[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





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Office of the Comptroller of the Currency





12 CFR Parts 3, 6, 32, et al.





Federal Reserve System





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Federal Deposit Insurance Corporation





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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.

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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.
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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.
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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.
---------------------------------------------------------------------------

    \20\ See ``Prudential Standards for Large Bank Holding 
Companies, Savings and Loan Holding Companies, and Foreign Banking 
Organizations,'' 84 FR 59032 (November 1, 2019).
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \25\ See 85 FR 15576 (March 18, 2020).
    \26\ 12 CFR 225.8(f)(2); 12 CFR 238.170(f)(2).
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    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).
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \89\ See 12 CFR part 1026.
---------------------------------------------------------------------------

    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).
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

    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).
---------------------------------------------------------------------------

    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).
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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).
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \112\ See 12 CFR 3.2, 217.2, and 324.2 for the definition of 
financial collateral.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \132\ The proposal generally would use the same approaches to 
determine the exposure amount of securitization exposures.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

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).
---------------------------------------------------------------------------

    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).
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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).
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \158\ Equity exposures, including preferred stock exposures, to 
the FHLBs and Farmer Mac would continue to receive a 20 percent risk 
weight.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \166\ While not done explicitly, the full look-through approach 
under the current capital rule does capture the leverage of an 
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 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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

 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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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
---------------------------------------------------------------------------

    \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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    [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.
---------------------------------------------------------------------------

    \175\ See 12 CFR 3.101 (OCC), 217.101 (Board), and 12 CFR 
324.101 (FDIC).
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

     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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

     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.
---------------------------------------------------------------------------

     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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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
---------------------------------------------------------------------------

    \188\ Trading revenue would correspond to trading revenue in the 
FR Y-9C (holding companies) and Call Report.
---------------------------------------------------------------------------

     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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

 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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    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:
---------------------------------------------------------------------------

    \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\
---------------------------------------------------------------------------

    \199\ In contrast, the business indicator includes only three 
years of financial statement data, which should be readily 
available.
---------------------------------------------------------------------------

    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).
---------------------------------------------------------------------------

    \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.''
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \209\ See Table 5 to Sec.  3.173 (OCC); Sec.  217.173 (Board); 
Sec.  324.173 (FDIC)--Credit Risk--General Disclosures.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \213\ See Table 9 to Sec.  3.173 (OCC); Sec.  217.173 (Board); 
Sec.  324.173 (FDIC)--Securitization.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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).
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \235\ See 84 FR 59230, 59249 (November 1, 2019).
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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).
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \237\ See 84 FR 59230, 59249 (November 1, 2019).
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

    \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).
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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).
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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).
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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).
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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).
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \286\ The process should include evaluation of empirical 
evidence supporting the methodologies used and evidence of a model's 
strengths and weaknesses.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
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    \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.
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    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\
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    \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 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.
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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\
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    \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\
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    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \338\ The other sector risk bucket refers to bucket 25 in Table 
7 to Sec.  __.209 of the proposed rule.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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).
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    \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\
---------------------------------------------------------------------------

    \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\
---------------------------------------------------------------------------

    \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).
---------------------------------------------------------------------------

    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).
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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).
---------------------------------------------------------------------------

    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).
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \383\ Sec.  __.213(c) of the proposed rule describes trading 
desk-level profit and loss attribution test requirements.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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).
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    \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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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:
---------------------------------------------------------------------------

    \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.

---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------

    \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.
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    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.
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    \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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    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.
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    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.
---------------------------------------------------------------------------

    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).
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    \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).
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
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    \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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    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:
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    \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\
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    \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.

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[[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.
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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.
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    \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.
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    \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.
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    \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.
---------------------------------------------------------------------------

    \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).
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    \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\
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    \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.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

    \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).
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \477\ See 78 FR 62018 (October 11, 2013).
    \478\ See 82 FR 42882 (September 12, 2017).
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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).
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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:
---------------------------------------------------------------------------

    \506\ Public Law 106-102, section 722, 113 Stat. 1338, 1471 
(1999).
---------------------------------------------------------------------------

     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\
---------------------------------------------------------------------------

    \507\ 12 U.S.C. 4802(a).
    \508\ 12 U.S.C. 4802.
---------------------------------------------------------------------------

    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.
[GRAPHIC] [TIFF OMITTED] TP18SE23.055

    (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]]

[GRAPHIC] [TIFF OMITTED] TP18SE23.056

    (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
[GRAPHIC] [TIFF OMITTED] TP18SE23.057


[[Page 64190]]


[GRAPHIC] [TIFF OMITTED] TP18SE23.058

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
[GRAPHIC] [TIFF OMITTED] TP18SE23.059


[[Page 64191]]


[GRAPHIC] [TIFF OMITTED] TP18SE23.060

    (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.
[GRAPHIC] [TIFF OMITTED] TP18SE23.061

[GRAPHIC] [TIFF OMITTED] TP18SE23.062

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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[GRAPHIC] [TIFF OMITTED] TP18SE23.090

    (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.

[[Page 64227]]

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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]]

[GRAPHIC] [TIFF OMITTED] TP18SE23.118

    (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.
BILLING CODE 6210-01-P; 6714-01-P; 4810-33-P
[GRAPHIC] [TIFF OMITTED] TP18SE23.119


[[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]]

[GRAPHIC] [TIFF OMITTED] TP18SE23.120

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.
BILLING CODE 6210-01-P; 6714-01-P; 4810-33-P
[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]]

[GRAPHIC] [TIFF OMITTED] TP18SE23.123

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.
BILLING CODE 6210-01-P; 6714-01-P; 4810-33-P
[GRAPHIC] [TIFF OMITTED] TP18SE23.125

    (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]]

[GRAPHIC] [TIFF OMITTED] TP18SE23.126

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.
BILLING CODE 6210-01-P; 6714-01-P; 4810-33-P

[[Page 64257]]

[GRAPHIC] [TIFF OMITTED] TP18SE23.127

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,
[GRAPHIC] [TIFF OMITTED] TP18SE23.128

    (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]]

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* * * * *

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