall
amount of capital that differs from the amount otherwise required under
the rule, if the regulator determines that the banking organization's
market risk-based capital requirements under the rule are not
commensurate with the risk of the banking organization's covered
positions, a specific covered position, or portfolios of such
positions, as applicable.
---------------------------------------------------------------------------
\290\ Notably, for securitization positions subject to subpart
F, the current capital rule provides a standardized measurement
method for capturing specific risks and a models-based measure
capturing general risks for calculating market risk-weighted assets.
---------------------------------------------------------------------------
As noted in section III.H.1.b. of this Supplementary Information,
the proposal would introduce a standardized methodology for calculating
market risk capital requirements and a new methodology for the internal
models approach to replace the framework in subpart F of the current
capital rule. Under the proposal, a banking organization that has one
or more model-eligible trading desks would be required to calculate
market risk capital requirements under both the standardized and the
models-based measures for market risk. Furthermore, if required by the
primary Federal supervisor, a banking organization that has one or more
model-eligible trading desk would be required to calculate the
standardized measure for market risk for each model-eligible trading
desk as if that trading desk were a standalone regulatory portfolio. A
banking organization with no model-eligible trading desks would only
calculate market risk capital requirements under the standardized
measure for market risk.
The agencies would have the authority to require a banking
organization to calculate capital requirements for specific positions
or categories of positions under either subpart D or E instead of under
subpart F of the capital rule, or under subpart F instead of under
subpart D or E of the capital rule, or under both subpart F and subpart
D or E, as applicable, to more appropriately reflect the risks of the
positions. Alternatively, under the proposal, the primary Federal
supervisor may require a banking organization to apply a capital add-on
for re-designations of specific positions or portfolios. These proposed
provisions would help the primary Federal supervisor ensure that a
banking organization's risk-based capital requirements appropriately
reflect the risks of such positions.
Additionally, for a banking organization that uses the models-based
measure for market risk, the agencies would reserve the authority to
require a banking organization to modify its observation period or
methodology (including the stress period) used to measure market risk,
when calculating the expected shortfall measure or stressed expected
shortfall. In this way, the proposal would help the primary Federal
supervisor ensure that a banking organization's internal models remain
sufficiently robust to capture risks in a dynamic market environment
and appropriately reflect the risks of such positions.
a. Standardized Measure for Market Risk
Under the proposal, the standardized measure for market risk would
consist of three main components: a sensitivities-based method, a
standardized default risk capital requirement, and a residual risk add-
on (together, the standardized approach). The proposed standardized
measure for market risk also would include three additional components
that would apply in more limited instances to specific positions: the
fallback capital requirement, the capital add-on requirement for re-
designations, and any additional capital requirement established by the
primary Federal supervisor as part of the proposal's reservation of
authority provisions.
The core component of the standardized approach is the
sensitivities-based capital requirement, which would capture non-
default market risk based on the estimated losses produced by risk
factor sensitivities \291\ under regulatorily determined stressed
conditions. The standardized default risk capital requirement captures
losses on credit and equity positions in the event of obligor default,
while the residual risk add-on serves to produce a simple, conservative
capital requirement for any other known risks that are not already
captured by first two components (sensitivities-based measure and the
standardized default risk capital), such as gap risk, correlation risk,
and behavioral risks such as prepayments. The fallback capital
requirement would apply in cases where a banking organization is unable
to calculate either the sensitivities-based capital requirement, such
as when a sensitivity is not available, or the standardized default
risk capital requirement.\292\ Additionally, the capital add-on
requirement for re-designations would apply in cases where a banking
organization re-classifies an instrument after initial designation as
being subject either to the market risk capital requirements under
subpart F or to capital requirements under subpart D or
[[Page 64110]]
E of the capital rule, respectively.\293\ Each of these components is
intended to help ensure the standardized measure for market risk
provides a simple, transparent, and risk-sensitive measure for
determining a banking organization's market risk capital requirements.
The standardized measure for market risk equals the sum of the above
components and any additional capital requirement established by the
primary Federal supervisor, as described in more detail in section
III.H.7 of this Supplementary Information.
---------------------------------------------------------------------------
\291\ A risk factor sensitivity is the change in value of an
instrument given a small movement in a risk factor that affects the
instrument's value.
\292\ See section III.H.6.c of this Supplementary Information
for a more detailed discussion on the fallback capital requirement.
\293\ See section III.H.6.d of this Supplementary Information
for a more detailed discussion of the capital add-on for re-
designations.
---------------------------------------------------------------------------
The agencies view the proposed standardized measure for market risk
as sufficiently risk sensitive to serve as a credible floor to the
models-based measure for market risk. If a trading desk does not
receive approval to use the internal models approach or fails to meet
the operational requirements of the models-based measure for market
risk on an on-going basis, the desk would be required to continue to
use the standardized approach to calculate its market risk capital
requirements. The conservative calibration of the risk weights and
correlations applied to a banking organization's market risk covered
positions would help ensure that risk-based capital requirements under
the standardized approach appropriately capture the market risks to
which a banking organization is exposed. Additionally, by relying on a
banking organization's models to produce risk factor sensitivities, the
proposed standardized measure for market risk would help ensure market
risk capital requirements appropriately capture a banking
organization's actual market risk exposure in a manner that minimizes
compliance burden and enhances risk-capture. Furthermore, the proposed
standardized measure for market risk would also promote comparability
in market risk capital requirements across banking organizations
subject to the proposal.
b. Models-Based Measure for Market Risk
To limit use of the internal models approach to only those trading
desks that can appropriately capture the risks of market risk covered
positions in internal models, model-eligible trading desks would be
required to satisfy the model eligibility criteria and processes (for
example, profit and loss attribution testing) introduced under the
proposal, as described in section III.H.5.d of this Supplementary
Information. Thus, under the proposal, a banking organization with
prior regulatory approval to use the models-based measure for market
risk could have some trading desks that are eligible for the internal
models approach and others that use the standardized approach.
Specifically, if the primary Federal supervisor were to approve a
banking organization to calculate market risk capital requirements for
one or more trading desks under the internal models approach, the
banking organization would be required to calculate the entity-wide
market risk capital requirement under the models-based measure for
market risk (IMAtotal), which would incorporate the capital
requirements under the standardized approach for model-ineligible
trading desks, according to the following formula, as provided under
Sec. __.204(c) of the proposed rule:
IMATotal = min ((IMAG,A + PLA add-on + SAU), SAall desks) + max
((IMAG,A-SAG,A),0) + fallback capital requirement + capital add-ons
Under the proposal, the core components of the models-based measure
for market risk capital requirements are the internal models approach
capital requirements for model-eligible trading desks, which capture
non-default market risks and the standardized default risk capital
requirement for model-eligible desks (IMAG,A), the standardized
approach capital requirements for model-ineligible trading desks (SAU),
the standardized approach capital requirement for market risk covered
positions and term repo-style transactions the banking organization
elects to include in model-eligible trading desks (SG,A) and the
additional capital requirements applied to model-eligible trading desks
with shortcomings in the internal models used for determining
regulatory capital requirements, (PLA addon) if applicable.
To limit the increase in capital requirements arising due to
differences in calculating risk-based capital requirements separately
\294\ between market risk covered positions held by trading desks
subject to the internal models approach and those held by trading desks
subject to the standardized approach, the models-based measure for
market risk would cap the sum of IMAG,A, the PLA add-on, and
SAU at the capital required for all trading desks under the
standardized approach:
---------------------------------------------------------------------------
\294\ Separate capital calculations could unnecessarily increase
capital requirement because they ignore the offsetting benefits
between market risk covered positions held by trading desks subject
to the internal models approach and those held by trading desks
subject to the standardized approach.
---------------------------------------------------------------------------
(min((IMAG,A + PLA add-on + SAU), SAall desks))
The other components of the models-based measure for market risk
include four other components that would only apply in more limited
circumstances; these include the capital requirement for instances
where the capital requirements for model-eligible desks under the
internal models approach exceed those under the standardized approach,
(max((IMAG,A-SAG,A), 0)),\295\ the fallback capital
requirement for instances where a banking organization is not able to
apply the standardized approach and the internal models approach, if
eligible,\296\ and the capital add-on to offset any potential capital
benefit that otherwise might have been received either from re-
designating an instrument or from including ineligible positions on a
model-eligible trading desk,\297\ as well as any additional capital
requirement established by the primary Federal supervisor pursuant to
the proposal's reservation of authority provisions.
---------------------------------------------------------------------------
\295\ As the standardized approach is less risk-sensitive than
the internal models approach, to the extent that the capital
requirement under the internal models approach exceeds that under
the standardized approach for model-eligible desks, the proposal
would require this difference to be reflected in the aggregate
capital requirement under the models-based measure for market risk.
\296\ See section III.H.6.c of this Supplementary Information
for a more detailed discussion on the fallback capital requirement.
\297\ See section III.H.6.d of this Supplementary Information
for a more detailed discussion on the capital add-on requirement for
re-designations.
---------------------------------------------------------------------------
The proposed models-based measure for market risk would provide
important improvements to the risk sensitivity and calibration of risk-
weighted assets for market risk. In addition to replacing the VaR-based
measure with an expected shortfall measure to capture tail risk, the
models-based measure for market risk would replace the fixed ten
business-day liquidity horizon in subpart F of the current capital rule
with ones that vary based on the underlying risk factors in order to
adequately capture the market risk of less liquid positions. The
proposal also would limit the regulatory capital benefit of hedging and
portfolio diversification across different asset classes, which
generally dissipates in stress periods.
Question 103: The agencies seek comment on all aspects of the
models-based measure for market risk calculation, including the capital
requirement for instances where the capital requirement under the
internal models approach for model-eligible
[[Page 64111]]
desks exceeds the amount required for such desks under the standardized
approach. What would be the benefits or drawbacks of capping the total
capital requirement under the models-based measure for market risk at
that required for all trading desks under the standardized approach?
c. Fallback Capital Requirement
The agencies recognize that a banking organization may not be able
to calculate market risk capital requirements for one or more of its
market risk covered positions in situations when a banking organization
is unable to calculate market risk requirements under the standardized
approach and the internal models approach, if eligible. For example, a
banking organization may not be able to calculate some risk factor
sensitivities or components for one or more market risk covered
positions due to an operational issue or a calculation failure. Such
issues could arise when a new market product is introduced and the
banking organization has not had sufficient time to develop models and
analytics to produce the required sensitivities or the new data feeds
for the proposed market risk capital calculations. In such cases, the
proposal would require a banking organization to apply the fallback
capital requirement to the affected market risk covered positions, as
further described below.
For purposes of calculating the standardized measure for market
risk, the proposal would require a banking organization to apply the
fallback capital requirement to each of the affected positions and
exclude such positions from the standardized approach capital
requirement.\298\
---------------------------------------------------------------------------
\298\ The respective components of the standardized approach
capital requirement are the sensitivities-based method capital
requirement, the standardized default risk capital requirement, and
the residual risk add-on.
---------------------------------------------------------------------------
For purposes of calculating the models-based measure for market
risk, unless the banking organization receives prior written approval
from its primary Federal supervisor, the proposal would require the
banking organization to exclude each market risk covered position for
which it is not able to apply the standardized approach or the internal
models approach, as applicable, from the respective components of
IMATotal \299\ As the fallback capital requirement would only apply in
instances where a banking organization is not able to apply the
internal models approach and the standardized approach to calculate
market risk capital requirements, the agencies consider that applying a
separate capital treatment for such positions is appropriate to ensure
that they are conservatively incorporated into the market risk capital
requirement.
---------------------------------------------------------------------------
\299\ The respective components of IMAtotal are: IMAG,A, SAU,
SAall desks, SAG,A, SAi (as part of the PLA add-on calculation), the
capital add-on for certain securitization and correlation trading
positions or equity positions in an investment fund on model-
eligible trading desks, and any additional capital requirement
established by the primary Federal supervisor. See section
III.H.8.b. of this Supplementary Information for further discussion
of each of these components. Also, see section III.H.6.d of this
Supplementary Information for further discussion on the capital add-
on for certain securitization and correlation trading positions held
on model-eligible desks.
---------------------------------------------------------------------------
Similar to the capital requirement for de minimis exposures in
subpart F of the capital rule, the fallback capital requirement would
equal the sum of the absolute fair value of each position subject to
the fallback capital requirement, unless the banking organization
receives prior written approval from its primary Federal supervisor to
use an alternative method to quantify the market risk capital
requirement for such positions.
Question 104: The fair value for derivative positions may
materially underestimate the exposure since the fair value of
derivatives is generally lower than the derivatives' potential exposure
(for example, fair value of a derivative swap contract is generally
zero at origination). Is the fallback capital requirement based on the
absolute fair value of the derivative positions appropriate? What could
be alternative methodologies for the fallback capital requirements for
derivatives (for example, the absolute value of the adjusted notional
amount or the effective notional amount of derivatives as defined in
the standardized approach for counterparty credit risk (SA-CCR)? What,
if any, alternative techniques would more appropriately measure the
market risk associated with market risk covered positions for which the
standardized approach cannot be applied?
d. Re-Designations and Other Capital Add-Ons
To reflect the proposed definition of market risk covered position,
the proposal would require a banking organization to have clearly
defined policies and procedures for identifying positions that are
market risk covered positions and those that are not, as well as for
determining whether, after such initial designation, a position needs
to be re-designated.\300\
---------------------------------------------------------------------------
\300\ See section III.H.5.a of this Supplementary Information.
---------------------------------------------------------------------------
A position's effect on risk-weighted assets can vary based on
whether it is a market risk covered position. Therefore, to offset any
potential capital benefit that otherwise might be received from re-
classifying a position, the proposal would introduce the capital add-on
requirement as a penalty for any re-designation. With prior written
approval from its primary Federal supervisor, the proposal would not
require a banking organization to apply the penalty to re-designations
arising from circumstances that are outside of the banking
organization's control (for example, changes in accounting standards or
in the characteristics of the instrument itself, such as an equity
being listed or de-listed). The agencies expect re-designations to be
extremely rare, and recognize that re-designations could occur, for
example, due to the termination of a business activity applicable to
the instrument. Given the very limited circumstances under which re-
designations would occur, any re-designation would be irrevocable,
unless the banking organization receives prior approval from its
primary Federal supervisor.
To calculate the capital add-on for a re-designation, a banking
organization would be required to calculate the total capital
requirements for the re-designated positions under subparts D, E (if
applicable), and F of the capital rule before and immediately after the
re-designation of a position. The proposal would require a banking
organization that is subject to subpart D of the capital rule to
calculate its total capital requirements separately under subpart D of
the capital rule and under the market risk capital requirements before
and immediately after the re-designation. If the total capital
requirement is lower as a result of the re-designation, then the
difference between the two would be the capital add-on for the re-
designation. In cases when a banking organization is also subject to
subpart E of the capital rule, the proposal would require the banking
organization to calculate total capital requirements separately under
subpart D of the capital rule and subpart E of the capital rule and
under the market risk capital requirements before and immediately after
the re-designation. If the total capital requirement is lower as a
result of the re-designation, then the difference would be the capital
add-on for the re-designation. As such, the proposal would require the
banking organization to apply a capital add-on for re-designated
positions in situations when such re-designations result in any
[[Page 64112]]
capital reduction under the market risk capital requirements.
The proposal would require a banking organization to calculate the
capital add-on requirement at the time of the re-designation. A banking
organization could reduce or eliminate the capital add-on as the
instrument matures, pays down, amortizes, or expires, or the banking
organization sells or exits (in whole or in parts) the position.
Under the standardized measure for market risk, the capital add-on
would include the capital add-on for re-designations. Under the models-
based measure for market risk, the capital add-on would include the
capital add-on for re-designations, as well as add-ons for any
securitization and correlation trading positions, or equity positions
in an investment fund, where a banking organization is not able to
identify the underlying positions held by an investment fund on a
quarterly basis on model-eligible trading desks, provided such
positions are not subject to the fallback capital requirement.
Specifically, for securitization and correlation trading positions and
equity positions in an investment fund, where a banking organization
cannot identify the underlying positions, on model-eligible trading
desks, the models-based measure for market risk includes a capital add-
on equal to the risk-based capital requirement for such positions
calculated under the standardized approach.
Question 105: What, if any, operational challenges could the
proposed capital add-on calculation pose? What, if any, changes should
the agencies consider making to the proposed exceptions to the capital
add-on, such as to address additional circumstances in which the
capital add-ons for re-designations should not apply, and why?
7. Standardized Measure for Market Risk
Under the proposal, the standardized measure for market risk would
consist of the standardized approach capital requirement and three
additional components that would apply in more limited instances to
specific positions: the fallback capital requirement, the capital add-
on requirement for re-designations and any additional capital
requirement established by the primary Federal supervisor.\301\ The
proposal would require a banking organization to calculate the
standardized measure for market risk at least weekly.
---------------------------------------------------------------------------
\301\ See sections III.H.6.c and III.H.6.d of this Supplementary
Information for a more detailed discussion on the fallback capital
requirement and the capital add-on requirement for re-designations,
respectively.
---------------------------------------------------------------------------
a. Sensitivities-Based Method (SBM)
Conceptually, the proposed sensitivities-based method is similar to
a simple stress test where a banking organization estimates the change
in value of its market risk covered positions by applying standardized
shocks to relevant market risk covered positions. The sensitivities-
based method uses risk weights that represent the standardized shocks
with each prescribed risk weight calibrated to a defined liquidity time
horizon consistent with the expected shortfall measurement framework
under stressed conditions. To help ensure consistency in the
application of risk-based capital requirements across banking
organizations, the proposal would establish the following process to
determine the sensitivities-based capital requirement for the
portfolio: (1) assign market risk covered positions to risk classes and
establish the risk factors for market risk covered positions within the
same risk class; (2) describe the method to calculate the sensitivity
of a market risk covered position for each of the prescribed risk
factors; (3) describe the shock applied to each risk factor, and (4)
describe the process for aggregating the weighted sensitivities within
each risk class and across risk classes.
Under the proposal, a banking organization would assign each market
risk covered position to one or more risk buckets within appropriate
risk classes for the position. The seven prescribed risk classes, based
on standard industry classifications, are interest rate risk, credit
spread risk for non-securitization positions, credit spread risk for
correlation trading positions, credit spread risk for securitization
positions that are not correlation trading positions, equity risk,
commodity risk, and foreign exchange risk. The risk buckets represent
common risk characteristics of a given risk class in recognition that
positions sharing such risk characteristics are highly correlated and
therefore affect the value of a market risk covered position in
substantially the same manner. Further, the proposed risk buckets
correspond to common industry practice as large trading banking
organizations often use bucketing structures similar to those set forth
in the proposal.
Once the risk buckets are identified for a position, the bank would
have to map the positions to the appropriate risk factors within the
risk bucket. For example, the price of a typical corporate bond
fluctuates primarily due to changes in interest rates and issuer credit
spreads. Therefore, a position in a corporate bond would be placed in
two separate risk classes, one for interest rate risk and one for
credit spread risk for non-securitization positions.\302\ For positions
within the credit spread risk class, a banking organization would group
the corporate bond position and other positions with similar credit
quality and operating in the same sector together in one risk bucket.
Further, the banking organization would apply the proposed risk factors
to each position within that bucket based on credit spread curves and
tenors of each position. All market risk covered positions would be
assigned to risk buckets within risk classes and mapped to risk factors
based on that assignment.
---------------------------------------------------------------------------
\302\ Under the proposal, a banking organization would have to
separately calculate the potential losses arising from the
position's sensitivity to changes in interest rates and changes in
the issuer's credit spread.
---------------------------------------------------------------------------
For each risk bucket, the proposed risk factors reflect the
specific market variables that impact the value of a position. The risk
factors are separately defined to measure their individual impact on
market risk covered positions' value from small changes in the value of
a risk factor (the movement in price (delta) and, where applicable, the
movement in volatility (vega)), and the additional change in the
positions' value not captured by delta for each relevant risk factor
(curvature) in stress.\303\
---------------------------------------------------------------------------
\303\ Vega and curvature risk estimates are required for
instruments with optionality or embedded prepayment option risk. For
example, for an equity option, the proposed delta risk factor
(equity spot price) would capture the impact on the option's value
from changes in the equity spot price, the proposed vega risk factor
(implied volatility) would capture the impact from changes in the
implied volatility, and the proposed curvature risk factors (equity
spot prices for the issuer) would capture other higher-order factors
from nonlinear risks.
---------------------------------------------------------------------------
Under the proposal, a banking organization would calculate the
sensitivity of a market risk covered position as prescribed under the
proposal to each of the proposed risk factors for delta, vega, and
curvature, as applicable. The proposed sensitivity calculations for
delta, vega, and curvature risk factors are intended to estimate how
much a market risk covered position's value might change as a result of
a specified change in the risk factor, assuming all other relevant risk
factors remain constant. For each risk factor, the banking organization
would sum the resulting delta sensitivities (and separately the vega
and curvature sensitivities) for all market risk covered positions
within the same risk bucket to produce a net sensitivity for each risk
factor, which is
[[Page 64113]]
the potential value impact on all of the banking organization's market
risk covered positions in the risk bucket as a result of a uniform
change in a risk factor.\304\
---------------------------------------------------------------------------
\304\ The proposed risk factors are intended to be sufficiently
granular such that only long and short exposures without basis risk
would be able to fully offset for purposes of calculating the net
sensitivity to a risk factor. For example, by defining the risk
factors for equity risk at the issuer level, the proposal would
allow long and short equity risk exposures to the same issuer to
fully offset for purposes of calculating the net equity risk factor
sensitivity, but only partially offset (correlations less than one)
for exposures to different issuers with the same level of market
capitalization, the same type of economy, and the same market sector
(such as those within the same equity risk bucket).
---------------------------------------------------------------------------
To capture how much the risk factor might change over a defined
time horizon in stress conditions and how that would change the value
of the market risk covered position, a banking organization would
multiply the net delta sensitivity and the net vega sensitivity,
respectively, to each risk factor within the risk bucket by the
proposed standardized risk weight for the risk bucket. The proposed
risk weights are intended to capture the amount that a risk factor
would be expected to move during the liquidity horizon of the risk
factor in stress conditions.\305\ To capture curvature risk, a banking
organization would be required to aggregate the incremental loss above
the delta capital requirement from applying larger upward and downward
shock scenarios to each risk factor.
---------------------------------------------------------------------------
\305\ The prescribed risk weights represent the estimated change
in the value of the market risk covered position as a result of a
standardized shock to the risk factor based on characteristics of
the position and historic price movements. Additionally, the
proposed risk weights are intended to help ensure comparability with
the proposed internal models approach described in section III.H.8
of this Supplementary Information, which generally would require
banking organizations' internal models to follow a methodology
similar to the one used to calibrate the risk weights when
determining risk-based requirements for market risk covered
positions under the standardized approach.
---------------------------------------------------------------------------
To account for the potential price impact of interactions between
the risk factors, the proposal would prescribe aggregation formulas for
calculating the total delta, vega, and curvature capital requirements
within risk buckets and across risk buckets. Specifically, the risk-
weighted sensitivities for delta, vega, and curvature risk,
respectively, first would be summed for a risk factor, then aggregated
across risk factors with common characteristics within their respective
risk buckets to arrive at bucket-level risk positions. These bucket-
level risk positions would then be aggregated for each risk class using
the prescribed aggregation formulas to produce the respective delta,
vega, and curvature risk capital requirements.
The aggregation formulas prescribe offsetting and diversification
benefits via correlation parameters. Under the proposal, the
correlation parameters specified for each risk factor pair are intended
to limit the risk-mitigating benefit of hedges and diversification,
given that the hedge relationship between an underlying position and
its hedge, as well as the relationship between different types of
positions, could decrease or become less effective in a time of stress.
Specifically, taking into account prescribed correlation parameters,
the banking organization would need to calculate the aggregate
requirements first within a risk bucket and then across risk buckets
within one risk class to produce the risk class-level capital
requirement for delta, vega, and curvature risk. The resulting capital
requirements for delta, vega, and curvature risk then would be summed
across risk classes, respectively, with no recognition of any
diversification benefits because in stress diversification across
different risk classes may become less effective.
To capture the potential for risk factor correlations to increase
or decrease in periods of stress, the calculation of risk bucket-level
capital requirements and risk class-level capital requirements for each
risk class would be repeated corresponding to three different
correlation scenarios--assuming high, medium and low correlations
between risk factor shocks--in order to calculate the overall delta,
vega, and curvature capital requirements for all risk classes to
determine the overall capital requirement for each scenario. The
prescribed correlation parameters in the intra-bucket and inter-bucket
aggregation formulas would be those used in the medium correlation
scenario. For the high and low correlation scenarios, a banking
organization generally would increase and decrease the medium
correlation parameters by 25 percent, respectively, to appropriately
reflect the potential changes in the historical correlations during a
crisis.\306\
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\306\ As the degree to which a pair of variables are linearly
related (the correlation) can only range from negative one to one,
the proposal would cap the correlation parameters under the high
scenario at no more than one (100 percent) and floor those under the
low scenario at no less than negative one. For highly correlated
positions, the low correlation scenario also would not always reduce
the correlation parameter by 25 percent.
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Finally, to determine the overall capital requirements for each of
the three correlation scenarios, the banking organization would sum the
separately calculated delta, vega, and curvature capital requirements
for all risk classes without recognition of any diversification
benefits, given that delta, vega, and curvature are intended to
separately capture different risks. The sensitivities-based capital
requirement would be the largest capital requirement resulting from the
three scenarios.
Question 106: The agencies seek comment on the sensitivities-based
method for market risk. To what extent does the sensitivities-based
method appropriately capture the risks of positions subject to the
market risk capital requirement? What additional features, adjustments
(such as to the treatment of diversification of risks), or alternative
methodology could the sensitivities-based method include to reflect
these risks more appropriately and why? Commenters are encouraged to
provide supporting data.
i. Risk Factors
Under the proposal, a banking organization would be required to map
all market risk covered positions within each risk class to the
specified risk factors in order to calculate the capital requirements
for delta, vega, and curvature. The proposed risk factors differ for
each risk class to reflect the specific market risk variables relevant
for each risk class (for example, no tenor is specified for the delta
risk factor for equity risk as equities do not have a stated maturity,
whereas the proposed tenors for credit spread delta risk reflect the
common maturities of positions within those risk classes). The granular
level at which the proposed risk factors would be defined is intended
to promote consistency and comparability in regulatory capital
requirements across banking organizations and to help ensure the
appropriate capitalization of market risk covered positions.
For risk classes that include specific tenors or maturities as risk
factors (for example, delta risk factors for interest rate risk), the
proposal would require a banking organization to assign the risk
factors to the proposed tenors through linear interpolation or a method
that is most consistent with the pricing functions used by the internal
risk management models. The banking organization's internal risk
management models, which are used by risk control units and reviewed by
auditors and regulators, would provide an appropriate basis for
determining regulatory capital requirements, without imposing the
operational burden of the time-consuming methods used by the front-
office models. Additionally, relying on banking organizations'
[[Page 64114]]
internal risk management models, rather than the front-office models,
to identify the relevant risk factors would help ensure that a control
function that is independent of business-line management would
determine the regulatory capital requirement for market risk.
I. Interest Rate Risk
Under the proposal, the delta risk factors for interest rate risk
would be separately defined for each currency along two dimensions:
tenor and interest rate curve. To value market risk covered positions
with interest rate risk, the proposal would require a banking
organization to construct and use interest rate curves for the currency
in which interest rate-sensitive market risk covered positions are
denominated (for example, interest rate curves from the overnight index
swap curve (OIS) or an alternative reference rate curve). The proposal
would require each of these curves to be treated as a distinct interest
rate curve due to the basis risk between them. Similarly, under the
proposal, a banking organization would be required to treat an onshore
currency curve (for example, locally traded contracts) and an offshore
currency curve (for example, contracts with the same maturity that are
traded outside the local jurisdiction) as two distinct curves. A
banking organization would be allowed to treat such curves as a single
curve only with the prior written approval from its primary Federal
supervisor.
As interest rate curves incorporate nominal inflation, an
additional delta risk factor would be required for instruments with
cash flows that are functionally dependent on a measure of inflation
(such as TIPS) to appropriately account for inflation risk.
Furthermore, the proposal would require an additional delta risk factor
for instruments with cash flows in different currencies to
appropriately reflect the cross-currency basis risk of each currency
over USD or EUR.\307\ Under the proposal, a banking organization would
not recognize the term structure when measuring delta capital
requirements for inflation risk and cross-currency basis risk.
Additionally, a banking organization would be required to consider the
inflation risk factor and the cross-currency basis risk factor, if
applicable, in addition to the sensitivity for the other delta risk
factors for the interest rate risk (currency, tenor and interest rate
curve) of the market risk covered position. Accordingly, a banking
organization would be required to allocate the sensitivities for
inflation risk and cross-currency basis risk in the relevant interest
rate curve for the same currency as other interest rate risk factors.
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\307\ Cross-currency basis is a basis added to a yield curve in
order to evaluate a swap for which the two legs are paid in two
different currencies. Market participants use cross currency basis
to price cross currency interest rate swaps paying a fixed or a
floating leg in one currency, receiving a fixed or a floating leg in
a second currency, and including an exchange of the notional amount
in the two currencies at the start date and at the end date of the
swap.
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The vega risk factors for interest rate risk would be the implied
volatilities of options referencing the interest rate of the underlying
instrument. The implied volatilities of inflation rate risk-sensitive
options and cross-currency basis risk-sensitive options would be
defined along the maturity of the option, whereas the implied
volatilities of interest-rate risk-sensitive options would be defined
along two dimensions: the maturity of the option and the residual
maturity of the underlying instrument at the expiration date of the
option. For example, a banking organization would calculate the vega
sensitivity of a European interest rate swaption that expires in 12
months referring to a one-year swap based on the maturity of the option
(12 months) as well as the residual maturity of the underlying
instrument (the swap's maturity of 12 months).
The proposal would define the curvature risk factors for interest
rate risk along one dimension: the interest rate curve of each currency
(no term structure would be considered).
Question 107: The agencies seek comment on the appropriateness of
requiring banking organizations with material exposure to emerging
market currencies to construct distinct onshore and offshore curves.
What, if any, operational burden may arise from such requirement and
why?
II. Credit Spread Risk
The proposal would separately define the credit spread risk factors
for non-securitization positions,\308\ securitization positions that
are not correlation trading positions (securitization positions non-
CTP), and correlation trading positions. The proposal would define the
delta risk factors for credit spread risk for non-securitization
positions along two dimensions: the credit spread curve of a relevant
issuer and the tenor of the position; the delta risk factors for credit
spread risk for securitization positions non-CTP would be defined also
along two dimensions: the credit spread curve of the tranche and the
tenor of the tranche; and the delta risk factors for credit spread risk
for correlation trading positions would be defined along two
dimensions: the credit spread curve of the underlying name and the
tenor of the underlying name. Under the proposal, the vega risk factors
for credit spread risk are the implied volatilities of options
referencing the credit spreads,\309\ defined along one dimension: the
option's maturity.
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\308\ Under the proposal, a non-securitization position would be
defined as a market risk covered position that is not a
securitization position or a correlation trading position and that
has a value that reacts primarily to changes in interest rates or
credit spreads.
\309\ When calculating the sensitivity for securitization
positions non-CTP, a banking organization would calculate the
sensitivities for credit spread risk based on the embedded
subordination of the position, such as the spread of the tranche.
For correlation trading positions, the credit spread risk
sensitivity would be based on the underlying names in the
securitization position, or nth-to-default position.
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The proposal would define the curvature risk factors for credit
spread risk for non-securitization positions along one dimension: the
credit spread curves of the issuer. The curvature risk factors for
credit spread risk for securitization positions non-CTP would be
defined along the relevant tranche credit spread curves of bond and
CDS, while for correlation trading positions along the bond and CDS
credit spread curve of each underlying name. The agencies recognize
that requiring a banking organization to estimate the bond-CDS basis
for each issuer would impose a significant operational burden with
limited benefit in terms of risk capture. To simplify the
sensitivities-based-method calculation for curvature risk in these
cases, the proposal would require banking organizations to ignore any
bond-CDS basis that may exist between the bond and CDS spreads and to
calculate the credit spread risk sensitivity as a single spread curve
across the relevant tenor points.
III. Equity Risk
Similar to interest rate risk, the delta risk factors for equity
risk would be separately defined for each issuer as the spot prices of
each equity (for example, for cash equity positions) and an equity repo
rate (for example, for term repo-style transactions), as appropriate.
Under the proposal, the vega risk factors for equity risk would be the
implied volatilities of options referencing the equity spot price,
defined along the maturity of the option. The curvature risk factors
for equity risk would be the equity spot price. There are no curvature
risk factors for equity repo rates.
[[Page 64115]]
IV. Commodity Risk
Similar to interest rate and equity risk, the delta risk factors
for commodity risk would be separately defined for each commodity type
\310\ along two dimensions: the contracted delivery location of the
commodity and the remaining maturity of the contract. A banking
organization could only treat separate contracts as having the same
delivery location if both contracts allow delivery in all of the same
locations.\311\ Additionally, the proposal would follow the established
pricing convention for commodities and require a banking organization
to use the remaining maturity of the contract to measure the delta
sensitivity for instruments with commodity risk. As the price impact of
risk factor changes varies significantly between different types of
commodities, the proposal would define the delta risk factors for each
commodity type to limit offsetting across commodity types, as such
offsetting could drastically understate the potential losses arising
from those positions.
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\310\ Under the proposal, any two commodities would be
considered distinct if the underlying commodity to be delivered
would cause the market to treat the two contracts as distinct (e.g.,
West Texas Intermediate oil and Brent oil).
\311\ For example, a contract that can be delivered in four
ports may have less sensitivity to each location defined risk factor
than a contract that can only be delivered in three of those ports.
If a banking organization has entered into a contract to deliver
1000 barrels of oil in port A, B, C or D, and a hedge contract to
receive 1000 barrels of oil on the same date in port A, B or C, if
on delivery day ports A, B and C are closed, the banking
organization is exposed to commodity risk in that it must deliver
1000 barrels of oil to port D without receiving 1000 barrels. As a
result, the two contracts would have different sensitivity to
location defined risk factors.
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To measure the price sensitivity of a commodity market risk covered
position, the proposal would require a banking organization to use
either the spot price or the forward price, depending on which risk
factor is used by the internal risk management models to price
commodity transactions. For example, if the internal risk management
model typically values electricity contracts based on forward prices
(rather than spot prices), the proposal would require the banking
organization to compute the delta capital requirement using the current
prices for futures and forward contracts. Similar to equity risk, the
proposal would define the commodity vega risk factors based on the
implied volatilities of commodity-sensitive options as defined along
the maturity of the option and the curvature risk factors based on the
constructed curve per commodity spot price.
Question 108: What, if any, risk factors would better serve to
appropriately capture the delta sensitivity for positions within the
commodity risk class and why?
V. Foreign Exchange Risk
The proposal would define the delta risk factors for foreign
exchange risk as the exchange rate between the currency in which the
market risk covered position is denominated and the reporting currency
of the banking organization. For market risk covered positions that
reference two currencies other than the reporting currency, the banking
organization generally would be required to calculate the delta risk
factors for foreign exchange risk using the exchange rates between each
of the non-reporting currencies and the reporting currency. For
example, for a foreign exchange forward referencing EUR/JPY, the
relevant risk factors for a USD-reporting banking organization to
consider would be the exchange rates for USD/EUR and USD/JPY.
To reduce operational burden and help ensure the delta capital
requirements reflect foreign exchange risk, the proposal would also
allow a banking organization to calculate delta risk factors for
foreign exchange risk relative to a base currency instead of the
reporting currency, if approved by the primary Federal supervisor.\312\
In this case, after designating a single currency as the base currency,
a banking organization would calculate the foreign exchange risk for
all currencies relative to the base currency, and then convert the
foreign exchange risk into the reporting currency using the spot
exchange rate (reporting currency/base currency). For example, if a
USD-reporting banking organization receives approval to calculate
foreign exchange risk using JPY as the base currency, for a foreign
exchange forward referencing EUR/JPY, the banking organization would
consider separate deltas for the EUR/JPY exchange rate risk and USD/JPY
foreign exchange translation risk and then translate the resulting
capital requirement to USD at the USD/JPY spot exchange rate.
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\312\ A banking organization would have to demonstrate to its
primary Federal supervisor that calculating foreign exchange risk
relative to its base currency provides an appropriate risk
representation of the banking organization's market risk covered
positions and that the foreign exchange risk between the base
currency and the reporting currency is addressed. In general, the
base currency would be the functional currency in which the banking
organization generates or expends cash. For example, a multinational
banking organization headquartered in the United States that
primarily transacts in and uses EUR to value its assets and
liabilities for internal accounting and risk management purposes
could use EUR as its base currency. As its consolidated financial
statement must be reported in USD, this multinational banking
organization would need to translate the value of those assets and
liabilities from the base currency (EUR) to the reporting currency
(USD). Since exchange rates fluctuate continuously, this conversion
could increase or decrease the value of those assets and liabilities
and thus generate foreign exchange gains (or losses) from non-
operating activity.
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The proposal would define the vega risk factors for foreign
exchange risk as the implied volatility of options that reference
exchange rates between currency pairs along one dimension: the maturity
of the option. For curvature, the foreign exchange risk factors would
be all exchange rates between the currency in which a market risk
covered position is denominated and the reporting currency (or the base
currency, if approved by the primary Federal supervisor).
The proposal would allow (but not require) a banking organization
to treat a currency's onshore exchange rate and an offshore exchange
rate as two distinct risk factors in the delta, vega and curvature
calculations for foreign exchange risk. While in stress the foreign
exchange risk posed by a currency's onshore exchange rate and an
offshore exchange rate may differ, as U.S. banking organizations
generally do not have material exposure to foreign exchange risk from a
currency's onshore and offshore basis, the prudential benefit of
requiring banking organizations to capture risk posed by such basis
would be limited, relative to the potential compliance burden.
Therefore, the agencies are proposing to allow, but not require,
banking organizations with material exposure to emerging market
currencies to recognize the different foreign exchange risks posed by
onshore and offshore exchange rate curves when calculating risk-based
capital requirements under the sensitivities-based method.
ii. Risk Factor Sensitivities
A fundamental element of the sensitivities-based method is the
sensitivity calculation, which estimates the change in the value of a
market risk covered position as a result of a regulatorily prescribed
change in the value of a risk factor, assuming all other risk factors
are held constant. To help ensure consistency and conservatism across
banking organizations, the proposal would set requirements on the
valuation models, currency, inputs, and sensitivity calculation, as
applicable, that a banking organization could use to measure the risk
factor sensitivity of a market risk covered position.
In general, the proposal would require a banking organization to
calculate risk factor sensitivities using the valuation
[[Page 64116]]
models used to report actual profits and losses for financial reporting
purposes.\313\ The valuation methods used by such models would provide
an appropriate basis for determining risk-based capital requirements
because such models are subject to requirements intended to enhance the
accuracy of the financial data produced by the models.\314\ The
agencies recognize that a banking organization can calculate risk
sensitivities for delta and vega or estimate curvature using valuation
methods and systems from equivalent internal risk management models.
The proposal would permit a banking organization with prior approval of
the primary Federal supervisor to calculate delta and vega
sensitivities and curvature scenarios using the valuation methods used
in its internal risk management models.
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\313\ Banking organizations would be required to have a prudent
valuation process, including the independent validations of the
valuation models used in the standardized approach.
\314\ Such requirements include the requirements from the
Sarbanes-Oxley Act of 2002. Public Law 107-204.
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For consistency and comparability in risk-based capital
requirements across banking organizations, the proposal would require
each banking organization to calculate all risk factor sensitivities in
the reporting currency of the banking organization, except for the
foreign exchange risk class where, with prior approval of the primary
Federal supervisor, the banking organization may calculate the
sensitivities relative to a base currency instead of the reporting
currency. To appropriately capture a banking organization's exposure to
market risk, the proposal would require banking organizations to use
fair values that exclude CVA in the calculation of risk factor
sensitivities.
I. Delta
Under the proposal, a banking organization would calculate the
delta capital requirement using the steps previously outlined in
section III.H.7.a of this Supplementary Information for its market risk
covered positions except those whose value exclusively depends on risk
factors not captured by any of the proposed risk classes (exotic
exposures).\315\ The proposal would require a banking organization to
separately calculate the market risk capital requirements for such
positions under the residual risk add-on as described in section
III.H.7.c of this SUPPLEMENTARY INFORMATION.
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\315\ Examples of exotic exposures not captured by any of the
proposed risk classes include but are not limited to longevity,
weather, and natural disasters derivatives.
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For purposes of calculating the delta capital requirement, the
proposal would require a banking organization to calculate the delta
sensitivity of a position using the sensitivity definitions provided in
the proposal for each risk factor and the valuation models used for
financial reporting, unless a banking organization receives prior
written approval to define delta sensitivities based on internal risk
management models.\316\ Based on the proposed sensitivity definitions,
the delta sensitivity would reflect the change in the value of a market
risk covered position resulting from a small specified shift of one
basis point or one percent change to a risk factor, assuming all other
relevant risk factors are held at the current level, divided by the
same specified shift to the risk factor.
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\316\ The proposal would define internal risk management models
as the valuation models that the independent risk control unit
within the banking organization uses to report market risks and
risk-theoretical profits and losses to senior management.
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For the equity spot price, commodity, and foreign exchange risk
factors, the delta sensitivity would equal the change in value of a
market risk covered position due to a one percentage point increase in
the risk factor divided by one percentage point. For the interest rate,
credit spread, and equity repo rate risk factors, the delta sensitivity
would equal the change in value of a market risk covered position due
to a one basis point increase in the risk factor divided by one basis
point. In the case of credit spread risk for securitizations non-CTP, a
banking organization would calculate the delta sensitivity for the
positions with respect to the credit spread of the tranche rather than
the credit spread of the underlying positions. For credit spread risk
for correlation trading positions, the delta sensitivity for credit
spread risk would be computed using a one basis point shift in the
credit spreads of the individual underlying names of the securitization
position or nth-to-default position.
When calculating the delta sensitivity for positions with
optionality, a banking organization would apply either the sticky
strike rule,\317\ the sticky delta rule,\318\ or, with the prior
approval from its primary Federal supervisor, another assumption.\319\
Each of these methods, or various combinations of such methods, would
measure appropriately the sensitivity of a risk factor within any of
the risk classes.
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\317\ Under the sticky strike rule, a banking organization would
assume that the implied volatility for an option remains unaffected
by changes in the underlying asset price for any given strike price.
\318\ Under the sticky delta rule, the banking organization
would assume that the implied volatility for a particular maturity
depends only on the ratio of the price of the underlying asset to
the strike price (sometimes called the moneyness of the option).
\319\ With prior approval from the primary Federal supervisor, a
banking organization could calculate risk factor sensitivities based
on internal risk management models provided the method would be most
consistent with the valuation methods.
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II. Vega
For market risk covered positions with optionality, the vega
sensitivity to a risk factor would equal the vega of an option
multiplied by the volatility of the option, which represents
approximately the change in the option's value as the result of a one
percentage point increase in the value of the option's volatility. To
measure the vega sensitivity of a market risk covered position, the
proposal would require a banking organization to use either the at-the-
money volatility of an option or the implied volatility of an option,
depending on which is used by the valuation models used for financial
reporting \320\ to determine the intrinsic value of volatility in the
price of the option.
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\320\ With the prior approval of the primary Federal supervisor,
a banking organization could use the type of volatility used in the
internal risk management models.
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The vega capital requirement would only apply to options or
instruments with embedded optionality, including instruments with
material prepayment risk. For purposes of calculating the vega capital
requirement, a banking organization would follow the steps previously
outlined and use the same risk buckets applied in the delta capital
calculation and the proposed vega risk weights.
Callable and puttable bonds that are priced based on the yield to
maturity of the instrument would not be subject to the vega capital
requirement. The agencies recognize that in practice a banking
organization may not be able to calculate vega risk for callable and
puttable bonds, as implied volatility for credit spread typically is
not used as an input for the pricing of such instruments, and thus
implied volatility is not captured by the internal models. Therefore,
the agencies are proposing to allow banking organizations to exclude
from the vega capital requirement callable and puttable bonds that are
priced based on the yield to maturity of the instrument, as the delta
capital requirement in these cases would be sufficiently conservative
to capture the potential vega risk arising from such exposures.
To calculate the vega sensitivity, the proposal would require a
banking
[[Page 64117]]
organization to assign options to buckets based on their maturity. As
the proposal defines the vega risk factors for interest rate risk along
two dimensions: the maturity (or expiry) of the option and the maturity
of the option's underlying instrument--a banking organization would be
required to group options within the interest rate risk class along
both of these two dimensions. To help ensure appropriately conservative
capital requirements, the proposal would require a banking organization
to (1) assign instruments with optionality that either do not have a
stated maturity (for example, cancellable swaps) or that have an
undefined maturity to the longest prescribed maturity tenor for vega,
and (2) subject such instruments to the residual risk add-on, as
described in section III.H.7.c of this SUPPLEMENTARY INFORMATION.
Similarly, for options that do not have a stated strike price or that
have multiple strike prices, or that are barrier options, the proposal
would require a banking organization to apply the maturity and strike
price used in its valuation models for financial reporting, unless the
banking organization has received approval to use internal risk
management models, to value the position and apply a residual risk add-
on.\321\ The agencies are proposing these constraints as a simple and
conservative approach for market risk covered positions that are
difficult to value in practice.
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\321\ Tranches of correlation trading positions that do not have
an implied volatility would not be subject to the vega risk capital
requirement. Such instruments would not be exempt from delta and
curvature capital requirements.
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Question 109: As the pricing conventions for certain products (for
example, callable and puttable bonds) do not explicitly use an implied
volatility, the agencies seek comment on the merits of allowing banking
organizations to ignore the optionality of callable and puttable bonds
that are priced using yield-to-maturity of the instrument if the option
is not exercised relative to the merits of specifying a value for
implied volatility (for example, 35 percent) to be used in calculating
the vega capital requirement for credit spread risk positions when the
implied volatility cannot be measured or is not readily available in
the market. What are the benefits and drawbacks of specifying a value
for the implied volatility for such products and what should the
specified value be set to and why? What, if any, alternative approaches
would better serve to appropriately capture the vega sensitivity for
positions within the credit spread risk class when the implied
volatility is not available?
Question 110: The agencies solicit comment on the appropriateness
of relying on a banking organization's internal pricing methods for
determining the maturity and strike price of positions without a stated
strike price or with multiple strike prices. What, if any, alternative
approaches (such as using the average maturity of options with multiple
exercise dates) would better serve to promote consistency and
comparability in risk-based capital requirements across banking
organizations? What are the benefits and drawbacks of such alternatives
compared to the proposed reliance on the internal pricing models of
banking organizations?
III. Curvature
The proposed curvature capital requirements are intended to capture
the price risks inherent in instruments with optionality that are not
already captured by delta (for example, the change in the value of an
option that exceeds what can be explained by the delta of the option
alone). Under the proposal, only options or positions that contain
embedded optionality, including positions with material prepayment
risk, which present material price risks not captured by delta, would
be subject to the curvature capital requirement. While linear
instruments may also exhibit a certain degree of non-linearity, it is
not always material for such instruments. Therefore, to allow for a
more accurate representation of risk, the proposal would permit a
banking organization, at its discretion, to make an election for a
trading desk \322\ to include instruments without optionality risk in
the curvature capital requirement, provided that the trading desk
consistently includes such positions through time.
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\322\ For a banking organization that has established a trading
desk structure with a single trading desk that uses the standardized
measure to calculate market risk capital requirements, the proposal
would allow such banking organization to make such an election for
the entire organization rather than on a trading desk by trading
desk basis. If such an election is made at the enterprise-wide
level, the proposal would require the banking organization to
consistently include positions without optionality within the
curvature calculation.
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The proposal would require a banking organization to use the same
risk buckets applied in the delta capital calculation to calculate
curvature capital requirements. To calculate the risk-weighted
sensitivity for each curvature risk factor within a risk bucket, the
proposal would require a banking organization to fully revalue all of
its market risk covered positions with optionality or that a banking
organization has elected to include in the calculation of its curvature
capital requirement after applying an upward shock and a downward shock
to the current value of the market risk covered position. To avoid
double counting, the banking organization would calculate the
incremental loss in excess of that already captured by the delta
capital requirement for all market risk covered positions subject to
the curvature capital requirements. The larger incremental loss
resulting from the upward and the downward shock would be the curvature
risk-weighted sensitivity.\323\ The below graphic provides a conceptual
illustration of the calculation of the curvature risk-weighted
sensitivity based on the upward and the downward shock scenarios.
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\323\ To promote consistency and comparability in regulatory
capital requirements across banking organizations, the proposal
would require that in cases where the incremental loss resulting
from the upward and the downward shock is the same, the banking
organization must select the scenario in which the sum of the
capital requirements of the curvature risk factors is greater.
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[[Page 64118]]
[GRAPHIC] [TIFF OMITTED] TP18SE23.031
In calculating the curvature risk-weighted sensitivity for the
interest rate, credit spread, and commodity risk classes, the banking
organization would apply the upward and downward shocks assuming a
parallel shift of all tenors for each curve based on the highest
prescribed delta risk weight for the applicable risk
bucket.324 325 The proposal would require a banking
organization to apply the highest risk weight across risk buckets to
each tenor point along the curve (parallel shift assumption) for
conservatism and to help ensure the curvature capital requirements
reflect incremental losses from curvature and not those due to changes
in the shape or slope of the curve. The proposal would require a
banking organization to perform this calculation at the risk bucket
level (not the risk class level). To the extent that applying the
downward shocks results in negative credit spreads, the proposal would
allow banking organizations to floor credit spreads at zero, which is
the natural floor for credit spreads given that negative CDS spreads
are not meaningful.
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\324\ As described in section III.H.7.a.iii.I of this
SUPPLEMENTARY INFORMATION, the proposed risk bucket structure used
to group the delta risk factors for interest rate risk (and the
corresponding risk weight for each risk bucket) is solely based on
the tenor of market risk covered position. For purposes of
calculating the curvature sensitivity for interest rate risk, the
proposal would require a banking organization to disregard the
bucketing structure and apply the highest prescribed delta risk
weight (the 1.7 percent risk weight applicable to the 0.25-year
tenor, or 1.7 percent divided by [radic]2 if the interest rate curve
references a currency that is eligible for a reduced risk weight) to
all tenors simultaneously for each yield curve.
\325\ As the curvature capital requirements would capture an
option's change in the value above that captured by delta, a banking
organization would calculate the curvature sensitivity to credit
spread risk for securitization positions non-CTP and correlation
trading positions using the spread of the tranche and the spread of
the underlying names, respectively.
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For the foreign exchange and equity risk classes, the upward and
downward shocks represent a relative shift of the foreign exchange spot
prices or equity spot prices, respectively, equal to the delta risk
weight prescribed for the risk factor. The agencies recognize that the
conversion of other currencies into either the reporting currency or
base currency, if applicable, would capture exchange rate fluctuations,
and thus overstate the sensitivity for foreign exchange risk. Thus, for
options that do not reference the reporting or base currency of the
banking organization as an underlying exposure, the proposal would
allow the banking organization to divide the net curvature risk
positions by a scalar of 1.5. The proposal would allow a banking
organization to apply the scalar of 1.5 to all market risk covered
positions subject to foreign exchange risk, provided that the banking
organization consistently applies the scalar to all market risk covered
positions with foreign exchange risk through time.
To aggregate the risk bucket-level capital requirements and risk
class-level capital requirements for curvature, a banking organization
would bifurcate positions into those with positive curvature and those
with negative curvature. For the purposes of calculating risk-based
capital requirements for curvature, positions with negative curvature
represent a capital benefit--as they reduce rather than increase risk
and thus risk-based capital requirements. For example, the downward
shock as depicted in the above graphic produces less of an estimated
price reduction under the curvature scenario than under the linear
delta shock (negative curvature). To prevent negative curvature capital
requirements from decreasing the overall capital required under the
sensitivities-based method, both the intra-bucket and inter-bucket
aggregation formulas would floor the curvature capital requirement at
zero. Additionally, both formulas include a variable \326\ to allow a
banking organization to recognize the risk-reducing benefits of market
risk covered positions with negative curvature in offsetting those with
positive curvature, while preventing the aggregation of market risk
covered positions with negative curvature from resulting in an overall
reduction in capital.
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\326\ Specifically, this refers to the psi variable ([Psi])
within the intra and inter-bucket aggregation formulas in Sec.
__.206(d)(2) and Sec. __.206(d)(3) of the proposed rule.
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Question 111: The agencies solicit comment on the appropriateness
of calculating the curvature risk-weighted sensitivity for the
commodity risk class using the upward and downward shocks assuming a
parallel shift of all tenors for each curve. Would a relative shift be
more appropriate for calculating risk-weighted sensitivity for the
commodity risk class and why?
iii. Risk Buckets and Corresponding Risk Weights
After determining the net sensitivity for each of the proposed risk
factors within each risk class, a banking organization would calculate
the risk-weighted sensitivity by multiplying the
[[Page 64119]]
net sensitivity for each risk factor by the risk weight prescribed for
each risk bucket.\327\ The proposed risk buckets and corresponding risk
weights are largely consistent with the framework issued by the Basel
Committee. However, to reflect the potential systematic risks that
positions may experience in a time of stress and avoid reliance on
external ratings in accordance with U.S. law, the agencies are
proposing to use alternative criteria to define the bucketing structure
for risk factors related to credit spread risk and to clarify the
application of the credit spread risk buckets for certain U.S.
products, as described in section III.H.7.a.iii.II of this
SUPPLEMENTARY INFORMATION.\328\ Additionally, to appropriately reflect
a jurisdiction's stage of economic development, the agencies are
proposing to use objective market economy criteria to define the
bucketing structure for risk factors related to equity risk, as
described in section III.H.7.a.iii.III of this SUPPLEMENTARY
INFORMATION. Furthermore, the agencies are proposing to include
electricity in the same risk bucket as gaseous combustibles in view of
the inherent relationship between the price of electricity and natural
gas and to simplify the proposal, as described in section
III.H.7.a.iii.IV of this SUPPLEMENTARY INFORMATION.
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\327\ Vega and curvature capital requirements would use the same
risk buckets as prescribed for delta. See Sec. __.209(c) and (d) of
the proposed rule. Table 11 to Sec. __.209 of the proposed rule
provides the proposed vega risk weights for each risk class, which
incorporate the liquidity horizons for each risk class (risk of
market illiquidity) from the Basel III reforms.
\328\ See 15 U.S.C. 78o-7 note.
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The proposed risk weight buckets and associated risk weights would
be appropriate to capture the specific, idiosyncratic risks of market
risk covered positions (for example, negative betas or variations in
capital structure). These components of the proposal also are largely
consistent with the Basel III reforms and would promote consistency and
comparability in market risk capital requirements among banking
organizations domestically and across jurisdictions. The sections that
follow describe the proposed risk buckets and associated risk weights
for each risk factor.
I. Interest Rate Risk
Table 1 to Sec. __.209 of the proposed rule sets forth the ten
proposed risk buckets for the interest rate risk factors of market risk
covered positions and the corresponding risk weight applicable to each
risk bucket.\329\ The proposal would require a banking organization to
use separate risk buckets for each currency, for each of ten proposed
tenors to capture most commonly traded instruments across market risk
covered positions held by a banking organization and align with
bucketing structures used by trading firms.
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\329\ The buckets reflect that interest rates at a longer tenor
have less uncertainty and thus lower volatility than interest rates
at a shorter tenor that are more receptive to changes in interest
rate risk.
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By delineating interest rate risk factors based on currency \330\
and tenor, the granularity of the proposed risk buckets is intended to
appropriately balance the risk sensitivity of the proposed framework
with providing consistency in risk-based requirements across banking
organizations by assigning similar risk weights to similar kinds of
positions.
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\330\ As noted in section III.H.7.a.i.I of this SUPPLEMENTARY
INFORMATION, under the proposal, each currency would represent a
separate risk factor for interest rate risk.
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Factors such as the stage of the economic cycle and the role of
exchange rates can cause interest rate risk to diverge significantly
across different currencies, particularly in stress periods.
Accordingly, the proposal would require banking organizations to
establish separate interest rate risk buckets for each currency.
OTC interest rate derivatives for liquid currencies have
significant trading activity relative to non-liquid currencies, which
means a banking organization faces a shorter liquidity horizon to
offload exposure to interest rate risk factors in liquid currencies.
Therefore, the proposal would allow a banking organization to divide
the proposed risk weight applicable to each interest rate risk factor
bucket by the square root of two if the interest rate risk factor
relates to a liquid currency listed in Sec. __.209(b)(1)(i) of the
proposed rule or any other currencies specified by the primary Federal
supervisor. This approach would allow a banking organization to apply a
lower risk weight for purposes of the delta capital requirements for
interest rate risk factors for the listed liquid currencies and any
other currencies specified by the primary Federal supervisor.
II. Credit Spread Risk
Tables 3, 5, and 7 to Sec. __.209 of the proposed rule set forth
the risk buckets and corresponding risk weights for the credit spread
risk factors of non-securitization positions, correlation trading
positions, and securitization positions non-CTP, respectively. Under
the proposal, a banking organization would group the credit spread risk
factors for non-securitization positions, correlation trading
positions, and securitization positions non-CTP into one of nineteen,
seventeen, or twenty-five proposed risk buckets, respectively, based on
market sector and credit quality. The credit quality of a market risk
covered position in a given sector is inversely related to its credit
spread. Accordingly, the risk buckets for credit spread risk consider
the credit quality of a given market risk covered position.
More specifically with respect to the consideration of credit
quality, the agencies are proposing to generally use the same approach
to delta credit spread risk buckets and corresponding risk weights
provided in the Basel III reforms for non-securitization positions,
correlation trading positions, and securitization positions non-CTP,
but to define the risk buckets using alternative criteria to capture
the creditworthiness of the obligor. The delta credit spread risk
buckets in the Basel III reforms are defined based on the applicable
credit ratings of the reference entity. Section 939A of the Dodd-Frank
Act required the agencies to remove references to credit ratings in
Federal regulations.\331\ Therefore, the agencies are proposing an
approach that would allow for a level of risk sensitivity in the delta
credit spread risk buckets and corresponding risk weights applicable to
non-securitizations, correlation trading positions, and securitization
positions non-CTP that would be generally consistent with the Basel III
reforms and not rely on external credit ratings. Specifically, the
agencies are proposing to define the delta credit spread risk buckets
and corresponding risk weights for non-securitizations, correlation
trading positions, and securitization positions non-CTP based on the
definitions for investment grade as defined in the agencies' existing
capital rule \332\ and the definitions of speculative grade \333\ and
sub-speculative grade \334\ as defined in the proposal.
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\331\ 15 U.S.C. 78o-7 note.
\332\ See 12 CFR 3.2 (OCC); 12 CFR 217.2 (Board); and 12 CFR
324.2 (FDIC).
\333\ The proposal would define speculative grade to mean that
the entity to which a banking organization is exposed through a loan
or security, or the reference entity with respect to a credit
derivative, has adequate capacity to meet financial commitments in
the near term, but is vulnerable to adverse economic conditions,
such that should economic conditions deteriorate, the issuer or the
reference entity would present an elevated default risk.
\334\ The proposal would define sub-speculative grade to mean
that the entity to which a banking organization is exposed through a
loan or a security, or the reference entity with respect to a credit
derivative, depends on favorable economic conditions to meet its
financial commitments, such that should economic conditions
deteriorate, the issuer or the reference entity likely would default
on its financial commitments.
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[[Page 64120]]
The credit spread risks of industries within the proposed sectors
react similarly to the same market or economic events by principle of
shared economic risk factors (for example, technology and
telecommunications). Furthermore, the proposal would provide sectors
similar to those contained in the Basel III reforms and specify a
treatment for certain U.S.-specific sectors (for example, GSE debt and
public sector entities). Specifically, the proposal would include GSE
debt and public sector entities in the sector for government-backed
non-financials, education, and public administration to appropriately
reflect the potential variability in the credit spreads of such
positions in the industry. Accordingly, assigning the same risk weight
to these positively correlated sectors would reduce administrative
burden and not have a material effect on risk sensitivity.
Some proposed sectors consist of different industries, for example
basic materials, energy, industrials, agriculture, manufacturing, and
mining and quarrying. Positions within the same industry that are
investment grade would be assigned to the same risk bucket because from
a market risk perspective an economic event causing volatility in an
industry tends to similarly affect all positions in the industry, even
if there may be differences in credit quality between individual
issuers within an industry.
The agencies recognize that there may be sectors that are not
expressly categorized by the proposed risk buckets, and that specifying
all sectors for such purpose may not be possible. The proposed risk
buckets would include an ``other sector'' category for market risk
covered positions that do not belong to any of the other risk buckets.
The proposed risk weights are based on empirical data which reflect
the historical stress period for which the risk factors within the risk
bucket caused the largest cumulative loss at various liquidity
horizons. As such, for speculative grade sovereigns and multilateral
development banks, the agencies are proposing a 3 percent risk weight
for such positions that are non-securitization positions (Table 3 to
Sec. __.209) and a 13 percent risk weight for such positions that are
correlation trading positions (Table 5 to Sec. __.209). Based on the
agencies' quantitative analysis of the historical data, the credit
spreads of speculative grade sovereign bonds have typically widened
more than 2 percent after a downgrade, and significantly more for sub-
speculative grade sovereigns.\335\ Additionally, for non-securitization
positions and correlation trading positions, the agencies are proposing
a separate risk bucket with higher risk weights (7 percent and 16
percent, respectively) for sub-speculative grade sovereigns and
multilateral development banks than for those of speculative grade,
because of the additional risk posed by sub-speculative exposures.
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\335\ The agencies are applying a similar methodology for
calibration of credit spread risk weight for sovereigns as the Basel
Committee used for calibrating risk weights for other asset classes,
which aligns the sensitivities-based method risk weight calibration
to the liquidity horizon adjusted stressed expected shortfall
specified in the internal model approach. The Basel Committee used
IHS Markit Credit Default Swap (CDS) data and calculated ten day
overlapping returns (such as absolute changes in CDS spreads of
sovereigns). For the period of stress, the agencies used the
European sovereign crisis as it was more representative of stress
risk for these exposures. The standard deviation obtained was
multiplied by 2.34 to reflect the expected shortfall quantile of
97.5. In the last step, the estimate was adjusted to meet the
sovereign liquidity horizon specified for internal models.
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For non-securitization positions, the agencies are proposing a 2.5
percent risk weight for all investment grade covered bonds \336\ to
reduce variability in risk-based capital requirements across banking
organizations and appropriately account for the preferential treatment
provided in the standardized default risk capital requirement.\337\ As
most U.S. banking organizations hold limited or no covered bonds, the
proposed 2.5 percent risk weight should have an immaterial impact on
the sensitivities-based capital requirement.
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\336\ As defined in Sec. __.201 of proposed subpart F of the
capital rule, a covered bond would mean a bond issued by a financial
institution that is subject to a specific regulatory regime under
the law of the jurisdiction governing the bond designed to protect
bond holders and satisfies certain other criteria.
\337\ See section III.H.7.b of this Supplementary Information
for a more detailed description of the preferential treatment
applied to covered bonds under the proposed standardized default
risk capital requirement.
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For securitization positions non-CTP (Table 7 to Sec. __.209), the
proposal would clarify the treatment of personal loans and dealer
floorplan loans within the delta credit spread risk buckets.
Specifically, the proposal would require a banking organization to
include personal loans within the risk bucket for credit card
securitizations and dealer floorplans within the risk bucket for auto
securitizations in order to appropriately reflect the lower credit
spread risk of these positions relative to those within the other
sector risk bucket.\338\
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\338\ The other sector risk bucket refers to bucket 25 in Table
7 to Sec. __.209 of the proposed rule.
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For securitization positions non-CTP, the proposal would also
clarify the delta credit spread risk buckets for residential mortgage-
backed securities to help ensure consistency in bucketing assignments
across banking organizations. Specifically, the agencies are proposing
to define prime residential mortgage-backed securities based on the
definition of qualified residential mortgages in the credit risk
retention rule \339\ and to define sub-prime residential mortgage-
backed securities based on the definitions of higher-priced mortgage
loans and high-cost mortgages in Regulation Z,\340\ respectively.
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\339\ The credit risk retention rule generally requires a
securitizer to retain not less than 5 percent of the credit risk of
certain assets that the securitizer, through the issuance of an
asset-backed security, transfers, sells, or conveys to a third
party. See 12 CFR part 43 (OCC); 12 CFR part 244 (Board); 12 CFR
part 373 (FDIC).
\340\ To help ensure that credit terms are disclosed in a
meaningful way so consumers can compare credit terms more readily
and knowledgeably, Regulation Z mandates regulations on how lenders
may calculate and disclose loan costs. See 12 CFR part 1026.
---------------------------------------------------------------------------
Under the proposal, prime residential mortgage-backed securities
would be defined as securities in which the underlying exposures
consist primarily of qualified residential mortgages as defined under
the credit risk retention rule. The eligibility criteria of the
qualified residential mortgage definition are designed to help ensure
the borrower's ability to repay.\341\ Residential mortgage-backed
securities that are primarily backed by qualified residential mortgage
loans carry significantly lower credit risk than those backed primarily
by non-qualifying loans. Therefore, the agencies are proposing to use
the existing definition of qualified residential mortgage in the credit
risk retention rule, which refers to the Regulation Z definition of
qualified mortgage to identify residential mortgage-backed securities
that are primarily backed by underlying loans with sufficiently low
credit risk to be classified as prime.
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\341\ Under the general definition for qualified mortgages in 12
CFR 1026.43(e)(2), a creditor must satisfy the statutory criteria
restricting certain product features and points and fees on the
loan, consider and verify certain underwriting requirements that are
part of the general ability-to-repay standard, and meet certain
other requirements.
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Similarly, the proposal would define a sub-prime residential
mortgage-backed security as a security in which the underlying
exposures consist primarily of higher-priced mortgage loans as defined
under Regulation Z (12 CFR 1026.35), high-cost mortgages as defined
under Regulation Z (12 CFR 1026.32), or both. In general, Regulation Z
defines
[[Page 64121]]
higher-priced mortgage loans \342\ and high-cost mortgages \343\ to
include consumer credit transactions secured by the consumer's
principal dwelling with an annual percentage rate \344\ that exceeds
the average prime offer rate (APOR) \345\ for a comparable transaction.
Consistent with Regulation Z, the best way to identify the subprime
market is by loan price rather than by borrower characteristics, which
could present operational difficulties and other problems. Therefore,
the agencies are proposing to use the existing definitions in
Regulation Z, which rely on a loan's annual percentage rate and other
characteristics, to identify residential mortgage-backed securities
that are primarily backed by underlying loans with sufficiently high
credit risk to be classified as sub-prime. In addition, the proposal
would reduce compliance burden for banking organizations by allowing
them to leverage criteria already being used to evaluate mortgage loans
for coverage under the prescribed Regulation Z thresholds.
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\342\ Under Regulation Z, a higher-priced mortgage loan is
defined as a closed-end consumer credit transaction secured by the
consumer's principal dwelling with an annual percentage rate that
exceeds the average prime offer rate for a comparable transaction as
of the date the interest rate is set by a certain amount of
percentage points depending on the type of loan. See 12 CFR
1026.35(a)(1).
\343\ Under Regulation Z, a high-cost mortgage is defined as a
closed- or open-end consumer credit transaction secured by the
consumer's principal dwelling and in which the annual percentage
rate exceeds the average prime offer rate for a comparable
transaction by a certain amount, or the transaction's total points
and fees exceed a certain amount, or under the terms of the loan
contract or open-end credit agreement, the creditor can charge a
prepayment penalty more than 36 months after consummation or account
opening, or prepayment penalties that can exceed, in total, more
than 2 percent of the amount prepaid. See 12 CFR 1026.32(a).
\344\ Annual percentage rates are derived from average interest
rates, points, and other loan pricing terms currently offered to
consumers by a representative sample of creditors for mortgage
transactions that have low-risk pricing characteristics. Other
pricing terms include commonly used indices, margins, and initial
fixed-rate periods for variable-rate transactions. Relevant pricing
characteristics include a consumer's credit history and transaction
characteristics such as the loan-to-value ratio, owner-occupant
status, and purpose of the transaction.
\345\ Loans with higher annual percentage rates or that have
higher points and fees or prepayment penalties generally are
extended to less creditworthy borrowers (for example, weaker
borrower credit histories, higher borrower debt-to-income ratios,
higher loan-to-value ratios, less complete income or asset
documentation, less traditional loan terms or payment schedules, or
combinations of these or other risk factors) and thus pose higher
credit risk.
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The agencies recognize that a securitization vehicle that holds
residential mortgage-backed securities may hold assets other than the
residential mortgage loans, such as interest rate swaps, to support its
liabilities. Furthermore, not all mortgage loans that satisfy the
requirements of the proposed definitions when the securitization
vehicle acquires the residential mortgage-backed securities will
continue to do so throughout the lifecycle of the position. To minimize
variability in risk-based capital requirements, reduce the operational
burdens imposed on banking organizations and help ensure consistency
and comparability in risk-based capital requirements across banking
organizations, the agencies are proposing to define prime and sub-prime
as those vehicles that primarily hold qualified residential mortgages
or high-priced mortgage loans and high-cost mortgages, respectively.
All other mortgage-backed securities would be defined as mid-prime
mortgage-backed securities.
Question 112: The agencies seek comment on the appropriateness of
adding the sub-speculative grade category for non-securitizations and
for correlation trading positions. What, if any, operational challenges
might the proposed bucketing structure pose for banking organizations
and why? What, if any, alternatives should the agencies consider to
better capture the risk of these positions?
Question 113: The agencies seek comment on the risk weight for
covered bonds. What, if any, alternative approaches would better serve
to differentiate the credit quality of highly rated covered bonds
without referring to credit ratings and why?
Question 114: The agencies seek comment on whether the proposed
definitions for each sector bucket appropriately capture the
characteristics to distinguish between the categories of residential
mortgage-backed securities. What would be the benefits and drawbacks of
using the definition of qualified residential mortgage in the credit
risk retention rule? What, if any, alternative approaches should the
agencies consider to more appropriately distinguish between the
categories of residential mortgage-backed securities?
Question 115: The agencies seek comment on whether the proposed
sector bucket definitions for residential mortgage-backed securities
are sufficiently clear. What, if any, additional criteria should the
agencies consider to define ``primarily'' in the context of residential
mortgage-backed securities (for example, quantitative limits or other
thresholds) and what are the associated benefits and drawbacks of doing
so?
Question 116: What, if any, operational challenges might the
proposed sector bucket definitions pose for banking organizations in
allocating the credit spread risk sensitivities of existing mortgage
exposures to the respective buckets and why? To what extent would using
one metric (for example, average prime offer rate) to define the sector
buckets address any such concerns?
Question 117: What, if any, other sector buckets require additional
clarification, and why?
III. Equity Risk
Table 8 to Sec. __.209 of the proposed rule provides the proposed
delta risk buckets and corresponding risk weights for market risk
covered positions with equity risk, which would be generally consistent
with those in the Basel III reforms.\346\ Under the proposal, a banking
organization would group the equity risk factors for market risk
covered positions into one of thirteen risk buckets based on market
capitalization, market economy, and sector.
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\346\ Vega and curvature capital requirements use the same risk
buckets as prescribed for delta. See Sec. __.209(c)(1), (d)(1) of
the proposed rule.
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The proposed risk buckets and associated risk weights for market
capitalization would differentiate between large and small market
capitalization issuers to appropriately reflect the relatively higher
volatility and increased equity risk of small market capitalization
issuers.\347\ Under the proposal, issuers with a consolidated market
capitalization equal to or greater than $2 billion would be classified
as large market capitalization issuers, and all other issuers would be
classified as small market capitalization issuers. The proposed large
market capitalization designation would help ensure an amount of
information and trading activity related to an issuer that is suitable
for the assignment of different risk weights relative to small market
capitalization issuers. The market capitalization data of publicly-
traded firms is readily available and
[[Page 64122]]
therefore would not be burdensome to identify.
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\347\ Relative to large market capitalization issuers,
instruments issued by those with small market capitalization are
typically less liquid and thus pose greater equity risk, as
investors holding these instruments may encounter difficulty in
buying or selling shares particularly during a stress event. Small
market capitalization issuers also typically have less access to
capital (such that they are less capable of obtaining sufficient
financing to bridge gaps in cash flow) and have a relatively shorter
operational history and thereby less evidence of a durable business
model. During downturns in the economic cycle, such complications
can increase the volatility (and therefore the equity risk) of
investments in such issuers.
---------------------------------------------------------------------------
For purposes of the market economy criteria, the agencies are
proposing to differentiate between ``liquid market economy'' countries
and territorial entities and emerging market economy countries and
territorial entities to appropriately reflect the higher volatility
associated with emerging market equities. Under the proposal, a banking
organization would use the following criteria to identify annually a
country or territorial entity with a liquid market economy: $10,000 or
more in per capita income, $95 billion or more in market capitalization
of all domestic stock markets, no single export sector or commodity
comprises more than 50 percent of the country or entity's total annual
exports, no material controls on liquidation of direct investment, and
free of sanctions imposed by the U.S. Office of Foreign Assets Control
against a sovereign entity, public sector entity, or sovereign-
controlled enterprise of the country or territorial entity.\348\
Countries or territorial entities that satisfy all five criteria or
that are in a currency union \349\ with at least one country or
territorial entity that satisfies all five criteria would be classified
as liquid market economies, and all others would be classified as
emerging market economies.
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\348\ According to the agencies' analysis of the data, the
initial list of ``Liquid Market Economies'' would include: United
States, Canada, Mexico, the 19 Euro area countries (Austria,
Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland,
Italy, Latvia, Lithuania, Luxembourg, Malta, the Netherlands,
Portugal, Slovakia, Slovenia, and Spain), non-Eurozone, western
European nations (the United Kingdom, Sweden, Denmark and
Switzerland), Japan, Australia, New Zealand, Singapore, Israel,
South Korea, Taiwan, Chile, and Malaysia.
\349\ The proposal would define a currency union as an agreement
by treaty among countries or territorial entities, under which the
members agree to use a single currency, where the currency used is
described in Sec. __.209(b)(1)(i) of the proposed rule.
---------------------------------------------------------------------------
In relying on a set of objective criteria, the proposed approach
for market economy risk buckets is designed to increase risk
sensitivity by delineating equities with lower volatility or higher
volatility in a manner consistent with the Basel III reforms while also
providing sufficient flexibility to a banking organization to reflect
changes to the list of market economies as more data become available.
For market risk trading positions with exposure to large market
capitalization issuers, the proposal would group trading positions into
one of four sectors for equity risk for each of the emerging market and
liquid market economy categories: (1) consumer goods and services,
transportation and storage, administrative and support service
activities, healthcare, and utilities; (2) telecommunications and
industrials; (3) basic materials, energy, agriculture, manufacturing,
and mining and quarrying; and (4) financials including government-
backed financials, real estate activities, and technology.
The proposed equity risk buckets are intended to reflect
differences in the extent to which equity prices in varying sectors are
affected by the business cycle (such as GDP growth). Differentiating
sectors for purposes of assigning risk weights to exposures to large
market capitalization issuers is relevant because some sectors are more
sensitive than others to the given phase in a business cycle. The
proposal groups together industries into sectors that tend to have
similar economic sensitivities, and therefore are sufficiently
homogenous from a risk perspective.
Conversely, among small market capitalization issuers, volatility
is more attributable to whether the trading position is related to an
emerging market economy or liquid market economy, regardless of the
sector. Therefore, the proposed risk buckets for small market
capitalization issuers delineate emerging market economies from liquid
market economies but do not delineate sectors.
In addition, the proposal includes three risk buckets representing
other sectors; equity indices that are both large market capitalization
and liquid market economy (non-sector specific); and other equity
indices (non-sector specific). As is the case with credit spread risk
buckets, the agencies recognize that specifying all sectors for the
purpose of applying risk buckets is infeasible. Accordingly, the last
three risk buckets set forth in Table 8 to Sec. __.209 are intended to
strike a balance between the risk sensitivity of these risk buckets and
operational burden. Equity indices aggregate risk across different
sectors, and accordingly require separate treatment from sector-
specific risk buckets. Nonetheless, equity indices that are both large
market capitalization and liquid market economy are relatively less
risky than other equity indices and can be identified in the course of
determining large market capitalization issuers and liquid market
economies, such that it would not impose a great burden to delineate
them as a separate risk bucket.
Question 118: The agencies solicit comment on the proposed
definition of liquid market economy. Specifically, would the proposed
criteria sufficiently differentiate between economies that have liquid
and deep equity markets? What, if any, alternative criteria should the
agencies consider and why? What, if any, of the proposed criteria
should the agencies consider eliminating and why?
Question 119: The agencies solicit comment related to the proposed
risk bucket structure for equity risk. What, if any, other
relationships should the agencies consider for highly correlated risks
among different equity types that are currently in different risk
buckets and why? Please describe the historical correlations between
such equities, and historical price shocks for purposes of assigning
the appropriate risk weight.
IV. Commodity Risk
Table 9 to Sec. __.209 of the proposed rule provides the proposed
delta risk buckets and corresponding risk weights for positions with
commodity risk. Under the proposal, a banking organization would group
commodity risk factors into one of eleven risk buckets based on the
following commodity classes: energy--solid combustibles; energy--liquid
combustibles; energy--carbon trading; freight; metals--non-precious;
gaseous combustibles and electricity; precious metals (including gold);
grains and oilseed; livestock and dairy; forestry and agriculturals;
and other commodity.
The proposed risk buckets and associated risk weights for commodity
risk would be distinguished by the underlying commodity types described
above to appropriately reflect differences in volatility (and therefore
market risk) between those commodity types. In general, the price
sensitivity of a commodity to changes in global supply and demand can
vary between commodity types due to production and storage cycles,
along with other factors. For example, energy commodities are generally
delivered year-round, whereas grain production is seasonal such that
deliverable futures contracts are available on dates to coincide with
harvest. Further, commodities within the proposed commodity types have
historically similar levels of volatility. The proposed commodity risk
buckets are intended to strike a balance between the risk sensitivity
of measuring market risk for the delineated commodity groups and the
operational burden of capturing the market risk of all commodities. As
is the case with credit spread risk buckets and equity risk buckets,
the agencies recognize that specifying all commodities for the purpose
of applying risk buckets is operationally difficult. Accordingly, the
proposal includes an additional ``other commodity'' risk bucket to
include commodities that do not fall into the prescribed categories.
[[Page 64123]]
As is the case with other risk buckets, the proposed risk weights
for commodity risk factors are based on empirical data during
historical periods of stress. The agencies are proposing to align the
delta risk factor buckets and corresponding risk weights with those
provided in the Basel III reforms, with one exception. The Basel III
reforms prescribe separate risk buckets with different risk weights for
electricity and gaseous combustibles. The agencies are proposing to
move electricity into the risk bucket for gaseous combustibles to allow
for greater recognition of hedges between these two commodities. The
proposed bucketing structure would reflect appropriately the inherent
relationship between the price of electricity and natural gas, as
empirical evidence demonstrates a strong correlation between price
movements of natural gas and electricity contracts.\350\
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\350\ The agencies are proposing to include electricity and gas
in the same bucket based on an analysis of correlations between
natural gas and electricity futures prices pairs across multiple
geographical regions. The analysis shows that pairwise correlations
between gas and electricity prices within the same region are high
and stable and in excess of the inter bucket correlation that would
be applied if the two financial instruments were bucketed
separately.
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Question 120: The agencies solicit comment related to the proposed
risk bucket structure and risk weights for commodities. What, if any,
other relationships should the agencies consider for highly correlated
risks among different commodity types that are currently in different
risk buckets and why? Please describe the historical correlations
between such commodities, and historical price shocks for purposes of
assigning the appropriate risk weight.
Question 121: The agencies solicit comment on the risk bucket for
energy--carbon trading. To what extent is the proposed 60 percent risk
weight reflective of the risk in carbon trading under stressed
conditions?
V. Foreign Exchange Risk
The proposal would require a banking organization to establish
separate risk buckets for each exchange rate between the currency in
which a market risk covered position is denominated and the reporting
currency (or, as applicable, alternative base currency). To calculate
the risk-weighted delta sensitivity for foreign exchange risk, the
proposal would require a banking organization to apply a 15 percent
risk weight to each currency pair, with one exception. Similar to the
proposed risk weights for interest rate risk, the proposal would allow
a banking organization to divide the proposed 15 percent risk weight by
the square root of two for certain liquid currency pairs specified
under the proposal,\351\ as well as any additional currencies specified
by the primary Federal supervisor. Given high trading activity and use
of such liquid currency pairs relative to non-liquid pairs, the
proposal incorporates the effect of a shorter liquidity horizon for
liquid currency pairs and would allow a banking organization to
appropriately reflect the lower foreign exchange risk posed by such
liquid currency pairs.
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\351\ The proposal would allow a banking organization to apply a
lower risk weight for any currency pair formed of the following
currencies: USD, EUR, JPY, GBP, AUD, CAD, CHF, MXN, CNY, NZD, HKD,
SGD, TRY, KRW, SEK, ZAR, INR, NOK, and BRL.
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iv. Correlation Parameters
In general, the proposed correlation parameters closely follow
those in the Basel III reforms, which are calibrated to capture market
correlations observed over a long time horizon that included a period
of stress based on empirical data.\352\ To appropriately reflect the
risk-mitigating benefits of hedges and diversification, the proposal
would prescribe the correlation parameters that a banking organization
would be required to use for each risk factor pair when calculating the
aggregate risk bucket and risk class level capital requirements for
delta, vega, and curvature.\353\ To determine the applicable
correlation parameter for purposes of calculating the risk bucket or
risk class level capital requirements, a banking organization would
apply the same criteria used to define the risk factors within each
risk class, as described in section III.H.7.a.i of this Supplementary
Information, with two exceptions.
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\352\ For example, the correlation parameters for vega,
curvature, delta interest rate risk, and delta equity risk are
identical to those in the Basel III reforms.
\353\ As there is only one risk factor prescribed for foreign
exchange risk, the proposal does not specify an intra-bucket
correlation parameter.
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First, in addition to the proposed risk factors for credit spread
risk of non-securitizations, securitization positions non-CTP, and
correlation trading positions,\354\ the proposal would require a
banking organization to consider the name (in the case of non-
securitization positions and correlation trading positions) and tranche
(in the case of securitization positions non-CTP) to determine the
applicable correlation parameters for risk factors within the same risk
bucket when calculating the aggregate risk bucket level capital
requirements for delta and vega.
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\354\ As described in section III.H.7.a.i.II of this
Supplementary Information, the proposal would define the delta risk
factors for credit spread risk along two dimensions: the credit
spread curve of the reference entity and the tenor of the position.
---------------------------------------------------------------------------
In the case of credit spread risk for securitization positions non-
CTP, the agencies generally are proposing to require a 100 percent
intra-bucket correlation parameter for securitization positions in the
same bucket and related to the same securitization tranche with more
than 80 percent overlap in notional terms and a 40 percent intra-bucket
correlation parameter otherwise. Furthermore, in the case of credit
spread risk for non-securitization and correlation trading positions,
banking organizations would need to apply a 35 percent intra-bucket
correlation factor for Uniform Mortgage-Backed Securities (UMBS) as
such positions would be treated as a separate name from Fannie Mae and
Freddie Mac.\355\
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\355\ In the to-be-announced (TBA) market, Freddie Mac and
Fannie Mae securities are not interchangeable and would be treated
as separate names under the proposal. As part of the single security
initiative, UMBS allows for either Fannie Mae or Freddie Mac to
deliver, thus creating the basis risk between the GSEs for such
securities.
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Second, for risk factors allocated to the ``other sector'' bucket
within the credit spread and equity risk classes,\356\ the risk bucket
level capital requirement would equal the sum of the absolute values of
the risk-weighted sensitivities for both the delta capital requirement
and the vega capital requirement (no correlation parameters would apply
to such exposures). Additionally, the proposal would require a banking
organization to assign a zero percent correlation parameter when
aggregating the delta risk-weighted sensitivity of exposures within the
``other sector'' risk bucket with those in any of the other bucket-
level capital requirements for credit spread and equity risk.
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\356\ The other sector buckets refer to buckets 17 in Tables 3
and 5 as well as buckets 25 and 11 in Tables 7 and 8, respectively,
of Sec. __.209 of the proposed rule.
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By requiring a banking organization to determine the maximum
possible loss under three correlation scenarios, the proposed
correlation parameters are sufficiently conservative to appropriately
capture the potential interactions between risk factors that the market
risk covered positions may experience in a time of stress.
Question 122: Related to securitization positions non-CTP, the
agencies seek comments on requiring banking organizations to apply a
100 percent delta correlation parameter for cases where the
securitization positions are in the same bucket, are related to the
same securitization tranche, and have more than 80 percent overlap in
notional terms. What, if any, alternative criteria should the agencies
consider for
[[Page 64124]]
application of the 100 percent correlation parameter and why? For
example, what are benefits and drawbacks of allowing a banking
organization to apply a 100 percent delta correlation parameter if the
securitization tranches can offset all or substantially all of the
price risk of the position? What challenges exist, if any, with respect
to banking organizations' ability to implement such criteria? What
quantitative measures can be used to implement these criteria? How
would a market stress impact the basis risk between securitization
tranches within the same risk buckets, and the ability to adequately
hedge all or substantially all of the price risk using similar but
unrelated securitized tranches?
Question 123: The agencies request comment on the appropriateness
of allowing banking organizations to apply a higher intra-bucket
correlation parameter of 99.5 percent to 99.9 percent for energy--
carbon trading. What would be the benefits and drawbacks of such a
higher correlation parameter relative to the correlation parameter of
40 percent currently contained in the proposal?
Question 124: The agencies request comment on requiring banking
organizations to apply a 35 percent correlation parameter for Uniform
Mortgage Backed Securities. What alternative correlation parameter
should the agencies consider for Uniform Mortgage Backed Securities and
why?
b. Standardized Default Risk Capital Requirement
The standardized default risk capital requirement is intended to
capture the incremental loss if the issuer of an equity or credit
position were to immediately default (the additional losses from jump-
to-default risk), which are not captured by the credit spread or equity
shocks under the sensitivities-based method. Thus, the proposed
standardized default risk capital requirement would apply only to non-
securitization debt or equity positions (except for U.S. sovereigns and
multilateral development banks), securitization positions non-CTP, and
correlation trading positions.
Under the proposal, a banking organization would be required to
separately calculate the standardized default risk capital requirement
for each of the three default risk categories (three risk classes that
could incur default risk) using the following five steps.
First, for each of the three default risk categories, the banking
organization would be required to group instruments with similar risk
characteristics throughout an economic cycle into the defined default
risk buckets as described in more detail below.
Second, to estimate the position-level losses from an immediate
issuer default, the banking organization would be required to calculate
the gross default exposure separately for each default risk position.
Additionally, the banking organization would be required to determine
the long and short direction of the gross default exposure based on
whether it would experience a loss (long) or gain (short) in the event
of a default.
Third, to estimate the portfolio-level losses of a trading desk
from an immediate issuer default, the banking organization would be
required to calculate the net default exposure for each obligor by
offsetting the gross long and short default exposures to the same
obligor, where permitted.
Fourth, to estimate and recognize hedging benefit between net long
and net short position of different issuers within the same default
bucket, the banking organization would be required to calculate the
hedge benefit ratio and apply the prescribed risk weights \357\ to the
net default exposures within the same default risk bucket for the class
of instruments.\358\ In general, the proposed risk buckets and
associated risk weights closely follow those in the Basel III reforms,
which are calibrated to reflect a through-the-cycle probability of
default. The hedge benefit ratio is calculated based on the aggregate
net long default positions and the aggregate net short default
positions. It is intended to recognize the partial hedging of net long
and net short default positions in distinct obligors due to systematic
credit risk. The bucket-level default risk capital requirement would
equal (1) the sum of the risk-weighted net long default positions minus
(2) the product of the hedge benefit ratio and the sum of the risk-
weighted absolute value of the net short default positions. For non-
securitization debt and equity positions and securitization positions
non-CTP, the results of this calculation would be floored at zero.
---------------------------------------------------------------------------
\357\ The proposal would require a banking organization to apply
the highest risk weight that is applicable under the investment
limits of an equity position in an investment fund that may invest
in primarily high-yield or distressed names under the fund's mandate
by first applying the highest risk weight that is applicable under
the fund's investment limits to defaulted instruments, followed by
sub-speculative grade, then speculative grade, then investment grade
securities. A banking organization may not recognize any offsetting
or diversification benefit when calculating the average risk weight
of the fund. See Sec. __.205(e)(3)(iii) of the proposed rule.
\358\ Specifically, a banking organization would first calculate
the hedge benefit ratio (the total net long jump-to-default risk
positions (numerator) divided by the sum of the total net long jump-
to-default risk positions and the sum of the absolute value of the
total net short positions (denominator), and then calculate the
risk-weighted exposure for each risk bucket by multiplying the
aggregate total net jump-to-default exposure by the risk weight
prescribed for the applicable risk bucket.
---------------------------------------------------------------------------
Fifth, to calculate the default risk capital requirement for each
default risk category, the banking organization would sum the risk
bucket-level capital requirements (except for correlation trading
positions). The aggregation for correlation trading positions is not
the simple sum but is the sum of the risk-bucket level capital
requirements for the net long default exposures plus half of the sum of
the risk-weighted exposures for the net short default exposures as
further described in in section III.H.7.b.iii of this Supplementary
Information. For conservatism, the proposal would require a banking
organization to calculate the total standardized default risk capital
requirement as the sum of each of the default risk category level
capital requirements without recognizing any diversification benefits
across different types of default risk categories.
i. Non-Securitization Debt or Equity Positions
I. Gross Default Exposure
Under the proposal, the standardized default risk capital
requirement for non-securitization debt or equity positions would
generally follow the calculation steps described above. To calculate
the gross default exposure for each non-securitization debt or equity
position, the proposal would require a banking organization to multiply
the notional amount (face value) of the instrument and the prescribed
loss given default (LGD) rate \359\ to determine the total potential
loss of principal at default and then add the cumulative profits
(losses) already realized on the position to avoid double-counting
realized losses, with one exception.\360\ For defaulted positions, the
proposal would require a banking organization to multiply the current
market value and the prescribed LGD rate to determine the gross default
exposure for the position. The proposed calculation methodology is
intended to appropriately quantify the gross default risk for most
securities, including those that are less common.
---------------------------------------------------------------------------
\359\ The loss rate from default is one minus the recovery rate.
\360\ As losses are recorded as a negative value, effectively
they would be subtracted from the overall exposure amount.
---------------------------------------------------------------------------
For the purpose of calculating the gross default exposure for each
non-securitization debt or equity position, the agencies are proposing
the following
[[Page 64125]]
LGD rates, which are generally consistent with those in the Basel III
reforms: 100 percent for equity and non-senior debt instruments and
defaulted positions, 75 percent for senior debt instruments, 75 percent
for GSE debt issued but not guaranteed by the GSEs, 25 percent for GSE
debt guaranteed by the GSEs, 25 percent for covered bonds, and zero
percent for instruments whose value is not linked to the recovery rate
of the issuer.\361\ GSE debt issued and guaranteed by the GSEs is
secured by residential properties that satisfy the rigorous
underwriting standards of the GSEs (for example, loan-to-value ratios
of less than 80 percent), and include a guarantee on the repayment of
principal by the GSE. As these characteristics are economically similar
to the requirements for covered bonds, the agencies are proposing to
extend the LGD rate applied to covered bonds to GSE debt issued and
guaranteed by the GSEs to appropriately capture the expected losses of
such positions in the event of default. As GSE debt instruments issued
but not guaranteed by the GSEs are similarly secured by high-quality
residential mortgages, the proposal would allow banking organizations
to treat such exposures as senior debt (subject to a 75 percent LGD
rate) rather than apply the higher proposed risk weight for equity and
non-senior debt instruments. For credit derivatives, a banking
organization would be required to use the LGD rate of the reference
exposure.
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\361\ For example, in the case of a call option on a bond, the
notional amount to be used in the jump-to-default calculation would
be zero given that in the event of default the call option would not
be exercised (the default would extinguish the call option's value,
with the loss captured through the reduced fair value of the
position).
---------------------------------------------------------------------------
For consistency across banking organizations, the proposal
specifies that a banking organization would be required to reflect the
notional amount of a non-securitization debt or equity position that
gives rise to a long gross default exposure as a positive value and the
corresponding loss as a negative value, and those that produce a short
exposure as a negative value and the corresponding gain as a positive
value. If the contractual or legal terms of a derivative contract allow
for the unwinding of the instrument, with no exposure to default risk,
the gross default exposure would equal zero.
Question 125: The agencies request comment on whether the proposed
formula for calculating gross default exposure appropriately captures
the gross default risk for all types of non-securitization debt and
equity instruments. What, if any, positions exist for which the formula
cannot be applied? What is the nature of such difficulties and how
could such concerns be mitigated? In particular, the agencies seek
comment on whether the proposed formula appropriately captures the
gross default risk of convertible instruments.
Question 126: The agencies request comment on the appropriateness
of the proposed LGD rates for non-securitization debt or equity
positions. What, if any, changes should the agencies consider making to
the categories to appropriately differentiate the LGD rates for various
instruments or for instruments with different seniority (for example,
senior versus non-senior)?
II. Net Default Exposure
To calculate the net default exposure for non-securitization debt
or equity positions, the proposal would permit a banking organization
to recognize either full or partial offsetting of the gross default
exposures for long and short positions if both reference the same
obligor and the short positions have the same or lower seniority as the
long positions.\362\ To appropriately reflect the net default risk, the
proposed calculation would not allow a banking organization to
recognize any offsetting of the gross default exposure for market risk
covered positions where the obligor is not identified, such as equity
positions in an investment fund, index instruments, and multi-
underlying options for which a banking organization elects to calculate
a single risk factor sensitivity (not to apply the look-through
approach).
---------------------------------------------------------------------------
\362\ For a market risk covered position that has an eligible
guarantee, to determine if the exposure is to the underlying obligor
or an exposure to the eligible guarantor, the credit risk mitigation
requirements set out in the capital rule would apply. See 12 CFR
3.36, 3.134 and 3.135 (OCC); 12 CFR 217.36, 217.134 and 217.135
(Board); 12 CFR 324.36, 324.134 and 324.135 (FDIC).
---------------------------------------------------------------------------
As the GSEs can default independently of one another, the agencies
are clarifying that banking organizations should treat Federal National
Mortgage Association (Fannie Mae), Federal Home Loan Mortgage
Corporation (Freddie Mac), and the Federal Home Loan Bank System as
separate obligors. As the single security initiative led by Fannie Mae
and Freddie Mac has homogenized the mortgage pool and security
characteristics for Uniform Mortgage-Backed Securities (UMBS), the
proposal would allow the banking organization to fully offset Uniform
Mortgage Backed Securities that are issued by two different obligors.
Full offsetting would be permitted for short and long market risk
covered positions with maturities greater than one year or positions
with perfectly matching maturities provided other criteria are met such
as if both long and short positions reference the same obligor and the
short positions have the same or lower seniority as the long positions.
To determine the offsetting treatment for market risk covered positions
with maturities of one year or less, a banking organization would be
required to scale the gross default exposure by the fraction of a year
corresponding to the maturity of the instrument, subject to a three-
month floor. In the case where long and short gross default exposures
both have maturities of one year or less, scaling would apply to both
the long and short gross default exposure. By allowing only partial
offsetting, the proposed scaling approach is intended to appropriately
reflect the risk posed by maturity mismatch between exposures and their
hedges within the one-year capital horizon. For example, under the
proposal, the gross default exposure for an instrument with a six-month
maturity would be weighted by one-half, whereas that for a one-week
repurchase agreement would be prescribed a three-month maturity and
weighted by one-fourth.
The proposal would permit a banking organization to assign a
maturity of either three months or one year to cash equity positions
that do not have a stated maturity. For derivative transactions, the
proposal would require a banking organization to use the maturity of
the derivative contract, rather than that of the underlying, to
determine the applicable scaling factor. To prevent broken hedges for
equity and derivative positions, the proposal would allow banking
organizations to assign the same maturity to a cash equity position as
the maturity of the derivative contract it hedges (permit full
offsetting). Similarly, the proposal would allow a banking organization
to align the maturity of an instrument with that of a derivative
contract for which that instrument could be delivered to satisfy the
derivative contract, and thus permit full offsetting between the
instrument and the derivative. For example, a banking organization may
assign the maturity of a derivative contract in the to-be-announced
(TBA) market that is hedging a security interest in a pool of mortgages
to that security interest provided that the delivery of the security
interest would satisfy the delivery terms of the TBA derivative
contract.
[[Page 64126]]
The net default exposure to an issuer would be the sum of the
maturity-weighted default exposures to the issuer.
Question 127: The agencies request comment on the appropriateness
of allowing banking organizations to net the gross default exposures of
derivative contracts and the underlying positions that are deliverable
to satisfy the derivative contract. What, if any, additional criteria
should the agencies consider to further clarify the netting of gross
default exposures and why? What, if any, positions should the agencies
consider allowing to net that would not exhibit default risk? For
example, what are the advantages and disadvantages of the agencies
allowing Uniform Mortgage Backed Securities that are issued by two
different obligors to fully offset, even though such a treatment would
not eliminate the default risk of either obligor independently?
Question 128: The agencies seek comment on the appropriateness of
the proposed treatment of GSE exposures. What, if any, alternative
methods should the agencies consider to measure more appropriately the
default risk associated with such positions? What would be the benefits
and drawbacks of such alternatives compared to the proposed treatment?
Question 129: The agencies seek comment on the appropriateness of
not allowing banking organizations to recognize any offsetting benefit
for market risk covered positions where the obligor is not identified.
What, if any, alternative methods should the agencies consider to
measure more appropriately the default risk associated with such
positions? What would be the benefits and drawbacks of such
alternatives compared to the proposed treatment?
III. Risk Buckets and Corresponding Risk Weights
Table 1 to Sec. __.210 of the proposed rule provides the proposed
default risk buckets and corresponding risk weights for non-
securitization debt or equity positions, which reflect counterparty
type and credit quality, respectively. Under the proposal, the risk
buckets and applicable risk weights would distinguish between the type
of obligor based on whether the exposure is to a non-U.S. sovereign, a
public sector entity or GSE, or a corporate and include a single bucket
for defaulted positions.
To capture the credit quality of the obligor, the agencies are
proposing default risk buckets that are generally consistent with those
provided in the Basel III reforms but defined using alternative
criteria. The default risk buckets for non-securitization positions in
the Basel III reforms are defined based on the applicable credit
ratings of the reference entity. As discussed previously in section
III.H.7.a.iii.II of this Supplementary Information, the agencies are
proposing an approach that does not rely on external credit ratings but
allows for a level of granularity in the default risk buckets (and
corresponding risk weights) applicable to non-securitization positions
and that is also generally consistent with the Basel III reforms.
Specifically, the agencies are proposing to define the default risk
buckets and corresponding risk weights for non-securitization positions
based on the definition for Investment Grade in the agencies' existing
capital rule and the proposed definitions of Speculative Grade and Sub-
speculative Grade.\363\
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\363\ Specifically, the agencies are proposing to apply a
methodology similar to prior rules, where the risk weights in the
Basel III reforms are adjusted based on a weighted average risk
weight calculated from the notional amount of issuance since 2007
for each category. For this analysis, the agencies used the Mergent
Fixed Income Securities database to identify notional issuance
amounts for several lookback periods. The weighted average risk
weight for each category was then slightly modified to account for
rounding, to reflect internal consistency (so that a corporate or
PSE exposure would not have a lower risk weight than a sovereign)
and to help ensure risk weights were stable through an entire credit
cycle. The agencies believe the amended risk weight table
appropriately satisfies the requirements of the Dodd-Frank Act,
while also meeting the intent of the Basel III reforms. See 15
U.S.C. 78o-7 note.
---------------------------------------------------------------------------
Question 130: The agencies solicit comment on the appropriateness
of the proposed risk weights and granularity in Table 1 to Sec.
__.210. What, if any, alternative approaches should the agencies
consider for assigning risk weights that would be consistent with the
prohibition on the use of credit ratings? Commenters are encouraged to
provide specific details on the mechanics of and rationale for any
suggested methodology.
ii. Securitization Positions Non-CTP
For securitization positions non-CTP, the process to calculate the
standardized default risk capital requirement would be identical to
that for non-securitization positions, except for the gross default
exposure calculation, the offsetting of long and short exposures in the
net default exposure calculation, and the proposed risk buckets and
corresponding risk weights.
I. Gross Default Exposure
Under the proposal, the gross default exposure for a securitization
position non-CTP equals the position's fair value. As the proposed
bucket-level risk weights described in section III.H.7.a.iii of this
Supplementary Information would already reflect the LGD rates for such
positions, a banking organization would not apply an LGD rate to
calculate the gross default exposure.
II. Net Default Exposure
First, the proposal would allow offsetting between securitization
exposures with the same underlying asset pool and belonging to the same
tranche. No offsetting would be permitted between securitization
exposures with different underlying asset pools, even where the
attachment and detachment points are the same.
Second, the proposal would permit a banking organization to offset
the gross default exposure of a securitization position non-CTP with
one or more non-securitization positions by decomposing the exposure of
non-tranched index instruments and replicating the exposures that make
up the entire capital structure of the securitized position.
Additionally, a banking organization would be required to exclude non-
securitization positions that are recognized as offsetting the gross
default exposure of a securitization position non-CTP from the
calculation of the standardized default risk capital requirement for
non-securitization debt and equity positions.
Third, the proposal would allow a banking organization to offset
the gross default exposure of a securitization position non-CTP through
decomposition if a collection of short securitization positions non-CTP
replicates a collection of long securitization positions non-CTP. For
example, if a banking organization holds a long position in the
securitization, and a short position in a mezzanine tranche that
attaches at 3 percent and detaches at 10 percent, the proposal would
permit the banking organization to decompose the securitization into
three tranches and offset the gross default exposures for the common
portion of the securitization (3-10 percent). In this case, the net
default exposure would reflect the long positions in the 0-3 percent
tranche and in the 10-100 percent tranche.
Question 131: The agencies seek comment on the proposed netting and
decomposition criteria for calculating the net default exposure for
securitization positions non-CTP. What, if any, alternative non-model-
based methodologies should the agencies consider that would
conservatively recognize some hedging benefits but still capture the
basis risk between non-identical positions?
[[Page 64127]]
III. Risk Buckets and Corresponding Risk Weights
To promote consistency and comparability in risk-based capital
requirements across banking organizations, the proposal would define
the risk bucket structure that a banking organization would be required
to use to group securitization positions non-CTP. Specifically, the
proposal would require a banking organization to classify
securitization positions non-CTP as corporate positions or based on the
asset class and the region of the underlying assets, following market
convention.\364\ Under the proposal, a banking organization would
assign each position to one risk bucket, and those with underlying
exposures in the same asset class and region to the same risk bucket.
Additionally, the proposal would require a banking organization to
assign any position that is not a corporate position and that it cannot
assign to a specific asset class or region to one of the ``other''
buckets.\365\
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\364\ The proposal would define the asset class buckets along
two dimensions: asset class and region. The region risk buckets
would include Asia, Europe, North America, and other. The asset
class risk buckets would include asset-backed commercial paper, auto
loans/leases, residential mortgage-backed securities, credit cards,
commercial mortgage-backed securities, collateralized loan
obligations, collateralized debt obligations squared, small and
medium enterprises, student loans, other retail, and other
wholesale.
\365\ Under the proposal, the other buckets would include other
retail and other wholesale (for asset class) and other (for region).
---------------------------------------------------------------------------
For consistency in the capital requirements for securitizations
under either subpart D or subpart E of the capital rule and to
recognize credit subordination,\366\ the proposed risk weights for
securitization positions non-CTP are based on the risk weights
calculated for securitization exposures under either subpart D or
subpart E of the capital rule.\367\
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\366\ For example, the general credit risk framework would apply
the SSFA to calculate the risk weight. The SSFA calculates the risk
weight based on characteristics of the tranche, such as the
attachment and detachment points and quality of the underlying
collateral.
\367\ 12 CFR 3.43, 3.143, 3.144 (OCC); 12 CFR 217.43, 217.143,
217.144 (Board); 12 CFR 324.43, 324.143, 324.144 (FDIC).
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To calculate the standardized default risk capital requirement for
securitization positions non-CTP, a banking organization would sum the
risk bucket-level capital requirements, except that a banking
organization could cap the standardized default risk capital
requirement for an individual cash securitization position non-CTP at
its fair value. For cash positions, the maximum loss on the exposure
would not exceed the fair value of the position even if each of the
underlying assets of the securitization were to immediately default.
Furthermore, the proposed treatment would align with the maximum
potential capital requirement for securitizations under either subpart
D or the proposed subpart E of the capital rule.\368\
---------------------------------------------------------------------------
\368\ 12 CFR 3.44(a) (OCC); 12 CFR 217.44(a) (Board); 12 CFR
324.44(a) (FDIC).
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Question 132: The agencies request comment on the proposed risk
buckets. What are the potential benefits and drawbacks of aligning the
default risk bucketing structure with the proposed delta risk buckets
for securitization positions non-CTP in the sensitivities-based method?
Commenters are encouraged to provide information regarding any
associated burden, complexity, and capital impact of such an alignment.
iii. Correlation Trading Positions
The process to calculate the standardized default risk capital
requirement for correlation trading positions would be the same as that
for non-securitization debt and equity positions, except for the
metrics used to measure gross default exposure, the offsetting of long
and short exposures in the net default exposure calculation, the risk
buckets, and the aggregation of the bucket level exposures across risk
buckets.
I. Gross Default Exposure
Under the proposal, the gross default exposure for a correlation
trading position equals the position's market value. To calculate the
gross default exposure for correlation trading positions that are nth-
to-default positions, the proposal would require a banking organization
to treat such positions as tranched positions and to calculate the
attachment point as (N-1) divided by the total number of single names
in the underlying basket or pool and the detachment point as N divided
by the total number of single names in the underlying basket or pool.
The proposed calculation is intended to appropriately reflect the
credit subordination of such positions.
II. Net Default Exposure
Similar to securitization positions non-CTP, to increase risk
sensitivity and permit greater offsetting of substantially similar
exposures, the proposal would permit banking organizations to offset
gross long and short default exposures in specific cases.
First, the proposal would allow a banking organization to offset
the gross default exposure of correlation trading positions that are
otherwise identical except for maturity, including index tranches of
the same series. This means the offsetting positions would need to have
the same underlying index family of the same series, and the same
attachment and detachment points.
Second, the proposal would allow a banking organization to offset
the gross default exposure of long and short exposures of tranches that
are perfect replications of non-tranched correlation trading positions.
For example, the proposal would allow a banking organization to offset
the gross default exposure of a long position in the CDX.NA.IG.24 index
with short positions that together comprise the entire index position
(for example, three distinct tranches that attach and detach at 0-3
percent, 3-10 percent, and 10-100 percent, respectively).
Third, the proposal would allow a banking organization to offset
the gross default exposure of indices and single-name constituents in
the indices through decomposition when the long and the short gross
default exposures are otherwise equivalent except for a residual
component. Under the proposal, a banking organization would account for
the residual exposure in the calculation of the net default exposure.
In such cases, the proposal would require that the decomposition into
single-name equivalent exposures account for the effect of marginal
defaults of the single names in the tranched correlation trading
position, where in particular the sum of the decomposed single name
amounts would be required to be consistent with the undecomposed value
of the tranched correlation trading position. Such decomposition
generally would be permissible for correlation trading positions (for
example, vanilla CDOs, index tranches or bespoke indices), but would be
prohibited for exotic securitizations (for example, CDO squared).
Fourth, the proposal would allow a banking organization to offset
the gross default exposure of different series (non-tranched) of the
same index through decomposition when the long and the short gross
default exposures are otherwise equivalent except for a residual
component. Under the proposal, a banking organization would account for
the residual exposure in the calculation of the net default exposure.
For example, assume that a banking organization holds a long position
in a CDS index that references 125 underlying credits and a short
position in the next series of the index that also references 125
credits. The two indices share the same 123 reference credits,
[[Page 64128]]
such that there are two unique credits in each index. Under the
proposal, a banking organization could offset the 123 names through
decomposition, in which case the net default exposure would reflect
only the two unique credits for the long index position and the two
unique credits for the short index position. Similarly, a banking
organization could offset the long exposure in 125 credits by selling
short an index that contains 123 of those same credits. In this case,
only the two residual names would be reflected in the net default
exposure.
Fifth, the proposal would allow a banking organization to offset
different tranches of the same index and series through replication and
decomposition and calculate a net default exposure on the unique
component only, if the residual component has the attachment and
detachment point nested with the original tranche or the combination of
tranches. For example, assume that a banking organization holds long
positions in two tranches, one that attaches at 5 percent and detaches
at 10 percent and another that attaches at 10 percent and detaches at
15 percent. To hedge this position, the banking organization holds a
short position in a tranche on the same index that attaches at 5
percent and detaches at 20 percent. In this case, the banking
organization's net default exposure would only be for the residual
portion of the tranche that attaches at 15 percent and detaches at 20
percent.
III. Risk Buckets and Corresponding Risk Weights
For correlation trading positions, the proposal would define risk
buckets by index, each index would comprise its own risk bucket.\369\
Under the proposal, a bespoke correlation trading position would be
assigned to its own unique bucket, unless it is substantially similar
to an index instrument, in which case the bespoke position would be
assigned to the risk bucket corresponding to the index. For a non-
securitization position that hedges a correlation trading position, a
banking organization would be required to assign such position and the
correlation trading position to the same bucket.
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\369\ A non-exhaustive list of indices include: the CDX North
America IG, iTraxx Europe IG, CDX HY, iTraxx XO, LCDX (loan index),
iTraxx LevX (loan index), Asia Corp, Latin America Corp, Other
Regions Corp, Major Sovereign (G7 and Western Europe) and Other
Sovereign.
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For consistency in the capital requirements for securitizations
under either subpart D or subpart E of the capital rule and to
recognize credit subordination,\370\ the proposed risk weights
corresponding to the proposed risk buckets for correlation trading
positions are based on the treatment under either subpart D or subpart
E of the capital rule.\371\
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\370\ For example, the general credit risk framework would apply
the SSFA to calculate the risk weight. The SSFA calculates the risk
weight based on characteristics of the tranche, such as the
attachment and detachment points and quality of the underlying
collateral.
\371\ 12 CFR 3.43, 3.143, 3.144 (OCC); 12 CFR 217.43, 217.143,
217.144 (Board); 12 CFR 324.43, 324.143, 324.144 (FDIC).
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The agencies recognize that the granularity of the proposed risk
bucket structure could result in several individual risk buckets
containing only net short exposures and thus overstate the offsetting
benefits of non-identical exposures if the total standardized default
risk capital requirement for correlation trading positions was
calculated as a sum of the bucket-level capital requirements. To
appropriately limit the benefit of risk buckets with short default
exposures offsetting those with long exposures, the total standardized
default risk capital requirement for correlation trading positions
would be calculated as the sum of the risk-bucket level capital
requirements for the net long default exposures plus half of the sum of
the risk-weighted exposures for the net short default exposures.
c. Residual Risk Capital Requirement
It is not possible in a standardized approach to sufficiently
specify all relevant distinctions between different market risks to
capture appropriately existing and future financial products.
Accordingly, the agencies are proposing the residual risk add-on
capital requirement (residual risk add-on) to reflect risks that would
not be fully reflected in the sensitivities-based capital requirement
or the standardized default risk capital requirement. Specifically, the
residual risk add-on is intended to capture exotic risks, such as
weather, longevity, and natural disasters, as well as other residual
risks, such as gap risk, correlation risk, and behavioral risks such as
prepayments.
To calculate the residual risk add-on, the proposal would require a
banking organization to risk weight the gross effective notional amount
of a market risk covered position by 1 percent for market risk covered
positions that are not subject to the standardized default risk capital
requirement and that have an exotic exposure and by 0.1 percent for
other market risk covered positions with residual risks (described in
the next section). The total residual risk add-on capital requirement
would equal the sum of such capital requirements across subject market
risk covered positions.
i. Positions Subject to the Residual Risk Add-On
The proposal would require a banking organization to calculate a
residual risk add-on for market risk covered positions that have an
exotic exposure, and certain market risk covered positions that carry
residual risks. As the potential losses of market risk covered
positions with exotic exposures (longevity risk, weather, natural
disaster, among many) would not be adequately captured under the
sensitivities-based method, the agencies are proposing a capital
requirement equal to 1 percent of the gross effective notional amount
of the market risk covered position, as an appropriately conservative
capital requirement for such exposures.
In contrast, market risk covered positions with other residual
risks would include those for which the primary risk factors are mostly
captured under the sensitivities-based method, but for which there are
additional, known risks that are not quantified in the sensitivities-
based method. Specifically, the proposal would include: (1) correlation
trading positions with three or more underlying exposures that are not
hedges of correlation trading positions; (2) options or positions with
embedded optionality, where the payoffs could not be replicated by a
finite linear combination of vanilla options or the underlying
instrument; and (3) options or positions with embedded optionality that
do not have a stated maturity or strike price or barrier, or that have
multiple strike prices or barriers.\372\ As the residual risk add-on is
intended as a supplement to the capital requirement under the
sensitivities-based method for these known risks, the agencies are
proposing a capital requirement equal to 0.1 percent of the gross
effective notional amount for market risk covered positions with other
residual risks.
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\372\ As proposed, the criteria are intended to capture (1)
correlation risks for basket options, best of options, basis
options, Bermudan options, and quanto options; (2) gap risks for
path dependent options, barrier options, Asian options and digital
options; and (3) behavior risks that might arise from early exercise
(call or put features, or pre-payment).
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In addition to positions with exotic or other residual risks, a
primary Federal supervisor may require a banking organization to
subject other market risk covered positions to the residual risk add-
on, if the proposed framework would not otherwise appropriately
[[Page 64129]]
capture the material risks of such positions. While the agencies
believe that the proposed definitions would reasonably identify
positions with risks not appropriately captured by other aspects of the
proposed framework, there could be instances where a market risk
covered position should be subject to the residual risk add-on in order
to capture appropriately the associated market risk of the exposure in
risk-based capital requirements. To allow the agencies to address such
instances on a case-by-case basis, the proposal would allow the primary
Federal supervisor to make such determinations, as appropriate.
ii. Excluded Positions
To promote appropriate capitalization of risk, the proposal would
allow certain positions to be excluded from the calculation of the
residual risk add-on if such positions would meet the following set of
exclusions. Specifically, the proposal would permit a banking
organization to exclude positions, other than those that have an exotic
exposure, from the residual risk add-on, if the position is either (1)
listed on an exchange; (2) eligible to be cleared by a CCP or QCCP; or
(3) an option that has two or fewer underlying positions and does not
contain path dependent pay-offs. The proposed exclusions would permit a
banking organization to exclude simple options, such as spread options,
which have two underlying positions, but not those for which the
payoffs cannot be replicated by a combination of traded financial
instruments. As spread options would be subject to the vega and
curvature requirements under the sensitivities-based method, the
agencies believe that subjecting spread options to the residual risk
add-on would be incommensurate with the risks of such positions and
could increase inappropriately the cost of hedging without a
corresponding reduction in risk. Additionally, as most agency mortgage-
backed securities and certain convertible instruments (for example,
callable bonds) are eligible to be cleared, the proposal would allow a
banking organization to exclude these instruments that are eligible to
be cleared from the residual risk add-on, despite the pre-payment risk
of such instruments.\373\
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\373\ As discussed in section III.H.7.c.ii of this Supplementary
Information, callable bonds that are priced as yield-to-maturity
would not be subject vega risk, as the risk factors for such
instruments would already be sufficiently captured under the
sensitivities-based method.
---------------------------------------------------------------------------
The proposal would also allow a banking organization to exclude
positions, including those with exotic exposures, from the residual
risk add-on if the banking organization has entered into a third-party
transaction that exactly matches the market risk covered position (a
back-to-back transaction). As the long position and short position of
two identical trades would completely offset, excluding such
transactions from the residual risk add-on would appropriately reflect
the lack of residual risk inherent in such transactions.
Furthermore, the proposal would allow a banking organization to
exclude certain offsetting positions that may exhibit insignificant
residual risks and for which the residual risk add-on would be overly
punitive. Specifically, the proposal would allow a banking organization
to exclude the following from the residual risk add-on: (1) positions
that can be delivered into a derivative contract where the positions
are held as hedges of the banking organization's obligation to fulfill
the derivative contract (for example, TBA and security interests in
associated mortgage pools) as well as the associated derivative
exposure; (2) any GSE debt issued or guaranteed by GSEs or any
securities issued and guaranteed by the U.S. government; (3) internal
transactions between two trading desks, if only one trading desk is
model-eligible; (4) positions subject to the fallback capital
requirement; and (5) any other types of positions that the primary
Federal supervisor determines are not required to be subject to the
residual risk add-on, as the material risks would be sufficiently
captured under other aspects of the proposed market risk framework. For
example, the agencies consider the following risks sufficiently
captured under the proposed market risk framework such that banking
organizations would not need to calculate a residual risk add-on for
positions that exhibit these risks: risks from cheapest-to-deliver
options; volatility smile risk; correlation risk arising from multi-
underlying European or American plain vanilla options; dividend risk;
and index and multi-underlying options that are well-diversified or
listed on exchanges for which sensitivities are captured by the capital
requirement under the sensitivities-based method.
Question 133: The agencies seek comment on all aspects of the
proposed residual risk add-on. Specifically, the agencies request
comment on whether there are alternative methods to identify more
precisely exotic exposures and other residual risks for which the
residual risk capital requirement is appropriate. What, if any,
additional instruments and offsetting positions should be excluded from
the residual risk add-on and why? What, if any, quantitative measures
should the agencies consider to identify or distinguish residual risks
and why?
Question 134: Would characterizing volatility and variance swaps as
bearing other residual risk more appropriately reflect the risks of
such exposures and why?
d. Treatment of Certain Market Risk Covered Positions
To promote consistency in risk-based capital requirements across
banking organizations and to help ensure appropriate capitalization
under the market risk capital rule, the proposal would prescribe the
treatment of market risk covered positions that are hybrid instruments,
index instruments, and multi-underlying options under the standardized
approach, as described below.
i. Hybrid Instruments
Hybrid instruments are instruments that have characteristics in
common with both debt and equity instruments, including traditional
convertible bonds. As hybrid instruments primarily react to changes in
interest rates, issuer credit spreads, and equity prices, the proposal
would require a banking organization to assign risk sensitivities for
these instruments into the interest rate risk class, credit spread risk
class for non-securitization positions, and equity risk class, as
applicable, when calculating the delta, curvature, and vega under the
sensitivities-based method. For the standardized default risk capital
requirement, the proposal would require a banking organization to
decompose a hybrid instrument into a non-securitization position and an
equity position and calculate default risk capital for each position
respectively. For example, a convertible bond can be decomposed into a
vanilla bond and an equity call option. The notional amount to be used
in the default risk capital calculation for the vanilla bond is the
notional amount of the convertible bond. The notional amount to be used
in the default risk capital calculation for the call option is zero
(because, in the event of default, the call option will not be
exercised). In this case, a default of an issuer of the convertible
bond would extinguish the call option's value and this loss would be
captured through the profit and loss component of the gross default
exposure amount calculation. The standardized default risk capital
requirement for the convertible bond would be the sum of the default
risk capital of the vanilla bond and the default risk capital
requirement for the equity option.
[[Page 64130]]
ii. Index Instruments and Multi-Underlying Options
When calculating the delta and curvature capital requirements under
the sensitivities-based method for index instruments and multi-
underlying options, the proposal generally would require a banking
organization to apply a look-through approach. However, it could treat
listed and well-diversified credit or equity indices \374\ as a single
position. The look-through approach would require a banking
organization to identify the underlying positions of the index
instrument or multi-underlying option and calculate market risk capital
requirements as if the banking organization directly held the
underlying exposures. Under the proposal, a banking organization would
be required to apply consistently the look-through approach through
time and consistently for all positions that reference the same index.
The proposed look-through approach would align the treatment of such
instruments with that of single-name positions and thus provide greater
hedging recognition by allowing such instruments to net with single-
name positions issued by the same company. Specifically, a banking
organization would be able to net the risk factor sensitivities of such
positions of the index instrument or multi-underlying option and
single-name positions without restriction when calculating delta and
curvature capital requirements under the sensitivities-based method.
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\374\ An equity or credit index would be considered well
diversified if it contains a large number of individual equity or
credit positions, with no single position representing a substantial
portion of the index's total market value.
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In certain situations, a banking organization may choose not to
apply a look-through approach to listed and well-diversified indices,
in which case a single sensitivity for the index would be used to
calculate the delta and curvature capital requirements. To assign the
sensitivity of the index to the relevant sector or index bucket, the
agencies are proposing a waterfall approach as a simple and risk-
sensitive method to appropriately capture the risk of such positions
based on the risk and diversification of the underlying assets. For
indices where at least 75 percent of the notional value of the
underlying constituents relate to the same sector (sector-specific
indices), taking into account the weightings of the index, the
sensitivity would be assigned to the corresponding sector bucket. For
equity indices that are not sector specific, the sensitivity would be
assigned to the large market cap and liquid market economy (non-sector
specific) bucket if least 75 percent of the market value of the index
constituents met both the large market cap and liquid market economy
criteria, and to the other equity indices (non-sector specific) bucket
otherwise. For credit indices that are not sector specific, the
sensitivity would be assigned to the investment grade indices bucket if
the credit quality of at least 75 percent of the notional value of the
underlying constituents was investment grade, and to the speculative
grade and sub-speculative grade indices bucket otherwise.\375\ To the
extent a credit or an equity index spans multiple risk classes, the
proposal would require the banking organization to allocate the index
proportionately to the relevant risk classes following the above
methodology.
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\375\ See section III.H.7.a of this SUPPLEMENTARY INFORMATION
for a more detailed description on the assignment of delta
sensitivities to the prescribed risk buckets under the proposed
sensitivities-based method.
---------------------------------------------------------------------------
When calculating vega capital requirements for multi-underlying
options (including index options), the proposal would permit, but not
require, a banking organization to apply the look-through approach
required for delta and calculate the vega capital requirements based on
the implied volatility of options on the underlying constituents.
Alternatively, under the proposal, a banking organization could
calculate the vega capital requirement for multi-underlying options
based on the implied volatility of the option, which typically is the
method used by banking organizations' financial reporting valuation
models for multi-underlying options. For indices, the proposal would
require a banking organization to calculate vega capital requirements
based on the implied volatility of the underlying options by applying
the same approach used for delta and curvature and using the same
sector-specific bucket or index bucket.
The default risk of multi-underlying options that are non-
securitization debt or equity positions is primarily a function of the
idiosyncratic default risk of the underlying constituents. Accordingly,
to capture appropriately the default risk of such positions, the
proposal would require a banking organization to apply the look-through
approach when calculating the standardized default risk capital
requirement for multi-underlying options that are non-securitization
debt or equity positions. When decomposing multi-underlying exposures
or index options, a banking organization would be required to set the
gross default exposure assigned to a single name, referenced by the
instrument, equal to the difference between the value of the instrument
assuming only the single name defaults (with zero recovery) and the
value of the instrument assuming none of the single names referenced by
the instrument default.
Similarly, for positions in credit and equity indices, the proposal
would allow a banking organization to decompose the index position when
calculating the standardized default risk capital requirement. By
aligning the treatment of positions in credit and equity indices with
that of single-name positions, the proposal would provide greater
hedging recognition as the banking organization would be able to offset
the gross default exposure of long and short positions in indices with
that of single-name positions included in the index. Alternatively, as
the underlying assets of credit and equity indices could react
differently to the same market or economic event, the proposal would
also allow a banking organization to treat such indices as a single
position for purposes of calculating the standardized default risk
capital requirement.
Question 135: The agencies seek comment on the proposed threshold
of 75 percent for assigning a credit or equity index to the
corresponding sector or the investment grade indices bucket. What would
be the benefits and drawbacks of the proposed threshold? What, if any,
alternative thresholds should the agencies consider that would more
appropriately measure the majority of constituents in listed and well-
diversified credit and equity indices?
Question 136: The agencies seek comment on all aspects of the
proposed treatment of index instruments and multi-underlying options
under the standardized measure for market risk. Specifically, the
agencies request comment on any potential challenges from requiring the
look-through approach for all index instruments and multi-underlying
options that are non-securitization debt or equity positions for the
standardized default risk capital calculation. What, if any,
alternative methods should the agencies consider that would more
appropriately measure the default risk associated with such positions?
What would be the benefits and drawbacks of such alternatives compared
to the proposed look-through requirement?
8. Models-Based Measure for Market Risk
The core components of the proposed models-based measure for market
risk capital requirements are internal models
[[Page 64131]]
approach capital requirements for model-eligible trading desks
(IMAG,A), the standardized approach capital requirements for model-
ineligible trading desks (SAU), and the PLA add-on that addresses
deficiencies in the banking organization's internal models, if
applicable.
a. Internal Models Approach
The internal models approach capital requirements for model-
eligible trading desks (IMAG,A) would consist of four components: (1)
the internally modelled capital calculation for modellable risk factors
(IMCC); (2) the stressed expected shortfall for non-modellable risk
factors (SES); (3) the standardized default risk capital requirement as
described in section III.H.7.b of this SUPPLEMENTARY INFORMATION; and
(4) the aggregate trading portfolio backtesting capital multiplier.
The first two components, IMCC and SES, would capture risk and
distinguish between risk factors for which there are sufficient real
price observations to qualify as modellable risk factors and those for
which there are not (non-modellable risk factors or NMRFs).\376\ The
proposal would require banking organizations to separately calculate
the capital requirement for both types of risk factors using an
expected shortfall methodology. Under the proposal, the capital
requirement for both modellable and non-modellable risk factors would
reflect the losses calibrated to a 97.5 percent threshold over a period
of substantial market stress and incorporate the prescribed liquidity
horizons applicable to each risk factor.
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\376\ To be deemed modellable, a risk factor must pass the Risk
Factor Eligibility Test (RFET) and satisfy data quality
requirements, as described in more detail in section III.H.8.a.i of
this SUPPLEMENTARY INFORMATION.
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Relative to the IMCC for modellable risk factors, the SES
calculation for non-modellable risk factors would provide significantly
less recognition for hedging and portfolio diversification due to the
lower quality inputs to the model; for example, limited data are
available to estimate the correlations between non-modellable risk
factors used by the model. These data limitations also increase the
possibility that a banking organization's internal models overstate the
diversification benefits (and therefore, understate the magnitude of
potential losses), as correlations increase during periods of stress
relative to levels in normal market conditions. Furthermore, the
conservative treatment of non-modellable risk factors under the SES
calculation would provide appropriate incentives for banking
organizations to enhance the quality of model inputs.
The third component of the internal models approach is the
standardized default risk capital requirement, as described in section
III.H.7.b of this SUPPLEMENTARY INFORMATION.
To calculate the overall capital required under the internal models
approach at the trading desk level, a banking organization would add
the standardized default risk capital requirement (DRCSA) to the
greater of (i) the sum of the capital requirements for modellable and
non-modellable risk factors as of the most recent reporting date
(IMCCt-1 and SESt-1, respectively), or (ii) the sum of the average
capital requirements for non-modellable risk factors over the prior 60
business days (SESaverage) and the product of the average capital
requirements for modellable risk factors over the prior 60 business
days (IMCCaverage) and a multiplication factor (mc) of at least 1.5,
which serves to capture model risk (the aggregate trading portfolio
backtesting multiplier).\377\ The overall capital requirement under the
internal models approach can be expressed by the following formula:
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\377\ The size of the multiplication factor could vary from 1.5
to 2 based on the results of the entity-wide backtesting. See
section III.H.8.c. of this SUPPLEMENTARY INFORMATION for further
discussion on the entity-wide backtesting, otherwise known as the
aggregate trading portfolio backtesting multiplier.
IMAG,A = DRCSA + (max ((IMCCt-1 + SESt-1), ((mc x
---------------------------------------------------------------------------
IMCCaverage) + SESaverage)))
Due to the capital multiplier (mc), the agencies generally expect
the capital requirements for modellable and non-modellable risk factors
to reflect those based on the prior 60 business day average, which
would reduce quarterly variation. The proposal would require a banking
organization to take into account the capital requirements as of the
most recent reporting date to capture situations where the banking
organization has significantly increased its risk taking. Thus, the max
function in the above formula would capture cases where risk has risen
significantly throughout the quarter so that the average over the
quarter is significantly less than the risk the banking organization
faces at the end of the quarter.
Question 137: The agencies seek comment on the internal models
approach for market risk. To what extent does the approach
appropriately capture the risks of positions subject to the market risk
capital requirement? What additional features, adjustments (such as to
the treatment of diversification of risks), or alternative methodology
could the approach include to reflect these risks more appropriately
and why? Commenters are encouraged to provide supporting data.
i. Risk Factor Identification and Model Eligibility
Under the proposal, a banking organization that intends to use the
internal models approach would be required to identify an appropriate
set of risk factors that is sufficiently representative of the risks
inherent in all of the market risk covered positions held by model-
eligible trading desks. Specifically, the proposal would require a
banking organization's expected shortfall models to include all the
applicable risk factors specified in the sensitivities-based method
under the standardized approach, with one exception, as well as those
used in either the banking organization's internal risk management
models or in the internal valuation models it uses to report actual
profits and losses for financial reporting purposes. If the risk
factors specified in the sensitivities-based method are not included in
the expected shortfall models used to calculate risk-based capital for
market risk under the internal models approach, the banking
organization would be required to justify the exclusions to the
satisfaction of its primary Federal supervisor. As a check on the
greater flexibility provided under the internal models approach,\378\
in comparison to the proposed sensitivities-based method, model-
eligible trading desks would be subject to PLA add-on and backtesting
requirements, which would help ensure the accuracy and conservativism
of the risk-based capital requirements estimated by the expected
shortfall models.
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\378\ Unlike the proposed standardized approach, which would
require a banking organization to obtain a prior written approval of
its primary Federal supervisor to calculate risk factor
sensitivities using the banking organization's internal risk
management models, as described in section III.H.7.a.ii of this
SUPPLEMENTARY INFORMATION, the internal models approach would allow
a banking organization to use either the banking organization's
internal risk management models or the internal valuation models
used to report actual profits and losses for financial reporting
purposes.
---------------------------------------------------------------------------
For the identified risk factors, the proposal would require a
banking organization to conduct the risk factor eligibility test to
determine which risk factors are modellable, and thus subject to the
IMCC, and which are non-
[[Page 64132]]
modellable, and thus subject to the SES capital requirements. For a
risk factor to be classified as a modellable risk factor, a banking
organization would be required to identify a sufficient number of real
prices that are representative of the risk factor (those that could be
used to infer the value of the risk factor), as described in section
III.H.8.a.i.I of this SUPPLEMENTARY INFORMATION. Evidence of a
sufficient number of real prices demonstrates the liquidity of the
underlying risk factor and helps to ensure there is a sufficient
quantity of historical data to appropriately capture the risk factor
under expected shortfall models used in the IMCC calculation.
Question 138: The agencies request comment on the appropriateness
of the proposed requirements for the risk factors included in the
internal models approach. What, if any, alternative requirements should
the agencies consider, such as requiring risk factor coverage to align
with the front office models, and why? Specifically, please describe
any operational challenges and impact on banking organizations' minimum
capital requirements that requiring the expected shortfall model to
align with the front-office models would create relative to the
proposal.
I. Real Price
To perform the risk factor eligibility test, a banking organization
would be required to map real prices observed to the risk factors that
affect the value of the market risk covered positions held by model-
eligible trading desks. For example, a banking organization could map
the price of a corporate bond to a credit spread risk factor. The
proposal would define a real price as a price at which the banking
organization has executed a transaction, a verifiable price for an
actual transaction between third parties transacting at arm's length,
or a price obtained from a committed quote made by the banking
organization itself or another party, subject to certain conditions
discussed below. Prices obtained from collateral reconciliations or
valuations would not be considered real price observations for purposes
of the risk factor eligibility test because these transactions do not
indicate market liquidity of the position.
The agencies recognize that a banking organization may need to
obtain pricing information from third parties to demonstrate the market
liquidity of the underlying risk factors, and this may pose unique
challenges for validation and other model risk management activities.
Therefore, the proposed definition of a real price would limit
recognition of prices obtained from third-party providers to prices (1)
from a transaction or committed quote that has been processed through a
third-party provider \379\ or (2) for which there is an agreement
between the banking organization and the third party that the third
party would provide evidence of the transaction or committed quote to
the banking organization upon request.
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\379\ Prices from a transaction or quote processed through a
trading platform or exchange would satisfy this requirement for
purposes of the proposed definition of real price.
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In certain cases, obtaining information on the prices of individual
transactions from third parties may raise legal concerns for the
banking organization, the third-party provider, or both.\380\
Therefore, the proposal would allow a banking organization to consider
information obtained from a third party on the number of corresponding
real prices observed and the dates at which they have been observed in
determining the model eligibility of risk factors, if the banking
organization is able to appropriately map this information to the risk
factors relevant to the market risk covered positions held by model-
eligible trading desks. For a banking organization to be able to use
such information for determining the model eligibility of risk factors,
the proposal would require that either the third-party provider's
internal audit function or another external party audit the validity of
the third-party provider's pricing information. Additionally, the
proposal would require the results and reports of the audit to either
be made public or available upon request to the banking
organization.\381\
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\380\ Banking organizations must ensure that exchanges of price
information among competitors or with third parties are not likely
to include acts or omissions that could result in a violation of
Federal antitrust laws, including the Sherman Act, 15 U.S.C. 1 et
seq., and the Federal Trade Commission Act, 15 U.S.C. 41 et seq.
\381\ If the audit on the third-party provider is not
satisfactory to the primary Federal supervisor (for example, the
auditor does not meet the independence or expertise standards of
U.S. securities exchanges), the supervisor may determine that data
from the third-party provider may not be used for purposes of the
risk factor eligibility test.
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The additional requirements for prices or other information
obtained from third parties to qualify as a real price under the
proposed definition would allow banking organizations to appropriately
demonstrate the market liquidity of a risk factor, while also ensuring
there is sufficient documentation for the banking organization and the
primary Federal supervisor to assess the validity of the prices or
other information obtained from a third party.
Question 139: What, if any, other information should the agencies
consider in defining a real price that would better demonstrate the
market liquidity for risk factors, such as valuations provided by an
exchange or central counterparty or valuations of individual derivative
contracts for the purpose of exchanging variation margin? What, if any,
conditions or limitations should the agencies consider applying to help
ensure the validity of such information, such as only allowing
information related to individual derivative transactions to qualify as
a real price and not information provided on a pooled basis?
II. Bucketing Approach
To determine whether a risk factor satisfies the risk factor
eligibility test, a banking organization would be required to (1) map
real prices to each relevant risk factor or set of risk factors, such
as a curve, and (2) define risk buckets at the risk factor level. Under
the proposal, a banking organization could choose either its own
bucketing approach or the standard bucketing approach. As the choice of
approach is at the risk factor level, the proposal would allow a
banking organization to adopt its own bucketing approach for some risk
factors and the standard bucketing approach for others. The number of
risk factor buckets should be driven by the banking organization's
trading strategies. For example, a banking organization with a complex
portfolio across many points on the yield curve could elect to define
more granular risk factor buckets for interest rate risk, such as
separate 3-month and 6-month buckets, than those prescribed under the
standard bucketing approach, which puts all maturities of less than 9
months in one bucket. Conversely, a banking organization with less
complex products could elect to use the less granular standard
bucketing approach.
Table 1 to Sec. __.214 of the proposal provides the proposed risk
factor buckets a banking organization would be required to use to group
real prices under the standard bucketing approach. The proposal would
define the risk factor buckets under the standard bucketing approach
based on the type of risk factor, the maturity of the instruments used
for the real prices, and the probability that an option has value (is
``in the money'') at the maturity of the instrument.\382\ The proposed
buckets are intended to balance between
[[Page 64133]]
the granularity of the risk factors allocated to each standardized
bucket and the compliance burden of tracking and mapping the allocation
of real prices to more granular buckets, especially as market
conditions change. Too frequent re-allocation of real prices may lead
to artificial and unwarranted regulatory capital requirement
volatility.
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\382\ Whether an option has value (is ``in the money'') at the
maturity of the instrument depends on the relationship between the
strike price of the option and the market price for the underlying
instrument (the spot price). A call option has value at maturity if
the strike price is below the spot price. A put option has value at
maturity if the strike price is above the spot price.
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When using its own bucketing approach, a banking organization would
be able to define more granular risk factor buckets than those
prescribed under the standard bucketing approach, provided that the
internal risk management model uses the same buckets or segmentation of
risk factors to calculate profits and losses for purposes of the PLA
test.\383\ While the use of more granular buckets could facilitate a
model-eligible trading desk's ability to pass the proposed PLA test, it
would also render the risk factor eligibility test more challenging as
the banking organization would need to source a sufficient number of
real prices for each additional risk factor bucket. Therefore, the
proposal would provide the banking organization the flexibility to
define its own bucketing structures and would place an additional
operational burden on the banking organization to demonstrate the
appropriateness of using a more granular bucketing structure.
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\383\ Sec. __.213(c) of the proposed rule describes trading
desk-level profit and loss attribution test requirements.
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As positions mature, a banking organization could continue to
allocate real prices identified within the prior 12 months to the risk
factor bucket that the banking organization initially used to reflect
the maturity of such positions. Alternatively, the banking organization
could re-allocate the real prices for maturing positions to the
adjacent (shorter) maturity bucket. To avoid overstating the market
liquidity of a risk factor, the proposal would allow the banking
organization to count a real price observation only once, either in the
initial bucket or the adjacent bucket to which it was re-allocated, but
not in both.
To enable banking organizations' internal models to capture market-
wide movements for a given economy, region, or sector, the proposal
would allow, but not require, a banking organization to decompose risks
associated with credit or equity indices into systematic risk factors
\384\ within its internal models.\385\ The proposal would only allow
the banking organization to include idiosyncratic risk factors \386\
related to the credit spread or equity risk of a specific issuer if
there are a sufficient number of real prices to pass the risk factor
eligibility test. Otherwise, such idiosyncratic risk factors would be a
non-modellable risk factor. The proposal would allow a banking
organization, where possible, to consider real prices of market indices
(for example, CDX.NA.IG and S&P 500 Index) and instruments of
individual issuers as representative for a systematic risk factor as
long as they share the same attributes (for example, economy, region,
sector, and rating) as the systematic risk factor. The proposed
treatment would allow the banking organization to align the treatment
of real prices for market indices with those for single-name positions
and, thus, provide greater hedging recognition.
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\384\ The proposal would define systematic risk factors as
categories of risk factors that present systematic risk, such as
economy, region, and sector. Systematic risk would be defined as the
risk of loss that could arise from changes in risk factors that
represent broad market movements and that are not specific to an
issue or issuer.
\385\ As a banking organization may not always be able to model
each constituent of the index, the agencies are not proposing to
require the banking organization to always decompose credit spread
and equity risk factors.
\386\ Idiosyncratic risk factors would be defined as categories
of risk factors that present idiosyncratic risk. Idiosyncratic risk
would be defined as the risk of loss in the value of a position that
arise from changes in risk factors unique to the issuer. These risks
would include the inherent risks associated with a specific issuance
or issuer that would change a position's value but are not
correlated with broader market movements (for example, the impact on
the position's value from departure of senior management or
litigation).
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To determine whether the risk factors in a bucket pass the risk
factor eligibility test, the proposal would require a banking
organization to allocate a real price to any risk bucket for which the
price is representative of the risk factors within the bucket and to
count all real prices mapped to a risk bucket. A real price may often
be used to infer values for multiple risk factors. By requiring real
prices to evidence the model eligibility of all risk factors related
with the observation, the proposal would more accurately capture the
market liquidity for the relevant risk factors.
Question 140: The agencies request comment on what, if any,
modifications to the proposed bucketing structure should be considered
to better reflect the risk factors used to price certain classes of
products. What would be the benefits or drawbacks of such alternatives
compared to the proposed bucketing structure?
III. Model Eligibility of Risk Factors
For a risk factor to pass the risk factor eligibility test, a
banking organization would be required on a quarterly basis to either
identify for each risk factor (i) at least 100 real prices in the
previous twelve-month period or (ii) at least 24 real prices in the
previous twelve-month period, if each 90-day period contains at least
four real prices.\387\ The proposed criteria are intended to help
ensure real prices capture products that exhibit either a minimum level
of trading activity throughout the year, or seasonal periods of
liquidity, such as commodities.
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\387\ As described in section III.H.8.a.i.I of this
SUPPLEMENTARY INFORMATION, in certain cases, a banking organization
would be allowed to obtain information on the prices of individual
transactions from third parties in determining the model eligibility
of risk factors.
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For any market risk covered position, the banking organization
could not count more than one real price observation in any single day
and would be required to count the real price as an observation for all
of the risk factors for which it is representative. Together, these
requirements are intended to help ensure that real prices capture more
accurately the market liquidity for the relevant risk factors and
prevent outdated prices from being used as model inputs.\388\
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\388\ For example, if several transactions occur on day one,
followed by a long period for which there are no real price
observations, the proposal would prevent a banking organization from
using the outdated day-one prices to estimate the fair value of its
current holdings.
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The agencies recognize that the banking organization may use a
combination of internal and external data for the risk factor
eligibility test. When a banking organization relies on external data,
the real prices may be provided with a time lag. Therefore, the
proposal would allow the banking organization to use a different time
period for purposes of the risk factor eligibility test than that used
to calibrate the current expected shortfall model, if such difference
is not greater than one month. For consistency in the time periods used
for internal and external data, the proposal would also allow the
period used for internal data for purposes of the risk factor
eligibility test to differ from that used to calibrate the expected
shortfall model, but only if the period used for internal data is
exactly the same as that used for external data.
For risk factors associated with new issuances, the observation
period for the risk factor eligibility test would begin on the issuance
date and the number of real prices required to pass the risk factor
eligibility test would be pro-rated until
[[Page 64134]]
12 months after the issuance date. For example, a bond that was issued
six months prior would require 50 real prices over the prior six-month
period to pass the risk factor eligibility test or at least 12 real
price observations with no 90-day period in which fewer than four real
price observations were identified for the risk factor. For market risk
covered positions that reference new reference rates, the proposal
would allow the banking organization to use quotes of discontinued
reference rates that the new reference rate is replacing to pass the
risk factor eligibility test until the new reference rate liquidity
improves.
If a standard or own bucket for risk factor eligibility contains a
sufficient number of real prices to pass the risk factor eligibility
test and the risk factors also satisfy the data quality requirements
for modellable risk factors described in the following section, all
risk factors within the bucket would be deemed modellable. Risk factors
within a bucket that fail to pass the risk factor eligibility test or
that do not satisfy the data qualify requirements would be classified
as non-modellable risk factors.
Question 141: What, if any, restrictions on the minimum observation
period for new issuances should the agencies consider and why?
Question 142: The agencies request comment on whether certain types
of risk factors should be considered to pass the risk factor
eligibility test based on sustained volume over time and through crisis
periods. What if any conditions should be met before these can be
considered real price observations and why?
IV. Data Quality Requirements
Under the proposal, once a risk factor has passed the risk factor
eligibility test, the banking organization would be required to choose
the most appropriate data for calculating the IMCC for modellable risk
factors. In calculating the IMCC, a banking organization could use
other data than that used to demonstrate the market liquidity of a risk
factor for purposes of the risk factor eligibility test, provided that
such data meet the data quality requirements listed below. Alternative
sources may provide updated data more frequently than would otherwise
be available from those used to obtain real prices. For example,
banking organizations may be able to obtain updated data more
frequently from internal systems than from third-party providers.
Additionally, in certain cases, a banking organization may not be able
to use the real prices to calculate the IMCC. For example, a banking
organization may receive data from a third-party provider on the dates
and number of real prices, as described in section III.H.8.a.i.I of
this SUPPLEMENTARY INFORMATION. While such data demonstrates the
liquidity of a risk factor for purposes of the risk factor eligibility
test, without the transaction prices, such real prices would not
provide any value to calibrate potential losses for a particular risk
factor.
To help ensure the appropriateness of the data and other
information used to calibrate the expected shortfall models for IMCC,
the proposal would establish data quality requirements for risk factors
to be deemed modellable risk factors. Under the proposal, any risk
factor that passes the risk factor eligibility test but subsequently
fails to meet any of the following seven proposed data quality
requirements would be a non-modellable risk factor.
First, the proposal would generally require that the data reflect
prices observed or quoted in the market. For any data not derived from
real prices, the proposal would require the banking organization to
demonstrate that such data are reasonably representative of real
prices. A banking organization should periodically reconcile the price
data used to calibrate its expected shortfall models for IMCC with that
used by the front office and internal risk management models, to
confirm the validity of the price data used to calculate the IMCC under
the internal models approach.\389\
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\389\ If real prices are not widely available, a banking
organization may use the prices estimated by the front office and
risk management models for this comparison.
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Second, the proposal would require the data used in the expected
shortfall models for IMCC to capture both the systematic risk and
idiosyncratic risk (as applicable) of modellable risk factors so that
the IMCC appropriately reflects the potential losses arising from
modellable risk factors.
Third, the proposal would require the data used to calibrate the
IMCC expected shortfall model to appropriately reflect the volatility
and correlation of risk factors of market risk covered positions.
Different data sources can provide dramatically different volatility
and correlation estimates for asset prices. When selecting the data
sources to be used in calculating the IMCC, a banking organization
should assess the quality and relevance of the data to ensure it would
be appropriately representative of real prices, not understate price
volatility, and accurately reflect the correlation of asset prices,
rates across yield curves, and volatilities within volatility surfaces.
Fourth, the proposal would allow the data used to calibrate the
IMCC expected shortfall model to include combinations of other
modellable risk factors. However, a risk factor derived from a
combination of modellable risk factors would be modellable only if this
risk factor also passes the risk factor eligibility test.
Alternatively, banking organizations may decompose the derived risk
factor into two components: a modellable component and a non-modellable
component that represents the basis between the modellable component
and the non-modellable risk factor. To derive modellable risk factors
from combinations of other modellable risk factors, banking
organizations could use common approaches, such as interpolation or
principal component analysis, if such approaches are conceptually
sound. In connection with implementation of any final rule based on
this proposal, the agencies would intend to use the supervisory process
to supplement the proposal through horizontal reviews to evaluate the
appropriateness of banking organizations' use of combinations of risk
factors to determine whether a risk factor is modellable. For example,
the agencies could require risk factors to be treated as non-modellable
if the banking organization were to use unsound extrapolation or
irregular bucketing approaches for modellable risk factors.
Fifth, the proposal would require a banking organization to update
the data inputs at a sufficient frequency and on at least a weekly
basis. While generally the banking organization should strive to update
the data inputs as frequently as possible, the agencies would require
the data to be updated weekly as requiring large data sets to be
updated more frequently may pose significant operational challenges.
For example, a banking organization that relies on a third-party
provider may not be able to receive updated data on a real time or
daily basis. The proposal would require a banking organization that
uses regressions to estimate risk factor parameters to re-estimate the
parameters on a regular basis. In addition, the agencies would expect a
banking organization to calibrate its expected shortfall models to
current market prices at a sufficient frequency, ideally no less
frequently than the calibration of front office models. A banking
organization would be required to have clear policies and procedures
for backfilling and gap-filling missing data.
Sixth, in determining the liquidity horizon-adjusted expected
shortfall-based measure, a banking organization
[[Page 64135]]
would be required to use data that are reflective of market prices
observed or quoted in periods of stress. Under the proposal, banking
organizations should source the data directly from the historical
period, whenever possible. Even if the characteristics of the market
risk covered positions currently being traded differ from those traded
during the historical stress period, the proposal would require a
banking organization to empirically justify the use of any prices in
the expected shortfall calculation in a stress period that differ from
those actually observed during a historical stress period. For market
risk covered positions that did not exist during a period of
significant financial stress, the proposal would require banking
organizations to demonstrate that the prices used match changes in the
prices or spreads of similar instruments during the stress period.
Seventh, the data for modellable risk factors could include proxies
if the banking organization were able to demonstrate the
appropriateness of such proxies to the satisfaction of the primary
Federal supervisor. At a minimum, a banking organization would be
required to have sufficient evidence demonstrating the appropriateness
of the proxies, such as an appropriate track record for their
representation of a market risk covered position. Additionally, any
proxies used would be required to (1) exhibit sufficiently similar
characteristics to the transactions they represent in terms of
volatility level and correlations and (2) be appropriate for the
region, credit spread cohort, quality, and type of instrument they are
intended to represent. Under the proposal, a banking organization's
proxying of new reference rates would be required to appropriately
capture the risk-free rate as well as credit spread, if applicable.
Even if a risk factor passes the risk factor eligibility test and
satisfies each of the seven proposed data quality requirements, the
primary Federal supervisor may determine the data inputs to be
unsuitable for use in calculating the IMCC. In such cases, the proposal
would require a banking organization to exclude the risk factor from
the expected shortfall model and subject it to the SES capital
requirements for non-modellable risk factors.
Question 143: The agencies request comment on the appropriateness
of the proposed data quality requirements for modellable risk factors.
What, if any, challenges might the proposed requirements pose for
banking organizations? What, if any, additional requirements should the
agencies consider to help ensure the data used to calculate the IMCC
appropriately capture the potential losses arising from modellable risk
factors?
Question 144: The agencies request comment on the appropriateness
of requiring banking organizations to update the data inputs used in
calculating the IMCC on at least a weekly basis. What, if any,
challenges might this pose for banking organizations? How could such
concerns be mitigated while ensuring the integrity of the data inputs
used to calculate regulatory capital requirements for modellable risk
factors?
Question 145: The agencies request comment on the appropriateness
of requiring banking organizations to re-estimate parameters in line
with the frequency specified in their policies and procedures. What, if
any, challenges might this pose for banking organizations?
Question 146: The agencies request comment on the operational
burden of requiring banking organizations to model the idiosyncratic
risk of an issuer that satisfies the risk factor eligibility test and
data quality requirements using data inputs for that issuer. What, if
any, alternative approaches should the agencies consider such as
allowing banking organizations to use data from similar names that
would appropriately capture the idiosyncratic risk of the issuer? What
would be the benefits and drawbacks of such alternatives relative to
the proposal?
ii. Internally Modelled Capital Calculation (IMCC) for Modellable Risk
Factors
The IMCC for modellable risk factors is intended to capture the
estimated losses for market risk covered positions on model-eligible
trading desks arising from changes in modellable risk factors during a
period of substantial market stress. As described in this section, the
IMCC for modellable risk factors would begin with the calculation each
business day of the expected shortfall-based measure for an entity-wide
level for each risk class and across risk classes for all model-
eligible trading desks, and also for a trading desk level throughout a
twelve-month period of stress, which then would be adjusted using risk-
factor specific liquidity horizons.
The proposal would require a banking organization to use one or
more internal models to calculate on an entity-wide level for each risk
class and across risk classes a daily expected shortfall-based measure
under stressed market conditions.\390\ While the proposal would allow a
banking organization's expected shortfall internal models to use any
generally accepted modelling approach (for example, variance-covariance
models, historical simulations,\391\ or Monte Carlo simulations) to
measure the expected shortfall for modellable risk factors, the
proposal would require the models to satisfy the proposed backtesting
and PLA testing requirements to demonstrate on an on-going basis that
such models are functioning effectively and to assess their performance
over time as conditions and model applications change.\392\
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\390\ As discussed in section III.H.8.a.ii.I of this
Supplementary Information, a banking organization may elect to
either use (1) the full set of risk factors employed by its internal
risk management models and directly calculate the daily expected
shortfall measure under the selected twelve-month period of stress
or (2) an appropriate subset of modellable risk factors to estimate
the potential losses that would be incurred throughout the selected
stress period, which would require the banking organization to
estimate a daily expected shortfall measure for both the current and
stress period.
\391\ The proposal would allow a banking organization to use
filtered historical simulation, as the approach generally reflects
current volatility and would maintain equal weighting of the
observations by rescaling all of the observations.
\392\ See sections III.H.8.b and III.H.8.c of this Supplementary
Information for further discussion on the PLA testing and
backtesting requirements, respectively.
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Additionally, the proposal would require a banking organization's
expected shortfall internal models to appropriately capture the risks
associated with options, including non-linear price characteristics,
within each of the risk classes as well as correlation and relevant
basis risks, such as basis risks between credit default swaps and
bonds. For options, at a minimum, the proposal would require a banking
organization's expected shortfall internal models to have a set of risk
factors that capture the volatilities of the underlying rates and
prices and model the volatility surface across both strike price and
maturity, which are necessary inputs for appropriately valuing the
options.
I. Expected Shortfall-Based Measure
To reflect the potential losses arising from modellable risk
factors on model-eligible trading desks throughout an appropriately
severe twelve-month period of stress (as described in section
III.H.8.a.ii.III of this Supplementary Information), the proposal would
require a banking organization to use one or more internal models to
calculate each business day an expected shortfall-based measure using a
one-tail, 97.5th percentile confidence interval at the
[[Page 64136]]
entity-wide level for each risk class and across all risk classes for
all model-eligible trading desks.\393\
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\393\ The proposal would also require banking organizations to
calculate a daily expected shortfall-based measure at the trading
desk level for the purposes of backtesting and PLA testing to
determine whether a model-eligible trading desk is subject to the
PLA add-on. See sections III.H.8.b and III.H.8.c of this
Supplementary Information for further discussion.
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Under the proposal, the requirement to exclude non-modellable risk
factors from expected shortfall-based internal models used to calculate
the IMCC could pose significant operational burden for entity-wide
backtesting and may also cause anomalies in the expected shortfall-
based calculation that render the IMCC relatively unstable.\394\
Accordingly, the proposal would allow a banking organization, with
approval from its primary Federal supervisor, to also capture in its
internal models the non-modellable risk factors on model-eligible
trading desks, though such positions would still be required to be
included in the SES measure for non-modellable risk factors, described
in section III.H.8.a.iii of this Supplementary Information. The
agencies view that this will provide a banking organization an
appropriate incentive to integrate the expected shortfall-based
internal models used to calculate the IMCC into its daily risk
management processes,\395\ which may not distinguish between modellable
and non-modellable risk factors.
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\394\ For example, when a single tenor point is excluded from
the shock to an interest rate curve, the resulting shock across the
curve may be unrealistic.
\395\ As described in more detail in section III.H.5.d.ii of
this Supplementary Information, the proposal would require a banking
organization that calculates the market risk capital requirements
under the models-based measure for market risk to incorporate its
internal models, including its expected shortfall internal models,
into its daily risk management process.
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To calculate the daily expected shortfall-based measure, a banking
organization would apply a base liquidity horizon of 10 days (the
shortest liquidity horizon for any risk factor bucket in each risk
factor class) to either the full set of modellable risk factors on its
model-eligible trading desks or an appropriate subset of modellable
risk factors throughout a twelve-month stress period (base expected
shortfall).
The agencies view that requiring a banking organization to directly
estimate the potential change in value of each of its market risk
covered positions held by model-eligible trading desks arising from the
full set of modellable risk factors throughout a twelve-month period of
stress may pose significant operational challenges. For example, a
banking organization may not be able to source sufficient data for all
modellable risk factors during the identified twelve-month stress
period. Thus, the proposal would allow a banking organization to use
either the full set of modellable risk factors employed by the expected
shortfall model (direct approach) or an appropriate subset (indirect
approach) of the entire portfolio of modellable risk factors for the
stress period.
Under the direct approach, the banking organization would directly
calculate the expected shortfall measure at the entity-wide level for
each risk class and across all risk classes throughout a twelve-month
period of stress and then apply the liquidity horizon adjustments
discussed in the following section.
Under the indirect approach, a banking organization would use a
reduced set of modellable risk factors to estimate the losses that
would be incurred throughout the stress period for the full set of
modellable risk factors. The proposal would require a banking
organization using the indirect approach to perform three separate
expected shortfall calculations at the entity-wide level for each risk
class and at the entity-wide level across risk classes: one using a
reduced set of risk factors for the stress period, one using the same
reduced set of risk factors for the current period, and one using the
full set of risk factors for the current period. Similar to the direct
approach, the proposal would require the banking organization to apply
the liquidity horizon adjustments discussed in the following section to
each of the three expected shortfall calculations to approximate the
entity-wide liquidity horizon-adjusted expected shortfall-based
measures for the full set of risk factors in stress.
Under the proposal, the banking organization would multiply the
liquidity horizon-adjusted expected shortfall-based measure for the
stress period based on the reduced set of risk factors (ESR,S) by the
ratio of the liquidity horizon-adjusted expected shortfall-based
measure in the current period based on the full set of risk factors
(ESF,C) to the lesser of the current liquidity-horizon adjusted
expected shortfall-based measure using the reduced set of risk factors
or ESF,C (ESR,C), as provided according to the following formula under
Sec. __.215(b)(6)(ii)(B) of the proposed rule, ES:
[GRAPHIC] [TIFF OMITTED] TP18SE23.032
The proposal would floor this ratio at one to prevent a reduction in
capital requirements due to using the reduced set of risk factors.
Additionally, the proposal would require the entity-wide liquidity
horizon-adjusted expected shortfall-based measure for the current
period based on the reduced set of risk factors (ESR,C),to explain at
least 75 percent of the variability of the losses estimated by the
liquidity horizon-adjusted expected shortfall-based measure in the
current period for the full set of risk factors (ESF,C) over the
preceding 60 business days. Under the proposal, compliance with the 75
percent variation requirement would be determined based on an out-of-
sample R\2\ measure, as defined according to the following formula
under Sec. __.215(b)(5)(ii)(C) of the proposed rule:
[GRAPHIC] [TIFF OMITTED] TP18SE23.033
Mean(ESF,C) would be the mean of ESF,C over the previous 60 business
days. This formula is intended to help ensure that the potential losses
estimated under the indirect approach appropriately reflect those that
would be produced by the full set of modellable risk factors, if such a
stress were to occur in the current period.
Furthermore, to help ensure the accuracy of this comparison, the
proposal would require a banking organization that uses the indirect
approach to update the reduced set of
[[Page 64137]]
risk factors whenever it updates its twelve-month stress period, as
described in section III.H.8.a.ii.III of this Supplementary
Information. The proposal would also require the reduced set of
modellable risk factors used to calculate the liquidity horizon-
adjusted expected shortfall-based measure for the stress period to have
a sufficiently long history of observations that satisfies the data
quality requirements for modellable risk factors, as described in
section III.H.8.a.i.IV of this Supplementary Information. In this
manner, the proposal would hold the inputs used for the indirect
approach to the same data quality requirements as those required of the
inputs used in the direct approach.
Question 147: What operational difficulties, if any, would be posed
by requiring banking organizations to exclude non-modellable risk
factors from the expected shortfall models for the purpose of the IMCC
calculation and entity-wide daily backtesting requirement?
Question 148: The agencies request comment on the appropriateness
of requiring the election of either the direct or the indirect approach
to apply to the entire portfolio of modellable risk factors for market
risk covered positions on model-eligible trading desks. What, if any,
alternatives should the agencies consider that would enable banking
organizations' expected shortfall models to more accurately measure
potential losses under the selected stress period, such as allowing
banking organizations to make this election at the level of the trading
desk, risk class, or risk factor? If this election is allowed at a more
granular level, how should the agencies consider addressing the
operational challenges associated with aggregating the various direct
and indirect expected shortfall measures into a single entity-wide
expected shortfall measure? What would be the benefits and drawbacks of
such alternatives compared to the proposed entity-wide election?
II. Liquidity Horizon Adjustments
To capture appropriately the potential losses from the longer
periods of time needed to reduce the exposure to certain risk factors
(for example, by selling assets or entering into hedges), a banking
organization would assign each modellable risk factor to the proposed
liquidity horizons specified in Table 2 to Sec. __.215 of the proposed
rule.
BILLING CODE 6210-01-P; 6714-01-P; 4810-33-P
[[Page 64138]]
[GRAPHIC] [TIFF OMITTED] TP18SE23.034
BILLING CODE 6210-01-C; 6714-01-C; 4810-33-C
The proposed liquidity horizons (10, 20, 40, 60, and 120 days)
would vary across risk factors, with longer horizons assigned to those
that would require longer periods of time to sell or hedge, except for
instruments with a maturity shorter than the respective liquidity
horizon. For instruments with a maturity shorter than the respective
liquidity horizon assigned to the risk factor, the banking organization
would be required to use the next longer liquidity horizon compared to
the maturity of the market risk covered position. For example, if an
investment grade corporate bond matures in 19 days, the proposal would
require a banking organization to assign the associated credit spread
risk factor a liquidity horizon of 20 days rather than the proposed 40-
day liquidity horizon. To map liquidity horizons for multi-underlying
instruments, such as credit and equity indices, the proposal would
require a banking organization to take a weighted average of the
liquidity horizons of risk factors corresponding to the underlying
constituents and the respective weighting of each within the index and
use the shortest liquidity horizon that is equal to or longer than the
weighted average.\397\ Furthermore, the proposal would require a
banking organization to apply a consistent liquidity horizon to both
the inflation risk factors and interest rate risk factors for a given
currency.
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\396\ Any currency pair formed by the following list of
currencies: USD, EUR, JPY, GBP, AUD, CAD, CHF, MXN, CNY, NZD, HKD,
SGD, TRY, KRW, SEK, ZAR, INR, NOK, BRL, and any additional
currencies specified by the primary Federal supervisor.
\397\ A weighted average would be based on the market value of
the instruments with the same liquidity horizon.
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In general, the proposed liquidity horizons closely follow the
Basel III reforms. The proposal would clarify the applicable liquidity
horizon for non-securitization positions issued or guaranteed by the
GSEs. Under the proposal, a banking organization would assign a
liquidity horizon of 20 days to GSE debt guaranteed by a GSE, and a
liquidity horizon of 40 days to all other
[[Page 64139]]
positions issued by the GSEs. The proposed 20-day liquidity horizon
would recognize that GSE debt instruments guaranteed by the GSEs
consistently trade in very large volumes and, similar to U.S. Treasury
securities, have historically been able to rapidly generate liquidity
for a banking organization, including during periods of severe market
stress. Consistent with the agencies' current capital rule, the
proposal would assign a longer 40-day liquidity horizon to all other
positions issued by the GSEs, as such positions are not as liquid or
readily marketable as those that are guaranteed by the GSEs. Together,
the proposed treatment is intended to promote consistency and
comparability in regulatory capital requirements across banking
organizations and to help ensure appropriate capitalization of such
positions under subpart F of the capital rule.
To encourage sound risk management and enable a banking
organization and the agencies to appropriately evaluate the conceptual
soundness of the expected shortfall models used to calculate the IMCC,
the proposal would require a banking organization to establish and
document procedures for performing risk factor mappings consistently
over time. Additionally, the proposal would require a banking
organization to map each of its risk factors to one of the risk factor
categories and the corresponding liquidity horizon in a consistent
manner on a quarterly basis to help ensure that the selected stress
period continues to appropriately reflect potential losses for the risk
factors of model-eligible trading desks over time.
To conservatively recognize empirical correlations across risk
factor classes, the proposal would require a banking organization to
calculate the liquidity horizon-adjusted expected shortfall-based
measure both at the entity-wide level for each risk class and across
risk classes for all model-eligible trading desks. To calculate the
entity-wide liquidity horizon-adjusted expected shortfall-based measure
for each risk class, the banking organization would be required to
scale up the 10-day base expected shortfall measure using the longer
proposed liquidity horizons for modellable risk factors within the same
risk class and assign either the same or a longer liquidity horizon;
all other modellable risk factors, including those within the same risk
class but assigned a shorter liquidity horizon, would be held constant
to appropriately reflect the incremental losses attributable to the
specific risk factors over the longer proposed liquidity horizon. The
banking organization would calculate separately the liquidity horizon-
adjusted expected shortfall-based measure for modellable risk factors
within the same risk class at each proposed liquidity horizon
consecutively, starting with the shortest (10 days). Specifically, a
banking organization would first compute the potential loss over the 0-
to 10-day period,\398\ then the potential loss over the subsequent 10-
to 20-day period--assuming that its exposure to risk factors within the
10-day liquidity horizon has been eliminated--and continue this
calculation for each of the proposed liquidity horizons, as described
in Table 1 to Sec. __.215 of the proposed rule. A banking organization
would then aggregate the losses for each period to determine the total
liquidity horizon-adjusted expected shortfall-based measure for the
risk class.
---------------------------------------------------------------------------
\398\ When computing losses over the 0- to 10-day period, the
proposal would require a banking organization to floor the time
period for extinguishing its exposure to a risk factor exposure at
10 days. For example, if an instrument would mature in two days, the
banking organization must still calculate the potential losses
assuming a 10-day liquidity horizon.
---------------------------------------------------------------------------
The liquidity horizon-adjusted expected shortfall-based measure for
each risk class would reflect both the losses under the expected
shortfall-based measure and the incremental losses at each proposed
liquidity horizon, according to the following formula, as provided
under Sec. __.215(b)(3) of the proposed rule:
[GRAPHIC] [TIFF OMITTED] TP18SE23.035
Where:
ES is the regulatory liquidity horizon-adjusted expected shortfall;
T is the length of the base liquidity horizon, 10 days;
EST(P) is the ES at base liquidity horizon T of a portfolio with
market risk covered positions P;
EST(P,j) is the ES at base liquidity horizon T of a portfolio with
market risk covered positions P for all risk factors whose liquidity
horizon corresponds to the index value, j, specified in Table 1 to
Sec. __.215 of the proposed rule;
LHj is the liquidity horizon corresponding to the index value, j,
specified in Table 1 to Sec. __.215 of the proposed rule.
To calculate the liquidity horizon-adjusted expected shortfall-
based measure at the entity-wide level across risk classes, the banking
organization would scale up the 10-day expected shortfall-based measure
for all modellable risk factors assigned either the same or a longer
liquidity horizon, without distinguishing between risk classes.
Otherwise, the process to calculate the entity-wide liquidity horizon-
adjusted expected shortfall-based measure would be the same as the
risk-class level calculation.
---------------------------------------------------------------------------
\399\ The incremental increase in time is represented by the
difference in the liquidity horizons, LHj-LHj-1. In the example,
from liquidity horizon 20 days to 40 days, this amount is 20 days,
or 40 days-20 days. The incremental increase in time is divided by
the base horizon of 10 days. Thus, the time scaling factor for
credit spread risk is the square root of 2.
---------------------------------------------------------------------------
For example, assume that a banking organization would be required
to calculate the liquidity horizon-adjusted expected shortfall-based
measure for a single, USD denominated, investment grade corporate bond,
whose price is only driven by two risk factors, interest rate risk and
credit spread risk. Under the proposal, the banking organization would
calculate the expected shortfall-based measure for both interest rate
risk and credit risk factors using the 10-day liquidity horizon, as
expressed by EST(P) in the above formula. According to Table 2 to Sec.
__.215 in the proposed rule, the liquidity horizon for interest rate
risk denominated in USD is 10 days and the liquidity horizon for credit
spread risk of investment grade issuers is 40 days. Therefore, the
banking organization would not extend the liquidity horizon for
interest rate risk but would for the credit spread risk. To determine
the liquidity horizon-adjusted expected shortfall-based measure for
credit spread risk, the banking organization would (1) scale the credit
spread risk by the square root of
[[Page 64140]]
the incremental increase in time (1 for liquidity horizon from 10 days
to 20 days and the square root of 2 for liquidity horizon from 20 days
to 40 days),\399\ (2) add the resulting liquidity horizon adjustment
for credit spread risk, as expressed by the second term in the above
formula and repeated below, to the base 10-day liquidity horizon
squared, and (3) calculate the square root of the sum of (1) and (2):
[GRAPHIC] [TIFF OMITTED] TP18SE23.036
As described above, the proposal would require the banking
organization to perform this calculation at the aggregate level, which
combines the risk factors for all risk classes and separately for each
risk class, such as interest rate risk and credit spread risk. The
proposal would require the banking organization to use the results of
these calculations as inputs into the overall capital calculation,
described in more detail below in section III.H.8.a.ii.IV of this
Supplementary Information.
Question 149: What, if any, risk factors exist that would not be
captured by the proposal for which the agencies should consider
designating a specific liquidity horizon and why?
Question 150: The agencies request comment on the appropriateness
of assigning a liquidity horizon for multi-underlying instruments based
on the weighted average of the liquidity horizons for the risk factors
corresponding to the underlying constituents and the respective
weighting of each within the index. What, if any, alternative
methodologies should the agencies consider, such as assigning the
liquidity horizon for credit and equity indices based on the longest
liquidity horizon applicable to the risk factors corresponding to the
underlying constituents? What would be the benefits and drawbacks of
such alternatives compared to the proposal? Commenters are encouraged
to provide data to support their responses.
Question 151: The agencies request comment on the appropriateness
of requiring banking organizations to use the next longer liquidity
horizon for instruments with a maturity shorter than the respective
liquidity horizon assigned to the risk factor. What, if any,
operational challenges might this pose for banking organizations? How
could such concerns be mitigated while still ensuring consistency and
comparability in regulatory capital requirements across banking
organizations?
III. Stress Period
To appropriately account for potential losses in stress, the
proposal would require a banking organization to calculate the entity-
wide expected shortfall-based measures for each risk class and across
risk classes described in section III.H.8.a.ii.I of this Supplementary
Information using the twelve-month period of stress for which its
market risk covered positions on model-eligible trading desks would
experience the largest cumulative loss. To identify the appropriate
period of stress, the proposal would require a banking organization to
consider all twelve-month periods spanning back to at least 2007 and,
depending on whether the banking organization elected to employ the
direct or indirect approach, select that in which either the full or
reduced set of risk factors would incur the largest cumulative
loss.\400\ The proposal would require a banking organization to equally
weight observations within each twelve-month stress period when
selecting the appropriate stress period.
---------------------------------------------------------------------------
\400\ Under the proposal, a banking organization that has
elected to use the direct approach would select the relevant stress
period using the full set of modellable risk factors, while that
using the indirect approach would use the reduced set of risk
factors to select the stress period.
---------------------------------------------------------------------------
To help ensure that the stress period continues to appropriately
reflect potential losses for the modellable risk factors of model-
eligible trading desks over time, the proposal would require a banking
organization to review and update, if appropriate, the twelve-month
stress period on at least a quarterly basis or whenever there are
material changes in the risk factors of model-eligible trading desks.
Question 152: The agencies seek comment on the appropriateness of
requiring banking organizations to use the same reduced set of risk
factors to both identify the appropriate stress period and calculate
the IMCCs. To what extent does the proposed approach provide banking
organizations sufficient flexibility to appropriately capture the risk
factors that may be present in some, but not all stress periods? What,
if any, alternative approaches should the agencies consider that would
better serve to capture such risk factors relative to the proposal?
IV. Total Internal Models Capital Calculations (IMCC)
The proposal would require a banking organization to use the
liquidity horizon-adjusted expected shortfall-based measures calculated
throughout the stress period at the entity-wide level for each risk
(IMCC(Ci)) and at the entity-wide level across risk classes (IMCC(C))
to calculate the IMCC for the modellable risk factors of model-eligible
trading desks. To constrain the empirical correlations and provide an
appropriate balance between perfect diversification and no
diversification between risk factor classes, the IMCC would equal half
of the entity-wide liquidity horizon-adjusted expected shortfall-based
measure across all risk classes plus half of the sum of the liquidity
horizon-adjusted expected shortfall measures for each risk class,
according to the following formula, as provided under Sec.
__.215(c)(4) of the proposed rule:
[GRAPHIC] [TIFF OMITTED] TP18SE23.037
Where:
i indexes the following risk classes: interest rate risk, credit
spread risk, equity risk, commodity risk and foreign exchange risk.
iii. Stressed Expected Shortfall (SES) for Non-Modellable Risk Factors
Under the proposal, the SES capital requirement for non-modellable
risk factors would be similar to the IMCC for modellable risk factors,
except that the SES calculation would provide significantly less
recognition for hedging and portfolio diversification relative to the
IMCC.
Under the proposal, a banking organization would have to use a
stress scenario that is calibrated to be at least as prudent as the
expected shortfall-
[[Page 64141]]
based measure for modellable risk factors and calculate the liquidity
horizon-adjusted expected shortfall-based measure for non-modellable
risk factors in stress using the same general process as proposed for
modellable risk factors, with three key differences. First, the
proposal would require a banking organization to separately carry out
such calculation for each non-modellable risk factor, as opposed to at
the risk class level. Second, the proposal would require a banking
organization to apply a minimum liquidity horizon adjustment of at
least 20 days, rather than 10 days. Third, the proposal would require a
banking organization to separately identify for each risk class the
stress period for which its market risk covered positions on model-
eligible trading desks would experience the largest cumulative loss,
except that a common twelve-month period of stress could be used for
all non-modellable risk factors arising from idiosyncratic credit
spread or equity risk due to spot, futures and forward prices, equity
repo rates, dividends and volatilities.
To calculate the aggregate SES capital requirement for non-
modellable risk factors, the proposal would require a banking
organization to separate non-modellable risk factors (the
ESNMRF) into those with idiosyncratic credit spread risk,
those with idiosyncratic equity risk, and those with systematic risk,
according to the following formula as provided under Sec. __.215(d)(2)
of the proposed rule:
[GRAPHIC] [TIFF OMITTED] TP18SE23.038
Where:
ISESNM,i is the stress scenario capital measure for non-modellable
idiosyncratic credit spread risk, i, aggregated with zero
correlation, and where I is a non-modellable idiosyncratic credit
spread risk factor;
ISESNM,j is the stress scenario capital measure for non-modellable
idiosyncratic equity risk, j, aggregated with zero correlation, and
where J is a non-modellable idiosyncratic equity risk factor;
SESNM,k is the stress scenario capital measure for the remaining
non-modellable systematic risk factors, k, and where K is the
remaining non-modellable risk factors in a model-eligible trading
desk; and
[rho] is equal to 0.6.
For non-modellable risk factors with systematic risk, the third
term would allow for a limited and appropriate diversification benefit
that depends on the level of [rho] parameter. For idiosyncratic non-
modellable risk factors that the banking organization demonstrates are
not related to broader market movements,\401\ the proposal would
provide greater diversification benefit by allowing such non-modellable
risk factors to be aggregated with zero correlation.
---------------------------------------------------------------------------
\401\ One way to show this is to regress equity return or
changes in credit spreads on systematic risk factors and show that
the residuals of these regressions are uncorrelated with each other.
---------------------------------------------------------------------------
Given the limited data available for non-modellable risk factors
from which to estimate correlations between such factors, the proposed
conservative capital treatment would address the potential risk of
lower quality inputs being used in calculating market risk capital
requirements for non-modellable risk factors (for example, the limited
data set overstates the diversification benefits and, therefore,
understates the magnitude of potential losses of non-modellable risk
factors).
In recognition of the data limitations of non-modellable risk
factors, the proposal would allow a banking organization to use proxies
in designing the stress scenario for each risk class of non-modellable
risk factors, as long as such proxies satisfy the data quality
requirements for modellable risk factors. Additionally, with approval
from its primary Federal supervisor, a banking organization may use an
alternative approach to design the stress scenario for each risk class
of non-modellable risk factors. However, when a banking organization is
not able to model a stress scenario for a risk factor class, or a
smaller subset of non-modellable risk factors, that is acceptable to
the primary Federal supervisor, the proposal would require the banking
organization to use a methodology that produces the maximum possible
loss.
Question 153: The agencies seek comment on the treatment of non-
modellable risk factors. Specifically, is the treatment for non-
modellable risk factors appropriate and commensurate with their risks?
What other treatments should the agencies consider and why? Should the
agencies consider scaling the resulting aggregate SES capital
requirement for non-modellable risk factors by a multiplier to better
reflect the risk profile of these risk factors and, if so, how should
that multiplier be calibrated and why?
iv. Aggregate Trading Portfolio Backtesting Capital Multiplier
Under subpart F of the current capital rule, each quarter, a
banking organization must compare each of its most recent 250 business
days of entity-wide trading losses (excluding fees, commissions,
reserves, net interest income, and intraday trading) with the
corresponding daily VaR-based measure calibrated to a one-day holding
period and at a one-tail, 99.0 percent confidence level. Depending on
the number of exceptions in the entity-wide backtesting results, a
banking organization must apply a multiplication factor, which can
range from 3 to 4, to a banking organization's VaR-based and stressed
VaR-based capital requirements for market risk.
The proposal generally would retain the backtesting requirements in
subpart F of the current capital rule, with two modifications. First,
the proposal would require backtesting of VaR-based measures against
both actual profit and loss as well as against hypothetical profit and
loss.\402\ Specifically, for the most recent 250 business days,\403\ a
banking organization would be required to separately compare each
business day's aggregate actual profit and loss for transactions on
model-eligible trading desks and aggregate hypothetical profit and loss
for transactions on model-eligible trading desks with the corresponding
aggregate VaR-based measures for that business day
[[Page 64142]]
calibrated to a one-day holding period at a one-tail, 99.0 percent
confidence level for market risk covered positions on all model-
eligible trading desks. Second, the proposal generally would require a
banking organization to apply a lower capital multiplier (mc), that
could range from a factor of 1.5 to 2, to the 60-day average estimated
capital required for modellable risk factors, based on the number of
exceptions in the entity-wide backtesting results.\404\
---------------------------------------------------------------------------
\402\ The proposal would define hypothetical profit and loss as
the change in the value of the market risk covered positions that
would have occurred due to changes in the market data at end of
current day if the end-of-previous-day market risk covered positions
remained unchanged. Valuation adjustments that are updated daily
would have to be included, unless the banking organization receives
approval from its primary Federal Supervisor to exclude them.
Valuation adjustments for which separate regulatory capital
requirements have been otherwise specified, commissions, fees,
reserves, net interest income, intraday trading, and time effects
would have to be excluded. See Sec. __.202 of the proposed rule.
\403\ In its first year of backtesting, a banking organization
would count the number of exceptions that have occurred since it
began backtesting.
\404\ The mechanics of the backtesting requirements for the
aggregate trading portfolio backtesting multiplier would be the same
as those at the trading desk level. Consistent with the trading desk
level backtesting requirements, the proposal would allow banking
organizations to disregard backtesting exceptions related to
official holidays and, in certain instances, those related to non-
modellable risk factors and technical issues. See section III.H.8.c
of this Supplementary Information for a detailed description of the
mechanics of the proposed backtesting requirements, including
circumstances in which a banking organization may disregard a
backtesting exemption.
CA = max((IMCCt-1 + SESt-1), ((mc x IMCCaverage)
---------------------------------------------------------------------------
+ SESaverage))
The proposed backtesting requirements would measure the
conservatism of the forecasting assumptions and the valuation methods
in the expected shortfall models used for determining risk-based
capital requirements by comparing the daily VaR-based measure against
the actual and hypothetical profits and losses. Such comparisons are a
critical part of a banking organization's ongoing risk management, as
they improve a banking organization's ability to make prompt
adjustments to the internal models used for determining risk-based
capital requirements to address factors such as changing market
conditions and model deficiencies. A high number of exceptions could
indicate modeling issues (for example, insufficiently conservative risk
factor shocks) and warrant increased capital requirements.
The proposed PLA add-on, as described in section III.H.8.b of this
Supplementary Information, would require a banking organization's
market risk capital requirement to reflect an additional capital
requirement for deficiencies in the accuracy of a banking
organization's internal models. Accordingly, the backtesting
requirements and associated multiplication factor provide appropriate
incentives for banking organizations to regularly update the internal
models used for determining regulatory capital requirements.
Question 154: What, if any, alternative techniques should the
agencies consider that would render the capital multiplier a more
appropriate measure of the robustness of a banking organization's
internal models? What are the benefits and drawbacks of such
alternatives compared to the proposed calculation for the aggregate
trading portfolio backtesting capital multiplier?
v. Default Risk Capital Requirement Under the Internal Models Approach
The agencies propose to require all banking organizations to use
the standardized default risk capital requirement regardless of whether
they use the IMCC plus SES or the sensitivities-based method plus the
residual risk add-on for non-default market risk factors. The agencies
propose this simplification to the internally modelled approach for
market risk in order to reduce the operational burden for a banking
organization and to further promote consistency in risk-based capital
requirements across banking organizations and within the capital rule.
b. PLA Add-On
Under the proposal, use of the internal models approach for a
model-eligible trading desk fundamentally would depend on the accuracy
of the potential future profits or losses estimated under the banking
organization's expected shortfall models relative to those produced by
the valuation methods used to report actual profits and losses for
financial reporting purposes (front office models). The proposed profit
and loss attribution test metrics \405\ would help ensure that the
theoretical changes in a model-eligible trading desk's revenue produced
by the internal risk management models are sufficiently close to the
hypothetical changes produced by valuation methods used by the banking
organization in the end-of-day valuation process and adequately capture
the risk factors used in such models. Thus, the proposed PLA test
metrics would measure the materiality of the simplifications of the
internal risk management models used by a model-eligible trading desk
relative to the front-office models and remove the eligibility of any
trading desk for which such simplifications are deemed material from
using the internal models approach to calculate its regulatory capital
requirement for market risk.
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\405\ The proposed PLA test metrics include (1) the Spearman
correlation metric which assesses the correlation between the risk-
theoretical profit and loss and the hypothetical profit and loss;
and (2) the Kolmogorov-Smirnov metric which assesses the similarity
of the distributions of the risk-theoretical profit and loss and the
hypothetical profit and loss.
---------------------------------------------------------------------------
The proposal would impose an additional capital requirement (the
PLA add-on) on model-eligible trading desks for which either or both of
the two desk-level PLA test metrics demonstrate deficiencies in the
ability of the banking organization's internal models to appropriately
capture the market risk of a model-eligible trading desk's market risk
covered positions. The PLA add-on would help ensure that model-eligible
trading desks with model deficiencies, but not disqualifying failures
of the PLA test metrics, are subject to more conservative capital
requirements relative to model-eligible trading desks without model
deficiencies. Additionally, the PLA add-on provides appropriate
incentives for such trading desks to address the potential gaps in data
and model deficiencies. However, a model-eligible trading desk that
passes both of the PLA test metrics could still be subject to the PLA
add-on if the primary Federal supervisor determines that the trading
desk no longer complies with all applicable requirements, as described
in section III.H.5.d of this Supplementary Information.
i. PLA Test
To measure the materiality of the simplifications (for example,
missing risk factors and differences in the way positions are valued)
within the expected shortfall models used by each model-eligible
trading desk, the PLA test would require a banking organization, for
each model-eligible trading desk, to compare the daily profit and loss
values produced by its internal risk management models (risk-
theoretical profit and loss) \406\ against the hypothetical profit and
loss produced by the front office models.
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\406\ The proposal would define risk-theoretical profit and loss
as the daily trading desk-level profit and loss on the end-of-
previous-day market risk covered positions generated by the banking
organization's internal risk management models. The risk-theoretical
profit and loss would have to take into account all risk factors,
including non-modellable risk factors, in the banking organization's
internal risk management models.
---------------------------------------------------------------------------
I. Data Input Requirements
For the sole purpose of the PLA test, the proposal would permit a
banking organization to align the risk factor input data used in the
valuations calculated by the internal risk management models with that
used in the front office models, if the banking organization
demonstrates that such an alignment would be appropriate. If the input
data for a given risk factor that is common to both the front office
models and the internal risk management models differs due to data
acquisition complications (specifically, different market data sources,
time fixing of market data sources, or transformations of market data
into input data suitable
[[Page 64143]]
for the risk factors of the underlying valuation engines), a banking
organization may adjust the input data used by the front office models
into a format that can be used by the internal risk management models.
When transforming the input data of the front office models into a
format that can be applied to the risk factors used in internal risk
management models, the banking organization would be required to
demonstrate that no differences in the risk factors or in the valuation
models have been omitted. The proposal would require a banking
organization to assess the effect of these input data alignments on
both the valuations produced by the internal risk management models and
the PLA test when designing or changing the input data alignment
process, or at the request of the primary Federal supervisor.
Additionally, the proposal would require a banking organization to
treat time effects \407\ in a consistent manner in the hypothetical
profit and loss and the risk-theoretical profit and loss.\408\
---------------------------------------------------------------------------
\407\ Time effects can include various elements such as the
sensitivity to time, or theta effect, and carry or costs of funding.
\408\ In particular, when time effects are included in (or
excluded from) the hypothetical profit and loss, they must also be
included in (or excluded from) the risk-theoretical profit and loss.
---------------------------------------------------------------------------
The proposed flexibility would allow the results of the PLA test
metrics to more accurately assess the consistency of the risk-
theoretical and hypothetical profit and loss for a particular model-
eligible trading desk, by focusing on differences due to the pricing
function and risk factor coverage rather than those arising from use of
different data inputs.
Furthermore, the proposal would allow, subject to approval by the
primary Federal supervisor, a banking organization, for a model-
eligible trading desk that holds a limited amount of securitization
positions or correlation trading positions pursuant to its trading or
hedging strategy, to include such positions for the purposes of the PLA
tests. Allowing such positions to be included would enable
securitization positions held as hedges to be recognized with the
underlying positions they are intended to hedge and thus minimize the
potential of PLA testing to incorrectly identify model deficiencies for
model-eligible trading desks due solely to the bi-furcation of such
hedges. For model-eligible trading desks with approval of the primary
Federal supervisor to incorporate securitization positions in their PLA
test metrics, the proposal would require the banking organization to
calculate the market risk capital requirements for such positions using
the more conservative capital treatment under the standardized approach
or the fallback capital requirement, as described in sections III.H.7
and III.H.6.c of this Supplementary Information, respectively.
II. PLA Test Metrics
For the PLA test, the banking organization, for each model-eligible
trading desk, would be required to compare, for the most recent 250
business days, the risk-theoretical profit and loss and the
hypothetical profit and loss using two test metrics: the Spearman
correlation and the Kolmogorov-Smirnov metric.
To calculate the Spearman correlation metric, the banking
organization, for each model-eligible trading desk, must compute, for
each of the most recent 250 business days, the rank order of the daily
hypothetical profit and loss, (RHPL), and the rank order of the daily
risk-theoretical profit and loss, (RRTPL), with the lowest profit and
loss value in the time series receiving a rank of 1, the next lowest
value receiving a rank of 2, etc. The Spearman correlation coefficient
for the two rank orders, RHPL and RRTPL, would be based on the
following formula:
[GRAPHIC] [TIFF OMITTED] TP18SE23.039
where cov(RHPL, RRTPL) is the covariance between RHPL and RRTPL and
[sigma]RHPL and [sigma]RRTPL are the standard
deviations of rank orders RHPL and RRTPL, respectively.
As a testing metric, the Spearman correlation coefficient is
intended to support sound risk management by assessing the correlation
between the daily risk-theoretical profit and loss and the hypothetical
profit and loss for a model-eligible trading desk. A high degree of
correlation would indicate directional consistency between the two
measures.
To calculate the Kolmogorov-Smirnov metric, the banking
organization, for each model-eligible trading desk, would identify the
number of daily observations over the most recent 250 business days
where the risk-theoretical profit and loss or separately the
hypothetical profit and loss is less than or equal to the specified
value. To appropriately weight the probability of each daily
observation,\409\ the proposal would define the empirical cumulative
distribution function as the number of daily observations multiplied by
0.004 (1/250). Under the proposal, the Kolmogorov-Smirnov metric would
be the largest absolute difference observed between these two empirical
cumulative distributions of profit and loss at any value, which could
be expressed as:
---------------------------------------------------------------------------
\409\ For example, if the internal risk management model
generates the same value for the model-eligible trading desk's
portfolio on two separate days, the proposal would require the
banking organization to assign a larger probability by requiring
each daily observation to be weighted at 0.004.
---------------------------------------------------------------------------
KS = max(abs(DHPL-DRTPL))
where DHPL is the empirical cumulative distribution of
hypothetical profit and loss produced by the front office models and
DRTPL the empirical cumulative distribution of risk-
theoretical profit and loss produced by the internal risk management
models.
As a testing metric, the Kolmogorov-Smirnov metric is intended to
support good risk management by requiring banking organizations to
assess the similarity of the distribution of the daily portfolio values
for a model-eligible trading desk generated by the internal risk
management models and the front office models. The closeness of the
distributions would indicate how accurately the internal risk-
management models capture the range of losses experienced by the model-
eligible trading desk across different market conditions with closer
distributions indicating greater accuracy with respect to pricing and
risk factor coverage. Applying this process over a given period would
provide information about the accuracy of the internal risk management
model's ability to appropriately reflect the shape of the whole
distribution of values for the model-eligible trading desk's portfolio
compared to the distribution of values generated by the front office
models, including information on the size and number of valuation
differences.
Based on the PLA test results for the two above metrics, a banking
organization would be required to allocate each model-eligible trading
desk to a PLA test zone as set out in Table 1 to Sec. __.213 of the
proposed rule.
The proposal would permit a banking organization to consider a
model-eligible trading desk to be in the green zone only if both of the
PLA test metrics fall into the green zone. Conversely, a banking
organization would consider a model-eligible trading desk to be in the
red zone if either of the PLA test metrics fall within the red zone.
The proposal would require a banking organization to consider all other
model-eligible trading desks (such as those with both metrics in the
amber zone or one metric in the amber zone and the other in the green
zone) in the amber zone. Additionally, under the proposal, the primary
Federal
[[Page 64144]]
supervisor could require a banking organization to assign a different
PLA test zone to a model-eligible trading desk than that based on PLA
test metrics of the model-eligible trading desk.\410\
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\410\ As discussed in more detail in section III.H.5.d.iv. of
this Supplementary Information, if for initial or on-going model
eligibility, the primary Federal supervisor subjects a model-
eligible trading desk to the PLA add-on, the model-eligible trading
desk would remain subject to the PLA add-on until either the model-
eligible trading desk (1) provides at least 250 business days of
backtesting and PLA test results that pass the trading-desk level
backtesting requirements and produce PLA metrics in the green zone,
or (2) receives written approval from the primary Federal supervisor
that the PLA add-on no longer applies.
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Question 155: The agencies seek comment on all aspects of the PLA
test metrics. What, if any, modifications should the agencies consider
that would enable the PLA tests to more appropriately measure the
robustness of a banking organization's internal models?
Question 156: The agencies seek comment on the appropriateness of
allowing banking organizations to align the risk input data between the
internal risk management models and the front-office models. What other
instances, if any, should the agencies consider to ensure accurate and
consistent assessment of the profit and losses produced by the internal
risk management models with those produced by the front office models
for a particular model-eligible trading desk?
Question 157: The agencies request comment on the benefits and
drawbacks of allowing banking organizations, with regulatory approval,
to include non-modellable risk factors for purposes of the PLA tests.
Should non-modellable risk factors be excluded from the PLA tests? Why
or why not? What, if any, further conditions should the agencies
consider including to appropriately limit the inclusion of non-
modellable risk factors for purposes of the PLA tests? Commenters are
encouraged to provide data to support their responses.
ii. Calculation of the PLA Add-On
Under the proposal, a banking organization would consider model-
eligible trading desks in the green zone or amber zone as passing the
PLA test for model eligibility purposes but would be required to apply
the PLA add-on to model-eligible trading desks within the amber zone.
The proposal would require a banking organization to calculate the PLA
add-on as the greater of zero and the aggregate capital benefit to the
banking organization from the internal models approach (the difference
between the capital requirements for all model-eligible trading desks
\411\ in the green or amber zone under the standardized approach
(SAG,A) and those under the internal models approach
(IMAG,A)), multiplied by a multiplication factor of k, as
defined according to the following formula under Sec. __.213(c)(4) of
the proposed rule:
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\411\ In calculating the PLA add-on, a banking organization must
exclude any securitization positions, including correlation trading
positions, held by a model-eligible desk, as such positions must be
subject to either the standardized approach or the fallback capital
requirement.
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PLA add-on = k x max ((SAG,A-IMAG,A),0)
Under the proposal, the value of k would equal half of the ratio of
the sum of the standardized approach capital requirements for each
model-eligible trading desk within the amber zone and those for each of
the model-eligible trading desks within either the green or amber zone
as defined according to the following formula under Sec.
__.213(c)(4)(i) of the proposed rule:
[GRAPHIC] [TIFF OMITTED] TP18SE23.040
Thus, the value of k would gradually increase from 0 to 0.5 as the
number of model-eligible trading desks within the amber zone increases,
which is intended to mitigate the potential cliff effect of
significantly increasing market risk capital requirements as a model-
eligible trading desk transitions from using the internal models
approach to the standardized approach.
iii. Application of the PLA Add-On
If, in the most recent 250 business day period, a trading desk that
the primary Federal supervisory previously approved to use the internal
models approach produces results in the PLA test red zone, the proposal
would require the banking organization to use the standardized approach
and calculate market risk capital requirements for the positions held
by the trading desk together with all other trading desks subject to
the standardized approach.\412\ Under the proposal, since deficiencies
identified by the PLA test metrics relate solely to the expected
shortfall models, if the expected shortfall model used by a trading
desk subsequently fails the PLA test, the banking organization would
calculate the market risk capital requirement for the trading desk
using the sensitivities-based method and the residual risk add-on, as
applicable. The proposal would not permit the banking organization to
use the internal models approach to calculate market risk capital
requirements for the trading desk until the trading desk (i) produces
PLA test results in either the green or amber zone and passes specific
trading desk level backtesting requirements over the most recent 250
business days, or (ii) receives approval from the primary Federal
supervisor.
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\412\ As discussed in section III.H.5.d.i of this Supplementary
Information, model-eligible trading desks that hold limited amounts
of securitization and correlation trading positions must calculate
regulatory capital requirements for such positions under the
standardized approach or fallback capital requirement, as
applicable. With regulatory approval, a banking organization may
include such positions within its internal models for the purposes
of the PLA tests and backtesting.
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c. Backtesting Requirements for Model-Eligible Trading Desks
Under the proposal, a banking organization may treat a trading desk
that conducts and successfully passes both backtesting and the PLA test
at the trading desk level on an ongoing quarterly basis as a model-
eligible trading desk. For determining the model eligibility of a
trading desk, the proposal would require the banking organization to
perform backtesting at the trading desk level. For the purpose of desk-
level backtesting, for each trading desk, a banking organization would
be required to compare each of its most recent 250 business days'
actual profit and loss and hypothetical profit and loss produced by the
front office models with the corresponding daily VaR-based measure
calculated by the banking organization's expected shortfall model under
the internal models approach. The proposal would require the banking
organization, for each trading desk, to calibrate the VaR-based measure
to a one-day holding period and at both the 97.5th percentile and the
99.0th percentile one-tail confidence levels.
Under the proposal, a backtesting exception would occur when the
daily actual profit and loss or the daily hypothetical profit and loss
of the trading desk exceeds the corresponding daily VaR-based measure
calculated by the banking organization's expected shortfall model. A
banking organization must count separately the number of backtesting
exceptions that occurred in the most recent 250 business days for
actual profit and loss at each confidence level and those that occurred
for hypothetical profit and loss at each confidence level. A trading
desk would become model-ineligible if, in the most recent 250 business
day period, the trading desk experiences any of the following: (1) 13
or more exceptions for actual profit and loss at the 99.0th percentile;
(2) 13 or more exceptions for hypothetical profit and loss at the
99.0th percentile; (3) 31 or more exceptions for
[[Page 64145]]
actual profit and loss at the 97.5th percentile; or (4) 31 or more
exceptions for hypothetical profit and loss at the 97.5th percentile.
In the event that either the daily actual or hypothetical profit and
loss is unavailable or the banking organization is unable to compute
them, or the banking organization is unable to compute the VaR-based
measure for a particular business day, the proposal would require the
banking organization to treat such an occurrence as a backtesting
exception unless related to an official holiday, in which case the
banking organization may disregard the backtesting exception. In
addition, with approval of the primary Federal supervisor, the banking
organization must disregard the backtesting exception if the banking
organization could demonstrate that the backtesting exception is due to
technical issues that are unrelated to the banking organization's
internal model; or if the banking organization could show that a
backtesting exception relates to one or more non-modellable risk
factors and the market risk capital requirement for these non-
modellable risk factors exceeds either (a) the difference between the
banking organization's VaR-based measure and actual loss or (b) the
difference between the banking organization's VaR-based measure and
hypothetical loss for that business day. In these cases, the banking
organization must demonstrate to the primary Federal supervisor that
the non-modellable risk factor has caused the relevant loss.
If in the most recent 250 business day period a trading desk
experiences either 13 or more backtesting exceptions at the 99.0th
percentile, or 31 or more backtesting exceptions at the 97.5th
percentile, the proposal would require the banking organization to use
the standardized approach to determine the market risk capital
requirements for the market risk covered positions held by the trading
desk. If a model-eligible trading desk is approved with less than 250
business days of trading desk level backtesting and PLA test results,
the proposal would require a banking organization to use all
backtesting data for the model-eligible trading desk and to prorate the
number of allowable exceptions by the number of business days for which
backtesting data are available for the model-eligible trading desk. The
proposal would allow the banking organization to return to using the
full internal models approach to calculate market risk capital
requirements for the trading desk if the banking organization (1)
remediates the internal model deficiencies such that the trading desk
successfully passes trading desk-level backtesting and reports PLA test
metrics in the green or amber zone or (2) receives approval of the
primary Federal supervisor.
Question 158: Should non-modellable risk factors be excluded from
the proposed backtesting requirements? Why or why not? What, if any,
further conditions should the agencies consider including to limit
appropriately the inclusion of non-modellable risk factors for purposes
of the backtesting requirements? Commenters are encouraged to provide
data to support their responses.
Question 159: The agencies invite comment on what, if any,
challenges requiring banking organizations to directly calculate the
internally modelled capital requirement for modellable risk factors
using a 10-day liquidity horizon for the purposes of the daily expected
shortfall-based measure for modellable risk factors could pose and a 1-
day VaR for the purposes of backtesting could pose. What, if any,
alternative methodologies should the agencies consider?
9. Treatment of Certain Market Risk Covered Positions
To promote consistency and comparability in the risk-based capital
requirements across banking organizations and to help ensure
appropriate capitalization of positions subject to subpart F of the
capital rule, the proposal would clarify the treatment of certain
market risk covered positions under the standardized and models-based
measures for market risk.
a. Net Short Risk Positions
The proposal would require a banking organization to calculate on a
quarterly basis its exposure arising from any net short credit or
equity position.\413\ A banking organization would be required to
include net short risk positions exceeding $20 million in its total
market risk capital requirement for the entire quarter, under both the
standardized measure for market risk and the models-based measure for
market risk, as applicable.
---------------------------------------------------------------------------
\413\ See section III.H.3.c of this Supplementary Information
for a more detailed discussion on net short risk positions.
---------------------------------------------------------------------------
The proposed quarterly approach is intended to reduce operational
burden of requiring a banking organization to capture temporary or
small differences arising from fluctuations in the value of positions
subject to the credit risk framework. Further, the proposed quarterly
calculation requirement should help ensure that banking organizations
are appropriately managing and monitoring net short risk positions
arising from exposures subject to subpart D or E of the capital rule at
intervals of sufficient frequency to prevent the formation of non-
negligible net short risk positions.
As proposed it may be difficult for a banking organization to apply
the standardized approach or internal models approach to net short risk
positions given that the composition of any particular net short
position could contain a different combination of various underlying
instruments. Therefore, if unable to calculate a risk factor
sensitivity for a net short risk position, the proposal would require
the banking organization to calculate market risk capital requirements
using the fallback capital requirement as described in section
III.H.6.c of this Supplementary Information.
b. Securitization Positions and Defaulted and Distressed Market Risk
Covered Positions
The proposal would require a banking organization to calculate
market risk capital requirements for securitization positions using the
standardized approach or the fallback capital requirement, as
applicable. The proposed treatment would address regulatory arbitrage
concerns as well as deficiencies in the modelling of securitization
positions that became more evident during the course of the financial
crisis that began in mid-2007.
The proposal would require a banking organization to include
defaulted and distressed market risk covered positions in only the
standardized default risk capital requirement. Such positions are not
required to be included in the sensitivities-based method or the
residual risk add-on of the standardized approach, or in the non-
default capital requirement for modellable and non-modellable risk
factors. Generally, distressed and defaulted positions trade based on
recovery, which is not driven by or reflective of the credit spread of
the issuer. Therefore, in addition to being operationally difficult,
requiring a banking organization to calculate the sensitivity of such
positions to changes in credit spreads may not be appropriate for the
purposes of quantifying the risk posed by such positions. Additionally,
subjecting defaulted and distressed positions to capital requirements
under the sensitivities-based method, residual risk add-on, or expected
shortfall measures for modellable and non-modellable risk factors would
increase the capital requirements for such positions beyond the maximum
[[Page 64146]]
potential loss of such holdings, as the standardized default risk
capital requirement already assigns a 100 percent risk weight and LGD
to such exposures. If unable to calculate the standardized default risk
capital requirement for such positions, the proposal would require the
banking organization to calculate market risk capital requirements
using the fallback capital requirement.\414\
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\414\ As described in more detail in section III.H.6.c of this
Supplementary Information, the fallback capital requirement would
apply in instances where a banking organization is unable to apply
the internal models approach and the standardized approach to
calculate market risk capital requirements.
---------------------------------------------------------------------------
As the amount of regulatory capital required under the fallback
capital requirement would equal the absolute fair value of the
position, the proposal would cap the overall market risk capital
requirement for defaulted, distressed, and securitization positions at
the maximum loss of the position. By capping the amount of regulatory
capital requirement for such positions at the total potential loss that
a banking organization could incur from holding such positions, the
proposal would align the risk-based requirements under the standardized
and internal models approaches, as applicable, with those under the
fallback capital requirement.
c. Equity Positions in an Investment Fund
i. Standardized Approach
For equity positions in an investment fund for which the banking
organization is able to use the look-through approach to calculate a
market risk capital requirement for its proportional ownership share of
each exposure held by the investment fund, the proposal would require a
banking organization to apply the look-through approach under the
standardized measure for market risk. Alternatively, a banking
organization could elect not to apply the look-through approach for
such positions if the investment fund closely tracks an index benchmark
or holds a listed and well-diversified index position. Generally, the
agencies would consider an equity position in an investment fund to
closely track the index if the standard deviation of the returns of the
investment fund (ignoring fees and commissions) over the prior year
differs from those of the index by only a small percentage (for
example, less than 1 percent). For an equity position in an investment
fund that closely tracks an index benchmark, the proposal would allow a
banking organization to treat the equity position in the investment
fund as if it was the tracked index in calculating the delta, vega, and
curvature capital requirements, given the high correlation of the
equity position with that of the index.\415\ Further, for equity
positions in an investment fund that holds a listed and well-
diversified index, the proposal would allow a banking organization to
calculate the delta, vega, and curvature capital requirements for the
underlying index position using the treatment for indices \416\ and
apply the look-through approach to the other underlying exposures of
the investment fund.
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\415\ In this situation, the banking organization would apply
the treatment for index instruments described in section
III.H.7.d.ii of this Supplementary Information.
\416\ In this situation, the banking organization would apply
the treatment for index instruments described in section
III.H.7.d.ii of this Supplementary Information.
---------------------------------------------------------------------------
For equity positions in an investment fund for which the banking
organization is not able to use the look-through approach to calculate
a market risk capital requirement for its proportional ownership share
of each exposure held by the investment fund, but where the banking
organization has access to daily price quotes for the investment fund
and to the information contained in the fund's mandate, the proposal
would allow the banking organization to calculate capital requirements
in one of three ways under the standardized measure for market risk.
For equity positions in an investment fund that closely tracks an index
benchmark, the banking organization could assume that the investment
fund is the tracked index and treat the equity position as an index
instrument when calculating the delta, vega, and curvature capital
requirement.\417\ Alternatively, the proposal would allow the banking
organization to calculate the delta, vega, and curvature capital
requirements for the equity position based on the hypothetical
portfolio of the investment fund or allocate the equity position in the
investment fund to the other sector risk bucket.
---------------------------------------------------------------------------
\417\ In this situation, the banking organization would apply
the treatment for index instruments described in section
III.H.7.d.ii of this Supplementary Information.
---------------------------------------------------------------------------
Under the proposed hypothetical portfolio approach, the banking
organization would need to assume that the investment fund invests to
the maximum extent permitted under its mandate in those exposures with
the highest applicable risk weight and continues to make investments in
the order of the exposure type with the next highest applicable risk
weight until the maximum total investment level is reached. If more
than one risk weight can be applied to a given exposure, the proposal
would require the banking organization to use the maximum applicable
risk weight in calculating the sensitivities-based method requirement.
Alternatively, the banking organization may assume that the investment
fund invests based on the most recent quarterly disclosure of the
fund's historical holdings of underlying positions. The proposal would
require a banking organization to weight the constituents of the
investment fund based on the hypothetical portfolio. Further, the
proposal would require a banking organization to calculate market risk-
based capital requirements for the hypothetical portfolio on a stand-
alone basis for all positions in the fund, separate from any other
position subject to market risk capital requirements.
Alternatively, the proposal's fallback method would allow a banking
organization to allocate equity positions in an investment fund to the
applicable other sector risk bucket.\418\ Under this approach, the
banking organization would determine whether, given the mandate of the
investment fund, to apply a higher risk weight in calculating the
standardized default risk capital requirement and whether to apply the
residual risk add-on. For example, if a banking organization determines
that the residual risk add-on applies, the banking organization must
assume that the investment fund has invested in such exposures to the
maximum extent permitted under its mandate. For equity positions in
publicly traded real estate investment trusts, the proposal would
require a banking organization to treat such exposures as a single
exposure and apply the risk weight applicable to exposures allocated to
the other sector risk bucket when calculating the delta, vega, and
curvature capital requirements under the sensitivities-based
method.\419\ While equity positions in publicly traded real estate
investment trusts are traded on the market, the underlying assets of
such trusts generally are not. Thus, often a banking organization will
not be able to calculate the risk factor sensitivity for each of the
underlying assets of the real estate investment trust. Requiring a
banking organization to treat equity positions in real estate
investment trusts as a single position would help ensure that market
risk capital requirements appropriately capture a banking
organization's market
[[Page 64147]]
risk exposure arising from such positions in a manner that minimizes
compliance burden and enhances risk-capture. As each of the proposed
alternative approaches would reflect a highly conservative capital
requirement, the agencies consider that the proposed alternatives would
help ensure a banking organization maintains sufficient capital against
potential losses arising from equity positions in an investment fund
for which the banking organization is unable to identify the underlying
positions held by the fund.
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\418\ Table 8 to Sec. __.209 of the proposed rule provides the
proposed delta risk buckets and corresponding risk weights for
positions within the equity risk class.
\419\ Under the proposal, such exposures would receive the 70
percent risk weight applicable to equity risk factors allocated to
bucket 11 in Table 8. See Sec. __.209(b)(5) of the proposed rule.
---------------------------------------------------------------------------
Similar to index instruments and multi-underlying options that are
non-securitization debt or equity positions, the default risk of equity
positions in an investment fund is primarily a function of the
idiosyncratic default risk of the underlying constituents. Accordingly,
to capture appropriately the default risk of such positions, the
proposal would require a banking organization to apply the look-through
approach when calculating the standardized default risk capital
requirement for equity positions in an investment fund that are non-
securitization debt or equity positions, with one exception. For equity
positions in an investment fund for which the banking organization
applies the hypothetical portfolio approach or the fallback method
described above, a banking organization would have to assume that the
fund invests in exposure types with the highest applicable risk weights
to the maximum extent permitted by the fund's mandate. For equity
positions in publicly traded real estate investment trusts that are
non-securitization debt or equity positions, the proposal would require
a banking organization to treat the exposures as a single exposure. As
discussed above, often a banking organization will not be able to
calculate the default risk for each of the underlying assets of the
real estate investment trust due to the idiosyncratic nature of the
underlying assets. The proposed treatment would help ensure the risk-
based requirements appropriately capture the default risk of such
positions in a manner that is consistent across banking organizations
and minimizes operational burden.
Question 160: The agencies seek comment on whether a banking
organization's ability under the proposal to treat an equity position
in an investment fund as an index position when the investment fund
closely tracks an index benchmark provides sufficient specificity to
help ensure consistent application across banking organizations. To
what extent would a specific quantitative measure more appropriately
capture the types of positions that should be treated as index
positions? What, if any, alternatives should the agencies consider
(such as specifying an absolute value of one percent) to better capture
the types of positions whose risks would more appropriately be captured
by the proposed market risk capital requirements for index positions
and why? Commenters are encouraged to provide specific details on the
mechanics, capital implications and rationale for any suggested
methodology.
Question 161: The agencies seek comment on requiring banking
organizations to calculate the residual risk add-on for equity
positions in investment funds, if, based on its mandate, the fund would
invest in the types of exposures that would be subject to the residual
risk add-on to the maximum extent permitted under the mandate. What, if
any, alternatives--such as allowing banking organizations to use the
historical risk characteristics of the fund--should the agencies
consider to better capture the residual risks of such positions?
Commenters are encouraged to provide specific details on the mechanics,
capital implications and rationale for any suggested methodology.
ii. Internal Models Approach
The proposal would only allow a banking organization to use the
internal models approach for equity positions in an investment fund for
which the banking organization is able to identify the underlying
positions held by the fund on a quarterly basis. Otherwise, these
positions would be calculated using the standardized approach or the
fallback capital requirement. Under the proposal, a banking
organization would be required to calculate the market risk capital
requirement for such positions held by a model-eligible desk by
applying the look-through approach or the hypothetical portfolio
approach based on the most recent quarterly disclosure of the
investment fund's historical holdings of underlying positions. In
addition, a banking organization also may use any other modelling
approach to calculate the internal models approach capital requirement
after receiving a prior approval from its primary Federal supervisor.
Question 162: What would be the advantages and drawbacks of
allowing banking organizations to decompose equity positions in
investment funds into the underlying holdings of the fund or based on
the hypothetical portfolio, for purposes of calculating capital
requirements under the internal models approach? Please provide
specific details on the mechanics, capital implications and rationale
for any suggested methodology, in particular the extent to which the
proposed backtesting and PLA requirements would help ensure appropriate
risk capture for positions in which the banking organization is only
able to perform a look-through on a quarterly basis.
d. Treatment of Term Repo-Style Transactions
Subpart F of the current capital rule permits a banking
organization to calculate a market risk capital requirement for
securities subject to repurchase and lending agreements with an
original maturity of more than one business day (term repo-style
transactions), regardless of whether such transactions meet the short-
term trading intent criterion of the definition of a market risk
covered position.\420\ Under the current capital rule, this optionality
is only available for term repo-style transactions for which the
banking organization separately calculates risk-based requirements for
counterparty credit risk using the collateral haircut approach under
subpart D or subpart E of the capital rule.\421\ Subparts D and E of
the capital rule permit a banking organization to recognize the credit
risk mitigation benefits of non-financial collateral under the
collateral haircut approach for these term repo-style transactions.
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\420\ While such transactions are similar to trading activities,
not all such transactions meet the short-term trading intent
criterion of the definition of covered position. For example,
certain repo-style transactions operate in economic substance as
secured loans and do not in normal practice represent trading
positions.
\421\ Under subpart F of the capital rule, a banking
organization that uses the simple VaR approach for purposes of
calculating counterparty credit risk capital requirements may also
include term repo-style transactions within the VaR-based measure
for market risk. As noted in section III.C.5.b.ii of this
Supplementary Information, the proposal would eliminate the simple
VaR approach for calculating risk-based requirements for
counterparty credit risk--and thus this optionality would only apply
in the context of the collateral haircut approach.
---------------------------------------------------------------------------
The proposal similarly would permit a banking organization to
include term repo-style transactions in market risk covered positions,
where the transactions are marked to market and provided that it
includes all of such term repo-style transactions in market risk
covered positions consistently over time. To help ensure appropriate
calibration of the market risk capital requirements, under the
proposal, a banking organization with the operational capability to
capture the market risk of both the collateral leg and
[[Page 64148]]
the cash leg of the transaction could opt into this treatment. In such
cases, the proposal would permit a banking organization to include term
repo-style transactions in the sensitivities-based method or the
expected shortfall model if held by a model-eligible trading desk. For
purposes of calculating market risk capital requirements under the
sensitivities-based method, the proposal would require a banking
organization to capture the risk factor sensitivities of the cash leg
to general interest rate risk and of the security leg to credit spread
risk, equity risk, commodity risk, and foreign exchange risk, as
applicable. The proposal would also require a banking organization to
separately calculate the standardized default risk capital requirement
to capture losses on the underlying reference exposure in the event of
issuer default as described in section III.H.7.b.i of this
Supplementary Information and the risk-based capital requirements for
counterparty credit risk using the collateral haircut approach as
described in section III.H.9.d of this Supplementary Information.
10. Reporting and Disclosure Requirements
The reporting and public disclosures required under the proposal
would strike a balance between the information necessary for ensuring
that a banking organization is conforming to the requirements of the
proposed market risk rule, the public policy benefits that result from
transparency of information, and a banking organization's compliance
burden. The proposal does not change the requirements under subpart F
regarding public disclosure policy and attestation, the frequency of
required disclosures, the location of disclosures, or the treatment of
proprietary and confidential information except that each of these
aspects of the proposal is discussed not only in regard to a banking
organization's public disclosures, but also in regard to its reporting
(public regulatory reports and, as applicable, confidential supervisory
reports).
a. Scope
The quantitative and qualitative disclosures required by this
section would not apply to a banking organization that is a
consolidated subsidiary of a bank holding company, savings and loan
holding company, or a depository institution that is subject to these
requirements, or of a non-U.S. banking organization subject to
comparable public disclosure requirements in its home jurisdiction.
The information contained within both public regulatory reports
and, as applicable, confidential supervisory reports described in the
proposal would be necessary for the primary Federal supervisor to
assess whether a banking organization has adequately implemented the
proposed market risk capital framework. Therefore, under the proposal,
any banking organization that is subject to the proposed market risk
capital requirements must provide public regulatory reports in the
manner and form prescribed by its primary Federal supervisor, including
any additional information and reports that the primary Federal
supervisor may require. Any such banking organization that also uses
the models-based measure for calculating market risk capital
requirements must provide confidential supervisory reports as discussed
below to its primary Federal supervisor in a manner and form prescribed
by that supervisor.
b. Quantitative and Qualitative Disclosures
The current capital rule requires a banking organization subject to
the market risk capital framework to disclose information related to
the composition of portfolios of covered positions as well as the
internal models used to calculate the market risk of covered positions.
The proposal would eliminate the existing quantitative disclosures
related to the calculations of VaR and incremental and comprehensive
risk capital requirements, which would no longer be necessary for
calculating risk-based capital requirements for market risk under the
proposal. The proposal would, however, retain existing quantitative
disclosures related to the aggregate amount of on-balance sheet and
off-balance sheet securitization positions by exposure type, as well as
the aggregate amount of correlation trading positions. Together, these
disclosures would ensure transparency regarding a banking
organization's securitizations, which have historically been sources of
uncertainty for regulators and market participants during periods of
financial stress. Finally, the proposal would add a quantitative
disclosure requiring a banking organization that uses the models-based
measure for calculating market risk capital requirements to disclose a
comparison of VaR-based estimates to actual gains or losses for each
material portfolio of market risk covered positions with an analysis of
important outliers. In addition to the requirement to disclose a
general description of a banking organization's internal capital
adequacy assessment methodology, a banking organization that uses the
models-based measure for calculating market risk capital requirements
would also be required to include such assessment for categories of
non-modellable risk factors.\422\ These additional disclosures, along
with the retained disclosures, would support the agencies' efforts to
supervise banking organizations subject to the market risk framework.
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\422\ The agencies would expect a banking organization to have
sound internal capital assessment processes which would include, but
not be limited to, identification of capital adequacy goals with
respect to risks, taking into account the strategic focus and
business plan of the banking organization, risk identification,
measurement, and documentation, as well as a process of internal
controls, reviews and audits.
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The proposal would also retain the existing qualitative disclosures
for material portfolios but with certain revisions reflecting the
changes to the market risk framework under the proposal. Specifically,
the requirement that a banking organization disclose characteristics of
internal models would be revised to also require that the banking
organization disclose information related to the models used to
calculate expected shortfall (ES), the frequency with which data is
updated, and a description of the calculation based on current and
stress observations. The existing requirement that a banking
organization disclose its internal capital adequacy assessment,
including a description of the methodologies used to achieve a capital
adequacy assessment consistent with the soundness standard, would be
subsumed into the quarterly quantitative disclosure requirements
described above. Qualitative disclosures that typically do not change
each quarter may be disclosed annually, provided any significant
changes are disclosed in the interim.
The proposal would add new qualitative disclosures related to a
banking organization's processes and policies for managing market risk.
Specifically, the proposed qualitative disclosures include (i) a
description of the structure and organization of the market risk
management system, including a description of the market risk
governance structure established to implement the strategies and
processes described below; (ii) a description of the polices and
processes for determining whether a position is designated as a market
risk covered position and the risk management policies for monitoring
market risk covered positions; (iii) a description of the scope and
nature of risk reporting and/or measurement
[[Page 64149]]
systems and the strategies and processes implemented by the banking
organization to identify, measure, monitor, and control the banking
organization's market risks, including polices for hedging; and (iv) a
description of the trading desk structure and the types of market risk
covered positions included on the trading desks or in trading desk
categories, including a description of the model-eligible trading desks
for which a banking organization calculates the non-default risk
capital requirement and any changes in the scope of model-ineligible
trading desks and the market risk covered positions on those desks.
Together, the additional disclosure requirements in the proposal would
increase transparency, encourage sound risk management practices, and
assist the regulatory review process of a banking organization subject
to the proposed market risk framework by providing clear information on
the policies and procedures that each banking organization has adopted
to manage and mitigate potential losses arising from market
fluctuations.
c. Public Reports
In addition to the public disclosure requirements, the proposal
would require that a banking organization provide a quarterly public
regulatory report of its measure for market risk. This public report,
the form of which would be specified by the agencies, would contain
information that the agencies deem necessary for assessing the manner
in which a banking organization has implemented the proposed market
risk rule. This, in turn, would help ensure the safety and soundness of
the financial system by facilitating the identification of problems at
a banking organization and ensuring that a banking organization has
implemented any corrective actions imposed by the agencies.
d. Confidential Supervisory Reports
Under the proposal, a banking organization using the models-based
measure to calculate market risk capital requirements would be required
to submit, via confidential regulatory reporting in the manner and form
prescribed by the primary Federal supervisor, data pertaining to its
backtesting and PLA testing.
To reflect the proposed changes to the market risk framework, the
proposal would require a banking organization to submit backtesting
information at both the aggregate level for model-eligible trading
desks as well as for each trading desk and PLA testing information for
model-eligible trading desks at the trading desk level on a quarterly
basis. This information would cover the previous 500 business days, or
all business days if 500 business days are not available, and would
have to be reported with no more than a 20-day lag. At the aggregate
level, the data would include the daily VaR-based measures calibrated
to the 99.0th percentile; the daily ES-based measure calibrated at the
97.5th percentile; the actual profit and loss; the hypothetical profit
and loss; and the p-value of the profit or loss for each day. At the
trading desk level, the data would include the daily VaR-based measure
for the trading desk calibrated at both the 97.5th and 99.0th
percentile; the daily ES-based measure calibrated at the 97.5th
percentile; the actual profit and loss; the hypothetical profit and
loss; the risk-theoretical profit and loss; and the p-values of the
profit or loss for each day.
The information in the proposed report would enable the agencies to
identify changes to the risk profiles of reporting banking
organizations as well as to monitor the risk inherent in the broader
banking system. Specifically, the collection of backtesting and PLA
data included in the proposed reports would enable the agencies to
determine the validity of a banking organization's internal models, and
whether these models accurately account for the risk associated with
exposure to price movements, changes in market structure, or market
events that affect specific assets. If the agencies find these models
to be flawed, the banking organization must then use the standardized
approach for calculating its market risk capital requirements, thereby
preventing divergence between a banking organization's risk profile and
its capital position. In addition, the proposed report would be a
valuable tool for a banking organization subject to the market risk
capital requirements under the proposal to verify that the proposed
market risk framework has been appropriately implemented.
11. Technical Amendments
a. Definition of Securitization
The proposal would streamline the definitions related to
securitizations in subpart F with those in subparts D and E of the
capital rule. Specifically, the proposal would eliminate the definition
of ``securitization'' from subpart F of the capital rule and revise the
definitions of ``securitization position'' and ``resecuritization
position'' to refer to the terms ``securitization exposure'' and
``resecuritization exposure,'' which are defined in Sec. __.2 of the
capital rule.'' \423\ These modifications would not change the scope of
positions that would be considered securitization positions and
resecuritization positions under subpart F of the capital rule, as
further described below. Rather, the proposed revisions would clarify
that the same types of positions are captured under subpart F as under
subparts D and E of the capital rule, which currently use substantially
similar, but separate definitions.
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\423\ Section 2 of the capital rule defines a securitization
exposure as an on- or off-balance sheet credit exposure (including
credit-enhancing representations and warranties) that arises from a
traditional or synthetic securitization (including a
resecuritization), or an exposure that directly or indirectly
references a securitization exposure. The agencies' capital rule
defines a traditional securitization, in part, as a transaction in
which all or a portion of the credit risk of one or more underlying
exposures is transferred to one or more third parties (other than
through the use of credit derivatives or guarantees), where the
credit risk associated with the underlying exposures has been
separated into at least two tranches reflecting different levels of
seniority. The definition includes certain other conditions, such as
requiring all or substantially all of the underlying exposures to be
financial exposures. See 12 CFR 3.2 s.v. securitization exposure,
traditional securitization (OCC); 12 CFR 217.2 securitization
exposure, traditional securitization (Board); and 12 CFR 324.2
securitization exposure, traditional securitization (FDIC).
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As discussed in section III.D. of this Supplementary Information,
only exposures that involve tranching of credit risk would qualify as
securitization exposures. The designation of securitization exposures
or resecuritization exposures and the calculation of risk-based
requirements for securitization exposures would generally depend upon
the economic substance of the transaction rather than its legal form.
Provided there is tranching of credit risk, securitization exposures
could include, among other things, asset-backed securities and
mortgage-backed securities, loans, lines of credit, liquidity
facilities, financial standby letters of credit, credit derivatives and
guarantees, loan servicing assets, servicer cash advance facilities,
reserve accounts, credit-enhancing representations and warranties, and
credit-enhancing interest-only strips (CEIOs). Securitization exposures
would also include assets sold with retained tranches. In contrast,
mortgage-backed pass-through securities (for example, those guaranteed
by the Federal Home Loan Mortgage Corporation or the Federal National
Mortgage Association) that feature various maturities but do not
involve tranching of credit risk do not meet the definition of a
securitization exposure. This treatment would not change under the
proposal,
[[Page 64150]]
and consistent with subpart F of the capital rule, only those
securities that involve tranching of credit risk would be considered
securitization positions.
I. Credit Valuation Adjustment Risk
1. Background
In general, OTC derivative contracts are bilateral agreements
either to make or receive payments or to buy or sell an underlying
asset on a certain date, or dates, in the future. The value of an OTC
derivative contract, and thus a party's exposure to its counterparty,
changes over the life of the contract based on movements in the value
of the reference rates, assets, commodity prices, or indices underlying
the contract. In addition to the exposure to changes in the market
value of OTC derivative contracts, there is also credit risk associated
with such contracts. Specifically, if a counterparty to an OTC
derivative contract, or a portfolio of such contracts subject to a
QMNA,\424\ defaults prior to the contract's expiration, the non-
defaulting party will experience a loss if the market value of the
contract, or of the portfolio of contracts under a QMNA, is positive at
the time of default. The risk of such a loss, known as counterparty
credit risk, exists even if the current market value of the contract,
or the portfolio under a QMNA, is negative because the future market
value may become positive if market conditions change. Under the
current capital rule, a banking organization determines risk-based
capital requirements for counterparty credit risk using the credit risk
framework, with exposure amounts determined via either the SA-CCR,
current exposure method (CEM), or internal models methodology, as
applicable.\425\
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\424\ ``Qualifying master netting agreement'' (QMNA) is defined
in Sec. __.2 of the capital rule. In order to recognize an
agreement as a QMNA, a banking organization must meet the
operational requirements in Sec. __.3(d) of the capital rule. See
12 CFR 3.2, and 3.3(d) (OCC); 12 CFR 217.2 and 217.3(d) (Board); and
12 CFR 324.2, and 324.3(d) (FDIC). In general, a QMNA means a
netting agreement that permits a banking organization to accelerate,
terminate, close-out on a net basis and promptly liquidate or set
off collateral upon default of the counterparty. The proposal would
retain these definitions.
\425\ See Sec. Sec. __.34 and __.132 of the current capital
rule.
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The valuation change of OTC derivative contracts resulting from the
risk of the counterparty's defaulting prior to the expiration of the
contracts, known as the credit valuation adjustment (CVA), depends on
(1) counterparty credit spreads, which reflect the creditworthiness of
the counterparty perceived by the market; and (2) credit exposure
generated by CVA risk covered positions \426\ that the market would
expect at various future points in time. Thus, CVA risk has two
components: a counterparty credit spread component (CVA increases as a
result of the deterioration in the creditworthiness of a counterparty
perceived by the market) and an exposure component (CVA increases as a
result of an increase in the expected future exposure).
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\426\ CVA risk covered positions are described in section
III.I.3 of this Supplementary Information.
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The proposal would require a banking organization subject to
Category I, II, III or IV standards to reflect in risk-weighted assets
the potential losses on OTC derivative contracts resulting from
increases in CVA for all OTC derivative contract counterparties,
subject to certain exceptions.\427\ The proposal would provide two
measures for calculating CVA risk capital requirements: (1) the basic
measure for CVA risk which includes the basic CVA approach (BA-CVA)
capital requirement, which recognizes only the credit spread component
of CVA risk and is similar to the current capital rule's simple CVA
approach, and (2) a standardized measure for CVA risk which includes a
new standardized CVA approach (SA-CVA) capital requirement and the
basic CVA approach capital requirement. The SA-CVA would account for
both credit spread and exposure components of CVA risk and would allow
a banking organization to recognize hedges for the exposure component
of CVA risk. The proposal would require a banking organization to
receive a prior approval from the primary Federal supervisor to
calculate the CVA risk capital requirements under the standardized
measure for CVA risk.
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\427\ The proposal would allow a banking organization to exclude
certain OTC derivative contracts recognized as a credit risk
mitigant and that receive substitution treatment under Sec. __.36
of the current capital rule or Sec. __.120 of the proposed rule
from the portfolio of OTC derivative contracts that are subject to
the CVA risk capital requirements (under both BA-CVA and SA-CVA).
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2. Scope of Application
The proposed capital requirements for CVA risk would apply to large
banking organizations and their subsidiary depository institutions
subject to Category I standards, and to large banking organizations
subject to Category II, III or IV standards. Under the proposal, these
banking organizations would be required to calculate a risk-weighted
asset amount for the CVA risk arising from their portfolio of OTC
derivative transactions that would be subject to the CVA risk capital
requirement, as described in the following section of this
Supplementary Information. The proposed scope would apply CVA risk
capital requirements to all large, complex banking organizations that,
due to their significant trading activity, operational scale, and
domestic and global presence, are subject to more stringent capital
requirements.
Under the proposal, the primary Federal supervisor of a banking
organization that does not meet the proposed scoping criteria for CVA
risk capital requirements could require the banking organization to
apply the risk-based capital requirements for CVA risk if the
supervisor deems it necessary or appropriate because of the level of
CVA risk of the banking organization's portfolio of OTC derivative
contracts or to otherwise ensure safe and sound banking practices. The
primary Federal supervisor could also exclude from application of the
proposed CVA risk capital requirements a banking organization that
meets the scoping criteria if the supervisor determines that (1) the
exclusion is appropriate based on the level of CVA risk of the banking
organization's CVA risk covered positions, and (2) such an exclusion
would be consistent with safe and sound banking practices. While the
agencies believe that the proposed scoping criteria for application of
CVA risk capital requirements would reasonably identify a banking
organization with significant CVA risk given the current risk profile
of a banking organization, there may be unique instances where a
banking organization either should or should not be required to reflect
CVA risk in its risk-based capital requirements. As such, the proposal
would allow the primary Federal supervisor to exercise its authority to
address such instances on a case-by-case basis.
3. CVA Risk Covered Positions and CVA Hedges
a. Definition of CVA Risk Covered Position
The proposal would define a CVA risk covered position as a
derivative contract that is not a cleared transaction. In addition, the
proposal would allow a banking organization to choose to exclude an
eligible credit derivative for which the banking organization
recognizes credit risk mitigation benefits from the calculation of CVA
risk.\428\
[[Page 64151]]
This approach would align the scope of the CVA framework with the scope
of instruments that present CVA risk. The proposal would allow a
banking organization to exclude certain OTC derivative contracts that
are credit risk mitigants from the CVA risk covered position definition
in order not to create a disincentive to hedge against credit default
risk in subpart D and E of the capital rule. For example, a CDS on a
loan that is recognized as a credit risk mitigant and receives
substitution treatment under Sec. __.120 of the proposed rule would
not be included in the portfolio of OTC derivative contracts that are
subject to the CVA risk capital requirements.
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\428\ A cleared transaction includes an exposure resulting from
a transaction that a CCP has accepted. For purposes of the CVA risk
capital requirement, a banking organization that is not a clearing
member may treat its exposure as directly facing the CCP (that is,
the banking organization would have no exposure to the clearing
member) and may exclude that cleared transaction from CVA risk
covered positions. However, in a client-facing derivative contract,
where a clearing member banking organization either is acting as a
financial intermediary and enters into an offsetting transaction
with a QCCP or where it provides a guarantee on the performance of
its client to a QCCP, the exposures would be included in CVA risk
covered positions. See the definitions of cleared transaction and
client-facing derivative transaction in 12 CFR 3.2 (OCC), 12 CFR
217.2 (Board), 12 CFR 324.2 (FDIC).
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The proposed definition of CVA risk covered position would also
exclude cleared derivative transactions because the primary risk of a
banking organization facing a CCP lies in the risk that a CCP
participant, not the CCP itself, defaults.\429\ Clearing members of the
CCP would be responsible for covering losses of a defaulted clearing
member's portfolio with the CCP; clearing member banking organizations
are subject to a capital requirement for such risk in Sec. __.35 of
the current capital rule.
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\429\ A CCP could only default if a sufficient number of members
default at the same time and the remaining clearing members of this
CCP are unable to contribute sufficient funds to make the
counterparties to the defaulting members whole.
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A banking organization generally does not calculate CVA for cleared
transactions or for securities financing transactions (SFTs) for
financial reporting purposes. Consistent with this industry practice,
the proposal would not consider a cleared transaction or an SFT to be a
CVA risk covered position and therefore would not extend the CVA risk-
based capital requirements to such positions.
The proposed definition of a CVA risk covered position would
include client-facing derivative transactions and would recognize the
potential CVA risk of such exposures through the risk-based
requirements for these exposures, as described in sections III.I.3.a
and III.I.4 of this Supplementary Information.
b. Recognition of CVA Hedges
The proposal would set forth general requirements for the
recognition of CVA hedges, as well as specific requirements under BA-
CVA and SA-CVA. The proposal would allow a banking organization to
include certain CVA hedges as risk-reducing elements in risk-weighted
asset calculations for CVA risk (eligible CVA hedges). The proposal
would define a CVA hedge as a transaction the banking organization
enters into with a counterparty that is a third party (external CVA
hedge) or an internal trading desk (internal CVA hedge),\430\ as
described in section III.I.3.b of this Supplementary Information and
manages for the purpose of mitigating CVA risk. An internal CVA hedge
is an internal derivative transaction that is usually executed between
a CVA risk management function, such as a CVA desk (or a functional
equivalent thereof), and a trading desk of the banking organization.
Every such internal CVA hedge has two offsetting positions: the
position of the CVA risk management function (the CVA segment) and the
position of the trading desk (the trading desk segment). In addition to
its ability to reduce CVA risk, a CVA hedge may also contribute to CVA
risk arising from the counterparty of the hedge, in which case the CVA
hedge, a derivative contract that is not a cleared transaction, could
also be a CVA risk covered position. Whether a CVA hedge is a CVA risk
covered position has no impact on its qualification as an eligible CVA
hedge. Specifically, a non-CVA risk covered position could be an
eligible CVA hedge if it meets the proposed eligibility criteria as
described below. For example, a banking organization could hedge its
CVA risk using a cleared transaction; in such cases, the CVA hedge
would effectively reduce the CVA risk of the banking organization,
though the transaction itself would not be a CVA risk covered position.
The proposed treatment of CVA hedges intends to provide better
alignment between the economic risks posed by such transactions and the
risk-based capital requirement for CVA risk. In this manner, the
proposal would provide incentives for a banking organization to manage
CVA risk prudently.
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\430\ Both BA-CVA and SA-CVA would recognize internal CVA hedges
that satisfy eligibility requirements of the specific approach and
require that a banking organization have a CVA risk management
function to manage internal CVA risk transfers as described in
section III.H.4. of this Supplementary Information.
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As described below, the proposal would include two approaches for
calculating CVA capital requirements: the basic approach or BA-CVA
\431\ and the standardized approach or SA-CVA.\432\ The BA-CVA is
simpler, but less risk sensitive, than the SA-CVA. For this reason,
these two approaches have different eligibility requirements for
recognizing the risk-mitigating benefits of CVA hedges.
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\431\ The basic approach capital requirement is discussed below
in section III.I.5.a of this Supplementary Information.
\432\ The standardized approach capital requirement is discussed
below in section III.I.5.b of this Supplementary Information.
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Under the BA-CVA, the proposal would allow a banking organization
to recognize in the CVA risk capital calculation the risk-mitigating
benefit of hedges of the counterparty credit spread component of CVA
risk. The only instruments that could be recognized as eligible hedges
under the BA-CVA are the following instruments that hedge credit spread
risk: index CDS, single-name CDS, and single-name contingent CDS. The
proposal would expand the set of instruments recognized as eligible CVA
hedges in the current capital rule. In addition to single-name CDS and
single-name contingent CDS that reference the counterparty directly,
the proposal would allow a banking organization to recognize as an
eligible CVA hedge a single-name credit instrument that references an
affiliate of the counterparty or that references an entity that belongs
to the same sector and region \433\ as the counterparty (together,
eligible indirect single-name CVA hedges). Although a banking
organization generally can hedge the credit spread risk of a
counterparty whose credit risk is actively traded (that is, liquid
counterparties) by using credit instruments that directly reference
that counterparty, instruments referencing illiquid counterparties are
thinly traded, if at all. For illiquid counterparties, a banking
organization typically uses credit instruments that reference a
sufficiently liquid entity whose credit spread is highly correlated
with the credit spread of the illiquid counterparty such as
counterparties that belong to the same sector and region. For this
reason, the BA-CVA would allow a banking organization to recognize the
risk-mitigating benefit of eligible indirect single-name CVA hedges,
but, given the potentially significant basis risk between the
counterparty and the hedge reference name, the BA-CVA would require a
banking organization to use a non-perfect correlation parameter between
the counterparty credit spread and the
[[Page 64152]]
hedge reference name credit spread in order to constrain the risk-
mitigating benefit of such indirect but eligible CVA hedges.\434\ The
restrictions on hedging instruments as stated above apply to both
external and internal hedging transactions. Additionally, for a banking
organization to recognize an internal CVA hedging transaction as an
eligible CVA hedge under the BA-CVA, the transaction would have to
satisfy the requirements of an eligible internal risk transfer of CVA
risk, as described in section III.H.4.c of this Supplementary
Information.
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\433\ Under the proposal, for BA-CVA purposes, a region would
refer to a country or territorial entity.
\434\ The aggregation formula in the BA-CVA calculation would
introduce new regulatory correlation parameters that quantify the
relationship between the credit spreads of the counterparty and of
the entity referenced by the hedge, thus restricting hedging
benefits. See section III.I.5.a.i of this Supplementary Information
for a more detailed description of the BA-CVA calculation.
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Under the SA-CVA, hedges of the counterparty credit spread
component of CVA risk would be recognized without the BA-CVA
restriction on eligible instrument types described above. Furthermore,
the SA-CVA would recognize as eligible CVA hedges instruments that are
used to hedge the exposure component of CVA risk. The SA-CVA would also
recognize both external and internal CVA hedging transactions as
eligible CVA hedges. Similar to the BA-CVA, a banking organization
would be able to recognize an internal CVA hedging transaction as an
eligible CVA hedge under the SA-CVA if the transaction satisfies the
requirements of an eligible internal risk transfer of CVA risk, as
described in section III.H.4.c of this Supplementary Information.
Under both the BA-CVA and SA-CVA, the proposal would not allow a
banking organization to recognize a fraction of an actual transaction
as an eligible CVA hedge. Instead, a banking organization would only be
permitted to recognize whole transactions as eligible CVA hedges. For
example, if a banking organization for internal risk management
purposes uses an interest rate swap to hedge interest rate risk for
both CVA and margin valuation adjustment, the banking organization
would either have to recognize the entire swap when calculating its
risk-based capital requirements for CVA risk or exclude the entire
swap. The proposed treatment intends to prevent a banking organization
from choosing a fraction of a hedging transaction to minimize its
capital charge.
Finally, under both the BA-CVA and SA-CVA, the proposal would not
allow a banking organization to recognize the risk mitigating benefits
of CVA hedges that are securitization positions or correlation trading
positions when calculating risk-based capital requirements for CVA
risk. As reliably pricing such instruments is difficult, the agencies
are concerned with the ability of a banking organization to measure
reliably the price sensitivity of such positions to the proposed risk
factors under the SA-CVA. The BA-CVA, as a very simplistic approach, is
even less suitable than the SA-CVA for adequately capturing the risk of
such instruments.
Question 163: The agencies seek comments on the proposed
interpretation of region for the purposes of BA-CVA. Would limiting a
region to a country or a territorial entity pose any challenges for
hedge recognition under BA-CVA? What, if any, other criteria or
interpretations should the agencies consider and why?
4. General Risk Management Requirements
The proposal would require a banking organization to satisfy
certain general risk management requirements related to the
identification and management of CVA risk covered positions and
eligible CVA hedges and also to comply with additional operational
requirements as described in section III.I.4.c. of this Supplementary
Information.
a. Identification and Management of CVA Risk Covered Positions and CVA
Hedges
Identification of CVA risk covered positions and CVA hedges is the
prerequisite of prudent CVA risk management. The proposal would
therefore require a banking organization subject to the proposed CVA
framework to identify all CVA risk covered positions, all transactions
that hedge or are intended to hedge CVA risk, and all eligible CVA
hedges. A banking organization that received approval from its primary
Federal supervisor to use the standardized measure for CVA risk would
be required to identify all eligible CVA hedges for the purposes of
calculating the BA-CVA and all eligible CVA hedges for the purpose of
calculating the SA-CVA. Furthermore, a banking organization that hedges
its CVA risk must have a clearly defined hedging policy for CVA risk
that is reviewed and approved by senior management at least annually.
The hedging policy would be required to quantify the level of CVA risk
that the banking organization is willing to accept and detail the
instruments, techniques, and strategies that the banking organization
would use to hedge CVA risk.
b. Documentation
The proposal would also require a banking organization to have
policies and procedures for determining its CVA risk capital
requirement and to document adequately all material aspects of its
management and identification of CVA risk covered positions and
eligible CVA hedges, and its control, oversight, and review processes.
Such general documentation requirements are intended to facilitate
regulatory review and a banking organization's internal risk management
and oversight processes.
The proposed requirements are intended to appropriately support the
active risk management and monitoring of CVA risk under the proposed
framework.
c. Additional Risk Management Requirements for Use of the Standardized
Measure for CVA Risk
In addition to the general risk management requirements, a banking
organization that has received approval from its primary Federal
supervisor to use the standardized measure for CVA risk would be
required to comply with additional operational requirements on
documentation, initial approval and ongoing performance of regulatory
CVA models as described below.
i. Documentation
The proposal would require a banking organization using the SA-CVA
to adequately document policies and procedures of the CVA desk, or
similar dedicated function, and the independent risk control unit.
Furthermore, the banking organization would be required to document the
internal auditing process; the internal policies, controls, and
procedures concerning the banking organization's CVA calculations for
financial reporting purposes; the initial and ongoing validation of
models used to calculate regulatory CVA (including exposure models);
and the banking organization's process to assess the performance of
models used for calculating regulatory CVA (including exposure models)
and implement remedies to mitigate model deficiency. The agencies
expect that a banking organization would document any adjustments, if
applicable, made to the CVA models to satisfy the operational
requirements described in section III.I.4.c. of this Supplementary
Information under SA-CVA. These enhanced documentation requirements are
designed to help ensure that exposure models under the SA-CVA
[[Page 64153]]
appropriately capture the CVA risk of CVA risk covered positions and
that a banking organization has effective and sound risk management and
oversight processes.
ii. Initial Approval
To receive approval from its primary Federal supervisor to use the
SA-CVA for any of its CVA risk covered positions, a banking
organization must be capable of calculating, on at least a monthly
basis, regulatory CVA (as described in section III.I.5.b.i of this
Supplementary Information), as well as the sensitivities of regulatory
CVA to counterparty credit spreads and market risk factors. Due to the
computational intensity associated with calculating regulatory CVA and
its sensitivities, the proposal would permit a banking organization to
choose to recognize in its risk-based capital requirement certain
netting sets of CVA risk covered positions under BA-CVA and other
netting sets under SA-CVA. Furthermore, the prior approval from the
primary Federal supervisor could specify which CVA risk covered
positions must be included in the calculation of the BA-CVA, and which
could be included in the calculation of the SA-CVA. If a banking
organization were to use both SA-CVA and BA-CVA for the calculations of
risk-based capital requirements for CVA risk, the proposal would
require the banking organization to assign each CVA hedge that the
banking organization intends to recognize in these calculations to one
of the two approaches (SA-CVA or BA-CVA). This assignment would have to
satisfy the eligibility requirements of the SA-CVA or the BA-CVA. For
example, a single-name CDS hedging the counterparty credit spread
component of CVA risk could be assigned to either the SA-CVA or the BA-
CVA, while an interest rate swap hedging the interest rate component of
CVA risk could only be assigned to the SA-CVA. With this proposed
requirement, the agencies intend to support appropriate risk
measurement and monitoring of CVA risk and help ensure that a banking
organization appropriately reflects the respective hedges in the
calculation of risk-based capital requirements for CVA risk.
To better align regulatory CVA with accounting CVA and to help
ensure that CVA capital requirements more accurately reflect CVA risk,
the proposal would require a banking organization to use CVA models
that it uses for financial reporting purposes (accounting CVA models)
to calculate regulatory CVA under the SA-CVA, adjusted, if necessary,
to satisfy the additional requirements as described in section
III.I.5.b of this Supplementary Information.
Furthermore, to support active management of CVA risk, the proposal
would require a banking organization that intends to use the SA-CVA to
have a CVA desk, or similar dedicated function, responsible for risk
management and hedging of CVA risk consistent with the banking
organization's CVA risk management and hedging policies and procedures.
The agencies view a designated CVA desk or designated function as the
best mechanism to support the active management of CVA risk.
The primary Federal supervisor may rescind its approval of the use
of the standardized measure for CVA risk in whole or in part, if it
determines that the banking organization's model no longer complies
with all applicable requirements or fails to reflect accurately the CVA
risk. If the primary Federal supervisor determines that a banking
organization's implementation of the SA-CVA risk no longer complies
with proposed requirements or fails to accurately reflect CVA risk, the
primary Federal supervisor could specify one or more CVA risk covered
positions or eligible CVA hedges must be included in the BA-CVA or
prescribe an alternative capital requirement.
iii. Ongoing Eligibility
For a banking organization approved to use the standardized measure
for CVA risk, the proposal would require the exposure models used in
the calculation of regulatory CVA to be part of a CVA risk management
framework that includes the identification, management, measurement,
approval, and internal reporting of CVA risk.
I. Control and Oversight
A banking organization that receives prior written approval from
its primary Federal supervisor to use the standardized measure for CVA
risk would be required to maintain an independent risk control unit
that is responsible for the effective initial and ongoing validation of
the models used for calculating regulatory CVA (including exposure
models), reports directly to senior management, and is independent of
the banking organization's trading desks and CVA desk, or similar
dedicated function, as well as the business unit that evaluates
counterparties and sets limits.
Senior management of the banking organization would be required to
have oversight of the CVA risk control process. In addition, the
banking organization would be required to have a regular independent
audit review of the overall CVA risk management process, including both
the activities of the CVA desk (or similar dedicated function) and of
the independent risk control unit. The agencies intend that, together,
the independent risk control unit and internal audit would provide
appropriate review and credible challenge of the effectiveness of CVA
risk management function.
II. Exposure Model Eligibility
The proposal would introduce requirements for a banking
organization that calculates the CVA risk-based capital requirements
under SA-CVA to further strengthen its CVA risk management processes
and promote effective CVA risk management pertaining specifically to
CVA exposure models. Such requirements would guide the banking
organization's internal CVA risk control unit and audit functions in
providing appropriate review and challenge of CVA risk management. In
particular, the proposal would require the banking organization to (1)
include exposure models for the regulatory CVA calculation in its CVA
risk management framework and (2) define criteria on which to assess
the exposure models and their inputs and have a written policy in place
describing the process for assessing the performance of exposure models
and for remedying unacceptable performance.
To help ensure that the CVA capital requirements are commensurate
with CVA risk, the proposal would require a banking organization to
have the exposure models used in regulatory CVA calculation be part of
its ongoing CVA risk management framework, including identification,
measurement, management, approval, and internal reporting of CVA risk.
Such requirements would subject the regulatory CVA exposure models to
ongoing effective measurement and management.
Specifically, the proposal would require a banking organization to
document the process for initial and ongoing validation of its models
used for calculating regulatory CVA, including exposure models, with
sufficient detail to enable a third party to understand the model's
operations, limitations, and key assumptions. A banking organization
would be required to validate, no less than annually, its CVA models
including exposure models, and would account for other circumstances,
such as a sudden change in market behavior, under which additional
validation would need to be conducted more frequently. In addition, a
banking organization would be
[[Page 64154]]
required to sufficiently document how the validation is conducted with
respect to data flows and portfolios, what analyses are used, and how
representative counterparty portfolios are constructed. As part of the
independent model validation, a banking organization would be required
to test the pricing models used to calculate exposure for given paths
of market risk factors against appropriate independent benchmarks for a
wide range of market states as part of the initial and ongoing model
validation process. The proposal would require the pricing models for
CVA risk covered positions that are options to account for the non-
linearity of option value with respect to market risk factors.
Additionally, a banking organization would be required to obtain
current and historical market data that are either independent of the
line of business or validated independently of the line of business, to
be used as an input for an exposure model, as well as comply with
applicable financial reporting standards. The proposal would require
well-developed data integrity processes to handle the data of erroneous
and anomalous observations, and that data be input into exposure models
in a timely and complete fashion and maintained in a secure database
that is subject to formal periodic audits. Where data used in the
exposure model are proxies for actual market data, the proposal would
require a banking organization to set internal policies to identify
suitable proxies and be able to demonstrate, empirically on an ongoing
basis, that the proxy data are a conservative representation of the
underlying risk under adverse market conditions.
To accurately calculate simulated paths of a discounted future
exposure required for regulatory CVA calculations as discussed below, a
banking organization's exposure models would need to capture and
accurately reflect transaction-specific information (for example, terms
and specifications). A banking organization would be required to verify
that transactions are assigned to the appropriate netting set within
the model. The terms and specifications would need to reside in a
secure database subject to at least annual formal audit. The
transmission of the transaction terms and specifications data to the
exposure model would also be subject to internal audit. The proposal
would require a banking organization to establish formal reconciliation
processes between the internal model and source data systems to verify
on an ongoing basis that transaction terms and specifications are being
reflected correctly or at least conservatively.
5. Measure for CVA Risk
To calculate the risk-based capital requirement for CVA risk, the
proposal would provide a basic measure for CVA risk and a standardized
measure for CVA risk. Under the proposal, the basic measure for CVA
risk would include risk-based capital requirements for all CVA risk
covered positions and eligible CVA hedges calculated using the BA-CVA,
and any other additional capital requirement for CVA risk established
by a banking organization's primary Federal supervisor if the primary
Federal supervisor determines that the capital requirement for CVA risk
as calculated under the BA-CVA is not commensurate with the CVA risk of
the banking organization's CVA risk covered positions. The standardized
measure for CVA risk would include risk-based capital requirements
calculated under (1) the SA-CVA for all standardized CVA risk covered
positions \435\ and standardized CVA hedges, (2) the BA-CVA for all
basic CVA risk covered positions \436\ and basic CVA hedges, and (3)
any additional capital requirement for CVA risk established by a
banking organization's primary Federal supervisor if the primary
Federal supervisor determines that the capital requirement for CVA risk
as calculated under the SA-CVA and BA-CVA is not commensurate with the
CVA risk of the banking organization's CVA risk covered positions. The
primary Federal supervisor may require the banking organization to
maintain an overall amount of capital that differs from the amount
otherwise required under the proposal, if the primary Federal
supervisor determines that the banking organization's CVA risk capital
requirements under the rule are not commensurate with the risk of the
banking organization's CVA risk covered positions, a specific CVA risk
covered position, or portfolios of such positions, as applicable.
---------------------------------------------------------------------------
\435\ The proposal would define standardized CVA risk covered
positions as all CVA risk covered positions that are not basic CVA
risk covered positions; these terms are used in the standardized
measure for CVA risk.
\436\ The proposal would define basic CVA risk covered positions
as CVA risk covered positions that must be included in the BA-CVA
because: (i) the banking organization does not have supervisory
approval to use the SA-CVA for these CVA risk covered positions;
(ii) the banking organization chooses to exclude the netting sets
with these CVA risk covered positions from the SA-CVA; or (iii)
these CVA risk covered positions are in a partial netting set
designated for inclusion in the BA-CVA by the banking organization
with prior approval from its primary Federal supervisor.
---------------------------------------------------------------------------
A banking organization would be required to use the basic measure
for CVA risk unless it has received prior written approval from the
primary Federal supervisor to use the standardized measure for CVA
risk.
A banking organization that has received prior written approval
from its primary Federal supervisor to use the standardized measure for
CVA risk would be required to include all CVA risk covered positions
that are outside of the approval scope of the SA-CVA in the BA-CVA.
Furthermore, a banking organization could choose to exclude any number
of in-scope netting sets from SA-CVA calculations and recognize them
instead in the BA-CVA. Given that the calculation of CVA sensitivities
to market risk factors in the SA-CVA is computationally intensive for
large netting sets, the proposal would allow a banking organization to
restrict application of the SA-CVA only to netting sets with the most
material CVA risk, for example. A banking organization may also
bifurcate CVA risk covered positions of a single netting set between
SA-CVA and BA-CVA, subject to a prior written supervisory approval for
each such case. Thus, for a banking organization that has received
prior written approval from its primary Federal supervisor to use the
standardized measure for CVA risk, the CVA capital requirement
generally would equal the SA-CVA capital requirement for its CVA risk
covered positions and eligible CVA hedges recognized under SA-CVA
(these CVA risk covered positions and eligible CVA hedges are referred
to as ``standardized'' in the proposal), plus the BA-CVA capital
requirement for its CVA risk covered positions and eligible CVA hedges
recognized under BA-CVA (these CVA risk covered positions and eligible
CVA hedges are referred to as ``basic'' in the proposal), if
applicable.
After calculating the CVA capital requirement using either the
basic measure for CVA risk or the standardized measure for CVA risk, a
banking organization's total capital requirements for CVA risk would
equal the CVA capital requirement multiplied by 12.5. Additionally, the
primary Federal supervisor could require the banking organization to
maintain an amount of regulatory capital that differs from the amounts
required under the basic measure for CVA risk or the standardized
measure for CVA risk.
a. Basic Approach for CVA Risk
Similar to the simple CVA approach in the current capital rule, the
capital
[[Page 64155]]
requirement for CVA risk under the BA-CVA would be calculated according
to a formula, described below, that approximates CVA expected
shortfall, which replaces value-at-risk in the simple CVA approach,
assuming fixed expected exposure profiles and based on a set of
simplifying assumptions. The assumptions provide that: (1) all credit
spreads have a flat term structure; (2) all credit spreads at the time
horizon have a lognormal distribution; (3) each single name credit
spread is driven by the combination of a single systematic risk factor
and an idiosyncratic risk factor; (4) the correlation between any
single name credit spread and the systematic risk factor is 0.5, and
(5) the single systematic risk factor drives all credit indices without
any idiosyncratic risk component.
The BA-CVA would improve upon the simple CVA approach in the
capital rule by: (1) providing limited recognition for the risk-
mitigating benefit of eligible single-name credit instruments that do
not reference a counterparty directly; (2) putting a restriction on
hedge effectiveness; (3) relying on risk weights derived from the SA-
CVA; and (4) introducing a new method of calculating risk weights for
credit indices.
Under the proposal, the risk-based capital requirement under the
BA-CVA would be calculated according to the following formula, as
provided under Sec. __.222(a) of the proposed rule:
Kbasic = 0.65 [middot] (b [middot] Kunhedged + (1-b) [middot] Khedged)
Where:
Kbasic is the risk-based capital requirement under the BA-CVA;
Kunhedged is the risk-based capital requirement for CVA positions
before recognizing the risk mitigating effect of eligible CVA
hedges;
Khedged is the risk-based capital requirement after recognizing such
hedges; and
b is a regulatory parameter set to 0.25.
The formula sets the capital requirement under the BA-CVA equal to
the weighted average of Kunhedged and Khedged scaled by a factor of
0.65 in order to ensure that the simpler and less risk-sensitive BA-CVA
method is calibrated appropriately relative to the SA-CVA. Applying the
weighted average in the BA-CVA capital requirement formula is a
conservative measure that implicitly recognizes the presence of the
expected exposure component of CVA risk by reducing the effectiveness
of eligible CVA hedges to 75 percent (preventing a banking
organization's eligible CVA hedges from fully offsetting the CVA risk
of its CVA risk covered positions).\437\ Thus, even if a banking
organization perfectly hedges the counterparty credit spread component
of CVA risk, the BA-CVA capital requirement would be equal to 0.65
[middot] (0.25 [middot] Kunhedged) For a banking organization that does
not hedge CVA risk, eliminating the recognition of eligible CVA hedges
would result in Khedged = Kunhedged, so that the BA-CVA calculation
would become:
---------------------------------------------------------------------------
\437\ Suppose, for example, that a banking organization
perfectly offsets the counterparty credit spread component of CVA
risk, so that Khedged = 0. Allowing the banking organization to set
the BA-CVA to zero in this case would not be prudent because there
is also the exposure component of CVA risk, which is not explicitly
captured by the BA-CVA.
Kbasic = 0.65 [middot] (Kunhedged)
i. Calculation of Kunhedged
Under BA-CVA, the proposal would first require a banking
organization to calculate the risk-based capital requirements for CVA
risk covered positions without recognizing the risk mitigating effect
of eligible CVA hedges, Kunhedged, for each counterparty on a stand-
alone basis (SCVAC) and then aggregate the respective standalone
counterparty capital requirements across counterparties, as expressed
by the following formula:
[GRAPHIC] [TIFF OMITTED] TP18SE23.041
The first term under the square root in the formula ((r [middot]
SCSCVAC)2) aggregates the systematic components of CVA risk, while the
second term under the square root in the formula ((1-r2)
[middot] SC(SCVAC2)) aggregates the idiosyncratic
components of CVA risk. The purpose of the Kunhedged formula is
intended to reflect the potential losses arising from unhedged CVA
risk.
I. Regulatory Correlation Parameter
One of the basic assumptions underlying the BA-CVA is that a single
risk factor drives systematic credit spread risk. This assumption is
important because it simplifies the credit spread correlation
structure. The proposed regulatory correlation parameter r of 0.5
approximates the correlation between the credit spread of a
counterparty and the systematic risk factor. The square of the
regulatory correlation parameter (0.25) approximates the correlation
between credit spreads of any two counterparties. The proposed value of
the regulatory correlation parameter is consistent with historically
observed correlations between credit spreads and would appropriately
recognize the diversification of CVA risk by ensuring that a banking
organization's exposure would be less than the sum of the CVA risks for
each counterparty.
II. Standalone CVA Capital Requirement for Each Counterparty (SCVAC)
SCVAC represents the capital requirement a banking organization
would be subject to under the BA-CVA if a single counterparty were the
only counterparty with which the banking organization has CVA risk
covered positions (that is ignoring the existence of the other
counterparties), and there are no eligible CVA hedges to consider. For
purposes of calculating SCVAC, the proposal first would require a
banking organization to calculate for each netting set the product of
the effective maturity MNS, the exposure at default amount EADNS, and
the regulatory discount factor DFNS, and sum the resulting products
across all netting sets with the same counterparty. The banking
organization would multiply the resulting quantity for each
counterparty by the supervisory risk weight of the counterparty RWC
from Table 1 to Sec. __.222 and divide by alpha ([alpha]), discussed
below, as expressed by the following formula: \438\
---------------------------------------------------------------------------
\438\ The above formula for SCVAc is a simplified representation
of how the expected shortfall of the counterparty credit spread
component of CVA risk of a single counterparty can be calculated.
---------------------------------------------------------------------------
[[Page 64156]]
[GRAPHIC] [TIFF OMITTED] TP18SE23.042
The proposal would set the exposure at default amount, EADNS, for
the netting set, NS, equal to the exposure amount calculated by the
banking organization for the same netting set for counterparty credit
risk capital requirements according to Sec. __.113 of the proposal,
which captures the potential losses in the event of the counterparty's
default. The effective maturity of the netting set, MNS, would equal
the weighted-average remaining maturity, measured in whole or
fractional years, of the individual CVA risk covered positions in the
netting set, NS, with the weight of each individual position set equal
to the ratio of the notional amount of the position to the aggregate
notional amount of all CVA risk covered positions in the netting
set.\439\ As the proposal would define the effective maturity of a
netting set as an average of the actual CVA risk covered position
maturities, the regulatory discount factor, DFNS, would scale down the
potential losses projected over the effective maturity of the netting
set to their net present value, using a 5 percent interest rate. The
proposed interest rate would be a reasonable discount factor and
consistent with the long-term historically observed average of long-
term interest rates. The proposal would define components of the
SCVAc calculation at a netting set level, thus clarifying
the use of counterparty-level exposure at default and effective
maturity calculated in the same way as the banking organization
calculates it for minimum capital requirements for counterparty credit
risk.
---------------------------------------------------------------------------
\439\ For a netting set consisting of a single transaction (for
example, a derivative contract that is not subject to a QMNA), the
effective maturity would equal the remaining contractual maturity of
the derivative contract.
---------------------------------------------------------------------------
A. Supervisory Risk Weights (RWc)
Table 1 to Sec. __.222 of the proposed rule provides the proposed
supervisory risk weights for each counterparty, RWc, which reflect the
potential variability of credit spreads based on a combination of the
sector and credit quality of the counterparty or of the eligible hedge
reference entity. With the exception of sovereigns and MDBs, each
sector would have two risk weights, one for counterparties that are
investment grade, as defined in the current rule,\440\ and one for
counterparties that are speculative grade or sub-speculative grade,
each as defined in the proposal.\441\ Sovereigns and MDBs would have
separate risk weights for counterparties that are speculative grade and
counterparties that are sub-speculative grade. The proposed supervisory
risk weights match the risk weights set out in the SA-CVA for
counterparty credit spread risk class.
---------------------------------------------------------------------------
\440\ See the definition of Investment Grade in the capital
rule. 12 CFR 3.2 (OCC); 12 CFR 217.2 (Board); 12 CFR 324.2 (FDIC).
\441\ See the definitions of Speculative Grade and Sub-
Speculative Grade in Sec. __.2 of the proposed rule.
---------------------------------------------------------------------------
The proposal would provide counterparty sectors similar to those
contained in the Basel III reforms and a treatment for certain U.S.-
specific counterparties (for example, GSEs and public sector entities).
Specifically, the proposal would include GSE debt and public sector
entities for government-backed non-financials, education, and public
administration to appropriately reflect the potential variability in
the credit spreads of such counterparties.
---------------------------------------------------------------------------
\442\ Under Sec. __.2 of the current capital rule, public
sector entity (PSE) means a state, local authority, or other
governmental subdivision below the sovereign level.
[GRAPHIC] [TIFF OMITTED] TP18SE23.043
Question 164: The agencies seek comments on the appropriateness of
the proposed risk weights of Table 1 to Sec. __.222 for financials,
including government-backed financials. What, if any, alternative risk
weights should the agencies consider? Please provide specific details
and supporting evidence on the alternative risk weights.
Question 165: The agencies seek comments on the appropriateness of
treating the counterparty credit risks of public-sector entities and
the GSEs in the same way as those of government-backed non-financials,
education, and public administration. What, if any, alternatives should
the agencies consider to more appropriately capture
[[Page 64157]]
the counterparty credit risk for such entities?
Question 166: The agencies seek comments on the appropriateness of
applying a 0.65 calibration factor in the formula setting the capital
requirement under the BA-CVA to ensure that CVA risk capital
requirements appropriately reflect CVA risk. What other level of the
calibration should the agencies consider and why?
B. Alpha Factor (a)
As previously discussed, when calculating a standalone CVA
counterparty-level capital requirement, the proposal would require a
banking organization to use the exposure amount that it uses in the
counterparty credit risk framework. The exposure amount determined in
the counterparty credit risk framework would be the sum of replacement
cost and potential future exposure multiplied by a multiplication
factor (the alpha factor) to capture certain risks (for example, wrong-
way risk \443\ and risks resulting from non-perfect granularity).\444\
CVA calculations are based on expected exposure, which in SA-CCR is
proxied by the sum of replacement cost and potential future exposure.
Accordingly, the proposal would remove the effect of this
multiplication factor from the risk-based capital requirement for CVA
risk by dividing the exposure at default amount used in the SCVAc
formula by the alpha factor. Specifically, the proposal would require
such banking organization to use the same alpha factor in calculating
the risk-based capital required under the BA-CVA as required in
exposure amount calculations under SA-CCR by setting the alpha factor
at 1.4 for derivative contracts with counterparties that are not
commercial end-users and at 1 for derivative contracts with commercial
end-users.
---------------------------------------------------------------------------
\443\ Wrong-way risk reflects the situation where exposure is
positively correlated with the counterparty's probability of
default--that is, the exposure amount of the derivative contract
increases as the counterparty's probability of default increases.
\444\ See 85 FR 4362 (January 24, 2020). Under SA-CCR, the alpha
factor generally is set at 1.4. However, for a derivative contract
with a commercial end-user counterparty, the alpha factor is removed
from the exposure amount formula. This is equivalent to applying an
alpha factor of 1 to these contracts.
---------------------------------------------------------------------------
Question 167: The agencies seek comment on using the counterparty
credit risk framework to calculate the exposure amount for the
standalone CVA counterparty-level capital requirement. Does the CVA
capital requirement pose particular issues in the case of nonfinancial
counterparties? If so, what modifications should the agencies consider
to mitigate such issues?
ii. Calculation of Khedged
The second component of the BA-CVA calculation, Khedged, represents
the risk-based capital requirements for CVA risk after recognizing the
risk mitigation benefits of eligible counterparty credit spread hedges,
as expressed by the following formula:
[GRAPHIC] [TIFF OMITTED] TP18SE23.044
In general, the calculation of Khedged follows that of Kunhedged,
but introduces new terms to reflect the risk-mitigating effect of
eligible CVA hedges.\445\ The first term, ((r [middot]
SC(SCVAc-SNHc)-IH)\2\), recognizes the risk mitigating
effect of single-name hedges (SNHc) and index hedges (IH) on the
systematic component of a banking organization's aggregate CVA risk.
The second term, ((1-r2) [middot] Sc(SCVAc-SNHc)\2\),
recognizes the risk mitigating effect of single-name hedges on the
aggregate idiosyncratic component of aggregate CVA risk. The third
term, ScHMAc, aggregates the components of
indirect single-name hedges that are not aligned with counterparty
credit spreads and is designed to limit the regulatory capital
reduction a banking organization may realize from indirect hedges given
that such hedges will not fully offset movements in a counterparty's
credit spread (that is, indirect hedges cannot reduce Khedged to zero).
---------------------------------------------------------------------------
\445\ The standalone CVA capital, SCVAc, and
regulatory correlation parameter, r, are defined in exactly the same
way as in the formula for CVA risk covered positions Kunhedged. See
section III.I.5.a.i. of this Supplementary Information.
---------------------------------------------------------------------------
I. Single-Name Hedges of Credit Spread Risk (SNHc)
Under the proposal, to calculate the capital reduction for a
single-name hedging instrument, a banking organization would multiply
the supervisory prescribed correlation (rhc) between the credit spread
of the counterparty and the hedging instrument, the supervisory risk
weight of the reference name of the hedging instrument (RWh), the
remaining maturity of the hedging instrument in years (MhSN), the
notional amount of the hedging instrument (BhSN) \446\ and the
supervisory discount factor (DFhSN). The offsetting benefit of all
single-name hedges of credit spread risk on the CVA risk of each
counterparty (SNHc) would equal the simple sum of the capital reduction
for each eligible CVA hedge that a banking organization uses to hedge
the counterparty credit spread component of CVA risk of a given
counterparty as expressed by the following formula:
---------------------------------------------------------------------------
\446\ Under the proposal, the notional amount for single-name
contingent CDS would be determined by the current market value of
the reference portfolio or instrument.
[GRAPHIC] [TIFF OMITTED] TP18SE23.045
Risk weights (RWh) would be based on a combination of the sector
and the credit quality of the reference name of the hedging instrument
as prescribed in Table 1 to Sec. __.222 included above. Parameter rhc
is the regulatory value of the correlation between the credit spread of
the counterparty and the credit spread of the reference name of an
eligible single-name hedge as prescribed in Table 2 to Sec. __.222
below.
[[Page 64158]]
[GRAPHIC] [TIFF OMITTED] TP18SE23.046
II. Hedge Mismatch Adjustment for Indirect Single-Name Hedges
(HMAc)
Under the proposal, the portion of the indirect hedges that are not
recognized in SNHc due to the imperfect regulatory prescribed
correlation would be reflected in the hedge mismatch adjustment, HMAc,
as expressed by the following formula:
[GRAPHIC] [TIFF OMITTED] TP18SE23.047
While the summation would cover all single-name hedges assigned to
counterparty c, only indirect hedges for which correlation with the
counterparty spread is non-perfect (that is, the regulatory prescribed
correlation (rhc) is less than one) would contribute to HMAc
III. Index Hedges of Credit Spread Risk (IH)
Under the proposal, the total amount by which index hedges of
credit spread risk reduce the systematic component of the aggregate CVA
risk across all counterparties, IH, would equal the simple sum of the
capital reduction amounts for eligible CVA hedges that are index
hedges, which would be calculated for each such hedge as the product of
the supervisory risk weight (RWi), the remaining maturity in years
(Miind), notional amount (Biind), and the supervisory discount factor
(DFiind)--as expressed by the following formula:
[GRAPHIC] [TIFF OMITTED] TP18SE23.048
Each term in the summation in the formula for IH above is a
simplified representation of how the expected shortfall for the market
value of a given index hedge can be calculated. Because of the BA-CVA's
underlying assumption that each credit index is driven by the same
systematic factor without any idiosyncratic risk component, the
expected shortfall of each individual index hedge would be aggregated
via simple summation across all such hedges, and the result of this
aggregation (IH) would appear only in the systematic risk component in
the formula for Khedged above.
To determine the appropriate supervisory risk weight (RWi) for each
index hedge, the proposal would require a banking organization to
adjust the supervisory risk weights in Table 1 to Sec. __.222.
Specifically, for index hedges where all the underlying constituents
belong to the same sector and are of the same credit quality, a banking
organization would assign the index hedge to the corresponding bucket
used for single-name positions and multiply the supervisory risk weight
by 0.7. For index hedges where the underlying constituents span
multiple sectors or are not of the same credit quality, the banking
organization would calculate the notional-weighted average of the risk
weights assigned to each underlying constituent in the index based on
the risk weights provided in Table 1 to Sec. __.222 and multiply the
result by 0.7. Multiplication by a factor of 0.7 is intended to
recognize diversification of idiosyncratic risk of individual index
constituents.
b. Standardized Approach for CVA Risk
The SA-CVA is an adaptation of the sensitivities-based method used
in the standardized measure for market risk as described in section
III.H.7.a of this Supplementary Information. The inputs to the SA-CVA
calculations are sensitivities of the aggregate regulatory CVA
(discussed in the following subsection) and of the market value of all
eligible CVA hedges under SA-CVA (discussed below in this section) to
delta and vega risk factors specified in the proposal. In general, the
proposed SA-CVA would closely follow the sensitivities-based method for
market risk with some exceptions. Broadly, the SA-CVA calculation would
reflect capital requirements for only delta and vega (but not
curvature), apply slightly different steps in the calculation of the
risk-weighted net sensitivity, use less granular risk factors and risk
buckets, and include a capital multiplier to account for model risk.
There are other specific differences between the SA-CVA and the
sensitivities-based method for market risk. Unlike the market risk of
trading instruments, CVA risk always depends on two types of risk
factors: the term structure of credit spreads of the counterparty and a
set of market risk factors that drives the expected exposure of the
banking organization to the counterparty. For this reason, the SA-CVA
would have six distinct risk classes for the CVA delta capital
requirement: counterparty credit spread and the five risk classes for
exposure-related market risk factors which are the interest rate,
foreign exchange, reference credit spread, equity, and commodity
[[Page 64159]]
risk classes. Regulatory CVA is approximately linear in counterparty
credit spreads and does not depend on their volatilities. Accordingly,
calculation of the CVA vega capital requirement would not be required
in the counterparty credit spread risk class. Expected exposure, on the
other hand, is always sensitive to volatilities of market risk factors
that drive market values of CVA risk covered positions. Because of
this, a banking organization would be required to calculate the CVA
vega capital requirements for the five exposure-related risk classes
regardless of the presence of options in CVA risk covered positions.
Regulatory CVA would require simulating future exposure that
depends on multiple market risk factors over long time horizons.
Calculation of each CVA sensitivity to an exposure-related market risk
factor would involve a separate regulatory CVA calculation, which could
limit the number of CVA sensitivities to market risk factors that a
banking organization could realistically calculate. Accordingly, the
agencies would reduce the granularity of both delta and vega risk
factors in the five exposure-related risk classes in the SA-CVA
compared to the sensitivities-based method for market risk. Curvature
calculations would not be required. For the five exposure-related risk
classes, the SA-CVA would use the same risk buckets, regulatory risk
weight calibrations, and correlation parameters as are used in the
sensitivities-based method for market risk, with necessary adjustments
for the SA-CVA's reduced granularity of market risk factors.
In contrast to market risk factors that drive exposure, CVA
sensitivities to counterparty credit spreads can be calculated based on
a single regulatory CVA calculation. In the counterparty credit spread
risk class, the SA-CVA would use the same granularity of risk factors
as are used in the sensitivities-based method for market risk. Vega and
curvature calculations would not be required in the counterparty credit
spread risk class because regulatory CVA would be approximately linear
with respect to counterparty credit spreads. For counterparty credit
spreads, the SA-CVA would adjust risk buckets and correlations based on
the role that counterparty credit spreads play in CVA calculations.
i. Regulatory CVA
Under the proposal, the aggregate regulatory CVA would equal the
simple sum of counterparty-level regulatory CVAs. Counterparty-level
regulatory CVA is intended to reflect an estimate of the market
expectation of future loss that a banking organization would incur on
its portfolio of derivatives with a counterparty in the event of the
counterparty's default, assuming that the banking organization survives
until the maturity of the longest instrument in the portfolio. For
consistency in the calculation of risk-based capital across banking
organizations, the proposal would require a banking organization to
apply a positive sign to non-zero losses, so that regulatory CVA is
always a positive quantity. The proposal would require a banking
organization to base the calculation of regulatory CVA for each
counterparty on at least three sets of inputs: the term structure of
market-implied probability of default (market-implied PD) of the
counterparty, the market-consensus expected loss-given-default (ELGD),
and the simulated paths of discounted future exposure. In addition to
the three specified inputs, the proposal would also allow a banking
organization to use models that incorporate additional inputs for
purposes of calculating regulatory CVA.
I. Term Structure of Market-Implied PD
The proposal would require a banking organization to use credit
spreads observed in the markets, if available, to estimate the term
structure of the market-implied PD based on market expectations of the
likelihood that the counterparty will default by a certain point in the
future. Relative to historical default probabilities, market-implied
PDs are typically substantially higher as they reflect the premium that
investors demand for accepting default risk.
As many counterparties' credit is not actively traded, the proposal
would allow a banking organization to use proxies to estimate the term
structure of market-implied PD. For these illiquid counterparties, a
banking organization would be required to estimate proxy credit spreads
from credit spreads observed in the market for the counterparty's
liquid peers, determined using, at a minimum, credit quality, industry,
and region. Alternatively, the proposal would permit a banking
organization to map an illiquid counterparty to a single liquid
reference name if a banking organization provides a justification to
its primary Federal supervisor for the appropriateness of such
mapping.\447\ In addition, for illiquid counterparties for which there
are no available credit spreads of liquid peers, the proposal would
permit a banking organization to use an estimate of credit risk to
proxy the credit spread of an illiquid counterparty (for example, to
use a more fundamental analysis of credit risk based on balance sheet
information or other approaches). To be able to use the fundamental
analysis of credit risk or similar approaches, a banking organization
would need the prior approval of its primary Federal supervisor and be
subject to supervisory review of its policies and procedures that
reasonably demonstrate that the analysis of credit risk produces a
credible proxy of the credit spread of the counterparty. While
historical default probabilities may form part of this analysis, the
resulting spread would have to relate to credit markets as well. This
requirement would ensure the estimated term structure of market-implied
PD reflects the market risk premium for counterparty credit risk.
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\447\ For example, a banking organization may be permitted to
use the credit spread curve of the home country as a proxy for that
of a municipality in the home country (that is, setting the
municipality credit spread equal to the sovereign credit spread plus
a premium).
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II. Market-Consensus ELGD
In general, the proposal would require a banking organization to
use the market-consensus ELGD value that is used to calculate the
market-implied PDs from the counterparty's credit spreads. The fraction
of exposure that a banking organization would lose in the event of a
counterparty default (that is, loss given default) depends on the
seniority of the derivative contracts that the banking organization has
with the counterparty at the time of default. Most CDS contracts, which
are used to calculate the market-implied PD, allow for delivery of
senior unsecured bonds and thus have the same seniority as senior
unsecured bonds in bankruptcy. By generally requiring a banking
organization to use the same market-consensus ELGD as the one used in
calculations of the market-implied PD from the credit spreads, the
proposal would require a banking organization to generally assume that
derivative contracts' seniority is the same as the seniority of senior
unsecured bonds. If a banking organization's derivative contracts with
the counterparty are more or less senior to senior unsecured bonds, the
proposal would allow a banking organization to adjust the market-
consensus ELGD to appropriately reflect the lower or higher losses
arising from such exposures. However, the proposal would not allow a
banking organization to use collateral provided by the counterparty as
the justification for changing the market-consensus ELGD as the banking
organization would already have considered collateral in determining
its exposure to the counterparty.
[[Page 64160]]
III. Simulated Paths of Discounted Future Exposure
To align regulatory CVA with industry practices, the regulatory CVA
calculation in the SA-CVA would generally be based on the exposure
models that a banking organization uses to calculate CVA for purposes
of financial reporting. Specifically, a banking organization would
obtain the simulated paths of discounted future exposure by using the
exposure models the banking organization uses for calculating CVA for
financial reporting, adjusted, if needed, to meet the requirements
imposed for regulatory CVA calculation, as described below. The
proposal would require that these exposure models be subject to the
same model calibration processes (with the exception of the margin
period of risk, which would have to meet the regulatory floors), and
use the same market and transaction data as the exposure models that
the banking organization uses for calculating CVA for financial
reporting purposes.
To produce the simulated paths of discounted future exposure, a
banking organization would price all standardized CVA risk covered
positions with the counterparty along simulated paths of relevant
market risk factors and discount the prices to today using risk-free
interest rates along the path. The banking organization would be
required to simulate all market risk factors material to the
transactions as stochastic processes for an appropriate number of paths
defined on an appropriate set of future time points extending to the
maturity of the longest transaction. The proposal would require drifts
of risk factors to be consistent with a risk-neutral probability
measure and would not permit historical calibration of drifts. The
banking organization would be required to calibrate volatilities and
correlations of market risk factors to current market data whenever
sufficient data exist in a given market, although the proposal would
permit a banking organization to use historical calibration of
volatilities and correlations if sufficient current market data are not
available. A banking organization's assumed distributions for modelled
risk factors would be required to account for the possible non-
normality of the distribution of exposures, including the existence of
leptokurtosis (that is, ``fat tails''), where appropriate. The banking
organization would be required to use the same netting recognition as
in its CVA calculations for financial reporting. Where a transaction
has a significant level of dependence between exposure and the
counterparty's credit quality, the banking organization would be
required to take this dependence into account.
The proposal would permit a banking organization to recognize
financial collateral as a risk mitigant for margined counterparties if
the financial collateral would be included in the net independent
collateral amount or variation margin amount and the collateral
management requirements in the SA-CCR are satisfied.
The proposal would require that (1) simulated paths of discounted
future exposure capture the effects of margining collateral that is
recognized as a risk mitigant along each exposure path; and (2) the
exposure model appropriately captures all the relevant contractual
features such as the nature of the margin agreement (that is,
unilateral versus bilateral), the frequency of margin calls, the type
of collateral, thresholds, independent amounts, initial margins, and
minimum transfer amounts.\448\ To determine collateral available to a
banking organization at a given exposure measurement time, the proposal
would require a banking organization's exposure model to assume that
the counterparty will not post or return any collateral within a
certain time period immediately prior to that time, known as the margin
period of risk (MPoR). The proposal specifies a minimum length of time
for the MPoR.
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\448\ Minimum transfer amount means the smallest amount of
variation margin that may be transferred between counterparties to a
netting set pursuant to the variation margin agreement.
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For client-facing derivative transactions, the minimum MPoR would
be equal to 4 + N business days, where N is the re-margining period
specified in the margin agreement. In particular, for margin agreements
with daily or intra-daily exchange of margin, the minimum MPoR would be
5 business days. For all other CVA risk covered positions, the minimum
MPoR is equal to 9 + N business days, or 10 business days for margin
agreements with daily or intra-daily exchange of margin.
ii. Calculation of the SA-CVA Approach
Conceptually, the proposed SA-CVA approach is similar to the
proposed sensitivities-based method under the market risk framework, as
described in section III.H.7.a of this Supplementary Information, in
that a banking organization would estimate the changes in regulatory
CVA arising from CVA risk covered positions and, if applicable,
eligible CVA hedges resulting from applying standardized shocks to the
relevant risk factors. As in the case of the proposed sensitivities-
based method, to help ensure consistency in the application of risk-
based capital requirements across banking organizations, the proposal
would establish the applicable risk factors, the method to calculate
the sensitivity of regulatory CVA and CVA hedges to each of the
prescribed risk factors, the shock applied to each risk factor, and the
process for aggregating the net weighted sensitivities within each risk
class and across risk classes to arrive at the total CVA risk-based
capital requirement for the portfolio under the SA-CVA. First, under
the proposal, a banking organization would identify one or more of the
specified risk classes that, in addition to counterparty credit spread
risk class, would be applicable to its CVA risk covered positions and
its CVA hedges. Based on standard industry classifications, the
proposed exposure-related risk classes represent the common, yet
distinct market variables that impact the value of CVA risk covered
positions and CVA hedges. The proposed sensitivity calculations for
delta and vega risk factors would estimate how much the aggregate
regulatory CVA arising from CVA risk covered positions and separately
the market value of all standardized CVA hedges would change as a
result of a small change in a given risk factor, while all other
relevant risk factors remain constant. For the sensitivity calculation,
a banking organization would be able to use either the standard risk
factor shifts or smaller values of risk factor changes, if such smaller
values are consistent with those used by the banking organization for
internal risk management.
Second, for each delta (and, separately, vega) risk factor, the
banking organization would multiply the measured sensitivity of the
aggregate CVA arising from CVA risk covered positions to that risk
factor and, separately, that of the market value of the aggregate
eligible CVA hedges to that risk factor by the standardized risk weight
proposed for that risk factor. A banking organization would then
subtract the resulting weighted sensitivity for the eligible CVA hedges
from the weighted sensitivity for the aggregate CVA arising from the
CVA risk covered positions to obtain the net weighted sensitivity to a
given risk factor. The agencies intend the proposed risk weights to
capture the amount that a risk factor would be expected to move during
the liquidity horizon of the risk factor in stress conditions and
generally would be consistent with the risk
[[Page 64161]]
weights in the proposed sensitivities-based method for market risk
outlined in section III.H.7.a.ii of the Supplementary Information.
Third, to aggregate CVA risk contributions of individual risk
factors, the proposal would provide aggregation formulas for
calculating the total delta and vega capital requirements for the
entire CVA portfolio. Within each risk class, the proposal would group
similar risk factors into risk buckets. Similar to the sensitivities-
based method for market risk, a banking organization would aggregate
the net risk-weighted sensitivities for delta (and, separately, for
vega) risk factors first within each risk bucket and then across risk
buckets within each risk class using the prescribed aggregation
formulas to produce the respective delta and vega risk-based capital
requirements. The agencies' intention is that the aggregation formulas
limit offsetting and diversification benefits via the prescribed
correlation parameters. Under the proposal, the correlation parameters
specified for each risk factor pair would limit the risk-mitigating
benefit of hedges and diversification, given that the hedge
relationship between the underlying position and the hedge as well as
the relationship between different types of positions could decrease or
become less effective in a time of stress.
Fourth, a banking organization would aggregate the resulting delta
and vega risk-class-level capital requirements as the simple sum across
risk classes with no recognition of any diversification benefits
because in stress diversification across different risk classes may
become less effective.
Finally, the overall risk-based capital requirement for CVA risk
would be the simple sum of the separately calculated delta and vega
capital requirements without recognition of any diversification
benefits as these measures are intended to capture different types of
risk and because in stress diversification may become less effective.
I. Delta and Vega
To appropriately capture linear CVA risks, the proposal would
require a banking organization to separately calculate the risk-based
capital requirements for delta and vega using the above steps. As the
sensitivity to vega risk is always material for CVA (as discussed
further below), the proposal would require a banking organization to
always measure the sensitivity of regulatory CVA to vega risk factors,
regardless of whether the CVA risk covered positions include positions
with optionality. When a banking organization calculates a sensitivity
of regulatory CVA to a vega risk factor, it would apply the appropriate
volatility shift to both types of volatilities that appear in exposure
models: volatilities used for generating risk factor paths and
volatilities used for pricing options.
II. Risk Classes
Under the proposal, a banking organization would be required to
identify all of the relevant risk factors for which it would calculate
sensitivities for delta risk and vega risk. Based on the identified
risk factors, a banking organization would be required to identify the
corresponding risk buckets within relevant risk classes. CVA of a
single counterparty can be represented as the product of counterparty
credit spread and expected exposure for various future time points,
aggregated across these time points. Because of this structure,
counterparty credit spread risk naturally presents itself as a separate
delta risk class that is always present in CVA risk regardless of the
type of CVA risk covered positions in the portfolio.\449\ The risk
classes specified for delta and vega risk factors related to expected
exposure under SA-CVA are generally consistent with those under the
sensitivities-based method for market risk and include interest rate,
foreign exchange, credit spread, equity, and commodity.
---------------------------------------------------------------------------
\449\ This is a fundamental distinction between CVA risk and
market risk, which, in the latter case, is entirely determined by
market risk covered positions.
---------------------------------------------------------------------------
For credit spread risk, the proposal would specify two distinct
risk classes that may share the same risk factors but would need to be
treated separately: (i) counterparty credit spread risk; and (ii)
reference credit spread risk. Reference credit spread risk would be
defined as the risk of loss that could arise from changes in the
underlying credit spread risk factors that drive the exposure component
of CVA risk. For example, a banking organization could have a portfolio
of derivatives with Firm X as a counterparty and, at the same time,
have a CDS referencing credit of Firm X in a portfolio of derivatives
with Firm Y. In such cases, under the SA-CVA, the same credit spreads
of Firm X would be treated as distinct risk factors in two sets of
sensitivity calculations: one within the counterparty credit spread
risk class calculations, and the other within the reference credit
spread risk class calculations. To incorporate credit spread hedges of
CVA risk properly, each such hedge would be designated as either a
counterparty credit spread hedge or a reference credit spread hedge and
included only in one calculation according to the designation.
Each risk class used for delta would also apply to vega, except for
counterparty credit spread risk. The regulatory CVA is approximately
linear in counterparty credit spreads and does not depend on their
volatilities. Accordingly, calculation of the CVA vega capital
requirement would not be required in the counterparty credit spread
risk class. On the other hand, expected exposure is always sensitive to
volatilities of market risk factors that drive market values of CVA
risk covered positions.\450\ Accordingly, for each of the five
exposure-related risk classes, a banking organization would be required
to compute vega risk factor sensitivities of the aggregate regulatory
CVA, in addition to delta risk factor sensitivities, regardless of
whether the portfolio includes options.
---------------------------------------------------------------------------
\450\ CVA expected exposure profile can be characterized as
today's price of a call option on the portfolio market value at that
time point (or on the increment of the portfolio market value over
the MPoR for a margined portfolio). Since the price of an option
depends both on the price and volatility of the underlying asset,
both delta and vega risk factor sensitivities materially contribute
to expected exposure variability, even when the portfolio of CVA
risk covered positions with a counterparty does not include options.
---------------------------------------------------------------------------
III. Risk Factors
Under the proposal, a banking organization would be required to
identify all of the relevant risk factors for which it would calculate
sensitivities for delta risk and vega risk. The proposed risk factors
differ for each risk class to appropriately reflect the specific market
risk variables relevant for each risk class.
To measure the impact of a small change in each of the risk factors
on the aggregate regulatory CVA and the market value of eligible CVA
hedges, the proposal would specify the sensitivity calculations that a
banking organization may use to calculate the CVA sensitivity to small
changes in each of the specified delta or vega risk factors, as
applicable.\451\ Specifically, for the equity, commodity, and foreign
exchange delta risk factors, the sensitivity would equal the change in
the aggregate regulatory CVA arising from CVA risk covered positions
and separately the market value of all eligible CVA hedges due to a one
[[Page 64162]]
percentage point increase in the delta risk factor divided by one
percentage point. For the interest rate, counterparty credit spread,
and reference credit spread delta risk factors, the sensitivity would
equal the change in the aggregate regulatory CVA arising from CVA risk
covered positions and separately the market value of all eligible CVA
hedges due to a one basis point increase in the risk factor divided by
one basis point. The sensitivity to a vega risk factor would equal the
change in the aggregate regulatory CVA arising from CVA risk covered
positions and separately the market value of all eligible CVA hedges
due to a one percentage point increase in the volatility risk factor
divided by one percentage point. When a banking organization calculates
the sensitivity of regulatory CVA arising from CVA risk covered
positions and separately of the market value of all eligible CVA hedges
to a vega risk factor, the banking organization would apply the shift
to the relevant volatility used for generating risk factor simulation
paths for regulatory CVA calculations. If there are options in the
portfolio with the counterparty, the shift would also be applied to the
relevant volatility used to price options along the simulation paths.
---------------------------------------------------------------------------
\451\ As previously noted, for the sensitivity calculation, a
banking organization would be able to use either the standard risk
factor shifts or smaller values of risk factor changes, if such
smaller values are consistent with those used by the banking
organization for internal risk management (for example, using
infinitesimal values of risk factor shifts in combination with
algorithmic differentiation techniques).
---------------------------------------------------------------------------
In cases where a CVA risk covered position or an eligible CVA hedge
references an index, the proposal would require a banking organization
to calculate the sensitivities of the aggregate regulatory CVA arising
from the CVA risk covered positions or the market value of the eligible
CVA hedges to all risk factors upon which the value of the index
depends. The sensitivity of the aggregate regulatory CVA or the market
value of the eligible CVA hedges to a risk factor would be calculated
by applying the shift of the risk factor to all index constituents that
depend on this risk factor and recalculating the aggregate regulatory
CVA or the market value of the eligible CVA hedges.
For the risk classes of counterparty credit spread risk, reference
credit spread risk, and equity risk, the SA-CVA would allow a banking
organization to introduce a set of additional risk factors that
directly correspond to qualified credit and equity indices.\452\ For a
CVA risk covered position or an eligible CVA hedge whose underlying is
a qualified index, its contribution to sensitivities to the index
constituents would be replaced with its contribution to a single
sensitivity to the underlying index, provided that (1) for listed and
well-diversified indices that are not sector specific where 75 percent
of notional value for credit indices or market value for equity indices
of the qualified index's constituents on a weighted basis are mapped to
the same sector, the entire index would have to be mapped to that
sector and treated as a single-name sensitivity in that bucket, and (2)
in all other cases, the sensitivity would have to be mapped to the
applicable index bucket. The proposal would provide this option because
some popular credit and equity indices involve a large number of
constituents \453\ and calculating sensitivities to each constituent
may be impractical for such indices.
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\452\ For delta risk, a credit or equity index would be
qualified if it is listed and well-diversified; for vega risk, any
credit or equity index would be qualified. If a banking organization
chooses to introduce such additional risk factors, the banking
organization would be required to calculate CVA sensitivities to the
qualified index risk factors in addition to sensitivities to the
non-index risk factors.
\453\ For example, the credit index CDX has 125 constituents,
equity index S&P 500 has 500 constituents.
---------------------------------------------------------------------------
A. Counterparty Credit Spread Risk
The proposal would define the counterparty credit spread delta risk
factors as the absolute shifts of credit spreads of individual entities
(counterparties and reference names for counterparty credit spread
hedges) and qualified indices (under the optional treatment of
qualified indices) for the following tenors: 0.5 years, 1 year, 3
years, 5 years, and 10 years.
In addition to single-name CVA counterparty credit spread hedges,
banking organizations use index hedges to hedge the systematic
component of counterparty credit spread risk. If an eligible CVA
counterparty credit spread risk hedge references a credit index, a
banking organization would be required to calculate delta sensitivities
of the market value of all eligible CVA hedges of counterparty credit
spread risk to the credit spread of each constituent entity included in
the index. In these calculations, a banking organization would be
required to shift the credit spread of each of the underlying
constituents of the index while holding the credit spreads of all
others constant.
The SA-CVA would offer an alternative, optional approach that
introduces additional index risk factors for qualified indices.
Specifically, for each qualified index referenced by eligible CVA
counterparty credit spread risk hedges, delta risk factors would be
absolute shifts of the qualified index for the following tenor points:
0.5 years, 1 year, 3 years, 5 years, and 10 years. Under this optional
approach, when a banking organization calculates sensitivities to
single-name credit spread risk factors, the qualified indices would
remain unchanged. For each distinct qualified credit index referenced
by an eligible CVA counterparty credit spread risk hedge, the banking
organization would perform a separate delta sensitivity calculation
where the entire credit index is shifted. The qualified index
sensitivity calculations would only affect eligible CVA hedges of
counterparty credit spread risk that reference the qualified indices.
This alternative is designed to reduce the complexity of constituent-
by-constituent calculations, as many popular credit indices have more
than a hundred constituents of sensitivities.
B. Risk Factors for Market Risk Classes
As noted above, given the computational intensity of calculating
the sensitivity of CVA to market risk factors and the less material
impact of such risk factors on the volatility of CVA, the proposal
would define the delta and vega risk factors for all five market risk
classes (interest rate risk, foreign exchange risk, reference credit
spread risk, equity risk, and commodity risk) in a much less granular
way than under the sensitivity-based method for market risk.
1. Interest Rate Risk
For both delta and vega risk factors in the interest rate risk
class, the proposal would define individual buckets by currency, which
would consist of interest rate risk factors and inflation rate risk
factors. For specified currencies (USD, EUR, GBP, AUD, CAD, SEK, or
JPY), the delta interest rate risk factors would be defined as the
simultaneous absolute change in all risk-free yields in a given
currency at each specified tenor point (1 year, 2 years, 5 years, 10
years, and 30 years) and the absolute change in the inflation rate of a
given currency. For all other currencies, the delta risk factors for
interest rate risk would be defined along two dimensions: the
simultaneous parallel shift in all risk-free yields in a given currency
and the absolute change in the inflation rate of a given currency.
As the specified currencies are intended to capture the set of
liquid currencies that would likely dominate a banking organization's
portfolios, the proposal would require a banking organization to
identify and apply more granular delta risk factors for such exposures
relative to those for all other currencies. Of the ten tenors used
under the sensitivities-based method in market risk, the proposed five
tenors are intended to capture the most commonly
[[Page 64163]]
used tenors based on the liquidity in interest rate OTC derivative
markets.
For all currencies, the interest rate vega risk factors for each
currency would be defined along two dimensions: the simultaneous
relative change of all interest rate volatilities for a given currency
and the simultaneous relative change of all inflation rate volatilities
for a given currency. For vega risk factors, the proposal would reduce
the granularity in the tenor dimension in the same manner for all
currencies given the computational intensity of calculating the vega
risk sensitivity and the less material impact of such risk factors on
the volatility of CVA.
2. Foreign Exchange Risk
The proposal would specify delta and vega risk buckets for foreign
exchange risk as individual foreign currencies. For each foreign
exchange risk bucket, the proposal would define one delta risk factor
and one vega risk factor. Specifically, the proposal would define (1)
the foreign exchange delta risk factor as the relative change in the
foreign exchange spot rate \454\ between a given foreign currency and
the reporting currency (or base currency); and (2) the foreign exchange
vega risk factor as the simultaneous, relative change of all
volatilities for an exchange rate between a banking organization's
reporting currency (or base currency) and another given currency. For
transactions that reference an exchange rate between a pair of non-
reporting currencies, the sensitivities to the foreign exchange spot
rates between the bank's reporting currency and each of the referenced
non-reporting currencies must be measured.
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\454\ Under the proposal, the foreign exchange spot rate would
be defined for purposes of CVA risk as the current market price of
one unit of another currency expressed in the units of the banking
organization's reporting (or base) currency.
---------------------------------------------------------------------------
3. Reference Credit Spread Risk
The proposal would define risk buckets for the delta and vega risk
factors by sector and credit quality which is consistent with the
definitions of risk buckets for non-securitization credit spread risk
that are used in the proposed sensitivities-based method for market
risk. The proposal would define one reference credit spread risk factor
per delta or vega risk bucket under the SA-CVA. Specifically, the
proposal would define (1) the delta risk factor as the simultaneous
absolute shift of all credit spreads of all tenors for all reference
entities in the bucket; and (2) the vega risk factor as the
simultaneous relative shift of the volatilities of all credit spreads
of all tenors for all reference entities in the bucket. In addition,
similar to the counterparty credit spread risk as described above in
section III.I.5.b.ii.III.A of the Supplementary Information, the SA-CVA
would offer an alternative, optional approach that introduces
additional index risk factors for qualified indices and allows a
banking organization to calculate delta and vega sensitivities of
aggregate regulatory CVA and eligible CVA hedges with respect to the
qualified indices instead of each constituent of the indices.
4. Equity Risk
The proposal would set the risk buckets for delta and vega risk
factors generally matching the risk buckets for equity risk in the
proposed sensitivities-based method for market risk. The proposal would
define one equity risk factor per delta or vega risk bucket to reduce
the complexity of calculating CVA sensitivities to equity risk factors.
The proposal would define (1) the delta risk factor as the simultaneous
relative change of all equity spot prices for all entities in the
bucket and (2) the vega risk factor as the simultaneous relative change
of all equity price volatilities for all entities in the bucket. In
addition, similarly to the counterparty credit spread risk and
reference credit spread risk as described in sections III.I.5.b.ii.III
and III.I.5.b.ii.III.B.3 of the Supplementary Information, the SA-CVA
would offer an alternative, optional approach that introduces
additional index risk factors for qualified indices and allows a
banking organization to calculate delta and vega sensitivities of
aggregate regulatory CVA and eligible CVA hedges with respect to the
qualified indices instead of each constituent of the indices.
5. Commodity Risk
The proposal would set the risk buckets for delta and vega risk
factors matching the risk buckets for commodity risk in the proposed
sensitivities-based method for market risk. The proposal would define
one commodity risk factor per delta or vega risk bucket under the SA-
CVA. Specifically, the proposal would define (1) the delta risk factor
as the simultaneous relative shift of all commodity spot prices for all
commodities in the bucket and (2) the vega risk factor as the
simultaneous relative shift of all commodity price volatilities for all
commodities in the bucket.
IV. Risk Buckets, Risk Weights, and Correlations
As noted above, there are six risk classes for delta risk factors
in the SA-CVA: the counterparty credit spread risk class and the five
risk classes for market risk factors that drive expected exposure
(interest rate, foreign exchange, reference credit spread, equity, and
commodity). In addition, there are five exposure-related risk classes
for vega risk factors. The granularity of risk factors in the
counterparty credit spread risk class matches the one in the non-
securitization credit spread risk class in the sensitivities-based
method for market risk, while the granularity of both delta and vega
risk factors in the exposure-related risk classes is greatly reduced.
A. Exposure-Related Risk Classes
The exposure component of regulatory CVA of a portfolio of CVA risk
covered positions is affected by delta and vega market risk factors in
a similar way as a portfolio of options on future market values (or
their increments). Therefore, there is no compelling reason for the
exposure-related risk classes in the SA-CVA to deviate from the bucket
structure, risk weights, and correlations used in the corresponding
risk classes in the sensitivities-based method for market risk, except
for accommodating the reduced granularity of exposure-related risk
factors in the SA-CVA. Accordingly, for both delta and vega risk
factors in the exposure-related risk classes, the SA-CVA would use the
bucket structure that matches the bucket structure of the corresponding
risk classes in the sensitivities-based method for market risk.
Furthermore, the proposal would set the values of all cross-bucket
correlations, [gamma]bc, used for aggregation of bucket-level capital
requirements across risk buckets within each exposure-related risk
class equal to the corresponding values used in the sensitivities-based
method for market risk.
For the foreign exchange, reference credit spread, equity, and
commodity risk classes, the SA-CVA would assign one delta (and,
separately, one vega) risk factor per risk bucket. Therefore, in
contrast to the sensitivities-based method for market risk, the SA-CVA
does not need to provide intra-bucket correlations, [rho]kl, for these
risk classes. Furthermore, because the sensitivities-based method for
market risk provides no more than one risk weight per risk bucket for
the corresponding risk classes (foreign exchange, non-securitization
credit spread, equity, and commodity),
[[Page 64164]]
the SA-CVA would generally match the values of these risk weights for
both delta and vega risk factors.\455\
---------------------------------------------------------------------------
\455\ The only exception would be foreign exchange delta risk:
the sensitivities-based method for market risk would use two values
for the delta risk weight (depending on the currencies), while the
SA-CVA would use a single delta risk weight (set approximately equal
to the lower of the two) regardless of the currency.
---------------------------------------------------------------------------
For the interest rate risk class, similar to the market risk, the
SA-CVA would have two groups of risk buckets/currencies: the
``specified'' currencies (USD, EUR, GBP, AUD, CAD, SEK, and JPY) and
the other currencies. However, while in the sensitivities-based method
for market risk the two groups only differ in the values of the risk
weights (the general risk weights can be divided by [radic]2 when
applied to the specified currencies), in the SA-CVA they would differ
both in the value of risk weights and in the level of granularity for
delta risk factors. As mentioned above, the SA-CVA would specify delta
risk factors for the specified currencies as the absolute changes of
the inflation rate and of the risk-free yields for the following five
tenors: 1 year, 2 years, 5 years, 10 years, and 30 years. Risk weights
for these risk factors would be set approximately equal to the general
risk weights for the inflation rate and for the corresponding tenors of
risk-free yields in the sensitivities-based method for market risk
divided by [radic]2. The intra-bucket correlations, [rho]kl, for the
specified currencies in the SA-CVA would approximately match the ones
between the corresponding tenors and the inflation rate in the
sensitivities-based method for market risk. For each of the non-
specified currencies, the SA-CVA would provide two delta risk factors
per bucket/currency: the absolute change of the inflation rate and the
parallel shift of the entire risk-free yield curve for a given
currency. The risk weights for these risk factors would approximately
match the ones for the inflation rate and for the 1-year risk free
yield in the sensitivities-based method for market risk. The intra-
bucket correlation between the two risk factors for the non-specified
currencies would be set equal to the value of the correlation between
the inflation rate and any tenor of the risk-free yield specified in
the sensitivities-based method for market risk. As stated above, the
SA-CVA would specify two vega risk factors for the interest rate risk
class for each bucket/currency: a simultaneous relative change of all
inflation rate volatilities and a simultaneous relative change of all
interest rate volatilities for a given currency. The SA-CVA would set
the vega risk weights for both risk factors equal to the single value
of the vega risk weight used for all interest rate vega risk factors in
the sensitivities-based method for market risk. The SA-CVA would set
the only intra-bucket interest rate vega correlation equal to the value
of the SA-CVA intra-bucket interest rate delta correlation for the non-
specified currencies.
Question 168: The agencies seek comment on the appropriateness of
the proposed risk buckets, risk weights and correlations for the
exposure-related risk classes. What, if any, alternative risk bucketing
structures, risk weights, or correlations should the agencies consider
and why?
B. Counterparty Credit Spread Risk Class
Fundamentally, counterparty credit spreads are no different from
reference credit spreads and, therefore, should follow the same
dynamics. Accordingly, the risk weights for counterparty credit spread
risk factors under the SA-CVA would exactly match those for reference
credit spread delta risk factors (and, thus, match the ones for non-
securitization credit spread delta risk factors in the sensitivities-
based method for market risk). While the common dynamics might suggest
using the same set of buckets for counterparty credit spread risk class
and the reference credit spread risk class, the proposal would modify
risk bucket definitions for non-securitization credit spread delta risk
factors in the sensitivities-based method for market risk in their
application to the counterparty credit spread risk class based on the
different role counterparty credit spreads play in CVA risk management.
The counterparty credit spread component of CVA risk is usually
substantially greater than the exposure component, and, therefore, is
the primary focus of CVA risk management by banking organizations.
Banking organizations often use single-name credit instruments to hedge
the counterparty credit spread component of CVA risk of individual
counterparties with large CVA and use index credit instruments to hedge
the systematic part of the counterparty credit spread component of the
aggregate (across counterparties) CVA risk. In order to improve
recognition of both single-name and index hedges of the counterparty
credit spread component of CVA risk and thus promote prudential CVA
risk management, the agencies propose, for the application in the
counterparty credit spread risk class, to modify the bucket structure
that is used for the non-securitization credit spread risk class in the
sensitivities-based method for market risk, as described below. These
modifications do not affect the risk weights in the counterparty credit
spread risk class that match exactly the corresponding risk weights in
the sensitivities-based method for market risk.
In the non-securitization credit spread risk class in the
sensitivities-based method for market risk, (1) investment grade
entities and (2) speculative and sub-speculative grade entities from
the same sector generally form two separate risk buckets based on
credit quality. This, however, could undermine the efficiency of hedges
of the counterparty credit spread component of CVA risk. In order to
prevent this, the proposal would merge the investment grade bucket and
speculative and sub-speculative grade bucket of each sector into a
single bucket.
Furthermore, banking organizations often use single-name sovereign
CDS as indirect single-name counterparty credit spread hedges of CVA
risk of illiquid counterparties such as GSEs and local governments.
However, in the non-securitization credit spread risk class in the
sensitivities-based method for market risk, such entities would belong
to the PSE, government-backed non-financials, GSE debt, education, and
public administration sector, which form a risk bucket separate from
sovereign exposures and MDBs. Thus, following the non-securitization
credit spread risk bucket structure of the sensitivities-based method
for market risk would result in a situation where the counterparty and
the reference entity of the hedge reside in different risk buckets,
thus substantially reducing the effectiveness of the hedge. In order to
prevent a such scenario, the proposal would merge the sovereign
exposures and MDBs sector and the PSE, government-backed non-
financials, GSE debt, education, and public administration sector into
a single risk bucket. To preserve hedging efficiency, the proposal
would move government-backed financials from the ``financials'' bucket
to the combined bucket that includes sovereign exposures.
The agencies propose to set the cross-bucket correlations,
[gamma]bc, equal to the corresponding correlations that would be
applicable under the assumption of the same credit quality in the non-
securitization credit spread risk class as in the sensitivities-based
method for market risk. The agencies propose to change both the
structure and the values of the intra-bucket correlations used in the
sensitivities-based method to better recognize indirect single-name
hedges where the reference name is in the same risk bucket as the
counterparty. Similar
[[Page 64165]]
to the non-securitization credit spread risk class in the
sensitivities-based method for market risk, the intra-bucket
correlations, [rho]kl, proposed for the counterparty credit spread risk
class would be equal to the product of three correlation parameters.
Two of the SA-CVA parameters--for tenor difference and name
difference--are the same as in the sensitivities-based method if risk
factors are identical but have higher values for non-identical risk
factors for better hedge recognition. The third SA-CVA parameter--for
credit quality difference--would replace the basis correlation
parameter of the sensitivities-based method. This parameter would equal
100 percent if the credit quality of the two names is the same
(treating speculative and sub-speculative grade as one credit quality
category) and 80 percent otherwise. The basis correlation parameter is
not needed in the SA-CVA because the SA-CVA does not make a distinction
between different credit curves referencing the same entity. On the
other hand, reference entities of the same sector, but different credit
quality would be in different risk buckets under the sensitivities-
based method, so the sensitivities-based method does not need the
credit quality difference correlation parameter.
Question 169: To what extent are the proposed risk buckets, risk
weights, and correlations for counterparty credit spread risk class
appropriate? What, if any, alternative risk bucketing structures, risk
weights, or correlations should the agencies consider and why?
V. Intra- and Inter-Bucket Aggregation
Consistent with the sensitivities-based method for market risk, the
proposal would require a banking organization first to separately
aggregate the risk-weighted net sensitivities for CVA delta and CVA
vega within their respective risk buckets and then across risk buckets
within each risk class using the prescribed aggregation formulas to
produce respective delta and vega risk capital requirements for CVA
risk.
First, for each risk bucket b, a banking organization would
aggregate all net weighted sensitivities for all risk factors within
this risk bucket according to the following formula:
[GRAPHIC] [TIFF OMITTED] TP18SE23.049
where WSk is the net weighted sensitivity to risk factor k, WSk\Hdg\,
is the weighted sensitivity of the market value of all standardized CVA
hedges to risk factor k, [rho]kl is the regulatory correlation
parameter between risk factors k and l within risk bucket b, and R is
the hedging disallowance parameter set at 0.01. While this formula is
similar to the intra-bucket aggregation formula in the sensitivities-
based method for market risk, it differs by the presence of an
additional term under the square root, proportional to the hedging
disallowance parameter R. The purpose of this term is to prevent
extremely small levels of Kb when most of the risk factors k are
perfectly hedged. For the case of perfect hedging (WSk = 0 for all k),
the term provides a floor equal to 10 percent of weighted sensitivities
of the standardized CVA hedges, aggregated as idiosyncratic risks.
---------------------------------------------------------------------------
\456\ Note that this definition of Sb differs from the one used
in the sensitivities-based method for market risk, where the floor
and the cap apply only when the quantity under the square root in
the aggregation formula is negative.
---------------------------------------------------------------------------
Second, a banking organization would aggregate bucket-level capital
requirements across risk buckets within the same risk class according
to the following formula:
[GRAPHIC] [TIFF OMITTED] TP18SE23.050
where [gamma]bc is the regulatory correlation parameter between bucket
b and bucket c; Sb is the sum of the net weighted sensitivities WSk
over all risk factors k in bucket b, floored by -Kb and capped by Kb;
and Sc is the sum of the net weighted sensitivities WSk over all risk
factors k in bucket c, floored by -Kc and capped by Kc as given by the
following formulas: \456\
[[Page 64166]]
[GRAPHIC] [TIFF OMITTED] TP18SE23.051
This aggregation formula differs from the one used in the
sensitivities-based method for market risk. In order to compensate for
a higher level of model risk in the calculation of sensitivities for
the aggregate regulatory CVA arising from the CVA risk covered
positions relative to that for market risk covered positions, the
proposed inter-bucket aggregation formula includes a multiplication
factor (mcva) with a default value equal to one but would allow the
primary Federal supervisor to increase the multiplier and scale up
risk-based capital required for each risk class (K), if the supervisor
determines that the banking organization's CVA model risk warrants such
an increase.\457\ The primary Federal supervisor would notify the
banking organization in writing that a different value must be used.
---------------------------------------------------------------------------
\457\ For example, the SA-CVA calculation does not fully account
for the dependence between the banking organization's exposure to a
counterparty and the counterparty's credit quality.
---------------------------------------------------------------------------
Finally, as with the sensitivities-based method for market risk,
the overall risk-based capital requirement for CVA risk would be the
simple sum of the separately calculated risk-class level delta and vega
capital requirements across risk classes without any recognition of any
diversification benefits given that delta and vega are intended to
separately capture different risks.
Question 170: To what extent are the proposed intra- and inter-
bucket aggregation methodologies appropriate? What, if any, alternative
methodologies should the agencies consider and why?
Question 171: What, if any, alternative methods should the agencies
consider for recognizing diversification across risk classes in the
calculation of the SA-CVA, and why?
Question 172: To what extent is the default value of one for the
multiplier appropriate or should the agencies consider a higher or
lower default value for the multiplier and why?
IV. Transition Provisions
The agencies are proposing a three-year transition period for two
provisions of the proposal: the expanded risk-based approach and, for
banking organizations subject to Category III or IV capital standards,
the AOCI regulatory capital adjustments described in section III.B of
this Supplementary Information. The main goal of the transition
provisions is to provide applicable banking organizations sufficient
time to adjust to the proposal while minimizing the potential impact
that implementation could have on their ability to lend.\458\
---------------------------------------------------------------------------
\458\ Any banking organization not subject to Category I, II,
III, or IV standards that becomes subject to Category I, II, III, or
IV standards during the proposed transition period, would be
eligible for the remaining time that the transition provisions
provide. Beginning July 1, 2028, no transitions under this proposal
would be provided to banking organizations that become subject to
Category I, II, III, or IV standards.
---------------------------------------------------------------------------
A. Transitions for Expanded Total Risk-Weighted Assets
As described in Table 9 below, a banking organization's expanded
total risk-weighted assets would be phased-in starting July 1, 2025,
until June 30, 2028. Specifically, a banking organization would
multiply expanded total risk-weighted assets as defined in the proposal
by the phase-in amount for each transition period provided in Table 9
and use that amount as the denominator of its risk-based capital ratios
in place of expanded total risk-weighted assets during the transition
period.
[GRAPHIC] [TIFF OMITTED] TP18SE23.052
B. AOCI Regulatory Capital Adjustments
From July 1, 2025 until June 30, 2028, for a banking organization
subject to Category III or IV capital standards, the aggregate amount
of net unrealized gains or losses on AFS debt securities and HTM
securities included in AOCI, accumulated adjustments related to defined
benefit pension obligations, and accumulated net gains or losses on
cash flow hedges related to items that are reported on the balance
sheet at fair value included in AOCI (AOCI adjustment amount) would be
transitioned as set forth in Table 10 below. Therefore, if a banking
organization's AOCI adjustment amount is positive, it would multiply
its AOCI adjustment amount by the percentage of the transition provided
in Table 10 below and subtract the resulting amount from its common
equity tier 1 capital.\459\ If a banking organization's AOCI adjustment
amount is negative, it would
[[Page 64167]]
perform the same calculation and subtract the resulting amount from its
common equity tier 1 capital. All other elements of the calculation of
regulatory capital would apply upon the effective date of the rule.
---------------------------------------------------------------------------
\459\ The proposal would require a banking organization to
subtract the percentage of the AOCI adjustment amount from the sum
of its common equity tier 1 capital elements before applying the
deductions for investments in capital instruments, covered debt
instruments, MSAs and temporary difference DTAs, if applicable. See
12 CFR 3.22(c) and (d) (OCC); 12 CFR 217.22(c) and (d) (Board); 12
CFR 324.22(c) and (d) (FDIC).
[GRAPHIC] [TIFF OMITTED] TP18SE23.053
Question 173: What are the advantages and disadvantages of the
proposed transition provisions? What alternatives to the proposed
implementation should the agencies consider and why, including to the
length and amounts of the proposed transitions? What, if any,
additional transitions should the agencies consider in connection with
the proposal, such as for aspects of the calculation of regulatory
capital other than related to AOCI? For example, if warranted, how
could the transitions be applied relative to the standardized approach?
Question 174: What are the advantages and disadvantages of
providing a transition for any increase in market risk capital
requirements, as described in the proposal? How should the transitional
amount be determined and what would be the appropriate time frame for a
transition and why? How should the transitional provision be designed
to ensure banking organizations do not have lower market risk capital
requirements during the transition period relative to the current rule,
while accounting for operational burden?
V. Impact and Economic Analysis
The agencies assessed the impact of the proposal on banking
organization capital requirements and its likely effect on economic
activity and resilience. The proposal is expected to strengthen risk-
based capital requirements for large banking organizations by improving
their comprehensiveness and risk sensitivity. Better alignment between
capital requirements and risk-taking helps to ensure that banks
internalize the risk of their operations. The agencies expect that the
benefits of strengthening risk-based capital requirements for large
banking organizations outweigh the costs.
Under the proposal, capital requirements for lending activities
would be determined by a combination of the credit risk and operational
risk frameworks. This would have the effect of modestly increasing
capital requirements for lending activity. Although a slight reduction
in bank lending could result from the increase in capital requirements,
the economic cost of this reduction would be more than offset by the
expected economic benefits associated with the increased resiliency of
the financial system. Additionally, the relative capital requirements
associated with different types of bank lending would change slightly,
which could lead to small changes in loan portfolio allocations.
Capital requirements for trading activities would be determined by
the market risk, CVA risk, and operational risk frameworks, and are
estimated to increase substantially, though the specific outcome will
depend on banking organizations' implementation of internal models. The
proposed market risk framework would capture a larger range of risks
and improve the resiliency of banking organizations relative to the
current capital rule, although it could also increase banking
organizations' costs of engaging in market making activities.
The remainder of this section reviews the agencies' analyses,
starting with a description of the banking-organization scope of the
proposal and the data used, followed by the resulting estimates of the
impact the proposed rule would have on the risk-weighted assets and
capital requirements of affected banking organizations. It then
discusses the economic impact of the proposal--cost and benefits--on
lending activity and trading activity respectively. This section
concludes with a discussion of the impact of the proposal on other
connected rules and regulations.
A. Scope and Data
The proposal would apply revised capital requirements to banking
organizations subject to Category I, II, III, or IV capital standards,
and to banking organizations with significant trading activity, while
retaining the current U.S. standardized approach for all banking
organizations. As of December 31, 2022, there were 37 top-tier U.S.
depository institution holding companies and 62 U.S.-based depository
institutions that report risk-based capital figures and are subject to
Category I, II, III, or IV standards. The 37 top-tier depository
institution holding companies include 25 U.S.-domiciled holding
companies (8 in Category I, 1 in Category II, 5 in Category III, and 11
in Category IV) and 12 U.S. intermediate holding companies of foreign
banking organizations (6 in Category III and 6 in Category IV).
To estimate the impact of the proposal on these large banking
organizations, the agencies utilized data collected in Quantitative
Impact Study (QIS) reports from the Basel III monitoring exercises as
well as regulatory financial reports (Call Report, FR Y-9C, FR Y-14,
and FFIEC 101). The year-end 2021 reports are used for estimating the
impact of the proposal on risk-weighted assets calculation and its
consequence on capital requirements and potential capital
shortfalls.\460\ Data over a longer time period--2015 to 2022--are used
to estimate the effect of AOCI recognition and the threshold
deductions.
---------------------------------------------------------------------------
\460\ The number of entities considered for the purpose of
impact estimates, based on year-end 2021 reports, may differ from
the number of entities reported above as in-scope, based on year-end
2022 reports.
---------------------------------------------------------------------------
B. Impact on Risk-Weighted Assets and Capital Requirements
To improve the risk sensitivity and robustness of risk-based
capital requirements, the proposal would revise calculations of risk-
weighted assets for large banking organizations. Consequently, a large
banking organization's risk-based capital requirements would change
even
[[Page 64168]]
though the minimum capital ratios would not. The impact of the proposal
depends on each banking organization's exposures. The current binding
risk-based capital requirement serves as the baseline relative to which
impacts are measured in the following analysis.
The impact estimates come with several caveats. First, these
estimates heavily rely on banking organizations' Basel III QIS
submissions. The Basel III QIS was conducted before the introduction of
a U.S. notice of proposed rulemaking, and therefore is based on banking
organizations' assumptions on how the Basel III reforms would be
implemented in the United States. For market risk, the impact of the
proposal further depends on banking organizations' assumptions on the
degree to which they will pursue the internal models versus the
standardized approach and their success in obtaining approval for
modeling. Second, for banking organizations that do not participate in
Basel III monitoring exercises, the agencies' estimates are primarily
based on banking organizations' regulatory filings, which do not
include sufficient granularity for precise estimates.\461\ In cases
where the proposed capital requirements are difficult to calculate
because there is no formula to apply (in particular, the proposed
market risk rule revisions), impact estimates are based on projections
of the other banking organizations that submitted QIS reports. Third,
estimates are based on banking organizations' balance sheets as of
year-end 2021, and do not account for potential changes in banking
structure, banking organization behavior, or market conditions since
that point.
---------------------------------------------------------------------------
\461\ For credit risk revisions, almost all banking
organizations subject to Category I or II capital standards, as well
as two banking organizations subject to Category III capital
standards, report their estimated impacts. For market risk
revisions, only the top trading firms report their estimated
impacts.
---------------------------------------------------------------------------
In aggregate across holding companies subject to Category I, II,
III or IV standards, the agencies estimate that the proposal would
increase total risk-weighted assets by 20 percent relative to the
currently binding measure of risk-weighted assets. Across depository
institutions subject to Category I, II, III or IV standards, the
agencies estimate that the proposal would increase risk-weighted assets
by 9 percent. Estimated impacts vary meaningfully across banking
organizations, depending on each banking organization's activities and
risk profile.\462\
---------------------------------------------------------------------------
\462\ The estimated increase in risk-weighted assets is 25
percent for holding companies subject to Category I or II standards,
6 percent for domestic holding companies subject to Category III or
IV standards, and 25 percent for intermediate holding companies of
foreign banking organizations subject to Category III and IV
standards.
---------------------------------------------------------------------------
As described previously, the proposal would replace the current
advanced approaches with the new expanded risk-based approach,
consisting of the new standardized approaches for credit, operational,
and CVA risk, and the new market risk framework. At the same time, the
proposal would not change the current U.S. standardized approach, other
than through the revisions to market risk. Table 11 provides risk-
weighted assets aggregated across holding companies, for both the
current U.S. standardized and advanced approaches as well as estimated
values under this proposal. Because banking organizations subject to
Category III or IV capital standards are not currently subject to the
advanced approaches, the table separates those banking organizations
from the ones subject to Category I or II capital standards.\463\
---------------------------------------------------------------------------
\463\ For brevity, the decomposition at the depository
institution level is omitted here. The comparison of risk-weighted
assets by risk category would look similar at the depository
institution level except that CVA risk and market risk risk-weighted
assets are considerably smaller because trading assets are largely
outside of the depository institutions.
[GRAPHIC] [TIFF OMITTED] TP18SE23.054
In general, the expanded risk-based framework would produce greater
overall risk-weighted assets than either of the current approaches. The
overall increase would lead to the expanded risk-based framework
becoming the binding risk-based approach for most large banking
organizations. As a result, the most commonly binding capital
requirement would shift from the current standardized approach to the
expanded risk-based approach. For a number of reasons, this would
result in capital requirements becoming more sensitive to the specific
risks of large banking organizations. The risk weights applicable to
credit risk exposures would be more granular under the expanded risk-
based approach than under the current standardized approach.
Additionally, the inclusion of
[[Page 64169]]
an operational and CVA risk component in the binding requirement
ensures that large banking organizations are more attuned to managing
these risks. Finally, the new market risk rule would be applicable
under both the U.S. standardized and expanded risk-based approaches,
improving capture of tail risks and other features that are difficult
to model.
While the proposal would not generally change the minimum required
capital ratios, the amount of required capital would change due to
changes to the calculation of risk-weighted assets. As a result of the
increases in risk-weighted assets, the agencies estimate that the
proposal would increase the binding common equity tier 1 capital
requirement, including minimums and buffers, of large holding companies
by around 16 percent.\464\ The aggregate percentage increase is smaller
for capital than for risk-weighted assets because for some banking
organizations in the sample, the stress capital buffer requirement is
determined by the dollar amount of the stress losses from the
supervisory stress tests and therefore does not increase with the
change in risk-weighted assets.\465\ Across depository institutions
subject to Category I, II, III or IV standards, the agencies estimate
that the proposal would increase the binding common equity tier 1
capital requirement by an estimated 9 percent, consistent with the
increase in risk-weighted assets for the depository institutions. The
percentage impact of the proposal on binding tier 1 capital
requirements would be smaller than for common equity tier 1 because the
supplementary leverage ratio, which is calculated as tier 1 capital
divided by total leverage exposure, binds in some large banking
organizations.
---------------------------------------------------------------------------
\464\ Further breakdown by category shows that the proposal
would increase binding common equity tier 1 capital requirements by
an estimated 19 percent for holding companies subject to Category I
or II capital standards, by an estimated 6 percent for Category III
and IV domestic holding companies, and by an estimated 14 percent
for Category III and IV intermediate holding companies of foreign
banking organizations. The impact assessment focuses on common
equity tier 1 capital because it is the highest quality of
regulatory capital and its minimum regulatory requirements are risk-
based.
\465\ This analysis assumes that the stress test losses
projected under the supervisory stress tests are unchanged by the
proposal, although the stress capital buffer requirement for each
banking organization is floored by 2.5 percent of risk-weighted
assets which would be generally higher due to the proposal.
---------------------------------------------------------------------------
At year-end 2021, five holding companies that were subject to
Category I or II capital standards had less common equity tier 1
capital than what the agencies estimate would have been required under
the proposal. To meet the proposed capital requirement, these five
holding companies would have needed to increase capital ratios between
16 and 105 basis points relative to their risk-weighted assets prior to
Basel III reforms. For comparison, the largest U.S. bank holding
companies annually earned an average of 180 basis points of capital
ratio between 2015 and 2022.\466\ All of the depository institutions,
as well as all holding companies that were subject to Category III or
IV capital standards, would have met the common equity tier 1 capital
requirements under the proposal.
---------------------------------------------------------------------------
\466\ Earned capital is computed as net income relative to risk-
weighted assets.
---------------------------------------------------------------------------
While most large banking organizations already have enough capital
to meet the proposed requirements, the proposal would likely result in
an increase in equity capital funding maintained by these banking
organizations. There is extensive academic literature on the impact of
bank capital on economic activity which typically focuses on the
tradeoff of safer individual banks and improved macroeconomic stability
against reduced credit supply and investment.\467\ Some studies further
consider the financial stability implications of potential migration of
banking activities to nonbanks.\468\ While quantification of the
economic costs and benefits of changes in bank capital is difficult and
highly contingent on the assumptions made, current capital requirements
in the United States are toward the low end of the range of optimal
capital levels described in the existing literature.\469\ On balance,
this literature concludes that there is room to increase capital
requirements from their current levels while still yielding positive
net benefits.
---------------------------------------------------------------------------
\467\ See Basel Committee on Banking Supervision, 2010, ``An
assessment of the long-term economic impact of stronger capital and
liquidity requirements;'' (BCBS, 2010) Slovik, Patrick and Boris
Courn[egrave]de, 2011, ``Macroeconomic Impact of Basel III'', OECD
Economics Department Working Papers 844; Booke, Martin et al., 2015,
``Measuring the macroeconomic costs and benefits of higher UK bank
capital requirements,'' Bank of England Financial Stability Paper
35; Dagher, Jihad, Giovanni Dell'Ariccia, Luc Laeven, Lev Ratnovski,
and Hui Tong, 2016, ``Benefits and Costs of Bank Capital,'' IMF
Staff Discussion Note 16/04 (Dagher et al., 2016); Firestone, Simon,
Amy Lorenc, and Ben Ranish, 2019, ``An Empirical Economic Assessment
of the Costs and Benefits of Bank Capital in the US,'' St. Louis
Review Vol. 101 (3) (Firestone, Lorenc, and Ranish, 2019).
\468\ See Begenau, Juliane and Tim Landvoigt, 2022, ``Financial
Regulation in a Quantitative Model of the Modern Banking System,''
The Review of Economic Studies 89(4): 1748-1784 (Begenau and
Landvoigt, 2022). See also Irani, Rustom M., Rajkamal Iyer, Ralf R.
Meisenzahl, and Jose-Luis Peydro, 2021, ``The Rise of Shadow
Banking: Evidence from Capital Regulation.'' The Review of Financial
Studies 34: 2181-2235.
\469\ Studies suggesting generally higher optimal capital
requirements include Miles, David, Jing Yang, and Gilberto
Marcheggiano, 2013, ``Optimal Bank Capital,'' The Economic Journal
123: 1-37; Dagher et al. (2016); Firestone, Lorenc, and Ranish
(2019); Begenau and Landvoigt (2022); and Van den Heuvel, Skander,
2022, ``The Welfare Effects of Bank Liquidity and Capital
Requirements,'' FEDS Working Paper. Some studies suggest somewhat
lower optimal capital requirements, for example, BCBS (2010) and
Elenev, Vadim, Tim Landvoight, Stijn van Nieuwerburgh, 2021, ``A
Macroeconomic Model with Financially Constrained Producers and
Intermediaries,'' Econometrica 89(3): 1361-1418.
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C. Economic Impact on Lending Activity
This subsection discusses the proposal's potential impact on
lending. Lending activity creates credit risk-weighted assets and
increases banking organizations' net interest income, which is a
significant driver of operational risk-weighted assets under the
expanded risk-based approach. Therefore, the agencies quantified how
the proposal would impact risk-weighted assets associated with lending
activity by adding changes to credit risk-weighted assets and the
interest income-related part of operational risk-weighted assets.
The agencies estimate that risk-weighted assets (RWA) associated
with banking organizations' lending activities would increase by $380
billion for holding companies subject to Category I, II, III, or IV
capital standards due to the proposal. This increase is roughly
equivalent to an increase of 30 basis points in required risk-based
capital ratios across large banking organizations. While this increase
in requirements could lead to a modest reduction in bank lending, with
possible implications for economic growth, the benefits of making the
financial system more resilient to stresses that could otherwise impair
growth are greater.\470\ Historical experience has demonstrated the
severe impact that distress or failure at individual banking
organizations can have on the stability of the U.S. banking system, in
particular banking organizations that would have been subject to the
proposal. The banking organizations that experience an increase in
their capital requirements under the proposal would be better able to
absorb losses and continue to serve households and businesses through
times of stress. Enhanced resilience of the banking sector supports
more stable
[[Page 64170]]
lending through the economic cycle and diminishes the likelihood of
financial crises and their associated costs.
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\470\ See Macroeconomic Assessment Group, 2010, ``Assessing the
macroeconomic impact of the transition to stronger capital and
liquidity requirements,'' Final Report; Brooke, Martin et al., 2015,
``Measuring the macroeconomic costs and benefits of higher UK bank
capital requirements,'' Bank of England Financial Stability Paper
35; Slovik, Patrick and Boris Courn[egrave]de, 2011, ``Macroeconomic
Impact of Basel III'', OECD Economics Department Working Papers 844;
Firestone, Lorenc, and Ranish (2019).
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Similarly, while increases in market risk capital requirements
could have some spillover impact on lending, increases in capital
requirements in general should also enhance the resilience of the
banking system, supporting lending and economic activity in downturns.
The agencies further analyzed asset class-level funding costs and
incentives for reallocation within banking organizations' lending
activities. The agencies estimate that the proposal would slightly
decrease marginal risk-weighted assets attributable to retail and
commercial real estate exposures and slightly increase marginal risk-
weighted assets attributable to corporate, residential real estate and
securitization exposures.\471\ From the marginal risk-weighted assets,
the agencies derive the marginal required capital for each asset class
under the proposal. The changes in required capital drive the cost of
funding for each asset class, which may in turn influence banking
organizations' portfolio allocation decisions. Based on the estimated
sensitivity of lending volumes to capital requirements found in the
existing literature,\472\ the agencies estimate that changes in asset
class-specific risk weights would change banking organizations'
portfolio allocations only by a few percentage points.
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\471\ The agencies estimate the marginal RWA under the expanded
risk-based approach and compare it to the marginal RWA under the
current U.S. standardized approach. Marginal RWA for each asset
class are defined as the incremental risk-weighted assets resulting
from an incremental dollar of exposure invested pro rata within the
asset class. This analysis considers the contribution of risk
exposures to risk-weighted assets holistically, accounting both for
their credit risk RWA as well as the incremental operational risk
RWA resulting from the exposures. The estimates derive from the
aggregate balance sheet of all holding companies subject to Category
I, II, III, or IV capital standards and, therefore, represent the
average exposure within each asset class at such banking
organizations.
\472\ See Aiyar, Shekhar, Charles W. Calomiris, and Tomasz
Wieladek, 2014, ``Does Macro-prudential Regulation Leak? Evidence
from a UK Policy Experiment,'' Journal of Money, Credit and Banking
46 (s1), 181-214; Behn, Markus, Rainer Haselmann, and Paul Wachtel,
2016, ``Procyclical Capital Regulation and Lending.'' Journal of
Finance 71 (2), 919-956; Bridges, Jonathan, David Gregory, Mette
Nielsen, Silvia Pezzini, Amar Radia, and Marco Spaltro, 2014, ``The
Impact of Capital Requirements on Bank Lending,'' Bank of England
Working Paper 486; Fraisse, Henri, Mathias L[eacute], and David
Thesmar, 2020, ``The Real Effects of Bank Capital Requirements,''
Management Science 66 (1), 5-23; Gropp, Reint, Thomas Mosk, Steven
Ongena, and Carlo Wix, 2020, ``Banks Response to Higher Capital
Requirements: Evidence from a Quasi-natural Experiment,'' Review of
Financial Studies 32 (1), 266-299; Plosser, Matthew C. and
Jo[atilde]o A. C. Santos, 2018, ``The Cost of Bank Regulatory
Capital,'' FRB of New York Staff Report 853.
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The proposal may have second-order effects on other banking
organizations, as a result of potential changes in large banking
organizations' lending decisions. Large banking organizations may shift
asset allocation toward assets that are assigned lower risk weights
under the proposal relative to current capital rule, which would affect
other lenders that compete in the same lending markets. The proposal
mitigates potential competitive benefits for large banking
organizations first by requiring that they continue to be subject to
the current standardized approach. This requirement guarantees that a
large banking organization covered by the proposal would maintain
equity capital funding at a level at least as high as that required by
the U.S. standardized approach for a banking organization not covered
by the proposal.
In addition, the proposal attempts to mitigate potential
competitive effects between U.S. banking organizations by adjusting the
U.S. implementation of the Basel III reforms, specifically by raising
the risk weights for residential real estate and retail credit
exposures. Without the adjustment relative to Basel III risk weights in
this proposal, marginal funding costs on residential real estate and
retail credit exposures for many large banking organizations could have
been substantially lower than for smaller organizations not subject to
the proposal. Though the larger organizations would have still been
subject to higher overall capital requirements, the lower marginal
funding costs could have created a competitive disadvantage for smaller
firms.
D. Economic Impact on Trading Activity
The agencies estimate that capital requirements primarily affecting
trading activities would increase substantially, though the actual
outcome will depend on banking organizations' particular exposures and
implementation of internal models. Based on the year-end of 2021 data
and QIS reports of large banking organizations, the agencies estimate
that the increase in RWA associated with trading activity (market risk
RWA, CVA risk RWA, and attributable operational risk RWA) would be
around $880 billion for large holding companies. Consequently, the
increase in RWA associated with trading activity would raise required
capital ratios by as much as roughly 67 basis points across large
holding companies subject to Category I, II, III, or IV capital
standards.
The academic literature documents important roles that financial
intermediaries play in lowering transaction costs and improving market
efficiency.\473\ Several banking organizations subject to the proposal
are major market makers in securities trading and important liquidity
providers in over-the-counter markets. Higher capital requirements for
trading activity could enhance the resilience of bank-affiliated broker
dealers and, therefore, benefit the provision of market liquidity,
especially during stress periods. Higher capital requirements in normal
times could also discourage the type of excessive risk-taking that
resulted in large losses during the 2007-09 financial crisis. Over the
long run, risk-weighted assets calibrated to better capture risks could
support a larger role for bank-affiliated dealers in market making and
enhance financial stability.
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\473\ See, e.g., Grossman, Sanford and Merton Miller, 1988,
``Liquidity and Market Structure,'' Journal of Finance 43: 617-633;
Duffie, Darrell, Nicolae G[acirc]rleanu, and Lasse Pedersen, 2005,
``Over-the-Counter Markets,'' Econometrica 73: 1815-1847; and
Duffie, Darrell and Bruno Strulovici, 2012, ``Capital Mobility and
Asset Pricing,'' Econometrica 80: 2469-2509.
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On the other hand, higher capital requirements on trading activity
may also reduce banking organizations' incentives to engage in certain
market making activities and may impair market liquidity. The
identification of causal effects of tighter capital requirements on
market liquidity is challenging, partly because historical changes in
capital regulations have often happened at the same time as changes in
other factors affecting market liquidity, such as other regulatory
changes, liquidity demand shocks, or the development of electronic
trading platforms. The observable effects of changes in capital
requirements can also vary depending on the measurements of market
liquidity.\474\ Therefore, existing empirical studies on the
relationship between capital requirements and market liquidity are
limited and empirical evidence on causal effects of higher capital
requirements on liquidity is mixed.\475\ The overall effect of higher
[[Page 64171]]
capital requirements on market making activity and market liquidity
remains a research question needing further study.
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\474\ For a discussion on difficulties in detangling impacts of
capital regulation on market liquidity, see Adrian, Tobias, Michael
Fleming, Or Shachar, and Erik Vogt, 2017, ``Market Liquidity after
the Financial Crisis,'' Annual Review of Financial Economics, Vol. 9
(1): 43-83. For time-varying bond market liquidity and mixed
evidence on the liquidity changes post the 2007-09 financial crisis,
see Anderson, Mike and Ren[eacute] M. Stulz, 2017, ``Is Post-crisis
Bond Liquidity Lower?'' National Bureau of Economic Research,
Working Paper, No. 23317.
\475\ Empirical research on causal effects of banking regulation
generally compares liquidity provision between bank-affiliated
dealers and non-bank dealers. For evidence that bank dealers commit
less capital to market-making activities, see Bessembinder, H., S.
Jacobsen, W. Maxwell, and K. Venkataraman, 2018, ``Capital
Commitment and Illiquidity in Corporate Bonds,'' Journal of Finance
73(4): 1615-1661, although this paper confirms that postcrisis
transaction costs have not increased materially. For evidence that
bank dealers did not differentially decrease intermediation activity
relative to non-bank dealers, see Boyarchenko, Nina, Anna Kovner,
and Or Shachar, 2022, ``It's What You Say and What You Buy: A
Holistic Evaluation of the Corporate Credit Facilities,'' Journal of
Financial Economics, Vol. 144(3): 695-731. For evidence based on
German bank data that largely confirms findings in Bessembinder
(2018), see Haselmann, Rainer, Thomas Kick, Shikhar Singla, and
Vikrant Vig, 2022, ``Capital Regulation, Market-Making, and
Liquidity,'' Goethe University LawFin Working Paper No. 44.
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E. Additional Impact Considerations
In addition to the impact on risk-weighted assets examined in
previous subsections, the proposal would also affect large banking
organizations through changes in the calculation of regulatory capital,
total loss-absorbing capacity (TLAC) and long-term debt (LTD)
requirements, single counterparty credit limits, as well as the
calculation of method 2 GSIB scores.
First, the proposal would revise the regulatory capital calculation
of banking organizations subject to Category III or IV capital
standards through the recognition of AOCI and the application of lower
deduction thresholds. Under the current capital framework, most banking
organizations subject to Category III or IV capital standards have
opted to exclude AOCI from their regulatory capital. The proposal would
withdraw this option and require AOCI to be included in regulatory
capital.
Notably, for holding companies subject to Category III or IV
capital standards that opted out of the AOCI inclusion, the majority
(at the end of 2022, more than 80 percent) of AOCI is attributable to
substantial unrealized losses on current or former available-for-sale
securities. Capital market and yield curve developments can at times
lead to substantial AOCI fluctuation. In recent years, the aggregate
AOCI related to the security holdings of holding companies subject to
Category III or IV capital standards fluctuated between an unrealized
gain of $25 billion and an unrealized loss of $108 billion. Therefore,
the agencies assessed the impact of AOCI inclusion and threshold
deduction changes from a long-run perspective, which provides a more
representative measure of the risk and portfolio management practices
of banking organizations over time.
The agencies used quarterly FR Y-9C data from 2015 Q1 to 2022 Q4 to
estimate the effect of AOCI recognition and quarterly FR Y-14Q data
from 2020 Q3 to 2022 Q4 for the estimation of the threshold deduction
effect. The impact of the proposal would generally be driven by the
AOCI recognition, albeit threshold deduction changes would dominate for
the U.S. intermediate holding companies of foreign banking
organizations subject to Category III capital standards. The
differential impact holds for both risk-based capital and leverage
ratios. The agencies estimate that the average long-run effect of both
proposed changes on domestic holding companies subject to Category III
standards would be equivalent to a 4.6-percent and 3.8-percent relative
increase in the common equity tier 1 and leverage capital requirements,
respectively. For the U.S. intermediate holding companies of foreign
banking organizations subject to Category III capital standards, the
average long-run effect of both proposed changes would be equivalent to
a 13.2-percent and 9.7-percent relative increase in the respective
requirements. For the holding companies of banking organizations
subject to Category IV capital standards, the average long-run effect
of both proposed changes would be equivalent to a 2.6-percent and 2.5-
percent relative increase in the respective capital requirements.
Finally, if affected banking organizations do not adjust their AOCI
management, for example by adjusting the relative size, fair value
hedging, or interest rate sensitivity of their available-for-sale
security portfolios, AOCI recognition could increase variation in
regulatory capital ratios over time and make them more correlated with
market cycles.
Second, the RWA changes under the proposal would affect the risk-
based TLAC and LTD requirements applicable to Category I bank holding
companies. While the leverage-based TLAC requirement was binding for
half of the bank holding companies subject to Category I capital
standards at the end of 2021, the RWA increases under this proposal
would make the risk-based TLAC requirement binding for all these
companies. The Board estimates \476\ that the average TLAC requirement
for bank holding companies subject to Category I capital standards
would increase by 15.2 percent as a result of the proposed RWA changes,
which would have created a moderate shortfall in TLAC for three of
these companies at the end of 2021. Similarly, while the leverage-based
LTD requirement was binding for all bank holding companies subject to
Category I capital standards at the end of 2021 Q4, the proposal would
make the risk-based LTD requirement binding for some of these
companies. The Board estimates that the average LTD requirement for
bank holding companies subject to Category I capital standards would
increase by 2.0 percent as a result of the RWA changes, which would not
have created a shortfall in LTD for any of these companies at the end
of 2021. Lastly, the RWA changes under the proposal could also increase
the TLAC and LTD requirements for the U.S. intermediate holding
companies of some globally systemically important foreign banking
organizations.
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\476\ In these paragraphs, the term ``Board estimates'' is used
instead of the term ``agencies estimate'' to reflect that the impact
assessment is related to Board rules, such as the TLAC, LTD, and
GSIB capital surcharge requirements.
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Third, the proposed elimination of the internal models method for
calculating derivatives exposures would require all large banking
organizations to use the standardized approach for counterparty credit
risk to calculate their single-counterparty credit limits. The agencies
estimate that the standardized approach for counterparty credit risk
would generally result in higher derivative exposures than the internal
models method. Therefore, credit limits for counterparties to which a
banking organization has derivatives exposure are likely to become more
stringent under the proposal.
Fourth, the proposed RWA changes would affect the method 2 scores
of U.S. GSIBs through the Short-Term Wholesale Funding component score,
which is based on the ratio of average weighted short-term wholesale
funding to average RWA. The Board estimates that the proposal would
decrease the method 2 scores by 32 points on average across U.S. GSIBs,
which would reduce their GSIB capital surcharges by about 16 basis
points. This effect would reduce the overall impact of the proposal on
the binding capital requirements of banking organizations subject to
Category I capital standards.
VI. Technical Amendments to the Capital Rule
The proposal would make certain technical corrections and
clarifications to several provisions of the capital rule, as described
below. Most of these proposed corrections or technical changes are
self-explanatory, such as updates to terminology to align with the
proposal, and would apply only to banking organizations that would be
subject to subpart E. In addition, there are several transition
provisions and temporary provisions that have expired
[[Page 64172]]
or no longer apply that the proposal would remove from the capital
rule. The proposal would also make technical updates to various aspects
of the capital rule to account for the proposed changes to subparts E
and F of the capital rule related to the removal and replacement of the
current internal model-based approaches for credit risk, operational
risk, and market risk. Also, the proposal would make certain technical
corrections to the rule to address errors, such updating the numbering
of footnotes in certain sections and correcting the definition of
qualifying master netting agreement to include criteria that were
originally included and inadvertently deleted. These revisions are not
all applicable to each agency and would only apply to a given agency as
appropriate.
In Sec. __.2, the proposal would remove references to subpart E
for purposes of the internal models approach in the definition of
residential mortgage exposure and the treatment of residential
mortgages managed as part of a segment of exposures with homogenous
risk characteristics.
In Sec. __.2 of the Board's and the OCC's capital rule, the
proposal would correct the definition of qualifying master netting
agreement to put back certain paragraphs related to a walkaway clause.
Under the 2013 capital rule,\477\ the definition of QMNA required that
the agreement not contain a walkaway clause and that a banking
organization must comply with certain operational requirements with
respect to the agreement. When the Board and OCC finalized the
restrictions in the qualified financial contracts stay rule \478\ and
made conforming amendments to the capital rule, certain paragraphs
related to a walkaway clause in the definition of QMNA were removed in
error. The Board and OCC propose to correct the error by inserting back
the two sub-paragraphs for the definition of QMNA.
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\477\ See 78 FR 62018 (October 11, 2013).
\478\ See 82 FR 42882 (September 12, 2017).
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In Sec. __.10(c)(2)(i) of the capital rule, the proposal would
clarify in the definition of total leverage exposure that total
leverage exposure amount could be reduced by any AACL for on-balance
sheet assets. The capital rule defines total leverage exposure to
include the carrying value of on-balance sheet assets without any
adjustment for AACL. The definition of carrying value does not allow
for the reduction in the on-balance sheet amount by any credit loss
allowances, except for allowances related to AFS securities and
purchased credit deteriorated assets. In the numerator of the
supplementary leverage ratio, the AACL flows through earnings and is
reflected in Tier 1 capital. To align the numerator and the denominator
of the SLR, the proposed change would allow banking organizations to
net the AACL from the denominator of the SLR.
The proposal would require banking organizations subject to
Category III or IV standards to use SA-CCR, including for purposes of
calculating total leverage exposure for derivatives under the
supplementary leverage ratio. In Sec. __.10(c) of the capital rule,
banking organizations subject to Category III or IV capital standards
are allowed to use the current exposure method when calculating the
total leverage exposure. The proposal would remove Sec.
__.10(c)(2)(ii)(A) and (iii)(A), which describe how total leverage
exposure is calculated when a banking organization uses the current
exposure method, since under the proposal only SA-CCR would be
permitted under the proposal.
The proposal would make a technical correction to Sec.
__.10(c)(2)(ix) of the capital rule to clarify the treatment of a
guarantee by a clearing member banking organization of the performance
of a clearing member client on repo-style transaction that the clearing
member client has with a central counterparty. Consistent with the
treatment of such exposures under the risk-based framework, the
proposal would require the clearing member banking organization to
treat the guarantee of client performance on a repo-style transaction
as a repo-style style transaction, just as it must treat such a
guarantee of client performance on a derivative contract as a
derivative contract.
Under the capital rule, Sec. __.300(a) covers the 2016 to 2018
transition for the capital conservation buffer and countercyclical
capital buffer. Sec. __.300(c) covers the transition for non-
qualifying capital instruments that expired in calendar year 2022.
Sec. __.300(e) covers the transition for prompt corrective action.
Sec. __.300(f) covers simplifications early adoption and has expired
by its terms.\479\ Sec. __.300(g) of the capital rule covers SA-CCR
transition and Sec. __.300(h) covers the default fund contribution
transition, both of which expired on January 1, 2022. The proposal
would update the terminology in Sec. __.300(a) and (c) of the capital
rule and would remove Sec. __.300(f) to (h).
---------------------------------------------------------------------------
\479\ See 84 FR 61804 (November 13, 2019).
---------------------------------------------------------------------------
Sec. __.303 of the capital rule covers a temporary exclusion from
total leverage exposure that ended March 31, 2021. Sec. __.304 of the
capital rule covers temporary changes to the community bank leverage
ratio framework that applied until December 31, 2021. The proposal
would remove Sec. __.303 and Sec. __.304 of the capital rule.
Similarly, Sec. __.12(a)(4) of the capital rule covers temporary
relief for the community bank leverage ratio that applied until
December 31, 2021, and would therefore be removed from the capital
rule.
A. Additional OCC Technical Amendments
Enhanced Supplementary Leverage Ratio
In addition to the technical amendments described above, the OCC is
proposing to revise the methodology it uses to identify which national
banks and Federal savings associations are subject to the enhanced
supplementary leverage ratio (eSLR) standard to ensure that the
standard applies only to those national banks and Federal savings
associations that are subsidiaries of a Board-identified U.S. GSIB.
In 2014, the agencies adopted a final rule that established the
eSLR standard for the largest, most interconnected U.S. banking
organizations (eSLR rule) in order to strengthen the overall regulatory
capital framework in the United States.\480\ The eSLR rule, as adopted
in 2014, applied to U.S. top-tier bank holding companies with
consolidated assets over $700 billion or more than $10 trillion in
assets under custody, or that are insured depository institution (IDI)
subsidiaries of holding companies that meet those thresholds. The eSLR
rule also provides that any subsidiary depository institutions of those
bank holding companies must maintain a 6 percent supplementary leverage
ratio to be deemed ``well capitalized'' under the prompt corrective
action (PCA) framework of each agency.\481\
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\480\ See 79 FR 24528 (May 1, 2014).
\481\ See 12 CFR part 6 (national banks) and 12 CFR part 165
(Federal savings associations) (OCC).
---------------------------------------------------------------------------
Subsequently, in 2015, the Board adopted a final rule establishing
a methodology for identifying a bank holding company as a U.S. GSIB and
applying a risk-based capital surcharge on such an institution (GSIB
surcharge rule).\482\ Under the GSIB surcharge rule, a U.S. top-tier
bank holding company that is not a subsidiary of a foreign banking
organization and that is an advanced approaches banking organization
must determine whether it is a U.S. GSIB by applying a multifactor
methodology based on size,
[[Page 64173]]
interconnectedness, substitutability, complexity, and cross-
jurisdictional activity.\483\ As part of the GSIB surcharge rule, the
Board revised the application of the eSLR standard to apply to any bank
holding company identified as a U.S. GSIB and to each Board-regulated
subsidiary depository institution of a U.S. GSIB.\484\
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\482\ 12 CFR 217.402; 80 FR 49082 (August 14, 2015).
\483\ 12 CFR part 217, subpart H. The methodology provides a
tool for identifying as GSIBs those banking organizations that pose
elevated risks.
\484\ The eSLR rule does not apply to intermediate holding
companies of foreign banking organizations as such banking
organizations are outside the scope of the GSIB surcharge rule and
cannot be identified as U.S. GSIBs.
---------------------------------------------------------------------------
The OCC's current eSLR rule applies to national banks and Federal
savings associations that are subsidiaries of U.S. top-tier bank
holding companies with more than $700 billion in total consolidated
assets or more than $10 trillion total in assets under custody. In
order to align with the Board's regulations for identifying U.S. GSIBs
and measuring the eSLR standard for holding companies and their
subsidiary depository institutions, the OCC is proposing to revise its
eSLR rule to ensure that the eSLR standard will apply to only those
national banks and Federal savings associations that are subsidiaries
of holding companies identified as U.S. GSIBs under the GSIB surcharge
rule.
Definition of Financial Collateral
In Sec. __.2 of the OCC's capital rule, the proposed rule would
correct an error in the definition of financial collateral by changing
the word ``and'' in paragraph (2) ``in which the national bank and
Federal Savings association has a perfected . . . [emphasis added]'' to
``or.'' The proposed correction would clarify that this requirement in
the definition of financial collateral applies to national banks or
Federal Savings associations, as relevant.
B. Additional FDIC Technical Amendments
In addition to the joint technical amendments described above, the
FDIC is proposing technical amendments to certain provisions of the
capital rule in part 324 of the FDIC's regulations. Specifically, the
FDIC proposes to correct a spelling error in the definition of
``financial institution'' in Sec. 324.2. Additionally, the FDIC
proposes to correct the footnote numbering in part 324 so that each
section with any footnote would begin with footnote 1. This would
affect the footnotes in Sec. Sec. 324.2, 324.4, 324.11, 324.20, and
324.22.
The FDIC also proposes removing expired or obsolete provisions from
various sections in part 324, including section 324.1(f), footnote 10
in Sec. 324.4, Sec. 324.10(b)(5), and Sec. 324.10(d)(4).
Finally, the FDIC proposes amending Sec. Sec. 324.401 and 324.403
of the prompt corrective action provisions of subpart H to remove
outdated transitions and obsolete references to part 325, and to
replace references to the advanced approaches consistent with the
proposal.
VII. Proposed Amendments to Related Rules and Related Proposals
A. OCC Amendments
Lending Limits Rule
The OCC's lending limit rule \485\ includes a definition of
eligible credit derivative, which references the definition of eligible
guarantee in the capital rule.\486\ This proposed rule would revise the
definition of eligible guarantee in 12 CFR part 3 to add a requirement
that an eligible guarantee must be provided by an eligible guarantor,
also as defined in 12 CFR part 3. To avoid imposing this additional
requirement of an eligible guarantor for eligible credit derivatives,
as defined for lending limit purposes, the OCC is proposing to revise
the definition of eligible credit derivative in 12 CFR part 32 to scope
out the new proposed requirement of an eligible guarantor.
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\485\ 12 CFR part 32.
\486\ See 12 CFR 32.2(m)(1).
---------------------------------------------------------------------------
B. Board Amendments
In connection with this proposal, the Board is proposing amendments
to various regulations that reference the capital rule in order to make
appropriate conforming amendments to reflect this proposal. For
example, references to advanced approaches risk-weighted assets would
be removed and replaced with expanded total risk-weighted assets,
consistent with the proposal. Such conforming changes would be made to
Regulation H (12 CFR part 208), Regulation Y (12 CFR part 225),
Regulation LL (12 CFR part 238), and Regulation YY (12 CFR part 252).
To the extent that other Board rules rely on items determined under the
capital rule, changes to the capital rule could impact the effective
requirements of such other Board rules. In addition to these proposed
amendments, as discussed elsewhere in this document, the proposal would
amend Regulation Y, Regulation LL, and Regulation YY as appropriate to
reflect the proposed stress capital buffer framework.
Question 175: What modifications, if any, should the Board consider
to this proposal or to other Board rules indirectly affected by this
proposal?
C. Related Proposals
The Board is separately issuing a proposal (the GSIB surcharge
proposal) that would amend the Board's framework under the capital rule
for identifying and establishing risk-based surcharges for global
systemically important bank holding companies (GSIBs). The GSIB
surcharge proposal would also amend the FR Y-15, which is the source of
inputs to the implementation of the GSIB framework under the capital
rule. The changes set forth in the GSIB surcharge proposal would
improve the sensitivity of the GSIB surcharge to changes in a GSIB's
systemic footprint and better measure systemic risk under the
framework.
As discussed in section II of this SUPPLEMENTARY INFORMATION, the
current proposal would broaden the scope of application of the
supplementary leverage ratio requirement. To account for this aspect of
the proposal, the GSIB surcharge proposal would require all banking
organizations that file the FR Y-15 to report data for the total
exposures systemic indicator as the average of daily values for on-
balance sheet items and the average of month-end values for off-balance
sheet items, to align with the calculation of total leverage exposure
for purposes of the supplementary leverage ratio requirement.
Question 176: What modifications, if any, should the Board consider
to this proposal due to the Board's separate GSIB proposal and why?
VIII. Administrative Law Matters
A. Paperwork Reduction Act
Certain provisions of the proposed rule contain ``collections of
information'' within the meaning of the Paperwork Reduction Act of 1995
(PRA).\487\ In accordance with the requirements of the PRA, the
agencies may not conduct or sponsor, and a respondent is not required
to respond to, an information collection unless it displays a currently
valid Office of Management and Budget (OMB) control number. The
information collection requirements contained in this joint notice of
proposed rulemaking have been submitted to OMB for review and approval
by the OCC and FDIC under section 3507(d) of the PRA (44 U.S.C.
3507(d)) and Sec. 1320.11 of OMB's implementing regulations (5 CFR
part
[[Page 64174]]
1320). The Board reviewed the proposed rule under the authority
delegated to the Board by OMB.
---------------------------------------------------------------------------
\487\ 44 U.S.C. 3501-3521.
---------------------------------------------------------------------------
The proposed rule contains revisions to current information
collections subject to the PRA. To implement these requirements, the
agencies would revise and extend for three years the (1) Reporting,
Recordkeeping, and Disclosure Requirements Associated with Regulatory
Capital Rules (OMB Nos. 1557-0318, 3064-0153, and 7100-0313) and (2)
Reporting, Recordkeeping, and Disclosure Requirements Associated with
Market Risk Capital Rules (OMB Nos. 1557-0247, 3064-0178, and 7100-
0314). The Board would also revise and extend for three years the (1)
Financial Statements for Holding Companies (FR Y-9; OMB No. 7100-0128),
(2) the Capital Assessments and Stress Testing (FR Y-14A/Q/M; OMB No.
7100-0341), and (3) the Systemic Risk Report (FR Y-15; OMB No. 7100-
0352).
The agencies, under the auspices of the FFIEC, would also propose
related revisions to (1) all versions of the Consolidated Reports of
Condition and Income (Call Reports) (FFIEC 031, FFIEC 041, and FFIEC
051; OMB Nos. 1557-0081; 3064-0052, and 7100-0036), (2) the Regulatory
Capital Reporting for Institutions Subject to the Advanced Capital
Adequacy Framework (FFIEC 101; OMB Nos. 1557-0239, 3064-0159, and 7100-
0319), and (3) the Market Risk Regulatory Report for Institutions
Subject to the Market Risk Capital Rule (FFIEC 102; OMB Nos. 1557-0325,
3064-0199, and 7100-0365), including by adding a new sub report, the
FFIEC 102a. The proposed revisions to these FFIEC reports will be
addressed in one or more separate Federal Register notices.
Comments are invited on the following:
(a) Whether the collections of information are necessary for the
proper performance of the agencies' functions, including whether the
information has practical utility;
(b) the accuracy of the agencies estimates of the burden of the
information collections, including the validity of the methodology and
assumptions used;
(c) ways to enhance the quality, utility, and clarity of the
information to be collected;
(d) ways to minimize the burden of the information collections on
respondents, including through the use of automated collection
techniques or other forms of information technology; and
(e) estimates of capital or start-up costs and costs of operation,
maintenance, and purchase of services to provide information.
Comments on aspects of this document that may affect reporting,
recordkeeping, or disclosure requirements and burden estimates should
be sent to the addresses listed in the ADDRESSES section of the
Supplementary Information. A copy of the comments may also be submitted
to the OMB desk officer for the Agencies: By mail to U.S. Office of
Management and Budget, 725 17th Street NW, #10235, Washington, DC 20503
or by facsimile to (202) 395-5806, Attention, Federal Banking Agency
Desk Officer.
1. Proposed Revisions, With Extension, of the Following Information
Collections
a. (1) Collection Title: Reporting, Recordkeeping, and Disclosure
Requirements Associated With Regulatory Capital Rules
OCC
OMB control number: 1557-0318.
Frequency: Quarterly, annually, event-generated.
Affected Public: Businesses or other for-profit.
Respondents: National banks and Federal savings associations.
Estimated number of respondents: 48 (48 expanded risk based
approach).
Estimated average hours per response:
One-Time
Standardized Approach
Recordkeeping
Section 3.35(b)(3)(i)(A)--2.
Section 3.37(c)(4)(i)(E)--80.
Sections 3.41(b)(3) and 3.41(c)(2)(i)--40.
Disclosure
Sections 3.42(e)(2), 3.62(a) through (c), 3.63(a) and (b), and 3.63
tables--226.25.
Expanded Risk Based Approach
Recordkeeping
Section 3.120(e)(1)--40.
Sections 3.130(c)(2)(i) and (ii)--81.
Sections 3.150(f)(1) and (2)--70.
Disclosure
Sections 3.162 and 3.162 Tables 1-14--328.
Ongoing
Minimum Capital Ratios
Reporting
Sections 3.22(b)(2)(iv), 3.22(c)(4), 3.22(c)(5)(i), 3.22(c)(6),
3.22(d)(2)(i)(C), and 3.22(d)(2)(iii)--6.
Section 3.22(h)(2)(iii)(A)--2.
Recordkeeping
Section 3.3(d)--8.
Standardized Approach
Reporting
Section 3.34(a)(1)(ii)--2.
Section 3.37(c)(4)(i)(E)--1.
Recordkeeping
Section 3.35(b)(3)(i)(A)--2.
Section 3.37(c)(4)(i)(E)--16.
Section 3.41(c)(2)(ii)--2.
Disclosure
Section 3.42(e)(2)--20.
Sections 3.62(a) through (c), 3.63(a) and (b), and 3.63 tables--
111.25.
Expanded Risk Based Approach
Reporting
Section 3.113(i)(3)(ii)(C)--2.
Section 3.114(d)(6)(vi)--2.
Section 3.150(d)(5)--20.
Sections 3.150(e)(3)(i) and (ii)--40.
Recordkeeping
Section 3.114(b)(3)(i)(A)--1.
Section 3.120(e)(1)--1.
Section 3.121(d)(2)(ii)(C)--1.
Section 3.130(b)(3)--39.
Section 3.130(c)(2)(ii)--2.
Sections 3.150(f)(1) and (2)--22.
Section 3.161(b)--1.
Disclosure
Sections 3.20(c)(1)(xiv) and 3.20(d)(1)(xi)--2.
Sections 3.162 and 3.162 Tables 1-14--90.
Estimated annual burden hours: 20,535 (11,818 initial setup and
8,717 ongoing).
Board
Collection identifier: FR Q.
OMB control number: 7100-0313.
Frequency: Quarterly, annually, event-generated.
Affected Public: Businesses or other for-profit.
Respondents: State member banks, certain bank holding companies,
U.S. intermediate holding companies, certain covered savings and loan
holding companies.
Estimated number of respondents: 1,004 (48 expanded risk based
approach).
Estimated average hours per response:
One-Time
Standardized Approach
Recordkeeping
Section 217.35(b)(3)(i)(A)--2.
Section 217.37(c)(4)(i)(E)--80.
Sections 217.41(b)(3) and 217.41(c)(2)(i)--40.
[[Page 64175]]
Disclosure
Sections 217.42(e)(2), 217.62(a) through (c), 217.63(a) and (b),
and 217.63 tables--226.25.
Expanded Risk Based Approach
Recordkeeping
Section 217.120(e)(1)--40.
Sections 217.130(c)(2)(i) and (ii)--81.
Sections 217.150(f)(1) and (2)--70.
Disclosure
Sections 217.162, 217.162 Tables 1-14--328, 217.162 Table 15 (Board
only)--30.
Ongoing
Minimum Capital Ratios
Reporting
Section 217.22(b)(2)(iv), (c)(4), (c)(5)(i), (c)(6), (d)(2)(i)(C),
and (d)(2)(iii)--6.
Section 217.22(h)(2)(iii)(A)--2.
Recordkeeping
Section 217.3(d)--8.
Standardized Approach
Reporting
Section 217.34(a)(1)(ii)--2.
Section 217.37(c)(4)(i)(E)--1.
Recordkeeping
Section 217.35(b)(3)(i)(A)--2.
Section 217.37(c)(4)(i)(E)--16.
Section 217.41(c)(2)(ii)--2.
Disclosure
Section 217.42(e)(2)--20.
Sections 217.62(a) through (c), 217.63(a) and (b), and
217.63 tables--111.25.
Expanded Risk Based Approach
Reporting
Section 217.113(i)(3)(ii)(C)--2.
Section 217.114(d)(6)(vi)--2.
Section 217.150(d)(5)--20.
Sections 217.150(e)(3)(i) and (ii)--40.
Recordkeeping
Section 217.114(b)(3)(i)(A)--1. Section 217.120(e)(1)--1.
Section 217.121(d)(2)(ii)(C)--1.
Section 217.130(b)(3)--39.
Section 217.130(c)(2)(ii)--2.
Sections 217.150(f)(1) and (2)--22.
Section 217.161(b)--1.
Disclosure
Sections 217.20(c)(1)(xiv) and 217.20(d)(1)(xi)--2.
Sections 217.162 and 217.162 Tables 1-14--90.
Section 217.162 Table 15 (Board only)--30.
Estimated annual burden hours: 77,001 (17,956 initial setup and
59,045 ongoing).
FDIC
OMB control number: 3064-0153.
Frequency: Quarterly, annually, event-generated.
Affected Public: Businesses or other for-profit.
Respondents: State nonmember banks, state savings associations, and
certain subsidiaries of those entities.
Estimated number of respondents: 3,038 (9 expanded risk based
approach).
Estimated average hours per response:
One-Time
Standardized Approach
Recordkeeping
Section 324.35(b)(3)(i)(A)--2.
Section 324.37(c)(4)(i)(E)--80.
Sections 324.41(b)(3) and 324.41(c)(2)(i)--40.
Disclosure
Sections 324.42(e)(2), 324.62(a) through (c), 324.63(a) and (b),
and 324.63 tables--226.25.
Expanded Risk Based Approach
Recordkeeping
Section 324.120(e)(1)--40.
Sections 324.130(c)(2)(i) and (ii)--81.
Sections 324.150(f)(1) and (2)--70.
Disclosure
Sections 324.162 and 324.162 Tables 1-14--328,
Ongoing
Minimum Capital Ratios
Reporting
Sections 324.22(b)(2)(iv), 324.22(c)(4), 324.22(c)(5)(i),
324.22(c)(6), 324.22(d)(2)(i)(C), and 324.22(d)(2)(iii)--6.
Section 324.22(h)(2)(iii)(A)--2.
Recordkeeping
Section 324.3(d)--8.
Standardized Approach
Reporting
Section 324.34(a)(1)(ii)--2.
Section 324.37(c)(4)(i)(E)--1.
Recordkeeping
Section 324.35(b)(3)(i)(A)--2.
Section 324.37(c)(4)(i)(E)--16.
Section 324.41(c)(2)(ii)--2.
Disclosure
Section 324.42(e)(2)--20.
Sections 324.62(a) through (c), 324.63(a) and (b), and 324.63
tables--111.25.
Expanded Risk Based Approach
Reporting
Section 324.113(i)(3)(ii)(C)--2.
Section 324.114(d)(6)(vi)--2.
Section 324.150(d)(5)--20.
Sections 324.150(e)(3)(i) and (ii)--40.
Recordkeeping
Section 324.114(b)(3)(i)(A)--1.
Section 324.120(e)(1)--1.
Section 324.121(d)(2)(ii)(C)--1.
Section 324.130(b)(3)--39.
Section 324.130(c)(2)(ii)--2.
Sections 324.150(f)(1) and (2)--22.
Section 324.161(b)--1.
Disclosure
Sections 324.20(c)(1)(xiv) and 324.20(d)(1)(xi)--2.
Sections 324.162 and 324.162 Tables 1-14--90.
Estimated annual burden hours: 118,392 (4,371 initial setup and
114,021 ongoing).
Current Actions: The proposal would modify the reporting,
recordkeeping, and disclosure requirements of the regulatory capital
rules by adding new requirements and revising existing reporting,
recordkeeping, and disclosure requirements. The citations for the
requirements retained from the current rule have been revised in
keeping with the broader proposal.
The proposed revisions would include new recordkeeping requirements
related to the legal status in bankruptcy of collateral posted to a
QCCP; the management of hedged exposures during bankruptcy,
reorganization, or restructuring; and the monitoring of operational
risk. The proposal would include new reporting requirements related to
the exclusion of certain operational loss data from a banking
organization's operational risk calculation. The proposal would also
revise existing disclosure requirements and add new disclosure
requirements. The disclosure requirements are laid out in 15 tables,
and the overall number of disclosure requirements has dropped by 54
line items, including all quantitative disclosures, which are now
included in regulatory reporting. Please see the disclosure section
III.G of this Supplementary Information for a detailed description of
the proposed revisions.
b. (2) Collection Title: Reporting, Recordkeeping, and Disclosure
Requirements Associated With Market Risk Capital Rules
OCC
OMB control number: 1557-0247.
Frequency: Quarterly, annually, weekly, event-generated.
Affected Public: Businesses or other for-profit.
Respondents: National banks and Federal savings associations.
[[Page 64176]]
Estimated number of respondents: 49.
Estimated average hours per response:
Reporting
Sections 3.201(b)(5)(i) and (ii), 3.202 Market risk covered
position (1)(ii)(A)(2), 3.204(d)(1), 3.204(d)(3)(i), 3.204(e)(1),
3.204(e)(2)(v), 3.204(e)(3), 3.204(g)(2), 3.204(g)(4), 3.205(f)(1)(ii),
3.205(h)(1)(ii)(B), 3.205(h)(1)(ii)(A)(3), 3.207(a)(3), (4), and (5),
3.207(a)(8), 3.208(b)(4), 3.208(h)(3)(ii), 3.212(a)(2),
3.212(b)(1)(iii)(C), 3.212(b)(3), 3.215(c)(1), 3.215(d)(1)(i),
3.221(a), 3.221(c)(2)(iii), 3.221(3), 3.223(a)(1), and
3.224(d)(3)(iii)--1,200.
Sections 3.204(g)(1)(iii), 3.212(b)(2), and 3.212(c)--300.
Section 3.224(d)(3)(ii)--2.
Recordkeeping
Section 3.203(a)(1)--96.
Section 3.203(a)(2)--16.
Section 3.203(b)(2)--16.
Sections 3.203(c), 3.203(h), 3.208(h)(1)(ii)(B), and
3.214(b)(7)(iv),(vi), and (vii)--96.
Section 3.203(e)(1)--12.
Section 3.203(e)(3)--12.
Section 3.203(f)--12.
Section 3.203(g)--12.
Sections 3.203(h)(2)(i)--80.
Section 3.203(h)(2)(ii)--12.
Sections 3.203(i) and 3.205(h)--48.
Sections 3.213--128.
Section 3.214(b)(7)(v)--12.
Section 3.217(c)--40.
Section 3.220(b)--40.
Sections 3.223(b)(4), 3.223(b)(7), and 3.223(b)(9),--40.
Section 3.223(b)(10)--12.
Disclosure
Section 3.217(d)--12.
Section 3.217(e)--12.
Sections 3.217(f)(1) and 3.217(f)(3)--16.
Section 3.217(f)(2)--8.
Estimated annual burden hours: 127,254.
Board
Collection identifier: FR 4201.
OMB control number: 7100-0314.
Frequency: Quarterly, annually, weekly, event-generated.
Affected Public: Businesses or other for-profit.
Respondents: Bank holding companies, savings and loan holding
companies, intermediate holding companies, and state member banks that
meet certain risk thresholds.
Estimated number of respondents: 33.
Estimated average hours per response:
Reporting
Sections 217.201(b)(5)(i) and (ii), 217.202 Market risk covered
position (1)(ii)(A)(2), 217.204(d)(1), 217.204(d)(3)(i), 217.204(e)(1),
217.204(e)(2)(v), 217.204(e)(3), 217.204(g)(2), 217.204(g)(4),
217.205(f)(1)(ii), 217.205(h)(1)(ii)(B), 217.205(h)(1)(ii)(A)(3),
217.207(a)(3), (4), and (5), 217.207(a)(8), 217.208(b)(4),
217.208(h)(3)(ii), 217.212(a)(2), 217.212(b)(1)(iii)(C), 217.212(b)(3),
217.215(c)(1), 217.215(d)(1)(i), 217.221(a), 217.221(c)(2)(iii),
217.221(3), 217.223(a)(1), and 217.224(d)(3)(iii)--1,200.
Sections 217.204(g)(1)(iii), 217.212(b)(2), and 217.212(c)--300.
Section 217.224(d)(3)(ii)--2.
Recordkeeping
Section 217.203(a)(1)--96.
Section 217.203(a)(2)--16.
Section 217.203(b)(2)--16.
Sections 217.203(c), 217.203(h), 217.208(h)(1)(ii)(B), and
217.214(b)(7)(iv), (vi), and (vii)--96.
Section 217.203(e)(1)--12.
Section 217.203(e)(3)--12.
Section 217.203(f)--12.
Section 217.203(g)--12.
Section 217.203(h)(2)(i)--80.
Section 217.203(h)(2)(ii)--12.
Sections 217.203(i) and 217.205(h)--48.
Sections 217.213--128.
Section 217.214(b)(7)(v)--12.
Section 217.217(c)--40.
Section 217.220(b)--40.
Sections 217.223(b)(4), 217.223(b)(7), and 217.223(b)(9)--40.
Section 217.223(b)(10)--12.
Disclosure
Section 217.217(d)--12.
Section 217.217(e)--12.
Sections 217.217(f)(1) and 217.217(f)(3)--16.
Section 217.217(f)(2)--8.
Estimated annual burden hours: 89,622.
FDIC
OMB control number: 3064-0178.
Frequency: Quarterly, annually, weekly, event-generated.
Affected Public: Businesses or other for-profit.
Respondents: State nonmember banks, state savings associations, and
certain subsidiaries of those entities.
Estimated number of respondents: 9.
Estimated average hours per response:
Reporting
Sections 324.201(b)(5)(i) and (ii), 324.202 Market risk covered
position (1)(ii)(A)(2).
Sections 324.204(d)(1), 324.204(d)(3)(i), 324.204(e)(1),
324.204(e)(2)(v), 324.204(e)(3), 324.204(g)(2), 324.204(g)(4),
324.205(f)(1)(ii), 324.205(h)(1)(ii)(B), 324.205(h)(1)(ii)(A)(3),
324.207(a)(3), (4), and (5),
Sections 324.207(a)(8), 324.208(b)(4), 324.208(h)(3)(ii),
324.212(a)(2), 324.212(b)(1)(iii)(C), 324.212(b)(3), 324.215(c)(1),
324.215(d)(1)(i), 324.221(a), 324.221(c)(2)(iii), 324.221(3),
324.223(a)(1), and 324.224(d)(3)(iii)--1,200.
Sections 324.204(g)(1)(iii), 324.212(b)(2), and 324.212(c)--300.
Section 324.224(d)(3)(ii)--2.
Recordkeeping
Section 324.203(a)(1)--96.
Section 324.203(a)(2)--16.
Section 324.203(b)(2)--16.
Sections 324.203(c), 324.203(h), 324.208(h)(1)(ii)(B), and
324.214(b)(7)(iv), (vi), and (vii)--96.
Section 324.203(e)(1)--12.
Section 324.203(e)(3)--12.
Section 324.203(f)--12.
Section 324.203(g)--12.
Sections 324.203(h)(2)(i)--80.
Section 324.203(h)(2)(ii)--12.
Sections 324.203(i) and 324.205(h)--48.
Sections 324.213--128.
Section 324.214(b)(7)(v)--12.
Section 324.217(c)--40.
Section 324.220(b)--40.
Sections 324.223(b)(4), 324.223(b)(7), and 324.223(b)(9)--40.
Section 324.223(b)(10)--12.
Disclosure
Section 324.217(d)--12.
Section 324.217(e)--12.
Sections 324.217(f)(1) and 324.217(f)(3)--16.
Section 324.217(f)(2)--8.
Estimated annual burden hours: 22,370.
Current Actions: The agencies are proposing to amend their market
risk information collections to reflect the proposed recordkeeping,
disclosure, and reporting requirements associated with the proposed
market risk capital requirements. In addition, the agencies are
proposing to add recordkeeping requirements to this information
collection associated with the proposed credit valuation adjustment.
Under the proposal, a banking organization that is subject to the
proposed market risk capital requirements would have to provide public
regulatory reports in the manner and form prescribed by its primary
Federal supervisor, including any additional information and reports
that the supervisor may require. A banking organization would have to
receive a prior written approval of its primary Federal supervisor for
calculating market risk capital requirements using
[[Page 64177]]
internal models. Section __.212(b)(2)(i) of the market risk rule
requires a banking organization that is subject to the market risk
capital requirements to obtain the prior written approval of the
primary Federal supervisor before using any internal model to calculate
its risk-based capital requirements.
Any such banking organization that received a prior written
approval from its primary Federal supervisor to calculate market risk
capital requirements under the models-based measure would have to
provide confidential supervisory reports to its primary Federal
supervisor in a manner and form prescribed by that supervisor.
Specifically, under the proposal, a banking organization using the
models-based measure to calculate market risk capital requirements
would be required to submit, via confidential regulatory reporting in
the manner and form prescribed by the primary Federal supervisor, data
pertaining to a trading desk's backtesting and PLA testing results. To
reflect the proposed changes to the market risk framework, the proposal
would require a banking organization to submit backtesting information
at both the aggregate level for model-eligible trading desks as well as
for each trading desk and profit and loss attribution (PLA) testing
information for model-eligible trading desks at the trading desk level
on a quarterly basis. Section __.203(h)(1) of the market risk rule
requires that a subject banking organization demonstrate to the
satisfaction of the primary Federal supervisor a comprehensive
understanding of the features of a securitization position that would
materially affect the performance of the position by conducting and
documenting the analysis set forth in Sec. __.203(h)(2).
The proposal would also include recordkeeping requirements for
banking organizations subject to the credit valuation adjustment. Those
include that a banking organization must (1) have a clear documented
hedging policy for credit valuation adjustment (CVA) risk, (2) document
identification and management of CVA risk covered positions and
eligible CVA hedges, (3) document the initial and ongoing validation of
models used for calculating regulatory CVA, and (4) maintain current
and historical data inputs to exposure models.
Disclosure requirements related to the proposed CVA are included in
section __.162, which would be part of subpart E of Regulation Q.
Therefore, those requirements are included in the Reporting,
Recordkeeping, and Disclosure Requirements Associated with Regulatory
Capital Rules information collections.
2. Proposed Revisions, With Extension, of the Following Information
Collections (Board Only)
a. (1) Collection Title: Financial Statements for Holding Companies
Collection identifier: FR Y-9C, FR Y-9LP, FR Y-9SP, FR Y-9ES, and
FR Y-9CS.
OMB control number: 7100-0128.
General description of report: The FR Y-9 family of reporting forms
continues to be the primary source of financial data on holding
companies (HCs) on which examiners rely between on-site inspections.
Financial data from these reporting forms is used to detect emerging
financial problems, review performance, conduct pre-inspection
analysis, monitor and evaluate capital adequacy, evaluate HC mergers
and acquisitions, and analyze an HC's overall financial condition to
ensure the safety and soundness of its operations. The FR Y-9C, FR Y-
9LP, and FR Y-9SP serve as standardized financial statements for the
consolidated HC. The Board requires HCs to provide standardized
financial statements to fulfill the Board's statutory obligation to
supervise these organizations. The FR Y-9ES is a financial statement
for HCs that are Employee Stock Ownership Plans. The Board uses the FR
Y-9CS (a free-form supplement) to collect additional information deemed
to be critical and needed in an expedited manner. HCs file the FR Y-9C
on a quarterly basis, the FR Y-9LP quarterly, the FR Y-9SP
semiannually, the FR Y-9ES annually, and the FR Y-9CS on a schedule
that is determined when this supplement is used.
Frequency: Quarterly, semiannually, and annually.
Affected Public: Businesses or other for-profit.
Respondents: Bank holding companies (BHCs), savings and loan
holding companies (SLHCs), securities holding companies (SHCs), and
U.S. Intermediate Holding Companies (IHCs) (collectively, holding
companies (HCs)).
Total estimated number of respondents:
Reporting
FR Y-9C (non-advanced approaches holding companies with less than
$5 billion in total assets): 107; FR Y-9C (non-advanced approaches with
$5 billion or more in total assets) 236; FR Y-9C (advanced approached
holding companies): 9; FR Y-9LP: 411; FR Y-9SP: 3,596; FR Y-9ES: 73; FR
Y-9CS: 236.
Recordkeeping
FR Y-9C: 352; FR Y-9LP: 411; FR Y-9SP: 3,596; FR Y-9ES: 73; FR Y-
9CS: 236.
Total estimated average hours per response:
Reporting
FR Y-9C (non-advanced approaches holding companies with less than
$5 billion in total assets): 35.34; FR Y-9C (non-advanced approaches
holding companies with $5 billion or more in total assets): 44.59, FR
Y-9C (advanced approached holding companies): 49.81; FR Y-9LP: 5.27; FR
Y-9SP: 5.45; FR Y-9ES: 0.50; FR Y-9CS: 0.50.
Recordkeeping
FR Y-9C: 1; FR Y-9LP: 1; FR Y-9SP: 0.50; FR Y-9ES: 0.50; FR Y-9CS:
0.50.
Total estimated change in burden: 49.
Total estimated annual burden hours: 114,538.
Current Actions: The Board is proposing to amend the FR Y-9C report
form and instructions to align with the proposal. The Board proposes to
revise Schedule HC-R, Part I, Regulatory Capital Components and Ratios,
to align, subject to certain transition provisions, the calculation of
regulatory capital for HCs subject to Category III and IV standards
with the calculation for HCs subject to Category I and II standards.
The Board proposes to make updates to Schedule HC-R, Part I, Line item
60, a, b and c to apply the stress capital buffer requirement to the
risk-based capital ratios derived from the expanded risk-based
approach, in addition to the standardized approach, as described in the
proposal. Additionally, the Board proposes to add one new memorandum
item to Schedule HC-D, Trading Assets and Liabilities, to capture
information about customer and proprietary reserve balances of broker-
dealers for purposes of determining the market-risk rule applicability
and revise Schedule HC-R, Part II, line item 27 to conform to changes
under the Board's market risk rule proposal. The Board would also apply
other minor conforming edits to the FR Y-9C report. The revisions are
proposed to be effective for the September 30, 2025, as of date.
The Board estimates that revisions to the FR Y-9C would increase
the estimated annual burden by 49 hours. The respondent count for the
FR Y-9C would not change because of these changes. The draft reporting
forms and instructions are available on the Board's public website at
https://www.federalreserve.gov/apps/reportingforms.
[[Page 64178]]
b. (2) Collection Title: Capital Assessments and Stress Test Reports
Collection identifier: FR Y-14A/Q/M.
OMB control number: 7100-0341.
General description of report: This family of information
collections is composed of the following three reports:
The annual FR Y-14A collects quantitative projections of
balance sheet, income, losses, and capital across a range of
macroeconomic scenarios and qualitative information on methodologies
used to develop internal projections of capital across scenarios.\488\
---------------------------------------------------------------------------
\488\ In certain circumstances, a firm may be required to re-
submit its capital plan. See 12 CFR 225.8(e)(4); 12 CFR
238.170(e)(4). Firms that must re-submit their capital plan
generally also must provide a revised FR Y-14A in connection with
their resubmission.
---------------------------------------------------------------------------
The quarterly FR Y-14Q collects granular data on various
asset classes, including loans, securities, trading assets, and pre-
provision net revenue (PPNR) for the reporting period.
The monthly FR Y-14M is comprised of three retail
portfolio- and loan-level schedules, and one detailed address-matching
schedule to supplement two of the portfolio- and loan-level schedules.
The data collected through the FR Y-14A/Q/M reports (FR Y-14
reports) provide the Board with the information needed to help ensure
that large firms have strong, firm[hyphen]wide risk measurement and
management processes supporting their internal assessments of capital
adequacy and that their capital resources are sufficient, given their
business focus, activities, and resulting risk exposures. The data
within the reports are used to set firms' stress capital buffer
requirements. The data are also used to support other Board supervisory
efforts aimed at enhancing the continued viability of large firms,
including continuous monitoring of firms' planning and management of
liquidity and funding resources, as well as regular assessments of
credit risk, market risk, and operational risk, and associated risk
management practices. Information gathered in this data collection is
also used in the supervision and regulation of respondent financial
institutions. Respondent firms are currently required to complete and
submit up to 17 filings each year: one annual FR Y-14A filing, four
quarterly FR Y-14Q filings, and 12 monthly FR Y-14M filings. Compliance
with the information collection is mandatory.
Frequency: Annually, quarterly, and monthly.
Affected Public: Businesses or other for-profit.
Respondents: These collections of information are applicable to
bank holding companies (BHCs), U.S. intermediate holding companies
(IHCs), and covered savings and loan holding companies (SLHCs) with
$100 billion or more in total consolidated assets, as based on: (i) the
average of the firm's total consolidated assets in the four most recent
quarters as reported quarterly on the firm's Consolidated Financial
Statements for Holding Companies (FR Y-9C); or (ii) if the firm has not
filed an FR Y-9C for each of the most recent four quarters, then the
average of the firm's total consolidated assets in the most recent
consecutive quarters as reported quarterly on the firm's FR Y-9C.
Reporting is required as of the first day of the quarter immediately
following the quarter in which the respondent meets this asset
threshold, unless otherwise directed by the Board.
Estimated number of respondents: FR Y-14A/Q: 36; FR Y-14M: 34;
\489\ FR Y-14 On-going Automation Revisions: 36; FR Y-14 Attestation
On-going: 8.
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\489\ The estimated number of respondents for the FR Y-14M is
lower than for the FR Y-14Q and FR Y-14A because, in recent years,
certain respondents to the FR Y-14A and FR Y-14Q have not met the
materiality thresholds to report the FR Y-14M due to their lack of
mortgage and credit activities. The Board expects this situation to
continue for the foreseeable future.
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Estimated average hours per response: FR Y-14A: 1,341; FR Y-14Q:
2,002; FR Y-14M: 1,071; FR Y-14 On-going Automation Revisions: 480; FR
Y-14 Attestation On-going: 2,560.
Estimated annual burden hours: FR Y-14A: 48,276; FR Y-14Q: 288,288;
FRY-14M: 436,968; FR Y-14 On-going Automation Revisions: 17,280; FR Y-
14 Attestation On-going: 20,480.
Current actions: The Board proposes several conforming revisions to
the FR Y-14A/Q/M reports based on the proposed rule. Specifically, the
Board proposes revisions related to capital, operational risk, and
credit risk mitigation. All revisions are proposed to be effective for
the July 31, 2025, as of date for the FR Y-14M, the September 30, 2025,
as of date for the FR Y-14Q, and the December 31, 2025, as of date for
the FR Y-14A.
Capital
Capital Ratios and Buffers
Banking organizations subject to Category I, II, or III standards
are required to project capital ratios and capital buffer requirements
assuming various scenarios under the generally applicable standardized
approach on FR Y-14A, Schedule A (Summary). Under the proposed rule, a
banking organization subject to Category I, II, III or IV standards
would be required to calculate its risk-based capital ratios under both
the new expanded risk-based approach and the current, generally
applicable standardized approach, and the lower of the two for each
ratio would be binding. In addition, all capital buffer requirements,
including the stress capital buffer, would apply regardless of whether
the expanded risk-based approach or the existing standardized approach
produces the binding ratio.
Since the binding capital ratios could be based on either the
standardized approach or the expanded risk-based approach, banking
organizations would be required to calculate both version of capital
ratios and capital buffers under the proposed rule. To allow banking
organizations to report values using either calculation method, the
Board proposes to revise FR Y-14A, Schedule A.1.d (Capital) to require
banking organizations subject to Category I, II, or III standards to
report certain items depending on which common equity tier 1 ratio is
binding as of the report date. Specifically, banking organizations
subject to Category I, II, or III standards that are also subject to
the expanded risk-based approach would be required to report the
following items if the common equity tier 1 ratio for a banking
organization under the expanded risk-based approach is binding as of
the report date:
Item 55 (Adjusted allowance for credit losses includable
in tier 2 capital);
[cir] As described in the preamble, the concept of eligible credit
reserves includable in tier 2 capital would be replaced by adjusted
allowance for credit losses includable in tier 2 capital for banking
organizations subject to the expanded risk-based approach. Therefore,
the Board proposes to revise item 55 to capture the adjusted allowance
for credit losses includable in tier 2 capital.
Item 58 (Expanded risk-based approach: Tier 2 capital
before deductions);
Item 59.b (Expanded risk-based approach: Tier 2 capital
deductions);
Item 61 (Expanded risk-based approach: Tier 2 capital);
Item 63 (Expanded risk-based approach: Total capital (sum
of items 50 and 61));
Item 95 (Expanded risk-based approach: Total Capital);
Item 97 (Total risk-weighted assets using expanded risk-
based approach);
[[Page 64179]]
Item 101 (Expanded risk-based approach: Common Equity Tier
1 Ratio (%));
Item 103 (Expanded risk-based approach: Tier 1 Capital
Ratio (%)); and
Item 105 (Expanded risk-based approach: Total risk-based
capital ratio (%)).
The items listed above are currently on the reporting form but are
not required to be submitted since banking organizations are not
required to project values calculated under the advanced approaches
framework. The Board is proposing to activate these items and remove
references to advanced approaches firms that exit parallel run from the
descriptions of the items, as well as to any other items that may refer
to the advanced approaches framework. Banking organizations would not
report these items if the common equity tier 1 ratio under the
standardized approach is binding as of the report date.
If a banking organization reports the items listed above, then it
would not be required to report the following items, which would only
be required if the common equity tier 1 ratio for a banking
organization under the standardized approach is binding as of the
report date:
Item 54 (Allowance for loan and lease losses includable in
tier 2 capital);
Item 57 (Tier 2 capital before deductions);
Item 59.a (Tier 2 capital deductions);
Item 60 (Tier 2 capital);
Item 62 (Total capital);
Item 94 (Total capital);
Item 96 (Total risk-weighted assets using standardized
approach);
Item 100 (Common Equity Tier 1 Ratio (%));
Item 102 (Tier 1 Capital Ratio (%)); and
Item 104 (Total risk-based capital ratio (%)).
The Board also proposes to remove language from the instructions
for Schedule A.1.d stating the banking organizations are not required
to project values calculated under the advanced approaches framework.
In addition, the Board proposes to allow the three items listed
below on Schedule A.1.d to be reported using the expanded risk-based
approach or the standardized approach, instead of only the standardized
approach, as currently required:
Item 134 (Maximum Payout Ratio);
Item 135 (Minimum Payout Amount); and
Item 146(a) (TLAC risk-weighted asset buffer).
The Board proposes to specify that these items be reported in the
same manner (i.e., using either the expanded risk-based approach or the
standardized approach) as the corresponding item on FR Y-9C, Schedule
HC-R (Regulatory Capital), Part I (Regulatory Capital Components and
Ratios).
Further, to ensure that applicable banking organizations remain in
compliance with distribution limitations, the Board is also proposing
to require banking organizations subject to the expanded risk-based
approach, which would include firms subject to Category IV standards,
to report the expanded risk-based approach versions of the common
equity tier 1 capital ratio, tier 1 capital ratio, and total capital
ratio, on FR Y-14A, Schedule C (Regulatory Capital Instruments) if the
expanded risk-based approach is binding for the common equity tier 1
capital ratio as of the report date. Banking organizations subject to
the expanded risk-based approach would continue to report the
standardized approach versions of these ratios if the standardized
approach is binding for the common equity tier 1 capital ratio as of
the report date.
Accumulated Other Comprehensive Income (AOCI)
Under the Board's regulatory capital rule, a banking organization
that is not subject to Category I or II standards was provided an
opportunity to make a one-time election to opt out of recognizing most
elements of AOCI and related deferred tax assets (DTAs) and deferred
tax liabilities (DTLs) in regulatory capital. Applicable banking
organizations are required to report the result of this decision on FR
Y-14A, Schedule A.1.d, item 18 (``AOCI opt-out election''). As
described in the proposed rule, banking organizations subject to
Category III and IV standards would be required to include all AOCI
components in common equity tier 1 capital elements, except gains and
losses on cash-flow hedges where the hedged item is not recognized on a
banking organization's balance sheet at fair value. As a result, the
Board is proposing to revise the instructions for item 18 to eliminate
the opt-out option for banking organizations subject to the proposed
expanded risk-based standards.
Regulatory Capital Deductions
Currently, a banking organization subject to Category I or II
standards has different regulatory capital deduction thresholds than a
banking organization subject to Category III or IV standards. Deducted
amounts are reported across various items on FR Y-14A, Schedule A.1.d
and FR Y-14Q, Schedule D (Regulatory Capital). As described in the
proposed rule, a banking organization subject to Category III and
Category IV standards would have the same deduction thresholds as
banking organization subject to Category I and II standards. For
alignment purposes, the Board proposes to revise applicable items on
Schedule A.1.d and Schedule D to specify which deduction thresholds
apply to banking organizations subject to expanded risk-based
standards.
General RWAs
Banking organizations subject to the advanced approaches framework
are required to report the RWA amount based on the internal ratings-
based (IRB) capital formula in Schedule A.1 (International Auto Loan)
and Schedule A.2 (US Auto Loan) of the FR Y-14Q. Since the Board is
proposing to remove the IRB approach from the capital rule, the Board
is also proposing to replace the reference to IRB on Schedules A.1 and
A.2, and to specify that banking organizations subject to expanded
risk-based standards should calculate RWAs as specified in the capital
rule on Schedules A.1 and A2.
Market Risk RWAs
As described in the preamble, the Board is proposing to introduce
two methodologies for calculating market risk RWAs: the standardized
measure and the models-based measure. A firm must receive approval from
its primary Federal supervisor to calculate the market risk capital
requirements under the models-based measure. If a firm has certain
trading desks that do not meet eligibility requirements for the
internal models approach, then the proposal would impose the
standardized measure for the ineligible trading desks.
The Board is proposing several revisions to market risk RWAs in the
proposed rule. To align with the proposed rule, the Board proposes to
replace the existing market risk RWA items (items 24 through 40) on FR
Y-14A, Schedule A.1.c.1 (Standardized RWA) with thirty-five items that
cover six categories under the standardized measure. These categories
would be:
Delta Capital Requirements;
Vega Capital Requirements;
Curvature Capital Requirements;
Default Risk Capital Requirements;
Residual Risk Add-on Components; and
Capital Add-ons.
The granularity of the proposed items would align with the
revisions described in the proposed rule and would provide the Board
with insight into the drivers of market risk RWAs, facilitating
understanding of how
[[Page 64180]]
changes in the projections of distinct exposure types contribute to
overall changes in market risk RWAs over the projection horizon. In
addition, to further increase insight into a banking organization's
market risk RWAs for those banking organizations that received approval
to calculate market risk capital requirements under the models-based
measure, the Board proposes to add items to capture total standardized
RWAs for model-ineligible trading desks and total RWAs under the
models-based measure for model-eligible trading desks that are
approved. All proposed market risk RWA items would only be reported by
firms subject to the market risk rule.
Operational Risk
The Board proposes several revisions to FR Y-14Q, Schedule E
(Operational Risk) to align with the changes described in the proposed
rule. Although the revisions described only apply to banking
organizations subject to expanded risk-based standards, for data
consistency and comparability purposes, the Board is proposing that the
operational risk revisions apply to all banking organizations that file
Schedule E.
Loss Events
The Board would make several revisions to the definition of
``operational loss'' and ``operational loss event'' in the proposed
rule. The instructions for Schedule E define an operational loss as a
financial loss resulting from an operational loss event, which is
defined as an event that is associated with any of the seven
operational loss event type categories:
Internal Fraud;
External Fraud;
Employment Practices and Workplace Safety;
Clients, Products, and Business Practices;
Damage to Physical Assets;
Business Disruption and System Failures; and
Execution, Delivery, and Process Management.
The seven event type categories are further defined in Table E.1.a
(Level 1 and Level 2 Event-Types). For congruency, the Board proposes
to align the definitions of ``operational loss'', ``operational loss
event,'' and the seven operational loss event type categories in
Schedule E.1 with the proposed definitions specified in the rule.
Banking organizations can currently report their operational loss
events on FR Y-14Q, Schedule E.1 (Operational Loss History) at the
event level (i.e., one single row for each operational loss event) or
at the impact level (i.e., across several rows, with each row
corresponding to a unique expense incurred at a certain point in time).
As described in the proposed rule, the calculation of annual net
operational losses would be based on a ten-year average. To ensure that
the Board can adequately capture losses over this timespan, the Board
proposes to require banking organizations to report loss events at the
impact level when a loss event involves more than one expense that
occurs over time. The Board proposes to further clarify that the
reported accounting date for loss events should be specific to each
impact and reflect the date the financial loss associated with the
impact was recorded on the banking organization's financial statements.
Timing Losses
Banking organizations are required to exclude timing losses from
Schedule E.1. Timing losses are operational risk events that cause a
temporary distortion of a banking organization's financial statements
in a particular financial reporting period but that can be fully
corrected when later discovered (e.g., revenue overstatement,
accounting, and mark-to-market errors). Since the Board is proposing to
have timing losses be considered operational losses, the Board also
proposes to revise the instructions for Schedule E.1. to require that
timing losses be reported. To clearly identify timing losses, the Board
proposes to add the ``Timing event flag'' item to Schedule E.1.
Loss Threshold
The instructions for Schedules E.1 and E.4 (Threshold Information)
do not require that banking organizations provide an explicit dollar
threshold for collecting and reporting operational loss events. Rather,
banking organizations are required to submit a complete history of
operational losses at and above the institution's established
collection threshold(s). As described in the proposed rule, a banking
organization would be required to include a loss event of $20,000 or
more on a net basis in its capital calculation. Given this, the Board
also proposes to specify that each banking organization's collection
and reporting threshold on Schedules E.1 and E.4 should be no greater
than $20,000 on a nominal and net loss basis (inclusive of non-
insurance recoveries).
Insurance Recoveries
Banking organizations are required to exclude insurance recoveries
from the ``Recovery Amount ($USD))'' item in Schedule E.1. Since the
Board is proposing to include insurance recoveries as part of the
internal loss multiplier calculation, the Board is also proposing to
add the ``Insurance Recovery Amount ($USD))'' item to Schedule E.1. To
avoid double counting of insurance recoveries, the Board proposes to
rename the ``Recovery Amount ($USD))'' item as ``Non-Insurance Recovery
Amount ($USD)),'' and to specify that only non-insurance recoveries are
reported in this item.
Credit Risk Mitigation
Banking organizations subject to the advanced approaches framework
report probability of default (PD), loss given default (LGD), expected
loss given default (ELGD), and exposure at default (EAD) values on FR
Y-14Q, Schedule A (Retail) and Schedule H (Wholesale), as well as FR Y-
14M, Schedule A (First Lien), Schedule B (Home Equity), and Schedule D
(Credit Card), calculated as specified in the Board's capital rule. On
Schedule H, these banking organizations report the advanced internal
ratings-based (IRB) parameter estimates for PD, LGD, and EAD. Since the
Board is proposing to revise the calculation of these values in the
capital rule as described in the proposal, the Board proposes to revise
FR Y-14Q, Schedules A and H, as well as FR Y-14M, Schedules A, B, and
D, to specify that banking organizations subject to expanded risk-based
standards should report PD, LGD, ELGD, and EAD items as specified in
the Board's capital rule, calculated as proposed. The Board is also
proposing to remove references to the IRB approach in Schedule H, and
to instead require banking organizations subject to expanded risk-based
standards to calculate PD, LGD, and EAD as described in the Board's
capital rule.
c. (3) Collection Title: Systemic Risk Report
Collection identifier: FR Y-15.
OMB control number: 7100-0352.
General description of report: The FR Y-15 quarterly report
collects systemic risk data from U.S. bank holding companies and
covered savings and loan holding companies with total consolidated
assets of $100 billion or more, any U.S.-based bank holding company
designated as a GSIB that does not meet the consolidated assets
threshold, and foreign banking organizations with $100 billion or more
in combined U.S. assets. The Board uses the FR Y-15 data to monitor, on
an ongoing basis, the systemic risk profile of subject institutions. In
addition, the FR Y-15 is used to (1) facilitate the
[[Page 64181]]
implementation of the GSIB capital surcharge under the capital rule,
(2) identify other institutions that may present significant systemic
risk, and (3) analyze the systemic risk implications of proposed
mergers and acquisitions.
Frequency: Quarterly.
Affected Public: Businesses or other for-profit.
Respondents: Top tier U.S. bank holding companies and covered
savings and loan holding companies with $100 billion or more in total
consolidated assets, any U.S.-based bank holding company designated as
a GSIB that does not meet that consolidated assets threshold, and
foreign banking organizations with combined U.S. assets of $100 billion
or more.
Estimated number of respondents: 53.
Estimated average hours per response: Reporting--49.8 hours;
Recordkeeping--0.25 hours.
Estimated annual burden hours: Reporting--10,558 hours; \490\
Recordkeeping--53 hours.
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\490\ This estimated total annual burden reflects adjustments
that have been made to the Board's burden methodology for the FR Y-
15 that provide a more consistent estimate of respondent burden
across different regulatory reports.
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Current Actions: The Board is proposing to amend the FR Y-15 form
and instructions to align with the proposed capital rule. As discussed
in section III.C.3.b of this Supplementary Information section, under
the proposal, a 40 percent credit conversion factor would apply to
commitments that are not unconditionally cancelable commitments for
purposes of calculating total leverage exposure for the supplementary
leverage ratio. The Board is proposing to make a conforming revision to
the FR Y-15 to align the reporting of data for the total exposures
systemic indicator with this change. The revisions are proposed to be
effective for the September 30, 2025, as of date.
The Board estimates that revisions to the FR Y-15 would increase
the estimated annual burden by 56 hours. The respondent count for the
FR Y-15 would not change because of these changes. The draft reporting
forms and instructions are available on the Board's public website at
https://www.federalreserve.gov/apps/reportingforms.
B. Regulatory Flexibility Act
OCC
The Regulatory Flexibility Act (RFA), 5 U.S.C. 601 et seq.,
requires an agency, in connection with a proposed rule, to prepare an
Initial Regulatory Flexibility Analysis describing the impact of the
rule on small entities (defined by the Small Business Administration
(SBA) for purposes of the RFA to include commercial banks and savings
institutions with total assets of $850 million or less and trust
companies with total assets of $47 million or less) or to certify that
the proposed rule would not have a significant economic impact on a
substantial number of small entities. The OCC currently supervises
approximately 661 small entities.\491\
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\491\ The OCC bases its estimate of the number of small entities
on the Small Business Administration's size standards for commercial
banks and savings associations, and trust companies, which are $850
million and $47 million, respectively. Consistent with the General
Principles of Affiliation 13 CFR 121.103(a), the OCC counts the
assets of affiliated banks when determining whether to classify an
OCC-supervised bank as a small entity. The OCC used December 31,
2022, to determine size because a ``financial institution's assets
are determined by averaging the assets reported on its four
quarterly financial statements for the preceding year.'' See, FN 8
of the U.S. Small Business Administration's Table of Size Standards.
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The OCC estimates that the proposed rule would impact none of these
small entities, as the scope of the rule only applies to banking
organizations with total assets of at least $100 billion or banking
organizations with significant trading activity. Therefore, the OCC
certifies that the proposed rule would not have a significant economic
impact on a substantial number of small entities.
Board
The Board is providing an initial regulatory flexibility analysis
with respect to this proposed rule. The Regulatory Flexibility Act
\492\ (``RFA''), requires an agency to consider whether the rule it
proposes will have a significant economic impact on a substantial
number of small entities.\493\ In connection with a proposed rule, the
RFA requires an agency to prepare and invite public comment on an
initial regulatory flexibility analysis describing the impact of the
rule on small entities, unless the agency certifies that the proposed
rule, if promulgated, will not have a significant economic impact on a
substantial number of small entities. An initial regulatory flexibility
analysis must contain (1) a description of the reasons why action by
the agency is being considered; (2) a succinct statement of the
objectives of, and legal basis for, the proposed rule; (3) a
description of, and, where feasible, an estimate of the number of small
entities to which the proposed rule will apply; (4) a description of
the projected reporting, recordkeeping, and other compliance
requirements of the proposed rule, including an estimate of the classes
of small entities that will be subject to the requirement and the type
of professional skills necessary for preparation of the report or
record; (5) an identification, to the extent practicable, of all
relevant Federal rules which may duplicate, overlap with, or conflict
with the proposed rule; and (6) a description of any significant
alternatives to the proposed rule which accomplish the stated
objectives of applicable statutes and minimize any significant economic
impact of the proposed rule on small entities.\494\
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\492\ 5 U.S.C. 601 et seq.
\493\ Under regulations issued by the Small Business
Administration (``SBA''), a small entity includes a depository
institution, bank holding company, or savings and loan holding
company with total assets of $850 million or less. See 13 CFR
121.201. Consistent with the SBA's General Principles of
Affiliation, the Board includes the assets of all domestic and
foreign affiliates toward the applicable size threshold when
determining whether to classify a particular entity as a small
entity. See 13 CFR 121.103. As of December 31, 2022, there were
approximately 2081 small bank holding companies, approximately 88
small savings and loan holding companies, and approximately 427
small state member banks.
\494\ 5 U.S.C. 603(b)-(c).
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The Board has considered the potential impact of the proposed rule
on small entities in accordance with the RFA. Based on its analysis and
for the reasons stated below, the Board believes that this proposed
rule will not have a significant economic impact on a substantial
number of small entities. Nevertheless, the Board is publishing and
inviting comment on this initial regulatory flexibility analysis. The
proposal would also make corresponding changes to the Board's reporting
forms.
As discussed in detail in sections I through VII of this
Supplementary Information, the proposed rule would substantially revise
the capital requirements applicable to large banking organizations and
to banking organizations with significant trading activity. The
revisions set forth in the proposal would improve the calculation of
risk-based capital requirements to better reflect the risks of these
banking organizations' exposures, reduce the complexity of the
framework, enhance the consistency of requirements across these banking
organizations, and facilitate more effective supervisory and market
assessments of capital adequacy. The revisions would include replacing
current requirements that include the use of banking organizations'
internal models for credit risk and operational risk with standardized
approaches and replacing the current market risk and credit valuation
adjustment risk requirements with revised approaches. The proposed
revisions are being
[[Page 64182]]
considered due to, and would be generally consistent with, recent
changes to international capital standards issued by the Basel
Committee on Banking Supervision.
The Board has broad authority under the International Lending
Supervision Act (``ILSA'') \495\ and the prompt corrective action
(``PCA'') provisions of the Federal Deposit Insurance Act \496\ to
establish regulatory capital requirements for the institutions it
regulates. For example, ILSA directs each Federal banking agency to
cause banking institutions to achieve and maintain adequate capital by
establishing minimum capital requirements as well as by other means
that the agency deems appropriate.\497\ The PCA provisions of the
Federal Deposit Insurance Act direct each Federal banking agency to
specify, for each relevant capital measure, the level at which an
insured depository institution subsidiary is well capitalized,
adequately capitalized, undercapitalized, and significantly
undercapitalized.\498\ In addition, the Board has broad authority to
establish regulatory capital standards for bank holding companies,
savings and loan holding companies, and U.S. intermediate holding
companies of foreign banking organizations under the Bank Holding
Company Act, the Home Owners' Loan Act, and the Dodd-Frank Reform and
Consumer Protection Act (``Dodd-Frank Act'').\499\
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\495\ 12 U.S.C. 3901-3911.
\496\ 12 U.S.C. 1831o.
\497\ 12 U.S.C. 3907(a)(1).
\498\ 12 U.S.C. 1831o(c)(2).
\499\ See 12 U.S.C. 1467a, 1844, 5365, 5371.
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As discussed in more detail in section II of the Supplementary
Information, the proposed rule would apply to banking organizations
with total assets of $100 billion or more and their subsidiary
depository institutions, as well as to banking organizations with
significant trading activity. Under the proposed rule, a banking
organization with significant trading activity would include any
banking organization with average aggregate trading assets and trading
liabilities, excluding customer and proprietary broker-dealer reserve
bank accounts, over the previous four calendar quarters equal to $5
billion or more, or equal to 10 percent or more of total consolidated
assets at quarter end as reported on the most recent quarterly
regulatory report. Accordingly, essentially all banking organizations
to which the proposed rule would apply exceed the SBA's $850 million
total asset threshold.
As discussed in more detail in the Paperwork Reduction Act section,
the proposed rule, once final, would require changes to the
Consolidated Financial Statements for Holding Companies report (FR Y-
9C) and the Capital Assessments and Stress Testing reports (FR Y-14A
and FR Y-14Q).
The Board is aware of no other Federal rules that duplicate,
overlap, or conflict with the proposed changes to the capital rule. The
Board also is aware of no significant alternatives to the proposed rule
that would accomplish the stated objectives of applicable statutes.
Because the proposed rule generally would not apply to any small
entities supervised by the Board, there are no alternatives that could
minimize the impact of the proposed rule on small entities.
Therefore, the Board believes that the proposed rule would not have
a significant economic impact on a substantial number of small entities
supervised by the Board.
The Board welcomes comment on all aspects of its analysis. In
particular, the Board requests that commenters describe the nature of
any impact on small entities and provide empirical data to illustrate
and support the extent of the impact.
FDIC
The Regulatory Flexibility Act (RFA) generally requires an agency,
in connection with a proposed rulemaking, to prepare and make available
for public comment an initial regulatory flexibility analysis that
describes the impact of the proposed rule on small entities.\500\
However, an initial regulatory flexibility analysis is not required if
the agency certifies that the proposed rule will not, if promulgated,
have a significant economic impact on a substantial number of small
entities. The Small Business Administration (SBA) has defined ``small
entities'' to include banking organizations with total assets of less
than or equal to $850 million.\501\ Generally, the FDIC considers a
significant economic impact to be a quantified effect in excess of 5
percent of total annual salaries and benefits or 2.5 percent of total
noninterest expenses. The FDIC believes that effects in excess of one
or more of these thresholds typically represent significant economic
impacts for FDIC-supervised institutions. For the reasons described
below, the FDIC certifies that the proposed rule will not have a
significant economic impact on a substantial number of small entities.
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\500\ 5 U.S.C. 601 et seq.
\501\ The SBA defines a small banking organization as having
$850 million or less in assets, where an organization's ``assets are
determined by averaging the assets reported on its four quarterly
financial statements for the preceding year.'' See 86 FR 69118 which
amends 13 CFR 121.201, (effective December 19, 2022.). In its
determination, the ``SBA counts the receipts, employees, or other
measure of size of the concern whose size is at issue and all of its
domestic and foreign affiliates.'' See 13 CFR 121.103. Following
these regulations, the FDIC uses a covered entity's affiliated and
acquired assets, averaged over the preceding four quarters, to
determine whether the covered entity is ``small'' for the purposes
of RFA.
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According to recent Call Reports, there are 3,038 FDIC-supervised
IDIs.\502\ Of these, approximately 2,325 would be considered small
entities for the purposes of RFA.\503\ As of December 31, 2022, there
were 37 top-tier U.S. depository institution holding companies and 62
U.S.-based depository institutions that report risk-based capital
figures and are subject to Category I, II, III, or IV standards.\504\
As of December 31, 2022, the FDIC supervises one institution that is a
subsidiary of a holding company subject to the Category I capital
standards, three institutions that are subsidiaries of holding
companies subject to the Category III capital standards, and five that
are subsidiaries of holding companies subject to the Category IV
standards.\505\ These nine FDIC-supervised institutions that would be
subject to this proposed rule should it be implemented are not
considered small entities for the purposes of the RFA since they are
owned by holding companies with over $850 million in total assets.
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\502\ Call Reports data, December 31, 2022.
\503\ Id.
\504\ On November 1, 2019, the banking agencies established four
risk-based categories in order to tailor requirements under the
agencies' regulatory capital and liquidity rules to banking
organizations with assets of $100 billion or more (84 FR 59230).
These Tailored Categories are defined in 12 CFR part 252 (84 FR
59032). The tailored holding company and depository institutions
counts are based on December 2022 Call Reports, FR Y-9C data, and FR
Y-15 data.
\505\ Counts are based on December 31, 2022 Call Reports, FR Y-
9C data, and FR Y-15 data. Note these counts of FDIC-supervised
institutions include three that are no longer within FDIC's
supervisory scope due to one merger and two failures in 2023. The
counts will be updated for the final rule to account for these
changes.
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As all FDIC-supervised small entities are outside the scope of the
proposed rule none would experience any direct effects, therefore, the
FDIC certifies that the proposed rule, if adopted, would not have a
significant economic effect on a substantial number of small entities.
The FDIC invites comments on all aspects of the supporting
information provided in this RFA section. In particular, would this
proposed rule have any significant effects on small entities that the
FDIC has not identified?
[[Page 64183]]
C. Plain Language
Section 722 of the Gramm-Leach Bliley Act \506\ requires the
Federal banking agencies to use plain language in all proposed and
final rules published after January 1, 2000. The agencies invite
comments on how to make these notices of proposed rulemaking easier to
understand. For example:
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\506\ Public Law 106-102, section 722, 113 Stat. 1338, 1471
(1999).
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Have the agencies presented the material in an organized
manner that meets your needs? If not, how could this material be better
organized?
Are the requirements in the notice of proposed rulemaking
clearly stated? If not, how could the proposed rule be more clearly
stated?
Does the proposed rule contain language that is not clear?
If so, which language requires clarification?
Would a different format (grouping and order of sections,
use of headings, paragraphing) make the proposed rule easier to
understand? If so, what changes to the format would make the proposed
rule easier to understand?
What else could the agencies do to make the proposed rule
easier to understand?
D. Riegle Community Development and Regulatory Improvement Act of 1994
Pursuant to section 302(a) of the Riegle Community Development and
Regulatory Improvement Act (RCDRIA),\507\ in determining the effective
date and administrative compliance requirements for new regulations
that impose additional reporting, disclosure, or other requirements on
IDIs, each Federal banking agency must consider, consistent with the
principle of safety and soundness and the public interest, any
administrative burdens that such regulations would place on depository
institutions, including small depository institutions, and customers of
depository institutions, as well as the benefits of such regulations.
In addition, section 302(b) of RCDRIA requires new regulations and
amendments to regulations that impose additional reporting,
disclosures, or other new requirements on IDIs generally to take effect
on the first day of a calendar quarter that begins on or after the date
on which the regulations are published in final form, with certain
exceptions, including for good cause.\508\
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\507\ 12 U.S.C. 4802(a).
\508\ 12 U.S.C. 4802.
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The agencies note that comment on these matters has been solicited
in other sections of this Supplementary Information section, and that
the requirements of RCDRIA will be considered as part of the overall
rulemaking process. In addition, the agencies also invite any other
comments that further will inform the agencies' consideration of
RCDRIA.
E. OCC Unfunded Mandates Reform Act of 1995 Determination
The OCC has analyzed the proposed rule under the factors in the
Unfunded Mandates Reform Act of 1995 (UMRA) (2 U.S.C. 1532). Under this
analysis, the OCC considered whether the proposed rule includes a
Federal mandate that may result in the expenditure by State, local, and
tribal governments, in the aggregate, or by the private sector, of $100
million or more in any one year (adjusted annually for inflation).
The OCC has determined this proposed rule is likely to result in
the expenditure by the private sector of $100 million or more in any
one year (adjusted annually for inflation). The OCC has prepared an
impact analysis and identified and considered alternative approaches.
When the proposed rule is published in the Federal Register, the full
text of the OCC's analysis will be available at: https://www.regulations.gov, Docket ID OCC-2023-0008.
F. Providing Accountability Through Transparency Act of 2023
The Providing Accountability Through Transparency Act of 2023 (12
U.S.C. 553(b)(4)) requires that a notice of proposed rulemaking include
the internet address of a summary of not more than 100 words in length
of the proposed rule, in plain language, that shall be posted on the
internet website under section 206(d) of the E-Government Act of 2002
(44 U.S.C. 3501 note).
In summary, in the proposal the bank regulatory agencies request
comment on a proposal to increase the strength and resilience of the
banking system. The proposal would modify large bank capital
requirements to better reflect underlying risks and increase the
consistency of how banks measure their risks.
The proposal and such a summary can be found at https://www.regulations.gov, https://www.federalreserve.gov/supervisionreg/reglisting.htm, https://www.fdic.gov/resources/regulations/federal-register-publications/, and https://occ.gov/topics/laws-and-regulations/occ-regulations/proposed-issuances/index-proposed-issuances.html.
Text of Common Rule
Subpart E--Risk-Weighted Assets--Expanded Risk-Based Approach
Sec. __.100 Purpose and applicability.
(a) Purpose. This subpart sets forth methodologies for determining
expanded total risk-weighted assets for purposes of the expanded
capital ratio calculations.
(b) Applicability.
(1) This subpart applies to any [BANKING ORGANIZATION] that is a
global systemically important BHC, a subsidiary of a global
systemically important BHC, a Category II [BANKING ORGANIZATION], a
Category III [BANKING ORGANIZATION], or a Category IV [BANKING
ORGANIZATION], as defined in Sec. __.2.
(2) The [AGENCY] may apply this subpart to any [BANKING
ORGANIZATION] if the [AGENCY] deems it necessary or appropriate to
ensure safe and sound banking practices.
(c) Notwithstanding any other provision of this section, a market
risk [BANKING ORGANIZATION] must exclude from its calculation of risk-
weighted assets under this subpart the risk-weighted asset amounts of
all market risk covered positions, as defined in subpart F of this part
(except foreign exchange positions that are not trading positions, OTC
derivative positions, cleared transactions, and unsettled
transactions).
Sec. __.101 Definitions.
(a) Terms that are set forth in Sec. __.2 and used in this subpart
have the definitions assigned thereto in Sec. __.2 unless otherwise
defined in paragraph (b) of this section.
(b) For purposes of this subpart, the following terms are defined
as follows:
Acquisition, development, or construction exposure (ADC) exposure
means a loan secured by real estate for the purpose of acquiring,
developing, or constructing residential or commercial real estate
properties, as well as all land development loans, and all other land
loans.
Bank exposure means an exposure to a depository institution,
foreign bank, or credit union.
Collateral upgrade transaction means a transaction in which a
[BANKING ORGANIZATION] lends to a counterparty one or more securities
that, on average, are subject to a lower haircut floor, as set forth in
Table 2 to Sec. __.121, than the securities received in exchange.
Credit obligation means an exposure where the lender but not the
obligor is
[[Page 64184]]
exposed to credit risk. The following exposures are not credit
obligations: derivative contracts, cleared transactions, default fund
contributions, repo-style transactions, eligible margin loans, equity
exposures, or securitization exposures.
Defaulted exposure means an exposure that is a credit obligation,
that is not an exposure to a sovereign entity, a real estate exposure,
or a policy loan, and where:
(1) For a retail exposure:
(i) The exposure is 90 days or more past due or in nonaccrual
status;
(ii) The [BANKING ORGANIZATION] has taken a partial charge-off,
write-down of principal, or negative fair value adjustment on the
exposure for credit-related reasons, until the [BANKING ORGANIZATION]
has reasonable assurance of repayment and performance for all
contractual principal and interest payments on the exposure; or
(iii) A distressed restructuring of the exposure was agreed to by
the [BANKING ORGANIZATION], until the [BANKING ORGANIZATION] has
reasonable assurance of repayment and performance for all contractual
principal and interest payments on the exposure as demonstrated by a
sustained period of repayment performance, provided that a distressed
restructuring includes the following made for credit-related reasons:
forgiveness or postponement of principal, interest, or fees, term
extension or an interest rate reduction; and
(2) For an exposure that is not a retail exposure:
(i) The obligor has a credit obligation to the [BANKING
ORGANIZATION] that is 90 days or more past due or in nonaccrual status;
or
(ii) The [BANKING ORGANIZATION] has determined that, based on
ongoing credit monitoring, the obligor is unlikely to pay its credit
obligations to the [BANKING ORGANIZATION] in full, without recourse by
the [BANKING ORGANIZATION]. For the purposes of this definition, a
[BANKING ORGANIZATION] must consider an obligor unlikely to pay its
credit obligations if:
(A) The obligor has any credit obligation that is 90 days or more
past due or in nonaccrual status with any creditor;
(B) Any credit obligation of the obligor has been sold at a credit-
related loss;
(C) A distressed restructuring of any credit obligation of the
obligor was agreed to by any creditor, provided that a distressed
restructuring includes the following made for credit-related reasons:
forgiveness or postponement of principal, interest, or fees, term
extension, or an interest rate reduction;
(D) The obligor is subject to a pending or active bankruptcy
proceeding; or
(E) Any creditor has taken a full or partial charge-off, write-down
of principal, or negative fair value adjustment on a credit obligation
of the obligor for credit-related reasons.
(3) For an exposure that is not a retail exposure, a [BANKING
ORGANIZATION] may consider an obligor no longer unlikely to pay its
credit obligations to the [BANKING ORGANIZATION] in full if the
[BANKING ORGANIZATION] determines the obligor is speculative grade or
investment grade.
(4) For purposes of this definition, overdrafts are past due once
the obligor has breached an advised limit or been advised of a limit
smaller than the current outstanding balance.
Defaulted real estate exposure means a real estate exposure where:
(1) For a residential mortgage exposure,
(i) The exposure is 90 days or more past due or in nonaccrual
status;
(ii) The [BANKING ORGANIZATION] has taken a partial charge-off,
write-down of principal, or negative fair value adjustment on the
exposure for credit-related reasons, until the [BANKING ORGANIZATION]
has reasonable assurance of repayment and performance for all
contractual principal and interest payments on the exposure; or
(iii) A distressed restructuring of the exposure was agreed to by
the [BANKING ORGANIZATION], provided that a distressed restructuring
includes the following made for credit-related reasons: forgiveness or
postponement of principal, interest, or fees, term extension, or an
interest rate reduction but does not include a loan modified or
restructured solely pursuant to the U.S. Treasury's Home Affordable
Mortgage Program.
(2) For a real estate exposure that is not a residential mortgage
exposure,
(i) The obligor has a credit obligation to the [BANKING
ORGANIZATION] that is 90 days or more past due or in nonaccrual status;
or
(ii) The [BANKING ORGANIZATION] has determined that, based on
ongoing credit monitoring, the obligor is unlikely to pay its credit
obligations to the [BANKING ORGANIZATION] in full, without recourse by
the [BANKING ORGANIZATION]. For the purposes of this definition, a
[BANKING ORGANIZATION] must consider an obligor unlikely to pay its
credit obligations if:
(A) The obligor has any credit obligation that is 90 days or more
past due or in nonaccrual status with any creditor;
(B) Any credit obligation of the obligor has been sold at a credit-
related loss;
(C) A distressed restructuring of any credit obligation of the
obligor was agreed to by any creditor, provided that a distressed
restructuring includes the following made for credit-related reasons:
forgiveness or postponement of principal, interest, or fees, term
extension, or an interest rate reduction;
(D) The obligor is subject to a pending or active bankruptcy
proceeding; or
(E) Any creditor has taken a full or partial charge-off, write-down
of principal, or negative fair value adjustment on a credit obligation
for credit-related reasons.
(3) For an exposure that is not a residential mortgage exposure, a
[BANKING ORGANIZATION] may consider an obligor no longer unlikely to
pay its credit obligations to the [BANKING ORGANIZATION] in full if the
[BANKING ORGANIZATION] determines the obligor is speculative grade or
investment grade.
Dependent on the cash flows generated by the real estate means, for
a real estate exposure, for which the underwriting, at the time of
origination, includes the cash flows generated by lease, rental, or
sale of the real estate securing the loan as a source of repayment. For
purposes of this definition, a residential mortgage exposure that is
secured by the borrower's principal residence is deemed not dependent
on the cash flows generated by the real estate.
Dividend income means all dividends received on securities not
consolidated in the [BANKING ORGANIZATION]'s financial statements.
Fee and commission expense means expenses paid for advisory and
financial services received.
Fee and commission income means income received from providing
advisory and financial services, including insurance income.
Grade A bank exposure means:
(1) A bank exposure for which the depository institution, foreign
bank, or credit union is investment grade and whose most recent capital
ratios meet or exceed the higher of:
(i) The minimum capital requirements and any additional amounts
necessary to not be subject to limitations on distributions and
discretionary bonus payments under capital rules established by the
prudential supervisor
[[Page 64185]]
of the depository institution, foreign bank, or credit union, and;
(ii) If applicable, the capital ratio requirements for the well
capitalized capital category under the regulations of the appropriate
Federal banking agency implementing 12 U.S.C. 1831o or under similar
regulations of the National Credit Union Administration.
(2) Notwithstanding paragraph (1) of this definition, an exposure
is not a Grade A bank exposure if:
(i) The capital ratios for the depository institution, foreign
bank, or credit union have not been publicly disclosed within the
previous 6 months;
(ii) The external auditor of the depository institution, foreign
bank, or credit union has issued an adverse audit opinion or has
expressed substantial doubt about the ability of the depository
institution, foreign bank, or credit union to continue as a going
concern within the previous 12 months; or
(iii) For a foreign bank, the capital standards imposed by the home
country supervisor on the foreign bank are not consistent with the
Capital Accord of the Basel Committee on Banking Supervision.
Grade B bank exposure means:
(1) A bank exposure that is not a Grade A bank exposure and for
which the depository institution, foreign bank, or credit union is
speculative grade or investment grade and whose most recent capital
ratios meet or exceed the higher of:
(i) The minimum capital requirements under capital rules
established by the prudential supervisor of the depository institution,
foreign bank, or credit union; and
(ii) If applicable, the capital ratio requirements for the
adequately-capitalized category under the regulations of the
appropriate Federal banking agency implementing 12 U.S.C. 1831o or
under similar regulations of the National Credit Union Administration.
(2) Notwithstanding paragraph (1) of this definition, an exposure
to a depository institution, foreign bank, or credit union is not a
Grade B bank exposure if:
(i) The capital ratios for the depository institution, foreign
bank, or credit union have not been publicly disclosed within the
previous 6 months;
(ii) The external auditor of the depository institution, foreign
bank, or credit union has issued an adverse audit opinion or has
expressed substantial doubt about the ability of the depository
institution, foreign bank, or credit union to continue as a going
concern within the previous 12 months; or
(iii) For a foreign bank, the capital standards imposed by the home
country supervisor on the foreign bank are not consistent with the
Capital Accord of the Basel Committee on Banking Supervision.
Grade C bank exposure means a bank exposure for which the
depository institution, foreign bank, or credit union does not qualify
as a Grade A bank exposure or a Grade B bank exposure.
Interest-earning assets means the sum of all gross outstanding
loans and leases, securities that pay interest, interest-bearing
balances, Federal funds sold, and securities purchased under agreement
to resell.
Net profit or loss on assets and liabilities not held for trading
means the sum of realized gains (losses) on held-to-maturity
securities, realized gains (losses) on available-for-sale securities,
net gains (losses) on sales of loans and leases, net gains (losses) on
sales of other real estate owned, net gains (losses) on sales of other
assets, venture capital revenue, net securitization income, and mark-
to-market profit or loss on bank liabilities.
Non-performing loan securitization (NPL securitization) means a
traditional securitization, or a synthetic securitization, that is not
a resecuritization, where parameter W (as defined in Sec.
__.133(b)(1)) for the underlying pool is greater than or equal to 90
percent at the origination cut-off date and at any subsequent date on
which assets are added to or removed from the pool due to replenishment
or restructuring.
Nonrefundable purchase price discount (NRPPD) means the difference
between the initial outstanding balance of the exposures in the
underlying pool and the price at which these exposures are sold by the
originator to the securitization SPE, when neither originator nor the
original lender are reimbursed for this difference. In cases where the
originator underwrites tranches of a NPL securitization for subsequent
sale, the NRPPD may include the differences between the notional amount
of the tranches and the price at which these tranches are first sold to
unrelated third parties. For any given piece of a securitization
tranche, only its initial sale from the originator to investors is
taken into account in the determination of NRPPD. The purchase prices
of subsequent re-sales are not considered.
Operational loss means all losses (excluding insurance or tax
effects) resulting from an operational loss event, including any
reduction in previously reported capital levels attributable to
restatements or corrections of financial statements. Operational loss
includes all expenses associated with an operational loss event except
for opportunity costs, forgone revenue, and costs related to risk
management and control enhancements implemented to prevent future
operational losses. Operational loss does not include losses that are
also credit losses and are related to exposures within the scope of the
credit risk-weighted assets framework (except for retail credit card
losses arising from non-contractual, third-party-initiated fraud, which
are operational losses).
Operational loss event means an event that results in loss due to
inadequate or failed internal processes, people, and systems or from
external events. This includes legal loss events and restatements or
corrections of financial statements that result in a reduction of
capital relative to amounts previously reported. Losses with a common
underlying trigger must be grouped into a single operational loss
event. Operational loss events are classified according to the
following seven operational loss event types:
(1) Internal fraud, which means the operational loss event type
that comprises operational losses resulting from an act involving at
least one internal party of a type intended to defraud, misappropriate
property, or circumvent regulations, the law, or company policy
excluding diversity and discrimination noncompliance events.
(2) External fraud, which means the operational loss event type
that comprises operational losses resulting from an act by a third
party of a type intended to defraud, misappropriate property, or
circumvent the law. Retail credit card losses arising from non-
contractual, third-party-initiated fraud (for example, identity theft)
are external fraud operational losses.
(3) Employment practices and workplace safety, which means the
operational loss event type that comprises operational losses resulting
from an act inconsistent with employment, health, or safety laws or
agreements, payment of personal injury claims, or payment arising from
diversity and discrimination noncompliance events.
(4) Clients, products, and business practices, which means the
operational loss event type that comprises operational losses resulting
from the nature or design of a product or from an unintentional or
negligent failure to meet a professional obligation to specific clients
(including fiduciary and suitability requirements).
(5) Damage to physical assets, which means the operational loss
event type that comprises operational losses
[[Page 64186]]
resulting from the loss of or damage to physical assets from natural
disaster or other events.
(6) Business disruption and system failures, which means the
operational loss event type that comprises operational losses resulting
from disruption of business or system failures, including hardware,
software, telecommunications, utility outage or disruptions.
(7) Execution, delivery, and process management, which means the
operational loss event type that comprises operational losses resulting
from failed transaction processing or process management or losses
arising from relations with trade counterparties and vendors.
Operational risk means the risk of loss resulting from inadequate
or failed internal processes, people, and systems or from external
events (including legal risk but excluding strategic and reputational
risk).
Other operating expense means expenses associated with financial
services not included in other elements of the Business Indicator, as
defined in Sec. __.150(d), and all expenses associated with
operational loss events. Other operating expense does not include
expenses excluded from the Business Indicator.
Other operating income means income not included in other elements
of the Business Indicator, as defined in Sec. __.150(d), and not
excluded from the Business Indicator.
Other real estate exposure means a real estate exposure that is not
a defaulted real estate exposure, a regulatory commercial real estate
exposure, a regulatory residential real estate exposure, a pre-sold
construction loan, a statutory multifamily mortgage, an HVCRE exposure,
or an ADC exposure.
Project finance exposure means a corporate exposure:
(1) For which the [BANKING ORGANIZATION] relies on the revenues
generated by a single project, both as the source of repayment and as
security for the loan;
(2) The exposure is to an entity that was created specifically to
finance, operate the physical assets of the project, or do both; and
(3) The borrowing entity has an immaterial amount of assets,
activities, or sources of income apart from the revenues from the
activities of the project being financed.
Project finance operational phase exposure means a project finance
exposure where the project has positive net cash flow that is
sufficient to support the debt service and expenses of the project and
any other remaining contractual obligation, in accordance with the
[BANKING ORGANIZATION]'s applicable loan underwriting criteria for
permanent financings, and where the outstanding long-term debt on the
project is declining.
Real estate exposure means an exposure that is neither a sovereign
exposure nor an exposure to a PSE and that is:
(1) A residential mortgage exposure;
(2) Secured by collateral in the form of real estate;
(3) A pre-sold construction loan;
(4) A statutory multifamily mortgage;
(5) An HVCRE exposure; or
(6) An ADC exposure.
Recovery means an inflow of funds or economic benefits received
from a third party in relation to an operational loss event. Recoveries
do not include receivables.
Regulatory commercial real estate exposure means a real estate
exposure that is not a regulatory residential real estate exposure, a
defaulted real estate exposure, an ADC exposure, a pre-sold
construction loan, a statutory multifamily mortgage, or an HVCRE
exposure, and that meets the following criteria:
(1) The exposure must be primarily secured by fully completed real
estate;
(2) The [BANKING ORGANIZATION] holds a first priority security
interest in the property that is legally enforceable in all relevant
jurisdictions; provided that when the [BANKING ORGANIZATION] also holds
a junior security interest in the same property and no other party
holds an intervening security interest, the [BANKING ORGANIZATION] must
treat the exposures as a single regulatory commercial real estate
exposure;
(3) The exposure is made in accordance with prudent underwriting
standards, including standards relating to the loan amount as a percent
of the value of the property;
(4) During underwriting of the loan, the [BANKING ORGANIZATION]
must have applied underwriting policies that took into account the
ability of the borrower to repay in a timely manner based on clear and
measurable underwriting standards that enable the [BANKING
ORGANIZATION] to evaluate relevant credit factors; and
(5) The property must be valued in accordance with Sec. __.103.
Regulatory residential real estate exposure means a first-lien
residential mortgage exposure that is not a defaulted real estate
exposure, an ADC exposure, a pre-sold construction loan, a statutory
multifamily mortgage, or an HVCRE exposure, and that meets the
following criteria:
(1) The exposure:
(i) Is secured by a property that is either owner-occupied or
rented;
(ii) Is made in accordance with prudent underwriting standards,
including standards relating to the loan amount as a percent of the
value of the property;
(iii) During underwriting of the loan, the [BANKING ORGANIZATION]
must have applied underwriting policies that took into account the
ability of the borrower to repay in a timely manner based on clear and
measurable underwriting standards that enable the [BANKING
ORGANIZATION] to evaluate these credit factors; and
(iv) The property must be valued in accordance with Sec. __.103.
(2) When a [BANKING ORGANIZATION] holds the first-lien and junior-
lien(s) residential mortgage exposure, and no other party holds an
intervening lien, the [BANKING ORGANIZATION] must treat the exposures
as a single regulatory residential real estate exposure.
Regulatory retail exposure means a retail exposure that meets all
of the following criteria:
(1) Product criterion. The exposure is a revolving credit or line
of credit, or a term loan or lease;
(2) Aggregate limit. The sum of the exposure amount and the amounts
of all other retail exposures to the obligor and to its affiliates does
not exceed $1 million; and
(3) Granularity limit. Notwithstanding paragraphs (1) and (2) of
this definition, if a retail exposure exceeds 0.2 percent of the
[BANKING ORGANIZATION]'s total retail exposures that meet criteria (1)
and (2) of this definition, only the portion up to 0.2 percent of the
[BANKING ORGANIZATION]'s total retail exposures may be considered a
regulatory retail exposure. Any excess portion is a retail exposure
that is not a regulatory retail exposure. For purposes of this
paragraph (3), off-balance sheet exposures are measured by applying the
appropriate credit conversion factor in Sec. __.112, and defaulted
exposures are excluded.
Retail exposure means an exposure that is not a real estate
exposure and that meets the following criteria:
(1) The exposure is to a natural person or persons, or
(2) The exposure is to an SME and satisfies the criteria in
paragraphs (1) through (3) of the definition of regulatory retail
exposure.
Senior securitization exposure means a securitization exposure that
has a first-priority claim on the cash flows from
[[Page 64187]]
the underlying exposures. When determining whether a securitization
exposure has a first-priority claim on the cash flows from the
underlying exposures, a [BANKING ORGANIZATION] is not required to
consider amounts due under interest rate derivative, currency
derivative, and servicer cash advance facility contracts; fees due; and
other similar payments. Both the most senior commercial paper issued by
an ABCP program and a liquidity facility that supports the ABCP program
may be senior securitization exposures if the liquidity facility
provider's right to reimbursement of the drawn amounts is senior to all
claims on the cash flows from the underlying exposures except amounts
due under interest rate derivative, currency derivative, and servicer
cash advance facility contracts; fees due; and other similar payments.
Small or medium-sized entity (SME) means an entity in which the
reported annual revenues or sales for the consolidated group of which
the entity is a part are less than or equal to $50 million for the most
recent fiscal year.
Subordinated debt instrument means a debt security that is a
corporate exposure, a bank exposure or an exposure to a GSE, including
a note, bond, debenture, similar instrument, or other debt instrument
as determined by the [AGENCY], that is subordinated by its terms, or
separate intercreditor agreement, to any creditor of the obligor, or
preferred stock that is not an equity exposure.
Synthetic excess spread means any contractual provisions in a
synthetic securitization that are designed to absorb losses prior to
any of the tranches of the securitization structure.
Transactor exposure means a regulatory retail exposure that is a
credit facility where the balance has been repaid in full at each
scheduled repayment date for the previous 12 months or an overdraft
facility where there has been no drawdown over the previous 12 months.
Total interest expense means interest expenses related to all
financial liabilities and other interest expenses.
Total interest income means interest income from all financial
assets and other interest income.
Trading revenue means the net gain or loss from trading cash
instruments and derivative contracts (including commodity contracts).
Sec. __.103 Calculation of loan-to-value (LTV) ratio.
(a) Loan-to-Value ratio. The loan-to-value (LTV) ratio must be
calculated as the extension of credit divided by the value of the
property.
(b) Extension of credit. For purposes of a LTV ratio calculated
under this section, the extension of credit is equal to the total
outstanding amount of the loan including any undrawn committed amount
of the loan.
(c) Value of the property. (1) For purposes of a LTV ratio
calculated under this section, the value of the property is the market
value of all real estate properties securing or being improved by the
extension of credit plus the amount of any readily marketable
collateral and other acceptable collateral, as defined in [REAL ESTATE
LENDING GUIDELINES], that secures the extension of credit, subject to
the following:
(i) For exposures subject to [APPRAISAL RULE], the market value of
property is a valuation that meets all requirements of that rule.
(ii) For exposures not subject to [APPRAISAL RULE]:
(A) The market value of real estate must be obtained from an
independent valuation of the property using prudently conservative
valuation criteria;
(B) The valuation must be done independently from the [BANKING
ORGANIZATION]'s origination and underwriting process, and
(C) To ensure that the market value of the real estate is
determined in a prudently conservative manner, the valuation must
exclude expectations of price increases and must be adjusted downward
to take into account the potential for the current market price to be
significantly above the value that would be sustainable over the life
of the loan.
(2) In the case where the exposure finances the purchase of the
property, the value of the property is the lower of the market value
obtained under paragraph (c)(1)(i) or (ii), as applicable, and the
actual acquisition cost.
(3) The value of the property must be measured at the time of
origination, except in the following circumstances:
(i) The [AGENCY] requires a [BANKING ORGANIZATION] to revise the
value of the property downward;
(ii) The value of the property must be adjusted downward due to an
extraordinary event that results in a permanent reduction of the
property value; or
(iii) The value of the property may be increased to reflect
modifications made to the property that increase the market value, as
determined according to the requirements in paragraphs (c)(1)(i) or
(ii) of this section.
(4) Readily marketable collateral and other acceptable collateral,
as defined in [REAL ESTATE LENDING GUIDELINES], must be appropriately
discounted by the [BANKING ORGANIZATION] consistent with the [BANKING
ORGANIZATION]'s usual practices for making loans secured by such
collateral.
Risk-Weighted Assets for Credit Risk
Sec. __.110 Calculation of total risk-weighted assets for general
credit risk.
(a) General risk-weighting requirements. A [BANKING ORGANIZATION]
must apply risk weights to its exposures as follows:
(1) A [BANKING ORGANIZATION] must determine the exposure amount of
each on-balance sheet exposure, each OTC derivative contract, and each
off-balance sheet commitment, trade and transaction-related
contingency, guarantee, repo-style transaction, financial standby
letter of credit, forward agreement, or other similar transaction that
is not:
(i) An unsettled transaction subject to Sec. __.115;
(ii) A cleared transaction subject to Sec. __.114;
(iii) A default fund contribution subject to Sec. __.114;
(iv) A securitization exposure subject to Sec. Sec. __.130 through
__.134;
(v) An equity exposure (other than an equity OTC derivative
contract) subject to Sec. Sec. __.140 through __.142.
(2) The [BANKING ORGANIZATION] must multiply each exposure amount
by the risk weight appropriate to the exposure based on the exposure
type or counterparty, eligible guarantor, or financial collateral to
determine the risk-weighted asset amount for each exposure.
(b) Total risk-weighted assets for general credit risk. Total
credit risk-weighted assets equals the sum of the risk-weighted asset
amounts calculated under this section.
Sec. __.111 General risk weights.
(a) Sovereign exposures--(1) Exposures to the U.S. government. (i)
Notwithstanding any other requirement in this subpart, a [BANKING
ORGANIZATION] must assign a zero percent risk weight to:
(A) An exposure to the U.S. government, its central bank, or a U.S.
government agency; and
(B) The portion of an exposure that is directly and unconditionally
guaranteed by the U.S. government, its central bank, or a U.S.
government agency. This includes a deposit or other exposure, or the
portion of a deposit or other exposure, that is insured or otherwise
[[Page 64188]]
unconditionally guaranteed by the FDIC or the National Credit Union
Administration.
(ii) A [BANKING ORGANIZATION] must assign a 20 percent risk weight
to the portion of an exposure that is conditionally guaranteed by the
U.S. government, its central bank, or a U.S. government agency. This
includes an exposure, or the portion of an exposure, that is
conditionally guaranteed by the FDIC or the National Credit Union
Administration.
(iii) A [BANKING ORGANIZATION] must assign a zero percent risk
weight to a Paycheck Protection Program covered loan as defined in
section 7(a)(36) of the Small Business Act (15 U.S.C. 636(a)(36)).
(2) Other sovereign exposures. In accordance with Table 1 to Sec.
__.111, a [BANKING ORGANIZATION] must assign a risk weight to a
sovereign exposure based on the CRC applicable to the sovereign or the
sovereign's OECD membership status if there is no CRC applicable to the
sovereign.
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(3) Certain sovereign exposures. Notwithstanding paragraph (a)(2)
of this section, a [BANKING ORGANIZATION] may assign to a sovereign
exposure a risk weight that is lower than the applicable risk weight in
Table 1 to Sec. __.111 if:
(i) The exposure is denominated in the sovereign's currency;
(ii) The [BANKING ORGANIZATION] has at least an equivalent amount
of liabilities in that currency; and
(iii) The risk weight is not lower than the risk weight that the
home country supervisor allows an organization engaged in the business
of banking under its jurisdiction to assign to the same exposures to
the sovereign.
(4) Exposures to a non-OECD member sovereign with no CRC. Except as
provided in paragraphs (a)(3), (5) and (6) of this section, a [BANKING
ORGANIZATION] must assign a 100 percent risk weight to an exposure to a
sovereign if the sovereign does not have a CRC.
(5) Exposures to an OECD member sovereign with no CRC. Except as
provided in paragraph (a)(6) of this section, a [BANKING ORGANIZATION]
must assign a 0 percent risk weight to an exposure to a sovereign that
is a member of the OECD if the sovereign does not have a CRC.
(6) Sovereign default. A [BANKING ORGANIZATION] must assign a 150
percent risk weight to a sovereign exposure immediately upon
determining that an event of sovereign default has occurred, or if an
event of sovereign default has occurred during the previous five years.
(b) Certain supranational entities and multilateral development
banks (MDBs). A [BANKING ORGANIZATION] must assign a zero percent risk
weight to exposures to the Bank for International Settlements, the
European Central Bank, the European Commission, the International
Monetary Fund, the European Stability Mechanism, the European Financial
Stability Facility, or an MDB.
(c) Exposures to GSEs. (1) A [BANKING ORGANIZATION] must assign a
20 percent risk weight to an exposure to a GSE that is not:
(i) An equity exposure; or
(ii) An exposure to a subordinated debt instrument issued by a GSE.
(2) A [BANKING ORGANIZATION] must assign a 150 percent risk weight
to an exposure to a subordinated debt instrument issued by a GSE,
unless a different risk weight is provided under paragraph (c)(3) of
this section.
(3) Notwithstanding paragraphs (c)(1) and (2) of this section, a
[BANKING ORGANIZATION] must assign a 20 percent risk weight to an
exposure to a subordinated debt instrument issued by a Federal Home
Loan Bank or the Federal Agricultural Mortgage Corporation (Farmer Mac)
that is not a defaulted exposure.
(d) Exposures to a depository institution, a foreign bank, or a
credit union. (1) A [BANKING ORGANIZATION] must assign a risk weight to
a bank exposure in accordance with Table 2 of this section, unless
otherwise provided under paragraph (d)(2) or (d)(3) of this section.
[[Page 64189]]
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(2) Notwithstanding paragraph (d)(1) of this section, a [BANKING
ORGANIZATION] must not assign a risk weight to an exposure to a foreign
bank lower than the risk weight applicable to a sovereign exposure of
the home country of the foreign bank unless:
(i) The exposure is in the local currency of the home country of
the foreign bank;
(ii) For an exposure to a branch of the foreign bank in a foreign
jurisdiction that is not the home country of the foreign bank, the
exposure is in the local currency of the jurisdiction in which the
foreign branch operates; or
(iii) The exposure is a self-liquidating, trade-related contingent
item that arises from the movement of goods and that has a maturity of
three months or less.
(3) Notwithstanding paragraph (d)(1) or (d)(2) of this section, a
[BANKING ORGANIZATION] must assign:
(i) A risk weight under Sec. __.141 to a bank exposure that is an
equity exposure; and
(ii) A 150 percent risk weight to a bank exposure that is an
exposure to a subordinated debt instrument or an exposure to a covered
debt instrument.
(e) Exposures to public sector entities (PSEs)--(1) Exposures to
U.S. PSEs. (i) A [BANKING ORGANIZATION] must assign a 20 percent risk
weight to a general obligation exposure of a PSE that is organized
under the laws of the United States or any state or political
subdivision thereof.
(ii) A [BANKING ORGANIZATION] must assign a 50 percent risk weight
to a revenue obligation exposure of a PSE that is organized under the
laws of the United States or any state or political subdivision
thereof.
(2) Exposures to foreign PSEs. (i) Except as provided in paragraphs
(e)(1) and (3) of this section, a [BANKING ORGANIZATION] must assign a
risk weight to a general obligation exposure to a PSE, in accordance
with Table 3 to Sec. __.111, based on the CRC that corresponds to the
PSE's home country or the OECD membership status of the PSE's home
country if there is no CRC applicable to the PSE's home country.
(ii) Except as provided in paragraphs (e)(1) and (e)(3) of this
section, a [BANKING ORGANIZATION] must assign a risk weight to a
revenue obligation exposure of a PSE, in accordance with Table 4 to
Sec. __.111, based on the CRC that corresponds to the PSE's home
country; or the OECD membership status of the PSE's home country if
there is no CRC applicable to the PSE's home country.
(3) A [BANKING ORGANIZATION] may assign a lower risk weight than
would otherwise apply under Tables 3 or 4 to Sec. __.111 to an
exposure to a foreign PSE if:
(i) The PSE's home country supervisor allows banks under its
jurisdiction to assign a lower risk weight to such exposures; and
(ii) The risk weight is not lower than the risk weight that
corresponds to the PSE's home country in accordance with Table 1 to
Sec. __.111.
BILLING CODE 6210-01-P; 6714-01-P; 4810-33-P
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[[Page 64190]]
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BILLING CODE 6210-01-C; 6714-01-C; 4810-33-C
(4) Exposures to PSEs from an OECD member sovereign with no CRC.
(i) A [BANKING ORGANIZATION] must assign a 20 percent risk weight to a
general obligation exposure to a PSE whose home country is an OECD
member sovereign with no CRC.
(ii) A [BANKING ORGANIZATION] must assign a 50 percent risk weight
to a revenue obligation exposure to a PSE whose home country is an OECD
member sovereign with no CRC.
(5) Exposures to PSEs whose home country is not an OECD member
sovereign with no CRC. A [BANKING ORGANIZATION] must assign a 100
percent risk weight to an exposure to a PSE whose home country is not a
member of the OECD and does not have a CRC.
(6) A [BANKING ORGANIZATION] must assign a 150 percent risk weight
to a PSE exposure immediately upon determining that an event of
sovereign default has occurred in a PSE's home country or if an event
of sovereign default has occurred in the PSE's home country during the
previous five years.
(f) Real estate exposures--(1) Statutory multifamily mortgages. A
[BANKING ORGANIZATION] must assign a 50 percent risk weight to a
statutory multifamily mortgage that is not a defaulted real estate
exposure.
(2) Pre-sold construction loans. A [BANKING ORGANIZATION] must
assign a 50 percent risk weight to a pre-sold construction loan that is
not a defaulted real estate exposure, unless the purchase contract is
cancelled, in which case a [BANKING ORGANIZATION] must assign a 100
percent risk weight.
(3) High-volatility commercial real estate (HVCRE) exposures. A
[BANKING ORGANIZATION] must assign a 150 percent risk weight to an
HVCRE exposure that is not a defaulted real estate exposure.
(4) ADC exposures that are not HVCRE exposures. A [BANKING
ORGANIZATION] must assign a 100 percent risk weight to an ADC exposure
that is not an HVCRE exposure or a defaulted real estate exposure.
(5) Regulatory residential real estate exposure. (i) A [BANKING
ORGANIZATION] must assign a risk weight to a regulatory residential
real estate exposure that is not dependent on the cash flows generated
by the real estate based on the exposure's LTV ratio in accordance with
Table 5 to Sec. __.111.
(ii) A [BANKING ORGANIZATION] must assign a risk weight to a
regulatory residential real estate exposure that is dependent on the
cash flows generated by the real estate based on the exposure's LTV
ratio in accordance with Table 6 to Sec. __.111.
BILLING CODE 6210-01-P; 6714-01-P; 4810-33-P
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[[Page 64191]]
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(6) Regulatory commercial real estate exposure. (i) A [BANKING
ORGANIZATION] must assign a risk weight to a regulatory commercial real
estate exposure that is not dependent on the cash flows generated by
the real estate based on the exposure's LTV and the risk weight
applicable to the borrower under this section, in accordance with Table
7 to Sec. __.111, provided that if the [BANKING ORGANIZATION] cannot
determine the risk weight applicable to the borrower under this
section, the [BANKING ORGANIZATION] must consider the risk weight of
the borrower to be 100 percent.
(ii) A [BANKING ORGANIZATION] must assign a risk weight to a
regulatory commercial real estate exposure that is dependent on the
cash flows generated by the real estate based on the exposure's LTV in
accordance with Table 8 to Sec. __.111.
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BILLING CODE 6210-01-C; 6714-01-C; 4810-33-C
(7) Other real estate exposures. A [BANKING ORGANIZATION] must
assign another real estate exposure a 150 percent risk weight, unless
the exposure is a residential mortgage exposure that is not dependent
on the cash flows generated by the real estate, which must be assigned
a 100 percent risk weight.
(8) Defaulted real estate exposures. A [BANKING ORGANIZATION] must
assign a defaulted real estate exposure a 150 percent risk weight,
unless the exposure is a residential mortgage exposure that is not
dependent on the cash flows generated by the real estate, which must be
assigned a 100 percent risk weight.
(9) Risk weight multiplier to certain exposures with currency
mismatch. Notwithstanding any other provision of this paragraph (f), a
[BANKING ORGANIZATION] must apply a 1.5 multiplier to the applicable
risk weight, subject to a maximum risk weight of 150 percent, to a
residential mortgage exposure to a borrower that does not have a source
of repayment in the currency of the loan equal to at least 90 percent
of the annual payment from either income generated through ordinary
business activities or from a contract with a financial institution
that provides funds denominated in the currency of the loan.
(g) Retail exposures. A [BANKING ORGANIZATION] must assign a risk
weight to a retail exposure according to the following:
(1) Regulatory retail exposures--(i) Regulatory retail exposures
that are not transactor exposures. A [BANKING ORGANIZATION] must assign
a 85 percent risk weight to a regulatory retail exposure that is not a
transactor exposure.
(ii) Transactor exposures. A [BANKING ORGANIZATION] must assign a
55 percent risk weight to a transactor exposure.
(2) Other retail exposures. A [BANKING ORGANIZATION] must assign a
110 percent risk weight to retail exposures that are not regulatory
retail exposures.
(3) Risk weight multiplier to certain exposures with currency
mismatch. Notwithstanding any other provision of paragraphs (g)(1) and
(2) of this section, a [BANKING ORGANIZATION] must apply a 1.5
multiplier to the applicable risk weight, subject to a maximum risk
weight of 150 percent, to any retail exposure in a foreign currency to
a
[[Page 64192]]
borrower that does not have a source of repayment in the foreign
currency equal to at least 90 percent of the annual payment amount from
either income generated through ordinary business activities or from a
contract with a financial institution that provides funds denominated
in the foreign currency.
(h) Corporate exposures. A [BANKING ORGANIZATION] must assign a 100
percent risk weight to a corporate exposure unless the corporate
exposure qualifies for a different risk weight under paragraphs (h)(1)
through (4).
(1) A [BANKING ORGANIZATION] must assign a 65 percent risk weight
to a corporate exposure that is an exposure to a company that is
investment grade and that has a publicly traded security outstanding or
that is controlled by a company that has a publicly traded security
outstanding.
(2) A [BANKING ORGANIZATION] must assign a 130 percent risk weight
to a project finance exposure that is not a project finance operational
phase exposure.
(3) A [BANKING ORGANIZATION] must assign risk weights to certain
exposures to a QCCP as follows:
(i) A [BANKING ORGANIZATION] must assign a 2 percent risk weight to
an exposure to a QCCP arising from the [BANKING ORGANIZATION] posting
cash collateral to the QCCP in connection with a cleared transaction
that meets the requirements of Sec. __.114(b)(3)(i)(A) and a 4 percent
risk weight to an exposure to a QCCP arising from the [BANKING
ORGANIZATION] posting cash collateral to the QCCP in connection with a
cleared transaction that meets the requirements of Sec.
__.114(b)(3)(i)(B).
(ii) A [BANKING ORGANIZATION] must assign a 2 percent risk weight
to an exposure to a QCCP arising from the [BANKING ORGANIZATION]
posting cash collateral to the QCCP in connection with a cleared
transaction that meets the requirements of Sec. __.114(c)(3)(i).
(4) A [BANKING ORGANIZATION] must assign a 150 percent risk weight
to a corporate exposure that is an exposure to a subordinated debt
instrument or an exposure to a covered debt instrument.
(5) Notwithstanding any other provision of this paragraph (h), a
[BANKING ORGANIZATION] must assign a 100 percent risk weight to:
(i) A corporate exposure that is for the purpose of acquiring or
financing equipment or physical commodities where repayment of the
exposure is dependent on the physical assets being financed or
acquired; or
(ii) A project finance operational phase exposure.
(i) Defaulted exposures. Notwithstanding any other provision of
this subpart, a [BANKING ORGANIZATION] must assign a 150 percent risk
weight to any exposure that is a defaulted exposure.
(j) Other assets. (1)(i) A bank holding company or savings and loan
holding company must assign a zero percent risk weight to cash owned
and held in all offices of subsidiary depository institutions or in
transit, and to gold bullion held in a subsidiary depository
institution's own vaults, or held in another depository institution's
vaults on an allocated basis, to the extent the gold bullion assets are
offset by gold bullion liabilities.
(ii) A [BANKING ORGANIZATION] must assign a zero percent risk
weight to cash owned and held in all offices of the [BANKING
ORGANIZATION] or in transit; to gold bullion held in the [BANKING
ORGANIZATION]'s own vaults or held in another depository institution's
vaults on an allocated basis, to the extent the gold bullion assets are
offset by gold bullion liabilities; and to exposures that arise from
the settlement of cash transactions (such as equities, fixed income,
spot foreign exchange and spot commodities) with a central counterparty
where there is no assumption of ongoing counterparty credit risk by the
central counterparty after settlement of the trade and associated
default fund contributions.
(2) A [BANKING ORGANIZATION] must assign a 20 percent risk weight
to cash items in the process of collection.
(3) A [BANKING ORGANIZATION] must assign a 100 percent risk weight
to DTAs arising from temporary differences that the [BANKING
ORGANIZATION] could realize through net operating loss carrybacks.
(4) A [BANKING ORGANIZATION] must assign a 250 percent risk weight
to the portion of each of the following items to the extent it is not
deducted from common equity tier 1 capital pursuant to Sec. __.22(d):
(i) MSAs; and
(ii) DTAs arising from temporary differences that the [BANKING
ORGANIZATION] could not realize through net operating loss carrybacks.
(5) A [BANKING ORGANIZATION] must assign a 100 percent risk weight
to all assets not specifically assigned a different risk weight under
this subpart and that are not deducted from tier 1 or tier 2 capital
pursuant to Sec. __.22.
(6) Notwithstanding the requirements of this section, a [BANKING
ORGANIZATION] may assign an asset that is not included in one of the
categories provided in this section to the risk weight category
applicable under the capital rules applicable to bank holding companies
and savings and loan holding companies at 12 CFR part 217, provided
that all of the following conditions apply:
(i) The [BANKING ORGANIZATION] is not authorized to hold the asset
under applicable law other than debt previously contracted or similar
authority; and
(ii) The risks associated with the asset are substantially similar
to the risks of assets that are otherwise assigned to a risk weight
category of less than 100 percent under this subpart.
(k) Insurance assets--(1) Assets held in a separate account. (i) A
bank holding company or savings and loan holding company must risk-
weight the individual assets held in a separate account that does not
qualify as a non-guaranteed separate account as if the individual
assets were held directly by the bank holding company or savings and
loan holding company.
(ii) A bank holding company or savings and loan holding company
must assign a zero percent risk weight to an asset that is held in a
non-guaranteed separate account.
(2) Policy loans. A bank holding company or savings and loan
holding company must assign a 20 percent risk weight to a policy loan.
Sec. __.112 Off-balance sheet exposures.
(a) General. (1) A [BANKING ORGANIZATION] must calculate the
exposure amount of an off-balance sheet exposure using the credit
conversion factors (CCFs) in paragraph (b) of this section. In the case
of commitments, a [BANKING ORGANIZATION] must multiply the committed
but undrawn amount of the exposure by the applicable CCF.
(2) Where a [BANKING ORGANIZATION] commits to provide a commitment,
the [BANKING ORGANIZATION] may apply the lower of the two applicable
CCFs.
(3) Where a [BANKING ORGANIZATION] provides a commitment structured
as a syndication or participation, the [BANKING ORGANIZATION] is only
required to calculate the exposure amount for its pro rata share of the
commitment.
(4) Where a [BANKING ORGANIZATION] provides a commitment, enters
into a repurchase agreement, or provides a credit-enhancing
representation and warranty, and such commitment, repurchase agreement,
or credit-enhancing representation and warranty is not a
[[Page 64193]]
securitization exposure, the exposure amount shall be no greater than
the maximum contractual amount of the commitment, repurchase agreement,
or credit-enhancing representation and warranty, as applicable.
(5) For purposes of this section, if a commitment does not have an
express contractual maximum amount that can be drawn, the committed but
undrawn amount of the commitment is equal to the average total drawn
amount over the period since the commitment was created or the prior
eight quarters, whichever period is shorter, multiplied by ten, minus
the current drawn amount.
(6) For purposes of this subpart, with respect to a repurchase or
reverse repurchase transaction, or a securities borrowing or securities
lending transaction, a [BANKING ORGANIZATION] must include in expanded
total risk-weighted assets the risk-weighted asset amount for
counterparty credit risk according to Sec. __.121 and the risk-
weighted asset amount for securities or posted collateral, where the
credit risk of the securities lent or posted as collateral remains with
the [BANKING ORGANIZATION].
(b) Credit Conversion Factors--(1) 10 percent CCF. A [BANKING
ORGANIZATION] must apply a 10 percent CCF to the unused portion of a
commitment that is unconditionally cancellable by the [BANKING
ORGANIZATION].
(2) 20 percent CCF. A [BANKING ORGANIZATION] must apply a 20
percent CCF to the amount of self-liquidating trade-related contingent
items that arise from the movement of goods, with an original maturity
of one year or less.
(3) 40 percent CCF. A [BANKING ORGANIZATION] must apply a 40
percent CCF to commitments, regardless of the maturity of the facility,
unless they qualify for a lower or higher CCF.
(4) 50 percent CCF. A [BANKING ORGANIZATION] must apply a 50
percent CCF to the amount of:
(i) Transaction-related contingent items, including performance
bonds, bid bonds, warranties, and performance standby letters of
credit; and
(ii) Note issuance facilities and revolving underwriting
facilities.
(5) 100 percent CCF. A [BANKING ORGANIZATION] must apply a 100
percent CCF to the amount of the following off-balance-sheet items and
other similar transactions:
(i) Guarantees;
(ii) Repurchase agreements (the off-balance sheet component of
which equals the sum of the current fair values of all positions the
[BANKING ORGANIZATION] has sold subject to repurchase);
(iii) Credit-enhancing representations and warranties that are not
securitization exposures;
(iv) Off-balance sheet securities lending transactions (the off-
balance sheet component of which equals the sum of the current fair
values of all positions the [BANKING ORGANIZATION] has lent under the
transaction);
(v) Off-balance sheet securities borrowing transactions (the off-
balance sheet component of which equals the sum of the current fair
values of all non-cash positions the [BANKING ORGANIZATION] has posted
as collateral under the transaction);
(vi) Financial standby letters of credit; and
(vii) Forward agreements.
Sec. __.113 Derivative contracts.
(a) Exposure amount for derivative contracts. A [BANKING
ORGANIZATION] must determine the exposure amount for a derivative
contract using the standardized approach for counterparty credit risk
(SA-CCR) under this section. A [BANKING ORGANIZATION] may reduce the
exposure amount calculated according to this section by the credit
valuation adjustment that the [BANKING ORGANIZATION] has recognized in
its balance sheet valuation of any derivative contracts in the netting
set. For purposes of this paragraph (a), the credit valuation
adjustment does not include any adjustments to common equity tier 1
capital attributable to changes in the fair value of the [BANKING
ORGANIZATION]'s liabilities that are due to changes in its own credit
risk since the inception of the transaction with the counterparty.
(b) Definitions. For purposes of this section, the following
definitions apply:
(1) End date means the last date of the period referenced by an
interest rate or credit derivative contract or, if the derivative
contract references another instrument, by the underlying instrument,
except as otherwise provided in this section.
(2) Start date means the first date of the period referenced by an
interest rate or credit derivative contract or, if the derivative
contract references the value of another instrument, by underlying
instrument, except as otherwise provided in this section.
(3) Hedging set means:
(i) With respect to interest rate derivative contracts, all such
contracts within a netting set that reference the same reference
currency;
(ii) With respect to exchange rate derivative contracts, all such
contracts within a netting set that reference the same currency pair;
(iii) With respect to credit derivative contract, all such
contracts within a netting set;
(iv) With respect to equity derivative contracts, all such
contracts within a netting set;
(v) With respect to a commodity derivative contract, all such
contracts within a netting set that reference one of the following
commodity categories: Energy, metal, agricultural, or other
commodities;
(vi) With respect to basis derivative contracts, all such contracts
within a netting set that reference the same pair of risk factors and
are denominated in the same currency; or
(vii) With respect to volatility derivative contracts, all such
contracts within a netting set that reference one of interest rate,
exchange rate, credit, equity, or commodity risk factors, separated
according to the requirements under paragraphs (b)(3)(i) through (v) of
this section.
(viii) If the risk of a derivative contract materially depends on
more than one of interest rate, exchange rate, credit, equity, or
commodity risk factors, the [AGENCY] may require a [BANKING
ORGANIZATION] to include the derivative contract in each appropriate
hedging set under paragraphs (b)(3)(i) through (v) of this section.
(c) Credit derivatives. Notwithstanding paragraphs (a) and (b) of
this section:
(1) A [BANKING ORGANIZATION] that purchases a credit derivative
that is recognized under Sec. __.120 as a credit risk mitigant for an
exposure that is not a market risk covered position under subpart F of
this part is not required to calculate a separate counterparty credit
risk capital requirement under this section so long as the [BANKING
ORGANIZATION] does so consistently for all such credit derivatives and
either includes all or excludes all such credit derivatives that are
subject to a master netting agreement from any measure used to
determine counterparty credit risk exposure to all relevant
counterparties for risk-based capital purposes.
(2) A [BANKING ORGANIZATION] that is the protection provider in a
credit derivative must treat the credit derivative as an exposure to
the reference obligor and is not required to calculate a counterparty
credit risk capital requirement for the credit derivative under this
section, so long as it does so consistently for all such credit
[[Page 64194]]
derivatives and either includes all or excludes all such credit
derivatives that are subject to a master netting agreement from any
measure used to determine counterparty credit risk exposure to all
relevant counterparties for risk-based capital purposes (unless the
[BANKING ORGANIZATION] is treating the credit derivative as a market
risk covered position under subpart F of this part, in which case the
[BANKING ORGANIZATION] must calculate a counterparty credit risk
capital requirement under this section).
(d) Equity derivatives. A [BANKING ORGANIZATION] must treat an
equity derivative contract as an equity exposure and compute a risk-
weighted asset amount for the equity derivative contract under Sec.
__.140-__.142 (unless the [BANKING ORGANIZATION] is treating the
contract as a market risk covered position under subpart F of this
part). In addition, if the [BANKING ORGANIZATION] is treating the
contract as a market risk covered position under subpart F of this
part, the [BANKING ORGANIZATION] must also calculate a risk-based
capital requirement for the counterparty credit risk of an equity
derivative contract under this section. If the [BANKING ORGANIZATION]
risk weights an equity derivative contract under Sec. __.140-__.142,
the [BANKING ORGANIZATION] may choose not to hold risk-based capital
against the counterparty credit risk of the equity derivative contract,
as long as it does so for all such contracts. Where an equity
derivative contract is subject to a qualified master netting agreement,
a [BANKING ORGANIZATION] using Sec. __.140-__.142 must either include
all or exclude all of the contracts from any measure used to determine
counterparty credit risk exposure.
(e) Exposure amount. (1) The exposure amount of a netting set, as
calculated under this section, is equal to 1.4 multiplied by the sum of
the replacement cost of the netting set, as calculated under paragraph
(f) of this section, and the potential future exposure of the netting
set, as calculated under paragraph (g) of this section.
(2) Notwithstanding the requirements of paragraph (e)(1) of this
section, the exposure amount of a netting set subject to a variation
margin agreement, excluding a netting set that is subject to a
variation margin agreement under which the counterparty to the
variation margin agreement is not required to post variation margin, is
equal to the lesser of the exposure amount of the netting set
calculated under paragraph (e)(1) of this section and the exposure
amount of the netting set calculated under paragraph (e)(1) of this
section as if the netting set were not subject to a variation margin
agreement.
(3) Notwithstanding the requirements of paragraph (e)(1) of this
section, the exposure amount of a netting set that consists of only
sold options in which the premiums have been fully paid by the
counterparty to the options and where the options are not subject to a
variation margin agreement is zero.
(4) Notwithstanding the requirements of paragraph (e)(1) of this
section, the exposure amount of a netting set in which the counterparty
is a commercial end-user is equal to the sum of replacement cost, as
calculated under paragraph (f) of this section, and the potential
future exposure of the netting set, as calculated under paragraph (g)
of this section.
(5) For purposes of the exposure amount calculated under paragraph
(e)(1) of this section and all calculations that are part of that
exposure amount, a [BANKING ORGANIZATION] may elect to treat a
derivative contract that is a cleared transaction that is not subject
to a variation margin agreement as one that is subject to a variation
margin agreement, if the derivative contract is subject to a
requirement that the counterparties make daily cash payments to each
other to account for changes in the fair value of the derivative
contract and to reduce the net position of the contract to zero. If a
[BANKING ORGANIZATION] makes an election under this paragraph (e)(5)
for one derivative contract, it must treat all other derivative
contracts within the same netting set that are eligible for an election
under this paragraph (e)(5) as derivative contracts that are subject to
a variation margin agreement.
(6) For purposes of the exposure amount calculated under paragraph
(e)(1) of this section and all calculations that are part of that
exposure amount, a [BANKING ORGANIZATION] may elect to treat a credit
derivative contract, equity derivative contract, or commodity
derivative contract that references an index as if it were multiple
derivative contracts each referencing one component of the index,
provided that the derivative contract is not an option or a CDO
tranche.
(7) For purposes of the exposure amount calculated under paragraph
(e)(1) of this section and all calculations that are part of that
exposure amount, with respect to a client-facing derivative transaction
or netting set of client-facing derivative transactions, a clearing
member [BANKING ORGANIZATION] may multiply the standard supervisory
haircuts applied for purposes of the net independent collateral amount
and variation margin amount by the scaling factor of the square root of
\1/2\ (which equals 0.707107). If the [BANKING ORGANIZATION] determines
that a longer period is appropriate, the [BANKING ORGANIZATION] must
use a larger scaling factor to adjust for a longer holding period as
provided below by the formula in this paragraph. In addition, the
[AGENCY] may require the [BANKING ORGANIZATION] to set a longer holding
period if the [AGENCY] determines that a longer period is appropriate
due to the nature, structure, or characteristics of the transaction or
is commensurate with the risks associated with the transaction.
[GRAPHIC] [TIFF OMITTED] TP18SE23.063
Where H = the holding period greater than or equal to five days
(f) Replacement cost of a netting set--(1) Netting set subject to a
variation margin agreement under which the counterparty must post
variation margin. The replacement cost of a netting set subject to a
variation margin agreement, excluding a netting set that is subject to
a variation margin agreement under which the counterparty is not
required to post variation margin, is the greater of:
(i) The sum of the fair values (after excluding any valuation
adjustments) of the derivative contracts within the netting set less
the sum of the net independent collateral amount and the variation
margin amount applicable to such derivative contracts;
(ii) The sum of the variation margin threshold and the minimum
transfer amount applicable to the derivative contracts within the
netting set less the net independent collateral amount applicable to
such derivative contracts; or
(iii) Zero.
(2) Netting sets not subject to a variation margin agreement under
which the counterparty must post variation margin. The replacement cost
of a netting set that is not subject to a variation margin agreement
under which the counterparty must post variation margin to the [BANKING
ORGANIZATION] is the greater of:
(i) The sum of the fair values (after excluding any valuation
adjustments) of the derivative contracts within the netting set less
the sum of the net independent collateral amount and variation margin
amount applicable to such derivative contracts; or
(ii) Zero.
(3) Multiple netting sets subject to a single variation margin
agreement. Notwithstanding paragraphs (f)(1) and
[[Page 64195]]
(2) of this section, the replacement cost for multiple netting sets
subject to a single variation margin agreement must be calculated
according to paragraph (j)(1) of this section.
(4) Netting set subject to multiple variation margin agreements or
a hybrid netting set. Notwithstanding paragraphs (f)(1) and (2) of this
section, the replacement cost for a netting set subject to multiple
variation margin agreements or a hybrid netting set must be calculated
according to paragraph (k)(1) of this section.
(g) Potential future exposure of a netting set. The potential
future exposure of a netting set is the product of the PFE multiplier
and the aggregated amount.
(1) PFE multiplier. The PFE multiplier is calculated according to
the following formula:
[GRAPHIC] [TIFF OMITTED] TP18SE23.064
Where:
V is the sum of the fair values (after excluding any valuation
adjustments) of the derivative contracts within the netting set;
C is the sum of the net independent collateral amount and the
variation margin amount applicable to the derivative contracts
within the netting set; and
A is the aggregated amount of the netting set.
(2) Aggregated amount. The aggregated amount is the sum of all
hedging set amounts, as calculated under paragraph (h) of this section,
within a netting set.
(3) Multiple netting sets subject to a single variation margin
agreement. Notwithstanding paragraphs (g)(1) and (2) of this section
and when calculating the potential future exposure for purposes of
total leverage exposure under Sec. __.10(c)(2)(ii), the potential
future exposure for multiple netting sets subject to a single variation
margin agreement must be calculated according to paragraph (j)(2) of
this section.
(4) Netting set subject to multiple variation margin agreements or
a hybrid netting set. Notwithstanding paragraphs (g)(1) and (2) of this
section and when calculating the potential future exposure for purposes
of total leverage exposure under Sec. __.10(c)(2)(ii), the potential
future exposure for a netting set subject to multiple variation margin
agreements or a hybrid netting set must be calculated according to
paragraph (k)(2) of this section.
(h) Hedging set amount--(1) Interest rate derivative contracts. To
calculate the hedging set amount of an interest rate derivative
contract hedging set, a [BANKING ORGANIZATION] may use either of the
formulas provided in paragraphs (h)(1)(i) and (ii) of this section:
(i) Formula 1 is as follows:
Hedging set amount = [(AddOnTB1IR)\2\ +
(AddOnTB2IR)\2\ + (Add OnTB3IR)\2\ + 1.4 * Add
OnTB1IR * Add OnTB2IR + 1.4 * Add
OnTB2IR * Add OnTB3IR + 0.6 * Add
OnTB1IR * Add OnTB3IR)]1/2
(ii) Formula 2 is as follows:
Hedging set amount = [bond]Add OnTB1IR[bond] + [bond]Add
OnTB2IR[bond] + [bond]Add OnTB3IR[bond]
Where in paragraphs (h)(1)(i) and (ii) of this section:
AddOnTB1IR is the sum of the adjusted derivative contract amounts,
as calculated under paragraph (i) of this section, within the
hedging set with an end date of less than one year from the present
date;
AddOnTB2IR is the sum of the adjusted derivative contract amounts,
as calculated under paragraph (i) of this section, within the
hedging set with an end date of one to five years from the present
date; and
AddOnTB3IR is the sum of the adjusted derivative contract amounts,
as calculated under paragraph (i) of this section, within the
hedging set with an end date of more than five years from the
present date.
(2) Exchange rate derivative contracts. For an exchange rate
derivative contract hedging set, the hedging set amount equals the
absolute value of the sum of the adjusted derivative contract amounts,
as calculated under paragraph (i) of this section, within the hedging
set.
(3) Credit derivative contracts and equity derivative contracts.
The hedging set amount of a credit derivative contract hedging set or
equity derivative contract hedging set within a netting set is
calculated according to the following formula:
[GRAPHIC] [TIFF OMITTED] TP18SE23.065
Where:
k is each reference entity within the hedging set.
K is the number of reference entities within the hedging set.
AddOn (Refk) equals the sum of the adjusted derivative contract
amounts, as determined under paragraph (i) of this section, for all
derivative contracts within the hedging set that reference entity k.
rk equals the applicable supervisory correlation factor, as provided
in Table 2 to this section.
(4) Commodity derivative contracts. The hedging set amount of a
commodity derivative contract hedging set within a netting set is
calculated according to the following formula:
[GRAPHIC] [TIFF OMITTED] TP18SE23.066
[[Page 64196]]
Where:
k is each commodity type within the hedging set.
K is the number of commodity types within the hedging set.
AddOn (Typek) equals the sum of the adjusted derivative contract
amounts, as determined under paragraph (i) of this section, for all
derivative contracts within the hedging set that reference commodity
type.
r equals the applicable supervisory correlation factor, as provided
in table 2 to this section.
(5) Basis derivative contracts and volatility derivative contracts.
Notwithstanding paragraphs (h)(1) through (4) of this section, a
[BANKING ORGANIZATION] must calculate a separate hedging set amount for
each basis derivative contract hedging set and each volatility
derivative contract hedging set. A [BANKING ORGANIZATION] must
calculate such hedging set amounts using one of the formulas under
paragraphs (h)(1) through (4) that corresponds to the primary risk
factor of the hedging set being calculated.
(i) Adjusted derivative contract amount--(1) Summary. To calculate
the adjusted derivative contract amount of a derivative contract, a
[BANKING ORGANIZATION] must determine the adjusted notional amount of
the derivative contract, pursuant to paragraph (i)(2) of this section,
and multiply the adjusted notional amount by each of the supervisory
delta adjustment, pursuant to paragraph (i)(3) of this section, the
maturity factor, pursuant to paragraph (i)(4) of this section, and the
applicable supervisory factor, as provided in Table 2 to this section.
(2) Adjusted notional amount. (i)(A) For an interest rate
derivative contract or a credit derivative contract, the adjusted
notional amount equals the product of the notional amount of the
derivative contract, as measured in U.S. dollars using the exchange
rate on the date of the calculation, and the supervisory duration, as
calculated by the following formula:
[GRAPHIC] [TIFF OMITTED] TP18SE23.067
Where:
S is the number of business days from the present day until the
start date of the derivative contract, or zero if the start date has
already passed; and
E is the number of business days from the present day until the end
date of the derivative contract.
(B) For purposes of paragraph (i)(2)(i)(A) of this section:
(1) For an interest rate derivative contract or credit derivative
contract that is a variable notional swap, the notional amount is equal
to the time-weighted average of the contractual notional amounts of
such a swap over the remaining life of the swap; and
(2) For an interest rate derivative contract or a credit derivative
contract that is a leveraged swap, in which the notional amount of all
legs of the derivative contract are divided by a factor and all rates
of the derivative contract are multiplied by the same factor, the
notional amount is equal to the notional amount of an equivalent
unleveraged swap.
(ii)(A) For an exchange rate derivative contract, the adjusted
notional amount is the notional amount of the non-U.S. denominated
currency leg of the derivative contract, as measured in U.S. dollars
using the exchange rate on the date of the calculation. If both legs of
the exchange rate derivative contract are denominated in currencies
other than U.S. dollars, the adjusted notional amount of the derivative
contract is the largest leg of the derivative contract, as measured in
U.S. dollars using the exchange rate on the date of the calculation.
(B) Notwithstanding paragraph (i)(2)(ii)(A) of this section, for an
exchange rate derivative contract with multiple exchanges of principal,
the [BANKING ORGANIZATION] must set the adjusted notional amount of the
derivative contract equal to the notional amount of the derivative
contract multiplied by the number of exchanges of principal under the
derivative contract.
(iii)(A) For an equity derivative contract or a commodity
derivative contract, the adjusted notional amount is the product of the
fair value of one unit of the reference instrument underlying the
derivative contract and the number of such units referenced by the
derivative contract.
(B) Notwithstanding paragraph (i)(2)(iii)(A) of this section, when
calculating the adjusted notional amount for an equity derivative
contract or a commodity derivative contract that is a volatility
derivative contract, the [BANKING ORGANIZATION] must replace the unit
price with the underlying volatility referenced by the volatility
derivative contract and replace the number of units with the notional
amount of the volatility derivative contract.
(3) Supervisory delta adjustment. (i) For a derivative contract
that is not an option contract or collateralized debt obligation
tranche, the supervisory delta adjustment is 1 if the fair value of the
derivative contract increases when the value of the primary risk factor
increases and -1 if the fair value of the derivative contract decreases
when the value of the primary risk factor increases.
(ii)(A) For a derivative contract that is an option contract, the
supervisory delta adjustment is determined by the formulas in Table 1
to this section, as applicable:
[[Page 64197]]
[GRAPHIC] [TIFF OMITTED] TP18SE23.068
(B) As used in the formulas in Table 1 to this section:
(1) F is the standard normal cumulative distribution function;
(2) R equals the current fair value of the instrument or risk
factor, as applicable, underlying the option;
(3) K equals the strike price of the option;
(4) T equals the number of business days until the latest
contractual exercise date of the option;
(5) The same value of l must be used for all option contracts that
reference the same underlying risk factor or instrument or, in the case
of interest rate option contracts, all interest rate option contracts
that are denominated in the same currency. l equals zero for all
derivative contracts except those option contracts where it is possible
for R to have negative values. For option contracts where it is
possible for R to have negative values, to determine the value of l for
a given risk factor or instrument, a [BANKING ORGANIZATION] must find
the lowest value, L, of R and K of all option contracts that reference
this risk factor or instrument or, in the case of interest rate option
contracts, the lowest value, L, of R and K of all interest rate option
contracts in a given currency, that the [BANKING ORGANIZATION] has with
all counterparties. Then, l is set as follows: when the underlying risk
factor is an interest rate, l=max{-L+0.1%,0{time} ; otherwise, l=max{-
1.1[middot]L,0{time} ; and
(6) s equals the supervisory option volatility, as provided in
Table 2 to this section.
(C) Notwithstanding paragraph (i)(3)(ii)(B)(5) of this section, a
[BANKING ORGANIZATION] may, with the prior approval of the [AGENCY],
specify a value for l in accordance with this paragraph for an option
contract, other than an interest rate option contract described in
paragraph (i)(3)(ii)(B)(5) of this section, if a different value for l
would be appropriate considering the range of values for the instrument
or risk factor, as appropriate, underlying the option contract. A
[BANKING ORGANIZATION] that specifies a value for l in accordance with
this paragraph for an option contract must assign the same value for l
to all option contracts with the same instrument or risk factor, as
applicable, underlying the option that the [BANKING ORGANIZATION] has
with all counterparties.
(iii)(A) For a derivative contract that is a collateralized debt
obligation tranche, the supervisory delta adjustment is determined by
the following formula:
[GRAPHIC] [TIFF OMITTED] TP18SE23.069
(B) As used in the formula in paragraph (i)(3)(iii)(A) of this
section:
(1) A is the attachment point, which equals the ratio of the
notional amounts of all underlying exposures that are subordinated to
the [BANKING ORGANIZATION]'s exposure to the total notional amount of
all underlying exposures, expressed as a decimal value between zero and
one; \30\
\30\ In the case of a first-to-default credit derivative, there are
no underlying exposures that are subordinated to the [BANKING
ORGANIZATION]'s exposure. In the case of a second-or-subsequent-to-
default credit derivative, the smallest (n-1) notional amounts of
the underlying exposures are subordinated to the [BANKING
ORGANIZATION]'s exposure.
(2) D is the detachment point, which equals one minus the ratio of
the notional amounts of all underlying exposures that are senior to the
[BANKING ORGANIZATION]'s exposure to the total notional amount of all
underlying exposures, expressed as a decimal value between zero and
one; and
(3) The resulting amount is designated with a positive sign if the
collateralized debt obligation tranche was used to purchase credit
protection by the [BANKING ORGANIZATION] and is designated with a
negative sign if the collateralized debt obligation tranche was used to
sell credit protection by the [BANKING ORGANIZATION].
(4) Maturity factor. (i)(A) The maturity factor of a derivative
contract that is subject to a variation margin agreement, excluding
derivative contracts that are subject to a variation margin agreement
under which the counterparty is not required to post variation margin,
is determined by the following formula:
[GRAPHIC] [TIFF OMITTED] TP18SE23.070
Where MPOR refers to the period from the most recent exchange of
collateral covering a netting set of derivative contracts with a
defaulting counterparty until the derivative contracts are closed
[[Page 64198]]
out and the resulting market risk is re-hedged.
(B) Notwithstanding paragraph (i)(4)(i)(A) of this section:
(1) For a derivative contract that is not a client-facing
derivative transaction, MPOR cannot be less than ten business days plus
the periodicity of re-margining expressed in business days minus one
business day;
(2) For a derivative contract that is a client-facing derivative
transaction, MPOR cannot be less than five business days plus the
periodicity of re-margining expressed in business days minus one
business day; and
(3) For a derivative contract that is within a netting set that is
composed of more than 5,000 derivative contracts that are not cleared
transactions, or a netting set that contains one or more trades
involving illiquid collateral or a derivative contract that cannot be
easily replaced, MPOR cannot be less than twenty business days.
(4) Notwithstanding paragraphs (i)(4)(i)(A) and (B) of this
section, for a netting set subject to more than two outstanding
disputes over margin that lasted longer than the MPOR over the previous
two quarters, the applicable floor is twice the amount provided in
paragraphs (i)(4)(i)(A) and (B) of this section.
(ii) The maturity factor of a derivative contract that is not
subject to a variation margin agreement, or derivative contracts under
which the counterparty is not required to post variation margin, is
determined by the following formula:
[GRAPHIC] [TIFF OMITTED] TP18SE23.071
Where M equals the greater of 10 business days and the remaining
maturity of the contract, as measured in business days.
(iii) For purposes of paragraph (i)(4) of this section, if a
[BANKING ORGANIZATION] has elected pursuant to paragraph (e)(5) of this
section to treat a derivative contract that is a cleared transaction
that is not subject to a variation margin agreement as one that is
subject to a variation margin agreement, the [BANKING ORGANIZATION]
must treat the derivative contract as subject to a variation margin
agreement with maturity factor as determined according to paragraph
(i)(4)(i) of this section, and daily settlement does not change the end
date of the period referenced by the derivative contract.
(5) Derivative contract as multiple effective derivative contracts.
A [BANKING ORGANIZATION] must separate a derivative contract into
separate derivative contracts, according to the following rules:
(i) For an option where the counterparty pays a predetermined
amount if the value of the underlying asset is above or below the
strike price and nothing otherwise (binary option), the option must be
treated as two separate options. For purposes of paragraph (i)(3)(ii)
of this section, a binary option with strike price K must be
represented as the combination of one bought European option and one
sold European option of the same type as the original option (put or
call) with the strike prices set equal to 0.95 * K and 1.05 * K so that
the payoff of the binary option is reproduced exactly outside the
region between the two strike prices. The absolute value of the sum of
the adjusted derivative contract amounts of the bought and sold options
is capped at the payoff amount of the binary option.
(ii) For a derivative contract that can be represented as a
combination of standard option payoffs (such as collar, butterfly
spread, calendar spread, straddle, and strangle), a [BANKING
ORGANIZATION] must treat each standard option component as a separate
derivative contract.
(iii) For a derivative contract that includes multiple-payment
options, (such as interest rate caps and floors), a [BANKING
ORGANIZATION] may represent each payment option as a combination of
effective single-payment options (such as interest rate caplets and
floorlets).
(iv) A [BANKING ORGANIZATION] may not decompose linear derivative
contracts (such as swaps) into components.
(j) Multiple netting sets subject to a single variation margin
agreement--(1) Calculating replacement cost. Notwithstanding paragraph
(f) of this section, a [BANKING ORGANIZATION] must assign a single
replacement cost to multiple netting sets that are subject to a single
variation margin agreement under which the counterparty must post
variation margin, calculated according to the following formula:
[GRAPHIC] [TIFF OMITTED] TP18SE23.072
Where:
NS is each netting set subject to the variation margin agreement MA;
VNS is the sum of the fair values (after excluding any valuation
adjustments) of the derivative contracts within the netting set NS;
and
CMA is the sum of the net independent collateral amount and the
variation margin amount applicable to the derivative contracts
within the netting sets subject to the single variation margin
agreement.
(2) Calculating potential future exposure. Notwithstanding
paragraph (g) of this section, a [BANKING ORGANIZATION] must assign a
single potential future exposure to multiple netting sets that are
subject to a single variation margin agreement under which the
counterparty must post variation margin equal to the sum of the
[[Page 64199]]
potential future exposure of each such netting set, each calculated
according to paragraph (g) of this section as if such nettings sets
were not subject to a variation margin agreement.
(k) Netting set subject to multiple variation margin agreements or
a hybrid netting set--(1) Calculating replacement cost. To calculate
replacement cost for either a netting set subject to multiple variation
margin agreements under which the counterparty to each variation margin
agreement must post variation margin, or a netting set composed of at
least one derivative contract subject to variation margin agreement
under which the counterparty must post variation margin and at least
one derivative contract that is not subject to such a variation margin
agreement, the calculation for replacement cost is provided under
paragraph (f)(1) of this section, except that the variation margin
threshold equals the sum of the variation margin thresholds of all
variation margin agreements within the netting set and the minimum
transfer amount equals the sum of the minimum transfer amounts of all
the variation margin agreements within the netting set.
(2) Calculating potential future exposure. (i) To calculate
potential future exposure for a netting set subject to multiple
variation margin agreements under which the counterparty to each
variation margin agreement must post variation margin, or a netting set
composed of at least one derivative contract subject to a variation
margin agreement under which the counterparty to the derivative
contract must post variation margin and at least one derivative
contract that is not subject to such a variation margin agreement, a
[BANKING ORGANIZATION] must divide the netting set into sub-netting
sets (as described in paragraph (k)(2)(ii) of this section) and
calculate the aggregated amount for each sub-netting set. The
aggregated amount for the netting set is calculated as the sum of the
aggregated amounts for the sub-netting sets. The multiplier is
calculated for the entire netting set.
(ii) For purposes of paragraph (k)(2)(i) of this section, the
netting set must be divided into sub-netting sets as follows:
(A) All derivative contracts within the netting set that are not
subject to a variation margin agreement or that are subject to a
variation margin agreement under which the counterparty is not required
to post variation margin form a single sub-netting set. The aggregated
amount for this sub-netting set is calculated as if the netting set is
not subject to a variation margin agreement.
(B) All derivative contracts within the netting set that are
subject to variation margin agreements in which the counterparty must
post variation margin and that share the same value of the MPOR form a
single sub-netting set. The aggregated amount for this sub-netting set
is calculated as if the netting set is subject to a variation margin
agreement, using the MPOR value shared by the derivative contracts
within the netting set.
[GRAPHIC] [TIFF OMITTED] TP18SE23.073
Sec. __.114 Cleared Transactions.
(a) General requirements--(1) Clearing member clients. A [BANKING
ORGANIZATION] that is a clearing member client must use the
methodologies described in paragraph (b) of this section to calculate
risk-weighted assets for a cleared transaction.
[[Page 64200]]
(2) Clearing members. A [BANKING ORGANIZATION] that is a clearing
member must use the methodologies described in paragraph (c) of this
section to calculate its risk-weighted assets for a cleared transaction
and paragraph (d) of this section to calculate its risk-weighted assets
for its default fund contribution to a CCP.
(b) Clearing member client [BANKING ORGANIZATIONS]--(1) Risk-
weighted assets for cleared transactions. (i) To determine the risk-
weighted asset amount for a cleared transaction, a [BANKING
ORGANIZATION] that is a clearing member client must multiply the trade
exposure amount for the cleared transaction, calculated in accordance
with paragraph (b)(2) of this section, by the risk weight appropriate
for the cleared transaction, determined in accordance with paragraph
(b)(3) of this section.
(ii) A clearing member client [BANKING ORGANIZATION]'s total risk-
weighted assets for cleared transactions is the sum of the risk-
weighted asset amounts for all of its cleared transactions.
(2) Trade exposure amount. (i) For a cleared transaction that is a
derivative contract or a netting set of derivative contracts, trade
exposure amount equals the exposure amount for the derivative contract
or netting set of derivative contracts calculated using Sec. __.113,
plus the fair value of the collateral posted by the clearing member
client [BANKING ORGANIZATION] and held by the CCP, clearing member, or
custodian in a manner that is not bankruptcy remote.
(ii) For a cleared transaction that is a repo-style transaction or
netting set of repo-style transactions, trade exposure amount equals
the exposure amount for the repo-style transaction calculated using the
methodology set forth in Sec. __.121, plus the fair value of the
collateral posted by the clearing member client [BANKING ORGANIZATION]
and held by the CCP, clearing member, or custodian in a manner that is
not bankruptcy remote.
(3) Cleared transaction risk weights. (i) For a cleared transaction
with a QCCP, a clearing member client [BANKING ORGANIZATION] must apply
a risk weight of:
(A) 2 percent if the collateral posted by the [BANKING
ORGANIZATION] to the QCCP or clearing member is subject to an
arrangement that prevents any loss to the clearing member client
[BANKING ORGANIZATION] due to the joint default or a concurrent
insolvency, liquidation, or receivership proceeding of the clearing
member and any other clearing member clients of the clearing member;
and the clearing member client [BANKING ORGANIZATION] has conducted
sufficient legal review to conclude with a well-founded basis (and
maintains sufficient written documentation of that legal review) that
in the event of a legal challenge (including one resulting from an
event of default or from liquidation, insolvency, or receivership
proceedings) the relevant court and administrative authorities would
find the arrangements to be legal, valid, binding, and enforceable
under the law of the relevant jurisdictions; or
(B) 4 percent, if the requirements of paragraph (b)(3)(i)(A) of
this section are not met.
(ii) For a cleared transaction with a CCP that is not a QCCP, a
clearing member client [BANKING ORGANIZATION] must apply the risk
weight applicable to the CCP under Sec. __.111.
(4) Collateral. (i) Notwithstanding any other requirement of this
section, collateral posted by a clearing member client [BANKING
ORGANIZATION] that is held by a custodian (in its capacity as a
custodian) in a manner that is bankruptcy remote from the CCP, clearing
member, and other clearing member clients of the clearing member, is
not subject to a capital requirement under this section.
(ii) A clearing member client [BANKING ORGANIZATION] must calculate
a risk-weighted asset amount for any collateral provided to a CCP,
clearing member or a custodian in connection with a cleared transaction
in accordance with requirements under subpart E or F of this part, as
applicable.
(c) Clearing member [BANKING ORGANIZATION]--(1) Risk-weighted
assets for cleared transactions. (i) To determine the risk-weighted
asset amount for a cleared transaction, a clearing member [BANKING
ORGANIZATION] must multiply the trade exposure amount for the cleared
transaction, calculated in accordance with paragraph (c)(2) of this
section by the risk weight appropriate for the cleared transaction,
determined in accordance with paragraph (c)(3) of this section.
(ii) A clearing member [BANKING ORGANIZATION]'s total risk-weighted
assets for cleared transactions is the sum of the risk-weighted asset
amounts for all of its cleared transactions.
(2) Trade exposure amount. A clearing member [BANKING ORGANIZATION]
must calculate its trade exposure amount for a cleared transaction as
follows:
(i) For a cleared transaction that is a derivative contract or a
netting set of derivative contracts, trade exposure amount equals the
exposure amount for the derivative contract or netting set of
derivative contracts calculated using Sec. __.113, plus the fair value
of the collateral posted by the clearing member [BANKING ORGANIZATION]
and held by the CCP in a manner that is not bankruptcy remote.
(ii) For a cleared transaction that is a repo-style transaction or
netting set of repo-style transactions, trade exposure amount equals
the exposure amount for the repo-style transaction calculated using the
methodology set forth in Sec. __.121, plus the fair value of the
collateral posted by the clearing member [BANKING ORGANIZATION] and
held by the CCP in a manner that is not bankruptcy remote.
(3) Cleared transaction risk weights. (i) A clearing member
[BANKING ORGANIZATION] must apply a risk weight of 2 percent to the
trade exposure amount for a cleared transaction with a QCCP.
(ii) For a cleared transaction with a CCP that is not a QCCP, a
clearing member [BANKING ORGANIZATION] must apply the risk weight
applicable to the CCP according to Sec. __.111.
(iii) Notwithstanding paragraphs (c)(3)(i) and (ii) of this
section, a clearing member [BANKING ORGANIZATION] may apply a risk
weight of zero percent to the trade exposure amount for a cleared
transaction with a QCCP where the clearing member [BANKING
ORGANIZATION] is acting as a financial intermediary on behalf of a
clearing member client, the transaction offsets another transaction
that satisfies the requirements set forth in Sec. __.3(a), and the
clearing member [BANKING ORGANIZATION] is not obligated to reimburse
the clearing member client in the event of the QCCP default.
(4) Collateral. (i) Notwithstanding any other requirement of this
section, collateral posted by a clearing member [BANKING ORGANIZATION]
that is held by a custodian in a manner that is bankruptcy remote from
the CCP is not subject to a capital requirement under this section.
(ii) A clearing member [BANKING ORGANIZATION] must calculate a
risk-weighted asset amount for any collateral provided to a CCP,
clearing member or a custodian in connection with a cleared transaction
in accordance with requirements under subparts E or F of this part, as
applicable.
(d) Default fund contributions--(1) General requirement. A clearing
member [BANKING ORGANIZATION] must determine the risk-weighted asset
amount for a default fund contribution
[[Page 64201]]
to a CCP at least quarterly, or more frequently if, in the opinion of
the [BANKING ORGANIZATION] or the [AGENCY], there is a material change
in the financial condition of the CCP. The total risk-weighted assets
for default fund contributions of a clearing member [BANKING
ORGANIZATION] is the sum of the [BANKING ORGANIZATION]'s risk-weighted
assets for all of its default fund contributions to all CCPs of which
the [BANKING ORGANIZATION] is a clearing member.
(2) Risk-weighted asset amount for default fund contributions to
nonqualifying CCPs. A clearing member [BANKING ORGANIZATION]'s risk-
weighted asset amount for default fund contributions to CCPs that are
not QCCPs equals the sum of such default fund contributions multiplied
by 1,250 percent, or an amount determined by the [AGENCY], based on
factors such as size, structure, and membership characteristics of the
CCP and riskiness of its transactions, in cases where such default fund
contributions may be unlimited.
(3) Risk-weighted asset amount for default fund contributions to
QCCPs. A clearing member [BANKING ORGANIZATION]'s risk-weighted asset
amount for default fund contributions to QCCPs equals the sum of its
capital requirement, KCM for each QCCP, as calculated under the
methodology set forth in paragraph (d)(4) of this section, multiplied
by 12.5.
(4) Capital requirement for default fund contributions to a QCCP. A
clearing member [BANKING ORGANIZATION]'s capital requirement for its
default fund contribution to a QCCP (KCM) is equal to:
[GRAPHIC] [TIFF OMITTED] TP18SE23.074
Where:
KCCP is the hypothetical capital requirement of the QCCP, as
determined under paragraph (d)(5) of this section;
DFpref is the prefunded default fund contribution of the clearing
member [BANKING ORGANIZATION] to the QCCP;
DFCCP is the QCCP's own prefunded amounts that are contributed to
the default waterfall and are junior or pari passu with prefunded
default fund contributions of clearing members of the CCP; and
DFCCPCMpref is the total prefunded default fund contributions from
clearing members of the QCCP to the QCCP.
(5) Hypothetical capital requirement of a QCCP. Where a QCCP has
provided its KCCP, a [BANKING ORGANIZATION] must rely on
such disclosed figure instead of calculating KCCP under this
paragraph (d)(5), unless the [BANKING ORGANIZATION] determines that a
more conservative figure is appropriate based on the nature, structure,
or characteristics of the QCCP. The hypothetical capital requirement of
a QCCP (KCCP), as determined by the [BANKING ORGANIZATION],
is equal to:
[GRAPHIC] [TIFF OMITTED] TP18SE23.075
Where:
CMi is each clearing member of the QCCP; and
EAi is the exposure amount of the QCCP to each clearing member of
the QCCP to the QCCP, as determined under paragraph (d)(6) of this
section.
(6) Exposure amount of a QCCP to a clearing member. (i) The
exposure amount of a QCCP to a clearing member is equal to the sum of
the exposure amount for derivative contracts determined under paragraph
(d)(6)(ii) of this section and the exposure amount for repo-style
transactions determined under paragraph (d)(6)(iii) of this section.
(ii) With respect to any derivative contracts between the QCCP and
the clearing member and any guarantees that the clearing member has
provided to the QCCP with respect to performance of a clearing member
client on a derivative contract, the exposure amount is equal to the
exposure amount of the QCCP to the clearing member for all such
derivative contracts and guaranteed derivative contracts calculated
under SA-CCR in Sec. __.113 (or, with respect to a QCCP located
outside the United States, under a substantially identical methodology
in effect in the jurisdiction) using a value of 10 business days for
purposes of Sec. __.113(i)(4), provided that for this calculation, in
place of the net independent collateral amount, the calculation must
include the fair value amount of the independent collateral, as
adjusted by the market price volatility haircut under Table 1 to Sec.
__.121, as applicable, posted to the QCCP by the clearing member,
including collateral posted on behalf of a client of the clearing
member in connection with a derivative contract for which the clearing
member has provided guarantees to the QCCP, plus the amount of the
prefunded default fund contribution, as adjusted by the market price
volatility haircut under Table 1 to Sec. __.121, as applicable, plus
the amount of the prefunded default fund contribution of the clearing
member to the QCCP.
(iii) With respect to any repo-style transactions between the
clearing member and the QCCP that are cleared transactions, exposure
amount (EA) is equal to:
EA = max {EBRMi- IMi - DFi; 0{time}
Where:
EBRMi is the exposure amount of the QCCP to each clearing member for
all repo-style transactions between the QCCP and the clearing
member, as determined under Sec. __.121 and without recognition of
the initial margin collateral posted by the clearing member to the
QCCP with respect to the repo-style transactions or the prefunded
default fund contribution of the clearing member institution to the
QCCP;
IMi is the initial margin collateral posted by each clearing member
to the QCCP with respect to the repo-style transactions; and
DFi is the prefunded default fund contribution of each clearing
member to the QCCP that is not already deducted in paragraph
(d)(6)(ii) of this section.
(iv) Exposure amount must be calculated separately for each
clearing member's sub-client accounts and sub-house account (i.e., for
the clearing member's proprietary activities). If the clearing member's
collateral and its client's collateral are held in the same default
fund contribution account, then
[[Page 64202]]
the exposure amount of that account is the sum of the exposure amount
for the client-related transactions within the account and the exposure
amount of the house-related transactions within the account. For
purposes of determining such exposure amounts, the independent
collateral of the clearing member and its client must be allocated in
proportion to the respective total amount of independent collateral
posted by the clearing member to the QCCP.
(v) If any account or sub-account contains both derivative
contracts and repo-style transactions, the exposure amount of that
account is the sum of the exposure amount for the derivative contracts
within the account and the exposure amount of the repo-style
transactions within the account. If independent collateral is held for
an account containing both derivative contracts and repo-style
transactions, then such collateral must be allocated to the derivative
contracts and repo-style transactions in proportion to the respective
product specific exposure amounts, calculated, excluding the effects of
collateral, according to Sec. __.121 for repo-style transactions and
to Sec. __.113 for derivative contracts.
(vi) Notwithstanding any other provision of paragraph (d) of this
section, with the prior approval of the [AGENCY], a [BANKING
ORGANIZATION] may determine the risk-weighted asset amount for a
default fund contribution to a QCCP according to Sec. __.35(d)(3)(i)
through (iii).
Sec. __.115 Unsettled Transactions.
(a) Definitions. For purposes of this section:
(1) Delivery-versus-payment (DvP) transaction means a securities or
commodities transaction in which the buyer is obligated to make payment
only if the seller has made delivery of the securities or commodities
and the seller is obligated to deliver the securities or commodities
only if the buyer has made payment.
(2) Payment-versus-payment (PvP) transaction means a foreign
exchange transaction in which each counterparty is obligated to make a
final transfer of one or more currencies only if the other counterparty
has made a final transfer of one or more currencies.
(3) A transaction has a normal settlement period if the contractual
settlement period for the transaction is equal to or less than the
market standard for the instrument underlying the transaction and equal
to or less than five business days.
(4) Positive current exposure of a [BANKING ORGANIZATION] for a
transaction is the difference between the transaction value at the
agreed settlement price and the current market price of the
transaction, if the difference results in a credit exposure of the
[BANKING ORGANIZATION] to the counterparty.
(b) Scope. This section applies to all transactions involving
securities, foreign exchange instruments, and commodities that have a
risk of delayed settlement or delivery. This section does not apply to:
(1) Cleared transactions that are marked-to-market daily and
subject to daily receipt and payment of variation margin;
(2) Repo-style transactions, including unsettled repo-style
transactions;
(3) One-way cash payments on OTC derivative contracts; or
(4) Transactions with a contractual settlement period that is
longer than the normal settlement period (which are treated as OTC
derivative contracts as provided in Sec. __.113).
(c) System-wide failures. In the case of a system-wide failure of a
settlement, clearing system or central counterparty, the [AGENCY] may
waive risk-based capital requirements for unsettled and failed
transactions until the situation is rectified.
(d) Delivery-versus-payment (DvP) and payment-versus-payment (PvP)
transactions. A [BANKING ORGANIZATION] must hold risk-based capital
against any DvP or PvP transaction with a normal settlement period if
the [BANKING ORGANIZATION]'s counterparty has not made delivery or
payment within five business days after the settlement date. The
[BANKING ORGANIZATION] must determine its risk-weighted asset amount
for such a transaction by multiplying the positive current exposure of
the transaction for the [BANKING ORGANIZATION] by the appropriate risk
weight in Table 1 to Sec. __.115.
[GRAPHIC] [TIFF OMITTED] TP18SE23.076
(e) Non-DvP/non-PvP (non-delivery-versus-payment/non-payment-
versus-payment) transactions. (1) A [BANKING ORGANIZATION] must hold
risk-based capital against any non-DvP/non-PvP transaction with a
normal settlement period if the [BANKING ORGANIZATION] has delivered
cash, securities, commodities, or currencies to its counterparty but
has not received its corresponding deliverables by the end of the same
business day. The [BANKING ORGANIZATION] must continue to hold risk-
based capital against the transaction until the [BANKING ORGANIZATION]
has received its corresponding deliverables.
(2) From the business day after the [BANKING ORGANIZATION] has made
its delivery until five business days after the counterparty delivery
is due, the [BANKING ORGANIZATION] must calculate the risk-weighted
asset amount for the transaction by treating the current fair value of
the deliverables owed to the [BANKING ORGANIZATION] as an exposure to
the counterparty and using the applicable counterparty risk weight
under this subpart.
(3) If the [BANKING ORGANIZATION] has not received its deliverables
by the fifth business day
[[Page 64203]]
after counterparty delivery was due, the [BANKING ORGANIZATION] must
assign a 1,250 percent risk weight to the current fair value of the
deliverables owed to the [BANKING ORGANIZATION].
(f) Total risk-weighted assets for unsettled transactions. Total
risk-weighted assets for unsettled transactions is the sum of the risk-
weighted asset amounts of all DvP, PvP, and non-DvP/non-PvP
transactions.
Credit Risk Mitigation
Sec. __.120 Guarantees and credit derivatives: Substitution approach.
(a) Scope--(1) A [BANKING ORGANIZATION] may recognize the credit
risk mitigation benefits of an eligible guarantee or eligible credit
derivative that is not an nth-to-default credit derivative by
substituting the risk weight associated with the protection provider
for the risk weight assigned to an exposure, as provided under this
section.
(2) This section applies to exposures for which:
(i) Credit risk is fully covered by an eligible guarantee or
eligible credit derivative; or
(ii) Credit risk is covered on a pro rata basis (that is, on a
basis in which the [BANKING ORGANIZATION] and the protection provider
share losses proportionately) by an eligible guarantee or eligible
credit derivative.
(3) Exposures on which there is a tranching of credit risk
(reflecting at least two different levels of seniority) generally are
securitization exposures subject to Sec. __.130 through __.134.
(4) If multiple eligible guarantees or eligible credit derivatives
cover a single exposure described in this section, a [BANKING
ORGANIZATION] may treat the hedged exposure as multiple separate
exposures each covered by a single eligible guarantee or eligible
credit derivative and may calculate a separate risk-weighted asset
amount for each separate exposure as described in paragraph (c) of this
section.
(5) If a single eligible guarantee or eligible credit derivative
covers multiple hedged exposures described in paragraph (a)(2) of this
section, a [BANKING ORGANIZATION] must treat each hedged exposure as
covered by a separate eligible guarantee or eligible credit derivative
and must calculate a separate risk-weighted asset amount for each
exposure as described in paragraph (c) of this section.
(b) Rules of recognition. (1) A [BANKING ORGANIZATION] may only
recognize the credit risk mitigation benefits of eligible guarantees
and eligible credit derivatives that are not nth-to-default credit
derivatives.
(2) A [BANKING ORGANIZATION] may only recognize the credit risk
mitigation benefits of an eligible credit derivative to hedge an
exposure that is different from the credit derivative's reference
exposure used for determining the derivative's cash settlement value,
deliverable obligation, or occurrence of a credit event if:
(i) The reference exposure ranks pari passu with, or is
subordinated to, the hedged exposure;
(ii) The reference exposure and the hedged exposure are to the same
legal entity, and
(iii) Legally enforceable cross-default or cross-acceleration
clauses are in place to ensure payments under the credit derivative are
triggered when the obligated party of the hedged exposure fails to pay
under the terms of the hedged exposure.
(c) Substitution approach--(1) Full coverage. If an eligible
guarantee or eligible credit derivative meets the conditions in
paragraphs (a) and (b) of this section and the protection amount (P) of
the guarantee or credit derivative is greater than or equal to the
exposure amount of the hedged exposure, a [BANKING ORGANIZATION] may
recognize the guarantee or credit derivative in determining the risk-
weighted asset amount for the hedged exposure by substituting the risk
weight applicable to the guarantor or credit derivative protection
provider under this subpart for the risk weight assigned to the
exposure.
(2) Partial coverage. If an eligible guarantee or eligible credit
derivative meets the conditions in paragraphs (a) and (b) of this
section and the protection amount (P) of the guarantee or credit
derivative is less than the exposure amount of the hedged exposure, the
[BANKING ORGANIZATION] must treat the hedged exposure as two separate
exposures (protected and unprotected) in order to recognize the credit
risk mitigation benefit of the guarantee or credit derivative.
(i) The [BANKING ORGANIZATION] may calculate the risk-weighted
asset amount for the protected exposure under this subpart E, where the
applicable risk weight is the risk weight applicable to the guarantor
or credit derivative protection provider.
(ii) The [BANKING ORGANIZATION] must calculate the risk-weighted
asset amount for the unprotected exposure under this subpart E, where
the applicable risk weight is that of the unprotected portion of the
hedged exposure.
(iii) The treatment provided in this section is applicable when the
credit risk of an exposure is covered on a partial pro rata basis and
may be applicable when an adjustment is made to the effective notional
amount of the guarantee or credit derivative under paragraph (d), (e),
or (f) of this section.
(d) Maturity mismatch adjustment. (1) A [BANKING ORGANIZATION] that
recognizes an eligible guarantee or eligible credit derivative in
determining the risk-weighted asset amount for a hedged exposure must
adjust the effective notional amount of the credit risk mitigant to
reflect any maturity mismatch between the hedged exposure and the
credit risk mitigant.
(2) A maturity mismatch occurs when the residual maturity of a
credit risk mitigant is less than that of the hedged exposure(s).
(3) The residual maturity of a hedged exposure is the longest
possible remaining time before the obligated party of the hedged
exposure is scheduled to fulfil its obligation on the hedged exposure.
If a credit risk mitigant has embedded options that may reduce its
term, the [BANKING ORGANIZATION] (protection purchaser) must adjust the
residual maturity of the credit risk mitigant. If a call is at the
discretion of the protection provider, the residual maturity of the
credit risk mitigant is at the first call date. If the call is at the
discretion of the [BANKING ORGANIZATION] (protection purchaser), but
the terms of the arrangement at origination of the credit risk mitigant
contain a positive incentive for the [BANKING ORGANIZATION] to call the
transaction before contractual maturity, the remaining time to the
first call date is the residual maturity of the credit risk mitigant.
(4) A credit risk mitigant with a maturity mismatch may be
recognized only if its original maturity is greater than or equal to
one year and its residual maturity is greater than three months.
(5) When a maturity mismatch exists, the [BANKING ORGANIZATION]
must apply the following adjustment to reduce the effective notional
amount of the credit risk mitigant:
Where:
Pm = E x (t-0.25)/(T-0.25),
(i) Pm = effective notional amount of the credit risk mitigant,
adjusted for maturity mismatch;
(ii) E = effective notional amount of the credit risk mitigant;
(iii) t = the lesser of T or the residual maturity of the credit
risk mitigant, expressed in years; and
[[Page 64204]]
(iv) T = the lesser of five or the residual maturity of the hedged
exposure, expressed in years.
(e) Adjustment for credit derivatives without restructuring as a
credit event. (1) If a [BANKING ORGANIZATION] recognizes an eligible
credit derivative that does not include as a credit event a
restructuring of the hedged exposure involving forgiveness or
postponement of principal, interest, or fees that results in a credit
loss event (that is, a charge-off, specific provision, or other similar
debit to the profit and loss account), the [BANKING ORGANIZATION] must
apply the adjustment in paragraph (e)(2) of this section to reduce the
effective notional amount of the credit derivative unless: the terms of
the hedged exposure and the reference exposure, if different from the
hedged exposure, allow the maturity, principal, coupon, currency, or
seniority status of the exposure to be amended outside of receivership,
insolvency, liquidation, or similar proceeding only by unanimous
consent of all parties, and the [BANKING ORGANIZATION] has conducted
sufficient legal review to conclude with a well-founded basis (and
maintains sufficient written documentation of that legal review) that
the hedged exposure is subject to the U.S. Bankruptcy Code, the Federal
Deposit Insurance Act, or a domestic or foreign insolvency regime with
similar features that allow for a company to liquidate, reorganize, or
restructure and provides for an orderly settlement of creditor claims.
(2) The [BANKING ORGANIZATION] must apply the following adjustment
to reduce the effective notional amount of any eligible credit
derivative that is subject to adjustment under paragraph (e)(1) of this
section:
Where:
Pr = Pm x 0.60,
(i) Pr = effective notional amount of the credit risk mitigant,
adjusted for lack of restructuring event (and maturity mismatch, if
applicable); and
(ii) Pm = effective notional amount of the credit risk mitigant
(adjusted for maturity mismatch, if applicable).
(f) Currency mismatch adjustment. (1) If a [BANKING ORGANIZATION]
recognizes an eligible guarantee or eligible credit derivative that is
denominated in a currency different from that in which the hedged
exposure is denominated, the [BANKING ORGANIZATION] must apply the
following formula to the effective notional amount of the guarantee or
credit derivative:
Where:
Pc = Pr x (1-HFX),
(i) Pc = effective notional amount of the credit risk mitigant,
adjusted for currency mismatch (and maturity mismatch and lack of
restructuring event, if applicable);
(ii) Pr = effective notional amount of the credit risk mitigant
(adjusted for maturity mismatch and lack of restructuring event, if
applicable); and
(iii) HFX = haircut appropriate for the currency mismatch between
the credit risk mitigant and the hedged exposure, as determined
under paragraphs (f)(2) through (3) of this section.
(2) Subject to paragraph (f)(3) of this section, a [BANKING
ORGANIZATION] must set HFX equal to eight percent.
(3) A [BANKING ORGANIZATION] must increase HFX as
determined under paragraph (f)(2) of this section if the [BANKING
ORGANIZATION] revalues the guarantee or credit derivative less
frequently than once every 10 business days using the following
formula:
Where:
HFX = 8% x (TM/10)\1/2\, where TM equals the greater of 10 or the
number of business days between revaluations.
Sec. __.121 Collateralized transactions.
(a) General. (1) To recognize the risk-mitigating effects of
financial collateral, a [BANKING ORGANIZATION] may use:
(i) The simple approach in paragraph (b) of this section for any
exposure that is not a derivative contract or a netting set of
derivative contracts; or
(ii) The collateral haircut approach in paragraph (c) of this
section for a repo-style transaction, eligible margin loan, or a
netting set of such transactions.
(2) A [BANKING ORGANIZATION] may use any approach described in this
section that is valid for a particular type of exposure or transaction;
however, it must use the same approach for similar exposures or
transactions.
(3) For purposes of this section, a [BANKING ORGANIZATION] may only
recognize the risk-mitigating effects of a corporate debt security that
meets the definition of financial collateral if the corporate issuer of
the debt security has a publicly traded security outstanding or is
controlled by a company that has a publicly traded security
outstanding.
(b) The simple approach--(1) General requirements. (i) A [BANKING
ORGANIZATION] may recognize the credit risk mitigation benefits of
financial collateral that secures any exposure that is not a derivative
contract or netting set of derivative contracts.
(ii) To qualify for the simple approach, the financial collateral
must meet the following requirements:
(A) The collateral must be subject to a collateral agreement for at
least the life of the exposure;
(B) The collateral must be revalued at least every six months; and
(C) The collateral (other than gold) and the exposure must be
denominated in the same currency.
(2) Risk weight substitution. (i) A [BANKING ORGANIZATION] may
apply a risk weight to the portion of an exposure that is secured by
the fair value of financial collateral (that meets the requirements of
paragraph (b)(1) of this section) based on the risk weight assigned to
the collateral under this subpart. For repurchase agreements, reverse
repurchase agreements, and securities lending and borrowing
transactions, the collateral is the instruments, gold, and cash the
[BANKING ORGANIZATION] has borrowed, purchased subject to resale, or
taken as collateral from the counterparty under the transaction. Except
as provided in paragraph (b)(3) of this section, the risk weight
assigned to the collateralized portion of the exposure may not be less
than 20 percent.
(ii) A [BANKING ORGANIZATION] must apply a risk weight to the
unsecured portion of the exposure based on the risk weight applicable
to the exposure under this subpart.
(3) Exceptions to the 20 percent risk weight floor and other
requirements. Notwithstanding paragraph (b)(2)(i) of this section, a
[BANKING ORGANIZATION] may assign a zero percent risk weight to the
collateralized portion of an exposure where:
(i) The financial collateral is cash on deposit; or
(ii) The financial collateral is an exposure to a sovereign that
qualifies for a zero percent risk weight under Sec. __.111, and the
[BANKING ORGANIZATION] has discounted the fair value of the collateral
by 20 percent.
(c) Collateral haircut approach--Exposure amount for eligible
margin loans and repo-style transactions--(1) General. A [BANKING
ORGANIZATION] may recognize the credit risk mitigation benefits of
financial collateral that secures an eligible margin loan, repo-style
transaction, or netting set of such transactions, and of any collateral
that secures a repo-style transaction that is included in the [BANKING
ORGANIZATION]'s measure for market risk under subpart F of this part,
by using the collateral haircut approach covered in paragraph (c)(2) of
this section.
(2) Collateral haircut approach--(i) Netting set amount
calculation. For
[[Page 64205]]
purposes of the collateral haircut approach, except as provided in
paragraph (c)(2)(ii) of this section, a [BANKING ORGANIZATION] must
determine the exposure amount for a netting set of eligible margin
loans or repo-style transactions according to the following formula:
[GRAPHIC] [TIFF OMITTED] TP18SE23.077
Where:
(A) E* is the exposure amount of the netting set after credit risk
mitigation;
(B) Ei is the current fair value of the instrument, cash, or gold
the [BANKING ORGANIZATION] has lent, sold subject to repurchase, or
posted as collateral to the counterparty;
(C) Ci is the current fair value of the instrument, cash, or gold
the banking organization has borrowed, purchased subject to resale,
or taken as collateral from the counterparty;
(D) netexposure = [verbar][Sigma]sEsHs[verbar][verbar];
(E) grossexposure = [Sigma]sEs[verbar]Hs[verbar];
(F) Es is the absolute value of the net position in a given
instrument or in gold, where the net position in a given instrument
or gold equals the sum of the current fair values of the instrument
or gold the [BANKING ORGANIZATION] has lent, sold subject to
repurchase, or posted as collateral to the counterparty, minus the
sum of the current fair values of that same instrument or gold the
[BANKING ORGANIZATION] has borrowed, purchased subject to resale, or
taken as collateral from the counterparty;
(G) Hs is the haircut appropriate to Es as described in Table 1 of
this section, as applicable. Hs has a positive sign if the
instrument or gold is net lent, sold subject to repurchase, or
posted as collateral to the counterparty; Hs has a negative sign if
the instrument or gold is net borrowed, purchased subject to resale,
or taken as collateral from the counterparty;
(H) N is the number of instruments with a unique Committee on
Uniform Securities Identification Procedures (CUSIP) designation or
foreign equivalent that the [BANKING ORGANIZATION] lends, sells
subject to repurchase, posts as collateral, borrows, purchases
subject to resale, or takes as collateral in the netting set,
including all collateral that the [BANKING ORGANIZATION] elects to
include within the credit risk mitigation framework, except that
instruments where the value Es is less than one tenth of the value
of the largest Es in the netting set are not included in the count
or gold, with any amount of gold given a value of one;
(I) Efx is the absolute value of the net position in each currency
fx different from the settlement currency;
(J) Hfx is the haircut appropriate for currency mismatch of currency
fx.
(ii) Single transaction exposure amount calculation. For purposes
of the collateral haircut approach, a [BANKING ORGANIZATION] must use
the following formula to calculate the exposure amount for an
individual eligible margin loan or repo-style transaction that is not a
part of a netting set:
E* = max{0; E x (1 + He)-C x (1-Hc-Hfx){time}
Where:
(A) E* is the exposure amount of the transaction after credit risk
mitigation.
(B) E is the current fair value of the specific instrument, cash, or
gold the banking organization has lent, sold subject to repurchase,
or posted as collateral to the counterparty;
(C) He is the haircut appropriate to E as described in
Table 1 of this section, as applicable.
(D) C is the current fair value of the specific instrument, cash, or
gold the banking organization has borrowed, purchased subject to
resale, or taken as collateral from the counterparty.
(E) Hc is the haircut appropriate to C as described in
Table 1 to this section, as applicable.
(F) H(fx) is the haircut appropriate for currency
mismatch between the collateral and exposure.
(iii) Market price volatility and currency mismatch haircuts. (A) A
[BANKING ORGANIZATION] must use the haircuts for market price
volatility (Hs) in Table 1 to this section, as adjusted in
certain circumstances as provided in paragraphs (c)(2)(iii)(C) through
(E) of this section.
BILLING CODE 6210-01-P; 6714-01-P; 4810-33-P
[[Page 64206]]
[GRAPHIC] [TIFF OMITTED] TP18SE23.078
BILLING CODE 6210-01-C; 6714-01-C; 4810-33-C
(B) For currency mismatches, a [BANKING ORGANIZATION] must use a
haircut for foreign exchange rate volatility (Hfx) of 8 percent, as
adjusted in certain circumstances under paragraphs (c)(2)(iii)(C) and
(D) of this section.
(C) For repo-style transactions, a [BANKING ORGANIZATION] may
multiply the haircuts provided in paragraphs (c)(2)(iii)(A) and (B) of
this section by the square root of \1/2\ (which equals 0.707107).
(D) A [BANKING ORGANIZATION] must adjust the haircuts provided in
paragraphs (c)(2)(iii)(A) and (B) of this section upward on the basis
of a holding period longer than ten business days for
[[Page 64207]]
eligible margin loans or a holding period longer than five business
days for repo-style transactions that are not cleared transactions
under the following conditions. If the number of trades in a netting
set exceeds 5,000 at any time during a quarter, a [BANKING
ORGANIZATION] must adjust the haircuts provided in paragraphs
(c)(2)(iii)(A) and (B) of this section upward on the basis of a holding
period of twenty business days for the following quarter except in the
calculation of exposure amount for purposes of Sec. __.114. If a
netting set contains one or more trades involving illiquid collateral,
a [BANKING ORGANIZATION] must adjust the haircuts provided in
paragraphs (c)(2)(iii)(A) and (B) of this section upward on the basis
of a holding period of twenty business days. If over the two previous
quarters more than two margin disputes on a netting set have occurred
that lasted longer than the holding period, then the [BANKING
ORGANIZATION] must adjust the haircuts provided in paragraphs
(c)(2)(iii)(A) and (B) of this section upward for that netting set on
the basis of a holding period that is at least two times the minimum
holding period for that netting set. The [BANKING ORGANIZATION] must
adjust the haircuts upward using the following formula:
[GRAPHIC] [TIFF OMITTED] TP18SE23.079
Where:
(1) Tm equals a holding period of longer than 10 business days for
eligible margin loans or longer than 5 business days for repo-style
transactions;
(2) Hs equals the market price volatility haircut provided in Table
1 of this section or to the foreign exchange rate volatility haircut
provided in paragraph (c)(3)(iii)(B) of this section; and
(3) Ts equals 10 business days for eligible margin loans or 5
business days for repo-style transactions.
(E) If the instruments a [BANKING ORGANIZATION] has lent, sold
subject to repurchase, or posted as collateral do not meet the
definition of financial collateral, the [BANKING ORGANIZATION] must use
a 30 percent haircut for market price volatility (Hs).
(d) Minimum haircut floors for certain eligible margin loans and
repo-style transactions--(1) General. To recognize the risk mitigation
benefit of financial collateral that secures an eligible margin loan or
repo-style transaction with an unregulated financial institution or
netting set of such transactions with an unregulated financial
institution, a [BANKING ORGANIZATION] must apply this paragraph (d). A
[BANKING ORGANIZATION] may not recognize the risk-mitigating benefits
of financial collateral that secures such transaction(s) unless the
requirements set forth in paragraphs (d)(3)(ii) or (d)(3)(iii) of this
section, as applicable, are satisfied.
(2) Transactions subject to the minimum haircut floors. (i) The
minimum haircut floors must be applied to any of the following
transactions with an unregulated financial institution that are not
cleared transactions:
(A) An eligible margin loan or repo-style transaction in which a
[BANKING ORGANIZATION] lends cash to an unregulated financial
institution in exchange for securities, unless all of the securities
are nondefaulted sovereign exposures; and
(B) A repo-style transaction that is a collateral upgrade
transaction.
(ii) Notwithstanding paragraph (d)(2)(i) of this section, the
following eligible margin loans and repo-style transactions with an
unregulated financial institution are exempted from the minimum haircut
floors:
(A) A transaction in which an unregulated financial institution
lends, sells subject to repurchase, or posts as collateral securities
to a [BANKING ORGANIZATION] in exchange for cash and the unregulated
financial institution uses the cash to fund one or more transactions
with the same or shorter maturity than the original transaction with
the [BANKING ORGANIZATION].
(B) A collateral upgrade transaction in which the unregulated
financial institution is unable to re-hypothecate, or contractually
agrees that it will not re-hypothecate, the securities it receives as
collateral against the securities lent.
(C) A transaction in which a [BANKING ORGANIZATION] borrows
securities for the purpose of meeting a current or anticipated demand,
including for delivery obligations, customer demand, or segregation
requirements, and not to provide financing to the unregulated financial
institution. The [BANKING ORGANIZATION] must maintain sufficient
written documentation that such transaction is for the purpose of
meeting a current or anticipated demand.
(3) Minimum haircut floors. (i) The minimum haircut floors,
expressed as percentages, are provided in tTable 2 to this section.
[[Page 64208]]
[GRAPHIC] [TIFF OMITTED] TP18SE23.080
(ii) Single-transaction haircut floors. For a single eligible
margin loan or repo-style transaction with an unregulated financial
institution that is not included in a netting set, a [BANKING
ORGANIZATION] must compare the haircut of the transaction with the
respective single-transaction haircut floor. If the haircut for the
transaction H is smaller than the single transaction haircut floor f,
the [BANKING ORGANIZATION] may not recognize the risk-mitigating
effects of financial collateral that secures the exposure under this
section.
(A) The haircut H equals to the ratio of the fair value of
financial collateral borrowed, purchased subject to resale, or taken as
collateral from the unregulated financial institution (CB) to the fair
value of financial collateral lent, sold subject to repurchase, or
posted as collateral (CL) expressed as a percent, minus 100 percent.
(B) The haircut floor f is calculated as:
(1) For a single cash-lent-for-security transaction, f is given in
Table 2 to this section.
(2) For a single security-for-security repo-style transaction, f is
calculated using the following formula, in which security L (haircut
floor fL given in Table 2 to this section) is lent, sold subject to
repurchase, or posted as collateral in exchange for borrowing,
purchasing subject to resale, or taking as collateral security B
(haircut floor fB given in Table 2 to this section):
[GRAPHIC] [TIFF OMITTED] TP18SE23.081
(iii) Portfolio haircut floors. For a netting set of eligible
margin loans or repo-style transactions with an unregulated financial
institution, a [BANKING ORGANIZATION] must compare the portfolio
haircut to the portfolio haircut floor. If the portfolio haircut H is
less than the portfolio haircut floor the [BANKING ORGANIZATION] may
not recognize the risk-mitigating effects of financial collateral that
secures the exposures. The portfolio haircut H and the portfolio
haircut floor f are calculated as:
[GRAPHIC] [TIFF OMITTED] TP18SE23.082
Where:
(A) CL equals the fair value of the net position in a given security
(or cash) the [BANKING ORGANIZATION] has lent, sold subject to
repurchase, or posted as collateral to the unregulated financial
institution;
[[Page 64209]]
(B) CB equals the fair value of the net position in a given security
the [BANKING ORGANIZATION] has borrowed, purchased subject to
resale, or taken as collateral from the unregulated financial
institution; and
(C) fL and fB are the respective haircut floors given in Table 2 to
this section for each security net lent (L) and net borrowed (B) by
the [BANKING ORGANIZATION].
Risk-Weighted Assets for Securitization Exposures
Sec. __.130 Operational criteria for recognizing the transfer of
risk.
(a) Operational criteria for traditional securitizations. A
[BANKING ORGANIZATION] that transfers exposures it has originated or
purchased to a securitization SPE or other third party in connection
with a traditional securitization may exclude the exposures from the
calculation of its risk-weighted assets only if each condition in this
section is satisfied. A [BANKING ORGANIZATION] that meets these
conditions must hold risk-based capital against any credit risk it
retains in connection with the securitization. A [BANKING ORGANIZATION]
that fails to meet these conditions must hold risk-based capital
against the transferred exposures as if they had not been securitized
and must deduct from common equity tier 1 capital any after-tax gain-
on-sale resulting from the transaction and any portion of a CEIO strip
that does not constitute after-tax gain-on-sale. If the transferred
exposures are in connection with a resecuritization and all of the
conditions in this paragraph (a) are satisfied, the [BANKING
ORGANIZATION] must exclude the exposures from the calculation of its
risk-weighted assets and must hold risk-based capital against any
credit risk it retains in connection with the resecuritization. The
conditions are:
(1) The exposures are not reported on the [BANKING ORGANIZATION]'s
consolidated balance sheet under GAAP;
(2) The [BANKING ORGANIZATION] has transferred to one or more third
parties credit risk associated with the underlying exposures;
(3) Any clean-up calls relating to the securitization are eligible
clean-up calls; and
(4) The securitization does not:
(i) Include one or more underlying exposures in which the borrower
is permitted to vary the drawn amount within an agreed limit under a
line of credit; and
(ii) Contain an early amortization provision.
(b) Operational criteria for synthetic securitizations. For
synthetic securitizations, a [BANKING ORGANIZATION] may recognize for
risk-based capital purposes the use of a credit risk mitigant to hedge
underlying exposures only if each condition in this paragraph (b) is
satisfied. A [BANKING ORGANIZATION] that meets these conditions must
hold risk-based capital against any credit risk of the exposures it
retains in connection with the synthetic securitization. A [BANKING
ORGANIZATION] that fails to meet these conditions or chooses not to
recognize the credit risk mitigant for purposes of this section must
instead hold risk-based capital against the underlying exposures as if
they had not been synthetically securitized. If the synthetic
securitization is a resecuritization and all of the conditions in this
paragraph (b) are satisfied, the [BANKING ORGANIZATION] must exclude
the underlying from the calculation of its risk-weighted assets and
must hold risk-based capital against any credit risk it retains in
connection with the resecuritization. The conditions are:
(1) The credit risk mitigant is:
(i) Financial collateral;
(ii) A guarantee that meets all criteria as set forth in the
definition of ``eligible guarantee'' in Sec. __.2, except for the
criteria in paragraph (3) of that definition; or
(iii) A credit derivative that is not an nth-to-default credit
derivative and that meets all criteria as set forth in the definition
of ``eligible credit derivative'' in Sec. __.2, except for the
criteria in paragraph (3) of the definition of ``eligible guarantee''
in Sec. __.2.
(2) The [BANKING ORGANIZATION] transfers credit risk associated
with the underlying exposures to one or more third parties, and the
terms and conditions in the credit risk mitigants employed do not
include provisions that:
(i) Allow for the termination of the credit protection due to
deterioration in the credit quality of the underlying exposures;
(ii) Require the [BANKING ORGANIZATION] to alter or replace the
underlying exposures to improve the credit quality of the underlying
exposures;
(iii) Increase the [BANKING ORGANIZATION]'s cost of credit
protection in response to deterioration in the credit quality of the
underlying exposures;
(iv) Increase the yield payable to parties other than the [BANKING
ORGANIZATION] in response to a deterioration in the credit quality of
the underlying exposures; or
(v) Provide for increases in a retained first loss position or
credit enhancement provided by the [BANKING ORGANIZATION] after the
inception of the securitization;
(3) The [BANKING ORGANIZATION] obtains a well-reasoned opinion from
legal counsel that confirms the enforceability of the credit risk
mitigant in all relevant jurisdictions;
(4) Any clean-up calls relating to the securitization are eligible
clean-up calls;
(5) No synthetic excess spread is permitted within the synthetic
securitization;
(6) Any applicable minimum payment threshold for the credit risk
mitigant is consistent with standard market practice; and
(7) The securitization does not:
(i) Include one or more underlying exposures in which the borrower
is permitted to vary the drawn amount within an agreed limit under a
line of credit; and
(ii) Contain an early amortization provision.
(c) Due diligence requirements for securitization exposures. (1)
Except for exposures that are deducted from common equity tier 1
capital and exposures subject to Sec. __.132(h), if a [BANKING
ORGANIZATION] is unable to demonstrate to the satisfaction of the
[AGENCY] a comprehensive understanding of the features of a
securitization exposure that would materially affect the performance of
the exposure, the [BANKING ORGANIZATION] must assign the securitization
exposure a risk weight of 1,250 percent. The [BANKING ORGANIZATION]'s
analysis must be commensurate with the complexity of the securitization
exposure and the materiality of the exposure in relation to its
capital.
(2) A [BANKING ORGANIZATION] must demonstrate its comprehensive
understanding of a securitization exposure under paragraph (c)(1) of
this section, for each securitization exposure by:
(i) Conducting an analysis of the risk characteristics of a
securitization exposure prior to acquiring the exposure and documenting
such analysis within 3 business days after acquiring the exposure,
considering:
(A) Structural features of the securitization that would materially
impact the performance of the exposure, for example, the contractual
cash flow waterfall, waterfall-related triggers, credit enhancements,
liquidity enhancements, fair value triggers, the performance of
organizations that service the exposure, and deal-specific definitions
of default;
[[Page 64210]]
(B) Relevant information regarding--
(1) The performance the underlying credit exposure(s), for example,
the percentage of loans 30, 60, and 90 days past due; default rates;
prepayment rates; loans in foreclosure; property types; occupancy;
average credit score or other measures of creditworthiness; average LTV
ratio; and industry and geographic diversification data on the
underlying exposure(s); and
(2) For resecuritization exposures, in addition to the information
described in paragraph (c)(2)(i)(B)(1) of this section, performance
information on the underlying securitization exposures, which may
include the issuer name and credit quality, and the characteristics and
performance of the exposures underlying the securitization exposures;
and
(C) Relevant market data of the securitization, for example, bid-
ask spread, most recent sales price and historic price volatility,
trading volume, implied market rating, and size, depth and
concentration level of the market for the securitization; and
(ii) On an on-going basis (no less frequently than quarterly),
evaluating, reviewing, and updating as appropriate the analysis
required under paragraph (c)(1) of this section for each securitization
exposure.
Sec. __.131 Exposure amount of a securitization exposure.
(a) On-balance sheet securitization exposure. The exposure amount
of an on-balance sheet securitization exposure (excluding a repo-style
transaction, eligible margin loan, OTC derivative contract that is not
a credit derivative, or cleared transaction that is not a credit
derivative) is equal to the [BANKING ORGANIZATION]'s carrying value of
the exposure. For a credit derivative, a [BANKING ORGANIZATION] must
apply Sec. __.132(i) or (j), as applicable.
(b) Off-balance sheet securitization exposure. Except as provided
in Sec. __.132(h), the exposure amount of an off-balance sheet
securitization exposure that is not a repo-style transaction, eligible
margin loan, OTC derivative contract (other than a credit derivative),
or cleared transaction (other than a credit derivative) is the notional
amount of the exposure. For an off-balance sheet securitization
exposure to an ABCP program, such as an eligible ABCP liquidity
facility, the notional amount may be reduced to the maximum potential
amount that the [BANKING ORGANIZATION] could be required to fund given
the ABCP program's current underlying assets (calculated without regard
to the current credit quality of those assets).
(c) Repo-style transaction, eligible margin loan, OTC derivative
contract that is not a credit derivative, or cleared transaction that
is not a credit derivative. The exposure amount of a securitization
exposure that is a repo-style transaction, eligible margin loan, or OTC
derivative contract (other than a credit derivative) is the exposure
amount as calculated in Sec. __.113 or Sec. __.121, as applicable,
and the exposure amount of a securitization exposure that is a cleared
transaction that is not a credit derivative is the exposure amount as
calculated in Sec. __.114.
Sec. __.132 Risk-weighted assets for securitization exposures.
(a) General approach. Except as provided elsewhere in this section
and in Sec. __.130:
(1) A [BANKING ORGANIZATION] may, subject to the limitation under
paragraph (e) of this section, apply the securitization standardized
approach (SEC-SA) in Sec. __.133 to the exposure if the exposure meets
the following requirements:
(i) The [BANKING ORGANIZATION] has accurate information on A, D, W,
and KG (as defined in Sec. __.133) for the exposure. Data used to
assign the parameters described in this paragraph (a)(1)(i) must be the
most currently available data. If the contracts governing the
underlying exposures of the securitization require payments on a
monthly or quarterly basis, the data used to assign the parameters
described in this paragraph (a)(1)(i) must be no more than 91 calendar
days old.
(ii) The [BANKING ORGANIZATION] has accurate information regarding
whether the exposure is a resecuritization exposure.
(2) If the securitization exposure is an interest rate derivative
contract, an exchange rate derivative contract, or a cash collateral
account related to an interest rate or exchange rate derivative
contract, the [BANKING ORGANIZATION] must assign a risk weight to the
exposure equal to the risk weight of a securitization exposure that is
pari passu to the interest rate derivative contract or exchange rate
derivative contract or, if such an exposure does not exist, the risk
weight of any subordinate securitization exposure.
(3) If the [BANKING ORGANIZATION] cannot apply, or chooses not to
apply, the securitization standardized approach in Sec. __.133, the
[BANKING ORGANIZATION] must apply a 1,250 percent risk weight to the
exposure.
(b) Total risk-weighted assets for securitization exposures. A
[BANKING ORGANIZATION]'s total risk-weighted assets for securitization
exposures equals the sum of the risk-weighted asset amount for
securitization exposures that the [BANKING ORGANIZATION] risk weights
under Sec. __.132 through __.134, as applicable.
(c) After-tax gain-on-sale resulting from a securitization.
Notwithstanding any other provision of this subpart, a [BANKING
ORGANIZATION] must deduct from common equity tier 1 capital any after-
tax gain-on-sale resulting from a securitization as well as the portion
of a CEIO that does not constitute an after-tax gain-on sale.
(d) Overlapping exposures. (1) If a [BANKING ORGANIZATION] has
multiple securitization exposures that provide duplicative coverage of
the underlying exposures of a securitization, the [BANKING
ORGANIZATION] is not required to hold duplicative risk-based capital
against the overlapping position. Instead, the [BANKING ORGANIZATION]
may assign to the overlapping securitization exposure the applicable
risk-based capital treatment under this subpart that results in the
highest risk-based capital requirement.
(2) If a [BANKING ORGANIZATION] has a securitization exposure that
partially overlaps with another exposure, the [BANKING ORGANIZATION]
may assign to the overlapping portion of the securitization exposure
the applicable risk-based capital treatment under this subpart that
results in the highest risk-based capital requirement. A [BANKING
ORGANIZATION] may treat two non-overlapping securitization exposures as
overlapping if the [BANKING ORGANIZATION] assumes that obligations with
respect to one of the exposures are larger than those established
contractually. In such an instance, the [BANKING ORGANIZATION] may
calculate its risk-weighted assets as if the exposures were overlapping
as long as the [BANKING ORGANIZATION] also assumes for capital purposes
that the obligations of the relevant exposure are larger than those
established contractually.
(3) If a [BANKING ORGANIZATION] has a securitization exposure under
this subpart that partially overlaps with a securitization exposure
that is a market risk covered position under subpart F of this part,
the [BANKING ORGANIZATION] may assign to the overlapping portion of the
securitization exposure the applicable risk-based
[[Page 64211]]
capital treatment under either this subpart or subpart F, whichever
results in the highest risk-based capital requirement.
(e) Implicit support. If a [BANKING ORGANIZATION] provides support
to a securitization in excess of the [BANKING ORGANIZATION]'s
contractual obligation to provide credit support to the securitization:
(1) The [BANKING ORGANIZATION] must calculate a risk-weighted asset
amount for underlying exposures associated with the securitization as
if the exposures had not been securitized and must deduct from common
equity tier 1 capital any after-tax gain-on-sale resulting from the
securitization and any portion of a CEIO strip that does not constitute
after-tax gain-on-sale; and
(2) The [BANKING ORGANIZATION] must disclose publicly:
(i) That it has provided implicit support to the securitization;
and
(ii) The risk-based capital impact to the [BANKING ORGANIZATION] of
providing such implicit support.
(f) Undrawn portion of a servicer cash advance facility. (1)
Notwithstanding any other provision of this subpart, a [BANKING
ORGANIZATION] that is a servicer under an eligible servicer cash
advance facility is not required to hold risk-based capital against
potential future cash advance payments that it may be required to
provide under the contract governing the facility.
(2) For a [BANKING ORGANIZATION] that acts as a servicer, the
exposure amount for a servicer cash advance facility that is a not an
eligible servicer cash advance facility is equal to the amount of all
potential future cash advance payments that the [BANKING ORGANIZATION]
may be contractually required to provide during the subsequent 12-month
period under the contract governing the facility.
(g) Interest-only mortgage-backed securities. Notwithstanding any
other provision of this subpart, the risk weight for a non-credit-
enhancing interest-only mortgage-backed security may not be less than
100 percent.
(h) Small-business loans and leases on personal property
transferred with retained contractual exposure. (1) Regardless of any
other provision of this subpart, a [BANKING ORGANIZATION] that has
transferred small-business loans and leases on personal property
(small-business obligations) with recourse must include in risk-
weighted assets only its contractual exposure to the small-business
obligations if all the following conditions are met:
(i) The transaction must be treated as a sale under GAAP;
(ii) The [BANKING ORGANIZATION] establishes and maintains, pursuant
to GAAP, a non-capital reserve sufficient to meet the [BANKING
ORGANIZATION]'s reasonably estimated liability under the contractual
obligation;
(iii) The small-business obligations are to businesses that meet
the criteria for a small-business concern established by the Small
Business Administration under section 3(a) of the Small Business Act
(15 U.S.C. 632 et seq.); and
(iv) The [BANKING ORGANIZATION] is well capitalized for purposes of
the Prompt Corrective Action framework (12 U.S.C. 1831o). For purposes
of determining whether a [BANKING ORGANIZATION] is well capitalized for
purposes of this paragraph (h), the [BANKING ORGANIZATION]'s capital
ratios must be calculated without regard to the capital treatment for
transfers of small-business obligations with recourse specified in
paragraph (h)(1) of this section.
(2) The total outstanding amount of contractual exposure retained
by a [BANKING ORGANIZATION] on transfers of small-business obligations
receiving the capital treatment specified in paragraph (h)(1) of this
section cannot exceed 15 percent of the [BANKING ORGANIZATION]'s total
capital.
(3) If a [BANKING ORGANIZATION] ceases to be well capitalized, or
exceeds the 15 percent capital limitation provided in paragraph (h)(2)
of this section, the capital treatment specified in paragraph (h)(1) of
this section will continue to apply to any transfers of small-business
obligations with retained contractual exposure that occurred during the
time that the [BANKING ORGANIZATION] was well capitalized and did not
exceed the capital limit.
(4) The risk-based capital ratios of the [BANKING ORGANIZATION]
must be calculated without regard to the capital treatment for
transfers of small-business obligations specified in paragraph (h)(1)
of this section for purposes of:
(i) Determining whether a [BANKING ORGANIZATION] is adequately
capitalized, undercapitalized, significantly undercapitalized, or
critically undercapitalized under the [AGENCY]'s prompt corrective
action regulations; and
(ii) Reclassifying a well-capitalized [BANKING ORGANIZATION] to
adequately capitalized and requiring an adequately capitalized [BANKING
ORGANIZATION] to comply with certain mandatory or discretionary
supervisory actions as if the [BANKING ORGANIZATION] were in the next
lower prompt-corrective-action category.
(i) Nth-to-default credit derivatives--(1) Protection provider. A
[BANKING ORGANIZATION] providing protection through a first-to-default
or second-to-default derivative is subject to capital requirements on
such instruments under this paragraph (i)(1).
(i) First-to-default. For first-to-default derivatives, a [BANKING
ORGANIZATION] must aggregate by simple summation the risk weights of
the assets covered up to a maximum of 1,250 percent and multiply by the
nominal amount of the protection provided by the credit derivative to
obtain the risk-weighted asset amount.
(ii) Nth-to-default. For second-to-default derivatives, in
aggregating the risk weights, a [BANKING ORGANIZATION] may exclude the
asset with the lowest risk-weighted amount from the risk-weighted
capital calculation. This risk-based capital treatment applies for nth-
to-default derivatives for which the n-1 assets with the lowest risk-
weighted amounts can be excluded from the risk-weighted capital
calculation.
(2) Protection purchaser. A [BANKING ORGANIZATION] is not permitted
to recognize a purchased nth-to-default credit derivative as a credit
risk mitigant. A [BANKING ORGANIZATION] must calculate the counterparty
credit risk of a purchased nth-to-default credit derivative under Sec.
__.113.
(j) Guarantees and credit derivatives other than nth-to-default
credit derivatives--(1) Protection provider. For a guarantee or credit
derivative (other than an nth-to-default credit derivative) provided by
a [BANKING ORGANIZATION] that covers the full amount or a pro rata
share of a securitization exposure's principal and interest, the
[BANKING ORGANIZATION] must risk-weight the guarantee or credit
derivative under paragraph (a) of this section as if it held the
portion of the reference exposure covered by the guarantee or credit
derivative.
(2) Protection purchaser. (i) A [BANKING ORGANIZATION] that
purchases a credit derivative (other than an nth-to-default credit
derivative) that is recognized under Sec. __.134 as a credit risk
mitigant (including via recognized collateral) is not required to
compute a separate counterparty credit risk capital requirement under
Sec. __.110.
(ii) If a [BANKING ORGANIZATION] cannot, or chooses not to,
recognize a purchased credit derivative as a credit risk mitigant under
Sec. __.134, the
[[Page 64212]]
[BANKING ORGANIZATION] must determine the exposure amount of the credit
derivative under Sec. __.113.
(A) If the [BANKING ORGANIZATION] purchases credit protection from
a counterparty that is not a securitization SPE, the [BANKING
ORGANIZATION] must determine the risk weight for the exposure according
to Sec. __.111.
(B) If the [BANKING ORGANIZATION] purchases credit protection from
a counterparty that is a securitization SPE, the [BANKING ORGANIZATION]
must determine the risk weight for the exposure according to this
section.
(k) Look-through approach. (1) Subject to paragraph (k)(2) of this
section, a [BANKING ORGANIZATION] may assign a risk weight to a senior
securitization exposure that is not a resecuritization exposure equal
to the greater of:
(i) The weighted-average risk weight of all the underlying
exposures where the weight for each exposure in the weighted-average
calculation is determined by the unpaid principal amount of the
exposure; and
(ii) 15 percent.
(2) A [BANKING ORGANIZATION] may assign a risk weight under this
paragraph (k) only if the [BANKING ORGANIZATION] has knowledge of the
composition of all of the underlying exposures.
(l) NPL securitization. Notwithstanding any other provision of this
subpart except for paragraph (e) of this section:
(1) If the NPL securitization is a traditional securitization and
the nonrefundable purchase price discount is greater than or equal to
50 percent of the outstanding balance of the pool of exposures, the
risk weight for a senior securitization exposure to an NPL
securitization is 100 percent.
(2) If the [BANKING ORGANIZATION] is an originating [BANKING
ORGANIZATION] with respect to the NPL securitization, the [BANKING
ORGANIZATION] may hold risk-based capital against the transferred
exposures as if they had not been securitized and must deduct from
common equity tier 1 capital any after-tax gain-on-sale resulting from
the transaction and any portion of a CEIO that does not constitute an
after-tax gain-on-sale.
Sec. __.133 Securitization standardized approach (SEC-SA).
(a) In general. The risk weight RWSEC SA assigned to a
securitization exposure, or portion of a securitization exposure, is
calculated according to the following formula:
[GRAPHIC] [TIFF OMITTED] TP18SE23.083
Where:
(1) KA is calculated under paragraph (b) of this section;
(2) A (attachment point) equals the greater of zero and the ratio,
expressed as a decimal value between zero and one, of the
outstanding balance of all underlying assets in the securitization
minus the outstanding balance of all tranches that rank senior or
pari passu to the tranche that contains the securitization exposure
of the [BANKING ORGANIZATION] (including the exposure itself) to the
outstanding balance of all underlying assets in the securitization,
as adjusted in accordance with paragraph (a)(6) of this section;
(3) D (detachment point) equals the greater of zero and the ratio,
expressed as a decimal value between zero and one, of the
outstanding balance of all underlying assets in the securitization
minus the outstanding balance of all tranches that rank senior to
the tranche that contains the securitization exposure of the
[BANKING ORGANIZATION] to the outstanding balance of all underlying
assets in the securitization, as adjusted in accordance with
paragraph (a)(6) of this section;
(4) RWFLOOR equals 100 percent for resecuritization exposures and
NPL securitization exposures and 15 percent for all other
securitization exposures; and
(5) KSEC SA is calculated according to the following formula:
[GRAPHIC] [TIFF OMITTED] TP18SE23.084
Where:
(i) [alpha] equals -1/(p*KA) (as KA is defined in this paragraph
(a)), where p equals 1.5 for a resecuritization exposure and 1 for
all other securitization exposures;
(ii) u equals D-KA (as D and KA are defined in this paragraph (a));
(iii) l equals max(A-KA, 0) (as A and KA are defined in this
paragraph (a)); and
(iv) e equals the base of the natural logarithm.
(6) A [BANKING ORGANIZATION] must include in the calculation of A
and D the funded portion of any reserve account funded by the
accumulated cash flows from the underlying exposures that is
subordinated to the [BANKING ORGANIZATION]'s securitization exposure.
Interest rate derivative contracts, exchange rate derivative contracts,
and cash collateral accounts related to these contracts must not be
included in the calculation of A and D. If the securitization exposure
includes a nonrefundable purchase price discount, the nonrefundable
purchase price discount must be included in the numerator and
denominator of A and D.
(b) Calculation of KA. KA is calculated under this paragraph (b)
according to the following formula:
KA = (1-W) [middot] KG + (W [middot] 0.5)
Where:
(1) W equals the ratio, expressed as a decimal value between zero
and one, of the sum of the outstanding balance of any underlying
exposures of the securitization that are not securitization
[[Page 64213]]
exposures and that meet any of the criteria in paragraphs (b)(1)(i)
through (vi) of this section to the outstanding balance of all
underlying exposures:
(i) Ninety days or more past due;
(ii) Subject to a bankruptcy or insolvency proceeding;
(iii) In the process of foreclosure;
(iv) Held as real estate owned;
(v) Has contractually deferred payments for 90 days or more, other
than principal or interest payments deferred on:
(A) Federally guaranteed student loans, in accordance with the
terms of those guarantee programs; or
(B) Consumer loans, including non-federally-guaranteed student
loans, provided that such payments are deferred pursuant to provisions
included in the contract at the time funds are disbursed that provide
for period(s) of deferral that are not initiated based on changes in
the creditworthiness of the borrower; or
(vi) Is in default; and
(2) KG equals the weighted average (with the outstanding balance
used as the weight for each exposure) total capital requirement,
expressed as a decimal value between zero and one, of the underlying
exposures calculated using this subpart E (that is, an average risk
weight of 100 percent represents a value of KG equal to 0.08), as
adjusted in accordance with paragraphs (b)(2)(i) and (ii) of this
section.
(i) For interest rate derivative contracts and exchange rate
derivative contracts, the positive current exposure times the risk
weight of the counterparty multiplied by 0.08 must be included in the
numerator of KG but must be excluded from the denominator of KG.
(ii) If a [BANKING ORGANIZATION] transfers credit risk via a
synthetic securitization to a securitization SPE and if the
securitization SPE issues funded obligations to investors, the [BANKING
ORGANIZATION] must include the total capital requirement (exposure
amount multiplied by risk weight multiplied by 0.08) of any collateral
held by the securitization SPE in the numerator of KG. The denominator
of KG is calculated without recognition of the collateral.
Sec. __.134 Recognition of credit risk mitigants for securitization
exposures.
(a) General. (1) An originating [BANKING ORGANIZATION] that has
obtained a credit risk mitigant to hedge its exposure to a synthetic or
traditional securitization that satisfies the operational criteria
provided in Sec. __.130 may recognize the credit risk mitigant under
Sec. __.120 or Sec. __.121, but only as provided in this section.
(2) An investing [BANKING ORGANIZATION] that has obtained a credit
risk mitigant to hedge a securitization exposure may recognize the
credit risk mitigant under Sec. __.120 or Sec. __.121, but only as
provided in this section.
(3) If the recognized credit risk mitigant hedges a portion of the
[BANKING ORGANIZATION]'s securitization exposure, the [BANKING
ORGANIZATION] must calculate its capital requirements for the hedged
and unhedged portions of the exposure separately. For each unhedged
portion, the [BANKING ORGANIZATION] must calculate capital requirements
according to Sec. __.131 and Sec. __.132. For each hedged portion,
the [BANKING ORGANIZATION] may recognize the credit risk mitigant under
Sec. __.120 or Sec. __.121, but only as provided in this section.
(4) When a [BANKING ORGANIZATION] purchases or sells credit
protection on a portion of a senior tranche, the lower-priority
portion, whether hedged or unhedged, must be considered a non-senior
securitization exposure.
(b) Mismatches. A [BANKING ORGANIZATION] must make any applicable
adjustment to the protection amount as required in Sec. __.120 for any
hedged securitization exposure. In the context of a synthetic
securitization, when an eligible guarantee, eligible credit derivative,
or a credit risk mitigant described in Sec. __.130(b)(1)(ii) or (iii)
covers multiple hedged exposures that have different residual
maturities, the [BANKING ORGANIZATION] must use the longest residual
maturity of any of the hedged exposures as the residual maturity of all
hedged exposures.
Risk-Weighted Assets for Equity Exposures
Sec. __.140 Introduction and exposure measurement.
(a) General. (1) To calculate its risk-weighted asset amounts for
equity exposures that are not equity exposures in investment funds, a
[BANKING ORGANIZATION] must use the approach provided in Sec. __.141.
A [BANKING ORGANIZATION] must use the approaches provided in Sec.
__.142 to calculate its risk-weighted asset amounts for other equity
exposures as provided in Sec. __.142.
(2) A [BANKING ORGANIZATION] must treat an investment in a separate
account (as defined in Sec. __.2) as if it were an equity exposure
subject to Sec. __.142.
(3) Stable value protection--(i) Stable value protection means a
contract where the provider of the contract is obligated to pay:
(A) The policy owner of a separate account an amount equal to the
shortfall between the fair value and cost basis of the separate account
when the policy owner of the separate account surrenders the policy; or
(B) The beneficiary of the contract an amount equal to the
shortfall between the fair value and book value of a specified
portfolio of assets.
(ii) A [BANKING ORGANIZATION] that purchases stable value
protection on its investment in a separate account must treat the
portion of the carrying value of its investment in the separate account
attributable to the stable value protection as an exposure to the
provider of the protection and the remaining portion of the carrying
value of its separate account as an equity exposure subject to Sec.
__.142.
(iii) A [BANKING ORGANIZATION] that provides stable value
protection must treat the exposure as an equity derivative with an
adjusted carrying value determined as the sum of paragraphs (b)(1) and
(2) of this section.
(b) Adjusted carrying value. For purposes of Sec. __.140 through
__.142, the adjusted carrying value of an equity exposure is:
(1) For the on-balance sheet component of an equity exposure, the
[BANKING ORGANIZATION]'s carrying value of the exposure;
(2) For the off-balance sheet component of an equity exposure that
is not an equity commitment, the effective notional principal amount of
the exposure, the size of which is equivalent to a hypothetical on-
balance sheet position in the underlying equity instrument that would
evidence the same change in fair value (measured in dollars) given a
small change in the price of the underlying equity instrument, minus
the adjusted carrying value of the on-balance sheet component of the
exposure as calculated in paragraph (b)(1) of this section; and
(3) For a commitment to acquire an equity exposure (an equity
commitment), the effective notional principal amount of the exposure is
multiplied by the following conversion factors (CFs):
(i) Conditional equity commitments receive a 40 percent conversion
factor.
(ii) Unconditional equity commitments receive a 100 percent
conversion factor.
Sec. __.141 Expanded simple risk-weight approach (ESRWA).
(a) General. A [BANKING ORGANIZATION]'s total risk-weighted
[[Page 64214]]
assets for equity exposures equals the sum of the risk-weighted asset
amounts for each of the [BANKING ORGANIZATION]'s equity exposures that
are not equity exposures subject to Sec. __.142, as determined under
this section, and the risk-weighted asset amounts for each of the
[BANKING ORGANIZATION]'s equity exposures subject to Sec. __.142, as
determined under Sec. __.142.
(b) Computation for individual equity exposures. A [BANKING
ORGANIZATION] must determine the risk-weighted asset amount for an
equity exposure that is not an equity exposure subject to Sec. __.142
by multiplying the adjusted carrying value of the exposure by the
lowest applicable risk weight in this paragraph (b).
(1) Zero percent risk weight equity exposures. An equity exposure
to a sovereign, the Bank for International Settlements, the European
Central Bank, the European Commission, the International Monetary Fund,
the European Stability Mechanism, the European Financial Stability
Facility, an MDB, and any other entity whose credit exposures receive a
zero percent risk weight under Sec. __.111 may be assigned a zero
percent risk weight.
(2) 20 percent risk weight equity exposures. An equity exposure to
a PSE, Federal Home Loan Bank, or the Federal Agricultural Mortgage
Corporation (Farmer Mac) must be assigned a 20 percent risk weight.
(3) 100 percent risk weight. The equity exposures set forth in this
paragraph (b)(3) must be assigned a 100 percent risk weight:
(i) An equity exposure that qualifies as a community development
investment under section 24 (Eleventh) of the National Bank Act; and
(ii) An equity exposure to an unconsolidated small business
investment company or held through a consolidated small business
investment company described in section 302 of the Small Business
Investment Act.
(4) 250 percent risk weight. The equity exposures set forth in this
paragraph (b)(4) must be assigned a 250 percent risk weight:
(i) An equity exposure that is publicly traded;
(ii) Significant investments in the capital of unconsolidated
financial institutions in the form of common stock that are not
deducted from capital pursuant to Sec. __.22(d)(2); and
(iii) Exposures that hedge equity exposures described in paragraph
(b)(4)(ii) of this section.
(5) 400 percent risk weight. An equity exposure that is not
publicly traded and is not described in paragraph (b)(6) of this
section, must be assigned a 400 percent risk weight.
(6) 1250 percent risk weight. An equity exposure to an investment
firm must be assigned a 1250 percent risk weight, provided that the
investment firm:
(i) Would meet the definition of a traditional securitization were
it not for the application of paragraph (8) of that definition; and
(ii) Has greater than immaterial leverage.
Sec. __.142 Equity exposures to investment funds.
(a) Available approaches. A [BANKING ORGANIZATION] must determine
the risk-weighted asset amount of an equity exposure to an investment
fund as described in this paragraph (a).
(1) If a [BANKING ORGANIZATION] has information from the investment
fund regarding the underlying exposures held by the investment fund
that is verified by an independent third party at least quarterly and
that is sufficient to calculate the risk-weighted asset amount for each
underlying exposure as calculated under this subpart as if each
exposure were held directly by the [BANKING ORGANIZATION], the [BANKING
ORGANIZATION] must use the full look-through approach described in
paragraph (b) of this section.
(2) If a [BANKING ORGANIZATION] does not have information
sufficient to use the full look-through approach under paragraph (b) of
this section but does have information sufficient to use the
alternative modified look-through approach described in paragraph (c)
of this section, the [BANKING ORGANIZATION] must use the alternative
modified look-through approach described in paragraph (c) of this
section.
(3) If a [BANKING ORGANIZATION] does not have sufficient
information to use either the full look-through approach described in
paragraph (b) of this section or the alternative modified look-through
approach described in paragraph (c) of this section, the [BANKING
ORGANIZATION] must assign a risk-weighted asset amount equal to the
adjusted carrying value of the equity exposure multiplied by a 1,250
percent risk weight.
(4) In order to determine a risk-weighted asset amount for a
securitization exposure held by an investment fund, for purposes of
either the full look-through approach described in paragraph (b) of
this section or the alternative modified look-through approach
described in paragraph (c) of this section, the [BANKING ORGANIZATION]
must use the approach described in paragraph (d) of this section.
(5) In order to determine a risk-weighted asset amount for an
equity investment in an investment fund held by another investment
fund, for purposes of either the full look-through approach described
in paragraph (b) of this section or the alternative modified look-
through approach described in paragraph (c) of this section, the
[BANKING ORGANIZATION] must use the approach described in paragraph (e)
of this section.
(b) Full look-through approach. Under the full look-through
approach, the risk-weighted asset amount for an equity exposure to an
investment fund is equal to the adjusted carrying value multiplied by
the risk weight (RWIF), which equals:
[GRAPHIC] [TIFF OMITTED] TP18SE23.085
Where:
(1) RWAon is the aggregate risk-weighted asset amount of the on-
balance sheet exposures of the investment fund determined under this
subpart E as if each exposure were held directly on balance sheet by
the [BANKING ORGANIZATION];
(2) RWAoff is the aggregate risk-weighted asset amount of the off-
balance sheet exposures of the investment fund, determined as the sum
of the exposure amount determined under Sec. __.112 multiplied by the
applicable risk weight under this subpart E, for each exposure, as if
each exposure were held off-balance sheet under the same terms by the
[BANKING ORGANIZATION];
[[Page 64215]]
(3) RWAderivatives is the aggregate risk-weighted asset amount of
the derivative contracts held by the investment fund, determined as the
sum of the exposure amount determined under Sec. __.113 multiplied by
the risk weight applicable to the counterparty under Sec. __.111 of
this subpart for each netting set, as if each derivative contract were
held directly by the [BANKING ORGANIZATION], subject to the following
conditions:
(i) If the [BANKING ORGANIZATION] cannot determine which netting
set a derivative contract is part of, the [BANKING ORGANIZATION] must
treat the derivative contract as constituting its own netting set;
(ii) If the [BANKING ORGANIZATION] cannot determine replacement
cost under Sec. __.113, the [BANKING ORGANIZATION] must assume that
replacement cost is equal to the notional amount of each derivative
contract and use a PFE multiplier under Sec. __.113 equal to one;
(iii) If the [BANKING ORGANIZATION] cannot determine potential
future exposure under Sec. __.113, the [BANKING ORGANIZATION] must
assume that potential future exposure is equal to 15 percent of the
notional amount of each derivative contract;
(iv) If the [BANKING ORGANIZATION] cannot determine whether the
counterparty is a commercial end-user, the [BANKING ORGANIZATION] must
assume that the counterparty is not a commercial end-user;
(v) If the derivative contract is a CVA risk covered position or
the [BANKING ORGANIZATION] cannot determine that a derivative contract
is not a CVA risk covered position as defined in Sec. __.201, the
[BANKING ORGANIZATION] must multiply the exposure amount by 1.5; and
(vi) If the [BANKING ORGANIZATION] cannot determine the risk-weight
of the counterparty under Sec. __.111, the [BANKING ORGANIZATION] must
apply a risk-weight of 100 percent;
(4) Total AssetsIF is the balance sheet total assets of the
investment fund; and
(5) Total EquityIF is the balance sheet total equity of the
investment fund.
(c) Alternative modified look-through approach. Under the
alternative modified look-through approach, the risk-weighted asset
amount for an equity exposure is determined in the same way as under
the full look-through approach specified in paragraph (b) of this
section, with the following exceptions:
(1) To calculate RWAon, a [BANKING ORGANIZATION] must assign the
total assets of the investment fund on a pro rata basis to different
risk weight categories under this subpart based on the investment
limits in the investment fund's prospectus, partnership agreement, or
similar contract that defines the investment fund investment fund's
permissible investments, other than for derivatives. The risk-weighted
asset amount for the [BANKING ORGANIZATION]'s equity exposure to the
investment fund equals the sum of each portion of the total assets of
the investment fund assigned to an exposure type multiplied by the
applicable risk weight under this subpart. If the sum of the investment
limits for all exposure types within the investment fund exceeds 100
percent, the [BANKING ORGANIZATION] must assume that the investment
fund invests to the maximum extent permitted under its investment
limits in the exposure type with the highest applicable risk weight
under this subpart and continues to make investments in descending
order of the exposure type with the next highest applicable risk weight
under this subpart until the maximum total investment level is reached.
If more than one exposure type applies to an exposure, the [BANKING
ORGANIZATION] must use the highest applicable risk weight.
(2) To calculate RWAoff, the [BANKING ORGANIZATION] must assume
that the investment fund invests to the maximum extent permitted under
its investment limits in the transactions with the highest applicable
credit conversion factor under Sec. __.112 and with the highest
applicable risk weight under this subpart.
(3) To calculate RWAderivatives, the [BANKING ORGANIZATION] must
assume that the investment fund has the maximum volume of derivative
contracts permitted under its investment limits and must assume,
notwithstanding paragraphs (b)(3)(ii) and (iii), that the replacement
cost plus potential future exposure under Sec. __.113 equals 115
percent of the notional amount.
(d) Equity exposures to investment funds with underlying
securitizations. To determine the risk-weighted asset amount for a
securitization exposure held by an investment fund, a [BANKING
ORGANIZATION] must:
(1) If applying the full look-through approach under paragraph (b)
of this section, apply a risk weight determined under Sec. __.133 or a
risk weight of 1,250 percent; and
(2) If applying the alternative modified look-through approach
under paragraph (c) of this section, apply a 1,250 percent risk weight.
(e) Equity exposures to an investment fund held by another
investment fund. To determine the risk-weighted asset amount for an
equity exposure to an investment fund held by another investment fund,
a [BANKING ORGANIZATION] must:
(1) For an equity exposure to an investment fund held directly by
the investment fund to which the [BANKING ORGANIZATION] has a direct
equity exposure, use the full look-through approach described in
paragraph (b) of this section, the alternative modified look-through
approach described in paragraph (c) of this section, or multiply the
exposure amount by a 1,250 percent risk weight; and
(2) For an equity exposure to an investment fund held indirectly,
through one or more additional investment funds, by the investment fund
to which the [BANKING ORGANIZATION] has a direct equity exposure,
multiply the exposure amount of the equity exposure to an investment
fund held indirectly by a 1,250 percent risk-weight, unless the
[BANKING ORGANIZATION] uses the full look-through approach described in
paragraph (b) of this section to calculate the risk-weighted asset
amount for the equity exposure to the investment fund that holds the
equity exposure, in which case the [BANKING ORGANIZATION] may use
either the full look-through approach described in paragraph (b) of
this section or multiply the exposure amount by a 1,250 percent risk
weight.
Risk-Weighted Assets for Operational Risk
Sec. __.150 Operational Risk Capital
(a) Risk-Weighted Assets for Operational Risk. Risk-weighted assets
for operational risk equals the operational risk capital requirement
multiplied by 12.5.
(b) Operational Risk Capital Requirement. A [BANKING
ORGANIZATION]'s operational risk capital requirement equals the
Business Indicator Component, as calculated pursuant to paragraph (c)
of this section, multiplied by the Internal Loss Multiplier, as
calculated pursuant to paragraph (e) of this section.
(c) Business Indicator Component. The Business Indicator Component
is calculated as follows:
(1) If the [BANKING ORGANIZATION]'s Business Indicator is less than
or equal to $1 billion, Business Indicator Component = 0.12 x Business
Indicator.
[[Page 64216]]
(2) If the [BANKING ORGANIZATION]'s Business Indicator is greater
than $1 billion and less than or equal to $30 billion, Business
Indicator Component = $120 million + 0.15 x (Business Indicator-$1
billion).
(3) If the [BANKING ORGANIZATION]'s Business Indicator is greater
than $30 billion, Business Indicator Component = $4.47 billion + 0.18 x
(Business Indicator-$30 billion).
(d) Business Indicator. (1) A [BANKING ORGANIZATION]'s Business
Indicator equals the sum of three components: the interest, lease, and
dividend component; the services component; and the financial
component.
(i) The interest, lease, and dividend component is calculated using
the following formula:
Interest, lease, and divided component
= min (Avg3y(Abs(total interest income
-total interest expense)), 0.0225
[middot] Avg3y(interest earning assets))
+ Avg3y(dividend income)
where Avg3y refers to the three-year average of the
expression in parenthesis; Abs refers to the absolute value of the
expression in parenthesis; and total interest income, total interest
expense, interest earning assets, and dividend income are the amounts
determined in accordance with paragraph (d)(2) of this section.
(ii) The services component is calculated using the following
formula:
Services component
= max (Avg3y(fee and commission income),
Avg3y(fee and commission expense))
+ max (Avg3y(other operating income),
Avg3y(other operating expense))
where Avg3y refers to the three-year average of the
expression in parenthesis; and fee and commission income, fee and
commission expense, other operating income, and other operating expense
are the amounts determined in accordance with paragraph (d)(2) of this
section.
(iii) The financial component is calculated using the following
formula:
Financial Component
= Avg3y(Abs(trading revenue))
+ Avg3y(Abs(net profit or loss on assets and liabilities
not held for trading))
where Avg3y refers to the three-year average of the
expression in parenthesis; Abs refers to the absolute value of the
expression in parenthesis; and trading revenue and net profit or loss
on assets and liabilities not held for trading are determined in
accordance with paragraph (d)(2) of this section.
(2) For purposes of paragraph (d)(1) of this section, to calculate
the three-year average of the Abs(total interest income-total interest
expense), dividend income, fee and commission income, fee and
commission expense, other operating income, other operating expense,
Abs(trading revenue), and Abs(net profit or loss on assets and
liabilities not held for trading), a [BANKING ORGANIZATION] must
calculate the average of the values of each of these items for each of
the three most recent preceding four-calendar-quarter periods. To
calculate the three-year average of interest-earning assets, a [BANKING
ORGANIZATION] must divide by 12 the sum of the quarterly values of
interest-earning assets over each of the previous 12 quarters. For
purposes of the calculations in this paragraph, the amounts used must
be based on the consolidated financial statements of the [BANKING
ORGANIZATION].
(3) For purposes of paragraph (d)(1) of this section, a [BANKING
ORGANIZATION] must exclude the following items from the calculation of
the Business Indicator:
(i) Expenses that are not related to financial services received by
the [BANKING ORGANIZATION], except when they relate to operational loss
events;
(ii) Loss provisions and reversals of provisions, except for those
relating to operational loss events;
(iii) Changes in goodwill; and
(iv) Applicable income taxes.
(4) For purpose of paragraph (d)(1) of this section, a [BANKING
ORGANIZATION] must reflect three full years of data for entities that
were acquired by or merged with the [BANKING ORGANIZATION], including
for any period prior to the acquisition or merger, in the [BANKING
ORGANIZATION]'s Business Indicator.
(5) With the prior approval of the [AGENCY], a [BANKING
ORGANIZATION] may exclude from the calculation of its Business
Indicator any interest income, interest expense, dividend income,
interest-earning assets, fee and commission income, fee and commission
expense, other operating income, other operating expense, trading
revenue, and net profit or loss on assets and liabilities not held for
trading associated with an activity if the [BANKING ORGANIZATION] has
ceased to directly or indirectly conduct the activity. Approval by the
[AGENCY] requires a demonstration that the activity does not carry
legacy legal exposure.
(e) Internal Loss Multiplier. (1) A [BANKING ORGANIZATION]'s
Internal Loss Multiplier is calculated using the following formula:
[GRAPHIC] [TIFF OMITTED] TP18SE23.086
where average annual total net operational losses are calculated
according to paragraph (e)(2) of this section; the Business Indicator
Component is calculated pursuant to paragraph (c) of this section;
exp(1) is Euler's number, which is approximately equal to 2.7183; and
ln is the natural logarithm.
(2) The calculation of average annual total net operational losses
is as follows:
(i) Average annual total net operational losses are the average of
annual total net operational losses over the previous ten years. For
purposes of this calculation, the previous ten years correspond to the
previous 40 quarters as of the reporting date.
(ii) The annual total net operational losses of a year equals the
sum of the total net operational losses of the quarters that compose
the year for purposes of the calculation in paragraph (e)(2)(i) of this
section.
(iii) The total net operational losses of a quarter equal the sum
of any portions of losses or recoveries of any material operational
losses allocated to the quarter.
(iv) A material operational loss is an operational loss incurred by
the [BANKING ORGANIZATION] that resulted in a net loss greater than or
[[Page 64217]]
equal to $20,000 after taking into account all subsequent recoveries
related to the operational loss.
(v) For purposes of this paragraph (e)(2), operational losses and
recoveries must be based on the date of accounting, including for legal
loss events. Reductions in the legal reserves associated with an
ongoing legal event are to be treated as recoveries for the calculation
of total net operational losses. Losses and recoveries related to a
common operational loss event, but with accounting impacts across
several quarters, must be allocated to the quarters in which the
accounting impacts occur.
(vi) If a [BANKING ORGANIZATION] does not have complete operational
loss event data meeting the requirements of paragraph (f)(2)(i) of this
section due to a lack of appropriate operational loss event data from a
merged or acquired business, the [BANKING ORGANIZATION] must calculate
the annual total net operational loss contribution for each year of
missing loss data of a merged or acquired business as follows:
(A) Annual total net operational loss for a merged or acquired
business that lacks loss data = Business Indicator contribution of
merged or acquired business that lacks loss data * Average annual total
net operational loss of the [BANKING ORGANIZATION] excluding amounts
attributable to the merged or acquired business/Business Indicator of
the [BANKING ORGANIZATION] excluding amounts attributable to the merged
or acquired business.
(B) Where ``Business Indicator contribution of merged or acquired
business that lacks loss data'' is the Business Indicator of the
[BANKING ORGANIZATION] including the merged or acquired business that
lacks loss data minus the Business Indicator of the [BANKING
ORGANIZATION] excluding amounts attributable to the merged or acquired
business.
(vii) Notwithstanding any other provision of paragraph (e)(2) of
this section, if a [BANKING ORGANIZATION] does not have operational
loss event data that meets the requirements of paragraph (f)(2)(i) of
this section for the entire ten-year period described in paragraph
(e)(2)(i) of this section after taking into account paragraph
(e)(2)(vi), the [BANKING ORGANIZATION] must adjust the calculations
under this paragraph (e) as follows:
(A) If the [BANKING ORGANIZATION] has five or more years of
operational loss event data that meets the requirements of paragraph
(f)(2)(i) of this section, the [BANKING ORGANIZATION] must calculate
average annual total net operational losses using only the data that
meets the requirements of paragraph (f)(2)(i) of this section.
(B) If the [BANKING ORGANIZATION] has less than five years of
operational loss event data that meets the requirements in paragraph
(f)(2)(i) of this section, the [BANKING ORGANIZATION] must set the
Internal Loss Multiplier to one.
(3) Notwithstanding paragraph (e)(2) of this section:
(i) A [BANKING ORGANIZATION] may request approval from the [AGENCY]
to exclude from the [BANKING ORGANIZATION]'s operational loss events
associated with an activity that the [BANKING ORGANIZATION] has ceased
to directly or indirectly conduct from the calculation of annual total
net operational losses. Approval by the [AGENCY] of the exclusion of
operational loss events relating to legal risk requires a demonstration
that the activity does not carry legacy legal exposure.
(ii) A [BANKING ORGANIZATION] may request the [AGENCY] to exclude
operational loss events that are no longer relevant to the [BANKING
ORGANIZATION]'s risk profile from the calculation of annual total
operational losses. To justify such exclusion, the [BANKING
ORGANIZATION] must provide adequate justification for why the
operational loss events are no longer relevant to its risk profile. In
order to be eligible for exclusion under this paragraph, an operational
loss event must have been included in the calculation of the [BANKING
ORGANIZATION]'s average annual total net operational losses for at
least the prior 12 quarters.
(iii) A [BANKING ORGANIZATION] may not request exclusion of
operational loss events under paragraph (e)(3)(i) or (ii) of this
section unless the operational loss events represent a total net
operational loss amount equal to five percent or more of average annual
total net operational losses prior to the requested exclusion.
(f) Operational Risk Management and Operational Loss Event Data
Collection Processes. (1) A [BANKING ORGANIZATION] must:
(i) Have an operational risk management function that:
(A) Is independent of business line management; and
(B) Is responsible for designing, implementing, and overseeing the
[BANKING ORGANIZATION]'s internal loss event data collection processes
as specified in paragraph (f)(2) and for overseeing the processes that
implement paragraphs (f)(1)(ii) and (f)(1)(iii) of this section;
(ii) Have and document a process to identify, measure, monitor, and
control operational risk in the [BANKING ORGANIZATION]'s products,
activities, processes, and systems; and
(iii) Report operational loss events and other relevant operational
risk information to business unit management, senior management, and
the board of directors (or a designated committee of the board).
(2) A [BANKING ORGANIZATION] must have operational loss event data
collection processes that meet the following requirements:
(i) The processes must produce operational loss event data that
satisfies the following criteria:
(A) Operational loss event data must be comprehensive and capture
all operational loss events that resulted in operational losses equal
to or higher than $20,000 (before any recoveries are taken into
account) from all activities and exposures of the [BANKING
ORGANIZATION];
(B) Operational loss event data must include operational loss event
data relative to entities that have been acquired by or merged with the
[BANKING ORGANIZATION] for ten full years, including for any period
prior to the acquisition or merger during the ten-year period; and
(C) Operational loss event data must include gross operational loss
amounts, recovery amounts, the date when the event occurred or began
(``occurrence date''), the date when the [BANKING ORGANIZATION] became
aware of the event (``discovery date''), and the date (or dates) when
losses or recoveries related to the event were recognized in the
[BANKING ORGANIZATION]'s profit and loss accounts (``accounting
date''). The [BANKING ORGANIZATION] must be able to map its operational
loss event data into the seven operational loss event type categories.
In addition, the [BANKING ORGANIZATION] must collect descriptive
information about the drivers of operational loss events.
(ii) Procedures for the identification and collection of internal
loss event data must be documented.
(iii) The [BANKING ORGANIZATION] must have processes to
independently review the comprehensiveness and accuracy of operational
loss event data.
(iv) The [BANKING ORGANIZATION] must subject the procedures in
paragraph (f)(2)(ii) of this section and the processes in (f)(2)(iii)
of this section
[[Page 64218]]
to regular independent reviews by internal or external audit functions.
Disclosures
Sec. __.160 Purpose and scope.
Sections __.160 through __.162 of this part establish public
disclosure requirements related to the capital requirements for a
[BANKING ORGANIZATION] subject to subpart E of this part, unless the
[BANKING ORGANIZATION] is a consolidated subsidiary of a bank holding
company, savings and loan holding company, or depository institution
that is subject to these disclosure requirements, or a subsidiary of a
non-U.S. banking organization that is subject to comparable public
disclosure requirements in its home jurisdiction.
Sec. __.161 Disclosure requirements.
(a) A [BANKING ORGANIZATION] described in Sec. __.160 must provide
timely public disclosures each calendar quarter of the information in
the applicable tables in Sec. __.162. If a significant change occurs
to the information required to be reported in the applicable tables in
Sec. __.162 or to the [BANKING ORGANIZATION]'s financial condition as
reported on the Call Report, for a [bank]; FR Y-9C, for a bank holding
company or savings and loan holding company; or FFIEC 101, as
applicable, then a brief discussion of this change and its likely
impact must be disclosed as soon as practicable thereafter. Qualitative
disclosures that typically do not change each quarter (for example, a
general summary of the [BANKING ORGANIZATION]'s risk management
objectives and policies, reporting system, and definitions) may be
disclosed annually after the end of the fourth calendar quarter,
provided that any significant changes are disclosed in the interim. The
[BANKING ORGANIZATION]'s management may provide all of the disclosures
required by Sec. __.162 in one place on the [BANKING ORGANIZATION]'s
public website or may provide the disclosures in more than one public
financial report or other regulatory report. If the [BANKING
ORGANIZATION] does not provide all of the disclosures as required by
Sec. __.162 in one place on the [BANKING ORGANIZATION]'s public
website, the [BANKING ORGANIZATION] must provide a summary table
specifically indicating the location(s) of all such disclosures on the
[BANKING ORGANIZATION]'s public website.
(b) A [BANKING ORGANIZATION] described in Sec. __.160 must have a
formal disclosure policy approved by the board of directors that
addresses its approach for determining the disclosures it makes. The
policy must address the associated internal controls and disclosure
controls and procedures. The board of directors and senior management
are responsible for establishing and maintaining an effective internal
control structure over financial reporting, including the disclosures
required by this subpart, and must ensure that appropriate review of
the disclosures takes place. One or more senior officers of the
[BANKING ORGANIZATION] must attest that the disclosures meet the
requirements of this subpart.
(c) If a [BANKING ORGANIZATION] described in Sec. __.160
reasonably concludes that specific commercial or financial information
that it would otherwise be required to disclose under this section
would be exempt from disclosure by the [AGENCY] under the Freedom of
Information Act (5 U.S.C. 552), then the [BANKING ORGANIZATION] is not
required to disclose that specific information pursuant to this
section. However, the [BANKING ORGANIZATION] must disclose more general
information about the subject matter of the requirement, together with
the fact that, and the reason why, the specific items of information
have not been disclosed.
Sec. __.162 Disclosures by [BANKING ORGANIZATION] described in Sec.
__.160.
(a) General disclosures. Except as provided in Sec. __.161, a
[BANKING ORGANIZATION] described in Sec. __.160 must make the
disclosures described in tables 1 through 15 of this section. The
[BANKING ORGANIZATION] must make these disclosures publicly available
for each of the last twelve quarters, or such shorter period beginning
in the quarter in which the [BANKING ORGANIZATION] becomes subject to
subpart E of this part.
BILLING CODE 6210-01-P; 6714-01-P; 4810-33-P
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(b) Risk management-related disclosure requirements. (1) The
[BANKING ORGANIZATION] must describe its risk management objectives and
policies for the organization overall, in particular:
(i) How the business model determines and interacts with the
overall risk profile (e.g., the key risks related to the business model
and how each of these risks is reflected and described in the risk
disclosures) and how the risk profile of the [BANKING ORGANIZATION]
interacts with the risk tolerance approved by the board;
(ii) The risk governance structure, including: responsibilities
attributed throughout the [BANKING ORGANIZATION] (e.g., oversight and
delegation of authority; breakdown of responsibilities by type of risk,
business unit, etc.); and relationships between the structures involved
in risk management processes (e.g., board of directors, executive
management, separate risk committee, risk management structure,
compliance function, internal audit function);
(iii) Channels to communicate, define, and enforce the risk culture
within the [BANKING ORGANIZATION] (e.g., code of conduct; manuals
containing operating limits or procedures to treat violations or
breaches of risk thresholds; procedures to raise and share risk issues
[[Page 64220]]
between business lines and risk functions);
(iv) The scope and nature of risk reporting and/or measurement
systems;
(v) Description of the process of risk information reporting
provided to the board and senior management, in particular the scope
and main content of reporting on risk exposure;
(vi) Qualitative information on stress testing (e.g., portfolios
subject to stress testing, scenarios adopted and methodologies used,
and use of stress testing in risk management); and
(vii) The strategies and processes to manage, hedge, and mitigate
risks that arise from the [BANKING ORGANIZATION]'s business model, and
the processes for monitoring the continuing effectiveness of hedges and
mitigants.
(2) For each separate risk area that is the subject of Tables 5
through 14 of Sec. __.162, the [BANKING ORGANIZATION] must describe
its risk management objectives and policies, including:
(i) The strategies and processes;
(ii) The structure and organization of the relevant risk management
function;
(iii) The scope and nature of risk reporting and/or measurement
systems; and
(iv) Policies for hedging and/or mitigating risk and strategies and
processes for monitoring the continuing effectiveness of hedges/
mitigants.
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(c) Regulatory capital instrument and other instruments eligible
for total loss absorbing capacity (TLAC) disclosures. (1) A [BANKING
ORGANIZATION] described in Sec. __.160 must provide a description of
the main features of its regulatory capital instruments, in accordance
with Table 15 of this section. If the [BANKING ORGANIZATION] issues or
repays a capital instrument, or in the event of a redemption,
conversion, write down, or other material change in the nature of an
existing instrument, but in no event less frequently than semiannually,
the [BANKING ORGANIZATION] must update the disclosures provided in
accordance with Table 15 of this section. A [BANKING ORGANIZATION] also
must disclose the full terms and conditions of all instruments included
in regulatory capital.
(2) In addition to the disclosure requirement in Sec.
__.162(c)(1), a [BANKING ORGANIZATION] that is a global systemically
important BHC also must provide a description of the main features of
each eligible debt security, as defined in 12 CFR 252.61, that the
[BANKING ORGANIZATION] has issued and outstanding, in accordance with
Table 15 of this section. If the global systemically important BHC
issues or repays an eligible debt security, or in the event of a
redemption, conversion, write down, or other material change in the
nature of an existing instrument, but in no event less frequently than
semiannually, the global systemically important BHC must update the
disclosures provided in accordance with Table 15 of this section. A
global systemically important BHC also must disclose the full terms and
conditions of all eligible debt securities.
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BILLING CODE 6210-01-C; 6714-01-C; 4810-33-C
Subpart F--Risk-Weighted Assets--Market Risk and Credit Valuation
Adjustment (CVA)
Sec. __.201 Purpose, applicability, and reservations of authority.
(a) Purpose. This subpart establishes risk-based capital
requirements in a manner that:
(1) For [BANKING ORGANIZATIONS] with significant exposure to market
risk, provides methods for these [BANKING ORGANIZATIONS] to calculate
their standardized measure for market risk and, if applicable, their
models-based measure for market risk, and establishes public disclosure
requirements; and
(2) For [BANKING ORGANIZATIONS] with significant exposure to CVA
risk, provides methods for these [BANKING ORGANIZATIONS] to calculate
their basic measure for CVA risk and, if applicable, their standardized
measure for CVA risk.
(b) Applicability--(1) Market Risk. The market risk capital
requirements and related public disclosure requirements specified in
Sec. __.203 through Sec. __.217 apply to a [BANKING ORGANIZATION]
that meets one or more of the standards in this paragraph (b)(1):
(i) The [BANKING ORGANIZATION] is:
(A) A depository institution holding company that is a global
systemically important BHC, Category II Board-regulated institution,
Category III Board-regulated institution, or Category IV Board-
regulated institution;
(B) A subsidiary of a holding company that is listed under
paragraph (b)(1)(i)(A) of this section, provided that the subsidiary
has engaged in trading activity over any of the four most recent
quarters; or
(ii) The [BANKING ORGANIZATION] has aggregate trading assets and
trading liabilities, excluding customer and proprietary broker-dealer
reserve bank accounts, equal to:
(A) 10 percent or more of quarter-end total assets as reported on
the most recent quarterly [REGULATORY REPORT]; or
(B) $5 billion or more, on average for the four most recent
quarters as reported in the [BANKING ORGANIZATION]'s [REGULATORY
REPORT]s.
(2) CVA Risk. The CVA risk-based capital requirements specified in
Sec. __.220 through Sec. __.225 apply to any [BANKING ORGANIZATION]
that is a global systemically important BHC, a subsidiary of a global
systemically important BHC, Category II [BANKING ORGANIZATION],
Category III [BANKING ORGANIZATION], or Category IV [BANKING
ORGANIZATION].
(3) Initial Applicability. A [BANKING ORGANIZATION] must meet the
requirements of this subpart beginning the quarter after a [BANKING
ORGANIZATION] meets the criteria of paragraph (b)(1) or (b)(2) of this
section, as applicable.
(4) Monitoring of Trading Assets and Liabilities. A [BANKING
ORGANIZATION] must monitor its aggregate trading assets and trading
liabilities to determine the applicability of this subpart F in
accordance with paragraph (b)(1) of this section.
(5) Ongoing applicability. (i) A [BANKING ORGANIZATION] that meets
at least one of the standards in paragraph (b)(1) of this section shall
remain subject to the relevant requirements of this subpart F unless
and until it does not meet any of the standards in paragraph (b)(1)(ii)
of this section for each of four consecutive quarters as reported in
the [BANKING ORGANIZATION]'s [REGULATORY REPORT]s, or it is no longer a
depository institution holding company that is a global systemically
important BHC, a Category II Board-regulated institution, a Category
III Board-
[[Page 64229]]
regulated institution, or Category IV Board-regulated institution; or
it is no longer a U.S. intermediate holding company that is a Category
II Board-regulated institution, a Category III Board-regulated
institution, or Category IV Board-regulated institution, as applicable,
and the [BANKING ORGANIZATION] provides notice to the [AGENCY].
(ii) A [BANKING ORGANIZATION] that meets the standard in paragraph
(b)(2) of this section shall remain subject to the relevant
requirements of this subpart F unless and until it no longer meets the
standard in paragraph (b)(2) of this section for each of four
consecutive quarters as reported in the [BANKING ORGANIZATION]'s
[REGULATORY REPORT]s and the [BANKING ORGANIZATION] provides notice to
the [AGENCY].
(6) Exclusions. The [AGENCY] may exclude a [BANKING ORGANIZATION]
that meets one or more of the standards of paragraph (b)(1) of this
section or the standard in paragraph (b)(2) of this section from
application of Sec. __.203 through Sec. __.217 or Sec. __.220
through Sec. __.225 if the [AGENCY] determines that the exclusion is
appropriate based on the level of market risk or level of CVA risk,
respectively, of the [BANKING ORGANIZATION] and is consistent with safe
and sound banking practices.
(7) Data Availability. A [BANKING ORGANIZATION] that does not have
four quarters of aggregate data on trading assets and trading
liabilities (excluding customer and proprietary broker-dealer reserve
bank accounts) must calculate the average in paragraph (b)(1)(ii)(B) of
this section by averaging as much data as the [BANKING ORGANIZATION]
has available, unless the [AGENCY] notifies the [BANKING ORGANIZATION]
in writing to use an alternative method.
(c) Reservations of authority. (1) The [AGENCY] may apply Sec.
__.203 through Sec. __.217 or Sec. __.220 through Sec. __.225 to any
[BANKING ORGANIZATION] if the [AGENCY] deems it necessary or
appropriate because of the level of market risk or CVA risk,
respectively, of the [BANKING ORGANIZATION] or to ensure safe and sound
banking practices.
(2) The [AGENCY] may require a [BANKING ORGANIZATION] to hold an
amount of capital greater than otherwise required under this subpart F
if the [AGENCY] determines that the [BANKING ORGANIZATION]'s capital
requirement for market risk or CVA risk as calculated under this
subpart F is not commensurate with the market risk or the CVA risk of
the [BANKING ORGANIZATION]'s market risk covered positions or CVA risk
covered positions, respectively.
(3) If the [AGENCY] determines that the risk-based capital
requirement calculated under this subpart F by the [BANKING
ORGANIZATION] for one or more market risk covered positions or CVA risk
covered positions or categories of such positions is not commensurate
with the risks associated with those market risk covered positions or
CVA risk covered positions or categories of such positions, the
[AGENCY] may require the [BANKING ORGANIZATION] to assign a different
risk-based capital requirement to the market risk covered positions or
CVA risk covered positions or categories of such positions that more
accurately reflects the risk of the market risk covered positions or
CVA risk covered positions or categories of such positions.
(4) The [AGENCY] may also require a [BANKING ORGANIZATION] to
calculate market risk capital requirements for specific positions or
categories of positions under this subpart F instead of risk-based
capital requirements under subpart D or subpart E of this part, as
applicable; or to calculate risk-based capital requirements for
specific exposures or categories of exposures under subpart D or
subpart E of this part, as applicable, instead of market risk capital
requirements under this subpart F, as appropriate, to more accurately
reflect the risks of the positions or exposures. In such cases, the
[AGENCY] may alternatively require a [BANKING ORGANIZATION] to apply
the capital add-ons for re-designations as described in Sec.
__.204(e).
(5) The [AGENCY] may require a [BANKING ORGANIZATION] that
calculates the models-based measure for market risk to modify the
methodology or observation period used to measure market risk.
(6) In making determinations under paragraphs (c)(1) through (5) of
this section, the [AGENCY] will apply notice and response procedures
generally in the same manner as the notice and response procedures set
forth in 12 CFR 3.404, 263.202, and 324.5(c).
(7) Nothing in this subpart F limits the authority of the [AGENCY]
under any other provision of law or regulation to take supervisory or
enforcement action, including action to address unsafe or unsound
practices or conditions, deficient capital levels, or violations of
law.
Sec. __.202 Definitions
(a) Terms set forth in Sec. __.2 and used in this subpart F have
the definitions assigned thereto in Sec. __.2.
(b) For the purposes of this subpart F, the following terms are
defined as follows:
Actual profit and loss means the actual profit and loss derived
from the daily trading activity for market risk covered positions.
Intraday trading, net interest income, and time effects must be
included; valuation adjustments for which separate regulatory capital
requirements have been otherwise specified, fees, reserves, and
commissions must be excluded.
Backtesting means the comparison of a [BANKING ORGANIZATION]'s
daily actual profit and loss and hypothetical profit and loss with the
VaR-based measure as described in Sec. __.204(g) and Sec. __.213(b).
Basic CVA hedge means an eligible CVA hedge that is included in the
basic CVA approach capital requirement under the standardized measure
for CVA risk, pursuant to Sec. __.221(c)(3).
Basic CVA risk covered position means a CVA risk covered position
that is included in the basic CVA approach capital requirement,
pursuant to Sec. __.221(c)(2).
Cash equity position means an equity position that is not a
derivative contract.
Committed quote means a price from an arm's-length provider at
which the provider of the quote must buy or sell the instrument.
Commodity position means a market risk covered position for which
price risk arises from changes in the price of one or more commodities.
Commodity risk means the risk of loss that could arise from changes
in underlying commodity risk factors.
Corporate position means a market risk covered position that is a
corporate exposure.
Correlation trading position means:
(1) Except as provided in paragraph (2) of this definition:
(i) A securitization position for which all or substantially all of
the value of the underlying exposures reference the credit exposures to
single name companies for which a two-way market exists, or on commonly
traded indices based on such exposures, for which a two-way market
exists; or
(ii) A position that is not a securitization position and that
hedges a position described in paragraph (1)(i) of this definition.
(2) Notwithstanding paragraph (1) of this definition, a correlation
trading position does not include:
(i) A resecuritization position;
(ii) A derivative of a securitization position that does not
provide a pro rata
[[Page 64230]]
share in the proceeds of a securitization tranche; or
(iii) A securitization position for which the underlying assets or
reference exposures are retail exposures, residential mortgage
exposures, or commercial mortgage exposures.
Counterparty credit spread risk means the risk of loss resulting
from a change in the credit spread of a counterparty that results in an
increase in CVA.
Covered bond means a bond issued by a financial institution that
satisfies all of the criteria in paragraphs (1) through (6) of this
definition from inception through its remaining maturity:
(1) The bond is subject to a specific regulatory regime under the
law of the jurisdiction governing the bond that is designed to protect
bond holders;
(2) The bond has a pool of underlying assets consisting exclusively
of:
(i) Claims on, or guaranteed by, sovereigns, their central banks,
PSEs, or MDBs;
(ii) Claims secured by first lien residential mortgages that would
qualify for a 55 percent or lower risk weight under subpart E of this
part; or
(iii) Claims secured by commercial real estate that would qualify
for a 100 percent or lower risk weight under subpart E of this part and
have a loan-to-value ratio of 60 percent or lower; and
(3) If the pool of underlying assets has any claims described in
paragraphs (2)(ii) or (iii) of this definition, then, for purposes of
calculating the loan-to-value ratios for these assets:
(i) The collateral is valued at or less than the current fair
market value under which the property could be sold under private
contract between a willing seller and an arm's-length buyer on the date
of valuation;
(ii) The issuing financial institution monitors the value of the
collateral regularly and at least once per year; and
(iii) A qualified professional evaluates the property when
information indicates that the value of the collateral may have
declined materially relative to general market prices or when a credit
event, such as a default, occurs;
(4) The nominal value of the pool of assets assigned to the bond
exceeds the bond's nominal outstanding value by at least 10 percent;
(5) If the law governing the bond does not provide for the
requirement in paragraph (4) of this definition, then the issuing
financial institution discloses publicly on a regular basis that the
issuing financial institution in practice meets the requirement in
paragraph (4) of this definition; and
(6) The proceeds deriving from the bond are invested by law in
assets that, during the entire duration of the bond--
(i) Are capable of covering claims attached to the bond; and
(ii) In the event of the failure of the issuer, would be used on a
priority basis for the payment of principal and accrued interest.
Credit spread risk means the risk of loss that could arise from
changes in underlying credit spread risk factors.
Credit valuation adjustment (CVA) means the fair value adjustment
to reflect counterparty credit risk in the valuation of derivative
contracts.
Cross-currency basis means the basis spread added to the associated
reference rate of the non-USD leg or non-EUR leg of a cross-currency
basis swap.
Currency union means an agreement by treaty among countries or
territorial entities, under which the members agree to use a single
currency, where the currency used is described in Sec.
__.209(b)(1)(iv).
Curvature risk means the incremental risk of loss of a market risk
covered position that is not captured by the delta capital requirement
arising from changes in the value of an option or embedded option and
is measured based on two stress scenarios (curvature scenarios)
involving an upward shock and a downward shock to each prescribed
curvature risk factor.
Customer and proprietary broker-dealer reserve bank accounts means
segregated accounts established by a subsidiary of a [BANKING
ORGANIZATION] that fulfill the requirements of 17 CFR 240.15c3-3 or 17
CFR 1.20.
CVA hedge means a transaction that a [BANKING ORGANIZATION] enters
into with a third party or an internal trading desk and manages for the
purpose of mitigating CVA risk.
CVA risk means the risk of loss due to an increase in CVA resulting
from the deterioration in the creditworthiness of a counterparty
perceived by the market or changes in the exposure of CVA risk covered
positions.
CVA risk covered position means a position that is a derivative
contract that is not a cleared transaction, provided that a position
that is an eligible credit derivative the credit risk mitigation
benefits of which are recognized under Sec. __.36 or Sec. __.120, as
applicable, may be excluded from being a CVA risk covered position.
Default risk means the risk of loss on a non-securitization debt or
equity position or a securitization position that could result from the
failure of an obligor to make timely payments of principal or interest
on its debt obligations, and the risk of loss that could result from
bankruptcy, insolvency, or similar proceeding.
Delta risk means the risk of loss that could result from changes in
the value of a position due to small changes in underlying risk
factors. Delta risk is measured based on the sensitivities of a
position to prescribed delta risk factors, which are specified in Sec.
__.207 and Sec. __.208 for purposes of calculating the sensitivities-
based capital requirement and Sec. __.224 and Sec. __.225 for
purposes of calculating the standardized CVA approach capital
requirement.
Eligible CVA hedge. (1) Except as provided in paragraph (2) of this
definition, eligible CVA hedge means a CVA hedge with an external party
or a CVA hedge that is the CVA segment of an internal risk transfer:
(i) For purposes of calculating the basic CVA approach capital
requirement, a CVA hedge of counterparty credit spread risk,
specifically:
(A) An index credit default swap (CDS); or
(B) A single-name CDS or a single-name contingent CDS that:
(1) References the counterparty directly; or
(2) References an affiliate of the counterparty; or
(3) References an entity that belongs to the same sector and region
as the counterparty.
(ii) For purposes of calculating the standardized CVA approach
capital requirement, eligible hedges can include:
(A) Instruments that hedge variability of the counterparty credit
spread component of CVA risk; and
(B) Instruments that hedge the exposure component of CVA risk.
(2) Notwithstanding paragraph (1) of this definition, an eligible
CVA hedge does not include:
(i) A CVA hedge that is not a whole transaction;
(ii) A securitization position; or
(iii) A correlation trading position.
Emerging market economy means a country or territorial entity that
is not a liquid market economy.
Equity position means a market risk covered position that is not a
securitization position or a correlation trading position and that has
a value that reacts primarily to changes in equity prices.
Equity risk means the risk of loss that could arise from changes in
underlying equity risk factors.
Equity repo rate means the equity repurchase agreement rate.
Exotic exposure means an underlying exposure that is not in scope
of any of
[[Page 64231]]
the risk classes under the sensitivities-based capital requirement or
is not captured by the standardized default risk capital requirement,
which includes, but is not limited to, longevity risk, weather risk,
and natural disaster risk.
Expected shortfall (ES) means a measure of the average of all
potential losses exceeding the VaR at a given confidence level and over
a specified horizon.
Exposure model means a CVA exposure model used by the [BANKING
ORGANIZATION] for financial reporting purposes or such a CVA exposure
model that has been adjusted to satisfy the requirements of this
subpart F.
Foreign exchange risk means the risk of loss that could arise from
changes in underlying foreign exchange risk factors.
Foreign exchange position means a position for which price risk
arises from changes in foreign exchange rates.
GSE debt means an exposure to a GSE that is not an equity exposure
or exposure to a subordinated debt instrument issued by a GSE.
Hedge means a position or positions that offset all, or
substantially all, of the price risk of another position or positions.
Hybrid instrument means an instrument that has characteristics in
common with both debt and equity instruments, including traditional
convertible bonds.
Hypothetical profit and loss means the change in the value of the
market risk covered positions that would have occurred due to changes
in the market data at end of current day if the end-of-previous-day
market risk covered positions remained unchanged. Valuation adjustments
that are updated daily must be included, unless the [BANKING
ORGANIZATION] has received approval from the [AGENCY] to exclude them.
Valuation adjustments for which separate regulatory capital
requirements have been otherwise specified, commissions, fees,
reserves, net interest income, intraday trading, and time effects must
be excluded.
Idiosyncratic risk means the risk of loss in the value of a
position that arises from changes in risk factors unique to the issuer.
Idiosyncratic risk factor means categories of risk factors that
present idiosyncratic risk.
Interest rate risk means the risk of loss that could arise from
changes in underlying interest rate risk factors.
Internal risk management model means a valuation model that the
independent risk control unit within the [BANKING ORGANIZATION] uses to
report market risks and risk-theoretical profits and losses to senior
management.
Internal risk transfer means a transfer, executed through internal
derivatives trades:
(1) Of credit risk or interest rate risk arising from an exposure
capitalized under subpart D or subpart E of this part to a trading desk
under this subpart F; or
(2) Of CVA risk from a CVA desk (or the functional equivalent if a
[BANKING ORGANIZATION] does not have any CVA desks) to a trading desk
under this subpart F.
Large market cap means a market capitalization equal to or greater
than $2 billion.
Liquid market economy means:
(1) A country or territorial entity that, based on an annual
review, the [BANKING ORGANIZATION] has determined meets all of the
following criteria:
(i) The country or territorial entity has at least $10,000 in gross
domestic product per capita in current prices;
(ii) The country or territorial entity has at least $95 billion in
total market capitalization of all domestic stock markets;
(iii) The country or territorial entity has export diversification
such that no single sector or commodity comprises more than 50 percent
of the country or territorial entity's total annual exports;
(iv) The country or territorial entity does not impose material
controls on liquidation of direct investment; and
(v) The country or territorial entity does not have sovereign
entities, public sector entities, or sovereign-controlled enterprises
subject to sanctions by the U.S. Office of Foreign Assets Control.
(2) A country or territorial entity that is in a currency union
with at least one country or territorial entity that meets the criteria
in paragraph (1) of this definition.
Liquidity horizon means the time required to exit or hedge a market
risk covered position without materially affecting market prices in
stressed market conditions.
Look-through approach means an approach in which a [BANKING
ORGANIZATION] treats a market risk covered position that has multiple
underlying exposures (such as an index instrument, multi-underlying
option, an equity position in an investment fund, or a correlation
trading position) as if the underlying exposures were held directly by
the [BANKING ORGANIZATION].
Market capitalization means the aggregate value of all outstanding
publicly traded shares issued by a company and its affiliates as
determined by multiplying each share price by the number of outstanding
shares.
Market risk means the risk of loss that could result from market
movements, such as changes in the level of interest rates, credit
spreads, equity prices, foreign exchange rates, or commodity prices.
Market risk covered position. (1) Except as provided in paragraph
(2) of this definition, market risk covered position means the
following positions:
(i) A trading asset or trading liability (whether on- or off-
balance sheet),\509\ as reported on [REGULATORY REPORT], that is a
trading position, a position that is held for the purpose of regular
dealing or making a market in securities or in other instruments, or
hedges another market risk covered position and that is free of any
restrictive covenants on its tradability or where the [BANKING
ORGANIZATION] is able to hedge the material risk elements of the
position in a two-way market; \510\ and
---------------------------------------------------------------------------
\509\ Securities subject to repurchase and lending agreements
are included as if they are still owned by the lender.
\510\ A position that hedges a trading position must be within
the scope of the [BANKING ORGANIZATION]'s hedging strategy as
described in Sec. __.203(a)(2).
---------------------------------------------------------------------------
(ii) The following positions, regardless of whether the position is
a trading asset or trading liability, and hedges of such positions:
(A) A foreign exchange position or commodity position, excluding:
(1) An eligible CVA hedge that mitigates the exposure component of
CVA risk; and
(2) Any structural position in a foreign currency that the [BANKING
ORGANIZATION] chooses to exclude with prior approval from the [AGENCY];
(B) A publicly traded equity position that is not excluded from
being a market risk covered position by paragraph (2)(iv) of this
definition;
(C) An equity position in an investment fund that is not excluded
from being a market risk covered position by paragraph (2)(vi) of this
definition;
(D) A net short risk position of $20 million or more;
(E) An embedded derivative on instruments that the [BANKING
ORGANIZATION] issued that relates to credit or equity risk that it
bifurcates for accounting purposes;
(F) The trading desk segment of an eligible internal risk transfer
of credit risk as described in Sec. __.205(h)(1)(i);
(G) The trading desk segment of an eligible internal risk transfer
of interest rate risk as described in Sec. __.205(h)(1)(ii);
[[Page 64232]]
(H) A position arising from a transaction between a trading desk
and an external party conducted as part of an internal risk transfer
described in Sec. __.205(h);
(I) The trading desk segment of an internal risk transfer of CVA
risk;
(J) The CVA segment of an internal risk transfer that is not an
eligible CVA hedge; and
(K) A CVA hedge with an external party that is not an eligible CVA
hedge.
(2) Notwithstanding paragraph (1) of this definition, a market risk
covered position does not include:
(i) An intangible asset, including a servicing asset;
(ii) A hedge of a trading position that the [AGENCY] determines to
be outside the scope of the [BANKING ORGANIZATION]'s trading and
hedging strategy required in Sec. __.203(a)(2);
(iii) An instrument that, in form or substance, acts as a liquidity
facility that provides support to asset-backed commercial paper;
(iv) A publicly traded equity position with restrictions on
tradability;
(v) A non-publicly traded equity position that is not an equity
position in an investment fund;
(vi) An equity position in an investment fund that does not meet at
least one of the two following criteria:
(A) The [BANKING ORGANIZATION] has access to the investment fund's
prospectus, partnership agreement, or similar contract that defines the
fund's permissible investments and investment limits and is able to use
the look-through approach to calculate a market risk capital
requirement for its proportional ownership share of each exposure held
by the investment fund; or
(B) The [BANKING ORGANIZATION] has access to the investment fund's
prospectus, partnership agreement, or similar contract that defines the
fund's permissible investments and investment limits and obtains daily
price quotes for the investment fund;
(vii) Any position a [BANKING ORGANIZATION] holds with the intent
to securitize;
(viii) A direct real estate holding;
(ix) A derivative instrument or an exposure to a fund that has
material exposure to the instrument types described in paragraphs
(2)(i) through (viii) of this definition as underlying assets;
(x) A debt security, for which the [BANKING ORGANIZATION] elects
the fair value option for purposes of asset and liability management;
(xi) A significant investment in the capital of unconsolidated
financial institutions in the form of common stock that is not deducted
from capital pursuant to Sec. __.22(c)(6);
(xii) An instrument held for the purpose of hedging a particular
risk of a position in the types of instruments described in paragraphs
(2)(i) through (x) of this definition;
(xiii) An eligible CVA hedge with an external party;
(xiv) The CVA segment of an internal risk transfer that is an
eligible CVA hedge; and
(xv) An equity position arising from deferred compensation plans,
employee stock ownership plans, and retirement plans.
Mid-prime RMBS means a security that references underlying
exposures that consist primarily of residential mortgages that is not a
prime RMBS or a sub-prime RMBS.
Model-eligible trading desk means a trading desk (including a
notional trading desk) that received approval of the [AGENCY] to be a
model-eligible trading desk pursuant to Sec. __.212(b)(2) and
continues to remain a model-eligible trading desk.
Model-ineligible trading desk means a trading desk that is not a
model-eligible trading desk.
Modellable risk factor means a risk factor that satisfies the risk
factor eligibility test as defined in Sec. __.214(b)(1) and has data
that satisfies the requirements specified in Sec. __.214(b)(7).
Net short risk position means a position that is calculated by
comparing the notional amounts of a [BANKING ORGANIZATION]'s long and
short positions for a given exposure, provided that the notional
amounts of the short position exceed the notional amounts of the long
position and that the position is: \511\
---------------------------------------------------------------------------
\511\ For equity derivatives, the notional long and short
positions are based on the adjusted notional amount, which is the
product of the current price of one unit of the stock (for example,
a share of equity) and the number of units referenced by the trade.
---------------------------------------------------------------------------
(1) From a credit derivative that the [BANKING ORGANIZATION]
recognizes as a guarantee for risk-weighted asset amount calculation
purposes under subpart D or subpart E of this part and other exposures
recognized under subpart D or subpart E of this part;
(2) Arises under subpart D or subpart E of this part from the
credit risk segment of an internal risk transfer described in Sec.
__.205(h)(1)(i) that the [BANKING ORGANIZATION] recognizes as a
guarantee for risk-weighted asset amount calculation purposes under
subpart D or subpart E of this part; and
(3) An equity position or a credit position that arises under
subpart D or subpart E of this part that is not referenced in paragraph
(1) or (2) of this definition provided that:
(i) For a [BANKING ORGANIZATION] that hedges at the single name
level, the notional amounts of the positions are compared at the name
or obligor level; and
(ii) For a [BANKING ORGANIZATION] that hedges at the portfolio
level using indices, the notional amounts of the positions are compared
at the portfolio level.
Non-modellable risk factor means a risk factor that does not
satisfy the risk factor eligibility test as defined in Sec.
__.214(b)(1) or does not have data that satisfies the requirements
specified in Sec. __.214(b)(7).
Non-securitization position means a market risk covered position
that is not a securitization position or a correlation trading position
and that has a value that reacts primarily to changes in interest rates
or credit spreads.
Non-securitization debt or equity position means a non-
securitization position or an equity position that is subject to
default risk.
Notional trading desk means a trading desk created for regulatory
capital purposes to account for market risk covered positions arising
under subpart D or subpart E of this part such as net short risk
positions, embedded derivatives on instruments that the [BANKING
ORGANIZATION] issued that relate to credit or equity risk that it
bifurcates for accounting purposes, and foreign exchange positions and
commodity positions. Notional trading desks are not required to fulfill
the requirements set forth in Sec. __.203(b)(2) and (c).
Pricing model means:
(1) A valuation model used for financial reporting such as models
used in reporting actual profits and losses; or
(2) A valuation model used for internal risk management.
Prime RMBS means a security that references underlying exposures
that consist primarily of qualified residential mortgages as defined
under 12 CFR 244.13(a).
Profit and loss attribution (PLA) means a method for assessing the
robustness of a [BANKING ORGANIZATION]'s internal models used to
calculate the ES-based measure in Sec. __.215(b) by comparing the
risk-theoretical profit and loss predicted by the internal models with
the hypothetical profit and loss.
PSE position means a market risk covered position that is an
exposure to a public sector entity (PSE).
[[Page 64233]]
p-value means the probability, when using the VaR-based measure for
purposes of backtesting, of observing a profit that is less than, or a
loss that is greater than, the profit or loss that actually occurred on
a given date.
Real price means:
(1) A price at which the [BANKING ORGANIZATION] has executed a
transaction;
(2) A verifiable price for an actual transaction between other
arm's-length parties;
(3) A price obtained from a committed quote made by the [BANKING
ORGANIZATION] itself or a third-party provider, provided that, for any
price obtained from a third-party provider:
(i) The transaction or committed quote has been processed through a
third-party provider; or
(ii) The third-party provider agrees to provide evidence of the
transaction or committed quote to the [BANKING ORGANIZATION] upon
request.
Reference credit spread risk means the risk of loss that could
arise from changes in the underlying credit spread risk factors that
drive the exposure component of CVA risk.
Resecuritization position means a market risk covered position that
is a resecuritization exposure.
Risk class means categories of risk that are used as the basis for
calculating the sensitivities-based capital requirement as specified in
Sec. __.206 and the standardized CVA approach capital requirement as
specified in Sec. __.224.
Risk factor means underlying variables, such as market rates and
prices that affect the value of a market risk covered position or a CVA
risk covered position. For purposes of calculating the sensitivities-
based capital requirement, the risk factors are specified in Sec.
__.208. For purposes of calculating the standardized CVA approach
capital requirement, the risk factors are specified in Sec. __.225.
Risk factor classes means, for purposes of calculating the non-
default risk capital measure, interest rate risk, equity risk, foreign
exchange risk, commodity risk, and credit risk, including related
options volatilities in each risk factor category set forth in Table 2
to Sec. __.215.
Risk-theoretical profit and loss means the daily trading desk-level
profit and loss on the end-of-previous-day market risk covered
positions generated by the [BANKING ORGANIZATION]'s internal risk
management models. The risk-theoretical profit and loss must take into
account all risk factors, including non-modellable risk factors, in the
[BANKING ORGANIZATION]'s internal risk management models.
Residential mortgage-backed security (RMBS) means a prime RMBS,
mid-prime RMBS, or sub-prime RMBS.
Securitization position means a market risk covered position that
is a securitization exposure.
Securitization position non-CTP means a securitization position
other than a correlation trading position.
Small market cap means a market capitalization of less than $2
billion.
Sovereign position means a market risk covered position that is a
sovereign exposure.
Standardized CVA hedge means a CVA hedge that is an eligible CVA
hedge that (1) is not a basic CVA hedge and (2) is included in the
standardized CVA approach capital requirement.
Standardized CVA risk covered position means a CVA risk covered
position that is not a basic CVA risk covered position.
Structural position in a foreign currency means a position that is
not a trading position and that is:
(1) Subordinated debt, equity, or minority interest in a
consolidated subsidiary that is denominated in a foreign currency;
(2) Capital assigned to foreign branches that is denominated in a
foreign currency;
(3) A position related to an unconsolidated subsidiary or another
item that is denominated in a foreign currency and that is deducted
from the [BANKING ORGANIZATION]'s tier 1 or tier 2 capital; or
(4) A position designed to hedge a [BANKING ORGANIZATION]'s capital
ratios or earnings against the effect on paragraph (1), (2), or (3) of
this definition of adverse exchange rate movements.
Sub-prime RMBS means a security that references underlying
exposures consisting primarily of higher-priced mortgage loans as
defined in 12 CFR 1026.35, high-cost mortgages as defined in 12 CFR
1026.32, or both.
Systematic risk means the risk of loss that could arise from
changes in risk factors that represent broad market movements and that
are not specific to an issue or issuer.
Systematic risk factors means categories of risk factors that
present systematic risk, such as economy, region, and sector.
Term repo-style transaction means a repo-style transaction that has
an original maturity in excess of one business day.
Trading desk means a unit of organization of a [BANKING
ORGANIZATION] that purchases or sells market risk covered positions
that is:
(1) Structured by the [BANKING ORGANIZATION] to implement a well-
defined business strategy;
(2) Organized to ensure appropriate setting, monitoring, and
management review of the desk's trading and hedging limits and
strategies; and
(3) Characterized by a clearly defined unit of organization that:
(i) Engages in coordinated trading activity with a unified approach
to the key elements described in Sec. __.203(b)(2) and (c);
(ii) Operates subject to a common and calibrated set of risk
metrics, risk levels, and joint trading limits;
(iii) Submits compliance reports and other information as a unit
for monitoring by management; and
(iv) Books its trades together.
Trading position means a position that is held by a [BANKING
ORGANIZATION] for the purpose of short-term resale or with the intent
of benefiting from actual or expected short-term price movements, or to
lock in arbitrage profits.
Two-way market means a market where there are independent bona fide
offers to buy and sell so that a price reasonably related to the last
sales price or current bona fide competitive bid and offer quotations
can be determined within one day and settled at that price within a
relatively short time frame conforming to trade custom.
Value-at-Risk (VaR) means the estimate of the maximum amount that
the value of one or more market risk covered positions could decline
due to market price or rate movements during a fixed holding period
within a stated confidence interval.
Vega risk means the risk of loss that could arise from changes in
the value of a position due to changes in the volatility of the
underlying exposure. Vega risk is measured based on the sensitivities
of a position to prescribed vega risk factors as specified in Sec.
__.207 and Sec. __.208 for purposes of calculating the sensitivities-
based capital requirement and Sec. __.224 and Sec. __.225 for
purposes of calculating the standardized CVA approach capital
requirement.
Sec. __.203 General requirements for market risk.
(a) Market risk covered positions--(1) Identification of market
risk covered positions. A [BANKING ORGANIZATION] must have clearly
defined policies and procedures for determining its market risk covered
positions, which the [BANKING ORGANIZATION] must update at least
[[Page 64234]]
annually. These policies and procedures must include:
(i) Identification of trading assets and trading liabilities that
are trading positions and of trading positions that are correlation
trading positions;
(ii) Identification of trading assets and trading liabilities that
are positions held for the purpose of regular dealing or making a
market in securities or other instruments;
(iii) Identification of equity positions in an investment fund that
are market risk covered positions;
(iv) Identification of positions that are market risk covered
positions, regardless of whether the position is a trading asset or
trading liability, including net short risk positions (and the
calculation of such positions), eligible internal risk transfer
positions as described in Sec. __.205(h), and embedded derivatives on
instruments that the [BANKING ORGANIZATION] issued that relate to
credit or equity risk that it must bifurcate for accounting purposes;
(v) Consideration of the extent to which a position, or a hedge of
its material risks, can be marked-to-market daily by reference to a
two-way market;
(vi) Consideration of possible impairments to the liquidity of a
position or its hedge;
(vii) Identification of positions that must be excluded from market
risk covered positions; and
(viii) A process for determining whether a position needs to be re-
designated after its initial identification as a market risk covered
position or otherwise, which must include re-designation restrictions
and a description of the events or circumstances under which a [BANKING
ORGANIZATION] would consider a re-designation, a process for
identifying such events or circumstances, and a process for obtaining
senior management approval and for notifying the [AGENCY] of material
re-designations.
(2) Market risk trading and hedging strategies. A [BANKING
ORGANIZATION] must have clearly defined trading and hedging strategies
for its market risk covered positions that are approved by senior
management of the [BANKING ORGANIZATION].
(i) The trading strategy must articulate the expected holding
period of, and the market risk associated with, each portfolio of
market risk covered positions.
(ii) The hedging strategy must articulate for each portfolio of
market risk covered positions the level of market risk that the
[BANKING ORGANIZATION] is willing to accept and must detail the
instruments, techniques, and strategies that the [BANKING ORGANIZATION]
will use to hedge the risk of the portfolio.
(b) Trading Desks--(1) Trading desk structure. A [BANKING
ORGANIZATION] must define its trading desk structure. That structure
must include:
(i) Definition of each trading desk;
(ii) Identification of model-eligible trading desks, consistent
with Sec. __.212(b);
(iii) Identification of model-ineligible trading desks used in both
the standardized measure for market risk and the models-based measure
for market risk (as applicable);
(iv) Identification of trading desks that are used for internal
risk transfers (as applicable); and
(v) Identification of notional trading desks (as applicable).
(2) Trading desk policies. For each trading desk that is not a
notional trading desk, a [BANKING ORGANIZATION] must have a clearly
defined policy that is approved by senior management of the [BANKING
ORGANIZATION] and describes the general strategy of the trading desk,
the risk and position limits established for the trading desk, and the
internal controls and governance structure established to oversee the
risk-taking activities of the trading desk, and that includes, at a
minimum:
(i) A written description of the general strategy of the trading
desk that addresses the economics of the business strategy, the primary
activities, and the trading and hedging strategies of the trading desk;
(ii) A clearly defined trading strategy for the trading desk's
market risk covered positions, approved by senior management of the
[BANKING ORGANIZATION], which details the types of market risk covered
positions purchased and sold by the trading desk; indicates which of
these are the main types of market risk covered positions purchased and
sold by the trading desk; and articulates the expected holding period
of, and the market risk associated with, each portfolio of market risk
covered positions held by the trading desk;
(iii) A clearly defined hedging strategy for the trading desk's
market risk covered positions, approved by senior management of the
[BANKING ORGANIZATION], which articulates for each trading desk the
level of market risk the [BANKING ORGANIZATION] is willing to accept
and details the instruments, techniques, and strategies that the
trading desk will use to hedge the risk of the portfolio;
(iv) A business strategy that includes regular reports on the
revenue, costs, and market risk capital requirements of the trading
desk; and
(v) A clearly defined risk scope that is consistent with the
trading desk's pre-established business strategy and objectives that
specify the trading desk's overall risk classes and permitted risk
factors.
(c) Active management of market risk covered positions. A [BANKING
ORGANIZATION] must have clearly defined policies and procedures
describing the internal controls, ongoing monitoring, management, and
authorization procedures, including escalation procedures, for actively
managing all market risk covered positions. At a minimum, these
policies and procedures must identify the key groups and personnel
responsible for overseeing the activities of the [BANKING
ORGANIZATION]'s trading desks that are not notional trading desks and
require:
(1) Determining the fair value of the market risk covered positions
on a daily basis;
(2) Ongoing assessment of the ability of trading desks to hedge
market risk covered positions and portfolio risks and of the extent of
market liquidity;
(3) Establishment by each trading desk of clear trading limits,
including limits on intraday exposures, with well-defined trader
mandates and articulation of why the risk factors used to establish the
limits appropriately reflect the general strategy of the trading desk;
(4) Establishment and daily monitoring by trading desks of the
following risk-management measurements:
(i) Trading limits, including limits on intraday exposures; usage;
and remediation of breaches;
(ii) Sensitivities to risk factors;
(iii) VaR and expected shortfall (as applicable);
(iv) Backtesting and p-values at the trading desk level and at the
aggregate level for all model-eligible trading desks (as applicable);
(v) Comprehensive profit and loss attribution (as applicable); and
(vi) Market risk covered positions and transaction volumes;
(5) Establishment and daily monitoring by a risk control unit
independent of the trading business unit of the risk-management
measurements listed in paragraph (c)(4) of this section;
(6) Strategy to appropriately mitigate risks when stress tests
reveal particular vulnerabilities to a given set of circumstances;
[[Page 64235]]
(7) Daily monitoring by senior management of information described
in paragraphs (c)(1) through (4) of this section;
(8) Reassessment of established limits on market risk covered
positions, performed by senior management annually or more frequently;
and
(9) Assessments of the quality of market inputs to the valuation
process, the soundness of key assumptions, the reliability of parameter
estimation in pricing models, and the stability and accuracy of model
calibration under alternative market scenarios, performed by qualified
personnel annually or more frequently.
(d) Stress testing. (1) A [BANKING ORGANIZATION] must stress test
the market risk of its market risk covered positions at the aggregate
level and on each trading desk at a frequency appropriate to manage
risk, but in no case less frequently than quarterly. The stress tests
must take into account concentration risk (including but not limited to
concentrations in single issuers, industries, sectors, or markets),
illiquidity under stressed market conditions, and risks arising from
the [BANKING ORGANIZATION]'s trading activities that may not be
adequately captured in the standardized measure for market risk or in
the models-based measure for market risk, as applicable.
(2) The results of the stress testing must be reviewed by the
[BANKING ORGANIZATION]'s senior management when available; and
reflected in the policies and limits set by the [BANKING
ORGANIZATION]'s management and its board of directors (or a committee
thereof).
(e) Control and oversight. (1) A [BANKING ORGANIZATION] must have
in place internal market risk management systems and processes for
identifying, measuring, monitoring, and managing market risk that are
conceptually sound.
(2) A [BANKING ORGANIZATION] must have a risk control unit that is
responsible for the design and implementation of the [BANKING
ORGANIZATION]'s market risk management system and that reports directly
to senior management and is independent from the business trading
units.
(3) A [BANKING ORGANIZATION] must have an internal audit function
independent of business line management that at least annually assesses
the effectiveness of the controls supporting the [BANKING
ORGANIZATION]'s market risk measurement systems, including the
activities of the business trading units and independent risk control
unit, the initial designation of positions as market risk covered
positions and any re-designations of positions, compliance with
policies and procedures, and the calculation of the [BANKING
ORGANIZATION]'s measures for market risk under this subpart F,
including the mapping of risk factors to liquidity horizons, as
applicable. At least annually, the internal audit function must report
its findings to the [BANKING ORGANIZATION]'s board of directors (or a
committee thereof).
(f) Valuation of market risk covered positions. A [BANKING
ORGANIZATION] must have a process for the prudent valuation of its
market risk covered positions that includes policies and procedures on
the valuation of its market risk covered positions, determining the
fair value of its market risk covered positions, independent price
verification, and independent validation of the valuation models and
valuation adjustments or reserves.
(g) Internal assessment of capital adequacy. A [BANKING
ORGANIZATION] must have a rigorous process for assessing its overall
capital adequacy in relation to its market risk. The assessment must
take into account risks that may not be captured fully by the
standardized measure for market risk or in the models-based measure for
market risk, including concentration and liquidity risk under stressed
market conditions.
(h) Due diligence requirements for securitization positions. (1) A
[BANKING ORGANIZATION] must demonstrate to the satisfaction of the
[AGENCY] a comprehensive understanding of the features of a
securitization position that would materially affect the performance of
the position. The [BANKING ORGANIZATION]'s analysis must be
commensurate with the complexity of the securitization position and the
materiality of the position in relation to its regulatory capital under
this part.
(2) A [BANKING ORGANIZATION] must demonstrate its comprehensive
understanding of a securitization position under this paragraph (h),
for each securitization position by:
(i) Conducting an analysis of the risk characteristics of a
securitization position prior to acquiring the exposure and documenting
such analysis promptly after acquiring the exposure, considering:
(A) Structural features of the securitization that would materially
impact the performance of the exposure, which may include the
contractual cash flow waterfall, waterfall-related triggers, credit
enhancements, liquidity enhancements, fair value triggers, the
performance of organizations that service the exposure, and deal-
specific definitions of default;
(B) Relevant information regarding--
(1) The performance of the underlying credit exposure(s) by
exposure amount, which may include the percentage of loans 30, 60, and
90 days past due; default rates; prepayment rates; loans in
foreclosure; property types; occupancy; average credit score or other
measures of creditworthiness; average loan-to-value ratio; and industry
and geographic diversification data on the underlying exposure(s); and
(2) For resecuritization positions, performance information on the
underlying securitization exposures by exposure amount, which may
include the issuer name and credit quality, and the characteristics and
performance of the exposures underlying the securitization exposures,
in addition to the information described in paragraph (h)(2)(i)(B)(1)
of this section; and
(C) Relevant market data of the securitization, which may include
bid-ask spreads, most recent sales price and historical price
volatility, trading volume, implied market rating, and size, depth and
concentration level of the market for the securitization; and
(ii) On an ongoing basis (not less frequently than quarterly),
evaluating and updating as appropriate the analysis required under this
section for each securitization position.
(i) Documentation. (1) A [BANKING ORGANIZATION] must adequately
document all material aspects of its identification, management, and
valuation of market risk covered positions, including internal risk
transfers and any re-designations of its positions, including market
risk covered positions; its control, oversight and review processes;
and its internal assessment of capital adequacy.
(2) A [BANKING ORGANIZATION] must adequately document its trading
desk structure and must document policies describing how each trading
desk satisfies the applicable requirements in this section.
(3) A [BANKING ORGANIZATION] that calculates the models-based
measure for market risk must adequately document all material aspects
of its internal models, including validation and review processes and
results and an explanation of the empirical techniques used to measure
market risk.
(4) A [BANKING ORGANIZATION] that calculates the models-based
measure for market risk must document policies and procedures around
processes related to:
[[Page 64236]]
(i) The risk factor eligibility test, including the description of
the mapping of real price observations to risk factors as described in
Sec. __.214(b)(1) and (b)(3);
(ii) Data alignment of hypothetical profit and loss and risk-
theoretical profit and loss time series used in PLA testing as
described in Sec. __.213(c)(1); and
(iii) The assignment of risk factors to liquidity horizons as
described in Sec. __.215(b)(11) and any empirical correlations
recognized with respect to risk factor classes.
Sec. __.204 Measure for market risk.
(a) General requirements. A [BANKING ORGANIZATION] must calculate
its measure for market risk as the standardized measure for market risk
in accordance with paragraph (b) of this section, unless the [BANKING
ORGANIZATION] has one or more model-eligible trading desks, in which
case the [BANKING ORGANIZATION] must calculate its measure for market
risk as the models-based measure for market risk in accordance with
paragraph (c) of this section. A [BANKING ORGANIZATION] must calculate
the standardized measure for market risk at least weekly and must
calculate the models-based measure for market risk daily.
(b) Standardized Measure for Market Risk. The standardized measure
for market risk equals the sum of the standardized approach capital
requirement as defined in this paragraph (b), the fallback capital
requirement as defined in paragraphs (d)(1) and (2) of this section,
the capital add-ons for re-designations of market risk covered
positions as defined in paragraph (e) of this section, and any
additional capital requirement established by the [AGENCY] pursuant to
Sec. __.201(c). The standardized approach capital requirement equals
the sum of the sensitivities-based capital requirement, the
standardized default risk capital requirement, and the residual risk
add-on as defined under this paragraph (b).
(1) Sensitivities-based capital requirement. A [BANKING
ORGANIZATION]'s sensitivities-based capital requirement equals the
sensitivities-based capital requirement, as calculated in accordance
with Sec. __.206 through Sec. __.209 for market risk covered
positions and for term repo-style transactions that the [BANKING
ORGANIZATION] elects to include in the calculation of its market risk
capital requirement.
(2) Standardized default risk capital requirement. A [BANKING
ORGANIZATION]'s standardized default risk capital requirement equals
the sum of the standardized default risk capital requirements for non-
securitization debt or equity positions, correlation trading positions,
and securitization positions non-CTP, as calculated in accordance with
Sec. __.210 for market risk covered positions and for term repo-style
transactions that the [BANKING ORGANIZATION] elects to include in the
calculation of its market risk capital requirement.
(3) Residual risk add-on. A [BANKING ORGANIZATION]'s residual risk
add-on equals any residual risk add-on that is required under Sec.
__.211(a) and calculated in accordance with Sec. __.211(b) for market
risk covered positions.
(c) Models-based Measure for Market Risk. The models-based measure
for market risk, IMATotal, equals:
IMATotal = min ((IMAG,A + PLA add-on + SAU), SAall desks) + max
((IMAG,A-SAG,A), 0) + fallback capital requirement + capital add-ons
Where,
(1) IMAG,A is calculated for market risk covered positions and term
repo-style transactions the [BANKING ORGANIZATION] elects to include in
market risk on model-eligible trading desks and equals the sum of the
non-default risk capital requirement, CA, as defined in paragraph
(c)(1)(i) of this section, and the default risk capital requirement.
The default risk capital requirement for model-eligible trading desks
is the standardized default risk capital requirement as defined in
paragraph (b)(2) of this section.
(i) The non-default risk capital requirement. A [BANKING
ORGANIZATION]'s non-default risk capital requirement, CA, is calculated
as follows:
CA = max ((IMCCt-1 + SESt-1), ((mc x IMCCaverage)
+ SESaverage))
where,
(A) IMCC is the internally modelled capital calculation, which is
the aggregate capital measure for modellable risk factors based on the
weighted average of the constrained and unconstrained ES-based measures
and calculated in accordance with Sec. __.215(c) for the most recent
outcome, denoted as t-1, and for the average of the previous 60
business days, denoted as average;
(B) SES is the stressed expected shortfall, which is the aggregate
capital measure for non-modellable risk factors that is required under
Sec. __.214(b) and calculated in accordance with Sec. __.215(d) for
the most recent outcome, denoted as t-1, and for the average of the
previous 60 business days, denoted as average; and
(C) The capital multiplier, mC, equals 1.5 unless otherwise
specified in paragraph (g) of this section.
(ii) [Reserved]
(2) PLA add-on equals any PLA add-on that is required under Sec.
__.212(b)(2)(ii)(D), Sec. __.212(b)(4), or Sec. __.213(c)(3)(iii) and
is calculated in accordance with Sec. __.213(c)(4);
(3) SAU equals the standardized approach capital requirement as
defined in paragraph (b) of this section for market risk covered
positions and term repo-style transactions the [BANKING ORGANIZATION]
elects to include in market risk on model-ineligible trading desks,
unless otherwise required under Sec. __.213(b)(3) and Sec.
__.213(c)(3)(iv).
(4) SAall desks equals the standardized approach capital
requirement as defined in paragraph (b) of this section for market risk
covered positions and term repo-style transactions the [BANKING
ORGANIZATION] elects to include in market risk on all trading desks;
(5) SAG,A equals the standardized approach capital requirement as
defined in paragraph (b) of this section for market risk covered
positions and term repo-style transactions the [BANKING ORGANIZATION]
elects to include in market risk on model-eligible trading desks;
(6) Fallback capital requirement equals any fallback capital
requirement as defined in paragraph (d) of this section; and
(7) Capital add-ons equal any capital add-ons for re-designations
as defined in paragraph (e) of this section, any capital add-on for
ineligible positions on model-eligible trading desks as defined in
paragraph (f) of this section, and any additional capital requirement
established by the [AGENCY] pursuant to Sec. __.201(c).
(d) Fallback capital requirement--(1) Calculation of the fallback
capital requirement. Unless the [BANKING ORGANIZATION] receives prior
written approval of the [AGENCY] to use alternative techniques that
appropriately measure the market risk associated with those market risk
covered positions, a [BANKING ORGANIZATION]'s fallback capital
requirement equals the sum of:
(i) The standardized approach capital requirement for any market
risk covered positions described by paragraph (d)(3)(ii)(A) for which
the [BANKING ORGANIZATION] is able to calculate all parts of the
standardized approach capital requirement; and
[[Page 64237]]
(ii) The sum of the absolute value of the fair values of all other
market risk covered positions that must be included in the fallback
capital requirement in accordance with paragraphs (d)(2)(ii) and
(d)(3)(ii) of this section, respectively.
(2) Standardized measure for market risk--(i) Market risk covered
positions excluded from certain calculations. Notwithstanding paragraph
(b) of this section, for a [BANKING ORGANIZATION] that calculates the
standardized measure for market risk, if for any reason, a [BANKING
ORGANIZATION] is unable to calculate the sensitivities-based capital
requirement or the standardized default risk capital requirement for a
market risk covered position, that position must be excluded from the
calculation of the standardized approach capital requirement.
(ii) Market risk covered positions included in the fallback capital
requirement. A [BANKING ORGANIZATION] that calculates the standardized
measure for market risk must include all market risk covered positions
excluded from the calculation of the standardized approach capital
requirement under paragraph (d)(2)(i) of this section in the
calculation of the fallback capital requirement.
(3) Models-based measure for market risk--(i) Market risk covered
positions excluded from certain calculations. Unless the [BANKING
ORGANIZATION] receives prior written approval from the [AGENCY], for a
[BANKING ORGANIZATION] that calculates the models-based measure for
market risk:
(A) Notwithstanding paragraph (c) of this section, in cases where,
for any reason, a [BANKING ORGANIZATION] is unable to calculate any
portion of IMAG,A, SAU, SAall desks, SAG,A, or SAi as part of the
calculation of the PLA add-on for a market risk covered position, that
market risk covered position must be excluded from the calculation of
IMAG,A, SAU, SAall desks, SAG,A, or SAi, respectively; and
(B) Notwithstanding paragraph (f) of this section, for a [BANKING
ORGANIZATION] that has any securitization positions or correlation
trading positions or equity positions in an investment fund, where a
[BANKING ORGANIZATION] is not able to identify the underlying positions
held by an investment fund on a quarterly basis, on model-eligible
trading desks, in cases where, for any reason, a [BANKING ORGANIZATION]
is unable to calculate any portion of the standardized approach capital
requirement for such position, that market risk covered position must
be excluded from the calculation of the capital add-on for ineligible
positions on model-eligible trading desks.
(ii) Market risk covered positions included in the fallback capital
requirement. A [BANKING ORGANIZATION] that calculates the models-based
measure for market risk must include the following market risk covered
positions in the calculation of the fallback capital requirement:
(A) All market risk covered positions on model-eligible trading
desks excluded from the calculation of IMAG,A under paragraph
(d)(3)(i)(A) of this section;
(B) All market risk covered positions on model-ineligible trading
desks excluded from the calculation of SAU under paragraph (d)(3)(i)(A)
of this section; and
(C) All securitization positions and correlation trading positions
excluded from the calculation of the capital add-on for securitization
and correlation trading positions on model-eligible trading desks under
paragraph (d)(3)(i)(B) of this section.
(e) Capital add-ons for re-designations. (1) After the initial
designation of an exposure to be capitalized under subpart D or subpart
E of this part or a position to be capitalized as a market risk covered
position under this subpart F, a [BANKING ORGANIZATION] may make a re-
designation if:
(i) The [BANKING ORGANIZATION] receives prior approval of senior
management and documents the re-designation; and
(ii) The [BANKING ORGANIZATION] sends notification within 30 days
of any material re-designation to the [AGENCY].
(2) For each re-designation, a [BANKING ORGANIZATION] must
calculate its capital add-on for re-designation following the approach
below:
(i) For the calculation of Expanded Total Risk-Weighted Assets, the
capital add-on for re-designation is the higher of zero and the total
capital requirement under subpart E of this part and under this subpart
before the re-designation minus the total capital requirement under
subpart E of this part and under this subpart after the re-designation.
(ii) For the calculation of Standardized Total Risk-Weighted
Assets, the capital add-on for re-designation is the higher of zero and
the total capital requirement under subpart D of this part and under
this subpart F before the re-designation minus the total capital
requirement under subpart D of this part and under this subpart after
the re-designation.
(iii) The capital add-on for re-designation must initially be
calculated at the time of the re-designation.
(iv) The capital add-on for re-designation is permitted to run off
as the exposure or position matures or expires.
(v) Notwithstanding paragraphs (e)(2)(i) through (iv) of this
section, with prior written approval from the [AGENCY], no capital add-
on for re-designation is required if the re-designation is due to
circumstances that are outside of the [BANKING ORGANIZATION]'s control,
including any re-designation required for accounting purposes or a
change in the characteristics of the exposure or position that would
change its qualification as a market risk covered position.
(3) Any re-designation is irrevocable unless the [BANKING
ORGANIZATION] receives written approval of the [AGENCY].
(f) Capital add-on for ineligible positions on model-eligible
trading desks. A [BANKING ORGANIZATION] must calculate its capital add-
on for ineligible positions on model-eligible trading desks for (1)
securitization positions or correlation trading positions on model-
eligible trading desks or (2) equity positions in an investment fund on
model-eligible trading desks, where a [BANKING ORGANIZATION] is not
able to identify the underlying positions held by an investment fund on
a quarterly basis, provided such positions are not included in
paragraph (d) of this section. The capital add-on for ineligible
positions on model-eligible trading desks is equal to the standardized
approach capital requirement as defined in paragraph (b) of this
section for such positions.
(g) Aggregate trading portfolio backtesting and capital multiplier.
(1) Beginning on the business day a [BANKING ORGANIZATION] begins
calculating the models-based measure for market risk, the [BANKING
ORGANIZATION] must generate backtesting data by separately comparing
each business day's aggregate actual profit and loss for transactions
on model-eligible trading desks and aggregate hypothetical profit and
loss for transactions on model-eligible trading desks with the
corresponding aggregate VaR-based measures for that business day
calibrated to a one-day holding period and at a one-tail, 99.0th
percent confidence level for market risk covered positions on all
model-eligible trading desks.
[[Page 64238]]
(i) An exception for actual profit and loss occurs when the
aggregate actual loss exceeds the corresponding aggregate VaR-based
measure. An exception for hypothetical profit and loss occurs when the
aggregate hypothetical loss exceeds the corresponding VaR-based
measure.
(ii) If either the business day's actual or hypothetical profit and
loss is not available or impossible to compute for a particular day, an
exception for actual profit and loss or for hypothetical profit and
loss, respectively, occurs. If the VaR-based measure for a business day
is not available or impossible to compute for a particular day,
exceptions for actual profit and loss and for hypothetical profit and
loss occur. No exception occurs if the unavailability or impossibility
is related to an official holiday.
(iii) With approval of the [AGENCY], a [BANKING ORGANIZATION] may
consider an exception not to have occurred if:
(A) The [BANKING ORGANIZATION] can demonstrate that the exception
is due to technical issues that are unrelated to the [BANKING
ORGANIZATION]'s internal models; or
(B) The [BANKING ORGANIZATION] can demonstrate that one or more
non-modellable risk factors caused the relevant loss, and the properly
scaled capital requirement for these non-modellable risk factors
exceeds the difference between the [BANKING ORGANIZATION]'s VaR-based
measure and the actual or hypothetical loss for that business day.
(2) A [BANKING ORGANIZATION] must specify the scope of its model-
eligible trading desks for the purposes of this paragraph (g) by
determining which trading desks are model-eligible trading desks, and
taking into consideration any changes to the model eligibility status
of trading desks as soon as practicable. A [BANKING ORGANIZATION] must
use this scope of model-eligible trading desks for the purposes of this
paragraph (g) unless the [AGENCY] notifies the [BANKING ORGANIZATION]
in writing that a different scope of model-eligible trading desks must
be used.
(3) A [BANKING ORGANIZATION] that calculates the models-based
measure for market risk must conduct aggregate trading portfolio
backtesting on a quarterly basis. In order to conduct aggregate trading
portfolio backtesting, a [BANKING ORGANIZATION] must count the number
of exceptions that have occurred over the most recent 250 business
days, provided that in the first year that the [BANKING ORGANIZATION]
begins backtesting, the [BANKING ORGANIZATION] must count the number of
exceptions that have occurred since the date that the [BANKING
ORGANIZATION] began backtesting. A [BANKING ORGANIZATION] must count
exceptions for aggregate actual profit and loss separately from
exceptions for aggregate hypothetical profit and loss. The overall
number of exceptions is the greater of the number of exceptions for
aggregate actual profit and loss and the number of exceptions for
aggregate hypothetical profit and loss.
(4) A [BANKING ORGANIZATION] must use the multiplication factor in
Table 1 of this section that corresponds to the overall number of
exceptions identified in paragraph (g)(3) of this section to determine
the multiplication factor for the non-default risk capital requirement
under paragraph (c)(1)(i)(C) of this section until the [BANKING
ORGANIZATION] conducts aggregate trading portfolio backtesting for the
next quarter, unless the [AGENCY] notifies the [BANKING ORGANIZATION]
in writing that a different adjustment or other action is appropriate.
[GRAPHIC] [TIFF OMITTED] TP18SE23.104
Sec. __.205 The treatment of certain market risk covered positions
and term repo-style transactions the [BANKING ORGANIZATION] elects to
include in market risk: net short risk positions; securitization
positions and defaulted and distressed positions; hybrid instruments;
index instruments and multi-underlying options; and equity positions in
an investment fund.
(a) Net short risk positions. A [BANKING ORGANIZATION] must
calculate its net short risk positions on a quarterly basis.
(b) Treatment of securitization positions and defaulted and
distressed market risk covered positions. (1) A [BANKING ORGANIZATION]
may cap the market risk capital requirement of securitization positions
and defaulted or distressed market risk covered positions at the
maximum loss of the market risk covered position.
(2) For purposes of calculating the standardized default risk
capital requirement, a [BANKING ORGANIZATION] must include defaulted
market risk covered positions. A [BANKING ORGANIZATION] does not need
to include defaulted market risk covered positions in the
sensitivities-based capital requirement, the residual risk add-on, or
the non-default risk capital requirement.
[[Page 64239]]
(c) Treatment of hybrid instruments in the standardized approach
capital requirement. For purposes of calculating the standardized
approach capital requirement, a [BANKING ORGANIZATION] must assign risk
sensitivities of hybrid instruments into the applicable risk classes
such as interest rate, credit spread, and equity risk for calculating
the delta, vega, and curvature capital requirements. For the
standardized default risk capital requirement, a [BANKING ORGANIZATION]
must decompose a hybrid instrument into a non-securitization position
and an equity position and calculate the standardized default risk
capital requirement for each position respectively.
(d) Treatment of index instruments and multi-underlying options in
the standardized approach capital requirement. (1) For purposes of
calculating the delta capital requirement under Sec. __.206(b) and the
curvature capital requirement under Sec. __.206(d):
(i) A [BANKING ORGANIZATION] must apply the look-through approach
for any market risk covered position that is an index instrument or a
multi-underlying option. Where the look-through approach is adopted:
(A) The curvature scenarios and delta sensitivities to constituent
risk factors from those index instruments and multi-underlying options
are allowed to net with the curvature scenarios and delta sensitivities
of single-name positions without restriction; and
(B) A [BANKING ORGANIZATION] must apply the look-through approach
consistently through time and must use the approach consistently for
all market risk covered positions that reference the same index.
(ii) Notwithstanding paragraph (d)(1)(i) of this section, for
market risk covered positions of listed and well-diversified indices, a
[BANKING ORGANIZATION] may choose not to apply the look-through
approach, in which case a single sensitivity shall be calculated to the
index and assigned to the relevant sector or index bucket as provided
in Sec. __.209 and in accordance with the below:
(A) Where at least 75 percent of the notional value of the
underlying constituents relate to the same sector (sector specific),
taking into account the weightings of such index, the sensitivity must
be assigned to the corresponding sector bucket, otherwise the
sensitivity must be mapped to an index bucket;
(B) For listed and well-diversified equity indices that are not
sector specific, where at least 75 percent of the market value of the
constituents in the index, taking into account the weightings of such
index, are both large market cap and liquid market economy, the
sensitivity must be assigned to bucket 12, otherwise the sensitivity
must be assigned to bucket 13 in Table 8 to Sec. __.209;
(C) For listed and well-diversified credit indices that are not
sector specific, where at least 75 percent of the notional value of the
constituents in the index, taking into account the weightings of such
index, are investment grade, the sensitivity must be assigned to bucket
18, otherwise the sensitivity must be assigned to bucket 19 in Table 3
to Sec. __.209; and
(D) Where an index spans multiple risk classes, a [BANKING
ORGANIZATION] must allocate the index proportionately to the relevant
risk classes following the methodology in paragraphs (d)(1)(ii)(A)
through (C) of this section.
(2) For purposes of calculating the vega capital requirement under
Sec. __.206(c):
(i) A [BANKING ORGANIZATION] may, for a multi-underlying option
(including an index option), calculate the vega capital requirement
based either on the implied volatility of the option or the implied
volatility of options on the underlying constituents; and
(ii) For indices, a [BANKING ORGANIZATION] must calculate the vega
capital requirement with respect to the implied volatility of the
multi-underlying options based on the same sector specific bucket or
index bucket used to calculate the delta capital requirement and the
curvature capital requirement in paragraph (d)(1)(ii) of this section.
(3) For purposes of calculating the standardized default risk
capital requirement under Sec. __.204(b)(2), a [BANKING ORGANIZATION]
may apply the look-through approach for multi-underlying options that
are non-securitization debt or equity positions.
(e) Treatment of equity positions in an investment fund in the
standardized approach capital requirement. (1) For an equity position
in an investment fund that is a market risk covered position, and for
which a [BANKING ORGANIZATION] is able to use the look-through approach
to calculate a market risk capital requirement for its proportional
ownership share of each exposure held by the investment fund, the
[BANKING ORGANIZATION] must apply the look-through approach for the
purposes of calculating the standardized measure for market risk for
any equity position in an investment fund, and treat the underlying
positions of the fund as if such positions were held directly by the
[BANKING ORGANIZATION].
(2) Notwithstanding paragraph (e)(1) of this section, for an equity
position in an investment fund that is a market risk covered position,
a [BANKING ORGANIZATION] may calculate the standardized measure for
market risk by applying the treatment in paragraphs (d)(1)(ii),
(d)(2)(ii), and (d)(3) of this section to:
(i) An index that is listed and well-diversified held by an
investment fund, in which the [BANKING ORGANIZATION] holds an equity
position; and
(ii) An investment fund, in which the [BANKING ORGANIZATION] holds
an equity position, that closely tracks an index benchmark, provided
that the [BANKING ORGANIZATION] must treat the investment fund as if it
were the tracked index.
(3) For any equity position in an investment fund that is a market
risk covered position, but for which the [BANKING ORGANIZATION] is not
able to use the look-through approach to calculate a market risk
capital requirement for its proportional ownership share of each
exposure held by the investment fund, the [BANKING ORGANIZATION] must
calculate the standardized measure for market risk for equity position
in the investment fund using one of the following methods in this
paragraph (e)(3). If multiple methods could apply, the [BANKING
ORGANIZATION] may choose from the applicable methods:
(i) Tracked index method. If the investment fund closely tracks an
index benchmark, the [BANKING ORGANIZATION] may treat the investment
fund as the tracked index and calculate the standardized measure for
market risk by applying the treatment in paragraphs (d)(1)(ii),
(d)(2)(ii), and (d)(3) of this section;
(ii) Hypothetical portfolio approach. The [BANKING ORGANIZATION]
may treat the investment fund as a hypothetical portfolio, provided
that:
(A) Market risk capital requirements for the decomposed positions
in the hypothetical portfolio are calculated on a stand-alone basis,
separate from other market risk covered positions;
(B) Weighting the constituents of the investment fund based on the
hypothetical portfolio; and
(C) The hypothetical portfolio is determined using one of the
following approaches, at the [BANKING ORGANIZATION]'s discretion:
(1) A hypothetical portfolio invested to the maximum extent
permitted under the fund's investment limits in the exposure type(s)
with the highest
[[Page 64240]]
applicable risk weight. If more than one risk weight can be applied to
a given exposure under the sensitivities-based capital requirement, the
maximum risk weight applicable must be used; or
(2) A hypothetical portfolio based on the most recent quarterly
disclosure of the investment fund's historical holdings of underlying
positions.
(iii) Fall back method. A [BANKING ORGANIZATION] may allocate its
equity positions in an investment fund to the other sector bucket 11 in
Table 8 to Sec. __.209.
(A) In applying this treatment, a [BANKING ORGANIZATION] must
determine whether, given the mandate of the investment fund, the risk
weight under the standardized default risk capital requirement is
sufficiently prudent and whether the residual risk add-on should apply.
In the case where the [BANKING ORGANIZATION] determines that the
residual risk add-on applies, a [BANKING ORGANIZATION] must assume that
the investment fund contains exposure types as described in Sec.
__.211(a) to the maximum extent permitted under the investment fund's
mandate for purposes of calculating the residual risk add-on.
(B) In applying this treatment, a [BANKING ORGANIZATION] must
calculate the standardized default risk capital requirement under Sec.
__.204(b)(2) for non-securitization debt or equity positions held by an
investment fund based on a hypothetical portfolio, assuming the
investment fund is invested to the maximum extent permitted under the
fund's investment limits in the exposure type(s) with the highest
applicable risk weight(s), in the same manner as described in paragraph
(e)(3)(ii)(C)(1) of this section.
(f) Treatment of equity positions in an investment fund in the
models-based measure for market risk. (1) For equity positions in an
investment fund, where a [BANKING ORGANIZATION] is able to identify the
underlying positions held by an investment fund on a quarterly basis,
the [BANKING ORGANIZATION] must calculate IMAG,A, using one of the
following approaches:
(i) The look-through approach for that position or based on the
hypothetical portfolio of the investment fund, consistent with
paragraph (e)(3)(ii)(C)(2) of this section; or
(ii) After receiving prior approval of the [AGENCY], an alternative
modelling approach.
(2) For equity positions in an investment fund, where a [BANKING
ORGANIZATION] is not able to identify the underlying positions held by
an investment fund on a quarterly basis, the [BANKING ORGANIZATION]
must not include such equity positions in the calculation of IMAG,A.
(g) Term repo-style transactions the [BANKING ORGANIZATION] elects
to include in market risk. (1) A [BANKING ORGANIZATION] may elect to
include a term repo-style transaction in market risk provided that:
(i) The transaction is marked to market;
(ii) The [BANKING ORGANIZATION] captures the market price risk and
the issuer-default risk of the transaction by:
(A) Including the risk factor sensitivity to each applicable risk
factor pursuant to Sec. __.208; and
(B) Calculating the standardized default risk capital requirement
under Sec. __.210 using:
(1) For the calculation of Expanded Total Risk-Weighted Assets, the
collateral haircut approach that would apply to the transaction under
Sec. __.121(c) multiplied by 8 percent; or
(2) For the calculation of Standardized Total Risk-Weighted Assets,
the collateral haircut approach that would apply to the transaction
under Sec. __.37(c) multiplied by 8 percent.
(iii) The [BANKING ORGANIZATION] elects to include all of its term
repo-style transactions in market risk and does so consistently over
time; and
(iv) The [BANKING ORGANIZATION] recognizes:
(A) For the calculation of Expanded Total Risk-Weighted Assets, the
credit risk mitigation benefits of collateral pursuant to Sec.
__.121(c); or
(B) For the calculation of Standardized Total Risk-Weighted Assets,
the credit risk mitigation benefits of collateral pursuant to Sec.
__.37(c).
(2) Term repo-style transactions the [BANKING ORGANIZATION] elects
to include in market risk must be treated as market risk covered
positions for the purposes of calculations under this part.
(h) Internal risk transfers. (1) A [BANKING ORGANIZATION] that is
subject to the market risk capital requirements in this subpart F may
recognize the risk mitigation benefits of an external hedge under
subpart D or subpart E of this part if the internal risk transfer meets
the applicable criteria in this paragraph (h).
(i) Credit risk. A [BANKING ORGANIZATION] may capitalize under
subpart D or subpart E of this part the leg of an eligible internal
risk transfer to hedge credit risk transferred by the trading desk to
another unit within the [BANKING ORGANIZATION].
(A) For credit risk, an eligible internal risk transfer means an
internal risk transfer for which:
(1) The documentation of the internal risk transfer identifies the
exposure under subpart D or subpart E of this part that is being hedged
and its source(s) of credit risk;
(2) The terms of the internal risk transfer, aside from amount, are
identical to the terms of the external hedge of credit risk; and
(3) The external hedge meets the requirements of Sec. __.36 or
Sec. __.120, as applicable.
(B) If the amount of the internal risk transfer exceeds the
exposure being hedged under subpart D or subpart E of this part, the
[BANKING ORGANIZATION] must treat the amount equal to the exposure
being hedged under subpart D or subpart E of this part as an eligible
internal risk transfer, and the excess amount as a separate internal
risk transfer that is not an eligible internal risk transfer, which
must be capitalized as a net short credit position.
(ii) Interest rate risk. A [BANKING ORGANIZATION] may capitalize
the trading desk segment of an eligible internal risk transfer as a
market risk covered position.
(A) For interest rate risk, an eligible internal risk transfer
means an internal risk transfer:
(1) For which the documentation of the internal risk transfer
identifies the exposure being hedged and its source(s) of interest rate
risk;
(2) That is capitalized on the trading desk on a stand-alone basis,
without regard to other market risks generated by activities in the
trading unit; and
(3) Is executed on a trading desk that the [BANKING ORGANIZATION]
has established for conducting internal risk transfers to hedge
interest rate risk and that has received approval from the [AGENCY] to
execute such internal risk transfers to hedge interest rate risk.
(B) The [BANKING ORGANIZATION] may request approval from the
[AGENCY] for a single dedicated notional trading desk to conduct
internal risk transfers to hedge interest rate risk.
(2) CVA Risk. A [BANKING ORGANIZATION] that is subject to the
market risk capital requirements and CVA risk-based capital
requirements in this subpart F may hedge CVA risk arising from a
derivative contract through internal CVA hedges executed with the
[BANKING ORGANIZATION]'s trading desk, using an eligible internal risk
transfer.
(i) The [BANKING ORGANIZATION] may consider the internal risk
transfer
[[Page 64241]]
of CVA risk to be an eligible internal risk transfer, if the following
requirements are satisfied:
(A) The CVA segment of the transaction is an eligible CVA hedge;
(B) The documentation of the internal risk transfer of CVA risk
identifies the CVA risk being hedged and the source(s) of such risk.
(C) If the internal risk transfer of CVA risk is subject to
curvature risk, default risk, or the residual risk add-on under the
market risk capital requirement, then the trading desk must execute an
external transaction with a third-party provider, identical in its
terms to the internal risk transfer of CVA risk.
(ii) The [BANKING ORGANIZATION] must designate a CVA desk or the
functional equivalent to manage internal risk transfers of CVA risk to
the [BANKING ORGANIZATION]'s trading desks.
Sec. __.206 Sensitivities-based capital requirement.
(a) Overview of the calculation. A [BANKING ORGANIZATION] must
follow the steps below to calculate the sensitivities-based capital
requirement:
(1) The [BANKING ORGANIZATION] must identify the market risks in
each of its portfolios of market risk covered positions and include the
relevant risk classes in its calculation of the sensitivities-based
capital requirement. The risk classes are:
(i) Interest rate risk;
(ii) Credit spread risk for non-securitization positions;
(iii) Credit spread risk for correlation trading positions;
(iv) Credit spread risk for securitization positions non-CTP;
(v) Equity risk;
(vi) Commodity risk; and
(vii) Foreign exchange risk.
(2) For each market risk covered position, a [BANKING ORGANIZATION]
must identify all of the relevant risk factors as described in Sec.
__.208 for which it will calculate sensitivities for delta risk and
vega risk as described in Sec. __.207 and curvature scenarios for
curvature risk as described in both paragraph (d) of this section and
in Sec. __.207. A [BANKING ORGANIZATION] must also identify the
corresponding buckets related to these risk factors as described in
Sec. __.209.
(3) To calculate risk-weighted sensitivities a [BANKING
ORGANIZATION] must aggregate the delta sensitivities and vega
sensitivities, respectively, for each risk factor across all market
risk covered positions and apply the corresponding risk weights as
described in Sec. __.209(b) and (c). To calculate the net curvature
risk position, a [BANKING ORGANIZATION] must aggregate the incremental
loss beyond the delta capital requirement by applying an upward and
downward shock to each risk factor in accordance with paragraph (d)(1)
of this section.
(4) For each bucket, a [BANKING ORGANIZATION] must calculate a
bucket-level risk position separately for delta risk and vega risk by
aggregating the risk-weighted sensitivities across risk factors with
common characteristics as described in paragraphs (b)(2) and (c)(2) of
this section. Similarly, for curvature risk, a [BANKING ORGANIZATION]
must calculate a bucket-level risk position for each bucket by
aggregating the net curvature risk positions within each bucket as
described in paragraph (d)(2) of this section.
(5) To calculate the risk class-level capital requirement a
[BANKING ORGANIZATION] must aggregate the bucket-level risk positions
for each risk class for delta risk, vega risk, and curvature risk
(separately) under three correlation scenarios in accordance with
paragraphs (b)(3), (c)(3), and (d)(3) of this section. For each risk
class, the risk class-level capital requirement is the sum of the delta
capital requirement, the vega capital requirement and the curvature
capital requirement for the respective correlation scenario.
(i) The delta capital requirement is described in paragraph (b) of
this section.
(ii) The vega capital requirement is described in paragraph (c) of
this section.
(iii) The curvature capital requirement is described in paragraph
(d) of this section.
(iv) The correlation scenarios are provided in paragraph (e) of
this section and Sec. __.209.
(6) To calculate the sensitivities-based capital requirement, a
[BANKING ORGANIZATION] must sum the risk class-level capital
requirements for each risk class under each correlation scenario. The
sensitivities-based capital requirement equals the largest capital
requirement produced under the three correlation scenarios.
(b) Delta capital requirement. For each risk class, a [BANKING
ORGANIZATION] must calculate the delta capital requirement for all of
its market risk covered positions, except for market risk covered
positions whose value at any point in time exclusively depends on an
exotic exposure. To calculate the delta capital requirement, for each
risk class, a [BANKING ORGANIZATION] must calculate its market risk
covered positions' delta sensitivities in accordance with Sec. __.207
to the relevant risk factors specified in Sec. __.208, multiply the
sensitivities by the corresponding risk weights specified in Sec.
__.209(b), and aggregate the resulting risk-weighted delta
sensitivities in accordance with the following:
(1) Weighted sensitivity calculation. For each risk factor, a
[BANKING ORGANIZATION] must calculate the delta sensitivity as
described in Sec. __.207. A [BANKING ORGANIZATION] must net the delta
sensitivities of a risk factor k, irrespective of the market risk
covered positions from which they derive, to produce a net delta
sensitivity, sk, across all market risk covered positions. The risk-
weighted delta sensitivity, WSk, equals the product of the net
sensitivity, sk, and the corresponding risk weight specified in Sec.
__.209(b).
(2) Within bucket aggregation. Unless otherwise specified in Sec.
__.209(b), for each bucket, b, specified Sec. __.209(b), a [BANKING
ORGANIZATION] must calculate the delta bucket-level risk position, Kb,
by aggregating the risk-weighted delta sensitivities of all risk
factors that are within the same bucket, using the correlation
parameter [rho]kl as specified in Sec. __.206(e) and Sec. __.209(b),
as follows:
[GRAPHIC] [TIFF OMITTED] TP18SE23.105
[[Page 64242]]
(3) Across bucket aggregation. A [BANKING ORGANIZATION] must
calculate the delta capital requirement for each risk class by
aggregating the delta bucket-level risk positions across all of the
buckets within the risk class, using the cross-bucket correlation
parameter [gamma]bc as specified in Sec. __.206(e) and Sec.
__.209(b), as follows:
[GRAPHIC] [TIFF OMITTED] TP18SE23.106
Where,
(i) Sb = [Sigma]kWSk for all risk factors in bucket b and Sc =
[Sigma]kWSk for all risk factors in bucket c; and
(ii) If Sb and Sc produce a negative number for the overall sum of
[Sigma]b(Kb\2\) + [Sigma]b([Sigma]c[ne]b
[gamma]bcSbSc), the [BANKING ORGANIZATION] must calculate the delta
capital requirement using an alternative specification, whereby:
(A) Sb = max(min([Sigma]kWSk, Kb), -Kb) for all risk factors in
bucket b; and
(B) Sc = max(min([Sigma]kWSk, Kc), -Kc) for all risk factors in
bucket c.
(c) Vega capital requirement. For each risk class, a [BANKING
ORGANIZATION] must calculate the vega capital requirement for market
risk covered positions that are options or are positions with embedded
optionality, including positions with material prepayment risk.
Callable and puttable bonds that are priced based on yield to maturity
are not required to estimate vega capital requirement. To calculate the
vega capital requirement, for each risk class, a [BANKING ORGANIZATION]
must calculate its market risk covered positions' vega sensitivities in
accordance with Sec. __.207 to the relevant risk factors specified in
Sec. __.208, multiply the sensitivities by the corresponding risk
weights specified in Sec. __.209(c), and aggregate the resulting risk-
weighted sensitivities for vega risk in accordance with the following:
(1) Weighted sensitivity calculation. For each risk factor, a
[BANKING ORGANIZATION] must calculate the vega sensitivity as described
in Sec. __.207(c). A [BANKING ORGANIZATION] must net the vega
sensitivities of a risk factor k, irrespective of the market risk
covered positions from which they derive, to produce a net vega
sensitivity, sk, across all market risk covered positions. The risk-
weighted vega sensitivity, WSk, equals the product of the net
sensitivity, sk, and the corresponding risk weight specified in Sec.
__.209(c).
(2) Within bucket aggregation. Unless otherwise specified in Sec.
__.209(c), for each bucket, b, specified in Sec. __.209(c), a [BANKING
ORGANIZATION] must calculate the vega bucket-level risk position, Kb,
by aggregating the risk-weighted vega sensitivities of all risk factors
that are within the same bucket, using the correlation parameter,
[rho]kl, as specified in Sec. __.206(e) and Sec. __.209(c), as
follows:
[GRAPHIC] [TIFF OMITTED] TP18SE23.107
(3) Across bucket aggregation. A [BANKING ORGANIZATION] must
calculate the vega capital requirement for each risk class by
aggregating the vega bucket-level risk positions across all of the
buckets within the risk class, using the cross-bucket correlation
parameter, [gamma]bc, specified in Sec. __.206(e) and Sec. __.209(c),
as follows:
[GRAPHIC] [TIFF OMITTED] TP18SE23.108
Where,
(i) Sb = [Sigma]kWSk for all risk factors in bucket b and Sc =
[Sigma]k WSk for all risk factors in bucket c;
and
(ii) If Sb and Sc produce a negative number
for the overall sum of [Sigma]b(Kb\2\) + [Sigma]b([Sigma]c[ne]b
[gamma]bcSbSc), the [BANKING ORGANIZATION] must calculate the vega
capital requirement using an alternative specification, whereby:
(A) Sb = max(min([Sigma]kWSk, Kb), -Kb) for all risk factors in
bucket b; and
(B) Sc = max(min([Sigma]kWSk, Kc), -Kc) for all risk factors in
bucket c.
(d) Curvature capital requirement. For each risk class, a [BANKING
ORGANIZATION] must calculate the curvature capital requirement by
applying an upward shock and a downward shock to each risk factor and
calculate the incremental loss in excess of that already captured by
the delta capital requirement for all market risk covered positions
that are options or positions with embedded optionality, including
positions with material prepayment risk, using the approach in
paragraph (d)(1) of this section and in accordance with Sec. __.207
and Sec. __.209(d). A [BANKING ORGANIZATION] may, on a trading desk by
trading desk basis, choose to include market risk covered positions
without optionality in the calculation of its curvature capital
requirement, provided that the [BANKING ORGANIZATION] does so
consistently through time.
(1) Curvature risk position calculation. For each market risk
covered position for which the curvature capital requirement is
calculated, an upward shock and a downward shock must be applied to
risk factor, k. The size of the shock, i.e., the risk weight, is
specified in Sec. __.209(d). The net curvature risk
[[Page 64243]]
position for the portfolio is calculated as,
[GRAPHIC] [TIFF OMITTED] TP18SE23.109
where,
(i) i is a market risk covered position subject to curvature risk
for risk factor k;
(ii) xk is the current level of risk factor k;
(iii) Vi(xk) is the value of market risk covered position i at the
current level of risk factor k;
(iv) Vi(xk(RW(curvature)+)) and
Vi(xk(RW(curvature)-)) denote the
value of market risk covered position i after xk is shifted (i.e.,
``shocked'') upward and downward, respectively;
(v) RWk(curvature) is the risk weight for
curvature risk for factor k and market risk covered position i; and
(vi) sik is the delta sensitivity of market risk covered position i
with respect to curvature risk factor k, such that:
(A) For the following risk classes, sik is the delta sensitivity of
market risk covered position i:
(1) Foreign exchange risk; and
(2) Equity risk;
(B) For the following risk classes, sik is the sum of the delta
sensitivities to all tenors of the relevant curve of market risk
covered position i with respect to curvature risk factor k:
(1) Interest rate risk;
(2) Credit spread risk for non-securitization positions;
(3) Credit spread risk for correlation trading positions;
(4) Credit spread risk for securitization positions non-CTP; and
(5) Commodity risk; and
(C) The delta sensitivity sik must be the delta sensitivity
described in Sec. __.207 used in calculating the delta capital
requirement.
(2) Within bucket aggregation. Unless otherwise specified in Sec.
__.209(d), for each bucket specified in Sec. __.209(d), a [BANKING
ORGANIZATION] must calculate a curvature bucket-level risk position by
aggregating the net curvature risk positions within the bucket using
the correlation parameter, [rho]kl, as specified in Sec. Sec.
__.206(e) and __.209(d) as follows:
[GRAPHIC] [TIFF OMITTED] TP18SE23.110
and
(i) The bucket-level capital requirement, Kb, is calculated as the
greater of the capital requirement under the upward scenario, Kb\+\, or
the capital requirement under the downward scenario, Kb-;
(ii) In the specific case where Kb\+\ = Kb-, if
[Sigma]k(CVRk\+\) > [Sigma]k(CVRk-) the upward scenario is
selected, otherwise the downward scenario is selected; and
(iii) [psi](CVRk, CVRl) = 0 if CVRk and CVRl both have negative
signs; and [psi](CVRk, CVRl) = 1 otherwise.
(3) Across bucket aggregation. A [BANKING ORGANIZATION] must
calculate the curvature capital requirement for each risk class by
aggregating the curvature bucket-level risk positions across buckets
within each risk class, using the prescribed cross-bucket correlation
parameter, [gamma]bc, as specified in Sec. Sec. __.206(e) and
__.209(d), as follows:
[GRAPHIC] [TIFF OMITTED] TP18SE23.111
[[Page 64244]]
where,
(i) Sb = [Sigma]k(CVRk\+\) for all risk factors in bucket b when
the upward scenario has been selected for bucket b, and Sb =
[Sigma]k(CVRk-) otherwise; and
(ii) [psi](Sb, Sc) = 0 if Sb and Sc both have negative signs, and
[psi](Sb, Sc) = 1 otherwise.
(e) Correlation scenarios. A [BANKING ORGANIZATION] must repeat the
aggregation of the bucket-level risk positions and risk class-level
capital requirements for delta risk, vega risk, and curvature risk for
three different values of the correlation parameters [rho]kl
(correlation between risk factors within a bucket) and [gamma]bc
(correlation across buckets within a risk class) as specified below:
(1) For the medium correlation scenario, the correlation parameters
[rho]kl and [gamma]bc specified in Sec. __.209 apply;
(2) For the high correlation scenario, the specified correlation
parameters [rho]kl and [gamma]bc are uniformly multiplied by 1.25, with
[rho]kl and [gamma]bc subject to a cap at 100 percent; and
(3) For the low correlation scenario, the specified correlation
parameters [rho]kl and [gamma]bc are replaced by,
[rho]kllow = max((2 x [rho]kl) - 100%, 75% x [rho]kl), and
[gamma]bclow = max((2 x [gamma]bc) - 100%, 75% x [gamma]bc).
Sec. __.207 Sensitivities-based capital requirement: calculation of
delta sensitivities, vega sensitivities and curvature scenarios.
(a) General requirements. For purposes of calculating the delta
capital requirement, the vega capital requirement, and the curvature
capital requirement, a [BANKING ORGANIZATION] must calculate the delta
sensitivities, vega sensitivities, and curvature scenarios in
accordance with the requirements set forth below.
(1) To calculate delta sensitivities, a [BANKING ORGANIZATION] must
use the sensitivity definitions for delta risk as provided in paragraph
(b) of this section.
(2) To calculate its vega sensitivities, a [BANKING ORGANIZATION]
must use the sensitivity definitions for vega risk as provided in
paragraph (c) of this section.
(3) A [BANKING ORGANIZATION] must calculate delta sensitivities,
vega sensitivities, and curvature scenarios based on the valuation
models used for financial reporting, except that, with prior written
approval from the [AGENCY], a [BANKING ORGANIZATION] may calculate
delta sensitivities, vega sensitivities, and curvature scenarios based
on the internal risk management models.
(4) For each risk factor as provided in Sec. __.208, a [BANKING
ORGANIZATION] must calculate the delta sensitivities, vega
sensitivities, and curvature scenarios as the change in the value of a
market risk covered position as a result of applying a specified shift
to each risk factor, assuming all other relevant risk factors are held
at the current level. In cases where applying this assumption is
ambiguous, a [BANKING ORGANIZATION] must perform the calculation
consistently with paragraph (a)(3) of this section. With prior written
approval from the [AGENCY], a [BANKING ORGANIZATION] may calculate
delta sensitivities, vega sensitivities, and curvature scenarios using
an alternative basis.
(5) When calculating delta sensitivities for market risk covered
positions that are options or positions with embedded options, a
[BANKING ORGANIZATION] must use one of the following assumptions:
(i) The dynamics of the implied volatility are such that when the
price of the underlying changes, the implied volatility of an option or
a market risk covered position with an embedded option will remain
unchanged for any given moneyness (sticky delta rule); or
(ii) When the price of the underlying changes, the implied
volatility of an option or a market risk covered position with an
embedded option will remain unchanged for any given strike price
(sticky strike rule); or
(iii) With prior written approval from the [AGENCY], another
assumption.
(6) The curvature scenarios and sensitivities to the delta risk
factors for credit spread risk for securitization positions non-CTP (as
specified in Sec. __.208(d)) must be calculated with respect to the
spread of the tranche rather than the spread of the underlying
position.
(7) The curvature scenarios and sensitivities to the delta risk
factors for credit spread risk for correlation trading positions (as
specified in Sec. __.208(e)) must be computed with respect to the
underlying names of the securitization position or nth-to-default
position.
(8) A [BANKING ORGANIZATION] must calculate the delta
sensitivities, vega sensitivities, and curvature scenarios for each
risk class in the reporting currency of the [BANKING ORGANIZATION],
except for the foreign exchange risk class where, with prior written
approval of the [AGENCY], the [BANKING ORGANIZATION] may calculate
sensitivities and curvature scenarios relative to a base currency
instead of the reporting currency as specified in Sec. __.208(h).
(9) A [BANKING ORGANIZATION] must calculate all sensitivities
ignoring the impact of CVA on fair values.
(b) Sensitivity definitions for delta risk--(1) Interest rate risk.
The delta sensitivity for interest rate risk is calculated by changing
the interest rate at tenor t of the relevant interest rate curve in a
given currency by one basis point (0.0001 in absolute terms) and
dividing the resulting change in the value of the market risk covered
position, Vi, by 0.0001 as follows:
[GRAPHIC] [TIFF OMITTED] TP18SE23.112
where,
(i) k is a given risk factor;
(ii) i is a given market risk covered position;
(iii) rt is the interest rate curve at tenor t;
(iv) cst is the credit spread curve at tenor t; and
(v) Vi is the value of the market risk covered position i as a
function of the interest rate curve and credit spread curve.
(2) Credit spread risk. The delta sensitivity for credit spread
risk for non-securitization positions, credit spread risk for
securitization positions non-CTP, and credit spread risk for
correlation trading positions is calculated by changing the relevant
credit spread at tenor t by one basis point (0.0001 in absolute terms)
and dividing the resulting change in the value of the market risk
covered position, Vi, by 0.0001 as follows:
[GRAPHIC] [TIFF OMITTED] TP18SE23.113
where,
(i) k is a given risk factor;
(ii) i is a given market risk covered position;
(iii) rt is the interest rate curve at tenor t;
(iv) cst is the credit spread curve at tenor t; and
(v) Vi is the value of the market risk covered position i as a
function of the interest rate curve and credit spread curve.
(3) Equity risk. A [BANKING ORGANIZATION] must calculate the delta
sensitivity for equity risk using the equity spot price and the equity
repo rate as follows:
(i) A [BANKING ORGANIZATION] must calculate the delta sensitivity
for equity spot price by changing the relevant equity spot price by one
percentage point (0.01 in relative terms) and dividing the resulting
change in the value of the market risk covered position, Vi, by 0.01 as
follows:
[[Page 64245]]
[GRAPHIC] [TIFF OMITTED] TP18SE23.114
where,
(A) k is a given equity;
(B) i is a given market risk covered position;
(C) EQk is the value of equity k; and
(D) Vi is the value of market risk covered position i as a function
of the price of equity k.
(ii) A [BANKING ORGANIZATION] must calculate the delta sensitivity
for equity repo rate by applying a parallel shift to the equity repo
rate term structure by one basis point (0.0001 in absolute terms) and
dividing the resulting change in the value of the market risk covered
position, Vi, by 0.0001 as follows:
[GRAPHIC] [TIFF OMITTED] TP18SE23.115
where,
(A) k is a given equity;
(B) RTSk is the repo term structure of equity k; and
(C) Vi is the value of market risk covered position i as a function
of the repo term structure of equity k.
(4) Commodity risk. A [BANKING ORGANIZATION] must calculate the
delta sensitivity for commodity risk by changing the relevant commodity
spot price by one percentage point (0.01 in relative terms) and
dividing the resulting change in the value of the market risk covered
position (Vi) by 0.01 as follows:
[GRAPHIC] [TIFF OMITTED] TP18SE23.116
where,
(i) k is a given commodity;
(ii) CTYk is the value of commodity k; and
(iii) Vi is the value of market risk covered position i as a
function of the spot price of commodity k:
(5) Foreign exchange risk. A [BANKING ORGANIZATION] must calculate
the delta sensitivity for foreign exchange risk by changing the
relevant exchange rate by one percentage point (0.01 in relative terms)
and dividing the resulting change in the value of the market risk
covered position, Vi, by 0.01 as follows:
[GRAPHIC] [TIFF OMITTED] TP18SE23.117
where,
(i) k is a given currency;
(ii) FXk is the exchange rate between a given currency and a
[BANKING ORGANIZATION]'s reporting currency or base currency, as
applicable, where the foreign exchange spot rate is the current market
price of one unit of another currency expressed in the units of the
[BANKING ORGANIZATION]'s reporting currency or base currency, as
applicable; and
(iii) Vi is the value of market risk covered position i as a
function of the exchange rate k.
(c) Sensitivity definitions for vega risk. (1) A [BANKING
ORGANIZATION] must calculate the vega sensitivity to a given risk
factor (provided in Sec. __.208) by multiplying vega by the volatility
of the option as follows:
sk = vega x volatility
where,
(i) vega is defined as the change in the value of the option, Vi,
as a result of a small amount of change to the volatility, [sigma]i,
which can be represented as ([part]Vi/
[part][sigma]i); and
(ii) volatility is defined as either the implied volatility or at-
the-money volatility of the option, depending on which is used by the
models used to calculate vega sensitivity to determine the intrinsic
value of volatility in the price of the option.
(2) For interest rate risk, a [BANKING ORGANIZATION] must map the
implied volatility of the option to one or more tenors specified in the
risk factors definitions in Sec. __.208(b)(2).
(3) A [BANKING ORGANIZATION] must assign market risk covered
positions that are options or positions with embedded options that do
not have a maturity to the longest prescribed maturity tenor.
(4) A [BANKING ORGANIZATION] must map market risk covered positions
that are options or positions with embedded options that do not have a
strike price, that have multiple strike prices, or are barrier options,
to the strike prices and maturities used for models used to calculate
vega sensitivity to value these positions.
Sec. __.208 Sensitivities-based capital requirement: risk factor
definitions.
(a) For purposes of calculating the sensitivities-based capital
requirement, a [BANKING ORGANIZATION] must identify all of the relevant
risk factors in accordance with the requirements in this section for
its market risk covered positions. Where specified, a [BANKING
ORGANIZATION] must use the tenors or maturities specified in this
section and assign risk factors and corresponding sensitivities to
specified tenors or maturities by linear interpolation or a method that
is most consistent with the pricing functions used by the internal risk
management models.
(b) Risk factors for interest rate risk--(1) Delta risk factors for
interest rate risk. The delta risk factors for interest rate risk are
defined for each currency and consist of interest rate risk factors as
well as inflation rate risk factors and cross-currency basis risk
factors, as applicable.
(i) For each currency, the delta risk factors for interest rate
risk are defined along two dimensions:
(A) An interest rate curve, for the currency, in which interest
rate-sensitive market risk covered positions are denominated; and
(B) Tenor: 0.25 years, 0.5 years, 1 year, 2 years, 3 years, 5
years, 10 years, 15 years, 20 years and 30 years.
[[Page 64246]]
(ii) For each currency (each interest rate risk bucket), a [BANKING
ORGANIZATION] must calculate, in addition to paragraph (b)(1)(i) of
this section, separate delta sensitivities for each of the following
delta risk factors, as applicable:
(A) Inflation rate risk factors. Inflation rate risk factors apply
to any market risk covered position whose cash flows are functionally
dependent on a measure of inflation (inflation positions). Inflation
rate risk factors must be based on the market-implied inflation rates
for each currency where term structure is not recognized. All inflation
rate risk for a given currency must be aggregated as the sum of the
delta sensitivities to the inflation rate risk factors of all inflation
positions.
(B) Cross-currency basis risk factors. The delta risk factors for
interest rate risk include one of two possible cross-currency basis
risk factors for each currency where term structure is not recognized.
The two cross-currency basis risk factors are basis of each currency
over USD or basis of each currency over EUR. Cross-currency bases that
do not relate to either basis over USD or basis over EUR must be
computed either on ``basis over USD'' or ``basis over EUR,'' but not
both.
(2) Vega risk factors for interest rate risk. The vega risk factors
for interest rate risk are defined for each currency and consist of:
(i) The implied volatilities of inflation rate risk-sensitive
options as defined along (b)(2)(iii)(A) of this section;
(ii) The implied volatilities of cross-currency basis risk-
sensitive options as defined along (b)(2)(iii)(A) of this section; and
(iii) The implied volatilities of interest rate risk-sensitive
options as defined along (b)(2)(iii)(A) and (B) of this section.
(A) The maturity of the option: 0.5 years, 1 year, 3 years, 5 years
and 10 years; and
(B) The residual maturity of the underlying instrument at the
expiry date of the option: 0.5 years, 1 year, 3 years, 5 years and 10
years.
(3) Curvature risk factors for interest rate risk. The curvature
risk factors for interest rate risk are defined along one dimension,
the relevant interest rate curve, per currency, where term structure is
not recognized. To calculate curvature scenarios, a [BANKING
ORGANIZATION] must shift all tenors provided in paragraph (b)(1)(i)(B)
of this section, in parallel. There is no curvature capital requirement
for inflation risk and cross-currency basis risks.
(4) On-shore and offshore variants of a currency must be treated as
separate currencies, unless a [BANKING ORGANIZATION] has received prior
approval of the [AGENCY] to treat on-shore and offshore variants as a
single currency.
(c) Risk factors for credit spread risk for non-securitization
positions--(1) Delta risk factors for credit spread risk for non-
securitization positions. The delta risk factors for credit spread risk
for non-securitization positions are defined along two dimensions:
(i) The issuer credit spread curve; and
(ii) Tenor: 0.5 years, 1 year, 3 years, 5 years and 10 years.
(2) Vega risk factors for credit spread risk for non-securitization
positions. For each credit spread curve, the vega risk factors for
credit spread risk for non-securitization positions are the implied
volatilities of options as defined along one dimension for the maturity
of the option: 0.5 years, 1 year, 3 years, 5 years and 10 years.
(3) Curvature risk factors for credit spread risk for non-
securitization positions. The curvature risk factors for credit spread
risk for non-securitization positions are defined along the relevant
issuer credit spread curves. For purposes of calculating curvature
scenarios, a [BANKING ORGANIZATION] must ignore the bond-CDS basis and
treat the bond-inferred spread curve of an issuer and the CDS-inferred
spread curve of that same issuer as a single spread curve. To calculate
curvature scenarios, a [BANKING ORGANIZATION] must shift all tenors
provided in paragraph (c)(1)(ii) of this section, in parallel.
(d) Risk factors for credit spread risk for securitization
positions non-CTP--(1) Delta risk factors for credit spread risk for
securitization positions non-CTP. The delta risk factors for credit
spread risk for securitization positions non-CTP are defined along two
dimensions:
(i) The tranche credit spread curve; and
(ii) Tenor of the tranche: 0.5 years, 1 year, 3 years, 5 years and
10 years.
(2) Vega risk factors for credit spread risk for securitization
positions non-CTP. For each tranche credit spread curve, the vega risk
factors for credit spread risk for securitization positions non-CTP are
the implied volatilities of options as defined along one dimension for
the maturity of the option: 0.5 years, 1 year, 3 years, 5 years and 10
years.
(3) Curvature risk factors for credit spread risk for
securitization positions non-CTP. The curvature risk factors for credit
spread risk for securitization positions non-CTP are defined along one
dimension, the relevant tranche credit spread curves. For purposes of
calculating curvature scenarios, a [BANKING ORGANIZATION] must ignore
the bond-CDS basis and treat the bond-inferred spread curve of a
tranche and the CDS-inferred spread curve of that same tranche as a
single spread curve. To calculate curvature scenarios, a [BANKING
ORGANIZATION] must shift all tenors provided in paragraph (d)(1)(ii) of
this section in parallel.
(e) Risk factors for credit spread risk for correlation trading
positions--(1) Delta risk factors for credit spread risk for
correlation trading positions. The delta risk factors for credit spread
risk for correlation trading positions are defined along two
dimensions:
(i) The underlying credit spread curve; and
(ii) Tenor of the underlying name: 0.5 years, 1 year, 3 years, 5
years and 10 years.
(2) Vega risk factors for credit spread risk for correlation
trading positions. For each underlying credit spread curve, the vega
risk factors for the credit spread risk for correlation trading
positions are the implied volatilities of options as defined along one
dimension for the maturity of the option: 0.5 years, 1 year, 3 years, 5
years and 10 years.
(3) Curvature risk factors for credit spread risk for correlation
trading positions. The curvature risk factors for credit spread risk
for correlation trading positions are defined along one dimension, the
relevant underlying credit spread curves. For purposes of calculating
curvature scenarios, a [BANKING ORGANIZATION] must disregard the bond-
CDS basis and treat the bond-inferred spread curve of a given name in
an index and the CDS-inferred spread curve of that same underlying name
as a single spread curve. To calculate curvature scenarios, a [BANKING
ORGANIZATION] must shift all tenors provided in paragraph (e)(1)(ii) of
this section in parallel.
(f) Risk factors for equity risk--(1) Delta risk factors for equity
risk. The delta risk factors for equity risk are defined for each
issuer and consist of equity spot prices and equity repo rates, as
appropriate.
(2) Vega risk factors for equity risk. The vega risk factors for
equity risk are defined for each issuer and consist of the implied
volatilities of the spot prices of equity risk-sensitive options as
defined along the maturity of the option: 0.5 years, 1 year, 3 years, 5
years and 10 years.
(3) Curvature risk factors for equity risk. The curvature risk
factors for equity risk are defined for each issuer and consist of all
equity spot prices.
[[Page 64247]]
There are no curvature risk factors for equity repo rates.
(g) Risk factors for commodity risk--(1) Delta risk factors for
commodity risk. The delta risk factors for commodity risk are all
commodity spot prices or forward prices and are defined along two
dimensions for each commodity:
(i) The contracted delivery location of the commodity; and
(ii) Remaining maturity of the contract: 0 years, 0.25 years, 0.5
years, 1 year, 2 years, 3 years, 5 years, 10 years, 15 years, 20 years
and 30 years.
(2) Vega risk factors for commodity risk. The vega risk factors for
commodity risk are the implied volatilities of commodity-sensitive
options as defined along one dimension for each commodity, the maturity
of the option: 0.5 years, 1 year, 3 years, 5 years and 10 years.
(3) Curvature risk factors for commodity risk. The curvature risk
factors for commodity risk are defined along one dimension per
commodity, the constructed curve per commodity spot prices or forward
prices, consistent with the delta risk factor, where term structure is
not recognized. For the calculation of sensitivities, all tenors
provided in paragraph (g)(1)(ii) of this section, are to be shifted in
parallel.
(h) Risk factors for foreign exchange risk--(1) Delta risk factors
for foreign exchange risk. The delta risk factors for foreign exchange
risk are all the exchange rates between the currency in which a market
risk covered position is denominated and the reporting currency.
(i) For market risk covered positions that reference an exchange
rate between a pair of non-reporting currencies, the delta risk factors
for foreign exchange risk are all the exchange rates between:
(A) The reporting currency; and
(B) The currency in which a market risk covered position is
denominated and any other currencies referenced by the market risk
covered position.
(ii) Alternatively, a [BANKING ORGANIZATION] may calculate delta
risk factors for foreign exchange risk relative to a base currency
instead of the reporting currency if approved by the [AGENCY]. In such
case a [BANKING ORGANIZATION] must account for the foreign exchange
risk against the base currency and the foreign exchange risk between
the reporting currency and the base currency (i.e., translation risk).
The resulting foreign exchange risk calculated relative to the base
currency must be converted to the capital requirements in the reporting
currency using the spot reporting/base exchange rate reflecting the
foreign exchange risk between the base currency and the reporting
currency.
(A) To use this alternative, a [BANKING ORGANIZATION] may only
consider a single currency as its base currency; and
(B) A [BANKING ORGANIZATION] must demonstrate to the [AGENCY] that
calculating foreign exchange risk relative to its base currency
provides an appropriate risk representation of the [BANKING
ORGANIZATION]'s market risk covered positions and that the translation
risk between the base currency and the reporting currency is addressed.
(2) Vega risk factors for foreign exchange risk. The vega risk
factors for foreign exchange risk-sensitive options are the implied
volatility of options that reference exchange rates between currency
pairs defined along the maturity of the option: 0.5 years, 1 year, 3
years, 5 years and 10 years.
(3) Curvature risk factors for foreign exchange risk. The curvature
risk factors for foreign exchange risk are all the exchange rates
between the currency in which a market risk covered position is
denominated and the reporting currency.
(i) For market risk covered positions that reference an exchange
rate between a pair of non-reporting currencies, the curvature risk
factors for foreign exchange risk are all the exchange rates between:
(A) The reporting currency; and
(B) The currency in which a market risk covered position is
denominated and any other currencies referenced by the market risk
covered position.
(ii) If the [BANKING ORGANIZATION] has received prior approval of
the [AGENCY] to use the base currency approach in paragraph (h)(1)(ii)
of this section, curvature risk factors for foreign exchange risk must
be calculated relative to the base currency instead of the reporting
currency, and then converted to the capital requirements in the
reporting currency using the spot reporting/base exchange rate.
(4) For all risk factors for foreign exchange risk, a [BANKING
ORGANIZATION] may distinguish between onshore and offshore variants of
a currency.
Sec. __.209 Sensitivities-based method: definitions of buckets, risk
weights and correlation parameters.
(a) For the purpose of calculating the sensitivities-based capital
requirement, a [BANKING ORGANIZATION] must identify all of the relevant
buckets, corresponding risk weights and correlation parameters for each
risk class as provided in paragraph (b) of this section (delta capital
requirement), paragraph (c) of this section (vega capital requirement),
and paragraph (d) of this section (curvature capital requirement), for
its market risk covered positions.
(b) Delta capital requirement--(1) Delta buckets, risk weights, and
correlations for interest rate risk. (i) A [BANKING ORGANIZATION] must
establish a separate interest rate risk bucket for each currency.
(ii) For calculating risk-weighted delta sensitivities, the risk
weights for each tenor of an interest rate curve are set out in Table 1
of this section.
[[Page 64248]]
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(iii) The risk weight for inflation rate risk factors and cross-
currency basis risk factors equals 1.6 percent.
(iv) For United States Dollar, Australian Dollar, Canadian Dollar,
Euro, Japanese Yen, Swedish Krona, and United Kingdom Pound, and any
other currencies specified by the [AGENCY], a [BANKING ORGANIZATION]
may divide the risk weights in paragraphs (b)(1)(ii) and (iii) of this
section by [radic]2.
(v) For purposes of aggregating risk-weighted delta sensitivities
of interest rate risk within a bucket as specified in Sec.
__.206(b)(2), a [BANKING ORGANIZATION] must use the following
correlation parameters:
(A) The correlation parameter rkl between risk-weighted delta
sensitivities WSk and WSl within the same bucket, with the same tenor
but different interest rate curves equals 99.9 percent. For cross-
currency basis risk for onshore and offshore curves, a [BANKING
ORGANIZATION] may choose to take the sum of the risk-weighted delta
sensitivities.
(B) The correlation parameter rkl between risk-weighted delta
sensitivities WSk and WSl within the same bucket, with different tenors
and the same interest rate curve are set out in table 2 of this
section.
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[[Page 64249]]
(C) The correlation parameter rkl between risk-weighted delta
sensitivities WSk and WSl within the same bucket, with different tenors
and different interest rate curves equals the correlation parameter rkl
specified in Table 2 of this section multiplied by 99.9 percent.
(D) The correlation parameter rkl between risk-weighted delta
sensitivities WSk and WSl to different inflation curves within the same
bucket equals 99.9 percent.
(E) The correlation parameter rkl between a risk-weighted delta
sensitivity WSk to the inflation curve and a risk weighted delta
sensitivity WSl to a given tenor of the relevant interest rate curve
equals 40 percent.
(F) The correlation parameter rkl equals zero percent between risk-
weighted delta sensitivity WSk to a cross-currency basis curve and a
risk weighted delta sensitivity WSl to each of the following curves:
(1) A given tenor of the relevant interest rate curve;
(2) The inflation curve; and
(3) Any other cross-currency basis curve.
(vi) For purposes of aggregating delta bucket-level risk positions
across buckets within the interest rate risk class as specified in
Sec. __.206(b)(3), the cross-bucket correlation parameter gbc equals
50 percent.
(2) Delta buckets, risk weights, and correlations for credit spread
risk for non-securitizations. (i) For credit spread risk for non-
securitizations, a [BANKING ORGANIZATION] must establish buckets along
two dimensions, credit quality and sector, as set out in Table 3 of
this section. In assigning a delta sensitivity to a sector, a [BANKING
ORGANIZATION] must follow market convention. A [BANKING ORGANIZATION]
must assign each delta sensitivity to one and only one of the sector
buckets in Table 3 of this section. Delta sensitivities that a [BANKING
ORGANIZATION] cannot assign to a sector must be assigned to the other
sector, bucket 17 in Table 3 of this section.
(ii) For calculating risk weighted delta sensitivities for credit
spread risk for non-securitizations, a [BANKING ORGANIZATION] must use
the risk weights in Table 3 of this section. The risk weights are the
same for all tenors within a bucket.
[[Page 64250]]
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BILLING CODE 6210-01-C; 6714-01-C; 4810-33-C
(iii) For purposes of aggregating risk weighted delta sensitivities
of credit spread risk for non-securitizations within a bucket as
specified in Sec. __.206(b)(2), a [BANKING ORGANIZATION] must use the
following correlation parameters:
(A) For buckets 1 to 16, the correlation parameter [rho]kl between
risk weighted delta sensitivities WSk and WSl equals:
rkl = rkl(name) x rkl(tenor) x rkl(basis)
where,
(1)rkl(name) equals 100 percent if the two names of the delta
sensitivities to risk factors k and l are identical, and 35 percent
otherwise;
(2) rkl(tenor) equals 100 percent if the two tenors of the delta
sensitivities to
[[Page 64251]]
risk factors k and l are identical, and 65 percent otherwise; and
(3) [rho]kl(basis) equals 100 percent if the two delta
sensitivities are related to the same curve, and 99.9 percent
otherwise.
(B) For bucket 17, the risk delta bucket level risk position equals
the sum of the absolute values of the risk weighted delta sensitivities
allocated to this bucket,
[GRAPHIC] [TIFF OMITTED] TP18SE23.121
(C) For buckets 18 and 19, the correlation parameter [rho]kl
between risk weighted delta sensitivities WSk and WSl equals:
[rho]kl(name) x [rho]kl(tenor) x [rho]kl(basis)
where,
(1) [rho]kl(name) equals 100 percent if the two names of the delta
sensitivities to risk factors k and l are identical, and 80 percent
otherwise;
(2) [rho]kl(tenor) equals 100 percent if the two tenors of the
delta sensitivities to risk factors k and l are identical, and 65
percent otherwise; and
(3)[rho]kl(basis) equals 100 percent if the two delta sensitivities
are related to the same curves, and 99.9 percent otherwise.
(iv) For purposes of aggregating delta bucket-level risk positions
across buckets within the credit spread risk for non-securitizations
risk class as specified in Sec. __.206(b)(3), a [BANKING ORGANIZATION]
must calculate the cross-bucket correlation parameter [gamma]bc as
follows with respect to buckets 1 to 19:
[gamma]bc(credit quality) x [gamma]bc(sector)
where,
(A) [gamma]bc(credit quality) equals 50 percent where the two
buckets b and c are both in the set of buckets 1 to 16, 18 and 19 and
have a different credit quality category, where speculative and sub-
speculative grade is treated as one credit quality category;
[gamma]bc(credit quality) equals 100 percent otherwise; and
(B) [gamma]bc(sector) equals 100 percent if the two buckets belong
to the same sector, and the specified values set out in Table 4 of this
section otherwise.
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[GRAPHIC] [TIFF OMITTED] TP18SE23.122
[[Page 64252]]
(3) Delta buckets, risk weights, and correlations for credit spread
risk for correlation trading positions. (i) For credit spread risk for
correlation trading positions, a [BANKING ORGANIZATION] must establish
buckets along two dimensions, credit quality and sector as set out in
Table 5 of this section. In assigning a delta sensitivity to a sector,
a [BANKING ORGANIZATION] must follow market convention. A [BANKING
ORGANIZATION] must assign each delta sensitivity to one and only one of
the sector buckets in Table 5 of this section. Delta sensitivities that
a [BANKING ORGANIZATION] cannot assign to a sector must be assigned to
the other sector, bucket 17 in Table 5 of this section.
(ii) For calculating risk weighted delta sensitivities for credit
spread risk for correlation trading positions, a [BANKING ORGANIZATION]
must use the risk weights in Table 5 of this section. The risk weights
are the same for all tenors within a bucket.
[[Page 64253]]
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BILLING CODE 6210-01-C; 6714-01-C; 4810-33-C
(iii) For purposes of aggregating risk weighted delta sensitivities
of credit spread risk for correlation trading positions within a bucket
as specified in Sec. __.206(b)(2), a [BANKING ORGANIZATION] must use
the following correlation parameters:
(A) For buckets 1 to 16, the correlation parameter [rho]kl between
risk weighted delta sensitivities WSk and WSl equals:
[rho]kl = [rho]kl(name) x [rho]kl(tenor) x [rho]kl(basis)
where,
(1) [rho]kl(name) equals 100 percent if the two names of delta
sensitivities to risk factors k and l are identical, and 35 percent
otherwise;
(2) [rho]kl(tenor) equals 100 percent if the two tenors of the
delta sensitivities to risk factors k and l are identical, and 65
percent otherwise; and
[[Page 64254]]
(3) [rho]kl(basis) equals 100 percent if the two delta
sensitivities are related to same curve, and 99 percent otherwise.
(B) For bucket 17, the delta bucket-level risk position equals the
sum of the absolute values of the risk weighted delta sensitivities
allocated to this bucket,
[GRAPHIC] [TIFF OMITTED] TP18SE23.124
(C) For purposes of aggregating delta bucket-level risk positions
across buckets within the credit spread risk for correlation trading
positions risk class as specified in Sec. __.206(b)(3), a [BANKING
ORGANIZATION] must calculate the cross-bucket correlation parameter gbc
as follows:
[gamma]bc = [gamma]bc(credit quality) x [gamma]bc(sector)
where,
(1) [gamma]bc(credit quality) equals 50 percent where the two
buckets b and c are both in buckets 1 to 16 and have a different credit
quality category, where speculative and sub-speculative grade is
treated as one credit quality category; [gamma]bc(credit quality)
equals 100 percent otherwise; and
(2) [gamma]bc(sector) equals 100 percent if the two buckets belong
to the same sector, and the specified values set out in Table 6 of this
section otherwise.
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(4) Delta buckets, risk weights, and correlations for credit spread
risk for securitization positions non-CTP. (i) For credit spread risk
for securitization positions non-CTP, a [BANKING ORGANIZATION] must
establish buckets along two dimensions, credit quality and sector, as
set out in Table 7 of this section. In assigning a delta sensitivity to
a credit quality, a [BANKING ORGANIZATION] must take into account the
structural features of the securitization position non-CTP. In
assigning a delta sensitivity to a sector, a [BANKING ORGANIZATION]
must follow market convention. Delta sensitivities of any tranche that
a [BANKING ORGANIZATION] cannot assign to a sector must be assigned to
the other sector bucket.
(ii) For calculating risk weighted delta sensitivities for credit
spread risk for securitization positions non-CTP, a [BANKING
ORGANIZATION] must use the risk weights in Table 7 of this section.
[[Page 64255]]
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BILLING CODE 6210-01-C; 6714-01-C; 4810-33-C
(iii) For purposes of aggregating risk weighted delta sensitivities
of credit spread risk for securitization positions non-CTP within a
bucket as specified in Sec. __.206(b)(2), a [BANKING ORGANIZATION]
must use the following correlation parameters:
(A) For buckets 1 through 24, the correlation parameter rkl between
risk weighted delta sensitivities WSk and WSl, equals:
rkl = rkl(tranche) x rkl(tenor) x rkl(basis)
where,
[[Page 64256]]
(1) rkl(tranche) equals 100 percent where the two delta
sensitivities to risk factors k and l are within the same bucket and
related to the same tranche, with more than 80 percent overlap in
notional terms and 40 percent otherwise;
(2) rkl(tenor) equals 100 percent if the two tenors of the delta
sensitivities to risk factors k and l are identical, and 80 percent
otherwise; and
(3) rkl(basis) equals 100 percent if the two delta sensitivities
reference the same curve, and 99.9 percent otherwise.
(B) For bucket 25, the delta bucket-level risk position equals the
sum of the absolute values of the risk weighted delta sensitivities
allocated to this bucket,
[GRAPHIC] [TIFF OMITTED] TP18SE23.197
(iv) For purposes of aggregating delta bucket-level risk positions
across buckets within the credit spread risk for securitization
positions non-CTP risk class as specified in Sec. __.206(b)(3), the
cross-bucket correlation parameter gbc equals zero percent.
(5) Delta buckets, risk weights, and correlations for equity risk.
(i) For equity risk, a [BANKING ORGANIZATION] must establish buckets
along three dimensions, market capitalization, economy and sector as
set out in Table 8 of this section. To assign a delta sensitivity to an
economy, a [BANKING ORGANIZATION], at least annually, must review and
update the countries and territorial entities that satisfy the
requirements of a liquid market economy using the most recent economic
data available. To assign a delta sensitivity to a sector, a [BANKING
ORGANIZATION] must follow market convention by using classifications
that are commonly used in the market for grouping issuers by industry
sector. A [BANKING ORGANIZATION] must assign each issuer to one of the
sector buckets and must assign all issuers from the same industry to
the same sector. Delta sensitivities of any equity issuer that a
[BANKING ORGANIZATION] cannot assign to a sector must be assigned to
the other sector. For multinational, multi-sector equity issuers, the
allocation to a particular bucket must be done according to the most
material economy and sector in which the issuer operates.
(ii) For calculating risk weighted delta sensitivities for equity
risk, a [BANKING ORGANIZATION] must use the risk weights in Table 8 of
this section.
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[[Page 64257]]
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BILLING CODE 6210-01-C; 6714-01-C; 4810-33-C
(iii) For purposes of aggregating risk weighted delta sensitivities
of equity risk within a bucket as specified in Sec. __.206(b)(2), a
[BANKING ORGANIZATION] must use the following correlation parameters:
(A) For buckets 1 through 10 and 12 through 13, the correlation
parameter rkl between two risk weighted delta sensitivities WSk and WSl
is as follows:
[[Page 64258]]
(1) rkl equals 99.9 percent, where one delta sensitivity is to an
equity spot price and the other delta sensitivity is to an equity repo
rate, and both are related to the same equity issuer;
(2) Where both delta sensitivities are to equity spot prices, or
both delta sensitivities are to equity repo rates, rkl equals:
(i) 15 percent between delta sensitivities assigned to buckets 1,
2, 3, and 4 of Table 8 of this section (large market cap, emerging
market economy);
(ii) 25 percent between delta sensitivities assigned to buckets 5,
6, 7 or 8 of Table 8 of this section (large market cap, liquid market
economy);
(iii) 7.5 percent between delta sensitivities assigned to bucket 9
of Table 8 of this section (small market cap, emerging market economy);
(iv) 12.5 percent between delta sensitivities assigned to bucket 10
of Table 8 of this section (small market cap, liquid market economy);
and
(v) 80 percent between delta sensitivities assigned to buckets 12
or 13 of Table 8 of this section (either index bucket); and
(3) Where one delta sensitivity is to an equity spot price and the
other delta sensitivity is to an equity repo rate, and each delta
sensitivity is related to a different equity issuer, the applicable
correlation parameter equals rkl, as defined in paragraph
(b)(5)(iii)(A)(2) of this section, multiplied by 99.9 percent; and
(B) For bucket 11, the delta bucket-level risk position equals the
sum of the absolute values of the risk weighted delta sensitivities
allocated to this bucket,
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(iv) For purposes of aggregating delta bucket-level risk positions
across buckets within the equity risk class as specified in Sec.
__.206(b)(3), the cross-bucket correlation parameter gbc equals:
(A) 15 percent if bucket b and bucket c fall within buckets 1 to 10
of Table 8 of this section;
(B) Zero percent if either of bucket b and bucket c is bucket 11 of
Table 8 of this section;
(C) 75 percent if bucket b and bucket c are buckets 12 and 13 of
Table 8 of this section (i.e., one is bucket 12 and one is bucket 13);
and
(D) 45 percent otherwise.
(6) Delta buckets, risk weights, and correlations for commodity
risk.
(i) For commodity risk, a [BANKING ORGANIZATION] must establish
buckets for each commodity type as set out in Table 9 of this section.
A [BANKING ORGANIZATION] must assign each contract to one of the
commodity buckets and must assign all contracts with the same
underlying commodity to the same bucket. Delta sensitivities of any
contract that a [BANKING ORGANIZATION] cannot assign to a commodity
type must be assigned to the other commodity bucket.
(ii) For calculating risk weighted delta sensitivities for
commodity risk, a [BANKING ORGANIZATION] must use the risk weights in
Table 9 of this section.
BILLING CODE 6210-01-P; 6714-01-P; 4810-33-P
[[Page 64259]]
[GRAPHIC] [TIFF OMITTED] TP18SE23.129
(iii) For purposes of aggregating risk weighted delta sensitivities
of commodity risk within a bucket as specified in Sec. __.206(b)(2), a
[BANKING ORGANIZATION] must use the following correlation parameters:
[[Page 64260]]
(A) For buckets 1 through 11, the correlation parameter [rho]kl
between two risk weighted delta sensitivities WSk and WSl equals:
[rho]kl = [rho]kl(cty) x
[rho]kl(tenor) x
[rho]kl(basis)
where,
(1) [rho]kl(cty) equals 100 percent where the
two delta sensitivities to risk factors k and l are identical, and the
intra-bucket correlation parameters set out in Table 10 of this section
otherwise;
(2) [rho]kl(tenor) equals 100 percent if the
two tenors of the delta sensitivities to risk factors k and l are
identical, and 99 percent otherwise; and
(3) [rho]kl(basis) equals 100 percent if the two delta
sensitivities are identical in the delivery location of a commodity,
and 99.9 percent otherwise.
[GRAPHIC] [TIFF OMITTED] TP18SE23.130
BILLING CODE 6210-01-C; 6714-01-C; 4810-33-C
(iv) For purposes of aggregating delta bucket-level risk positions
across buckets within the commodity risk class as specified in Sec.
__.206(b)(3), the cross-bucket correlation parameter [gamma]bc equals:
(A) 20 percent if bucket b and c fall within buckets 1 to 10 of
Table 10 of this section; and
(B) Zero percent if either bucket b and c is bucket number 11 of
Table 10 of this section.
(7) Delta buckets, risk weights, and correlations for foreign
exchange risk. (i) For foreign exchange risk, a [BANKING ORGANIZATION]
must establish buckets for each exchange rate between the currency in
which a market risk covered position is denominated and the reporting
currency (or alternative base currency).
(ii) For calculating risk weighted delta sensitivities for foreign
exchange risk, a [BANKING ORGANIZATION] must apply a risk weight equal
to 15 percent, except for any currency pair formed by the following
list of currencies, a [BANKING ORGANIZATION] may divide the above risk
weight by [radic]2: United States Dollar, Australian Dollar, Brazilian
Real, Canadian Dollar, Chinese Yuan, Euro, Hong Kong Dollar, Indian
Rupee, Japanese Yen, Mexican Peso, New Zealand Dollar, Norwegian Krone,
Singapore Dollar, South African Rand, South Korean Won, Swedish Krona,
Swiss Franc, Turkish Lira, United Kingdom Pound, and any additional
currencies specified by the [AGENCY].
(iii) For purposes of aggregating delta bucket-level risk positions
across buckets within the foreign exchange risk class, the cross-bucket
correlation parameter [gamma]bc equals 60 percent.
(c) Vega capital requirement--(1) Vega buckets. For each risk
class, a [BANKING ORGANIZATION] must use the same buckets as specified
in paragraph (b) of this section for the calculation of the vega
capital requirement.
(2) Vega risk weights. For calculating risk weighted sensitivities
for vega risk as described in Sec. __.206(c)(1), a [BANKING
ORGANIZATION] must use the corresponding risk weight for each risk
class specified in Table 11 of this section.
(i) Equity risk (large market cap and indices) applies to vega risk
factors that correspond to buckets 1 to 8, 12 and 13 of Table 8 of this
section.
(ii) Equity risk (small market cap and other sector) applies to
vega risk factors that correspond to buckets 9 to 11 of Table 8 of this
section.
[[Page 64261]]
[GRAPHIC] [TIFF OMITTED] TP18SE23.131
(3) Vega correlation parameters. For purposes of aggregating risk
weighted vega sensitivities within a bucket as specified in Sec.
__.206(c)(2) a [BANKING ORGANIZATION] must use the following
correlation parameters:
(i) For interest rate risk, where tenor is a dimension of the risk
factor, correlation parameter rkl equals:
[rho]kl = min(([rho]kl(option maturity) x
[rho]kl(underlying maturity)), 1)
where,
(A) [rho]kl(option maturity) equals
[GRAPHIC] [TIFF OMITTED] TP18SE23.132
with [alpha] set at 1 percent and Tk (respectively Tl) denoting the
maturity of the option from which the vega sensitivity VRk (VRl) is
derived, expressed as a number of years; and
(B) [rho]kl(underlying maturity) equals:
[GRAPHIC] [TIFF OMITTED] TP18SE23.133
with [alpha] set at 1 percent and TkU (respectively TlU) denoting the
maturity of the underlying of the option from which the sensitivity VRk
(VRl) is derived, expressed as a number of years after the maturity of
the option.
(ii) Except as noted in paragraph (c)(3)(iii) of this section, for
purposes of aggregating risk weighted vega sensitivities within a
bucket of:
(A) Interest rate risk, where term structure is not recognized
(inflation rate risk factors and cross-currency basis risk factors);
and
(B) The other risk classes (numbered 2 through 8 in Table 11 of
this section), the correlation parameter [rho]kl equals:
[rho]kl = min(([rho]kl(delta) x
[rho]kl(option maturity), 1)
where,
(A) [rho]kl(option maturity) equals:
[GRAPHIC] [TIFF OMITTED] TP18SE23.134
with [alpha] set at 1 percent and Tk (respectively Tl) denoting the
maturity of the option from which the vega sensitivity VRk (VRl) is
derived, expressed as a number of years; and
(2) [rho]kl(delta) equals the correlation
between the delta risk factors that correspond to vega risk factors k
and l. For instance, if k is the vega risk factor from equity option X
and l is the vega risk factor from equity option Y then
[rho]kl(delta) is the delta correlation
applicable between X and Y. Specifically:
(i) For the risk classes of credit spread risk for non-
securitization positions and credit spread risk for correlation trading
positions, the vega risk correlation parameter,
[rho]kl(delta), equals the corresponding delta
correlation parameter, [rho]kl(name), as
specified in paragraphs (b)(2)(iii)(A)(1) and (b)(3)(iii)(A)(1) of this
section, respectively;
(ii) For the risk class of credit spread risk for securitization
positions non-CTP, the vega risk correlation parameter,
[rho]kl(delta), equals the corresponding delta
correlation parameter, kl(tranche), as specified
in paragraph (b)(4)(iii)(A)(1) of this section; and
(iii) For the risk class of commodity risk, the vega risk
correlation parameter, [rho]kl(delta), equals the
corresponding delta correlation parameter,
[rho]kl(cty), as specified in paragraph
(b)(6)(iii)(A)(1) of this section.
(iii) For purposes of aggregating risk weighted vega sensitivities
within the other sector buckets (for credit spread risk for non-
securitizations, bucket 17 in table 3 to Table 3 of this section, for
credit spread risk for correlation trading positions, bucket 17 in
Table 5 of this section, for credit spread risk for securitization
positions non-CTP, bucket 25 in Table 7 of this section, and for equity
risk, bucket 11 in Table 8 of this section), the vega bucket-level risk
position equals the sum of the absolute values of the risk weighted
vega sensitivities allocated to this bucket.
(iv) For purposes of aggregating vega bucket-level risk positions
across different buckets within a risk class as specified in Sec.
__.206(c)(3), a [BANKING ORGANIZATION] must use the same cross-bucket
correlation parameters [gamma]bc as specified for delta risk in
paragraph (b) of this section.
(d) The curvature capital requirement--(1) Curvature buckets. For
each risk class, a [BANKING ORGANIZATION] must use the same buckets as
specified in paragraph (b) of this section for the calculation of the
curvature capital requirement.
(2) Curvature risk weights. (i) For calculating the net curvature
risk
[[Page 64262]]
position CVRk, as described in Sec. __.206(d)(1), for the risk classes
of foreign exchange risk and equity risk, the curvature risk weight
that represents a shock to risk factor k is a relative shift equal to
the delta risk weight corresponding to risk factor k.
(A) For options that do not reference a [BANKING ORGANIZATION]'s
reporting currency or base currency as an underlying exposure, a
[BANKING ORGANIZATION] may divide the net curvature risk positions
CVRk\+\ and CVRk- for foreign exchange risk by a scalar of
1.5.
(B) A [BANKING ORGANIZATION] may apply the scalar of 1.5
consistently to all market risk covered positions subject to foreign
exchange risk, provided curvature scenarios are calculated for all
currencies, including curvature scenarios calculated by shocking the
reporting currency (or base currency where used) relative to all other
currencies.
(ii) For calculating the net curvature risk position CVRk, as
described in Sec. __.206(d)(1), for the risk classes below, the
curvature risk weight corresponding to risk factor k is the parallel
shift of all the tenors for each curve based on the highest prescribed
delta risk weight for each bucket:
(A) Interest rate risk;
(B) Credit spread risk for non-securitization positions;
(C) Credit spread risk for correlation trading positions;
(D) Credit spread risk for securitization positions non-CTP; and
(E) Commodity risk.
(iii) A [BANKING ORGANIZATION] may floor credit spreads at zero in
cases where applying the delta risk weight described in paragraph
(d)(2)(ii) of this section results in negative credit spreads for the
credit spread risk classes referenced in paragraphs (d)(2)(ii)(B)
through (D) of this section.
(3) Curvature correlation parameters. For purposes of aggregating
the net curvature risk positions within a bucket as described in Sec.
__.206(d)(2), a [BANKING ORGANIZATION] must use the following
correlation parameters:
(i) Except as noted in paragraph (d)(3)(vi) of this section, for
the risk class of interest rate risk, the curvature risk correlation
parameter, [rho]kl, equals 99.8 percent where risk factors k and l
relate to different interest rate curves and 100 percent otherwise;
(ii) Except as noted in paragraph (d)(3)(vi) of this section, for
the risk classes of credit spread risk for non-securitization positions
and credit spread risk for correlation trading positions, the curvature
risk correlation parameter, [rho]kl, equals the corresponding delta
correlation parameter, [rho]kl(name), as
specified in paragraphs (b)(2)(iii)(A)(1) and (b)(3)(iii)(A)(1) of this
section, respectively, squared.
(iii) Except as noted in paragraph (d)(3)(vi) of this section, for
the risk class of credit spread risk for securitization positions non-
CTP, the curvature risk correlation parameter, [rho]kl, equals the
corresponding delta correlation parameter,
[rho]kl(tranche), as specified in paragraph
(b)(4)(iii)(A) of this section, squared;
(iv) Except as noted in paragraph (d)(3)(vi) of this section, for
the risk class of commodity risk, the curvature risk correlation
parameter, [rho]kl, equals the corresponding delta correlation
parameter, [rho]kl(cty), as specified in paragraph (b)(6)(iii)(A)(1) of
this section, squared;
(v) Except as noted in paragraph (d)(3)(vi) of this section, for
the risk class of equity risk, the curvature risk correlation
parameter, [rho]kl, equals the corresponding delta correlation
parameters, [rho]kl, as specified in paragraph (b)(5)(iii)(A)(2) of
this section, squared;
(vi) For purposes of aggregating the net curvature risk positions
within the other sector buckets (for credit spread risk for non-
securitizations, bucket 17 in Table 3 of this section, for credit
spread risk for correlation trading positions, bucket 17 in Table 5 of
this section, for credit spread risk for securitization positions non-
CTP, bucket 25 in Table 7 of this section, and for equity risk, bucket
11 in Table 8 of this section), the curvature bucket-level risk
position equals:
[GRAPHIC] [TIFF OMITTED] TP18SE23.135
(4) For purposes of aggregating curvature bucket-level risk
positions across buckets within each risk class as specified in Sec.
__.206(d)(3), a [BANKING ORGANIZATION] must calculate the cross-bucket
correlation parameters [gamma]bc for curvature risk by squaring the
corresponding delta correlation parameters [gamma]bc.
(5) In applying the high and low correlations scenarios in Sec.
__.206(e), a [BANKING ORGANIZATION] must calculate the curvature
capital requirements by applying the correlation parameters, [rho]kl,
as calculated in paragraph (d)(3) of this section and the cross-bucket
correlation parameter [gamma]bc as calculated in paragraph (d)(4) of
this section.
Sec. __.210 Standardized default risk capital requirement.
(a) Overview of the standardized default risk capital requirements.
(1) A [BANKING ORGANIZATION] must calculate default risk capital
requirements for its market risk covered positions, including defaulted
market risk covered positions, that are subject to default risk
(default risk positions) across the following default risk categories:
(i) Non-securitization debt or equity positions, other than U.S.
sovereign positions or MDBs;
(ii) Securitization positions non-CTP; and
(iii) Correlation trading positions.
(2) For each default risk category, the standardized default risk
capital requirement must be calculated as follows:
(i) Assign each default risk position to one of the prescribed
buckets.
(ii) Calculate the gross default exposure for each default risk
position.
(iii) Calculate obligor-level net default exposure by offsetting,
where permissible, the gross default exposure amounts of long and short
default risk positions.
(A) To account for defaults within the one-year capital horizon, a
[BANKING ORGANIZATION] must scale the gross default exposures for
default risk positions of maturity less than one year, and their
hedges, by the corresponding fraction of a year. The maturity weighting
applied to the gross default exposure for any default risk position
with a maturity of less than three months (such as short-term lending)
must be floored at three months. No scaling is applied to the gross
default exposures for default risk positions with maturities of one
year or greater.
(1) A [BANKING ORGANIZATION] may assign unhedged cash equity
positions to a maturity of either three months or one year. For cash
equity positions that hedge derivative contracts, a [BANKING
[[Page 64263]]
ORGANIZATION] may assign the same maturity to the cash equity position
as the maturity of the derivative contract it hedges.
(2) For derivative transactions, eligibility for offsetting
treatment is determined by the maturity of the derivative contract, not
the maturity of the underlying. In the case where a default risk
position can be delivered into a derivative contract that it hedges in
fulfillment of the contract, a [BANKING ORGANIZATION] may align the
maturity of the default risk position with the derivative contract it
hedges to permit full offsetting.
(B) A [BANKING ORGANIZATION] may offset gross default exposures of
different maturities that meet the offsetting criterion specified for
the default risk category as follows:
(1) Gross default exposures with maturities longer than the one-
year capital horizon may be fully offset;
(2) Gross default exposures with a mix of long and short exposures
where some maturities are less than the one-year capital horizon must
be weighted by the ratio of each gross default exposure's maturity
relative to the one-year capital horizon. In the case where long and
short gross default exposures both have maturities under the one-year
capital horizon, scaling must be applied to both the long and short
gross default exposure.
(iv) Within a bucket, a [BANKING ORGANIZATION] must:
(A) Calculate a hedge benefit ratio (HBR) to recognize hedging
between long and short net default exposures within a bucket as
follows:
[GRAPHIC] [TIFF OMITTED] TP18SE23.136
where,
(1) Net defulat exposure(long) equals the
aggregate net long default exposure, calculated as the simple sum of
the net long default exposures across obligors;
(2) Net defulat exposure(short) equals the
aggregate net short default exposure, calculated as the simple sum of
the net short default exposures across obligors.
(B) Assign risk weights to the obligor-level net default exposures
using the corresponding risk weights specified for the default risk
category; and
(C) Generate bucket-level default risk capital requirements by
aggregating risk weighted obligor-level net default exposures according
to the specified aggregation formulas in paragraphs (b)(3)(ii),
(c)(3)(iii) and (d)(3)(iv) of this section.
(v) The standardized default risk capital requirement for non-
securitization debt and equity positions or securitization positions
non-CTP equals the sum of the bucket-level default risk capital
requirements. The standardized default risk capital requirement for
correlation trading positions must be calculated in accordance with the
aggregation formula in paragraph (d)(3)(v) of this section.
(3) A [BANKING ORGANIZATION] may not recognize any diversification
benefits across default risk categories. The overall standardized
default risk capital requirement is the sum of the default risk capital
requirement for each default risk category.
(4) For purposes of calculating the standardized default risk
capital requirement, a [BANKING ORGANIZATION] may apply the look-
through approach to credit and equity indices that are non-
securitization debt or equity positions.
(b) Standardized default risk capital requirement for non-
securitization debt or equity positions--(1) Gross default exposure.
(i) A [BANKING ORGANIZATION] must calculate the gross default exposure
for each non-securitization debt or equity position.
(ii) A [BANKING ORGANIZATION] must determine the long and short
direction of a gross default exposure with respect to whether there
would be a loss (long) or a gain (short) in the event of a default.
(iii) A [BANKING ORGANIZATION] must calculate the gross default
exposure based on the loss given default (LGD) rate, notional amount
(or face value) and the cumulative profit and loss (P&L) already
realized on the non-securitization position, as follows:
Gross default exposure(long) = max((LGD rate x
notional amount + P&L), 0)
Gross default exposure(short) = min((LGD rate x
notional amount + P&L), 0)
(iv) When applying the look-through approach to multi-underlying
exposures or index options, a [BANKING ORGANIZATION] must set the gross
default exposure assigned to a single name, referenced by the
instrument, equal to the difference between the value of the instrument
assuming only the single name defaults (with zero recovery) and the
value of the instrument assuming none of the single names referenced by
the instrument default.
(v) A [BANKING ORGANIZATION] must assign LGD rates to non-
securitization debt or equity positions as follows:
(A) 100 percent for equity and non-senior debt and defaulted
positions;
(B) 75 percent for senior debt;
(C) 75 percent for GSE debt issued, but not guaranteed, by GSEs;
(D) 25 percent for GSE debt guaranteed by GSEs;
(E) 25 percent for covered bonds; and
(F) Zero percent if the value of the non-securitization debt or
equity position is not linked to the recovery rate of the defaulter.
(vi) For credit derivatives, a [BANKING ORGANIZATION] must use the
LGD rate of the reference exposure.
(vii) A [BANKING ORGANIZATION] must reflect the notional amount of
a non-securitization debt or equity position that gives rise to a long
(short) gross default exposure as a positive (negative) value and the
loss (gain) as a negative (positive) value. If the contractual or legal
terms of the derivative contract allow for the unwinding of the
instrument, with no exposure to default risk, the gross default
exposure equals zero.
(viii) For all non-securitization debt or equity positions, the
notional amount equals the amount of the non-securitization debt or
equity position relative to which the loss of principal is calculated.
For a call option on a non-securitization position, the notional amount
to be used in the gross default exposure calculation is zero.
(2) Net default exposures. To calculate the net default exposure to
an obligor, a [BANKING ORGANIZATION] must sum the maturity-weighted
default exposures to the issuer and in doing so, may offset long and
short gross default exposures to the same obligor, provided the short
gross default exposures have the same or lower seniority relative to
the long gross default exposures. In determining whether a market risk
covered position that has an eligible guarantee is an exposure to the
underlying obligor or an exposure to the eligible guarantor, the credit
risk mitigation requirements set out in Sec. __.36 and Sec. __.120
and Sec. __.121 apply. For purposes of this section, GSEs may be
considered eligible guarantors and each GSE must be considered a
separate obligor, provided that a [BANKING ORGANIZATION]
[[Page 64264]]
may fully offset long and short gross default exposures to Uniform
Mortgage-Backed Securities that are issued by two different obligors.
(3) Calculation of the standardized default risk capital
requirement for non-securitization debt or equity positions. (i) To
calculate the standardized default risk capital requirement for non-
securitization debt or equity positions, a [BANKING ORGANIZATION] must
assign each non-securitization debt or equity position to one of four
buckets:
(A) Non-U.S. sovereign positions;
(B) PSE and GSE debt positions;
(C) Corporate positions; and
(D) Defaulted positions.
(ii) A [BANKING ORGANIZATION] must calculate the bucket-level
default risk capital requirement, DRCb, for each bucket, b, for non-
securitization debt or equity positions as follows:
[GRAPHIC] [TIFF OMITTED] TP18SE23.137
where i refers to a non-securitization debt or equity position
belonging to bucket b and the corresponding risk weights, RWi, are set
out in Table 1 of this section:
[GRAPHIC] [TIFF OMITTED] TP18SE23.138
(iii) The standardized default risk capital requirement for non-
securitization debt or equity positions equals the sum of the four
bucket-level default risk capital requirements.
(c) Standardized default risk capital requirement for
securitization positions non-CTP-- (1) Gross default exposure. (i) A
[BANKING ORGANIZATION] must determine the gross default exposure for
each securitization position non-CTP using the approach for non-
securitization debt or equity positions in paragraphs (b)(1)(i), (ii),
and (vi) of this section, treating each securitization position non-CTP
as a non-securitization debt or equity position. The gross default
exposure for a securitization position non-CTP equals the position's
market value.
(2) Net default exposure. (i) A [BANKING ORGANIZATION] may offset
long and short securitization positions non-CTP if the positions have
the same underlying asset pools and belong to the same tranche.
(ii) A [BANKING ORGANIZATION] may offset long and short
securitization positions non-CTP with one or more long and short non-
securitization positions by decomposing the exposures of the non-
tranched index instruments. To recognize offsetting for securitization
positions non-CTP, a [BANKING ORGANIZATION] must sum the equivalent
underlying assets of the decomposed non-tranche index instruments to
the equivalent replicating tranches that span the entire capital
structure of the securitized instrument. Non-securitization positions
that are recognized as offsetting in this way must be excluded from the
calculation of the standardized default risk capital requirement for
non-securitization debt or equity positions under paragraph (b) of this
section.
(iii) Securitization positions non-CTP that can be replicated
through decomposition may offset. Specifically, if a collection of long
securitization positions non-CTP can be replicated by a collection of
short securitization positions non-CTP, then the long and
[[Page 64265]]
short securitization positions non-CTP may offset.
(3) Calculation of the standardized default risk capital
requirement for securitization positions non-CTP. (i) To calculate the
standardized default risk capital requirement for securitization
positions non-CTP, a [BANKING ORGANIZATION] must assign each
securitization position non-CTP to one of the following buckets:
(A) Corporate positions;
(B) Asset class buckets defined along two dimensions:
(1) Asset class: asset-backed commercial paper, auto loans/leases,
RMBS, credit cards, commercial mortgage-backed securities,
collateralized loan obligations, collateralized debt obligations
squared, small and medium enterprises, student loans, other retail, and
other wholesale; and
(2) Region: Asia, Europe, North America, and other.
(ii) When assigning securitization positions non-CTP to a bucket, a
[BANKING ORGANIZATION] must rely on market convention for classifying
securitization positions non-CTP by asset class and region of the
underlying assets. In addition, a [BANKING ORGANIZATION] must assign:
(A) Each securitization position non-CTP to exactly one bucket and
must assign all securitization positions non-CTP with underlying
exposures in the same asset class and region to the same bucket;
(B) Any securitization position non-CTP that is not a corporate
position and that a [BANKING ORGANIZATION] cannot assign to a specific
asset class or region, must be assigned to one of the ``other''
buckets.
(iii) A [BANKING ORGANIZATION] must calculate the bucket-level
default risk capital requirement, DRCb, for each bucket, b, for
securitization positions non-CTP as follows:
[GRAPHIC] [TIFF OMITTED] TP18SE23.139
where,
(A) i refers to a securitization position non-CTP belonging to
bucket b;
(B) HBR equals the hedge benefit ratio specified in paragraph
(a)(2)(iv)(A) of this section; and
(C) RWi equals:
(1) For the calculation of Expanded Total Risk-Weighted Assets, the
corresponding risk weight that would apply to the securitization
exposure under Sec. __.132 or Sec. __.133 multiplied by 8 percent; or
(2) For the calculation of Standardized Total Risk-Weighted Assets,
the corresponding risk weight that would apply to the securitization
exposure under Sec. __. 42, Sec. __.43, or Sec. __.44 multiplied by
8 percent.
(3) Provided that a [BANKING ORGANIZATION] may cap the standardized
default risk capital requirement for an individual cash securitization
position non-CTP at its fair value.
(iv) The standardized default risk capital requirement for
securitization positions non-CTP equals the sum of the bucket-level
default risk capital requirements.
(d) Standardized default risk capital requirement for correlation
trading positions--(1) Gross default exposure. (i) A [BANKING
ORGANIZATION] must determine the gross default exposure for each
correlation trading position using the approach for non-securitization
debt or equity positions in paragraphs (b)(1)(i), (ii), and (vi) of
this section, including the determination of the direction (long or
short) of the correlation trading position, provided that the gross
default exposure for a correlation trading position is its market
value.
(ii) A [BANKING ORGANIZATION] must treat a Nth-to-default position
as a tranched position with attachment and detachment points calculated
as:
[GRAPHIC] [TIFF OMITTED] TP18SE23.140
where ``total names'' is the total number of single names in the
underlying basket or pool.
(2) Net default exposure. (i) A [BANKING ORGANIZATION] may
recognize offsetting for correlation trading positions that are
otherwise identical, except for maturity, including index tranches of
the same series.
(ii) A [BANKING ORGANIZATION] may offset combinations of long gross
default exposures and combinations of short gross default exposures of
tranches that are perfect replications of non-tranched correlation
trading positions.
(iii) A [BANKING ORGANIZATION] may offset long and short gross
default exposures of the types of exposures
[[Page 64266]]
listed in paragraphs (d)(2)(i) and (ii) through decomposition, provided
that the long and short gross default exposures are otherwise
equivalent except for a residual component and that a [BANKING
ORGANIZATION] must account for the residual exposure in the calculation
of the net default exposure.
(iv) A [BANKING ORGANIZATION] may offset long and short gross
default exposures of different tranches of the same index and series
through replication and decomposition, if the residual component has
the attachment and detachment point nested with the original tranche or
the combination of tranches. A [BANKING ORGANIZATION] must account for
the residual component of the unhedged tranche.
(3) Calculation of the standardized default risk capital
requirement for correlation trading positions. (i) To calculate the
default risk capital requirement for a correlation trading position, a
[BANKING ORGANIZATION] must assign each index to a bucket of its own.
(ii) A [BANKING ORGANIZATION] must assign a bespoke correlation
trading position that is substantially similar to an index to the
bucket corresponding to the index. A [BANKING ORGANIZATION] must assign
each bespoke correlation trading position that is not substantially
similar to an index to a bucket of its own.
(iii) For a non-securitization position that hedges a correlation
trading position, a [BANKING ORGANIZATION] must assign such position
and the related correlation trading position to the same bucket.
(iv) A [BANKING ORGANIZATION] must calculate the bucket-level
default risk capital requirement, DRCb, for each bucket, b, for
correlation trading positions as follows:
[GRAPHIC] [TIFF OMITTED] TP18SE23.141
where,
(A) i refers to a correlation trading position belonging to bucket
b.
(B) HBRCTP equals the hedge benefit ratio specified in paragraph
(a)(2)(iv)(A) of this section, but calculated using the combined long
and short net default exposures across all indices in the correlation
trading position default risk category.
(C) The summation of risk-weighted net default exposures in the
formula spans all exposures relating to the index.
(D) RWi equals:
(1) For tranched correlation trading positions:
(i) For the calculation of Expanded Total Risk-Weighted Assets, the
corresponding risk weight that would apply to the securitization
exposure under Sec. __.132 or Sec. __.133 multiplied by 8 percent; or
(ii) For the calculation of Standardized Total Risk-Weighted
Assets, the corresponding risk weight that would apply to the
securitization exposure under Sec. __. 42, Sec. __.43, or Sec. __.44
multiplied by 8 percent.
(2) For non-tranched hedges of correlation trading positions, the
same risk weights as for non-securitization debt or equity positions,
provided that such hedges must be excluded from the calculation of the
standardized default risk capital requirement for non-securitization
debt or equity positions.
(v) A [BANKING ORGANIZATION] must calculate the standardized
default risk capital requirement for correlation trading positions by
aggregating the bucket-level capital requirements as follows:
[GRAPHIC] [TIFF OMITTED] TP18SE23.142
Sec. __.211 Residual risk add-on.
(a) A [BANKING ORGANIZATION] must calculate the residual risk add-
on for all market risk covered positions identified as follows:
(1) Market risk covered positions that have an exotic exposure.
(2) Market risk covered positions that are:
(i) Correlation trading positions with three or more underlying
exposures, except for market risk covered positions that are hedges of
correlation trading positions;
(ii) Subject to the curvature capital requirement (excluding any
market risk covered positions without optionality that a [BANKING
ORGANIZATION] chooses to include in the calculation of its curvature
capital requirement as described under Sec. __.206(d)) or the vega
capital requirements and have pay-offs that cannot be replicated as a
finite linear combination of vanilla options or the underlying
instrument;
(iii) Options or positions with embedded options that do not have a
maturity; and
(iv) Options or positions with embedded options that do not have a
strike price or barrier, or that have multiple strike prices or
barriers.
(3) Any other market risk covered positions that the [AGENCY]
determines must be subject to the residual risk add-on in order to
capture the material risks of the position.
(4) Notwithstanding paragraph (a)(2) of this section, a [BANKING
ORGANIZATION] may exclude the following market risk covered positions
from the residual risk add-on:
(i) Market risk covered position that are listed;
(ii) Market risk covered position that are eligible to be cleared
by a CCP or QCCP; and
[[Page 64267]]
(iii) Market risk covered position that are options without path
dependent pay-offs or with two or fewer underlyings.
(5) Notwithstanding paragraphs (a)(1) and (2) of this section, a
[BANKING ORGANIZATION] may exclude the following market risk covered
positions from the residual risk add-on:
(i) In the case where a market risk covered position is a
transaction that exactly matches that with a third-party transaction
(back-to-back transactions), both transactions;
(ii) In the case where a market risk covered position can be
delivered into a derivative contract that it hedges in fulfillment of
the contract, both the market risk covered position and the derivative
contract;
(iii) Securities issued or guaranteed by the U.S. government or GSE
debt;
(iv) Any market risk covered position that is subject to the
fallback capital requirement;
(v) Internal transactions between two trading desks, if only one
trading desk is a model-eligible trading desk; and
(vi) Any other market risk covered positions that the [AGENCY]
determines are not required to be subject to the residual risk add-on
because the material risks are sufficiently capitalized under this
subpart F.
(b) Calculation of the residual risk add-on. (1) The residual risk
add-on equals the sum of the gross effective notional amounts of market
risk covered positions identified in paragraph (a) of this section,
multiplied by the prescribed risk weight as set out as follows:
(i) The risk weight for market risk covered positions identified in
paragraph (a)(1) of this section is 1.0 percent.
(ii) The risk weight for market risk covered positions identified
in paragraph (a)(2) of this section is 0.1 percent.
(2) For purposes of calculating the residual risk add-on, the gross
effective notional amount means the notional amount as a [BANKING
ORGANIZATION] reports in the most recent Call Report or FR Y-9C.
Internal Models Approach
Sec. __.212 Operational requirements for the models-based measure for
market risk.
(a) General requirements. In order to calculate the models-based
measure for market risk, a [BANKING ORGANIZATION] must:
(1) Have at least one model-eligible trading desk; and
(2) Receive prior written approval from the [AGENCY] of the
[BANKING ORGANIZATION]'s trading desk structure.
(b) Trading desk identification and approval process--(1)
Identification of trading desks. A [BANKING ORGANIZATION] must identify
a trading desk for which the [BANKING ORGANIZATION] will seek approval
to be a model-eligible trading desk and in making this identification
must:
(i) Consider whether having the trading desk be a model-eligible
trading desk would better reflect the market risk of the market risk
covered positions on the trading desk;
(ii) Exclude any trading desk that includes more than de minimis
amounts of securitization positions or correlation trading positions;
and
(iii) For any trading desk that includes de minimis amounts of
securitization positions or correlation trading positions:
(A) Subject securitization positions and correlation trading
positions to the capital add-ons for ineligible positions on model-
eligible trading desks under Sec. __.204(f);
(B) Not consider securitization positions and correlation trading
positions on model-eligible trading desks to be market risk covered
positions on a model-eligible trading desk; and
(C) Exclude securitization positions and correlation trading
positions on model-eligible trading desks from aggregate trading
portfolio backtesting, under Sec. __.204(g), and the relevant trading
desks' backtesting and PLA-testing, under Sec. __.213, unless the
[BANKING ORGANIZATION] receives approval from the [AGENCY] to include
such positions for backtesting and PLA-testing purposes.
(2) Approval process for trading desks. A [BANKING ORGANIZATION]
must receive prior written approval of the [AGENCY] for a trading desk
to be a model-eligible trading desk. To receive such approval, a
[BANKING ORGANIZATION] must:
(i) Receive approval by [AGENCY] of the internal models to be used
by the trading desk pursuant to Sec. __.212(c); and
(ii) Comply with one of the following:
(A) Provide at least 250 business days of trading desk level
backtesting and PLA test results for the trading desk to the [AGENCY];
(B) Provide at least 125 business days of trading desk level
backtesting and PLA test results for the trading desk to the [AGENCY]
and demonstrate to the satisfaction of the [AGENCY] that the internal
models will be able to meet the backtesting and PLA testing on an
ongoing basis;
(C) Demonstrate that the trading desk consists of similar market
risk covered positions to another trading desk of the [BANKING
ORGANIZATION], which has been approved by the [AGENCY] and has provided
at least 250 business days of trading desk level backtesting and PLA
test results to the [AGENCY]; or
(D) Subject the trading desk to the PLA add-on until the trading
desk provides at least 250 business days of trading desk-level
backtesting and PLA test results, produces results in the PLA test
green zone, and passes trading desk-level backtesting.
(3) Changes to trading desk structure. (i) A [BANKING ORGANIZATION]
must receive prior written approval from the [AGENCY] before the
[BANKING ORGANIZATION] implements any change to its trading desk
structure that would result in a material change in the [BANKING
ORGANIZATION]'s market risk capital requirement for a portfolio of
market risk covered positions.
(ii) A [BANKING ORGANIZATION] must promptly notify the [AGENCY]
when the [BANKING ORGANIZATION] makes any change to its trading desk
structure that would result in a non-material change in the [BANKING
ORGANIZATION]'s market risk capital requirement for a portfolio of
market risk covered positions.
(4) The [AGENCY] may rescind its approval of a model-eligible
trading desk or subject such trading desk to the PLA add-on if the
[AGENCY] determines that the trading desk no longer complies with any
of the applicable requirements of this subpart F, provided that the
trading desk may not be subjected to the PLA add-on if the approval for
a stressed expected shortfall methodology used by the trading desk was
rescinded. A model-eligible trading desk that becomes subject to the
PLA add-on under this paragraph (b)(4) shall remain subject to the PLA
add-on until the [AGENCY] determines that the trading desk is no longer
subject to the PLA add-on under this paragraph (b)(4).
(c) Approval of internal models and stressed expected shortfall
methodologies--(1) Initial approval. A [BANKING ORGANIZATION] must
receive prior written approval of the [AGENCY] to use an internal model
for the ES-based measure in Sec. __.215(b), and the stressed expected
shortfall methodologies. To receive [AGENCY] approval of an internal
model or methodology, a [BANKING ORGANIZATION] must demonstrate:
(i) The internal model properly measures all the material risks of
the
[[Page 64268]]
market risk covered positions to which it is applied;
(ii) The internal model has been properly validated, consistent
with paragraph (d)(3) of this section;
(iii) The level of sophistication of the internal model or
methodology is commensurate with the complexity and amount of its
market risk covered positions; and
(iv) The internal model or methodology meets the applicable
requirements of this subpart F.
(2) Changes to internal models. (i) A [BANKING ORGANIZATION] must
receive prior written approval from the [AGENCY] before the [BANKING
ORGANIZATION] implements any change to an approved model, including any
change to its modelling assumptions, that would result in a material
change in the [BANKING ORGANIZATION]'s IMCC for a trading desk.
(ii) A [BANKING ORGANIZATION] must promptly notify the [AGENCY]
when the [BANKING ORGANIZATION] makes any change to an approved model,
including any change to its modelling assumptions, that would result in
a non-material change in the [BANKING ORGANIZATION]'s IMCC for a
trading desk.
(3) If the [AGENCY] determines that the [BANKING ORGANIZATION] no
longer complies with this subpart F or that the [BANKING
ORGANIZATION]'s internal models or methodologies fail to accurately
reflect the risks of any of the [BANKING ORGANIZATION]'s market risk
covered positions, the [AGENCY] may rescind its approval of an internal
model or methodology previously approved under paragraph (c)(1) of this
section, or impose the PLA add-on on the trading desk using the
internal model for the ES-based measure pursuant to paragraph (b)(4) of
this section. When approval for an internal model or methodology is
rescinded, any trading desk that had used that internal model or
methodology must be a model-ineligible trading desk.
(d) Review, risk management, and validation. (1) A [BANKING
ORGANIZATION] must, no less frequently than annually, review its
internal models in light of developments in financial markets and
modeling technologies, and enhance those internal models as appropriate
to ensure that they continue to meet the [AGENCY]'s standards for model
approval and employ risk measurement methodologies that are the most
appropriate for the [BANKING ORGANIZATION]'s market risk covered
positions.
(2) A [BANKING ORGANIZATION] must integrate the internal models
used for calculating the ES-based measure in Sec. __.215(b) into its
daily risk management process.
(3) A [BANKING ORGANIZATION] must validate its internal models
initially and on an ongoing basis. A [BANKING ORGANIZATION] must
revalidate its internal models when it makes any material changes to
the models or when there have been significant structural changes in
the market or changes in the composition of the [BANKING
ORGANIZATION]'s market risk covered positions that might lead to the
[BANKING ORGANIZATION]'s internal models to be no longer adequate. The
[BANKING ORGANIZATION]'s validation process must be independent of the
internal models' development, implementation, and operation, or the
validation process must be subjected to an independent review of its
adequacy and effectiveness. Validation must include:
(i) An evaluation of the conceptual soundness of the internal
models;
(ii) An evaluation that the internal models adequately reflect all
material risks and that assumptions are appropriate and do not
underestimate risk;
(iii) An ongoing monitoring process that includes verification of
processes and the comparison of the [BANKING ORGANIZATION]'s model
outputs with relevant internal and external data sources or estimation
techniques;
(iv) An outcomes analysis process that includes backtesting and PLA
testing at the trading desk level; and
(v) Backtesting conducted at the aggregate level for all model-
eligible trading desks.
(e) Supervisory action for model-eligible trading desks. If
required by the [AGENCY], a [BANKING ORGANIZATION] that has one or more
model-eligible trading desks must calculate the standardized measure
for market risk for each model-eligible trading desk as if that trading
desk were a standalone regulatory portfolio. For each such model-
eligible trading desk, the [BANKING ORGANIZATION] must sum the risk
class-level capital requirements for each risk class under each
correlation scenario as described in Sec. __.206. For each such model-
eligible trading desk, the sensitivities-based capital requirement
equals the largest capital requirement produced under the three
correlation scenarios for the trading desk.
Sec. __.213 Trading desk level backtesting and PLA testing.
(a) A model-eligible trading desk must conduct backtesting as
described in paragraph (b) of this section and PLA testing as described
in paragraph (c) of this section at the trading desk level on a
quarterly basis.
(b) Trading desk level backtesting requirements. (1) Beginning on
the business day a trading desk becomes a model-eligible trading desk,
the [BANKING ORGANIZATION] must generate backtesting data by separately
comparing each business day's actual profit and loss and hypothetical
profit and loss with the corresponding VaR-based measure calculated by
the [BANKING ORGANIZATION]'s internal models for that business day, at
both the 97.5th percentile and the 99.0th percentile one-tail
confidence levels at the trading desk level.
(i) An exception for actual profit and loss at either percentile
occurs when the actual loss of the model-eligible trading desk exceeds
the corresponding VaR-based measure calculated at that percentile. An
exception for hypothetical profit and loss at either percentile occurs
when the hypothetical loss of the model-eligible trading desk exceeds
the corresponding VaR-based measure calculated at that percentile.
(ii) If either the business day's actual or hypothetical profit and
loss is not available or the [BANKING ORGANIZATION] is unable to
compute the business day's actual or hypothetical profit and loss, an
exception for actual profit and loss or for hypothetical profit and
loss, respectively, at each percentile occurs. If the VaR-based measure
for a business day is not available or the [BANKING ORGANIZATION] is
unable to compute the VaR-based measure for a particular business day,
exceptions for actual profit and loss and for hypothetical profit and
loss at each percentile occur. No exception will occur if the
unavailability or inability is related to an official holiday.
(iii) With approval of the [AGENCY], a [BANKING ORGANIZATION] may
consider an exception not to have occurred if:
(A) The [BANKING ORGANIZATION] can demonstrate that the exception
is due to technical issues that are unrelated to the [BANKING
ORGANIZATION]'s internal models; or
(B) The [BANKING ORGANIZATION] can demonstrate that one or more
non-modellable risk factors caused the relevant loss, and the capital
requirement for these non-modellable risk factors exceeds the
difference between the [BANKING ORGANIZATION]'s VaR-based measure
[[Page 64269]]
and the actual or hypothetical loss for that business day.
(2) In order to conduct backtesting, a [BANKING ORGANIZATION] must
count the number of exceptions over the most recent 250 business days.
A [BANKING ORGANIZATION] must count exceptions for actual profit and
loss at each percentile separately from exceptions for hypothetical
profit and loss.
(3) If any given model-eligible trading desk experiences either
more than 12 exceptions for actual profit and loss or 12 exceptions for
hypothetical profit and loss at the 99.0th percentile or 30 exceptions
for actual profit and loss or 30 exceptions for hypothetical profit and
loss at the 97.5th percentile in the most recent 250 business day
period, then the trading desk becomes, upon the completion of the
[AGENCY]'s quarterly review of the relevant backtesting data, a model-
ineligible trading desk.
(4) Notwithstanding paragraphs (b)(2) and (3) of this section, in
cases where a model-eligible trading desk is approved pursuant to Sec.
__.212(b)(2)(ii)(B), (C) or (D):
(i) The model-eligible trading desk that has fewer than 250
business days of backtesting data available must use all available
backtesting data; and
(ii) The [BANKING ORGANIZATION] must prorate the number of
allowable exceptions under paragraph (b)(3) of this section by the
number of business days for which backtesting data are available for
the model-eligible trading desk.
(5) A trading desk that becomes a model-ineligible trading desk
under paragraph (b)(3) of this section becomes a model-eligible trading
desk when:
(i) The trading desk produces results in the PLA test green zone or
PLA test amber zone and the trading desk experiences less than or equal
to 12 exceptions for actual profit and loss and 12 exceptions for
hypothetical profit and loss at the 99.0th percentile and 30 exceptions
for actual profit and loss and 30 exceptions for hypothetical profit
and loss at the 97.5th percentile in the most recent 250 business day
period; or
(ii) The [BANKING ORGANIZATION] receives approval of the [AGENCY].
(c) Trading desk level PLA test requirements--(1) General
requirements. At the trading desk level, the [BANKING ORGANIZATION]
must compare each of its most recent 250 business days' hypothetical
profit and loss with the corresponding daily risk-theoretical profit
and loss. Time effects must be treated in a consistent manner in the
hypothetical profit and loss and the risk-theoretical profit and loss.
(i) For the purpose of PLA testing, the [BANKING ORGANIZATION] may
align risk-theoretical profit and loss input data for its risk factors
with the data used in hypothetical profit and loss, where the [BANKING
ORGANIZATION] is able to demonstrate that hypothetical profit and loss
input data can be used appropriately for risk-theoretical profit and
loss purposes.
(ii) The [BANKING ORGANIZATION] may adjust risk-theoretical profit
and loss input data when the input data for a given risk factor that is
included in both the risk-theoretical profit and loss and the
hypothetical profit and loss differs due to different market data
sources, time fixing of market data sources, or transformations of
market data into input data suitable for the risk factors of the
underlying valuation engines. When transforming input data into a
format that can be applied to the risk factors used in internal risk
management models, the [BANKING ORGANIZATION] must demonstrate that no
differences in the risk factors or in the valuation models have been
omitted.
(iii) The [BANKING ORGANIZATION] must be able to assess the effect
that input data alignments would have on the risk-theoretical profit
and loss. The [BANKING ORGANIZATION] must be able to compare the risk-
theoretical profit and loss based on the hypothetical profit and loss
aligned market data with the risk-theoretical profit and loss based on
market data without alignment. This comparison must be performed when
designing or changing the input data alignment process or at the
request of the [AGENCY].
(2) PLA test metrics. (i) A [BANKING ORGANIZATION] must calculate
each metric in this paragraph (c)(2) at the trading desk level, using
the most recent 250 business days of the risk-theoretical profit and
loss and the hypothetical profit and loss.
(ii) Spearman correlation metric. The Spearman correlation metric
assesses the correlation between the risk-theoretical profit and loss
and the hypothetical profit and loss.
(A) For a time series of hypothetical profit and loss, a [BANKING
ORGANIZATION] must compute the rank order, RHPL, of the hypothetical
profit and loss based on the size, where the lowest value in the
hypothetical profit and loss time series receives a rank of 1, and the
next lowest value receives a rank of 2 and so on.
(B) Similarly, a [BANKING ORGANIZATION] must compute the rank
order, RRTPL, of the time series of the risk-theoretical profit and
loss.
(C) A [BANKING ORGANIZATION] must calculate the Spearman
correlation metric for the two rank orders, RHPL and RRTPL, as follows:
[GRAPHIC] [TIFF OMITTED] TP18SE23.143
Where cov(RHPL, RRTPL) is the covariance between RHPL and RRTPL and
sRHPL and sRTPL are the standard deviations of rank orders RHPL and
RRTPL, respectively.
(iii) Kolmogorov-Smirnov metric. The Kolmogorov-Smirnov metric
assesses the similarity of the distributions of the risk-theoretical
profit and loss and the hypothetical profit and loss.
(A) A [BANKING ORGANIZATION] must calculate the empirical
cumulative distribution function of the risk-theoretical profit and
loss where, for any value of risk-theoretical profit and loss, the
empirical cumulative distribution is the product of 0.004 and the
number of risk-theoretical profit and loss observations that are less
than or equal to the specified risk-theoretical profit and loss.
(B) A [BANKING ORGANIZATION] must calculate the empirical
cumulative distribution function of hypothetical profit and loss where,
for any value of hypothetical profit and loss, the empirical cumulative
distribution is the product of 0.004 and the number of hypothetical
profit and loss observations that are less than or equal to the
specified hypothetical profit and loss.
(C) A [BANKING ORGANIZATION] must calculate the Kolmogorov-Smirnov
metric as the largest absolute difference observed between these two
empirical cumulative distribution functions at any profit and loss
value.
(3) PLA test metrics evaluation. (i) A [BANKING ORGANIZATION] must
identify the PLA test zone of the trading desk's PLA test results as
set out in Table 1 of this section, provided that if either metric is
in the red zone, the PLA test zone must be identified as red, and if
one metric is in the amber zone and one in the green zone, the PLA test
zone must be identified as amber.
[[Page 64270]]
[GRAPHIC] [TIFF OMITTED] TP18SE23.144
(ii) Notwithstanding paragraph (c)(3)(i) of this section, the
[AGENCY] may determine that a [BANKING ORGANIZATION] must identify the
PLA test zone of a trading desk's PLA test results as a different PLA
test zone.
(iii) Upon the completion of the quarterly review of the relevant
PLA test data, a trading desk that produces results in the PLA test
amber zone, pursuant to paragraph (c)(3)(i) or (c)(3)(ii) of this
section, is subject to the PLA add-on.
(iv) Upon the completion of the quarterly review of the relevant
PLA test data, a trading desk that produces results in the PLA test red
zone, pursuant to paragraph (c)(3)(i) or (c)(3)(ii) of this section, is
a model-ineligible trading desk.
(v) A trading desk that becomes a model-ineligible trading desk
under paragraph (c)(3)(iv) of this section will become a model-eligible
trading desk when:
(A) The trading desk produces results in the PLA test green zone or
PLA test amber zone; and in the most recent 250 business day period,
the trading desk experiences less than or equal to 12 backtesting
exceptions for actual profit and loss and 12 exceptions for
hypothetical profit and loss at the 99.0th percentile or less than or
equal to 30 backtesting exceptions for actual profit and loss and 30
backtesting exceptions for hypothetical profit and loss at the 97.5th
percentile; or
(B) The [BANKING ORGANIZATION] receives approval of the [AGENCY].
(4) PLA add-on. The PLA add-on, if required under paragraph
(c)(3)(iii) of this section, Sec. __.212(b)(2)(ii)(D), or Sec.
__.212(b)(4), equals:
PLA add-on = k x max ((SAG,A-IMAG,A), 0)
where,
[GRAPHIC] [TIFF OMITTED] TP18SE23.145
(A) SAi denotes the standardized approach capital requirement for
market risk covered positions on trading desk, i;
(B) Si[isin]ASAi equals the sum of the standardized approach
capital requirement, calculated separately, for each trading desk i
that is subject to the PLA add-on; and
(C) Si[isin]G,ASAi equals the sum of the standardized approach
capital requirement, calculated separately, for each model-eligible
trading desk i (including trading desks subject to the PLA add-on).
Sec. __.214 Risk factor identification and model eligibility.
(a) Identification of risk factors. A [BANKING ORGANIZATION] must
identify an appropriate set of risk factors to be used for purposes of
calculating the aggregate capital measure for modellable risk factors,
IMCC, and the aggregate capital measure for non-modellable risk
factors, SES, subject to the requirements below:
(1) The set of risk factors must be sufficient to represent the
risks inherent in the market risk covered positions held by model-
eligible trading desks;
(2) The [BANKING ORGANIZATION] must include all risk factors
included in the [BANKING ORGANIZATION]'s internal risk management
models or models used in reporting actual profits and losses; and
(3) The [BANKING ORGANIZATION] must include all risk factors that
are specified in Sec. __.208 for each corresponding risk class. In the
event the [BANKING ORGANIZATION] does not incorporate all such risk
factors, the [BANKING ORGANIZATION] must be able to support this
omission to the satisfaction of the [AGENCY].
(b) Model eligibility of risk factors. A [BANKING ORGANIZATION]
that calculates the models-based measure for market risk must determine
which risk factors are modellable using the risk factor eligibility
test described in paragraph (b)(1) of this section. If the [AGENCY]
determines that a risk factor is non-modellable, then a [BANKING
ORGANIZATION] must not consider that risk factor as modellable. The
[BANKING ORGANIZATION] must calculate its market risk capital
requirements for modellable risk factors using the ES-based measure in
Sec. __.215(b) and must calculate its market risk capital requirements
for non-modellable risk factors using stressed expected shortfall
methodologies in accordance with Sec. __.215(d).
(1) Risk factor eligibility test. For a risk factor to be
classified as modellable, a [BANKING ORGANIZATION] must identify a
sufficient number of real prices, as specified in this paragraph
(b)(1), that are representative of the risk factor. A real price is
representative of a risk factor provided it can be used by the [BANKING
ORGANIZATION] to inform the value of the risk factor. For contracts
that reference new reference rates to replace discontinued reference
rates, [BANKING ORGANIZATIONS] are permitted to use discontinued
reference rate quotes to pass the risk factor eligibility test until
new reference rate liquidity improves. For any market risk covered
position, the [BANKING ORGANIZATION] must not count more than one real
price observation in a single day and the real price that the [BANKING
ORGANIZATION] observes must be counted as an observation for all of the
risk factors for which it is representative. In addition, for new
issuances, the observation period for the risk factor eligibility test
may begin on the issuance date and the number of real price
observations required to pass the risk factor eligibility test may be
prorated until 12 months after the issuance date. To pass the risk
factor eligibility test, a risk factor must meet either of the
following criteria, on a quarterly basis.
(i) The [BANKING ORGANIZATION] must identify at least 24 real price
observations in the previous 12-month period for the risk factor, and
there must be no 90-day period in the previous 12-month period in which
fewer than four real price observations are identified for the risk
factor; or
(ii) The [BANKING ORGANIZATION] must identify at least 100 real
price observations for the risk factor over the previous 12-month
period.
(2) When one or more actual transactions between arm's-length
parties occurred on a specific date, only one real price may be
counted.
[[Page 64271]]
(3) When a [BANKING ORGANIZATION] uses real prices from a third-
party provider:
(i) The third-party provider must provide a minimum necessary set
of identifier information to enable the [BANKING ORGANIZATION] to map
real prices observed to risk factors;
(ii) The third-party provider must be subject to an audit regarding
the validity of its pricing information and the results and reports of
this audit must be made public or available on request to the [BANKING
ORGANIZATION], provided that if the audit of a third-party provider is
not satisfactory to the [AGENCY], the data from the third-party
provider may not be used for purposes of the risk factor eligibility
test; and
(iii) When the real price observations are provided with a time
lag, the period used for the risk factor eligibility test may differ
from the period used to calibrate the [BANKING ORGANIZATION]'s ES-based
measure, provided that the difference is no greater than one month.
(4) When a [BANKING ORGANIZATION] uses real prices from internal
sources, the period used for the risk factor eligibility test may also
differ from the period used to calibrate the [BANKING ORGANIZATION]'s
ES-based measure, as long as the period used for internal data is
exactly the same as the period used for external data.
(5) Bucketing approaches. For the risk factor eligibility test, a
[BANKING ORGANIZATION] must allocate each real price observation into
one bucket for a risk factor and must count all real price observations
allocated to a bucket in order to establish whether the risk factors in
the bucket pass the risk factor eligibility test. To allocate real
price observations into buckets, the [BANKING ORGANIZATION] must group
risk factors on a curve or surface level. Each bucket may be defined by
using either of the bucketing approaches specified in this paragraph
(b)(5).
(i) Own bucketing approach. Under this approach, each bucket must
include only one risk factor. Each risk factor must correspond to a
risk factor included in the risk-theoretical profit and loss of the
[BANKING ORGANIZATION]. Real price observations may be mapped to more
than one risk factor.
(ii) Standard bucketing approach. Under this approach, the [BANKING
ORGANIZATION] must use the standard buckets as set out as follows:
(A) For interest rate, foreign exchange and commodity risk factors
with a single maturity dimension (excluding implied volatilities), (t,
where t is measured in years), the buckets corresponding to the t
values in row (A) of Table 1 of this section must be used.
(B) For interest rate, foreign exchange and commodity risk factors
with several maturity dimensions (excluding implied volatilities) (t,
where t is measured in years), the buckets corresponding to the t
values in row (B) of Table 1 of this section must be used.
(C) Credit spread and equity risk factors with one or several
maturity dimensions (excluding implied volatilities) (t, where t is
measured in years), the buckets corresponding to the t values in row
(C) of Table 1 of this section must be used.
(D) For any risk factors with one or several strike dimensions (the
probability that an option is ``in the money'' at maturity, d), the
buckets corresponding to the d values in row (D) of Table 1 of this
section must be used.
(E) For expiry and strike dimensions of implied volatility risk
factors (excluding those of interest rate swaptions), only the buckets
corresponding to the t or d values in rows (C) and (D), respectively,
of Table 1 of this section must be used.
(F) For maturity, expiry and strike dimensions of implied
volatility risk factors from options on swaps, only the buckets
corresponding to the t or d values in row (B), (C) and (D),
respectively, of Table 1 of this section must be used.
(G) For options markets where alternative definitions of moneyness
are customary, a [BANKING ORGANIZATION] must convert the standard
buckets to the market-standard convention using the [BANKING
ORGANIZATION]'s own pricing models.
[GRAPHIC] [TIFF OMITTED] TP18SE23.146
(iii) For purposes of the risk factor eligibility test, a real
price observation must be counted in a single bucket based on the
maturity or based on the probability that an option is ``in the money''
at maturity associated with the position. Real price observations that
have been identified within the prior 12 months may be counted in the
maturity bucket to which they were initially allocated. Alternatively,
a [BANKING ORGANIZATION] may re-allocate these real price observations
to the shorter maturity bucket that reflects the market risk covered
position's remaining maturity.
(iv) A [BANKING ORGANIZATION] may decompose risks associated with
credit or equity indices into systematic risk factors within its
internal models designed to capture market-wide
[[Page 64272]]
movements for a given economy, region or sector. A [BANKING
ORGANIZATION] may include idiosyncratic risk factors of specific
issuers provided there are a sufficient number of real price
observations to pass the risk factor eligibility test.
(6) Calibration. The [BANKING ORGANIZATION] must choose the most
appropriate data for modellable risk factors to calibrate the ES-based
measure. For the calibration, the [BANKING ORGANIZATION] may use
different data than the data used to pass the risk factor eligibility
test.
(7) Data for modellable risk factors. In order to determine the
data used to calibrate the ES-based measure, a [BANKING ORGANIZATION]
must comply with this paragraph (b)(7). In cases where a risk factor
has passed the risk factor eligibility test, but the related data does
not comply with this paragraph (b)(7), such risk factor must be treated
as a non-modellable risk factor.
(i) The data used may include combinations of modellable risk
factors.
(ii) The data must allow the internal models used to calculate the
ES-based measure to capture both idiosyncratic risk and systematic
risk, if applicable.
(iii) The data must allow the internal models used to calculate the
ES-based measure to reflect volatility and correlation of risk factors
of market risk covered positions.
(iv) The data must be reflective of prices observed or quoted in
the market. Where data used are not derived from real price
observations, the [BANKING ORGANIZATION] must be able to demonstrate
that the data used are reasonably representative of real price
observations.
(v) The data must be updated at a sufficient frequency, and at a
minimum on a weekly basis. Where the [BANKING ORGANIZATION] uses
regressions to estimate risk factor parameters, these must be re-
estimated on a regular basis. The [BANKING ORGANIZATION] must have
clear policies and procedures for backfilling and gap-filling missing
data.
(vi) The data to determine the liquidity horizon-adjusted ES-based
measure must be reflective of market prices observed or quoted in the
period of stress. The data should be sourced directly from the
historical period whenever possible. The [BANKING ORGANIZATION] must
empirically justify any instances where the market prices used in the
period of stress are different from the market prices actually observed
during that period. In cases where market risk covered positions that
are currently traded did not exist during a period of significant
financial stress, the [BANKING ORGANIZATION] must demonstrate that the
prices used match changes in prices or spreads of similar instruments
during the stress period.
(vii) The data may include proxies provided the [BANKING
ORGANIZATION] can demonstrate to the satisfaction of the [AGENCY] that
the proxies are appropriate and that the following standards are
satisfied:
(A) There is sufficient evidence demonstrating the appropriateness
of the proxies, such as an appropriate track record for their
representation of a market risk covered position;
(B) Proxies must have sufficiently similar characteristics to the
transactions they represent in terms of volatility level and
correlations;
(C) Proxies must be appropriate for the region, credit spread,
quality and type of instrument they are intended to represent; and
(D) Proxying of new risk-free reference rates, during the stressed
period, must appropriately capture the risk-free rate as well as credit
spread, if applicable.
(viii) The [AGENCY] may determine that the data for modellable risk
factors is unsuitable to calibrate the [BANKING ORGANIZATION]'s ES-
based measure.
Sec. __.215 The non-default risk capital measure.
(a) A [BANKING ORGANIZATION] that calculates the non-default risk
capital measure must calculate the ES-based measure, the aggregate
capital measure for modellable risk factors, IMCC, and the aggregate
capital measure for non-modellable risk factors, SES, in accordance
with this section.
(b) ES-based measure. Any internal model used by a [BANKING
ORGANIZATION] to calculate the ES-based measure must meet the following
minimum requirements:
(1) The ES-based measure must be computed for each business day at
the trading desk level, at the aggregate level, and on the aggregate
for each risk class for all model-eligible trading desks;
(2) The ES-based measure must be calculated using a one-tail,
97.5th percentile confidence level; and
(3) A liquidity horizon-adjusted ES-based measure must be
calculated from an ES-based measure at a base liquidity horizon of 10
days, with scaling applied to this base horizon result as specified
below:
[GRAPHIC] [TIFF OMITTED] TP18SE23.147
where,
(i) ES is the regulatory liquidity horizon-adjusted ES;
(ii) T is the length of the base liquidity horizon, 10 days;
(iii) EST(P) is the ES at base liquidity horizon T of a portfolio
with market risk covered positions P;
(iv) EST(P,j) is the ES at base liquidity horizon T of a portfolio
with market risk covered positions P for all risk factors whose
liquidity horizon LHj is at least as long as j;
(v) LHj is the liquidity horizon corresponding to the index value,
j, specified in Table 1 of this section:
(4) The time series of changes in risk factors over the base
liquidity horizon T may be calculated using observations of price
differentials from overlapping 10-day periods, provided, a [BANKING
ORGANIZATION] must not scale up from a shorter horizon; and
[[Page 64273]]
[GRAPHIC] [TIFF OMITTED] TP18SE23.148
(5) Stress period. A [BANKING ORGANIZATION] must identify a 12-
month period of stress over the observation horizon in which the
[BANKING ORGANIZATION]'s market risk covered positions on model-
eligible trading desks would experience the largest loss, provided
that:
(i) To identify the period of stress, a [BANKING ORGANIZATION] must
use either the full set of risk factors or a reduced set of risk
factors;
(ii) Any [BANKING ORGANIZATION] using a reduced set of risk factors
to identify the period of stress must:
(A) Specify a reduced set of risk factors for which there is a
sufficiently long history of observations;
(B) Update the reduced set of risk factors whenever the [BANKING
ORGANIZATION] updates its 12-month period of stress; and
(C) Ensure that the variation of the full ES-based measure
explained by the ES-based measure for the reduced set of risk factors
over the previous 60 business days is at least 75 percent, where the
variation explained equals
[GRAPHIC] [TIFF OMITTED] TP18SE23.149
where,
(1) ESF,C is the liquidity horizon-adjusted ES-based measure based
on the most recent 12-month observation period (the current ES-based
measure) using the full set of risk factors;
(2) ESR,C is the lesser of (i) the current liquidity horizon-
adjusted ES-based measure using the reduced set of factors or (ii)
ESF,C; and
(3) Mean(ESF,C) is the mean of ESF,C over the previous 60 business
days.
(iii) The observation horizon for determining the most stressful
12-month period, at a minimum, must span back to 2007;
(iv) Observations within this period must be equally weighted; and
(v) A [BANKING ORGANIZATION] must update, as appropriate, its 12-
month stressed period at least quarterly, or whenever there are
material changes in the risk factors in the portfolio.
(6) Liquidity horizon-adjusted ES-based measure. A [BANKING
ORGANIZATION] must calibrate the liquidity horizon-adjusted ES-based
measure to a period of stress for its entire portfolio of market risk
covered positions (on model-eligible trading desks) using one of the
two approaches set forth in this paragraph (b)(6).
(i) Direct approach. A [BANKING ORGANIZATION] using the direct
approach must use the full set of risk factors to calculate the
liquidity horizon-adjusted ES-based measure, provided a [BANKING
ORGANIZATION] may use proxies to fill in data on missing risk factors
in accordance with Sec. __.214(b)(7)(vii).
(ii) Indirect approach. A [BANKING ORGANIZATION] using the indirect
approach must follow the steps below to calculate the liquidity
horizon-adjusted ES-based measure:
(A) Calculate a liquidity horizon-adjusted ES-based measure in
accordance with paragraph (b)(3) of this section;
(B) Convert the three types of liquidity horizon-adjusted ES-based
measures defined below into one liquidity horizon-adjusted ES-based
measure, as follows:
[GRAPHIC] [TIFF OMITTED] TP18SE23.150
where,
(1) ESR,S is the liquidity horizon-adjusted ES-based measure for
the [BANKING ORGANIZATION]'s market risk covered positions (on model-
eligible trading desks) using the reduced set of risk factors,
calculated based on the 12-month period of stress;
(2) ESF,C is the liquidity horizon-adjusted ES-based measure based
on the most recent 12-month observation period (the current ES-based
measure) using the full set of risk factors; and
(3) ESR,C is the lesser of:
(i) the current liquidity horizon-adjusted ES-based measure using
the reduced set of factors; or
(ii) ESF,C.
(7) Input data. A [BANKING ORGANIZATION] must update its input data
for internal models used to calculate the ES-based measure no less
frequently than quarterly and reassess its input data whenever market
prices are subject to material changes. This updating process must be
flexible enough to allow for updates when warranted by material changes
in market prices.
(8) Risk capture. Internal models used to calculate the ES-based
measure must address non-linearities, as well as correlation and
relevant basis risks, such as basis risk between credit default swaps
and bonds.
[[Page 64274]]
(9) Empirical correlations. A [BANKING ORGANIZATION] may recognize
empirical correlations within risk factor classes. Empirical
correlations across risk factor classes are constrained by the
aggregation scheme as described in paragraph (c) of this section.
(10) Options. With respect to options, a [BANKING ORGANIZATION]'s
internal models used to calculate the ES-based measure must:
(i) Capture the risks associated with options, including non-linear
price characteristics, within each of the risk factor classes;
(ii) Have a set of risk factors that captures the volatilities of
the underlying rates and prices of options; and
(iii) Model the volatility surface across both strike price and
maturity.
(11) Assignment of liquidity horizons. At a minimum on a quarterly
basis, a [BANKING ORGANIZATION] must consistently assign a liquidity
horizon of 10, 20, 40, 60, or 120 days to each of its risk factors, and
must consistently map each of its risk factors to one of the risk
factor categories and corresponding liquidity horizons, n, in Table 2
of this section in accordance with the requirements of this paragraph
(b)(11).
(i) On a trading desk level basis, the minimum liquidity horizon is
the corresponding value, n, for the risk factor category in tTable 2 of
this section, unless otherwise specified in paragraphs (b)(11)(ii) and
(iii) of this section.
(ii) If the maturity of a market risk covered position is shorter
than the respective liquidity horizon, n, of the risk factor category
as set forth in Table 2 of this section, the minimum liquidity horizon
is the next longer liquidity horizon, n, from the maturity of the
market risk covered position.
(iii) The minimum liquidity horizon for credit and equity indices
and other similar multi-underlying instruments must be the shortest
liquidity horizon, n, that is equal to or longer than the weighted
average of the liquidity horizons of the underlyings, calculated by
multiplying the respective liquidity horizon, n, of the risk factor
category as set forth in Table 2 of this section of each individual
underlying by its weight in the index and summing the weighted
liquidity horizons across all underlyings.
(iv) Inflation risk factors must be mapped consistently with the
liquidity horizon for the interest rate risk factor category for a
given currency.
BILLING CODE 6210-01-P; 6714-01-P; 4810-33-P
[GRAPHIC] [TIFF OMITTED] TP18SE23.151
BILLING CODE 6210-01-C; 6714-01-C; 4810-33-C
(c) Modellable risk factors. A [BANKING ORGANIZATION] must
calculate an aggregate capital measure for modellable risk factors,
IMCC, on each business day in accordance with the below:
---------------------------------------------------------------------------
\1\ Any currency pair formed by the following list of
currencies: United States Dollar, Australian Dollar, Brazilian Real,
Canadian Dollar, Chinese Yuan, Euro, Hong Kong Dollar, Indian Rupee,
Japanese Yen, Mexican Peso, New Zealand Dollar, Norwegian Krone,
Singapore Dollar, South African Rand, South Korean Won, Swedish
Krona, Swiss Franc, Turkish Lira, United Kingdom Pound, and any
additional currencies specificed by the [AGENCY] under Sec.
__.209(b)(7)(ii).
---------------------------------------------------------------------------
(1) For all model-eligible trading desks, a [BANKING ORGANIZATION]
must include all modellable risk factors in its internal models used to
calculate
[[Page 64275]]
the aggregate liquidity horizon-adjusted ES-based measure. With prior
written approval of [AGENCY], a [BANKING ORGANIZATION] also may include
non-modellable risk factors in its internal models used to calculate
the aggregate liquidity horizon-adjusted ES-based measure.
(2) The [BANKING ORGANIZATION] must calculate its aggregate
liquidity horizon-adjusted ES-based measure, IMCC(C), using the
liquidity horizon-adjusted ES-based measure specified in paragraph (b)
of this section, with no supervisory constraints on cross-risk class
correlations.
(3) The [BANKING ORGANIZATION] must also calculate a series of
partial liquidity horizon-adjusted ES-based measures (with risk factors
of all other risk factor classes held constant) for each risk factor
class using the liquidity horizon-adjusted ES-based measure specified
in paragraph (b) of this section. These partial, non-diversifiable
liquidity horizon-adjusted ES-based measures, IMCC(Ci), must be summed
to provide an aggregated risk factor class ES-based measure. The stress
period used to calculate IMCC(C) and IMCC(Ci) must be the same.
(4) The aggregate capital measure for modellable risk factors,
IMCC, must be calculated as the weighted average of the constrained and
unconstrained ES-based measures as follows:
[GRAPHIC] [TIFF OMITTED] TP18SE23.153
Where,
(i) [rho] equals 0.5;
(ii) i indexes the following risk classes: interest rate risk,
credit spread risk, equity risk, commodity risk and foreign exchange
risk;
(iii) IMCC(C) equals the aggregate liquidity horizon-adjusted ES-
based measure specified in paragraph (c)(2) of this section; and
(iv) IMCC(Ci) equals the partial liquidity horizon-adjusted ES-
based measure specified in paragraph (c)(3) of this section for risk
class i.
(d) Non-modellable risk factors. (1) General. A [BANKING
ORGANIZATION] must calculate an aggregate capital measure for non-
modellable risk factors, SES, using stressed expected shortfall
methodologies that meet the following requirements:
(i) The [BANKING ORGANIZATION] must calculate a capital measure for
each non-modellable risk factor using a stress scenario that is
calibrated to be at least as prudent as the ES-based measure used for
modellable risk factors as described in paragraph (b) of this section,
provided that to determine the applicable stress scenario, the [BANKING
ORGANIZATION] must select a common 12-month period of stress for all
non-modellable risk factors in the same risk factor class, that in
determining the stress scenario, a [BANKING ORGANIZATION] may use
proxies, provided the proxies meet the standards in Sec.
__.214(b)(7)(vii), that, with approval of the [AGENCY], a [BANKING
ORGANIZATION] also may use an alternative approach to determine the
stress scenario, and that:
(A) Methodologies used to calculate any stressed expected shortfall
for non-modellable risk factors must address non-linearities, as well
as correlation and relevant basis risks, such as basis risk between
credit default swaps and bonds;
(B) For each non-modellable risk factor, the liquidity horizon of
the stress scenario must be the greater of (1) the risk factor's
liquidity horizon assigned pursuant to paragraph (b)(11) of this
section and (2) 20 days; and
(C) For non-modellable risk factors arising from idiosyncratic
credit spread risk or from idiosyncratic equity risk due to spot,
futures and forward prices, equity repo rates, dividends and
volatilities, the [BANKING ORGANIZATION] may apply a common 12-month
period of stress; and
(ii) When the [BANKING ORGANIZATION] cannot determine a stress
scenario for a risk factor class, or a smaller set of non-modellable
risk factors under paragraph (d)(1)(i) of this section, that is
acceptable to the [AGENCY], the [BANKING ORGANIZATION] must use the
scenario that produces the maximum possible loss as the stress
scenario.
(2) Stressed expected shortfall calculation. A [BANKING
ORGANIZATION] must calculate the aggregate capital measure, SES, for
non-modellable idiosyncratic credit spread risk factors, i, non-
modellable idiosyncratic equity risk factors, j, and the remaining non-
modellable risk factors, k, as follows:
[GRAPHIC] [TIFF OMITTED] TP18SE23.154
where,
(i) ISESNM,i is the stress scenario capital measure for non-
modellable idiosyncratic credit spread risk, i, aggregated with zero
correlation;
(ii) I is a non-modellable idiosyncratic credit spread risk factor;
(iii) ISESNM,j is the stress scenario capital measure for non-
modellable idiosyncratic equity risk, j, aggregated with zero
correlation;
(iv) J is a non-modellable idiosyncratic equity risk factor;
(v) SESNM,k is the stress scenario capital measure for the
remaining non-modellable risk factors, k;
(vi) K is the remaining non-modellable risk factors in a model-
eligible trading desk; and
(vii) [rho] equals 0.6.
Sec. __.216 [RESERVED]
Sec. __.217 Market risk reporting and disclosures.
(a) Scope. This section applies to [BANKING ORGANIZATIONS] subject
to the market risk capital requirements as described in Sec.
__.201(b)(1), provided that a [BANKING ORGANIZATION] that is a
consolidated subsidiary of a bank holding company,
[[Page 64276]]
covered savings and loan holding company that is a banking organization
as defined in 12 CFR 238.2, or a depository institution that is subject
to these requirements or of a non-U.S. banking organization that is
subject to comparable public disclosure requirements in its home
jurisdiction is not required to make the disclosures required by
paragraph (f) of this section.
(b) Timing. A [BANKING ORGANIZATION] must make the reports and
disclosures described herein beginning on [THE FIRST DATE OF THE
QUARTER THE RULE TAKES EFFECT]. A [BANKING ORGANIZATION] must make
timely public reports and disclosures each calendar quarter. If a
significant change occurs, such that the most recent reporting amounts
are no longer reflective of the [BANKING ORGANIZATION]'s capital
adequacy and risk profile, then a brief discussion of this change and
its likely impact must be provided in a public disclosure as soon as
practicable thereafter. Qualitative disclosures that typically do not
change each quarter may be disclosed annually, provided any significant
changes are disclosed in the interim.
(c) Reporting and disclosure policy. The [BANKING ORGANIZATION]
must have a formal reporting and disclosure policy approved by the
board of directors that addresses the [BANKING ORGANIZATION]'s approach
for determining its market risk reports and disclosures. The policy
must address the associated internal controls and reporting and
disclosure controls and procedures. The board of directors and senior
management must ensure that appropriate verification of the reports and
disclosures takes place and that effective internal controls and
reporting and disclosure controls and procedures are maintained. One or
more senior officers of the [BANKING ORGANIZATION] must attest that the
reports and disclosures meet the requirements of this subpart F, and
the board of directors and senior management are responsible for
establishing and maintaining an effective internal control structure
over financial reporting, including the reports and disclosures
required by this section.
(d) Proprietary and confidential information. If a [BANKING
ORGANIZATION] reasonably believes that reporting or disclosure of
specific commercial or financial information would materially prejudice
its position by making public certain information that is either
proprietary or confidential in nature, the [BANKING ORGANIZATION] is
not required to publicly report or disclose these specific items, but
must report or disclose more general information about the subject
matter of the requirement, together with the fact that, and the reason
why, the specific items of information have not been disclosed.
(e) Location. The [BANKING ORGANIZATION] must either provide all of
the public reports and disclosures required by this section in one
place on the [BANKING ORGANIZATION]'s public website or provide the
reporting and disclosures in more than one public financial report or
other public regulatory reports, provided that the [BANKING
ORGANIZATION] publicly provides a summary table specifically indicating
the location(s) of all such reporting and disclosures.
(f) Disclosures and reports--(1) Quarterly public disclosures. A
[BANKING ORGANIZATION] must disclose publicly the following information
at least quarterly:
(i) The aggregate amount of on-balance sheet and off-balance sheet
securitization positions by exposure type;
(ii) The soundness criteria on which the [BANKING ORGANIZATION]'s
internal capital adequacy assessment is based and a description of each
methodology used to achieve a capital adequacy assessment that is
consistent with the required soundness criteria, including, for a
[BANKING ORGANIZATION] that calculates the models-based measure for
market risk, for categories of non-modellable risk factors;
(iii) The aggregate amount of correlation trading positions; and
(iv) For a [BANKING ORGANIZATION] that calculates the models-based
measure for market risk, a comparison of VaR-based estimates with
actual gains or losses experienced by the [BANKING ORGANIZATION] for
each material portfolio of market risk covered positions, including an
analysis of important outliers.
(2) Annual public disclosures. A [BANKING ORGANIZATION] must
provide timely public disclosures of the following information at least
annually:
(i) A description of the structure and organization of the market
risk management system, including a description of the market risk
governance structure established to implement the strategies and
processes of the [BANKING ORGANIZATION] described in this paragraph
(f);
(ii) A description of the policies and processes for determining
whether a position is designated as a market risk covered position and
the risk management policies for monitoring market risk covered
positions;
(iii) The composition of material portfolios of market risk covered
positions;
(iv) A description of the scope and nature of risk reporting and/or
measurement systems and the strategies and processes implemented by the
[BANKING ORGANIZATION] to identify, measure, monitor and control the
[BANKING ORGANIZATION]'s market risks, including policies for hedging;
(v) A description of the trading desk structure and the types of
market risk covered positions included on the trading desks or in
trading desk categories, which must include:
(A) A description of the model-eligible trading desks for which a
[BANKING ORGANIZATION] calculates the non-default risk capital
requirement; and
(B) Any changes in the scope of model-ineligible trading desks and
the market risk covered positions on those trading desks.
(vi) The [BANKING ORGANIZATION]'s valuation policies, procedures,
and methodologies for each material portfolio of market risk covered
positions including, for securitization positions, the methods and key
assumptions used for valuing such securitization positions, any
significant changes since the last reporting period, and the impact of
such change;
(vii) The characteristics of the internal models used for purposes
of calculating the models-based measure for market risk and the
specific approaches used in the validation of these models. For the
non-default risk capital requirement, this must include a general
description of the model(s) used to calculate the ES-based measure in
Sec. __.215(b), the frequency by which data is updated, and a
description of the calculation based on current and stressed
observations.
(viii) A description of the approaches used for validating and
evaluating the accuracy of internal models and modeling processes for
purposes of this subpart F;
(ix) For each market risk category (that is, interest rate risk,
credit spread risk, equity risk, foreign exchange risk, and commodity
risk), a description of the stress tests applied to the market risk
covered positions subject to the factor;
(x) The results of the comparison of the [BANKING ORGANIZATION]'s
internal estimates for purposes of this subpart F with actual outcomes
during a sample period not used in model development;
[[Page 64277]]
(xi) A description of the [BANKING ORGANIZATION]'s processes for
monitoring changes in the credit and market risk of securitization
positions, including how those processes differ for resecuritization
positions; and
(xii) A description of the [BANKING ORGANIZATION]'s policy
governing the use of credit risk mitigation to mitigate the risks of
securitization positions and resecuritization positions.
(3) Public reports. A [BANKING ORGANIZATION] subject to the market
risk capital requirements as described in Sec. __.201(b)(1) must
provide, in the manner and form prescribed by the [AGENCY], a public
report of its measure for market risk, on a quarterly basis. A [BANKING
ORGANIZATION] must report additional information and reports as the
[AGENCY] may require.
(4) Confidential supervisory reports. (i) A [BANKING ORGANIZATION]
that calculates the models-based measure for market risk must provide
to the [AGENCY], in the manner and form prescribed by the [AGENCY], a
confidential supervisory report of backtesting and PLA testing
information, on a quarterly basis.
(ii) A [BANKING ORGANIZATION] must report to the [AGENCY] the
following information at the aggregate level for all model-eligible
trading desks for each business day over the previous 500 business
days, or all available business days, if 500 business days are not
available, with no more than a 20-day lag:
(A) Daily VaR-based measures calibrated to the 99.0th percentile as
described in Sec. __.204(g)(1);
(B) Daily ES-based measure calculated in accordance with Sec.
__.215(b) calibrated at the 97.5th percentile;
(C) The actual profit and loss;
(D) The hypothetical profit and loss; and
(E) The p-value of the profit or loss on each day, which is the
probability of observing a profit that is less than, or a loss that is
greater than, the amount reported for purposes of paragraph
(f)(4)(ii)(C) of this section based on the model used to calculate the
VaR-based measure described in paragraph (f)(4)(ii)(A) of this section.
(iii) A [BANKING ORGANIZATION] must report to the [AGENCY] the
following information for each trading desk for each business day over
the previous 500 business days, or all available business days, if 500
business days are not available, with no more than a 20-day lag:
(A) Daily VaR-based measures for the trading desk calibrated at
both the 97.5th percentile and the 99.0th percentile as described in
Sec. __.213(b)(1);
(B) Daily ES-based measure calculated in accordance with Sec.
__.215(b) calibrated at the 97.5th percentile;
(C) The actual profit and loss;
(D) The hypothetical profit and loss;
(E) Risk-theoretical profit and loss; and
(F) The p-values of the profit or loss on each day (that is, the
probability of observing a profit that is less than, or a loss that is
greater than, the amount reported for purposes of paragraph
(f)(4)(iii)(C) of this section based on the model used to calculate the
VaR-based measure described in paragraph (f)(4)(iii)(A) of this
section).
Sec. __.220 General requirements for CVA risk.
(a) Identification of CVA risk covered positions and eligible CVA
hedges. A [BANKING ORGANIZATION] must:
(1) Identify all CVA risk covered positions and all transactions
that hedge or are intended to hedge CVA risk;
(2) Identify all eligible CVA hedges; and
(3) For a [BANKING ORGANIZATION] that has approval to use the
standardized measure for CVA risk, identify all eligible CVA hedges for
the purposes of calculating the basic CVA approach capital requirement
and all eligible CVA hedges for the purpose of calculating the
standardized CVA approach capital requirement.
(b) CVA hedging policy. A [BANKING ORGANIZATION] that hedges its
CVA risk must have a clearly defined hedging policy for CVA risk that
is reviewed and approved by senior management at least annually. The
hedging policy must quantify the level of CVA risk that the [BANKING
ORGANIZATION] is willing to accept and must detail the instruments,
techniques, and strategies that the [BANKING ORGANIZATION] will use to
hedge CVA risk.
(c) Documentation. A [BANKING ORGANIZATION] must have policies and
procedures for determining its CVA risk-based capital requirement. A
[BANKING ORGANIZATION] must adequately document all material aspects of
its identification and management of CVA risk covered positions and
eligible CVA hedges, and control, oversight, and review processes. A
[BANKING ORGANIZATION] that calculates the standardized measure for CVA
risk must adequately document:
(1) Policies and procedures of the CVA desk, or similar dedicated
function, and the independent risk control unit;
(2) The internal auditing process;
(3) The internal policies, controls, and procedures concerning the
[BANKING ORGANIZATION]'s CVA calculations for financial reporting
purposes;
(4) The initial and ongoing validation of the [BANKING
ORGANIZATION]'s models used for calculating regulatory CVA under Sec.
__.224(d), including exposure models; and
(5) The [BANKING ORGANIZATION]'s process to assess the performance
of models used for calculating regulatory CVA under Sec. __.224(d),
including exposure models, and implement remedies.
Sec. __.221 Measure for CVA risk.
(a) General requirements. A [BANKING ORGANIZATION] must calculate
its measure for CVA risk as the basic measure for CVA risk in
accordance with paragraph (b) of this section, unless the [BANKING
ORGANIZATION] has prior written approval of the [AGENCY] and chooses to
calculate its measure for CVA risk as the standardized measure for CVA
risk in accordance with paragraph (c) of this section.
(b) Basic measure for CVA risk. The basic measure for CVA risk
equals the basic CVA approach capital requirement as provided in Sec.
__.222 for all CVA risk covered positions and eligible CVA hedges, plus
any additional capital requirement for CVA risk established by the
[AGENCY] pursuant to Sec. __.201(c).
(c) Standardized measure for CVA risk. The standardized measure for
CVA risk equals the sum of the standardized CVA approach capital
requirement as provided in paragraph (c)(1) of this section for all
standardized CVA risk covered positions and standardized CVA hedges,
the basic CVA approach capital requirement as provided in Sec. __.222
for all basic CVA risk covered positions and basic CVA hedges, and any
additional capital requirement for CVA risk established by the [AGENCY]
pursuant to Sec. __.201(c).
(1) The standardized CVA approach capital requirement equals the
sum of the CVA delta capital requirement and the CVA vega capital
requirement as calculated in accordance with Sec. __.224.
(2) A [BANKING ORGANIZATION] that has received approval from the
[AGENCY] to use the standardized measure for CVA risk must include the
following CVA risk covered positions as basic CVA risk covered
positions to be included in the calculation of the basic CVA approach
capital requirement:
(i) Any CVA risk covered position that the [AGENCY] specifies must
be included in the basic CVA approach capital requirement pursuant to
Sec. __.223(a)(1);
[[Page 64278]]
(ii) Any CVA risk covered position in a netting set that the
[BANKING ORGANIZATION] chooses to exclude from the calculation of the
standardized CVA approach capital requirement; and
(iii) Any CVA risk covered position in a partial netting set
designated for inclusion in the basic CVA approach that the [BANKING
ORGANIZATION] has prior written approval from the [AGENCY] to create
from splitting a netting set into two netting sets.
(3) A [BANKING ORGANIZATION] that has received approval from the
[AGENCY] to use the standardized measure for CVA risk must include the
following eligible CVA hedges as basic CVA hedges to be included in the
calculation of the basic CVA approach capital requirement:
(i) Any eligible CVA hedge that the [AGENCY] specifies must be
included in the basic CVA approach capital requirement pursuant to
Sec. __.223(a)(1); and
(ii) Any CVA hedge that is an eligible CVA hedge for purposes of
calculating the basic CVA approach capital requirement that the
[BANKING ORGANIZATION] chooses to include in the basic CVA approach
capital requirement.
Sec. __.222 Basic CVA approach.
(a) Basic CVA approach capital requirement. The basic CVA approach
capital requirement equals Kbasic, which is calculated as follows:
Kbasic = 0.65 [middot] ([beta] [middot] Kunhedged + (1-[beta]) [middot]
Khedged)
Where,
(1) The parameter, [beta], equals 0.25;
(2) Kunhedged is calculated as follows:
[GRAPHIC] [TIFF OMITTED] TP18SE23.155
Where,
(i) The correlation parameter, [rho], equals 50 percent;
(ii) [Sigma]c(. . .) refers to a summation across all
counterparties, c, of CVA risk covered positions;
(iii) SCVAc is equal to:
[GRAPHIC] [TIFF OMITTED] TP18SE23.156
Where,
(A) [alpha] equals:
(1) 1 for counterparties for which the [BANKING ORGANIZATION]
calculates exposure amount under Sec. __.113(e)(4); and
(2) 1.4 for all other counterparties.
(B) [Sigma]N(. . .) refers to a summation across all netting sets
with the counterparty;
(C) MNS is the effective maturity for the netting set, NS, measured
in years, calculated as the weighted-average remaining maturity of the
individual CVA risk covered positions within the netting set, with the
weight of each individual position equal to the notional amount of the
position divided by the aggregate notional amount of all positions in
the netting set;
(D) EADNS is the EAD of the netting set, NS, provided that a
[BANKING ORGANZATION] must determine the EAD for a netting set, NS,
using the same methodology it uses to calculate the exposure amount for
counterparty credit risk for its OTC derivative contracts under Sec.
__.113;
(E) DFNS is a discount factor equal to (1-e[supcaret](-0.05*MNS))/
(0.05*MNS); and
(F) RWc is the risk weight for counterparty c, based on the sector
and credit quality of the counterparty, as specified in Table 1 of this
section.
[[Page 64279]]
[GRAPHIC] [TIFF OMITTED] TP18SE23.157
(3) Khedged is calculated as follows:
[GRAPHIC] [TIFF OMITTED] TP18SE23.158
Where,
(i) The correlation parameter, [rho], is defined in paragraph
(a)(2)(i) of this section;
(ii) [Sigma]c(. . .) refers to a summation across all
counterparties, c, of CVA risk covered positions, SCVAc, as defined in
paragraph (a)(2)(iii) of this section;
(iii) SNHc is calculated as follows:
[GRAPHIC] [TIFF OMITTED] TP18SE23.159
Where,
(A) The summation in the formula refers to a summation across all
single-name eligible CVA hedges, h, that the [BANKING ORGANIZATION]
uses to hedge the CVA risk of counterparty, c;
(B) rhc is the correlation between the credit spread of
counterparty, c, and the credit spread of a single-name hedge, h, of
counterparty, c, as specified in Table 2 of this section;
(C) RWh is the risk weight of single-name hedge, h, as prescribed
in Table 1 of this section, for the sector and credit quality of the
reference name of the hedge;
(D) MhSN is the remaining maturity of single-name hedge, h,
measured in years;
(E) BhSN is the notional amount of single-name hedge, h, provided
that, for single-name contingent CDS, the notional amount is determined
by the current market value of the reference portfolio or instrument;
and
(F) DFhSN is the discount factor and is calculated as:
[GRAPHIC] [TIFF OMITTED] TP18SE23.160
[[Page 64280]]
[GRAPHIC] [TIFF OMITTED] TP18SE23.161
(iv) IH is calculated as follows:
[GRAPHIC] [TIFF OMITTED] TP18SE23.162
Where,
(A) [Sigma]i(. . .) refers to a summation across all eligible CVA
hedges that are index hedges, i, that the [BANKING ORGANIZATION] uses
to hedge CVA risk;
(B) RWi is the risk weight of the index hedge, i, as follows:
(1) For an index hedge where all index constituents belong to the
same sector and are of the same credit quality, the value in Table 1 of
this section corresponding to that sector and credit quality,
multiplied by 0.7; or
(2) For an index spanning multiple sectors or with a mixture of
investment grade constituents and other grade constituents, the
notional-weighted average of the risk weights from Table 1 of this
section corresponding to the sectors and credit qualities of the
constituents, multiplied by 0.7;
(C) Miind is the remaining maturity of the index hedge, i, measured
in years;
(D) Biind is the notional amount of the index hedge, i; and
(E) DFiind is the discount factor and is calculated as (1-
e[supcaret](-0.05*MNS))/(0.05*MNS); and
(v) HMAc is calculated as follows where all terms have the same
definitions as set out in paragraph (a)(3)(iii) of this section:
[GRAPHIC] [TIFF OMITTED] TP18SE23.163
(b) [Reserved]
Sec. __.223 Requirements for the standardized measure for CVA risk.
(a) Eligibility requirements. (1) A [BANKING ORGANIZATION] must
receive written approval of the [AGENCY] prior to using the
standardized measure for CVA risk for calculating CVA capital
requirements. Such approval may specify certain CVA risk covered
positions and eligible CVA hedges that must be included in the
calculation of the basic CVA approach capital requirement. In order to
be eligible to use the standardized measure for CVA risk, a [BANKING
ORGANIZATION] must meet the following requirements:
(i) A [BANKING ORGANIZATION] must be able to calculate, on at least
a monthly basis, regulatory CVA and CVA sensitivities to market risk
factors and counterparty credit spreads specified in Sec. __.224 and
Sec. __.225.
(ii) A [BANKING ORGANIZATION] must have a CVA desk, or a similar
dedicated function, responsible for CVA risk management and hedging
consistent with the [BANKING ORGANIZATION]'s policies and procedures.
(iii) A [BANKING ORGANIZATION] must meet all of the requirements
listed in paragraph (b) of this section and the requirements in Sec.
__.220(c) on an ongoing basis. The [AGENCY] may rescind its approval of
the use of the standardized measure for CVA risk (in whole or in part),
if the [AGENCY] determines that the model no longer complies with this
subpart or fails to reflect accurately the CVA risk of the [BANKING
ORGANIZATION]'s CVA risk covered positions.
(2) The [AGENCY] may specify that one or more CVA risk covered
positions or one or more eligible CVA hedges must be included in the
basic CVA approach capital requirement or prescribe an alternative
capital requirement, if the [AGENCY] determines that the [BANKING
ORGANIZATION]'s implementation of the standardized CVA approach capital
requirement no longer complies with this subpart F or fails to reflect
accurately the CVA risk.
(b) Ongoing requirements. (1) Exposure models used in the
calculation of regulatory CVA under Sec. __.224(d) must be part of a
CVA risk management framework that includes the identification,
measurement, management, approval, and internal reporting of CVA risk.
(2) Senior management must have oversight of the risk control
process.
(3) A [BANKING ORGANIZATION] must have an independent risk control
unit that is responsible for the effective initial and ongoing
validation (no less than annual) of the models used for calculating
regulatory CVA under Sec. __.224(d), including exposure models. This
unit must be independent from the business unit that evaluates
counterparties and sets limits, a [BANKING ORGANIZATION]'s trading
desks, and the CVA desk, or similar dedicated function, and must report
directly to senior management of the [BANKING ORGANIZATION].
(4) A [BANKING ORGANIZATION] must document the process for initial
and ongoing validation of its models used for calculating regulatory
CVA under Sec. __.224(d), including exposure models, which must
recreate the analysis, to a level of detail that would
[[Page 64281]]
enable a third party to understand how the models operate, their
limitations, and their key assumptions. This documentation must set out
the minimum frequency (no less than annual) with which ongoing
validation will be conducted as well as other circumstances (such as a
sudden change in market behavior) under which additional validation
must be conducted more frequently. In addition, the documentation must
sufficiently describe how the validation is conducted with respect to
data flows and portfolios, what analyses are used, and how
representative counterparty portfolios are constructed.
(5) A [BANKING ORGANIZATION] must test the pricing models used to
calculate exposure for given paths of market risk factors against
appropriate independent benchmarks for a wide range of market states as
part of the initial and ongoing model validation process. A [BANKING
ORGANIZATION]'s pricing models for options must account for the non-
linearity of option value with respect to market risk factors.
(6) An independent review of the overall CVA risk management
process must be conducted as part of the [BANKING ORGANIZATION]'s own
regular internal auditing process. This review must include both the
activities of the CVA desk, or similar dedicated function, and of the
independent risk control unit.
(7) A [BANKING ORGANIZATION] must define criteria on which to
assess the exposure models and their inputs and have a written policy
in place to describe the process to assess the performance of exposure
models and remedy unacceptable performance.
(8) A [BANKING ORGANIZATION]'s exposure models must capture
transaction-specific information in order to aggregate exposures at the
level of the netting set. A [BANKING ORGANIZATION] must verify that
transactions are assigned to the appropriate netting set within the
model.
(9) A [BANKING ORGANIZATION]'s exposure models must reflect
transaction terms and specifications accurately. The terms and
specifications must reside in a secure database that is subject to
formal and periodic audit no less than annually. The transmission of
transaction terms and specifications data to the exposure model must
also be subject to internal audit, and formal reconciliation processes
must be in place between the internal model and source data systems to
verify on an ongoing basis that transaction terms and specifications
are being reflected correctly or at least conservatively.
(10) A [BANKING ORGANIZATION] must acquire current and historical
market data that are either independent of the lines of business or
validated independently from the lines of business and be compliant
with applicable accounting standards. The data must be input into the
exposure models in a timely and complete fashion, and maintained in a
secure database subject to formal and periodic audit. A [BANKING
ORGANIZATION] must also have a well-developed data integrity process to
handle the data of erroneous and anomalous observations. In the case
where an exposure model relies on proxy market data, a [BANKING
ORGANIZATION] must set internal policies to identify suitable proxies
and the [BANKING ORGANIZATION] must demonstrate empirically on an
ongoing basis that the proxy provides a conservative representation of
the underlying risk under adverse market conditions.
Sec. __.224 Calculation of the standardized CVA approach.
(a) General. A [BANKING ORGANIZATION] must calculate the CVA delta
capital requirement pursuant to paragraph (b) of this section and the
CVA vega capital requirement pursuant to paragraph (c) of this section,
in both cases for all standardized CVA risk covered positions and for
the market value of all standardized CVA hedges, in accordance with the
requirements set forth below.
(1) For each standardized CVA risk covered position and
standardized CVA hedge, a [BANKING ORGANIZATION] must identify all of
the relevant risk factors as described in Sec. __.225 for which it
will calculate sensitivities for delta risk and vega risk as described
in paragraphs (b) and (c) of this section. A [BANKING ORGANIZATION]
must also identify the corresponding buckets related to these risk
factors as described in Sec. __.225.
(2) A [BANKING ORGANIZATION] must assign a standardized CVA hedge
that mitigates credit spread delta risk either to the counterparty
credit spread risk class or to the reference credit spread risk class.
(b) CVA delta capital requirement. (1) General. The CVA delta
capital requirement equals the sum of the risk class-level CVA delta
capital requirements calculated pursuant to paragraph (b)(4) of this
section for each of the following six risk classes:
(i) Interest rate risk;
(ii) Foreign exchange risk;
(iii) Counterparty credit spread risk;
(iv) Reference credit spread risk;
(v) Equity risk; and
(vi) Commodity risk.
(2) Net weighted sensitivity calculation. For each risk factor, k,
specified in Sec. __.225(a), a [BANKING ORGANIZATION] must:
(i) Calculate the CVA delta sensitivity of aggregate regulatory CVA
to the risk factor, SkCVA, and the CVA delta sensitivity of the
aggregate market value of standardized CVA hedges to the risk factor,
SkHdg, pursuant to paragraph (e) of this section.
(ii) Calculate the weighted CVA delta sensitivity to the risk
factor, WSkCVA, and the weighted hedge delta sensitivity to the risk
factor, WSkHdg, by multiplying SkCVA and SkHdg, respectively, by the
corresponding risk weight, RWk, specified in Sec. __.225(a):
WSkCVA = RWk [middot] SkCVA
WSkHdg = RWk [middot] SkHdg
(iii) Calculate the net weighted delta sensitivity, WSk, by
subtracting the weighted hedge delta sensitivity, WSkHdg, from the
weighted CVA delta sensitivity, WSkCVA:
WSk = WSkCVA - WSkHdg
(3) Within bucket aggregation. For each bucket, b, as provided in
Sec. __.225(a), a [BANKING ORGANIZATION] must calculate the bucket-
level CVA delta capital requirement, Kb, by aggregating the net
weighted delta sensitivities for each risk factor in a bucket, b, using
the buckets and correlation parameters, [rho]kl, applicable to each
risk class as specified in Sec. __.225(a), as follows:
[GRAPHIC] [TIFF OMITTED] TP18SE23.164
[[Page 64282]]
where R is the hedging disallowance parameter equal to 0.01.
(4) Across bucket aggregation. A [BANKING ORGANIZATION] must
calculate the risk class-level CVA delta capital requirement, K, by
aggregating the bucket-level CVA delta capital requirements, Kb, for
each bucket in the risk class using the correlation parameters,
[gamma]bc, applicable to each risk class as specified in Sec.
__.225(a), as follows:
[GRAPHIC] [TIFF OMITTED] TP18SE23.165
where,
(i) Sb is defined for bucket, b, as:
[GRAPHIC] [TIFF OMITTED] TP18SE23.166
(ii) Sc is defined for bucket c as:
[GRAPHIC] [TIFF OMITTED] TP18SE23.167
(iii) The multiplier, mCVA, equals 1, unless the [AGENCY] notifies
the [BANKING ORGANIZATION] in writing that a different value must be
used. The [AGENCY] may increase a [BANKING ORGANIZATION]'s multiplier
if it determines that the [BANKING ORGANIZATION]'s CVA model risk
warrants it.
(c) CVA vega capital requirement. (1) General. The CVA vega capital
requirement equals the sum of the risk class-level CVA vega capital
requirements calculated pursuant to paragraph (c)(4) of this section
for each of the following five risk classes:
(i) Interest rate risk;
(ii) Foreign exchange risk;
(iii) Reference credit spread risk;
(iv) Equity risk; and
(v) Commodity risk.
(2) Net weighted sensitivity calculation. For each risk factor, k,
specified in Sec. __.225(b), a [BANKING ORGANIZATION] must:
(i) Calculate the CVA vega sensitivity of aggregate regulatory CVA
to the risk factor, SkCVA, and the CVA vega sensitivity of the
aggregate market value of standardized CVA hedges to the risk factor,
SkHdg, pursuant to paragraph (e) of this section.
(ii) Calculate the weighted CVA vega sensitivity to the risk
factor, WSkCVA, and the weighted hedge vega sensitivity to the risk
factor, WSkHdg, by multiplying SkCVA and SkHdg, respectively, by the
corresponding risk weight, RWk, specified in Sec. __.225(b):
WSkCVA = RWk [middot] SkCVA
WSkHdg = RWk [middot] SkHdg
(iii) Calculate the net weighted vega sensitivity, WSk, by
subtracting the weighted hedge vega sensitivity, WSkHdg, from the
weighted CVA vega sensitivity, WSkCVA:
WSk = WSkCVA-WSkHdg
(3) Within bucket aggregation. For each bucket, b, as provided in
Sec. __.225(b), a [BANKING ORGANIZATION] must calculate the bucket-
level CVA vega capital requirement, Kb, by aggregating the net weighted
vega sensitivities for each risk factor in a bucket, b, using the
buckets and correlation parameters, [rho]kl, applicable to each risk
class as specified in Sec. __.225(b), as follows:
[GRAPHIC] [TIFF OMITTED] TP18SE23.168
where R is the hedging disallowance parameter equal to 0.01.
(4) Across bucket aggregation. A [BANKING ORGANIZATION] must
calculate the risk class-level CVA vega capital requirement, K, by
aggregating the bucket-level CVA vega capital requirements, Kb, far
each bucket in the risk class using the correlation parameters,
[gamma]bc, applicable to each risk class as specified in Sec.
__.225(b), as follows:
[GRAPHIC] [TIFF OMITTED] TP18SE23.169
where,
(i) Sb is defined for bucket b as:
[[Page 64283]]
[GRAPHIC] [TIFF OMITTED] TP18SE23.170
(ii) Sc is defined for bucket c as:
[GRAPHIC] [TIFF OMITTED] TP18SE23.171
(iii) The multiplier, mCVA, equals 1, unless the [AGENCY] notifies
the [BANKING ORGANIZATION] in writing that a different value must be
used. The [AGENCY] may increase a [BANKING ORGANIZATION]'s multiplier
if it determines that the [BANKING ORGANIZATION]'s CVA model risk
warrants it.
(d) Calculation of regulatory CVA. A [BANKING ORGANIZATION] must
calculate aggregate regulatory CVA as the sum of regulatory CVA for
each counterparty.
(1) A [BANKING ORGANIZATION] must calculate regulatory CVA at the
counterparty level as the expected loss resulting from default of the
counterparty and assuming non-default of the [BANKING ORGANIZATION]. In
expressing the regulatory CVA, non-zero losses must have a positive
sign.
(2) The calculation of regulatory CVA must be based, at a minimum,
on the following inputs, consistent with the requirements of this
paragraph (d) of this section:
(i) Term structure of market-implied probability of default;
(ii) Market-consensus expected loss-given-default; and
(iii) Simulated paths of discounted future exposure.
(3) The term structure of market-implied probability of default
must be estimated from credit spreads observed in the markets. For
counterparties whose credit is not actively traded (illiquid
counterparties), the market-implied probability of default must be
estimated from proxy credit spreads, estimated for such counterparties
according to the following requirements:
(i) A [BANKING ORGANIZATION] must estimate the credit spread curves
of illiquid counterparties from credit spreads observed in the markets
of the counterparty's liquid peers via an algorithm that is based, at a
minimum, on the following inputs:
(A) A measure of credit quality;
(B) Industry; and
(C) Region;
(ii) A [BANKING ORGANIZATION] may map an illiquid counterparty to a
single liquid reference name if the [BANKING ORGANIZATION] demonstrates
to the [AGENCY] that such mapping is appropriate; and
(iii) When no credit spread of any of the counterparty's peers is
available due to the counterparty's specific type, a [BANKING
ORGANIZATION] may, with the approval of the [AGENCY], use an estimate
of credit risk to proxy the spread of an illiquid counterparty;
provided that where a [BANKING ORGANIZATION] uses historical
probabilities of default as part of this assessment, the resulting
spread must relate to credit markets and cannot be based on historical
probabilities of default alone.
(4) The market-consensus expected loss-given-default value must be
the same as the one used to calculate the market-implied probability of
default from credit spreads unless the seniority of the exposure
resulting from CVA risk covered positions differs from the seniority of
senior unsecured bonds.
(5) The simulated paths of discounted future exposure are produced
by pricing all standardized CVA risk covered positions with the
counterparty along simulated paths of relevant market risk factors and
discounting the prices to today using risk-free interest rates along
the path.
(6) All market risk factors material for the transactions with a
counterparty must be simulated as stochastic processes for an
appropriate number of paths defined on an appropriate set of future
time points extending to the maturity of the longest transaction.
(7) For transactions with a significant level of dependence between
exposure and the counterparty's credit quality, a [BANKING
ORGANIZATION] must account for this dependence in regulatory CVA
calculations.
(8) For margined counterparties, only financial collateral that
qualifies for inclusion in the net independent collateral amount or
variation margin amount under Sec. __.113 may be recognized as a risk
mitigant.
(9) For margined counterparties, the simulated paths of discounted
future exposure must capture the effects of margining collateral that
is recognized as a risk mitigant along each exposure path. All of the
relevant contractual features such as the nature of the margin
agreement (unilateral vs bilateral), the frequency of margin calls, the
type of collateral, thresholds, independent amounts, initial margins,
and minimum transfer amounts must be appropriately captured by the
exposure model. To determine collateral available to a [BANKING
ORGANIZATION] at a given exposure measurement time point, the exposure
model must assume that the counterparty will not post or return any
collateral within a certain time period immediately prior to that time
point, the margin period of risk (MPoR). For a client-facing derivative
transaction that is a standardized CVA risk covered position, the MPoR
must not be less than 4 + N business days. For all other standardized
CVA risk covered positions, the MPoR must not be less than 9 + N
business days. For purposes of this paragraph (d)(9), N is the re-
margining period specified in the margin agreement.
(10) A [BANKING ORGANIZATION] must obtain the simulated paths of
discounted future exposure using the same CVA exposure models used by
the [BANKING ORGANIZATION] for financial reporting purposes, adjusted
to meet the requirements of this section. For purposes of this section,
a [BANKING ORGANIZATION] must use the same model calibration process,
market data, and transaction data as the [BANKING ORGANIZATION] uses in
its CVA calculations for financial reporting purposes, adjusted to meet
the requirements of this calculation.
(11) A [BANKING ORGANIZATION]'s generation of market risk factor
paths underlying the exposure models must satisfy the following
requirements:
(i) Drifts of risk factors must be consistent with a risk-neutral
probability measure and a [BANKING ORGANIZATION] may not calibrate
drifts of risk factors on a historical basis;
(ii) A [BANKING ORGANIZATION] must calibrate the volatilities and
correlations of market risk factors to market data; provided that,
where sufficient data from a liquid derivatives market does not exist,
a [BANKING ORGANIZATION] may calibrate
[[Page 64284]]
volatilities and correlations of market risk factors on a historical
basis; and
(iii) The distribution of modelled risk factors must adequately
account for the possible non-normality of the distribution of
exposures.
(12) For purposes of the calculation of the regulatory CVA, a
[BANKING ORGANIZATION] must recognize netting in the same manner as
used by the [BANKING ORGANIZATION] for financial reporting purposes.
(e) CVA Sensitivities. For purposes of calculating the CVA delta
capital requirement and the CVA vega capital requirement, a [BANKING
ORGANIZATION] must calculate the CVA delta sensitivities and CVA vega
sensitivities in accordance with the requirements set forth below.
(1) Reference value. For purposes of calculating the CVA delta
sensitivity or CVA vega sensitivity of aggregate regulatory CVA to a
risk factor, SkCVA, the reference value is the aggregate regulatory CVA
of all standardized CVA risk covered positions. For purposes of
calculating the CVA delta sensitivity or CVA vega sensitivity of
aggregate market value of standardized CVA hedges to a risk factor,
SkHdg, the reference value is the aggregate market value of all
standardized CVA hedges.
(2) CVA delta sensitivities definitions--(i) Interest rate risk.
(A) For currencies specified in Sec. __.225(a)(1)(ii), a [BANKING
ORGANIZATION] must calculate the CVA delta sensitivity to each delta
risk factor by changing the risk-free yield for a given tenor for all
curves in a given currency by 0.0001 and dividing the resulting change
in the reference value by 0.0001. A [BANKING ORGANIZATION] must measure
the delta sensitivity to the inflation rate by changing the inflation
rate by 0.0001 and dividing the resulting change in the reference value
by 0.0001.
(B) For currencies not specified in Sec. __.225(a)(1)(ii), a
[BANKING ORGANIZATION] must measure the CVA delta sensitivity to each
delta risk factor by applying a parallel shift to all risk-free yield
curves in a given currency by 0.0001 and dividing the resulting change
in the reference value by 0.0001. A [BANKING ORGANIZATION] must measure
the delta sensitivity to the inflation rate by changing the inflation
rate by 0.0001 and dividing the resulting change in the reference value
by 0.0001.
(ii) Foreign exchange risk. A [BANKING ORGANIZATION] must measure
the CVA delta sensitivity to each delta risk factor by multiplying the
current value of the exchange rate between the [BANKING ORGANIZATION]'s
reporting currency and the other currency (i.e., the value of one unit
of another currency expressed in units of the reporting currency) by
1.01 and dividing the resulting change in the reference value by 0.01.
For transactions that reference an exchange rate between a pair of non-
reporting currencies, a [BANKING ORGANIZATION] must measure the CVA
delta sensitivities to the foreign exchange spot rate between the
[BANKING ORGANIZATION]'s reporting currency and each of the referenced
non-reporting currencies.
(iii) Counterparty credit spread risk. For each entity and each
tenor point, a [BANKING ORGANIZATION] must measure the CVA delta
sensitivity to each delta risk factor for counterparty credit risk by
shifting the relevant credit spread by 0.0001 and dividing the
resulting change in the reference value by 0.0001.
(iv) Reference credit spread risk. A [BANKING ORGANIZATION] must
measure the CVA delta sensitivity to each delta risk factor for
reference credit spread risk by simultaneously shifting all of the
credit spreads for all tenors of all reference names in the bucket by
0.0001 and dividing the resulting change in the reference value by
0.0001.
(v) Equity risk. A [BANKING ORGANIZATION] must measure the CVA
delta sensitivity to each delta risk factor for equity risk by
multiplying the current values of all of the equity spot prices for all
reference names in the bucket by 1.01 and dividing the resulting change
in the reference value by 0.01.
(vi) Commodity risk. A [BANKING ORGANIZATION] must measure the CVA
delta sensitivities to each delta risk factor for commodity risk by
multiplying the current values of all of the spot prices of all
commodities in the bucket by 1.01 and dividing the resulting change in
the reference value by 0.01.
(3) CVA vega sensitivities definitions--(i) Interest rate risk. A
[BANKING ORGANIZATION] must measure the CVA vega sensitivity to each
vega risk factor by multiplying the current values of all interest rate
or inflation rate volatilities, respectively, by 1.01 and dividing the
resulting change in the reference value by 0.01.
(ii) Foreign exchange risk. A [BANKING ORGANIZATION] must measure
the CVA vega sensitivity to each vega risk factor for foreign exchange
risk by multiplying the current values of all volatilities for a given
exchange rate between the [BANKING ORGANIZATION]'s reporting currency
and another currency by 1.01 and dividing the resulting change in the
reference value by 0.01. For transactions that reference an exchange
rate between a pair of non-reporting currencies, a [BANKING
ORGANIZATION] must measure the volatilities of the foreign exchange
spot rates between the [BANKING ORGANIZATION]'s reporting currency and
each of the referenced non-reporting currencies.
(iii) Reference credit spread risk. A [BANKING ORGANIZATION] must
measure the CVA vega sensitivity to each vega risk factor for reference
credit spread risk by multiplying the current values of the
volatilities of all credit spreads of all tenors for all reference
names in the bucket by 1.01 and dividing the resulting change in the
reference values by 0.01.
(iv) Equity risk. A [BANKING ORGANIZATION] must measure the CVA
vega sensitivity to each risk factor for equity risk by multiplying the
current values of the volatilities for all reference names in the
bucket by 1.01 and dividing the resulting change in the reference value
by 0.01.
(v) Commodity risk. A [BANKING ORGANIZATION] must measure the CVA
vega sensitivity to each vega risk factor for commodity risk by
multiplying the current values of the volatilities for all commodities
in the bucket by 1.01 and dividing the resulting change in the
reference value by 0.01.
(4) Notwithstanding paragraphs (e)(2) and (3) of this section, a
[BANKING ORGANIZATION] may use smaller values of risk factor changes
than what is specified in paragraphs (e)(2) and (3) of this section if
doing so is consistent with internal risk management calculations.
(5) When CVA vega sensitivities are calculated, the volatility
shift must apply to both types of volatilities that appear in exposure
models:
(i) Volatilities used for generating risk factor paths; and
(ii) Volatilities used for pricing options.
(6) In cases where a standardized CVA risk covered position or a
standardized CVA hedge references an index, the sensitivities of the
aggregate regulatory CVA or the market value of the eligible CVA hedge
to all risk factors upon which the value of the index depends must be
calculated. The sensitivity of the aggregate regulatory CVA or the
market value of the standardized CVA hedge to risk factor, k, must be
calculated by applying the shift of risk factor, k, to all index
constituents that depend on this risk factor and recalculating the
aggregate regulatory
[[Page 64285]]
CVA or the market value of the standardized CVA hedge.
(7) Notwithstanding paragraph (e)(6) of this section:
(i) For the risk classes of counterparty credit spread risk,
reference credit spread risk, and equity risk, a [BANKING ORGANIZATION]
may choose to introduce a set of additional risk factors that directly
correspond to qualified credit and equity indices;
(ii) For delta risk, a credit or equity index is qualified if it is
listed and well-diversified; for vega risk, any credit or equity index
is qualified. If a [BANKING ORGANIZATION] chooses to introduce such
additional risk factors, a [BANKING ORGANIZATION] must calculate CVA
sensitivities to the qualified index risk factors in addition to
sensitivities to the non-index risk factors; and
(iii) For a standardized CVA risk covered position or a
standardized CVA hedge whose underlying is a qualified index, its
contribution to sensitivities to the index constituents is replaced
with its contribution to a single sensitivity to the underlying index,
provided that:
(A) For listed and well-diversified equity indices that are not
sector specific, where 75 percent of market value of the constituents
of the index, taking into account the weightings of the constituents,
are mapped to the same sector, the entire index must be mapped to that
sector and treated as a single-name sensitivity in that bucket;
(B) For listed and well-diversified credit indices that are not
sector specific, where 75 percent of notional value of the constituents
of the index, taking into account the weightings of the constituents,
are mapped to the same sector, the entire index must be mapped to that
sector and treated as a single-name sensitivity in that bucket; and
(C) In all other cases, the sensitivity must be mapped to the
applicable index bucket.
Sec. __.225 Standardized CVA approach: definitions of buckets, risk
factors, risk weights, and correlation parameters.
(a) CVA delta capital requirement--(1) Interest rate risk--(i)
Delta buckets for interest rate risk. A [BANKING ORGANIZATION] must
establish a separate interest rate risk bucket for each currency.
(ii) For the purposes of this section, specified currencies mean
United States Dollar, Australian Dollar, Canadian Dollar, Euro,
Japanese Yen, Swedish Krona, and United Kingdom Pound, and any
additional currencies specified by the [AGENCY].
(A) Delta risk factors for interest rate risk, specified
currencies. The delta risk factors for interest rate risk for the
specified currencies are the absolute changes of the inflation rate and
of the risk-free yields for the following five tenors: 1 year, 2 years,
5 years, 10 years, and 30 years.
(B) Delta risk weights for interest rate risk, specified
currencies. The delta risk weights, RWk, for interest rate risk for the
specified currencies are set out in Table 1 of this section.
[GRAPHIC] [TIFF OMITTED] TP18SE23.172
(C) Delta within-bucket correlation parameter for interest rate
risk, specified currencies. The correlation parameters, [rho]kl,
related to the specified currencies are set out in Table 2 of this
section.
[GRAPHIC] [TIFF OMITTED] TP18SE23.173
(iii) For currencies not specified in paragraph (a)(2)(ii) of this
section:
(A) Delta risk factors for interest rate risk, other currencies.
The delta risk factors for interest rate risk equal the absolute change
of the inflation rate and the parallel shift of the entire risk-free
yield curve for a given currency;
(B) Delta risk weights for interest rate risk, other currencies.
The delta risk weights, RWk, for both the risk-free yield curve and the
inflation rate equal 1.58 percent; and
(C) Delta within-bucket correlation parameter for interest rate
risk, other currencies. The correlation parameter, [rho]kl, between the
risk-free yield curve and the inflation rate equals 40 percent.
(iv) Delta cross-bucket correlation parameter for interest rate
risk. The delta cross-bucket correlation parameter, [gamma]bc, for
interest rate risk equals 50 percent for all currency pairs.
[[Page 64286]]
(2) Foreign exchange risk--(i) Delta buckets for foreign exchange
risk. A [BANKING ORGANIZATION] must establish a separate delta foreign
exchange risk bucket for each currency, except for a [BANKING
ORGANIZATION]'s own reporting currency.
(ii) Delta risk factors for foreign exchange risk. The delta risk
factors for foreign exchange risk equal the relative change of the
foreign exchange spot rate between a given currency and a [BANKING
ORGANIZATION]'s reporting currency or base currency, where the foreign
exchange spot rate is the current market price of one unit of another
currency expressed in the units of the [BANKING ORGANIZATION]'s
reporting currency or base currency.
(iii) Delta risk weights for foreign exchange risk. The delta risk
weights, RWk, for foreign exchange risk for all exchange rates between
the [BANKING ORGANIZATION]'s reporting currency or base currency and
another currency equal 11 percent.
(iv) Delta cross-bucket correlation parameter for foreign exchange
risk. The delta cross-bucket correlation parameter, [gamma]bc, for
foreign exchange risk equals 60 percent for all currency pairs.
(3) Counterparty credit spread risk--(i) Delta buckets for
counterparty credit spread risk. Delta buckets for counterparty credit
spread risk are set out in Table 3 of this section. Delta buckets 1 to
7 represent the non-index risk factors and bucket 8 is available for
the optional treatment of qualified indices. Under the optional
treatment of qualified indices, only standardized CVA hedges of
counterparty credit spread risk and reference qualified indices can be
assigned to bucket 8, whereas buckets 1 to 7 must be used for
calculations of CVA delta sensitivities for standardized CVA risk
covered positions and all single-name and all non-qualified index
hedges. For any CVA index hedge assigned to buckets 1 to 7, the
sensitivity of the hedge to each index constituent must be calculated
as described in Sec. __.224(e)(6).
(ii) Delta risk factors for counterparty credit spread risk. The
delta risk factors for counterparty credit spread risk equal the
absolute shifts of credit spreads of individual entities
(counterparties and reference names for counterparty credit spread
hedges) and qualified indices (under the optional treatment of
qualified indices) for the following tenors: 0.5 years, 1 year, 3
years, 5 years, and 10 years.
(iii) Delta risk weights for counterparty credit spread risk. The
delta risk weights, RWk, for counterparty credit spread risk are set
out in Table 3 of this section. The same risk weight for a given bucket
and given credit quality applies to all tenors.
BILLING CODE 6210-01-P; 6714-01-P; 4810-33-P
[GRAPHIC] [TIFF OMITTED] TP18SE23.174
BILLING CODE 6210-01-C; 6714-01-C; 4810-33-C
[[Page 64287]]
(iv) Delta within-bucket correlation parameters, [rho]kl, for
counterparty credit spread risk. The delta correlation parameters,
[rho]kl, for counterpart credit spread risk must be defined as follows:
(A) For buckets 1 through 7, a [BANKING ORGANIZATION] must
calculate the correlation parameter, [rho]kl, between two weighted
sensitivities WSk and WSl as follows:
[rho]kl = [rho]kl(tenor) [middot]
[rho]kl(name) [middot]
[rho]kl(quality)
where,
(1) [rho]kl(tenor) equals 100 percent if the
two tenors are the same, and 90 percent otherwise;
(2) [rho]kl(name) equals 100 percent if the
two names are the same, 90 percent if the two names are distinct but
are affiliates, and 50 percent otherwise; and
(3) [rho]kl(quality) equals 100 percent if
the credit quality of the two names is the same (where speculative and
sub-speculative grade is treated as one credit quality category), and
80 percent otherwise.
(B) For bucket 8, a [BANKING ORGANIZATION] must calculate the
correlation parameter, [rho]kl, between two weighted sensitivities WSk
and WSl as follows:
[rho]kl = [rho]kl(tenor) [middot]
[rho]kl(name) [middot]
[rho]kl(quality)
where,
(1) [rho]kl(tenor) equals 100 percent if the
two tenors are the same, and 90 percent otherwise;
(2) [rho]kl(name) equals 100 percent if the
two indices are the same and of the same series, 90 percent if the two
indices are the same but of distinct series, and 80 percent otherwise;
and
(3) [rho]kl(quality) equals 100 percent if
the credit quality of the two indices is the same (where speculative
and sub-speculative grade is treated as one credit quality category),
and 80 percent otherwise.
(v) Delta cross-bucket correlation parameters for counterparty
credit spread risk. The delta cross-bucket correlation parameters,
[gamma]bc, for counterparty credit spread risk are set out in Table 4
of this section.
BILLING CODE 6210-01-P; 6714-01-P; 4810-33-P
[GRAPHIC] [TIFF OMITTED] TP18SE23.175
(4) Reference credit spread risk--(i) Delta buckets for reference
credit spread risk. Delta buckets for reference credit spread risk are
set out in Table 5 of this section.
(ii) Delta risk factors for reference credit spread risk. The delta
risk factor for reference credit spread risk equals the simultaneous
absolute shift of all credit spreads for all tenors of all reference
names in the bucket.
(iii) Delta risk weights for reference credit spread risk. The
delta risk weights, RWk, for reference credit spread risk are set out
in Table 5 of this section.
[[Page 64288]]
[GRAPHIC] [TIFF OMITTED] TP18SE23.176
(iv) Delta cross-bucket correlation parameters for reference credit
spread risk. The delta cross-bucket correlation parameter, [gamma]bc,
for reference credit spread risk equals:
[[Page 64289]]
(A) The cross-bucket correlation parameters, [gamma]bc, between
buckets of the same credit quality (where speculative and sub-
speculative grade is treated as one credit quality category) are set
out in Table 6 of this section.
[GRAPHIC] [TIFF OMITTED] TP18SE23.177
(B) The cross-bucket correlation parameters, [gamma]bc, between
buckets 1 to 14 of different credit quality (where speculative and sub-
speculative grade is treated as one credit quality category), are set
out in Table 7 of this section.
[GRAPHIC] [TIFF OMITTED] TP18SE23.178
(5) Equity risk--(i) Delta buckets for equity risk. For equity
risk, a [BANKING ORGANIZATION] must establish buckets along three
dimensions: the reference entity's market capitalization, economy and
sector as set out in Table 8 of this section. To assign a delta
sensitivity to an economy, a [BANKING ORGANIZATION], at least annually,
must review and update the countries and territorial entities that
satisfy the requirements of a liquid market economy using the most
recent economic data available. To assign a delta sensitivity to a
sector, a [BANKING ORGANIZATION] must follow market convention by using
classifications that are commonly used in the market for grouping
issuers by industry sector. A [BANKING ORGANIZATION] must assign each
issuer to one of the sector buckets and must assign all issuers from
the same industry to the same sector. Delta sensitivities of any equity
issuer that a [BANKING ORGANIZATION] cannot assign to a sector must be
assigned to the other sector. For multinational, multi-sector equity
issuers, the allocation to a particular bucket must be done according
to the most material economy and sector in which the issuer operates.
(ii) Delta risk factors for equity risk. The delta risk factor for
equity risk equals the simultaneous relative shift of all equity spot
prices for all reference entities in the bucket.
[[Page 64290]]
(iii) Delta risk weights for equity risk. The delta risk weights,
RWk, for equity risk are set out in Table 8 of this section.
[GRAPHIC] [TIFF OMITTED] TP18SE23.179
(iv) Delta cross-bucket correlation parameters for equity risk. The
delta cross-bucket correlation parameter, [gamma]bc, for equity risk
equals 15 percent for all cross-bucket pairs that assigned to bucket
numbers 1 to 10 and zero percent for all cross-bucket pairs that
include bucket 11. The cross-bucket correlation between buckets 12 and
13 equals 75 percent and the cross-bucket correlation between buckets
12 or 13 and any of the buckets 1 through 10 equals 45 percent.
(6) Commodity risk--(i) Delta buckets for commodity risk. Delta
buckets for commodity risk are set out in Table 9 of this section.
(ii) Delta risk factors for commodity risk. The delta risk factor
for commodity risk equals the simultaneous relative shift of all of the
commodity spot prices for all commodities in the bucket.
(iii) Delta risk weights for commodity risk. The delta risk
weights, RWk, for commodity risk are set out in Table 9 of this
section.
[[Page 64291]]
[GRAPHIC] [TIFF OMITTED] TP18SE23.180
BILLING CODE 6210-01-C; 6714-01-C; 4810-33-C
(iv) Delta cross-bucket correlation parameters for commodity risk.
The delta cross-bucket correlation, [gamma]bc, for commodity risk
equals 20 percent for all
[[Page 64292]]
cross-bucket pairs assigned to bucket numbers 1 to 10 and zero percent
for all cross-bucket pairs that include bucket 11.
(b) CVA vega capital requirement--(1) Interest rate risk.
(i) Vega buckets for interest rate risk. A [BANKING ORGANIZATION]
must establish a separate vega interest rate risk bucket for each
currency.
(ii) Vega risk factors for interest rate risk. The vega risk
factors for interest rate risk for all currencies equal a simultaneous
relative change of all inflation rate volatilities for each currency
and a simultaneous relative change of all interest rate volatilities
for each currency.
(iii) Vega risk weights for interest rate risk. The vega risk
weights, RWk, for interest rate risk equal 100 percent.
(iv) Vega within-bucket correlation parameters for interest rate
risk. The vega within-bucket correlation parameter, [rho]kl, for
interest rate risk equals 40 percent.
(v) Vega cross-bucket correlation parameter for interest rate risk.
The vega cross-bucket correlation parameter, [gamma]bc, for interest
rate risk equals 50 percent for all currency pairs.
(2) Foreign exchange risk--(i) Vega buckets for foreign exchange
risk. A [BANKING ORGANIZATION] must establish a separate vega foreign
exchange risk bucket for each currency, except for a [BANKING
ORGANIZATION]'s own reporting currency.
(ii) Vega risk factors for foreign exchange risk. The vega risk
factors for foreign exchange risk equal the simultaneous, relative
change of all volatilities for the exchange rate between a [BANKING
ORGANIZATION]'s reporting currency or base currency and each other
currency.
(iii) Vega risk weights for foreign exchange risk. The vega risk
weights, RWk, for foreign exchange risk equal 100 percent.
(iv) Vega cross-bucket correlation parameter for foreign exchange
risk. The vega cross-bucket correlation parameter, [gamma]bc, for
foreign exchange risk equals 60 percent for all currency pairs.
(3) Reference credit spread risk--(i) Vega buckets for reference
credit spread risk. Vega buckets for reference credit spread risk are
set out in Table 5 of this section.
(ii) Vega risk factors for reference credit spread risk. The vega
risk factors for reference credit spread risk equal the simultaneous
relative shift of the volatilities of all credit spreads of all tenors
for all reference names in the bucket.
(iii) Vega risk weights for reference credit spread risk. The vega
risk weights, RWk, for reference credit spread risk equal 100 percent.
(iv) Vega cross-bucket correlation parameters for reference credit
spread risk. The vega cross-bucket correlation parameter, [gamma]bc,
for reference credit spread risk is defined in the same manner as the
delta cross-bucket correlation parameter for reference credit spread
risk, pursuant to paragraph (a)(4)(iv) of this section.
(4) Equity risk--(i) Vega buckets for equity risk. The vega buckets
for equity risk are defined in the same manner as the delta buckets for
equity risk, pursuant to paragraph (a)(5)(i) of this section.
(ii) Vega risk factors for equity risk. The vega risk factor for
equity risk equals the simultaneous relative shift of the volatilities
for all reference entities in the bucket.
(iii) Vega risk weights for equity risk. The vega risk weights,
RWk, for equity risk equal 78 percent for large market cap buckets and
100 percent otherwise.
(iv) Vega cross-bucket correlation parameters for equity risk. The
vega cross-bucket correlation parameter, [gamma]bc, for equity risk
equals 15 percent for all cross-bucket pairs that fall within bucket
numbers 1 to 10 and zero percent for all cross-bucket pairs that
include bucket 11. The cross-bucket correlation between buckets 12 and
13 is set at 75 percent and the cross-bucket correlation between
buckets 12 or 13 and any of the buckets 1 to 10 is 45 percent.
(5) Commodity risk--(i) Vega buckets for commodity risk. The vega
buckets for commodity risk are defined in the same manner as the delta
buckets for commodity risk, pursuant to paragraph (a)(6)(i) of this
section.
(ii) Vega risk factors for commodity risk. The vega risk factor for
commodity risk equals the simultaneous relative shift of the
volatilities for all commodities in the bucket.
(iii) Vega risk weights for commodity risk. The vega risk weights
for commodity risk RWk are 100 percent.
(iv) Vega cross-bucket correlation parameters for commodity risk.
The vega cross-bucket correlation parameter, [gamma]bc, for commodity
risk equals 20 percent for all cross-bucket pairs that fall within
bucket numbers 1 to 10 and zero percent for all cross-bucket pairs that
include bucket 11.
End of Common Rule.
List of Subjects
12 CFR Part 3
Administrative practice and procedure, Banks, banking, Federal
Reserve System, Investments, National banks, Reporting and
recordkeeping requirements, Savings associations.
12 CFR Part 6
Federal Reserve System, National banks, Penalties.
12 CFR Part 32
National banks, Reporting and recordkeeping requirements, Savings
Associations.
12 CFR Part 208
Confidential business information, Crime, Currency, Federal Reserve
System, Mortgages, Reporting and recordkeeping requirements,
Securities.
12 CFR Part 217
Administrative practice and procedure, Banks, Banking, Capital,
Federal Reserve System, Holding companies.
12 CFR Part 225
Administrative practice and procedure, Banks, banking, Federal
Reserve System, Holding companies, Reporting and recordkeeping
requirements, Securities.
12 CFR Part 238
Administrative practice and procedure, Banks, banking, Federal
Reserve System, Holding companies, Reporting and recordkeeping
requirements, Securities.
12 CFR Part 252
Administrative practice and procedure, Banks, banking, Credit,
Federal Reserve System, Holding companies, Investments, Qualified
financial contracts, Reporting and recordkeeping requirements,
Securities.
12 CFR Part 324
Administrative practice and procedure, Banks, banking, Capital
adequacy, Reporting and recordkeeping requirements, Savings
associations, State non-member banks.
Adoption of Common Rule
The proposed adoption of the common rule by the agencies, as
modified by the agency-specific text, is set forth below:
DEPARTMENT OF THE TREASURY
Office of the Comptroller of the Currency
12 CFR Chapter I
Authority and Issuance
For the reasons set forth in the common preamble, the OCC proposes
to amend parts 3, 6, and 32 of chapter I of
[[Page 64293]]
title 12 of the Code of Federal Regulations as follows:
PART 3--CAPITAL ADEQUACY STANDARDS
0
1. The authority citation for part 3 continues to read as follows:
Authority: 12 U.S.C. 93a, 161, 1462, 1462a, 1463, 1464, 1818,
1828(n), 1828 note, 1831n note, 1835, 3907, 3909, 5412(b)(2)(B), and
Pub. L. 116-136, 134 Stat. 281.
0
2. In Sec. 3.1, revise paragraphs (c)(3)(ii), (c)(4)(i) and (iii), and
(f) to read as follows:
Sec. 3.1 Purpose, applicability, reservations of authority, and
timing.
* * * * *
(c) * * *
(3) * * *
(ii) Each national bank or Federal savings association subject to
subpart E of this part must use the methodologies in subpart E (and
subpart F of this part for a market risk national bank or Federal
savings association) to calculate expanded total risk-weighted assets.
(4) * * *
(i) Except for a national bank or Federal savings association
subject to subpart E of this part, each national bank or Federal
savings association with total consolidated assets of $50 billion or
more must make the public disclosures described in subpart D of this
part.
* * * * *
(iii) Each national bank or Federal savings association subject to
subpart E of this part must make the public disclosures described in
subpart E of this part.
* * * * *
(f) Transitions and timing-- (1) Transitions. Notwithstanding any
other provision of this part, a national bank or Federal savings
association must make any adjustments provided in subpart G of this
part for purposes of implementing this part.
(2) Timing. A national bank or Federal savings association that
changes from one category to another category, or that changes from
having no category to having a category, must comply with the
requirements of its category in this part, including applicable
transition provisions of the requirements in this part, no later than
on the first day of the second quarter following the change in the
national bank's or Federal savings association's category.
0
3. In Sec. 3.2:
0
a. Redesignate footnotes 3 through 9 as footnotes 1 through 7.
0
b. Remove the definitions for ``Advanced approaches national bank or
Federal savings association'', ``Advanced approaches total risk-
weighted assets'', and ``Advanced market risk-weighted assets'';
0
c. Revise the definitions for ``Category II national bank or Federal
savings association'' and ``Category III national bank or Federal
savings association'';
0
d. Add, in alphabetical order, the definition for ``Category IV
national bank or Federal savings association'';
0
e. Revise newly redesignated footnote 1 to paragraph (2) of the
definition for ``Cleared transaction'' and the definition for
``Corporate exposure'';
0
f. Remove the definition for ``Credit-risk-weighted assets'';
0
g. Add, in alphabetical order, the definition for ``CVA risk-weighted
assets'';
0
h. Revise the definition for ``Effective notional amount'';
0
i. Remove the definition for ``Eligible credit reserves'';
0
j. Revise paragraph (10) of the definition for ``Eligible guarantee'';
0
k. Add, in alphabetical order, the definition for ``Expanded total
risk-weighted assets'';
0
l. Remove the definition for ``Expected credit loss (ECL)'';
0
m. Revise paragraphs (1) and (4) through (8) of the definition for
``Exposure amount'', paragraph (2) of the definition for ``Financial
collateral'', paragraph (5)(i) of the definition for ``Financial
institution'', and the definitions for ``Indirect exposure'' and
``Market risk national bank or Federal savings association'';
0
n. Add, in alphabetical order, the definition for ``Market risk-
weighted assets'';
0
o. Revise the definitions for ``Net independent collateral amount'',
``Netting set'', ``Non-significant investment in the capital of an
unconsolidated financial institution'', ``Protection amount (P)'',
paragraph (2) of the definition for ``Qualifying central counterparty
(QCCP)'', and paragraphs (3) and (4) of the definition for ``Qualifying
master netting agreement'';
0
p. In the definition of ``Residential mortgage exposure'':
0
i. Remove paragraph (2);
0
ii. Redesignate paragraphs (1)(i) and (ii) as paragraphs (1) and (2),
respectively; and
0
iii. In newly redesignated paragraph (2), remove the words ``family;
and'' and add in their place the word ``family.'';
0
q. Revise the definition for ``Significant investment in the capital of
an unconsolidated financial institution'';
0
r. Remove the definition for ``Specific wrong-way risk'';
0
s. Revise the definitions for ``Speculative grade'' and ``Standardized
market risk-weighted assets'', paragraphs (1)(vi) and (2) of the
definition for ``Standardized total risk-weighted assets'', and the
definitions for ``Sub-speculative grade'', ``Synthetic exposure'', and
``Unregulated financial institution'';
0
t. Add, in alphabetical order, the definition for ``Total credit risk-
weighted assets'';
0
u. Remove the definition for ``Value-at-risk (VaR)'';
0
v. Revise the definition for ``Variation margin amount'';
0
w. Remove the definition for ``Wrong-way risk''; and
The additions and revisions read as follows:
Sec. 3.2 Definitions
* * * * *
Category II national bank or Federal savings association means a
national bank or Federal savings association that is not a subsidiary
of a global systemically important BHC, as defined pursuant to 12 CFR
252.5, and that:
(1) Is a subsidiary of a Category II banking organization, as
defined pursuant to 12 CFR 252.5 or 12 CFR 238.10, as applicable; or
(2)(i) Has total consolidated assets, calculated based on the
average of the national bank's or Federal savings association's total
consolidated assets for the four most recent calendar quarters as
reported on the Call Report, equal to $700 billion or more. If the
national bank or Federal savings association has not filed the Call
Report for each of the four most recent calendar quarters, total
consolidated assets is calculated based on its total consolidated
assets, as reported on the Call Report, for the most recent quarter or
the average of the most recent quarters, as applicable; or
(ii)(A) Has total consolidated assets, calculated based on the
average of the national bank's or Federal savings association's total
consolidated assets for the four most recent calendar quarters as
reported on the Call Report, of $100 billion or more but less than $700
billion. If the national bank or Federal savings association has not
filed the Call Report for each of the four most recent quarters, total
consolidated assets is based on its total consolidated assets, as
reported on the Call Report, for the most recent quarter or average of
the most recent quarters, as applicable; and
(B) Has cross-jurisdictional activity, calculated based on the
average of its cross-jurisdictional activity for the four most recent
calendar quarters, of $75 billion or more. Cross-jurisdictional
activity is the sum of cross-jurisdictional claims and cross-
[[Page 64294]]
jurisdictional liabilities, calculated in accordance with the
instructions to the FR Y-15 or equivalent reporting form.
(3) After meeting the criteria in paragraph (2) of this definition,
a national bank or Federal savings association continues to be a
Category II national bank or Federal savings association until the
national bank or Federal savings association has:
(i) Less than $700 billion in total consolidated assets, as
reported on the Call Report, for each of the four most recent calendar
quarters; and
(ii)(A) Less than $75 billion in cross-jurisdictional activity for
each of the four most recent calendar quarters. Cross-jurisdictional
activity is the sum of cross-jurisdictional claims and cross-
jurisdictional liabilities, calculated in accordance with the
instructions to the FR Y-15 or equivalent reporting form; or
(B) Less than $100 billion in total consolidated assets, as
reported on the Call Report, for each of the four most recent calendar
quarters.
Category III national bank or Federal savings association means a
national bank or Federal savings association that is not a subsidiary
of a global systemically important banking organization or a Category
II national bank or Federal savings association and that:
(1) Is a subsidiary of a Category III banking organization, as
defined pursuant to 12 CFR 252.5 or 12 CFR 238.10, as applicable; or
(2)(i) Has total consolidated assets, calculated based on the
average of total consolidated assets for the four most recent calendar
quarters as reported on the Call Report, equal to $250 billion or more.
If the national bank or Federal savings association has not filed the
Call Report for each of the four most recent calendar quarters, total
consolidated assets is calculated based on its total consolidated
assets, as reported on the Call Report, for the most recent quarter or
average of the most recent quarters, as applicable; or
(ii)(A) Has total consolidated assets, calculated based on the
average of total consolidated assets for the four most recent calendar
quarters as reported on the Call Report, of $100 billion or more but
less than $250 billion. If the national bank or Federal savings
association has not filed the Call Report for each of the four most
recent calendar quarters, total consolidated assets is calculated based
on its total consolidated assets, as reported on the Call Report, for
the most recent quarter or average of the most recent quarters, as
applicable; and
(B) Has at least one of the following in paragraphs (2)(ii)(B)(1)
through (3) of this definition, each calculated as the average of the
four most recent calendar quarters, or if the national bank or Federal
savings association has not filed each applicable reporting form for
each of the four most recent calendar quarters, for the most recent
quarter or quarters, as applicable:
(1) Total nonbank assets, calculated in accordance with the
instructions to the FR Y-9LP or equivalent reporting form, equal to $75
billion or more;
(2) Off-balance sheet exposure equal to $75 billion or more. Off-
balance sheet exposure is a national bank's or Federal savings
association's total exposure, calculated in accordance with the
instructions to the FR Y-15 or equivalent reporting form, minus the
total consolidated assets, as reported on the Call Report; or
(3) Weighted short-term wholesale funding, calculated in accordance
with the instructions to the FR Y-15 or equivalent reporting form,
equal to $75 billion or more.
(iii) After meeting the criteria in paragraph (2)(ii) of this
definition, a national bank or Federal savings association continues to
be a Category III national bank or Federal savings association until
the national bank or Federal savings association:
(A) Has:
(1) Less than $250 billion in total consolidated assets, as
reported on the Call Report, for each of the four most recent calendar
quarters;
(2) Less than $75 billion in total nonbank assets, calculated in
accordance with the instructions to the FR Y-9LP or equivalent
reporting form, for each of the four most recent calendar quarters;
(3) Less than $75 billion in weighted short-term wholesale funding,
calculated in accordance with the instructions to the FR Y-15 or
equivalent reporting form, for each of the four most recent calendar
quarters; and
(4) Less than $75 billion in off-balance sheet exposure for each of
the four most recent calendar quarters. Off-balance sheet exposure is a
national bank's or Federal savings association's total exposure,
calculated in accordance with the instructions to the FR Y-15 or
equivalent reporting form, minus the total consolidated assets of the
national bank or Federal savings association, as reported on the Call
Report; or
(B) Has less than $100 billion in total consolidated assets, as
reported on the Call Report, for each of the four most recent calendar
quarters; or
(C) Is a Category II national bank or Federal savings association.
* * * * *
Category IV national bank or Federal savings association means a
national bank or Federal savings association that is not a Category II
national bank or Federal savings association or Category III national
bank or Federal savings association and that:
(1) Is a subsidiary of a Category IV banking organization, as
defined pursuant to 12 CFR 252.5 or 12 CFR 238.10, as applicable; or
(2) Has total consolidated assets, calculated based on the average
of total consolidated assets for the four most recent calendar quarters
as reported on the Call Report, of $100 billion or more. If the
national bank or Federal savings association has not filed the Call
Report for each of the four most recent calendar quarters, total
consolidated assets is calculated based on the average of its total
consolidated assets, as reported on the Call Report, for the most
recent quarter(s) available.
(3) After meeting the criterion in paragraph (2) of this
definition, a national bank or Federal savings association continues to
be a Category IV national bank or Federal savings association until it:
(i) Has less than $100 billion in total consolidated assets, as
reported on the Call Report, for each of the four most recent calendar
quarters; or
(ii) Is a Category II national bank or Federal savings association
or Category III national bank or Federal savings association.
* * * * *
Cleared transaction * * *
(2) * * * \1\
* * * * *
Corporate exposure means an exposure to a company that is not:
(1) An exposure to a sovereign, the Bank for International
Settlements, the European Central Bank, the European Commission, the
International Monetary Fund, the European Stability Mechanism, the
European Financial Stability Facility, a multi-lateral development bank
(MDB), a depository institution, a foreign bank, or a credit union, a
public sector entity (PSE);
(2) An exposure to a Government-Sponsored Enterprises (GSE);
(3) For purposes of subpart D of this part, a residential mortgage
exposure;
(4) A pre-sold construction loan;
(5) A statutory multifamily mortgage;
(6) A high volatility commercial real estate (HVCRE) exposure;
(7) A cleared transaction;
(8) A default fund contribution;
(9) A securitization exposure;
(10) An equity exposure;
(11) An unsettled transaction;
(12) A policy loan;
[[Page 64295]]
(13) A separate account;
(14) A Paycheck Protection Program covered loan as defined in
section 7(a)(36) or (37) of the Small Business Act (15 U.S.C.
636(a)(36)-(37));
(15) For purposes of subpart E of this part, a real estate
exposure, as defined in Sec. 3.101 of this part; or
(16) For purposes of subpart E of this part, a retail exposure as
defined in Sec. 3.101 of this part.
* * * * *
CVA risk-weighted assets means the measure for CVA risk calculated
under Sec. 3.221(a) multiplied by 12.5.
* * * * *
Effective notional amount means for an eligible guarantee or
eligible credit derivative, the lesser of the contractual notional
amount of the credit risk mitigant and the exposures amount of the
hedged exposure, multiplied by the percentage coverage of the credit
risk mitigant.
* * * * *
Eligible guarantee * * *
(10) Is provided by an eligible guarantor.
* * * * *
Expanded total risk-weighted assets means the greater of:
(1) The sum of:
(i) Total credit risk-weighted assets;
(ii) Total risk-weighted assets for equity exposures as calculated
under Sec. Sec. 3.141 and 3.142;
(iii) Risk-weighted assets for operational risk as calculated under
Sec. 3.150;
(iv) Market risk-weighted assets; and
(v) CVA risk-weighted assets; minus
(vi) Any amount of the national bank's or Federal savings
association's adjusted allowance for credit losses that is not included
in tier 2 capital and any amount of allocated transfer risk reserves;
or
(2)(i) 72.5 percent of the sum of:
(A) Total credit risk-weighted assets;
(B) Total risk-weighted assets for equity exposures as calculated
under Sec. Sec. 3.141 and 3.142;
(C) Risk-weighted assets for operational risk as calculated under
Sec. 3.150;
(D) Standardized market risk-weighted assets; and
(E) CVA risk-weighted assets; minus
(ii) Any amount of the national bank's or Federal savings
association's adjusted allowance for credit losses that is not included
in tier 2 capital and any amount of allocated transfer risk reserves.
* * * * *
Exposure amount means:
(1) For the on-balance sheet component of an exposure (other than
an available-for-sale or held-to-maturity security, if the national
bank or Federal savings association has made an AOCI opt-out election
(as defined in Sec. 3.22(b)(2)); an OTC derivative contract; a repo-
style transaction or an eligible margin loan for which the national
bank or Federal savings association determines the exposure amount
under Sec. 3.37 or Sec. 3.121, as applicable; a cleared transaction;
a default fund contribution; or a securitization exposure), the
national bank's or Federal savings association's carrying value of the
exposure.
* * * * *
(4) For the off-balance sheet component of an exposure (other than
an OTC derivative contract; a repo-style transaction or an eligible
margin loan for which the national bank or Federal savings association
calculates the exposure amount under Sec. 3.37 or Sec. 3.121, as
applicable; a cleared transaction; a default fund contribution; or a
securitization exposure), the notional amount of the off-balance sheet
component multiplied by the appropriate credit conversion factor (CCF)
in Sec. 3.33 or Sec. 3.112, as applicable.
(5) For an exposure that is an OTC derivative contract, the
exposure amount determined under Sec. 3.34 or Sec. 3.113, as
applicable.
(6) For an exposure that is a cleared transaction, the exposure
amount determined under Sec. 3.35 or Sec. 3.114, as applicable.
(7) For an exposure that is an eligible margin loan or repo-style
transaction for which the national bank or Federal savings association
calculates the exposure amount as provided in Sec. 3.37 or Sec.
3.121, as applicable, the exposure amount determined under Sec. 3.37
or Sec. 3.121, as applicable.
(8) For an exposure that is a securitization exposure, the exposure
amount determined under Sec. 3.42 or Sec. 3.131, as applicable.
* * * * *
Financial collateral * * *
(2) In which the national bank or Federal savings association has a
perfected, first-priority security interest or, outside of the United
States, the legal equivalent thereof (with the exception of cash on
deposit; and notwithstanding the prior security interest of any
custodial agent or any priority security interest granted to a CCP in
connection with collateral posted to that CCP).
Financial institution * * *
(5) * * *
(i) 85 percent or more of the total consolidated annual gross
revenues (as determined in accordance with applicable accounting
standards) of the company in either of the two most recent calendar
years were derived, directly or indirectly, by the company on a
consolidated basis from the activities; or
* * * * *
Indirect Exposure means an exposure that arises from the national
bank's or Federal savings association's investment in an investment
fund which holds an investment in the national bank's or Federal
savings association's own capital instrument, or an investment in the
capital of an unconsolidated financial institution. For a national bank
or Federal savings association subject to subpart E of this part,
indirect exposure also includes an investment in an investment fund
that holds a covered debt instrument.
* * * * *
Market risk national bank or Federal savings association means a
national bank or Federal savings association that is described in Sec.
3.201(b)(1).
Market risk-weighted assets means the measure for market risk
calculated pursuant to Sec. 3.204(a) multiplied by 12.5.
* * * * *
Net independent collateral amount means the fair value amount of
the independent collateral, as adjusted by the haircuts under Sec.
3.121(c)(2)(iii), as applicable, that a counterparty to a netting set
has posted to a national bank or Federal savings association less the
fair value amount of the independent collateral, as adjusted by the
haircuts under Sec. 3.121(c)(2)(iii), as applicable, posted by the
national bank or Federal savings association to the counterparty,
excluding such amounts held in a bankruptcy-remote manner or posted to
a QCCP and held in conformance with the operational requirements in
Sec. 3.3.
Netting set means:
(1) A group of transactions with a single counterparty that are
subject to a qualifying master netting agreement and that consist only
of:
(i) Derivative contracts;
(ii) Repo-style transactions; or
(iii) Eligible margin loans.
(2) For derivative contracts, netting set also includes a single
derivative contract between a national bank or Federal savings
association and a single counterparty.
Non-significant investment in the capital of an unconsolidated
financial institution means an investment by a national bank or Federal
savings association subject to subpart E of this part in the capital of
an unconsolidated financial institution where the national bank or
Federal savings association owns 10 percent or less of the issued
[[Page 64296]]
and outstanding common stock of the unconsolidated financial
institution.
* * * * *
Protection amount (P) means, with respect to an exposure hedged by
an eligible guarantee or eligible credit derivative, the effective
notional amount of the guarantee or credit derivative, reduced to
reflect any currency mismatch, maturity mismatch, or lack of
restructuring coverage (as provided in Sec. 3.36 or Sec. 3.120, as
appropriate).
* * * * *
Qualifying central counterparty (QCCP) * * *
(2) (i) Provides the national bank or Federal savings association
with the central counterparty's hypothetical capital requirement or the
information necessary to calculate such hypothetical capital
requirement, and other information the national bank or Federal savings
association is required to obtain under Sec. Sec. 3.35(d)(3) and
3.113(d)(3);
(ii) Makes available to the OCC and the CCP's regulator the
information described in paragraph (2)(i) of this definition; and
(iii) Has not otherwise been determined by the OCC to not be a QCCP
due to its financial condition, risk profile, failure to meet
supervisory risk management standards, or other weaknesses or
supervisory concerns that are inconsistent with the risk weight
assigned to qualifying central counterparties under Sec. Sec. 3.35 and
3.113.
Qualifying master netting agreement * * *
(3) The agreement does not contain a walkaway clause (that is, a
provision that permits a non-defaulting counterparty to make a lower
payment than it otherwise would make under the agreement, or no payment
at all, to a defaulter or the estate of a defaulter, even if the
defaulter or the estate of the defaulter is a net creditor under the
agreement); and
(4) In order to recognize an agreement as a qualifying master
netting agreement for purposes of this subpart, a national bank or
Federal savings association must comply with the requirements of Sec.
3.3(d) with respect to that agreement.
* * * * *
Significant investment in the capital of an unconsolidated
financial institution means an investment by a national bank or Federal
savings association subject to subpart E of this part in the capital of
an unconsolidated financial institution where the national bank or
Federal savings association owns more than 10 percent of the issued and
outstanding common stock of the unconsolidated financial institution.
* * * * *
Speculative grade means that the entity to which the national bank
or Federal savings association is exposed through a loan or security,
or the reference entity with respect to a credit derivative, has
adequate capacity to meet financial commitments in the near term, but
is vulnerable to adverse economic conditions, such that should economic
conditions deteriorate, the issuer or the reference entity would
present an elevated default risk.
Standardized market risk-weighted assets means the standardized
measure for market risk calculated under Sec. 3.204(b) multiplied by
12.5.
Standardized total risk-weighted assets means:
(1) * * *
(vi) For a market risk national bank or Federal savings association
only, market risk-weighted assets; minus
(2) Any amount of the national bank's or Federal savings
association's allowance for loan and lease losses or adjusted allowance
for credit losses, as applicable, that is not included in tier 2
capital and any amount of allocated transfer risk reserves.
* * * * *
Sub-speculative grade means that the entity to which the national
bank or Federal savings association is exposed through a loan or
security, or the reference entity with respect to a credit derivative,
depends on favorable economic conditions to meet its financial
commitments, such that should such economic conditions deteriorate the
issuer or the reference entity likely would default on its financial
commitments.
* * * * *
Synthetic exposure means an exposure whose value is linked to the
value of an investment in the national bank or Federal savings
association's own capital instrument or to the value of an investment
in the capital of an unconsolidated financial institution. For a
national bank or Federal savings association subject to subpart E of
this part, synthetic exposure includes an exposure whose value is
linked to the value of an investment in a covered debt instrument.
* * * * *
Total credit risk-weighted assets means the sum of:
(1) Total risk-weighted assets for general credit risk as
calculated under Sec. 3.110;
(2) Total risk-weighted assets for cleared transactions and default
fund contributions as calculated under Sec. 3.114;
(3) Total risk-weighted assets for unsettled transactions as
calculated under Sec. 3.115; and
(4) Total risk-weighted assets for securitization exposures as
calculated under Sec. 3.132.
* * * * *
Unregulated financial institution means a financial institution
that is not a regulated financial institution, including any financial
institution that would meet the definition of ``Financial institution''
under this section but for the ownership interest thresholds set forth
in paragraph (4)(i) of that definition.
* * * * *
Variation margin amount means the fair value amount of the
variation margin, as adjusted by the standard supervisory haircuts
under Sec. 3.121(c)(2)(iii), as applicable, that a counterparty to a
netting set has posted to a national bank or Federal savings
association less the fair value amount of the variation margin, as
adjusted by the standard supervisory haircuts under Sec.
3.121(c)(2)(iii), as applicable, posted by the national bank or Federal
savings association to the counterparty.
* * * * *
\1\ For the standardized approach treatment of these exposures,
see Sec. 3.34(e) (OTC derivative contracts) or Sec. 3.37(c) (repo-
style transactions). For the expanded risk-based approach treatment
of these exposures, see Sec. 3.113 (OTC derivative contracts) or
Sec. 3.121 (repo-style transactions).
* * * * *
Sec. 3.3 [Amended]
0
4. In Sec. 3.3, remove and reserve paragraph (c).
0
5. In Sec. 3.10:
0
a. Revise paragraph (a)(1)(v);
0
b. In paragraph (b) introductory text, remove the words ``paragraph
(c)'' and add in their the words ``paragraph (d)'';
0
c. Revise paragraph (c);
0
d. In paragraph (d):
0
i. Revise the introductory text;
0
ii. Remove the words ``advanced approaches'' from paragraphs (d)(1)(ii)
and (d)(2)(ii) and and add in their place the word ``expanded''; and
0
iii. Revise paragraph (d)(3)(ii); and
0
f. In paragraph (e)(1), remove the phrase ``(national banks), 12 CFR
167.3(c) (Federal savings associations)''.
The revisions read as follows:
Sec. 3.10 Minimum capital requirements.
(a) * * *
(1) * * *
(v) For a national bank or Federal savings association subject to
subpart E of this part, a supplementary leverage ratio of 3 percent.
* * * * *
(c) Supplementary leverage ratio. (1) The supplementary leverage
ratio of a national bank or Federal savings
[[Page 64297]]
association subject to subpart E of this part is the ratio of its tier
1 capital to total leverage exposure. Total leverage exposure is
calculated as the sum of:
(i) The mean of the on-balance sheet assets calculated as of each
day of the reporting quarter; and
(ii) The mean of the off-balance sheet exposures calculated as of
the last day of each of the most recent three months, minus the
applicable deductions under Sec. 3.22(a), (c), and (d).
(2) For purposes of this part, total leverage exposure means the
sum of the items described in paragraphs (c)(2)(i) through (viii) of
this section, as adjusted pursuant to paragraph (c)(2)(ix) of this
section for a clearing member national bank or Federal savings
association and paragraph (c)(2)(x) of this section for a custodial
banking organization:
(i) The balance sheet carrying value of all of the national bank's
or Federal savings association's on-balance sheet assets, net of
adjusted allowances for credit losses, plus the value of securities
sold under a repurchase transaction or a securities lending transaction
that qualifies for sales treatment under GAAP, less amounts deducted
from tier 1 capital under Sec. 3.22(a), (c), and (d), less the value
of securities received in security-for-security repo-style
transactions, where the national bank or Federal savings association
acts as a securities lender and includes the securities received in its
on-balance sheet assets but has not sold or re-hypothecated the
securities received, and less the fair value of any derivative
contracts;
(ii) (A) The potential future credit exposure (PFE) for each
netting set to which the national bank or Federal savings association
is a counterparty (including cleared transactions except as provided in
paragraph (c)(2)(viii) of this section and, at the discretion of the
national bank or Federal savings association, excluding a forward
agreement treated as a derivative contract that is part of a repurchase
or reverse repurchase or a securities borrowing or lending transaction
that qualifies for sales treatment under GAAP), as determined under
Sec. 3.113(g), in which the term C in Sec. 3.113(g)(1) equals zero,
and, for any counterparty that is not a commercial end-user, multiplied
by 1.4. For purposes of this paragraph (c)(2)(ii)(A), a national bank
or Federal savings association may set the value of the term C in Sec.
3.113(g)(1) equal to the amount of collateral posted by a clearing
member client of the national bank or Federal savings association in
connection with the client-facing derivative transactions within the
netting set; and
(B) A national bank or Federal savings association may choose to
exclude the PFE of all credit derivatives or other similar instruments
through which it provides credit protection when calculating the PFE
under Sec. 3.113, provided that it does so consistently over time for
the calculation of the PFE for all such instruments;
(iii)(A) The replacement cost of each derivative contract or single
product netting set of derivative contracts to which the national bank
or Federal savings association is a counterparty, calculated according
to the following formula, and, for any counterparty that is not a
commercial end-user, multiplied by 1.4:
Replacement Cost = max{V-CVMr + CVMp; 0{time}
Where:
V equals the fair value for each derivative contract or each
netting set of derivative contracts (including a cleared transaction
except as provided in paragraph (c)(2)(viii) of this section and, at
the discretion of the national bank or Federal savings association,
excluding a forward agreement treated as a derivative contract that
is part of a repurchase or reverse repurchase or a securities
borrowing or lending transaction that qualifies for sales treatment
under GAAP);
CVMr equals the amount of cash collateral received from a
counterparty to a derivative contract and that satisfies the
conditions in paragraphs (c)(2)(iii)(B) through (H) of this section,
or, in the case of a client-facing derivative transaction, the
amount of collateral received from the clearing member client; and
CVMp equals the amount of cash collateral that is posted to a
counterparty to a derivative contract and that has not offset the
fair value of the derivative contract and that satisfies the
conditions in paragraphs (c)(2)(iii)(B) through (H) of this section,
or, in the case of a client-facing derivative transaction, the
amount of collateral posted to the clearing member client;
(B) Notwithstanding paragraph (c)(2)(iii)(A) of this section, where
multiple netting sets are subject to a single variation margin
agreement, a national bank or Federal savings association must apply
the formula for replacement cost provided in Sec. 3.113(j)(1), in
which the term CMA may only include cash collateral that satisfies the
conditions in paragraphs (c)(2)(iii)(B) through (H) of this section;
and
(C) For purposes of paragraph (c)(2)(iii)(A) of this section a
national bank or Federal savings association must treat a derivative
contract that references an index as if it were multiple derivative
contracts each referencing one component of the index if the national
bank or Federal savings association elected to treat the derivative
contract as multiple derivative contracts under Sec. 3.113(e)(6);
(D) For derivative contracts that are not cleared through a QCCP,
the cash collateral received by the recipient counterparty is not
segregated (by law, regulation, or an agreement with the counterparty);
(E) Variation margin is calculated and transferred on a daily basis
based on the mark-to-fair value of the derivative contract;
(F) The variation margin transferred under the derivative contract
or the governing rules of the CCP or QCCP for a cleared transaction is
the full amount that is necessary to fully extinguish the net current
credit exposure to the counterparty of the derivative contracts,
subject to the threshold and minimum transfer amounts applicable to the
counterparty under the terms of the derivative contract or the
governing rules for a cleared transaction;
(G) The variation margin is in the form of cash in the same
currency as the currency of settlement set forth in the derivative
contract, provided that for the purposes of paragraph (c)(2)(iii)(E) of
this section, currency of settlement means any currency for settlement
specified in the governing qualifying master netting agreement and the
credit support annex to the qualifying master netting agreement, or in
the governing rules for a cleared transaction; and
(H) The derivative contract and the variation margin are governed
by a qualifying master netting agreement between the legal entities
that are the counterparties to the derivative contract or by the
governing rules for a cleared transaction, and the qualifying master
netting agreement or the governing rules for a cleared transaction must
explicitly stipulate that the counterparties agree to settle any
payment obligations on a net basis, taking into account any variation
margin received or provided under the contract if a credit event
involving either counterparty occurs;
(iv) The effective notional principal amount (that is, the apparent
or stated notional principal amount multiplied by any multiplier in the
derivative contract) of a credit derivative, or other similar
instrument, through which the national bank or Federal savings
association provides credit protection, provided that:
(A) The national bank or Federal savings association may reduce the
effective notional principal amount of the credit derivative by the
amount of any reduction in the mark-to-fair value of the credit
derivative if the reduction is recognized in common equity tier 1
capital;
[[Page 64298]]
(B) The national bank or Federal savings association may reduce the
effective notional principal amount of the credit derivative by the
effective notional principal amount of a purchased credit derivative or
other similar instrument, provided that the remaining maturity of the
purchased credit derivative is equal to or greater than the remaining
maturity of the credit derivative through which the national bank or
Federal savings association provides credit protection and that:
(1) With respect to a credit derivative that references a single
exposure, the reference exposure of the purchased credit derivative is
to the same legal entity and ranks pari passu with, or is junior to,
the reference exposure of the credit derivative through which the
national bank or Federal savings association provides credit
protection; or
(2) With respect to a credit derivative that references multiple
exposures, the reference exposures of the purchased credit derivative
are to the same legal entities and rank pari passu with the reference
exposures of the credit derivative through which the national bank or
Federal savings association provides credit protection, and the level
of seniority of the purchased credit derivative ranks pari passu to the
level of seniority of the credit derivative through which the national
bank or Federal savings association provides credit protection;
(3) Where a national bank or Federal savings association has
reduced the effective notional principal amount of a credit derivative
through which the national bank or Federal savings association provides
credit protection in accordance with paragraph (c)(2)(iv)(A) of this
section, the national bank or Federal savings association must also
reduce the effective notional principal amount of a purchased credit
derivative used to offset the credit derivative through which the
national bank or Federal savings association provides credit
protection, by the amount of any increase in the mark-to-fair value of
the purchased credit derivative that is recognized in common equity
tier 1 capital; and
(4) Where the national bank or Federal savings association
purchases credit protection through a total return swap and records the
net payments received on a credit derivative through which the national
bank or Federal savings association provides credit protection in net
income, but does not record offsetting deterioration in the mark-to-
fair value of the credit derivative through which the national bank or
Federal savings association provides credit protection in net income
(either through reductions in fair value or by additions to reserves),
the national bank or Federal savings association may not use the
purchased credit protection to offset the effective notional principal
amount of the related credit derivative through which the national bank
or Federal savings association provides credit protection;
(v) Where a national bank or Federal savings association acting as
a principal has more than one repo-style transaction with the same
counterparty and has offset the gross value of receivables due from a
counterparty under reverse repurchase transactions by the gross value
of payables under repurchase transactions due to the same counterparty,
the gross value of receivables associated with the repo-style
transactions less any on-balance sheet receivables amount associated
with these repo-style transactions included under paragraph (c)(2)(i)
of this section, unless the following criteria are met:
(A) The offsetting transactions have the same explicit final
settlement date under their governing agreements;
(B) The right to offset the amount owed to the counterparty with
the amount owed by the counterparty is legally enforceable in the
normal course of business and in the event of receivership, insolvency,
liquidation, or similar proceeding; and
(C) Under the governing agreements, the counterparties intend to
settle net, settle simultaneously, or settle according to a process
that is the functional equivalent of net settlement, (that is, the cash
flows of the transactions are equivalent, in effect, to a single net
amount on the settlement date), where both transactions are settled
through the same settlement system, the settlement arrangements are
supported by cash or intraday credit facilities intended to ensure that
settlement of both transactions will occur by the end of the business
day, and the settlement of the underlying securities does not interfere
with the net cash settlement;
(vi) The counterparty credit risk of a repo-style transaction,
including where the national bank or Federal savings association acts
as an agent for a repo-style transaction and indemnifies the customer
with respect to the performance of the customer's counterparty in an
amount limited to the difference between the fair value of the security
or cash its customer has lent and the fair value of the collateral the
borrower has provided, calculated as follows:
(A) If the transaction is not subject to a qualifying master
netting agreement, the counterparty credit risk (E*) for transactions
with a counterparty must be calculated on a transaction by transaction
basis, such that each transaction i is treated as its own netting set,
in accordance with the following formula, where Ei is the
fair value of the instruments, gold, or cash that the national bank or
Federal savings association has lent, sold subject to repurchase, or
provided as collateral to the counterparty, and Ci is the
fair value of the instruments, gold, or cash that the national bank or
Federal savings association has borrowed, purchased subject to resale,
or received as collateral from the counterparty:
Ei* = max {0, [Ei-Ci]{time} ; and
(B) If the transaction is subject to a qualifying master netting
agreement, the counterparty credit risk (E*) must be calculated as the
greater of zero and the total fair value of the instruments, gold, or
cash that the national bank or Federal savings association has lent,
sold subject to repurchase or provided as collateral to a counterparty
for all transactions included in the qualifying master netting
agreement ([Sigma]Ei), less the total fair value of the
instruments, gold, or cash that the national bank or Federal savings
association borrowed, purchased subject to resale or received as
collateral from the counterparty for those transactions
([Sigma]Ci), in accordance with the following formula:
E* = max {0, [[Sigma]Ei- [Sigma]Ci]{time}
(vii) If a national bank or Federal savings association acting as
an agent for a repo-style transaction provides a guarantee to a
customer of the security or cash its customer has lent or borrowed with
respect to the performance of the customer's counterparty and the
guarantee is not limited to the difference between the fair value of
the security or cash its customer has lent and the fair value of the
collateral the borrower has provided, the amount of the guarantee that
is greater than the difference between the fair value of the security
or cash its customer has lent and the value of the collateral the
borrower has provided;
(viii) The credit equivalent amount of all off-balance sheet
exposures of the national bank or Federal savings association,
excluding repo-style transactions, repurchase or reverse repurchase or
securities borrowing or lending transactions that qualify for sales
treatment under GAAP, and derivative transactions, determined using the
applicable credit conversion factor under Sec. 3.112(b), provided,
[[Page 64299]]
however, that the minimum credit conversion factor that may be assigned
to an off-balance sheet exposure under this paragraph is 10 percent;
and
(ix) For a national bank or Federal savings association that is a
clearing member:
(A) A clearing member national bank or Federal savings association
that guarantees the performance of a clearing member client with
respect to a cleared transaction must treat its exposure to the
clearing member client as a derivative contract or repo-style
transaction, as applicable, for purposes of determining its total
leverage exposure;
(B) A clearing member national bank or Federal savings association
that guarantees the performance of a CCP with respect to a transaction
cleared on behalf of a clearing member client must treat its exposure
to the CCP as a derivative contract or repo-style transaction, as
applicable, for purposes of determining its total leverage exposure;
(C) A clearing member national bank or Federal savings association
that does not guarantee the performance of a CCP with respect to a
transaction cleared on behalf of a clearing member client may exclude
its exposure to the CCP for purposes of determining its total leverage
exposure;
(D) Notwithstanding paragraphs (c)(2)(ix)(A) through (C) of this
section, a national bank or Federal savings association that is a
clearing member may exclude from its total leverage exposure the
effective notional principal amount of credit protection sold through a
credit derivative contract, or other similar instrument, that it clears
on behalf of a clearing member client through a CCP as calculated in
accordance with paragraph (c)(2)(iv) of this section; and
(E) A national bank or Federal savings association may exclude from
its total leverage exposure a clearing member's exposure to a clearing
member client for a derivative contract if the clearing member client
and the clearing member are affiliates and consolidated for financial
reporting purposes on the national bank's or Federal savings
association's balance sheet.
(x) A custodial banking organization shall exclude from its total
leverage exposure the lesser of:
(A) The amount of funds that the custodial banking organization has
on deposit at a qualifying central bank; and
(B) The amount of funds in deposit accounts at the custodial
banking organization that are linked to fiduciary or custodial and
safekeeping accounts at the custodial banking organization. For
purposes of this paragraph (c)(2)(x), a deposit account is linked to a
fiduciary or custodial and safekeeping account if the deposit account
is provided to a client that maintains a fiduciary or custodial and
safekeeping account with the custodial banking organization and the
deposit account is used to facilitate the administration of the
fiduciary or custodial and safekeeping account.
(d) Expanded capital ratio calculations. A national bank or Federal
savings association subject to subpart E of this part must determine
its regulatory capital ratios as described in paragraphs (d)(1) through
(3) of this section.
* * * * *
(3) * * *
(ii) The ratio of the national bank's or Federal savings
association's expanded risk-based approach-adjusted total capital to
expanded total risk-weighted assets. A national bank's or Federal
savings association's expanded risk-based approach-adjusted total
capital is the national bank's or Federal savings association's total
capital after being adjusted as follows:
(A) A national bank or Federal savings association subject to
subpart E must deduct from its total capital any adjusted allowance for
credit losses included in its tier 2 capital in accordance with Sec.
3.20(d)(3); and
(B) A national bank or Federal savings association subject to
subpart E must add to its total capital any adjusted allowance for
credit losses up to 1.25 percent of the sum of the national bank's or
Federal savings association's total credit risk-weighted assets.
* * * * *
0
6. In Sec. 3.11, revise paragraphs (b)(1) introductory text, and
(b)(1)(ii) and (iii) to read as follows:
Sec. 3.11 Capital conservation buffer and countercyclical capital
buffer amount.
* * * * *
(b) * * *
(1) General. A national bank or Federal savings association subject
to subpart E of this part must calculate a countercyclical capital
buffer amount in accordance with this paragraph (b) for purposes of
determining its maximum payout ratio under table 1 to this section.
* * * * *
(ii) Amount. A national bank or Federal savings association subject
to subpart E of this part has a countercyclical capital buffer amount
determined by calculating the weighted average of the countercyclical
capital buffer amounts established for the national jurisdictions where
the national bank's or Federal savings association's private sector
credit exposures are located, as specified in paragraphs (b)(2) and (3)
of this section.
(iii) Weighting. The weight assigned to a jurisdiction's
countercyclical capital buffer amount is calculated by dividing the
total risk-weighted assets for the national bank's or Federal savings
association's private sector credit exposures located in the
jurisdiction by the total risk-weighted assets for all of the national
bank's or Federal savings association's private sector credit
exposures. The methodology a national bank or Federal savings
association uses for determining risk-weighted assets for purposes of
this paragraph (b) must be the methodology that determines its risk-
based capital ratios under Sec. 3.10. Notwithstanding the previous
sentence, the risk-weighted asset amount for a private sector credit
exposure that is a covered position under subpart F of this part is its
standardized default risk capital requirement as determined under Sec.
3.210 multiplied by 12.5.
* * * * *
0
7. In Sec. 3.12, revise paragraph (a)(2) and remove paragraph (a)(4)
to read as follows:
Sec. 3.12 Community bank leverage ratio framework.
(a) * * *
(2) For purposes of this section, a qualifying community banking
organization means a national bank or Federal savings association that
is not a national bank or Federal savings association subject to
subpart E of this part and that satisfies all of the following
criteria:
* * * * *
0
8. In Sec. 3.20, revise paragraphs (c)(1)(xiv), (d)(1)(xi), and (d)(3)
to read as follows:
Sec. 3.20 Capital components and eligibility criteria for regulatory
capital instruments.
* * * * *
(c) * * *
(1) * * *
(xiv) For a national bank or Federal savings association subject to
subpart E of this part, the governing agreement, offering circular, or
prospectus of an instrument issued after the date upon which the
national bank or Federal savings association becomes subject to subpart
E must disclose that the holders of the instrument may be fully
subordinated to interests held by the U.S. government in the event that
the national bank or Federal savings association enters into a
receivership, insolvency, liquidation, or similar proceeding.
* * * * *
[[Page 64300]]
(d) * * *
(1) * * *
(xi) For a national bank or Federal savings association subject to
subpart E of this part, the governing agreement, offering circular, or
prospectus of an instrument issued after the date on which the national
bank or Federal savings association becomes subject to subpart E must
disclose that the holders of the instrument may be fully subordinated
to interests held by the U.S. government in the event that the national
bank or Federal savings association enters into a receivership,
insolvency, liquidation, or similar proceeding.
* * * * *
(3) ALLL or AACL, as applicable, up to 1.25 percent of the national
bank's or Federal savings association's standardized total risk-
weighted assets, not including any amount of the ALLL or AACL, as
applicable (and for a market risk national bank or Federal savings
association institution, excluding its market risk weighted assets).
* * * * *
0
9. In Sec. 3.21:
0
a. In paragraph (a)(1), remove the words ``an advanced approaches
national bank or Federal savings association'' and add in their place
the words ``subject to subpart E of this part'';
0
b. In paragraph (b):
0
i. Revise paragraph (b)(1) introductory text;
0
ii. Remove the words ``advanced approaches'' wherever they appear in
paragraphs (b)(1)(i) and (b)(2);
0
iii. In paragraph (b)(3) introductory text, remove the words ``an
advanced approaches'' and add in their place the word ``a'' and remove
the words ``the advanced approaches''; and
0
iv. Remove the words ``advanced approaches'' wherever they appear in
paragraphs (b)(3)(ii), and (b)(4) and (5).
The revision read as follows:
Sec. 3.21 Minority interest.
* * * * *
(b) (1) Applicability. For purposes of Sec. 3.20, a national bank
or Federal savings association subject to subpart E of this part is
subject to the minority interest limitations in this paragraph (b) if:
* * * * *
0
10. In Sec. 3.22:
0
a. Redesignate footnotes 21 through 31 as footnotes 1 through 11.
0
b. Revise paragraphs (a)(1)(ii) and (a)(4);
0
c. Remove and reserve paragraph (a)(6);
0
d. Revise paragraphs (a)(7), (b)(1)(ii) and (iii), (b)(2)(i) through
(iii), (b)(2)(iv) introductory text, newly designated footnote 3 to
paragraph (c) introductory text, and paragraph (c)(1) introductory
text;
0
e. Add paragraph (c)(1)(iv);
0
f. Revise paragraph (c)(2) introductory text, paragraphs (c)(2)(ii)(D),
(c)(3)(ii), (c)(4), (c)(5)(i) through (iii), (c)(6), paragraph (d)(1)
introductory text, and paragraphs (d)(2), (f), and (g); and
The revisions and addition read as follows:
Sec. 3.22 Regulatory capital adjustments and deductions.
(a) * * *
(1) * * *
(ii) For a national bank or Federal savings association subject to
subpart E of this part, goodwill that is embedded in the valuation of a
significant investment in the capital of an unconsolidated financial
institution in the form of common stock (and that is reflected in the
consolidated financial statements of the national bank or Federal
savings association), in accordance with paragraph (d) of this section;
* * * * *
(4)(i) For a national bank or Federal savings association that is
not subject to subpart E of this part, any gain-on-sale in connection
with a securitization exposure;
(ii) For a national bank or Federal savings association subject to
subpart E of this part, any gain-on-sale in connection with a
securitization exposure and the portion of any CEIO that does not
constitute an after-tax gain-on-sale;
* * * * *
(7) With respect to a financial subsidiary, the aggregate amount of
the national bank's or Federal savings association's outstanding equity
investment, including retained earnings, in its financial subsidiaries
(as defined in 12 CFR 5.39). A national bank or Federal savings
association must not consolidate the assets and liabilities of a
financial subsidiary with those of the parent bank, and no other
deduction is required under paragraph (c) of this section for
investments in the capital instruments of financial subsidiaries.
* * * * *
(b) * * *
(1) * * *
(ii) A national bank or Federal savings association that is subject
to subpart E of this part, and a national bank or Federal savings
association that has not made an AOCI opt-out election (as defined in
paragraph (b)(2) of this section), must deduct any accumulated net
gains and add any accumulated net losses on cash flow hedges included
in AOCI that relate to the hedging of items that are not recognized at
fair value on the balance sheet.
(iii) A national bank or Federal savings association must deduct
any net gain and add any net loss related to changes in the fair value
of liabilities that are due to changes in the national bank's or
Federal savings association's own credit risk. A national bank or
Federal savings association subject to subpart E of this part must
deduct the difference between its credit spread premium and the risk-
free rate for derivatives that are liabilities as part of this
adjustment.
(2) * * *
(i) A national bank or Federal savings association that is not
subject to subpart E of this part may make a one-time election to opt
out of the requirement to include all components of AOCI (with the
exception of accumulated net gains and losses on cash flow hedges
related to items that are not fair-valued on the balance sheet) in
common equity tier 1 capital (AOCI opt-out election). A national bank
or Federal savings association that makes an AOCI opt-out election in
accordance with this paragraph (b)(2) must adjust common equity tier 1
capital as follows:
(A) Subtract any net unrealized gains and add any net unrealized
losses on available-for-sale debt securities;
(B) Subtract any accumulated net gains and add any accumulated net
losses on cash flow hedges;
(C) Subtract any amounts recorded in AOCI attributed to defined
benefit postretirement plans resulting from the initial and subsequent
application of the relevant GAAP standards that pertain to such plans
(excluding, at the national bank's or Federal savings association's
option, the portion relating to pension assets deducted under paragraph
(a)(5) of this section); and
(D) Subtract any net unrealized gains and add any net unrealized
losses on held-to-maturity securities that are included in AOCI.
(ii) A national bank or Federal savings association that is not
subject to subpart E of this part must make its AOCI opt-out election
in the Call Report during the first reporting period after the national
bank or Federal savings association is required to comply with subpart
A of this part. If the national bank or Federal savings association was
previously subject to subpart E of this part, the national bank or
Federal savings association must make its AOCI opt-out election in the
Call Report during the first reporting period after
[[Page 64301]]
the national bank or Federal savings association is not subject to
subpart E of this part.
(iii) With respect to a national bank or Federal savings
association that is not subject to subpart E, each of its subsidiary
banking organizations that is subject to regulatory capital
requirements issued by the Board of Governors of the Federal Reserve,
the Federal Deposit Insurance Corporation, or the Office of the
Comptroller of the Currency\1\ must elect the same option as the
national bank or Federal savings association pursuant to this paragraph
(b)(2).
(iv) With prior notice to the OCC, a national bank or Federal
savings association resulting from a merger, acquisition, or purchase
transaction and that is not subject to subpart E of this part may
change its AOCI opt-out election in its Call Report filed for the first
reporting period after the date required for such national bank or
Federal savings association to comply with subpart A of this part if:
* * * * *
(c) * * * \3\
(1) Investment in the national bank's or Federal savings
association's own capital or covered debt instruments. A national bank
or Federal savings association must deduct an investment in the
national bank's or Federal savings association's own capital
instruments, and a national bank or Federal savings association subject
to subpart E of this part also must deduct an investment in the
national bank's or Federal savings association's own covered debt
instruments, as follows:
* * * * *
(iv) A national bank or Federal savings association subject to
subpart E of this part must deduct an investment in the institution's
own covered debt instruments from its tier 2 capital elements, as
applicable. If the national bank or Federal savings association does
not have a sufficient amount of tier 2 capital to effect this
deduction, the institution must deduct the shortfall amount from the
next higher (that is, more subordinated) component of regulatory
capital.
* * * * *
(2) Corresponding deduction approach. For purposes of subpart C of
this part, the corresponding deduction approach is the methodology used
for the deductions from regulatory capital related to reciprocal cross
holdings (as described in paragraph (c)(3) of this section),
investments in the capital of unconsolidated financial institutions for
a national bank or Federal savings association that is not subject to
subpart E of this part (as described in paragraph (c)(4) of this
section), non-significant investments in the capital of unconsolidated
financial institutions for a national bank or Federal savings
association subject to subpart E of this part (as described in
paragraph (c)(5) of this section), and non-common stock significant
investments in the capital of unconsolidated financial institutions for
a national bank or Federal savings association subject to subpart E of
this part (as described in paragraph (c)(6) of this section). Under the
corresponding deduction approach, a national bank or Federal savings
association must make deductions from the component of capital for
which the underlying instrument would qualify if it were issued by the
national bank or Federal savings association itself, as described in
paragraphs (c)(2)(i) through (iii) of this section. If the national
bank or Federal savings association does not have a sufficient amount
of a specific component of capital to effect the required deduction,
the shortfall must be deducted according to paragraph (f) of this
section.
* * * * *
(ii) * * *
(D) For a national bank or Federal savings association subject to
subpart E of this part, a tier 2 capital instrument if it is a covered
debt instrument.
* * * * *
(3) * * *
(ii) A national bank or Federal savings association subject to
subpart E of this part must deduct an investment in any covered debt
instrument that the institution holds reciprocally with another
financial institution, where such reciprocal cross holdings result from
a formal or informal arrangement to swap, exchange, or otherwise intend
to hold each other's capital or covered debt instruments, by applying
the corresponding deduction approach in paragraph (c)(2) of this
section.
(4) Investments in the capital of unconsolidated financial
institutions. A national bank or Federal savings association that is
not subject to subpart E of this part must deduct its investments in
the capital of unconsolidated financial institutions (as defined in
Sec. 3.2) that exceed 25 percent of the sum of the national bank or
Federal savings association's common equity tier 1 capital elements
minus all deductions from and adjustments to common equity tier 1
capital elements required under paragraphs (a) through (c)(3) of this
section by applying the corresponding deduction approach in paragraph
(c)(2) of this section.\4\ The deductions described in this section are
net of associated DTLs in accordance with paragraph (e) of this
section. In addition, with the prior written approval of the OCC, a
national bank or Federal savings association that underwrites a failed
underwriting, for the period of time stipulated by the OCC, is not
required to deduct an Investment in the capital of an unconsolidated
financial institution pursuant to this paragraph (c) to the extent the
investment is related to the failed underwriting.\5\
(5) * * *
(i) A national bank or Federal savings association subject to
subpart E of this part must deduct its non-significant investments in
the capital of unconsolidated financial institutions (as defined in
Sec. 3.2) that, in the aggregate and together with any investment in a
covered debt instrument (as defined in Sec. 3.2) issued by a financial
institution in which the national bank or Federal savings association
does not have a significant investment in the capital of the
unconsolidated financial institution (as defined in Sec. 3.2), exceeds
10 percent of the sum of the national bank's or Federal savings
association's common equity tier 1 capital elements minus all
deductions from and adjustments to common equity tier 1 capital
elements required under paragraphs (a) through (c)(3) of this section
(the 10 percent threshold for non-significant investments) by applying
the corresponding deduction approach in paragraph (c)(2) of this
section.\6\ The deductions described in this paragraph are net of
associated DTLs in accordance with paragraph (e) of this section. In
addition, with the prior written approval of the OCC, a national bank
or Federal savings association subject to subpart E of this part that
underwrites a failed underwriting, for the period of time stipulated by
the OCC, is not required to deduct from capital a non-significant
investment in the capital of an unconsolidated financial institution or
an investment in a covered debt instrument pursuant to this paragraph
(c)(5) to the extent the investment is related to the failed
underwriting.\7\ For any calculation under this paragraph (c)(5)(i), a
national bank or Federal savings association subject to subpart E of
this part may exclude the amount of an investment in a covered debt
instrument under paragraph (c)(5)(iii) or (iv) of this section, as
applicable.
(ii) For a national bank or Federal savings association subject to
subpart E of this part, the amount to be deducted under this paragraph
(c)(5) from a specific capital component is equal to:
(A) The national bank's or Federal savings association's aggregate
non-
[[Page 64302]]
significant investments in the capital of an unconsolidated financial
institution and, if applicable, any investments in a covered debt
instrument subject to deduction under this paragraph (c)(5), exceeding
the 10 percent threshold for non-significant investments, multiplied by
(B) The ratio of the national bank's or Federal savings
association's aggregate non-significant investments in the capital of
an unconsolidated financial institution (in the form of such capital
component) to the national bank's or Federal savings association's
total non-significant investments in unconsolidated financial
institutions, with an investment in a covered debt instrument being
treated as tier 2 capital for this purpose.
(iii) For purposes of applying the deduction under paragraph
(c)(5)(i) of this section, a national bank or Federal savings
association subject to subpart E of this part that is not a subsidiary
of a global systemically important banking organization, as defined in
12 CFR 252.2, may exclude from the deduction the amount of the national
bank's or Federal savings association's gross long position, in
accordance with Sec. 3.22(h)(2), in investments in covered debt
instruments issued by financial institutions in which the national bank
or Federal savings association does not have a significant investment
in the capital of the unconsolidated financial institutions up to an
amount equal to 5 percent of the sum of the national bank's or Federal
savings association's common equity tier 1 capital elements minus all
deductions from and adjustments to common equity tier 1 capital
elements required under paragraphs (a) through (c)(3) of this section,
net of associated DTLs in accordance with paragraph (e) of this
section.
* * * * *
(6) Significant investments in the capital of unconsolidated
financial institutions that are not in the form of common stock. If a
national bank or Federal savings association subject to subpart E of
this part has a significant investment in the capital of an
unconsolidated financial institution, the national bank or Federal
savings association must deduct from capital any such investment issued
by the unconsolidated financial institution that is held by the
national bank or Federal savings association other than an investment
in the form of common stock, as well as any investment in a covered
debt instrument issued by the unconsolidated financial institution, by
applying the corresponding deduction approach in paragraph (c)(2) of
this section.\8\ The deductions described in this section are net of
associated DTLs in accordance with paragraph (e) of this section. In
addition, with the prior written approval of the OCC, for the period of
time stipulated by the OCC, a national bank or Federal savings
association subject to subpart E of this part that underwrites a failed
underwriting is not required to deduct the significant investment in
the capital of an unconsolidated financial institution or an investment
in a covered debt instrument pursuant to this paragraph (c)(6) if such
investment is related to such failed underwriting.
(d) * * *
(1) A national bank or Federal savings association that is not
subject to subpart E of this part must make deductions from regulatory
capital as described in this paragraph (d)(1).
* * * * *
(2) A national bank or Federal savings association subject to
subpart E of this part must make deductions from regulatory capital as
described in this paragraph (d)(2).
(i) A national bank or Federal savings association subject to
subpart E of this part must deduct from common equity tier 1 capital
elements the amount of each of the items set forth in this paragraph
(d)(2) that, individually, exceeds 10 percent of the sum of the
national bank's or Federal savings association's common equity tier 1
capital elements, less adjustments to and deductions from common equity
tier 1 capital required under paragraphs (a) through (c) of this
section (the 10 percent common equity tier 1 capital deduction
threshold).
(A) DTAs arising from temporary differences that the national bank
or Federal savings association could not realize through net operating
loss carrybacks, net of any related valuation allowances and net of
DTLs, in accordance with paragraph (e) of this section. A national bank
or Federal savings association subject to subpart E of this part is not
required to deduct from the sum of its common equity tier 1 capital
elements DTAs (net of any related valuation allowances and net of DTLs,
in accordance with Sec. 3.22(e)) arising from timing differences that
the national bank or Federal savings association could realize through
net operating loss carrybacks. The national bank or Federal savings
association must risk weight these assets at 100 percent. For a
national bank or Federal savings association that is a member of a
consolidated group for tax purposes, the amount of DTAs that could be
realized through net operating loss carrybacks may not exceed the
amount that the national bank or Federal savings association could
reasonably expect to have refunded by its parent holding company.
(B) MSAs net of associated DTLs, in accordance with paragraph (e)
of this section.
(C) Significant investments in the capital of unconsolidated
financial institutions in the form of common stock, net of associated
DTLs in accordance with paragraph (e) of this section.\10\ Significant
investments in the capital of unconsolidated financial institutions in
the form of common stock subject to the 10 percent common equity tier 1
capital deduction threshold may be reduced by any goodwill embedded in
the valuation of such investments deducted by the national bank or
Federal savings association pursuant to paragraph (a)(1) of this
section. In addition, with the prior written approval of the OCC, for
the period of time stipulated by the OCC, a national bank or Federal
savings association subject to subpart E of this part that underwrites
a failed underwriting is not required to deduct a significant
investment in the capital of an unconsolidated financial institution in
the form of common stock pursuant to this paragraph (d)(2) if such
investment is related to such failed underwriting.
(ii) A national bank or Federal savings association subject to
subpart E of this part must deduct from common equity tier 1 capital
elements the items listed in paragraph (d)(2)(i) of this section that
are not deducted as a result of the application of the 10 percent
common equity tier 1 capital deduction threshold, and that, in
aggregate, exceed 17.65 percent of the sum of the national bank's or
Federal savings association's common equity tier 1 capital elements,
minus adjustments to and deductions from common equity tier 1 capital
required under paragraphs (a) through (c) of this section, minus the
items listed in paragraph (d)(2)(i) of this section (the 15 percent
common equity tier 1 capital deduction threshold). Any goodwill that
has been deducted under paragraph (a)(1) of this section can be
excluded from the significant investments in the capital of
unconsolidated financial institutions in the form of common stock.\11\
(iii) For purposes of calculating the amount of DTAs subject to the
10 and 15 percent common equity tier 1 capital deduction thresholds, a
national bank or Federal savings association subject to subpart E of
this part may exclude DTAs and DTLs relating to adjustments made
[[Page 64303]]
to common equity tier 1 capital under paragraph (b) of this section. A
national bank or Federal savings association subject to subpart E of
this part that elects to exclude DTAs relating to adjustments under
paragraph (b) of this section also must exclude DTLs and must do so
consistently in all future calculations. A national bank or Federal
savings association subject to subpart E of this part may change its
exclusion preference only after obtaining the prior approval of the
OCC.
* * * * *
(f) Insufficient amounts of a specific regulatory capital component
to effect deductions. Under the corresponding deduction approach, if a
national bank or Federal savings association does not have a sufficient
amount of a specific component of capital to effect the full amount of
any deduction from capital required under paragraph (d) of this
section, the national bank or Federal savings association must deduct
the shortfall amount from the next higher (that is, more subordinated)
component of regulatory capital. Any investment by a national bank or
Federal savings association subject to subpart E of this part in a
covered debt instrument must be treated as an investment in the tier 2
capital for purposes of this paragraph (f). Notwithstanding any other
provision of this section, a qualifying community banking organization
(as defined in Sec. 3.12) that has elected to use the community bank
leverage ratio framework pursuant to Sec. 3.12 is not required to
deduct any shortfall of tier 2 capital from its additional tier 1
capital or common equity tier 1 capital.
(g) Treatment of assets that are deducted. A national bank or
Federal savings association must exclude from standardized total risk-
weighted assets and, as applicable, expanded total risk-weighted assets
any item that is required to be deducted from regulatory capital.
* * * * *
\1\ These rules include the regulatory capital requirements set
forth at 12 CFR part 3 (OCC); 12 CFR part 225 (Board); 12 CFR part
325, and 12 CFR part 390 (FDIC).
* * * * *
\3\ The national bank or Federal savings association must
calculate amounts deducted under paragraphs (c) through (f) of this
section after it calculates the amount of AACL includable in tier 2
capital under Sec. 3.20(d)(3).
\4\ With the prior written approval of the OCC, for the period
of time stipulated by the OCC, a national bank or Federal savings
association is not required to deduct a non-significant investment
in the capital instrument of an unconsolidated financial institution
or an investment in a covered debt instrument pursuant to this
paragraph if the financial institution is in distress and if such
investment is made for the purpose of providing financial support to
the financial institution, as determined by the OCC.
\5\ Any non-significant investments in the capital of an
unconsolidated financial institution that is not required to be
deducted under this paragraph (c)(4) or otherwise under this section
must be assigned the appropriate risk weight under subparts D, E, or
F of this part, as applicable.
\6\ With the prior written approval of the OCC, for the period
of time stipulated by the OCC, a national bank or Federal savings
association subject to subpart E of this part is not required to
deduct a non-significant investment in the capital of an
unconsolidated financial institution or an investment in a covered
debt instrument pursuant to this paragraph if the financial
institution is in distress and if such investment is made for the
purpose of providing financial support to the financial institution,
as determined by the OCC.
\7\ Any non-significant investment in the capital of an
unconsolidated financial institution or any investment in a covered
debt instrument that is not required to be deducted under this
paragraph (c)(5) or otherwise under this section must be assigned
the appropriate risk weight under subparts D, E, or F of this part,
as applicable.
\8\ With prior written approval of the OCC, for the period of
time stipulated by the OCC, a national bank or Federal savings
association subject to subpart E of this part is not required to
deduct a significant investment in the capital of an unconsolidated
financial institution, including an investment in a covered debt
instrument, under this paragraph (c)(6) or otherwise under this
section if such investment is made for the purpose of providing
financial support to the financial institution as determined by the
OCC.
* * * * *
\10\ With the prior written approval of the OCC, for the period
of time stipulated by the OCC, a national bank or Federal savings
association subject to subpart E of this part is not required to
deduct a significant investment in the capital instrument of an
unconsolidated financial institution in distress in the form of
common stock pursuant to this section if such investment is made for
the purpose of providing financial support to the financial
institution as determined by the OCC.
\11\ The amount of the items in paragraph (d)(2) of this section
that is not deducted from common equity tier 1 capital pursuant to
this section must be included in the risk-weighted assets of the
national bank or Federal savings association subject to subpart E of
this part and assigned a 250 percent risk weight for purposes of
standardized total risk-weighted assets and assigned the appropriate
risk weight for the investment under subpart E of this part for
purposes of expanded total risk-weighted assets.
Sec. 3.30 [Amended]
0
11. In Sec. 3.30, in paragraph (b), remove the words ``covered
positions'' and add in their place the words ``market risk covered
positions''.
0
12. In Sec. 3.34, revise paragraph (a) to read as follows:
Sec. 3.34 Derivative contracts.
(a) Exposure amount for derivative contracts--(1) National bank or
Federal savings association not subject to subpart E of this part.
(i) A national bank or Federal savings association that is not
subject to subpart E of this part must use the current exposure
methodology (CEM) described in paragraph (b) of this section to
calculate the exposure amount for all its OTC derivative contracts,
unless the national bank or Federal savings association makes the
election provided in paragraph (a)(1)(ii) of this section.
(ii) A national bank or Federal savings association that is not
subject to subpart E of this part may elect to calculate the exposure
amount for all its OTC derivative contracts under the standardized
approach for counterparty credit risk (SA-CCR) in Sec. 3.113 by
notifying the OCC, rather than calculating the exposure amount for all
its derivative contracts using CEM. A national bank or Federal savings
association that elects under this paragraph (a)(1)(ii) to calculate
the exposure amount for its OTC derivative contracts under SA-CCR must
apply the treatment of cleared transactions under Sec. 3.114 to its
derivative contracts that are cleared transactions and to all default
fund contributions associated with such derivative contracts, rather
than applying Sec. 3.35. A national bank or Federal savings
association that is not subject to subpart E of this part must use the
same methodology to calculate the exposure amount for all its
derivative contracts and, if a national bank or Federal savings
association has elected to use SA-CCR under this paragraph (a)(1)(ii),
the national bank or Federal savings association may change its
election only with prior approval of the OCC.
(2) National bank or Federal savings association subject to subpart
E of this part. A national bank or Federal savings association that is
subject to subpart E of this part must calculate the exposure amount
for all its derivative contracts using SA-CCR in Sec. 3.113 for
purposes of standardized total risk-weighted assets. A national bank or
Federal savings association subject to subpart E of this part must
apply the treatment of cleared transactions under Sec. 3.114 to its
derivative contracts that are cleared transactions and to all default
fund contributions associated with such derivative contracts for
purposes of standardized total risk-weighted assets.
* * * * *
[[Page 64304]]
0
13. In Sec. 3.35, revise paragraph (a)(3) to read as follows:
Sec. 3.35 Cleared transactions.
(a) * * *
(3) Alternate requirements. Notwithstanding any other provision of
this section, a national bank or Federal savings association that is
subject to subpart E of this part or a national bank or Federal savings
association that is not subject to subpart E of this part and that has
elected to use SA-CCR under Sec. 3.34(a)(1) must apply Sec. 3.114 to
its derivative contracts that are cleared transactions rather than this
section.
* * * * *
Sec. 3.37 [Amended]
0
14. In Sec. 3.37, in paragraph (c)(1), remove the words ``VaR-based
measure'' and add in their place the words ``measure for market risk''.
0
15. Revise Sec. 3.61 to read as follows:
Sec. 3.61 Purpose and scope.
Sections 3.61 through 3.63 of this subpart establish public
disclosure requirements related to the capital requirements described
in subpart B of this part for a national bank or Federal savings
association with total consolidated assets of $50 billion or more as
reported on the national bank's or Federal savings association's most
recent year-end Call Report that is not making public disclosures
pursuant to Sec. Sec. 3.160 and 3.161 of this part. A national bank or
Federal savings association with total consolidated assets of $50
billion or more as reported on the national bank's or Federal savings
association's most recent year-end Call Report that is not making
public disclosures pursuant to Sec. Sec. 3.160 and 3.161 of this part
must comply with Sec. 3.62 unless it is a consolidated subsidiary of a
bank holding company, savings and loan holding company, or depository
institution that is subject to the disclosure requirements of Sec.
3.62 or a subsidiary of a non-U.S. banking organization that is subject
to comparable public disclosure requirements in its home jurisdiction.
For purposes of this section, total consolidated assets are determined
based on the average of the national bank's or Federal savings
association's total consolidated assets in the four most recent
quarters as reported on the Call Report or the average of the national
bank or Federal savings association's total consolidated assets in the
most recent consecutive quarters as reported quarterly on the national
bank's or Federal savings association's Call Report if the national
bank or Federal savings association has not filed such a report for
each of the most recent four quarters.
0
16. In Sec. 3.63:
0
a. In table 3, revise entry (c); and
0
b. Remove paragraphs (d) and (e).
The revision reads as follows:
Sec. 3.63 Disclosures by national banks or Federal savings
associations described in Sec. 3.61.
* * * * *
Table 3 to Sec. 3.63--Capital Adequacy
* * * * *
[GRAPHIC] [TIFF OMITTED] TP18SE23.181
Subparts E and F [Amended]
0
17. Subparts E and F are amended as follows:
0
a. Revise subparts E and F as set forth at the end of the common
preamble;
0
b. Remove ``[AGENCY]'' and add ``OCC'' in its place wherever it
appears;
0
c. Remove ``[BANKING ORGANIZATION]'' and add ``national bank or Federal
savings association'' in its place wherever it appears;
0
d. Remove ``[BANKING ORGANIZATION]'s'' and add ``national bank's or
Federal savings association's'' in its place, wherever it appears;
0
e. Remove ``[REAL ESTATE LENDING GUIDELINES]'' and add ``12 CFR part
34, appendix A to subpart D'' in its place wherever it appears;
0
f. Remove ``[APPRAISAL RULE]'' and add ``12 CFR part 34, subpart C'' in
its place wherever it appears;
0
g. Remove ``[REGULATORY REPORT]'' and add ``Call Report'' in its place
wherever it appears; and
0
h. Remove ``__.'' and add ``3.'' in its place wherever it appears.
0
18. In Sec. 3.100, revise paragraph (b)(1) introductory text to read
as follows:
Sec. 3.100 Purpose and applicability.
* * * * *
(b) * * *
(1) This subpart applies to any national bank or Federal savings
association that is a subsidiary of a global systemically important
BHC, a Category II national bank or Federal savings association, a
Category III national bank or Federal savings association, or a
Category IV national bank or Federal savings association, as defined in
Sec. 3.2.
* * * * *
Sec. 3.111 [Amended]
0
19. In Sec. 3.111:
0
a. Remove paragraph (j)(1)(i);
0
b. Redesignate paragraph (j)(1)(ii) as paragraph (j)(1); and
0
c. Remove paragraphs (k).
0
20. In Sec. 3.132, revise paragraphs (h)(1)(iv) and (h)(4)(i) to read
as follows.
Sec. 3.132 Risk-weighted assets for securitization exposures.
* * * * *
(h) * * *
(1) * * *
(iv) The national bank or Federal savings association is well
capitalized, as defined in part 6 of this chapter. For purposes of
determining whether a national bank or Federal savings association is
well capitalized for purposes of this paragraph (h), the national
bank's or Federal savings association's capital ratios must be
calculated without regard to the capital treatment for transfers of
small-business obligations with recourse specified in paragraph (h)(1)
of this section.
* * * * *
(4) * * *
(i) Determining whether a national bank or Federal savings
association is adequately capitalized,
[[Page 64305]]
undercapitalized, significantly undercapitalized, or critically
undercapitalized under part 6 of this chapter; and
* * * * *
0
21. In Sec. 3.162, revise paragraph (c) as follows:
Sec. 3.162 Disclosures by a national bank or Federal savings
association described in Sec. 3.160.
* * * * *
(c) Regulatory capital instrument and other instruments eligible
for total loss absorbing capacity (TLAC) disclosures. A national bank
or Federal savings association described in Sec. 3.160 must provide a
description of the main features of its regulatory capital instruments,
in accordance with table 15 to paragraph (c). If the national bank or
Federal savings association issues or repays a capital instrument, or
in the event of a redemption, conversion, write down, or other material
change in the nature of an existing instrument, but in no event less
frequently than semiannually, the national bank or Federal savings
association must update the disclosures provided in accordance with
table 15 to paragraph (c). A national bank or Federal savings
association also must disclose the full terms and conditions of all
instruments included in regulatory capital.
0
22. In Sec. 3.201, revise paragraphs (b)(1)(i), (b)(2), (b)(4)(i),
(b)(5)(i), and (c)(6) to read as follows:
Sec. 3.201 Purpose, applicability, and reservations of authority.
* * * * *
(b) * * *
(1) * * *
(i) The national bank or Federal savings association is:
(A) A Category II national bank or Federal savings association, a
Category III national bank or Federal savings association, or a
Category IV national bank or Federal savings association;
(B) A subsidiary of a global systemically important BHC; or
* * * * *
(2) CVA Risk. The CVA risk-based capital requirements specified in
Sec. Sec. 3.220 through 3.225 apply to any national bank or Federal
savings association that is a subsidiary of a global systemically
important BHC, a Category II national bank or Federal savings
association, a Category III national bank or Federal savings
association, or a Category IV national bank or Federal savings
association.
* * * * *
(4) * * *
(i) A national bank or Federal savings association that meets at
least one of the standards in paragraph (b)(1) of this section shall
remain subject to the relevant requirements of this subpart F unless
and until it does not meet any of the standards in paragraph (b)(1)(ii)
of this section for each of four consecutive quarters as reported in
the national bank's or Federal savings association's Call Report, it is
no longer a subsidiary of a depository institution holding company,
Category II national bank or Federal savings association, or a Category
III national bank or Federal savings association and the national bank
or Federal savings association provides notice to the OCC.
* * * * *
(5) * * *
(i) A national bank or Federal savings association that meets at
least one of the standards in paragraph (b)(1) of this section shall
remain subject to the relevant requirements of this subpart F unless
and until it does not meet any of the standards in paragraph (b)(1)(ii)
of this section for each of four consecutive quarters as reported in
the national bank's or Federal savings association's Call Report, and
it is not a subsidiary of a global systemically important BHC, a
Category II national bank or Federal savings association, a Category
III national bank or Federal savings association, or Category IV
national bank or Federal savings association, and the national bank or
Federal savings association provides notice to the OCC.
* * * * *
(c) * * *
(6) In making determinations under paragraphs (c)(1) through (5) of
this section, the OCC will apply notice and response procedures
generally in the same manner as the notice and response procedures set
forth in 12 CFR 3.404.
* * * * *
0
23. In Sec. 3.300:
0
a. Revise paragraph (a);
0
b. Add paragraph (b);
0
c. Remove paragraphs (c) and (d);
0
d. Redesignate paragraph (e) as new paragraph (c); and
0
e. Remove paragraphs (f) through (h).
The revision and addition read as follows:
Sec. 3.300 Transitions.
(a) Transition adjustments for AOCI. Beginning July 1, 2025, a
Category III national bank or Federal savings association or a Category
IV national bank or Federal savings association must subtract from the
sum of its common equity tier 1 elements, before making deductions
required under Sec. 3.22(c) or (d), the AOCI adjustment amount
multiplied by the percentage provided in Table 1 to Sec. 3.300. The
transition AOCI adjustment amount is the sum of:
(1) Net unrealized gains or losses on available-for-sale debt
securities, plus
(2) Accumulated net gains or losses on cash flow hedges, plus
(3) Any amounts recorded in AOCI attributed to defined benefit
postretirement plans resulting from the initial and subsequent
application of the relevant GAAP standards that pertain to such plans,
plus
(4) Net unrealized holding gains or losses on held-to-maturity
securities that are included in AOCI.
[GRAPHIC] [TIFF OMITTED] TP18SE23.182
[[Page 64306]]
(b) Expanded total risk-weighted assets. Beginning July 1, 2025, a
national bank or Federal savings association subject to subpart E of
this part must comply with the requirements of subpart B of this part
using transition expanded total risk-weighted assets as calculated
under this paragraph in place of expanded total risk-weighted assets.
Transition expanded total risk-weighted assets is a national bank or
Federal savings association's expanded total risk-weighted assets
multiplied by the percentage provided in Table 2 to Sec. 3.300.
[GRAPHIC] [TIFF OMITTED] TP18SE23.183
* * * * *
0
24. In Sec. 3.301:
0
a. Remove paragraph (b)(5);
0
b. Revise paragraph (c)(2);
0
c. Revise paragraph (d)(2)(ii); and
0
d. Remove and reserve paragraph (e).
The revisions read as follows:
Sec. 3.301 Current expected credit losses (CECL) transition.
* * * * *
(c) * * *
(2) For purposes of the election described in paragraph (a)(1) of
this section, a national bank or Federal savings association subject to
subpart E of this part must increase total leverage exposure for
purposes of the supplementary leverage ratio by seventy-five percent of
its CECL transitional amount during the first year of the transition
period, increase total leverage exposure for purposes of the
supplementary leverage ratio by fifty percent of its CECL transitional
amount during the second year of the transition period, and increase
total leverage exposure for purposes of the supplementary leverage
ratio by twenty-five percent of its CECL transitional amount during the
third year of the transition period.
(d) * * *
(2) * * *
(ii) A national bank or Federal savings association subject to
subpart E of this part that has elected the 2020 CECL transition
provision described in this paragraph (d) may increase total leverage
exposure for purposes of the supplementary leverage ratio by one-
hundred percent of its modified CECL transitional amount during the
first year of the transition period, increase total leverage exposure
for purposes of the supplementary leverage ratio by one hundred percent
of its modified CECL transitional amount during the second year of the
transition period, increase total leverage exposure for purposes of the
supplementary leverage ratio by seventy-five percent of its modified
CECL transitional amount during the third year of the transition
period, increase total leverage exposure for purposes of the
supplementary leverage ratio by fifty percent of its modified CECL
transitional amount during the fourth year of the transition period,
and increase total leverage exposure for purposes of the supplementary
leverage ratio by twenty-five percent of its modified CECL transitional
amount during the fifth year of the transition period.
* * * * *
Sec. 3.302 [Amended]
0
25. In Sec. 3.302, remove the words ``advanced approaches total risk-
weighted assets'' and add in their place the words ``expanded total
risk-weighted assets''.
Sec. Sec. 3.303 and 3.304 [Removed and Reserved]
0
26. Remove and reserve Sec. Sec. 3.303 and 3.304.
Sec. 3.305 [Amended]
0
27. In Sec. 3.305, remove the words ``advanced approaches total risk-
weighted assets'' and add in their place the words ``expanded total
risk-weighted assets''.
PART 6--PROMPT CORRECTIVE ACTION
0
28. The authority citation for part 6 continues to read as follows:
Authority: 12 U.S.C. 93a, 1831o, 5412(b)(2)(B).
0
29. In Sec. 6.2:
0
a. Remove the definition for ``Advanced approaches national bank or
advanced approaches Federal savings association'';
0
b. Add, in alphabetical order, the definition for ``National bank or
Federal savings association subject to part 3, subpart E of this
chapter''; and
0
c. Revise the definition for ``Total risk-weighted assets''.
The addition and revision read as follows:
Sec. 6.2 Definitions.
* * * * *
National bank or Federal savings association subject to part 3,
subpart E of this chapter means a bank that is subject to part 3,
subpart E of this chapter.
* * * * *
Total risk-weighted assets means standardized total risk-weighted
assets, and for a national bank or Federal savings association subject
to part 3, subpart E of this chapter, also includes expanded risk-
weighted assets, as defined in Sec. 3.2 of this chapter.
0
30. In Sec. 6.4, revise paragraphs (a)(1)(iv)(B), (b)(1)(i)(D)(2),
(b)(2)(iv)(B), and (b)(3)(iv)(B) to read as follows:
Sec. 6.4 Capital measures and capital categories.
(a) * * *
(1) * * *
(iv) * * *
(B) With respect to a national bank or Federal savings association
subject to subpart E of part 3 of this chapter, the supplementary
leverage ratio; and
* * * * *
[[Page 64307]]
(b) * * *
(1) * * *
(i) * * *
(D) * * *
(2) With respect to a national bank or Federal savings association
that is controlled by a bank holding company designated as a global
systemically important bank holding company pursuant to Sec. 252.82 of
this title, the national bank or Federal savings association has a
supplementary leverage ratio of 6.0 percent or greater; and
* * * * *
(2) * * *
(iv) * * *
(B) With respect to national bank or Federal savings association
subject to subpart E of part 3 of this chapter, the national bank or
Federal savings association has a supplementary leverage ratio of 3.0
percent or greater;
* * * * *
(3) * * *
(iv) * * *
(B) With respect to national bank Federal savings association
subject to subpart E of part 3 of this chapter, the national bank or
Federal savings association has a supplementary leverage ratio of less
than 3.0 percent.
* * * * *
PART 32--LENDING LIMITS
0
31. The authority citation for part 32 continues to read as follows:
Authority: 12 U.S.C. 1 et seq., 12 U.S.C. 84, 93a, 1462a, 1463,
1464(u), 5412(b)(2)(B), and 15 U.S.C. 1639h.
0
32. In Sec. 32.2, revise paragraph (m)(1) to read as follows:
Sec. 32.2 Definitions.
* * * * *
(m) Eligible credit derivative * * *
(1) The derivative contract meets the requirements of paragraphs
(1) through (9) of an eligible guarantee, as defined in Sec. 3.2 of
this chapter, and has been confirmed by the protection purchaser and
the protection provider;
* * * * *
0
33. In Sec. 32.9, revise paragraphs (b)(1)(i)(C), (b)(1)(iv), and
(c)(1)(i) and (iii) to read as follows:
Sec. 32.9 Credit exposure arising from derivative and securities
financing transactions.
* * * * *
(b) * * *
(1) * * *
(i) * * *
(C) Calculation of potential future credit exposure. A bank or
savings association shall calculate its potential future credit
exposure by using any appropriate model the use of which has been
approved in writing for purposes of this section by the appropriate
Federal banking agency. Any substantive revisions to a model made after
the appropriate Federal banking agency has approved the use of the
model must be approved by the agency before a bank or savings
association may use the revised model for purposes of this part.
* * * * *
(iv) Standardized Approach for Counterparty Credit Risk Method. The
credit exposure arising from a derivative transaction (other than a
credit derivative transaction) under the Standardized Approach for
Counterparty Credit Risk Method shall be calculated pursuant to 12 CFR
3.113(c)(5) or 324.113(c)(5), as appropriate.
* * * * *
(c) * * *
(1) * * *
(i) Model method. A bank or savings association may calculate the
credit exposure of a securities financing transaction by using any
appropriate model the use of which has been approved in writing for
purposes of this section by the appropriate Federal banking agency. Any
substantive revisions to a model made after the appropriate Federal
banking agency has approved the use of the model must be approved by
the agency before a bank or savings association may use the revised
model for purposes of this part.
* * * * *
(iii) Basel collateral haircut method. A bank or savings
association may calculate the credit exposure of a securities financing
transaction pursuant to 12 CFR 3.113(b)(2)(i) and (ii) or
324.113(b)(2)(i) and (ii), as appropriate.
* * * * *
Board of Governors of the Federal Reserve System
12 CFR Chapter II
Authority and Issuance
For the reasons set forth in the common preamble, the Board of
Governors of the Federal Reserve System proposes to amend chapter II of
title 12 of the Code of Federal Regulations as follows:
PART 208--MEMBERSHIP OF STATE BANKING INSTITUTIONS IN THE FEDERAL
RESERVE SYSTEM (REGULATION H)
0
34. The authority citation for part 208 continues to read as follows:
Authority: 12 U.S.C. 24, 36, 92a, 93a, 248(a), 248(c), 321-338a,
371d, 461, 481-486, 601, 611, 1814, 1816, 1817(a)(3), 1817(a)(12),
1818, 1820(d)(9), 1833(j), 1828(o), 1831, 1831o, 1831p-1, 1831r-1,
1831w, 1831x, 1835a, 1882, 2901-2907, 3105, 3310, 3331-3351, 3905-
3909, 5371, and 5371 note; 15 U.S.C. 78b, 78I(b), 78l(i), 78o-
4(c)(5), 78q, 78q-1, 78w, 1681s, 1681w, 6801, and 6805; 31 U.S.C.
5318; 42 U.S.C. 4012a, 4104a, 4104b, 4106, and 4128.
Subpart D--Prompt Corrective Action
0
35. Revise Sec. 208.41 to read as follows:
Sec. 208.41 Definitions for purposes of this subpart.
For purposes of this subpart, except as modified in this section or
unless the context otherwise requires, the terms used have the same
meanings as set forth in section 38 and section 3 of the FDI Act. As
used in this subpart:
Bank means an insured depository institution as defined in section
3 of the FDI Act (12 U.S.C. 1813).
Bank subject to subpart E of 12 CFR part 217 means a bank that is
subject to part 217, subpart E of this chapter.
Common equity tier 1 capital means the amount of capital as defined
in Sec. 217.2 of this chapter.
Common equity tier 1 risk-based capital ratio means the ratio of
common equity tier 1 capital to total risk-weighted assets, as
calculated in accordance with Sec. 217.10(b)(1) or Sec. 217.10(d)(1)
of this chapter, as applicable.
Control--(1) Control has the same meaning assigned to it in section
2 of the Bank Holding Company Act (12 U.S.C. 1841), and the term
controlled shall be construed consistently with the term control.
(2) Exclusion for fiduciary ownership. No insured depository
institution or company controls another insured depository institution
or company by virtue of its ownership or control of shares in a
fiduciary capacity. Shares shall not be deemed to have been acquired in
a fiduciary capacity if the acquiring insured depository institution or
company has sole discretionary authority to exercise voting rights with
respect to the shares.
(3) Exclusion for debts previously contracted. No insured
depository institution or company controls another insured depository
institution or company by virtue of its ownership or control of shares
acquired in securing or collecting a debt previously contracted in good
faith, until two years after the date of acquisition. The two-year
period may be extended at the discretion of the appropriate Federal
banking agency for up to three one-year periods.
[[Page 64308]]
Controlling person means any person having control of an insured
depository institution and any company controlled by that person.
Global systemically important BHC has the same meaning as in Sec.
217.2 of this chapter.
Leverage ratio means the ratio of tier 1 capital to average total
consolidated assets, as calculated in accordance with Sec. 217.10 of
this chapter.
Management fee means any payment of money or provision of any other
thing of value to a company or individual for the provision of
management services or advice to the bank, or related overhead
expenses, including payments related to supervisory, executive,
managerial, or policy making functions, other than compensation to an
individual in the individual's capacity as an officer or employee of
the bank.
Supplementary leverage ratio means the ratio of tier 1 capital to
total leverage exposure, as calculated in accordance with Sec. 217.10
of this chapter.
Tangible equity means the amount of tier 1 capital, plus the amount
of outstanding perpetual preferred stock (including related surplus)
not included in tier 1 capital.
Tier 1 capital means the amount of capital as defined in Sec.
217.20 of this chapter.
Tier 1 risk-based capital ratio means the ratio of tier 1 capital
to total risk-weighted assets, as calculated in accordance with Sec.
217.10(b)(2) or Sec. 217.10(d)(2) of this chapter, as applicable.
Total assets means quarterly average total assets as reported in a
bank's Call Report, minus items deducted from tier 1 capital. At its
discretion the Federal Reserve may calculate total assets using a
bank's period-end assets rather than quarterly average assets.
Total leverage exposure means the total leverage exposure as
defined in Sec. 217.10(c)(2) of this chapter.
Total risk-based capital ratio means the ratio of total capital to
total risk-weighted assets, as calculated in accordance with Sec.
217.10(b)(3) or Sec. 217.10(d)(3) of this chapter, as applicable.
Total risk-weighted assets means standardized total risk-weighted
assets, and for an expanded risk-based bank also includes expanded
total risk-weighted assets, as defined in Sec. 217.2 of this chapter.
Subpart D [Amended]
0
36. In subpart D:
0
a. Remove the words ``advanced approaches bank'' and ``advanced
approaches banks'' wherever they appear and add in their place the
words ``bank subject to subpart E of 12 CFR part 217'' and ``banks
subject to subpart E of 12 CFR part 217'', respectively; and
0
b. Remove the words ``bank or bank that is a Category III Board-
regulated institution (as defined in Sec. 217.2 of this chapter),''
wherever they appear and add in their place the word ``bank,''.
Subpart G--Financial Subsidiaries of State Member Banks
0
37. In Sec. 208.73:
0
a. Revise paragraph (a) introductory text;
0
b. Remove paragraph (b); and
0
c. Redesignate paragraphs (c) through (f) as (b) through (e),
respectively.
The revision reads as follows:
Sec. 208.73 What additional provisions are applicable to state member
banks with financial subsidiaries?
(a) Capital requirements. A state member bank that controls or
holds an interest in a financial subsidiary must comply with the rules
set forth in Sec. 217.22(a)(7) of Regulation Q (12 CFR 217.22(a)(7))
in determining its compliance with applicable regulatory capital
standards (including the well capitalized standard of Sec.
208.71(a)(1)).
* * * * *
0
38. In Appendix C, revise footnote 2 to read as follows:
Appendix C to Part 208--Interagency Guidelines for Real Estate Lending
Policies
* * * * *
\2\ The term ``total capital'' refers to that term as defined in
12 CFR part 3, 12 CFR part 217, or 12 CFR part 324, as applicable.
PART 217--CAPITAL ADEQUACY OF BANK HOLDING COMPANIES, SAVINGS AND
LOAN HOLDING COMPANIES, AND STATE MEMBER BANKS (REGULATION Q)
0
39. The authority citation for part 217 reads as follows:
Authority: 12 U.S.C. 248(a), 321-338a, 481-486, 1462a, 1467a,
1818, 1828, 1831n, 1831o, 1831p-1, 1831w, 1835, 1844(b), 1851, 3904,
3906-3909, 4808, 5365, 5368, 5371, and 5371 note, and sec. 4012,
Pub. L. 116-136, 134 Stat. 281.
0
40. Revise subparts E and F of part 217 as set forth at the end of the
common preamble.
0
41. In part 217, subparts E and F:
0
a. Remove ``[AGENCY]'' and add ``Board'' in its place wherever it
appears;
0
b. Remove ``[BANKING ORGANIZATION]'' and add ``Board-regulated
institution'' in its place wherever it appears;
0
c. Remove ``[BANKING ORGANIZATION]'s'' and add ``Board-regulated
institution's'' in its place wherever it appears;
0
d. Remove ``[REAL ESTATE LENDING GUIDELINES]'' and add ``12 CFR part
208, appendix C'' in its place wherever it appears;
0
e. Remove ``[APPRAISAL RULE]'' and add ``12 CFR part 208, subpart E, or
12 CFR part 225, subpart G, as applicable'' in its place wherever it
appears; and
0
f. Remove ``__.'' and add ``217.'' in its place wherever it appears.
Subpart A--General Provisions
0
42. In Sec. 217.1:
0
a. Add paragraph (c)(6); and
0
b. Revise paragraph (f).
The addition and revision read as follows:
Sec. 217.1 Purpose, applicability, reservations of authority, and
timing.
* * * * *
(c) * * *
(6) Transitions. Notwithstanding any other provision of this part,
a Board-regulated institution must make any adjustments provided in
subpart G of this part for purposes of implementing this part.
* * * * *
(f) Timing. A Board-regulated institution that changes from one
category of Board-regulated institution to another of such categories,
or that changes from having no category of Board-regulated institution
to having a such category, must comply with the requirements of its
category in this part, including applicable transition provisions of
the requirements in this part, no later than on the first day of the
second quarter following the change in the company's category.
0
43. In Sec. 217.2:
0
a. Remove the definitions for ``Advanced approaches Board-regulated
institution'', ``Advanced approaches total risk-weighted assets'', and
``Advanced market risk-weighted assets'';
0
b. In the definition for ``Category II Board-regulated institution'':
0
i. Remove paragraph (3);
0
ii. Redesignate paragraph (4) as paragraph (3);
0
iii. Revise newly redesignated paragraph (3)(i);
0
iv. In newly redesiganted paragraph (3)(iii) introductory text, remove
the words ``paragraph (4)(i) of this section'' and add, in their place,
the words ``paragraph (3)(ii) of this definition'';
0
c. In the definition of ``Category III Board-regulated institution'':
0
i. Remove paragraph (3);
[[Page 64309]]
0
ii. Redesignate paragraph (4) as paragraph (3);
0
iii. Revise newly redesignated paragraph (3) introductory text;
0
iv. Revise newly redesignated paragraph (3)(i); and
0
vi. In newly redesignated paragraph (3)(iv) introductory text, remove
the words ``paragraph (4)(ii) of this definition'' and add, in their
place, the words ``paragraph (3)(ii) of this definition'';
0
d. Add, in alphabetical order, the definition for ``Category IV Board-
regulated institution''; e. Revise footnote 3 to paragraph (2) of the
definition for ``Cleared transaction.''
0
f. Revise the definition for ``Corporate exposure'';
0
g. Remove the definition for ``Credit-risk-weighted assets'';
0
h. Add, in alphabetical order, the definition for ``CVA risk-weighted
assets'';
0
i. Revise the definition for ``Effective notional amount'';
0
j. Remove the definition for ``Eligible credit reserves'';
0
k. Revise the definition for ``Eligible guarantee'';
0
l. Add, in alphabetical order, ``Expanded total risk-weighted assets'';
0
m. Remove the definition for ``Expected credit loss (ECL)'';
0
n. Revise the definitions for ``Exposure amount'', ``Market risk Board-
regulated institution'', ``Net independent collateral amount'', Netting
set'', ``Protection amount (P)'', and paragraphs (3) and (4) of the
definition for ``Qualifying master netting agreement'';
0
o. In the definition of ``Residential mortgage exposure'':
0
i. Remove paragraph (2);
0
ii. Redesignate paragraphs (1)(i) and (1)(ii) as paragraphs (1) and
(2), respectively; and
0
iii. In newly redesignated paragraph (2), remove the words ``family;
and'' and add, in their place, the word ``family.'';
0
p. Remove the definition for ``Specific wrong-way risk'';
0
q. Revise the definitions for ``Speculative grade'', ``Standardized
market risk-weighted assets'', ``Standardized total risk-weighted
assets'', ``Sub-speculative grade'';
0
r. Add, in alphabetical order, the definition for ``Total credit risk-
weighted assets'';
0
s. Revise the definition for ``Unregulated financial institution'';
0
r. Remove the definition for ``Value-at-risk (VaR)''; and
0
s. Revise the definition for ``Variation margin amount''.
The additions and revisions read as follows:
Sec. 217.2 Definitions.
* * * * *
Category II Board-regulated institution means:
* * * * *
(3) * * *
(i) Is a subsidiary of a Category II banking organization, as
defined pursuant to Sec. 252.5 of this chapter or Sec. 238.10 of this
chapter, as applicable; or
* * * * *
Category III Board-regulated institution means:
* * * * *
(3) A state member bank that is not a Category II Board-regulated
institution and that:
(i) Is a subsidiary of a Category III banking organization, as
defined pursuant to Sec. 252.5 of this chapter or Sec. 238.10 of this
chapter, as applicable; or
* * * * *
Category IV Board-regulated institution means:
(1) A depository institution holding company that is identified as
a Category IV banking organization pursuant to Sec. 252.5 of this
chapter or Sec. 238.10 of this chapter, as applicable;
(2) A U.S. intermediate holding company that is identified as a
Category IV banking organization pursuant to Sec. 252.5 of this
chapter;
(3) A state member bank that is not a Category II Board-regulated
institution or Category III Board-regulated institution and that:
(i) Is a subsidiary of a Category IV banking organization, as
defined pursuant to Sec. 252.5 of this chapter or Sec. 238.10 of this
chapter, as applicable; or
(ii) Has total consolidated assets, calculated based on the average
of the depository institution's total consolidated assets for the four
most recent calendar quarters as reported on the Call Report of $100
billion or more. If the depository institution has not filed the Call
Report for each of the four most recent calendar quarters, total
consolidated assets is calculated based on its total consolidated
assets, as reported on the Call Report, for the most recent quarter or
the average of the four most recent quarters, as applicable.
(iii) After meeting the criterion in paragraph (3)(ii) of this
definition, a state member bank continues to be a Category IV Board-
regulated institution until the state member bank:
(A) Has less than $100 billion in total consolidated assets, as
reported on the Call Report, for each of the four most recent calendar
quarters; or
(B) Is a Category II or Category III Board-regulated institution.
* * * * *
Cleared transaction * * *
(2) * * * \3\
\3\ For the standardized approach treatment of these exposures,
see Sec. 217.34(e) (OTC derivative contracts) or Sec. 217.37(c)
(repo-style transactions). For the expanded risk-based treatment of
these exposures, see Sec. 217.113 (OTC derivative contracts) or
Sec. 217.121 (repo-style transactions).
* * * * *
Corporate exposure means an exposure to a company that is not:
(1) An exposure to a sovereign, the Bank for International
Settlements, the European Central Bank, the European Commission, the
International Monetary Fund, the European Stability Mechanism, the
European Financial Stability Facility, a multi-lateral development bank
(MDB), a depository institution, a foreign bank, or a credit union, a
public sector entity (PSE);
(2) An exposure to a government-sponsored enterprise (GSE);
(3) For purposes of subpart D of this part, a residential mortgage
exposure;
(4) A pre-sold construction loan;
(5) A statutory multifamily mortgage;
(6) A high volatility commercial real estate (HVCRE) exposure;
(7) A cleared transaction;
(8) A default fund contribution;
(9) A securitization exposure;
(10) An equity exposure;
(11) An unsettled transaction;
(12) A policy loan;
(13) A separate account;
(14) A Paycheck Protection Program covered loan as defined in
section 7(a)(36) or (37) of the Small Business Act (15 U.S.C.
636(a)(36)-(37));
(15) For purposes of subpart E of this part, a real estate
exposure, as defined in Sec. 217.101; or
(16) For purposes of subpart E of this part, a retail exposure as
defined in Sec. 217.101.
* * * * *
CVA risk-weighted assets means the measure for CVA risk calculated
under Sec. 217.221(a) multiplied by 12.5.
* * * * *
Effective notional amount means for an eligible guarantee or
eligible credit derivative, the lesser of the contractual notional
amount of the credit risk mitigant and the exposures amount of the
hedged exposure, multiplied by the percentage coverage of the credit
risk mitigant.
* * * * *
Eligible guarantee means a guarantee that:
(1) Is written;
(2) Is either:
[[Page 64310]]
(i) Unconditional, or
(ii) A contingent obligation of the U.S. government or its
agencies, the enforceability of which is dependent upon some
affirmative action on the part of the beneficiary of the guarantee or a
third party (for example, meeting servicing requirements);
(3) Covers all or a pro rata portion of all contractual payments of
the obligated party on the reference exposure;
(4) Gives the beneficiary a direct claim against the protection
provider;
(5) Is not unilaterally cancelable by the protection provider for
reasons other than the breach of the contract by the beneficiary;
(6) Except for a guarantee by a sovereign, is legally enforceable
against the protection provider in a jurisdiction where the protection
provider has sufficient assets against which a judgment may be attached
and enforced;
(7) Requires the protection provider to make payment to the
beneficiary on the occurrence of a default (as defined in the
guarantee) of the obligated party on the reference exposure in a timely
manner without the beneficiary first having to take legal actions to
pursue the obligor for payment;
(8) Does not increase the beneficiary's cost of credit protection
on the guarantee in response to deterioration in the credit quality of
the reference exposure;
(9) Is not provided by an affiliate of the Board-regulated
institution, unless the affiliate is an insured depository institution,
foreign bank, securities broker or dealer, or insurance company that:
(i) Does not control the Board-regulated institution; and
(ii) Is subject to consolidated supervision and regulation
comparable to that imposed on depository institutions, U.S. securities
broker-dealers, or U.S. insurance companies (as the case may be); and
(10) Is provided by an eligible guarantor.
* * * * *
Expanded total risk-weighted assets means the greater of:
(1) The sum of:
(i) Total credit risk-weighted assets;
(ii) Total risk-weighted assets for equity exposures as calculated
under Sec. 217.141 and 217.142;
(iii) Risk-weighted assets for operational risk as calculated under
Sec. 217.150;
(iv) Market risk-weighted assets; and
(v) CVA risk-weighted assets; minus
(vi) Any amount of the Board-regulated institution's adjusted
allowance for credit losses that is not included in tier 2 capital and
any amount of allocated transfer risk reserves; or
(2) (i) 72.5 percent of the sum of:
(A) Total credit risk-weighted assets;
(B) Total risk-weighted assets for equity exposures as calculated
under Sec. 217.141 and 217.142;
(C) Risk-weighted assets for operational risk as calculated under
Sec. 217.150;
(D) Standardized market risk-weighted assets; and
(E) CVA risk-weighted assets; minus
(ii) Any amount of the Board-regulated institution's adjusted
allowance for credit losses that is not included in tier 2 capital and
any amount of allocated transfer risk reserves.
* * * * *
Exposure amount means:
(1) For the on-balance sheet component of an exposure (other than
an available-for-sale or held-to-maturity security, if the Board-
regulated institution has made an AOCI opt-out election (as defined in
Sec. 217.22(b)(2)); an OTC derivative contract; a repo-style
transaction or an eligible margin loan for which the Board-regulated
institution determines the exposure amount under Sec. 217.37 or Sec.
217.121, as applicable; a cleared transaction; a default fund
contribution; or a securitization exposure), the Board-regulated
institution's carrying value of the exposure.
(2) For a security (that is not a securitization exposure, equity
exposure, or preferred stock classified as an equity security under
GAAP) classified as available-for-sale or held-to-maturity if the
Board-regulated institution has made an AOCI opt-out election (as
defined in Sec. 217.22(b)(2)), the Board-regulated institution's
carrying value (including net accrued but unpaid interest and fees) for
the exposure less any net unrealized gains on the exposure and plus any
net unrealized losses on the exposure.
(3) For available-for-sale preferred stock classified as an equity
security under GAAP if the Board-regulated institution has made an AOCI
opt-out election (as defined in Sec. 217.22(b)(2)), the Board-
regulated institution's carrying value of the exposure less any net
unrealized gains on the exposure that are reflected in such carrying
value but excluded from the Board-regulated institution's regulatory
capital components.
(4) For the off-balance sheet component of an exposure (other than
an OTC derivative contract; a repo-style transaction or an eligible
margin loan for which the Board-regulated institution calculates the
exposure amount under Sec. 217.37 or Sec. 217.121, as applicable; a
cleared transaction; a default fund contribution; or a securitization
exposure), the notional amount of the off-balance sheet component
multiplied by the appropriate credit conversion factor (CCF) in Sec.
217.33 or Sec. 217.112, as applicable.
(5) For an exposure that is an OTC derivative contract, the
exposure amount determined under Sec. 217.34 or Sec. 217.113, as
applicable.
(6) For an exposure that is a cleared transaction, the exposure
amount determined under Sec. 217.35 or Sec. 217.114, as applicable.
(7) For an exposure that is an eligible margin loan or repo-style
transaction for which the bank calculates the exposure amount as
provided in Sec. 217.37 or Sec. 217.131, as applicable, the exposure
amount determined under Sec. 217.37 or Sec. 217.121, as applicable.
(8) For an exposure that is a securitization exposure, the exposure
amount determined under Sec. 217.42 or Sec. 217.131, as applicable.
* * * * *
Market risk Board-regulated institution means a Board-regulated
institution that is described in Sec. 217.201(b)(1).
Market risk-weighted assets means the measure for market risk
calculated pursuant to Sec. 217.204(a) multiplied by 12.5.
* * * * *
Net independent collateral amount means the fair value amount of
the independent collateral, as adjusted by the haircuts under Sec.
217.121(c)(2)(iii), as applicable, that a counterparty to a netting set
has posted to a Board-regulated institution less the fair value amount
of the independent collateral, as adjusted by the haircuts under Sec.
217.121(c)(2)(iii), as applicable, posted by the Board-regulated
institution to the counterparty, excluding such amounts held in a
bankruptcy-remote manner or posted to a QCCP and held in conformance
with the operational requirements in Sec. 217.3
Netting set means:
(1) A group of transactions with a single counterparty that are
subject to a qualifying master netting agreement and that consist only
of:
(i) Derivative contracts;
(ii) Repo-style transactions; or
(iii) Eligible margin loans.
(2) For derivative contracts, netting set also includes a single
derivative
[[Page 64311]]
contract between a Board-regulated institution and a single
counterparty.
* * * * *
Protection amount (P) means, with respect to an exposure hedged by
an eligible guarantee or eligible credit derivative, the effective
notional amount of the guarantee or credit derivative, reduced to
reflect any currency mismatch, maturity mismatch, or lack of
restructuring coverage (as provided in Sec. 217.36 or 217.120, as
appropriate).
* * * * *
Qualifying master netting agreement means a written, legally
enforceable agreement provided that:
* * * * *
(3) The agreement does not contain a walkaway clause (that is, a
provision that permits a non-defaulting counterparty to make a lower
payment than it otherwise would make under the agreement, or no payment
at all, to a defaulter or the estate of a defaulter, even if the
defaulter or the estate of the defaulter is a net creditor under the
agreement); and
(4) In order to recognize an agreement as a qualifying master
netting agreement for purposes of this subpart, a Board-regulated
institution must comply with the requirements of Sec. 217.3(d) with
respect to that agreement.
* * * * *
Speculative grade means that the entity to which the Board-
regulated institution is exposed through a loan or security, or the
reference entity with respect to a credit derivative, has adequate
capacity to meet financial commitments in the near term, but is
vulnerable to adverse economic conditions, such that should economic
conditions deteriorate, the issuer or the reference entity would
present an elevated default risk.
Standardized market risk-weighted assets means the standardized
measure for market risk calculated under Sec. 217.204(b) multiplied by
12.5.
Standardized total risk-weighted assets means:
(1) The sum of:
(i) Total risk-weighted assets for general credit risk as
calculated under Sec. 217.31;
(ii) Total risk-weighted assets for cleared transactions and
default fund contributions as calculated under Sec. 217.35;
(iii) Total risk-weighted assets for unsettled transactions as
calculated under Sec. 217.38;
(iv) Total risk-weighted assets for securitization exposures as
calculated under Sec. 217.42;
(v) Total risk-weighted assets for equity exposures as calculated
under Sec. 217.52 and Sec. 217.53; and
(vi) For a market risk Board-regulated institution only, market
risk-weighted assets; less
(2) Any amount of the Board-regulated institution's allowance for
loan and lease losses or adjusted allowance for credit losses, as
applicable, that is not included in tier 2 capital and any amount of
``allocated transfer risk reserves.''
* * * * *
Sub-speculative grade means that the entity to which the Board-
regulated institution is exposed through a loan or security, or the
reference entity with respect to a credit derivative, depends on
favorable economic conditions to meet its financial commitments, such
that should such economic conditions deteriorate the issuer or the
reference entity likely would default on its financial commitments.
* * * * *
Total credit risk-weighted assets means the sum of:
(1) Total risk-weighted assets for general credit risk as
calculated under Sec. 217.110;
(2) Total risk-weighted assets for cleared transactions and default
fund contributions as calculated under Sec. 217.114;
(3) Total risk-weighted assets for unsettled transactions as
calculated under Sec. 217.115; and
(4) Total risk-weighted assets for securitization exposures as
calculated under Sec. 217.132.
* * * * *
Unregulated financial institution means a financial institution
that is not a regulated financial institution, including any financial
institution that would meet the definition of ``financial institution''
under this section but for the ownership interest thresholds set forth
in paragraph (4)(i) of that definition.
* * * * *
Variation margin amount means the fair value amount of the
variation margin, as adjusted by the standard supervisory haircuts
under Sec. 217.121(c)(2)(iii), as applicable, that a counterparty to a
netting set has posted to a Board-regulated institution less the fair
value amount of the variation margin, as adjusted by the standard
supervisory haircuts under Sec. 217.121(c)(2)(iii), as applicable,
posted by the Board-regulated institution to the counterparty.
* * * * *
Sec. 217.3 [Amended]
0
44. In Sec. 217.3, remove and reserve paragraph (c).
Subpart B--Capital Ratio Requirements and Buffers
0
45. In Sec. 217.10:
0
a. Revise paragraph (a)(1)(v);
0
b. Revise paragraph (b) introductory text;
0
c. Revise paragraph (c);
0
d. Revise paragraph (d) introductory text; and
0
e. Revise paragraph (d)(3)(ii).
The revisions read as follows:
Sec. 217.10 Minimum capital requirements.
(a) * * *
(1) * * *
(v) For a Board-regulated institution subject to subpart E of this
part, a supplementary leverage ratio of 3 percent.
* * * * *
(b) Standardized capital ratio calculations. Other than as provided
in paragraph (d) of this section:
* * * * *
(c) Supplementary leverage ratio. (1) The supplementary leverage
ratio of a Board-regulated institution subject to subpart E of this
part is the ratio of its tier 1 capital to total leverage exposure.
Total leverage exposure is calculated as the sum of:
(i) The mean of the on-balance sheet assets calculated as of each
day of the reporting quarter; and
(ii) The mean of the off-balance sheet exposures calculated as of
the last day of each of the most recent three months, minus the
applicable deductions under Sec. 217.22(a), (c), and (d).
(2) For purposes of this part, total leverage exposure means the
sum of the items described in paragraphs (c)(2)(i) through (viii) of
this section, as adjusted pursuant to paragraph (c)(2)(ix) of this
section for a clearing member Board-regulated institution and paragraph
(c)(2)(x) of this section for a custodial banking organization:
(i) The balance sheet carrying value of all of the Board-regulated
institution's on-balance sheet assets, net of adjusted allowances for
credit losses, plus the value of securities sold under a repurchase
transaction or a securities lending transaction that qualifies for
sales treatment under GAAP, less amounts deducted from tier 1 capital
under Sec. 217.22(a), (c), and (d), less the value of securities
received in security-for-security repo-style transactions, where the
Board-regulated institution acts as a securities lender and includes
the securities received in its on-balance sheet assets but has not sold
or re-hypothecated the securities received, and less the fair value of
any derivative contracts;
(ii)(A) The PFE for each netting set to which the Board-regulated
institution is
[[Page 64312]]
a counterparty (including cleared transactions except as provided in
paragraph (c)(2)(ix) of this section and, at the discretion of the
Board-regulated institution, excluding a forward agreement treated as a
derivative contract that is part of a repurchase or reverse repurchase
or a securities borrowing or lending transaction that qualifies for
sales treatment under GAAP), as determined under Sec. 217.113(g), in
which the term C in Sec. 217.113(g)(1) equals zero, and, for any
counterparty that is not a commercial end-user, multiplied by 1.4. For
purposes of this paragraph (c)(2)(ii)(A), a Board-regulated institution
may set the value of the term C in Sec. 217.113(g)(1) equal to the
amount of collateral posted by a clearing member client of the Board-
regulated institution in connection with the client-facing derivative
transactions within the netting set; and
(B) A Board-regulated institution may choose to exclude the PFE of
all credit derivatives or other similar instruments through which it
provides credit protection when calculating the PFE under Sec.
217.113, provided that it does so consistently over time for the
calculation of the PFE for all such instruments;
(iii)(A)(1) The replacement cost of each derivative contract or
single product netting set of derivative contracts to which the Board-
regulated institution is a counterparty, calculated according to the
following formula, and, for any counterparty that is not a commercial
end-user, multiplied by 1.4:
Replacement Cost = max{V-CVMr + CVMp; 0{time}
Where:
V equals the fair value for each derivative contract or each netting
set of derivative contracts (including a cleared transaction except
as provided in paragraph (c)(2)(ix) of this section and, at the
discretion of the Board-regulated institution, excluding a forward
agreement treated as a derivative contract that is part of a
repurchase or reverse repurchase or a securities borrowing or
lending transaction that qualifies for sales treatment under GAAP);
CVMr equals the amount of cash collateral received from a
counterparty to a derivative contract and that satisfies the
conditions in paragraphs (c)(2)(iii)(B) through (F) of this section,
or, in the case of a client-facing derivative transaction, the
amount of collateral received from the clearing member client; and
CVMp equals the amount of cash collateral that is posted
to a counterparty to a derivative contract and that has not offset
the fair value of the derivative contract and that satisfies the
conditions in paragraphs (c)(2)(iii)(B) through (F) of this section,
or, in the case of a client-facing derivative transaction, the
amount of collateral posted to the clearing member client;
(2) Notwithstanding paragraph (c)(2)(iii)(A)(1) of this section,
where multiple netting sets are subject to a single variation margin
agreement, a Board-regulated institution must apply the formula for
replacement cost provided in Sec. 217.113(j)(1), in which the term CMA
may only include cash collateral that satisfies the conditions in
paragraphs (c)(2)(iii)(B) through (F) of this section; and
(3) For purposes of paragraph (c)(2)(iii)(A)(1) of this section, a
Board-regulated institution must treat a derivative contract that
references an index as if it were multiple derivative contracts each
referencing one component of the index if the Board-regulated
institution elected to treat the derivative contract as multiple
derivative contracts under Sec. 217.113(e)(6);
(B) For derivative contracts that are not cleared through a QCCP,
the cash collateral received by the recipient counterparty is not
segregated (by law, regulation, or an agreement with the counterparty);
(C) Variation margin is calculated and transferred on a daily basis
based on the mark-to-fair value of the derivative contract;
(D) The variation margin transferred under the derivative contract
or the governing rules of the CCP or QCCP for a cleared transaction is
the full amount that is necessary to fully extinguish the net current
credit exposure to the counterparty of the derivative contracts,
subject to the threshold and minimum transfer amounts applicable to the
counterparty under the terms of the derivative contract or the
governing rules for a cleared transaction;
(E) The variation margin is in the form of cash in the same
currency as the currency of settlement set forth in the derivative
contract, provided that for the purposes of this paragraph
(c)(2)(iii)(E), currency of settlement means any currency for
settlement specified in the governing qualifying master netting
agreement and the credit support annex to the qualifying master netting
agreement, or in the governing rules for a cleared transaction; and
(F) The derivative contract and the variation margin are governed
by a qualifying master netting agreement between the legal entities
that are the counterparties to the derivative contract or by the
governing rules for a cleared transaction, and the qualifying master
netting agreement or the governing rules for a cleared transaction must
explicitly stipulate that the counterparties agree to settle any
payment obligations on a net basis, taking into account any variation
margin received or provided under the contract if a credit event
involving either counterparty occurs;
(iv) The effective notional principal amount (that is, the apparent
or stated notional principal amount multiplied by any multiplier in the
derivative contract) of a credit derivative, or other similar
instrument, through which the Board-regulated institution provides
credit protection, provided that:
(A) The Board-regulated institution may reduce the effective
notional principal amount of the credit derivative by the amount of any
reduction in the mark-to-fair value of the credit derivative if the
reduction is recognized in common equity tier 1 capital;
(B) The Board-regulated institution may reduce the effective
notional principal amount of the credit derivative by the effective
notional principal amount of a purchased credit derivative or other
similar instrument, provided that the remaining maturity of the
purchased credit derivative is equal to or greater than the remaining
maturity of the credit derivative through which the Board-regulated
institution provides credit protection and that:
(1) With respect to a credit derivative that references a single
exposure, the reference exposure of the purchased credit derivative is
to the same legal entity and ranks pari passu with, or is junior to,
the reference exposure of the credit derivative through which the
Board-regulated institution provides credit protection; or
(2) With respect to a credit derivative that references multiple
exposures, the reference exposures of the purchased credit derivative
are to the same legal entities and rank pari passu with the reference
exposures of the credit derivative through which the Board-regulated
institution provides credit protection, and the level of seniority of
the purchased credit derivative ranks pari passu to the level of
seniority of the credit derivative through which the Board-regulated
institution provides credit protection;
(3) Where a Board-regulated institution has reduced the effective
notional principal amount of a credit derivative through which the
Board-regulated institution provides credit protection in accordance
with paragraph (c)(2)(iv)(A) of this section, the Board-regulated
institution must also reduce the effective notional principal amount of
a purchased credit derivative used to offset the credit derivative
through which the Board-regulated institution provides credit
protection, by the
[[Page 64313]]
amount of any increase in the mark-to-fair value of the purchased
credit derivative that is recognized in common equity tier 1 capital;
and
(4) Where the Board-regulated institution purchases credit
protection through a total return swap and records the net payments
received on a credit derivative through which the Board-regulated
institution provides credit protection in net income, but does not
record offsetting deterioration in the mark-to-fair value of the credit
derivative through which the Board-regulated institution provides
credit protection in net income (either through reductions in fair
value or by additions to reserves), the Board-regulated institution may
not use the purchased credit protection to offset the effective
notional principal amount of the related credit derivative through
which the Board-regulated institution provides credit protection;
(v) Where a Board-regulated institution acting as a principal has
more than one repo-style transaction with the same counterparty and has
offset the gross value of receivables due from a counterparty under
reverse repurchase transactions by the gross value of payables under
repurchase transactions due to the same counterparty, the gross value
of receivables associated with the repo-style transactions less any on-
balance sheet receivables amount associated with these repo-style
transactions included under paragraph (c)(2)(i) of this section, unless
the following criteria are met:
(A) The offsetting transactions have the same explicit final
settlement date under their governing agreements;
(B) The right to offset the amount owed to the counterparty with
the amount owed by the counterparty is legally enforceable in the
normal course of business and in the event of receivership, insolvency,
liquidation, or similar proceeding; and
(C) Under the governing agreements, the counterparties intend to
settle net, settle simultaneously, or settle according to a process
that is the functional equivalent of net settlement, (that is, the cash
flows of the transactions are equivalent, in effect, to a single net
amount on the settlement date), where both transactions are settled
through the same settlement system, the settlement arrangements are
supported by cash or intraday credit facilities intended to ensure that
settlement of both transactions will occur by the end of the business
day, and the settlement of the underlying securities does not interfere
with the net cash settlement;
(vi) The counterparty credit risk of a repo-style transaction,
including where the Board-regulated institution acts as an agent for a
repo-style transaction and indemnifies the customer with respect to the
performance of the customer's counterparty in an amount limited to the
difference between the fair value of the security or cash its customer
has lent and the fair value of the collateral the borrower has
provided, calculated as follows:
(A) If the transaction is not subject to a qualifying master
netting agreement, the counterparty credit risk (E*) for transactions
with a counterparty must be calculated on a transaction by transaction
basis, such that each transaction i is treated as its own netting set,
in accordance with the following formula, where Ei is the
fair value of the instruments, gold, or cash that the Board-regulated
institution has lent, sold subject to repurchase, or provided as
collateral to the counterparty, and Ci is the fair value of
the instruments, gold, or cash that the Board-regulated institution has
borrowed, purchased subject to resale, or received as collateral from
the counterparty:
Ei* = max {0, [Ei--Ci]{time} ; and
(B) If the transaction is subject to a qualifying master netting
agreement, the counterparty credit risk (E*) must be calculated as the
greater of zero and the total fair value of the instruments, gold, or
cash that the Board-regulated institution has lent, sold subject to
repurchase or provided as collateral to a counterparty for all
transactions included in the qualifying master netting agreement
([Sigma]Ei), less the total fair value of the instruments,
gold, or cash that the Board-regulated institution borrowed, purchased
subject to resale or received as collateral from the counterparty for
those transactions ([Sigma]Ci), in accordance with the
following formula:
E* = max {0, [[Sigma]ei- [Sigma]ci]{time}
(vii) If a Board-regulated institution acting as an agent for a
repo-style transaction provides a guarantee to a customer of the
security or cash its customer has lent or borrowed with respect to the
performance of the customer's counterparty and the guarantee is not
limited to the difference between the fair value of the security or
cash its customer has lent and the fair value of the collateral the
borrower has provided, the amount of the guarantee that is greater than
the difference between the fair value of the security or cash its
customer has lent and the value of the collateral the borrower has
provided;
(viii) The credit equivalent amount of all off-balance sheet
exposures of the Board-regulated institution, excluding repo-style
transactions, repurchase or reverse repurchase or securities borrowing
or lending transactions that qualify for sales treatment under GAAP,
and derivative transactions, determined using the applicable credit
conversion factor under Sec. 217.112(b), provided, however, that the
minimum credit conversion factor that may be assigned to an off-balance
sheet exposure under this paragraph is 10 percent; and
(ix) For a Board-regulated institution that is a clearing member:
(A) A clearing member Board-regulated institution that guarantees
the performance of a clearing member client with respect to a cleared
transaction must treat its exposure to the clearing member client as a
derivative contract or repo-style transaction, as applicable, for
purposes of determining its total leverage exposure;
(B) A clearing member Board-regulated institution that guarantees
the performance of a CCP with respect to a transaction cleared on
behalf of a clearing member client must treat its exposure to the CCP
as a derivative contract or repo-style transaction, as applicable, for
purposes of determining its total leverage exposure;
(C) A clearing member Board-regulated institution that does not
guarantee the performance of a CCP with respect to a transaction
cleared on behalf of a clearing member client may exclude its exposure
to the CCP for purposes of determining its total leverage exposure;
(D) A Board-regulated institution that is a clearing member may
exclude from its total leverage exposure the effective notional
principal amount of credit protection sold through a credit derivative
contract, or other similar instrument, that it clears on behalf of a
clearing member client through a CCP as calculated in accordance with
paragraph (c)(2)(iv) of this section; and
(E) Notwithstanding paragraphs (c)(2)(ix)(A) through (C) of this
section, a Board-regulated institution may exclude from its total
leverage exposure a clearing member's exposure to a clearing member
client for a derivative contract if the clearing member client and the
clearing member are affiliates and consolidated for financial reporting
purposes on the Board-regulated institution's balance sheet.
(x) A custodial banking organization shall exclude from its total
leverage exposure the lesser of:
(A) The amount of funds that the custodial banking organization has
on deposit at a qualifying central bank; and
[[Page 64314]]
(B) The amount of funds in deposit accounts at the custodial
banking organization that are linked to fiduciary or custodial and
safekeeping accounts at the custodial banking organization. For
purposes of this paragraph (c)(2)(x), a deposit account is linked to a
fiduciary or custodial and safekeeping account if the deposit account
is provided to a client that maintains a fiduciary or custodial and
safekeeping account with the custodial banking organization and the
deposit account is used to facilitate the administration of the
fiduciary or custodial and safekeeping account.
(d) Expanded capital ratio calculations. A Board-regulated
institution subject to subpart E of this part must determine its
regulatory capital ratios as described in paragraphs (d)(1) through (3)
of this section.
* * * * *
(3) * * *
(ii) The ratio of the Board-regulated institution's expanded risk-
based approach-adjusted total capital to expanded total risk-weighted
assets. A Board-regulated institution's expanded risk-based approach-
adjusted total capital is the Board-regulated institution's total
capital after being adjusted as follows:
(A) A Board-regulated institution subject to subpart E of this part
must deduct from its total capital any AACL included in its tier 2
capital in accordance with Sec. 217.20(d)(3); and
(B) A Board-regulated institution subject to subpart E of this part
must add to its total capital any AACL up to 1.25 percent of the Board-
regulated institution's total credit risk-weighted assets.
* * * * *
0
46. Revise Sec. 217.11 to read as follows:
Sec. 217.11 Capital conservation buffer, countercyclical capital
buffer amount, and GSIB surcharge.
(a) Capital conservation buffer--(1) Composition of the capital
conservation buffer. The capital conservation buffer is composed solely
of common equity tier 1 capital.
(2) Definitions. For purposes of this section, the following
definitions apply:
(i) Eligible retained income. The eligible retained income of a
Board-regulated institution is the greater of:
(A) The Board-regulated institution's net income, calculated in
accordance with the instructions to the FR Y-9C or Call Report, as
applicable, for the four calendar quarters preceding the current
calendar quarter, net of any distributions and associated tax effects
not already reflected in net income; and
(B) The average of the Board-regulated institution's net income,
calculated in accordance with the instructions to the FR Y-9C or Call
Report, as applicable, for the four calendar quarters preceding the
current calendar quarter.
(ii) Maximum payout amount. A Board-regulated institution's maximum
payout amount for the current calendar quarter is equal to the Board-
regulated institution's eligible retained income, multiplied by its
maximum payout ratio.
(iii) Maximum payout ratio. The maximum payout ratio is the
percentage of eligible retained income that a Board-regulated
institution can pay out in the form of distributions and discretionary
bonus payments during the current calendar quarter. For a Board-
regulated institution that is not subject to 12 CFR 225.8 or 238.170,
the maximum payout ratio is determined by the Board-regulated
institution's capital conservation buffer, calculated as of the last
day of the previous calendar quarter, as set forth in table 1 to Sec.
217.11(a)(4)(iv) of this section. For a Board-regulated institution
that is subject to 12 CFR 225.8 or 238.170, the maximum payout ratio is
determined under paragraph (c)(1)(ii) of this section.
(iv) Private sector credit exposure. Private sector credit exposure
means an exposure to a company or an individual that is not an exposure
to a sovereign, the Bank for International Settlements, the European
Central Bank, the European Commission, the European Stability
Mechanism, the European Financial Stability Facility, the International
Monetary Fund, a MDB, a PSE, or a GSE.
(v) Leverage buffer requirement. A bank holding company's leverage
buffer requirement is 2.0 percent.
(vi) Stress capital buffer requirement. (A) The stress capital
buffer requirement for a Board-regulated institution subject to 12 CFR
225.8 or 238.170 is the stress capital buffer requirement determined
under 12 CFR 225.8 or 238.170 except as provided in paragraph
(a)(2)(vi)(B) of this section.
(B) If a Board-regulated institution subject to 12 CFR 225.8 or
238.170 has not yet received a stress capital buffer requirement, its
stress capital buffer requirement for purposes of this part is 2.5
percent.
(3) Calculation of capital conservation buffer. (i) A Board-
regulated institution that is not subject to 12 CFR 225.8 or 238.170
has a capital conservation buffer equal to the lowest of the following
ratios, calculated as of the last day of the previous calendar quarter:
(A) The Board-regulated institution's common equity tier 1 capital
ratio minus the Board-regulated institution's minimum common equity
tier 1 capital ratio requirement under Sec. 217.10;
(B) The Board-regulated institution's tier 1 capital ratio minus
the Board-regulated institution's minimum tier 1 capital ratio
requirement under Sec. 217.10; and
(C) The Board-regulated institution's total capital ratio minus the
Board-regulated institution's minimum total capital ratio requirement
under Sec. 217.10; or
(ii) Notwithstanding paragraphs (a)(3)(i)(A) through (C) of this
section, if a Board-regulated institution's common equity tier 1, tier
1, or total capital ratio is less than or equal to the Board-regulated
institution's minimum common equity tier 1, tier 1, or total capital
ratio requirement under Sec. 217.10, respectively, the Board-regulated
institution's capital conservation buffer is zero.
(4) Limits on distributions and discretionary bonus payments. (i) A
Board-regulated institution that is not subject to 12 CFR 225.8 or
238.170 shall not make distributions or discretionary bonus payments or
create an obligation to make such distributions or payments during the
current calendar quarter that, in the aggregate, exceed its maximum
payout amount.
(ii) A Board-regulated institution that is not subject to 12 CFR
225.8 or 238.170 and that has a capital conservation buffer that is
greater than 2.5 percent plus 100 percent of its applicable
countercyclical capital buffer amount in accordance with paragraph (b)
of this section is not subject to a maximum payout amount under
paragraph (a)(2)(ii) of this section.
(iii) Except as provided in paragraph (a)(4)(iv) of this section, a
Board-regulated institution that is not subject to 12 CFR 225.8 or
238.170 may not make distributions or discretionary bonus payments
during the current calendar quarter if the Board-regulated
institution's:
(A) Eligible retained income is negative; and
(B) Capital conservation buffer was less than 2.5 percent as of the
end of the previous calendar quarter.
(iv) Notwithstanding the limitations in paragraphs (a)(4)(i)
through (iii) of this section, the Board may permit a Board-regulated
institution that is not subject to 12 CFR 225.8 or 238.170 to make a
distribution or discretionary bonus payment upon a request of the
Board-regulated institution, if the Board determines that the
distribution or discretionary bonus payment would not be contrary to
the purposes of this section, or to the safety and soundness of the
Board-regulated institution. In
[[Page 64315]]
making such a determination, the Board will consider the nature and
extent of the request and the particular circumstances giving rise to
the request.
[GRAPHIC] [TIFF OMITTED] TP18SE23.184
(v) Additional limitations on distributions may apply under 12 CFR
225.4 and 263.202 to a Board-regulated institution that is not subject
to 12 CFR 225.8 or 238.170.
(b) Countercyclical capital buffer amount--(1) General. A Board-
regulated institution subject to subpart E of this part must calculate
a countercyclical capital buffer amount in accordance with this
paragraph (b) for purposes of determining its maximum payout ratio
under Table 1 to Sec. 217.11(a)(4)(iv) of this section and, if
applicable, Table 2 to Sec. 217.11(c)(4)(iii) of this section.
(i) Extension of capital conservation buffer. The countercyclical
capital buffer amount is an extension of the capital conservation
buffer as described in paragraph (a) or (c) of this section, as
applicable.
(ii) Amount. A Board-regulated institution subject to subpart E of
this part has a countercyclical capital buffer amount determined by
calculating the weighted average of the countercyclical capital buffer
amounts established for the national jurisdictions where the Board-
regulated institution's private sector credit exposures are located, as
specified in paragraphs (b)(2) and (3) of this section.
(iii) Weighting. The weight assigned to a jurisdiction's
countercyclical capital buffer amount is calculated by dividing the
total risk-weighted assets for the Board-regulated institution's
private sector credit exposures located in the jurisdiction by the
total risk-weighted assets for all of the Board-regulated institution's
private sector credit exposures. The methodology a Board-regulated
institution uses for determining risk-weighted assets for purposes of
this paragraph (b) must be the methodology that determines its risk-
based capital ratios under Sec. 217.10. Notwithstanding the previous
sentence, the risk-weighted asset amount for a private sector credit
exposure that is a covered position under subpart F of this part is its
standardized default risk capital requirement as determined under Sec.
217.210 multiplied by 12.5.
(iv) Location. (A) Except as provided in paragraphs (b)(1)(iv)(B)
and (C) of this section, the location of a private sector credit
exposure is the national jurisdiction where the borrower is located
(that is, where it is incorporated, chartered, or similarly established
or, if the borrower is an individual, where the borrower resides).
(B) If, in accordance with subpart D or E of this part, the Board-
regulated institution has assigned to a private sector credit exposure
a risk weight associated with a protection provider on a guarantee or
credit derivative, the location of the exposure is the national
jurisdiction where the protection provider is located.
(C) The location of a securitization exposure is the location of
the underlying exposures, or, if the underlying exposures are located
in more than one national jurisdiction, the national jurisdiction where
the underlying exposures with the largest aggregate unpaid principal
balance are located. For purposes of this paragraph (b), the location
of an underlying exposure shall be the location of the borrower,
determined consistent with paragraph (b)(1)(iv)(A) of this section.
(2) Countercyclical capital buffer amount for credit exposures in
the United States--(i) Initial countercyclical capital buffer amount
with respect to credit exposures in the United States. The initial
countercyclical capital buffer amount in the United States is zero.
(ii) Adjustment of the countercyclical capital buffer amount. The
Board will adjust the countercyclical capital buffer amount for credit
exposures in the United States in accordance with applicable law.\1\
[[Page 64316]]
\1\ The Board expects that any adjustment will be based on a
determination made jointly by the Board, OCC, and FDIC.
(iii) Range of countercyclical capital buffer amount. The Board
will adjust the countercyclical capital buffer amount for credit
exposures in the United States between zero percent and 2.5 percent of
risk-weighted assets.
(iv) Adjustment determination. The Board will base its decision to
adjust the countercyclical capital buffer amount under this section on
a range of macroeconomic, financial, and supervisory information
indicating an increase in systemic risk including, but not limited to,
the ratio of credit to gross domestic product, a variety of asset
prices, other factors indicative of relative credit and liquidity
expansion or contraction, funding spreads, credit condition surveys,
indices based on credit default swap spreads, options implied
volatility, and measures of systemic risk.
(v) Effective date of adjusted countercyclical capital buffer
amount--(A) Increase adjustment. A determination by the Board under
paragraph (b)(2)(ii) of this section to increase the countercyclical
capital buffer amount will be effective 12 months from the date of
announcement, unless the Board establishes an earlier effective date
and includes a statement articulating the reasons for the earlier
effective date.
(B) Decrease adjustment. A determination by the Board to decrease
the established countercyclical capital buffer amount under paragraph
(b)(2)(ii) of this section will be effective on the day following
announcement of the final determination or the earliest date
permissible under applicable law or regulation, whichever is later.
(vi) Twelve-month sunset. The countercyclical capital buffer amount
will return to zero percent 12 months after the effective date that the
adjusted countercyclical capital buffer amount is announced, unless the
Board announces a decision to maintain the adjusted countercyclical
capital buffer amount or adjust it again before the expiration of the
12-month period.
(3) Countercyclical capital buffer amount for foreign
jurisdictions. The Board will adjust the countercyclical capital buffer
amount for private sector credit exposures to reflect decisions made by
foreign jurisdictions consistent with due process requirements
described in paragraph (b)(2) of this section.
(c) Calculation of buffers for Board-regulated institutions subject
to 12 CFR 225.8 or 238.170--(1) Limits on distributions and
discretionary bonus payments. (i) General. A Board-regulated
institution that is subject to 12 CFR 225.8 or 238.170 shall not make
distributions or discretionary bonus payments or create an obligation
to make such distributions or payments during the current calendar
quarter that, in the aggregate, exceed its maximum payout amount.
(ii) Maximum payout ratio. The maximum payout ratio of a Board-
regulated institution that is subject to 12 CFR 225.8 or 238.170 is the
lowest of the payout ratios determined by its capital conservation
buffer; and, if applicable, leverage buffer; as set forth in table 2 to
Sec. 217.11(c)(3)(iii).
(iii) Capital conservation buffer requirement. A Board-regulated
institution that is subject to 12 CFR 225.8 or 238.170 has a capital
conservation buffer requirement equal to its stress capital buffer
requirement plus its applicable countercyclical capital buffer amount
in accordance with paragraph (b) of this section plus its applicable
GSIB surcharge in accordance with paragraph (d) of this section.
(iv) No maximum payout amount limitation. A Board-regulated
institution that is subject to 12 CFR 225.8 or 238.170 is not subject
to a maximum payout amount under paragraph (a)(2)(ii) of this section
if it has:
(A) A capital conservation buffer, calculated under paragraph
(c)(2) of this section, that is greater than its capital conservation
buffer requirement calculated under paragraph (c)(1)(iii) of this
section; and
(B) If applicable, a leverage buffer, calculated under paragraph
(c)(3) of this section, that is greater than its leverage buffer
requirement as set forth in paragraph (a)(2)(v) of this section.
(v) Negative eligible retained income. Except as provided in
paragraph (c)(1)(vi) of this section, a Board-regulated institution
that is subject to 12 CFR 225.8 or 238.170 may not make distributions
or discretionary bonus payments during the current calendar quarter if,
as of the end of the previous calendar quarter, the Board-regulated
institution's:
(A) Eligible retained income is negative; and
(B) (1) Capital conservation buffer was less than its capital
conservation buffer requirement; or
(2) If applicable, leverage buffer was less than its leverage
buffer requirement.
(vi) Prior approval. Notwithstanding the limitations in paragraphs
(c)(1)(i) through (v) of this section, the Board may permit a Board-
regulated institution that is subject to 12 CFR 225.8 or 238.170 to
make a distribution or discretionary bonus payment upon a request of
the Board-regulated institution, if the Board determines that the
distribution or discretionary bonus payment would not be contrary to
the purposes of this section, or to the safety and soundness of the
Board-regulated institution. In making such a determination, the Board
will consider the nature and extent of the request and the particular
circumstances giving rise to the request.
(vii) Other limitations on distributions. Additional limitations on
distributions may apply under 12 CFR 225.4, 225.8, 238.170, 252.63,
252.165, and 263.202 to a Board-regulated institution that is subject
to 12 CFR 225.8 or 238.170.
(2) Capital conservation buffer. (i) The capital conservation
buffer for Board-regulated institutions subject to 12 CFR 225.8 or
238.170 is composed solely of common equity tier 1 capital.
(ii) A Board-regulated institution that is subject to 12 CFR 225.8
or 238.170 has a capital conservation buffer that is equal to the
lowest of the following ratios, calculated as of the last day of the
previous calendar quarter:
(A) The Board-regulated institution's common equity tier 1 capital
ratio minus the Board-regulated institution's minimum common equity
tier 1 capital ratio requirement under Sec. 217.10;
(B) The Board-regulated institution's tier 1 capital ratio minus
the Board-regulated institution's minimum tier 1 capital ratio
requirement under Sec. 217.10; and
(C) The Board-regulated institution's total capital ratio minus the
Board-regulated institution's minimum total capital ratio requirement
under Sec. 217.10; or
(iii) Notwithstanding paragraph (c)(2)(ii) of this section, if a
Board-regulated institution's common equity tier 1, tier 1, or total
capital ratio is less than or equal to the Board-regulated
institution's minimum common equity tier 1, tier 1, or total capital
ratio requirement under Sec. 217.10, respectively, the Board-regulated
institution's capital conservation buffer is zero.
(3) Leverage buffer. (i) The leverage buffer is composed solely of
tier 1 capital.
(ii) A global systemically important BHC has a leverage buffer that
is equal to the global systemically important BHC's supplementary
leverage ratio minus 3 percent, calculated as of the last day of the
previous calendar quarter.
(iii) Notwithstanding paragraph (c)(3)(ii) of this section, if the
global systemically important BHC's
[[Page 64317]]
supplementary leverage ratio is less than or equal to 3 percent, the
global systemically important BHC's leverage buffer is zero.
[GRAPHIC] [TIFF OMITTED] TP18SE23.185
(d) GSIB surcharge. A global systemically important BHC must use
its GSIB surcharge calculated in accordance with subpart H of this part
for purposes of determining its maximum payout ratio under Table 2 to
Sec. 217.11(c)(3)(iii).
Subpart C--Definition of Capital
0
47. In Sec. 217.20, revise paragraphs (c)(1)(xiv), (d)(1)(xi) and
(d)(3) to read as follows:
Sec. 217.20 Capital components and eligibility criteria for
regulatory capital instruments.
* * * * *
(c) * * *
(1) * * *
(xiv) For a Board-regulated institution subject to subpart E of
this part, the governing agreement, offering circular, or prospectus of
an instrument issued after the date upon which the Board-regulated
institution becomes subject to subpart E must disclose that the holders
of the instrument may be fully subordinated to interests held by the
U.S. government in the event that the Board-regulated institution
enters into a receivership, insolvency, liquidation, or similar
proceeding.
* * * * *
(d) * * *
(1) * * *
(xi) For a Board-regulated institution subject to subpart E of this
part, the governing agreement, offering circular, or prospectus of an
instrument issued after the date on which the Board-regulated
institution becomes subject to subpart E must disclose that the holders
of the instrument may be fully subordinated to interests held by the
U.S. government in the event that the Board-regulated institution
enters into a receivership, insolvency, liquidation, or similar
proceeding.
* * * * *
(3) ALLL or AACL, as applicable, up to 1.25 percent of the Board-
regulated institution's standardized total risk-weighted assets not
including any amount of the ALLL or AACL, as applicable (and excluding
the case of a market risk Board-regulated institution, its market risk
weighted assets).
* * * * *
0
48. In Sec. 217.21:
0
a. In paragraph (a)(1), remove the words ``an advanced approaches
Board-regulated institution'' and add in their place the words
``subject to subpart E of this part''; and
0
b. Revise paragraph (b).
The revision reads as follows:
Sec. 217.21 Minority interest.
* * * * *
(b) (1) Applicability. For purposes of Sec. 217.20, a Board-
regulated institution that is subject to subpart E of this part is
subject to the minority interest limitations in this paragraph (b) if:
(i) A consolidated subsidiary of the Board-regulated institution
has issued regulatory capital that is not owned by the Board-regulated
institution; and
(ii) For each relevant regulatory capital ratio of the consolidated
subsidiary, the ratio exceeds the sum of the subsidiary's minimum
regulatory capital requirements plus its capital conservation buffer.
(2) Difference in capital adequacy standards at the subsidiary
level. For purposes of the minority interest calculations in this
section, if the consolidated subsidiary issuing the capital is not
subject to capital adequacy standards similar to those of the Board-
regulated institution, the Board-regulated institution must assume that
the capital adequacy standards of the Board-regulated institution apply
to the subsidiary.
(3) Common equity tier 1 minority interest includable in the common
equity tier 1 capital of the Board-regulated institution. For each
[[Page 64318]]
consolidated subsidiary of a Board-regulated institution, the amount of
common equity tier 1 minority interest the Board-regulated institution
may include in common equity tier 1 capital is equal to:
(i) The common equity tier 1 minority interest of the subsidiary;
minus
(ii) The percentage of the subsidiary's common equity tier 1
capital that is not owned by the Board-regulated institution,
multiplied by the difference between the common equity tier 1 capital
of the subsidiary and the lower of:
(A) The amount of common equity tier 1 capital the subsidiary must
hold, or would be required to hold pursuant to this paragraph (b), to
avoid restrictions on distributions and discretionary bonus payments
under Sec. 217.11 or equivalent standards established by the
subsidiary's home country supervisor; or
(B) (1) The standardized total risk-weighted assets of the Board-
regulated institution that relate to the subsidiary multiplied by
(2) The common equity tier 1 capital ratio the subsidiary must
maintain to avoid restrictions on distributions and discretionary bonus
payments under Sec. 217.11 or equivalent standards established by the
subsidiary's home country supervisor.
(4) Tier 1 minority interest includable in the tier 1 capital of
the Board-regulated institution. For each consolidated subsidiary of
the Board-regulated institution, the amount of tier 1 minority interest
the Board-regulated institution may include in tier 1 capital is equal
to:
(i) The tier 1 minority interest of the subsidiary; minus
(ii) The percentage of the subsidiary's tier 1 capital that is not
owned by the Board-regulated institution multiplied by the difference
between the tier 1 capital of the subsidiary and the lower of:
(A) The amount of tier 1 capital the subsidiary must hold, or would
be required to hold pursuant to this paragraph (b), to avoid
restrictions on distributions and discretionary bonus payments under
Sec. 217.11 or equivalent standards established by the subsidiary's
home country supervisor, or
(B) (1) The standardized total risk-weighted assets of the Board-
regulated institution that relate to the subsidiary multiplied by
(2) The tier 1 capital ratio the subsidiary must maintain to avoid
restrictions on distributions and discretionary bonus payments under
Sec. 217.11 or equivalent standards established by the subsidiary's
home country supervisor.
(5) Total capital minority interest includable in the total capital
of the Board-regulated institution. For each consolidated subsidiary of
the Board-regulated institution, the amount of total capital minority
interest the Board-regulated institution may include in total capital
is equal to:
(i) The total capital minority interest of the subsidiary; minus
(ii) The percentage of the subsidiary's total capital that is not
owned by the Board-regulated institution multiplied by the difference
between the total capital of the subsidiary and the lower of:
(A) The amount of total capital the subsidiary must hold, or would
be required to hold pursuant to this paragraph (b), to avoid
restrictions on distributions and discretionary bonus payments under
Sec. 217.11 or equivalent standards established by the subsidiary's
home country supervisor, or
(B) (1) The standardized total risk-weighted assets of the Board-
regulated institution that relate to the subsidiary multiplied by
(2) The total capital ratio the subsidiary must maintain to avoid
restrictions on distributions and discretionary bonus payments under
Sec. 217.11 or equivalent standards established by the subsidiary's
home country supervisor.
0
49. In Sec. 217.22:
0
a. Revise paragraphs (a)(1) and (4); and
0
b. Remove paragraph (a)(6); and
0
c. Redesignate paragraph (a)(7) as new paragraph (a)(6); and
0
d. In paragraph (b)(2)(i), remove the words ``an advanced approaches
Board-regulated institution'' and add in their place the words
``subject to subpart E of this part'';
0
e. Revise paragraph (b)(2)(ii);
0
f. In paragraph (b)(2)(iii), remove the words ``an advanced approaches
Board-regulated institution'' and add in their place the words
``subject to subpart E of this part'';
0
g. In paragraph (b)(2)(iv), remove the words ``or FR Y-9SP'';
0
h. In footnote 22, in paragraph (b)(2)(iv)(A), remove the words ``12
CFR part 225 (Board)'', and add in its place ``12 CFR part 217
(Board)'';
0
i. Revise paragraph (c)(2);
0
j. In paragraph (c)(4), remove the words ``an advanced approaches
Board-regulated institution'' and add in their place the words
``subject to subpart E of this part''; and
0
k. Revise paragraphs (c)(5)(i) and (ii), (c)(6), and (d)(2).
The revisions read as follows:
Sec. 217.22 Regulatory capital adjustments and deductions.
(a) * * *
(1)(i) Goodwill, net of associated deferred tax liabilities (DTLs)
in accordance with paragraph (e) of this section; and
(ii) For a Board-regulated institution subject to subpart E of this
part, goodwill that is embedded in the valuation of a significant
investment in the capital of an unconsolidated financial institution in
the form of common stock (and that is reflected in the consolidated
financial statements of the Board-regulated institution), in accordance
with paragraph (d) of this section;
* * * * *
(4) (i) For a Board-regulated institution that is not subject to
subpart E of this part, any gain-on-sale in connection with a
securitization exposure;
(ii) For a Board-regulated institution subject to subpart E of this
part, any gain-on-sale in connection with a securitization exposure and
the portion of any CEIO that does not constitute an after-tax gain-on-
sale;
(b) * * *
(2) * * *
(ii) A Board-regulated institution that is not subject to subpart E
of this part must make its AOCI opt-out election in the Call Report
during the first reporting period after the Board-regulated institution
is required to comply with subpart A of this part. If the Board-
regulated institution was previously subject to subpart E of this part,
the Board-regulated institution must make its AOCI opt-out election in
the Call Report during the first reporting period after the Board-
regulated institution is not subject to subpart E of this part.
* * * * *
(c) * * *
(2) Corresponding deduction approach. For purposes of subpart C of
this part, the corresponding deduction approach is the methodology used
for the deductions from regulatory capital related to reciprocal cross
holdings (as described in paragraph (c)(3) of this section),
investments in the capital of unconsolidated financial institutions for
a Board-regulated institution that is not subject to subpart E of this
part (as described in paragraph (c)(4) of this section), non-
significant investments in the capital of unconsolidated financial
institutions for a Board-regulated institution subject to subpart E of
this part (as described in paragraph (c)(5) of this section), and non-
common stock significant investments in the capital of
[[Page 64319]]
unconsolidated financial institutions for a Board-regulated institution
subject to subpart E of this part (as described in paragraph (c)(6) of
this section). Under the corresponding deduction approach, a Board-
regulated institution must make deductions from the component of
capital for which the underlying instrument would qualify if it were
issued by the Board-regulated institution itself, as described in
paragraphs (c)(2)(i) through (iii) of this section. If the Board-
regulated institution does not have a sufficient amount of a specific
component of capital to effect the required deduction, the shortfall
must be deducted according to paragraph (f) of this section.
* * * * *
(5) * * *
(i) A Board-regulated institution subject to subpart E of this part
must deduct its non-significant investments in the capital of
unconsolidated financial institutions (as defined in Sec. 217.2) that,
in the aggregate and together with any investment in a covered debt
instrument (as defined in Sec. 217.2) issued by a financial
institution in which the Board-regulated institution does not have a
significant investment in the capital of the unconsolidated financial
institution (as defined in Sec. 217.2), exceeds 10 percent of the sum
of the Board-regulated institution's common equity tier 1 capital
elements minus all deductions from and adjustments to common equity
tier 1 capital elements required under paragraphs (a) through (c)(3) of
this section (the 10 percent threshold for non-significant investments)
by applying the corresponding deduction approach in paragraph (c)(2) of
this section.\26\ The deductions described in this paragraph are net of
associated DTLs in accordance with paragraph (e) of this section. In
addition, with the prior written approval of the Board, a Board-
regulated institution subject to subpart E of this part that
underwrites a failed underwriting, for the period of time stipulated by
the Board, is not required to deduct from capital a non-significant
investment in the capital of an unconsolidated financial institution or
an investment in a covered debt instrument pursuant to this paragraph
(c)(5) to the extent the investment is related to the failed
underwriting.\27\ For any calculation under this paragraph (c)(5)(i), a
Board-regulated institution subject to subpart E of this part may
exclude the amount of an investment in a covered debt instrument under
paragraph (c)(5)(iii) or (iv) of this section, as applicable.
(ii) For a Board-regulated institution subject to subpart E of this
part, the amount to be deducted under this paragraph (c)(5) from a
specific capital component is equal to:
(A) The Board-regulated institution's aggregate non-significant
investments in the capital of an unconsolidated financial institution
and, if applicable, any investments in a covered debt instrument
subject to deduction under this paragraph (c)(5), exceeding the 10
percent threshold for non-significant investments, multiplied by
(B) The ratio of the Board-regulated institution's aggregate non-
significant investments in the capital of an unconsolidated financial
institution (in the form of such capital component) to the Board-
regulated institution's total non-significant investments in
unconsolidated financial institutions, with an investment in a covered
debt instrument being treated as tier 2 capital for this purpose.
* * * * *
(6) Significant investments in the capital of unconsolidated
financial institutions that are not in the form of common stock. If a
Board-regulated institution subject to subpart E of this part has a
significant investment in the capital of an unconsolidated financial
institution, the Board-regulated institution must deduct from capital
any such investment issued by the unconsolidated financial institution
that is held by the Board-regulated institution other than an
investment in the form of common stock, as well as any investment in a
covered debt instrument issued by the unconsolidated financial
institution, by applying the corresponding deduction approach in
paragraph (c)(2) of this section.\28\ The deductions described in this
section are net of associated DTLs in accordance with paragraph (e) of
this section. In addition, with the prior written approval of the
Board, for the period of time stipulated by the Board, a Board-
regulated institution subject to subpart E of this part that
underwrites a failed underwriting is not required to deduct the
significant investment in the capital of an unconsolidated financial
institution or an investment in a covered debt instrument pursuant to
this paragraph (c)(6) if such investment is related to such failed
underwriting.
* * * * *
(d) * * *
(2) A Board-regulated institution subject to subpart E of this part
must make deductions from regulatory capital as described in this
paragraph (d)(2).
(i) A Board-regulated institution subject to subpart E of this part
must deduct from common equity tier 1 capital elements the amount of
each of the items set forth in this paragraph (d)(2) that,
individually, exceeds 10 percent of the sum of the Board-regulated
institution's common equity tier 1 capital elements, less adjustments
to and deductions from common equity tier 1 capital required under
paragraphs (a) through (c) of this section (the 10 percent common
equity tier 1 capital deduction threshold).
(A) DTAs arising from temporary differences that the Board-
regulated institution could not realize through net operating loss
carrybacks, net of any related valuation allowances and net of DTLs, in
accordance with paragraph (e) of this section. A Board-regulated
institution subject to subpart E of this part is not required to deduct
from the sum of its common equity tier 1 capital elements DTAs (net of
any related valuation allowances and net of DTLs, in accordance with
Sec. 217.22(e)) arising from timing differences that the Board-
regulated institution could realize through net operating loss
carrybacks. The Board-regulated institution must risk weight these
assets at 100 percent. For a state member bank that is a member of a
consolidated group for tax purposes, the amount of DTAs that could be
realized through net operating loss carrybacks may not exceed the
amount that the state member bank could reasonably expect to have
refunded by its parent holding company.
(B) MSAs net of associated DTLs, in accordance with paragraph (e)
of this section.
(C) Significant investments in the capital of unconsolidated
financial institutions in the form of common stock, net of associated
DTLs in accordance with paragraph (e) of this section.\30\ Significant
investments in the capital of unconsolidated financial institutions in
the form of common stock subject to the 10 percent common equity tier 1
capital deduction threshold may be reduced by any goodwill embedded in
the valuation of such investments deducted by the Board-regulated
institution pursuant to paragraph (a)(1) of this section. In addition,
with the prior written approval of the Board, for the period of time
stipulated by the Board, a Board-regulated institution subject to
subpart E of this part that underwrites a failed underwriting is not
required to deduct a significant investment in the capital of an
unconsolidated financial institution in the form of common stock
pursuant to this paragraph (d)(2) if such investment is related to such
failed underwriting.
[[Page 64320]]
(ii) A Board-regulated institution subject to subpart E of this
part must deduct from common equity tier 1 capital elements the items
listed in paragraph (d)(2)(i) of this section that are not deducted as
a result of the application of the 10 percent common equity tier 1
capital deduction threshold, and that, in aggregate, exceed 17.65
percent of the sum of the Board-regulated institution's common equity
tier 1 capital elements, minus adjustments to and deductions from
common equity tier 1 capital required under paragraphs (a) through (c)
of this section, minus the items listed in paragraph (d)(2)(i) of this
section (the 15 percent common equity tier 1 capital deduction
threshold). Any goodwill that has been deducted under paragraph (a)(1)
of this section can be excluded from the significant investments in the
capital of unconsolidated financial institutions in the form of common
stock.\31\
(iii) For purposes of calculating the amount of DTAs subject to the
10 and 15 percent common equity tier 1 capital deduction thresholds, a
Board-regulated institution subject to subpart E of this part may
exclude DTAs and DTLs relating to adjustments made to common equity
tier 1 capital under paragraph (b) of this section. A Board-regulated
institution subject to subpart E of this part that elects to exclude
DTAs relating to adjustments under paragraph (b) of this section also
must exclude DTLs and must do so consistently in all future
calculations. A Board-regulated institution subject to subpart E of
this part may change its exclusion preference only after obtaining the
prior approval of the Board.
* * * * *
\26\ With the prior written approval of the Board, for the
period of time stipulated by the Board, a Board-regulated
institution subject to subpart E of this part is not required to
deduct a non-significant investment in the capital of an
unconsolidated financial institution or an investment in a covered
debt instrument pursuant to this paragraph if the financial
institution is in distress and if such investment is made for the
purpose of providing financial support to the financial institution,
as determined by the Board.
\27\ Any non-significant investment in the capital of an
unconsolidated financial institution or any investment in a covered
debt instrument that is not required to be deducted under this
paragraph (c)(5) or otherwise under this section must be assigned
the appropriate risk weight under subparts D, E, or F of this part,
as applicable.
\28\ With prior written approval of the Board, for the period of
time stipulated by the Board, a Board-regulated institution subject
to subpart E of this part is not required to deduct a significant
investment in the capital of an unconsolidated financial
institution, including an investment in a covered debt instrument,
under this paragraph (c)(6) or otherwise under this section if such
investment is made for the purpose of providing financial support to
the financial institution as determined by the Board.
* * * * *
\30\ With the prior written approval of the Board, for the
period of time stipulated by the Board, a Board-regulated
institution subject to subpart E of this part is not required to
deduct a significant investment in the capital instrument of an
unconsolidated financial institution in distress in the form of
common stock pursuant to this section if such investment is made for
the purpose of providing financial support to the financial
institution as determined by the Board.
\31\ The amount of the items in paragraph (d)(2) of this section
that is not deducted from common equity tier 1 capital pursuant to
this section must be included in the risk-weighted assets of the
Board-regulated institution subject to subpart E of this part and
assigned a 250 percent risk weight for purposes of standardized
total risk-weighted assets and assigned the appropriate risk weight
for the investment under subpart E of this part for purposes of
expanded total risk-weighted assets.
Subpart D--Risk-Weighted Assets--Standardized Approach
Sec. 217.30 [Amended]
0
50. In Sec. 217.30, in paragraph (b), remove the words ``covered
positions'' and add in their place the words ``market risk covered
positions''.
Sec. 217.34 [Amended]
0
51. In Sec. 217.34, in paragraph (a), remove the citation ``Sec.
217.132(c)'' wherever it appears, and add in its place the citation
``Sec. 217.113''.
0
52. In Sec. 217.37, revise paragraph (c)(1) to read as follows:
Sec. 217. 37 Collateralized transactions.
* * * * *
(c) Collateral haircut approach--(1) General. A Board-regulated
institution may recognize the credit risk mitigation benefits of
financial collateral that secures an eligible margin loan, repo-style
transaction, collateralized derivative contract, or single-product
netting set of such transactions, and of any collateral that secures a
repo-style transaction that is included in the Board-regulated
institution's measure for market risk under subpart F of this part by
using the collateral haircut approach in this section. A Board-
regulated institution may use the standard supervisory haircuts in
paragraph (c)(3) of this section or, with prior written approval of the
Board, its own estimates of haircuts according to paragraph (c)(4) of
this section.
* * * * *
Sec. 217.61 [Amended]
0
53. In Sec. 217.61:
0
a. Remove the citation ``Sec. 217.172'' wherever it appears, and add
in its place the citations ``Sec. Sec. 217.160 and 217.161''; and
0
b. Remove the sentence ``An advanced approaches Board-regulated
institution that has not received approval from the Board to exit
parallel run pursuant to Sec. 217.121(d) is subject to the disclosure
requirements described in Sec. Sec. 217.62 and 217.63.''.
0
54. In Sec. 217.63:
0
a. In table 3, revise entry (c); and
0
b. Remove paragraphs (d) and (e).
The revision reads as follows:
Sec. 217.63 Disclosures by Board-regulated institutions described in
Sec. 217.61.
* * * * *
[[Page 64321]]
[GRAPHIC] [TIFF OMITTED] TP18SE23.186
* * * * *
Subpart G--Transition Provisions
0
55. In Sec. 217.300:
0
a. Revise paragraph (a);
0
b. Add paragraph (b); and
0
c. Remove and reserve paragraphs (f) through (i).
The revision and addition read as follows:
Sec. 217.300 Transitions.
(a) Transition adjustments for AOCI. Beginning July 1, 2025, a
Category III Board-regulated institution or a Category IV Board-
regulated institution must subtract from the sum of its common equity
tier 1 elements, before making deductions required under Sec.
217.22(c) or (d), the AOCI adjustment amount multiplied by the
percentage provided in Table 1 to Sec. 217.300.
The transition AOCI adjustment amount is the sum of:
(1) Net unrealized gains or losses on available-for-sale debt
securities, plus
(2) Accumulated net gains or losses on cash flow hedges, plus
(3) Any amounts recorded in AOCI attributed to defined benefit
postretirement plans resulting from the initial and subsequent
application of the relevant GAAP standards that pertain to such plans,
plus
(4) Net unrealized holding gains or losses on held-to-maturity
securities that are included in AOCI.
[GRAPHIC] [TIFF OMITTED] TP18SE23.187
(b) Expanded total risk-weighted assets. Beginning July 1, 2025, a
Board-regulated institution subject to subpart E of this part must
comply with the requirements of subpart B of this part using transition
expanded total risk-weighted assets as calculated under this paragraph
(b) in place of expanded total risk-weighted assets. Transition
expanded total risk-weighted assets is a Board-regulated institution's
expanded total risk-weighted assets multiplied by the percentage
provided in Table 2 to Sec. 217.300.
[[Page 64322]]
[GRAPHIC] [TIFF OMITTED] TP18SE23.188
* * * * *
0
56. In Sec. 217.301:
0
a. Remove paragraph (b)(5);
0
b. Revise paragraph (c)(2);
0
c. Revise paragraph (d)(2)(ii); and
0
d. Remove and reserve paragraph (e).
The revisions read as follows:
Sec. 217.301 Current expected credit losses (CECL) transition.
* * * * *
(c) * * *
(2) For purposes of the election described in paragraph (a)(1) of
this section, a Board-regulated institution subject to subpart E of
this part must increase total leverage exposure for purposes of the
supplementary leverage ratio by seventy-five percent of its CECL
transitional amount during the first year of the transition period,
increase total leverage exposure for purposes of the supplementary
leverage ratio by fifty percent of its CECL transitional amount during
the second year of the transition period, and increase total leverage
exposure for purposes of the supplementary leverage ratio by twenty-
five percent of its CECL transitional amount during the third year of
the transition period.
(d) * * *
(2) * * *
(ii) A Board-regulated institution subject to subpart E of this
part that has elected the 2020 CECL transition provision described in
this paragraph (d) may increase total leverage exposure for purposes of
the supplementary leverage ratio by one-hundred percent of its modified
CECL transitional amount during the first year of the transition
period, increase total leverage exposure for purposes of the
supplementary leverage ratio by one hundred percent of its modified
CECL transitional amount during the second year of the transition
period, increase total leverage exposure for purposes of the
supplementary leverage ratio by seventy-five percent of its modified
CECL transitional amount during the third year of the transition
period, increase total leverage exposure for purposes of the
supplementary leverage ratio by fifty percent of its modified CECL
transitional amount during the fourth year of the transition period,
and increase total leverage exposure for purposes of the supplementary
leverage ratio by twenty-five percent of its modified CECL transitional
amount during the fifth year of the transition period.
* * * * *
Sec. 217.303 [Removed and Reserved]
0
57. Remove and reserve Sec. 217.303.
Sec. 217.304 [Removed and Reserved]
0
58. Remove and reserve Sec. 217.304.
Sec. Sec. 217.1, 217.2, 217.10, 217.12, 217.22, 217.34, 217.35,
217.61, 217.300, Appendix A to Part 217 [Amended]
0
59. In the table below, for each section indicated in the left column,
remove the words indicated in the middle column from wherever it
appears in the section, and add the words indicated in the right
column:
BILLING CODE 6210-01-P; 6714-01-P; 4810-33-P
[[Page 64323]]
[GRAPHIC] [TIFF OMITTED] TP18SE23.189
[[Page 64324]]
0
60. In Appendix A to part 217, revise footnotes 2 and 4 to read as
follows:
Appendix A to Part 217--The Federal Reserve Board's Framework for
Implementing the Countercyclical Capital Buffer
* * * * *
\2\ 12 CFR 217.11(b). The CCyB applies only to banking
organizations subject to subpart E of the Federal banking agencies'
capital rule, which generally applies to those banking organizations
with greater than $250 billion in average total consolidated assets
and those banking organizations with greater than $100 billion in
average total consolidated assets and at least $75 billion in
average total nonbank assets, average weighted short-term wholesale
funding, or average off-balance-sheet exposure. See, e.g., 12 CFR
217.100(b).
* * * * *
\4\ The CcyB was subject to a phase-in arrangement between 2016
and 2019.
* * * * *
0
61. Redesignate the footnotes in part 217, as follows:
[GRAPHIC] [TIFF OMITTED] TP18SE23.190
[[Page 64325]]
BILLING CODE 6210-01-C; 6714-01-C; 4810-33-C
PART 225--BANK HOLDING COMPANIES AND CHANGE IN BANK CONTROL
(REGULATION Y)
0
62. 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, 3906,
3907, and 3909; 15 U.S.C. 1681s, 1681w, 6801, and 6805.
Subpart A--General Provisions
0
63. In Sec. 225.8:
0
a. Remove paragraph (d)(1);
0
b. Redesignate paragraphs (d)(2) through (21) as (d)(1) through (20),
respectively;
0
c. Revise newly redesignated paragraphs (d)(9) and (16);
0
d. Add paragraph (e)(1)(iv); and
0
e. Revise paragraph (f)(2).
The revisions and addition read as follows:
Sec. 225.8 Capital planning and stress capital buffer requirement.
* * * * *
(d) * * *
(9) Effective capital distribution limitations means any
limitations on capital distributions established by the Board by order
or regulation, including pursuant to 12 CFR 217.11, 225.4, 252.63,
252.165, and 263.202.
* * * * *
(16) Regulatory capital ratio means a capital ratio for which the
Board has established minimum requirements for the bank holding company
by regulation or order, including, as applicable, any regulatory
capital ratios calculated under 12 CFR part 217 and the deductions
required under 12 CFR 248.12.
* * * * *
(e) * * *
(1) * * *
(iv) For purposes of paragraph (e) of this section, a bank holding
company must calculate its regulatory capital ratios using either 12
CFR part 217, subpart D, or 12 CFR part 217, subpart E, whichever
subpart resulted in the higher amount of total risk-weighted assets as
of the last day of the previous capital plan cycle.
* * * * *
(f) * * *
(2) Stress capital buffer requirement calculation. A bank holding
company's stress capital buffer requirement is equal to the greater of:
(i) The following calculation:
(A) The bank holding company's common equity tier 1 capital ratio
as of the last day of the previous capital plan cycle, unless otherwise
determined by the Board; minus
(B) The bank holding company's lowest projected common equity tier
1 capital ratio in any quarter of the planning horizon under a
supervisory stress test; plus
(C) The ratio of:
(1) The sum of the bank holding company's planned common stock
dividends (expressed as a dollar amount) for each of the fourth through
seventh quarters of the planning horizon; to
(2) The risk-weighted assets of the bank holding company in the
quarter in which the bank holding company had its lowest projected
common equity tier 1 capital ratio in any quarter of the planning
horizon under a supervisory stress test; and
(ii) 2.5 percent.
* * * * *
PART 238--SAVINGS AND LOAN HOLDING COMPANIES (REGULATION LL)
0
64. The authority citation for part 238 continues to read as follows:
Authority: 5 U.S.C. 552, 559; 12 U.S.C. 1462, 1462a, 1463,
1464, 1467, 1467a, 1468, 5365; 1813, 1817, 1829e, 1831i, 1972; 15
U.S.C. 78l.
Subpart O--Supervisory Stress Test Requirements for Covered Savings
and Loan Holding Companies
0
65. In Sec. 238.130:
0
a. Remove the definition of ``Advanced approaches''; and
0
b. Revise the definition of ``Regulatory capital ratio''.
The revision reads as follows:
Sec. 238.130 Definitions.
* * * * *
Regulatory capital ratio means a capital ratio for which the Board
has established minimum requirements for the company by regulation or
order, including, as applicable, any regulatory capital ratios
calculated under 12 CFR part 217 and the deductions required under 12
CFR 248.12; for purposes of this section, regulatory capital ratios may
be calculated using each of 12 CFR part 217, subpart D, and 12 CFR part
217, subpart E.
* * * * *
Subpart P--Company-Run Stress Test Requirements for Savings and
Loan Holding Companies
0
66. In Sec. 238.141:
0
a. Remove the definition of ``Advanced approaches''; and
0
b. Revise the definition of ``Regulatory capital ratio''.
The revision reads as follows:
Sec. 238.141 Definitions.
* * * * *
Regulatory capital ratio means a capital ratio for which the Board
has established minimum requirements for the company by regulation or
order, including, as applicable, any regulatory capital ratios
calculated under 12 CFR part 217 and the deductions required under 12
CFR 248.12; except that a savings and loan holding company must
calculate its regulatory capital ratios using either 12 CFR part 217,
subpart D, or 12 CFR part 217, subpart E, whichever subpart resulted in
the higher amount of total risk-weighted assets as of the last day of
the previous stress test cycle.
* * * * *
Subpart Q--Single Counterparty Credit Limits for Covered Savings
and Loan Holding Companies
Sec. 238.151 [Amended]
0
67. In Sec. 238.151, remove the words ``in table 1 to Sec. 217.132 of
this chapter'' wherever they appear and add in their place the words
``in table 1 to Sec. 217.121 of this chapter''.
Sec. 238.153 [Amended]
0
68. In Sec. 238.153, remove the words ``any of the methods that the
covered company is authorized to use under 12 CFR part 217, subparts D
and E'' wherever they appear and add in their place the words ``the
method specified in 12 CFR part 217 subpart E''.
Subpart S--Capital Planning and Stress Capital Buffer Requirement
0
69. In Sec. 238.170:
0
a. Remove paragraph (d)(1);
0
b. Redesignate paragraphs (d)(2) through (18) as (d)(1) through (17),
respectively;
0
c. Revise newly redesignated paragraphs (d)(9) and (14);
0
d. Add paragraph (e)(1)(iv); and
0
e. Revise paragraph (f)(2).
The revisions and addition read as follows:
Sec. 238.170 Capital planning and stress capital buffer requirement.
* * * * *
(d) * * *
(9) Effective capital distribution limitations means any
limitations on capital distributions established by the Board by order
or regulation, including pursuant to 12 CFR 217.11.
* * * * *
(14) Regulatory capital ratio means a capital ratio for which the
Board has established minimum requirements for
[[Page 64326]]
the covered savings and loan holding company by regulation or order,
including, as applicable, any regulatory capital ratios calculated
under 12 CFR part 217 and the deductions required under 12 CFR 248.12.
* * * * *
(e) * * *
(1) * * *
(iv) For purposes of this paragraph (e), a savings and loan holding
company must calculate its regulatory capital ratios using either 12
CFR part 217, subpart D, or 12 CFR part 217, subpart E, whichever
subpart resulted in the higher amount of total risk-weighted assets as
of the last day of the previous capital plan cycle.
* * * * *
(f) * * *
(2) Stress capital buffer requirement calculation. A covered
savings and loan holding company's stress capital buffer requirement is
equal to the greater of:
(i) The following calculation:
(A) The covered savings and loan holding company's common equity
tier 1 capital ratio as of the last day of the previous capital plan
cycle, unless otherwise determined by the Board; minus
(B) The covered savings and loan holding company's lowest projected
common equity tier 1 capital ratio in any quarter of the planning
horizon under a supervisory stress test; plus
(C) The ratio of:
(1) The sum of the covered savings and loan holding company's
planned common stock dividends (expressed as a dollar amount) for each
of the fourth through seventh quarters of the planning horizon; to
(2) The risk-weighted assets of the covered savings and loan
holding company in the quarter in which the covered savings and loan
holding company had its lowest projected common equity tier 1 capital
ratio in any quarter of the planning horizon under a supervisory stress
test; and
(ii) 2.5 percent.
* * * * *
PART 252--ENHANCED PRUDENTIAL STANDARDS (REGULATION YY)
0
70. The authority citation for part 252 continues to read as follows:
Authority: 12 U.S.C. 321-338a, 481-486, 1467a, 1818, 1828,
1831n, 1831o, 1831p-1, 1831w, 1835, 1844(b), 1844(c), 3101 et seq.,
3101 note, 3904, 3906-3909, 4808, 5361, 5362, 5365, 5366, 5367,
5368, 5371.
Subpart B--Company-Run Stress Test Requirements for State Member
Banks With Total Consolidated Assets Over $250 Billion
0
71. In Sec. 252.12:
0
a. Remove the definition of ``Advanced approaches''; and
0
b. Revise the definition of ``Regulatory capital ratio''.
The revision reads as follows:
Sec. 252.12 Definitions.
* * * * *
Regulatory capital ratio means a capital ratio for which the Board
has established minimum requirements for the state member bank by
regulation or order, including, as applicable, any regulatory capital
ratios calculated under 12 CFR part 217 and the deductions required
under 12 CFR 248.12; except that the state member bank must calculate
its regulatory capital ratios using either 12 CFR part 217, subpart D,
or 12 CFR part 217, subpart E, whichever subpart resulted in the higher
amount of total risk-weighted assets as of the last day of the previous
stress test cycle.
* * * * *
Subpart E--Supervisory Stress Test Requirements for Certain U.S.
Banking Organizations With $100 Billion or More in Total
Consolidated Assets and Nonbank Financial Companies Supervised by
the Board
0
72. In Sec. 252.42:
0
a. Remove the definition of ``Advanced approaches''; and
0
b. Revise the definition of ``Regulatory capital ratio''.
The revision reads as follows:
Sec. 252.42 Definitions.
* * * * *
Regulatory capital ratio means a capital ratio for which the Board
has established minimum requirements for the company by regulation or
order, including, as applicable, any regulatory capital ratios
calculated under 12 CFR part 217 and the deductions required under 12
CFR 248.12; for purposes of this section regulatory capital ratios may
be calculated using each of 12 CFR part 217, subpart D, and 12 CFR part
217, subpart E.
* * * * *
Subpart F--Company-Run Stress Test Requirements for Certain U.S.
Bank Holding Companies and Nonbank Financial Companies Supervised
by the Board
0
73. In Sec. 252.52:
0
a. Remove the definition of ``Advanced approaches''; and
0
b. Revise the definition of ``Regulatory capital ratio''.
The revision reads as follows:
Sec. 252.52 Definitions.
* * * * *
Regulatory capital ratio means a capital ratio for which the Board
has established minimum requirements for the company by regulation or
order, including, as applicable, any regulatory capital ratios
calculated under 12 CFR part 217 and the deductions required under 12
CFR 248.12; except that the covered company must calculate its
regulatory capital ratios using either 12 CFR part 217, subpart D, or
12 CFR part 217, subpart E, whichever subpart resulted in the higher
amount of total risk-weighted assets as of the last day of the previous
stress test cycle.
* * * * *
Subpart G--External Long-term Debt Requirement, External Total
Loss-absorbing Capacity Requirement and Buffer, and Restrictions on
Corporate Practices for U.S. Global Systemically Important Banking
Organizations
0
74. In Sec. 252.61, revise the definition of ``Total risk-weighted
assets'' to read as follows:
Sec. 252.61 Definitions.
* * * * *
Total risk-weighted assets means the greater of standardized total
risk-weighted assets and expanded total risk-weighted assets, each as
calculated under part 217 of this chapter.
Subpart H--Single-Counterparty Credit Limits
Sec. 252.71 [Amended]
0
75. In Sec. 252.71, remove the words ``in Table 1 to Sec. 217.132 of
the Board's Regulation Q (12 CFR 217.132)'' wherever they appear and
add in their place the words ``in Table 1 to Sec. 217.121 of the
Board's Regulation Q (12 CFR 217.121)''.
Sec. 252.73 [Amended]
0
76. In Sec. 252.73, remove the words ``any of the methods that the
covered company is authorized to use under the Board's Regulation Q (12
CFR part 217, subparts D and E)'' wherever they appear and add, in
their place, the words ``the method specified in 12 CFR part 217
subpart E''.
[[Page 64327]]
Subpart N--Enhanced Prudential Standards for Foreign Banking
Organizations With Total Consolidated Assets of $100 Billion or
More and Combined U.S. Assets of Less Than $100 Billion
0
77. In Sec. 252.147, revise paragraph (e)(1)(i) to read as follows:
Sec. 252.147 U.S. intermediate holding company requirement for
foreign banking organizations with combined U.S. assets of less than
$100 billion and U.S. non-branch assets of $50 billion or more.
* * * * *
(e) * * *
(1) * * *
(i) A U.S. intermediate holding company must comply with 12 CFR
part 217 in the same manner as a bank holding company.
* * * * *
Subpart O--Enhanced Prudential Standards for Foreign Banking
Organizations With Total Consolidated Assets of $100 Billion or
More and Combined U.S. Assets of $100 Billion or More
0
78. In Sec. 252.153, revise paragraph (e)(1)(i) to read as follows:
Sec. 252.153 U.S. intermediate holding company requirement for
foreign banking organizations with combined U.S. assets of $100 billion
or more and U.S. non-branch assets of $50 billion or more.
* * * * *
(e) * * *
(1) * * *
(i) A U.S. intermediate holding company must comply with 12 CFR
part 217 in the same manner as a bank holding company.
* * * * *
Subpart Q--Single Counterparty Credit Limits
Sec. 252.171 [Amended]
0
79. In Sec. 252.171, remove the words ``in Table 1 to Sec. 217.132 of
the Board's Regulation Q (12 CFR 217.132)'' wherever they appear and
add in their place the words ``in Table 1 to Sec. 217.121 of the
Board's Regulation Q (12 CFR 217.121)''.
Sec. 252.173 [Amended]
0
80. In Sec. 252.173, remove the words ``any of the methods that the
covered company is authorized to use under the Board's Regulation Q (12
CFR part 217, subparts D and E)'' wherever they appear and add, in
their place, the words ``the method specified in 12 CFR part 217
subpart E''.
Federal Deposit Insurance Corporation
12 CFR Chapter III
Authority and Issuance
For the reasons stated in the common preamble, the Federal Deposit
Insurance Corporation proposes to amend 12 CFR part 324 as follows:
PART 324--CAPITAL ADEQUACY OF FDIC-SUPERVISED INSTITUTIONS
0
81. The authority citation for part 324 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; 5371; 5412; Pub. L. 102-233,
105 Stat. 1761, 1789, 1790 (12 U.S.C. 1831n note); Pub. L. 102-242,
105 Stat. 2236, 2355, as amended by Pub. L. 103-325, 108 Stat. 2160,
2233 (12 U.S.C. 1828 note); Pub. L. 102-242, 105 Stat. 2236, 2386,
as amended by Pub. L. 102-550, 106 Stat. 3672, 4089 (12 U.S.C. 1828
note); Pub. L. 111-203, 124 Stat. 1376, 1887 (15 U.S.C. 78o-7 note),
Pub. L. 115-174; section 4014 Sec. 201, Pub. L. 116-136, 134 Stat.
281 (15 U.S.C. 9052).
0
82. Revise subpart E and subpart F of part 324 as set forth at the end
of the common preamble.
0
83. For purposes of part 324, Subpart E and subpart F of the common
rule are amended as follows:
0
a. Remove ``[AGENCY]'' and add ``FDIC'' in its place wherever it
appears;
0
b. Remove ``[BANKING ORGANIZATION]'' and add ``FDIC-supervised
institution'' in its place wherever it appears;
0
c. Remove ``[BANKING ORGANIZATIONS]'' and add ``FDIC-supervised
institutions'' in its place wherever it appears;
0
d. Remove ``[BANKING ORGANIZATION]'s'' and add ``FDIC-supervised
institution's'' in its place, wherever it appears;
0
e. Remove ``[bank]'' and add ``FDIC-supervised institution'' in its
place, wherever it appears;
0
f. Remove ``[REAL ESTATE LENDING GUIDELINES]'' and add ``12 CFR part
365, Subpart A, Appendix A'' in its place wherever it appears;
0
g. Remove ``[APPRAISAL RULE]'' and add ``12 CFR part 323, Subpart A''
in its place wherever it appears;
0
h. Remove ``__.'' And add ``324.'' In its place wherever it appears;
0
i. Remove ``[REGULATORY REPORT]'' and add ``Call Report'' in its place
wherever it appears.
Subpart A--General Provisions
0
84. In Sec. 324.1, revise paragraph (f) to read as follows.
Sec. 324.1 Purpose, applicability, reservations of authority, and
timing.
* * * * *
(f) Transitions and timing--(1) Transitions. Notwithstanding any
other provision of this part, an FDIC-supervised institution must make
any adjustments provided in subpart G of this part for purposes of
implementing this part.
(2) Timing. An FDIC-supervised institution that changes from one
category to another category, or that changes from having no category
to having a category, must comply with the requirements of its category
in this part, including applicable transition provisions of the
requirements in this part, no later than on the first day of the second
quarter following the change in the FDIC-supervised institution's
category.
* * * * *
0
85. Amend Sec. 324.2 as follows:
0
a. Redesignate footnotes 3 through 9 as footnotes 1 through 7,
respectively.
0
b. Remove the definitions for ``Advanced approaches FDIC-supervised
institution'', ``Advanced approaches total risk-weighted assets'', and
``Advanced market risk-weighted assets'';
0
c. Revise the definitions for ``Category II FDIC-supervised
institution'' and ``Category III FDIC-supervised institution'';
0
d. Add the definition for ``Category IV FDIC-supervised institution''
in alphabetical order;
0
e. Revise newly redesignated footnote 1 to paragraph (2) of the
definition for ``Cleared transaction'';
0
f. Revise the definition for ``Corporate exposure'';
0
g. Remove the definition for ``Credit-risk-weighted assets;
0
h. Add the definition for ``CVA risk-weighted assets'' in alphabetical
order;
0
i. Revise the definition for ``Effective notional amount'';
0
j. Remove the definition for ``Eligible credit reserves'';
0
k. Revise the definition for ``Eligible guarantee'';
0
l. Add the definition for ``Expanded total risk-weighted assets'' in
alphabetical order;
0
m. Remove the definition for ``Expected credit loss (ECL)'';
0
n. Revise the definitions for ``Exposure amount'', paragraph (5)(i) of
the definition for ``Financial institution'', and the definition for
``Market risk FDIC-supervised institution'';
0
o. Add the definition for ``Market risk-weighted assets'' in
alphabetical order;
0
p. Revise the definitions for ``Net independent collateral amount'',
[[Page 64328]]
``Netting set'', and ``Protection amount (P)'';
0
q. In the definition for ``Residential mortgage exposure'':
0
i. Remove paragraph (2);
0
ii. Redesignate paragraphs (1)(i) and (ii) as paragraphs (1) and (2),
respectively; and
0
iii. In newly redesiganted paragraph (2), remove the words ``family;
and'' and add, in their place, the word ``family.'';
0
r. Remove the definition for ``Specific wrong-way risk'';
0
s. Revise the definitions for ``Speculative grade'', ``Standardized
market risk-weighted assets'', ``Standardized total risk-weighted
assets'', and ``Sub-speculative grade'';
0
t. Add the definition for ``Total credit risk-weighted assets'' in
alphabetical order;
0
u. Revise the definition for ``Unregulated financial institution'';u.
Remove the definition for ``Value-at-Risk (VaR)'';
0
v. Revise the definition for ``Variation margin amount'';
The additions and revisions read as follows:
Sec. 324.2 Definitions.
* * * * *
Category II FDIC-supervised institution means an FDIC-supervised
institution that is not a subsidiary of a global systemically important
BHC, as defined pursuant to 12 CFR 252.5, and that:
(1) Is a subsidiary of a Category II banking organization, as
defined pursuant to 12 CFR 252.5 or 12 CFR 238.10, as applicable; or
(2)(i) Has total consolidated assets, calculated based on the
average of the FDIC-supervised institution's total consolidated assets
for the four most recent calendar quarters as reported on the Call
Report, equal to $700 billion or more. If the FDIC-supervised
institution has not filed the Call Report for each of the four most
recent calendar quarters, total consolidated assets is calculated based
on its total consolidated assets, as reported on the Call Report, for
the most recent quarter or the average of the most recent quarters, as
applicable; or
(ii)(A) Has total consolidated assets, calculated based on the
average of the FDIC-supervised institution's total consolidated assets
for the four most recent calendar quarters as reported on the Call
Report, of $100 billion or more but less than $700 billion. If the
FDIC-supervised institution has not filed the Call Report for each of
the four most recent quarters, total consolidated assets is based on
its total consolidated assets, as reported on the Call Report, for the
most recent quarter or average of the most recent quarters, as
applicable; and
(B) Has cross-jurisdictional activity, calculated based on the
average of its cross-jurisdictional activity for the four most recent
calendar quarters, of $75 billion or more. Cross-jurisdictional
activity is the sum of cross-jurisdictional claims and cross-
jurisdictional liabilities, calculated in accordance with the
instructions to the FR Y-15 or equivalent reporting form.
(3) After meeting the criteria in paragraph (2) of this definition,
an FDIC supervised-institution continues to be a Category II FDIC-
supervised institution until the FDIC-supervised institution has:
(i) Less than $700 billion in total consolidated assets, as
reported on the Call Report, for each of the four most recent calendar
quarters; and
(ii) (A) Less than $75 billion in cross-jurisdictional activity for
each of the four most recent calendar quarters. Cross-jurisdictional
activity is the sum of cross-jurisdictional claims and cross-
jurisdictional liabilities, calculated in accordance with the
instructions to the FR Y-15 or equivalent reporting form; or
(B) Less than $100 billion in total consolidated assets, as
reported on the Call Report, for each of the four most recent calendar
quarters.
Category III FDIC-supervised institution means an FDIC-supervised
institution that is not a subsidiary of a global systemically important
banking organization or a Category II FDIC-supervised institution and
that:
(1) Is a subsidiary of a Category III banking organization, as
defined pursuant to 12 CFR 252.5 or 12 CFR 238.10, as applicable; or
(2)(i) Has total consolidated assets, calculated based on the
average of the FDIC-supervised institution's total consolidated assets
for the four most recent calendar quarters as reported on the Call
Report, equal to $250 billion or more. If the FDIC-supervised
institution has not filed the Call Report for each of the four most
recent calendar quarters, total consolidated assets is calculated based
on its total consolidated assets, as reported on the Call Report, for
the most recent quarter or average of the most recent quarters, as
applicable; or
(ii)(A) Has total consolidated assets, calculated based on the
average of the FDIC-supervised institution's total consolidated assets
for the four most recent calendar quarters as reported on the Call
Report, of $100 billion or more but less than $250 billion. If the
FDIC-supervised institution has not filed the Call Report for each of
the four most recent calendar quarters, total consolidated assets is
calculated based on its total consolidated assets, as reported on the
Call Report, for the most recent quarter or average of the most recent
quarters, as applicable; and
(B) Has at least one of the following in paragraphs (2)(ii)(B)(1)
through (3) of this definition, each calculated as the average of the
four most recent calendar quarters, or if the FDIC-supervised
institution has not filed each applicable reporting form for each of
the four most recent calendar quarters, for the most recent quarter or
quarters, as applicable:
(1) Total nonbank assets, calculated in accordance with the
instructions to the FR Y-9LP or equivalent reporting form, equal to $75
billion or more;
(2) Off-balance sheet exposure equal to $75 billion or more. Off-
balance sheet exposure is a FDIC-supervised institution's total
exposure, calculated in accordance with the instructions to the FR Y-15
or equivalent reporting form, minus the total consolidated assets of
the FDIC-supervised institution, as reported on the Call Report; or
(3) Weighted short-term wholesale funding, calculated in accordance
with the instructions to the FR Y-15 or equivalent reporting form,
equal to $75 billion or more.
(iii) After meeting the criteria in paragraph (2)(ii) of this
definition, an FDIC-supervised institution continues to be a Category
III FDIC-supervised institution until the FDIC-supervised institution:
(A) Has:
(1) Less than $250 billion in total consolidated assets, as
reported on the Call Report, for each of the four most recent calendar
quarters;
(2) Less than $75 billion in total nonbank assets, calculated in
accordance with the instructions to the FR Y-9LP or equivalent
reporting form, for each of the four most recent calendar quarters;
(3) Less than $75 billion in weighted short-term wholesale funding,
calculated in accordance with the instructions to the FR Y-15 or
equivalent reporting form, for each of the four most recent calendar
quarters; and
(4) Less than $75 billion in off-balance sheet exposure for each of
the four most recent calendar quarters. Off-balance sheet exposure is
an FDIC-supervised institution's total exposure, calculated in
accordance with the instructions to the FR Y-15 or equivalent reporting
form, minus the total consolidated assets of the FDIC-supervised
institution, as reported on the Call Report; or
(B) Has less than $100 billion in total consolidated assets, as
reported on the
[[Page 64329]]
Call Report, for each of the four most recent calendar quarters; or
(C) Is a Category II FDIC-supervised institution.
Category IV FDIC-supervised institution means an FDIC-supervised
institution that is not a subsidiary of a global systemically important
banking organization, a Category II FDIC-supervised institution, or a
Category III FDIC-supervised institution and that:
(1) Is a subsidiary of a Category IV banking organization, as
defined pursuant to 12 CFR 252.5 or 12 CFR 238.10, as applicable; or:
(2) Has total consolidated assets, calculated based on the average
of the FDIC-supervised institution's total consolidated assets for the
four most recent calendar quarters as reported on the Call Report, of
$100 billion or more. If the FDIC-supervised institution has not filed
the Call Report for each of the four most recent calendar quarters,
total consolidated assets is calculated based on the average of its
total consolidated assets, as reported on the Call Report, for the most
recent quarter(s) available.
(3) After meeting the criterion in paragraph (2) of this
definition, an FDIC-supervised institution continues to be a Category
IV FDIC-supervised institution until it:
(i) Has less than $100 billion in total consolidated assets, as
reported on the Call Report, for each of the four most recent calendar
quarters; or
(ii) Is a Category II FDIC-supervised institution or Category III
FDIC-supervised institution.
* * * * *
Cleared transaction * * *
(2) * * *
\1\ For the standardized approach treatment of these exposures,
see Sec. 324.34(e) (OTC derivative contracts) or Sec. 324.37(c)
(repo-style transactions). For the expanded risk-based approach
treatment of these exposures, see Sec. 324.113 (OTC derivative
contracts) or Sec. 324.121 (repo-style transactions).
* * * * *
Corporate exposure means an exposure to a company that is not:
(1) An exposure to a sovereign, the Bank for International
Settlements, the European Central Bank, the European Commission, the
International Monetary Fund, the European Stability Mechanism, the
European Financial Stability Facility, a multi-lateral development bank
(MDB), a depository institution, a foreign bank, or a credit union, a
public sector entity (PSE);
(2) An exposure to a government-sponsored enterprises (GSE);
(3) For purposes of subpart D of this part, a residential mortgage
exposure;
(4) A pre-sold construction loan;
(5) A statutory multifamily mortgage;
(6) A high volatility commercial real estate (HVCRE) exposure;
(7) A cleared transaction;
(8) A default fund contribution;
(9) A securitization exposure;
(10) An equity exposure;
(11) An unsettled transaction;
(12) A policy loan;
(13) A separate account;
(14) A Paycheck Protection Program covered loan as defined in
section 7(a)(36) or (37) of the Small Business Act (15 U.S.C.
636(a)(36)-(37));
(15) For purposes of subpart E of this part, a real estate
exposure, as defined in Sec. 324.101; or
(16) For purposes of subpart E of this part, a retail exposure as
defined in Sec. 324.101.
* * * * *
CVA risk-weighted assets means the measure for CVA risk calculated
under Sec. 324.221(a) multiplied by 12.5.
* * * * *
Effective notional amount means for an eligible guarantee or
eligible credit derivative, the lesser of the contractual notional
amount of the credit risk mitigant and the exposures amount of the
hedged exposure, multiplied by the percentage coverage of the credit
risk mitigant.
* * * * *
Eligible guarantee means a guarantee that:
(1) Is written;
(2) Is either:
(i) Unconditional, or
(ii) A contingent obligation of the U.S. government or its
agencies, the enforceability of which is dependent upon some
affirmative action on the part of the beneficiary of the guarantee or a
third party (for example, meeting servicing requirements);
(3) Covers all or a pro rata portion of all contractual payments of
the obligated party on the reference exposure;
(4) Gives the beneficiary a direct claim against the protection
provider;
(5) Is not unilaterally cancelable by the protection provider for
reasons other than the breach of the contract by the beneficiary;
(6) Except for a guarantee by a sovereign, is legally enforceable
against the protection provider in a jurisdiction where the protection
provider has sufficient assets against which a judgment may be attached
and enforced;
(7) Requires the protection provider to make payment to the
beneficiary on the occurrence of a default (as defined in the
guarantee) of the obligated party on the reference exposure in a timely
manner without the beneficiary first having to take legal actions to
pursue the obligor for payment;
(8) Does not increase the beneficiary's cost of credit protection
on the guarantee in response to deterioration in the credit quality of
the reference exposure;
(9) Is not provided by an affiliate of the FDIC-supervised
institution, unless the affiliate is an insured depository institution,
foreign bank, securities broker or dealer, or insurance company that:
(i) Does not control the FDIC-supervised institution; and
(ii) Is subject to consolidated supervision and regulation
comparable to that imposed on depository institutions, U.S. securities
broker-dealers, or U.S. insurance companies (as the case may be); and
(10) Is provided by an eligible guarantor.
* * * * *
Expanded total risk-weighted assets means the greater of:
(1) The sum of:
(i) Total credit risk-weighted assets;
(ii) Total risk-weighted assets for equity exposures as calculated
under Sec. Sec. 324.141 and 324.142;
(iii) Risk-weighted assets for operational risk as calculated under
Sec. 324.150;
(iv) Market risk-weighted assets; and
(v) CVA risk-weighted assets; minus
(vi) Any amount of the FDIC-supervised institution's adjusted
allowance for credit losses that is not included in tier 2 capital and
any amount of allocated transfer risk reserves; or
(2)(i) 72.5 percent of the sum of:
(A) Total credit risk-weighted assets;
(B) Total risk-weighted assets for equity exposures as calculated
under Sec. 324.141 and 324.142;
(C) Risk-weighted assets for operational risk as calculated under
Sec. 324.150;
(D) Standardized market risk-weighted assets; and
(E) CVA risk-weighted assets; minus
(ii) Any amount of the FDIC-supervised institution's adjusted
allowance for credit losses that is not included in tier 2 capital and
any amount of allocated transfer risk reserves.
* * * * *
Exposure amount means:
(1) For the on-balance sheet component of an exposure (other than
an available-for-sale or held-to-maturity security, if the FDIC-
supervised institution has made an AOCI opt-out election (as defined in
Sec. 324.22(b)(2)); an OTC derivative contract; a repo-style
transaction or an eligible margin loan for which the FDIC-supervised
[[Page 64330]]
institution determines the exposure amount under Sec. 324.37 or Sec.
324.121, as applicable; a cleared transaction; a default fund
contribution; or a securitization exposure), the FDIC-supervised
institution's carrying value of the exposure.
(2) For a security (that is not a securitization exposure, equity
exposure, or preferred stock classified as an equity security under
GAAP) classified as available-for-sale or held-to-maturity if the FDIC-
supervised institution has made an AOCI opt-out election (as defined in
Sec. 324.22(b)(2)), the FDIC-supervised institution's carrying value
(including net accrued but unpaid interest and fees) for the exposure
less any net unrealized gains on the exposure and plus any net
unrealized losses on the exposure.
(3) For available-for-sale preferred stock classified as an equity
security under GAAP if the FDIC-supervised institution has made an AOCI
opt-out election (as defined in Sec. 324.22(b)(2)), the FDIC-
supervised institution's carrying value of the exposure less any net
unrealized gains on the exposure that are reflected in such carrying
value but excluded from the FDIC-supervised institution's regulatory
capital components.
(4) For the off-balance sheet component of an exposure (other than
an OTC derivative contract; a repo-style transaction or an eligible
margin loan for which the FDIC-supervised institution calculates the
exposure amount under Sec. 324.37 or Sec. 324.121, as applicable; a
cleared transaction; a default fund contribution; or a securitization
exposure), the notional amount of the off-balance sheet component
multiplied by the appropriate credit conversion factor (CCF) in Sec.
324.33 or Sec. 324.112, as applicable.
(5) For an exposure that is an OTC derivative contract, the
exposure amount determined under Sec. 324.34 or Sec. 324.113, as
applicable.
(6) For an exposure that is a cleared transaction, the exposure
amount determined under Sec. 324.35 or Sec. 324.114, as applicable.
(7) For an exposure that is an eligible margin loan or repo-style
transaction for which the FDIC-supervised institution calculates the
exposure amount as provided in Sec. 324.37 or Sec. 324.121, as
applicable, the exposure amount determined under Sec. 324.37 or Sec.
324.121, as applicable.
(8) For an exposure that is a securitization exposure, the exposure
amount determined under Sec. 324.42 or Sec. 324.131, as applicable.
* * * * *
Financial institution * * *
(5) * * *
(i) 85 percent or more of the total consolidated annual gross
revenues (as determined in accordance with applicable accounting
standards) of the company in either of the two most recent calendar
years were derived, directly or indirectly, by the company on a
consolidated basis from the activities; or
* * * * *
Market risk FDIC-supervised institution means a FDIC-supervised
institution that is described in Sec. 324.201(b)(1).
Market risk-weighted assets means the measure for market risk
calculated pursuant to Sec. 324.204(a) multiplied by 12.5.
* * * * *
Net independent collateral amount means the fair value amount of
the independent collateral, as adjusted by the haircuts under Sec.
324.121(c)(2)(iii), as applicable, that a counterparty to a netting set
has posted to an FDIC-supervised institution less the fair value amount
of the independent collateral, as adjusted by the haircuts under Sec.
324.121(c)(2)(iii), as applicable, posted by the FDIC-supervised
institution to the counterparty, excluding such amounts held in a
bankruptcy-remote manner or posted to a QCCP and held in conformance
with the operational requirements in Sec. 324.3.
Netting set means:
(1) A group of transactions with a single counterparty that are
subject to a qualifying master netting agreement and that consist only
of:
(i) Derivative contracts;
(ii) Repo-style transactions; or
(iii) Eligible margin loans.
(2) For derivative contracts, netting set also includes a single
derivative contract between an FDIC-supervised institution and a single
counterparty.
* * * * *
Protection amount (P) means, with respect to an exposure hedged by
an eligible guarantee or eligible credit derivative, the effective
notional amount of the guarantee or credit derivative, reduced to
reflect any currency mismatch, maturity mismatch, or lack of
restructuring coverage (as provided in Sec. 324.36 or Sec. 324.120,
as appropriate).
* * * * *
Speculative grade means that the entity to which the FDIC-
supervised institution is exposed through a loan or security, or the
reference entity with respect to a credit derivative, has adequate
capacity to meet financial commitments in the near term, but is
vulnerable to adverse economic conditions, such that should economic
conditions deteriorate, the entity would present an elevated default
risk.
Standardized market risk-weighted assets means the standardized
measure for market risk calculated under Sec. 324.204(b) multiplied by
12.5.
Standardized total risk-weighted assets means:
(1) The sum of:
(i) Total risk-weighted assets for general credit risk as
calculated under Sec. 324.31;
(ii) Total risk-weighted assets for cleared transactions and
default fund contributions as calculated under Sec. 324.35;
(iii) Total risk-weighted assets for unsettled transactions as
calculated under Sec. 324.38;
(iv) Total risk-weighted assets for securitization exposures as
calculated under Sec. 324.42;
(v) Total risk-weighted assets for equity exposures as calculated
under Sec. 324.52 and Sec. 324.53; and
(vi) For a market risk FDIC-supervised institution only, market
risk-weighted assets; less
(2) Any amount of the FDIC-supervised institution's allowance for
loan and lease losses or adjusted allowance for credit losses, as
applicable, that is not included in tier 2 capital and any amount of
``allocated transfer risk reserves.''
* * * * *
Sub-speculative grade means that the entity to which the FDIC-
supervised institution is exposed through a loan or security, or the
reference entity with respect to a credit derivative, depends on
favorable economic conditions to meet its financial commitments, such
that should such economic conditions deteriorate the entity likely
would default on its financial commitments.
* * * * *
Total credit risk-weighted assets means the sum of:
(1) Total risk-weighted assets for general credit risk as
calculated under Sec. 324.110;
(2) Total risk-weighted assets for cleared transactions and default
fund contributions as calculated under Sec. 324.114;
(3) Total risk-weighted assets for unsettled transactions as
calculated under Sec. 324.115; and
(4) Total risk-weighted assets for securitization exposures as
calculated under Sec. 324.132.
* * * * *
Unregulated financial institution means a financial institution
that is not a regulated financial institution, including any financial
institution that
[[Page 64331]]
would meet the definition of ``Financial institution'' under this
section but for the ownership interest thresholds set forth in
paragraph (4)(i) of that definition.
* * * * *
Variation margin amount means the fair value amount of the
variation margin, as adjusted by the standard supervisory haircuts
under Sec. 324.121(c)(2)(iii), as applicable, that a counterparty to a
netting set has posted to an FDIC-supervised institution less the fair
value amount of the variation margin, as adjusted by the standard
supervisory haircuts under Sec. 324.121(c)(2)(iii), as applicable,
posted by the FDIC-supervised institution to the counterparty.
* * * * *
Sec. 324.3 [Amended]
0
86. In Sec. 324.3, remove and reserve paragraph (c).
0
87. In Sec. 324.4:
0
a. Redesignate footnote 10 as footnote 1; and
0
b. Revise newly redesignated footnote 1.
The revision reads as follows:
Sec. 324.4 Inadequate capital as an unsafe or unsound practice or
condition.
* * * * *
\1\ The term total assets shall have the same meaning as
provided in 12 CFR 324.401(g).
Subpart B--Capital Ratio Requirements and Buffers
0
88. In Sec. 324.10, revise paragraphs (a)(1)(v), (b) introductory
text, (b)(5), (c), (d) introductory text, (d)(3)(ii), and (d)(4) to
read as follows.
Sec. 324.10 Minimum capital requirements.
* * * * *
(a) * * *
(1) * * *
(v) For an FDIC-supervised institution subject to subpart E of this
part, a supplementary leverage ratio of 3 percent.
* * * * *
(b) Standardized capital ratio calculations. Other than as provided
in paragraph (d) of this section:
* * * * *
(5) State savings association tangible capital ratio. A state
savings association's tangible capital ratio is the ratio of the state
savings association's core capital (tier 1 capital) to total assets.
For purposes of this paragraph (b)(5), the term total assets shall have
the meaning provided in Sec. 324.401(g).
* * * * *
(c) Supplementary leverage ratio. (1) The supplementary leverage
ratio of an FDIC-supervised institution subject to subpart E of this
part is the ratio of its tier 1 capital to total leverage exposure.
Total leverage exposure is calculated as the sum of:
(i) The mean of the on-balance sheet assets calculated as of each
day of the reporting quarter; and
(ii) The mean of the off-balance sheet exposures calculated as of
the last day of each of the most recent three months, minus the
applicable deductions under Sec. 324.22(a), (c), and (d).
(2) For purposes of this part, total leverage exposure means the
sum of the items described in paragraphs (c)(2)(i) through (viii) of
this section, as adjusted pursuant to paragraph (c)(2)(ix) of this
section for a clearing member FDIC-supervised institution and paragraph
(c)(2)(x) of this section for a custody bank:
(i) The balance sheet carrying value of all of the FDIC-supervised
institution's on-balance sheet assets, net of adjusted allowances for
credit losses, plus the value of securities sold under a repurchase
transaction or a securities lending transaction that qualifies for
sales treatment under GAAP, less amounts deducted from tier 1 capital
under Sec. 324.22(a), (c), and (d), less the value of securities
received in security-for-security repo-style transactions, where the
FDIC-supervised institution acts as a securities lender and includes
the securities received in its on-balance sheet assets but has not sold
or re-hypothecated the securities received, and less the fair value of
any derivative contracts;
(ii)(A) The potential future exposure (PFE) for each netting set to
which the FDIC-supervised institution is a counterparty (including
cleared transactions except as provided in paragraph (c)(2)(ix) of this
section and, at the discretion of the FDIC-supervised institution,
excluding a forward agreement treated as a derivative contract that is
part of a repurchase or reverse repurchase or a securities borrowing or
lending transaction that qualifies for sales treatment under GAAP), as
determined under Sec. 324.113(g), in which the term C in Sec.
324.113(g)(1) equals zero, and, for any counterparty that is not a
commercial end-user, multiplied by 1.4. For purposes of this paragraph
(c)(2)(ii)(A), an FDIC-supervised institution may set the value of the
term C in Sec. 324.113(g)(1) equal to the amount of collateral posted
by a clearing member client of the FDIC-supervised institution in
connection with the client-facing derivative transactions within the
netting set; and
(B) An FDIC-supervised institution may choose to exclude the PFE of
all credit derivatives or other similar instruments through which it
provides credit protection when calculating the PFE under Sec.
324.113, provided that it does so consistently over time for the
calculation of the PFE for all such instruments;
(iii)(A)(1) The replacement cost of each derivative contract or
single product netting set of derivative contracts to which the FDIC-
supervised institution is a counterparty, calculated according to the
following formula, and, for any counterparty that is not a commercial
end-user, multiplied by 1.4:
Replacement Cost = max{V-CVMr + CVMp; 0{time}
Where:
V equals the fair value for each derivative contract or each netting
set of derivative contracts (including a cleared transaction except
as provided in paragraph (c)(2)(ix) of this section and, at the
discretion of the FDIC-supervised institution, excluding a forward
agreement treated as a derivative contract that is part of a
repurchase or reverse repurchase or a securities borrowing or
lending transaction that qualifies for sales treatment under GAAP);
CVMr equals the amount of cash collateral received from a
counterparty to a derivative contract and that satisfies the
conditions in paragraphs (c)(2)(iii)(B) through (F) of this section,
or, in the case of a client-facing derivative transaction, the
amount of collateral received from the clearing member client; and
CVMp equals the amount of cash collateral that is posted to a
counterparty to a derivative contract and that has not offset the
fair value of the derivative contract and that satisfies the
conditions in paragraphs (c)(2)(iii)(B) through (F) of this section,
or, in the case of a client-facing derivative transaction, the
amount of collateral posted to the clearing member client;
(2) Notwithstanding paragraph (c)(2)(iii)(A)(1) of this section,
where multiple netting sets are subject to a single variation margin
agreement, a FDIC-supervised institution must apply the formula for
replacement cost provided in Sec. 324.113(j)(1), in which the term CMA
may only include cash collateral that satisfies the conditions in
paragraphs (c)(2)(iii)(B) through (F) of this section; and
(3) For purposes of paragraph (c)(2)(iii)(A) of this section, a
FDIC-supervised institution must treat a derivative contract that
references an index as if it were multiple derivative contracts each
referencing one component of the index if the FDIC-supervised
institution elected to treat the derivative contract as multiple
derivative contracts under Sec. 324.113(e)(6);
[[Page 64332]]
(B) For derivative contracts that are not cleared through a QCCP,
the cash collateral received by the recipient counterparty is not
segregated (by law, regulation, or an agreement with the counterparty);
(C) Variation margin is calculated and transferred on a daily basis
based on the mark-to-fair value of the derivative contract;
(D) The variation margin transferred under the derivative contract
or the governing rules of the CCP or QCCP for a cleared transaction is
the full amount that is necessary to fully extinguish the net current
credit exposure to the counterparty of the derivative contracts,
subject to the threshold and minimum transfer amounts applicable to the
counterparty under the terms of the derivative contract or the
governing rules for a cleared transaction;
(E) The variation margin is in the form of cash in the same
currency as the currency of settlement set forth in the derivative
contract, provided that for the purposes of this paragraph
(c)(2)(iii)(E), currency of settlement means any currency for
settlement specified in the governing qualifying master netting
agreement and the credit support annex to the qualifying master netting
agreement, or in the governing rules for a cleared transaction; and
(F) The derivative contract and the variation margin are governed
by a qualifying master netting agreement between the legal entities
that are the counterparties to the derivative contract or by the
governing rules for a cleared transaction, and the qualifying master
netting agreement or the governing rules for a cleared transaction must
explicitly stipulate that the counterparties agree to settle any
payment obligations on a net basis, taking into account any variation
margin received or provided under the contract if a credit event
involving either counterparty occurs;
(iv) The effective notional principal amount (that is, the apparent
or stated notional principal amount multiplied by any multiplier in the
derivative contract) of a credit derivative, or other similar
instrument, through which the FDIC-supervised institution provides
credit protection, provided that:
(A) The FDIC-supervised institution may reduce the effective
notional principal amount of the credit derivative by the amount of any
reduction in the mark-to-fair value of the credit derivative if the
reduction is recognized in common equity tier 1 capital;
(B) The FDIC-supervised institution may reduce the effective
notional principal amount of the credit derivative by the effective
notional principal amount of a purchased credit derivative or other
similar instrument, provided that the remaining maturity of the
purchased credit derivative is equal to or greater than the remaining
maturity of the credit derivative through which the FDIC-supervised
institution provides credit protection and that:
(1) With respect to a credit derivative that references a single
exposure, the reference exposure of the purchased credit derivative is
to the same legal entity and ranks pari passu with, or is junior to,
the reference exposure of the credit derivative through which the FDIC-
supervised institution provides credit protection; or
(2) With respect to a credit derivative that references multiple
exposures, the reference exposures of the purchased credit derivative
are to the same legal entities and rank pari passu with the reference
exposures of the credit derivative through which the FDIC-supervised
institution provides credit protection, and the level of seniority of
the purchased credit derivative ranks pari passu to the level of
seniority of the credit derivative through which the FDIC-supervised
institution provides credit protection;
(3) Where an FDIC-supervised institution has reduced the effective
notional principal amount of a credit derivative through which the
FDIC-supervised institution provides credit protection in accordance
with paragraph (c)(2)(iv)(A) of this section, the FDIC-supervised
institution must also reduce the effective notional principal amount of
a purchased credit derivative used to offset the credit derivative
through which the FDIC-supervised institution provides credit
protection, by the amount of any increase in the mark-to-fair value of
the purchased credit derivative that is recognized in common equity
tier 1 capital; and
(4) Where the FDIC-supervised institution purchases credit
protection through a total return swap and records the net payments
received on a credit derivative through which the FDIC-supervised
institution provides credit protection in net income, but does not
record offsetting deterioration in the mark-to-fair value of the credit
derivative through which the FDIC-supervised institution provides
credit protection in net income (either through reductions in fair
value or by additions to reserves), the FDIC-supervised institution may
not use the purchased credit protection to offset the effective
notional principal amount of the related credit derivative through
which the FDIC-supervised institution provides credit protection;
(v) Where an FDIC-supervised institution acting as a principal has
more than one repo-style transaction with the same counterparty and has
offset the gross value of receivables due from a counterparty under
reverse repurchase transactions by the gross value of payables under
repurchase transactions due to the same counterparty, the gross value
of receivables associated with the repo-style transactions less any on-
balance sheet receivables amount associated with these repo-style
transactions included under paragraph (c)(2)(i) of this section, unless
the following criteria are met:
(A) The offsetting transactions have the same explicit final
settlement date under their governing agreements;
(B) The right to offset the amount owed to the counterparty with
the amount owed by the counterparty is legally enforceable in the
normal course of business and in the event of receivership, insolvency,
liquidation, or similar proceeding; and
(C) Under the governing agreements, the counterparties intend to
settle net, settle simultaneously, or settle according to a process
that is the functional equivalent of net settlement, (that is, the cash
flows of the transactions are equivalent, in effect, to a single net
amount on the settlement date), where both transactions are settled
through the same settlement system, the settlement arrangements are
supported by cash or intraday credit facilities intended to ensure that
settlement of both transactions will occur by the end of the business
day, and the settlement of the underlying securities does not interfere
with the net cash settlement;
(vi) The counterparty credit risk of a repo-style transaction,
including where the FDIC-supervised institution acts as an agent for a
repo-style transaction and indemnifies the customer with respect to the
performance of the customer's counterparty in an amount limited to the
difference between the fair value of the security or cash its customer
has lent and the fair value of the collateral the borrower has
provided, calculated as follows:
(A) If the transaction is not subject to a qualifying master
netting agreement, the counterparty credit risk (E*) for transactions
with a counterparty must be calculated on a transaction by transaction
basis, such that each transaction i is treated as its own netting set,
in accordance with the following formula, where Ei is the
fair value of the instruments, gold, or cash that the FDIC-supervised
institution has lent, sold subject to repurchase, or provided as
[[Page 64333]]
collateral to the counterparty, and Ci is the fair value of
the instruments, gold, or cash that the FDIC-supervised institution has
borrowed, purchased subject to resale, or received as collateral from
the counterparty:
Ei* = max {0, [Ei-Ci]{time} ; and
(B) If the transaction is subject to a qualifying master netting
agreement, the counterparty credit risk (E*) must be calculated as the
greater of zero and the total fair value of the instruments, gold, or
cash that the FDIC-supervised institution has lent, sold subject to
repurchase or provided as collateral to a counterparty for all
transactions included in the qualifying master netting agreement
([Sigma]Ei), less the total fair value of the instruments,
gold, or cash that the FDIC-supervised institution borrowed, purchased
subject to resale or received as collateral from the counterparty for
those transactions ([Sigma]Ci), in accordance with the
following formula:
E* = max {0, [[Sigma]ei- [Sigma]ci]{time}
(vii) If an FDIC-supervised institution acting as an agent for a
repo-style transaction provides a guarantee to a customer of the
security or cash its customer has lent or borrowed with respect to the
performance of the customer's counterparty and the guarantee is not
limited to the difference between the fair value of the security or
cash its customer has lent and the fair value of the collateral the
borrower has provided, the amount of the guarantee that is greater than
the difference between the fair value of the security or cash its
customer has lent and the value of the collateral the borrower has
provided;
(viii) The credit equivalent amount of all off-balance sheet
exposures of the FDIC-supervised institution, excluding repo-style
transactions, repurchase or reverse repurchase or securities borrowing
or lending transactions that qualify for sales treatment under GAAP,
and derivative transactions, determined using the applicable credit
conversion factor under Sec. 324.112(b), provided, however, that the
minimum credit conversion factor that may be assigned to an off-balance
sheet exposure under this paragraph (c)(2)(viii) is 10 percent; and
(ix) For an FDIC-supervised institution that is a clearing member:
(A) A clearing member FDIC-supervised institution that guarantees
the performance of a clearing member client with respect to a cleared
transaction must treat its exposure to the clearing member client as a
derivative contract or repo-style transaction, as applicable, for
purposes of determining its total leverage exposure;
(B) A clearing member FDIC-supervised institution that guarantees
the performance of a CCP with respect to a transaction cleared on
behalf of a clearing member client must treat its exposure to the CCP
as a derivative contract or repo-style transaction, as applicable, for
purposes of determining its total leverage exposure;
(C) A clearing member FDIC-supervised institution that does not
guarantee the performance of a CCP with respect to a transaction
cleared on behalf of a clearing member client may exclude its exposure
to the CCP for purposes of determining its total leverage exposure;
(D) An FDIC-supervised institution that is a clearing member may
exclude from its total leverage exposure the effective notional
principal amount of credit protection sold through a credit derivative
contract, or other similar instrument, that it clears on behalf of a
clearing member client through a CCP as calculated in accordance with
paragraph (c)(2)(iv) of this section; and
(E) Notwithstanding paragraphs (c)(2)(ix)(A) through (C) of this
section, an FDIC-supervised institution may exclude from its total
leverage exposure a clearing member's exposure to a clearing member
client for a derivative contract if the clearing member client and the
clearing member are affiliates and consolidated for financial reporting
purposes on the FDIC-supervised institution's balance sheet.
(x) A custody bank shall exclude from its total leverage exposure
the lesser of:
(A) The amount of funds that the custody bank has on deposit at a
qualifying central bank; and
(B) The amount of funds in deposit accounts at the custody bank
that are linked to fiduciary or custodial and safekeeping accounts at
the custody bank. For purposes of this paragraph (c)(2)(x), a deposit
account is linked to a fiduciary or custodial and safekeeping account
if the deposit account is provided to a client that maintains a
fiduciary or custodial and safekeeping account with the custody bank
and the deposit account is used to facilitate the administration of the
fiduciary or custodial and safekeeping account.
* * * * *
(d) Expanded capital ratio calculations. An FDIC-supervised
institution subject to subpart E of this part must determine its
regulatory capital ratios as described in paragraphs (d)(1) through (3)
of this section.
* * * * *
(3) * * *
(ii) The ratio of the FDIC-supervised institution's expanded risk-
based approach-adjusted total capital to expanded total risk-weighted
assets. An FDIC-supervised institution's expanded risk-based approach-
adjusted total capital is the FDIC-supervised institution's total
capital after being adjusted as follows:
(A) A FDIC-supervised institution subject to subpart E of this part
must deduct from its total capital any AACL included in its tier 2
capital in accordance with Sec. 324.20(d)(3); and
(B) An FDIC-supervised institution subject to subpart E of this
part must add to its total capital any AACL up to 1.25 percent of the
FDIC-supervised institution's total credit risk-weighted assets.
(4) State savings association tangible capital ratio. A state
savings association's tangible capital ratio is the ratio of the state
savings association's core capital (tier 1 capital) to total assets.
For purposes of this paragraph, the term total assets shall have the
meaning provided in 12 CFR 324.401(g).
* * * * *
0
89. In Sec. 324.11:
0
a. In paragraph (b)(1), remove the words ``advanced approaches FDIC-
supervised institution or a Category III FDIC-supervised institution''
and add in their place the words ``FDIC-supervised institution subject
to subpart E of this part'';
0
b. Revise paragraph (b)(1)(iii).
0
c. In paragraph (b)(2)(ii), redesignate footnote 11 as footnote 1; and
The revision reads as follows:
Sec. 324.11 Capital conservation buffer and countercyclical capital
buffer amount.
* * * * *
(b) * * *
(1) * * *
(iii) Weighting. The weight assigned to a jurisdiction's
countercyclical capital buffer amount is calculated by dividing the
total risk-weighted assets for the FDIC-supervised institution's
private sector credit exposures located in the jurisdiction by the
total risk-weighted assets for all of the FDIC-supervised institution's
private sector credit exposures. The methodology an FDIC-supervised
institution uses for determining risk-weighted assets for purposes of
this paragraph (b) must be the methodology that determines its risk-
based capital ratios under Sec. 324.10. Notwithstanding the previous
sentence, the risk-weighted asset amount for a private sector credit
exposure that is a covered position under subpart F of this part is its
standardized default risk
[[Page 64334]]
capital requirement as determined under Sec. 324.210 multiplied by
12.5.
* * * * *
Sec. 324.12 [Amended]
0
90. In Sec. 324.12, remove paragraph (a)(4).
Subpart C--Definition of Capital
0
91. In Sec. 324.20:
0
a. Revise paragraphs (c)(1)(xiv), (d)(1)(xi), and (d)(3); and
0
b. Redesignate footnotes 12 through 23 as footnotes 1 through 12,
respectively;
The revisions read as follows:
Sec. 324.20 Capital components and eligibility criteria for
regulatory capital instruments.
* * * * *
(c) * * *
(1) * * *
(xiv) For an FDIC-supervised institution subject to subpart E of
this part, the governing agreement, offering circular, or prospectus of
an instrument issued after the date upon which the FDIC-supervised
institution becomes subject to subpart E must disclose that the holders
of the instrument may be fully subordinated to interests held by the
U.S. government in the event that the FDIC-supervised institution
enters into a receivership, insolvency, liquidation, or similar
proceeding.
* * * * *
(d) * * *
(1) * * *
(xi) For an FDIC-supervised institution subject to subpart E of
this part, the governing agreement, offering circular, or prospectus of
an instrument issued after the date on which the FDIC-supervised
institution becomes subject to subpart E must disclose that the holders
of the instrument may be fully subordinated to interests held by the
U.S. government in the event that the FDIC-supervised institution
enters into a receivership, insolvency, liquidation, or similar
proceeding.
* * * * *
(3) ALLL or AACL, as applicable, up to 1.25 percent of the FDIC-
supervised institution's standardized total risk-weighted assets not
including any amount of the ALLL or AACL, as applicable (and excluding
the case of a market risk FDIC-supervised institution, its market risk
weighted assets).
* * * * *
0
92. In Sec. 324.21:
0
a. In paragraph (a)(1), remove the words ``an advanced approaches FDIC-
supervised institution'' and add in their place the words ``subject to
subpart E of this part''; and
0
b. Revise paragraph (b).
The revision reads as follows:
Sec. 324.21 Minority interest.
* * * * *
(b) (1) Applicability. For purposes of Sec. 324.20, an FDIC-
supervised institution that is subject to subpart E of this part is
subject to the minority interest limitations in this paragraph (b) if:
(i) A consolidated subsidiary of the FDIC-supervised institution
has issued regulatory capital that is not owned by the FDIC-supervised
institution; and
(ii) For each relevant regulatory capital ratio of the consolidated
subsidiary, the ratio exceeds the sum of the subsidiary's minimum
regulatory capital requirements plus its capital conservation buffer.
(2) Difference in capital adequacy standards at the subsidiary
level. For purposes of the minority interest calculations in this
section, if the consolidated subsidiary issuing the capital is not
subject to capital adequacy standards similar to those of the FDIC-
supervised institution subject to subpart E of this part, the FDIC-
supervised institution subject to subpart E of this part must assume
that the capital adequacy standards of the FDIC-supervised institution
apply to the subsidiary.
(3) Common equity tier 1 minority interest includable in the common
equity tier 1 capital of the FDIC-supervised institution. For each
consolidated subsidiary of an FDIC-supervised institution subject to
subpart E of this part, the amount of common equity tier 1 minority
interest the FDIC-supervised institution may include in common equity
tier 1 capital is equal to:
(i) The common equity tier 1 minority interest of the subsidiary;
minus
(ii) The percentage of the subsidiary's common equity tier 1
capital that is not owned by the FDIC-supervised institution,
multiplied by the difference between the common equity tier 1 capital
of the subsidiary and the lower of:
(A) The amount of common equity tier 1 capital the subsidiary must
hold, or would be required to hold pursuant to this paragraph (b), to
avoid restrictions on distributions and discretionary bonus payments
under Sec. 324.11 or equivalent standards established by the
subsidiary's home country supervisor; or
(B) (1) The standardized total risk-weighted assets of the FDIC-
supervised institution that relate to the subsidiary multiplied by
(2) The common equity tier 1 capital ratio the subsidiary must
maintain to avoid restrictions on distributions and discretionary bonus
payments under Sec. 324.11 or equivalent standards established by the
subsidiary's home country supervisor.
(4) Tier 1 minority interest includable in the tier 1 capital of
the FDIC-supervised institution subject to subpart E of this part. For
each consolidated subsidiary of the FDIC-supervised institution subject
to subpart E of this part, the amount of tier 1 minority interest the
FDIC-supervised institution may include in tier 1 capital is equal to:
(i) The tier 1 minority interest of the subsidiary; minus
(ii) The percentage of the subsidiary's tier 1 capital that is not
owned by the FDIC-supervised institution multiplied by the difference
between the tier 1 capital of the subsidiary and the lower of:
(A) The amount of tier 1 capital the subsidiary must hold, or would
be required to hold pursuant to this paragraph (b), to avoid
restrictions on distributions and discretionary bonus payments under
Sec. 324.11 or equivalent standards established by the subsidiary's
home country supervisor, or
(B) (1) The standardized total risk-weighted assets of the FDIC-
supervised institution that relate to the subsidiary multiplied by
(2) The tier 1 capital ratio the subsidiary must maintain to avoid
restrictions on distributions and discretionary bonus payments under
Sec. 324.11 or equivalent standards established by the subsidiary's
home country supervisor.
(5) Total capital minority interest includable in the total capital
of the FDIC-supervised institution. For each consolidated subsidiary of
the FDIC-supervised institution subject to subpart E of this part, the
amount of total capital minority interest the FDIC-supervised
institution may include in total capital is equal to:
(i) The total capital minority interest of the subsidiary; minus
(ii) The percentage of the subsidiary's total capital that is not
owned by the FDIC-supervised institution multiplied by the difference
between the total capital of the subsidiary and the lower of:
(A) The amount of total capital the subsidiary must hold, or would
be required to hold pursuant to this paragraph (b), to avoid
restrictions on distributions and discretionary bonus payments under
Sec. 324.11 or equivalent standards established by the subsidiary's
home country supervisor, or
(B) (1) The standardized total risk-weighted assets of the FDIC-
supervised
[[Page 64335]]
institution that relate to the subsidiary multiplied by
(2) The total capital ratio the subsidiary must maintain to avoid
restrictions on distributions and discretionary bonus payments under
Sec. 324.11 or equivalent standards established by the subsidiary's
home country supervisor.
0
93. In Sec. 324.22:
0
a. Redesignate footnotes 22 through 31 as footnotes 1 through 10,
respectively;
0
b. Revise paragraph (a)(4), and remove and reserve paragraph (a)(6);
0
c. Revise paragraph (b)(1)(ii);
0
d. In paragraph (b)(2)(i), remove the words ``an advanced approaches
FDIC-supervised institution'' and add, in their place, the words
``subject to subpart E of this part'';
0
e. Revise paragraphs (b)(2)(ii), (b)(2)(iii), and (b)(2)(iv)
introductory text, and (c)(2) introductory text;
0
f. In paragraph (c)(4), remove the words ``an advanced approaches FDIC-
supervised institution'' and add in their place the words ``subject to
subpart E of this part''; and
0
e. Revise paragraphs (c)(5)(i) and (ii), (c)(6), (d)(1) introductory
text, (d)(2), and (f),
The revisions read as follows:
Sec. 324.22 Regulatory capital adjustments and deductions.
* * * * *
(a) * * *
(4) (i) For an FDIC-supervised institution that is not subject to
subpart E of this part, any gain-on-sale in connection with a
securitization exposure;
(ii) For an FDIC-supervised institution subject to subpart E of
this part, any gain-on-sale in connection with a securitization
exposure and the portion of any CEIO that does not constitute an after-
tax gain-on-sale;
* * * * *
(b) * * *
(1) * * *
(ii) An FDIC-supervised institution that is subject to subpart E of
this part, and a FDIC-supervised institution that has not made an AOCI
opt-out election (as defined in paragraph (b)(2) of this section), must
deduct any accumulated net gains and add any accumulated net losses on
cash flow hedges included in AOCI that relate to the hedging of items
that are not recognized at fair value on the balance sheet.
* * * * *
(2) * * *
(i) An FDIC-supervised institution that is not subject to subpart E
of this part may make a one-time election to opt out of the requirement
to include all components of AOCI (with the exception of accumulated
net gains and losses on cash flow hedges related to items that are not
fair-valued on the balance sheet) in common equity tier 1 capital (AOCI
opt-out election). An FDIC-supervised institution that makes an AOCI
opt-out election in accordance with this paragraph (b)(2) must adjust
common equity tier 1 capital as follows:
* * * * *
(ii) An FDIC-supervised institution that is not subject to subpart
E of this part must make its AOCI opt-out election in the Call Report
during the first reporting period after the FDIC-supervised institution
is required to comply with subpart A of this part. If the FDIC-
supervised institution was previously subject to subpart E of this
part, the FDIC-supervised institution must make its AOCI opt-out
election in the Call Report during the first reporting period after the
FDIC-supervised institution is not subject to subpart E of this part.
(iii) With respect to an FDIC-supervised institution that is not
subject to subpart E of this part, each of its subsidiary banking
organizations that is subject to regulatory capital requirements issued
by the Federal Reserve, the FDIC, or the OCC \1\ must elect the same
option as the FDIC-supervised institution pursuant to this paragraph
(b)(2).
(iv) With prior notice to the FDIC, an FDIC-supervised institution
resulting from a merger, acquisition, or purchase transaction that is
not subject to subpart E of this part may change its AOCI opt-out
election in its Call Report filed for the first reporting period after
the date required for such FDIC-supervised institution to comply with
subpart A of this part as set forth in Sec. 324.1(f) if:
* * * * *
(c) * * *
(2) Corresponding deduction approach. For purposes of subpart C of
this part, the corresponding deduction approach is the methodology used
for the deductions from regulatory capital related to reciprocal cross
holdings (as described in paragraph (c)(3) of this section),
investments in the capital of unconsolidated financial institutions for
an FDIC-supervised institution that is not subject to subpart E of this
part (as described in paragraph (c)(4) of this section), non-
significant investments in the capital of unconsolidated financial
institutions for an FDIC-supervised institution subject to subpart E of
this part (as described in paragraph (c)(5) of this section), and non-
common stock significant investments in the capital of unconsolidated
financial institutions for an FDIC-supervised institution subject to
subpart E of this part (as described in paragraph (c)(6) of this
section). Under the corresponding deduction approach, an FDIC-
supervised institution must make deductions from the component of
capital for which the underlying instrument would qualify if it were
issued by the FDIC-supervised institution itself, as described in
paragraphs (c)(2)(i) through (iii) of this section. If the FDIC-
supervised institution does not have a sufficient amount of a specific
component of capital to effect the required deduction, the shortfall
must be deducted according to paragraph (f) of this section.
* * * * *
(5) * * *
(i) An FDIC-supervised institution subject to subpart E of this
part must deduct its non-significant investments in the capital of
unconsolidated financial institutions (as defined in Sec. 324.2) that,
in the aggregate and together with any investment in a covered debt
instrument (as defined in Sec. 324.2) issued by a financial
institution in which the FDIC-supervised institution does not have a
significant investment in the capital of the unconsolidated financial
institution (as defined in Sec. 324.2), exceeds 10 percent of the sum
of the FDIC-supervised institution's common equity tier 1 capital
elements minus all deductions from and adjustments to common equity
tier 1 capital elements required under paragraphs (a) through (c)(3) of
this section (the 10 percent threshold for non-significant investments)
by applying the corresponding deduction approach in paragraph (c)(2) of
this section.\5\ The deductions described in this paragraph are net of
associated DTLs in accordance with paragraph (e) of this section. In
addition, with the prior written approval of the FDIC, an FDIC-
supervised institution subject to subpart E of this part that
underwrites a failed underwriting, for the period of time stipulated by
the FDIC, is not required to deduct from capital a non-significant
investment in the capital of an unconsolidated financial institution or
an investment in a covered debt instrument pursuant to this paragraph
(c)(5) to the extent the investment is related to the failed
underwriting.\6\ For any calculation under this paragraph (c)(5)(i), an
FDIC-supervised institution subject to subpart E of this part may
exclude the amount of an investment in a covered debt instrument under
paragraph (c)(5)(iii) or (iv) of this section, as applicable.
(ii) For an FDIC-supervised institution subject to subpart E of
this part, the
[[Page 64336]]
amount to be deducted under this paragraph (c)(5) from a specific
capital component is equal to:
(A) The FDIC-supervised institution's aggregate non-significant
investments in the capital of an unconsolidated financial institution
and, if applicable, any investments in a covered debt instrument
subject to deduction under this paragraph (c)(5), exceeding the 10
percent threshold for non-significant investments, multiplied by
(B) The ratio of the FDIC-supervised institution's aggregate non-
significant investments in the capital of an unconsolidated financial
institution (in the form of such capital component) to the FDIC-
supervised institution's total non-significant investments in
unconsolidated financial institutions, with an investment in a covered
debt instrument being treated as tier 2 capital for this purpose.
* * * * *
(6) Significant investments in the capital of unconsolidated
financial institutions that are not in the form of common stock. If an
FDIC-supervised institution subject to subpart E of this part has a
significant investment in the capital of an unconsolidated financial
institution, the FDIC-supervised institution must deduct from capital
any such investment issued by the unconsolidated financial institution
that is held by the FDIC-supervised institution other than an
investment in the form of common stock, as well as any investment in a
covered debt instrument issued by the unconsolidated financial
institution, by applying the corresponding deduction approach in
paragraph (c)(2) of this section.\7\ The deductions described in this
section are net of associated DTLs in accordance with paragraph (e) of
this section. In addition, with the prior written approval of the FDIC,
for the period of time stipulated by the FDIC, an FDIC-supervised
institution subject to subpart E of this part that underwrites a failed
underwriting is not required to deduct the significant investment in
the capital of an unconsolidated financial institution or an investment
in a covered debt instrument pursuant to this paragraph (c)(6) if such
investment is related to such failed underwriting.
(d) * * *
(1) An FDIC-supervised institution that is not subject to subpart E
of this part must make deductions from regulatory capital as described
in this paragraph (d)(1).
* * * * *
(2) An FDIC-supervised institution subject to subpart E of this
part must make deductions from regulatory capital as described in this
paragraph (d)(2).
(i) An FDIC-supervised institution subject to subpart E of this
part must deduct from common equity tier 1 capital elements the amount
of each of the items set forth in this paragraph (d)(2) that,
individually, exceeds 10 percent of the sum of the FDIC-supervised
institution's common equity tier 1 capital elements, less adjustments
to and deductions from common equity tier 1 capital required under
paragraphs (a) through (c) of this section (the 10 percent common
equity tier 1 capital deduction threshold).
(A) DTAs arising from temporary differences that the FDIC-
supervised institution could not realize through net operating loss
carrybacks, net of any related valuation allowances and net of DTLs, in
accordance with paragraph (e) of this section. An FDIC-supervised
institution subject to subpart E of this part is not required to deduct
from the sum of its common equity tier 1 capital elements DTAs (net of
any related valuation allowances and net of DTLs, in accordance with
Sec. 324.22(e)) arising from timing differences that the FDIC-
supervised institution could realize through net operating loss
carrybacks. The FDIC-supervised institution must risk weight these
assets at 100 percent. For an FDIC-supervised institution that is a
member of a consolidated group for tax purposes, the amount of DTAs
that could be realized through net operating loss carrybacks may not
exceed the amount that the FDIC-supervised institution could reasonably
expect to have refunded by its parent holding company.
(B) MSAs net of associated DTLs, in accordance with paragraph (e)
of this section.
(C) Significant investments in the capital of unconsolidated
financial institutions in the form of common stock, net of associated
DTLs in accordance with paragraph (e) of this section.\9\ Significant
investments in the capital of unconsolidated financial institutions in
the form of common stock subject to the 10 percent common equity tier 1
capital deduction threshold may be reduced by any goodwill embedded in
the valuation of such investments deducted by the FDIC-supervised
institution pursuant to paragraph (a)(1) of this section. In addition,
with the prior written approval of the FDIC, for the period of time
stipulated by the FDIC, an FDIC-supervised institution subject to
subpart E of this part that underwrites a failed underwriting is not
required to deduct a significant investment in the capital of an
unconsolidated financial institution in the form of common stock
pursuant to this paragraph (d)(2) if such investment is related to such
failed underwriting.
(ii) A FDIC-supervised institution subject to subpart E of this
part must deduct from common equity tier 1 capital elements the items
listed in paragraph (d)(2)(i) of this section that are not deducted as
a result of the application of the 10 percent common equity tier 1
capital deduction threshold, and that, in aggregate, exceed 17.65
percent of the sum of the FDIC-supervised institution's common equity
tier 1 capital elements, minus adjustments to and deductions from
common equity tier 1 capital required under paragraphs (a) through (c)
of this section, minus the items listed in paragraph (d)(2)(i) of this
section (the 15 percent common equity tier 1 capital deduction
threshold). Any goodwill that has been deducted under paragraph (a)(1)
of this section can be excluded from the significant investments in the
capital of unconsolidated financial institutions in the form of common
stock.\10\
(iii) For purposes of calculating the amount of DTAs subject to the
10 and 15 percent common equity tier 1 capital deduction thresholds, a
FDIC-supervised institution subject to subpart E of this part may
exclude DTAs and DTLs relating to adjustments made to common equity
tier 1 capital under paragraph (b) of this section. A FDIC-supervised
institution subject to subpart E of this part that elects to exclude
DTAs relating to adjustments under paragraph (b) of this section also
must exclude DTLs and must do so consistently in all future
calculations. A FDIC-supervised institution subject to subpart E of
this part may change its exclusion preference only after obtaining the
prior approval of the FDIC.
* * * * *
(f) Insufficient amounts of a specific regulatory capital component
to effect deductions. Under the corresponding deduction approach, if a
FDIC-supervised institution does not have a sufficient amount of a
specific component of capital to effect the full amount of any
deduction from capital required under paragraph (d) of this section,
the FDIC-supervised institution must deduct the shortfall amount from
the next higher (that is, more subordinated) component of regulatory
capital. Any investment by a FDIC-supervised institution subject to
subpart E of this part in a covered debt instrument must be treated as
an investment in the tier 2 capital for
[[Page 64337]]
purposes of this paragraph (f). Notwithstanding any other provision of
this section, a qualifying community banking organization (as defined
in Sec. 324.12) that has elected to use the community bank leverage
ratio framework pursuant to Sec. 324.12 is not required to deduct any
shortfall of tier 2 capital from its additional tier 1 capital or
common equity tier 1 capital.
* * * * *
\1\ These rules include the regulatory capital requirements set
forth at 12 CFR part 3 (OCC); 12 CFR part 217 (Board); 12 CFR part
324 (FDIC).
* * * * *
\5\ With the prior written approval of the FDIC, for the period
of time stipulated by the FDIC, an FDIC-supervised institution
subject to subpart E of this part is not required to deduct a non-
significant investment in the capital of an unconsolidated financial
institution or an investment in a covered debt instrument pursuant
to this paragraph if the financial institution is in distress and if
such investment is made for the purpose of providing financial
support to the financial institution, as determined by the FDIC.
\6\ Any non-significant investment in the capital of an
unconsolidated financial institution or any investment in a covered
debt instrument that is not required to be deducted under this
paragraph (c)(5) or otherwise under this section must be assigned
the appropriate risk weight under subparts D, E, or F of this part,
as applicable.
\7\ With prior written approval of the FDIC, for the period of
time stipulated by the FDIC, an FDIC-supervised institution subject
to subpart E of this part is not required to deduct a significant
investment in the capital of an unconsolidated financial
institution, including an investment in a covered debt instrument,
under this paragraph (c)(6) or otherwise under this section if such
investment is made for the purpose of providing financial support to
the financial institution as determined by the FDIC.
* * * * *
\9\ With the prior written approval of the FDIC, for the period
of time stipulated by the FDIC, an FDIC-supervised institution
subject to subpart E of this part is not required to deduct a
significant investment in the capital instrument of an
unconsolidated financial institution in distress in the form of
common stock pursuant to this section if such investment is made for
the purpose of providing financial support to the financial
institution as determined by the FDIC.
\10\ The amount of the items in paragraph (d)(2) of this section
that is not deducted from common equity tier 1 capital pursuant to
this section must be included in the risk-weighted assets of the
FDIC-supervised institution subject to subpart E of this part and
assigned a 250 percent risk weight for purposes of standardized
total risk-weighted assets and assigned the appropriate risk weight
for the investment under subpart E of this part for purposes of
expanded total risk-weighted assets.
Subpart D--Risk-Weighted Assets--Standardized Approach
Sec. 324.30 [Amended]
0
94. In Sec. 324.30, in paragraph (b), remove the words ``covered
positions'' and add in their place the words ``market risk covered
positions''.
0
95. In Sec. 324.34, revise paragraph (a) to read as follows:
Sec. 324.34 Derivative contracts.
(a) Exposure amount for derivative contracts--(1) An FDIC-
supervised institution not subject to subpart E of this part. (i) An
FDIC-supervised institution that is not subject to subpart E of this
part must use the current exposure methodology (CEM) described in
paragraph (b) of this section to calculate the exposure amount for all
its OTC derivative contracts, unless the FDIC-supervised institution
makes the election provided in paragraph (a)(1)(ii) of this section.
(ii) An FDIC-supervised institution that is not subject to subpart
E of this part may elect to calculate the exposure amount for all its
OTC derivative contracts under the standardized approach for
counterparty credit risk (SA-CCR) in Sec. 324.113 by notifying the
FDIC, rather than calculating the exposure amount for all its
derivative contracts using CEM. An FDIC-supervised institution that
elects under this paragraph (a)(1)(ii) to calculate the exposure amount
for its OTC derivative contracts under SA-CCR must apply the treatment
of cleared transactions under Sec. 324.114 to its derivative contracts
that are cleared transactions and to all default fund contributions
associated with such derivative contracts, rather than applying Sec.
324.35. An FDIC-supervised institution that is not subject to subpart E
of this part must use the same methodology to calculate the exposure
amount for all its derivative contracts and, if an FDIC-supervised
institution has elected to use SA-CCR under this paragraph (a)(1)(ii),
the FDIC-supervised institution may change its election only with prior
approval of the FDIC.
(2) An FDIC-supervised institution subject to subpart E of this
part. An FDIC-supervised institution that is subject to subpart E of
this part must calculate the exposure amount for all its derivative
contracts using SA-CCR in Sec. 324.113 for purposes of standardized
total risk-weighted assets. An FDIC-supervised institution subject to
subpart E of this part must apply the treatment of cleared transactions
under Sec. 324.114 to its derivative contracts that are cleared
transactions and to all default fund contributions associated with such
derivative contracts for purposes of standardized total risk-weighted
assets.
* * * * *
0
96. In Sec. 324.35, revise paragraph (a)(3) to read as follows:
Sec. 324.35 Cleared transactions.
(a) * * *
(3) Alternate requirements. Notwithstanding any other provision of
this section, an FDIC-supervised institution that is subject to subpart
E of this part or an FDIC-supervised institution that is not subject to
subpart E of this part and that has elected to use SA-CCR under Sec.
324.34(a)(1) must apply Sec. 324.114 to its derivative contracts that
are cleared transactions rather than this section.
0
97. In Sec. 324.37, revise paragraph (c)(1) to read as follows:
Sec. 324.37 Collateralized transactions.
* * * * *
(c) Collateral haircut approach--(1) General. An FDIC-supervised
institution may recognize the credit risk mitigation benefits of
financial collateral that secures an eligible margin loan, repo-style
transaction, collateralized derivative contract, or single-product
netting set of such transactions, and of any collateral that secures a
repo-style transaction that is included in the FDIC-supervised
institution's measure for market risk under subpart F of this part by
using the collateral haircut approach in this section. An FDIC-
supervised institution may use the standard supervisory haircuts in
paragraph (c)(3) of this section or, with prior written approval of the
FDIC, its own estimates of haircuts according to paragraph (c)(4) of
this section.
* * * * *
Sec. 324.61 [Amended]
0
98. In Sec. 324.61:
0
a. Remove the citation ``Sec. 324.172'' wherever it appears, and add
in its place the citations ``Sec. Sec. 324.160 and 324.161''; and
0
b. Remove the sentence ``An advanced approaches FDIC-supervised
institution that has not received approval from the FDIC to exit
parallel run pursuant to Sec. 324.121(d) is subject to the disclosure
requirements described in Sec. Sec. 324.62 and 324.63.''.
0
99. In Sec. 324.63:
0
a. In table 3, revise entry (c); and
0
b. Remove paragraphs (d) and (e).
The revision reads as follows:
Sec. 324.63 Disclosures by FDIC-supervised institutions described in
Sec. 324.61.
* * * * *
[[Page 64338]]
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* * * * *
Subpart E--Risk-Weighted Assets--Expanded Risk-Based Approach
0
100. In Sec. 324.100, revise paragraph (b)(1) to read as follows:
Sec. 324.100 Purpose and applicability.
* * * * *
(b) * * *
(1) This subpart applies to any FDIC-supervised institution that is
a subsidiary of a global systemically important BHC or a Category II
FDIC-supervised institution, a Category III FDIC-supervised
institution, or a Category IV FDIC-supervised institution, as defined
in Sec. 324.2.
* * * * *
Sec. 324.111 [Amended]
0
101. In Sec. 324.111:
0
a. Remove paragraph (j)(1)(i) and redesignate paragraph (j)(1)(ii) as
paragraph (j)(1); and
0
b. Remove paragraphs (k).
0
102. In Sec. 324.132, revise paragraphs (h)(1)(iv) and (h)(4)(i) to
read as follows:
Sec. 324.132 Risk-weighted assets for securitization exposures.
* * * * *
(h) * * *
(1) * * *
(iv) The FDIC-supervised institution is well capitalized, as
defined in subpart H of this part. For purposes of determining whether
a FDIC-supervised institution is well capitalized for purposes of this
paragraph (h), the FDIC-supervised institution's capital ratios must be
calculated without regard to the capital treatment for transfers of
small-business obligations with recourse specified in paragraph (h)(1)
of this section.
* * * * *
(4) * * *
(i) Determining whether a FDIC-supervised institution is adequately
capitalized, undercapitalized, significantly undercapitalized, or
critically undercapitalized under subpart H of this part; and
* * * * *
0
103. In Sec. 324.162, revise paragraph (c) as follows:
Sec. 324.162 Mechanics of risk-weighted asset calculation.
* * * * *
(c) Regulatory capital instrument and other instruments eligible
for total loss absorbing capacity (TLAC) disclosures. A FDIC-supersvied
institution described in Sec. 324.160 must provide a description of
the main features of its regulatory capital instruments, in accordance
with table 15 to paragraph (c). If the FDIC-supervised institution
issues or repays a capital instrument, or in the event of a redemption,
conversion, write down, or other material change in the nature of an
existing instrument, but in no event less frequently than semiannually,
the FDIC-supervised institution must update the disclosures provided in
accordance with table 15 to paragraph (c). A FDIC-supervised
institution also must disclose the full terms and conditions of all
instruments included in regulatory capital.
BILLING CODE 6210-01-P; 6714-01-P; 4810-33-P
[[Page 64339]]
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[[Page 64340]]
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BILLING CODE 6210-01-C; 6714-01-C; 4810-33-C
Subpart F--Risk-Weighted Assets--Market Risk and Credit Valuation
Adjustment (CVA)
0
104. In Sec. 324.201:
0
a. Revise paragraphs (b)(1)(i), (b)(2), and (b)(5)(i); and
0
b. In paragraph (c)(6), remove the citations ``12 CFR 3.404, 12 CFR
263.202,''.
The revisions are as follows:
Sec. 324.201 Purpose, applicability, and reservation of authority.
* * * * *
(b) * * *
(1) * * *
(i) The FDIC-supervised institution is:
(A) A Category II FDIC-supervised institution, a Category III FDIC-
supervised institution or a Category IV FDIC-supervised institution;
(B) A subsidiary of a global systemically important BHC; or
* * * * *
(2) CVA Risk. The CVA risk-based capital requirements specified in
Sec. 324.220 through Sec. 324.225 apply to any FDIC-supervised
institution that is a subsidiary of a global systemically important
BHC, a Category II FDIC-supervised institution, a Category III FDIC-
supervised institution, or a Category IV FDIC-supervised institution.
* * * * *
(5) * * *
(i) An FDIC-supervised institution that meets at least one of the
standards in paragraph (b)(1) of this section shall remain subject to
the relevant requirements of this subpart F unless and until it does
not meet any of the standards in paragraph (b)(1)(ii) of this section
for each of four consecutive quarters as reported in the FDIC-
supervised institution's Call Report, and it is not a subsidiary of a
global systemically important BHC, a Category II FDIC-supervised
institution, a Category III FDIC-supervised institution, or Category IV
FDIC-supervised institution, and the FDIC-supervised institution
provides notice to the FDIC.
* * * * *
0
105. In Sec. 324.202, revise the definition for ``Prime RMBS'' to read
as follows:
Sec. 324.202 Definitions.
* * * * *
Prime RMBS means a security that references underlying exposures
that consist primarily of qualified residential mortgages as defined
under Sec. 373.13(a) of this subchapter.
* * * * *
Subpart G--Transition Provisions
0
106. In Sec. 324.300:
0
a. Revise paragraph (a);
0
b. Add paragraph (b);
0
c. Remove paragraphs (c) and (d);
0
d. Redesignate paragraph (e) as new paragraph (c); and
0
e. Remove paragraphs (f) through (h).
The revision and addition read as follows:
Sec. 324.300 Transitions.
(a) Transition adjustments for AOCI. Beginning July 1, 2025, a
Category III FDIC-supervised institution or a Category IV FDIC-
supervised institution must subtract from the sum of its common equity
tier 1 elements, before making deductions required under Sec.
324.22(c) or (d), the AOCI adjustment amount multiplied by the
percentage provided in Table 1 to Sec. 324.300.
The transition AOCI adjustment amount is the sum of:
(1) Net unrealized gains or losses on available-for-sale debt
securities, plus
(2) Accumulated net gains or losses on cash flow hedges, plus
(3) Any amounts recorded in AOCI attributed to defined benefit
postretirement plans resulting from the initial and subsequent
application of the relevant GAAP standards that pertain to such plans,
plus
[[Page 64341]]
(4) Net unrealized holding gains or losses on held-to-maturity
securities that are included in AOCI.
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(b) Expanded total risk-weighted assets. Beginning July 1, 2025, an
FDIC-supervised institution subject to subpart E of this part must
comply with the requirements of subpart B of this part using transition
expanded total risk-weighted assets as calculated under this paragraph
in place of expanded total risk-weighted assets. Transition expanded
total risk-weighted assets is an FDIC-supervised institution's expanded
total risk-weighted assets multiplied by the percentage provided in
Table 2 to Sec. 324.300.
[GRAPHIC] [TIFF OMITTED] TP18SE23.195
* * * * *
0
107. In Sec. 324.301:
0
a. Remove paragraph (b)(5);
0
b. Revise paragraph (c)(2);
0
c. Revise paragraph (d)(2)(ii); and
0
d. Remove and reserve paragraph (e).
The revisions read as follows:
Sec. 324.301 Current expected credit losses (CECL) transition.
* * * * *
(c) * * *
(2) For purposes of the election described in paragraph (a)(1) of
this section, an FDIC-supervised institution subject to subpart E of
this part must increase total leverage exposure for purposes of the
supplementary leverage ratio by seventy-five percent of its CECL
transitional amount during the first year of the transition period,
increase total leverage exposure for purposes of the supplementary
leverage ratio by fifty percent of its CECL transitional amount during
the second year of the transition period, and increase total leverage
exposure for purposes of the supplementary leverage ratio by twenty-
five percent of its CECL transitional amount during the third year of
the transition period.
(d) * * *
(2) * * *
(ii) An FDIC-supervised institution subject to subpart E of this
part that has elected the 2020 CECL transition provision described in
this paragraph (d) may increase total leverage exposure for purposes of
the supplementary leverage ratio by one-hundred percent of its modified
CECL transitional amount during the first year of the transition
period, increase total leverage exposure for purposes of the
supplementary leverage ratio by one hundred percent of its modified
CECL transitional amount during the second year of the transition
period, increase total leverage exposure for purposes of the
supplementary leverage ratio by seventy-five percent of its modified
CECL transitional amount during the third year of the transition
period, increase total leverage exposure for purposes of the
supplementary leverage ratio by fifty percent of its modified CECL
transitional amount during the fourth year of the transition period,
and increase total leverage exposure for purposes of the supplementary
leverage ratio by twenty-five percent of its modified CECL transitional
amount during the fifth year of the transition period.
* * * * *
Sec. 324.303 [Removed and Reserved]
0
108. Remove and reserve Sec. 324.303.
Sec. 324.304 [Removed and Reserved]
0
109. Remove and reserve Sec. 324.304.
Subpart H--Prompt Corrective Action
0
110. In Sec. 324.401:
[[Page 64342]]
0
a. Revise paragraph (c);
0
b. Remove and reserve paragraph (f); and
0
c. Revise paragraph (g).
The revisions read as follows:
Sec. 324.401 Authority, purpose, scope, other supervisory authority,
disclosure of capital categories, and transition procedures.
* * * * *
(c) Scope. This subpart H implements the provisions of section 38
of the FDI Act as they apply to FDIC-supervised institutions and
insured branches of foreign banks for which the FDIC is the appropriate
Federal banking agency. Certain of these provisions also apply to
officers, directors and employees of those insured institutions. In
addition, certain provisions of this subpart apply to all insured
depository institutions that are deemed critically undercapitalized.
* * * * *
(g) For purposes of subpart H, total assets means quarterly average
total assets as reported in an FDIC-supervised institution's Call
Report, minus amounts deducted from tier 1 capital under Sec.
324.22(a), (c), and (d). At its discretion, the FDIC may calculate
total assets using an FDIC-supervised institution's period-end assets
rather than quarterly average assets.
0
111. Amend Sec. 324.403, by revising paragraphs (a)(1)(iv)(B),
(b)(2)(vi), and (b)(3)(v) to read as follows:
Sec. 324.403 Capital measures and capital category definitions.
(a) * * *
(1) * * *
(iv) * * *
(B) With respect to an FDIC-supervised institution subject to
subpart E of this part, the supplementary leverage ratio.
* * * * *
(b) * * *
(2) * * *
(vi) An FDIC-supervised institution subject to subpart E of this
part will be deemed to be ``adequately capitalized'' if it satisfies
paragraphs (b)(2)(i) through (v) of this section and has a
supplementary leverage ratio of 3.0 percent or greater, as calculated
in accordance with Sec. 324.10.
(3) * * *
(v) An FDIC-supervised institution subject to subpart E of this
part will be deemed to be ``undercapitalized'' if it has a
supplementary leverage ratio of less than 3.0 percent, as calculated in
accordance with Sec. 324.10.
* * * * *
Sec. Sec. 324.1, 324.2, 324.10, 324.12, 324.22, 324.61, 324.302,
324.305 [Amended]
0
112. In the table below, for each section indicated in the left column,
remove the words indicated in the middle column from wherever it
appears in the section, and add the words indicated in the right
column:
BILLING CODE 6210-01-P; 6714-01-P; 4810-33-P
[[Page 64343]]
[GRAPHIC] [TIFF OMITTED] TP18SE23.196
Michael J. Hsu,
Acting Comptroller of the Currency.
By order of the Board of Governors of the Federal Reserve
System.
Ann E. Misback,
Secretary of the Board.
Federal Deposit Insurance Corporation.
By order of the Board of Directors.
Dated at Washington, DC, on July 27, 2023.
James P. Sheesley,
Assistant Executive Secretary.
[FR Doc. 2023-19200 Filed 9-1-23; 8:45 am]
BILLING CODE 6210-01-C; 6714-01-C; 4810-33-C
