[Federal Register Volume 91, Number 59 (Friday, March 27, 2026)]
[Proposed Rules]
[Pages 14952-15329]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2026-05959]
[[Page 14951]]
Vol. 91
Friday,
No. 59
March 27, 2026
Part III
Department of the Treasury
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Office of the Comptroller of the Currency
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12 CFR Parts 3, 6, and 32
Federal Reserve System
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12 CFR Parts 208, 217, et al.
Federal Deposit Insurance Corporation
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12 CFR Part 324
Regulatory Capital Rule: Category I and II Banking Organizations,
Banking Organizations With Significant Trading Activity, and Optional
Adoption for Other Banking Organizations; Proposed Rule
Federal Register / Vol. 91, No. 59 / Friday, March 27, 2026 /
Proposed Rules
[[Page 14952]]
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DEPARTMENT OF THE TREASURY
Office of the Comptroller of the Currency
12 CFR Parts 3, 6, and 32
[Docket ID OCC-2026-0265]
RIN 1557-AF52
FEDERAL RESERVE SYSTEM
12 CFR Parts 208, 217, 225, 238, and 252
[Docket No. 1887]
RIN 7100-AH20
FEDERAL DEPOSIT INSURANCE CORPORATION
12 CFR Part 324
RIN 3064-AF29
Regulatory Capital Rule: Category I and II Banking Organizations,
Banking Organizations With Significant Trading Activity, and Optional
Adoption for Other Banking Organizations
AGENCY: Office of the Comptroller of the Currency (OCC), Treasury; the
Board of Governors of the Federal Reserve System (Board); and the
Federal Deposit Insurance Corporation (FDIC).
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 proposing to modernize the capital
requirements applicable to Category I and II depository institution
holding companies and depository institutions, as well as revise the
market risk capital framework for banking organizations with
significant trading activity (the proposal). The proposal would improve
the regulatory capital framework for covered banking organizations by
enhancing its risk sensitivity and consistency and by simplifying core
components of its design. The agencies expect the proposal would
support the safety and soundness of covered banking organizations and
U.S. financial stability while promoting lending and other financial
intermediation activities in the banking system over a range of
economic conditions.
DATES: Comments must be received by June 18, 2026.
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: Category I and II Banking Organizations,
Banking Organizations with Significant Trading Activity, and Optional
Adoption for Other Banking Organizations'' to facilitate the
organization and distribution of the comments and identify the number
of the specific question(s) to which you are responding. You may submit
comments by any of the following methods:
Federal eRulemaking Portal--Regulations.gov:
Go to https://regulations.gov/. Enter Docket ID ``OCC-2026-0265''
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. EST, 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-2026-0265'' 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-2026-0265''
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. EST, 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-1887,
and RIN 7100-AH20 by any of the following methods:
Agency website: https://www.federalreserve.gov/apps/proposals/. Follow the instructions for submitting comments, including
attachments. Preferred Method.
Mail: Benjamin W. McDonough, Secretary, Board of Governors
of the Federal Reserve System, 20th Street and Constitution Avenue NW,
Washington, DC 20551.
Hand Delivery/Courier: Same as mailing address.
Other Means: [email protected]. You must include the
docket number in the subject line of the message.
Comments received are subject to public disclosure. In general,
comments received will be made available on the Board's website at
https://www.federalreserve.gov/apps/proposals/ without change and will
not be modified to remove personal or business information including
confidential, contact, or other identifying information. Comments
should not include any information such as confidential information
that would be not appropriate for public disclosure. Comments should
identify the number for the specific question(s) to which they respond.
Public comments may also be viewed electronically or in person in Room
M-4365A, 2001 C St. NW, Washington, DC 20551, between 9 a.m. and 5 p.m.
during Federal business weekdays.
FDIC: You may submit comments to the FDIC, identified by RIN 3064-
AF29 and identify the number for the specific question(s) to which you
are responding, by any of the following methods:
Agency website: https://www.fdic.gov/resources/regulations/federal-register-publications. Follow instructions for submitting comments on
the FDIC's website.
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Mail: Jennifer M. Jones, Deputy 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, Technical Expert, or
Diana Wei, Risk Expert, Capital Policy, (202) 649-6370; Carl Kaminski,
Assistant Director, Ron Shimabukuro, Senior Counsel, Kevin
Korzeniewski, Counsel, Daniel Perez, Counsel, Christopher Rafferty,
Counsel, or Joanne Phillips, Counsel, 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; Andrew
Willis, Manager, (202) 430-1667; Missaka Nuwan Warusawitharana,
Manager, (202) 452-3461; 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, Lead Financial Institution Policy Analyst, (202) 452-
3164; Division of Supervision and Regulation; or Jay Schwarz, Deputy
Associate General Counsel, (202) 452-2970; Mark Buresh, Senior Special
Counsel, (202) 452-5270; 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; Michael Maloney, Senior
Policy Analyst; Iris Li, Senior Policy Analyst; Olga Lionakis, Senior
Policy Analyst; Richard Smith, Capital Markets Policy Analyst; Ernest
Barkett, Financial Analyst; Kyle McCormick, Senior Policy Analyst;
Keith Bergstresser, Senior Policy Analyst; Lauren Brown, Senior Risk
and Policy Analyst; Rachel Romm-Nisson, Risk Analytics Specialist; Jim
Yu, Senior Policy Analyst, Peter Yen, Senior Policy Analyst; Huiyang
Zhou, Senior Quantitative Risk Specialist; Soo Jeong Kim, Capital
Markets Policy Analyst; Capital Markets and Accounting Policy Branch,
Division of Risk Management Supervision; Catherine Wood, Counsel;
Merritt Pardini, Counsel; Kevin Zhao, Senior Attorney; Nicholas Soyer,
Attorney, Michael Overmyer, Special Counsel, 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. Statutory Authority
B. Objectives of the Proposal
C. Overview of the Proposal
II. Scope, Design, and Other Overarching Issues
A. Scope of Application
B. Single Set of Risk-Based Requirements
C. Removal of Internal Models for Credit and Operational Risk
D. Overlaps With the Stress Capital Buffer Requirement
E. Indexing of Thresholds
F. The Role of International Standards in Developing U.S.
Capital Requirements
G. Treatments Retained from the Current Standardized Approach
III. Definition of Capital
IV. Calculation of Risk-Weighted Assets Under the Expanded Risk-
Based Approach
A. Credit Risk
1. Exposure Amounts
2. Proposed Risk Weights for Credit Risk
3. Off-Balance Sheet Exposures
4. Counterparty Credit Risk-Related Exposures
5. Credit Risk Mitigation
B. Securitization Framework
1. Definitions
2. Operational Requirements
3. Exposure Amount of a Securitization Exposure
4. Securitization Standardized Approach (SEC-SA)
5. Exceptions to the SEC-SA Risk-Based Capital Treatment for
Securitization Exposures
6. Credit Risk Mitigation for Securitization Exposures
C. Equity Exposures
1. Adjusted Carrying Value
2. Simple Risk-Weight Approach (SRWA)
D. Operational Risk
1. Business Indicator
2. Business Indicator Component
3. Alternative Simple Approaches
4. Operational Risk Management
V. Calculation of Risk-Weighted Assets Under the Market Risk
Framework
A. Market Risk
1. Background
2. Scope and Application of the Proposed Rule
3. Measure for Market Risk
4. Market Risk Covered Position
5. Internal Risk Transfers
6. General Requirements for Market Risk
7. Standardized Non-Default Capital Requirement
8. Models-Based Non-Default Capital Requirement
9. Default Risk Capital Requirement
10. Treatment of Certain Market Risk Covered Positions
11. Reporting and Disclosure Requirements
12. Technical Amendments
B. 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
6. Reporting and Disclosure Requirements
VI. Disclosure Requirements
A. Proposed Disclosure Requirements
B. Specific Public Disclosure Requirements
VII. Estimated Impact on Capital Requirements
A. Standalone Effect of Proposed Capital Rule Changes
1. Impact on Other Banking Organizations
B. Cumulative Effect of Proposed Capital Rule Changes
1. Cumulative Impact of Recent Proposals on Capital Requirements
2. Cumulative Impact of Recent Proposals on Common Eequity Tier
1 Capital Requirements by Risk Type
C. Impact by Banking Activities
1. Impact on Risk-Weighted Assets by Banking Activity
2. Cumulative Impact of Recent Proposals on Common Equity Tier 1
Capital Requirements by Banking Activity
D. Data and Estimation Methodology
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1. Estimation of Risk-Weighted Assets Under the Proposed
Expanded Risk-Based Approach
2. Extrapolation of Estimates to Other Time Periods and Banking
Organizations
3. Attribution of Risk-Weighted Assets to Banking Activities
4. Estimation of Capital Requirements
5. Attribution of Stress Capital Buffer Requirement to Risk
Categories
VIII. Economic Analysis
A. Overview of the Baseline
1. Capital Ratios of Category I and II Banking Organizations--
Cross Section
2. Capital Ratios of Banking Organizations--Time Series
3. Portfolio Characteristics of Category I and II Banking
Organizations--by Revenue
4. Portfolio Characteristics of Category I and II Banking
Organizations--by Broad Asset Class
5. Dependency of the U.S. Economy on the Banking System
6. Nonbank Financial Intermediaries
B. Reasonable Alternatives
1. Alternative 1: Dual Calculation Implementation
2. Alternative 2: BCBS Models-Based Implementation
3. Alternative 3: BCBS Standardized Implementation
4. Quantitative Estimates and Discussion
C. Macroeconomic Effects and the Analysis of the Proposal With
Respect to Estimates of Optimal Capital Levels
1. Impact of the Proposals
2. Development of the Literature on the Optimal Level of Capital
in the Banking System
3. General Equilibrium Models of Optimal Capital Levels
4. Limitations of Applying the Academic Studies on Optimal
Capital Levels To Evaluating the Proposals
5. Differences Across U.S. Households
6. Benefits From Improved Risks Measurement
7. Microprudential Consequences of the Proposals
D. Effects on Lending (Including Credit Cards, Residential
Mortgages, and Business Lending)
1. Credit Cards
2. Residential Mortgages
3. Corporate Loans
E. Effects on Trading
1. Changes in Capital Requirements Across Different Trading
Activities
2. Impact on Banking Organizations
3. Impacts on Markets
F. Effect on Competitiveness
1. On Internationally Active Banks
2. On Smaller Banks
3. On Nonbank Financial Intermediaries
4. On Consumer Welfare and Barriers to Entry
G. Conclusion
IX. Technical Amendments to the Capital Rule
A. Additional OCC Technical Amendments
B. Additional FDIC Technical Amendments
X. Related Proposals and Proposed Amendments to Related Rules
A. Related Proposals
B. OCC Amendments
C. Board Amendments
XI. 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. Executive Orders 12866, 13563, and 14192
G. Providing Accountability Through Transparency Act of 2023
I. Introduction
The Office of the Comptroller of the Currency (OCC), the Board of
Governors of the Federal Reserve System (Board), and the Federal
Deposit Insurance Corporation (FDIC) (collectively, the agencies) are
proposing to modernize the capital requirements applicable to Category
I and II depository institution holding companies and depository
institutions (henceforth Category I and II banking organizations) and
the market risk capital framework applicable to banking organizations
with significant trading activity.\1\ The proposal would improve the
regulatory capital framework for covered banking organizations by
enhancing its risk sensitivity and consistency, as well as by
simplifying core components of its design.\2\ Improving the risk
sensitivity of the regulatory capital framework would mean that a
banking organization's capital requirements more readily increase or
decrease due to changes in the risk of its business activities.
Improving the consistency of the regulatory capital framework would
mean that the regulatory capital framework would apply similar capital
requirements to exposures with similar risks across different banking
organizations.
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\1\ In 2019, the agencies adopted rules establishing four
categories of capital standards for U.S. banking organizations with
$100 billion or more in total consolidated assets and foreign
banking organizations with $100 billion or more in combined U.S.
assets. Under this framework, Category I standards apply to U.S.-
domiciled bank holding companies identified as global systemically
important BHCs and their depository institution subsidiaries.
Category II 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 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 exposures and their depository
institution subsidiaries. Category IV 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 217.400, 238.10, 252.5, (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 (Nov. 1, 2019); ``Changes to Applicability Thresholds for
Regulatory Capital and Liquidity Requirements,'' 84 FR 59230 (Nov.
1, 2019).
\2\ The term covered banking organizations refers to Category I
and II banking organizations, banking organizations with significant
trading activity, and banking organizations that elect to use the
expanded risk-based approach (as discussed further below).
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Elements of the proposal would address comments received from the
Economic Growth and Regulatory Paperwork Reduction Act (EGRPRA) public
notices.\3\ Consistent with other recent efforts to modify the
regulatory capital framework, the agencies expect the proposal would
support the safety and soundness of covered banking organizations and
U.S. financial stability while promoting lending and other financial
intermediation activities by covered banking organizations over a range
of economic conditions.\4\
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\3\ The agencies, together with the Federal Financial
Institutions Examination Council, commenced a review under the
Economic Growth and Regulatory Paperwork Reduction Act of 1996 in
2024 to identify outdated or otherwise unnecessary regulatory
requirements. The agencies will continue reviewing and considering
these comments as part of any final rulemaking. Public Law 104-208,
Div. A, Title II, section 2222, 110 Stat. 3009-414, (1996) (codified
at 12 U.S.C. 3311). See also Regulatory Publication and Review Under
the Economic Growth and Regulatory Paperwork Reduction Act of 1996,
90 FR. 35241 (Jul. 25, 2025).
\4\ Other recent initiatives to modernize the capital framework
include the finalized changes to the enhanced supplementary leverage
ratio standards, which would reinforce the role of leverage
requirements as a backstop to risk-based capital requirements and
address unintended incentive effects (see 90 FR 55248 (Dec. 1,
2025); the community bank leverage ratio proposal, which would
reduce regulatory burden while continuing to ensure the safety and
soundness of community banks (see 90 FR 55048 (Dec. 1, 2025); and
recent proposals to revise the Board's stress testing framework,
which would improve its transparency and reduce excess volatility in
the stress capital buffer requirement (see 90 FR 16843 (Apr. 22,
2025) and 90 FR 51856 (Nov. 18, 2025)).
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Requirements under the proposal would generally be consistent with
international capital standards issued by the Basel Committee on
Banking Supervision (Basel Committee).\5\ Where appropriate, however,
the proposal may differ from the standards published by the Basel
Committee (Basel standards) to reflect specific characteristics of U.S.
markets, requirements under U.S. generally accepted accounting
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principles (GAAP),\6\ practices of U.S. banking organizations, and U.S.
statutory mandates and policy objectives. For example, the proposal
would remove the current requirement to deduct mortgage servicing
assets (MSAs) from regulatory capital and instead subject all MSAs to a
250 percent risk weight. This aspect of the proposal is intended to
remove a regulatory disincentive for residential mortgage servicing and
origination, reducing impacts on broader policy objectives regarding
the U.S. housing market.
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\5\ 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. The
consolidated Basel framework is available at https://www.bis.org/basel_framework/. For additional discussion of the revisions to the
Basel framework with which this proposal would align, see also
https://www.bis.org/bcbs/publ/d424.htm, https://www.bis.org/bcbs/publ/d457.htm, and https://www.bis.org/bcbs/publ/d507.htm.
\6\ GAAP often serve as a foundational measurement component for
U.S. capital requirements. See also 12 U.S.C. 1831n (generally
requiring that financial reports required by the agencies from
banking organizations use U.S. GAAP).
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The agencies expect that the proposal would increase the common
equity tier 1 capital requirements of Category I and II holding
companies by about 1.2 percent, while decreasing corresponding
requirements for Category I and II subsidiary depository institutions
by 5.1 percent.\7\ Together with the GSIB surcharge proposal and the
stress testing changes proposed in October 2025,\8\ the Board expects
that the common equity tier 1 capital requirements for Category I and
II holding companies would decline by 5.0 percent (see section VII for
additional discussion of capital impact).\9\ The agencies performed
extensive economic analysis to assess the potential effects of the
proposal, including together with related proposals (see section VIII).
The improvements in risk sensitivity, simplicity, transparency and
consistency of risk-based capital requirements expected to result from
the proposal justify its expected costs.
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\7\ The revisions introduced by the proposal to the calculation
of risk-weighted assets would also modify Category I bank holding
companies' total loss-absorbing capacity (TLAC) requirements and
long-term debt requirements.
\8\ See 90 FR 51856 (Nov. 18, 2025).
\9\ A banking organization for which the Board is the primary
Federal supervisor must maintain capital ratios above the sum of its
minimum requirements and buffer requirements to avoid restrictions
on capital distributions and discretionary bonus payments.
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The agencies seek comment on all aspects of the proposal.\10\
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\10\ In 2023, the agencies published a proposal to revise the
capital rule based on the Basel Committee framework. 88 FR 64028
(Sept. 18, 2023). The agencies are rescinding the 2023 proposal.
Members of the public that seek to submit comments on the current
proposal must submit comments in line with the procedures described
in this proposal.
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A. Statutory Authority
Congress has authorized the agencies to establish risk-based
capital requirements and standards for banking organizations subject to
this proposal. Section 165 of the Dodd-Frank Wall Street Reform and
Consumer Protection Act (Dodd-Frank Act),\11\ as amended by section 401
of the Economic Growth, Regulatory Relief, and Consumer Protection
Act,\12\ requires the Board to establish enhanced prudential standards
that include risk-based capital requirements for bank holding companies
with $250 billion or more in total consolidated assets.\13\ The prompt
corrective action framework in section 38 of the Federal Deposit
Insurance Act (FDI Act) requires the agencies to prescribe capital
standards for insured depository institutions that include a risk-based
capital requirement and provides that the agencies may establish any
additional relevant capital measures to carry out the purpose of that
section.\14\ Various other statutory authorities provide the agencies
with broad discretionary authority to set capital requirements and
standards for banking organizations supervised by the agencies,
including national banking associations, state-chartered banks, savings
associations, and depository institution holding companies.\15\
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\11\ Dodd-Frank Wall Street Reform and Consumer Protection Act,
Public Law 111-203, 124 Stat. 1376 (2010).
\12\ Economic Growth, Regulatory Relief, and Consumer Protection
Act, Public Law 115-174, 132 Stat. 1296 (2018).
\13\ See 12 U.S.C. 5365(a)(1), (b)(1)(A)(i). Section 165 of the
Dodd-Frank Act also provides that the Board may apply any prudential
standard established under section 165 to any bank holding company
with $100 billion or more in total consolidated assets to which the
prudential standard does not otherwise apply, under certain
circumstances. 12 U.S.C. 5365(a)(2)(C). Section 165, in relevant
part, also applies to foreign banks or companies that are treated as
a bank holding company for purposes of the Bank Holding Company Act.
See 12 U.S.C. 3106(a), 5311(a)(1). See also section 401(g) of the
Economic Growth, Regulatory Relief, and Consumer Protection Act
(regarding the Board's authority to establish enhanced prudential
standards for foreign banking organizations with total consolidated
assets of $100 billion or more). 12 U.S.C. 5365 note.
\14\ See 12 U.S.C. 1831o(c)(1)(A), (c)(1)(B)(i).
\15\ See 12 U.S.C. 93a (national banking associations); 12
U.S.C. 248(i), 324, 327, 329 (state member banks); 12 U.S.C. 1463
(savings associations); 12 U.S.C. 1467a(g)(1) (savings and loan
holding companies); 12 U.S.C. 1844(b) (bank holding companies); 12
U.S.C. 3106 (certain U.S. operations of foreign banking
organizations); 12 U.S.C. 3902(1)-(2), 3907(a), 3909(a), (c)(1)-(2)
(depository institutions; affiliates of depository institutions,
including holding companies; and certain U.S. operations of foreign
banking organizations); 12 U.S.C. 5371 (insured depository
institutions, depository institution holding companies, and nonbank
financial companies supervised by the Board). Additional statutory
authorities relevant to the agencies' capital rule can be found in
the authority citations in the capital rule. See 12 CFR part 3
(OCC); 12 CFR part 217 (Board); 12 CFR part 324 (FDIC).
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B. Objectives of the Proposal
The proposal aims to improve the capital framework for covered
banking organizations by enhancing its risk sensitivity, reducing
complexity, and improving transparency and consistency.
Risk sensitivity is a core feature of risk-based capital
requirements. The proposed framework aims to improve the alignment of
regulatory capital requirements with the risks presented by banking
organizations' exposures. Such alignment could help promote safe and
sound banking organizations that can lend through a range of economic
conditions.
To further improve the capital framework, the proposal seeks to
reduce complexity by simplifying its overall design. Redundant or
unnecessarily complex requirements, such as multiple risk-based capital
frameworks applying to the same banking organization, add costs that
outweigh any incremental benefits presented by such an approach,
whereas a simpler framework reduces compliance burden and strengthens
transparency. Clear and transparent requirements support safety and
soundness by making it easier for supervisors, investors, and other
stakeholders to assess the financial condition of banking
organizations. A central element of the proposal's effort to reduce
redundancy is better integration with the Board's stress testing
framework, which is achieved by considering jointly the calibrations of
this proposal and the proposed stress test model changes that would
inform stress capital buffer requirements.
The proposal would also promote consistency. Consistent capital
requirements hold banking organizations with similar risk profiles to
similar standards, thereby reducing unwarranted divergence. Consistency
is also valuable internationally. The proposal is generally aligned
with the Basel standards, with some differences as discussed in section
II.F of this Supplementary Information. Broadly consistent regulatory
frameworks should reduce complexity and compliance costs for banking
organizations with cross-border operations, including both U.S. banking
organizations operating abroad and foreign banking organizations
operating in the United States.
By improving risk-based capital requirements, the proposal would
bolster the role of large U.S. banking organizations in supporting the
broader economy. The reforms that followed the 2007-09 financial crisis
substantially increased the resilience of the U.S.
[[Page 14956]]
banking system. However, in some cases, these post-crisis reforms have
imposed burdens that contributed to the migration of some activities,
such as mortgage origination and servicing, outside of the regulated
banking sector.\16\ Revising the regulatory capital framework to better
align requirements with risks--and in so doing easing requirements on
some lower-risk, traditional banking activities--would contribute to
U.S. banking organizations becoming better positioned to support the
economy.
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\16\ According to the 2024 Financial Stability Oversight Council
report on nonbank mortgage servicing, nonbank mortgage companies
originated approximately two-thirds of mortgages in the United
States and owned the servicing rights on 54 percent of mortgage
balances in 2022. In 2008, nonbank mortgage companies only accounted
for 39 percent of mortgage originations and owned the servicing
rights on 4 percent of mortgage balances. See page 3 FSOC Report on
Nonbank Mortgage Servicing 2024 at https://home.treasury.gov/system/files/261/FSOC-2024-Nonbank-Mortgage-Servicing-Report.pdf.
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C. Overview of the Proposal
The proposal would streamline the risk-based capital requirements
applicable to Category I and II banking organizations. Currently, these
banking organizations are subject to two sets of risk-based capital
ratio requirements: one based on the standardized approach (which also
generally applies to other banking organizations) and the other based
on an internal models framework, the advanced approaches.\17\ Under the
proposal, Category I and II banking organizations would be subject to a
single set of risk-based capital ratio requirements based on the
``expanded risk-based approach''--which would include requirements for
credit risk, equity risk, and operational risk--and the revised market
risk framework.\18\ The standardized approach would no longer apply to
these banking organizations, and the advanced approaches would be
removed from the regulatory capital framework. As discussed further
below, other banking organizations could choose to adopt the expanded
risk-based approach that would be required for Category I and II
banking organizations.
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\17\ See 12 CFR part 3, subparts D and E (OCC); 12 CFR part 217,
subparts D and E (Board); 12 CFR part 324, subparts D and E (FDIC).
\18\ For purposes of this discussion, unless otherwise noted,
the revised market risk framework is inclusive of requirements for
credit valuation adjustment risk, as applicable.
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The expanded risk-based approach is a standardized framework that
would promote the simplicity, risk sensitivity, transparency, and
consistency objectives of the proposal. This approach would improve
risk sensitivity relative to the current standardized approach by
varying capital requirements according to several new risk factors,
such as loan-to-value ratios for real estate exposures, repayment
history for retail exposures, and assessed creditworthiness for
corporate exposures. Unlike the current standardized approach, the
expanded risk-based approach would include a specific operational risk
capital requirement. This difference, in part, supports the different
calibration of credit risk weights under the expanded risk-based
approach relative to the risk weights under the standardized approach.
The proposal would also revise the market risk framework, which
would be applicable to Category I and II depository institution holding
companies and to other banking organizations with significant trading
activity. Significant trading activity would be defined to mean (1)
more than $5 billion in trading activity or (2) trading activity equal
to or higher than 10 percent of the banking organization's total
assets. The new framework would improve risk sensitivity and
consistency by revising the models-based approach for market risk and
introducing a standardized approach for market risk. To reduce burden
without a meaningful loss in resilience, the proposal would raise the
threshold for applicability of the market risk framework from having
trading activity of at least $1 billion to having trading activity of
at least $5 billion.
As part of the revised market risk framework, the proposal would
include a risk-sensitive and consistent framework for capturing the
risks associated with credit valuation adjustment risk for derivative
exposures.\19\ This framework would apply to (1) Category I and II
depository institution holding companies, (2) depository institutions
that are subsidiaries of Category I or II depository institution
holding companies and have significant trading activity, and (3) other
banking organizations with significant trading activity that also have
at least $1 trillion in notional derivative exposure.
---------------------------------------------------------------------------
\19\ Credit valuation adjustment risk is the exposure to changes
in the valuation of derivative contracts driven by changes in
counterparty credit risk.
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The proposal would retain banking organizations' ability to use
internal models, with supervisory approval, to calculate market risk
capital requirements. Market risk is more effectively modeled than
credit and operational risk because relevant data is observed at a much
higher frequency and depth, providing the basis for both model
calibration and empirical verification of model appropriateness.
The agencies consider the proposed requirements under the expanded
risk-based approach to be appropriate for Category I and II banking
organizations given their risk profiles, complexity, risk management
resources, and international activities. The agencies recognize that
the risk-sensitive requirements under the expanded risk-based approach
may appeal to other banking organizations with certain business models
and risk management systems. Therefore, the proposal would allow other
banking organizations to elect to use the expanded risk-based approach.
Banking organizations that choose this option would also be subject to
the definition of capital that applies to Category I and II banking
organizations.\20\
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\20\ This definition of capital would include the requirement to
reflect accumulated other comprehensive income in regulatory capital
and to use the deductions framework that applies to Category I and
II banking organizations.
---------------------------------------------------------------------------
In addition to the changes to the calculation of risk-weighted
assets, the proposal would change the definition of regulatory capital
applicable to Category I and II banking organizations by removing the
threshold-based deduction for mortgage servicing assets. Thus, all
mortgage servicing assets would receive a 250 percent risk weight under
the proposal, consistent with the risk weight in the current capital
rule for MSAs that do not exceed the deduction thresholds. This
proposed revision would eliminate a strong disincentive for mortgage
origination and mortgage servicing by banking organizations.
The proposal would also amend certain dollar-based regulatory
thresholds, where appropriate, to reflect inflation and ensure that
such thresholds preserve their intended application in real terms over
time.\21\ Consistent with this proposal, the agencies are reviewing
other thresholds throughout out the regulatory framework.
---------------------------------------------------------------------------
\21\ Certain thresholds in FDIC regulations are also indexed to
reflect inflation. See 90 FR 55789 (Dec. 1, 2025).
---------------------------------------------------------------------------
Finally, the proposal would revise disclosure requirements to
facilitate market participants' understanding of the financial
condition and risk management practices of banking organizations
subject to the expanded risk-based approach.\22\ In addition, to align
with these revisions, the agencies anticipate proposing revisions to
the
[[Page 14957]]
reporting forms of the Federal Financial Institutions Examination
Council (FFIEC) that would apply to covered banking organizations.
---------------------------------------------------------------------------
\22\ The disclosure requirements would only apply to the top
tier of a consolidated banking organization.
---------------------------------------------------------------------------
In a separate rulemaking, the agencies are proposing modifications
to the standardized approach risk-based capital requirements
(standardized approach proposal), which would apply to banking
organizations that do not use the expanded risk-based approach. Also,
the Board is separately issuing a notice of proposed rulemaking that
would revise the U.S. global systemically important banking holding
company (GSIB) surcharge calculation applicable to Category I bank
holding companies and the systemic risk report applicable to large
holding companies (GSIB surcharge proposal).
Question 1: The agencies invite comment on the interaction of the
revisions in the proposal with other existing rules and with other
notices of proposed rulemaking.
Question 2: What would be an appropriate amount of time between the
publication of any final rule and its effective date, and why?
II. Scope, Design, and Other Overarching Issues
A. Scope of Application
The proposal would require Category I and II banking organizations
to use the expanded risk-based approach. These banking organizations
present substantial systemic risks due to their size, complexity,
interconnectedness, and cross-jurisdictional activity. Application of
the expanded risk-based approach to them would provide granular, risk-
sensitive, and standardized requirements that align with international
standards.
While the expanded risk-based approach was designed for application
to banking organizations that operate globally across multiple business
lines, such as Category I and II banking organizations, the agencies
are aware that the more differentiated treatments for traditional
banking exposures such as mortgage, corporate, and retail exposures may
appeal to certain smaller banking organizations. Therefore, the
proposal would provide all banking organizations subject to the capital
rule with the option of adopting the expanded risk-based approach in
its entirety.
Under the proposal, a banking organization that chooses to adopt
the expanded risk-based approach would become subject to the same
definition of capital as Category I and II banking organizations and,
therefore, be required to reflect most elements of accumulated other
comprehensive income in regulatory capital even if it subsequently
changes to the standardized approach. This is consistent with the one-
time election to recognize accumulated other comprehensive income in
regulatory capital in the current standardized approach and avoids
changes in accumulated other comprehensive income recognition based on
interest rate cycles. For a banking organization that chooses to adopt
the proposed expanded risk-based approach, the inclusion of most
elements of other accumulated other comprehensive income in regulatory
capital would be subject to a transition period of five years from the
effective date of any final rule.\23\
---------------------------------------------------------------------------
\23\ This transition period would mirror the transition period
under the standardized approach proposal provided to Category III
and IV banking organizations that do not currently recognize
accumulated other comprehensive income in regulatory capital.
---------------------------------------------------------------------------
To align with a banking organization's annual capital planning
processes, any change in election between the expanded risk-based
approach and the standardized approach would take effect 12 months
after the date on which the banking organization provides written
notice of the change in election to its primary Federal supervisor.
This requirement would help ensure that any change in election reflects
structural balance sheet considerations and not short-term capital
reductions.
Banking organizations with significant trading activities face an
elevated level of market risk and, therefore, would continue to be
subject to the market risk framework. The proposal would increase the
current dollar-based threshold for the application of market risk
capital requirements from $1 billion to $5 billion or more of trading
assets and trading liabilities. The proposal would also 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 would continue to be
subject to market risk capital requirements if their trading assets and
trading liabilities represent 10 percent or more of total assets.
Banking organizations that do not meet the thresholds for being subject
to market risk capital requirements would calculate risk-weighted
assets for trading exposures under the standardized approach or the
expanded risk-based approach, as applicable. Additionally, under the
proposal, Category I and II depository institution holding companies
would be subject to market risk capital requirements regardless of the
amount of their trading activities.
The proposal would apply capital requirements for credit valuation
adjustment risk to all Category I and II depository institution holding
companies, as well as to their subsidiary depository institutions that
are subject to the market risk framework. In addition, capital
requirements for credit valuation adjustment risk would apply to other
banking organizations subject to the market risk framework that have
over-the-counter derivative notional amounts of $1 trillion or more.
Due to their substantial derivative portfolios, these banking
organizations have meaningful exposure to losses resulting from changes
to their credit valuation adjustment accounting reserve. This threshold
aims to balance coverage of credit valuation adjustment risk and
burden. According to data reported in the FR Y-9C form, depository
institution holding companies above this threshold accounted for over
98 percent of the over-the-counter derivative exposures of depository
institution holding companies as of 2025Q2.
Question 3: What are the advantages and disadvantages of the
proposed scope of application of the expanded risk-based approach?
Question 4: What are the advantages and disadvantages of allowing
all banking organizations to adopt the expanded risk-based approach?
What are the challenges associated with adopting the expanded risk-
based approach for Category III, IV, and smaller banking organizations?
To what extent would this optionality limit the transparency and
consistency of the risk-based capital requirements? What limitations or
restrictions on how frequently a banking organization could switch from
the expanded risk-based approach to the standardized approach and vice
versa should the agencies include and why?
B. Single Set of Risk-Based Requirements
Under the proposal, banking organizations would be subject to a
single set of risk-based capital ratio requirements.\24\ This contrasts
with the current framework, which requires Category I and II banking
organizations to calculate two sets of risk-based capital ratios: one
using the standardized approach and the other
[[Page 14958]]
using the internal models-based advanced approaches. By employing risk-
sensitive, simplified, consistent, and transparent requirements,
aligned with international standards, the expanded risk-based approach
would result in an appropriate stand-alone requirement.
---------------------------------------------------------------------------
\24\ This revision would be consistent with comments received
under EGRPRA as commenters requested that banking organizations be
required to calculate risk-weighted assets under a single approach.
---------------------------------------------------------------------------
The capital conservation buffer requirement would apply to the
risk-based capital ratios of Category I and II banking organizations in
the same manner as it currently applies to the standardized approach
ratios. For Category I depository institution holding companies, the
capital conservation buffer requirement would continue to consist of
the stress capital buffer requirement, the countercyclical capital
buffer (if activated), and the GSIB surcharge. For Category II
depository institution holding companies, the capital conservation
buffer would continue to consist of the stress capital buffer
requirement plus the countercyclical capital buffer (if activated). For
the subsidiary depository institutions of Category I or II depository
institution holding companies, the capital conservation buffer
requirement would continue to equal 2.5 percent plus the
countercyclical capital buffer requirement (if activated).
C. Removal of Internal Models for Credit and Operational Risk
The proposal would eliminate the advanced approaches framework and
introduce in its place the expanded risk-based approach to improve the
consistency and transparency of the risk-based capital requirements
applicable to Category I and II banking organizations. This approach
would help address many of the challenges associated with the use of
internal models to calculate risk-based capital requirements for credit
risk and operational risk.
In 2007, the agencies jointly issued a final rule requiring large,
internationally active banking organizations to calculate risk-based
capital requirements for credit risk and operational risk under the
advanced approaches.\25\ In seeking to ensure that these banking
organizations are adequately capitalized, the advanced approaches
require banking organizations to estimate their exposure to severe
unexpected losses.\26\ However, available information since adoption of
this rule suggests that the advanced approaches do not always result in
consistent minimum requirements across U.S. banking organizations with
similar risk profiles.\27\ While internal models to calculate risk-
based capital requirements for credit risk and operational risk do
provide valuable information and may be more accurate in some cases
than standardized approaches, as discussed below the severity of the
outcomes the advanced approaches rule requires banking organizations to
model coupled with data limitations and the subjectivity embedded in
modeling assumptions has presented substantial challenges.
---------------------------------------------------------------------------
\25\ See Risk-Based Capital Standards: Advanced Capital Adequacy
Framework--Basel II, 72 FR 69288 (Dec. 7, 2007). The agencies
subsequently revised certain aspects of the advanced approaches
framework in the rulemakings that established the current capital
rule. See 78 FR 62018 (Oct. 11, 2013).
\26\ For both credit risk and operational risk, the advanced
approaches capital requirements aimed to cover the risk of loss over
a one-year window at the 99.9th percentile level. See 72 FR 69288
(Dec. 7, 2007); 12 CFR part 3 (OCC); part 217 (Board); part 324
(FDIC).
\27\ See, e.g., Tobias Berg, and Philipp Koziol ``An analysis of
the consistency of banks' internal ratings,'' Journal of Banking and
Finance 78, 27-41 (2017), https://dx.doi.org/10.1016/j.jbankfin.2017.01.013; and Barbora Stepankova, and Petr Teply,
``Consistency of Banks' Internal Probability of Default Estimates:
Empirical Evidence from the COVID-19 crisis,'' Journal of Banking
and Finance 154, 106969 (2023), https://doi.org/10.1016/j.jbankfin.2023.106969.
---------------------------------------------------------------------------
Financial risk models designed to capture severe loss events can
suffer from substantial uncertainty.\28\ Such uncertainty can result in
substantial and unwarranted differences in capital requirements across
similar exposures that are unrelated to differences in risk.
---------------------------------------------------------------------------
\28\ See Jon Danielsson, ``Blame the Models,'' Journal of
Financial Stability, 321-28 (2008), https://doi.org/10.1016/j.jfs.2008.09.003.
---------------------------------------------------------------------------
The advanced approaches require banking organizations to estimate
loss given default conditional on an economic downturn. Ensuring that
banking organizations' loss given default estimates are consistent with
the risk of their exposures has proven challenging for several reasons,
including (1) limited data on loss given default and its drivers under
downturn conditions; (2) inconsistencies in constructing the loss given
default variables, arising from factors such as methodological
differences and difficulties in capturing all cash inflows and outflows
after default;\29\ and (3) difficulty in verifying certain modeling
assumptions, such as the time window used to calculate loss given
default in an economic downturn. To a lesser degree, verifying the
appropriateness of banking organizations' probability of default models
is challenging in some cases due to limited data for certain low
default portfolios and varying practices in identifying defaults across
banking organizations.30 31
---------------------------------------------------------------------------
\29\ For example, horizontal supervisory reviews have found
material deviations in loss rates at different banking organizations
with respect to the same defaulted exposure.
\30\ For example, banking organizations have followed different
practices regarding whether to count technical defaults (which are
situations where the borrower failed to uphold an aspect of the loan
agreement but has not failed to make regularly scheduled payments)
as defaults for purposes of modeling probability of default.
\31\ Various analyses conducted by the Basel Committee, to which
the agencies contributed, demonstrated significant divergence across
banking organizations in credit risk-weighted assets calculated
under the internal models-based approaches that could not be
explained by differences in the riskiness of banking organizations'
portfolios. See https://www.bis.org/publ/bcbs256.pdf and https://www.bis.org/bcbs/publ/d363.pdf.
---------------------------------------------------------------------------
For operational risk, banking organizations subject to the advanced
approaches are required to estimate the 99.9th percentile of the
distribution of the aggregated annual operational losses under the
advanced measurement approaches (AMA). This requirement has presented
substantial challenges for banking organizations and supervisors as a
considerable amount of relevant data would be needed to empirically
verify model performance. Given the severe outcome that the requirement
is designed to estimate, model and parameter uncertainty can result in
substantial divergence in model outcomes and, consequently, substantial
divergence in capital requirements.\32\ In addition, infrequent large
operational loss events tend to have substantial influence on model
outcomes and can result in substantial volatility.\33\ Together, these
factors result in substantial uncertainty in internally modeled
operational risk capital requirements and likely inconsistent
requirements across banking organizations with similar operational risk
profiles.
---------------------------------------------------------------------------
\32\ See G. Mignola, and R. Ugoccioni, ``Sources of Uncertainty
in Modeling Operational Risk Losses,'' Journal of Operational Risk
1(2): 33-50 (2006); J. Ne[scaron]lehov[aacute], P. Embrechts, and V.
Chavez-Demoulin, ``Infinite Mean Models and the LDA for Operational
Risk,'' Journal of Operational Risk 1(1): 3-25 (2006); and E. Cope,
G. Mignola, G. Antonini, and R. Ugoccioni, ``Challenges and Pitfalls
in Measuring Operational Risk from Loss Data,'' Journal of
Operational Risk 4(4): 3-27 (2009).
\33\ See E. Cope, G. Mignola, G. Antonini, and R. Ugoccioni,
``Challenges and Pitfalls in Measuring Operational Risk from Loss
Data'' Journal of Operational Risk 4(4): 3-27 (2009); and J. Opdyke,
and A. Cavallo, ``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 (2012).
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Taken together, the severe outcomes that the advanced approaches
rule expects banking organizations to model, the limitations of
available data, and the subjectivity of modeling assumptions
[[Page 14959]]
contribute to concerns about the reliability of internal model outputs
and unwarranted divergences in risk-based capital requirements for
credit and operational risk across banking organizations.
The application of the stress capital buffer requirement to
Category I and II bank holding companies also reduces the usefulness of
retaining the advanced approaches for these banking organizations.
Under the proposal, the stress capital buffer requirement would apply
to the single set of risk-based capital ratios to which these bank
holding companies would be subject, providing risk-sensitive capital
requirements that reflect a granular, forward-looking assessment of
risks. In this context, removing the advanced approaches simplifies the
framework without reducing the resilience of Category I and II bank
holding companies.
Under the current capital rule, banking organizations are required
to maintain capital commensurate with the level and nature of all risks
to which they are exposed \34\ and to have a process for assessing
their overall capital adequacy in relation to their risk profile and a
comprehensive strategy for maintaining an appropriate level of
capital.\35\ In addition, certain large banking organizations are
required to develop and maintain a capital plan \36\ and conduct
internal stress tests.\37\ The proposal would not change these
requirements. As discussed above, the advanced approaches have
limitations as a means to set consistent minimum risk-based capital
requirements. However, internal models can provide valuable information
to a banking organization's internal risk management, stress testing,
and planning functions and can be used to complement minimum capital
requirements in assessing a banking organization's capital adequacy.
Category I and II banking organizations, as well as other banking
organizations, should continue to employ internal modeling capabilities
for sound risk management as appropriate for the complexity of their
activities.
---------------------------------------------------------------------------
\34\ See 12 CFR 3.10(e)(1) (OCC); 12 CFR 217.10(e)(1) (Board);
12 CFR 324.10(e)(1) (FDIC).
\35\ See 12 CFR 3.10(e)(2) (OCC); 12 CFR 217.10(e)(2) (Board);
12 CFR 324.10(e)(2) (FDIC).
\36\ See 12 CFR 225.8; 12 CFR 238.170.
\37\ See 12 CFR part 46 (OCC); 12 CFR part 238, subparts P and
R, and 12 CFR part 252, subparts B and F (Board); 12 CFR part 325
(FDIC).
---------------------------------------------------------------------------
The proposal would continue to allow the use of internal models to
calculate market risk capital requirements, but only for trading desks
where modeling can be demonstrated to be appropriate. Market risk is
more easily and effectively modeled than credit and operational risk
because data on trading positions are observed at a much higher
frequency and depth, in particular for commonly traded instruments.
Trading creates price observations, which in turn provide daily
feedback on model calibration and performance to support empirical
verification through techniques such as back-testing. For these
reasons, the benefits of retaining models are larger for market risk
than for other exposure types.
Question 5: What are the advantages and disadvantages of removing
internal models for credit risk and operational risk? Are there
alternatives that the agencies should consider and if so, why?
Question 6: The Basel standards include a floor to risk-weighted
assets, the ``output floor,'' which corresponds to 72.5 percent of
risk-weighted assets calculated only using standardized approaches. The
proposal would not include this output floor because proposed
requirements would be almost completely standardized and, therefore,
the output floor would be unlikely to bind in most situations. What
would be the advantages and disadvantages of including a floor to risk-
weighted assets corresponding to 72.5 percent of the risk-weighted
assets calculated using only the standardized approaches in the
proposal.
D. Overlaps With the Stress Capital Buffer Requirement
In proposing these revised risk-based capital requirements for
Category I and II banking organizations, the Board is mindful of the
overlaps between the capital and stress testing frameworks. Together,
this proposal and a recent proposal to enhance the transparency and
public accountability of the Board's stress test,\38\ which requested
public comment on certain revisions to the Board's stress test models,
aim to improve risk sensitivity of requirements in a way that considers
the cumulative effect of the entire capital framework.
---------------------------------------------------------------------------
\38\ See Enhanced Transparency and Public Accountability of the
Supervisory Stress Test Models and Scenarios; Modifications to the
Capital Planning and Stress Capital Buffer Requirement Rule,
Enhanced Prudential Standards Rule, and Regulation LL, 90 FR 51856
(Nov. 18, 2025).
---------------------------------------------------------------------------
The stress capital buffer requirement represents an explicitly
forward-looking element in the risk-based capital requirements of large
bank holding companies. Informed by the Board's stress testing
framework, the stress capital buffer requirement aims to capture
exposures comprehensively and granularly under conditions of severe
stress.
Under the current rule, a bank holding company's stress capital
buffer requirement is applied to its risk-based capital ratios
calculated under the standardized approach, which do not include a
specific requirement for operational risk, and is not applied to the
bank holding company's requirements under the advanced approaches. This
historical choice was motivated, in part, by the goal of limiting
redundancy between the stress capital buffer requirement, based on the
Board's forward-looking assessment of stress risks, and the bank
holding company's modeling of tail risks under the advanced
approaches.\39\
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\39\ ``In addition, both the supervisory stress test and the
advanced approaches are calibrated to reflect tail risks; thus it
could be duplicative to require a firm to meet the requirements of
the advanced approaches on a post-stress basis.'' 83 FR 18160 (Apr.
25, 2018).
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Consistent with international standards, the proposed expanded
risk-based approach would include a specific measure of operational
risk in risk-weighted assets. Also, the proposed changes to the market
risk framework would improve the measurement of tail risks in ways that
are expected to raise minimum market risk capital requirements for the
most complex banking organizations.
The outstanding Board stress testing proposal would introduce
meaningful revisions to stress test models and scenarios, including the
models for operational risk and trading positions. Operational risk
modeling would be enhanced by focusing on the more robust historical
simulation model. Similarly, the stress test proposal would improve the
modeling of trading positions under the global market shock component
of the severely adverse scenario by better measuring their liquidity
horizons. Both proposed revisions, on their own and independent of
other factors, are projected to somewhat reduce aggregate projected
stress capital buffer requirements.\40\
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\40\ As the Board noted in October 2025, in aggregate, the
proposed stress test model and scenario changes inform the Board's
determination of a firm's stress capital buffer requirement and are
not expected materially change capital requirements for firms
subject to the supervisory stress test, across various stress test
scenarios and jump-off conditions at the start of the test. That
proposal included illustrative analysis that considered the
potential effects of the proposed stress test model changes,
independent of other factors and components that inform the Board's
stress capital buffer determinations for specific firms, within the
2024 and 2025 supervisory stress tests. In that analysis,
implementing the proposed model changes and proposed revisions to
the global market shock component of the severely adverse scenario
in the 2024 and 2025 stress tests would have, independent of other
factors, increased the aggregate projected common equity tier 1
(CET1) stress ratio, on average, by 29 basis points, which would
have corresponded to a reduction in stress capital buffer
requirements of approximately 23 basis points or approximately 2.2
percent of current required capital. See 90 Federal Register 51856,
51874-51877 (Nov. 18, 2025). The analysis estimates that the
proposed model changes would reduce stress capital buffer
requirements by approximately 13 basis points and that the proposed
revisions to the global market shock scenario component would reduce
stress capital buffer requirements by approximately 10 basis points.
For U.S. GSIBs, the analysis estimates a decline of 25 basis points
in stress capital buffer requirements. See also Federal Reserve
Board--Federal Reserve Board requests comment on proposals to
enhance the transparency and public accountability of its annual
stress test; Dodd-Frank Act Stress Tests 2026 (Dec. 1, 2025).
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[[Page 14960]]
In summary, this proposal is projected to increase the minimum
requirements for operational risk and market risk, while the stress
test proposal's analysis of the proposed model changes estimated a
decrease in related requirements for these risks, as they inform the
stress capital buffer requirement. The Board expects both sets of
revisions to improve risk sensitivity and coherence of the capital
framework, while the revisions in this proposal would contribute to
international consistency. The capital impact of these revisions would
largely offset each other, and the Board considers that the combined
calibration of these risks would be appropriate (see section VII for
additional analysis of the cumulative calibration of requirements by
risk type).
Question 7: The current Board stress testing methodology reflects a
constant balance sheet assumption and assumes that a banking
organization's risk-weighted assets generally remain unchanged over the
nine-quarter projection horizon. What would be the advantages and
disadvantages of adjusting the stress testing methodology to project
changes in risk-weighted assets for banking organizations subject to
the expanded risk-based approach and banking organizations subject to
the market risk framework? For example, what would be the advantages
and disadvantages of projecting changes in the risk-weighted assets
applicable to credit exposures to better reflect deteriorations in
obligors' credit quality during a stress period (such as migrating
corporate exposures in the investment grade 65 percent risk weight
category into the general corporate category or from the general
corporate category into the past due category)? What would be the
advantages and disadvantages of adjusting risk-weighted assets for
operational risk by projecting lower income amounts during a stress
period? What, if any, changes should the Board consider to better
project risk-weighted assets for trading positions and derivatives
during a stress period in light of the proposed market risk framework,
including the proposed credit valuation adjustment risk requirement
(these may include revisions to reflect changes in modelability of risk
factors and volatility)?
E. Indexing of Thresholds
The proposal uses certain thresholds to differentiate requirements
based on a banking organization's size, risk profile, and complexity as
well as on the characteristics of the exposures. However, static
dollar-based thresholds can lead to unintended consequences if
threshold levels are not periodically updated or indexed to inflation.
For example, banking organizations can become subject to additional
requirements and burden over time for reasons unrelated to changes in
their risk profile. Under the proposal, certain dollar-based thresholds
would be adjusted in the future to reflect inflation, pursuant to a
pre-determined indexing methodology.\41\ Indexing dollar-based
thresholds would preserve threshold levels in real terms, which would
efficiently and transparently preserve the thresholds' intended
application and align with intended policy objectives over time.
---------------------------------------------------------------------------
\41\ This revision would also be consistent with comments
received under EGRPRA as commenters requested indexing of thresholds
going forward to reflect inflation.
---------------------------------------------------------------------------
The proposed indexing methodology would adjust thresholds based on
the consumer price index for urban wage earners and clerical workers
(CPI-W) published by the U.S. Bureau of Labor Statistics. The use of
CPI-W to index thresholds is consistent with other bank regulations,
such as those relating to the Community Reinvestment Act and the
Board's Regulation CC.\42\ Further, the indexing methodology included
under the proposal would generally align with the methodology used to
adjust certain thresholds within FDIC regulations.\43\ Specifically,
certain dollar thresholds would be adjusted at the end of every
consecutive two-year period based on the cumulative percent change of
the non-seasonally adjusted CPI-W since the effective date of any final
rule. This two-year period is intended to provide an appropriate
cadence for capturing meaningful changes in inflation on a timely basis
while minimizing the burden of adjustment. To address the possibility
of periods of unusual inflation, the indexing methodology would also
allow for discretionary adjustment to thresholds by the agencies during
an off year. The proposal would also not lower thresholds in the event
of deflation.\44\ Additionally, thresholds adjusted under the proposed
indexing methodology would be rounded based on the size of the
threshold (e.g., billions, millions, thousands), generally, to the
nearest two significant digits, as appropriate.\45\
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\42\ The agencies' regulations that implement the Community
Reinvestment Act define small and intermediate-small banks by
reference to asset-size criteria expressed in dollar amounts, which
are adjusted annually based on the year-to-year change in inflation
through a Federal Register notice. Specifically, this adjustment
corresponds to the average of the Consumer Price Index for Urban
Wage Earners and Clerical Workers, not seasonally adjusted, for each
12-month period ending in November, with rounding to the nearest
million. See, e.g., Community Reinvestment Act Regulations Asset-
Size Thresholds, 89 FR 106480, 106481 (Dec. 30, 2024). See also 12
CFR 229.11.
\43\ See Adjusting and Indexing Certain Regulatory Thresholds,
90 FR 55789 (Dec. 1, 2025).
\44\ Any periods of deflation would be reflected in future
threshold increases, as threshold adjustments in the future would be
based on the positive net cumulative change in CPI-W.
\45\ For example, a threshold that would otherwise be calculated
as $5.964 million would be rounded to $6.0 million, or the nearest
$0.1 million.
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The proposal would index the following thresholds: (1) the $1
million threshold for a retail exposure to qualify as regulatory
retail; (2) the $50 million annual revenue threshold for a borrower to
qualify as a small or medium-sized entity; (3) the $10 million
threshold used to determine whether a company in which a covered
banking organization owns equity instruments meets the definition of
financial institution; (4) the $1 billion and the $30 billion business
indicator thresholds that determine the marginal coefficients
applicable for the calculation of the business indicator component in
the operational risk capital requirement; (5) the $20,000 threshold for
mandatory collection of operational loss events; (6) the $5 billion
trading activity threshold for application of the market risk
framework; (7) the $1 trillion derivatives exposure threshold for
application of the credit valuation adjustment risk requirement; (8)
the $20 million threshold above which net short positions must be
included in the market risk framework; and (9) the $2 billion threshold
for an equity issuer to be classified as having large market
capitalization in the market risk standardized approach.
To effectuate threshold changes under the proposal, the agencies
would announce threshold adjustments pursuant to the indexing
methodology by publishing the updated thresholds.
[[Page 14961]]
Threshold adjustments would be calculated based on cumulative CPI-W
data through August of the year in which the adjustment is made,
relative to the same initial baseline.\46\
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\46\ The U.S. Bureau of Labor Statistics publishes the CPI-W on
a monthly basis.
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Question 8: What are the advantages and disadvantages of the
proposed approach for indexing thresholds? What alternatives should the
agencies consider and why? What are the advantages and disadvantages of
using a different index for adjusting thresholds, such as nominal GDP
or the GDP deflator, instead of CPI-W?
Question 9: Are there specific thresholds within the proposal that
can result in an increase in operational burden when indexed? If so,
which are they and why?
Question 10: What are the advantages and disadvantages of
discretionary off-year adjustments for periods of unusual inflation?
Should the agencies consider a framework for adjustment in off years,
such as based on inflation or other threshold and, if so, why?
F. The Role of International Standards in Developing U.S. Capital
Requirements
The agencies participate in international fora, including the Basel
Committee, that support broadly aligned prudential financial regulation
across major economies, consistent with the agencies' mandates and
various statutory authorizations.\47\ Standards issued by these
international fora are not binding under U.S. law. The agencies
routinely consider the potential benefits of such standards as part of
a reasoned decision-making process when developing domestic rulemakings
to implement prudential requirements.
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\47\ See, e.g., 12 U.S.C. 1828 note, 3901, 3907, 3911, and 5373;
see also 22 U.S.C. 9522 note; Federal Deposit Insurance Corporation
Improvement Act of 1991 Sec. 305(b)(2), Public Law 102-242, 105
Stat. 2236, 2355.
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Where appropriate and consistent with the agencies' statutory
authorities and policy objectives, maintaining consistency between
domestic financial regulatory policy and international standards can
generate significant benefits, particularly regarding large,
internationally active banking organizations. Large, internationally
active banks and the U.S. financial system more broadly are highly
interconnected with the global financial system. Promoting the
application of suitable and robust prudential standards across
jurisdictions can enhance the resilience of the U.S. financial system
by reducing the likelihood of distress or other problems that arise in
a foreign jurisdiction having negative effects in the United
States.\48\
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\48\ The Basel Committee was originally formed after the failure
of Herstatt Bank in Germany in 1974, which contributed to serious
disruptions to foreign currency and banking markets within and
beyond Germany, demonstrating the need for better coordination among
bank regulators in different jurisdictions. See https://www.bis.org/bcbs/history.htm.
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Comparability of standards across jurisdictions can also reduce
complexity and compliance costs for banking organizations with
significant cross-border operations or activities.\49\ In particular,
similar prudential standards enable the agencies and foreign
supervisors to look to home country capital regimes when such
requirements are generally consistent with international standards.\50\
For example, similar prudential standards help to facilitate the
Board's assessment of the capital adequacy of foreign banking
organizations in connection with applications to establish operations
within the United States.\51\ In addition, consistent standards help
ensure that foreign banking organizations with U.S. operations are
subject to standards at the consolidated level that promote safety and
soundness and competitive equity with U.S. banking organizations. The
adoption of similar prudential standards across many jurisdictions
means that, consistent with section 165 of the Dodd-Frank Wall Street
Reform and Consumer Protection Act (Dodd-Frank Act),\52\ the Board's
enhanced prudential standards for large foreign banking organizations
may rely on the home country capital and stress testing regimes
applicable to a foreign banking organization, avoiding unnecessary
duplication of requirements.\53\ Additionally, comparability of
standards across jurisdictions helps home country and host country
supervisors, along with banking organization management and public
markets, understand and monitor positions and risks across
jurisdictions by providing all parties with a set of shared principles,
concepts, and measuring tools.\54\
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\49\ See GAO Report ``Bank Capital Requirements--Potential
Effects of New Changes on Foreign Holding Companies and U.S. Banks
Abroad'' (Jan. 2012), https://www.gao.gov/assets/gao-12-235.pdf; see
also GAO Report ``International Banking--International Coordination
of Bank Supervision: The Record to Date'' (Feb. 1986), https://www.gao.gov/assets/nsiad-86-40.pdf.
\50\ See, e.g., Board of Governors of the Federal Reserve System
and U.S. Department of the Treasury, ``Capital Equivalency Report''
(June 1992), https://fraser.stlouisfed.org/title/capital-equivalency-report-9009; 12 U.S.C. 3105(j).
\51\ See, e.g., 12 CFR 211.24, 225.2(r)(3).
\52\ Public Law 111-203, 124 Stat. 1376 (2010). In applying
section 165 to a foreign-based bank holding company, the Dodd-Frank
Act directs the Board to give due regard to the principle of
national treatment and equality of competitive opportunity, and to
take into account the extent to which the foreign banking
organization is subject, on a consolidated basis, to home country
standards that are comparable to those applied to financial
companies in the United States. See 12 U.S.C. 5365(b)(2).
\53\ See, e.g., 12 CFR 252.143(a). Absent home-country standards
consistent with the Basel Capital Framework, a foreign banking
organization would be required to demonstrate to the Board's
satisfaction that it would meet Basel Capital Framework standards at
the consolidated level were those standards to apply. See 79 FR
17240 (Mar. 27, 2014).
\54\ See GAO Report ``International Banking--International
Coordination of Bank Supervision: The Record to Date'' (Feb. 1986),
https://www.gao.gov/assets/nsiad-86-40.pdf.
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Notwithstanding these benefits, the agencies have, at various
times, concluded that departures from international standards are
appropriate and desirable in light of domestic requirements or
considerations, or where U.S. regulators simply believe different
standards are more appropriate. Consistent with previous rulemakings
that implemented aspects of the Basel standards in the United
States,\55\ the proposal may differ from the Basel standards in certain
areas to reflect factors such as specific characteristics of U.S.
markets, requirements under GAAP,\56\ practices of U.S. banking
organizations, and U.S. legal requirements and policy objectives.\57\
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\55\ For example, the GSIB surcharge framework adopted by the
Board includes a second method for calculating GSIB surcharges that
is different from the Basel GSIB surcharge methodology. See 80 FR
49082 (Aug. 14, 2015). Additionally, alignment with the Basel
standards can be achieved without using all methods specified in
them and, in the past, the agencies have chosen not to adopt some
methods included within the Basel standards. See, e.g., 61 FR 47358
(Sept. 6, 1996), 72 FR 69288 (Dec. 7, 2007), and 78 FR 62018 (Oct.
11, 2013).
\56\ See 12 U.S.C. 1831n.
\57\ See, e.g., 12 U.S.C. 1831bb and 5371; 15 U.S.C. 78o-7 note.
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G. Treatments Retained From the Current Standardized Approach
Taking the current standardized approach as a starting point, the
proposal would generally adopt treatments consistent with the Basel
standards when they would improve the risk sensitivity and consistency
of the requirements applicable to covered banking organizations, do not
conflict with existing U.S. law, and are appropriate for U.S. banking
organizations. Many elements of the expanded risk-based approach would
be consistent with the Basel standards and different in some respects
from the treatment under the current standardized approach. In some
cases, the current standardized approach is
[[Page 14962]]
appropriately risk sensitive for application to Category I and II
banking organizations and, therefore, the agencies are retaining those
treatments with minimal or no change.\58\
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\58\ For example, the expanded risk-based approach would treat
sovereign exposures, certain exposures to government-sponsored
entities, and exposures to public sector entities the same as the
current standardized approach.
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III. Definition of Capital
Under the proposal, all banking organizations required to apply the
expanded risk-based approach, or that choose to adopt the expanded
risk-based approach, would be subject to the same definition of
capital. The proposal would broadly maintain the definition of capital
for Category I and II banking organizations in the current capital
rule, with one modification to eliminate the requirement to deduct MSAs
\59\ above a threshold from common equity tier 1 capital.\60\ Banking
organizations that choose to adopt the expanded risk-based approach
would, therefore, be required to include most components of accumulated
other comprehensive income in regulatory capital.
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\59\ An MSA arises when a banking organization sells a loan to a
third party but retains the obligation to service the loan in
exchange for a fee. Banking organizations may also purchase, sell,
or transfer MSAs separately from the underlying mortgage loans.
\60\ In addition, the proposal would require a banking
organization to deduct from common equity tier 1 capital any portion
of a credit-enhancing interest only strip that does not constitute
an after-tax-gain-on sale, as discussed in section IV.B.5.f. of this
SUPPLEMENTARY INFORMATION.
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Under the current capital rule, Category I and II banking
organizations 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 (collectively, threshold items) that
individually exceed 10 percent of the banking organization's common
equity tier 1 capital minus certain deductions and adjustments. In
addition, these banking organizations must deduct from common equity
tier 1 capital the aggregate amount of the threshold items that exceeds
15 percent of common equity tier 1 capital.
Under the proposal, Category I and II banking organizations would
no longer be required to deduct any amount of MSAs from common equity
tier 1 capital and would not consider MSAs when calculating the
aggregate deduction amount for temporary difference DTAs and
significant investments in the capital of unconsolidated financial
institutions in the form of common stock. Instead, MSAs would be
subject to a 250 percent risk weight, consistent with the treatment in
the current capital rule for MSAs that do not exceed the deduction
thresholds.\61\ MSAs can be a useful tool for banking organizations to
manage interest rate risk. The value of MSAs generally increases when
interest rates rise, which extends the expected duration of related
servicing fees. As a result, they may provide a hedge against losses on
other assets that decline in value in the same interest rate
environment.
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\61\ The agencies' standardized approach proposal would make the
same modification to the definition of regulatory capital for all
other banking organizations.
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Moreover, MSAs are important for banking organizations to maintain
their relationship with borrowers by retaining customer-facing
relationships even after transferring the underlying loans, allowing
cross-selling of products. Banking organizations can also improve
efficiency by increasing scale. A deduction approach for MSAs can
discourage banking organizations from creating economies of scale,
which can hinder their ability to compete in mortgage underwriting or
servicing businesses and to manage risks.
At the same time, MSAs have long been subject to elevated capital
requirements because of the high level of uncertainty regarding the
ability of banking organizations to realize value from these assets,
especially under adverse financial conditions. MSAs may face
significant valuation risk, which mainly stems from prepayment risk,
default risk, and liquidity risk. For example, increased refinancing of
mortgage loans due to lower interest rates can quickly erode the value
of MSA portfolios, as can increased incidents of mortgage defaults.
MSAs can also be difficult to value, as banking organization portfolios
of MSAs can be heterogeneous and MSA valuations rely on assessments of
future economic variables. Maintaining the 250 percent risk weight for
MSAs would promote regulatory capital requirements that are
commensurate with the risk of these assets.\62\
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\62\ In the 2013 capital rule (78 FR 62069, Oct 11, 2013), in
connection with section 475 of the Federal Deposit Insurance
Corporation Improvement Act of 1991 (12 U.S.C. 1828 note), the
agencies made a finding that the treatment under the capital rule of
readily marketable purchased MSAs would not have an adverse effect
on the Deposit Insurance Fund or the safety and soundness of insured
depository institutions. The proposal would continue to apply a 250
percent risk weight to all MSAs, while removing the threshold
deduction, and the agencies continue to consider the proposed
treatment to not have an adverse effect on the Deposit Insurance
Fund or the safety and soundness of insured depository institutions.
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Question 11: What are the advantages and disadvantages of the
proposed treatment of MSAs? What are the implications of the proposed
treatment of MSAs for banking organizations' mortgage origination
business? To what extent does the 250 percent risk weight appropriately
reflect the risk of these assets throughout the economic cycle? Given
the potential volatility of MSAs under certain circumstances, what are
the advantages and disadvantages of the agencies imposing a higher
limit on MSA as a percentage of common equity tier 1 capital (for
example, 100 percent) and why? What are the advantages and
disadvantages of differentiating the treatment of MSAs based on the
size of the banking organization (for example, banking organizations
with assets under $10 billion or over $100 billion) or applicable
capital framework (for example, banking organizations that elect the
community bank leverage ratio framework)?
IV. Calculation of Risk-Weighted Assets Under the Expanded Risk-Based
Approach
A. 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. Certain transactions give rise to
counterparty credit risk, which generally refers to the risk that a
counterparty to a transaction will default before the final settlement
of the transaction and will fail to make all the payments required by
the transaction. Transactions that give rise to counterparty credit
risk include repo-style transactions, eligible margin loans, and
derivatives transactions. Counterparty credit exposure is determined by
the market value of the transaction, which fluctuates with market
conditions. Thus, the current exposure to a counterparty's default
continuously changes and the future exposure is uncertain.
Under the proposal, a banking organization subject to the expanded
[[Page 14963]]
risk-based approach would follow similar mechanics to those in the
current standardized approach to determine its risk-weighted assets for
credit risk. Such a banking organization would first determine the
exposure amount of each on-balance sheet exposure, derivative contract,
and off-balance sheet commitment, trade and transaction-related
contingency, guarantee, repo-style transaction, financial standby
letter of credit, forward agreement, or other similar transaction
(excluding certain transaction types or exposures as specified in the
proposed rule). In certain cases, exposure amount is measured at the
netting-set level. The banking organization would then multiply the
exposure amount by the risk weight appropriate to the exposure based on
the exposure type or counterparty. In addition, the proposal would
allow for the recognition of certain credit risk mitigants through
adjustments to the risk-weighted asset amount for protected exposures.
Section IV.A.1. of this SUPPLEMENTARY INFORMATION describes in
general terms the approaches for determining exposure amount under the
proposal; section IV.A.2. of this SUPPLEMENTARY INFORMATION describes
the risk-weight treatment for credit exposures under the proposal;
section IV.A.3. of this SUPPLEMENTARY INFORMATION describes the
proposed exposure measurement of off-balance sheet exposures; section
IV.A.4. of this SUPPLEMENTARY INFORMATION describes the proposed
exposure measurement for counterparty credit risk-related exposures;
and section IV.A.5. of this SUPPLEMENTARY INFORMATION describes the
available approaches for recognizing the benefits of credit risk
mitigants including certain guarantees, certain credit derivatives,
financial collateral, and prepaid credit protection arrangements.
1. Exposure Amounts
a. On-Balance Sheet Exposure Amount
Under the proposal, as under the current standardized approach, the
exposure amount of an on-balance sheet exposure would generally be the
banking organization's carrying value \63\ of the exposure, consistent
with the value of the asset on the balance sheet as determined in
accordance with GAAP. Continuing to use the carrying value of an asset
under GAAP to determine a banking organization's exposure amount would
minimize burden and provide a consistent framework that can be easily
applied across all banking organizations because, in most cases, GAAP
serves as the basis for the information presented in financial
statements and regulatory reports.\64\
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\63\ 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 IV.A.4, IVA.5.b.,
and IV.B. of this Supplementary Information. The standardized
approach proposal also includes a technical amendment that would
modify the term adjusted allowance for credit losses (AACL) and
carrying value to exclude allowance for credit losses (ACLs) on
purchased seasoned loans (PSLs) in addition to those on purchased
credit deteriorated (PCD) assets and available-for-sale (AFS) debt
securities. The standardized approach proposal also amends the
definition of AACL and carrying value to provide the same treatment
as PCD assets to other assets that may in the future become subject
to the gross approach following a change to GAAP by FASB.
\64\ See 12 U.S.C. 1831n.
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b. Off-Balance Sheet Exposure Amount
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
obligors or counterparties to provide credit or other support. Such
arrangements may not be recorded on-balance sheet under GAAP until the
arrangement is drawn upon. These off-balance sheet exposures often
include commitments, contingent items, guarantees, certain repo-style
transactions, financial standby letters of credit, and forward
agreements. Under the proposal, consistent with the current
standardized approach, in most cases a banking organization determines
the exposure amount for an off-balance sheet component of an exposure
by multiplying the notional amount of the off-balance sheet component
by the appropriate credit conversion factor specified in the rule. The
proposed credit conversion factors would range from 10 percent to 100
percent to reflect the likelihood that a given off-balance sheet item
would become an on-balance sheet credit exposure, taking into account
the contractual features of the off-balance sheet item. For example, a
100 percent credit conversion factor would apply to a guarantee
provided by a banking organization because the banking organization is
effectively assuming the risk of the guaranteed exposure and thus such
an off-balance sheet item should be converted at the full amount. In
contrast, with respect to commitments, often an obligor does not draw
down on the commitment or only draws down a portion of the available
credit, so such off-balance sheet items would be converted at less than
100 percent. Thus, the proposal would vary the credit conversion
factors according to the likelihood that different types of off-balance
sheet items may become on-balance sheet credit exposures.
c. Approaches for Determining Exposure Amount for Counterparty Credit
Risk-Related Transactions
The current capital rule includes several approaches that a banking
organization may use to calculate the exposure amount for repo-style
transactions, eligible margin loans, derivative transactions, and
netting sets of such transactions. These approaches take into account
the offsetting of positions and financial collateral that meets the
criteria in the rule within a netting set and incorporate both current
and potential future exposure. For purposes of the expanded risk-based
approach, the proposal would continue to include the collateral haircut
approach for eligible margin loans and repo-style transactions, and
netting sets of such transactions, and the standardized approach for
counterparty credit risk (SA-CCR) for derivative contracts, netting
sets of such transactions, and would expand SA-CCR to qualifying cross-
product netting sets of derivative transactions and certain repo-style
transactions, with modifications further described below in section
IV.A.4. of this SUPPLEMENTARY INFORMATION.
To determine the exposure amount for eligible margin loans, repo-
style transactions, or the netting sets of such transactions, the
proposed expanded risk-based approach would include the collateral
haircut approach with two proposed modifications to increase risk
sensitivity: (1) adjustments to the market price volatility haircuts;
and (2) a modified formula that reflects netting and diversification
benefits, each further described below in section IV.A.4.a. of this
SUPPLEMENTARY INFORMATION. A banking organization would have the option
of applying SA-CCR to certain repo-style transactions that are subject
to a qualifying cross-product master netting agreement that includes
derivative transactions.
To determine the exposure amount for derivative contracts, the
proposed expanded risk-based approach would require banking
organizations to apply SA-CCR, with certain modifications to better
reflect evolving market dynamics
[[Page 14964]]
and the potential for increased central clearing. The agencies are
proposing to revise SA-CCR to permit the netting of collateralized-to-
market and settled-to-market client-facing derivative transactions and
incorporate non-cleared repo-style transactions. Specifically, the
agencies are proposing to permit a banking organization to elect to
treat as a derivative contract any non-cleared repo-style transaction
subject to a qualifying cross-product master netting agreement that
also contains a derivative contract. These proposed amendments and
other proposed technical revisions to SA-CCR are described below in
section IV.A.4.b. of this SUPPLEMENTARY INFORMATION.
As stated earlier, the proposal would increase simplicity,
transparency, consistency, and comparability of capital requirements by
reducing banking organization's use of models. Therefore, the proposal
does not include the internal models methodology (IMM) or the simple
value-at-risk (VaR) methodology for measuring counterparty credit risk
or the use of a banking organization's own estimates of haircuts for
purposes of the collateral haircut approach.
2. Proposed Risk Weights for Credit Risk
The proposed expanded risk-based approach would introduce credit
risk weights that generally align with the Basel standards and use many
of the same definitions in Sec. __.2 of the current capital rule. Some
elements of the proposed expanded risk-based approach for credit risk
would apply the same risk weights provided in the current standardized
approach, including exposures to sovereigns, specified supranational
entities \65\ and multilateral development banks,\66\ 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,\67\ public sector
entities (PSEs), exposures that are 90 days or more past due or in
nonaccrual,\68\ and certain insurance assets. Consistent with statutory
mandates, the proposal would also maintain the same risk-weight
treatment provided in the current standardized approach to pre-sold
construction loans, statutory multifamily mortgages, and high-
volatility commercial real estate (HVCRE) exposures.
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\65\ Under the proposal, specified supranational entities would
include the Bank for International Settlements, the European Central
Bank, the European Commission, the International Monetary Fund, the
European Stability Mechanism, and the European Financial Stability
Facility. Consistent with the current capital rule, exposures to
such entities would continue to be subject to a zero percent risk
weight for the purposes of the expanded risk-based approach.
\66\ Under the proposal, multilateral development bank would
include International Bank for Reconstruction and Development, the
Multilateral Investment Guarantee Agency, the International Finance
Corporation, the Inter-American Development Bank, the Asian
Development Bank, the African Development Bank, the European Bank
for Reconstruction and Development, the European Investment Bank,
the European Investment Fund, the Nordic Investment Bank, the
Caribbean Development Bank, the Islamic Development Bank, the
Council of Europe Development Bank, and any other multilateral
lending institution or regional development bank in which the U.S.
government is a shareholder or contributing member or which the
primary Federal supervisor determines poses comparable credit risk.
Consistent with the current capital rule, exposures to these
entities would continue to be subject to a zero percent risk weight
for the purposes of the expanded risk-based approach
\67\ For treatment of other exposures to GSEs, see discussion
related to equity exposures in section IV.C. and subordinated
exposures in section IV.A.2.f. of this SUPPLEMENTARY INFORMATION.
\68\ Certain residential mortgage exposures that are 90 days
past due or in nonaccrual would receive a higher risk weight under
the proposal. See section IV.A.2.c.v of this SUPPLEMENTARY
INFORMATION.
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Relative to the advanced approaches under the current capital rule,
the proposed expanded risk-based approach would result in more
consistent and 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 divergence 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 expanded risk-based approach would introduce new
risk weights for exposures to depository institutions, foreign banks,
and credit unions; subordinated exposures, including those to GSEs; and
real estate, retail, and corporate exposures. The proposed risk weights
for each of these categories are described in the following sections of
this SUPPLEMENTARY INFORMATION.
Question 12: What are the pros and cons of continuing the risk-
weights in the current standardized approach for sovereigns, specified
supranational entities and multilateral development banks, GSEs in the
form of senior debt and guaranteed exposures, FHLB and Farmer Mac
equity exposures, PSEs, exposures that are 90 days or more past due or
in nonaccrual, insurance assets, and other exposures?
Question 13: To enhance the risk sensitivity of the rule, what
alternatives to ``exposures that are 90 days or more past due or in
nonaccrual'' should the agencies consider to identify exposures in or
near default? What are the advantages and disadvantages of using an
approach similar to the definition of defaulted exposures in the
advanced approaches, that would include exposures where (a) 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 (b) 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, or an interest rate reduction?
a. Exposures to Government-Sponsored Enterprises
The proposal would assign a 20 percent risk weight to most GSE \69\
exposures, consistent with the current standardized approach. GSE
exposures that are subordinated exposures or equity exposures, however,
would receive higher risk weights. As discussed later in sections IV.C.
and IV.A.2.f. of this SUPPLEMENTARY INFORMATION, equity exposures and
subordinated exposures would generally be subject to an increased risk
weight to reflect their heightened risk relative to senior credit
exposures. As an exception to this general rule, the proposal would
apply a 20 percent risk weight to all exposures to FHLB or Farmer Mac,
including equity exposures and exposures to subordinated debt
instruments, which is consistent with the treatment under the current
standardized approach.
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\69\ 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).
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b. Exposures to Depository Institutions, Foreign Banks, and Credit
Unions
The proposal would define the scope of exposures to depository
institutions,
[[Page 14965]]
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 a depository
institution, foreign bank, or credit union.70 71
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\70\ 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 (Oct. 11,
2013).
\71\ The proposal would require banking organizations to apply a
150 percent risk weight to bank exposures that are either
subordinated exposures, as described in section IV.A.2.f. of this
SUPPLEMENTARY INFORMATION, or covered debt instruments that are not
deducted.
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The proposed treatment for bank exposures supports the simplicity,
transparency, and consistency objectives of the proposal in a manner
that is appropriately risk sensitive. The proposal would provide three
categories for bank exposures that are ranked from the highest to the
lowest in terms of creditworthiness: Grade A, Grade B, and Grade C. The
assignment of a bank exposure to a category would be based on the
indicators of creditworthiness of 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,\72\ or under similar rules of the National Credit Union
Administration.\73\ For a bank exposure to be considered investment
grade, a banking organization would have to determine that the obligor
has adequate capacity to meet financial commitments, consistent with
the current rule.\74\ 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, including if the obligor depository institution
were in the grace period under the CBLR framework.\75\ As a result,
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.
Additionally, as described further in the next paragraph, a Grade A
exposure to depository institutions that have opted into the CBLR
framework would receive a reduced risk weight relative to other Grade A
exposures.
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\72\ 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).
\73\ See 12 CFR part 702 (National Credit Union Administration).
\74\ 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.
\75\ See 12 CFR 3.12(a)(1) (OCC); 12 CFR 217.12(a)(1) (Board);
12 CFR 324.12(a)(1) (FDIC). See also 90 FR 55048 (Dec. 1, 2025).
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Certain Grade A exposures to depository institutions, foreign
banks, and credit unions would be subject to a 30 percent risk weight,
whereas the others would be assigned a 40 percent risk weight.
Specifically, a banking organization could assign a 30 percent risk
weight to Grade A exposures to: (1) Category I, II, or III depository
institutions with a common equity tier 1 capital ratio of 14 percent or
higher and a supplementary leverage ratio (SLR) of five percent or
higher; (2) depository institutions that have opted into the CBLR
framework; and (3) depository institutions not subject to the SLR or
CBLR framework with a common equity tier 1 capital ratio of 14 percent
or higher and a tier 1 leverage ratio of five percent or higher.\76\ To
qualify for the 30 percent risk weight, a foreign bank obligor would
have to meet the same requirements of having a 14 percent or higher
common equity tier 1 capital ratio and a five percent or higher
leverage ratio as determined by the applicable capital standards of the
foreign bank's home country jurisdiction.\77\ Under this proposed
criteria, 68.3 percent of U.S. depository institutions would meet the
criteria for a highly capitalized bank exposure and be assigned a 30
percent risk weight, based on Call Report data as of June 30, 2025.
Grade A exposures to credit unions would be subject to the 30 percent
risk weight if the obligor credit union has a net worth ratio of 9
percent or higher.\78\ These requirements would be broadly consistent
with those in the Basel standards and provide a preferential risk
weight for institutions presenting a materially lower credit risk than
other Grade A bank exposures. The 30 percent risk weight for exposures
to banks with materially higher capital levels would increase risk
sensitivity while maintaining competitive equity across various sizes
of obligor institutions.
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\76\ An exposure to a depository institution that has not opted
into the CBLR framework and is not required to calculate a common
equity tier 1 ratio and a SLR or tier 1 leverage ratio, as
applicable, under the agencies' capital rule would not qualify for
the 30 percent risk weight.
\77\ The Grade A foreign bank would have to meet the five
percent Basel leverage ratio level for the 30 percent risk weight,
as implemented by the foreign bank's home country. The Basel
leverage ratio is substantially similar to the supplementary
leverage ratio under the agencies' capital rule.
\78\ For comparison, a well-capitalized credit union must have a
net worth ratio (NWR) of 7 percent or greater. A NWR of 9 percent
was selected given that is the level used in their Complex Credit
Union Leverage Ratio (CCULR) framework. The average NWR of Risk-
Based Capital reporters was 9.83 percent as of 2025 Q2. See
Quarterly Credit Union Data Summary 2025 Q2 (Page 20) and Risk-Based
Capital Frequently Asked Questions [verbar] NCUA.
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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-
[[Page 14966]]
capitalized category \79\ under the agencies' prompt corrective action
framework, or under similar rules of the National Credit Union
Administration.
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\79\ See 12 CFR 6.4(b)(2) (OCC); 12 CFR 208.43(b)(2) (Board); 12
CFR 324.403(b)(2) (FDIC).
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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 broadly consistent with
international capital standards issued by the Basel Committee. This
requirement aims to maintain competitive equity and recognize
creditworthiness of institutions subject to capital standards that are
broadly consistent--the capital standards issued by the Basel Committee
are comparable to U.S. capital rules.
Under the proposal, an exposure to a foreign bank 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.
In addition, an exposure would not qualify as a Grade A or Grade B
bank exposure if: (1) the obligor depository institution, foreign bank,
or credit union does not have capital ratios that are publicly
disclosed within the last six months; or (2) 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.
A Grade C bank exposure would mean a bank exposure that does not
qualify as a Grade A or Grade B bank exposure.
The proposal would 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 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) for an
exposure to a branch of a 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.\80\ 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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\80\ See Table 1 in 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 20 percent to 150 percent. The
proposal provides more granular and higher risk weights for bank
exposures compared to the standardized approach to better reflect the
range of credit risks presented by these exposures. In addition, the
proposal better accounts for financial system interconnectedness
inherent in exposures to depository institutions, foreign banks, and
credit unions, which can pose systemic risk to the financial system.
[GRAPHIC] [TIFF OMITTED] TP27MR26.060
The proposed risk weights in Table 1 for exposures to depository
institutions, credit unions and foreign banks, especially those that
are Grade A, reflect that those institutions present reduced credit
risk relative to exposures to other types of financial institutions or
companies. U.S. depository institutions and credit unions are subject
to strong capital requirements, are subject to robust federal
supervision, and have limitations in the types of riskier financial
transactions in which they can engage. Foreign banks that qualify as
Grade A would have broadly consistent capital standards as U.S.
depository institutions and also would be subject to regulatory and
supervisory frameworks broadly equivalent with those in the Basel
standards. Additionally, the proposed risk weights for bank exposures
under the expanded risk-based approach would be more risk sensitive
than the current standardized
[[Page 14967]]
approach as the expanded risk-based approach incorporates more credit-
risk indicators and characteristics of the obligor depository
institution, foreign bank, or credit union.
Question 14: What would be the advantages and disadvantages of the
agencies treating an exposure to a nonbank financial institution such
as foreign holding companies or broker dealer subsidiary institutions
that are located in a foreign jurisdiction as a foreign bank exposure,
when that foreign jurisdiction has determined that the given type of
financial institution is regulated and supervised in that jurisdiction
in a manner equivalent to banks?
Question 15: What are the advantages and disadvantages of assigning
a 30 percent risk weight to Grade A bank exposures meeting the
additional criteria discussed above? To what extent would the lower 30
percent risk weight contribute to the pro-cyclicality of bank capital
requirements? To what extent might the risk weight contribute to credit
contraction during economic downturns and credit acceleration during
economic expansions?
Question 16: The agencies seek comment on the appropriateness of
the additional requirements that must be met to for Grade A bank
exposures to qualify for a 30 percent risk weight. What alternative
calibration of common equity tier 1 capital ratio and supplementary
leverage ratio levels would be appropriate for Category I, II, and III
Grade A depository institutions to receive a 30 percent risk weight?
What alternative calibration of common equity tier 1 capital ratio and
tier 1 leverage ratio levels would be appropriate for depository
institutions not subject to the CBLR framework or SLR to receive a 30
percent risk weight? Please provide analytical support.
Question 17: The agencies seek comment on whether the proposed
treatment for exposures to depository institutions, foreign banks, and
credit unions is appropriate for uninsured trust banks that do not have
capital ratios that were publicly disclosed within the last six months,
including such entities that issue payment stablecoins. What
alternative calibrations or approaches should the agencies consider to
differentiate the financial strength of uninsured trust banks that
would be appropriately risk-sensitive and consistent with the objective
of establishing simple, transparent, and consistent requirements?
Question 18: What would be the advantages and disadvantages of the
agencies requiring broadly consistent capital standards in the foreign
jurisdiction, as well as robust regulatory and supervisory frameworks
that are consistent with international capital standards issued by the
Basel Committee for certain foreign banks to qualify as Grade A and
Grade B? What are appropriate alternative indicators that could be used
to determine whether a foreign bank qualifies for a Grade A
classification? What are the advantages and disadvantages of looking to
the applicable capital requirements in foreign jurisdictions for
determining if a Grade A foreign bank meets the thresholds described
above to be eligible to apply a 30 percent risk weight? What
alternatives should the agencies consider to determine whether a
foreign bank has sufficient capital to warrant applying a 30 percent
risk weight to a Grade A foreign bank exposure?
c. 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) primarily secured by
collateral in the form of real estate,\81\ (3) a pre-sold construction
loan,\82\ (4) a statutory multifamily mortgage,\83\ (5) a high
volatility commercial real estate (HVCRE) exposure,\84\ 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
would be unchanged from the current standardized approach.
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\81\ For purposes of the proposal, ``primarily 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.
\82\ 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.
\83\ 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.
\84\ Section 214 of the Economic Growth, Regulatory Relief, and
Consumer Protection Act imposes certain requirements on high
volatility commercial real estate acquisition, development, or
construction loans. Section 214 of Public Law 115-174, 132 Stat.
1296 (2018). See 12 U.S.C. 1831bb.
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Risks related to exposures secured by real estate depend on what
type of real estate secures the exposure. Residential real estate loans
generally have lower historical charge off rates than commercial real
estate exposures.\85\ Residential real estate exposures are generally
amortizing, often have stricter underwriting standards for leverage
than commercial real estate, and often are easier to value. In
addition, residential and commercial real estate exposures that are
deemed prudently underwritten reflect reduced credit risk relative to
those real estate exposures that are not prudently underwritten.\86\
The proposal would therefore 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 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, and hotels); and (3) in the case of regulatory
residential or regulatory commercial real estate exposures, the loan-
to-value (LTV) ratio of the exposure.
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\85\ See ``Charge Off Rates for Loans and Leases at Commercial
Banks,'' https://www.federalreserve.gov/releases/chargeoff/delallsa.htm.
\86\ See sections IV.A.2.c.i. and ii of this SUPPLEMENTARY
INFORMATION for more information about the prudential criteria
differentiating regulatory residential and regulatory commercial
real estate exposures.
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The 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. These
criteria include a requirement that loans are made in accordance with
prudent underwriting standards as described in
[[Page 14968]]
the existing Interagency Guidelines for Real Estate Lending Policies
(real estate lending guidelines).\87\ Loans that are prudently
underwritten are less likely to lead to credit losses. Thus, the risk
weights proposed for these exposures are lower than for other real
estate exposures.
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\87\ 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).
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Moreover, real estate loans for which repayment is dependent on the
cash flows generated by the real estate can expose a banking
organization to elevated credit risk relative to real estate exposures
where repayment is not dependent on cash flows generated by the
property,\88\ as the obligor 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.\89\ Exposures
that are dependent on the cash flows generated by real estate to repay
the loan can also be affected by local market conditions and, thus,
present elevated credit risk relative to exposures that are serviceable
by the income, cash, or other assets of the obligor. For example, an
increase in the supply of competitive rental property can lower demand
and suppress cash flows needed to support repayment of a loan.
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\88\ Loans secured by real estate where the repayment of the
loan does not depend on cash flows generated by the real estate
include owner-occupied properties, where repayment of the loan is
generally based on the income or revenue of the borrower. See
additional discussion of dependent on the cash flows generated by
the real estate in section IV.A.2.c.iii. of this SUPPLEMENTARY
INFORMATION.
\89\ 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.
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In addition, LTV ratios are a meaningful risk indicator for the
credit quality of a real estate exposure because the amount of an
obligor's equity in a real estate property is negatively correlated
with default risk and provides banking organizations with a degree of
protection against losses.\90\ LTV ratios are also one of several key
factors that market participants, including banking organizations,
consider for differentiating credit risk.\91\ Therefore, under the
proposal, exposures with lower LTV ratios generally would receive a
lower risk weight than comparable real estate exposures with higher LTV
ratios.
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\90\ Id., at 30. For evidence on the correlation between LTV and
loss rates in mortgage loans, see Laurie Goodman and Jun Zhu, ``Bank
Capital Notice of Proposed Rulemaking--A Look at the Provisions
Affecting Mortgage Loans in Bank Portfolios,'' Urban Institute
(2023), https://www.urban.org/sites/default/files/2023-09/BankCapitalNoticeofProposedRulemaking.pdf; and Sewin Chan, Andrew
Haughwout, Andrew Hayashi, and Wilbert van der Klaauw,
``Determinants of Mortgage Default and Consumer Credit Use: The
Effects of Foreclosure Laws and Foreclosure Delays,'' Federal
Reserve Bank of New York, Staff Report No. 732 (2015), https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr732.pdf.
\91\ See Avery et al, ``Credit Risk, Credit Scoring, and the
Performance of Home Mortgages,'' Federal Reserve Board of Governors,
Federal Reserve Bulletin (1996), https://www.federalreserve.gov/pubs/bulletin/1996/796lead.pdf. See also 12 CFR part 1240.
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The proposed scope, risk drivers, and risk weights described below
are generally consistent with those in the Basel standards.
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 of the current capital rule) that is not an ADC
exposure, a pre-sold construction loan, a statutory multifamily
mortgage, or an HVCRE exposure, provided the exposure meets certain
prudential criteria.\92\ First, the loan would be required to be
secured by a residential 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 supervisory LTVs as described in the interagency real estate
lending guidelines.\93\ Third, during the underwriting process, the
banking organization would be required to apply underwriting policies
that account for the ability of the obligor to repay based on clear and
measurable underwriting standards that enable the banking organization
to evaluate these credit factors. The agencies expect these
underwriting standards to be consistent with the agencies' safety and
soundness and real estate lending guidelines.\94\ Fourth, the property
must be valued in accordance with the proposed requirements included in
the proposed LTV ratio calculation, as discussed below in section
IV.A.2.c.iv. of this SUPPLEMENTARY INFORMATION. Finally, the loan must
not have been modified or restructured.\95\
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\92\ 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.
\93\ For more information on determining the value of the
property, see section IV.A.2.c.iv. of this SUPPLEMENTARY
INFORMATION.
\94\ See 12 CFR part 30, appendix C and 12 CFR part 34, appendix
A to subpart D (OCC); 12 CFR part 208, appendix C (Board); 12 CFR
parts 364 and 365 (FDIC).
\95\ Consistent with the current standardized approach, a
residential real estate loan that is modified or restructured solely
pursuant to the U.S. Treasury's Home Affordable Mortgage Program is
not modified or restructured under this criterion for regulatory
residential real estate exposures.
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As discussed, residential real estate exposures that meet these
criteria present relatively lower credit risk than other residential
real estate exposures. Loans on property that are owner-occupied or
rented have both a consistent expected flow of payments on the loan, as
well as an occupant of the property that is present. Evaluating the
ability of the obligor to repay using consistent and transparent
metrics allows banking organizations and supervisors to more easily
compare the obligor's ability to repay with other borrowers in the
banking organization's loan portfolio. Modified or restructured loans
reflect that there might be deterioration in the ability of the
borrower to repay and, though not necessarily indications of likely
default, merit higher applicable risk weights than those that have no
such indications of potential deterioration in credit quality.
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, 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 would
be required to be primarily secured by fully completed real estate.\96\
Second, the banking organization would be required to hold a first
priority security interest in the property that is legally enforceable
in all relevant jurisdictions.\97\ Third, the exposure would be
required to be made in accordance with prudent underwriting standards,
including standards relating to supervisory LTVs. Fourth, during the
underwriting process, the banking organization would be required to
apply underwriting policies that account for the ability of the obligor
to repay in a timely manner
[[Page 14969]]
based on clear and measurable underwriting standards that enable the
banking organization to evaluate these credit factors. The agencies
expect that these underwriting standards would be consistent with the
agencies' safety and soundness and real estate lending guidelines. The
property would be required to be valued in accordance with the
requirements included in the proposed LTV ratio calculation, as
discussed below. Finally, the loan must not have been modified or
restructured.
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\96\ Commercial properties where the construction is complete
and the property is ready for its intended use.
\97\ 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 the criteria for a
regulatory commercial real estate exposure.
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As previously discussed, commercial real estate exposures that meet
these criteria would present relatively lower credit risk than other
commercial real estate exposures. Loans on property that is still under
construction are reliant on the completion of the property for
repayment of the loan, which can be delayed or interrupted by many
factors such as changes in market condition or financial difficulty of
the obligor.\98\ A perfected, first priority security interest would
provide the banking organization with priority for repayment in the
case of bankruptcy of the obligor.\99\ Evaluating the ability of the
obligor to repay using consistent and transparent metrics allows
banking organizations and supervisors to more easily compare the
obligor's ability to repay with other borrowers in the banking
organization's loan portfolio. As with residential exposures, permanent
commercial real estate loans that have been modified or restructured
indicate there might be a deterioration in the ability of the borrower
to repay, meriting higher applicable risk weights than those that have
no such indications.
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\98\ See, e.g., https://www.occ.gov/publications-and-resources/publications/comptrollers-handbook/files/commercial-real-estate-lending/pub-ch-commercial-real-estate.pdf.
\99\ See, e.g., https://www.occ.treas.gov/static/ots/exam-handbook/ots-exam-handbook-214aa.pdf.
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Question 19: What are the pros and cons of the proposed
requirements for real estate exposures to qualify as regulatory
commercial real estate exposures? How would the requirement for the
banking organization to hold a first-priority security interest in the
property that is legally enforceable in all relevant jurisdictions
impact loans to different types of commercial borrowers? For those
commercial real estate exposures where banking organizations do not
hold a first priority security interest in the underlying property,
what, if any, alternatives should the agencies consider that would
result in the same priority for repayment in the case of bankruptcy of
the obligor?
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 obligor's ability to service the loan is
dependent on cash flows generated by the real estate.
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 the dependence on cash flows generated from the
real estate is a conservative and straightforward measure of credit
risk. Reliance on cash flows from the property for repayment of a loan
indicates increased risk of nonpayment relative to when the borrower
has sufficient funds from other sources, such as income or business
profits, for full repayment of the loan. Given their increased credit
risk, the proposal would assign higher risk weights to exposures that
are dependent on proceeds or cash flows generated from the real estate
itself to service the loan.
Under the proposal, additional loan characteristics can affect
whether an exposure would be considered dependent on cash flows
generated by the real estate. The proposal's definition of dependent on
the cash flows generated by the real estate would exclude any
residential mortgage exposure that is secured by the obligor's
principal residence, as such mortgage exposures present reduced credit
risk relative to real estate exposures that are secured by the
obligor's non-principal residence.\100\ For residential properties that
are not the obligor'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 obligor's personal income and
resources, rather than rental income (or resale or refinance of the
property), to ascertain the obligor's capacity to repay the loan.\101\
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\100\ See Breck Robinson, Federal Reserve Bank of Richmond, and
Richard M. Todd, Federal Reserve Bank of Minneapolis, ``The Role of
Non-Owner-Occupied Homes in the Current Housing and Foreclosure
Cycle,'' Pg. 6, which cites multiple studies that loans on non-owner
occupied properties have higher loss rates on mortgages to non-
occupant owners than on mortgages to owner-occupants, at least after
controlling for credit scores and other standard underwriting
criteria. https://www.richmondfed.org/~/media/richmondfedorg/
publications/research/working_papers/2010/pdf/wp10-11.pdf.
\101\ 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.
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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 often dependent on
the cash flows generated by the real estate for repayment of the loan.
In the case of a loan to an obligor to purchase or refinance real
estate where the obligor will operate a business, such as a retail
store or factory, and rely solely on the revenues from the business or
resources of the obligor 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 obligor will rely solely on the
sale of products from the farm or other resources of the obligor other
than rental, resale, or other income from the real estate for
repayment.
Question 20: What are the pros and cons of the agencies
establishing a ``materially'' dependent on cash flows test that would
consider the source of repayment to be partly from the borrower's own
resources and partly from the cash flows/income generated by the real
estate? What, if any, quantitative threshold should the agencies
consider in determining whether a real estate exposure is dependent on
cash flows generated by the real estate (for example, the cash flows
generated from real estate reflect between 5 and 50 percent of amount
needed for repayment of the loan)? Further, if the agencies decide to
adopt a quantitative threshold, either for regulatory residential or
regulatory commercial real estate exposures, what should the agencies
consider when calibrating such a threshold for regulatory residential,
and separately for regulatory commercial real estate
[[Page 14970]]
exposures, and what would be the appropriate calibration levels for
each? Provide specific examples, including calculations and supporting
data. Relatedly, please provide views on how to define cash flows and
what expenses, if any, the agencies should consider.
iv. Calculating the Loan-to-Value Ratio
The proposal would require a banking organization to use LTV ratios
to assign a risk weight to a regulatory residential or regulatory
commercial real estate exposure. The proposed calculation of the 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.
Under the proposal, an LTV ratio would be calculated as the
extension of credit divided by the value of the property. The extension
of credit would mean the total outstanding amount of the loan including
the notional total of 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 would allow a banking
organization to assign a lower risk weight to a loan over time as the
principal is repaid. Similarly, if an extension of credit increases, a
banking organization would reflect that increase in the LTV ratio.
For purposes of the LTV ratios in Tables 2, 3, 4, 5 below, 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 for these purposes 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).\102\ During the 2007-2009 housing
market stress, the performance of private mortgage insurance
deteriorated at the same time as the underlying exposures.\103\ Under
the proposal and consistent with the current capital rule, private
mortgage insurance is considered when banking organizations identify if
a residential mortgage exposure is made in accordance with prudent
underwriting standards. As discussed earlier, under the proposal a
residential mortgage exposure must be made in accordance with prudent
underwriting standards and must meet other requirements to be
considered regulatory residential real estate exposures and therefore
eligible to be risk weighted according to the LTV table described
below.\104\
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\102\ A guarantor is not an eligible guarantor under the current
capital rule if the guarantor's creditworthiness is positively
correlated with the credit risk of the exposures for which it has
provided guarantees. 78 FR 62141 (Oct.11, 2013).
\103\ See Laurie Goodman and Karan Kuhl, ``Sixty Years of
Private Mortgage Insurance in the United States,'' The Urban
Institute Housing Finance Policy Center, August 2017. Pg. 7, https://www.urban.org/sites/default/files/publication/92676/2017_08_18_sixty_years_of_pmi_finalizedv3_3.pdf.
\104\ As described in section IV.A.2.c.i. of this SUPPLEMENTARY
INFORMATION, regulatory residential mortgage exposures must be made
in accordance with prudent underwriting standards, including
standards relating to supervisory LTVs, which allow for the
consideration of private mortgage insurance for permanent mortgage
or home equity loans on owner-occupied, 1- to 4-family residential
properties.
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The value of the property would mean the value at the time of
origination of all real estate properties securing the extension of
credit, including the increased estimated value of the property if the
property is being improved by an extension of credit. The value of the
property would also include 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
(collectively, the appraisal rule),\105\ 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 out of 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.
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\105\ See 12 CFR part 34, subpart C or subpart G (OCC); 12 CFR
part 208, subpart E or 12 CFR part 225, subpart G (Board); 12 CFR
part 323 (FDIC).
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In addition, when the real estate exposure finances the purchase of
the property, the value would be the lower of (1) the actual
acquisition cost of the property and (2) the market value obtained from
either (i) the valuation requirements under the appraisal rule (if
applicable) or (ii) as described above, an independent valuation of the
property using prudently conservative valuation criteria and that is
separate from the banking organization's origination and underwriting
process.
Using the value of a 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 a new 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 from 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, by an auction, or by a similarly available daily
bid and ask price market. 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.
[[Page 14971]]
Under the proposal, other acceptable collateral would include, among
other items, unconditional irrevocable standby letters of credit for
the benefit of the banking organization. Readily marketable collateral
and other acceptable collateral must be appropriately discounted by the
banking organization consistent with the banking organization's usual
practices for making loans secured by such collateral. The
reasonableness of a banking organization's underwriting criteria would
continue to be reviewed through the supervisory process to help ensure
its real estate lending policies are consistent with safe and sound
banking practices.
Question 21: What other approaches should the agencies consider to
recognize private mortgage insurance in the determination of the risk
weight of residential mortgage exposures? What would be the pros and
cons of providing explicit recognition of private mortgage insurance in
the calculation of LTV ratio for purposes of determining the risk
weights for regulatory real estate exposures? What, if any, increases
in procyclicality and incentives for increased risk-taking by banking
organizations might such recognition create? What conditions could the
agencies impose on such recognition to mitigate concerns about the
wrong-way risk of monoline credit insurance? In recognition that
private mortgage insurance may not provide protection under all
relevant stress events, what are the advantages and disadvantages of
recognizing a portion (such as 50 percent) of the value of the private
mortgage insurance in determining the total outstanding amount of the
loan in the calculation of the LTV ratio? Please provide any data and
analysis supporting alternative approaches.
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 without PMI and whether the exposure is dependent
on the cash flows generated by the real estate, in accordance with
Tables 2 and 3 below.\106\ 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 are meaningful determinants of credit risk for real estate
exposures. The proposed risk weights in each LTV ratio category are
intended to reflect differences in the credit risk of these
exposures.\107\
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\106\ Residential real estate exposures that are 90 days past
due or in nonaccrual would be assigned 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
would be assigned a 100 percent risk weight.
\107\ The risk weight assigned to loans does not impact the
appropriate treatment of loans under the agencies' other regulations
and guidance, such as the supervisory LTV limits under the real
estate lending guidelines.
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The proposed risk weights in Tables 2 and 3 would appropriately
balance the benefits of risk sensitivity, transparency, and consistency
in the risk weight for real estate exposures across banking
organizations subject to the expanded risk-based approach. Applying
lower risk weights to loans with lower LTVs aligns the credit risk of
the loan with the applicable risk weight, and relying on cash flows
from the property for repayment has historically indicated increased
credit risk that merits higher risk weights.
The proposal would also recognize the reduction in credit risk of
regulatory residential real estate exposures due to amortization, as
the obligor pays down principal and builds equity.\108\ The risk
weights for such exposures could decrease throughout the life of the
respective loans as obligors make payments. For example, analysis by
the agencies indicates that residential mortgage loans issued in the 90
percent to 100 percent LTV ratio category would have a lifetime average
risk weight approximately five percentage points
[[Page 14972]]
lower than the applicable risk weight at origination.\109\
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\108\ 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 limited circumstances. See
also Luis Otero Gonz[aacute]lez, Pablo Dur[aacute]n Santomil,
Milagros Vivel B[uacute]a and Rub[eacute]n Lado Sestayo, ``The
Impact of Loan-to-Value on The Default Rate of Residential MBS''
Journal of Credit Risk (July 2016), https://www.risk.net/journal-of-credit-risk/2465626/the-impact-of-loan-to-value-on-the-default-rate-of-residential-mortgage-backed-securities.
\109\ See section VII of this SUPPLEMENTARY INFORMATION for more
information explaining the analysis of the estimated ``effective''
risk weights applicable to residential mortgage exposures under the
proposal.
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The agencies recognize that some home buyers, especially low- and
moderate-income home buyers or those in historically underserved
markets, are more likely to be obligors of loans with higher LTV ratios
and thus higher risk weights under the approach described above. As a
result, borrowing costs for some low- and moderate-income home buyers
could be higher relative to obligors with lower LTV ratios. However,
many low-to-moderate income borrowers obtain mortgages through loan
programs administered by the Federal Housing Administration (FHA) or
Department of Veterans Affairs (VA). Consistent with the current
capital rule, banking organizations generally would apply a 20 percent
risk weight to real estate exposures guaranteed by the U.S. government
through the FHA or VA under the proposal. In addition, the proposed
risk weights applicable to regulatory residential real estate exposures
that have high LTV ratios would be generally consistent with the
applicable risk weights under the current standardized approach for
residential real estate exposures. The agencies estimate that the
proposed risk-based capital requirements for regulatory residential
real estate exposures that are not dependent on the cash flows of the
real estate--reflecting both credit risk weights and estimated
operational risk requirements--would be lower than the applicable risk-
based capital requirements for residential real estate mortgages
exposures under the current standardized approach for exposures with
LTV ratios at or below 90 percent and very similar for such exposures
with LTV ratios between 90 and 99 percent.\110\
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\110\ According to agency analysis, effective risk weights,
which reflect both credit risk weights and estimated add-ons to
reflect operational risk, are relatively constant or falling for
almost all types of mortgage obligors relative to the applicable 50
percent risk weight for prudently underwritten residential mortgage
exposures in the current standardized framework. For instance, for
low-to-moderate income obligors, the total equivalent risk weight
under the proposal is estimated to be 46 percent (42 percent from
credit risk and 4 percent from operational risk). See the economic
analysis presented in section VIII.D.2 of this SUPPLEMENTARY
INFORMATION.
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Question 22: Given the proposed treatment of residential real
estate exposures, how, if at all, would the proposed risk weights
impact home affordability and home ownership opportunities,
particularly for low-to-moderate income obligors or customers in other
historically underserved markets? Please provide supporting data.
Question 23: What alternative approaches for determining applicable
risk weights to residential real estate exposures should the agencies
consider and why? Please provide data supporting alternative
approaches, including factors that were the basis for underwriting the
loans and the historical repayment performance of the loans.
vi. Risk Weights for Regulatory Commercial Real Estate Exposures
Similar to the proposed approach 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, in accordance with
Tables 4 and 5 below. Further, in the case of a regulatory commercial
real estate exposure that is not dependent on cash flows generated by
the real estate for repayment, a banking organization would be required
to assign the risk weight applicable to the obligor, as reflected in
Table 4. If the LTV ratio of such an exposure 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 obligor would be, the banking organization would be
required to assign a 100 percent risk weight to the exposure unless the
exposures is 90 days more past due or in nonaccrual.\111\
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\111\ Commercial real estate exposures that are 90 days past due
or in nonaccrual would be assigned a 150 percent risk weight.
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[GRAPHIC] [TIFF OMITTED] TP27MR26.064
Regulatory commercial real estate exposures not dependent on cash
flows generated by the real estate often involve situations where the
borrowing entity occupies the property or the obligor has significant
other cash flows to repay the loan that the banking organization
considered when underwriting the loan. While these exposures generally
present lower credit risk relative to exposures to commercial real
estate dependent on cash flows
[[Page 14973]]
generated by the real estate, or other types of corporate exposures
where real estate collateral is not present, the risk profile of the
obligor impacts the applicable risk weight to appropriately reflect the
credit quality of the obligor in addition to the real estate
collateral. Therefore, the applicable risk weights in Table 4 for
regulatory commercial real estate exposures not dependent on cash flows
generated by the real estate reflect both the LTV ratio and the risk
profile of the obligor. In contrast, because the risks of commercial
real estate exposures dependent on cash flows generated by the real
estate are more dependent on the property, the risk weights in Table 5
reflect only the LTV ratio as a risk driver and generally are higher
relative to Table 4.
vii. 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.\112\ Real estate exposures that meet the definition of ADC
exposure but do not meet the definition of HVCRE exposure and are not
90 days past due or in nonaccrual 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 the
LTV ratio. 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 amortizing permanent loans for completed
residential or commercial real estate. ADC exposures have heightened
risk compared to permanent commercial real estate exposures, reflecting
uncertainty for unforeseen issues with construction or market
conditions, compared to the expected cash flow on a fully leased and
constructed commercial property. The proposal would be consistent with
the current standardized approach, as ADC exposures are generally
subject to a risk weight of 100 percent or more under the current
standardized approach.\113\
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\112\ 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.
\113\ OCC Commercial Real Estate Lending Handbook 2.0, https://www.occ.gov/publications-and-resources/publications/comptrollers-handbook/files/commercial-real-estate-lending/pub-ch-commercial-real-estate.pdf.
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viii. Other Real Estate Exposures
The proposal would define other real estate exposures as real
estate exposures that are not 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
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 would
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.
The 100 percent risk weight would apply to other real estate
exposures that are a residential mortgage exposure that is not
dependent on the cash flows generated by the real estate, which could
include junior lien home equity lines of credit (where the banking
organization does not also hold the first lien) and other second
mortgages, as these exposures reflect heightened credit risk compared
to first-lien exposures because the banking organization would receive
repayment only after more senior creditors in the instance of the
obligor defaulting. In addition, if a banking organization does not
adequately evaluate the creditworthiness of an obligor for an owner-
occupied residential mortgage exposure, or if the obligor 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.
d. Retail Exposures
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 be defined as an exposure
that is not a real estate exposure, and is an exposure to a natural
person or persons or an exposure to a small or medium-sized entity
(SME) \114\ 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 recognizes that many small companies
have characteristics more similar to those of a natural person than of
a larger corporation with respect to financial resources and the time
horizon under which it operates. 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 the advanced approaches,
which includes a broader range of exposures, including residential 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 not include real estate exposures.
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\114\ Under the proposal, 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 standards 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.
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The proposal would differentiate the risk-weight treatment for
retail exposures based on whether the exposure (1) qualifies as a
regulatory
[[Page 14974]]
retail exposure, (2) further qualifies as a transactor exposure; or (3)
does not qualify for either of the previous categories and therefore is
treated as an other retail exposure. The proposed risk weights assigned
to retail exposures consider characteristics such as payment history
and exposure size the latter of which is individually generally small
in dollar-per-loan volume for exposures captured within the scope of
the proposal's retail exposure definition. 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 an 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).
In addition, under the proposal, the amount of retail exposures to a
single obligor and its affiliates that a banking organization could
treat as regulatory retail exposures would be limited. 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).\115\ Limiting the types of
products and the dollar amount of exposures to a single obligor that
would qualify as regulatory retail exposures under the proposal would
help ensure that the regulatory retail treatment applies only to a set
of small exposures to a diversified group of obligors. A banking
organization would include all outstanding and committed but unfunded
regulatory retail exposures in determining the aggregated total to a
single obligor and its affiliates.
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\115\ The $1 million threshold for a retail exposure to qualify
as regulatory retail would be indexed using CPI-W. See section II.E.
of this SUPPLEMENTARY INFORMATION. For an off-balance sheet
exposure, the full notional amount of the exposure would apply
towards the $1 million threshold. If a retail exposure to a single
obligor and its affiliates does exceed the $1 million threshold,
then none of the exposures to that obligor would qualify as
regulatory retail exposures.
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Under the proposal, if an exposure to an SME does not meet the
eligible product criterion and the aggregate limit criterion described
above, then none of the exposures to that SME would qualify as retail
exposures and all 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 it meets the definition of a transactor exposure. An
exposure would not be a transactor exposure if the credit facility has
a balance or the facility includes installment payments, even if the
obligor was not required to make a payment, including when the credit
facility had a promotional offer such as a zero percent interest.
Under the proposal, a banking organization would assign a risk
weight of 45 percent to a regulatory retail exposure that is a
transactor exposure and a 75 percent risk to a regulatory retail
exposure that is not a transactor exposure. All other retail exposures
would be assigned a 100 percent risk weight. The proposed relatively
low 45 percent risk weight for a transactor exposure is appropriate
because such obligors have a demonstrated history of full and timely
repayment. A regulatory retail exposure that is not a transactor
exposure warrants the proposed 75 percent risk weight, which would be
lower than the proposed 100 percent risk weight for all other retail
exposures, due to mitigating factors related to size or concentration
risk. Any retail exposure that would not qualify as a regulatory retail
or a transactor exposure warrants a risk weight of 100 percent. The
proposed retail categories, risk weights, and risk indicators are
largely consistent with the Basel standards.
Question 24: 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 25: What, if any, changes to the methodology for the
aggregate limit calculation should the agencies consider? What are the
pros and cons of treating the amount of retail exposures to a single
obligor, when aggregated, below $1 million as regulatory retail
exposures, while the amount of exposures above $1 million to the same
obligor in aggregate would be treated as other retail exposures? The
agencies seek comment on whether there is a differentiation of risk to
the same obligor for exposures above and below the aggregate limit.
e. 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
company 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 the general creditworthiness of the
obligor; each exposure's level of subordination and the expected source
of repayment.\116\ First, a banking organization would be permitted to
assign a 65 percent risk weight to a corporate exposure that is an
exposure to a company that is investment grade based on the banking
organization's internal ratings system, subject to the criteria
outlined further below. 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.\117\ Third, a banking organization would assign a 100
percent risk weight to a project finance exposure that is in the
operational phase; otherwise, such an exposure would receive a 130
percent risk weight.
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\116\ The proposal would require banking organizations to apply
a 150 percent risk weight to corporate exposures that are either
subordinated exposures, as described in section IV.A.2.f. of this
SUPPLEMENTARY INFORMATION, or covered debt instruments that are not
deducted. See the Federal Reserve Board's rule on ``Total Loss-
Absorbing Capacity, Long-Term Debt, and Clean Holding Company
Requirements for Systemically Important U.S. Bank Holding Companies
and Intermediate Holding Companies of Systemically Important Foreign
Banking Organizations'' 12 CFR part 252.
\117\ See 12 CFR 3.32(f)(2) and (3) (OCC); 12 CFR 217.32(f)(2)
and (3) (Board); 12 CFR 324.32(f)(2) and (3) (FDIC).
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Fourth, a banking organization would assign a 100 percent risk
weight to 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. This would include exposures that finance income-producing
assets or projects that engage in non-real estate activities where the
[[Page 14975]]
obligor entity itself has no independent capacity to repay the loan.
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 broadly reflects the relative
risk of such corporate exposures, as exposures not deemed investment
grade generally pose greater credit risk than that of investment grade
corporate exposures.
i. Investment Grade Companies
Under the proposal, a banking organization would be permitted to
assign a 65 percent risk weight to a corporate exposure that is not a
subordinated exposure and is an exposure to a company that the banking
organization, using one or more internal credit risk rating systems
that meet certain requirements, determines is investment grade, as that
term is defined in Sec. __.2 of the capital rule. The definition of
investment grade, which would remain unchanged under the proposal,
requires that the entity has adequate capacity to meet its financial
commitments for the projected life of the asset or exposure.\118\ The
rule further provides that an 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. Thus, the
investment grade classification is intended to apply to companies of
high credit quality.\119\
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\118\ See 12 CFR 3.2 (definition of investment grade) (OCC); 12
CFR 217.2 (definition of investment grade) (Board); 12 CFR 324.2
(definition of investment grade) (FDIC).
\119\ The use of the investment grade definition in the current
capital rule was expanded in 2013 as part of a set of alternatives
to external credit ratings for calculating risk-weighted assets for
certain exposures, to implement section 939A of the Dodd Frank Act.
These alternative creditworthiness standards were designed to be
consistent with safety and soundness while also exhibiting risk
sensitivity similar to external credit rating categories. See 15
U.S.C. 78o-7 note. Prior to the 2013 capital rule, investment grade
was used in several areas of the capital rule, including in the
market risk framework, the treatment of securitization and equity
exposures, and in the requirements for recognizing certain
guarantees and collateral in the calculation of risk-weighted
assets. See Risk-Based Capital Guidelines: Market Risk, 77 FR 53060
(Aug. 30, 2012) (when the concept was initially introduced). In the
now-superseded capital rule that contained such references, a long-
term credit rating of BBB- or better and a short-term credit rating
of A3 or better were provided as examples of credit ratings
considered to be investment grade. See Risk-Based Capital Standards:
Advanced Capital Adequacy Framework--Basel II, 72 FR 69288, (Dec. 7,
2007).
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Corporate exposures typically exhibit significant differences in
default probabilities, loss severities, and correlation with broader
economic conditions based on many factors including the financial
strength and stability of the obligor. An investment grade designation
would provide a mechanism to increase risk sensitivity in the capital
framework by subdividing corporate exposures by credit risk. Further,
assigning separate risk weights for corporate exposures to investment
grade companies and non-investment grade companies would align capital
requirements more closely with actual risk.
To help promote the consistency and reliability of a banking
organization's investment grade determinations for purposes of
assigning a 65 percent risk weight to a corporate exposure and to
promote comparability in such determinations across banking
organizations, the proposal would set forth requirements for any
internal credit risk rating system used by banking organizations for
such purposes. Additionally, a banking organization would have to meet
proposed requirements when validating such systems.
The proposal would require that the internal credit risk rating
system that a banking organization would rely upon to make investment
grade determinations also be used to inform material business or risk
management decisions, such as those related to accounting, regulatory
reporting, risk management and measurement, loan loss reserve
estimation, capital planning, loan pricing, or supporting board of
directors' decision making. Using existing systems would allow banking
organizations to leverage existing data on obligors that are used for
other purposes to support their investment grade determinations under
the proposal, thus reducing regulatory burden. In addition, given their
importance in fundamental business processes, such systems are subject
to internal controls, oversight, and validation processes that help
ensure their reliability.
The banking organization would be required to define which obligor
rating grades within its internal credit risk rating system(s) are
considered to be investment grade, as that term is defined in Sec.
__.2 of the capital rule. Because the rating assessment and the
corresponding determination of investment grade would occur at the
obligor level, such determinations would not include exposure level
loss given default factors, such as credit enhancements, transaction
structure, and collateral.\120\ The proposal would require the internal
credit risk rating system to assign a rating grade for each obligor in
an accurate and timely manner, no less frequently than annually and
whenever the banking organization receives new material information
regarding the creditworthiness of the obligor. The proposal would also
require the internal credit risk rating system to incorporate both
quantitative and qualitative factors relating to the historical and
projected patterns of payment behaviors, the financial situation and
performance of each obligor, and any relevant developments that affect
the investment grade determination. Examples of quantitative risk
factors fitting these characteristics include, but are not limited to,
metrics relating to cash flow available to cover debt obligations,
levels of equity relative to debt, and quantities of liquid assets
relative to liabilities. Qualitative risk factors could include the
business model and economic sector of the obligor, the obligor's
willingness to repay, and market conditions. A banking organization
would not be permitted to rely solely on third-party assessments of
credit risk in its rating of obligors for purposes of determining
investment grade status. The proposal would require a banking
organization, at least annually, to validate the robustness,
consistency, and reliability of its internal credit risk rating system,
using data from at least one full credit cycle and taking care to
ensure that benign and stressful periods are appropriately represented.
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\120\ Under the proposal, credit risk mitigation techniques
could not be used to support investment grade determinations. See
section IV.A.5. of this SUPPLEMENTARY INFORMATION for a description
of how credit risk mitigants, such as guarantees and collateral, can
reduce the risk-weighted asset amount for certain exposures.
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As part of the validation of the internal credit rating system, the
proposal would require a banking organization to evaluate whether the
performance of the obligors identified by the internal credit risk
rating system as investment grade is consistent with the definition of
investment grade in Sec. __.2 of the capital rule, including by
benchmarking the investment grade ratings resulting from the internal
credit risk rating system with external information relating to the
creditworthiness of obligors. Such benchmarking may include comparisons
to external credit ratings of obligors produced by third parties. Using
external information as part of validating the internal credit risk
rating system could identify areas for improvement in the system and
may enhance consistency in investment
[[Page 14976]]
grade determinations across banking organizations.
Also, as part of the validation, the proposal would require a
banking organization to assess the reliability, accuracy, completeness,
timeliness, and appropriateness of the data sources used as part of the
investment grade determinations. The proposal would require a banking
organization to incorporate available information that is reasonably
expected to support a robust evaluation of the internal credit rating
system, including information regarding the performance of companies
that have ceased operations or that have been sold to a third party to
address potential survivorship bias. Properly accounting for obligors
that are sold to a third party or that cease operations would reduce
the likelihood of rating grades being skewed.
The proposal also would require a banking organization to ensure
that the validation process is independent of the internal credit risk
system's development, implementation, and operation, or subject the
validation process to an independent review of its adequacy and
effectiveness. These requirements around independence would help ensure
the objectivity, reliability, and integrity of the validation process.
Consistent with requirements under the current advanced approaches,
the proposal would require the validation process to incorporate
default data covering a period of at least five years and include a
period of stress. If the banking organization has relevant data that
extends beyond the five-year period, it would be required to
incorporate that data into the validation process. The banking
organization also would not be permitted to place undue weight on data
from periods of favorable or benign economic conditions relative to
economic downturn conditions. Appropriately reflecting and balancing
all relevant data over at least five years would help support an
accurate credit assessment.
Question 26: The agencies seek comment on the proposed treatment of
corporate exposures to companies that the banking organization
determines are investment grade. What, if any, operational challenges
might the proposed approach pose for banking organizations? How should
the agencies consider addressing such challenges?
Question 27: The agencies seek comment on the pros and cons of an
alternative approach to determining eligibility for the 65 percent risk
weight that would include requirements that banking organizations
demonstrate that the obligors meet certain quantitative thresholds
using commonly defined metrics such as probability of default in order
to demonstrate if the obligor merits an investment grade rating. What,
if any, operational challenges or limitations might numerical threshold
requirements pose for banking organizations in meeting the proposed
ratings criteria?
Question 28: What would be the pros and cons of requiring a banking
organization to receive prior approval of its internal credit risk
rating system from its primary Federal supervisor before applying the
preferential 65 percent risk weight compared to evaluation of its
compliance with the capital rule requirements by its primary Federal
supervisor during routine supervisory review processes? The agencies
are seeking feedback on the benefits that a preapproval process may
provide versus the operational burden imposed by such a process.
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 a power plant, manufacturing plant,
transportation infrastructure, telecommunications installation, or
other similar installation), both as the source of repayment and as
security for the exposure. 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.
In addition, a project finance exposure also must: (1) be to an obligor
entity that was created specifically to finance the project, operate
the physical assets of the project, or do both, and (2) the borrowing
entity must only have an immaterial amount of assets, activities, or
sources of income, apart from revenues from the activities of the
project being financed. 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 borrowing entity or the market value or sale of
the project or the real estate on which the project sits.\121\
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\121\ 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.
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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 of the project. The proposal
would define a project finance operational phase exposure as a project
finance exposure for which 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 obligations, in accordance
with the banking organization's applicable loan underwriting criteria
for permanent financings, and for which the outstanding long-term debt
of the project is declining. Prior to the operational phase
classification, the proposal would require a banking organization 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,
and produce expected revenue, 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 or other challenges could
disrupt timely completion of the project and the expected timing of the
transition to the operational phase. These unanticipated changes could
impact the ability of the project to generate cash flows as projected
and to repay creditors.
Under the proposal, an exposure that is considered to be secured by
collateral in the form of real estate \122\ where the banking
organization relies on real estate collateral to grant credit, would
not be considered a project finance exposure and would be assigned a
risk weight as described in section IV.A.2.c. of this SUPPLEMENTARY
INFORMATION.
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\122\ 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 IV.A.2.c 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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[[Page 14977]]
f. Subordinated Exposures
The proposal would introduce a definition and risk weight treatment
for subordinated exposures. Subordinated exposures present a greater
risk of loss to an investing banking organization relative to more
senior exposures to the same issuer or borrower because subordinated
exposures have a lower priority of repayment in the event of default.
The proposed definition of a subordinated exposure would capture
exposures that are financial instruments, such as debt securities and
loans, and present heightened credit risk but are not equity exposures,
as outlined in section IV.C. of this SUPPLEMENTARY INFORMATION. The
proposal would define a subordinated exposure as a corporate exposure,
a bank exposure, or an exposure to a GSE, that is subordinated by its
terms or separate intercreditor agreement to the general creditors of
the obligor, or an exposure to preferred stock that is not an equity
exposure. A subordinated exposure would not include a retail exposure
or a debt security issued by a sovereign, public sector entity,
multilateral development bank, or supranational entity, or an exposure
that would be captured under the securitization framework.
For these purposes, an exposure would be subordinated if the
documentation creating or evidencing such indebtedness (or a separate
intercreditor agreement) provides for the issuer's or obligor's general
creditors to rank senior to the payment of such indebtedness in the
event the issuer or obligor becomes the subject of a bankruptcy or
other insolvency proceeding. The scope of the definition of a
subordinated exposure is meant to capture the types of entities that
issue subordinated instruments and for which the level of subordination
is a meaningful determinant of the credit risk of the instrument. The
definition also captures instances where a banking organization makes
or purchases a loan that is subordinated to the general creditors of
the obligor. Limiting the scope of subordinated exposures to those
junior to general creditors, as proposed, would apply a heightened risk
weight to only those exposures for which subordination results in a
heightened credit risk relative to general creditors.
The proposal would apply a 150 percent risk weight to exposures
that meet the definition of a subordinated exposure, consistent with
the Basel standards. Relative to the current standardized approach, the
proposal provides more risk-sensitive approaches for several exposure
categories, including bank exposures, corporate exposures, and
exposures to GSEs, as described above in sections IV.A.2.a.-c. of this
SUPPLEMENTARY INFORMATION. The relative risk associated with those
exposures and the applicable risk weights for those exposures are based
on those exposures being in a senior loss position. Therefore, the
applicable risk weights for a subordinated exposure should reflect the
heightened credit risk of such exposures.
Question 29: The agencies seek comment on the scope of the proposed
definition of a subordinated exposure. What, if any, operational
challenges might the proposed definition pose for banking
organizations, and how should the agencies consider addressing such
challenges? The agencies seek comment on what, if any, exposures the
proposed definition would capture that commenters believe would not
reflect heightened credit risk that merits a heightened risk weight?
The agencies also seek comment on what, if any, subordinated exposures
the agencies have excluded from the proposed definition that merit a
heightened risk weight?
3. Off-Balance Sheet Exposures
The proposal would better capture the risk of certain off-balance
sheet exposures relative to the current standardized approach by
revising the definition of commitment to clarify the off-balance sheet
exposures that would be subject to risk-based capital requirements,
modifying the credit conversion factors applicable to commitments, and
introducing an exposure methodology for commitments without pre-set
limits.
a. Definition of Commitment
The current capital rule defines a commitment as any legally
binding arrangement that obligates a banking organization to extend
credit or to purchase assets.\123\ Such an arrangement is treated as a
commitment even when the banking organization has the unilateral right
to cancel the arrangement at any time. The agencies have received
questions from banking organizations regarding whether certain types of
arrangements, such as advised credit lines and uncommitted lines, would
be commitments even if they are unconditionally cancelable. In
addition, the agencies have observed an inconsistent application of the
current definition of commitment. The proposal would revise the
definition of commitment to clarify that any contractual arrangement
under which a banking organization and an obligor agree to the terms
applicable to one or more future extensions of credit, purchases of
assets, or issuances of credit substitutes by the banking organization
is a commitment, whether or not the arrangement is unconditionally
cancelable. Consistent with the current capital rule, an
unconditionally cancelable commitment would include a commitment that
permits a banking organization to, at any time, with or without cause,
refuse to extend credit, purchase assets, or issue credit substitutes
under the arrangement (to the extent permitted under applicable law).
Similarly, the proposal clarifies that a contractual arrangement to
extend credit, purchase assets, or issue credit substitutes, but which
does not obligate the banking organization to do so, is also considered
a commitment that is unconditionally cancelable.\124\ This approach
would promote comparable treatment across banking organizations subject
to the capital rule.
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\123\ See 12 CFR 3.2 (OCC); 12 CFR 217.2 (Board); 12 CFR 324.2
(FDIC).
\124\ The proposal would remove the definition of
``unconditionally cancelable,'' and revise the definition of
``commitment'' to indicate which commitments are considered
unconditionally cancelable.
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Commitments represent an arrangement where the banking organization
could expect to purchase assets or to extend credit to an obligor, in
which case the credit becomes an on-balance sheet asset. The scope of
the definition is, therefore, not intended to be limited to those
situations in which the banking organization is obligated to provide
some amount of credit to an obligor. The agencies do not, however,
intend for the definition of commitment to include arrangements where a
banking organization has merely offered potential terms to a potential
obligor or that continue to be subject to negotiation between the
parties. For the purpose of the regulatory capital rule, a commitment
does not and would not include pre-approval letters for residential
mortgage loans, credit card offers, or other offers that have not yet
been agreed upon by both parties to the transaction.
Examples of arrangements that would generally be considered
commitments under the proposal include fronting commitments, where a
banking organization agrees to fund the obligations of other members of
a syndicate of lenders, and commitment letters, where a banking
organization agrees to provide financing in connection with an
acquisition or other transaction to be entered into by the
[[Page 14978]]
obligor. The proposal would also include other off-balance sheet
activities such as advised lines or ``uncommitted'' facilities as
commitments (even if they are unconditionally cancelable or provide
that the banking organization is not obligated to perform). For
example, an arrangement under which a banking organization retains full
discretion as to whether to extend credit to a potential borrower, but
under which the banking organization and the potential borrower have
agreed to the material terms on which such lending would take place if
the banking organization chose to extend credit, is an unconditionally
cancelable commitment under the proposal. An unconditionally cancelable
commitment also includes an arrangement where a banking organization
provides an initial line of credit with an additional amount that the
banking organization may extend in the future subject to prior approval
by the banking organization, with the agreed upon terms of the future
unconditionally cancelable line.
Exposures without pre-set limits on the amount of credit that can
be extended would also be unconditionally cancelable commitments under
the proposal. With some retail products, such as with charge cards, the
banking organization does not disclose a pre-set credit limit to its
obligors. For charge cards, or similar types of off-balance sheet
exposures, each attempt to borrow by an obligor is individually
underwritten at the time of purchase and requires the approval of the
banking organization. Nevertheless, because the banking organization
and the borrower have agreed to the material terms on which such
lending would take place, such arrangements meet the definition of
commitment and, therefore, should be treated as unconditionally
cancelable commitments for regulatory capital purposes.\125\
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\125\ See section IV.A.3.c. of this SUPPLEMENTARY INFORMATION
for the proposed methodology to determine the exposure amount for
retail exposures with no pre-set limit.
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Question 30: The agencies seek comment on the proposed definition
of commitment. Does the proposal appropriately capture as off-balance
sheet exposures arrangements where the banking organization is not
legally obligated to extend credit, purchase assets, or issue credit
substitutes but which nonetheless arise out of a contractual
arrangement to extend credit or purchase assets? To what extent would
the proposed definition affect a banking organization's business
practices regarding commitments and similar arrangements, including how
banking organizations treat such arrangements for regulatory capital
and reporting purposes? Please provide any rationale or data that may
be helpful for the agencies to consider.
b. Credit Conversion Factors
Consistent with the current rule, under the proposed rule a banking
organization would calculate the exposure amount of an off-balance
sheet exposure by multiplying the off-balance sheet component, which is
usually the contractual amount, by the applicable credit conversion
factor. The resulting exposure amount would then be assigned to the
relevant risk-weight category for the exposure. The proposed expanded
risk-based approach would incorporate the same credit conversion
factors from the current capital rule, except with respect to
commitments.\126\
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\126\ Note issuance facilities and revolving underwriting
facilities are forms of revolving credit. Notes issued under note
issuance facilities and revolving underwriting facilities are short-
term instruments issued under a legally binding medium-term
contractual arrangement. Under a revolving underwriting facility,
the underwriting banking organization agrees to provide loans should
the issue fail, but under a note issuance facility the banking
organization could either lend to the issuer or purchase the
outstanding notes. Consistent with the current rule and with the
Basel standards, the proposal would require banking organizations to
apply a 50 percent credit conversion factor to the off-balance sheet
amount of note issuance facilities and revolving underwriting
facilities, regardless of whether a lower credit conversion factor
would otherwise apply.
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Relative to the current standardized approach and consistent with
the Basel standards, the proposal would simplify the credit conversion
factors applicable to the unused portion of a commitment that is not
unconditionally cancelable relative to the current standardized
approach. For these commitments, the proposal would no longer
differentiate credit conversion factors by original maturity of one
year or less and greater than one year.\127\ Under the proposal, a
commitment that is not unconditionally cancelable would be subject to a
credit conversion factor of 40 percent regardless of the maturity of
the facility.\128\ This would remove the one-year mark as a dividing
line between substantially different treatments, which would remove any
regulatory incentive to structure transactions around that line. The 40
percent credit conversion factor would align with international
standards and reflect that most outstanding commitments that are not
unconditionally cancelable have a maturity greater than one year.\129\
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\127\ Currently, commitments that are not unconditionally
cancelable with an original maturity of one year or less receive a
20 percent credit conversion factor and those with an original
maturity of more than one year receive a 50 percent credit
conversion factor. 12 CFR 3.33(b)(2) (OCC); 12 CFR 217.33(b)(2)
(Board); 12 CFR 324.33(b)(2) (FDIC).
\128\ Under the proposal, a 40 percent CCF would also apply to
commitments that are not unconditionally cancelable commitments for
purposes of calculating the total leverage exposure for the
supplementary leverage ratio framework and for the calculation of
the Size Category of the FR Y-15 Systemic Risk Report form.
\129\ The FR Y-9C indicates (see HC-R Part II items 18.a and b)
that prior to application of the credit conversion factor, as of Q2
2025, 84 percent of the exposure and 85 percent of the standardized
risk-weighted assets of Category I and II bank holding companies
have original maturity exceeding one year.
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For the unused portion of a commitment that is unconditionally
cancelable \130\ by the banking organization, the proposal would
require a banking organization to apply a credit conversion factor of
10 percent. Under the current capital rule, unconditionally cancelable
commitments receive a credit conversion factor of zero percent.
Although unconditionally cancelable commitments allow banking
organizations to cancel such commitments at any time without prior
notice, subject to compliance with consumer protection laws, in
practice, risk management practices of the banking organization may
constrain the organization's willingness to cancel such
commitments.\131\ In addition, banking organizations may extend credit
or provide funding to support the viability of obligors to which the
banking organization has significant ongoing exposure, even when
obligors 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 otherwise, such as for less substantial customer relationships,
cause the banking organization to cancel a commitment. For these
reasons, the agencies are proposing nonzero credit conversion factors
for unconditionally cancelable commitments.
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\130\ As discussed in section IV.A.3.a. of this SUPPLEMENTARY
INFORMATION, the proposal would provide that a commitment is
unconditionally cancelable if by its terms, it either: (a) provides
that a banking organization is not obligated to extend credit,
purchase assets, or issue credit substitutes; or (b) permits a
banking organization to, at any time, with or without cause, refuse
to extend credit, purchase assets, or issue credit substitutes under
the arrangement (to the extent permitted under applicable law).
\131\ See, e.g., 12 CFR 1002.9 (adverse action notices), 12 CFR
1026.9(c) (subsequent disclosure requirements for open-end credit),
and 12 CFR 1026.40(f) (limitations on changes to home equity lines
of credit).
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Under the proposal, certain retail credit card exposures would be
subject to reduced risk-weights relative to the current standardized
approach, as
[[Page 14979]]
discussed in section IV.A.2.d. of this SUPPLEMENTARY INFORMATION.
However, the overall risk-weighted asset amount associated with such
exposures may be higher relative to the current standardized approach
due to the increase in the credit conversion factors described
above.\132\
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\132\ For additional considerations of the proposed approach,
data on credit conversion factors, and on the impact of the proposal
on credit cards, see the economic analysis presented in section
VIII.E.1. of this SUPPLEMENTARY INFORMATION.
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Question 31: What additional factors, if any, should the agencies
consider for determining the applicable credit conversion factors for
commitments?
Question 32: What other approaches to setting a credit conversion
factor for unconditionally cancelable commitments should the agencies
consider and why? To what extent and under what circumstances should an
obligor's historical usage patterns for unconditionally cancelable
commitments that are transactor exposures affect the credit conversion
factor for such exposures? What average utilization rate (for example,
10 percent) over what time period (for example, 24 months) would
support a credit conversion factor lower than 10 percent? Please
include any relevant data.
Question 33: What are the advantages and disadvantages relative to
the proposal of using the current treatment for commitments, that are
not unconditionally cancelable which differentiates credit conversion
factors based on maturity, and would apply a 20 percent credit
conversion factor to those commitments with an original maturity of one
year or less, and a 50 percent credit conversion factor to those with
an original maturity of more than one year?
Question 34: What are the advantages and disadvantages of applying
the proposed 40 percent credit conversion factor for commitments
regardless of maturity that are not unconditionally cancelable to the
supplementary leverage ratio framework and to the Size Category of the
FR Y-15?
c. Commitments With No Pre-Set Limit
Most off-balance sheet exposures, such as credit card lines, 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. For commitments that are retail
exposures that do not have an 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 (undrawn
exposure amount).
For commitments that are retail exposures, the undrawn exposure
amount would be calculated by using the exposure's highest drawn amount
over the previous 24 months as an indicator of the amount of credit a
banking organization is likely to extend to an obligor in the future.
Specifically, under the proposal, a banking organization would first
identify the largest drawn amount by a retail obligor over the prior 24
months or, if the banking organization has offered the product to the
obligor for fewer than 24 months, the largest drawn amount since the
commitment was first issued. The off-balance sheet exposure amount
would be calculated by first subtracting the current drawn amount from
the largest drawn amount and then multiplying this difference by the
applicable credit conversion factor.\133\ The risk-weighted asset
amount would be the off-balance sheet exposure amount multiplied by the
applicable risk weight for the obligor.
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\133\ Under the proposal, the methodology for calculating the
undrawn exposures amount for retail commitments with no explicit
contractual pre-set limit would also apply for purposes of
calculating total leverage exposure for the supplementary leverage
ratio.
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A substantial share of uncapped commitments are in the form of
retail charge cards, and these exposures have characteristics that
suggest the highest drawn balance method described above is a
reasonable proxy to estimate the undrawn exposure amount. A charge card
does not have a pre-set credit limit, its balance is generally required
to be paid in full at the end of each statement period, and charge card
transactions are generally underwritten separately and reviewed by the
issuing banking organization for approval or denial. Therefore, a
charge card obligor's spending pattern, which reflects a banking
organization's approval of the charge card obligor's usage, is
indicative of the off-balance sheet exposure amount for a retail charge
card.
As an example of the proposed treatment, assume a retail obligor's
charge card had a maximum drawn amount of $4,000 during the period of
the prior 24 months and a current drawn amount of $3,000.\134\ To
determine the off-balance sheet exposure amount of the charge card, a
banking organization would (1) identify the maximum drawn amount over
the prior 24 months ($4,000), (2) subtract the applicable drawn amount
of $3,000 from $4,000 ($1,000), and (3) multiply $1,000 by the
applicable credit conversion factor (assuming a credit conversion
factor of 10 percent, $100). For this example, assume the obligor's
charge card would qualify as a regulatory retail exposure that is a
transactor exposure. Applying the proposed 45 percent risk weight for
transactor exposures to the off-balance sheet exposure amount of $100
would result in a risk-weighted asset amount of $45, which would apply
in addition to the risk-weighted asset amount of $1,350 for the on-
balance sheet exposure (the drawn amount of $3,000).
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\134\ The maximum balance would reflect the highest drawn amount
on any date during the previous 24 months for the retail account
with no pre-set limit over the period.
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Question 35: What are the advantages and disadvantages of the
proposed treatment for commitments to retail obligors with no express
contractual maximum amount or pre-set limit? What other time period or
approach should the agencies consider for calculating the highest drawn
amount (for example, using month-end balance or statement balances),
and why?
Question 36: What would be the advantages and disadvantages of
applying a multiplier to the highest drawn amount to calculate the off-
balance sheet exposure amount (for example, multiplying the highest
drawn balance by a figure between 1.5 and 3) to calculate the off-
balance sheet exposure amount? \135\ If applied, how should such
multiplier be calibrated? What data should the agencies use to
calibrate such a multiplier?
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\135\ If a multiplier of two were applied to the maximum drawn
amount over the prior 24 months, under the example presented above,
the off-balance sheet exposure amount would equal $5,000, which
corresponds to $4,000 times two minus $3,000. The other steps of the
process would remain unchanged and would result in a risk-weight
asset amount of $225 for the off-balance sheet exposure.
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Question 37: The agencies seek feedback on commitments that contain
no express contractual maximum amount but also contain features such as
a ``pay over time'' limit, which allows a borrower to carry a balance
with interest on certain charges. What would be the advantages and
disadvantages of incorporating the ``pay over time'' limit as a floor
when calculating the highest drawn amount under the proposal? For
example, assume the maximum drawn amount over the prior 24 months is
$4,000 and the ``pay over time'' limit is $5,000. Under this
alternative, the applicable drawn amount would be subtracted from
$5,000 instead of $4,000.
Question 38: The proposal would apply the specific treatment
described above to commitments to retail obligors with no contractual
maximum or pre-set
[[Page 14980]]
limit. The agencies seek comment on the appropriate treatment for
commitments to non-retail obligors with no contractual maximum amount
or pre-set limit. The agencies request comment on the product types,
structures, risks, materiality, and loss history of commitments to non-
retail obligors with no contractual maximum amount or pre-set limit.
Please provide specific product examples and relevant data. What would
be the advantages and disadvantages of applying the proposed treatment
for commitments to retail obligors with no pre-set limit to such
commitments to non-retail obligors? What would be the advantages and
disadvantages of using the average total drawn amount over the period
since the commitment to a non-retail obligor was created or the prior
24 months, whichever period is shorter, for the committed but undrawn
amount? What would be the advantages and disadvantages of applying a
multiplier to the highest drawn amount (for example, multiplying the
highest drawn balance by a figure between 1.5 and 3) to calculate the
off-balance sheet exposure amount? If applied, how should such
multiplier be calibrated? What other alternative treatments should the
agencies consider, and why? Please provide any rationale or data that
may be helpful for the agencies to consider.
4. Counterparty Credit Risk-Related Exposures
Under the current capital rule, a covered banking organization is
required to use the standardized approach to counterparty credit risk
(SA-CCR) to calculate the exposure amount of derivative contracts. The
proposal would retain this treatment, with the following modification.
For noncleared repo-style transactions that are included in a
qualifying cross-product netting set that includes derivatives, a
banking organization may elect to use SA-CCR to calculate the exposure
amount of the netting set. Where a banking organization does not make
such an election, it would use the collateral haircut approach to
calculate the exposure amount for a repo-style transaction. Consistent
with the current capital rule, the proposal would continue to allow
banking organizations to use either the collateral haircut approach or
the simple approach to calculate the exposure amount for eligible
margin loans and repo-style transactions, provided that the banking
organization uses the same approach for similar exposures or
transactions.
a. Collateral Haircut Approach
Under the proposal, as under the current capital rule, a banking
organization would be permitted to recognize the credit risk-mitigation
benefits of collateral supporting repo-style transactions, eligible
margin loans, and netting sets of such transactions by adjusting its
exposure amount to its counterparty to recognize financial collateral
received and any collateral posted to the counterparty. The expanded
risk-based approach would incorporate the collateral haircut approach
in the current standardized approach with some modifications that are
generally consistent with the Basel standards. The collateral haircut
approach would continue to 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 currency mismatch.
To increase the risk-sensitivity of the collateral haircut approach,
the proposal would modify certain of the standard market price
volatility haircuts. At the same time, to reduce unwarranted divergence
in risk-weighted assets, the proposal would no longer allow a banking
organization to use its own internal estimates for calculating
haircuts.
i. Formula for Determining Exposure Amount
The proposal would introduce a new formula for calculating the
exposure amount of eligible margin loans, repo-style transactions, or
netting sets thereof. The proposed exposure amount equation is revised
from the current formula to improve the recognition of the risk-
mitigating benefits of netting and portfolio diversification. The
proposed formula would revert to the current collateral haircut
approach formula in cases where there are no variables to populate the
second and the third components as described below. The modification
would increase the risk sensitivity of the capital requirement for such
transactions relative to the current collateral haircut approach. Under
the proposal, the exposure amount (E*) of a netting set of eligible
margin loans or repo-style transactions or an individual transaction
that is not part of a netting set would be determined according to the
following formula:
[GRAPHIC] [TIFF OMITTED] TP27MR26.065
Where:
E* is the exposure amount of the eligible margin loan,
repo-style transaction, or 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 = [sum]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. __.115, 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
[[Page 14981]]
resale, or taken as collateral from the counterparty.
N is the number of instruments with a unique Committee on
Uniform Securities Identification Procedures (CUSIP) designation or
foreign equivalent, with certain exceptions. N includes 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]i Ci)
would capture the baseline exposure of eligible margin loans, repo-
style transactions, or netting sets thereof, after accounting for the
value of any collateral received. The second (0.4 x
netexposure) and third (0.6 x (grossexposure/
[verbar]N)) components in the above formula would allow for the partial
recognition of the netting and diversification benefit of instruments
exchanged between a banking organization and a given counterparty
within a netting set. The net exposure component partially recognizes
the offsetting of gross exposures between a given instrument that is
both lent and received as collateral within a netting set.
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 component would capture the
impact of diversification in the types of instruments lent or received.
The fourth component ([Sigma]fx(Efx x Hfx)) would capture any
adjustment to reflect currency mismatch, if applicable.
When determining the market price volatility and currency mismatch
haircuts, the banking organization would use the market price
volatility haircuts described in the following section and a standard 8
percent currency mismatch haircut, subject to certain adjustments.
Question 39: What are the pros and cons of basing N for purposes of
the collateral haircut approach on the number of unique CUSIPs in a
netting set? What alternatives should the agencies consider and how
would such alternatives align with the goal of identifying the number
of instruments for purposes of measuring diversification in the pool?
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. __.115 below, when calculating the
exposure amount 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.
Proposed Table 1 to Sec. __.115
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\136\ Includes a foreign PSE that receives a zero percent risk
weight.
\137\ Includes senior securitization exposures with a risk
weight greater than or equal to 100 percent and sovereign exposures
with a risk weight greater than 100 percent.
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[[Page 14982]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.066
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 14983]]
prominently in the instrument's market price volatility, as described
below.
The proposal would apply haircuts primarily based on residual
maturity, rather than a combination of residual maturity and underlying
risk weight as under the current capital rule, for non-sovereign
investment grade 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 changes in both interest rates
and the creditworthiness of the issuer.
Because securitization exposures tend to be more volatile than
corporate debt, 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. Because senior securitization exposures
absorb losses only after more junior securitization exposures, these
exposures have an added layer of security and distinct market price
volatility. Therefore, the proposal would only specify term-based
haircuts for investment grade senior securitization exposures that
receive a risk weight of less than 100 percent under the securitization
framework. Other securitization exposures would receive the 30 percent
market price volatility haircut applicable to ``other'' exposure types.
The proposal would require a banking organization to apply market
price volatility haircuts of 20 percent for main index equities
(including convertible bonds) and gold, 30 percent for other publicly
traded equities and convertible bonds, and 30 percent for other
exposure types. Equities in a main index typically are more liquid than
those that are not included in a main index, in part because 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 current collateral haircut approach in
which a banking organization would apply the highest haircut applicable
to any security in which the fund can invest. Under the proposal, a
banking organization could treat exchange traded fund (ETF) shares in
the same manner as mutual fund shares and apply haircuts based on the
underlying instruments in the fund. Given that ETFs (like mutual funds)
benefit from diversification and tend to have lower levels of price
volatility compared to non-pooled investment vehicles, a look-through
approach is more risk sensitive than applying the publicly traded
equities haircut for ETF shares. The proposal also would include an
alternative method available to a banking organization if the mutual
fund or ETF qualifies for the full look-through approach described in
section IV.C. of this SUPPLEMENTARY INFORMATION. This alternative
method would provide a more risk-sensitive calculation of the haircut
on fund shares collateral by using the weighted average of haircuts
applicable to the instruments held by the fund.\138\
---------------------------------------------------------------------------
\138\ If the mutual fund qualifies for the full look-through
approach under the proposed equity framework, as described in
section IV.C. of this SUPPLEMENTARY INFORMATION, but would be
treated as a market risk covered position as described in section
V.A.4. 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, consistent with the Basel standards, the proposal
would require 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. __.115.
b. Standardized Approach to Counterparty Credit Risk
The agencies incorporated SA-CCR for calculating the exposure
amount of derivative contracts into the capital rule in 2020.\139\ This
change required advanced approaches banking organizations to use SA-CCR
instead of the current exposure methodology when calculating
standardized total risk-weighted assets and total leverage exposure.
Similarly, the proposal would require a covered banking organization to
use SA-CCR to determine the exposure amount for derivatives under the
expanded risk-based approach and the supplementary leverage ratio.\140\
The proposal would also revise SA-CCR in certain ways to better reflect
risks associated with evolving market practices. Specifically, for
risk-based capital purposes, the proposal would revise SA-CCR to
recognize qualifying cross-product master netting agreements for non-
cleared transactions and incorporate certain non-cleared (such as
client-facing) repo-style transactions. Additionally, the proposal
would revise SA-CCR to permit the netting of collateralized-to-market
and settled-to-market client-facing derivative transactions. The
agencies are also proposing technical revisions to assist banking
organizations in implementing SA-CCR in a consistent manner and more
appropriately reflect the counterparty credit risk posed by derivative
transactions.
---------------------------------------------------------------------------
\139\ 85 FR 4362 (Jan. 24, 2020).
\140\ 12 CFR 3.10(c)(2)(ii)-(iii), 12 CFR 3.34(a) (OCC); 12 CFR
217.10(c)(2)(ii)-(iii), 12 CFR 217.34(a) (Board); 12 CFR
324.10(c)(2)(ii)-(iii), 12 CFR 324.34(a)(a) (FDIC).
---------------------------------------------------------------------------
Question 40: Consistent with the current rule, the proposal would
require a banking organization to multiply the sum of the replacement
cost of a netting set, calculated as stipulated by the SA-CCR
framework, and the potential future exposure of a netting set by a
factor of 1.4 if the relevant counterparty is not a commercial end-
user, versus a factor of 1.0 if the counterparty is a commercial end-
user. Currently, the SA-CCR framework of the capital rule requires
banking organizations to identify whether counterparties are commercial
end-users. What would be the advantages or disadvantages of allowing
banking organizations to apply the higher factor of 1.4 for all
derivative transactions, rather than having to distinguish based on
whether the counterparty qualifies as a commercial end-user? Please
provide any rationale or data that may be helpful for the agencies to
consider.
Question 41: For purposes of the supplementary leverage ratio, the
proposal would not modify SA-CCR to recognize qualifying cross-product
master netting agreements for non-cleared transactions or to
incorporate certain non-cleared (including client-facing) repo-style
transactions, given that it is meant to serve as a non-risk-based
measure. What are the advantages and disadvantages of modifying the
supplementary leverage ratio to recognize such cross-product netting?
If the agencies were to consider such recognition, what if any
adjustments to the measure should be considered to align with the
supplementary leverage ratio's non-risk-based nature and why?
[[Page 14984]]
i. Amend SA-CCR To Recognize the Netting of Non-Cleared Repo-Style
Transactions and Derivative Transactions
A netting set refers to a group of transactions between a banking
organization and a single counterparty governed by a qualifying master
netting agreement. Qualifying master netting agreements create a single
net legal obligation for all individual transactions covered by the
agreement and allow for close-out netting upon the event of default. By
treating all transactions under the agreement as one combined
obligation, these agreements recognize risk-offsets between
transactions.
Cross-product netting is a risk management technique that involves
the inclusion of multiple types of financial products in one netting
set. Generally, cross-product netting reduces risk exposure by allowing
banking organizations to recognize offsets between positive and
negative exposures across different financial product types and to
calculate a single net exposure amount for collateral and default
management. Cross-product netting sets allow the benefits of qualifying
master netting agreements (such as close-out netting) to apply for a
broader set of transactions than those included in a single-product
netting set.\141\ For example, if a banking organization has a $5
million positive exposure to a counterparty under one swap transaction
and a $2 million negative exposure to the same counterparty under a
repo-style transaction, cross-product netting would allow for a net
exposure of only $3 million to be recognized, rather than two separate
exposures of $5 million and $2 million. Recognizing the risk-mitigating
benefits of cross-product netting better aligns capital requirements
with risk because it allows offsetting risks between products to be
recognized and capitalized jointly rather than separately.
---------------------------------------------------------------------------
\141\ Under the proposal, cross-product netting sets would be
governed by qualifying cross-product master netting agreements as
described below.
---------------------------------------------------------------------------
Consolidating exposures across products into a single netting set
can also simplify risk management processes for banking organizations
and reduce operational burden. The quantity of netting sets would
generally be reduced, as banking organizations would be able to net
transactions with multiple products together. Thus, a banking
organization's net exposure to a single counterparty typically would be
lower, reducing counterparty credit risk. Additionally, cross-product
netting allows banking organizations to improve collateral management
and expand liquidity efficiency across different product types. Instead
of calculating collateral requirements and posting collateral for
transactions of each product type (such as derivative and repo-style
transactions) separately, cross-product netting allows for collateral
requirements to be determined on a net basis for all transaction types
in the same netting set.
The capital rule currently recognizes cross-product netting in the
advanced approaches, under which banking organizations can measure
counterparty credit exposure of a cross-product netting set using the
internal models methodology (IMM). Since the agencies' are proposing to
remove the IMM from the capital rule, the proposed revisions to SA-CCR
to recognize qualifying cross-product master netting agreements and
incorporate certain repo-style transactions for risk-based capital
purposes would provide an avenue for banking organizations to recognize
the benefits of cross-product netting in a standardized, transparent
manner rather than through a banking organization's internal model. The
proposed modifications to the exposure amount calculation in SA-CCR
would recognize the risk-mitigating benefits of cross-product netting
for banking organizations helping to facilitate market liquidity.
Recognizing the benefits of cross-product netting in SA-CCR would
also allow banking organizations to better serve in their role as
clearing members. Many clients of clearing members do not meet the
requirements to become a clearing member of a central counterparty. As
a result, without a clearing member stepping in to act as an
intermediary, money market funds, pension funds, insurance funds, hedge
funds, and other clients may not have access to central counterparty
services and market access more broadly. The proposed revision to
permit the netting of derivatives and non-cleared repo-style
transactions would include clearing members' intermediation-related
transactions, which are typically considered client-facing transactions
under the capital rule.\142\ Permitting cross-product netting for
derivative transactions and repo-style transactions in SA-CCR promotes
smooth market functioning and liquidity and better aligns the risk-
based capital treatment of intermediation-related transactions with
their economics.
---------------------------------------------------------------------------
\142\ Client-facing transactions are not considered cleared
transactions under the capital rule. See 12 CFR 3.2 cleared
transaction, (2) (OCC); 12 CFR 217.2 cleared transaction, (2)
(Board); 12 CFR 324.2 cleared transaction, (2) (FDIC).
---------------------------------------------------------------------------
To incorporate non-cleared repo-style transactions subject to a
qualifying cross-product master netting agreement in SA-CCR, the
proposal would treat them as forward derivative transactions with the
security underlying the repo-style transaction determining the SA-CCR
asset class.\143\
---------------------------------------------------------------------------
\143\ Under the current capital rule, a qualifying cross-product
master netting agreement is generally defined, as a qualifying
master netting agreement that provides for termination and close-out
netting rights across multiple types of financial transactions. As a
type of qualifying master netting agreement, a qualifying cross-
product master netting agreement would be required, among other
provisions, to create, upon an event of default, a single legal
obligation for all individual transactions covered by the agreement
and to provide the banking organization with the right to liquidate
or set-off any collateral provided in respect of any of the
transactions covered by the agreement against the net amount owed
across all the individual transactions. Accordingly, if a banking
organization's rights upon an event of default to net certain
transaction types (e.g., derivatives) against other transaction
types (e.g., repo-style transactions), or to apply collateral
provided in respect of one type of transaction against amounts owed
on other types of transactions, were restricted or limited under the
relevant contractual agreements or applicable law, a banking
organization would not be permitted recognize cross-product netting.
---------------------------------------------------------------------------
The agencies are proposing to include a restriction on the amount
of offsetting for recognized between derivatives and repo-style
transactions within SA-CCR to capture the mismatch between maturities
of repo-style transactions and those of derivative contracts.\144\ In
addition, for an entire cross-product netting set, banking
organizations would have to calculate the exposure amount for the
subset of the cross-product netting set that includes only derivative
contracts and the exposure amount for the subset of the cross-product
netting set that includes only repo-style transactions. The exposure
amount for the entire cross-product netting set
[[Page 14985]]
would be a weighted average of two exposure numbers. One exposure
amount would be the combined exposure for repo-style transactions and
derivatives in the cross-product netting set using SA-CCR, weighted by
a maturity ratio (MR). The other exposure amount would be the sum of
the exposure amounts of the repo-style transactions in the netting set
using the collateral haircut approach and the exposure amounts of
derivatives transactions in the netting set using SA-CCR, weighted by
(1-MR). MR would be the maturity ratio factor determined by the ratio
of the notional average weighted maturity of the repo-style
transactions to the notional average weighted maturity of the
derivatives contracts or repo-style transactions within the cross-
product netting set, whichever is longer. The maturities calculated
this way would be floored by 10 business days and capped by 1 year. The
MR would be capped at 1.
---------------------------------------------------------------------------
\144\ The SA-CCR framework allows for offsetting positions to
net for purposes of measuring exposure. In general, such netting can
occur at a particular moment in time, so no short-term transaction
can have any impact on exposure at long time horizons. Because of
this, time averaging for the purposes of exposure calculation should
be performed after exposure contributions of individual transactions
are aggregated to the netting set exposure for each future time
point. However, to simplify calculations, SA-CCR performs time
averaging for each transaction in the netting set prior to the
aggregation. This leads to a possibility of short-term transactions
materially offsetting the risk of long-term transactions. This is
not a major concern for netting sets of derivatives, which often
have medium and long-term durations. However, because repo-style
transactions are primarily short-term (often overnight), applying
SA-CCR to a cross-product netting set would likely overstate the
impact of repo-style transactions on the netting set exposure. The
proposed maturity mismatch restriction on cross-product netting
would mitigate this overstatement.
---------------------------------------------------------------------------
Permitting the netting of repo-style transactions and derivative
transactions subject to qualifying cross-product master netting
agreements in SA-CCR and the proposed limitation on offsetting
transactions promotes responsible counterparty credit risk mitigation
and ensures the capital requirement better reflects such transactions'
risk profile and economic relationship. Recognizing cross-product
netting in SA-CCR would create capital efficiency for banking
organizations, align with banking organizations' risk management
practices for counterparty credit risk, and promote smooth market
functioning and liquidity.
The agencies have proposed to permit the netting of repo-style
transactions and derivative transactions subject to qualifying master
netting agreements in SA-CCR, and not to recognize cross product
netting of eligible margin loans. Although eligible margin loans have
similarities to repo-style transactions, such as both being
collateralized by liquid and readily marketable securities, they differ
from repo-style and derivative transactions in that eligible margin
loans are not typically included in qualifying master netting
arrangements. The agencies are seeking input on whether and how cross-
product netting should be recognized for eligible margin loans. The
proposal also would not permit cross-product netting for cleared
transactions, as cleared transactions are typically not included in
netting sets with non-cleared transactions. The agencies are seeking
feedback on the scope of the proposed recognition of cross-product
netting, including whether the scope of cross-product netting should be
expanded to include cleared transactions.
Question 42: The agencies seek comment on what, if any, challenges
banking organizations may face in using SA-CCR to determine exposure
amounts for counterparty credit risk (e.g., whether SA-CCR could
underestimate or overstate the exposure amount for some portfolios).
What are the advantages and disadvantages of retaining the IMM for
counterparty credit risk? If the IMM were retained, what corresponding
modifications should the agencies make to the current version of the
IMM to maintain appropriate alignment between SA-CCR and IMM?
Question 43: What, if any, additional changes should be made to the
scope of cross-product netting recognition under SA-CCR? For example,
if the scope of cross-product netting recognition in SA-CCR were
expanded to eligible margin loans, what would be the advantages and
disadvantages of this expanded scope? What are the advantages and
disadvantages of extending cross-product netting recognition in SA-CCR
to cleared transactions?
Question 44: Are there any modifications to the operational
requirements for qualifying cross-product master netting agreements
that the agencies should consider in connection with the recognition of
netting of certain repo-style transactions in SA-CCR?
ii. Netting of Collateralized-to-Market (CTM) and Settled-to-Market
(STM) Client-Facing Derivative Transactions
Under SA-CCR in the current capital rule, the exposure amount of a
derivative netting set is calculated as the sum of replacement cost and
potential future exposure (PFE) multiplied by an alpha factor. While
the capital rule allows netting of all derivative contracts within a
netting set in the replacement cost calculations, netting across
margined and unmargined derivative contracts in the same netting set is
limited to cleared transactions for purposes of the PFE calculations.
Settled-to-market derivative contracts are those in which daily
payments are made to settle the mark-to-market exposure. These payments
are made on a periodic basis to reflect changes in exposure that arise
from marking a derivative contract to fair value, and they are similar
to traditional exchanges of variation margin, except that, in a
settled-to-market contract, the payment to the receiving party
extinguishes the amount owed to the receiving party arising from the
change in fair value and thus effectively settles the outstanding
amount due on the contract. In contrast, a collateralized-to-market
derivative contract is a form of derivative transaction for which
exchanges of variation margin that occur on a periodic (often daily)
basis collateralize any outstanding payment obligation of a
counterparty. The counterparties in a collateralized-to-market contract
secure, but do not settle, mark-to-market exposures as they arise.
Settled-to-market derivative contracts and collateralized-to-market
derivative contracts are functionally and economically similar from a
counterparty credit risk perspective. SA-CCR therefore allows a
clearing member banking organization to elect, at the netting set
level, to treat all cleared settled-to-market derivative contracts
within the netting set as subject to a variation margin agreement and
receive the benefits of netting with cleared collateralized-to-market
derivative contracts for the purposes of PFE calculations, provided
that both sets of contracts share the same margin period of risk.\145\
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\145\ 12 CFR 3.132(c)(5)(v) (OCC); 12 CFR 217.132(c)(5)(v)
(Board); 12 CFR 324.132(c)(5)(v) (FDIC). This would also be
consistent with comments received under EGRPRA as commenters
requested allowance of netting of settled-to-market and
collateralized-to-market.
---------------------------------------------------------------------------
The exposure of a clearing member to its client when facilitating a
client's cleared transaction (a client-facing derivative transaction)
is treated as a non-cleared transaction under the capital rule because
the clearing member's exposure is to the client, not the central
counterparty. Because some clearing members enter into client-facing
derivative transactions in the form of settled-to-market and
collateralized-to-market transactions, there can be situations where
both types of derivatives are a part of the same netting set. Because
client-facing derivative transactions are not cleared transactions,
banking organizations currently do not have the option to treat client-
facing derivative transactions that are settled-to-market contracts as
if subject to a variation margin agreement, and clearing member banking
organizations therefore cannot net client-facing settled-to-market
derivative contracts and collateralized-to-market derivative contracts
for purposes of SA-CCR.
The proposal would amend SA-CCR to allow clearing member banking
organizations the option to treat client-facing settled-to-market
derivative contracts as collateralized-to-market (i.e., margined)
derivative contracts, thus permitting netting between client-facing
settled-to-market and
[[Page 14986]]
collateralized-to-market contracts for the purposes of PFE
calculations. This proposed approach would align the netting treatment
of cleared derivative exposures with the netting treatment of their
related client-facing derivative exposures, as well as facilitate
efficient hedging. This proposed revision is also important for cross-
product netting, as certain derivative transactions are settled-to-
market, whereas repo-style transactions are often collateralized-to-
market.
Question 45: What are the advantages and disadvantages of
permitting banking organizations to treat bilateral settled-to-market
derivative transactions as collateralized-to-market derivative
transactions for purposes of SA-CCR?
iii. Potential Change to the Hypothetical Capital Requirement for QCCP
Default Fund Contribution Calculation
Financial market participants are increasingly exploring cross-
margining arrangements, which facilitate the aggregation of positions
across multiple central counterparties and allow for initial margin to
be determined on a net basis, with recognition of risk-offsets that
exist among different positions.\146\ Cross-margining agreements
generally allow a clearing member to post initial margin to multiple
central counterparties on a net basis, taking into account offsetting
positions the clearing member holds with each central counterparty. As
a result, cross-margining agreements may more accurately reflect the
economic risk of the transactions associated with each central
counterparty subject to the relevant cross-margining agreement.
Although cross-margining has historical precedent, in recent years
there have been significant developments, refinements, and increased
adoption of cross-margining practices across the financial industry.
Cross-margining arrangements may involve netting sets that contain
multiple products, as central counterparties in the United States
generally specialize in clearing a single specific product type such as
repo-style transactions or derivatives.\147\ For example, under a
cross-margining agreement, a clearing member with an agreement to sell
a U.S. Treasury security at one QCCP could recognize risk-offsets that
exist with an interest rate future at a different QCCP in determining
the margin it posts at each QCCP. Cross-margining agreements also
generally include policies and procedures for QCCPs participating in
such agreements to manage the default of a clearing member.
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\146\ See https://www.dtcc.com/news/2025/december/15/dtcc-files-to-expand-cme-group-cross-margining-arrangement.
\147\ See https://investor.cmegroup.com/news-releases/news-release-details/cme-group-and-dtcc-launch-enhanced-treasury-cross-margining.
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Central counterparties use default funds, to which clearing members
contribute, to cover potential losses that may arise if a clearing
member defaults. Clearing members are generally required to contribute
to the default funds in proportion to each clearing member's share of
the central counterparty's transactions, whether in the form of
bilateral transactions or clearing member client transactions
guaranteed by the clearing member. The capital rule defines such
default fund contributions as the funds contributed to, or commitments
made by a clearing member, to a central counterparty's mutualized loss
sharing arrangement. Banking organizations that are clearing members
are required to include in risk-weighted assets an amount representing
the risk of their default fund contributions. For contributions to
qualifying central counterparties (QCCPs), the risk-weighted asset
amount is derived using the hypothetical capital requirement of a
qualifying central counterparty, Kccp, representing its counterparty
credit risk exposures to all its clearing members and their clients.
Kccp incorporates an exposure amount for each transaction cleared by
the QCCP, reduced by initial margin, variation margin, and funded
default fund contributions.
Under the current capital rule, clearing member banking
organizations are not able to reflect the risk-offsets recognized by
cross-margining programs in their Kccp calculations. Together with
lower margin requirements resulting from cross-margining programs, this
may result in banking organizations being required to hold additional
capital when engaging in offsetting activities. As cross-margining
arrangements are increasingly adopted, this potential misalignment
could become increasingly consequential.
Without revisions to the default fund contribution framework's Kccp
formula, clearing member banking organizations would not be able to
reflect potential risk-reductions recognized by cross-margining
arrangements in their hypothetical capital requirement calculation. A
consequence could be that banking organizations may be less likely to
intermediate transactions as clearing members, which could be
problematic for money market funds, pension funds, insurance funds,
hedge funds, and other clients that may not have direct access to
central counterparty services and market access more broadly.
The agencies are therefore seeking comment on potential
modifications to the capital rule's requirements related to default
fund contributions to recognize cross-margining arrangements among
QCCPs that meet certain criteria. QCCPs are either regulated and
supervised as designated financial market utilities, or, if the QCCP is
located outside of the United States, in a manner equivalent to a
designated financial market utility. Such supervision and regulations
can include evaluation of margining practices. Accordingly, the
agencies are seeking feedback on proposed revisions to the Kccp formula
described below, if a QCCP's cross-margining arrangements are subject
to appropriate oversight by the QCCP's primary regulators.
More specifically, the agencies are requesting comment on the below
potential approach for calculating the exposure amount for derivatives
and repo-style transactions that are subject to a valid cross-margining
agreement for purposes of Kccp. The formula used in this approach would
allow for the recognition of the risk-mitigating benefits of cross-
margining programs and portfolio diversification relative to the
current Kccp formula.
KCCPi = [Sigma]j exposureQCCPi,j * 1.6% exposureQCCPi,j =
exposureNon-XMi,j + Allocation Factori,j * exposureXMi,j
Where:
exposureQCCPi,j represents the exposure amount of QCCPi to each of
its clearing members j,
exposureNon-XMi,j represents the exposure amount for
positions not subject to a cross-margining agreement at QCCPi for
clearing member j,
exposureXMi,j represents the exposure amount for
positions subject to a cross-margining agreement at QCCPi for
clearing member j.
Allocation Factori,j is the allocation factor for clearing member j
at QCCPi which is assigned based on the ratio of gross
notional positions held at QCCPi divided by the sum of
all gross notional positions held across all QCCPs subject to the
cross-margining agreement. This allocation factor must be between 0
and 1.
Question 46: What are the advantages and disadvantages of
recognizing the benefits of cross-margining arrangements, for Kccp
purposes, under the capital rule?
Question 47: If the agencies were to permit recognition of
offsetting positions that are facilitated by cross-margining agreements
among QCCPs that satisfy certain criteria, what criteria and
operational requirements should the agencies establish for a qualifying
cross-margining agreement? For example, should the agencies require
that a qualifying cross-margining agreement be
[[Page 14987]]
approved by the QCCPs' primary regulator or regulators? Alternatively,
should the agencies require that banking organizations receive a legal
opinion verifying the validity and enforceability of the agreement
under applicable law of the relevant jurisdictions, or that banking
organizations conduct sufficient legal review, including ongoing due
diligence, to have a well-founded basis for concluding the agreement
would be enforceable under applicable law?
Question 48: What revisions, if any, should the agencies make to
the cleared transactions framework in consideration of cross-margining
agreements? What are the advantages and disadvantages of extending
recognition of cross-margining agreements for default fund contribution
capital requirements to cleared transaction capital requirements?
Question 49: What alternatives to the allocation factor described
in the proposed formula for the hypothetical capital requirement for
cross-margined portfolios should the agencies consider and why?
iv. 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.\148\ 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 capital 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 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, because collateral is a component of
the calculations of both the replacement cost and PFE. It does not make
sense to reduce that exposure amount further by subtracting collateral
held by the QCCP.
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\148\ See 12 CFR 3.133(d) (OCC); 12 CFR 217.133(d) (Board); 12
CFR 324.133(d) (FDIC).
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The proposal would therefore 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 would allow for the appropriate
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 replacement cost 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 market price
volatility haircuts under Table 1 to Sec. __.115 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 cleared derivative transactions.
When calculating its trade exposure amount for a cleared
transaction, a banking organization under the current 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 framework of the
capital 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.\149\ The expanded risk-based approach would
not include these heightened requirements and would align the
requirements for the exclusion of collateral from the trade exposure
amount of banking organizations under the expanded risk-based approach
with the standardized approach.
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\149\ 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 capital 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.\150\
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\150\ 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] TP27MR26.067
where A is the attachment point and D is the detachment point.
The capital 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 purchase or sale 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
the proposal would revise the sign specification for the
[[Page 14988]]
supervisory delta adjustment for CDO tranches as follows: positive if
the CDO tranches were used by the banking organization to purchase
credit protection and negative if the CDO tranches were used by the
banking organization to sell credit protection.
IV. Supervisory Delta for Options Contracts
The supervisory delta adjustment for option contracts in SA-CCR 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. SA-CCR 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 capital 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.
Negative values of the instrument or risk factor underlying an
option contract can occur in other asset classes as well. For example,
whenever 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 include
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 capital
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
capital rule: to set the lowest possible value of the underlying
instrument or risk factor slightly below the lowest observed value.
Because non-interest-rate instruments and risk factors can have vastly
different magnitudes and, moreover, be expressed in different units
(e.g., different currencies), it is challenging to determine a
universal additive offset value for all values of non-interest-rate
instruments and risk factors. Because of this, 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
prior 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 more appropriate,
considering the range of values for the instrument or risk factor
underlying option contracts. 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 50: 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 SA-CCR, 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.\151\ 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
(for example, 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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\151\ 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.\152\ Credit derivatives and guarantees can reduce
[[Page 14989]]
the credit risk of an exposure by placing a legal obligation on a
third-party protection provider to compensate the banking organization
for losses associated with a credit event of the original obligor.\153\
Similarly, the use of collateral often 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 in some
circumstances reduce the risk-based capital requirement associated with
that exposure.
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\152\ Consistent with the current capital rule, the proposal
would not require banking organizations to recognize a credit risk
mitigant that it has obtained. 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.
\153\ 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 (such as the creditworthiness of the issuer of the collateral)
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.\154\
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\154\ See 12 CFR 3.2, 217.2, and 324.2 for the definition of
financial collateral.
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The proposal would largely incorporate the treatments for
collateralized transactions, guarantees, and credit derivatives from
the current capital rule's standardized approach with enhancements to
increase risk sensitivity. For eligible guarantees and eligible credit
derivatives, the proposal would generally retain the substitution
approach from the standardized approach of the current capital rule
with two modifications. Specifically, the proposal would modify the
treatment for eligible credit derivatives that do not include
restructuring as a credit event and no longer permit the recognition of
credit protection from nth-to-default credit derivatives.\155\
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\155\ See section IV.B.5.b. of this Supplementary Information.
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For collateralized transactions where financial collateral secures
exposures that are not derivative contracts or netting sets of
derivative contracts, the proposal would generally retain the simple
approach from the current capital rule's standardized approach with the
following two modifications.\156\ First, the proposal would replace the
requirement that financial collateral be subject to a collateral
agreement with conditions including the requirement that the banking
organization have the right to liquidate or take legal possession of
the collateral upon an event of default. Second, the proposal would
permit banking organizations to recognize, under the simple approach,
the credit risk mitigation benefits of financial collateral with a
maturity or currency mismatch, after applying certain adjustments.
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\156\ The collateral haircut approach also would be available to
banking organizations to recognize the benefits of collateral for
eligible margin loans and for repo-style transactions. For netting
sets containing certain repo-style transactions and derivative
contracts that are subject to a qualifying cross product master
netting agreement, a banking organization also would be able to
determine its exposure amount using SA-CCR as described in section
IV.A.4.b. of this SUPPLEMENTARY INFORMATION.
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The proposal would also introduce eligible prepaid credit
protection arrangements as a credit risk mitigant available to all
exposure types, including securitizations, and permit banking
organizations to recognize the credit risk mitigation benefits of the
protection amount of the prepaid credit protection arrangement,
discounted to reflect any applicable maturity and currency mismatch
adjustments.
a. Guarantees and Credit Derivatives
i. Substitution Approach
Consistent with the standardized approach in the current capital
rule, the proposal would permit a banking organization 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 counterparty to the eligible credit derivative
(protection provider) for the risk weight applicable to the hedged
exposure. To recognize the risk mitigating benefits of a guarantee or
credit derivative for risk-based capital purposes, the proposal would
continue to require the issuer of or counterparty to the eligible
guarantee or eligible credit derivative, respectively, to be an
eligible guarantor.\157\ The proposal would rely on the definition of
eligible guarantor in Sec. __.2 of the capital rule, which, among
other criteria, requires an entity to have issued and outstanding an
unsecured debt security without credit enhancement that is investment
grade at the time the guarantee is issued or anytime thereafter.\158\
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\157\ Under the advanced approaches framework in the current
capital rule, an eligible guarantee need not be issued by an
eligible guarantor unless the exposure is a securitization exposure.
Under the proposal, an eligible guarantee would need to be issued by
an eligible guarantor.
\158\ A banking organization would not have to apply the
proposed internal credit risk rating system criteria, as described
in section IV.A.2.e. of this SUPPLEMENTARY INFORMATION, in order to
determine whether an entity satisfies the investment grade
requirement included in in the definition of eligible guarantor. The
proposed internal credit risk rating system criteria would be
required in order for the 65 percent risk weight to be available for
purposes of the substitution approach.
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Question 51: The agencies seek comment on the requirement that the
entity has issued and outstanding an unsecured debt security without
credit enhancement that is investment grade to meet the definition of
an eligible guarantor. What, if any, alternatives to this requirement
should the agencies consider to help to ensure that eligible guarantors
can be expected to perform on guarantees and what would the pros and
cons of those alternatives be?
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 results 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
[[Page 14990]]
(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 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 provide an additional layer of security
by significantly reducing the 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 operation of the
applicable 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 conditions are intended to 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 would be
afforded similar recognition under the capital framework.
Question 52: The agencies seek comment on 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. What are the cost and benefits of this
approach? What, if any, less restrictive conditions for receiving full
recognition should the agencies consider that would more appropriately
capture credit derivatives that provide similar protection as those
that include restructuring as a credit event receive and why? For
example, what would be the advantages and disadvantages of requiring
the consent of all parties directly and adversely affected by a
restructuring, rather than the unanimous consent of all parties? What
would be the advantages and disadvantages of requiring the consent of
all parties affected by any change in lien position or priority in the
hedged or referenced exposure?
Question 53: 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 and
how should this be considered for purposes of the proposal?
Question 54: In order for a banking organization to recognize the
credit risk mitigation benefits of an eligible credit derivative, the
current capital rule requires that legally-enforceable cross-default or
cross-acceleration clauses be in place and that the reference exposure
and the hedged exposure be to the same legal entity. What would be the
advantages and disadvantages of allowing recognition of credit
derivatives where (1) the reference exposure is to a different legal
entity than the hedged exposure, (2) the reference exposure's legal
entity is guaranteed by its parent company, and (3) the parent company
is subject to a binding cross-default or cross-acceleration provision
related to the hedged exposure's debt.
b. Collateralized Transactions
Consistent with the current capital rule, a banking organization
would be permitted to recognize the risk-mitigating benefits of
financial collateral using the simple approach 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.\159\
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\159\ A banking organization would not have to apply the
proposed internal credit risk rating system criteria in order to
determine whether the issuer of long-term or short-term debt
securities that are not resecuritization exposures is investment
grade and are eligible to be considered financial collateral under
the capital rule. However, the proposed internal credit risk rating
system criteria would be required in order for the 65 percent risk
weight to be available for purposes of risk weight substitution. See
definition of financial collateral in Sec. __.2 of the capital
rule. 12 CFR 3.2 (OCC); 12 CFR 217.2 (Board); 12 CFR 324.2 (FDIC).
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Under the current capital rule, a requirement for recognizing the
credit risk mitigation benefit of financial collateral under the simple
approach is that the collateral must be subject to a collateral
agreement for at least the life of the exposure. The proposal would not
include this requirement under the simple approach because the
requirement is overly broad and not relevant for certain transaction
types. For example, while the right to close out a transaction would be
relevant with respect to a repurchase agreement, it may not be relevant
with respect to a loan. Instead, the proposal would require that the
legal mechanism by which the financial collateral is pledged or
transferred be enforceable and provide the banking organization with an
ability to exercise its applicable legal rights with respect to the
collateral in a timely manner upon an event of default. Depending on
the characteristics of the type of exposure and the financial
collateral in question, those rights may include the right to liquidate
or take legal possession of the financial collateral, to set off
amounts owed by the banking organization against amounts owed by the
obligor, and to close out the underlying transaction. However, not all
of these rights may be applicable with respect to all types of
exposures and financial collateral, and a banking organization would
only be required to have those rights that are applicable for the type
of exposure and financial collateral in question. This requirement, in
combination with the definition of financial collateral--which, in
part, requires a banking organization to have a perfected, first-
priority security interest (or the legal equivalent thereof) in the
collateral--and the other requirements of Sec. __.121(b)(1) would
provide a sufficient basis for recognizing the collateral under the
simple approach.
The requirement under the current capital rule that financial
collateral be subject to a collateral agreement often prevents a
banking organization from recognizing financial collateral as a credit
risk mitigant under the simple
[[Page 14991]]
approach if the banking organization's exercise of its rights may be
stayed in a bankruptcy of the obligor. This has generally meant that a
banking organization could not use the simple approach to recognize
financial collateral in respect of collateralized loans because the
exercise of a banking organization's collateral rights with respect to
a loan would often be subject to a stay in the bankruptcy or insolvency
of a borrower under the applicable law. Under the proposal, the fact
that a banking organization's rights may be subject to a stay in the
event of an obligor's bankruptcy would not preclude the banking
organization from recognizing the credit risk mitigation benefits of
financial collateral, provided the banking organization has a well-
founded basis for concluding that it will be able to exercise its
rights in a timely manner. The proposed change would permit banking
organizations to recognize the credit risk mitigation benefits of
financial collateral that protects exposures arising from many types of
loans and traditional credit products. Other elements of the simple
approach, such as the 20 percent risk-weight floor, help to address the
risk of declines in the value of collateral.
Typically, financial collateral in respect of a collateralized
transaction is pledged by the obligor of that exposure. In some cases,
collateral may be pledged or transferred by a party other than the
obligor. A third-party pledgor may be the parent or an affiliate of an
obligor or an unrelated party that is providing credit risk protection
to the banking organization. While collateral provided by a third party
may be an effective credit risk mitigant, it may also pose unique
risks. In particular, depending on the laws of the applicable
jurisdictions and the terms of the relevant legal agreements, the
bankruptcy or insolvency of a pledgor prior to an event of default of
the obligor may terminate or impair the banking organization's rights
to the collateral. In these circumstances, financial collateral does
not provide an effective credit risk mitigant. Consequently, the
proposal would require that the bankruptcy or insolvency of a third-
party pledgor not result in the termination or impairment of the
banking organization's rights in respect of the financial collateral.
There may be situations where obligors have the ability to remove
collateral that they are contractually obligated to maintain when a
banking organization is experiencing stress. This risk is most apparent
when financial collateral takes the form of cash on deposit at a
banking organization, where a banking organization's deposit systems
may not reflect the obligor's contractual obligation to maintain the
deposit at the banking organization. It may also arise, in respect of
other types of financial collateral, depending on the custody
arrangement and associated controls in respect of the collateral.
Financial collateral is not an effective credit risk mitigant if a
banking organization cannot appropriately safeguard its rights in
respect of such financial collateral. Consequently, the proposal would
also require a banking organization to be able to reasonably
demonstrate the ability to protect and enforce its rights in respect of
any financial collateral.
Other safeguards relating to the simple approach are intended to
sufficiently calibrate the benefits of the proposal's recognition of
financial collateral for a broader scope of products. For example, the
maturity mismatch adjustment, which is described in greater detail
below, reduces the benefit of financial collateral based on the
difference between the residual maturity of the legal mechanism by
which financial collateral is pledged and that of the secured exposure.
Additionally, for a situation with a maturity mismatch, the proposal
would only allow for recognition of the credit risk mitigant where the
original maturity of the legal mechanism is greater than or equal to
one year and the residual maturity of the legal mechanism is greater
than three months. These requirements, taken together with the other
requirements in section __.121 of the proposal, would incentivize
banking organizations to utilize credit risk mitigants that provide
effective credit risk transfer.
Question 55: Under the simple approach, the current capital rule
requires that collateral be revalued at least every six months. The
agencies recognize that, in practice, most collateral agreements for
liquid collateral provide for more frequent valuation. The proposal
would remove the requirement for collateral agreements. Given that
financial collateral is generally liquid, what would be the advantages
and disadvantages of requiring a more frequent minimum revaluation
interval--such as quarterly--under the simple approach? Please provide
rationale supporting or opposing a more frequent revaluation
requirement.
Question 56: The proposal would maintain the current capital rule's
definition of financial collateral and allow banking organizations to
recognize the risk-mitigating benefits of cash on deposit, including
cash held by a third-party custodian or trustee. The agencies invite
comment on whether the definition of financial collateral is
sufficiently clear with respect to cash collateral held for a banking
organization by a third-party custodian or trustee. What would be the
advantages or disadvantages of revising the ``cash on deposit'' prong
of the definition of financial collateral to explicitly recognize cash
on deposit at any third-party depository institution, regardless of
whether it is a custodian or trustee? In addition, what would be the
appropriate risk weight for the collateralized exposure where the
financial collateral is, directly or indirectly, in the form of a
deposit claim on a third-party depository institution and why? What
would be the advantages and disadvantages of subjecting the
collateralized exposure to the 20 percent risk weight floor? What, if
any, other alternative approaches should the agencies consider and why?
Question 57: The agencies seek comment on the appropriateness of
the calibration of the market price volatility haircuts. Commenters are
encouraged to submit data with their response.
c. Prepaid Credit Protection
The proposal would introduce eligible prepaid credit protection
arrangements as an additional type of credit risk mitigant. The
proposal would define a prepaid credit protection arrangement as a
contractual agreement in which a protection purchaser receives an
initial amount in cash from a protection provider that the protection
purchaser is required to repay, less any losses that the protection
purchaser incurs due to a credit event on the protected exposures, such
as borrower default on the protected exposures. In this type of
arrangement, the amount paid by the protection provider is not
collateral that secures a future obligation of the protection provider;
rather, it is consideration for a right to future payments, contingent
on the performance of the protected exposure(s), from the protection
purchaser. This form of credit risk mitigant effectively transfers
credit risk to the protection provider, as the banking organization's
liability created by the prepaid credit protection arrangement
generally would be reduced at the same time the banking organization
incurs a loss on the protected exposure(s). A common example of a
prepaid credit protection arrangement are fully funded credit-linked
notes issued by a banking organization that transfer the credit risk of
a reference exposure or portfolio of
[[Page 14992]]
reference exposures to third party investors.\160\
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\160\ See, e.g., Frequently Asked Questions, 12 CFR part 217, Q2
and Q3, https://www.federalreserve.gov/supervisionreg/legalinterpretations/reg-q-frequently-asked-questions.htm. This
revision would also be consistent with comments received under
EGRPRA as commenters requested recognition of the risk-mitigation
benefits of credit-linked notes.
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Under the proposal, a prepaid credit protection arrangement would
be required to meet specific requirements to be recognized for risk-
based capital purposes as an eligible prepaid credit protection
arrangement. Specifically, the proposal would define an eligible
prepaid credit protection arrangement as a prepaid credit protection
arrangement that:
(1) Is written;
(2) Is unconditional;
(3) Covers all or a pro rata portion of all contractual payments
due to be paid on the reference exposure or reference exposures;
(4) Provides that the amount and timing of payments due from the
protection purchaser to the protection provider are incorporated into
the arrangement and the arrangement only allows these terms to change
in the event of a breach of the arrangement by the protection
purchaser;
(5) Provides that entry of the protection provider into
receivership, insolvency, liquidation, conservatorship, or similar
proceeding does not change the amounts or timing of payments due by the
protection purchaser under the arrangement;
(6) Is legally valid and enforceable under applicable law of the
relevant jurisdictions;
(7) Upon a failure by the obligor on the one or more reference
exposures to make a contractually required payment, or the occurrence
of other credit events as described in the arrangement, allows the
protection purchaser promptly to reduce the outstanding balance of the
initial principal amount due to the protection provider by the loss of
the protection purchaser on the reference exposures without input from
the protection provider; and
(8) Does not increase the protection purchaser's cost of credit
protection in response to deterioration in the credit quality of any of
the reference exposures.
The protection amount of an eligible prepaid credit protection
arrangement would be the effective notional amount of the prepaid
credit protection, reduced to reflect any currency mismatch or maturity
mismatch. The effective notional amount for an eligible prepaid credit
protection arrangement would be the lesser of the contractual notional
amount of the credit risk mitigant and the exposure amount of the
reference exposure(s), multiplied by the percentage coverage of the
credit risk mitigant.
Under the proposal, if the protection amount of the eligible
prepaid credit protection arrangement is greater than or equal to the
exposure amount of the reference exposure, a banking organization would
be allowed to assign a zero percent risk weight to the exposure.
If the protection amount of the eligible prepaid credit protection
arrangement is less than the exposure amount of the reference
exposure(s) and any losses are shared on a pro rata basis between the
banking organization and the protection provider,\161\ the proposal
would require the banking organization to treat the reference
exposure(s) as two separate exposures, protected and unprotected, in
order to recognize the credit risk mitigation benefit of the eligible
prepaid credit protection arrangement. In such cases, a banking
organization would apply a zero percent risk weight to the protected
exposure. The banking organization would calculate its risk-weighted
asset amount for the unprotected exposure under the expanded risk-based
approach using the risk weight assigned to the exposure and an exposure
amount equal to the exposure amount of the original reference exposure
minus the protection amount.
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\161\ Exposures on which there is a tranching of credit risk
(reflecting at least two different levels of seniority) generally
are securitization exposures, as described in section IV.B. of this
SUPPLEMENTARY INFORMATION.
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Question 58: Under the definition of eligible prepaid credit
protection arrangement, the proposal would require that a protection
purchaser be able to reduce the outstanding balance due to the
protection provider promptly upon realizing or otherwise recognizing a
loss on the reference exposure, in the event that the obligor on one or
more reference exposures fails to make a contractually required
payment, or the occurrence of other credit events as described in the
arrangement. What, if any, are the exposure types in respect of which,
or circumstances when, a protection purchaser may be exposed to losses
before such losses are manifested in a way that would permit a
reduction in the protection purchaser's repayment obligation? For
example, what would be the instances where nonpayment or other loss on
the reference exposure may not always result in an accounting write-
down of the eligible prepaid credit protection arrangement at the same
time? What, if any, changes to the proposed definitions of prepaid
credit protection arrangement and eligible prepaid credit protection
arrangement should the agencies consider to further ensure that a
protection purchaser would be able to reduce its repayment obligation
on a prepaid credit protection arrangement as contemporaneously as
possible with the manifestation of losses in respect of a reference
exposure?
Question 59: The proposal would define the protection amount of an
eligible prepaid credit protection arrangement to mean the effective
notional amount of the prepaid credit protection. Certain credit-linked
notes that may qualify as eligible prepaid credit protection under the
proposal, are sometimes accounted for on a fair value basis. The fair
value of such credit-linked notes may be affected by factors other than
losses or credit events (for example, a change in interest rates) in
respect of the reference exposure. As a result, at the time that credit
losses in respect of the reference exposure are realized, the fair
value of the credit-linked note, and the amount by which the banking
organization may set off its losses in respect of the reference
exposure, may be less than the notional amount of the note. What, if
any, modifications to the proposal should the agencies consider to
address the risk that a banking organization may not be able to set off
losses on a reference exposure against the full notional amount of a
prepaid credit protection instrument? What would be the advantages and
disadvantages of defining the protection amount of an eligible prepaid
credit protection instrument to be the instrument's carrying value (For
example, the fair value if the banking organizations elects this
accounting treatment)?
Question 60: The definition of prepaid credit protection requires
that the protection purchaser is obligated to repay the initial
principal amount to the protection provider on or before the maturity
date of the transaction, less any losses that the protection purchaser
realizes or otherwise recognizes due to nonpayment of all contractual
payments due to be paid on the reference exposure by the obligors. The
agencies seek comment as to whether the definition is sufficiently
broad to capture the types of prepaid credit protection arrangements
that banking organizations may enter into to transfer credit risk. For
example, may prepaid credit protection arrangements be structured to
allow for a reduction in the initial principal amount of the
arrangement upon the recognition of losses on one or more reference
[[Page 14993]]
exposures due to credit quality deterioration of the exposures, even in
the absence of any nonpayment. If so, what if any changes to the
definition of prepaid credit protection should the agencies consider?
d. Maturity and Currency Mismatch Adjustment
The simple approach in the current capital rule does not permit a
banking organization to recognize credit risk mitigation benefits where
the transaction is subject to a collateral agreement that has a shorter
tenor than that of the secured exposure.\162\ To improve the risk-
sensitivity of the simple approach, the proposal would permit banking
organizations to recognize financial collateral and prepaid credit
protection with a maturity mismatch after adjusting the fair value of
the financial collateral or the effective notional amount of the
eligible prepaid credit protection arrangement to reflect any maturity
mismatch.\163\
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\162\ For determining maturity mismatch, the comparison is
between the remaining maturity of the protected exposure against the
remaining maturity of the legal mechanism by which financial
collateral is pledged. For example, if the legal mechanism by which
financial collateral is pledged to a 5-year loan has a 5-year term,
even if the remaining maturity of the collateral is 2 years, there
would be no maturity mismatch under the proposal as long as the
security interest transfers without any breaks to the proceeds of
the matured collateral or replacement collateral.
\163\ The proposal would define residual maturity as the longest
possible remaining time before the obligated party of the secured
exposure is scheduled to fulfill its obligation on the reference
exposure. If a contract has embedded options that may reduce its
term, the proposal would require the banking organization to adjust
the residual maturity of the contract. If a call is at the
discretion of the protection provider, the residual maturity of the
contract would be at the first call date. If the call is at the
discretion of the banking organization, but the terms of the
arrangement at origination of the contract contain a positive
incentive for the banking organization to cancel the contract before
contractual maturity, the remaining time to the first call date
would be the residual maturity of the contract.
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Under the proposal, the residual maturity of an eligible prepaid
credit protection arrangement would be determined in the same manner as
applies to eligible credit derivatives and eligible guarantees under
the current capital rule. For financial collateral that is not cash on
deposit at the banking organization, but including cash held for the
banking organization by a third-party custodian or trustee, the
residual maturity of any amount of such financial collateral would be
the earliest date on which the banking organization's rights in respect
of such amount of financial collateral may be terminated without the
pledgor being subject to a contemporaneous requirement to pledge
additional financial collateral. For financial collateral that is cash
on deposit at the banking organization, the residual maturity of any
amount of such collateral would be the earliest date on which a
depositor may withdraw such amount, notwithstanding any notice
requirements or early withdrawal fees or penalties. For example, if an
obligor is subject to a loan covenant requiring the obligor to maintain
a certain deposit balance at the banking organization until the
maturity of the loan, the residual maturity of the cash on deposit
would be the remaining maturity of the loan. Any amount of a deposit
balance that an obligor is contractually permitted to withdraw,
however, would have a residual maturity of the earliest date on which
the deposit may be withdrawn. If an obligor may withdraw a deposit at
any time, including where an obligor may be subject to a notice period
or an early withdrawal fee or penalty, the residual maturity would be
zero, notwithstanding any stated maturity date of the deposit
instrument.
Under the proposal, a banking organization would be required to
apply the same adjustment to reduce the fair value of the financial
collateral or the effective notional amount of the prepaid credit
protection arrangement as currently applies to eligible credit
derivatives and eligible guarantees under the substitution approach:
Pm = E x [(t-0.25)/(T-0.25)]
Where:
Pm = fair value of the financial collateral or effective
notional amount of the eligible prepaid credit protection
arrangement, adjusted for maturity mismatch;
E = fair value of the financial collateral or effective
notional amount of the eligible prepaid credit protection
arrangement;
t = the lesser of T or the residual maturity of the credit
risk mitigant, expressed in years; and
T = the lesser of five or the residual maturity of the
secured exposure or reference exposure, as applicable, expressed in
years.
Similarly, the proposal would eliminate the current capital rule's
requirement that financial collateral be denominated in the same
currency as the secured exposure for a banking organization to use the
simple approach. The proposal would permit banking organizations to
recognize the credit risk mitigation benefits of financial collateral
and eligible prepaid credit protection arrangements when denominated in
a different currency than the currency of the secured exposure, after
adjusting the fair value or the effective notional amount, as
applicable, to reflect any currency mismatch. Under the proposal, a
banking organization would use the following formula to adjust the fair
value of the financial collateral or the effective notional amount of
the eligible prepaid credit protection arrangement:
Pc = Pr x (1-HFX)
Where:
Pc = fair value of the financial collateral or
effective notional amount of the eligible prepaid credit protection
arrangement, adjusted for currency mismatch (and maturity mismatch,
if applicable).
Pr = fair value of the financial collateral or
effective notional amount of the eligible prepaid credit protection
arrangement (adjusted for maturity mismatch, if applicable).
HFX = haircut appropriate for the currency
mismatch between the financial collateral and the secured exposure
or the eligible prepaid credit protection arrangement and the
reference exposure.
Consistent with substitution approach for guarantees and credit
derivatives in the current capital rule, the proposal would require
banking organizations to use a standard supervisory haircut of 8
percent for HFX (based on a ten business-day holding period and daily
marking-to-market and remargining). If a banking organization revalues
the financial collateral or eligible prepaid credit protection
arrangement less frequently than once every 10 business days, the
proposal would require the banking organization to scale up the haircut
using the following square root of time formula:
[GRAPHIC] [TIFF OMITTED] TP27MR26.068
Where:
TM = the greater of 10 or the number of business days
between revaluations.
Question 61: The agencies seek comment on the effectiveness of the
credit risk mitigation of collateral and eligible prepaid credit
protection arrangement when there is a maturity mismatch between the
credit risk mitigant and the hedged reference portfolio, for example,
longer-dated assets that are protected by a shorter-dated prepaid
credit protection arrangement. The agencies seek comment on whether the
banking organization has effectively mitigated credit risk if the
losses on the assets are estimated to occur after the expiration of the
prepaid credit protection arrangement. Does the proposed maturity
mismatch adjustment sufficiently capitalize for the residual risks of
hedging longer-dated assets with shorter-term prepaid credit protection
[[Page 14994]]
arrangement? Please provide supporting data and analysis.
B. Securitization Framework
The securitization framework is designed to produce capital
requirements for exposures that involve tranching of the credit risk of
one or more underlying financial exposures.\164\ The risk and
complexity posed by securitizations differ relative to direct exposures
to the underlying financial exposures because the credit risk of those
exposures is divided into different levels of risk using a wide range
of structural mechanisms.\165\ The performance of a securitization
exposure depends not only on the structure of the securitization, but
also on the performance of the underlying exposures \166\ and certain
parties to the securitization structure, including the asset servicer
and any liquidity facility provider. Such structural features and the
involvement of these parties makes securitization exposures susceptible
to additional risks as compared to direct exposures to the underlying
financial exposures.
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\164\ To segment the credit risk of the underlying financial
exposures (``reference portfolio''), securitization exposures divide
the reference portfolio into different slices (known as
``tranches'') such that any cash flows or losses are allocated to
the various tranches based on a predetermined order of priority.
This payment structure is sometimes referred to as the cash flow
waterfall (or simply the ``waterfall'') and dictates the manner in
which interest or principal payments from the reference portfolio
must be allocated, creating different risk-return profiles for each
tranche.
\165\ For example, assume a banking organization extends a loan
to a bankruptcy remote special purpose entity which holds financial
exposures (including equity securities) and the fair value of the
underlying financial assets exceeds that of the loan. Under this
transaction, the underlying financial exposures are pledged as
collateral to the lender. As the excess collateral would initially
absorb any losses arising from non-payment on the loan (after which
the banking organization would be exposed to any subsequent losses),
the loan would generally be viewed as tranched and could qualify as
a securitization exposure under the proposal, if the transaction
satisfies all of the other applicable requirements. Consistent with
the current capital rule, to the extent the fair value of the
collateral declines such that it no longer exceeds the outstanding
principal balance of the banking organization's exposure to the
borrower, the transaction would no longer involve tranching of
credit or equity risk--and thus would not qualify as a
securitization exposure under the proposal. Rather, the banking
organization would be required to calculate risk-based capital
requirements for the exposure using the general credit risk
framework as described in section IV.A. of this SUPPLEMENTARY
INFORMATION.
\166\ Consistent with the current capital rule, the proposal
would define equity exposure to include exposures to equity
instruments that do not have mandatory contractual payments, among
other requirements. Accordingly, under the proposal, the performance
of underlying equity exposures would refer to both changes in the
fair value of the equity exposures and whether the issuer(s) of the
equity exposures is subject to a bankruptcy or insolvency
proceeding.
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The proposed securitization framework would incorporate the
securitization framework in the current standardized approach with the
following modifications: (1) a revised definition of and additional
operational requirements for synthetic securitizations; (2) a modified
treatment for resecuritizations that meet the operational requirements;
(3) a modified definition of an eligible clean-up call; (4) a new
securitization standardized approach (SEC-SA), as a replacement to the
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 lower risk-weight floor for
securitization exposures that are not resecuritization exposures, and a
higher risk-weight floor for resecuritization exposures; (5) a revised
treatment for purchased and sold nth-to-default credit derivatives that
would prohibit banking organizations from recognizing any risk-
mitigating benefit for such exposures; (6) a revised treatment for
certain derivative contracts that are not credit derivatives and a new
treatment for derivative contracts that do not provide credit
enhancement; (7) new provisions to expand the scope of securitization
exposures for which a banking organization may apply the overlapping
exposure treatment; (8) a new treatment and eligibility criteria for
certain senior securitization exposures (the ``look-through
approach''); (9) a modification to the treatment for credit-enhancing
interest only strips; and (10) a new framework for non-performing loan
securitizations. The proposal would also introduce certain minor
technical edits to the definitions of traditional securitization and
synthetic securitization to clarify the existing scope of exposures
subject to the securitization framework under the current capital rule.
1. Definitions
The proposal would generally retain the existing definitions of
traditional securitization and synthetic securitization under the
current capital rule, except for (1) revising the definition of
synthetic securitization to include prepaid credit protection
arrangements, and (2) introducing technical modifications to the
definitions of traditional securitization and synthetic securitization
that are intended to clarify the existing scope of exposures subject to
the securitization framework under the current capital rule.
a. Synthetic Securitization
As discussed in section IV.A.5. of this SUPPLEMENTARY INFORMATION,
the proposal would permit banking organizations to recognize risk
mitigating benefits of eligible prepaid credit protection arrangements.
Consistent with these provisions, the proposal would revise the
definitional and operational criteria for synthetic securitizations to
include prepaid credit protection arrangements as structures that can
qualify as synthetic securitizations and to include eligible prepaid
credit protection arrangements as an eligible credit risk mitigant
within the securitization framework. Under the proposal, a transaction
would meet the definitional and operational criteria of synthetic
securitization if all or a portion of the credit risk of one or more
underlying exposures is transferred to one or more third parties
through prepaid credit protection arrangements, and the transaction
satisfies all other requirements of the securitization framework under
the proposal.
b. Technical Modifications
The proposal would modify paragraph (3) within the definitions of
traditional securitization and synthetic securitization to clarify that
the performance of the securitization exposure is expected to depend
solely upon the performance of the underlying exposures, aside from the
performance of common supporting transaction participants such as
servicers and trustees. For example, a transaction would not satisfy
this criterion if there is an expectation that any sources outside of
the underlying exposures would fund the interest or principal payments
due on the securitization exposures.
Consistent with the current capital rule, the proposed modification
would continue to permit certain transactions where a party provides a
specified amount of credit protection to qualify as a securitization
exposure. As an example, consider a multi-seller ABCP conduit that
funds itself entirely with a single class of commercial paper and
purchases assets such as wholesale loan exposures from multiple
sellers. As is typical in such multi-seller ABCP conduits, each seller
provides first-loss protection by over-collateralizing its loans sold
to the conduit. To ensure a high credit rating on the commercial paper
issued by the ABCP conduit, a banking organization sponsor may provide
either a pool-specific liquidity facility or a program-wide credit
[[Page 14995]]
enhancement such as a guarantee on a portion of the losses not
protected by the seller over-collateralization. Consistent with the
current capital rule, under the proposal, commercial paper issued by
the ABCP conduit with a pool-specific liquidity facility generally
would be a securitization exposure because the pool-specific liquidity
facility represents a tranche of the credit risk of the underlying
exposures (that is the repayment of the liquidity facility depends upon
the underlying exposures) and losses are allocated through
subordination. Conversely, if the sponsor provides a program-wide
credit enhancement that covers all credit losses across multiple asset
pools without reference to asset-level performance (not just those
above the seller-provided credit enhancement) or seller-specific
subordination, the commercial paper generally would not be a
securitization exposure, as the commercial paper holders are primarily
exposed to the default risk of the sponsor instead of the underlying
exposures and the commercial paper does not represent a tranched risk
position. The proposed modification is intended to clarify that a
securitization exposure to such program-wide guarantees, including
guarantees provided by an operating company to a special purpose entity
it establishes, generally would not satisfy the definition of
traditional or synthetic securitization.
Additionally, the proposal would modify paragraph (1) of the
definition of traditional securitization to clarify that a transaction
transferring equity risk could be subject to the securitization
framework if all of the other definitional criteria are satisfied. The
securitization framework generally applies to exposures to companies
with material liabilities that are not operating companies,\167\ and
whose underlying exposures are primarily financial exposures (including
when all or substantially all of the underlying assets are equity
exposures). For exposures to companies with material liabilities that
are not operating companies and whose underlying exposures are all or
substantially all financial exposures, the risk-based capital treatment
under the current capital rule reflects how the risk of exposures to
such entities depends primarily on the degree of leverage employed by
the company. Accordingly, the current capital rule generally requires
banking organizations to apply the securitization framework to
determine the risk-weighted asset amount for exposures to non-operating
companies with material liabilities, unless the primary Federal
supervisor determines that the exposure is not a traditional
securitization based on the transaction's leverage, risk profile or
economic substance. The proposal would modify paragraph (1) of
definition of traditional securitization to clarify that this treatment
would also apply to exposures to such companies with material
liabilities, where all or a portion of the credit or equity 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
or prepaid credit protection arrangements).\168\ As a result, the
proposed definition of traditional securitization would continue to
include exposures to companies with material liabilities that are not
operating companies, where all or substantially all of the underlying
assets are financial exposures, and whose funding structure results in
the risk associated with the underlying exposures being separated into
at least two tranches with different levels of seniority.
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\167\ See 78 FR 62018, 62112 (Oct. 11, 2013).
\168\ Consistent with the current capital rule, under the
proposal, a banking organization would use the equity framework to
calculate risk-based capital requirements for equity exposures to
companies where all or substantially all of the underlying assets
are financial assets and that have no material liabilities. See
definition of investment fund in Sec. __.2 of the current capital
rule and the treatment of equity exposures to investment funds in
Sec. __.142 of the proposed rule.
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Question 62: What additional clarifications, if any, should the
agencies consider for the proposed modification to paragraph (3) of the
definition of traditional and synthetic securitization and why?
Question 63: What additional clarifications, if any, should the
agencies consider for the proposed modification to paragraph (1) of the
definition of traditional securitization and why? What would be the
advantages and disadvantages of making similar changes to paragraph (1)
of the definition of synthetic securitization?
Question 64: The agencies seek comment on the appropriateness of
requiring covered banking organizations to use the general risk-weight
framework for certain overcollateralized exposures if the fair value of
underlying equity exposures declines such that there is no longer
overcollateralization? What would be the advantages and disadvantages
of requiring covered banking organizations to use the general risk-
weight framework (rather than the securitization framework) to
determine the applicable risk weight for securitization exposures where
the underlying exposures are primarily equity exposures and the fair
value of the underlying equity exposures has significantly declined?
What criteria should the agencies consider to capture only those
securitization exposures for which such an approach would more
appropriately capture the risk and why?
2. Operational Requirements
The proposed operational requirements would be consistent with the
operational requirements in the standardized approach of the current
capital rule, with five exceptions as described below and directly
above in section IV.A.1.a. of this SUPPLEMENTARY INFORMATION. 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.\169\
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\169\ In the case of non-performing loan securitizations, as
described in section IV.B.5.g. of this SUPPLEMENTARY INFORMATION,
the proposal would allow a banking organization that meets the
operational requirements to choose to hold risk-based capital
against the transferred exposures as if they had not been
securitized and deduct from common equity tier 1 capital any after-
tax gain-on-sale resulting from the transaction.
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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.\170\ 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
[[Page 14996]]
reduce the borrowers' credit line availability.
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\170\ Under the capital rule, an originating banking
organization, with respect to a securitization, means a banking
organization that: (1) directly or indirectly originated or
securitized the underlying exposures included in the securitization;
or (2) serves as an ABCP program sponsor to the securitization. See
12 CFR 3.2 (OCC); 12 CFR 217.2 (Board); 12 CFR 324.2 (FDIC).
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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 the standardized approach of the current capital
rule. The current capital rule defines an early amortization provision
as a provision in the documentation governing a securitization that,
when triggered, causes investors in the securitization exposures to be
repaid before the original stated maturity of the securitization
exposures, with certain exceptions.\171\ 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. Aligning this treatment for both traditional
and synthetic securitizations would provide greater consistency within
the securitization framework and reduce the likelihood that a banking
organization would provide implicit support for synthetic
securitization exposures.
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\171\ Under the capital rule, the exceptions to the 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. See
definition of early amortization provision in Sec. __.2 of the
capital rule. 12 CFR 3.2 (OCC); 12 CFR 217.2 (Board); 12 CFR 324.2
(FDIC).
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Question 65: 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? In
particular, is the current rule's exception where early amortization
``is triggered solely by events not directly related to the performance
of the underlying exposures or the originating institution (such as
material changes in tax laws or regulations)'' sufficiently clear? What
types of early termination events should qualify as events not directly
related to either the performance of the underlying exposures or the
originating banking organization? Should events not directly related to
the performance of the underlying exposures or the originating banking
organization include customary provisions designed to protect against
non-performance of various contractual obligations by one of the
parties facilitating the securitization (including the originating
banking organization, if it has such a transaction facilitating role,
for example by acting as a servicer)? Commenters are also asked to
describe under what circumstances could a provision in a revolving loan
securitization that, when triggered, causes investors in the
securitization exposures to be repaid before the original stated
maturity of the securitization exposures, leaves investors ``fully
exposed to future draws by borrowers on the underlying exposures even
after the provision is triggered'', or otherwise should be deemed not
to be an early amortization provision. What are the advantages and
disadvantages of ``fully exposed'' encompassing only cash-funded
exposures versus also including exposures in the form of contractual
commitments to provide funding?
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 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
exposures, 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 proposal would require the banking organization to
maintain capital against all the underlying exposures as if they had
not been synthetically securitized.
Question 66: What clarifications or modifications should the
agencies consider for the above proposed definition of synthetic excess
spread and why?
Question 67: 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
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.\172\ A contractual minimum payment
threshold refers to the delinquency condition that must exist before a
credit event is deemed to have occurred under the terms of the credit
protection. The proposed minimum payment threshold criterion is
intended to prohibit an originating banking organization from
recognizing any risk mitigating benefit for 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.
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\172\ For example, for derivative contracts written under ISDA
Master Agreement documentation, standard market practice for
contractual minimum payment thresholds would generally be $1 million
(or the equivalent in other currencies), such as established in ISDA
Credit Derivatives Definitions. See ISDA Credit Derivatives
Definitions Section 4.5 ``Failure to Pay'' and Section 4.9(d)
``Payment Requirement.''
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Question 68: 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 exposure arising from a traditional
securitization, if the operational requirements have been met, an
originating banking organization would be required to exclude the
transferred exposures from the
[[Page 14997]]
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 exposure, the proposal would not provide the
option for a banking organization to elect to treat a resecuritization
exposure 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 resecuritization exposures it retains in connection with the
synthetic securitization. These proposed operational requirements for
resecuritization exposures are consistent with the Basel standards.
e. Clean-Up Calls
The proposal would use the definition of a clean-up call in the
current capital rule without change. The capital rule defines a clean-
up call as a contractual provision that permits an originating banking
organization or servicer to call securitization exposures before their
stated maturity date or call date. For an originating banking
organization to exclude the underlying exposures from its risk-based
capital calculation, any clean-up call associated with a securitization
must be an eligible clean-up call.
The proposal would expand the definition of an eligible clean-up
call. Under the current capital rule, an eligible clean-up call is
defined as a clean-up call that is exercisable solely at the discretion
of the originator or servicer, is not structured to avoid allocating
losses to securitization exposures held by investors or otherwise
structured to provide credit enhancement to the securitization, and is
only exercisable when 10 percent or less of the principal amount of the
initial pool of underlying or reference exposures is outstanding. The
proposal would expand the definition of an eligible clean-up call to
also include clean-up calls exercisable when certain regulatory and tax
events occur, in addition to the existing criteria under the current
capital rule. Specifically, the modification would permit the exercise
of a clean-up call upon the occurrence of (1) a regulatory event that
significantly changes the risk-weighted asset amount for the
securitization exposure under applicable risk-weighted asset standards
of the agencies, or (2) a tax event that significantly changes the tax
treatment of the securitization exposure under applicable tax laws. The
events must represent final actions, such as a final rule adopted by
the agencies or taxing authority, or a law enacted by Congress.
Proposed rules or legislative bills would not satisfy this requirement.
Question 69: What, if any, other modifications should the agencies
consider for the definition of an eligible clean-up call and why?
3. Exposure Amount of a Securitization Exposure
The proposal would maintain the exposure calculation methodology in
the current capital rule for both on-balance-sheet and off-balance-
sheet securitization exposures. The exposure amount for an on-balance-
sheet securitization exposure that is not a repo-style transaction, an
eligible margin loan, or a derivative contract (other than a credit
derivative) would equal the carrying value of the exposure. For off-
balance- sheet securitization exposures that are not a repo-style
transaction, eligible margin loan, or derivative contract (other than a
credit derivative), the exposure amount would equal the notional amount
of the exposure.\173\ For a securitization exposure that is a repo-
style transaction, eligible margin loan, or derivative contract (other
than a credit derivative), the exposure amount would be calculated
based on the proposed counterparty credit risk framework, described in
section IV.A.4. of this SUPPLEMENTARY INFORMATION.
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\173\ The proposal would generally maintain the current capital
rule's treatment for off-balance sheet securitization exposures to
ABCP programs, with certain exceptions. The proposal would not
include the specific treatments provided for such exposures in
__.42(c)(3)(ii)-(iii) and __.44 in the current capital rule. The
other elements of the proposed securitization framework (for
example, the look through approach for senior securitization
exposures) are intended to better reflect the risk of such
exposures.
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Question 70: What, if any, clarifications should the agencies
consider regarding the determination of the exposure amount for
securitization exposures where one or more of the underlying exposures
are off-balance sheet exposures (such as unfunded commitments)?
Specifically, what are the advantages and disadvantages of a
modification that would clarify that banking organizations could apply
the same credit conversion factors described in section IV.A.1.b. of
this SUPPLEMENTARY INFORMATION when calculating the components of the
SEC-SA (GG, W parameter, attachment point A and detachment point D) for
a securitization exposure where one or more of the underlying exposures
are off-balance sheet exposures? What would be the effect of such a
clarification on the volatility of the capital requirements?
4. 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 generally consistent with the Basel standards. The SEC-SA
would be 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
exposures that are adjusted to reflect (1) delinquencies in such
exposures, (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 exposures to the
underlying financial exposures.
To calculate the risk weight for a securitization exposure using
the SEC-SA, a banking organization would be required to 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 securitization exposure. For synthetic securitizations,
the proposal would permit banking organizations to choose not to
recognize the credit risk mitigant and hold risk-based capital against
the underlying exposures as if they had not been synthetically
securitized.
Under the proposed SEC-SA, the risk weight assigned to a
securitization exposure, or portion of a securitization
[[Page 14998]]
exposure, would be determined according to the formula under Sec.
__.133(a) of the proposed rule, expressed as:
[GRAPHIC] [TIFF OMITTED] TP27MR26.069
Where:
RWFLOOR is equal to 100 percent for resecuritization
exposures and 15 percent for all other securitization exposures.
KA represents the delinquency-adjusted, weighted-average
capital requirement of the underlying exposures, as described in
section IV.B.4.c. of this SUPPLEMENTARY INFORMATION.
A represents the attachment point of the securitization
exposure, as described in section IV.B.4.a. of this SUPPLEMENTARY
INFORMATION.
D represents the detachment point of the securitization
exposure, as described in section IV.B.4.a. of this SUPPLEMENTARY
INFORMATION.
[GRAPHIC] [TIFF OMITTED] TP27MR26.070
u = D-KA
l = max(A-KA,0)
e equals the base of the natural logarithm.
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 (1) the current dollar
amount of underlying exposures that are subordinated to the exposure of
the banking organization to (2) 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 current capital rule generally requires a banking
organization to recognize cash or securities that are included in a
reserve account in the calculation of parameter A.\174\
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\174\ Consistent with the current capital rule, the proposal
would require banking organizations to treat any assets that are
included in a reserve account as underlying exposures of the
securitization exposure, which must be reflected in parameters A and
D as well as KG and the W parameter.
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The proposal would generally retain the existing definitions of
attachment point and detachment point under the current capital rule,
with one modification. Specifically, the proposal would not allow a
banking organization 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 securities, 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.\175\
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\175\ For example, assume a securitization has assets
denominated in U.S. dollars and liabilities denominated in euros,
and that the securitization executes a USD-EUR foreign exchange swap
with a banking organization. The transaction would serve to hedge
the foreign exchange risk of the securitization's assets and
liabilities, but would not provide credit enhancement to any of the
tranches of the securitization.
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b. Definition of W Parameter
Under the current capital rule, parameter W, which is expressed as
a decimal value between zero and one, reflects the proportion of
underlying exposures that are not performing or are delinquent,
according to criteria outlined in the rule.\176\ The proposal would
retain the current capital rule's definition of parameter W, with two
modifications. Specifically, the proposal would revise the definition
of parameter W to (1) exclude any exposure that is directly and
unconditionally guaranteed by the U.S. government, its central bank, or
a U.S. government agency from the calculation of W, up to the amount of
the guarantee; and (2) clarify that for resecuritization exposures, any
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.
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\176\ Consistent with the current capital rule, the proposal
would define equity exposure to include exposures to equity
instruments that do not have mandatory contractual payments, among
other requirements. Accordingly, under the proposal, for purposes of
determining the W parameter for a securitization exposure, a banking
organization would not treat an underlying equity exposure as being
past due or in default on payments, but could treat an underlying
equity exposure as subject to a bankruptcy or insolvency proceeding
if the issuer of the equity exposure were subject to such a
proceeding. See definition of equity exposure in Sec. __.2 of the
capital rule. 12 CFR 3.2 (OCC); 12 CFR 217.2 (Board); 12 CFR 324.2
(FDIC).
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[[Page 14999]]
Under the proposal, a banking organization would exclude from the
calculation of parameter W any exposure that is directly and
unconditionally guaranteed by the U.S. government, its central bank, or
a U.S. government agency, up to the amount of the guarantee. By
allowing banking organizations to reflect the risk mitigation effects
of the U.S. government's guarantee, the proposed modification is
intended to more appropriately align the capital requirement with the
risk of such securitization exposures. For example, when a banking
organization invests in a securitization exposure where all of the
underlying exposures are unconditionally guaranteed by the U.S.
government, the banking organization may set parameter W equal to zero.
For resecuritization exposures, parameter W would be the ratio of
the sum of the current dollar amount of any underlying exposures of the
resecuritization that meet any of the criteria in paragraphs
__.133(b)(1)(i) through (vi) of the proposal that are not
securitization exposures to the current dollar amount of all underlying
exposures. Underlying securitization exposures do not need to be
included in the numerator of parameter W because the risk weight of the
underlying securitization exposure as calculated by the SEC-SA would
already reflect 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 reflects the fact that the risk associated with
securitization exposures generally arises from the underlying assets
failing to perform as expected, resulting in investors receiving less
cashflow than expected from the securitization exposure, rather than
from securitization exposure itself failing to make payments due to
investors.
Question 71: The agencies seek comment on the appropriateness of
requiring banking organizations to only include equity exposures when
the issuer is subject to a bankruptcy or insolvency proceeding in the W
parameter calculation. What, if any, alternative approaches (such as
requiring banking organizations to include equity exposures when the
issuer has an obligation to the banking organization that is 90-days or
more past due) should the agencies consider that would more
appropriately capture the proportion of underlying exposures that are
not performing or are delinquent and why? What, if any, operational
concerns could such alternatives pose?
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 parameter 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 unpaid principal used as the weight for
each exposure), calculated using the proposed risk weights in the
expanded risk-based approach, as described in section IV.A.2. of this
SUPPLEMENTARY INFORMATION.
The proposal would retain the current capital rule's definition of
KG, with two modifications. First, for interest rate
derivative contracts and exchange rate derivative contracts, the
proposal would require banking organizations to include in the
numerator of KG (and exclude from the denominator of
KG) the product of (1) the positive current exposure, (2)
the risk weight of the counterparty, and (3) by 0.08, consistent with
the Basel standards. This accounts for the issue where, 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, the proposal would clarify the existing requirement that
banking organizations must determine the risk weight applicable to an
underlying equity exposure under the simple risk-weight approach, as
described in section IV.C.2. of this SUPPLEMENTARY INFORMATION, based
on the characteristics of the underlying equity exposure. Consistent
with the treatment under the current capital rule, banking
organizations would not be able to consider the underlying equity
exposures as a non-significant equity exposure that receive a 100
percent risk weight when determining KG. Unlike equity
exposures to investment funds (as defined), traditional securitizations
can include transactions with companies that have material liabilities
and structures that allocate losses based on a predetermined order of
priority (rather than on a pro-rata basis). Accordingly, unlike the
look-through approaches applicable to underlying equity securities held
by investment funds, the proposal would clarify that banking
organizations may not calculate risk-based capital requirements for
securitization exposures with underlying equity exposures as though the
underlying equity exposures were on the banking organization's balance
sheet. This clarification to the current capital rule promotes the risk
sensitivity of the securitization framework by requiring banking
organizations to reflect a risk weight based on the underlying
exposure's risk characteristics and appropriately differentiates
between the risk-based capital treatment applicable to investment funds
and to securitization exposures.
Question 72: Recognizing that banking organizations may not always
know the delinquency status of each underlying exposure, 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, what would be the benefits and drawbacks of allowing the
banking organization to (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, if any, should the agencies consider
and why?
Question 73: The agencies seek comment on the appropriateness of
requiring banking organizations to reflect underlying past due
exposures in both the KG and the W parameter components when
calculating KA. To what extent could including past due exposures in
both components result in overly punitive capital requirements for such
exposures under SEC-SA? What, if any, alternatives (such as not
applying the heightened 150 risk weight for past
[[Page 15000]]
due exposures for purposes of calculating KG) should the agencies
consider and why? Commenters are encouraged to provide specific
examples, including calculations and supporting data.
d. Supervisory Risk-Weight Floors
Consistent with the SSFA in the current capital rule, the SEC-SA
would require banking organizations to apply a risk-weight floor to all
securitization exposures. The proposed risk-weight floor is intended to
ensure that banking organizations maintain a minimum level of capital
to account for risks that may not otherwise be captured by SEC-SA, such
as modeling risks and correlation. 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 or equity risk,
senior tranches are still exposed to some amount of credit or equity
risk on the underlying exposures. Therefore, a minimum capital
requirement continues to be appropriate for all securitization
exposures.
For resecuritization exposures, the proposed SEC-SA approach would
require banking organizations to apply a risk-weight floor of 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.\177\
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\177\ 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 likely
to be correlated due to their system-wide nature; therefore,
resecuritizations can be expected to have higher default
correlations than other types of securitizations.
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Question 74: The agencies seek comment on the proposed 100 percent
risk-weight floor for resecuritization exposures. What modifications,
if any, should the agencies consider to the 100 percent risk-weight
floor for resecuritization exposures and why? For example, what would
be the pros and cons of excluding certain types of resecuritization
exposures--such as resecuritizations of servicer cash advance
receivables--from the 100 percent risk-weight floor and why? Commenters
are encouraged to provide data (such as loss history) to support their
recommendations.
5. Exceptions to the SEC-SA Risk-Based Capital Treatment for
Securitization Exposures
Securitization exposures sometimes contain 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.
Therefore, the proposal would include additional approaches for certain
types of securitization exposures to more appropriately align the
capital requirement with the risk of such securitization exposures.
a. Purchased Credit Derivatives
As discussed previously in section IV.B.1.b. of this SUPPLEMENTARY
INFORMATION, the proposal would modify paragraph (1) of the definition
of traditional securitization to clarify that the securitization
framework generally applies to exposures to companies with material
liabilities that are not operating companies, and whose underlying
exposures are primarily financial exposures. To further clarify the
scope of exposures subject to the securitization framework under the
current capital rule, the proposal would also remove the definition of
securitization special purpose entity (SPE).
Under the current capital rule, if a banking organization purchases
a credit derivative (other than an nth-to-default credit derivative)
that is recognized as a credit risk mitigant (including via recognized
collateral) under the securitization framework, the banking
organization is not required to compute a separate counterparty credit
risk capital requirement. For purchased credit derivatives that a
banking organization cannot or chooses not to recognize as a credit
risk mitigant under the securitization framework, the current capital
rule requires the banking organization to calculate an exposure amount
using SA-CCR and to determine the applicable risk weight based on
whether or not the counterparty is a securitization SPE.\178\
Specifically, if the counterparty is a securitization SPE, the banking
organization must determine the risk weight based on the securitization
framework; if the counterparty is not a securitization SPE, the banking
organization must apply the risk weight applicable to the counterparty
under the general credit risk framework.
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\178\ Securitization SPE under Sec. __. 2 of the current
capital rule means a corporation, trust, or other entity organized
for the specific purpose of holding underlying exposures of a
securitization, the activities of which are limited to those
appropriate to accomplish this purpose, and the structure of which
is intended to isolate the underlying exposures held by the entity
from the credit risk of the seller of the underlying exposures to
the entity. See 12 CFR 3.2 (OCC); 12 CFR 217.2 (Board); 12 CFR 324.2
(FDIC).
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Consistent with the proposed technical modification to the
definition of traditional securitization,\179\ the proposal would (1)
remove the definition of securitization SPE, and (2) clarify that the
risk weight applicable to purchased credit derivatives that a banking
organization cannot or chooses not to recognize as a credit risk
mitigant would be based on whether the counterparty is a securitization
(that is, a non-operating company that holds the underlying exposures
of a securitization transaction).
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\179\ The proposal would retain the existing definition of
securitization exposure under the current capital rule. Under Sec.
__. 2 of the current capital rule, securitization exposure means (1)
an on-balance sheet or off-balance sheet credit exposure (including
credit-enhancing representations and warranties) that arises from a
traditional securitization or synthetic securitization (including a
resecuritization), or (2) an exposure that directly or indirectly
references a securitization exposure described in paragraph (1) of
this definition. See 12 CFR 3.2 (OCC); 12 CFR 217.2 (Board); 12 CFR
324.2 (FDIC).
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b. Nth-to-Default Credit Derivatives
Nth-to-default credit derivatives provide credit protection on a
group of reference exposures only after a specific number (n) of the
reference exposures default.\180\ As nth-to-default credit derivatives
tranche the credit risk of the reference exposures based on the order
in which defaults occur within the group of reference exposures, such
credit derivatives would generally qualify as securitization exposures
under the proposal, consistent with the current capital rule. Under the
current capital rule, banking organizations that have purchased credit
protection in the form of an nth-to-default credit derivative may
recognize the risk-mitigating benefit of that derivative under the
credit risk mitigation framework applicable to securitization exposures
if certain conditions are met. If a banking organization sells
protection in the form of an nth-to-default credit derivative, the
current capital rule requires the banking
[[Page 15001]]
organization to calculate risk-weighted assets as the product of (1)
the exposure amount produced by SA-CCR, and (2) either the risk weight
produced by the SSFA or a 1,250 percent risk weight.
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\180\ Consistent with the current capital rule, the proposal
would define an nth-to-default credit derivative as a credit
derivative the provides credit protection only for the nth-
defaulting reference exposure in a group of reference exposures. See
12 CFR 3.2 (OCC); 12 CFR 217.2 (Board); 12 CFR 324.2 (FDIC).
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Nth-to-default credit derivatives provide protection only for a
limited number of default event(s) and, therefore, do not provide
continuous or comprehensive coverage of credit risk for the entire
basket of reference exposures. Furthermore, the current capital
treatment of nth-to-default credit derivatives may not appropriately
capture the default correlation among the reference exposures. For
example, assume a banking organization with exposure to five corporate
entities purchases an nth-to-default credit derivative that pays out
upon the default of the second of the five corporate entities. In such
a case, the banking organization would remain exposed to any losses
incurred upon the first corporate entity default, as well as losses
from any defaults beyond the second corporate entity default, if
applicable. Conversely, a banking organization that sells an nth-to-
default credit derivative that provides protection against the default
of the second corporate entity could incur losses exceeding the
premiums collected from the protection purchaser if the defaults of the
underlying corporates are highly correlated. Furthermore, the risk
weight produced by the SEC-SA may not appropriately capture the risk of
sold nth-to-default credit derivatives, which are priced based on the
expected default correlation among the reference exposures.\181\
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\181\ As a standardized approach, the SEC-SA calculation does
not explicitly capture default correlation among the underlying
exposures (such as the possibility that multiple underlying
exposures will default simultaneously or that the default of one
underlying exposure may affect the likelihood of another underlying
exposure defaulting). Instead, default correlation effects are
implicitly incorporated through the supervisory parameter (p) in the
SEC-SA calculation, which serves as a proxy for the concentration
and correlation of the underlying exposures.
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Accordingly, consistent with the Basel standards, while nth-to-
default credit derivatives would continue to be securitization
exposures, the proposal would not permit banking organizations to
recognize any risk-mitigating benefit for nth-to-default credit
derivatives for which the banking organization is the protection
purchaser under the proposed securitization framework. Rather, the
proposal would require banking organizations to calculate risk-weighted
assets for counterparty credit risk using the exposure amount produced
by SA-CCR, as described in section IV.A.4.b. of this SUPPLEMENTARY
INFORMATION and the risk weight applicable to the protection provider
under the general credit risk framework.
Similarly, consistent with the Basel standards, while nth-to-
default credit derivatives in which the banking organization is the
seller of protection would continue to be securitization exposures, the
proposal would prohibit the banking organization from using the SEC-SA
to determine the applicable risk weight. Rather, the proposal would
generally require banking organizations to calculate the risk-weighted
asset amount by multiplying the notional amount of the protection
provided by the nth-to-default credit derivative by the sum of the risk
weights applicable to each of the underlying reference exposures, up to
a maximum of 1,250 percent. In aggregating the risk weights for second-
or-later-to-default credit derivatives, the proposal would permit
banking organizations to exclude the (n-1) assets with the lowest risk
weights from the calculation.\182\ This approach would require a
banking organization to maintain capital based on the risk
characteristics of all the underlying reference exposures in the basket
on which it is providing protection, while recognizing that the banking
organization is not required to make a payment unless ``n'' names in
the basket default.
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\182\ For example, assume a banking organization sells a first-
to-default credit derivative that provides protection on three
underlying corporate entities, two of which would be subject to a 65
percent risk weight and one to a 100 percent risk weight under the
proposal. The proposal would require the banking organization to
multiply the sum of the three risk-weights (230 percent) by the
notional amount of protection provided by the first-to-default
credit derivative. If the banking organization sold a second-to-
default credit derivative that provided protection on the same three
corporate entities, the proposal would require the banking
organization to multiply the sum of the two highest applicable risk-
weights (165 percent) by the notional amount of protection provided
by the second-to-default credit derivative.
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c. Derivative Contracts That Do Not Provide Credit Enhancements
The proposal would revise the risk weight for securitization
exposures that are derivative contracts (other than protection provided
by a banking organization in the form of a credit derivative) that have
a first priority claim on the cash flows from the underlying exposures,
notwithstanding amounts due under interest rate or currency derivative
contracts, fees, or other similar payments. The current capital rule
permits banking organizations to assign a risk-weighted asset amount
for such securitization exposures equal to the exposure amount
calculated under SA-CCR (corresponding to a 100 percent risk weight).
The proposal would eliminate this option. Instead, a banking
organization would determine the risk-weighted asset amount by
multiplying (1) the exposure amount produced by the counterparty credit
risk framework, as described in section IV.A.4. of this SUPPLEMENTARY
INFORMATION, and (2) either the risk weight applicable to the exposure
under the securitization framework or a 1,250 percent risk weight. The
proposed treatment would be more risk sensitive and more accurately
reflect the risks of such exposures than a flat 100 percent risk
weight.
Additionally, 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 underlying exposures are linked to a floating interest
rate. To neutralize these foreign exchange or interest rate risks, a
securitization 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 paid to the derivative counterparty
tend to have a claim senior to the investors in the cash flow
waterfall, 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, consistent with the Basel
standards, 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.
Question 75: The current capital rule provides banking
organizations the
[[Page 15002]]
option to assign a 100 percent risk weight to securitization exposures
that are derivative contracts (other than protection provided by a
banking organization in the form of a credit derivative) that have a
first priority claim on the cash flows from the underlying exposures
(notwithstanding amounts due under interest rate or currency derivative
contracts, fees, or other similar payments). The agencies seek comment
on the advantages and disadvantages of retaining this option. What, if
any, operational burden would banking organizations face if this option
were retained or eliminated? What, if any, clarifications should the
agencies consider regarding the determination of the attachment point
and detachment point for such securitization exposures, and why?
d. Overlapping Exposures
To enhance the risk sensitivity of the securitization framework,
the proposal would introduce new provisions to address instances where
one of the banking organization's securitization exposures would
preclude the banking organization from incurring losses under all
circumstances on one or more separate securitization exposures also
held by the banking organization (overlapping exposures). The
standardized approach of the current capital rule includes provisions
to limit the double counting of risks in situations involving
overlapping securitization exposures. If a banking organization has
multiple securitization exposures that provide duplicative coverage to
the underlying exposures of a securitization (such as when a banking
organization provides a program-wide credit enhancement and multiple
pool-specific liquidity facilities to an ABCP program), the banking
organization is not required to hold duplicative risk-based capital
against the overlapping position. Instead, the banking organization may
apply to the overlapping position the applicable risk-based capital
treatment under the securitization framework that results in the
highest risk-based capital requirement.
Consistent with the Basel standards, the proposal would expand the
treatment of overlapping exposures to allow banking organizations to
also apply this treatment (1) where one or more of the overlapping
securitization exposures would be subject to the expanded risk-based
approach and other(s) to the proposed market risk framework, and (2) to
securitization exposures that partially overlap for purposes of the
expanded risk-based approach.
First, to the extent that one or more of the such securitization
exposures would be subject to the expanded risk-based approach and
others to the revised market risk framework, the proposal would allow
banking organizations to reflect only the greater of the risk-based
capital requirement produced by the expanded risk-based approach or the
market risk capital framework, provided the banking organization is
able to calculate and compare the capital requirements for the relevant
exposures.
Second, if a banking organization has two or more securitization
exposures that partially overlap, the proposal would permit the banking
organization to treat the exposures as overlapping exposures, provided
the banking organization can demonstrate that one of its securitization
exposures can fully absorb losses arising from its other securitization
exposures. For example, if a banking organization provides a program-
wide credit enhancement to an ABCP conduit that covers only the portion
of the losses above the seller-provided protection \183\ and the
banking organization also holds commercial paper issued by the ABCP
conduit, the banking organization would be permitted to reflect the
risk-weighted asset amount only for the program-wide credit
enhancement, provided the banking organization demonstrates, for
purposes of calculating risk-based capital requirements, that the
program-wide credit enhancement would require the banking organization
to fully absorb any losses arising from the ABCP conduit. As the risk-
based capital requirement for the program-wide credit enhancement would
be treated as covering any losses on the commercial paper, the proposal
would not require the banking organization to also maintain additional
risk-based capital against the securitization exposure(s) arising from
the commercial paper.
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\183\ For example, typically in the case of multi-seller ABCP
conduits, each seller provides first-loss protection by over-
collateralizing the conduit to which it sells loans.
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In this regard, the proposal aims to increase risk-sensitivity by
allowing banking organizations to appropriately reflect the risk of
such overlapping exposures within the calculation of risk-weighted
assets while also providing sufficient flexibility if doing so would
impose significant burden.\184\
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\184\ For example, the proposed market risk capital framework
would require banking organizations to calculate risk-based capital
requirements at the trading desk level. Thus, the cost associated
with requiring banking organizations to calculate market risk
capital requirements for an individual securitization exposure may
outweigh any improvement in risk sensitivity associated with the
proposed treatment for overlapping exposures described above.
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Question 76: 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?
e. Look-Through Approach for Senior Securitization Exposures
Consistent with the Basel standards, the proposal would introduce a
provision that would allow a banking organization to assign to a senior
securitization exposure that is not a resecuritization exposure a risk
weight equal to 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 proposal would require a banking organization
to use (1) the unpaid principal amount of underlying exposures as the
weight for each exposure, and (2) determine the risk weight applicable
to an underlying equity exposure based on the characteristics of the
underlying equity exposure.\185\
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\185\ As discussed in section IV.B.4.c. of this SUPPLEMENTARY
INFORMATION, the non-significant equity exposure treatment does not
apply to equity securities underlying a securitization.
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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, currency
derivative contracts, and servicer cash advance facility
contracts,\186\ or any fees and other similar payments to be made by
the securitization 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
[[Page 15003]]
drawn amounts is senior to all claims on the cash flows from the
underlying exposures, except amounts due under interest rate derivative
contracts, currency derivative contracts, and servicer cash advance
facility contracts, fees due, and other similar payments. Accordingly,
under the proposed look-through approach, if a senior securitization
exposure's underlying exposures consists solely of past due loans with
a weighted-average risk weight of 150 percent, the risk weight for the
senior securitization exposure would be no more than 150 percent.
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\186\ Consistent with the current capital rule, the proposal
would define a servicer cash advance facility as 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. See 12 CFR 3.2 (OCC); 12 CFR
217.2 (Board); 12 CFR 324.2 (FDIC).
---------------------------------------------------------------------------
Consistent with the proposed 15 percent floor under the SEC-SA, the
proposal would require banking organizations to floor the total risk-
based capital requirement under the look-through approach at 15
percent. The proposed 15 percent floor is intended to appropriately
reflect the minimum amount of risk-based capital that a banking
organization should maintain for senior securitization exposures given
that the process of securitization can introduce risks that are not
present in directly holding the underlying exposures. For example, the
transformation of risk profiles through the securitization process and
the introduction of payment waterfalls, among other structural
features, can add complexity to modeling and correlation assumptions.
Question 77: What are the advantages and disadvantages of the
proposed 15 percent risk weight floor in the look-through approach and
why?
f. Credit-Enhancing Interest Only Strips
The proposal would require a banking organization to deduct from
common equity tier 1 capital any portion of a credit-enhancing
interest-only strip\187\ 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 credit-
enhancing interest-only strips would be different than under
standardized approach in the current capital rule, which requires a
risk weight of 1,250 percent for these items. The proposal would
require banking organizations to deduct credit-enhancing interest-only
strips from common equity tier 1 capital because valuations of credit-
enhancing interest-only strips 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
credit-enhancing interest-only strips 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 risk-based capital ratio, given the various capital ratios,
buffers, and add-ons applicable to banking organizations subject to the
proposed expanded risk-based approach, applying a deduction provides a
more consistent treatment across capital ratios and greater consistency
with the Basel standards.
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\187\ Consistent with the current capital rule, the proposal
would define a credit-enhancing interest-only strip as an on-balance
sheet asset that, in form or in substance (1) represents a
contractual right to receive some or all of the interest and no more
than a minimal amount of principal due on the underlying exposures
of a securitization; and (2) exposes the holder of the CEIO to
credit risk directly or indirectly associated with the underlying
exposures that exceeds a pro rata share of the holder's claim on the
underlying exposures, whether through subordination provisions or
other credit-enhancement techniques. See 12 CFR 3.2 (OCC); 12 CFR
217.2 (Board); 12 CFR 324.2 (FDIC).
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g. Non-Performing Loan Securitizations
The proposal would define a non-performing loan securitization as a
traditional securitization, that is not a resecuritization, where
parameter W for the underlying exposures is greater than or equal to 90
percent at the origination cut-off date \188\ and at any subsequent
date on which exposures are added to or removed from the pool of
underlying exposures due to replenishment or restructuring. A
securitization exposure that meets the definition of a resecuritization
exposure would be excluded from the definition of a non-performing loan
securitization.
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\188\ Cut-off date is the date on which the composition of the
underlying exposures collateralizing a securitization transaction is
established. This means that all exposures to be included in a
securitization must already be in existence and meet the non-
performing loan criteria as of that date.
---------------------------------------------------------------------------
In a typical non-performing loan securitization, the originating
banking organization sells non-performing loans to a securitization at
a significant discount to the outstanding loan balances, reflecting the
nonperforming nature of the underlying exposures. This nonrefundable
purchase price discount functions as a form of credit enhancement to
investors. Unlike securitizations of performing loans, which
principally depend on the cash flows of the underlying loans, the
performance of non-performing loan securitizations depends in part on
the performance of workouts on defaulted loans and on the liquidation
of underlying collateral for those loans which are unable to be cured,
both which are uncertain and could be volatile.
Consistent with the Basel standards, the proposal would introduce a
specific capital treatment for non-performing loan securitization
exposures. A banking organization would assign a risk weight of 100
percent to a non-performing loan securitization exposure if the
following conditions are satisfied: (1) the transaction structure meets
the definition of a traditional securitization; (2) the securitization
contains 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 underlying exposures at inception of the transaction;
and (3) the banking organization's securitization exposure is a senior
securitization exposure, as described in section IV.B.5.e. of this
SUPPLEMENTARY INFORMATION.\189\ Applying the SEC-SA to senior
securitizations of non-performing loans that meet these criteria would
result in capital requirements that do not appropriately reflect the
nonrefundable purchase price discount associated with these
transactions. The SEC-SA is calibrated on the assumption that the
underlying exposures at origination of the securitization are generally
performing and is therefore inappropriate for senior exposures to
securitizations of non-performing loans that meet these criteria.
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\189\ If the banking organization is an originating banking
organization with respect to the non-performing loan 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 non-performing loan securitization exposure is not a senior
securitization exposure or the nonrefundable purchase price discount is
less than 50 percent, the banking organization would be required to
apply the SEC-SA to determine the applicable risk weight (including by
reflecting all delinquent exposures in the calculation of parameter W),
subject to a risk weight floor of 100 percent. Compared to other
securitizations, the higher supervisory risk-weight floor of 100
percent for non-performing loan securitization exposures reflects the
greater dependence of non-performing loan securitizations on the
servicer's ability to generate recovery cashflows through loan
workouts, borrower renegotiations, or enforcement against collateral.
If the securitization exposure does not meet the requirements for use
of the SEC-SA, the proposal would require the banking
[[Page 15004]]
organization to assign a risk weight of 1,250 to the securitization
exposure.
Question 78: The agencies seek comment on the proposed 100 percent
risk-weight floor for non-performing loan securitization exposures.
What modifications, if any, should the agencies consider to the 100
percent risk-weight floor for non-performing loan securitization
exposures and why? Commenters are encouraged to provide data (such as
loss history) to support their recommendations.
i. Attachment and Detachment Points for NPL Securitizations Subject to
the SEC-SA
Under the proposal, the nonrefundable purchase price discount would
equal the difference between the outstanding principal balance of the
underlying exposures at the time of sale and the price at which these
exposures are sold by the securitization originator \190\ on a final
basis, without recourse, to a company the activities of which are
limited to those appropriate for the specific purpose of holding the
underlying exposures of a securitization. The purchase price discount
would be considered non-refundable when neither the securitization
originator nor the original lender are reimbursed with respect to that
difference. For any given tranche of the securitization, a banking
organization may take into account only the initial sale from the
securitization originator in the determination of the non-refundable
purchase price discount. In cases where the securitization originator
underwrites tranches of a non-performing loan securitization for
subsequent sale, an investing banking organization may include in the
calculation of the nonrefundable purchase price discount the difference
between the outstanding principal balance of the underlying exposures
at time of sale and the price at which the securitization originator
subsequently sells all of the underwritten tranches to unrelated third
parties.
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\190\ While originator typically refers to the party originating
the underlying loans, in the non-performing loan context it refers
to the party arranging the non-performing loan securitization (that
is, the securitizer).
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Because the calculation of both parameters A and D depend on the
current dollar amount of the underlying exposures, 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 sells on a
final basis, without recourse, a pool of mortgage loans with an
outstanding principal balance of $100 million to a securitization at a
price of $60 million. The nonrefundable purchase price discount would
be the difference between the outstanding principal balances of the
underlying mortgages at the time of sale to the securitization and the
price at which the originating banking organization sold these
mortgages to the securitization company (that is, $40 million). Assume
that the securitization company issues $60 million in securitization
tranches of which the originating banking organization purchases the
senior $50 million tranche and an investing banking organization
purchases the $10 million subordinate tranche. Parameter A for the
investing banking organization's exposure would equal 40 percent (that
is, the ratio of $40 million to $100 million). In this case, the
purchase price discount functions as the effective first-loss position
in the securitization structure. 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, after selling the $100 million pool of
mortgage loans to a securitization company at a price of $60 million,
the originating banking organization underwrites both the senior
tranche and the subordinate tranche and later sells both tranches to
third parties at a 20 percent discount (that is, the $10 million
subordinated tranche is sold for a price of $8 million and the $50
million senior tranche is sold for a price of $40 million), the
proposal would allow the investing banking organizations to assign an
attachment point that reflects the extent to which losses have
effectively been absorbed by the non-refundable purchase price
discount, as measured by the difference between the outstanding
principal amount of the underlying exposures ($100 million) and the
aggregate price at which the originating bank subsequently sells those
securitization tranches to unrelated third parties ($48 million). The
originating banking organization as underwriter absorbs the additional
20 percent price discount at the sale of the tranches.\191\ Thus, the
investing banking organization that purchases the $8 million
subordinate tranche would be permitted to assign an attachment point of
52 percent and a detachment point of 60 percent to its securitization
exposure; the investing banking organization that purchases the $40
million senior tranche would be permitted to assign an attachment point
of 60 percent and a detachment point of 100 percent to its
securitization exposure.
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\191\ Under the proposal, a purchase price discount would only
qualify as a non-refundable purchase price discount if neither the
securitization originator nor the original lender receive
reimbursement of the discount. If, in the above example, the
securitization company repays the originating banking organization,
acting in its role as underwriter, for the purchase price discount
from the sale of the tranches to third-party investors, the purchase
price discount would not qualify as a non-refundable purchase price
discount and the investing banking organizations would not be
permitted to recognize such a discount in the calculation of
parameters A and D.
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6. Credit Risk Mitigation for Securitization Exposures
The proposal would incorporate the credit risk mitigation framework
for securitization exposures in the current standardized approach, with
one exception.\192\ 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
[[Page 15005]]
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. Because the former transaction would not be
considered a senior securitization exposure eligible for the look-
through approach, 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 this case, the proposal would allow the banking
organization to treat the securitization exposure (which attaches at 20
percent and detaches at 100 percent) as a senior securitization
exposure.
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\192\ As discussed in section IV.A.4. of this SUPPLEMENTARY
INFORMATION, the proposal would increase consistency and
comparability of capital requirements by reducing the use of bank
models. Therefore, the proposal does not include the model-based
approaches currently contained in the credit risk mitigation
framework under the advanced approaches (such as allowing banking
organizations to use their own internal estimates for calculating
haircuts under the collateral haircut approach and allowing the use
of the internal models methodology or simple value at risk
methodology for measuring counterparty credit risk). Instead,
consistent with the standardized approach in the current capital
rule, the proposed credit risk mitigation framework for
securitization exposures would permit the recognition of a credit
risk mitigant only to the extent consistent with the requirements of
Sec. __.120 or 121, as applicable, as well as the requirements of
the proposed securitization framework.
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C. 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 equity instrument and is a residual claim on the assets
and income of the issuer. An equity exposure entitles a banking
organization to no more than the pro-rata residual value of a company
after all other creditors are repaid.\193\ 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.
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\193\ For example, exposures that could be characterized as an
equity exposure under the current capital rule and under the
proposal include a short position in an equity security or an equity
total return swap. See 12 CFR 3.2 (OCC); 12 CFR 217.2 (Board); 12
CFR 324.2 (FDIC) for the definition of equity exposure.
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Under the proposal, for banking organizations subject to the market
risk framework, material publicly traded equity exposures would
generally be subject to the proposed market risk framework \194\
described in section V.A. of this SUPPLEMENTARY INFORMATION, unless
restrictions exist on the tradability of such exposures. Similarly,
equity exposures to investment funds would be subject to the proposed
market risk framework when the following conditions are met: (1) 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 (2) the banking
organization is either able to calculate a market risk capital
requirement for its proportional ownership share of each exposure held
by the investment fund, or obtain daily price quotes. For banking
organizations with significant trading activity, the proposed equity
framework would therefore primarily cover illiquid or infrequently
traded equity exposures. For banking organizations without significant
trading activity, the proposed equity framework would be used to
calculate risk-weighted assets for all equity exposures.
---------------------------------------------------------------------------
\194\ See Sec. __.202 for the proposed definition of market
risk covered position.
---------------------------------------------------------------------------
The proposed framework would largely maintain the current
standardized approach equity framework. The proposal would make one
targeted modification to align the treatment of commitments within the
expanded risk-based approach. Specifically, the proposal would simplify
the current rule's conversion factors for conditional commitments to
acquire an equity exposure.
1. Adjusted Carrying Value
The proposal would retain the risk-weighted asset amount
calculation under the current capital rule.\195\ In addition, the
proposal would maintain the current capital rule's methods for
calculating the adjusted carrying value for equity exposures, with one
exception. Consistent with the update to credit conversion factors
described in section IV.A.3.b. of this SUPPLEMENTARY INFORMATION, the
proposal would simplify the treatment of conditional commitments to
acquire an equity exposure by removing 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. This change is consistent with the Basel
standards, promoting international alignment, and removes incentives
for firms to structure commitments based on maturity date to avoid the
higher 50 percent conversion factor under the current rule in favor of
the lower 20 percent conversion factor.
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\195\ See 78 FR 62124.
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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 1 below.
[[Page 15006]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.071
2. Simple Risk-Weight Approach (SRWA)
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\196\ 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 this derivative is the current value of shares of
common stock of company X minus the adjusted carrying value of any
on-balance sheet amount associated with the derivative.
\197\ 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. __.114(d) of the proposal.
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Under the proposal, the risk-weighted asset amount for an equity
exposure, except for equity exposures to investment funds, would be the
product of the adjusted carrying value of the equity exposure
multiplied by the lowest applicable risk weight, as described in Table
2 below. The proposed simple risk-weight approach maintains the same
risk weights applicable to equity exposures under the current capital
rule.
[[Page 15007]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.072
a. Alternative Approach
The proposal would maintain the current capital rule's treatment of
non-significant equity exposures. Non-significant equity exposures
means equity exposures to the extent that the aggregate adjusted
carrying value of the banking organization's equity exposure does not
exceed 10 percent of the banking organization's total capital.\201\
Non-significant equity exposures receive a 100 percent risk weight
under the current capital rule.
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\198\ Under the proposal, specified supranational entities would
include the Bank for International Settlements, the European Central
Bank, the European Commission, the International Monetary Fund, the
European Stability Mechanism, and the European Financial Stability
Facility. Consistent with the current capital rule, equity exposures
to such entities would continue to be subject to a zero percent risk
weight for the purposes of the simple risk weight approach.
\199\ See 78 FR 62124 (Oct. 11, 2013).
\200\ 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).
\201\ See __.141(b).
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To increase the risk sensitivity of the proposed equity framework,
the agencies considered the following alternative approach: (1) remove
the 100 percent risk weight for non-significant equity exposures, (2)
introduce a 100 percent risk weight for certain tax equity financing
transactions and equity exposures to Small Business Investment
Companies,\202\ (3) lower the risk weight for publicly traded equity
exposures from 300 percent to 250 percent,\203\ and (4) increase the
risk weight applicable to equity exposures to investment firms with
greater than immaterial leverage
[[Page 15008]]
and that would meet the definition of a traditional securitization were
it not for the application of paragraph (8) of that definition from 600
percent to 1,250 percent. Outside of those changes under consideration,
the agencies would retain the current capital rule's risk weights for
equity exposures, the hedge pair treatment, and look-through approaches
for equity investment in funds. This alternative approach would
increase risk sensitivity 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. Conversely, the agencies recognize that
implementing this alternative approach would increase the operational
burden associated with the proposal as banking organizations have
developed internal reporting systems and processes to apply the current
capital rule's 100 percent risk weight for non-significant equity
exposures.
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\202\ 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).
\203\ The 250 percent risk weight for publicly traded equities
would be consistent with the Basel standards.
---------------------------------------------------------------------------
Given that the proposed equity framework captures a more limited
set of exposures compared to the current rule,\204\ the agencies
determined that the cost associated with replacing the current
treatment for non-significant equity exposures may be higher than the
improvement in risk sensitivity associated with the alternative
approach described above. As such, to balance risk sensitivity with
burden, the proposed simple risk weight approach retains the current
capital rule's treatment for non-significant equity exposures.
---------------------------------------------------------------------------
\204\ A significant portion of publicly traded equity exposures
and equity investment in funds exposures will be considered market
risk covered positions. See Sec. __.202 for the proposed definition
of market risk covered position.
---------------------------------------------------------------------------
Question 79: What are the advantages and disadvantages of the
proposed 40 percent conversion factor for calculating the adjusted
carrying value of conditional equity commitments? How appropriate is
this proposed conversion factor for capturing the risk that such
commitments will become on-balance sheet equity exposures? What
alternative approaches or conversion factor values might better reflect
the risk profile of conditional equity commitments, and what would be
the potential costs and benefits of such alternatives?
Question 80: What are the advantages and disadvantages of using a
treatment for conditional commitments which differentiates conversion
factors based on maturity, and would apply a 20 percent credit
conversion factor to those commitments with an original maturity of one
year or less, and a 50 percent conversion factor to those with an
original maturity of more than one year?
Question 81: The agencies request comment on the proposed 100
percent risk weight for non-significant equity exposures. What are the
advantages or disadvantages of replacing the proposed treatment of
equity exposures with the alternative approach described above? What
other alternatives should the agencies consider, and what would be the
advantages and disadvantages of such alternatives?
Question 82: For what, if any, types of exposures would a 100
percent risk weight and classification as non-significant equity
exposure be inappropriate and why? What specific characteristics of
these exposures would warrant a different risk weight treatment?
Question 83: Certain equity exposures, such as certain tax equity
financing transactions, may have a different risk profile than general
equity exposures. What types of equity exposures have risk profiles
that differ materially from general equity exposures? What risk weights
would be appropriate for such exposures, and what are the benefits and
costs of applying different risk weight treatments? Please provide
relevant data to support your views, including historical loss data and
information on risk characteristics of these exposures.
D. Operational Risk
The proposal would include an operational risk capital requirement.
Operational risk is defined in the current capital rule as the risk of
loss resulting from inadequate or failed internal processes, people,
and systems, or from external events.\205\ It includes a wide range of
risks, such as fraud, system failures, business disruptions, damage to
physical assets, cyberattacks, and litigation. Operational risk is
present across banking products, activities, processes, and systems and
has resulted in substantial financial losses for large banking
organizations in the United States.\206\
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\205\ See 12 CFR 3.101 (OCC); 217.101 (Board); 12 CFR 324.101
(FDIC). Under the proposal, the definition of operational risk would
include legal risk, but exclude strategic risk.
\206\ There are several examples of large banking organizations
experiencing severe operational losses. Multiple banking
organizations have suffered substantial losses due to rogue trading.
Large U.S. banking organizations have also experienced billions of
dollars in operational losses from legal settlements relating to
improper loan origination, securitization, and foreclosure practices
associated with the 2007-09 global financial crisis. Some banking
organizations have experienced substantial losses from legal
settlements relating to the violation of sanctions put in place by
the United States. Additionally, a large banking organization
experienced substantial operational losses due to a fake-accounts
scandal.
See, e.g., M. Jeremy, ``Leeson pleads guilty to two charges in
Barings collapse, and may cooperate,'' The Wall Street Journal (Dec.
1, 1995); and Nicola Clark and David Jolly, ``French Bank Says Rogue
Trader Lost $7 Billion,'' The New York Times, (Jan. 25, 2008).
See, e.g., U.S. Dep't of Justice, Press Release, Federal
Government and State Attorneys General Reach $25 Billion Agreement
with Five Largest Mortgage Servicers to Address Mortgage Loan
Servicing and Foreclosure Abuses (Feb. 9, 2012), https://www.justice.gov/opa/pr/federal-government-and-state-attorneys-general-reach-25-billion-agreement-five-largest; U.S. Dep't of
Justice, Press Release, Justice Department, Federal and State
Partners Secure Record $13 Billion Global Settlement with JPMorgan
for Misleading Investors About Securities Containing Toxic Mortgages
(Nov. 9, 2013), https://www.justice.gov/opa/pr/justice-department-federal-and-state-partners-secure-record-13-billion-global-settlement; FHFA, Press Release, FHFA Announces $9.3 Billion
Settlement With Bank of America Corporation (Mar. 26, 2014), https://www.fhfa.gov/news/news-release/fhfa-announces-9.3-billion-settlement-with-bank-of-america-corporation; U.S. Dep't of Justice,
Press Release, Bank of America to Pay $16.65 Billion in Historic
Justice Department Settlement for Financial Fraud Leading up to and
During the Financial Crisis (Aug. 21, 2014), 21, 2014), https://www.justice.gov/opa/pr/bank-america-pay-1665-billion-historic-justice-department-settlement-financial-fraud-leadinghttps://www.justice.gov/opa/pr/bank-america-pay-1665-billion-historic-justice-department-settlement-financial-fraud-leading; U.S. Dept' of
Justice, Press Release, Justice Department, Federal and State
Partners Secure Record $7 Billion Global Settlement with Citigroup
for Misleading Investors About Securities Containing Toxic Mortgages
(July 14, 2014), https://www.justice.gov/opa/pr/justice-department-federal-and-state-partners-secure-record-7-billion-global-settlementhttps://www.justice.gov/opa/pr/justice-department-federal-and-state-partners-secure-record-7-billion-global-settlement; U.S.
Dep't of Justice, Press Release, BNP Paribas Sentenced for
Conspiring to Violate the International Emergency Economic Powers
Act and the Trading with the Enemy Act (May 1, 2015), https://www.justice.gov/opa/pr/bnp-paribas-sentenced-conspiring-violate-international-emergency-economic-powers-act-and;U.S. Dep't of
Justice, Press Release, Morgan Stanley Agrees to Pay $2.6 Billion
Penalty in Connection with Its Sale of Residential Mortgage Backed
Securities (Feb. 11, 2016), https://www.justice.gov/opa/pr/morgan-stanley-agrees-pay-26-billion-penalty-connection-its-sale-residential-mortgage-backed; U.S. Dep't of Justice, Press Release,
Deutsche Bank Agrees to Pay $7.2 Billion for Misleading Investors in
its Sale of Residential Mortgage-Backed Securities (Jan. 17, 2017),
https://www.justice.gov/opa/pr/deutsche-bank-agrees-pay-72-billion-misleading-investors-its-sale-residential-mortgage-backed; U.S.
Dep't of Justice, Press Release, Credit Suisse Agrees to Pay $5.28
Billion in Connection with its Sale of Residential Mortgage-Backed
Securities (Jan. 18, 2017), https://www.justice.gov/opa/pr/deutsche-bank-agrees-pay-72-billion-misleading-investors-its-sale-residential-mortgage-backed; U.S. Dep't of Justice, Press Release,
Credit Suisse Agrees to Pay $5.28 Billion in Connection with its
Sale of Residential Mortgage-Backed Securities (Jan. 18, 2017),
https://www.justice.gov/opa/pr/credit-suisse-agrees-pay-528-billion-connection-its-sale-residential-mortgage-backed; and U.S. Dep't of
Treasury, Office of Foreign Assets Control, Press Release,
Settlement Agreement between the U.S. Department of the Treasury's
Office of Foreign Assets Control and JPMorgan Chase Bank, N.A.
(JPMC), and Finding of Violation issued to JPMC (Oct. 5, 2018),
https://ofac.treasury.gov/recent-actions/20181005 (each describing a
settlement between the U.S. government and large banking
organizations involving substantial payments by banking
organizations to resolve allegations of misconduct).
See, e.g., Jackie Wattles, Ben Geir, Matt Egan, and Danielle
Wiener-Bronner, ``Wells Fargo's 20-Month Nightmare,'' CNN Money
(Apr. 24, 2018).
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[[Page 15009]]
In total, Category I and II holding companies have experienced over
$308 billion in operational losses between 2007Q1 and 2025Q2.\207\
These totals include large operational losses from activities that
typically do not result in substantial credit or market risk-weighted
assets, such as certain fee-based activities, indicating that
operational risk can represent the main source of risk for activities
that have a limited balance sheet footprint.
---------------------------------------------------------------------------
\207\ The $308 billion figure was calculated by adding together
all operational loss events that resulted in a net loss amount of
$20,000 or more and were reported in the FR Y-14Q form.
---------------------------------------------------------------------------
In addition to their substantial stand-alone materiality, empirical
academic research supports that operational losses tend to increase
during economic downturns.\208\ In some cases, operational losses only
become apparent once a banking organization is otherwise under stress,
with economic downturns and reductions in asset values exposing
previous operational failures and fraud.\209\ For example, the
operational failures and fraud of a rogue trader within Barings Bank
only became known after the fall in asset values within Asian financial
markets following the 1995 Kobe earthquake. These operational losses
ultimately resulted in the bank's failure.\210\ Similarly, substantial
operational losses followed from the Enron and Worldcom fraud scandals,
which coincided with a stock market downturn in the early 2000s.\211\
The fall in asset values during the 2007-09 financial crisis was a key
factor in exposing Bernard Madoff's ponzi scheme and mortgage servicing
abuses, which led to severe operational losses for certain large
banking organizations.\212\
---------------------------------------------------------------------------
\208\ Using a summary measure for the macroeconomic environment,
Abdymomunov et al. (2020) find that operational losses increase by
16.5 percent for a one standard deviation decrease in the
macroeconomic measure. Similarly, Allen and Bali (2007) find that
operational risk is cyclical and relates to measures of the
macroeconomy and systemic risk. Chernobai et al. (2011) find that
operational risk is higher for firms with higher credit risk. Hess
(2011) finds that measures of operational risk for several business
lines increased meaningfully after the 2007-09 financial crisis.
Cope and Carrivick (2013) find that operational loss frequency and
severity increased due to the 2007-09 financial crisis. And Aldosoro
et al. (2023) find that operational losses peaked during the 2007-09
financial crisis and that operational losses increase after periods
of accommodative monetary policy. Relatedly, Berger et al. (2022)
find that operational losses increase the systemic risk posed by
large U.S. banking organizations. See Abdymomunov, Azamat, Filippo
Curti, and Atanas Mihov, ``U.S Banking Sector Operational Losses and
the Macroeconomic Environment,'' Journal of Money, Credit, and
Banking, Vol. 52, No.1, pages 115-144 (2020); Allen, Linda, and
Turan G. Bali, ``Cyclicality in catastrophic and operational risk
measurements,'' Journal of Banking & Finance 31, pages 1191-1235
(2007); Chernobai, Anna, Phillippe Jorion, and Fan Yu, ``The
Determinants of Operational Risk in U.S. Financial Institutions,''
Journal of Financial and Quantitative Analysis, Vol. 46, No. 6,
pages 1683-1725 (2011); Hess, Christian, ``The impact of the
financial crisis on operational risk in the financial services
industry: empirical evidence,'' The Journal of Operational Risk,
Volume 6, Number 1, pages 23-35 (2011); Cope, Eric W., and Luke
Carrivick, ``Effects of the financial crisis on banking operational
losses,'' Journal of Operational Risk 8(3), pages 3-29 (2013);
Aldosoro, Inaki, Leonardo Gambacorta, Paolo Giudici, and Thomas
Leach, ``Operational and Cyber Risks in the Financial Sector,''
International Journal of Central Banking Vol. 19, No. 5, pages 341-
402 (2023); Berger, Allen N., Filippo Curti, Atanas Mihov, and John
Sedunov, ``Operational Risk is More Systemic than You Think:
Evidence from U.S. Bank Holding Companies;'' Journal of Banking and
Finance 143, 106619 (2022).
\209\ See Paul Povel, Rajdeep Singh, and Andrew Winton, ``Booms,
Busts, and Fraud'' The Review of Financial Studies, 1219-1254
(2007); and Robert T. Stewart, ``Bank fraud and the macroeconomy,''
Journal of Operational Risk 11(1), 71-82 (2016).
\210\ The inclusion of operational risk in the Basel II
standards was driven in part by Barings Bank's failure in 1995.
Barings Bank, originally founded in 1762, collapsed after
discovering that one of its Singapore branch traders lost $1.3
billion in unauthorized derivatives trades made through the bank's
error accounts. One of the lessons from the failure of Barings Bank
is that a bank's capital could be depleted through rogue traders and
other operational events, not just through credit and market losses.
See Michael S. Barr, Howell E. Jackson, Margaret E. Tahyar,
Financial Regulation: Law and Policy (2021).
\211\ On the operational losses caused by the Enron scandal, see
https://www.nytimes.com/2005/06/15/business/jp-morgan-chase-to-pay-enron-investors-22-billion.html; https://www.nytimes.com/2005/06/15/business/jp-morgan-chase-to-pay-enron-investors-22-billion.html;
https://www.nytimes.com/2008/03/27/business/27enron.html; https://www.nytimes.com/2008/03/27/business/27enron.html; and Vaugh K.
Reynolds, ``The Citigroup and J.P Morgan Chase Enron Settlements:
The Impact on the Financial Industry'' North Carolina Banking
Institute--Financial Accounting and Derivatives (2004), https://scholarship.law.unc.edu/cgi/viewcontent.cgi?article=1143&context=ncbi.
On the operational losses caused by the WorldCom scandal, see
https://www.nytimes.com/2005/03/13/business/yourmoney/worldcom-teaches-a-pricey-lesson.html and https://www.wsj.com/articles/SB110985786525469459.
\212\ On the operational losses caused by the Bernard Madoff
scandal, see https://www.justice.gov/usao-sdny/pr/manhattan-us-attorney-and-fbi-assistant-director-charge-announce-filing-criminal.
On operational losses resulting from mortgage servicing abuses, see
https://www.justice.gov/opa/pr/federal-government-and-state-attorneys-general-reach-25-billion-agreement-five-largest.
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For these reasons, the agencies are proposing to account for
operational risk together with credit risk and market risk in the
capital framework applicable to Category I and II banking organizations
to help ensure their safety and soundness and bolster U.S. financial
stability.
Under the current capital rule, Category I and II banking
organizations are required to calculate risk-weighted assets for
operational risk using the AMA,\213\ which is 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, introducing challenges to capital planning
processes.\214\ 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 evaluating the adequacy of operational risk
capital across banking organizations. To address these concerns, the
proposal would remove the AMA and introduce a standardized approach for
operational risk that seeks to address the operational risks currently
covered by the AMA.
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\213\ The agencies adopted the AMA for operational risk as part
of the advanced approaches capital framework in 2007. See 72 FR
69288 (Dec. 7, 2007).
\214\ See, e.g., Cope, E., G. Mignola, G. Antonini, and R.
Ugoccioni. 2009. Challenges and Pitfalls in Measuring Operational
Risk from Loss Data. Journal of Operational Risk 4(4): 3-27; and
Opdyke, J., and A. Cavallo. 2012. Estimating Operational Risk
Capital: The Challenges of Truncation, the Hazards of Maximum
Likelihood Estimation, and the Promise of Robust Statistics. Journal
of Operational Risk 7(3): 3-90.
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Consistent with the Basel standards, risk-weighted assets for
operational risk would be equal to 12.5 times the business indicator
component.\215,216\ 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.
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\215\ 12.5 is the amount by which the measure of operational
risk exposure needs to be multiplied so that the risk-weighted
assets it generates are equivalent to an 8 percent total capital
requirement.
\216\ The proposal would not include the internal loss
multiplier that was included under the agencies 2023 proposal, which
is equivalent to setting the internal loss multiplier equal to one.
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Banking organizations with higher overall business volume are
larger and more complex, which is likely to result in more operational
risk exposure.\217\
[[Page 15010]]
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, the proposal
would set a banking organization's operational risk capital requirement
in line with its business volume.
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\217\ Recent research connecting operational risk to higher
business volume includes Frame, McLemore, and Mihov (2020), Haste
Makes Waste: Banking Organization Growth and Operational Risk,
Federal Reserve Bank of Dallas, https://www.dallasfed.org/research/papers/2020/wp2023; Curti, Frame, and Mihov (2019), Are the Largest
Banking Organizations Operationally More Risky?, Journal of Money,
Credit and Banking Vol. 54, Issue 5, 1223-1259, https://doi.org/10.1111/jmcb.12933; and Abdymomunov and Curti (2020), Quantifying
and Stress Testing Operational Risk with Peer Banks' Data, Journal
of Financial Services Research Vol. 57, 287-313, https://link.springer.com/article/10.1007/s10693-019-00320-w.
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Question 84: The Basel standards includes an optional scalar called
the internal loss multiplier, which is calculated based on a banking
organization's historical internal operational losses. The internal
loss multiplier would scale the business indicator component in the
calculation of risk-weighted assets for operational risk. The internal
loss multiplier is calculated as follows:
Internal loss multiplier = ln(exp(1)-1 + (15 * average annual total net
operational losses/business indicator component)\0.8\)
where ln is the natural logarithm and exp(1) is the Euler's number,
which is approximately equal to 2.7183.
Should the agencies include the internal loss multiplier in the
calculation of operational risk-weighted assets and, if so, why? If the
internal loss multiplier is included in the calculation of the
operational risk-weighted assets, should the ``15'' factor included in
its calculation be adjusted to better reflect the operational risks of
U.S. Category I and II banking organizations, within a range between 5
and 15? Please provide any analysis justifying a recommendation.
1. Business Indicator
Under the proposal, the business indicator would be based on the
sum of the following two components: an interest, lease, and dividend
component and a noninterest 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
to banking products, activities, processes, and systems, these
components aim to comprehensively capture a banking organization's
financial activities and thus serve as a proxy for its 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 noninterest
component aims to capture fee and commission-based activities, trading
activity and other activities that are associated with a banking
organization's assets and liabilities.
Under the proposal, all inputs to the business indicator would be
based on three-year rolling averages. For example, a business indicator
input reported at the end of the third calendar quarter of 2025 would
be the average of the values for the fourth quarter of 2022 through the
third quarter of 2023, the fourth quarter of 2023 through the third
quarter of 2024, and the fourth quarter of 2024 through the third
quarter of 2025. The one exception are interest-earning assets, which
would be calculated as the average of the quarter-end values of
interest-earning assets for the previous 12 quarters.\218\
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\218\ Unlike the other inputs used to calculate the business
indicator, interest-earning assets are balance-sheet items, rather
than income statement items, and thus their use in the business
indicator does not represent a flow over a one-year period, but
rather a point-in-time value. The use of average interest-earning
assets for the previous 12 quarters instead of, for example, the
average interest-earning assets for the ending quarter of the last
three years aims to increase the robustness of the average used in
the calculation.
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The use of three-year averages would capture a banking
organization's activities over time and help reduce the impact of
temporary fluctuations. Basing the business indicator on a shorter time
period, such as a single year of data, would likely result in a more
volatile capital requirement, which could challenge the incorporation
of the operational risk capital requirement into capital planning
processes and 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. The use of three-year averages aims to balance the stability
and responsiveness of the 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 would be publicly reported as separate
inputs to the applicable calculations.
The inputs to each component of the business indicator would not
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 for
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)
where Avg3y refers to the three-year average of the quantity in
parentheses; Abs refers to the absolute value of the quantity in
parentheses; total interest income would mean interest income from all
financial assets and other interest income;\219\ total interest expense
would mean interest expenses related to all financial liabilities and
other interest expenses;\220\ 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;\221\ and dividend income would
mean all dividends
[[Page 15011]]
received on securities not consolidated in the banking organization's
financial statements.\222\
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\219\ 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.
\220\ Total interest expense would correspond to total interest
expense in the FR Y-9C (holding companies) and Call Report.
\221\ 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.
\222\ Dividend income is currently included in total interest
income in the FR Y-9C (holding companies) and Call Report.
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The interest, lease, and dividend component would 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 expense portion of the interest, lease, and
dividend component would be calculated as the absolute value of the
difference between total interest income and total interest expense
(which constitutes net interest income) and be subject to a ceiling
equal to 2.25 percent of the banking organization's 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. Given that operational risk is
unlikely to increase proportionally to increases in net interest
margin, the net interest income input would be capped at 2.25 percent
of interest-earning assets, consistent with the Basel standards.
The proposal would add dividend income to the net interest income
input to capture investment activities that produce dividends instead
of interest income (for example, investment in equities and mutual
funds).
Question 85: The proposal would include interest income and
expenses in the interest component and noninterest income and certain
noninterest expenses in the noninterest component. Income and expenses
relating to operating leases are typically characterized as noninterest
income and noninterest expenses, respectively, in regulatory reports.
However, income and certain expenses relating to operating leases are
included in the interest component under the Basel standards. What
would be the advantages and disadvantages of including (1) income from
operating leases and (2) depreciation and impairments relating to
operating leased assets in the interest component rather than the
noninterest component?
b. The Noninterest Component
Under the proposal, the noninterest component would account for fee
and commission-based activities, trading activity, and other activities
that are associated with a banking organization's assets and
liabilities and would be calculated as follows:
Noninterest component = Avg3y(Abs(total noninterest income + realized
gains (losses) on held-to-maturity securities + realized gains (losses)
on available-for-sale debt securities-noninterest expense for BI-
0.7*(total noninterest income from investment management, investment
services, and non-lending treasury services-noninterest expense for BI
from investment management, investment services, and non-lending
treasury services)) + total operational losses)
where Avg3y refers to the three-year average of the quantity in
parentheses; Abs refers to the absolute value of the quantity in
parentheses; total noninterest income, realized gains (losses) on held-
to-maturity securities, and realized gains (losses) on available-for-
sale debt securities are as reported in the consolidated financial
statements of the banking organization; \223\ noninterest expense for
BI means expense reported as other noninterest expense, excluding
expenses that relate to non-financial services received by the banking
organization and total operational losses; \224\ investment management
means activities related to asset management, wealth management and
private banking, including the professional management of mutual funds
and institutional accounts, and professional portfolio management and
advisory services for individuals; investment services means activities
related to asset servicing (which include custody, fund services,
securities lending, liquidity services, collateral management, and
other asset servicing; as well as recording keeping services for 401K
and employee benefit plans, but exclude funding or guarantee products
offered to such clients), issuer services (which include corporate
trust, shareowner services, depository receipts, and other issuer
services), and other investment services (which include clearing and
other investment services); non-lending treasury services means
activities related to cash management, global payments, and deposit
services (and excludes any lending or card activities); and total
operational losses equals the sum of all operational losses within the
relevant period.
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\223\ The total noninterest income, realized gains (losses) on
held-to-maturity securities, and realized gains (losses) on
available-for-sale debt securities to be used in the calculation of
the noninterest component align with the corresponding values in the
banking organization's Call Report or FR Y-9C report. Ahead of the
implementation of any final rule, the agencies plan to issue an
update to the FFIEC 101 report, which would include reporting
instructions for all items relevant to the calculation of risk-
weighted assets for operational risk.
\224\ Other noninterest expense is as reported in the
consolidated financial statements of the banking organization.
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The netting of income and expenses in the calculation of the
noninterest component would provide two main benefits relative to how
the Basel standards treats these sources of income in the calculation
of the business indicator. First, this net treatment would be similar
to the approach used for the interest, lease, and dividend component
and, therefore, would improve the consistency of treatments between the
two components. Second, the one-step netting of all noninterest income
and expenses would help ensure that the operational risk requirements
treat noninterest income and expenses consistently despite the range of
acceptable accounting practices across banking organizations. For
example, certain expenses are accounted for as ``contra revenues'' by
some banking organizations, but not by others.\225\ The proposed
approach would avoid the variability in the calculation of risk-
weighted assets for operational risk that could result from
inconsistent accounting classification of more granular items.
---------------------------------------------------------------------------
\225\ Contra revenues are reductions to a revenue account in an
accounting statement (typically, most expenses are included in
accounting statements through expense accounts).
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The operational risk capital requirement is designed to reflect all
operational risks to which a banking organization is exposed,
regardless of the activity or legal entity in which this risk resides.
The proposal would, therefore, include the income and expense of a
banking organization's insurance activities within the business
indicator calculation.
The agencies have received feedback from the public regarding the
relative operational risk of certain activities. In particular,
industry experts have argued that investment management (including
asset management and wealth management), investment services (including
custody), and treasury services pose low operational risk. In
considering this feedback, the agencies reviewed the operational loss
and income data currently reported by Category I and II bank holding
companies in the FR Y-14Q. The aggregate ratio of operational losses to
business line income for all Category I and II holding companies was
calculated from 2009Q1 to 2025Q2.\226\
[[Page 15012]]
This analysis shows that the aggregate ratio of historical operational
losses to income for investment management activities, investment
services, and treasury services is approximately 32 percent of the same
ratio for the Category I and II holding companies as a whole.
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\226\ Operational loss data was obtained from FR Y-14Q Schedule
E. Income data was obtained from FR Y-14Q Schedule G. Only
observations for which both the operational losses and the necessary
income elements were reported are included in this analysis.
[GRAPHIC] [TIFF OMITTED] TP27MR26.073
Considering the findings of this analysis, the proposal would
reduce by 70 percent the noninterest income and expenses from
investment management, investment services, and non-lending treasury
services used in the calculation of the noninterest income component
and, thereby, reflect the lower operational risk that these activities
have presented historically.\227\
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\227\ The definition of treasury services currently employed in
the FR Y-14 includes certain lending activities such as trade
finance and corporate and commercial credit cards. To ensure that
lending activities are treated consistently by the operational risk
framework, the proposal would not include lending activities within
treasury services in the scope of activities whose contribution to
the noninterest component would be reduced by 70 percent.
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There are substantial practical difficulties in designing and
implementing scalars to differentiate the contribution of business
lines to the operational risk capital requirement. The existing
segmentation of business lines for purposes of reporting operational
losses, income, and expenses does not align in all cases. Also, banking
organizations' practices around classification of operational losses
and income vary, and there may be meaningful variability across banking
organizations with respect to the ratio of operational losses to income
at the business line level. In addition, introducing differentiated
scalars across multiple business lines could introduce inconsistency
across banking organizations, as the business line classification of
income or expense would have risk-based capital consequences.
Addressing such potential inconsistency would necessitate significant
supervisory review of business line income and expense classification,
which would result in additional compliance costs for banking
organizations. Further, differentiation of operational risk
requirements across business lines would introduce additional
inconsistencies relative to the Basel standards. Given these
considerations, the proposal would only differentiate
[[Page 15013]]
the contribution of investment management, investment services, and
non-lending treasury services activities to the noninterest component.
The proposal would reflect operational losses within the business
indicator. Empirical research suggests observed operational losses are
a meaningful indicator of a banking organization's operational risk
exposure.\228\ Including expenses related to operational loss events in
the business indicator is therefore consistent with the operational
risk requirement's objective of supporting a banking organization's
resilience to operational risk. Specifically, the proposal would add
total operational losses within the noninterest component. This
approach is consistent with how operational losses contribute
positively to other operating expense under the Basel standards and,
therefore, would contribute positively to the business indicator under
the Basel standards when other operating expense is higher than other
operating income.\229\
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\228\ See Filippo Curti and Marco Migueis, ``The Information
Value of Past Losses in Operational Risk,'' Journal of Operational
Risk Volume 18, Number 2, 1-36 (2023), https://doi.org/10.21314/JOP.2022.033.
\229\ Subtracting operational losses from the noninterest
component (and thereby the business indicator)--as would occur if
operational losses were retained within noninterest expense for BI--
would not be appropriate because operational losses would generally
be reducing risk-weighted assets for operational risk.
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The proposed noninterest component, including the downscaling of
income net of expenses from investment management, investment services,
and non-lending treasury services activities, would improve the
consistency of requirements across Category I and II banking
organizations and better reflect the operational risk of their
activities.
Question 86: What are the advantages and disadvantages of the
proposed design of the noninterest component, including any impact on
specific business models? Which alternatives, if any, should the
agencies consider and why? Please provide supporting data with your
response.
Question 87: What are the advantages and disadvantages of the
proposed downscaling of the income and expense from investment
management, investment services, and non-lending treasury services
activities? What are the advantages and disadvantages of the proposed
calibration approach? Should the agencies consider differentiated
scalars (both increasing and decreasing requirements) across multiple
business lines and why? What alternatives, if any, should the agencies
consider and why? Please include data to support your views.
C. Exclusions From the Business Indicator
Consistent with the Basel standards, the business indicator under
the proposal 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.
Also consistent with the Basel standards, the proposal would
exclude loss provisions and reversal of provisions (except for those
related to operational loss events) or changes in goodwill from the
business indicator, as these items reflect accounting adjustments
rather than financial transactions. In addition, the business indicator
would be neutral relative to applicable income taxes by excluding them
from the expense considered.
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.
Question 88: Under what circumstances, if any, would it be
appropriate for the business indicator to also exclude income relating
to non-financial activities provided by a banking organization, such as
an exclusion for income relating to non-financial activities provided
to foreign affiliates or parents (recharge income)? What are the
advantages and disadvantages of such exclusion, and what distinguishes
such potentially excluded income from other income relating to non-
financial activities? Please provide any data that would be useful to
consider on this issue, including data that would allow the agencies to
estimate the impact of such exclusion.
2. Business Indicator Component
Under the proposal, the business indicator component would rise
with the size of the business indicator, but at three different rates.
It would increase by 12 percent for each unit of business indicator up
to $1 billion, by 15 percent for each unit above $1 billion and up to
$30 billion, and by 18 percent for each unit above $30 billion. As
described in section II.E., these thresholds would be indexed to
inflation over time. Table 3 below presents the formulas that can be
used to calculate the business indicator component given a banking
organization's business indicator.
[[Page 15014]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.074
The proposed higher rate of increase of the business indicator
component as a banking organization's business indicator rises above $1
billion and $30 billion reflects 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.\231\ Similarly, academic studies have found that
larger U.S. bank holding companies have higher operational losses per
dollar of total assets.\232\
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\230\ $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).
\231\ 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.
\232\ 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. Alternative Simple Approaches
In developing the proposal, the agencies considered alternative
approaches to the proposed framework for determining a banking
organization's operational risk capital requirement. These alternatives
would rely on simpler measures of size and complexity that may provide
an appropriate proxy for operational risk exposure. Specifically, the
agencies considered an income-based approach and an asset-based
approach as alternatives. Each of these approaches could provide a
simple alternative for determining operational risk capital, which
could easily be measured from existing regulatory reporting.
Under an income-based approach, size and complexity--and associated
operational risk exposure--could be measured using a broad measure of
income, such as gross income, similar to the Basel Committee's basic
indicator approach.\233\ Under the Basel Committee's basic indicator
approach, risk-weighted assets for operational risk equal 15 percent of
average annual gross income, defined as net interest income plus net
noninterest income, over the previous three years where annual gross
income is positive, multiplied by 12.5. Notably, the definition of
gross income under the basic indicator approach excludes certain income
statement items.\234\
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\233\ See Basel Committee on Banking Supervision (2006):
``International Convergence of Capital Measurement and Capital
Standards,'' https://www.bis.org/publ/bcbs128.htm. Upon the adoption
of the new approach for calculating operational risk capital to the
Basel standards, the basic indicator approach is no longer part of
the Basel framework.
The agencies have previously considered simple options for
operational risk, including the basic indicator approach. See 73 FR
43982, https://www.govinfo.gov/content/pkg/FR-2008-07-29/pdf/E8-16262.pdf.
\234\ The basic indicator approach specifies that gross income
should (1) be gross of any provisions (for example, for unpaid
interest), (2) be gross of operating expenses, including fees paid
to outsourcing service providers, (3) exclude realized gains or
losses from the sale of securities in the banking book such as from
securities classified as ``held to maturity'' and ``available for
sale,'' and (4) exclude extraordinary or irregular items as well as
income derived from insurance.
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In an income-based alternative closest to the Basel Committee's
basic indicator approach, the agencies would define gross income in a
given year as net-interest income plus noninterest income minus
noninterest expense, where noninterest expense excludes salaries and
employee benefits, expenses of premises and fixed assets, goodwill
impairment losses, and amortization expense and impairment losses for
other intangible assets. Like in the Basel Committee's basic indicator
approach, the calculation of risk-weighted assets for operational risk
under this approach would equal the product of the gross income scalar
and average annual gross income over the previous three years where
annual gross income is positive, multiplied by 12.5.
To appropriately calibrate an operational risk capital requirement
based on gross income, the agencies considered two alternatives. In the
first alternative, the scalar determining the capital requirement would
be calibrated to result in a similar amount of aggregate required
capital as under the proposed standardized approach for operational
risk. Analysis by the agencies suggests that a scalar between 15 and 20
percent would be necessary to achieve the target calibration.\235\ As a
second alternative, the gross income scalar could be set to cover the
operational risk exposure of Category I and II banking organizations
demonstrated by their historical operational losses.
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\235\ Based on data from form FR Y-9C, Schedule HI, between
2022Q3 to 2025Q2. Net-interest income would correspond to line 3
from Schedule HI, noninterest income to line 5.m, and noninterest
expense excluding salaries and employee benefits, expenses of
premises and fixed assets, goodwill impairment losses, and
amortization expense and impairment losses for other intangible
assets to line 7.d.
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The agencies also considered potential modifications to gross
income. For example, gross income could be defined solely as net-
interest income plus net-noninterest income, with no exclusions for
noninterest expenses. Based on agency analysis of FR Y-9C data between
2022Q3 to 2025Q2, such an approach would require a gross-income scalar
between 35 and 45 percent to result in a similar amount of aggregate
required capital as under the proposed standardized approach for
operational risk.
Separately, both gross income definitions discussed above could be
modified to add operational losses (similar to the methodology within
the noninterest component under the proposal's operational risk
standardized approach). Such a modification would ensure that
operational losses are positively reflected in operational risk capital
requirements and could incentivize better operational risk management.
Under such a
[[Page 15015]]
modification, operational losses would be excluded from noninterest
expense.
The agencies also considered an alternative that would use an
institution's balance sheet, rather than income, for calculating the
operational risk capital requirement. Such an approach could use total
consolidated assets as an alternative, simple measure of size and
complexity and, therefore, as a proxy for operational risk exposure.
Asset size is a common proxy for size and complexity in the agencies'
regulatory framework.
In an asset-based approach, a scalar would be applied to total
assets to determine the operational risk capital requirement. To result
in a similar aggregate amount of required capital as under the proposed
standardized approach for operational risk, analysis by the agencies
suggests that a scalar between 0.4 percent and 0.5 percent would be
appropriate. Similar to the income-based approach, the scalar in an
asset-based approach could be calibrated to cover the operational risk
exposure of Category I and II banking organizations demonstrated by
their historical operational losses.
An approach based on total assets could be modified to capture off-
balance sheet activities, which may improve how the requirement
captures operational risk exposure at the cost of some additional
complexity.\236\
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\236\ The current capital rule applies certain adjustments to
capture off-balance sheet activities. For example, the standardized
approach for credit risk utilizes credit conversion factors to
incorporate off-balance sheet activities into risk-weighted assets.
Similarly, the supplementary leverage ratio incorporates off-balance
sheet activities into the calculation of total leverage exposure.
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Relative to an approach based on income, an approach based on the
balance sheet of a banking organization may not appropriately capture
the operational risks associated with activities with small footprint
in terms of on-balance sheet assets and few quantifiable off-balance
sheet exposures.
Using gross income or total assets instead of the business
indicator to set the operational risk capital requirement would result
in a simpler method for calculating the operational risk requirement
than the proposal. However, such approaches may be less risk sensitive
than the proposed requirement based on the business indicator. Also,
use of the business indicator as a proxy for operational risk exposure
provides for greater alignment with the Basel standard than these
alternatives, consistent with a broader objective of the proposal.
Still, the agencies welcome comments on all aspects of these potential
alternatives and on alternative calibrations.
Question 89: The agencies invite comments on the use of a simple
approach for determining a banking organization's operational risk
capital requirement. Are there any aspects associated with using a
simple approach that should be considered? What are the advantages and
disadvantages of a simple approach relative to the proposed
standardized approach for operational risk? Which aspects of the
proposed standardized approach for operational risk would provide for
greater risk sensitivity relative to the simple approaches discussed
above? To what extent should risk sensitivity be an objective for the
operational risk capital requirement, and how should that be weighed
against complexity?
Question 90: The agencies invite comments on an approach based on
gross income for determining a banking organization's operational risk
capital requirement. What are the advantages and disadvantages of such
an approach? What are the advantages and disadvantages of excluding
salaries and employee benefits, expenses of premises and fixed assets,
goodwill impairment losses, and amortization expense and impairment
losses for other intangible assets from the definition of gross income?
What are the advantages and disadvantages of adding operational losses
to gross income in the calculation of the operational risk capital
requirement? Provide any analysis supporting your recommendation.
Question 91: The agencies invite comments on an asset-based
approach for determining a banking organization's operational risk
capital requirement. What are the advantages and disadvantages of such
an approach? What are the advantages and disadvantages of including
off-balance sheet exposures on the size proxy used in such an approach?
How should off-balance sheet exposures be measured under such an
alternative? Provide any analysis supporting your recommendation.
Question 92: The agencies invite comments on how to calibrate an
income-based or an assets-based approach, if such an approach were to
be adopted. What are the advantages and disadvantages of using
projected requirements under the proposed standardized approach as the
basis for calibration?
For calibration of an income-based approach: (1) In a gross income
variant where salaries and employee benefits, expenses of premises and
fixed assets, goodwill impairment losses, and amortization expense and
impairment losses for other intangible assets are excluded from the
calculation, would a scalar between 15 percent and 20 percent be
appropriate and why?(2) In a gross income variant where gross income
does not have the exclusions under (1), would a scalar between 35 and
percent and 45 be appropriate and why?
For the calibration of an asset-based approach would a scalar
between 0.4 percent and 0.5 percent be appropriate and why?
What are the advantages and disadvantages of calibrating the
operational risk capital requirement such that it would capture
operational risk exposure as demonstrated by banking organizations'
historical operational losses? If the agencies were to follow such a
calibration approach, which methodology should be used to estimate
operational risk exposure and why? Provide any analysis supporting your
recommendations.
4. Operational Risk Management
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.\237\ Thus, consistent with the current advanced
approaches qualification requirements applicable to Category I and II
banking organizations, the proposal would require that banking
organizations subject to the expanded risk-based approach have an
operational risk management function that is independent of business
line management. This independent operational risk management function
would design, implement, and oversee the comprehensiveness and accuracy
of operational loss event data and its collection processes and oversee
other aspects of the banking organization's operational risk
management. In addition, banking organizations subject to the expanded
risk-based approach 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). Lastly, the proposal would require
banking organizations subject to the expanded risk-based approach to
have
[[Page 15016]]
operational loss event data collection processes that meet certain
requirements.
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\237\ The interagency paper titled ``Sound Practices to
Strengthen Operational Resilience'' (Nov. 2, 2020) notes that
operational resilience ``is the outcome of effective operational
risk management combined with sufficient financial and operational
resources to prepare, adapt, withstand, and recover from
disruptions.''
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V. Calculation of Risk-Weighted Assets Under the Market Risk Framework
A. 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).\238\ Although adoption of the 1996
rule was a constructive step in capturing market risk for risk-based
capital standards, the 1996 rule did not sufficiently capture the risks
associated with financial instruments that became prevalent in the
years following its adoption. This became evident during the 2007-2009
financial crisis, when the 1996 rule did not fully capture banking
organizations' increased exposures to traded credit and other
structured products, such as collateralized debt obligations (CDO),
credit default swaps (CDS), mortgage-related securitizations, and
exposures to other less liquid products.
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\238\ Risk-Based Capital Standards: Market Risk, 61 FR 47358
(Sept. 6, 1996). The agencies' market risk capital rules were
located at 12 CFR part 3, appendix B (OCC), 12 CFR part 208,
appendix E and 12 CFR part 225, appendix E (Board), and 12 CFR part
325, appendix C (FDIC).
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In August 2012, the agencies issued a final rule that modified the
capital rule to address these deficiencies.\239\ Specifically, the rule
added a stressed value-at-risk (VaR) measure, a capital requirement for
default and migration risk (the incremental risk capital requirement),
a comprehensive risk measurement for correlation trading portfolios, 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 increasing the comprehensiveness and quality of the
standards for internal models used to calculate market risk capital
requirements.\240\
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\239\ Risk-Based Capital Guidelines: Market Risk, 77 FR 53059
(Aug. 30, 2012).
\240\ 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 covered savings and loan holding companies
with material exposure to market risk subject to the market risk
rule, 78 FR 62018 (Oct. 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 (Dec. 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
adequately capture tail risks beyond the VaR confidence level). To
address these shortcomings, the Basel Committee established minimum
capital requirements for market risk.\241\ To increase risk
sensitivity, transparency, and consistency of the market risk capital
requirements, the proposal would replace the existing market risk
capital framework within the capital rule with a new framework that is
based on the revised framework of the Basel Committee (Basel
standards).
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\241\ 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.
The Basel Committee published a new, more robust framework, which
established minimum capital requirements for market risk, ``Minimum
capital requirements for market risk,'' January 2016, www.bis.org/bcbs/publ/d352.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 simple, transparent, and 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
market risk capital framework in the current capital rule. The proposed
standardized and models-based measures would improve the risk-
sensitivity of market risk capital requirements by replacing the VaR-
based measure of market risk with an expected shortfall-based measure
that better accounts for extreme losses.\242\ 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 appropriately capture the market risk of
less liquid positions.\243\
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\242\ 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. The risk weights
within the standardized measure were calibrated based on the
expected shortfall-based measure in the models-based measure for
market risk.
\243\ The proposal would define liquidity horizon as the time
required to exit or hedge a market risk covered position without
materially affecting market prices in stressed market conditions.
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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 capital 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.\244\
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\244\ A banking organization that has regulatory approval to use
internal models to measure market risk under the current rule would
be required to obtain new approval to use the models-based measure
for market risk under the proposed framework.
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In contrast to the current framework which, subject to approval by
the primary Federal supervisor, allows the use of internal models at
the level of the consolidated banking organization, 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. Under the proposal, a banking
organization would be required to conduct and successfully pass two
quantitative tests (a backtesting requirement \245\ and a profit and
loss attribution (PLA) requirement \246\) at the trading desk level in
order to use the models-based approach. The trading desk-level approach
is intended to limit use of the models-based approach to only those
trading desks that can appropriately capture the risk of market risk
covered positions in banking organizations' internal models. The
[[Page 15017]]
agencies recognize the potential difficulties that a banking
organization could experience when performing the proposed desk-level
PLA test. To improve the ability of banking organizations to use more
risk-sensitive modeled approaches, where appropriate, the proposal
would provide a three-year transition period during which there would
be no automatic consequences based on PLA test results. This extended
transition period for implementation of the PLA test would allow
banking organizations to gain experience with the test, provide time to
improve their systems and processes, and address any potential gaps in
data and model performance. The delayed transition would also provide
the agencies an additional opportunity to monitor the effectiveness of
the PLA test metric and thresholds.
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\245\ The proposed desk-level backtesting requirements are
intended to measure the accuracy and conservatism of the forecasting
assumptions and valuation methods used in the desk's internal
models.
\246\ The proposed desk-level PLA testing requirements are
intended to measure the accuracy of the potential future profits or
losses estimated by the valuation models used for internal risk
management purposes relative to those produced by the financial
reporting models. For purposes of this SUPPLEMENTARY INFORMATION,
the term ``financial reporting model'' refers to the valuation
methods used to report actual profits and losses for financial
reporting purposes.
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The proposal would also revise the criteria for determining whether
a banking organization is subject to the market risk capital
requirements to (1) reflect the inflation since 1996 and growth in the
capital markets as well as to reflect CPI-W going forward; (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 tailoring rule.\247\ In general, the revised criteria would
take into account the prudential benefits of the proposed market risk
capital requirements and the potential costs, including compliance
costs.
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\247\ See 84 FR 59230, 59249 (Nov. 1, 2019).
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In addition, the proposal would help promote consistency and
comparability in market risk capital requirements across banking
organizations by strengthening the criteria for identifying positions
subject to the proposed market risk capital requirement and by
proposing a risk-based capital treatment of transfers of risk between a
trading 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
Under the current capital rule, any banking organization with
aggregate trading assets and trading liabilities that, as of the most
recent calendar quarter, equal $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.
The proposal would revise the criteria for determining whether a
banking organization is subject to market risk capital requirements.
Under the proposal, a Category I or Category II depository institution
holding company would be subject to market risk capital requirements.
In addition, a banking organization with average aggregate trading
assets and trading liabilities, excluding customer and proprietary
broker-dealer reserve bank accounts,\248\ 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 would be subject to market risk
capital requirements.\249\
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\248\ 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).
\249\ See section II.E. of this SUPPLEMENTARY INFORMATION for a
more detailed discussion on indexing nominal thresholds in the
proposal going forward to reflect CPI-W.
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The proposed scope is designed to apply market risk capital
requirements to the largest and most complex banking organizations. As
the agencies noted in the preamble to the final tailoring 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 necessitate more stringent capital
requirements.\250\ Further, because such banking organizations are
generally the most internationally active and interconnected banking
organizations, the proposed scope of the market risk capital
requirements (which are based largely on the international framework
adopted by the Basel Committee), should help promote competitive equity
among U.S. banking organizations and their foreign peers and
competitors, and reduce opportunities for regulatory arbitrage across
jurisdictions.
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\250\ See 84 FR 59230, 59249 (Nov. 1, 2019).
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In addition to applying market risk capital requirements to the
largest banking organizations, the proposed rule would retain and
increase the trading activity threshold from $1 billion to $5 billion
to reflect inflation since 1996 and growth in the capital markets. The
agencies are also proposing to index the $5 billion trading activity
threshold based on the CPI-W going forward. Additionally, 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
market risk capital requirements under the proposal. This means that
any subsidiary depository institution of a Category I and II depository
institution holding company or any banking organization that is not a
Category I or II banking organization would be subject to market risk
capital requirements if it has trading activity that 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.\251\ 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.\252\
Furthermore, for purposes of determining applicability of market risk
capital requirements, 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 or
suffer loss 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
[[Page 15018]]
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 its market risk capital requirements.
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\251\ 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.
\252\ If the banking organization has not reported trading
assets and trading liabilities for each of the preceding four
calendar quarters, the threshold would be based on the average
amount of trading assets and trading liabilities over the quarters
that the banking organization has reported, unless the primary
Federal supervisor notifies the banking organization in writing to
use an alternative method.
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b. Application of Proposed Rule
The proposal would require a banking organization to comply with
the market risk capital requirements (as well as the related reporting
and public disclosure requirements) beginning the quarter after the
banking organization meets any of the proposed scoping criteria. To
avoid volatility in requirements, a banking organization that is not a
Category I or II depository institution holding company would remain
subject to market risk capital requirements unless and until its
trading activity falls below the threshold criteria for each of the
prior four consecutive quarters.
Implementing the proposed market risk capital requirements would
require significant operational preparation. Therefore, the agencies
expect 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.
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 the market risk framework of the current capital rule
for the primary Federal supervisor to either: (1) require a banking
organization that does not meet the proposed criteria to calculate a
market risk capital requirement, or (2) exclude a banking organization
that meets the proposed criteria from such calculation, as appropriate.
Question 93: 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 94: 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. Measure for Market Risk
Under the current capital rule, a banking organization subject to
market risk capital requirements must use one or more internal models
to calculate market risk capital requirements for its covered
positions.\253\ 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
supervisor 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.
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\253\ Notably, for securitization positions subject to the
market risk capital framework, the current capital rule provides a
standardized measurement method for capturing specific risks and a
models-based measure for capturing general risks for purposes of
calculating market risk-weighted assets.
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The proposal would introduce a standardized methodology for
calculating market risk capital requirements (standardized measure for
market risk) and a new models-based methodology (models-based measure
for market risk) to replace the market risk capital framework of the
current capital rule. A banking organization with no model-eligible
trading desks would calculate market risk capital requirements under
the standardized measure for market risk. Alternatively, with prior
approval from its primary Federal supervisor, a banking organization
that has one or more model-eligible trading desks would be required to
calculate market risk capital requirements under the models-based
measure for market risk.\254\
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\254\ The proposal would require a banking organization to
calculate the standardized measure for market risk on a weekly basis
and the models-based measure for market risk, if applicable, on a
daily basis.
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If a trading desk does not receive approval to use the models-based
non-default capital requirement or fails to meet the operational
requirements of the models-based non-default capital requirement on an
on-going basis, the desk would be required to use the standardized non-
default capital requirement to calculate its market risk capital
requirements. The agencies view the proposed standardized non-default
capital requirement as sufficiently risk sensitive to serve as a
credible alternative to the models-based non-default capital
requirement given the conservative calibration of the risk weights and
correlations applied to market risk covered positions under the
standardized non-default capital requirement. Additionally, by relying
in part on inputs a banking organization uses for its own internal risk
management or financial reporting purposes, the proposed standardized
non-default capital requirement 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 promote comparability in market risk capital
requirements across banking organizations subject to the proposal.
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 better,
the models-based measure for market risk would replace the fixed ten
business-day liquidity horizon in the market risk capital framework of
the current capital rule with liquidity horizons 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 may dissipate in stress periods.
At a high level, both the proposed standardized measure and the
models-based measure for market risk would consist of a non-default
capital
[[Page 15019]]
requirement specific to each measure; a default risk capital
requirement, which would be the same under both the standardized and
models-based measures for market risk; a fallback capital requirement;
and a capital add-on for re-designations. Each measure would include
any additional capital requirement established by the primary Federal
supervisor. Figure 1 illustrates the components of the standardized
measure for market risk and Figure 2 illustrates the components of the
models-based measure for market risk. Each of the components is
described below in this section.
[GRAPHIC] [TIFF OMITTED] TP27MR26.075
[GRAPHIC] [TIFF OMITTED] TP27MR26.076
[[Page 15020]]
a. Standardized Non-Default Capital Requirement
Under the proposal, the standardized non-default capital
requirement would consist of two components: a sensitivities-based
method capital requirement and a residual risk add-on, each further
described in section V.A.7. of this SUPPLEMENTARY INFORMATION. The
sensitivities-based capital requirement captures non-default market
risk based on the estimated losses produced by risk factor
sensitivities \255\ under regulatorily determined stressed
conditions.\256\ The residual risk add-on serves to produce a simple,
conservative capital requirement for any other known risks that are not
already captured by the sensitivities-based method capital requirement
or the default risk capital requirement, including gap risk,
correlation risk, and behavioral risks, such as prepayments.
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\255\ 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.
\256\ 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). As discussed further in
section V.A.6.d.i. of this SUPPLEMENTARY INFORMATION, model-eligible
trading desk would be allowed to hold insignificant amounts of
model-ineligible positions such as securitization positions,
correlation trading positions, or certain equity positions in
investment funds. The proposal would require a banking organization
to calculate the non-default capital requirement for model-
ineligible positions using the standardized non-default capital
requirement.
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b. Non-Default Capital Requirement Under the Models-Based Measure
Under the proposal, a banking organization that has received prior
supervisory approval to use the models-based measure for market risk
could have some trading desks that are eligible for the models-based
non-default capital requirement (model-eligible trading desks) and
others that are not (model-ineligible trading desks).\257\ The proposal
would limit use of the models-based non-default capital requirement to
those trading desks that can appropriately capture the risks of market
risk covered positions in internal models and that satisfy the model
eligibility criteria and processes (for example, desk-level
backtesting) introduced under the proposal, as described in section
V.A.6.d. of this SUPPLEMENTARY INFORMATION. Specifically, if the
primary Federal supervisor were to approve a banking organization to
calculate market risk capital requirements for one or more model-
eligible trading desks under the models-based non-default capital
requirement, the banking organization would be required to calculate
the entity-wide market risk capital requirement under the models-based
measure for market risk, which would incorporate the capital
requirements for model-eligible and model-ineligible positions,
according to the following formula, as provided under Sec. __.204(c)
of the proposed rule:
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\257\ As discussed further in section V.A.6.d.i. of this
SUPPLEMENTARY INFORMATION, model-eligible trading desk would be
allowed to hold insignificant amounts of model-ineligible positions
such as securitization positions, correlation trading positions, or
certain equity positions in investment funds. The proposal would
require a banking organization to calculate the non-default capital
requirement for model-ineligible positions using the standardized
non-default capital requirement.
Models-based measure for market risk = NDCR + DRC + fallback capital
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requirement + capital add-on for redesignations
Consistent with the standardized non-default capital requirement as
discussed above, the non-default capital requirement under the models-
based measure (NDCR) is intended to capture potential losses arising
from changes in risk factors under severe stress conditions. More
specifically, the proposal would set the non-default capital
requirement under the models-based measure equal to the sum of (1) the
models-based non-default capital requirement for model-eligible
positions (IMAG,A) and (2) the difference between the standardized non-
default capital requirement for all trading desks (SAall desks) and the
standardized non-default capital requirement for model-eligible
positions (SAG,A).
NDCR = IMAG,A + (SAall desks-SAG,A)
The agencies recognize that simply adding the standardized non-
default capital requirements for model-ineligible positions and the
models-based non-default capital requirements for model-eligible
positions (IMAG,A) together would disregard potential diversification
effects between these two types of market risk covered positions. In
order to appropriately reflect the marginal contribution of model-
ineligible positions subject to the standardized non-default capital
requirement, the proposal would require a banking organization to
calculate the standardized non-default capital requirement for all
market risk covered positions on all trading desks (SAall desks) and
subtract the amount required under the standardized non-default capital
requirement for model-eligible positions (SAG,A). To appropriately
capture implied diversification benefits between model-eligible and
model-ineligible positions across trading desks, the proposal would
require a banking organization to calculate the non-default capital
requirement as the sum of the models-based non-default capital
requirement for model-eligible positions (IMAG,A) and the adjusted
standardized non-default capital requirement for model ineligible
positions (SAall desks-SAG,A).
In some circumstances, non-default capital requirement for model-
eligible positions (IMAG,A) may exceed the standardized non-default
capital requirement for model-eligible positions (SAG,A). In such
cases, the non-default capital requirement under the models-based
measure (NDCR) would exceed the standardized non-default capital
requirement for all market risk covered positions on all trading desks
(SAall desks). While there can be merit in requiring a banking
organization to reflect higher capital requirements produced by the
models-based non-default capital requirement for model-eligible
positions, there could be instances when the higher capital
requirements are not commensurate with the risk profile of the banking
organization's market risk covered positions. To address such
situations, the proposal would allow a banking organization, with prior
approval from the primary Federal supervisor, to cap the amount of
capital required under the non-default capital requirement of the
models-based measure (NDCR) at the standardized non-default capital
requirement for all trading desks (SAall desks). To receive approval to
cap the non-default capital requirement under the models-based measure,
a banking organization would be required to demonstrate to the primary
Federal supervisor that the aggregate market risk capital requirement
with the cap would be adequate with respect to the risk profile of the
banking organization's market risk covered positions and consistent
with safety and soundness.\258\
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\258\ For example, periods of sudden and extreme market
volatility (such as the COVID pandemic) may significantly increase
the number of aggregate trading portfolio backtesting exceptions,
which can result in models-based non-default capital requirement
being unduly conservative relative to the market risk to which the
banking organization is exposed.
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Question 95: The agencies seek comment on the recognition of
diversification benefits between model-eligible and model-ineligible
positions across trading desks. What are the advantages and
disadvantages of
[[Page 15021]]
requiring a banking organization to calculate the models-based non-
default capital requirement as the sum of the models-based non-default
capital requirement for model-eligible positions (IMAG,A) and the
adjusted standardized non-default capital requirement for model
ineligible positions (SAall desks-SAG,A), and why? If the agencies were
to consider not recognizing any diversification benefits between model-
eligible and model-ineligible positions across trading desks, should
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the agencies consider adopting the following formula:
Models Based Non -Default Capital Requirement = min ((IMAG,A + PLA add-
on + SAU), SAall desks) + max ((IMAG,A-SAG,A),0)
Where, SAu would be the standardized approach capital requirement
for market risk covered positions for model-ineligible trading
desks.
What are the advantages and disadvantages of calculating the
models-based non-default capital requirement as the sum of the models-
based non-default capital requirement for model-eligible trading desks
and the standardized non-default capital requirement for model-
ineligible trading desks, capped at the capital requirement for all
trading desks under the standardized non-default capital requirement,
plus the difference between the models-based non-default capital
requirement for model-eligible desks and the standardized non-default
capital requirement for model-eligible desks? If the agencies were to
consider this alternative, what adjustments should be made? Why? Please
include any supporting empirical data, including during periods of
market stress, and rationale that would be helpful for evaluating this
alternative.
Question 96: The agencies seek comment on allowing a banking
organization to cap the non-default risk capital requirement under the
models-based measure at the amount required by the standardized non-
default capital requirement for all trading desks upon approval by the
primary Federal supervisor. What are the advantages and disadvantages
of the proposed cap, and why? If the agencies were to consider allowing
the cap to be in effect in all circumstances, without prior approval,
what are the advantages and disadvantages of the proposed supervisory
approval requirement, and why? Commenters are encouraged to provide
supporting rationale and data.
Question 97: In order to provide appropriate incentives for banking
organizations to use internal models, what, if any, alternatives to
capping the amount of capital required under the non-default risk
capital requirement within the models-based measure at the amount
required by the standardized non-default capital requirement for all
trading desks should the agencies consider, and why?
c. Default Risk Capital Requirement
The default risk capital requirement, further described in section
V.A.9. of this SUPPLEMENTARY INFORMATION, would capture losses on
credit and equity positions in the event of issuer default for purposes
of both the standardized measure for market risk and the models-based
measure for market risk. To recognize offsetting of long and short
positions across model-eligible and model-ineligible positions, the
models-based measure for market risk would require banking
organizations to perform a single calculation of the default risk
capital requirement that includes all market risk covered positions.
d. 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 under the standardized non-default
capital requirement, the models-based non-default capital requirement,
or the default risk capital requirement. 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 non-default capital
requirement and the default risk capital requirement.\259\
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\259\ The respective components of the standardized non-default
capital requirement are the sensitivities-based method capital
requirement and the residual risk add-on.
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For purposes of calculating the models-based measure for market
risk, the proposal would require the banking organization to apply the
fallback capital requirement to each market risk covered position for
which it is not able to apply the models-based non-default capital
requirement, the standardized non-default capital requirement, or the
default risk capital requirement, as applicable, and exclude such
positions from the respective components of models-based measure for
market risk.
The fallback capital requirement would equal the sum of the
absolute value of the fair value of each position subject to the
fallback capital requirement, unless the banking organization receives
prior approval from its primary Federal supervisor to use an
alternative method to quantify the market risk capital requirement for
such positions. The fallback capital requirement would only apply in
instances where a banking organization is not able to capture all
relevant risks of market risk covered positions under the standardized
non-default capital requirement, the models-based non-default capital
requirement, or the default risk capital requirement. As such, 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. The agencies
also recognize that using the fair value for derivatives can materially
underestimate the exposure to the derivative positions given the fair
market value of any given derivatives can change daily, often with a
magnitude much greater than their current fair value. Therefore, for
derivative positions that represent more than de-minimis exposure, the
banking organizations should notify their primary Federal supervisor.
In such cases, the banking organization can propose an alternative
methodology (subject to approval from the primary Federal supervisor)
or the primary Federal supervisor can mandate a methodology for the
banking organization to adopt for the fallback capital requirement.
Question 98: The fair value for derivative positions may materially
underestimate the exposure because 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). What are the advantages and disadvantages of using the
absolute fair value of the derivative positions for the calculation of
the fallback capital requirement? What could be alternative
methodologies for the fallback capital requirements for
[[Page 15022]]
derivative positions? What, if any, alternative techniques would more
appropriately measure the market risk associated with market risk
covered positions for which the standardized non-default capital
requirement cannot be applied?
Question 99: What are the advantages and disadvantages of asking a
banking organization to notify its primary Federal supervisor if the
banking organization has derivative positions that represent more than
de-minimis exposure and it plans to use an alternative methodology to
calculate the fallback capital requirement, and why? What are the
advantages and disadvantages of requiring a banking organization to
notify its primary Federal supervisor, and why?
e. Capital Add-On for Re-Designations
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 as being a market risk covered position or not.
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-
designating a position, the proposal would introduce the capital add-on
requirement to compensate for any re-designation. 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 or to the
capital requirements under the standardized approach or the expanded
risk-based approach, respectively. With prior notification to the
primary Federal supervisor, the proposal would not require a banking
organization to apply the capital add-on for 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 its total capital
requirements for the re-designated positions separately under the
standardized approach or the expanded risk-based approach, as
applicable, and under market risk capital framework before and
immediately after the re-designation of a position. 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 to avoid any resultant reduction in 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. The
capital add-on requirement would decline proportionate to the balance
sheet value relative to the time of the re-designation. This could
occur when an instrument matures, pays down, amortizes, or expires, or
the banking organization sells or exits (in whole or in parts) the
position.
Question 100: 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? For
example, what would be advantages and disadvantages of exempting
transactions in high quality liquid assets (HQLA) between a business
unit of a banking organization that engages in asset-liability
management and internal trading desk from the re-designation framework,
and why?
Question 101: The agencies seek comment on whether the re-
designation framework should include a grace period (for example, 10
business days) that would allow a banking organization to identify and
correct any errors during the initial re-designation process. What are
the advantages and disadvantages of the grace period and why?
f. Additional Capital Requirement and Other Provisions
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 primary Federal supervisor also would have the authority to
require a banking organization to calculate capital requirements for
specific positions or categories of positions under either the
standardized approach or the expanded risk-based approach instead of
under the market risk capital framework, or under the market risk
capital framework instead of under the standardized approach or the
expanded risk-based approach, 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 such 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. Furthermore, the
primary Federal supervisor could require a banking organization that
has one or more model-eligible trading desks to calculate the
standardized non-default risk capital requirement for each model-
eligible trading desk as if that trading desk were a standalone
regulatory portfolio. This situation could arise when, for example, a
banking organization is unable to empirically justify the correlation
of a trading desk's losses with other model-eligible trading desks.
4. Market Risk Covered Position
Market risk capital requirements under the current capital rule
apply to a banking organization's covered positions, which are defined
to include, subject to certain restrictions: (i) any trading asset or
trading liability as
[[Page 15023]]
reported on a banking organization's regulatory reports that is a
trading position \260\ 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 \261\ or commodity
position regardless of whether such position is a trading asset or
trading liability. The definition of a covered position also explicitly
excludes certain positions. Thus, the definition is structured into
three broad categories, each subject to certain conditions: trading
assets or liabilities that are covered positions, positions that are
covered positions regardless of whether they are trading assets or
trading liabilities, and exclusions.
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\260\ 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.
\261\ With prior approval from its primary Federal supervisor,
the proposal would allow a banking organization to exclude from its
market risk covered positions any structural position in a foreign
currency, which is defined as a position that is not a trading
position and that is (i) a subordinated debt, equity or minority
interest in a consolidated subsidiary that is denominated in a
foreign currency; (ii) capital assigned to foreign branches that is
denominated in a foreign currency; (iii) a position related to an
unconsolidated subsidiary or another item that is denominated in a
foreign currency and that is deducted from the banking
organization's tier 1 or tier 2 capital, or (iv) a position designed
to hedge a banking organization's capital ratios or earnings against
the effect of adverse exchange rate movements on (i), (ii), or
(iii).
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The proposal would retain the structure and major elements of the
existing definition of covered position (re-designated as ``market risk
covered position'') with several modifications. These modifications aim
to better align the definition of market risk covered position with
those positions the agencies consider 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 capture
positions that have exposures to market risk and 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
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.\262\ 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 market
risk.
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\262\ Consistent with the current capital rule, 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.
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b. Positions That Would Be Market Risk Covered Positions Under the
Proposal Regardless of Whether They are Trading Assets or Trading
Liabilities
The proposal would include as market risk covered positions certain
positions or hedges of such positions regardless of whether the
position is a trading asset or trading liability.\263\ Consistent with
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. To incentivize prudent hedging and sound risk management,
the proposal would also exclude foreign exchange and commodity
positions that are CVA hedges from the definition of market risk
covered position.\264\
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\263\ A position that hedges a trading position would be
required to be within the scope of the banking organization's
hedging strategy as described in Sec. __.203(a)(2) of the proposed
rule. 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 market risk capital requirements.
\264\ The proposal would define CVA hedge as 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.
Thus, the proposal would exclude from market risk capital
requirements any CVA hedge--regardless of whether or not a banking
organization is subject to CVA risk capital requirements.
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The proposal would also expand the types of positions that would be
market risk covered positions, even if not categorized as trading
assets or trading liabilities, to include the following, each discussed
further below: (i) certain equity positions in an investment fund;
\265\ (ii) net short risk positions; (iii) certain publicly traded
equity positions; \266\ (iv) certain 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 or elects the fair value option for purposes of financial
reporting; \267\ (v) certain positions associated with internal risk
transfer under the proposal; \268\ and (vi) certain instruments
resulting from securities underwriting commitments.
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\265\ Equity positions in investment funds arising from bank-
owned life insurance, corporate owned-life insurance owned by an
affiliate, or that the banking organization has acquired for the
purpose of providing such fund with sufficient initial equity to
permit the fund to attract unaffiliated investors and held for less
than five years (``seed capital investments'') and any hedges of
such positions that qualify for effective hedge pair treatment under
Sec. __.52(c) of the current rule or Sec. __.141(c) of the
proposal would not be included in the scope of market risk covered
position.
\266\ Equity positions arising from deferred compensation plans
and hedges of such positions that qualify for effective hedge pair
treatment under Sec. __.52(c) of the current rule or Sec.
__.141(c) of the proposal would not be included in the scope of
market risk covered position.
\267\ With prior approval from its primary Federal supervisor,
the proposal would allow a banking organization to include in the
scope of market risk covered positions an entire instrument with an
embedded derivative issued by the banking organization and that
relates to credit or equity risk and for which the banking
organization elects the fair value option for purposes of financial
reporting.
\268\ See section V.A.5. of this SUPPLEMENTARY INFORMATION for
further detail on eligible internal risk transfer positions.
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First, the proposal would include as a market risk covered position
an equity position in an investment fund for which the banking
organization has access to the fund's prospectus, partnership
agreement, or similar contract that defines the fund's permissible
investments and investment limits, and which meets one of two
conditions. Specifically, the banking organization would either need to
(i) be able to use the look-through approach to calculate a market risk
capital requirement for its proportional ownership share of each
exposure held by the investment fund, or (ii) obtain daily price quotes
for the investment fund.
The current covered position definition relies in part on the legal
form of the investment fund by referencing the Investment Company Act
of 1940 \269\ to determine whether an equity position in such a fund is
a covered position. In contrast, the proposed criteria would capture
equity positions for which there is sufficient transparency for the
positions to be reliably valued on a daily basis. This valuation could
come either from an observable market price for the equity position in
the investment fund itself or
[[Page 15024]]
from the banking organization's ability to identify the underlying
positions held by the investment fund.
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\269\ 15 U.S.C. 80a-1 et seq.
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Second, the proposal would introduce a new term, net short risk
positions, to describe credit and equity exposures that are outright
short positions or 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.\270\ The agencies propose to
include any net short risk position of at least $20 million, adjusted
to reflect CPI-W, in market risk covered positions in order to help
ensure that such exposures are appropriately reflected in banking
organizations' risk-based capital requirements.\271\
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\270\ The proposal would retain, without modification, the
existing definition of trading position in the market risk capital
framework of the current capital rule. See 12 CFR 3.202 (OCC); 12
CFR 217.202 (Board); 12 CFR 324.202 (FDIC).
\271\ As discussed in section II.E. of this SUPPLEMENTARY
INFORMATION, the proposal would index the $20 million threshold for
net short risk positions going forward on an annual basis to reflect
CPI-W.
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For example, assume a banking organization purchases an eligible
credit derivative (for example, a credit default swap) to mitigate the
credit risk arising from a loan that is not a market risk covered
position and the notional amount of protection provided by the credit
default swap exceeds the loan exposure amount. The banking organization
is exposed to additional market risk on the exposure arising from the
difference between the amount of protection purchased and the amount of
protected exposure because the value of the protection would fall if
the credit spread of the credit default swap narrows. Neither the
standardized approach nor the expanded risk-based approach 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 that meet or exceed the proposed dollar threshold
described above as market risk covered positions.
To calculate the exposure amount of a net short risk position, the
proposal would require a banking organization to compare the notional
amounts of its long and short credit positions and the adjusted
notional amounts of its long and short equity positions that are not
market risk covered positions.\272\ 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, a banking organization would need to evaluate its long
and short equity and credit exposures for all positions referencing a
single name or obligor to determine if it has a net short risk
position. For index hedges, a banking organization would need to
evaluate its long and short equity and credit exposures for all
positions that are not market risk covered positions in the hedged
portfolio (aggregating across all relevant individual exposures) to
determine if it has a net short risk position for any hedged portfolio.
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\272\ For equity derivatives, the adjusted notional amount would
be the product of the current price of one unit of the stock (for
example, a share of equity) and the number of units referenced by
the trade.
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Exposures arising from net short risk positions are a potential
area where a banking organization may maintain insufficient capital
relative to the market risk. The agencies nonetheless recognize that
requiring a banking organization to capture every net short exposure
that may arise, regardless of size or duration, when calculating its
market risk capital requirements could be burdensome. 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.\273\
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\273\ For net short-risk positions, banking organizations may
use their spot, quarter-end calculations for the purposes of their
weekly calculations of the standardized measure for market risk or
daily calculations of the models-based measure for market risk.
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Third, the proposal generally would include as market risk covered
positions all publicly traded equity positions \274\ regardless of
whether they are trading assets or trading liabilities, provided that
there are no restrictions on the tradability of such positions.
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\274\ The proposal would not change the current capital rule's
definition of publicly traded as traded on: (1) any exchange
registered with the SEC as a national securities exchange under
section 6 of the Securities Exchange Act of 1934 (15 U.S.C. 78f); or
(2) any non-U.S.-based securities exchange that is registered with,
or approved by, a national securities regulatory authority and that
provides a liquid, two-way market for the instrument in question.
Consistent with the current capital rule, the proposal would define
a two-way market as a market where there are independent bona fide
offers to buy and sell so that a price reasonably related to the
last sales price or current bona fide competitive bid and offer
quotations can be determined within one day and settled at that
price within a relatively short time frame conforming to trade
custom.
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Fourth, a banking organization may issue hybrid instruments that
contain an embedded derivative related to credit or equity risk and a
host contract, and bifurcate the derivative and the host contract for
accounting purposes under GAAP or elect the fair value option for such
an embedded derivative for purposes of financial reporting.\275\ 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.\276\ This approach
[[Page 15025]]
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 of such derivatives on a
daily basis, and also appropriately exclude conventional instruments
with an embedded derivative for which the capital requirements under
the standardized approach or the expanded risk-based approach, as
applicable, would be appropriate.\277\ If a banking organization elects
to report the entire hybrid instrument at fair value under the fair
value option for accounting purposes (rather than bifurcating the
derivative and host contract), the proposal would allow the banking
organization to treat the entire instrument (and any associated hedges)
as a market risk covered position with prior approval from the primary
Federal supervisor. The agencies recognize such hybrid instruments can
also present market risk, which banking organizations may choose to
hedge either at the level of the embedded derivative or the entire
instrument. To encourage sound risk management without unduly
increasing operational burden or decreasing the overall capital
required under the market risk framework,\278\ the proposal would allow
banking organizations to treat the entire instrument (as well as any
associated hedges) as a market risk covered position with prior
approval from the primary Federal supervisor.\279\
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\275\ 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).
\276\ For purposes of regulatory reporting, the instructions to
the FR 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.
\277\ For example, a conventional mortgage loan contains an
embedded prepayment or call option.
\278\ For example, a banking organization can choose to hedge
structured notes issued by a banking organization that are linked to
credit or equity risk with trading instruments even if the banking
organization does not view the structured note as a trading
position.
\279\ The agencies anticipate that such approval would be
granted in limited circumstances such as where the instrument or
associated hedges trade or may be hedged in liquid, two-way markets.
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Fifth, the proposed definition of market risk covered position
would include certain transactions of internal risk transfers, as
described in section V.A.5. 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,
interest rate risk, or CVA risk; \280\ and (2) certain external
transactions \281\ based on eligibility of the risk transfers, executed
by a trading desk related to an internal risk transfer of credit or
interest rate 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 the standardized
approach, the expanded risk-based approach, or the market risk capital
framework of the capital rule.
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\280\ Under the proposal, only banking organizations subject to
CVA risk capital requirements would be required to treat the trading
desk segment of an eligible internal risk transfer of CVA risk as a
market risk covered position, as described in section V.B.2. of this
SUPPLEMENTARY INFORMATION. The proposed definition of market risk
covered position would not include the trading desk segment of an
eligible internal risk transfer of CVA risk for banking
organizations subject to the market risk framework but not CVA risk
framework.
\281\ An external transaction generally refers to a transaction
between a banking organization and an unaffiliated third party
(except that in the case of a banking organization that is a
depository institution, a transaction with an affiliate that is not
a direct or indirect subsidiary of the depository institution would
also be an external transaction for purposes of the depository
institution's stand-alone capital requirement).
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Sixth, the proposed definition of market risk covered position
would include instruments resulting from securities underwriting
commitments where the securities are expected to be purchased by the
banking organization on the settlement date, except those that a
banking organization expects to classify as held to maturity or
available for sale upon purchase. In general, such positions are held
for sale or otherwise to support the banking organization's trading
activities and, therefore, expose a banking organization to significant
market risk. The agencies recognize that there may be circumstances
under which the banking organization, as underwriter, might hold
securities for investment purposes that it could not sell in the
distribution. As such securities are not reflective of a banking
organization's trading activity, the proposal would exclude instruments
that a banking organization expects to purchase for held to maturity or
available for sale purposes from the definition of market risk covered
position.
c. Exclusions From the Proposed Definition of Market Risk Covered
Position
The definition of a covered position in the current capital rule
explicitly excludes certain positions.\282\ These excluded instruments
and positions generally reflect the fact that they are either deducted
from regulatory capital, explicitly addressed under the standardized
approach and advanced approaches 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.
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\282\ See 77 FR 53060, 53064-65 (Aug. 30, 2012) for a more
detailed discussion on these exclusions under the market risk
capital rule.
---------------------------------------------------------------------------
Consistent with the current capital rule, the proposal would
continue to exclude from the definition of market risk covered
positions: (1) any intangible asset, including any servicing asset; (2)
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; (3) any instrument that,
in form or substance, acts as a liquidity facility that provides
support to asset-backed commercial paper; (4) any position a banking
organization holds with the intent to securitize; and (5) any CVA
hedge.\283\ The proposed definition would also continue to exclude from
market risk covered positions any direct real estate holdings.\284\
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.\285\
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\283\ See definition of ``CVA hedge'' and ``market risk covered
position'' under Sec. __.202 of the proposal rule.
\284\ 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.
\285\ See 77 FR 53060, 53065 (August 30, 2012) for the agencies'
interpretive guidance on the treatment of such indirect holdings
under the market risk capital framework of the capital rule.
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The proposed definition would also exclude the following from the
definition of market risk covered position: (1) any non-publicly traded
equity positions, other than certain equity positions in investment
funds, (2) any publicly traded equity position that has restrictions on
tradability; (3) any 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, as applicable, (4) 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,\286\
and (5) equity positions that
[[Page 15026]]
qualify as effective hedges pursuant to Sec. __.52(c) of the current
capital rule or Sec. __.141(c) of the proposal.
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\286\ For example, the proposal would exclude equity positions
in investment funds arising from bank-owned life insurance and
corporate owned-life insurance owned by an affiliate from the scope
of market risk covered position. Such positions are held for the
purpose of covering the cost of providing benefits to employees and
retirement planning, and not with trading intent. Similarly, the
proposal would exclude equity positions in investment funds arising
from seed capital investments from the definition of market risk
covered position. A banking organization typically invests a limited
amount of its own capital as part of organizing the fund to produce
investment performance as a record of the fund's investment strategy
(``track record''). Only once a track record is established would
the banking organization market the fund to investors with trading
intent. As investors may demand a track record of at least five
years before investing in the fund, the proposal would exclude
equity positions in investment funds arising from seed capital
investments, if the banking organization has held the fund for less
than five years from the date on which the investment adviser or
similar entity to the fund begins making initial investments
pursuant to the written strategy of the fund upon its establishment.
The exclusion is not intended to be used in situations where an
investment manager provides additional capital to a fund after the
fund has developed a track record. See (2)(x) and (2)(xiv) within
the definition of market risk covered position under Sec. __.202 of
the proposal.
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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. 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.
Question 102: 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? \287\
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\287\ For banking organizations subject to market risk capital
requirements under 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 (re-designated as ``market risk
covered position''), as described in section V.A.4. of this
SUPPLEMENTARY INFORMATION, 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. See 12 CFR
44.3(b) (OCC); 12 CFR 248.3(b) (Board); 12 CFR 351.3(b) (FDIC).
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Question 103: The proposal would include as a market risk covered
position an equity position in an investment fund that satisfies the
conditions described in the definition of ``market risk covered
position'' in Sec. __.202. Consistent with the definition of
``investment fund'' under the current capital rule, to be an eligible
market risk covered position, an equity position must be in a company
(1) where all or substantially all of the assets of the company are
financial assets, and (2) that has no material liabilities. The
agencies seek comment on whether a more specific definition of eligible
``investment fund'' would be appropriate for market risk covered
positions. For example, what other vehicles that do not meet the
criteria of the ``investment fund'' definition but would be subject to
market risk capital requirements, in a manner that such positions would
be most appropriately subject to market risk capital requirements, such
as an investment fund with material liabilities? What are the
advantages and disadvantages of subjecting such investment funds to
market risk capital requirements, and why? Alternatively, what
additional conditions or limitations should the agencies consider to
place on investment funds eligible for being a market risk covered
position, beyond those currently in the proposal?
Question 104: 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? In
addition, what are the advantages and disadvantages of excluding equity
positions in investment funds arising from bank-owned life insurance or
corporate-owned life insurance from the definition of market risk
covered positions?
Question 105: 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 106: 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 107: 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?
5. Internal Risk Transfers
A banking organization may choose to hedge the risks of certain
positions \288\ held by a banking unit or a CVA desk by having one of
its trading desks obtain the hedge for a banking unit or a CVA desk
exposure. 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 \289\
(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
[[Page 15027]]
the external portion of the hedge, potentially misrepresenting the risk
position of the banking organization.
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\288\ Such risks can include credit, interest rate, or CVA risk
arising from exposures that are subject to risk-based requirements
under the standardized approach, the expanded risk-based approach,
or the market risk capital framework of the capital rule.
\289\ 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 that is not a subsidiary of the depository
institution would not qualify as transactions within the same
banking organization for the depository institution. Such
transactions would qualify as transactions within the same banking
organization for the consolidated holding company.
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Accordingly, the proposal would define internal risk transfers and
establish a set of requirements including documentation and other
conditions for a banking organization to recognize certain types of
internal risk transfers in risk-based capital requirements. The
proposal would define internal risk transfers as transfers executed
through internal derivatives trades of credit risk or interest rate
risk arising from an exposure capitalized under the standardized
approach of the capital rule or the proposed expanded risk-based
approach 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.\290\ 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.\291\
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\290\ An internal risk transfer transaction would comprise two
perfectly offsetting segments--one segment for each of two parties
to the transaction.
\291\ As described in section V.A.7.b.ii. of this SUPPLEMENTARY
INFORMATION, for transfers of risk between a trading desk that uses
the standardized non-default capital requirement and a trading desk
that uses the models-based non-default capital requirement, a
banking organization may exclude the leg of the transaction acquired
by the trading desk using the standardized non-default capital
requirement from the residual risk add-on.
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In practice, for internal risk management purposes, most banking
organizations already document the source of risk being hedged and the
trading desk providing the hedge.\292\ 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 view
that 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.
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\292\ The agencies recognize that some internal risk transfers
will be executed by means of legally binding contracts entered into
between affiliates, while others will be executed between business
units within the same legal entity under other arrangements, and
that the form of documentation used by a banking organization may
vary accordingly.
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a. Internal Risk Transfers of Credit Risk
The Basel standards introduce a risk-based capital treatment for
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
standards in specifying the criteria for internal risk transfer
eligibility and clarifying the scope of exposures subject to market
risk capital requirements. Specifically, a banking organization would
be required to maintain documentation identifying the underlying
exposure under the standardized approach or the expanded risk-based
approach, as applicable, 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 at trade initiation.
The agencies recognize that under certain circumstances a banking
organization could choose to novate to a CCP an external transaction
entered into in connection with an internal risk transfer. Because such
transactions could be subject to compression, the terms of the internal
risk transfer, aside from amount, would not be identical to the terms
of the external hedge of credit risk post trade initiation. As such,
the proposal would require the terms of the external hedge and the
internal risk transfer to be identical only at trade initiation.
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 the standardized
approach or the expanded risk-based approach. Because 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 out each other
provided the amounts and terms of both transactions match.
Nevertheless, if the internal risk transfer results in a net short
credit position greater than $20 million for the banking unit, the
trading desk would be required to calculate market risk-based capital
requirements for such positions. 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 the standardized
approach or the expanded risk-based approach.
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 the standardized approach or
the expanded risk-based approach, as applicable.
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.\293\ 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. If a banking organization
conducts internal transfers of interest rate risk on a dedicated
notional trading desk, the proposal would require a banking
organization to calculate market risk capital requirements for such
positions on the dedicated notional trading desk on a standalone basis
apart from all other market risk covered positions. Specifically, a
banking organization would be required to calculate either the
standardized measure for market risk or the models-based measure for
market risk, if
[[Page 15028]]
applicable, for the internal risk transfer positions on the dedicated
notional trading desk separate from all other market risk covered
positions.
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\293\ The proposal would not require a banking organization to
purchase the hedge from a third party for such transactions to
qualify as an internal risk transfer, because tracking interest rate
risk transfers can be operationally burdensome.
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When these requirements are met, the internal risk transfer 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 the standardized
approach or the expanded risk-based approach, as applicable, 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.\294\
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\294\ As the trading desk segments of eligible internal risk
transfers of interest rate risk would be market risk covered
positions, to the extent a trading desk enters into external hedges
to mitigate the risk of such positions, the external hedge would
also be subject to the market risk capital rule and could in whole
or in part offset the market risk of the eligible internal risk
transfer.
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For transactions that do not meet these requirements, a banking
organization would be required to exclude the internal interest rate
risk transfer (the trading desk segment) from its market risk covered
positions. The entire amount of any external hedge of an ineligible
internal risk transfer would be a market risk covered position.
c. Internal Risk Transfers of CVA Risk
For banking organizations that are subject to CVA risk capital
requirements, 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.\295\
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\295\ Under the proposal, the requirements for internal CVA risk
transfers would not apply to banking organizations that are not
subject to the proposed CVA risk capital requirement. See section
V.B.2. of this SUPPLEMENTARY INFORMATION for the scope of banking
organizations that would be subject to CVA risk capital requirements
under the proposal.
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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: the position of the CVA desk
(the CVA segment) and the position of the trading desk (the trading
desk segment). 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, at either the desk or
portfolio level, an internal written record of internal derivative
transaction(s) executed between the CVA desk and the trading desk,
including identifying the underlying exposure(s) being hedged by the
CVA desk and the sources of such risk.
In addition to the above-mentioned requirements for the internal
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 V.B.3. of this
SUPPLEMENTARY INFORMATION.\296\
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\296\ While the basic approach for CVA applies certain
restrictions on eligible instrument types for hedges to be
recognized as eligible, the standardized approach for CVA risk
allows for a broader set of hedging instruments. Moreover, the
standardized approach for CVA risk would also recognize as eligible
hedges instruments that are used to hedge the exposure component of
CVA risk.
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For eligible internal risk transfers of CVA risk, the banking
organization would be required to treat the CVA segment as an eligible
CVA hedge when calculating the CVA risk capital requirement and treat
the trading desk segment as a market risk covered position. 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.
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 exclude both the trading desk segment and the CVA segment
of the internal transfer of CVA risk from market risk-weighted assets,
thus disregarding the ineligible internal CVA risk transfer. 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 the standardized approach or the
expanded risk-based approach, as applicable. The proposed definition of
market risk covered position would generally include equity positions
that are publicly traded with no restrictions on tradability, with a
few exceptions.\297\ Given the expanded scope of equity positions that
would be subject to the proposed market risk capital requirements,
primarily illiquid or irregularly traded equity positions would remain
subject to the standardized approach or the expanded risk-based
approach, as applicable.\298\ In general, banking organizations would
not be able to hedge the material risk elements of illiquid or
irregularly traded equity positions in a liquid, two-way market. For
publicly traded equity exposures still subject to the standardized
approach or the expanded risk-based approach, as applicable, banking
organizations may apply the hedge pair treatment, which allows for the
recognition of risk-mitigating benefits of hedged transactions. Given
the narrower scope of equity positions subject to the standardized
approach or the expanded risk-based approach, as applicable, and the
option to apply hedge pair treatment for publicly traded exposures, the
proposal would not allow a banking organization to recognize internal
transfers of equity risk of such positions.
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\297\ For example, the proposed market risk covered position
would exclude equity positions arising from deferred compensation
plans and hedges of such positions that qualify for effective hedge
pair treatment under Sec. __.52(c) of the current capital rule and
under Sec. __.141(c) of the proposed rule. See section V.A.4.b. of
this SUPPLEMENTARY INFORMATION for the proposed definition of market
risk covered position.
\298\ Consistent with the current capital rule, the proposed
equity risk framework under the expanded risk-based approach would
allow firms to apply the effective hedge pair treatment to equity
exposures not subject to market risk capital requirements for which
the banking organization can demonstrate that the hedge transaction
at initiation satisfies one of the three hedge effectiveness tests.
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Question 108: The agencies seek comment on any operational
challenges
[[Page 15029]]
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 109: The agencies seek comment on the extent to which the
proposed internal risk transfer framework would incentivize hedging and
prudent risk management and/or potentially misrepresent the risk
profile of a banking organization. What, if any, additional
requirements or other modifications should the agencies consider?
Question 110: 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 111: 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 that would appropriately exclude the types of
positions that should be captured under the standardized approach or
the expanded risk-based approach, as applicable, and also impose less
operational burden relative to the proposal?
Question 112: 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? What would be an alternative approach
for calculating a standalone capital requirement for internal transfers
of interest rate risk? What would be the advantages and disadvantages
of allowing a banking organization to calculate the market risk capital
requirements for the internal risk transfers of interest rate risk
together with other market risk exposures, and why?
Question 113: The agencies seek comment on the proposed
documentation requirements for an internal risk transfer of credit
risk, interest rate risk, or CVA risk to qualify as an eligible
internal risk transfer. What, if any, changes to the proposed
documentation requirements should the agencies consider, particularly
in cases in which CVA risk is hedged on a portfolio basis? What, if
any, alternatives should the agencies consider that would appropriately
capture the types of positions that should be recognized under the
standardized approach or the expanded risk-based approach, as
applicable?
Question 114: The agencies seek comment on not allowing 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 the standardized
approach or the expanded risk-based approach, as applicable. Given the
proposed scope of equity positions that would be subject to the
proposed market risk capital requirements and the retention of
effective hedge pair treatment, under what circumstances would there be
a need for internal equity risk transfers? What would be advantages and
disadvantages of including the concept of internal risk transfer to
equity risk and why?
6. General Requirements for Market Risk
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
V.A.4. and V.A.6.b. of this SUPPLEMENTARY INFORMATION. The proposal
would also make certain technical corrections related to the
requirements around valuation of market risk covered positions.\299\
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\299\ Specifically, to align with the GAAP considerations for
valuation of market risk covered positions, the proposal would
eliminate the market risk capital rule requirement that a banking
organization's process for valuing covered positions must consider,
as appropriate, unearned credit spreads, close-out costs, early
termination costs, investing and funding costs, liquidity, and model
risk. See 12 CFR 3.203(b)(2) (OCC); 12 CFR 217.203(b)(2) (Board); 12
CFR 324.203(b)(2) (FDIC).
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a. Identification of Market Risk Covered Positions
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 V.A.4. 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 the market risk capital framework or to the standardized
approach or the expanded risk-based approach, as applicable, 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 V.A.3.e. 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.\300\
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\300\ As described in further detail in section V.A.3.e. 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 the standardized approach or the expanded risk-based
approach of the capital rule, as applicable, as a market risk
covered position.
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In addition to the requirements for identifying market risk covered
positions, the proposal would require a banking organization to have
clearly defined trading and hedging strategies for its market risk
covered positions that are approved by the banking organization's
senior management. Consistent with the current 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
[[Page 15030]]
the level of market risk that the banking organization is 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 models-based non-default capital requirement 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 V.A.6.c. of this SUPPLEMENTARY INFORMATION. The proposal would
also require the banking organization to satisfy certain additional
operational requirements, as described below in section V.A.6.d. of
this SUPPLEMENTARY INFORMATION, in order for the banking organization
to calculate the market risk capital requirements for trading desks
under the models-based non-default capital requirement.
The proposal would define a 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. Second, 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.\301\ This
approach would recognize the different strategies and objectives of
discrete units in a banking organization's trading operations. The
proposed parameters provide sufficient specificity to enable more
precise measures of market risk for the purpose of determining risk-
based capital requirements, while taking into account the potential
variation in trading practices across banking organizations. In this
regard, the proposal aims to reduce the regulatory compliance burden
for banking organizations by providing flexibility to align the
proposed trading desk definition with the organizational structure that
banking organizations may already have in place to carry out their
trading activities.
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\301\ A banking organization subject to the market risk capital
requirements under the proposal would be required to use the same
trading desk structure it establishes pursuant to the proposed
market risk capital framework to demonstrate compliance with the
prohibitions and restrictions on proprietary trading under the
Volcker Rule. See 12 CFR 44.3(e)(14) (OCC); 12 CFR 248.3(e)(14)
(Board); 12 CFR 351.3(e)(14) (FDIC).
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Question 115: What, if any, changes should the agencies consider
making to the definition of a trading desk and why? What, if any, other
key factors do 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 116: 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 standards?
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 on instruments issued by the banking organization that
relate to credit or equity risk, as well as foreign exchange and
commodity exposures that are not trading assets or trading liabilities.
When a banking organization enters into such positions, it may do so in
a manner that causes these positions to appear not to originate from a
banking organization's existing trading desks.
To address the issue that certain trading desk-level requirements
are not applicable to these types of activities and positions, the
proposal would introduce the concept of a notional trading desk \302\
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 V.A.6.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 models-based non-
default capital requirement, 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.\303\
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\302\ 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 the standardized
approach or the expanded risk-based approach of the capital rule, as
applicable, such as net short risk positions, certain embedded
derivatives on instruments that the banking organization issued that
relate to credit or equity risk, instruments with an embedded
derivative that the banking organization issued that relate to
credit or equity risk that it elects the fair value option for
purposes of financial reporting, and foreign exchange positions and
commodity positions that are not trading assets or trading
liabilities.
\303\ See section V.A.6.d. of this SUPPLEMENTARY INFORMATION for
further discussion on the additional operational requirements
applicable to model-eligible trading desks.
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The agencies are proposing to require a banking organization to
identify any notional trading desks as part of the trading desk
structure requirement, described in section V.A.6.b.iii. of this
SUPPLEMENTARY INFORMATION, to help
[[Page 15031]]
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 117: 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. Specifically, 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
models-based measure for market risk,\304\ (3) trading desks that are
used for internal risk transfers (as applicable), and (4) notional
trading desks (as applicable).\305\
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\304\ The list of model-ineligible trading desks should include
both those for which the banking organization has elected to
calculate market risk capital requirements under the standardized
non-default capital requirement as well as any trading desks that
previously received approval to use the models-based non-default
capital requirement but subsequently reported the PLA test metric in
the red zone, as described in more detail in section V.A.8.e. 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.
\305\ A banking organization could also seek approval for a
notional trading desk to be a model-eligible trading desk. Any such
desk that is approved would be subject to backtesting and profit and
loss attribution testing at the trading desk level.
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Additionally, before calculating market risk capital requirements
under the models-based measure for market risk, the proposal would
require a banking organization to receive prior approval from the
primary Federal supervisor of its trading desk structure. As part of
the model approval process described in section V.A.6.d.iv. of this
SUPPLEMENTARY INFORMATION, the primary Federal supervisor 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 primary
Federal supervisor 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
The current capital rule requires a banking organization to have
clearly defined trading and hedging strategies for its 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 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.\306\ At a minimum, this would include the business
strategy for each trading desk; \307\ a 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; a 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; and 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.
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\306\ Under the proposal, these requirements would generally not
apply to notional trading desks, except those with prior approval
from the primary Federal supervisor to use the models-based non-
default capital requirement.
\307\ Under the proposal, the business strategy must include
regular reports on the revenue, costs, and market risk capital
requirements of the trading desk.
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Together, the proposed requirements are intended to help ensure
that each trading desk engages only in those activities that are
permitted by senior management and that any exceptions would be
elevated to the appropriate organizational level. For example, the
proposed requirement for a banking organization to document trading,
hedging, and business strategies, including the internal controls
established to manage the risks arising from the trading strategy, at
the level of the organization responsible for implementing the general
business strategy, is intended to help ensure appropriate monitoring of
the risk limits set by senior management. Additionally, the proposed
requirements would help to assist the primary Federal supervisor in
monitoring compliance, particularly when assessing whether the trading
activities conducted by a trading desk are consistent with the general
strategy of the desk and the appropriateness of the limits established
for the desk. For example, the requirement for a trading desk to list
the types of instruments traded by the desk to hedge risks arising from
its business strategy would help to assist the primary Federal
supervisor in providing effective supervisory oversight of the trading
desk's activities.
c. Operational Requirements
The current capital rule requires a banking organization to satisfy
certain operational requirements for active management of market risk
covered positions, stress testing and internal assessment of capital
adequacy, 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 V.A.6.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
financial reporting and internal risk management models \308\ used by
banking
[[Page 15032]]
organizations provide an adequate basis for determining risk-based
capital requirements for market risk covered positions.\309\ To help
ensure such adequacy, the proposal would reinforce a banking
organization's prudent valuation practices by incorporating
requirements that build on the agencies' overall framework for market
risk management.\310\ including In addition to facilitating the
regulatory review process, the proposed revisions are intended to
assist a banking organization's independent risk control unit and audit
functions in providing appropriate review of and challenge to model
risk management, thereby promoting effective model risk management.
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\308\ 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.
\309\ As a banking organization's financial reporting models are
already subject to requirements to support the accuracy of the
financial data produced (such as the requirements from the Sarbanes-
Oxley Act of 2002, Pub. L. 107-204), such models would satisfy the
proposed independent validation requirements described in more
detail in section V.A.6.c.iii. of this SUPPLEMENTARY INFORMATION.
\310\ The supervisory guidance set forth in the Board's
Supervision and Regulation (SR) Letter 11-7 and OCC's Bulletin 2011-
12, Supervisory Guidance on Model Risk Management includes prudent
valuation practices for banking organizations subject to market risk
capital requirements.
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The general risk management requirements described in this section
would apply to all banking organizations subject to the proposed market
risk capital framework.
i. Active Management of Market Risk Covered Positions
The current capital rule requires a banking organization to have
clearly defined policies and procedures for actively managing all
positions subject to market risk capital requirements, including
establishing and conducting daily monitoring of position limits.\311\
These requirements are appropriate to support active management and
monitoring under the current framework; the proposal adds enhancements
to support active management and monitoring at the trading desk level.
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\311\ 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) (OCC); 12 CFR 217.203(b)(1) (Board); 12 CFR
324.203(b)(1) (FDIC).
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Accordingly, the proposal would require a banking organization to
have clearly defined policies and procedures that describe its internal
controls, as well as its ongoing monitoring, management, and
authorization procedures, including escalation procedures, for the
active management of all market risk covered positions. At a minimum,
these policies and procedures must identify key groups and personnel
responsible for overseeing the activities of the banking organization's
trading desks that are not notional trading desks.
Further, the proposal would specify a broader set of risk metrics
for the monitoring requirement, which would 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, limit usage, and remedial actions taken
in response to limit breaches; (2) sensitivities to risk factors; (3)
market risk covered positions and transaction volumes; and, as
applicable, (4) VaR and expected shortfall; (5) backtesting and p-
values \312\ 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 V.A.8.d.-f. of this
SUPPLEMENTARY INFORMATION). These risk metrics are the minimum elements
necessary to support adequate daily monitoring of market risk covered
positions at the trading desk level.
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\312\ Under the proposal, p-value would be defined as the
probability, when using the VaR-based measure for purposes of
backtesting, of observing a profit that is less than, or a loss that
is greater than, the profit or loss that actually occurred on a
given date.
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Consistent with the current 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 for model-
eligible trading desks 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
The current 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 current stress testing and internal
assessment of capital adequacy requirements to reflect both the entity-
wide and the trading-desk level elements for model-eligible positions
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 for model-eligible
positions 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 or 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
[[Page 15033]]
management levels of the banking organization and addressed in a timely
manner.
iii. Control and Oversight
The current 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 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 the
current requirements in 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 the calculation of the banking organization's
measures for market risk, 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.\313\
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\313\ A banking organization's financial reporting models
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, such as the requirements from the Sarbanes-Oxley Act of
2002. Pub. L. 107-204. Accordingly, banking organizations that rely
on financial reporting models for purposes of calculating risk-based
capital requirements would satisfy the proposed prudent valuation
requirement.
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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 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.
iv. Documentation
Similar to the enhancements to policies and procedures described
above, the proposal would enhance the documentation requirements in the
capital rule to reflect the proposed market risk capital framework.
Specifically, a banking organization would be required to document
adequately all material aspects of its identification, management, and
valuation of market risk covered positions, including internal risk
transfers and any re-designations of positions between the market risk
capital framework and the standardized approach or the expanded risk-
based approach of the capital rule, as applicable. Consistent with the
current capital rule, the proposal would require a banking organization
to document adequately 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 desk satisfies applicable requirements. These
enhancements would help ensure that a banking organization
appropriately treats all market risk covered positions under the
capital rule.
d. Additional Operational Requirements for the Models-Based Measure for
Market Risk
Under the current capital rule, a banking organization must use an
internal VaR-based model to calculate risk-based capital requirements
for its covered positions. Under the proposal, only a banking
organization that receives approval from its primary Federal supervisor
to use the models-based non-default capital requirement for at least
one model-eligible trading desk would be required to calculate market
risk capital requirements under the models-based measure for market
risk.
As a condition for use of the models-based non-default capital
requirement, the proposal would require a trading desk to satisfy
certain additional operational requirements, which are intended to help
ensure that the 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
described in sections V.A.8.e. and V.A.8.f. of this SUPPLEMENTARY
INFORMATION, would help ensure that the internal models used to
calculate a trading desk's risk-based capital requirements are
sufficiently accurate and conservative relative to the models used to
report actual profits and losses for financial reporting purposes
(financial reporting models).\314\ In this way, the additional
operational requirements are intended
[[Page 15034]]
to help ensure that the internal models of a trading desk properly
measure all material risks of the market risk covered positions to
which they are applied, and the sophistication of the internal models
is commensurate with the complexity and extent of trading activity
conducted by the trading desk.
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\314\ The proposed backtesting requirements are intended to
measure the conservatism of the forecasting assumptions and
valuation methods in the internal models used to determine risk-
based capital requirements relative to those used in the financial
reporting models. The proposed PLA testing requirement is intended
to measure the accuracy of the potential future profits or losses
estimated by the valuation models used for internal risk management
purposes (internal risk management models) relative to those
produced by the valuation models used for financial reporting. If a
trading desk fails to satisfy either the backtesting requirements
or, after the three-year transition period, the proposed PLA test
requirements, it would no longer be able to calculate risk-based
capital requirements using the models-based non-default capital
requirement. In this way, the proposal would only allow trading
desks for which the internal models are sufficiently conservative
and accurate to use the models-based non-default capital requirement
to calculate market risk capital requirements.
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As described above, the proposal would require eligibility for use
of the models-based non-default capital requirement 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 the controls used for
financial reporting, the proposed requirements would enhance prudent
capital management for banking organizations that use the models-based
measure for market risk.
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 the models-based non-default capital
requirement from the primary Federal supervisor.
Additionally, the proposal generally would prohibit a banking
organization from seeking model approval for trading desks that hold
securitization positions, correlation trading positions, or certain
equity positions in investment funds (together ``model-ineligible
positions''), with one exception.\315\ Given the operational
difficulties of requiring a banking organization to bifurcate trading
desks that hold an insignificant amount of model-ineligible 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 models-based
non-default capital requirement for such desks, the proposal would
require the banking organization to separately calculate market risk
capital requirements for such model-ineligible positions held by a
model-eligible trading desk under either the standardized non-default
capital requirement or the fallback capital requirement, and otherwise
treat such positions as if they were not held by the desk.\316\
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\315\ As described in section V.A.10.e.ii. of this SUPPLEMENTARY
INFORMATION, an equity position in an investment fund could be a
model-eligible position to the extent a banking organization is able
to identify the underlying positions held by an investment fund on a
quarterly basis.
\316\ Specifically, the proposal would require a banking
organization to exclude any insignificant amount of model-ineligible
positions held by the model-eligible trading desk from the aggregate
trading portfolio backtesting and the relevant desk-level
backtesting and profit and loss attribution metric, unless the
banking organization receives approval from its primary Federal
supervisor to include such positions.
---------------------------------------------------------------------------
Question 118: The agencies seek comment on the benefits and
drawbacks of requiring trading desks that hold an insignificant amount
of model-ineligible positions to exclude from the models-based non-
default capital requirement 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 measure 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
to use the models-based non-default risk capital requirement to
calculate market risk capital requirements.
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 regulatory 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 \317\ 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 the banking organization's market risk covered
positions that might result in the internal models no longer adequately
capturing the market risk of the market risk covered positions held by
the model-eligible trading desk.
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\317\ 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. As a banking organization's financial
reporting models provide an appropriate basis for determining risk-
based capital requirements because such models are subject to the
requirements of the Sarbanes-Oxley Act of 2002, including external
audit, banking organizations that rely on financial reporting models
for purposes of calculating risk-based capital requirements would
satisfy the proposed prudent valuation requirement.
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The proposal also would require a banking organization to establish
a validation process that, at a minimum, includes an evaluation of the
internal models' (1) conceptual soundness \318\ and (2) adequacy in
appropriately capturing and reflecting all material risks, including
ensuring that the assumptions are appropriate and do not underestimate
risks. Additionally, the proposal would require a banking organization
to perform ongoing monitoring to review and verify processes, including
by comparing the outputs of the internal models with relevant internal
and external data sources or estimation techniques. The results of this
comparison provide a valuable diagnostic tool for identifying potential
weaknesses in a banking organization's models. As part of this
comparison, a banking organization would be expected to investigate the
source of differences between the model estimates and the relevant
internal or external data or estimation techniques and whether the
extent of the differences is appropriate.
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\318\ 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 of the current 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.
[[Page 15035]]
iii. Documentation
In addition to the general documentation requirements applicable to
all banking organizations described in section V.A.6.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 (1) the determination of
which risk factors are modellable and which are not modellable (risk
factor quantitative and qualitative tests), including a description of
how the banking organization maps real price observations to risk
factors; (2) the alignment of the profits and losses reported by
financial reporting models and the internal risk management models for
purposes of the PLA test; \319\ and (3) the assignment of risk factors
to liquidity horizons, and any empirical correlations recognized with
respect to risk factor classes.
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\319\ See section V.A.8.e. of this SUPPLEMENTARY INFORMATION for
a more detailed description of the proposed PLA test.
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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 models-
based non-default capital requirement 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 trading desk.
iv. Model Eligibility
For a banking organization to use the models-based measure for
market risk, the proposal would require the banking organization to
receive the prior approval from its primary Federal supervisor for at
least one trading desk to apply the models-based non-default capital
requirement. 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.\320\ 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 requirements; (3) the level of sophistication of the
internal model or methodology is commensurate with the complexity and
amount of the market risk covered positions to which it would be
applied; and (4) the internal model or methodology meets all applicable
requirements.
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\320\ The proposal would require a banking organization to
receive approval from the primary Federal supervisor for both the
expected shortfall internal model and the stressed expected
shortfall methodology used by the trading desk. As the initial
approval process for each would be the same, for simplicity, the
term ``internal models'' used throughout this section is intended to
refer to both.
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To receive approval as a model-eligible trading desk, the proposal
would require a trading desk to satisfy one of the following
criteria.\321\ 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. 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 a PLA metric in the green zone, as
further described in sections V.A.8.e. and V.A.8.f. of this
SUPPLEMENTARY INFORMATION, respectively.\322\
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\321\ As discussed in section V.A.8.e. of this SUPPLEMENTARY
INFORMATION, to receive approval as a model-eligible desk during the
three-year PLA test transition period, the proposal would require
the banking organization to provide backtesting 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 requirements on an on-going basis. During the three-
year transition period, a banking organization would not be required
to submit PLA test results to its primary Federal supervisor in
order to receive approval to use an internal model by the trading
desk. The proposal would nevertheless require a banking organization
to submit quarterly PLA test results to its primary Federal
supervisor for monitoring purposes without automatic consequences
for PLA test results.
\322\ Under the proposal, there would be no automatic
consequences for the PLA test results during the three-year
transition period. Accordingly, during the transition period, a
banking organization would not be able to seek model approval for
trading desks with less than six months of backtesting results and
that do not consist of market risk covered positions similar to
those of another trading desk that has received approval as model-
eligible.
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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 test 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 (using the
PLA and backtesting results) the accuracy and conservatism of the
internal models used by the desk 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 PLA test and backtesting results
and has received approval from its primary Federal supervisor. The
internal models used by trading desks that meet all the requirements to
the satisfaction of the primary Federal supervisor except the PLA test
and backtesting requirements would be subject to a PLA add-on until the
desk produces one year of satisfactory PLA test and backtesting results
in the green zone.\323\ 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.
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\323\ Based on the PLA test results, a banking organization
would be required to allocate each model-eligible trading desk to a
PLA test zone (green, amber, or red) as set out in Table 1 to Sec.
[thinsp]__.213 of the proposed rule.
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II. Ongoing Eligibility and Changes to Trading Desk Structure or
Internal Models and Stressed Expected Shortfall Methodologies
The current capital rule requires a banking organization to
promptly notify its primary Federal supervisor when (1) extending the
use of a model that the primary Federal supervisor has approved to an
additional business line
[[Page 15036]]
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 an exposure type, 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 approval from its primary Federal
supervisor before implementing any change to its trading desk
structure, internal models or methodologies (including any material
change to its modelling assumptions) that would (1) in the case of
trading desk structure, materially impact the market risk capital
requirements for a portfolio of market risk covered positions; or (2)
in the case of internal models or methodologies, result in a material
change in the banking organization's expected shortfall-based measure
for a trading desk, the internally modelled capital calculation, or the
stressed expected shortfall calculation under the models-based non-
default capital requirement. 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.\324\ Whether a
banking organization would be required to receive prior 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.
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\324\ In such cases, a banking organization should notify the
primary Federal supervisor in writing, in a manner acceptable to the
supervisor (such as through email, where appropriate).
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The proposal also would require a model-eligible trading desk to
perform and successfully pass quarterly backtesting and PLA testing
requirements on an ongoing basis in order to maintain its approval
status.\325\ As banking organizations' quarterly review of backtesting
and PLA test results would take place after a quarter is over, the
proposal would permit a banking organization to rely on the models-
based non-default capital requirement for model-eligible trading desks
that previously received approval from the primary Federal supervisor
during the 30 calendar day period following the end of a calendar
quarter while updating its use of internal models based on the results
of the quarterly review.
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\325\ The desk-level backtesting and PLA testing requirements
are described in sections V.A.8.e. and V.A.8.f. of this
SUPPLEMENTARY INFORMATION, respectively. While the proposal would
require a banking organization to submit quarterly PLA test results
to its primary Federal supervisor during the three-year transition
period, a banking organization's model-eligible trading desk would
only be required to successfully pass quarterly backtesting
requirements on an on-going basis to maintain its approval status
during that three-year transition period.
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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 or methodology 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 non-
default capital requirement, 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.\326\
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\326\ Under the proposal, there would be no automatic
consequences for the PLA test results during the three-year
transition period. Thus, the PLA add-on would not be an alternative
if the primary Federal supervisor rescinds its approval during the
three-year transition period.
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The agencies recognize that even if a banking organization's
internal 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 non-default capital requirement,
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 non-default capital
requirement. 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 internal 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 internal 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 V.A.8.c.
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 non-default
capital requirement. 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 V.A.8.e. 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.
7. Standardized Non-Default Capital Requirement
Under the proposal, the standardized non-default risk capital
requirement would comprise two components: (1) the sensitivities-based
capital requirement, which captures non-default market risk based on
the estimated losses produced by risk factor sensitivities under
regulatorily determined stressed conditions, and (2) the residual risk
add-on, which serves to produce a simple, conservative capital
requirement for any other risks that are not already fully captured by
sensitivities-based measure or the default risk capital requirement,
such as gap risk, correlation risk, and behavioral risks such as
prepayments.
a. Sensitivities-Based Method
Conceptually, the proposed sensitivities-based method is similar to
a simple stress test in which 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
[[Page 15037]]
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: (1) identify all relevant risk factors associated with a
market risk covered position and allocate them to one of seven risk
classes; (2) allocate such risk factors to a corresponding bucket
within the appropriate risk classes; (3) calculate the sensitivity of a
market risk covered position for each of the prescribed risk factors by
applying regulatory prescribed risk weights to the net sensitivity of
risk factors within each bucket; (4) aggregate the weighted
sensitivities across risk factors within a corresponding bucket
(bucket-level capital requirement); (5) aggregate the bucket-level risk
positions for each risk class (risk class-level capital requirement);
and (6) aggregate the risk class-level capital requirements for each
risk class under each correlation scenario.
First, under the proposal, a banking organization would identify
all relevant risk factors associated with its market risk covered
positions and then assign such risk factors to one or more of seven
risk classes. The seven prescribed risk classes, which are based on
standard industry classifications, are interest rate risk, credit
spread risk for non-securitization positions,\327\ 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
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).\328\ 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.\329\
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\327\ 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.
\328\ 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.
\329\ 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.
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Second, the proposal would require a banking organization to
allocate all identified risk factors associated with a market risk
covered positions to a corresponding bucket within the appropriate risk
class. The proposal specifies buckets for each risk class, which
represent common risk characteristics of a given risk class, in
recognition that positions sharing such risk characteristics are highly
correlated and therefore their values tend to change in substantially
the same manner. Further, the proposed buckets correspond to common
industry practice as large trading banking organizations often use
bucketing structures similar to those set forth in the proposal. For
example, for positions within the credit spread non-securitization risk
class, a banking organization would group the corporate bond position
and other positions with similar credit quality and issuers operating
in the same sector together in one 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.
Third, 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
sensitivities, 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 separately sum the resulting delta, vega, and curvature
sensitivities for all market risk covered positions within the same
bucket to produce a net sensitivity for each risk factor, which is the
potential value impact on all of the banking organization's market risk
covered positions in the bucket as a result of a uniform change in a
risk factor.\330\
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\330\ 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 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).
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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, for each risk factor within a bucket by the proposed
standardized risk weight for the 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.\331\ 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.
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\331\ 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 models-based non-default capital requirement described
in section V.A.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 non-default capital requirement.
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Fourth, 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 buckets and across 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
buckets to arrive at bucket-level risk positions. Lastly, 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
[[Page 15038]]
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 risk factors, could decrease or become less
effective in a time of stress. Specifically, taking into account
prescribed correlation parameters, a banking organization would need to
calculate the aggregate requirements first within a bucket and then
across 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 bucket-level
capital requirements and risk class-level capital requirements for each
risk class would be calculated using three different correlation
scenarios--assuming high, medium and low correlations between risk
factor shocks. The banking organization would use this process to
calculate the overall delta, vega, and curvature capital requirements
for all risk classes and 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.\332\
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\332\ As the degree to which a pair of variables are linearly
related (the correlation) can only range from negative one to one,
the proposal would cap the correlation parameters under the high
scenario at no more than one (100 percent) and floor those under the
low scenario at no less than negative one. For highly correlated
positions, the low correlation scenario also would not always reduce
the correlation parameter by 25 percent.
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Finally, to determine the overall capital requirements for each of
the three correlation scenarios, the banking organization would sum the
separately calculated delta, vega, and curvature capital requirements
for all risk classes without recognition of any diversification
benefits, given that delta, vega, and curvature sensitivities are
intended to separately capture different risks. The sensitivities-based
capital requirement would be the largest capital requirement resulting
from the three correlation scenarios.
Question 119: 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.
Question 120: The agencies seek comment on approaches to allow
further recognition of diversification between risk classes that are
not eligible for the models-based non-default capital requirement (such
as securitizations) and risk classes that are eligible for the models-
based non-default capital requirement within the sensitivities-based
method of the standardized non-default capital requirement. What other
areas in the sensitivities-based method should the agencies consider
where it would be prudent to enhance the recognition of
diversification, and why? Commenters should provide evidence to
demonstrate the additional recognition of diversification is
commensurate with the risk of the combined positions both in normal
times and under stress.
i. Risk Factors
The proposal would require a banking organization to map all
relevant risk factors associated with a market risk covered position to
a risk class and then allocate such risk factors to a corresponding
bucket within the appropriate risk classes 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 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 financial reporting
models. Additionally, relying on banking organizations' internal risk
management models, rather than the financial reporting 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 each
currency in which interest rate-sensitive market risk covered positions
are denominated. By defining each interest rate curve as a distinct
risk factor, the proposed delta risk factors for interest rate risk
would require banking organizations to reflect the basis risk between
different interest rate curves (for example, interest rate curves from
the overnight index swap curve (OIS) or an alternative reference rate
curve).
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.\333\ Under
[[Page 15039]]
the proposal, a banking organization would not recognize the term
structure for inflation risk and cross-currency basis risk for each
currency. 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 to the interest rate
bucket for each currency.
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\333\ Cross-currency basis is a basis added to a yield curve in
order to evaluate a swap for which the two legs are paid in two
different currencies. Market participants use cross-currency basis
to price cross currency interest rate swaps paying a fixed or a
floating leg in one currency, receiving a fixed or a floating leg in
a second currency, and including an exchange of the notional amount
in the two currencies at the start date and at the end date of the
swap.
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The vega risk factors for interest rate risk would be the implied
volatilities of options referencing the interest rate of the underlying
instrument. The implied volatilities of inflation rate risk-sensitive
options and cross-currency basis risk-sensitive options would be
defined along the maturity of the option, whereas the implied
volatilities of interest-rate risk-sensitive options would be defined
along two dimensions: the maturity of the option and the residual
maturity of the underlying instrument at the expiration date of the
option. For example, a banking organization would calculate the vega
sensitivity of a European interest rate swaption that expires in 12
months referring to a one-year swap based on the maturity of the option
(12 months) as well as the residual maturity of the underlying
instrument (the swap's maturity of 12 months).
The proposal would define the curvature risk factors for interest
rate risk along one dimension: the interest rate curve of each currency
(no term structure would be considered).
II. Credit Spread Risk
The proposal would separately define the credit spread risk factors
for non-securitization positions,\334\ 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. Lastly, 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,\335\ defined along one dimension: the
option's maturity.
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\334\ 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.
\335\ When calculating the sensitivity for securitization
positions non-CTP, a banking organization would calculate the
sensitivities for credit spread risk based on the embedded
subordination of the position, such as the spread of the tranche.
For correlation trading positions, the credit spread risk
sensitivity would be based on the underlying names in the
securitization position, or nth-to-default position.
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The proposal would define the curvature risk factors for credit
spread risk for non-securitization positions along one dimension: the
credit spread curve of the issuer. The curvature risk factors for
credit spread risk for securitization positions non-CTP would be
defined along the relevant bond and CDS credit spread curve of the
tranche, and 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.
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
\336\ 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.\337\ 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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\336\ 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 (for
example, West Texas Intermediate oil and Brent oil).
\337\ For example, a contract that can be delivered in four
ports may have less sensitivity to each location defined risk factor
than a contract that can only be delivered in three of those ports.
If a banking organization has entered into a contract to deliver
1000 barrels of oil in port A, B, C or D, and a hedge contract to
receive 1000 barrels of oil on the same date in port A, B or C, if
on delivery day ports A, B and C are closed, the banking
organization is exposed to commodity risk in that it must deliver
1000 barrels of oil to port D without receiving 1000 barrels. As a
result, the two contracts would have different sensitivity to
location defined risk factors.
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To measure the price sensitivity of a commodity market risk covered
position, the proposal would require a banking organization to use
either the spot price or the forward price, depending on which risk
factor is used by the internal risk management models to price
commodity transactions. For example, if the internal risk management
model typically values electricity contracts based on forward prices
(rather than spot prices), the proposal would require the banking
organization to compute the delta capital requirement using the current
prices for futures and forward contracts. Similar to equity risk, the
proposal would define the commodity vega risk factors based on the
implied volatilities of commodity-sensitive options as defined along
the maturity of the option and the curvature risk factors based on the
constructed curve per commodity spot price.
[[Page 15040]]
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 would be
the exchange rates for USD/EUR and USD/JPY.
To reduce operational burden, the proposal would 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.\338\ 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 calculate separate
deltas for the EUR/JPY exchange rate risk and USD/JPY foreign exchange
translation risk and then translate the resulting capital requirement
to USD at the USD/JPY spot exchange rate.
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\338\ 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). Because exchange rates fluctuate continuously, this
conversion could increase or decrease the value of those assets and
liabilities and thus generate foreign exchange gains (or losses)
from non-operating activity.
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The proposal would define the vega risk factors for foreign
exchange risk as the implied volatility of options that reference
exchange rates between currency pairs along one dimension: the maturity
of the option. For curvature, the foreign exchange risk factors would
be all exchange rates between the currency in which a market risk
covered position is denominated and the reporting currency (or the base
currency, if approved by the primary Federal supervisor).
ii. Risk Factor Sensitivities
A fundamental element of the sensitivities-based method is the risk
factor 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.
The proposal would require a banking organization to calculate risk
factor sensitivities using either the valuation methods used in its
financial reporting models or internal risk management models.\339\ 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.
Accordingly, the proposal would also permit a banking organization to
use the valuation methods used in its internal risk management models
to calculate delta and vega sensitivities and curvature scenarios.
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\339\ The proposal would require banking organizations to have a
prudent valuation process, including the independent validations of
the valuation models used in the standardized non-default capital
requirement. The financial reporting models 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, such as the
requirements from the Sarbanes-Oxley Act of 2002. Public Law 107-
204. Accordingly, banking organizations that rely on financial
reporting models for purposes of calculating risk factor
sensitivities would satisfy the proposed prudent valuation
requirement.
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For consistency and comparability in risk-based capital
requirements across banking organizations, the proposal would require
each banking organization to calculate all risk factor sensitivities in
the reporting currency of the banking organization, except for the
foreign exchange risk class where, with prior approval of the primary
Federal supervisor, the banking organization may calculate the
sensitivities relative to a base currency instead of the reporting
currency. To appropriately capture a banking organization's exposure to
market risk, the proposal would require banking organizations to use
fair values that exclude CVA in the calculation of risk factor
sensitivities.
Question 121: The agencies seek comment on the advantages and
disadvantages of allowing a banking organization to use the risk factor
sensitivities from the previous day in limited circumstances when a
banking organization is unable to calculate such sensitivity for the
day, and why?
I. Delta
Under the proposal, a banking organization would calculate the
delta capital requirement using the steps previously outlined in
section V.A.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).\340\ 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
V.A.7.b. of this SUPPLEMENTARY INFORMATION.
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\340\ Examples of exotic exposures not captured by any of the
proposed risk classes include but are not limited to longevity,
weather, and natural disasters derivatives.
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For purposes of calculating the delta capital requirement, the
proposal would require a banking organization to calculate the delta
sensitivity of a position using the sensitivity definitions provided in
the proposal for each risk factor. Based on the proposed sensitivity
definitions, the delta sensitivity would reflect the change in the
value of a market risk covered position resulting from a small
specified shift of one basis point or one percent change to a risk
factor, assuming all other relevant risk factors are held at the
current level, divided by the same specified shift to the risk factor.
For the equity spot price, commodity, and foreign exchange risk
factors, the delta sensitivity would equal the change in value of a
market risk covered position due to a one percentage point increase in
the risk factor divided by one percentage point. For the interest rate,
credit spread, and equity repo rate
[[Page 15041]]
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,\341\ the sticky delta rule,\342\ or, with the prior
approval from its primary Federal supervisor, another assumption that
is consistent with the banking organization's internal models. Each of
these methods, or various combinations of such methods, is intended to
measure appropriately the sensitivity of a risk factor within any of
the risk classes.
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\341\ 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.
\342\ Under the sticky delta rule, the banking organization
would assume that the implied volatility for a particular maturity
depends only on the ratio of the price of the underlying asset to
the strike price (sometimes called the moneyness of the option).
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II. Vega
For market risk covered positions with optionality, the vega
sensitivity to a risk factor would equal the vega of an 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, multiplied by the volatility of the option. 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 financial reporting models or the
internal risk management models to determine the intrinsic value of
volatility in the price of the option.
The vega capital requirement would only apply to options or
instruments with embedded optionality, including instruments with
material prepayment risk. For purposes of calculating the vega capital
requirement, a banking organization would follow the steps previously
outlined for purposes of calculating the delta capital requirements and
use the same buckets for each risk class as those specified for the
delta capital calculation and use the corresponding 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 proposal would 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.
The proposal would require a banking organization to assign the
sensitivity to implied volatility based on the option 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, cancelable 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 V.A.7.b. 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 either its financial reporting models or internal risk
management models to value the position and apply a residual risk add-
on.\343\ The agencies are proposing these constraints as a simple and
conservative approach for market risk covered positions that are
difficult to value in practice.
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\343\ Tranches of correlation trading positions that do not have
an implied volatility would not be subject to the vega risk capital
requirement. Such instruments would not be exempt from delta and
curvature capital requirements.
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Question 122: 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, would be subject to the curvature capital requirement because
they present material price risks not captured by delta. 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 \344\ to include instruments without optionality in the
curvature capital requirement, provided that the trading desk
consistently includes such positions through time.
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\344\ For a banking organization that has established a trading
desk structure with a single trading desk that uses the standardized
measure to calculate market risk capital requirements, the proposal
would allow such banking organization to make such an election for
the entire organization rather than on a trading desk by trading
desk basis. If such an election is made at the enterprise-wide
level, the proposal would require the banking organization to
consistently include positions without optionality within the
curvature calculation.
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The proposal would require a banking organization to use the same
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 bucket, the proposal would require
a banking organization to fully revalue all of its market risk
[[Page 15042]]
covered positions with optionality as well as any market risk covered
position that a banking organization has elected to include in the
calculation of its curvature capital requirement, as applicable, 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.\345\ The below
graphic provides a conceptual illustration of the calculation of the
curvature risk-weighted sensitivity based on the upward and the
downward shock scenarios.
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\345\ 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.
[GRAPHIC] [TIFF OMITTED] TP27MR26.077
In calculating the curvature risk-weighted sensitivity for the
interest rate, credit spread, and commodity risk classes, a banking
organization would apply the upward and downward shocks assuming a
relative shift of all tenors for each curve based on the highest
prescribed delta risk weight for the applicable
bucket.346 347 The proposal would require a banking
organization to apply the highest risk weight for each bucket to all
tenor points along the curve 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
bucket level (not the risk class level). To the extent that applying
the downward shocks results in negative credit spreads, the proposal
would allow a banking organization to floor credit spreads at zero,
which is the natural floor for credit spreads given that negative CDS
spreads are not meaningful.
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\346\ As described in section V.A.7.a.iii.I. of this
SUPPLEMENTARY INFORMATION, the proposed bucket structure used to
group the delta risk factors for interest rate risk (and the
corresponding risk weight for each 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.
\347\ As the curvature capital requirements would capture an
option's change in the value above that captured by delta, a banking
organization would calculate the curvature sensitivity to credit
spread risk for securitization positions non-CTP and correlation
trading positions using the spread of the tranche and the spread of
the underlying names, respectively.
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For the foreign exchange and equity risk classes, the upward and
downward shocks represent a relative shift of the foreign exchange spot
prices or equity spot prices, respectively, equal to the delta risk
weight prescribed for the risk factor. The agencies recognize that the
conversion of other currencies into either the reporting currency or
base currency, if applicable, would capture exchange rate fluctuations,
and thus overstate the sensitivity for foreign exchange risk. Thus, for
options that do not reference the reporting or base currency of the
banking organization as an underlying exposure, the proposal would
allow the banking organization to divide the net curvature risk
positions by a scalar of 1.5, provided that the banking organization
consistently applies the scalar to all market risk covered positions
with foreign exchange risk through time.
To aggregate the 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
lower 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 limit the effect of negative curvature
capital requirements on the overall capital required under the
sensitivities-based method, both the intra-bucket and inter-bucket
aggregation formulas would
[[Page 15043]]
floor the curvature capital requirement at zero. Additionally, both
formulas include a variable \348\ 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 limiting the reduction in the overall capital resulting from the
aggregation of market risk covered positions with negative curvature.
---------------------------------------------------------------------------
\348\ Specifically, this refers to the psi variable ([Psi])
within the intra and inter-bucket aggregation formulas in Sec.
__.206(d)(2) and Sec. __.206(d)(3) of the proposed rule.
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Question 123: For consistency with flooring credit spreads at zero
when the downward shock for curvature results in negative credit
spreads, the agencies seek comment on whether the agencies should allow
banking organizations to cap the level of shock (for example,
RWKCurvature) at the difference between the current level of the credit
spread risk curvature risk factor and zero when calculating the
curvature risk. What would be advantages and disadvantages of this cap
and why?
Question 124: 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. 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 net sensitivity for
each risk factor by the risk weight prescribed for the applicable
bucket.\349\ The proposed 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 buckets for certain U.S. products, as described in
section V.A.7.a.iii.II. of this SUPPLEMENTARY INFORMATION.\350\
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
V.A.7.a.iii.III. of this SUPPLEMENTARY INFORMATION. Furthermore, the
proposal would include electricity in the same 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 V.A.7.a.iii.IV. of this. SUPPLEMENTARY INFORMATION.
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\349\ 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 standards.
\350\ See 15 U.S.C. 78o-7 note.
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The proposed buckets and associated risk weights are intended to
appropriately 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 standards 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 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 buckets for the interest rate risk factors of market risk
covered positions and the corresponding risk weight applicable to each
bucket.\351\ The proposal would require a banking organization to use
separate buckets for each currency, for each of ten proposed tenors to
capture most commonly traded instruments across market risk covered
positions held by a banking organization and align with bucketing
structures used by trading firms.
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\351\ The buckets reflect that interest rates at a longer tenor
have less uncertainty and thus lower volatility than interest rates
at a shorter tenor that are more receptive to changes in interest
rate risk.
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By delineating interest rate risk factors based on currency \352\
and tenor, the granularity of the proposed buckets is intended to
appropriately balance the risk sensitivity of the proposed framework
with providing consistency in risk-based requirements across banking
organizations by assigning similar risk weights to similar kinds of
positions.
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\352\ As noted in section V.A.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 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)(iv) 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, vega, and curvature
capital requirements, as applicable, 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 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 twenty, sixteen, or
twenty-five proposed 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
buckets for credit spread risk consider the credit quality of a given
market risk covered position. More specifically, the proposal would
generally use the same approach to delta credit spread buckets and
corresponding risk weights provided in the Basel standards for non-
securitization positions, correlation trading positions, and
securitization positions non-CTP, except that the proposal would define
the buckets using alternative criteria to capture the creditworthiness
of the obligor. The delta credit spread buckets
[[Page 15044]]
in the Basel standards 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.\353\ Therefore, the agencies are proposing an approach
that would allow for a level of risk sensitivity in the delta credit
spread buckets and corresponding risk weights that would be generally
consistent with the Basel standards and not rely on external credit
ratings. Specifically, the proposal would categorize the delta credit
spread 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 \354\ and the definitions of
speculative grade \355\ and sub-speculative grade \356\ as defined in
the proposal.
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\353\ 15 U.S.C. 78o-7 note.
\354\ See 12 CFR 3.2 (OCC); 12 CFR 217.2 (Board); 12 CFR 324.2
(FDIC).
\355\ 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.
\356\ 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.
---------------------------------------------------------------------------
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 standards 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. Accordingly, assigning the same risk weight to these
positively correlated sectors would reduce administrative burden and
not have a material effect on risk sensitivity. Relative to the Basel
standards, the proposal would expand the scope of the financials,
including government-backed financials, bucket to apply to real estate
activities. This clarification aligns the treatment of real estate
activities across the credit spread risk sector buckets and equity
sector buckets.
Some of the proposed sector buckets consist of different
industries, for example basic materials, energy, industrials,
agriculture, manufacturing, and mining and quarrying. Positions within
the same sector that are the same credit quality would be assigned to
the same bucket because from a market risk perspective an economic
event causing volatility in a sector tends to similarly affect all
positions in the industries operating in that sector, even if there may
be differences in credit quality between individual issuers within a
sector. When calculating the delta and curvature capital requirements
for securitization indices, the proposal would allow a banking
organization to apply the look-through approach or treat the index as a
single position, as described in section V.A.10.d.i. of this
SUPPLEMENTARY INFORMATION.
The agencies recognize that there may be sectors that are not
expressly categorized by the proposed buckets, and that specifying all
sectors for such purpose may not be possible. The proposed buckets
would include an ``other sector'' category for market risk covered
positions that do not belong to any of the other buckets.
The proposed risk weights are based on empirical data which reflect
the historical stress period for which the risk factors within the
bucket caused the largest cumulative loss at various liquidity
horizons. As such, for speculative grade sovereign exposures,
multilateral development banks, and specified supranational entities
\357\ 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).\358\ Based on
the agencies' quantitative analysis of the historical data, the credit
spreads of speculative grade sovereign bonds have typically widened
more than 200 basis points after a downgrade, and significantly more
for sub-speculative grade sovereigns.\359\ Multilateral development
banks and specified supranational entities exhibit similar credit
spread risk as sovereign exposures and merit similar risk weights.
Additionally, for non-securitization positions and correlation trading
positions, the proposal would include separate buckets with higher risk
weights (7 percent and 16 percent, respectively) for sub-speculative
grade sovereign exposures, multilateral development banks, and
specified supranational entities than for those of speculative grade,
because of the additional risk posed by sub-speculative exposures.
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\357\ Under the proposal, specified supranational entities would
include the Bank for International Settlements, the European Central
Bank, the European Commission, the International Monetary Fund, the
European Stability Mechanism, and the European Financial Stability
Facility. Consistent with the current capital rule, exposures to
such entities would continue to be subject to a zero percent risk
weight for purposes of general credit risk under the proposal.
\358\ The agencies calibrated the credit spread risk weights for
speculative and sub-speculative sovereign exposures by applying a
methodology similar to what the Basel Committee used for calibrating
risk weights for other asset classes. In particular, the agencies
used a methodology that aligned the sensitivities-based method risk
weight calibration to the liquidity horizon-adjusted stressed
expected shortfall specified in the models-based non-default capital
requirement. For calibration, the agencies used IHS Markit credit
default swap data and calculated ten-day overlapping absolute
changes in sovereign credit default swap spreads. For the period of
stress, the agencies used the period from May 2011 to May 2012
during the European sovereign debt crisis, which is representative
of stress risk for these exposures. The agencies calibrated the risk
weight by multiplying the standard deviation of the absolute changes
in sovereign spreads over the stress period by 2.34 and by the
square root of the applicable liquidity horizon divided by ten days.
The agencies multiplied the standard deviation by 2.34 to ensure the
risk weight was calibrated to the same 97.5 percent threshold
required in the expected shortfall measure and to align with the
calculation of other risk weights. The multiplication by the square
root of the ratio of the liquidity horizon to ten days was done to
convert the metric to the appropriate liquidity horizon specified in
the models-based non-default capital requirement.
\359\ The result of calibration based on the IHS Markit credit
default swap data is a seven percent risk weight for sub-speculative
grade. Credit default swap data were used for sub-speculative
sovereign exposures because credit default swap spreads generally
reflect the credit spread risk characteristics of sub-speculative
grade sovereign issuers. For speculative grade sovereign exposures,
the proposal would assign a three percent risk weight, rather than
the two percent risk weight specified in the Basel standards,
because the analysis described above shows that the credit spreads
of speculative grade sovereign bonds have typically widened more
than two percent after a downgrade. In addition, the proposed three
percent risk weight for such exposures would support the agencies'
objectives of ensuring an appropriate level of conservativeness
while also differentiating between the relative risks of speculative
and sub-speculative grade sovereign exposures.
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For securitization positions non-CTP (Table 7 to Sec. _.209), the
proposal would clarify the treatment of personal loans and dealer
floorplan loans within the delta credit spread buckets. Specifically,
the proposal would require a banking organization to include personal
loans within the bucket for credit card securitizations and dealer
floorplans within the bucket for auto securitizations in order to
appropriately
[[Page 15045]]
reflect the lower credit spread risk of these positions relative to
those within the other sector bucket.\360\
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\360\ 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 buckets for residential mortgage-backed
securities to help ensure consistency in bucketing assignments across
banking organizations. Specifically, the proposal would define prime
residential mortgage-backed securities based on the definition of
qualified residential mortgages in the credit risk retention rule \361\
and would define sub-prime residential mortgage-backed securities based
on the definitions of higher-priced mortgage loans and high-cost
mortgages in Regulation Z,\362\ respectively.
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\361\ 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).
\362\ 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.\363\ 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 proposal would use the existing
definition of qualified residential mortgage in the credit risk
retention rule, which refers to the Regulation Z definition of
qualified mortgage to identify residential mortgage-backed securities
that are primarily backed by underlying loans with sufficiently low
credit risk to be classified as prime.
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\363\ Under the general definition for qualified mortgages in 12
CFR 1026.43(e)(2), a creditor must satisfy the statutory criteria
restricting certain product features and points and fees on the
loan, consider and verify certain underwriting requirements that are
part of the general ability-to-repay standard, and meet certain
other requirements.
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Similarly, the proposal would define a sub-prime residential
mortgage-backed security as a security in which the underlying
exposures consist primarily of higher-priced mortgage loans as defined
under Regulation Z (12 CFR 1026.35), high-cost mortgages as defined
under Regulation Z (12 CFR 1026.32), or both. In general, Regulation Z
defines higher-priced mortgage loans \364\ and high-cost mortgages
\365\ to include consumer credit transactions secured by the consumer's
principal dwelling with an annual percentage rate \366\ that exceeds
the average prime offer rate (APOR) \367\ for a comparable transaction.
Consistent with Regulation Z, the subprime market is identified by loan
price rather than by borrower characteristics, which could present
operational difficulties and other problems. Therefore, the proposal
would 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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\364\ 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).
\365\ 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).
\366\ 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.
\367\ Loans with higher annual percentage rates or that have
higher points and fees or prepayment penalties generally are
extended to less creditworthy borrowers (for example, weaker
borrower credit histories, higher borrower debt-to-income ratios,
higher loan-to-value ratios, less complete income or asset
documentation, less traditional loan terms or payment schedules, or
combinations of these or other risk factors) and thus pose higher
credit risk.
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The agencies recognize that a securitization vehicle that holds
residential mortgage-backed securities may hold assets other than the
residential mortgage loans, such as interest rate swaps, to support its
liabilities. Furthermore, not all mortgage loans that satisfy the
requirements of the proposed definitions when the securitization
vehicle acquires the residential mortgage-backed securities will
continue to do so throughout the lifecycle of the position. To minimize
variability in risk-based capital requirements, reduce the operational
burdens imposed on banking organizations and help ensure consistency
and comparability in risk-based capital requirements across banking
organizations, the proposal would 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 125: 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 126: The agencies seek comment on the treatment of certain
sovereign exposures. What would be the advantages and disadvantages of
applying a zero percent credit spread risk weight to short-term (less
than one year) U.S. sovereign exposures such as U.S. Treasury
securities that are investment grade, and why? What, if any,
alternative risk weight treatment should the agencies consider for
sovereign exposures that are primarily exposed to interest rate risk,
rather than credit spread risk, and why?
Question 127: 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 128: 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
[[Page 15046]]
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 129: 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 130: 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 131: 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 buckets and corresponding risk weights for market risk covered
positions with equity risk, which would be generally consistent with
those in the Basel standards.\368\ Under the proposal, a banking
organization would group the equity risk factors for market risk
covered positions into one of thirteen buckets based on market
capitalization, market economy, and sector.
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\368\ Vega and curvature capital requirements use the same
buckets as prescribed for delta. See Sec. _.209(c)(1), (d)(1) of
the proposed rule.
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The proposed sector buckets and associated risk weights 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.\369\ Under the
proposal, issuers with a consolidated market capitalization equal to or
greater than $2 billion, adjusted to reflect CPI-W,\370\ 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 differentiating risks between large and small market
capitalization issuers. The market capitalization data of publicly
traded firms is readily available and therefore would not be burdensome
to identify.
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\369\ 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.
\370\ See section II.E. of this SUPPLEMENTARY INFORMATION for a
more detailed discussion on indexing nominal thresholds in the
proposal going forward to reflect CPI-W.
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For purposes of the market economy criteria, the proposal would
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: (1) $10,000
or more in per capita income, (2) $95 billion or more in market
capitalization of all domestic stock markets, (3) no single export
sector or commodity comprises more than 50 percent of the country or
entity's total annual exports, (4) no material controls on liquidation
of direct investment, and (5) 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.\371\ Countries or territorial entities that satisfy
all five criteria or that are in a currency union \372\ 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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\371\ 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.
\372\ 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.
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In relying on a set of objective criteria, the proposed approach
for market economy buckets is designed to increase risk sensitivity by
distinguishing between equities with lower volatility or higher
volatility in a manner consistent with the Basel standards while also
providing sufficient flexibility to reflect changes to the list of
market economies as countries' profiles evolve.
For market risk covered positions with exposure to large market
capitalization issuers, the proposal would group equity risk factors
into one of four sectors 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 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 a
market risk covered position is related to an emerging market economy
or liquid market economy, regardless of the sector. Therefore, the
proposed 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 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 buckets, the
agencies recognize that specifying all sectors for the purpose of
applying buckets is infeasible. Accordingly, the last three buckets set
forth in Table 8 to Sec. _.209 are intended to strike a balance
between risk sensitivity and operational burden.
[[Page 15047]]
Equity indices aggregate risk across different sectors and accordingly
require separate treatment from sector-specific 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 bucket.
Question 132: 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 133: The agencies solicit comment related to the proposed
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 buckets and why?
Please describe the historical correlations between such equities, and
historical price shocks for purposes of assigning the appropriate risk
weight.
Question 134: The agencies solicit comment related to the use of
materiality criteria to identify annually a country or territorial
entity with a liquid market economy. What are the advantages and
disadvantages of indexing such thresholds in the proposal to reflect
CPI-W going forward, and why?
IV. Commodity Risk
Table 9 to Sec. _.209 of the proposed rule provides the proposed
delta buckets and corresponding risk weights for positions with
commodity risk. Under the proposal, a banking organization would group
commodity risk factors into one of twelve 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;
other commodity; and commodity index.
The proposed 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
generally historically similar levels of volatility and high
correlation. The proposed commodity 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
buckets and equity buckets, the agencies recognize that specifying all
commodities for the purpose of applying buckets is operationally
difficult. Accordingly, the proposal includes an additional ``other
commodity'' bucket to conservatively capture the risk of additional
commodities that are not otherwise specified and a commodity index
bucket to include indexes that may track multiple commodities. The
commodity index bucket is introduced to capture the diversified risk of
pooling several commodities together that do not concentrate into a
particular sector.
As is the case with other 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 standards, with two exceptions. First, the Basel standards
prescribe separate buckets with different risk weights for electricity
and gaseous combustibles. The proposal would include a single bucket
for electricity and gaseous combustibles to allow for greater
recognition of hedges between these two commodities.\373\ 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.\374\ Second, the
proposal would introduce a bucket for commodity indices with a
prescribed risk weight of 30 percent and intra bucket correlation of 50
percent.\375\
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\373\ 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.
\374\ The calibration of the risk weight for the gas and
electricity commodity risk bucket in the sensitivities-based method
followed the stressed expected shortfall calibration methodology
specified in the models-based non-default capital requirement,
accounting for variations in liquidity horizons. The agencies used
Thomson Reuters to obtain spot price data for electricity and gas
risk factors and calculated ten-day overlapping returns constructed
as rt = (pt-pt/10)/pt/10, where r is the return, p is the spot price
for gas and electricity risk factors for the most recent outcome,
denoted as t, and for the date that is 10 business days prior to t,
denoted as t/10. The 97.5 percent expected shortfall was calculated
as the average of the m worst returns, where m = n * 2.5 percent
rounded to the nearest integer, and n is the number of ten-day
returns that had all values for both pt and pt/10. For the period of
stress, the agencies used the period between September 1, 2008 and
August 31, 2009, when the S&P Goldman Sachs Commodity Index had the
highest month-end 99th percentile VaR. The resulting estimated risk
weight for electricity and gas was 48 percent. For the calibration
of the intra-bucket correlation parameter between natural gas and
electricity, the agencies used Bloomberg to source data on 10 series
of commodity futures (five series for each commodity, representing
five distinct markets with high trading activity for both natural
gas and electricity, specifically, the United States, United
Kingdom, France, Germany, and the Netherlands) and calculated ten-
day overlapping returns for each series as rt = (pt - pt/10)/pt/10.
To estimate the pairwise correlation between gas and electricity,
the agencies used the period between January 2018 and December 2022,
which included the time of unprecedented commodity market
volatility. The resulting estimated average pairwise correlation
between electricity and natural gas was 66 percent.
\375\ The agencies are applying a similar methodology for the
calibration of the commodity index bucket risk weight as the Basel
Committee used for calibrating risk weights for all 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. When calibrating commodity
risk weights the Basel Committee used data on prices and calculated
ten day overlapping returns (such as relative changes in prices).
For the period of stress, the agencies used the second half of 2008
and the first half 2009 stress period. The standard deviation
obtained was multiplied by 2.34 to reflect the expected shortfall
quantile of 97.5. The estimate was adjusted to meet the commodity
liquidity horizon specified for internal models. The last step takes
the average of the estimates across several commodity indices. The
intra-bucket correlation was calibrated following the Basel
Committees methodology of calculating long term correlations for the
sensitivities-based method. Specifically, the index bucket intra-
bucket correlation was estimated for returns over the period
starting in late 2000 to early 2024.
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Question 135: The agencies solicit comment related to the proposed
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 buckets
and why? Please describe the historical correlations between such
commodities,
[[Page 15048]]
and historical price shocks for purposes of assigning the appropriate
risk weight.
Question 136: The agencies solicit comment on the 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 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,\376\ as well as any additional currencies specified by
the primary Federal supervisor. Given high trading activity and use of
such liquid currency pairs relative to non-liquid pairs, the proposal
incorporates the effect of a shorter liquidity horizon for liquid
currency pairs and would allow a banking organization to appropriately
reflect the lower foreign exchange risk posed by such liquid currency
pairs.
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\376\ The proposal would allow a banking organization to apply a
lower risk weight for any currency pair formed of the following
currencies: USD, EUR, JPY, GBP, AUD, CAD, CHF, MXN, CNY, NZD, HKD,
SGD, TRY, KRW, SEK, ZAR, INR, NOK, and BRL.
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iv. Correlation Parameters
To appropriately reflect the risk-mitigating benefits of hedges and
diversification, the proposal would prescribe the correlation
parameters \377\ that a banking organization would be required to use
for each risk factor pair when calculating the aggregate bucket and
risk class level capital requirements for delta, vega, and
curvature.\378\ The proposed correlation parameters which closely
follow those in the Basel standards are calibrated to capture market
correlations observed over a long time horizon that included a period
of stress based on empirical data.\379\ To determine the applicable
correlation parameter for purposes of calculating the 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 V.A.7.a.i. of this SUPPLEMENTARY
INFORMATION, with two exceptions.
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\377\ The correlation parameter measures how different risk
factors (for example, interest rates at various points on a curve)
move together and determines how banking organizations could
diversify risk and offset risks with each other.
\378\ As there is only one risk factor prescribed for foreign
exchange risk, the proposal does not specify an intra-bucket
correlation parameter.
\379\ For example, the correlation parameters for vega,
curvature, delta interest rate risk, and delta equity risk are
identical to those in the Basel standards.
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First, in addition to the proposed risk factors for credit spread
risk of non-securitizations, securitization positions non-CTP, and
correlation trading positions,\380\ 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
bucket when calculating the aggregate bucket level capital requirements
for delta and vega.
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\380\ As described in section V.A.7.a.i.II. of this
SUPPLEMENTARY INFORMATION, the proposal would define the delta risk
factors for credit spread risk along two dimensions: the credit
spread curve of the reference entity and the tenor of the position.
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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,
the proposal would allow banking organizations to treat Uniform
Mortgage-Backed Security (UMBS) positions, including to-be-announced
(TBA) securities and UMBS-eligible deliverable pools,\381\ as exposures
to a single obligor, regardless of the issuing entity of the UMBS. The
single security initiative led by Fannie Mae and Freddie Mac has
homogenized the mortgage pool and security characteristics for UMBS,
such that positions issued by different obligors have immaterial
observed basis risk.\382\ In addition, because mortgage pools delivered
by either Fannie Mae or Freddie Mac can satisfy an UMBS TBA security,
no significant pricing difference has been observed since the
introduction of the single security initiative, as shown by empirical
studies on agency mortgage-backed securities.\383\
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\381\ Chapter 8 of the Securities Industry and Financial Markets
Association (SIFMA) Uniform Practices guidelines states that all
UMBS and Supers, which are single class, pass-through, TBA-eligible
securities, are good delivery for an UMBS TBA trade, regardless of
issuer. See SIFMA, Chapter 8: Standard Requirements for Delivery on
Settlements of UMBS and Ginnie Mae Securities, Uniform Practices
(2024), https://www.sifma.org/wp-content/uploads/2023/02/uniform-practices-2023-chapter-8.pdf.
\382\ See, e.g., Haoyang Liu, Zhaogang Song, and James Vickery,
``Defragmenting Markets: Evidence from Agency MBS'' (December 2021),
https://www.newyorkfed.org/research/staff_reports/sr965.html. The
research paper finds that Fannie Mae mortgage-backed securities
command a liquidity premium over Freddie Mac, of about 17 cents per
$100 face value in price and about 4 basis points in yield.
Furthermore, the difference in trading costs between Fannie Mae and
Freddie Mac in the TBA market overall is extremely small, only 2
basis points.
\383\ See id.
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Second, for risk factors allocated to the ``other sector'' bucket
within the credit spread and equity risk classes,\384\ the 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'' bucket with those in any of the other bucket-level
capital requirements for credit spread and equity risk.
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\384\ The other sector buckets refer to buckets 18 and 16 in
Tables 3 and 5, respectively, as well as buckets 25 and 11 in Tables
7 and 8, respectively, of Sec. _.209 of the proposed rule.
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The agencies consider that 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 137: 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 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
[[Page 15049]]
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 buckets, and the ability to adequately hedge all or substantially
all of the price risk using similar but unrelated securitized tranches?
Question 138: 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 139: 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. Residual Risk Capital Requirement
It is not possible in a standardized methodology, such as the
sensitivities-based method, to sufficiently specify all relevant
distinctions between different market risks to capture appropriately
existing and future financial products. Accordingly, the proposed
residual risk add-on capital requirement (residual risk add-on) is
intended to reflect risks that would not be fully reflected in the
sensitivities-based capital requirement or the default risk capital
requirement, as described in sections V.A.7.a. and V.A.9. of this
SUPPLEMENTARY INFORMATION, respectively. 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 have an exotic exposure \385\ 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.
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\385\ Under the proposal, an exotic exposure means an underlying
exposure that is not in scope of any of the risk classes under the
sensitivities-based capital requirement or is not captured by the
default risk capital requirement, which includes, but is not limited
to, longevity risk, weather risk, and natural disaster risk.
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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 those with known residual risks that are not
captured by the sensitivities-based method or the default risk capital
requirement. 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 proposed residual risk add-on capital requirement would
equal to 1 percent of the gross effective notional amount of the market
risk covered position, which is intended 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 or the default risk
capital requirement, but for which there are additional risks that are
not fully captured by those components. Specifically, under the
proposal, market risk positions with other residual risks 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.\386\ As the residual risk add-on is intended as a supplement
to the capital requirements under the sensitivities-based method or
default risk capital requirement for these known risks, the residual
risk add-on capital requirement for market risk covered positions with
other residual risks would equal to 0.1 percent of the gross effective
notional amount of the market risk covered position.
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\386\ As proposed, the criteria are intended to capture (1)
correlation risks for basket options, best of options, basis
options, Bermudan options, and quanto options; (2) gap risks for
path dependent options, barrier options, Asian options and digital
options; and (3) behavior risks that might arise from early exercise
(call or put features, or pre-payment).
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Furthermore, in situations when a banking organization cannot use
the look-through approach to calculate the market risk capital
requirements for an equity position in investment fund and when the
investment fund's mandate permits the fund to invest in exposures with
exotic or other residual risks, the proposal would require a banking
organization to subject that portion of the exposure amount resulting
from an equity position in an investment fund to the residual risk add-
on.
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 capture
the material risks of such positions. While the proposed definitions
are intended to 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 market risk covered positions to be excluded from the
calculation of the residual risk add-on if such positions meet the
following set of exclusions. Specifically, the proposal would permit a
banking organization to exclude market risk covered positions, other
than those that have an exotic exposure, from the residual risk add-on,
if the position is (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 instruments. As spread options would be subject
to the vega and curvature requirements under the sensitivities-based
method, subjecting spread options to the residual risk add-on would be
incommensurate with the risks of such
[[Page 15050]]
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.\387\
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\387\ As discussed in section V.A.7.a.ii.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 by the delta
capital requirement under the sensitivities-based method.
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The proposal would also allow a banking organization to exclude
market risk covered 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 debt issued or guaranteed by a GSE or any securities
issued and guaranteed by the U.S. government; (3) positions subject to
the fallback capital requirement; (4) internal transactions between two
trading desks, if only one trading desk is model-eligible; 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. Based on these criteria, the
agencies expect that a banking organization would not need to calculate
a residual risk add on for the following 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 140: 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 141: Would characterizing volatility and variance swaps as
bearing other residual risk more appropriately reflect the risks of
such exposures and why?
8. Models-Based Non-Default Capital Requirement
Under the proposal, the models-based non-default capital
requirement for model-eligible positions (I M A G,A) \388\ would
consist of four components: (1) the internally modelled capital
calculation (IMCC); (2) the stressed expected shortfall (SES); (3) the
aggregate trading portfolio backtesting capital multiplier; and (4) the
PLA add-on.
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\388\ As described in section V.A.3.b. of this SUPPLEMENTARY
INFORMATION, the total non-default capital requirement under the
models-based measure generally would equal to the sum of (1) the
models-based non-default capital requirement (IMAG,A) and (2) the
difference between the standardized non-default capital requirement
for all trading desks (SAall desks) and the standardized non-default
capital requirement for model-eligible positions (SAG,A).
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Like the sensitivities-based method in the standardized non-default
capital requirement, the first two components, IMCC and SES, are
intended to capture the potential losses arising from changes in risk
factors during a period of substantial market stress. The IMCC and SES
would distinguish between risk factors for which there is appropriate
data for the twelve-month historical stress period used by the model
and a sufficient number of real prices in the current period to qualify
as modellable risk factors and those for which there is not (non-
modellable risk factors or NMRFs).\389\ The proposal would generally
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 twelve-month period of
substantial market stress and incorporate the prescribed liquidity
horizons applicable to each risk factor.
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\389\ Non-modellable risk factors for which there is appropriate
data for the twelve-month historical stress period used by the
expected shortfall models, but insufficient real prices in the
current period (type A non-modellable risk factors) would be subject
to both IMCC and SES as described in section V.A.8.a. 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 of hedging and portfolio diversification due to the
lower quality inputs to the expected shortfall models; for example,
limited data on the market prices observed or quoted during the twelve-
month historical stress period are available to estimate the
correlations between non-modellable risk factors used by the expected
shortfall model. These data limitations can increase the possibility
that a banking organization's expected shortfall models overstate the
diversification benefits or understate price volatility (and therefore,
understate the magnitude of potential losses) of such non-modellable
risk factors. Furthermore, the conservative treatment of non-modellable
risk factors that do not meet the proposed data quality standards would
provide appropriate incentives for banking organizations to enhance the
quality of data inputs used in the expected shortfall models.
Under the proposal, the overall capital required under the models-
based non-default capital requirement (IMAG,A) would equal the sum of
the capital requirements for modellable and non-modellable risk factors
and the PLA add-on to address shortcomings in the valuation models used
to determine regulatory capital, if applicable. The capital
requirements for modellable and non-modellable risk factors would equal
the greater of (i) the sum of such capital requirements as of the most
recent reporting date (IMCCt-1 and SESt-1, respectively), or (ii) the
sum of the average of such 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
[[Page 15051]]
(IMCCaverage) and a multiplication factor (mc) of at least 1.5, which
serves to capture a model's performance over time based on the
aggregate trading portfolio backtesting.\390\ The overall capital
requirement under the models-based non-default capital requirement can
be expressed by the following formula:
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\390\ The size of the multiplication factor could vary from 1.5
to 2 based on the results of the entity-wide backtesting for all
model-eligible positions. See section V.A.8.d. of this SUPPLEMENTARY
INFORMATION for further discussion on the entity-wide backtesting
for all model-eligible positions, otherwise known as the aggregate
trading portfolio backtesting multiplier.
IMAG,A = max ((IMCCG,A + SESt-1), ((mc x IMCCaverage) + SESaverage)) +
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PLA add-on
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 relative to
the prior 60-day average with the capital multiplier. Thus, the max
function in the above formula would capture cases where risk has risen
significantly throughout the quarter such that the average over the
quarter is significantly less than the risk the banking organization
faces at the end of the quarter.
Question 142: The agencies seek comment on the models-based non-
default capital requirement. 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.
a. Risk Factor Identification and Model Eligibility
Under the proposal, a banking organization that intends to use the
models-based non-default capital requirement would be required to
identify an appropriate set of risk factors that is sufficiently
representative of the risks inherent in all of the model-eligible
positions on 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 non-default capital requirement as
well as those used in either the banking organization's financial
reporting or internal risk management models. If the risk factors
specified in the sensitivities-based method are not included in the
expected shortfall models, the banking organization would be required
to justify the exclusions to the satisfaction of its primary Federal
supervisor. To help ensure that the expected shortfall models
appropriately capture the market risk of a banking organization's
model-eligible positions held by model-eligible trading desks,\391\
model-eligible trading desks would be subject to PLA test \392\ and
backtesting requirements, which would help ensure the accuracy and
conservativism of the risk-based capital requirements estimated by the
banking organization's expected shortfall models.
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\391\ For example, unlike the proposed standardized non-default
capital requirement, which would require a banking organization to
use a prescribed set of risk buckets and correlation parameters, as
described in section V.A.7.a.iii. of this SUPPLEMENTARY INFORMATION,
the models-based non-default capital requirement would allow a
banking organization to use its own bucketing structure and
correlation parameters.
\392\ As described in section V.A.1.b. of this SUPPLEMENTARY
INFORMATION, the proposal would provide a three-year transition
period during which there would be no automatic consequences for PLA
test results.
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For each identified risk factor, a banking organization would
conduct two separate risk factor eligibility tests to determine whether
the risk factor is subject to the IMCC, SES, or both. The first is a
qualitative test, which determines whether the data and other
information used to calibrate the expected shortfall models for IMCC
appropriately capture the risk factor. The second is a quantitative
test, which determines whether there are a sufficient number of real
prices over the prior twelve months that are representative of the risk
factor to infer the value of the risk factor.\393\ A risk factor that
satisfies both tests would be classified as a modellable risk factor
and would be subject to the IMCC, but not SES. Non-modellable risk
factors would be classified as either type A or type B. Type A non-
modellable risk factors would be those that satisfy the qualitative
test but not the quantitative test and would be subject to both IMCC
and SES; all other risk factors would be type B non-modellable risk
factors and would be subject to SES.
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\393\ 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.
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The agencies recognize that requiring banking organizations to
exclude all non-modellable risk factors from expected shortfall models
used to calculate the IMCC could be operationally burdensome and can
render the models-based non-default risk capital requirement relatively
unstable given that some modelling approaches rely on co-dependencies
between risk factors that are modellable and non-modellable.
Accordingly, the proposal would require type A non-modellable risk
factors to be included in the calculation of both the IMCC and SES. The
inclusion of type A non-modellable risk factors in IMCC is intended to
reflect the higher quality data available for such risk factors
relative to type B non-modellable risk factors. The agencies also
recognize that if type A non-modellable risk factors are not included
in the calculation of the IMCC, it could create perverse incentives for
banking organizations to claim a modellable risk factor that is highly
correlated with other risk factors as a type A non-modellable risk
factor to receive more favorable diversification treatment in the SES
under the proposal. As such, requiring type A non-modellable risk
factors to be included in the IMCC would help address regulatory
arbitrage concerns by ensuring that capital requirements would not fall
in response to a modellable risk factor becoming a type A non-
modellable risk factor.
The agencies recognize, however, that type A non-modellable risk
factors may have inherently higher risk than typical modellable risk
factors due to infrequent price observations that can lead to model
risk and a more elevated liquidity risk. Therefore, the proposal would
also require type A non-modellable risk factors to be included in SES
to account for any additional risks that might not be fully captured
within the IMCC calculation. Given that the IMCC calculation captures
model-estimated correlations among risk factors, type A non-modellable
risk factors would therefore receive full diversification (zero
correlation) within the SES calculation. The remaining type B non-
modellable risk factors would be subject to a more conservative
treatment with a supervisory correlation, or rho, of 0.36.
To capture the inherently higher risk associated with type A non-
modellable risk factors in the models-based non-default capital
requirement, the agencies also considered an alternative approach that
would only require banking organizations to capture type A non-
modellable risk factors in IMCC but not
[[Page 15052]]
in the SES. The alternative approach would instead require banking
organizations to assign minimum liquidity horizons to type A non-
modellable risk factors that are one-level higher than those required
for modellable risk factors in the IMCC calculation, as described in
section V.A.8.b.ii. of this SUPPLEMENTARY INFORMATION, unless the
position's maturity is shorter than the respective liquidity
horizon.\394\ As the proposed IMCC calculation limits model-estimated
diversification across risk classes, assigning higher minimum liquidity
horizons to type A non-modellable risk factors could appropriately
capture the inherently higher model and liquidity risk of such risk
factors.
---------------------------------------------------------------------------
\394\ For example, for an investment grade corporate bond, the
banking organization would be required to assign a liquidity horizon
of sixty days rather than forty days, if the associated credit
spread risk factor was a type A non-modellable risk factor.
---------------------------------------------------------------------------
The agencies recognize that implementing this alternative approach
could increase the operational burden associated with the proposal.
This alternative may also increase variability in the market risk
capital requirements across banking organizations, if banking
organizations are also allowed to increase the minimum liquidity
horizon assigned to modellable risk factors to align with the higher
minimum liquidity horizon assigned to type A non-modellable risk
factors, as under the current proposal. Accordingly, to capture the
elevated model and liquidity risk of type A non-modellable risk factors
in a consistent manner across banking organizations without imposing
undue operational burden, the proposal would require banking
organizations to include type A non-modellable risk factors in both
IMCC and SES.
Question 143: The agencies request comment on the appropriateness
of the proposed requirements for the risk factors included in the
models-based non-default capital requirement. What, if any, alternative
requirements should the agencies consider, such as requiring risk
factor coverage to align with the financial reporting 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 financial reporting models
would create relative to the proposal.
Question 144: The agencies seek comment on whether it is
appropriate to include type A non-modellable risk factors within IMCC
and SES calculations. What, if any, adjustments (such as permitting
banking organizations to treat type A non-modellable risk factors as
type B non-modellable risk factors) should the agencies consider to
more appropriately reflect type A non-modellable risk factors within
the models-based non-default capital requirement and why? Commenters
are encouraged to provide supporting data.
Question 145: The agencies seek comment on whether the alternative
approach described above would more appropriately capture the
inherently higher model and liquidity risk associated with a type A
non-modellable risk factors due to infrequent price observations. What
would be advantages and disadvantages of requiring a higher minimum
liquidity horizon for type A non-modellable risk factors to capture
their risks within IMCC? How would banking organizations implement and
ensure consistency in the appropriate treatment of these risk factors
when there is already flexibility to scale up liquidity horizons above
the minimum requirement for both modellable risk factors and non-
modellable risk factors? What would be the impact on capital
requirements of capturing type A non-modellable risk factors with a
higher minimum liquidity horizon only within the IMCC calculation?
What, if any, other alternative approaches should the agencies consider
to more appropriately capture the risks of type A non-modellable risk
factors (for example, applying capital multiplier (mc) adjustment to
the 60-day average IMCC when it incorporates type A non-modellable risk
factors), and why? In such cases, what would be the appropriate higher
capital multiplier for the IMCC? What are the advantages and
disadvantages of using a higher capital multiplier (mc) adjustment to
the 60-day average IMCC as shown in the example table below in place of
the higher minimum liquidity horizon?
[GRAPHIC] [TIFF OMITTED] TP27MR26.078
a. Qualitative Test
To help ensure the appropriateness of the data and other
information used to calibrate the expected shortfall models for the
IMCC, the proposal would establish data quality requirements for risk
factors to be eligible for inclusion within the IMCC. A risk factor
that fails to meet any of the following six proposed data quality
requirements would be a type B non-modellable risk factor, excluded
from the calculation of
[[Page 15053]]
IMCC and subject to the more conservative treatment within the SES
calculation.
First, the proposal would require the data used in the expected
shortfall models to calculate the IMCC to capture both the systematic
risk and idiosyncratic risk, as applicable, of a risk factor, so that
the IMCC appropriately reflects the potential losses arising from the
risk factor.
Second, the proposal would require the data used to calculate the
expected shortfall-based measure to reflect the volatility and
correlation of risk factors of model-eligible 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.
Third, the proposal would generally require that the data used to
calculate the expected shortfall-based measure reflect prices observed
or quoted in the market. For any data not derived from real prices, the
banking organization must be able 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 the IMCC with that used by its financial reporting
\395\ and internal risk management models, to confirm the validity of
the price data used to calculate the IMCC.
---------------------------------------------------------------------------
\395\ As described in section V.A.6.d. of this SUPPLEMENTARY
INFORMATION, the term ``financial reporting models'' used throughout
this section is intended to refer to the models a banking
organization uses to report actual profits and losses for financial
reporting purposes.
---------------------------------------------------------------------------
Fourth, the proposal would require a banking organization to update
the data at a sufficient frequency to accurately reflect the
performance of the risk factor, at a minimum on a weekly basis. While
generally banking organizations should strive to update the data inputs
as frequently as possible, the proposal would only require banking
organizations to update the data on a weekly basis, as requiring large
data sets to be updated more frequently may pose significant
operational challenges.\396\ The proposal would also 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 to
accurately reflect the performance of the risk factor, ideally no less
frequently than the calibration of financial reporting models. The
proposal would also require a banking organization to have clear
policies and procedures for updating the sources of data used as well
as for backfilling and gap-filling missing data.
---------------------------------------------------------------------------
\396\ 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.
---------------------------------------------------------------------------
Fifth, in determining the liquidity horizon-adjusted expected
shortfall-based measure within IMCC, a banking organization that uses a
reduced set of risk factors to calculate the expected shortfall-based
measure \397\ would be required to use data that are reflective of
market prices observed or quoted in the twelve-month historical stress
period used by the expected shortfall model.\398\ Under the proposal,
banking organizations should source the data directly from the
historical stress period, whenever possible. There may be cases where
the characteristics of positions currently being traded in the market
differ from those traded during the historical stress period used by
the expected shortfall model. The proposal would require a banking
organization to empirically justify any instance where the market
prices used for the historical stress period in the expected shortfall
calculation differ from the market prices actually observed for that
period. For model-eligible positions that did not exist during the
historical stress period, the proposal would require banking
organizations to demonstrate that the prices used match changes in the
prices or spreads of similar instruments traded during that period.
---------------------------------------------------------------------------
\397\ As discussed in section V.A.8.b.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 historical stress period or (2) an
appropriate subset of 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.
\398\ As described in more detail in section V.A.8.b.iii. of
this SUPPLEMENTARY INFORMATION, for purposes of calculating the IMCC
daily expected shortall measures, the proposal would require a
banking organization to use the twelve-month historical stress
period in which its model-eligible positions on model-eligible
trading desks would experience the largest loss.
---------------------------------------------------------------------------
Sixth, the proposal would allow the data for risk factors to
include proxies if the banking organization is 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 model-eligible positions. 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.
Even if a risk factor satisfies each of the six proposed data
quality requirements, a banking organization's primary Federal
supervisor may determine the data inputs to be unsuitable for use in
calculating the IMCC (for example, where the data inputs reflect
variation that is less than the bid-ask spread for a product). Any risk
factor that does not satisfy the proposed data quality requirements
would be a type B non-modellable risk factor, which the banking
organization would be required to exclude from the IMCC calculation and
include in the more conservative SES calculation.
Question 146: The agencies request comment on the appropriateness
of the proposed data quality requirements for 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 and
type A non-modellable risk factors?
Question 147: 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?
ii. Quantitative Test
For risk factors that pass the qualitative test, the banking
organization would then need to determine whether there are a
sufficient number of real prices in the prior twelve months
(quantitative test) for the risk factor to qualify as a modellable risk
factor. The quantitative test would require a banking organization to
establish buckets for each relevant risk factor or set of risk factors,
and assign real prices to the relevant bucket(s). If the number of real
prices allocated to the bucket equals or exceeds the
[[Page 15054]]
minimum number required under the proposal, the risk factor would
qualify as a modellable risk factor.
I. Real Price
To perform the quantitative test, the proposal would first require
a banking organization to map real prices observed over the prior
twelve months to each of the risk factors that affect the value of the
model-eligible positions. For example, as the price of a typical
corporate bond fluctuates primarily due to changes in interest rates
and issuer credit spreads, a banking organization could map the price
of a corporate bond to a credit spread risk factor and an interest rate
risk factor. The proposal would define a real price as (1) a price at
which the banking organization has executed a transaction, (2) a price
provided by an exchange, a qualifying central counterparty, a sovereign
entity, a specified supranational entity, or a multilateral development
bank, (3) a verifiable price for an actual transaction between third
parties transacting at arm's length or obtained from a bona fide
competitive bid or offer made by the banking organization itself or
another party transacting at arm's length, subject to certain
conditions discussed below.
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 generally
limit recognition of prices obtained from third-party providers to only
those for which (1) the transaction, bid, or offer has been processed
through a third-party provider, or (2) the third-party provider agrees
to provide evidence of the transaction, bid, or offer to the banking
organization upon request.\399\
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\399\ The additional requirements for prices or other
information obtained from third parties to qualify as a real price
would not apply to prices (1) obtained from an exchange or a
qualifying central counterparty, or (2) provided by an exchange, a
qualifying central counterparty, a sovereign entity, a specified
supranational entity or a multilateral development bank. As such
entities are subject to extensive regulation and oversight
(including requirements regarding maintaining accurate data), the
proposed requirements are unnecessary to assess the validity of the
prices or other information obtained from such third-parties.
---------------------------------------------------------------------------
In certain cases, obtaining information on the prices of individual
transactions from third parties may raise legal concerns for a banking
organization, a third-party provider, or both.\400\ 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
whether a risk factor satisfies the quantitative test, if the banking
organization is able to appropriately map this information to the risk
factors relevant to the model-eligible positions. For a banking
organization to be able to use such information for determining the
model eligibility of a risk factor, 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 that the results
and reports of the audit either be made public or available upon
request to the banking organization.\401\
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\400\ 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
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.
\401\ If the audit on the third-party provider is not
satisfactory to a banking organization's 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 quantitative test.
---------------------------------------------------------------------------
The additional requirements described above for prices or other
information obtained from third parties to qualify as a real price for
purposes of the quantitative test 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 148: 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 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
or subject to a loss threshold or minimum transfer requirement for
exchanging variation margins?
II. Bucketing Approach
Under the proposal, a banking organization would be required to (1)
establish buckets for each relevant risk factor or set of risk factors,
and (2) assign real prices to each relevant bucket to determine whether
each bucket has the minimum number of real price observations to
satisfy the quantitative test. A banking organization could choose to
apply 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 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 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
buckets a banking organization would be required to use to group real
prices under the standard bucketing approach. The proposal would define
the 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.\402\ The proposed buckets are intended
to balance between the granularity of the risk factors allocated to
each standardized bucket and the compliance burden of tracking and
mapping the allocation of real prices to more granular buckets,
especially as market conditions change. Too frequent re-allocation of
real prices may lead to artificial and unwarranted regulatory capital
requirement volatility.
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\402\ 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 buckets than those prescribed under the
standard bucketing approach. While the
[[Page 15055]]
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
quantitative test more challenging as the banking organization would
need to source a sufficient number of real prices for each additional
bucket. Therefore, the proposal would provide a banking organization
the flexibility to define its own bucketing structures and would place
an additional operational burden on the banking organization to
demonstrate the appropriateness of using a more granular bucketing
structure.
As positions mature, a banking organization could continue to
allocate real prices identified within the prior twelve months to the
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' expected shortfall 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 \403\ within its expected shortfall
models.\404\ 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 banking
organizations to align the treatment of real prices for market indices
with those for single-name positions and, thus, provide greater hedging
recognition.
---------------------------------------------------------------------------
\403\ 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.
\404\ As banking organizations may not always be able to model
each constituent of the index, the proposal would not require
banking organizations to always decompose credit spread and equity
risk factors.
---------------------------------------------------------------------------
To determine whether each bucket has the minimum number of real
prices required to satisfy the quantitative test, the proposal would
require a banking organization to allocate each real price to any
bucket for which the price is representative of the risk factor(s)
within the bucket and to count all real prices mapped to a bucket. As
real price may often be used to infer values for multiple risk factors,
requiring banking organizations to assign real prices to all of the
buckets for which it is representative would more accurately capture
the market liquidity for the relevant risk factors.
Question 149: What, if any, modifications to the proposed bucketing
structure should the agencies consider 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. Minimum Number of Real Price Observations
For a risk factor to pass the quantitative test, the proposal would
require a banking organization on a quarterly basis to identify a
minimum number of real prices for the bucket corresponding to the
relevant risk factor(s). Specifically, the proposal would require the
banking organization to identify in the previous twelve-month period at
least 24 real prices for the most liquid risk factors (those with a
liquidity horizon of 20 days or less, as described in section
V.A.8.b.ii. of this SUPPLEMENTARY INFORMATION) and at least 16 real
prices for all other risk factors.
The proposed criteria are intended to help ensure real prices
capture products that exhibit a minimum level of trading activity
throughout the year. Aligning the minimum number of real prices
required to pass the quantitative test with the liquidity horizon
assigned to the risk factor in the IMCC calculation is intended to
enhance the risk sensitivity of the models-based non-default capital
requirement. The longer liquidity horizons assigned to less liquid risk
factors within the IMCC calculation should appropriately capture the
illiquidity of such risk factors. As such, the proposal would require a
banking organization to identify fewer real prices for less liquid risk
factors to pass the quantitative test and qualify as modellable risk
factors.
For risk factors associated with new issuances, the proposal would
allow a banking organization to consider the observation period for
purposes of the quantitative test to begin on the issuance date and
pro-rate the minimum number of real prices required to pass the
quantitative test until twelve months after the issuance date. For
example, for a bond that was issued six months prior, the proposal
would require at least 8 real prices for the bucket relating to for the
issuer credit spread risk, prorated from the 16 real price annual
requirement.
For any model-eligible position, the banking organization could not
count more than one real price in any single day and would be required
to count the real price for all of the buckets for which it is
representative. The agencies recognize that the banking organization
may use a combination of internal and external data for the
quantitative 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 quantitative test than that used to
calibrate the expected shortfall model, if such difference is not
greater than one month. 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.\405\
---------------------------------------------------------------------------
\405\ 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 model-eligible positions on model-eligible trading desks.
---------------------------------------------------------------------------
If a bucket contains a sufficient number of real prices to pass the
quantitative test, the risk factor(s) within that bucket would qualify
as a modellable risk factor. Risk factors that pass both the
quantitative and qualitative tests would be deemed modellable and
included in the IMCC, but not the SES.
Question 150: What, if any, restrictions on the minimum observation
period for new issuances should the agencies consider and why?
Question 151: What, if any, operational challenges could the
proposed quantitative test pose? What, if any, changes should the
agencies consider making to the quantitative test, such as excluding
risk factors from the quarterly real price observation requirement if
the banking organization can demonstrate the substantial market depth
and liquidity of such risk factors over time? What criteria (such as
exchange listing criteria for the New York Stock Exchange) should the
agencies consider to appropriately differentiate between risk factors
with liquid and deep markets that should be
[[Page 15056]]
subject to the qualitative test only once versus those that should be
subject on a quarterly basis, and why?
Question 152: The agencies seek comment on the framework of
identifying a minimum number of real prices for the bucket
corresponding to the relevant risk factor(s) in order to pass the
quantitative test. Specifically, the agencies seek comment on adjusting
the real price observations based on liquidity horizons for risk factor
category. For example, for investment grade corporate positions (the
credit spread risk category) with a liquidity horizon of 40 days, a
banking organization would be required to have at least 8 real price
observations for the risk factor in the last 12 months to be able to
pass the quantitative test. What would the advantages and disadvantages
of this approach and why?
b. Internally Modelled Capital Calculation (IMCC)
The IMCC is intended to capture the estimated losses for model-
eligible positions arising from changes in modellable and type A non-
modellable risk factors over a twelve-month historical period of
substantial market stress. As described in this section, the IMCC would
begin with the calculation of a daily expected shortfall-based measure
over a twelve-month historical stress period on both an entity-wide
level for each risk class and on an entity-wide level across risk
classes for all model-eligible positions, each of which then would be
adjusted using risk-factor specific liquidity horizons.\406\
---------------------------------------------------------------------------
\406\ As discussed in section V.A.8.b.i. of this SUPPLEMENTARY
INFORMATION, if a banking organization elects to use a subset of
modellable risk factors to estimate the potential losses that would
be incurred throughout the selected stress period, the proposal
would require the banking organization to estimate a daily expected
shortfall measure for the current period as well as the historical
stress period.
---------------------------------------------------------------------------
While the proposal would allow a banking organization's expected
shortfall models to use any generally accepted modelling approach (for
example, variance-covariance models, historical simulations,\407\ or
Monte Carlo simulations) to calculate the expected shortfall-based
measure, the proposal would require the models to satisfy the proposed
backtesting and PLA testing requirements on an on-going basis to help
ensure that the models are functioning effectively over time as
conditions and model applications change.\408\
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\407\ 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.
\408\ See sections V.A.8.e. and V.A.8.f. of this SUPPLEMENTARY
INFORMATION for further discussion on the proposed desk-level PLA
testing and backtesting requirements, respectively.
---------------------------------------------------------------------------
Additionally, the proposal would require a banking organization's
expected shortfall 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 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 the risk factors
throughout an appropriately severe, historical twelve-month period of
stress (as described in section V.A.8.b.iii. of this SUPPLEMENTARY
INFORMATION), the proposal would require a banking organization to use
one or more expected shortfall models to calculate on each business day
an expected shortfall-based measure using a one-tail, 97.5th percentile
confidence interval at the entity-wide level for each risk class and
across all risk classes for all model-eligible positions.\409\
---------------------------------------------------------------------------
\409\ 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 to calculate the PLA add-
on. See section V.A.8.f. of this SUPPLEMENTARY INFORMATION for
further discussion.
---------------------------------------------------------------------------
To calculate the daily expected shortfall-based measure, a banking
organization would apply a base liquidity horizon of 10 days (the
shortest liquidity horizon applicable to any risk factor category) to
either the full set of risk factors for its model-eligible positions or
an appropriate subset of risk factors throughout the twelve-month
historical stress period (base expected shortfall). Requiring a banking
organization to directly estimate the potential change in value of each
of its model-eligible positions arising from the full set of risk
factors throughout the twelve-month historical stress period may pose
significant operational challenges. For example, a banking organization
may not be able to source sufficient data for all risk factors during
the identified twelve-month historical stress period. Thus, the
proposal would allow a banking organization to use either the full set
of risk factors employed by the expected shortfall models (direct
approach) or an appropriate subset (indirect approach) to estimate the
losses that would be incurred throughout the twelve-month historical
stress period.\410\
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\410\ 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 quantitative test, provided that
such data satisfy the qualitative test. 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
V.A.8.a.ii.I. of this SUPPLEMENTARY INFORMATION. While such data
demonstrates the liquidity of a risk factor for purposes of the
quantitative test, without the transaction prices, such real prices
would not provide any value to calibrate potential losses for a
particular risk factor.
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Under the direct approach, the banking organization would directly
calculate the daily expected shortfall measure at the entity-wide level
for each risk class and across all risk classes for all model-eligible
positions throughout the twelve-month historical stress period 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 risk factors in IMCC to estimate the losses that would
be incurred throughout the twelve-month historical stress period for
the full set of risk factors. The proposal would require a banking
organization using the indirect approach to calculate three separate
daily expected shortfall measures 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 twelve-month historical 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 measures to approximate the entity-wide liquidity horizon-
adjusted expected shortfall-based measures for the full set of risk
factors in stress.
Specifically, the proposal would require banking organizations that
use the indirect approach to multiply the liquidity horizon-adjusted
expected shortfall-based measure for the
[[Page 15057]]
historical 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 liquidity horizon-adjusted expected
shortfall-based measure using the reduced set of risk factors based on
the most recent twelve-month period (ESR,C), as provided according to
the following formula under Sec. __.215(b)(6)(ii)(B) of the proposed
rule:
[GRAPHIC] [TIFF OMITTED] TP27MR26.079
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] TP27MR26.080
Where:
ESF,C,h 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 calculated at date h,
which ranges from one day prior to date t to 60 days prior to date
t;
ESR,C,h is the current liquidity horizon-adjusted ES-based measure
using the reduced set of risk factors calculated at date h, which
ranges from one day prior to date t to 60 days prior to date t; and
Mean(ESF,C) is 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 the
historical 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 risk factors whenever it updates
its twelve-month historical stress period, as described in section
V.A.8.b.iii. of this SUPPLEMENTARY INFORMATION. The proposal would also
require the reduced set of risk factors used to calculate the liquidity
horizon-adjusted expected shortfall-based measure for the twelve-month
historical stress period in IMCC to have a sufficiently long history of
observations that satisfies criteria five within the qualitative risk
factor eligibility test, as described in section V.A.8.a.i. of this
SUPPLEMENTARY INFORMATION. In this manner, the proposal would hold the
inputs used for the indirect approach to the same data quality
standards requirements as those for inputs used in the direct approach.
Question 153: The agencies request comment on the appropriateness
of requiring the election of either the direct or the indirect approach
to be made at the entity-wide level for all risk factors of model-
eligible 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?
[[Page 15058]]
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 risk factor in IMCC to a proposed
minimum liquidity horizons, as specified in Table 2 to Sec. __.215 of
the proposed rule.
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\411\ 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.
---------------------------------------------------------------------------
BILLING CODE 4810-33- 6210-01- 6714-01-P
[GRAPHIC] [TIFF OMITTED] TP27MR26.081
[[Page 15059]]
BILLING CODE 4810-33- 6210-01- 6714-01-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. For each
model-eligible trading desk, the proposal would generally require
banking organizations to assign the same minimum liquidity horizon to
each risk factor within the same risk categories as specified in Table
2 to Sec. __.215 for all model-eligible positions, with two
exceptions.
For instruments with a maturity shorter than the respective
liquidity horizon assigned to the risk factor, the proposal would
require banking organizations to use the next longer liquidity horizon
compared to the maturity of the model-eligible position. For example,
if an investment grade corporate bond matures in nineteen days, the
proposal would require a banking organization to assign the associated
credit spread risk factor a liquidity horizon of twenty days rather
than the proposed forty-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.\412\ 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, as specified in Table 2 to Sec. __.215 of the proposal.
---------------------------------------------------------------------------
\412\ A weighted average would be based on the market value of
the instruments with the same liquidity horizon.
---------------------------------------------------------------------------
The proposal would also specify the applicable liquidity horizon
for non-securitization positions issued by GSEs, as such instruments
are unique to the United States. Consistent with the current capital
rule, the proposal would assign a longer forty-day liquidity horizon to
debt instruments issued by the GSEs, as such instruments are not as
liquid or readily marketable as U.S. Treasury securities and other
exposures directly and unconditionally backed by the full faith and
credit of the United States (such as mortgage-backed securities issued
by Ginnie Mae). Additionally, as multilateral development banks and
specified supranational entities have similar liquidity risk profiles
as sovereign exposures, the proposal would require banking
organizations to apply the liquidity horizons applicable to sovereigns
to multilateral development banks and specified supranational entities.
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 the proposed market risk framework.
To encourage sound risk management and enable banking organizations
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 have in place internal risk
management systems and processes 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
historical stress period continues to appropriately reflect potential
losses for the risk factors of model-eligible positions over time.\413\
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\413\ As described in section V.A.8.b.iii. of this SUPPLEMENTARY
INFORMATION, the proposal would require banking organizations to
calculate the entity-wide expected shortfall-based measures for each
risk class and across risk classes using the twelve-month historical
stress period in which either the full or reduced set of risk
factors would incur the largest loss.
---------------------------------------------------------------------------
To conservatively recognize empirical correlations across risk
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 at the entity-wide level
across risk classes for all model-eligible positions. To calculate the
entity-wide liquidity horizon-adjusted expected shortfall-based measure
for each risk class, the banking organization would (1) calculate the
ten-day base expected shortfall measure for each risk factor category
as specified in Table 2 to Sec. __.215 of the proposal, (2) scale up
the ten-day base expected shortfall measure using the longer proposed
liquidity horizons for each risk factor category within the same risk
class. When scaling up the ten-day base expected shortfall measure for
the risk factor category(s) assigned a liquidity horizon of more than
ten-days within the same risk class, the banking organization would
hold all other risk factors, including those within the same risk class
but assigned a shorter liquidity horizon, constant to appropriately
reflect the incremental losses attributable to the specific risk factor
categories within the same risk class over the longer proposed
liquidity horizon. In this manner, the proposal would require a banking
organization to calculate separately the liquidity horizon-adjusted
expected shortfall-based measure for risk factors within the same risk
class at each proposed liquidity horizon consecutively, starting with
the shortest (ten days). Specifically, for each risk factor category
within the same risk class, a banking organization would first compute
the potential loss over the zero to ten-day period,\414\ then the
potential loss over the subsequent ten- to twenty-day period--assuming
that its exposure to risk factors within the ten-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.
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\414\ When computing losses over the zero to ten-day period, the
proposal would require a banking organization to floor the time
period for extinguishing its exposure to a risk factor exposure at
ten days. For example, if an instrument would mature in two days,
the banking organization must still calculate the potential losses
assuming a ten-day liquidity horizon.
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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:
[[Page 15060]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.082
Where:
ES is the liquidity horizon-adjusted expected shortfall-based
measure;
T is the length of the base liquidity horizon, 10 days;
EST(P) is 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 is at least as long as the liquidity horizon corresponding
to the index value, j, LHj, as 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 for all
model-eligible positions, a banking organization would scale up the
ten-day expected shortfall-based measure for all 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.
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 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 ten-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 ten days and the liquidity horizon for
credit spread risk of investment grade issuers is forty days.
Therefore, the banking organization would not extend the liquidity
horizon for interest rate risk factor but would for the credit spread
risk factor. To determine the liquidity horizon-adjusted expected
shortfall-based measure for the credit spread risk factor, the banking
organization would (1) scale the credit spread risk factor by the
square root of the incremental increase in time (one for liquidity
horizon from ten to twenty days and the square root of two for
liquidity horizon from twenty to forty days),\415\ (2) add the
resulting liquidity horizon adjustment for credit spread risk factor,
as expressed by the second term in the above formula and repeated
below, to the base ten-day liquidity horizon squared, and (3) calculate
the square root of the sum of (1) and (2):
---------------------------------------------------------------------------
\415\ The incremental increase in time is represented by the
difference in the liquidity horizons, LHj-LHj-1. In the example, the
incremental increase in time for the liquidity horizon of twenty
days and forty days would be twenty days (forty days minus twenty
days). The incremental increase in time is divided by the base
horizon of ten days. Thus, the time scaling factor for credit spread
risk is the square root of two.
[GRAPHIC] [TIFF OMITTED] TP27MR26.083
As described above, the proposal would require the banking
organization to perform this calculation for all model-eligible
positions at the entity-wide level across risk classes and separately
at the entity-wide level 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 models-based non-default capital requirement, described in
more detail below in section V.A.8.b.iv. of this SUPPLEMENTARY
INFORMATION.
Question 154: 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 155: 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 156: 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 V.A.8.b.i. of this SUPPLEMENTARY
INFORMATION using the twelve-month historical stress period during
which its model-eligible positions would experience the largest loss
according to the banking organizations' policies and procedures
approved by its primary Federal supervisor. To identify the appropriate
stress period, 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 the period in which either the full
or reduced set of risk factors would incur the largest loss.\416\ The
proposal would require a banking organization to equally weight
observations within each twelve-month historical stress period when
selecting the appropriate stress period.
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\416\ Under the proposal, a banking organization that has
elected to use the direct approach would select the relevant stress
period using the full set of modellable risk factors, while that
using the indirect approach would use the reduced set of risk
factors to select the stress period.
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To help ensure that the twelve-month historical stress period
continues to appropriately reflect potential losses for the risk
factors of model-eligible positions over time, the proposal would
require a banking organization to review and update the twelve-month
historical
[[Page 15061]]
stress period on at least a quarterly basis, if appropriate, or
whenever there are material changes in the risk factors of model-
eligible positions.
Question 157: 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 twelve-month historical 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?
Question 158: The agencies are considering options to define the
largest loss when identifying the appropriate twelve-month historical
stress period. For example, what are the advantages and disadvantages
of defining the largest loss based on amounts banking organizations use
for financial reporting, and why? What are the advantages and
disadvantages of requiring firms to have policies and procedures
approved by a banking organization's primary Federal supervisor to
identify the twelve-month historical stress period during based on the
largest loss, and why?
iv. Total Internal Models Capital Calculations (IMCC)
The proposal would require banking organizations to use the
liquidity horizon-adjusted expected shortfall-based measures calculated
throughout the twelve-month historical stress period at the entity-wide
level for each risk class (IMCC(Ci)) and at the entity-wide level
across risk classes (IMCC(C)) to calculate the IMCC for model-eligible
positions. To constrain the empirical correlations and provide an
appropriate balance between perfect diversification and no
diversification across risk 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] TP27MR26.084
Where:
[omega] equals 0.5;
i is the index of risk classes, which are the following: interest
rate risk, credit spread risk, equity risk, commodity risk and
foreign exchange risk.
IMCC(C) equals the aggregate liquidity horizon-adjusted ES-based
measure across all risk classes; and
(iv) IMCC(Ci) equals the partial liquidity horizon-adjusted ES-based
measure for each risk class (i).
c. Stressed Expected Shortfall (SES) for Non-Modellable Risk Factors
Under the proposal, the SES for non-modellable risk factors would
be similar to the IMCC for modellable and type A non-modellable risk
factors, except that, relative to the IMCC, the SES calculation would
provide significantly less recognition for hedging and portfolio
diversification for type B non-modellable risk factors and
significantly more for type A non-modellable risk factors.
Under the proposal, a banking organization would have to calculate
the liquidity horizon-adjusted expected shortfall-based measure for
non-modellable risk factors using the same general process as proposed
for modellable and type A non-modellable risk factors in IMCC, with
three key differences. First, the proposal would require a banking
organization to separately carry out such calculation for each non-
modellable risk factor, rather than at the risk class level. Second,
the proposal would require a banking organization to apply a minimum
liquidity horizon adjustment of at least twenty days, rather than ten
days. Third, the proposal would require a banking organization to
identify a common twelve-month historical stress period for all non-
modellable risk factors within the same risk class, which is calibrated
to be at least as conservative as the twelve-month historical stress
period used within IMCC. To reduce operational burden, the proposal
would allow banking organizations to apply the same twelve-month
historical stress period used to calculate IMCC for purposes of the
common twelve-month historical stress period used for each risk class
within the SES calculation. If a banking organization is not able to
determine a stress scenario capital requirement for a risk factor, the
proposal would require the banking organization to set the SES capital
requirement equal to the maximum possible loss for that risk factor.
Alternatively, 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.
In recognition of the data limitations of non-modellable risk
factors, the proposal would allow a banking organization that receives
approval to use an alternative approach to use proxies in determining
the common twelve-month historical stress period for each risk class of
non-modellable risk factors, as long as such proxies satisfy the data
quality requirements of the qualitative test.\417\
---------------------------------------------------------------------------
\417\ See section V.A.8.a.i. of this SUPPLEMENTARY INFORMATION
for a description of the data quality requirements in the
qualitative test.
---------------------------------------------------------------------------
To calculate the SES for non-modellable risk factors, the proposal
would require a banking organization to separate non-modellable risk
factors into type A and type B non-modellable risk factors. A banking
organization would calculate the SES for both types of non-modellable
risk factors, according to the following formula as provided under
Sec. __.215(d)(2) of the proposed rule:
[[Page 15062]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.085
Where:
(i) SESNM,k is the stress scenario capital measure for the type A
non-modellable risk factor k;
(i) K is the number of type A non-modellable risk factors;
(iii) rb is 0.36;
(iv) SESNM,j is the stress scenario capital measure for the type B
non-modellable risk factor j; and
(ii) Jis the number of type B non-modellable risk factors.
For type B non-modellable risk factors, the second term would allow
for a limited and appropriate diversification benefit that depends on
the level of r parameter. The first term would provide type A non-
modellable risk factors a greater diversification benefit by allowing
such non-modellable risk factors to be aggregated with zero correlation
because they passed the qualitative test.
Given the limited data available for type B non-modellable risk
factors from which to estimate correlations between such factors
throughout the twelve-month historical stress period, the proposed
conservative capital treatment of type B non-modellable risk factors
would address the potential risk of lower quality inputs being used in
calculating market risk capital requirements for such factors (for
example, the risk that the limited data set overstates the
diversification benefits and, therefore, understates the magnitude of
potential losses of type B non-modellable risk factors).
Type A non-modellable risk factors would already be captured within
the IMCC, which limits the model-estimated diversification benefit
across risk classes. Thus, the IMCC would capture most of the risk
arising from type A non-modellable risk factors. Yet, unlike modellable
risk factors, type A non-modellable risk factors can pose higher model
risk and elevated liquidity risk due to infrequent price observations.
To appropriately capture such additional risks that may not be fully
captured by IMCC, type A non-modellable risk factors would also be
included in the SES calculation.\418\
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\418\ Unlike type B non-modellable risk factors, type A non-
modellable risk factors would receive full diversification (zero
correlation) with other type A non-modellable risk factors in the
SES calculation.
---------------------------------------------------------------------------
Question 159: The agencies seek comment on the proposed rho
parameter (rb) for type B non-modellable risk factors. What are the
advantages and disadvantages of the proposed rho parameter(rb)? What
are the advantages and disadvantages of reducing the rho parameter (rb)
to a lower value (such as 0.0625 or 0.16), and why? Please provide any
data and rationale that would be useful to consider for this purpose.
Question 160: What are the advantages and disadvantages of the
proposed calculation of the stressed expected shortfall capital
requirement for non-modellable risk factors? Alternatively, what are
the advantages and disadvantages of requiring a banking organization to
separate non-modellable risk factors into those with idiosyncratic
credit spread risk, those with idiosyncratic equity risk, and those
with systematic risk, according to the following formula, and why?
Specifically, what are the advantages and disadvantages of the
following alternative formula for calculating the stressed expected
shortfall capital requirement for non-modellable risk factors:
[GRAPHIC] [TIFF OMITTED] TP27MR26.086
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.
If the agencies were to consider this alternative approach, what
further adjustments should they also consider (such as using a
different correlation parameter, [rho] , between 0 and 1.0)? Please
provide any data and rationale, including data from a wide range of
stressed market conditions, that would be useful for evaluating this
alternative.
d. Aggregate Trading Portfolio Backtesting Capital Multiplier
Under 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
the current capital rule, with two modifications. First, the proposal
would require backtesting of the VaR-based measures against both the
actual and the hypothetical profits and losses produced by the
financial reporting
[[Page 15063]]
models.\419\ Specifically, for the most recent 250 business days,\420\
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 calibrated to a one-
day holding period at a one-tail, 99.0 percent confidence level for
transactions on all model-eligible trading desks.\421\ 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 and
type A non-modellable risk factors, based on the number of exceptions
in the entity-wide backtesting results.\422\
---------------------------------------------------------------------------
\419\ 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.
\420\ In its first year of backtesting, a banking organization
would count the number of exceptions that have occurred since it
began backtesting.
\421\ As described in section V.A.6.d.i. of this SUPPLEMENTARY
INFORMATION, 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 model-
ineligible positions pursuant to its trading or hedging strategy, to
include such positions for the purposes of the aggregate trading
portfolio backtesting requirement as well as for the desk-level PLA
and backtesting requirements.
\422\ 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, model-ineligible positions and technical
issues. See section V.A.8.f. of this SUPPLEMENTARY INFORMATION for a
detailed description of the mechanics of the proposed trading desk-
level backtesting requirements, including circumstances in which a
banking organization may disregard a backtesting exemption.
IMAG,A = max ((IMCCt - 1 + SESt-1),((mc x IMCCaverage) + SESaverage)) +
---------------------------------------------------------------------------
PLA add on
The proposed backtesting requirements would measure the
conservatism of the forecasting assumptions and the valuation methods
used in the internal models by comparing the daily VaR-based measure
against the actual and hypothetical profits and losses produced by the
financial reporting models. 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
pricing models that impact the expected shortfall calculation 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 backtesting requirements and associated multiplication factor
provide appropriate incentives for banking organizations to regularly
update the internal models used for calculating expected shortfall-
based measure in determining regulatory capital requirements.
Question 161: The agencies request comment on the appropriateness
of the proposed calculation for the aggregate trading portfolio
backtesting capital multiplier. What, if any, changes should the
agencies consider that would appropriately measure the robustness of a
banking organization's internal models used in calculating the expected
shortfall-based measure but impose less operational burden relative to
the proposal?
e. PLA Test and Add-On
Under the proposal, use of the models-based non-default capital
requirement for a model-eligible trading desk fundamentally would
depend on the accuracy of the potential future profits or losses
estimated by the banking organization's internal risk management models
relative to those produced by its financial reporting models. The
proposed profit and loss attribution test metric \423\ 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 financial reporting models in the banking
organization's end-of-day valuation process and adequately capture the
risk factors used in such models. Thus, the proposed PLA test metric
would measure the materiality of the simplifications of the internal
risk management models used by a model-eligible trading desk relative
to the financial reporting models and remove the eligibility of any
trading desk for which such simplifications are deemed material from
using the models-based non-default capital requirement to calculate its
regulatory capital requirement for market risk.
---------------------------------------------------------------------------
\423\ The proposed PLA test metric refers to 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 proposed models-based non-default capital requirement would
include an additional capital requirement (the PLA add-on) for model-
eligible trading desks for which the desk-level PLA test metric
demonstrates deficiencies in the ability of the valuation methods used
by the banking organization's internal risk management models to
appropriately capture the market risk of the model-eligible positions
but does not disqualify the eligibility of the models. The PLA add-on
would help ensure that banking organizations with model-eligible
trading desks with non-disqualifying model deficiencies are subject to
more conservative capital requirements relative to banking
organizations with model-eligible trading desks without such
deficiencies.\424\ Additionally, the PLA add-on would provide
appropriate incentives for banking organizations with model-eligible
trading desks with model deficiencies to address the potential gaps in
data and model deficiencies.
---------------------------------------------------------------------------
\424\ As described in section V.A.6.d.iv. of this SUPPLEMENTARY
INFORMATION, a model-eligible trading desk that passes the PLA test
metric 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.
---------------------------------------------------------------------------
The agencies recognize the potential difficulties for banking
organizations in implementing the proposed desk-level PLA test metric.
To improve the ability of banking organizations to use more risk-
sensitive modeled approaches for non-default capital requirement, where
appropriate, the proposal would provide a three-year transition period
during which there would be no automatic consequences for PLA test
results. During this period, a banking organization would be required
to submit quarterly PLA test results to its primary Federal supervisor.
The test results would not have any automatic regulatory consequences
during the transition period. This extended transition period for
implementation of the PLA test would allow banking organizations to
gain experience with the test and provide time to improve their systems
and processes and address potential gaps in data and model
[[Page 15064]]
performance. Furthermore, the delayed implementation would allow more
time to develop and refine the valuation methods used in the expected
shortfall models without the potential cliff effects that could arise
when one or more model-eligible trading desks having PLA test results
in the amber or red zone. The delayed transition of PLA test automatic
consequences would also provide the agencies an additional opportunity
to monitor the effectiveness of the PLA test metric and identify the
root causes leading to poor testing performances while allowing banking
organizations to gain experience with the tests and improve their
systems and models.
Question 162: The agencies seek comment on the proposed three-year
transition period for the PLA test. What are the benefits and drawbacks
of delaying for three years the automatic consequences of having PLA
test results in the amber or red zones? To what extent does the
proposed time period facilitate banking organizations' ability to gain
experience with the tests and address any potential gaps in data and
model performance? Please provide any rationale that would be useful to
consider for this purpose.
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) \425\ against the hypothetical profit and
loss produced by the financial reporting models.
---------------------------------------------------------------------------
\425\ 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 and
positions, including non-modellable risk factors and model-
ineligible positions, 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 financial reporting 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 financial
reporting 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 for the risk factors of the
underlying valuation engines), a banking organization may adjust the
input data used by the financial reporting models into a format that
can be used by the internal risk management models. When transforming
the input data of the financial reporting 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 \426\ in a
consistent manner in the hypothetical profit and loss and the risk-
theoretical profit and loss.\427\ The proposed flexibility would allow
the results of the PLA test metric 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.
---------------------------------------------------------------------------
\426\ Time effects can include various elements such as the
sensitivity to time, or theta effect, and carry or costs of funding.
\427\ In particular, when time effects are excluded from the
hypothetical profit and loss, they must also be excluded from the
risk-theoretical profit and loss. A banking organization that
excludes time effects must do so consistently for purposes of
backtesting and the PLA test.
---------------------------------------------------------------------------
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 model-ineligible
positions pursuant to its trading or hedging strategy,\428\ to include
such positions for the purposes of the PLA tests. Allowing such
positions to be included would enable model-ineligible positions held
as hedges to be recognized with the underlying positions they are
intended to hedge and thus minimize the potential for the PLA test 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 model-ineligible positions in their PLA test metric, 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 non-default
capital requirement or the fallback capital requirement, as described
in sections V.A.7. and V.A.3.d. of this SUPPLEMENTARY INFORMATION,
respectively.
---------------------------------------------------------------------------
\428\ Model-ineligible positions include equity positions in an
investment fund where the banking organization is not able to
identify the underlying positions held by an investment fund on a
quarterly basis, securitization positions, and correlation trading
positions.
---------------------------------------------------------------------------
II. PLA Test Metric
For the PLA test, the banking organization would be required to
compare, for each model-eligible trading desk, the risk-theoretical
profit and loss and the hypothetical profit and loss for the most
recent 250 business days using the Kolmogorov-Smirnov metric.
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,\429\ 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:
---------------------------------------------------------------------------
\429\ 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 financial reporting 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
[[Page 15065]]
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 financial reporting
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 financial reporting models, including information on
the size and number of valuation differences.
Based on the PLA test results for the Kolmogorov-Smirnov metric, 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. Additionally, under the proposal, the primary
Federal 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 metric of the model-eligible trading desk.\430\
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\430\ As discussed in more detail in section V.A.6.d.iv. of this
SUPPLEMENTARY INFORMATION, if, after the three-year transition
period, the primary Federal supervisor subjects a model-eligible
trading desk to the PLA add-on as part of the initial approval or
for on-going model eligibility, 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 metric in the green zone,
or (2) receives approval from the primary Federal supervisor that
the PLA add-on no longer applies.
---------------------------------------------------------------------------
Question 163: What, if any, modifications should the agencies
consider with respect to the PLA test? Commenters are encouraged to
provide specific details on the mechanics, empirical support, capital
implications, and rationale for any suggested modifications.
Question 164: 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 financial reporting 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
financial reporting models for a particular model-eligible trading
desk?
Question 165: 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. If a banking organization has
one or more model-eligible trading desks within the amber zone, the
proposal would require the banking organization to reflect the PLA add-
on in the models-based non-default risk capital requirement, as
described above in section V.A.8. of this SUPPLEMENTARY
INFORMATION.\431\ Under the proposal, a banking organization would
calculate the PLA add-on as the greater of zero and the aggregate
capital benefit to the banking organization from the models-based non-
default capital requirement (the difference between the capital
requirements for all model-eligible trading desks \432\ in the green or
amber zone under the standardized non-default capital requirement
(SAG,A) and those under the models-based non-default capital
requirement ((IMCCt-1 + SESt-1), ((mc x
IMCCaverage) + SESaverage)), multiplied by a multiplication factor of
k, as defined according to the following formula under Sec.
__.213(c)(4) of the proposed rule:
---------------------------------------------------------------------------
\431\ As described in section V.A.1.b. of this SUPPLEMENTARY
INFORMATION, the proposal would provide a three-year transition
period during which there would be no automatic consequences for PLA
test results. While banking organizations would be required to
report PLA test results during the transition period, the PLA add-on
would not apply until after the expiration of the three-year
transition period.
\432\ In calculating the PLA add-on, the proposal would require
a banking organization to exclude any model-ineligible positions
held by a model-eligible desk, as such positions must be subject to
either the standardized non-default capital requirement or the
fallback capital requirement.
\433\ As discussed in section V.A.6.d.i. of this SUPPLEMENTARY
INFORMATION, model-eligible trading desks that hold limited amounts
of model-ineligible positions must calculate regulatory capital
requirements for such positions under the standardized non-default
capital requirement 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 desk-
level PLA and backtesting requirements as well as the aggregate
trading portfolio backtesting requirement.
PLA add-on = k x max ((SAG,A-max ((IMCCt-1 +
---------------------------------------------------------------------------
SESt-1), ((mc x IMCCaverage) + SESaverage))), 0)
Under the proposal, the value of k would equal half of the ratio of
the sum of the standardized non-default capital requirement 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] TP27MR26.087
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 models-based non-
default capital requirement to the standardized non-default capital
requirement.
iii. Application of the PLA Add-On
After the three-year transition period, if, in the most recent 250
business day period, a trading desk that the primary Federal
supervisory previously approved to use the models-based non-default
capital requirement produces results in the PLA test red zone, the
proposal would require the banking organization to use the standardized
non-default capital requirement and calculate market risk capital
[[Page 15066]]
requirements for the positions held by the trading desk together with
all other trading desks subject to the standardized non-default capital
requirement.\433\ The proposal would not permit the banking
organization to use the models-based non-default capital requirement 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.\434\
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\434\ During the three-year transition period, a banking
organization may use the models-based non-default capital
requirement to calculate market risk capital requirements for the
trading desk once the desk produces satisfactory desk-level
backtesting results for the most recent 250 business days.
---------------------------------------------------------------------------
f. 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.\435\ 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
financial reporting models with the corresponding daily VaR-based
measure calculated by the banking organization's internal models. 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. Time effects must be treated in a consistent manner
in the hypothetical profit and loss metric used for purposes the
backtesting and PLA tests.
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\435\ During the three-year transition period, a banking
organization may treat a trading desk that conducts and successfully
passes backtesting at the trading desk level on an ongoing quarterly
basis as a model-eligible trading desk.
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Under the proposal, a backtesting exception would occur when the
daily actual profit and loss or the daily hypothetical profit and loss
produced by the financial reporting model for the trading desk exceeds
the corresponding daily VaR-based measure. 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 desk
experiences any of the following: (1) 12 or more exceptions for actual
profit and loss at the 99.0th percentile; (2) 12 or more exceptions for
hypothetical profit and loss at the 99.0th percentile; (3) 30 or more
exceptions for actual profit and loss at the 97.5th percentile; or (4)
30 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 impossible to compute, the proposal
would require the banking organization to treat such an occurrence as a
backtesting exception for the actual profit and loss or hypothetical
profit and loss, respectively. If the VaR-based measure for a
particular business day is unavailable or impossible to compute, an
exception for actual and hypothetical profit and loss is deemed to have
occurred. No exception is deemed to have occurred if the unavailability
or the impossibility is related to an official holiday; in such cases
the banking organization may disregard the backtesting exception. In
addition, with approval of the primary Federal supervisor, the banking
organization may 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
financial reporting or internal models; or to one or more model-
ineligible positions; or if the banking organization could demonstrate
that a backtesting exception relates to one or more non-modellable risk
factors or to one more model-ineligible positions and the portion of
the stressed expected shortfall or standardized non-default capital
requirement attributed to these non-modellable risk factors or model-
ineligible positions, respectively, for that business day exceeds the
difference between the banking organization's VaR-based measure and the
actual or hypothetical loss for that business day.\436\
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\436\ It is not sufficient to compare the size of backtesting
exceptions to standalone SES for individual non-modellable risk
factors or standalone standardized non-default capital requirements
for model-ineligible positions because the sum of standalone capital
requirements for individual non-modellable risk factors or model-
ineligible positions would almost always be smaller than the
relevant aggregate capital requirement. Instead, the size of
backtesting exceptions needs to be compared to the portion of the
aggregate SES or standardized non-default capital requirement that
can be attributed to those non-modellable risk factors or model in-
eligible positions, accounting for recognition of diversification
within each formula. For example, one approach for determining the
portion of the aggregate SES attributable to a particular non-
modellable risk factor is to multiply the risk factor's standalone
SES by its marginal contribution to the aggregate SES (i.e., for
non-modellable risk factor i, attribute (aSES/aSESnm,i) [middot]
SESnm,i), which is a valid method for apportioning the aggregate SES
because the SES formula is homogenous of degree one.
\437\ To receive approval as a model-eligible desk during the
three-year transition period, the proposal would require the banking
organization to provide backtesting results for the trading desk and
demonstrate to the satisfaction of the primary Federal supervisor
that the expected shortfall models would be able to satisfy the
backtesting requirements on an on-going basis. See section
V.A.6.d.iv.I. of this SUPPLEMENTARY INFORMATION for the criteria for
a trading desk to receive approval as a model-eligible trading desk.
\438\ Under the proposal, there would be no automatic
consequences for the PLA test results during the three-year
transition period. Accordingly, during the transition period, a
banking organization's model-eligible trading desk would only be
required to successfully pass quarterly trading desk-level
backtesting requirements to return to using the models-based non-
default capital requirement.
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If in the most recent 250 business day period a trading desk
experiences either 12 or more backtesting exceptions at the 99.0th
percentile, or 30 or more backtesting exceptions at the 97.5th
percentile, the proposal would require the banking organization to use
the standardized non-default capital requirement 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.\437\ The proposal would allow the banking organization to
return to using the models-based non-default capital requirement 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 metric in the green or amber zone or
(2) receives approval of the primary Federal supervisor.\438\
Question 166: Should non-modellable risk factors be excluded from
the proposed backtesting requirements? Why or why not? What, if any,
further
[[Page 15067]]
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 167: 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?
Question 168: The agencies invite comment on whether notional desks
that are model-eligible desks and primarily hold foreign exchange and
commodity positions to hedge banking book exposures should be excluded
from PLA testing and backtesting requirements. What would be the
potential benefits and drawbacks of providing such an exclusion for
these specific desk types? Would alternative treatment or modified
requirements for these desks be more appropriate and if so, why?
9. Default Risk Capital Requirement
The 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 or the models-based non-default capital
requirement. Thus, the proposed default risk capital requirement would
apply only to non-securitization debt or equity positions (except for
U.S. sovereigns, specified supranational entities, and multilateral
development banks), securitization positions non-CTP, and correlation
trading positions. To recognize offsetting of long and short positions
across model-eligible and model-ineligible desks, the proposal would
allow a banking organizations that has one or more model-eligible
trading desks to perform a single calculation of the default risk
capital requirement across model-eligible and model-ineligible trading
desks.
Under the proposal, a banking organization would be required to
separately calculate the default risk capital requirement for each of
the three default risk categories (three position types 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
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 \439\ to the
net default exposures within the same default bucket for the class of
instruments.\440\ In general, the proposed buckets and associated risk
weights closely follow those in the Basel standards, 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 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.
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\439\ The proposal would require a banking organization that
applies a hypothetical portfolio approach 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)(ii) of the proposed rule.
\440\ 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.
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Fifth, to calculate the default risk capital requirement for each
default risk category, the banking organization would sum the 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
section V.A.9.c.iii. of this SUPPLEMENTARY INFORMATION. For
conservatism, the proposal would require a banking organization to
calculate the total 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.
a. Non-Securitization Debt or Equity Positions
i. Gross Default Exposure
Under the proposal, the 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 \441\ 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.\442\ The proposed calculation methodology
is intended to appropriately quantify the gross default risk for most
securities, including those that are less common.
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\441\ The loss rate from default is one minus the recovery rate.
\442\ As losses are recorded as a negative value, effectively
they would be subtracted from the overall exposure amount.
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For the purpose of calculating the gross default exposure for each
non-securitization debt or equity position, the proposal would require
banking
[[Page 15068]]
organizations to use the following LGD rates, which are generally
consistent with those in the Basel standards: 100 percent for equity
and non-senior debt instruments, and defaulted positions,\443\ 75
percent for senior debt instruments, unless a lower LGD is assigned, 75
percent for GSE debt issued but not guaranteed by the GSEs, 50 percent
for U.S. PSEs,\444\ 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.\445\ GSE debt issued
and guaranteed by the GSEs is secured generally by residential
properties that satisfy the specific 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 proposal would 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 debt positions in U.S. PSEs, the proposal would allow a banking
organization to apply an LGD rate aligned with the average loss given
default for such entities, rather than applying the higher LGD rate for
senior debt. For credit derivatives, a banking organization would be
required to use the LGD rate of the reference exposure.
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\443\ The proposal would allow a banking organization to treat a
distressed position as a defaulted position for the purpose of
calculating market risk capital requirements. Furthermore, to
prevent situations when the default capital requirement would
increase the capital requirements for defaulted positions beyond the
maximum potential loss, a banking organization would be able to
calculate the gross default exposure for defaulted positions by
multiplying the current market value and the prescribed LGD rate.
\444\ The proposed LGD rate for U.S. PSEs is consistent with the
debt-size weighted average LGD rate using Moody's municipal bonds
data between 1970 and 2022. The debt-size weighted average LGD rate
is derived as one minus the ultimate recovery rate, which is based
on the recovery value creditors actually received at the resolution
of the default relative to what the creditors should have
contractually received inclusive of any accrued interest. For
issuers with a range of estimated recovery rates, the proposed LGD
rate is consistent with both the worst LGD and the mid-point LGD,
for municipal bonds over this period. The data used in the analysis
is from Moody's data on U.S. municipal bond defaults and recoveries
1970-2022 published by Moody's Investors Service Data Report. See
Moody's Investors Service Data Report, U.S. Municipal Bond Defaults
and Recoveries, 1970-2022 (July 19, 2023).
\445\ 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).
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For consistency across banking organizations, the proposal
specifies that a banking organization would be required to reflect the
notional amount \446\ 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.
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\446\ For all non-securitization debt or equity positions, the
notional amount would equal 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
would be zero.
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Question 169: 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 170: 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.\447\ 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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\447\ 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 Sec. __.36 of the current capital rule
and Sec. __.120 of the proposed rule would apply. See 12 CFR 3.36
(OCC); 12 CFR 217.36 (Board); 12 CFR 324.36 (FDIC).
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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), the Federal Agricultural Mortgage
Corporation (Farmer Mac) and a Federal Home Loan Bank 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 UMBS 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
[[Page 15069]]
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.
The net default exposure to an issuer would be the sum of the
maturity-weighted default exposures to the issuer.
Question 171: 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? What
would be the advantages and disadvantages of allowing a banking
organization to offset short dated futures with longer-dated
derivatives when the underlying exposures match, and why?
iii. Buckets and Corresponding Risk Weights
Table 1 to Sec. __.210 of the proposed rule provides the proposed
default buckets and corresponding risk weights for non-securitization
debt or equity positions, which reflect counterparty type and credit
quality, respectively. Under the proposal, the 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 proposal would
define the default buckets in a manner that is generally consistent
with those provided in the Basel standards but uses alternative
criteria. The default buckets for non-securitization positions in the
Basel standards are defined based on the applicable credit ratings of
the reference entity. As discussed previously in section
V.A.7.a.iii.II. of this SUPPLEMENTARY INFORMATION, the proposed
approach does not rely on external credit ratings but allows for a
level of granularity in the default buckets (and corresponding risk
weights) applicable to non-securitization positions that is generally
consistent with the Basel standards. Specifically, the proposal would
define the default 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.\448\
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\448\ The agencies propose to modify the Basel standards'
ratings-based risk weights, as in previous rules, to instead use
grade-based risk weights, calculated as a weighted average of the
ratings-based risk weights. The weighting scheme for this
calculation would be derived from the notional amount of bond
issuances in each grade category from 2007 through 2019. For this
analysis, the agencies used the Mergent Fixed Income Securities
Database to identify bond notional issuance amounts for the period
from January 1, 2007 through December 31, 2019. See LSEG Mergent,
https://wrds-www.wharton.upenn.edu/pages/about/data-vendors/lseg-mergent/. This look back period (from January 1, 2007 to December
31, 2019) was selected to: (i) capture issuance activity across
varying market conditions, including pre-crisis, crisis, and initial
recovery phases; (ii) ensure sufficient data availability,
reliability, and through the cycle stability. The methodology
employed by the agencies proceeded in two distinct analytical
stages. First, the original Basel III standardized approach risk
weights based on external credit ratings, as set forth in the Basel
Committee on Banking Supervision's finalized standards published in
December 2017 and revised in 2019, were adjusted by the
proportionate share of bond issuances in each corresponding Basel
rating category during the look back period (January 1, 2007-
December 31, 2019). This adjustment reflects the actual distribution
of market issuance activity across rating grades and serves to
calibrate the risk weights to observed market behavior rather than
theoretical rating-based classifications. Second, following this
proportionate adjustment, the ratings-based risk weights were
collapsed and consolidated to form three simplified creditworthiness
categories: (a) ``Investment Grade,'' (b) ``Non-Investment Grade,''
and (c) ``Sub-Investment Grade.'' This categorical consolidation was
applied uniformly across three principal exposure types: corporate
exposures, public sector entity (PSE) exposures, and sovereign
exposures. The agencies determined that this two-stage methodology--
consisting of proportionate adjustment followed by categorical
consolidation--achieves an appropriate balance among the following
regulatory objectives: (i) alignment with the fundamental risk-
sensitivity principles underlying the Basel framework; (ii)
consistency with Section 939A of the Dodd-Frank Wall Street Reform
and Consumer Protection Act (codified at 15 U.S.C. 78o-7 note);
(iii) operational simplicity and administrability for banking
organizations of varying sizes and complexity; (iv) consistency with
observed market issuance patterns during the relevant look back
period (January 1, 2007-December 31, 2019); and (v) stability of
risk weights across credit cycles.
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Question 172: 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.
b. Securitization Positions Non-CTP
For securitization positions non-CTP, the process to calculate the
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 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 market value. As the proposed
bucket-level risk weights described in section V.A.7.a.iii.II. 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
[[Page 15070]]
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 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 173: 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?
iii. Buckets and Corresponding Risk Weights
To promote consistency and comparability in risk-based capital
requirements across banking organizations, the proposal would define
the 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.\449\ Under the proposal, a banking organization would
assign each position to one bucket, and those with underlying exposures
in the same asset class and region to the same 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.\450\
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\449\ 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. See Sec. __.210(c)(3)(B) of the proposed rule.
\450\ Under the proposal, the other buckets would include other
retail and other wholesale (for asset class) and other (for region).
See Sec. __.210(c)(3)(B) of the proposed rule.
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For consistency in the capital requirements for securitizations
under either the standardized approach or the expanded risk-based
approach, as applicable, and to recognize credit subordination,\451\
the proposed risk weights for securitization positions non-CTP are
based on the proposed risk weights calculated for securitization
exposures under either the proposed standardized approach or expanded
risk-based approach of the capital rule.
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\451\ For example, consistent with the existing SSFA, the
proposed SEC-SA would use the risk weights applicable to the
underlying exposures within the general credit risk framework to
calculate the risk weight for the securitization exposure. The SEC-
SA calculates the risk weight for a securitization exposure based on
characteristics of the tranche, such as the attachment and
detachment points and quality of the underlying collateral.
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To calculate the default risk capital requirement for
securitization positions non-CTP, a banking organization would sum the
bucket-level capital requirements, except that a banking organization
could cap the 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 the standardized approach or the expanded
risk-based approach, as applicable, of the capital rule.\452\
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\452\ See Sec. __.44(a) of the current capital rule and Sec.
__.132(a)(3) of the proposed rule.
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Question 174: The agencies request comment on the proposed buckets.
What are the potential benefits and drawbacks of aligning the default
bucketing structure with the proposed delta 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.
c. Correlation Trading Positions
The process to calculate the 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 buckets, and the
aggregation of the bucket level exposures across 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
[[Page 15071]]
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. 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, 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 single-name credits for the long index position and the two
unique single-name 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. In such cases, the banking organization would be required to
account for the residual component of the unhedged tranche within the
default risk capital requirement. 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. Buckets and Corresponding Risk Weights
For correlation trading positions, the proposal would define
buckets by index, each index would comprise its own bucket.\453\ 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 bucket corresponding to the index. For a non-securitization
position that hedges a correlation trading position, a banking
organization would be required to assign such position and the
correlation trading position to the same bucket.
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\453\ A non-exhaustive list of indices include: the CDX North
America IG, iTraxx Europe IG, CDX HY, iTraxx XO, LCDX (loan index),
iTraxx LevX (loan index), Asia Corp, Latin America Corp, Other
Regions Corp, Major Sovereign (G7 and Western Europe) and Other
Sovereign.
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For consistency in the proposed capital requirements for
securitizations under either the standardized approach or the expanded
risk-based approach of the capital rule and to recognize credit
subordination,\454\ the proposed risk weights corresponding to the
proposed buckets for correlation trading positions are based on the
proposed treatment under either the standardized approach or the
expanded risk-based approach of the capital rule.\455\ For non-tranched
hedges of correlation trading positions or decomposed single-name
exposures, the proposal would allow a banking organization to apply the
same risk weights and loss given default rates as for non-
securitization debt or equity positions, provided that such hedges or
decomposed single-name exposures are excluded from the default risk
capital requirement for non-securitization debt or equity positions.
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\454\ For example, consistent with the existing SSFA, the
proposed SEC-SA would use the risk weights applicable to the
underlying exposures within the general credit risk framework to
calculate the risk weight for the securitization exposure. The SEC-
SA calculates the risk weight for a securitization exposure based on
characteristics of the tranche, such as the attachment and
detachment points and quality of the underlying collateral.
\455\ See Sec. __.42 of the current capital rule and Sec.
__.132 of the proposed rule.
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The agencies recognize that the granularity of the proposed bucket
structure could result in several individual buckets containing only
net short exposures and thus overstate the offsetting benefits of non-
identical exposures if the total 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
buckets with short default exposures offsetting those with long
exposures, the total 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.
10. 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 the proposed market
risk framework, 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.\456\ A banking organization would be required to
include any net short risk position of at least $20 million, adjusted
to reflect CPI-W, 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.
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\456\ See section V.A.4.b. of this SUPPLEMENTARY INFORMATION for
a more detailed discussion on net short risk positions.
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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
[[Page 15072]]
organizations are appropriately managing and monitoring net short risk
positions arising from exposures subject to the standardized approach
or the expanded risk-based approach 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 non-default capital requirement or models-based non-
default capital requirement 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 V.A.3.d. 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 non-default capital requirement 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.\457\
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\457\ As discussed further in section V.A.6.d.i. of this
SUPPLEMENTARY INFORMATION, model-eligible trading desk would be
allowed to hold insignificant amounts of model-ineligible positions,
including securitization positions. For model-eligible trading desks
that hold insignificant amounts of such positions, the proposal
would require a banking organization to exclude any model-ineligible
positions held by the model-eligible trading desk from (1) the
aggregate trading portfolio backtesting; and (2) the relevant desk-
level backtesting and profit and loss attribution metric, unless the
banking organization receives approval from its primary Federal
supervisor to include such positions.
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The proposal would require a banking organization to include
defaulted market risk covered positions in the default risk capital
requirement. The proposal would allow a banking organization to extend
the treatment of defaulted market risk covered positions to distressed
market positions. Such positions are not required to be included in the
standardized non-default capital requirement or in the models-based
non-default capital requirement. 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 standardized or models-based non-
default capital requirement would increase the capital requirements for
such positions beyond the maximum potential loss of such holdings, as
the default risk capital requirement already assigns a 100 percent risk
weight and 100 percent LGD to such exposures. If a banking organization
is unable to calculate the 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.\458\
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\458\ As described in more detail in section V.A.3.d. of this
SUPPLEMENTARY INFORMATION, the fallback capital requirement would
apply in instances where a banking organization is unable to
calculate market risk capital requirements for one or more of its
market risk covered positions under either the standardized non-
default capital requirement, the models-based non-default capital
requirement, if eligible, or the default risk capital requirement.
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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 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 models-based non-default capital requirements, as applicable, with
those under the fallback capital requirement.
c. Hybrid Instruments
i. Standardized Non-Default Capital Requirement
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 capital
requirements under the sensitivities-based method.
ii. Default Risk Capital Requirement
For the 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 the
default risk capital requirement 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
calculation of the default risk capital requirement for the vanilla
bond is the notional amount of the convertible bond. The notional
amount to be used in the calculation of the default risk capital
requirement 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
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.
d. Index Instruments and Multi-Underlying Options
i. Standardized Non-Default Capital Requirement
When calculating the delta and curvature capital requirements under
the sensitivities-based method for index instruments and multi-
underlying options, the proposal would allow a banking organization to
apply the look-through approach or the single sensitivity approach.
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 the
look-through approach consistently through time and 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
[[Page 15073]]
positions issued by the same company. Specifically, a banking
organization would be able to net risk factor sensitivities of such
positions of the index instrument or multi-underlying option and other
single-name positions without restriction when calculating delta and
curvature capital requirements under the sensitivities-based method.
The single sensitivity approach would require a banking
organization to calculate a single sensitivity to the index and then
assign the index instrument or multi-underlying option to a relevant
bucket to calculate the delta and curvature capital requirements. To
assign the sensitivity of the index to the relevant sector or index
bucket, the proposal includes a waterfall approach as a simple and
risk-sensitive method to appropriately reflect 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;
otherwise, the proposal would require a banking organization to assign
the sensitivity to an appropriate index bucket. For equity indices that
are not sector specific, the proposal would require a banking
organization to assign the sensitivity to the large market cap and
liquid market economy (non-sector specific) equity indices 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
is investment grade, and to the speculative grade and sub-speculative
grade indices bucket otherwise.\459\ 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. For credit
indices the proposal would allow a banking organization to use delta
sensitivity for equity risk of the index adjusted by the index's
effective duration as a proxy to calculate delta sensitivity for
interest rate risk and credit spread risk for non-securitizations in
the sensitivities-based method. This approach would help ensure a more
risk sensitive treatment of credit indices when the look-through
approach is not possible or practical. Furthermore, a banking
organization would need to assign credit spread risk and interest rate
risk delta sensitivities to the closest tenors using interpolation. The
delta sensitivity for interest rate risk should be assigned based on
currency. To calculate the vega capital requirement for options on
credit indices under the single sensitivity approach, the proposal
would require a banking organization to follow the steps outlined in
section V.A.7.a.ii.I. of this SUPPLEMENTARY INFORMATION and use the
same buckets as applied in the delta capital calculation. When
calculating curvature for options on credit indices, the proposal would
allow a banking organization to use a single shock measured as the
delta risk weight multiplied by the index's effective duration.
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\459\ See section V.A.7.a.iii. of this SUPPLEMENTARY INFORMATION
for a more detailed description on the assignment of delta
sensitivities to the prescribed buckets under the proposed
sensitivities-based method.
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When calculating vega capital requirements for index instruments
and multi-underlying options (including index options), the proposal
would permit, but not require, a banking organization to apply the
look-through approach 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 models for
multi-underlying options. For indices, the proposal would require a
banking organization to calculate vega capital requirements with
respect to the implied volatility based on the same sector specific
bucket or index bucket used to calculate the delta capital requirement
and the curvature capital requirement, or an appropriate sector
specific or index bucket otherwise.
ii. Models-Based Non-Default Capital Requirement
When calculating the models-based non-default capital requirement
for indices and multi-underlying options the proposal would allow, but
not require, a banking organization 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 index's
historical holdings of underlying positions. In addition, a banking
organization may use any other modelling approach to calculate the
models-based non-default capital requirement after receiving a prior
approval from its primary Federal supervisor.
iii. Default Risk Capital Requirement
The default risk of credit and equity indices as well as 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 allow a banking
organization to apply the look-through approach when calculating the
default risk capital requirement for indices and multi-underlying
options that are non-securitization debt or equity positions. When
decomposing multi-underlying exposures or indices, 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 and the value of the instrument assuming none of the
single names referenced by the instrument default. 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 constituents of credit and equity
indices and multi-underlying options could react differently to the
same market or economic event, the proposal would also allow a banking
organization to treat such positions as a single position for purposes
of calculating the default risk capital requirement, provided the index
or multi-underlying option substantially meets the criteria for the
applicable bucket. Also, the proposal would allow a banking
organization to treat the index or multi-underlying option as a single
sub-speculative exposure. For example, a banking organization may
choose to apply a single sub-speculative exposure approach when it
would be operationally challenging for a banking organization to apply
the look-through approach or perform the analysis to identify an
appropriate bucket for a single exposure.
[[Page 15074]]
Question 175: 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 176: The agencies seek comment on the calculation of vega
capital requirement for credit indices for which a banking organization
chooses to apply a single sensitivity approach. To mitigate any
operational burden that could arise from using the single sensitivity
approach in order to calculate the vega capital requirement, what would
be the advantages and disadvantages of allowing a banking organization
to calculate the vega capital requirement according to the backstop
fund method? Please specify how a banking organization would perform
such calculation.
e. Equity Positions in an Investment Fund
i. Standardized Non-Default Capital Requirement
For equity positions in an investment fund or portions of such
positions 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 allow a banking organization to apply the
look-through approach under the standardized measure for market risk.
If a banking organization is able to use the look-through approach to
calculate market risk capital requirements for only a portion of the
underlying positions in the fund, the proposal would require a banking
organization to treat the equity position in the investment fund as two
separate market risk covered positions: one as a market risk covered
position for which the banking organization is able to apply the look-
through approach and the rest as a market risk covered position for
which the banking organization is not able to apply the look-through
approach. In this circumstance, each position would represent the
proportional amount of original position corresponding to the portion
of the investment fund that the banking organization is able to use the
look-through approach or not able to use the look-through approach,
respectively.
Alternatively, a banking organization could elect not to apply the
look-through approach for such positions and, instead, apply the single
sensitivity approach if the investment fund meets the criteria to be
assigned to the relevant bucket as described in further detail in
section V.A.10.d.i. of this SUPPLEMENTARY INFORMATION. For equity or
debt positions in publicly traded real estate investment trusts, the
proposal would allow a banking organization to treat such exposures as
a single exposure and apply the risk weight applicable to exposures
allocated to the financial sector bucket when calculating the delta,
vega, and curvature capital requirements under the sensitivities-based
method.\460\ 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, a banking organization will
generally not be able to calculate the risk factor sensitivity for each
of the underlying assets of the real estate investment trust and
perform a full look through. Allowing 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 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 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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\460\ Under the proposal, such exposures would receive the 55
percent or 50 percent risk weight applicable to equity risk factors
allocated to buckets 4 or 8, respectively, in Table 8 to Sec.
__.209 of the proposed rule. Similarly, such exposures would receive
the five percent or 12 percent risk weight applicable to
counterparty credit spread risk for non-securitization risk factors
allocated to buckets 3 and 11, respective, in Table 3 to Sec.
__.209 of the proposed rule.
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Additionally, for equity positions in an investment fund or
portions of such positions where a banking organization is not able to
apply the look-through approach, the proposal would allow the banking
organization to either apply the tracked index method, the hypothetical
portfolio approach or the backstop fund method, as applicable. A
banking organization could apply the tracked index method if the
investment fund closely tracks an index benchmark or the investment
fund's mandate or prospectus requires that it tracks an index with
tracking performance published quarterly. Generally, the agencies would
consider an equity position in an investment fund to closely track the
index if 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 an equity position in an investment fund
that closely tracks an index benchmark or if its mandate or prospectus
requires that it tracks an index and publishes its tracking performance
on a quarterly basis, 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.\461\ Further, for equity positions in an investment
fund that holds an 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 \462\ and apply the look-through approach or the single
sensitivity approach to the other underlying exposures of the
investment fund.
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\461\ In this situation, the banking organization would apply
the treatment for index instruments described in section V.A.10.d.i.
of this SUPPLEMENTARY INFORMATION.
\462\ In this situation, the banking organization would apply
the treatment for index instruments described in section V.A.10.d.i.
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 weigh the constituents of the
investment fund based on the hypothetical portfolio.
[[Page 15075]]
To address any potential operational burden that can arise from the
above discussed approaches for equity positions in an investment fund,
the proposal would permit a banking organization to use an effective
risk weight calculated by third parties in the calculation of market
risk capital requirements for the look-through approach,\463\
hypothetical portfolio approach, and tracked index method. Under this
approach, the fund's exposure would be assigned to one or more
appropriate buckets without the requirement to look-through the fund,
and with diversification allowed with other exposures.
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\463\ If a banking organization relies on a third party to
calculate the effective risk weight, the banking organization should
be able to have understanding of how the third party calculates the
risk weight and be able to verify that the calculation was conducted
in a manner consistent with the requirements of the capital rule.
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Alternatively, the proposal's backstop fund method would allow a
banking organization to allocate equity positions in an investment fund
to the applicable other sector bucket.\464\ This approach would be a
simple conservative measure in situations when, due to computational or
operational challenges, a banking organization is unable to apply other
allowed approaches to calculate the standardized non-default capital
requirement. In situations when the mandate of the investment fund
allows investments in positions subject to the residual risk add-on,
such as positions with exposures to exotic risks or residual risks, the
banking organization would need to calculate residual risk add on
requirement for the equity position in the investment fund assuming
that the investment fund has invested in such exposures to the maximum
extent permitted under its mandate.
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\464\ 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.
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ii. Models-Based Non-Default Capital Requirement
The proposal would only allow a banking organization to use the
models-based non-default capital requirement 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.\465\
Otherwise, these positions would be calculated using the standardized
non-default capital requirement 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 models-based non-default capital
requirement after receiving a prior approval from its primary Federal
supervisor.
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\465\ The proposal would allow a banking organization to use the
models-based non-default capital requirement for portions of 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 such
exposures held by the investment fund. For portions of equity
positions in an investment fund for which the banking organization
is unable to use the look-through approach, the banking organization
would use one of the approaches discussed in section V.A.10.e.i. of
this SUPPLEMENTARY INFORMATION.
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Question 177: What would be the advantages and disadvantages 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 models-based non-default capital requirement?
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.
iii. Default Risk Capital Requirement
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 allow a banking organization to apply the look-through
approach when calculating the default risk capital requirement for
equity positions in an investment fund that are non-securitization debt
or equity positions. Alternatively, for positions in an investment fund
that closely tracks an index benchmark or for which a banking
organization can identify the main investment strategy specified in the
fund's mandate or prospectus, a banking organization would be allowed
to treat an exposure to the fund as a single-name exposure assigned to
an appropriate default bucket for non-securitization debt and equity
positions.\466\ In situations when a banking organization is unable to
use either the look-through approach or apply the single exposure
treatment to calculate the default risk capital requirement for such
positions due to some potential operational limitations, the proposal
would allow a banking organization to treat a fund as a single-name
sub-speculative exposure with the highest risk weight applicable to the
fund (for example, 50 percent risk weight as specified in Table 1 to
Sec. __.210 of the proposed rule).
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\466\ See Table 1 to Sec. _210 of the proposed rule provides
the proposed default risk buckets and corresponding risk weights for
the non-securitization debt and equity risk positions.
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For equity positions in an investment fund for which the banking
organization applies the hypothetical portfolio approach under the
standardized non-default capital requirement described above, the
proposal would require a banking organization to apply the same
hypothetical portfolio approach for purposes of calculating the default
risk capital requirement for such positions.
For equity positions in an investment fund for which the banking
organization applies the backstop fund method under the standardized
non-default capital requirement, the proposal would allow a banking
organization to use either the hypothetical portfolio approach for
purposes of calculating the default risk capital requirement for such
positions or treat the fund as a single sub-speculative exposure. 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 178: 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
[[Page 15076]]
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 179: The agencies seek comment on requiring banking
organizations to calculate the default risk capital requirement 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.
f. Treatment of Term Repo-Style Transactions
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.\467\ 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 the standardized approach or the
advanced approaches of the capital rule.\468\ The standardized approach
and the advanced approaches 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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\467\ 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.
\468\ Under the market risk capital framework in the current
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
IV.A.1. of this SUPPLEMENTARY INFORMATION, the proposal would
eliminate the simple VaR approach for calculating risk-based
requirements for counterparty credit risk--and thus this optionality
would only apply in the context of the collateral haircut approach.
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The proposal would retain the treatment of term repo-style
transactions in the current capital rule. 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.
In such cases, the proposal would permit a banking organization to
include term repo-style transactions in the sensitivities-based method
or models-based non-default capital requirement if held by a model-
eligible trading desk. For purposes of calculating market risk capital
requirements under the sensitivities-based method or the models-based
non-default capital requirement, the proposal would require a banking
organization to capture the risk factor sensitivities of the cash leg
to general interest rate risk. The proposal would also require a
banking organization to separately calculate the default risk capital
requirement to capture losses on the underlying reference exposure in
the event of issuer default as described in section V.A.9.a. of this
SUPPLEMENTARY INFORMATION and the risk-based capital requirements for
counterparty credit risk using the collateral haircut approach as
described in section IV.A.4.a. of this SUPPLEMENTARY INFORMATION.
Question 180: The proposal would retain the current capital rule's
treatment of repurchase and lending agreements with an original
maturity of more than one business day (term repo-style transactions).
What are the advantages and disadvantages of allowing a banking
organization to treat repurchase agreements with no specified maturity
date (open repurchase transactions) or those which maturity date
automatically renews until canceled by a participating party (evergreen
repurchase transactions), and why? To what extent open and evergreen
repurchase transactions have different risk profiles from term repo-
style transactions?
11. Reporting and Disclosure Requirements
The reporting and public disclosures required under the proposal
are intended to 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
the current capital rule 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
[[Page 15077]]
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 the
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 promote 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 market risk 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 market risk would also be required to include
such assessment for categories of non-modellable risk factors.\469\
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\469\ The agencies would expect a banking organization to have
sound internal capital assessment processes which would include, but
not be limited to, identification of capital adequacy goals with
respect to risks, taking into account the strategic focus and
business plan of the banking organization, risk identification,
measurement, and documentation, as well as a process of internal
controls, reviews, and audits.
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The proposal would also retain the existing qualitative disclosures
for material portfolios but with certain revisions to reflect 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 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 models-based 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 for model-eligible trading desks at both the aggregate
level and for each trading desk, as well as PLA testing information for
each model-eligible trading desk, 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 primary
Federal supervisor 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 primary Federal supervisor 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 primary Federal supervisor finds these models to be
flawed, the banking organization must then use the standardized non-
default capital requirement for calculating its market risk capital
requirements, thereby preventing divergence between a banking
organization's risk profile and
[[Page 15078]]
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.
12. Technical Amendments
The proposal would streamline the definitions related to
securitizations in the market risk capital framework with those in the
standardized approach or the expanded risk-based approach of the
capital rule. Specifically, the proposal would eliminate the definition
of ``securitization'' from the market risk capital framework 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.\470\ These modifications would not change the scope of
positions that would be considered securitization positions and
resecuritization positions under the market risk capital framework.
Rather, the proposed revisions would clarify that the same types of
positions are captured under the market risk capital framework as under
the standardized approach and the proposed expanded risk-based
approach, which currently use substantially similar, but separate
definitions.
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\470\ 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 s.v. securitization
exposure, traditional securitization (Board); 12 CFR 324.2 s.v.
securitization exposure, traditional securitization (FDIC).
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B. 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
qualifying master netting agreement or a qualifying cross-product
master netting agreement,\471\ 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
qualifying master netting agreement, 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 qualifying master netting agreement, 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 SA-CCR, the current exposure methodology,
or the internal models methodology, as applicable.\472\
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\471\ ``Qualifying master netting agreement'' is defined in
Sec. __.2 of the current capital rule. In order to recognize an
agreement as a qualifying master netting agreement, a banking
organization must meet the operational requirements in Sec. __.3(d)
of the current capital rule. See 12 CFR 3.2, and 3.3(d) (OCC); 12
CFR 217.2 and 217.3(d) (Board); 12 CFR 324.2, and 324.3(d) (FDIC).
In general, a qualifying master netting agreement 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 this definition, except as discussed in section IX of this
SUPPLEMENTARY INFORMATION, whereby the proposal would modify the
definition in the Board's and OCC's rule to address a prior error.
\472\ 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 \473\ that the market would
expect at various future points in time. Thus, CVA risk has two
components: a counterparty credit spread component (CVA increases as a
result of the deterioration in the creditworthiness of a counterparty
perceived by the market) and an exposure component (CVA increases as a
result of an increase in the expected future exposure).
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\473\ CVA risk covered positions are described in section
V.B.3.a. of this SUPPLEMENTARY INFORMATION.
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The proposal would revise the criteria for determining whether a
banking organization is subject to CVA risk capital requirements. Under
the proposal, a Category I or Category II depository institution
holding company and its depository institution subsidiaries that are
subject to the market risk framework, as well as any banking
organization with significant OTC derivatives that is subject to the
market risk framework, would be required 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.\474\
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\474\ 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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The proposal would provide two measures for calculating CVA risk
capital requirements: (1) the basic measure for CVA risk that 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 that includes a new standardized CVA approach (SA-
CVA) capital requirement and the BA-CVA 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. Under the proposal, only banking
organizations that use SA-CCR for counterparty credit risk would be
eligible to use the standardized measure to calculate its CVA risk
capital requirements.\475\ Additionally, the proposal would require the
banking organization to receive a prior approval from the primary
Federal supervisor to calculate the CVA risk capital requirements under
the SA-CVA approach.
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\475\ The proposal would require banking organizations that use
the current exposure methodology to calculate exposure amounts for
counterparty credit risk to use the BA-CVA measure to calculate CVA
risk capital requirements.
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2. Scope of Application
The proposed capital requirements for CVA risk would apply to a
Category I or
[[Page 15079]]
Category II depository institution holding company, a subsidiary
depository institution of a Category I or II banking organization that
is subject to the proposed market risk capital requirements, and to any
banking organization subject to the proposed market risk capital
requirements that has average aggregate OTC derivatives gross notional
amounts of $1 trillion or more, adjusted to reflect CPI-W, over the
prior four quarters. 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.
Consistent with the current capital rule, the proposed scope would
apply CVA risk capital requirements to the largest and complex banking
organizations that, due to their significant trading activity,
operational scale, and domestic and global presence, are subject to
more stringent capital requirements. As Category I or II banking
organizations 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. At the same time, the proposal would
apply CVA risk capital requirements to subsidiary depository
institutions of Category I or II banking organizations only if the
subsidiary is subject to market risk capital requirements. The proposed
criterion is intended to tailor the proposed CVA risk capital
requirements to only those subsidiary depository institutions with
significant trading activity and increased exposure to CVA risk, and
thus reduce operational burden for those with less exposure to CVA
risk.
In addition to applying CVA risk capital requirements to the
largest banking organizations, the proposed rule would introduce
activity-based thresholds. The proposed CVA risk capital requirement
would apply to a banking organization that is subject to the proposed
market risk capital requirements and that has average aggregate OTC
derivatives gross notional amounts of $1 trillion or more, adjusted to
reflect CPI-W,\476\ over the prior four consecutive quarters. Due to
their substantial derivative portfolios, these banking organizations
have meaningful exposure to losses resulting from changes to their
credit valuation adjustment accounting reserve.
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\476\ See section II.E. of this SUPPLEMENTARY INFORMATION for a
more detailed discussion on indexing nominal thresholds in the
proposal going forward to reflect CPI-W.
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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 consider 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.
Question 181: The agencies seek comment on the appropriateness of
the proposed scope of application of CVA risk capital requirements.
What, if any, alternative thresholds should the agencies consider and
why?
Question 182: What are the advantages or disadvantages of using an
average aggregate OTC derivatives gross notional amount of $1 trillion
or more for the scope of application threshold, and why?
3. CVA Risk Covered Positions and CVA Hedges
1. Definition of CVA Risk Covered Position
The proposal would define a CVA risk covered position as a
derivative contract that is not a client-facing derivative transaction
or 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 its CVA risk capital requirement.\477\
This approach would align the scope of the CVA framework with the scope
of instruments that present CVA risk. The proposal would also allow a
banking organization to exclude certain OTC derivative contracts that
are credit risk mitigants from the CVA risk covered positions in order
not to create a disincentive to hedge against credit default risk in
the standardized approach or the expanded risk-based approach of the
capital rule, as applicable. For example, a CDS on a loan borrower that
is recognized as a credit risk mitigant and receives substitution
treatment under Sec. __.120 of the proposed rule would not be included
in the portfolio of OTC derivative contracts that are subject to the
CVA risk capital requirements.
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\477\ 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. Additionally, when a clearing member banking
organization is either (1) acting as a financial intermediary and
entering into an offsetting transaction with a QCCP or (2) providing
a guarantee on the performance of its client to a QCCP, the banking
organization may exclude the client-facing derivative transaction
from CVA risk covered positions. See the definitions of cleared
transaction and client-facing derivative transaction in 12 CFR 3.2
(OCC), 12 CFR 217.2 (Board), 12 CFR 324.2 (FDIC).
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A banking organization generally does not calculate accounting CVA
for cleared transactions, client-facing derivative transactions, or for
securities financing transactions (SFTs) for financial reporting
purposes. Consistent with industry practice and to align the scope of
the CVA framework with the scope of instruments that present CVA risk,
the proposed definition of CVA risk covered position would not include
a cleared transaction, a client-facing derivative transaction, or an
SFT. Therefore, the CVA risk-based capital requirements would not apply
to such positions under the proposal.
The proposal would exclude cleared derivative transactions from the
CVA risk-based capital requirements because the primary risk of a
banking organization facing a CCP lies in the risk that a CCP
participant, not the CCP itself, defaults.\478\ Clearing members of
[[Page 15080]]
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. __.116 of the proposal or Sec. __.35 of the current capital
rule, as applicable.
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\478\ A CCP could only default if a sufficient number of members
default at the same time and the remaining clearing members of this
CCP are unable to contribute sufficient funds to make the
counterparties to the defaulting members whole.
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In addition, in light of the systemic risk-reducing benefits of
derivatives clearing and to minimize potential unintended consequences
for client clearing activities, the proposal would also exclude from
CVA risk capital requirements client-facing derivative transactions
which generally present low CVA risk.\479\ Client-facing derivative
transactions generally are highly collateralized transactions subject
to netting, daily or intraday margin requirements, immediate close-out,
and significant regulatory oversight, thus resulting in small expected
exposure amounts for clearing members to their clients. While this
expected exposure does result in CVA in the economic sense, it is
usually immaterial and banking organizations do not include it in the
CVA they calculate for accounting purposes. Given these considerations,
subjecting such transactions to the CVA risk capital requirements would
be incommensurate with the risk of such transactions.
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\479\ See 88 FR 64028, at 64150 n. 428 (Sept. 18, 2023). See
also 12 CFR 3.2 (definitions of cleared transaction and client-
facing derivative transaction) (OCC); 12 CFR 217.2 (definitions of
cleared transaction and client-facing derivative transaction)
(Board); 12 CFR 324.2 (definitions of cleared transaction and
client-facing derivative transaction) (FDIC).
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2. 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),\480\ as
described in section V.B.3.b. of this SUPPLEMENTARY INFORMATION, and
manages for the purpose of mitigating CVA risk.
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\480\ 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 V.A.5.c. of this SUPPLEMENTARY INFORMATION.
---------------------------------------------------------------------------
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 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.
As described below, the proposal would include two approaches for
calculating CVA capital requirements: the basic approach or BA-CVA
\481\ and the standardized approach or SA-CVA.\482\ 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.
---------------------------------------------------------------------------
\481\ The basic approach for calculating CVA capital
requirements (BA-CVA) is discussed below in section V.B.5.a. of this
SUPPLEMENTARY INFORMATION.
\482\ The standardized approach for calculating CVA capital
requirements (SA-CVA) is discussed below in section V.B.5.b. of this
SUPPLEMENTARY INFORMATION.
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Under the BA-CVA, the proposal would allow a banking organization
to recognize in the CVA risk capital calculation the risk-mitigating
benefit of hedges of the counterparty credit spread component of CVA
risk, where the only instruments that could be recognized as eligible
hedges are the following instruments: index CDS, single-name CDS, and
single-name contingent CDS. The proposal would expand the set of
instruments recognized as eligible CVA hedges relative to the simple
CVA approach within the current capital rule to include 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
\483\ 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 may use 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 hedge reference name credit
spread in order to constrain the risk-mitigating benefit of such
indirect but eligible CVA hedges.\484\ 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
V.A.5.c. of this SUPPLEMENTARY INFORMATION.
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\483\ Under the proposal, for BA-CVA purposes, a region would
refer to a country or territorial entity.
\484\ 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 V.B.5.a. 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
[[Page 15081]]
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 V.A.5.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 requirement.
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 183: The agencies seek comments on the proposed
interpretation of region for the purposes of BA-CVA. To what extent
would limiting a region to a country or a territorial entity pose
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 V.B.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 and all
transactions that hedge or are intended to hedge CVA risk. For
transactions that hedge or are intended to hedge CVA risk, the proposal
would require the banking organization to identify which are eligible
CVA hedges and which are ineligible CVA hedges.\485\ 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.
---------------------------------------------------------------------------
\485\ The proposal would exclude ineligible CVA hedges from both
market risk and CVA risk capital requirements. Accordingly, this
proposed requirement is intended 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.
---------------------------------------------------------------------------
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 deficiencies. 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 V.B.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
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 V.B.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
[[Page 15082]]
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 V.B.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 models no longer comply 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 types of 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 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 to 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 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
[[Page 15083]]
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 be 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 \486\ and standardized CVA hedges, (2) the BA-CVA for all
basic CVA risk covered positions \487\ 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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\486\ 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.
\487\ 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; or
(ii) the banking organization chooses to exclude the netting sets
with these CVA risk covered positions from the SA-CVA.
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Banking organizations that use the current exposure methodology for
counterparty credit risk would be required to use the basic measure for
CVA risk. A banking organization that uses SA-CCR for counterparty
credit risk would only be able to use the standardized measure for CVA
risk if it has received prior approval from the primary Federal
supervisor. A banking organization that has received prior 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. A banking organization may also bifurcate CVA risk
covered positions of a single netting set between SA-CVA and BA-CVA.
Thus, for a banking organization that has received prior 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 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.
[[Page 15084]]
The BA-CVA would improve upon the simple CVA approach in the
current 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).\488\ 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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\488\ 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] TP27MR26.088
The first term under the square root in the formula (([rho]
[middot] [Sigma] CSCVAC)2) aggregates the systematic components of CVA
risk, while the second term under the square root in the formula ((1-
[rho]2) [middot] [Sigma]C(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 [rho] 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 generally 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: \489\
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\489\ 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.
[GRAPHIC] [TIFF OMITTED] TP27MR26.089
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
[[Page 15085]]
requirements according to Sec. __. 34 of the current rule or Sec. __.
113 of the proposal,\490\ 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.\491\ 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 generally consistent with historical 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.
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\490\ Under the proposal, banking organizations that would be
subject to the proposed expanded risk-based approach or that have
elected to use SA-CCR to calculate counterparty credit risk exposure
amounts would be required to use the Exposure Amount for the single
product netting set or the Exposure Amountderivatives for cross-
product netting set calculated under SA-CCR for purposes of EADNS
within the proposed BA-CVA approach. See Sec. __.34 of the current
rule or Sec. __.113 through Sec. __.114 of the proposed rule, as
applicable. All other banking organizations would be required to use
the exposure amount produced by the current exposure methodology for
purposes of EADNS within the proposed BA-CVA approach.
\491\ For a netting set consisting of a single transaction (for
example, a derivative contract that is not subject to a qualifying
master netting agreement, 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 sovereign exposures, specified
supranational entities, and MDBs, each sector would have two risk
weights, one for counterparties that are investment grade, as defined
in the current rule,\492\ and one for counterparties that are
speculative grade or sub-speculative grade, each as defined in the
proposal.\493\ Sovereign exposures, specified supranational entities,
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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\492\ 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).
\493\ See the definitions of Speculative Grade and Sub-
Speculative Grade in Sec. __.2 of the proposed rule.
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The proposal would provide counterparty sectors generally similar
to those contained in the Basel standards and a treatment for certain
U.S.-specific counterparties (for example, GSEs and public sector
entities). Specifically, the proposal would group GSEs and public
sector entities (PSEs) with government-backed non-financials, education
and public administration to appropriately reflect the potential
variability in the credit spreads of such counterparties, as shown in
Table 1 to Sec. __.222 below.
[GRAPHIC] [TIFF OMITTED] TP27MR26.090
Counterparty credit spread risk for financial entities is a large
component of CVA-related capital requirements and the financial sector
bucket comprises a broad category of financial entities including
financial institutions as defined in the capital rule,\495\ mutual
funds, pension funds, registered investment companies, hedge funds, and
other financial entities. Although regulated financial entities have
many similar characteristics to other financial entities, such as hedge
funds and private equity funds, they also differ in ways that may
significantly affect CVA risk. For example, regulated financial
entities typically differ from other financial entities in capital
structure, scope and risk of activities, regulatory frameworks, and are
also subject to robust disclosure requirements, regulatory oversight,
or supervision. Therefore, regulated financial entities may present a
different risk profile for
[[Page 15086]]
purposes of CVA risk compared to other financial entities and the
agencies are seeking comments on a potential modification to the
proposed supervisory risk weights that would introduce separate
supervisory risk weights for counterparty credit spread risk within the
financial sector bucket to reflect potential differences in risk
profiles between regulated financial entities and other financial
entities. The agencies seek feedback on the appropriateness of
assigning lower supervisory risk weights (such as a range between 3 and
5 percent for investment grade and a range between 8.5 and 12 percent
for speculative or sub-speculative) to certain regulated financial
entities to better differentiate risk profiles of the various types of
entities within the financial sector bucket.\496\ The agencies seek
feedback on whether these additional supervisory risk weights would
enhance the risk-sensitivity of the CVA risk capital requirement by
better capturing differences in the risk profiles of the various
entities within the financials sector bucket.
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\494\ 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.
\495\ See 12 CFR 3.2 (OCC); 12 CFR 217.2 (Board); 12 CFR 324.2
(FDIC).
\496\ For example, banks, insurance companies, broker-dealers,
pension funds, and investment companies registered with the SEC
under the 1940 Act or foreign equivalents thereof (registered
investment companies).
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Question 184: 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? What are the advantages and
disadvantages of subjecting regulated financial entities (such as
banks, insurance companies, broker-dealers, pension funds, and
registered investment companies or their foreign equivalents) to lower
risk weights? Please provide specific details and supporting evidence
on the alternative risk weights.
Question 185: 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 entities. What, if any,
alternatives should the agencies consider to more appropriately capture
the counterparty credit risk for such entities?
Question 186: 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
calibration should the agencies consider and why? If IMM were retained
as a method to calculate the capital requirements for counterparty
credit risk, what if any adjustments to the multiplier should the
agencies consider to reflect the generally reduced capital requirements
for banking organizations that use IMM for purposes of calculating the
BA-CVA?
B. Alpha Factor ([alpha])
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 under SA-CCR 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 \497\ and risks resulting from non-perfect
granularity).\498\ 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
counterparties that are commercial end-users.
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\497\ 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.
\498\ See 85 FR 4362 (Jan. 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.
---------------------------------------------------------------------------
Unlike SA-CCR, the exposure amount determined in the counterparty
credit risk framework under the current exposure methodology does not
reflect a multiplication factor. Accordingly, the proposal would set
the alpha factor equal to 1 for banking organizations that use the
current exposure methodology to calculate exposure amount in the
counterparty credit risk framework.
Question 187: 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 CVA hedges, as expressed by the
following formula:
[GRAPHIC] [TIFF OMITTED] TP27MR26.091
[[Page 15087]]
In general, the calculation of Khedged follows that of Kunhedged,
but introduces new terms to reflect the risk-mitigating effect of
eligible CVA hedges.\499\ The first term, ((r [middot]
[Sigma]C(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] [Sigma]c(SCVAc-
SNHc)2), recognizes the risk mitigating effect of single-
name hedges on the aggregate idiosyncratic component of aggregate CVA
risk. The third term, [Sigma]cHMAc, 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).
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\499\ 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
V.B.5.a.i. of this SUPPLEMENTARY INFORMATION.
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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) \500\ 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:
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\500\ 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] TP27MR26.092
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.
[GRAPHIC] [TIFF OMITTED] TP27MR26.093
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] TP27MR26.094
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:
[[Page 15088]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.095
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
V.A.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
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 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 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 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
[[Page 15089]]
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 the banking organization demonstrates to its primary
Federal supervisor the appropriateness of such mapping.\501\ 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). 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 help ensure that the
estimated term structure of market-implied PD reflects the market risk
premium for counterparty credit risk.
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\501\ For example, a banking organization may be permitted to
use the credit spread curve of the home country as a proxy for that
of a municipality in the home country (that is, setting the
municipality credit spread equal to the sovereign credit spread plus
a premium).
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II. Market-Consensus ELGD
In general, the proposal would require a banking organization to
use the market-consensus ELGD value that is used to calculate the
market-implied PDs from the counterparty's credit spreads. The fraction
of exposure that a banking organization would lose in the event of a
counterparty default (that is, loss given default) depends on the
seniority of the derivative contracts that the banking organization has
with the counterparty at the time of default. Most CDS contracts, which
are used to calculate the market-implied PD, allow for delivery of
senior unsecured bonds and thus have the same seniority as senior
unsecured bonds in bankruptcy. By generally requiring a banking
organization to use the same market-consensus ELGD as the one used in
calculations of the market-implied PD from the credit spreads, the
proposal would require a banking organization to generally assume that
derivative contracts' seniority is the same as the seniority of senior
unsecured bonds. If a banking organization's derivative contracts with
the counterparty are more or less senior to senior unsecured bonds, the
proposal would allow a banking organization to adjust the market-
consensus ELGD to appropriately reflect the lower or higher losses
arising from such exposures. However, the proposal would not allow a
banking organization to use collateral provided by the counterparty as
the justification for changing the market-consensus ELGD as the banking
organization would already have considered collateral in determining
its exposure to the counterparty.
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 the 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 calibrations 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 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.\502\ To determine collateral available to a
banking organization at a given exposure measurement time, the proposal
would require a banking organization's exposure model to assume that
the counterparty will not post or return any collateral within a
certain time period immediately prior to that time, known as the margin
period of risk (MPoR). The proposal specifies a minimum length of time
for the MPoR. For all CVA risk covered positions, the minimum MPoR is
equal to 9 + N business days, or 10 business days for margin agreements
[[Page 15090]]
with daily or intra-daily exchange of margin.
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\502\ 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.
---------------------------------------------------------------------------
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 V.A.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 weights in the proposed
sensitivities-based method for market risk outlined in section
V.A.7.a.iii. 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 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 bucket and then across 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 the
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 buckets within relevant risk classes. The 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.\503\ 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.
---------------------------------------------------------------------------
\503\ 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
[[Page 15091]]
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.\504\ 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.
---------------------------------------------------------------------------
\504\ 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.\505\ 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
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.
---------------------------------------------------------------------------
\505\ 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 credit and equity indices.\506\ For a CVA risk
covered position or an eligible CVA hedge whose underlying is an 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 an index where at least 75
percent of notional value for credit indices or market value for equity
indices of the 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 \507\ and calculating sensitivities to each constituent
may be impractical for such indices.
---------------------------------------------------------------------------
\506\ If a banking organization chooses to introduce such
additional risk factors, the banking organization would be required
to calculate CVA sensitivities to the index risk factors in addition
to sensitivities to the non-index risk factors.
\507\ For example, the credit index CDX has 125 constituents and
the equity index S&P 500 has 500 constituents.
---------------------------------------------------------------------------
C. 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 indices (under the optional treatment of 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.
[[Page 15092]]
The SA-CVA would offer an alternative, optional approach that
introduces additional index risk factors for indices. Specifically, for
each index referenced by eligible CVA counterparty credit spread risk
hedges, delta risk factors would be absolute shifts of the 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
indices would remain unchanged. For each distinct 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 index
sensitivity calculations would only affect eligible CVA hedges of
counterparty credit spread risk that reference the 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.
D. Risk Factors for Exposure-Related 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 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 buckets for foreign
exchange risk as individual foreign currencies. For each foreign
exchange 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 \508\ 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.
---------------------------------------------------------------------------
\508\ 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 buckets for the delta and vega risk
factors by sector and credit quality which is consistent with the
definitions of 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 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
V.B.5.b.ii.III.A. of this 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 buckets for delta and vega risk factors
generally matching the 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 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 V.B.5.b.ii.III.A.
and V.B.5.b.ii.III.B.3. of this 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 buckets for delta and vega risk factors
matching the 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 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
[[Page 15093]]
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. 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 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 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 bucket for the
corresponding risk classes (foreign exchange, non-securitization credit
spread, equity, and commodity), the SA-CVA would generally match the
values of these risk weights for both delta and vega risk factors.\509\
---------------------------------------------------------------------------
\509\ 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 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
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 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 188: The agencies seek comment on the appropriateness of
the proposed buckets, risk weights, and correlations for the exposure-
related risk classes. What, if any, alternative 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. 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 bucket definitions
and structure for the counterparty credit spread risk class based on
different counterparty types and the different roles 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. To
promote prudent risk management by improving recognition of certain
hedges of the counterparty credit spread component of CVA risk and to
better align the calibration of the CVA risk capital framework with the
underlying economic risk, 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 would not generally affect the risk weights
(Table 3 to Sec. __.225) in the counterparty credit spread risk class
that would generally follow the corresponding risk weights in the
sensitivities-based method for market risk.
Banking organizations often use single-name credit instruments to
hedge the counterparty credit spread
[[Page 15094]]
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 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 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 bucket separate from
sovereign exposures, specified supranational entities, and MDBs. Thus,
following the non-securitization credit spread 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 buckets, thus substantially reducing the effectiveness of the
hedge. In order to prevent a such scenario, the proposal would merge
the sovereign exposures, specified supranational entities, and MDBs
sector and the PSE, government-backed non-financials, GSE debt,
education, and public administration sector into a single 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 bucket as the
counterparty. Similar 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 buckets under the sensitivities-based
method, so the sensitivities-based method does not need the credit
quality difference correlation parameter.
To promote prudent risk management by improving recognition of
cross-sector index hedges of the counterparty credit spread component
of CVA risk, the agencies are proposing to increase the inter-bucket
correlation between bucket 8 (the index bucket) and buckets 1 through 6
from 45 to 70 percent. While the sensitivities-based method applies a
correlation value of 45 percent for cross-sector indices within the
non-securitization credit spread risk class, this would not
appropriately reflect counterparty credit spread risk within the CVA
risk framework. Counterparty credit spread risk class has a very
specific structure for purposes of the CVA risk, where firms would
offset the aggregate CVA amount, which is essentially a weighted sum of
individual counterparty credit spreads with positive weights, with a
cross-bucket index hedge, which represents its own bucket. Thus, for
purposes of the CVA risk capital requirement, the correlation parameter
between a specific single-name bucket and the index bucket should
reflect the actual correlation between the bucket-level CVA and a
cross-bucket index. Because the bucket-level CVA is a weighted sum of
the individual counterparty credit spreads within the bucket, it has a
substantial amount of idiosyncratic credit spread risk diversified away
and can be, therefore, viewed as a single-bucket index. Thus, the
correlation between the bucket-level CVA and the cross-bucket index is
comparable to the correlation between a single-bucket index and a
cross-bucket index. The agencies consider that this correlation is
substantially higher than 45 percent and are proposing to increase it
to 70 percent. This increase would improve recognition of cross-bucket
index hedges of counterparty credit spread component of CVA risk in SA-
CCR.
Question 189: The agencies seek comments on the appropriateness of
the proposed risk weights of Table 3 to Sec. __.225 for financials,
including government-backed financials. What, if any, alternative risk
weights should the agencies consider? Should regulated financial
institutions (such banks, insurance companies, broker dealers, pension
funds, registered investment companies, and their foreign equivalents)
be subject to lower risk weights? Please provide specific details and
supporting evidence on the alternative risk weights.
Question 190: To what extent are the proposed buckets, risk
weights, and correlations for counterparty credit spread risk class
appropriate? What, if any, alternative 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 buckets and then across 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 bucket b, a banking organization would aggregate
all net weighted sensitivities for all risk factors within this bucket
according to the following formula:
[[Page 15095]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.096
where WSk is the net weighted sensitivity to risk factor k,
WSkHdg is the weighted sensitivity of the market value of
all standardized CVA hedges to risk factor k, [rho]kl is the regulatory
correlation parameter between risk factors k and l within bucket b, and
R is the hedging disallowance parameter set at 0.01.
While this formula is similar to the intra-bucket aggregation
formula in the sensitivities-based method for market risk, it differs
by the presence of an additional term under the square root,
proportional to the hedging disallowance parameter R. The purpose of
this term is to prevent extremely small levels of Kb when most of the
risk factors k are perfectly hedged. For the case of perfect hedging
(WSk = 0 for all k), the term provides a floor equal to 10
percent of weighted sensitivities of the standardized CVA hedges,
aggregated as idiosyncratic risks.
Second, a banking organization would aggregate bucket-level capital
requirements across buckets within the same risk class according to the
following formula:
[GRAPHIC] [TIFF OMITTED] TP27MR26.097
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: \510\
---------------------------------------------------------------------------
\510\ 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.
[GRAPHIC] [TIFF OMITTED] TP27MR26.098
[GRAPHIC] [TIFF OMITTED] TP27MR26.099
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.\511\ The primary Federal supervisor would
notify the banking organization in writing that a different value must
be used.
---------------------------------------------------------------------------
\511\ 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 191: 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 192: 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 193: 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?
6. Reporting and Disclosure Requirements
Table 1 to Sec. __.217, ``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 GSIB's CVA risk
management framework, including processes implemented to identify,
measure, monitor, and control CVA risks and effectiveness of CVA
hedges. Table 2 to Sec. __.217, ``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
[[Page 15096]]
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.
VI. Disclosure Requirements
A. 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
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 most of the
existing required 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 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 that are not required by the proposal.
Under the current capital rule, Category I and II banking
organizations generally are subject to enhanced public disclosure in
comparison to other banking organizations. Under the proposal, the
enhanced public disclosure requirements would generally apply to any
Category I and II banking organizations and any banking organization
that opts into the expanded risk-based approach. Consistent with the
current capital rule, the proposed enhanced public disclosure
requirements would be required of the top tier banking organization
within a consolidated organization and not other entities within the
consolidated organization. Disclosure table 4 would only apply to
Category I and II banking organizations. These enhanced disclosure
requirements would promote transparency for market participants.
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.
B. Specific Public Disclosure Requirements
The proposed changes to disclosure requirements pertaining to the
risk-based capital framework are described below.\512\ Disclosure
tables 1,\513\ 2,\514\ 3,\515\ 4,\516\ 11 \517\ (table 9 to Sec.
__.162 in the proposal), and 12 \518\ (table 10 to Sec. __.162 in the
proposal) in Sec. __. 173 of the current capital rule would be
retained without material modification, although some of the table
numbers would change.
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\512\ The table numbers refer to the table numbers included in
the proposed rule.
\513\ See Table 1 to Sec. 3.173 (OCC); Sec. 217.173 (Board);
Sec. 324.173 (FDIC)--Scope of Application.
\514\ See Table 2 to Sec. 3.173 (OCC); Sec. 217.173 (Board);
Sec. 324.173 (FDIC)--Capital Structure.
\515\ See Table 3 to Sec. 3.173 (OCC); Sec. 217.173 (Board);
Sec. 324.173 (FDIC)--Capital Adequacy.
\516\ See Table 4 to Sec. 3.173 (OCC); Sec. 217.173 (Board);
Sec. 324.173 (FDIC)--Capital Conservation and Countercyclical
Capital Buffers.
\517\ 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.
\518\ See Table 12 to 3.173 (OCC); Sec. 217.173 (Board); Sec.
324.173 (FDIC)--Interest Rate Risk for Non-Trading Activities.
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The proposal would retain the requirement that Category I and II
banking organizations disclose their 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 Category I or II banking organization to
describe its risk management objectives as they relate to the
organization overall. The required disclosures would include
information regarding how each Category I and II banking organization's
business model determines and interacts with the overall risk profile;
how this risk profile aligns with the parameters of the risk tolerance
approved by its board of directors; 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 Category I and II
banking organizations' approaches 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.\519\ In addition, the proposal would require Category I
and II banking organizations to disclose certain additional information
regarding its risk management policies and objectives for credit risk.
Specifically, the proposal would require Category I and II banking
organizations to enhance their existing disclosures by describing how
their 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, Category I and
II banking organizations would be required to disclose the
organizational structure of their credit risk management and control
function as well as interactions with other functions. Category I and
II banking organizations would also be required to disclose information
on their policies related to reporting of credit risk exposure and the
credit risk management function that are provided to the banking
organization's leadership.
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\519\ See Table 5 to Sec. 3.173 (OCC); Sec. 217.173 (Board);
Sec. 324.173 (FDIC)--Credit Risk--General Disclosures.
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Table 6 to Sec. __.162, ``General Disclosure for Counterparty
Credit Risk-Related Exposures,'' would include the disclosures Category
I and II banking organizations are required to make under the current
capital rule regarding their approach to managing counterparty credit
risk.\520\ The proposal would also include new disclosure requirements
regarding Category I and II banking organizations' methodology for
assigning economic capital for counterparty credit risk exposures as
well as their policies
[[Page 15097]]
regarding wrong-way risk exposures. Additionally, the proposal would
further require Category I and II banking organizations to disclose
their 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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\520\ See Table 7 to Sec. 3.173 (OCC); Sec. 217.173 (Board);
Sec. 324.173 (FDIC)--General Disclosure for Counterparty Credit
Risk of OTC Derivative Contracts, Repo-Style Transactions, and
Eligible Margin Loans.
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Table 7 to Sec. __.162, ``Credit Risk Mitigation,'' would include
the disclosures Category I and II banking organizations are required to
make under the current rule regarding their approach to credit risk
mitigation.\521\ In addition, the proposal would specify that Category
I and II banking organizations must provide a meaningful breakdown of
their 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,\522\ 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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\521\ See Table 8 to Sec. 3.173 (OCC); Sec. 217.173 (Board);
Sec. 324.173 (FDIC)--Credit Risk Mitigation.
\522\ See section IV.A.5. of this SUPPLEMENTARY INFORMATION for
a more detailed discussion on the types of credit risk mitigants
that a banking organization would be allowed to recognize for
purposes of calculating risk-based capital requirements.
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Table 8 to Sec. __.162, ``Securitization,'' would include the
disclosures Category I and II bank holding companies are required to
make under the current capital rule regarding their approach to
securitization.\523\ In addition to the existing qualitative
disclosures related to securitization, the proposal would require
disclosure of whether the banking organization provides implicit
support to a securitization and the risk-based capital impact of such
support.
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\523\ See Table 9 to Sec. 3.173 (OCC); Sec. 217.173 (Board);
Sec. 324.173 (FDIC)--Securitization.
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Table 11 to Sec. __.162, ``Additional Disclosure Related to the
Credit Quality of Assets,'' is a new disclosure table that would
require Category I and II 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 12 to Sec. __.162, ``General Qualitative Information on a
Banking Organization's Operational Risk Framework,'' is a new
disclosure table that would require a Category I and II banking
organizations 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;
the systems and data used to calculate 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 13 to Sec. __.162, ``Main Features of Regulatory Capital
Instruments and of Other TLAC-Eligible Instruments,'' is a new
disclosure table that would require Category I banking organizations to
disclose information regarding the terms and features of its regulatory
capital instruments and other instruments eligible for TLAC.\524\ In
addition, the proposal would require a Category I bank holding company
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. Category I bank holding companies would
also be required to describe the main features of their covered debt
positions and provide disclosures of the full terms and conditions of
all covered debt positions.
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\524\ For purposes of Table 13, 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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Question 194: The agencies invite comment on the utility of the
proposed public disclosure requirements. What additional
considerations, if any, should the agencies consider with regard to the
scope and granularity of the proposal's disclosure requirements? What
are the advantages and disadvantages of the proposed disclosure
requirements?
VII. Estimated Impact on Capital Requirements
The proposal would revise the calculation of risk-weighted assets
for Category I and II banking organizations and other banking
organizations choosing to adopt the expanded risk-based approach, as
well as the calculation of market risk and CVA risk requirements for a
small number of other banking organizations. These changes would in
turn affect these banking organizations' risk-based capital
requirements. The impact on required capital would depend on banking
organizations' risk exposures as well as the other capital requirements
to which they are subject.
The remainder of this section provides estimates of the impact of
the proposal on risk-weighted assets and capital requirements, with
particular focus on Category I and II banking organizations. Section
VII.A provides the impact of this proposal relative to the current
capital requirements, inclusive of applicable buffer requirements and
reflecting recently finalized changes to the enhanced supplementary
leverage ratio standards (recent eSLR changes).\525\ To provide a
broader perspective of recent capital reforms, section VII.B provides
cumulative impact estimates of both recent and concurrent capital-
related proposals that would affect these banking organizations. The
set of proposals considered jointly includes the recent eSLR changes,
the Board's GSIB surcharge proposal, and proposed changes to the
Board's supervisory stress test.\526\ Section VII.C attributes the
impact across several broad areas of banking activity. Section VII.D
describes the data and estimation methodology used in this section.
Discussion of the economic impact of these changes to capital
requirements is provided in section VIII.
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\525\ See 90 FR 55248 (Dec. 1, 2025).
\526\ See Federal Reserve Board Requests Comment on Proposals to
Enhance the Transparency and Public Accountability of its Annual
Stress Test (Oct. 24, 2025), https://www.federalreserve.gov/newsevents/pressreleases/bcreg20251024a.htm.
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A. Standalone Effect of Proposed Capital Rule Changes
Table VII.1 below presents the estimated impact of the proposal on
aggregate capital requirements for Category I and II banking
organizations. While banking organizations' minimum regulatory capital
ratios and capital
[[Page 15098]]
buffer requirements have distinct, complementary purposes, the
estimates in this proposal represent requirements inclusive of GSIB
surcharge and stress capital buffer requirements, as described below,
in order to present impact as a single quantity. In addition, the
standalone impact estimates of the proposal on tier 1 capital
requirements reflect the recent eSLR changes. The methodology behind
the estimates is described in section VII.D.
[GRAPHIC] [TIFF OMITTED] TP27MR26.100
The agencies estimate that the proposal would increase aggregate
common equity tier 1 capital requirements for Category I and II bank
holding companies by about 1.4 percent relative to current requirements
and would increase their aggregate tier 1 capital requirements by about
1.6 percent. Across Category I and II depository institution
subsidiaries, the proposal is estimated to decrease aggregate common
equity tier 1 and tier 1 capital requirements by about 4.8 and 2.3
percent, respectively. The proposal would increase aggregate capital
requirements for holding companies but decrease them for depository
institutions because the proposal has a different impact on their
aggregate risk-weighted assets, detailed below. Specifically, market
risk-weighted assets, which generally increase under the proposal, and
operational risk-weighted assets are relatively concentrated at the
holding company level. The decrease in tier 1 capital requirements for
depository institutions is limited by binding leverage requirements for
several banks.
The capital impact estimates are based on balance sheets as of 2025
Q2 and GSIB surcharges that would be applicable in early 2026 under the
current rule.\527\ The estimates represent a simple average of the
impact calculated using the stress capital buffer requirement from the
2024 stress test and the impact using the stress capital buffer
requirement from the 2025 stress test. While the specific stress test
and level of the resulting stress capital buffer requirement has little
effect on the percentage impact of this proposal,\528\ it can
materially change the impact of other capital changes considered
cumulatively with the proposal. The analysis therefore considers an
average across two years to mitigate effects of a specific year on the
impact estimates.
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\527\ These GSIB surcharges are based on the firm-specific
minimum of GSIB scores from year-end 2023 and 2024 derived from FR
Y-15 Systemic Risk Report data.
\528\ For example, the increase in aggregate common equity tier
1 capital requirements is 1.5 and 1.3 percent when using stress
capital buffer requirements from 2024 and 2025, respectively.
However, the capital impact of the enhanced supplementary leverage
ratio proposal on aggregate tier 1 capital requirements of Category
I and II bank holding companies would have been a decrease of 0.4
percent and 4.2 percent using 2024 and 2025 stress capital buffer
requirements respectively.
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As detailed in section VII.D.5, the methodology behind these
estimates abstracts from bucketing and rounding effects that are
present in the capital rule and that would primarily add noise to
estimates. In addition, capital requirements include amounts of assets
that are subject to threshold-based capital deductions so that deducted
and risk-weighted portions of such exposures are treated comparably.
The cumulative effect of these methodological choices is small in
aggregate.\529\
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\529\ If using bucketed GSIB surcharges and rounded stress
capital buffer requirements, and excluding threshold deductions from
requirements, the estimated change in the aggregate common equity
tier 1 capital requirements of Category I and II banking
organizations would be an increase of about 0.9 percent.
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As described in section VII.D.1, the estimated changes in risk-
weighted assets are extrapolated from the Federal Reserve's Basel III
Endgame Special Data Collection. This data collection details exposures
as of Q2 2023 under the agencies' 2023 Basel III proposal. Adjustments,
as described in section VII.D.1.c, are applied to these data to reflect
the current proposal, and the resulting estimates are then extrapolated
to data as of Q2 2025. This extrapolation procedure, also described in
section VII.D.2, accounts for changes in the composition of exposures
across different areas of risk, but does not reflect changes in impact
associated with changes in the composition of exposures within each of
these areas. For example, the extrapolated estimates reflect changes in
impact due to a different growth rate of residential real estate
lending and trading activities, but would not reflect changes in impact
due to a shift in the LTV ratios of the real estate exposures or the
composition of the risk within market risk covered positions. Thus,
there may be a tradeoff whereby estimates with as of dates closer to Q2
2023 may more accurately reflect capital impact at that point in time
than later estimates, but later estimates may still be more informative
of impact going forward given that they account for how banking
activity has shifted at a high level. Regardless, when using risk
exposures and banking activity as of intermediate calendar quarters
between Q2 2023 and Q2 2025, the estimated aggregate impact on common
equity tier 1 capital requirements varies between an increase of 0.6
percent and an increase of 1.4 percent. Thus, changes in the broad
composition of large banking organizations' balance sheets and activity
over the past few years, as measured, have not materially affected the
estimated impact of this proposal on capital requirements.
Importantly, all of these impact estimates are made ex-ante--before
banking activity and risk exposures have adjusted to any changes in
incentives that may result from the proposal.\530\ As the proposal goes
into
[[Page 15099]]
effect, banking organizations might increase activities that would
receive relative reductions in requirements or decrease activities that
would receive relative increases in requirements, which could result in
a lower ex-post level of capital requirements.
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\530\ Arguably, to the extent that some aspects of the
proposal's impact might have been anticipated in advance, some of
the impact of its effect on incentives may already be reflected in
banking organizations' risk exposures and activity.
---------------------------------------------------------------------------
While all impact estimates in this proposal reflect aggregates
across banking organizations, the impact on individual banking
organizations would vary. Across the nine Category I and II bank
holding companies, the standard deviation of the percentage impact on
common equity tier 1 capital requirements is estimated at about 8.7
percent. In general, firm-specific impact is well explained by
variation in exposure to risk categories or engagement in business
activities that face different impacts under the proposal.
While this proposal would change both the numerator and denominator
of risk-based capital ratios,\531\ the impact operates primarily
through the denominator, risk-weighted assets. To simplify discussion
of the impact of the proposal on requirements at a more granular level,
the analysis focuses on changes to risk-weighted assets.
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\531\ The impact on the numerator includes the removal of
capital deductions for above-threshold mortgage servicing assets.
While no Category I or II banking organizations currently have any
such deductions, the removal of the deduction treatment may have a
significant effect on these banking organizations' incentives to
originate and service mortgages, as discussed in section VIII.D.2.
In addition, impact estimates account for changes to required
capital ratios due to how changes in risk-weighted assets affected
the stress capital buffer requirement and the short-term wholesale
funding score in the current GSIB surcharge rule. Also, the proposal
affects capital requirements by removing the advanced approaches
requirements, which occasionally are larger than standardized
requirements for some banking organizations.
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Table VII.2 provides risk-weighted assets for Category I and II
bank holding companies aggregated by risk category across the current
standardized approach, the advanced approaches,\532\ and the proposed
expanded risk-based approach. Under the proposal, the aggregate risk-
weighted assets for such Category I and II banking organizations would
increase by about 1.9 percent compared to the current standardized
approach (which produces the binding risk-based capital requirements
for nearly all of the banking organizations). Market risk-weighted
assets increase by approximately 20 percent under the proposal.
However, as discussed in section VII.C, the cumulative effect on the
requirements applicable to trading activities of this and related
capital proposals is more moderate. Meanwhile, combined risk-weighted
assets for credit, operational, and CVA risks are roughly equal to
general credit risk-weighted assets under the current standardized
approach. For the depository institution subsidiaries of these
organizations, risk-weighted assets would decrease by 3.0 percent
relative to the standardized approach on aggregate, consistent with the
relatively smaller amount of trading activity at the level of the
depository institution.
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\532\ For purposes of sections VII and VIII, the term ``advanced
approaches'' refers to a banking organization's total risk-weighted
asset amount based on the sum of its risk-weighted assets calculated
for credit, CVA, and operational risks plus, if applicable, risk-
weighted assets for market risk, minus certain deductions.
[GRAPHIC] [TIFF OMITTED] TP27MR26.101
[[Page 15100]]
1. Impact on Other Banking Organizations 533 534
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\533\ Data in the ``Total'' rows of the table also reflect
deductions from risk-weighted assets for excess allowances for
credit losses and allocated transfer risk reserves.
\534\ Includes all depository institution subsidiaries of
Category I and II bank holding companies.
---------------------------------------------------------------------------
In addition to the revisions to the capital requirements of
Category I and II banking organizations, the proposal would introduce
certain changes to the capital requirements of non-Category I or II
banking organizations. Specifically, the proposed market risk capital
requirements would apply to banking organizations with significant
trading activity, while no longer applying to a small number that would
not meet the proposed applicability thresholds. In addition, some of
the banking organizations that would remain subject to market risk
capital requirements and have substantial exposure to OTC derivatives
would become subject to capital requirements for CVA risk. For these
non-Category I and II banking organizations that would remain subject
to market risk capital requirements, the proposed market risk and CVA
requirements would increase common equity tier 1 capital requirements
by 0.9 percent.\535\
---------------------------------------------------------------------------
\535\ The aggregate impact is small as the additional CVA
requirements are significantly offset by estimated reductions in
market risk-weighted assets for smaller banking organizations under
the proposal.
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Furthermore, other banking organizations would have the option to
apply the expanded risk-based approach. The agencies estimate that
three Category III or IV holding companies would see a reduction in
capital requirements in the range of three to seven percent if they
were to choose to apply the expanded risk-based approach instead of the
concurrently proposed revised standardized approach. In addition, the
agencies estimate that about a third of banking organizations below
Category IV would see reductions in capital requirements of between
five and ten percent if they were to apply the expanded risk-based
approach, although only a small number might see a reduction in capital
requirements greater than ten percent. However, various features of the
expanded risk-based approach that are appropriate for larger and more
complex banking organizations, such as the requirements to adopt SA-CCR
and reflect most elements of accumulated other comprehensive income in
regulatory capital, may make the framework unappealing to many smaller
banking organizations. Section VIII.F.2 considers further how other
banking organizations' may respond to the optional application of this
rule.
Lastly, while banking organizations that remain below the Category
I and II applicability thresholds would retain this optionality, those
that subsequently become Category I or II banking organizations would
become subject to the proposal's requirements. The different treatment
of business activities under the proposal may affect the incentives of
smaller banking organizations that plan to elect to use the expanded
risk-based approach.
B. Cumulative Effect of Proposed Capital Rule Changes
Other recently finalized or proposed revisions that relate to the
regulatory capital framework could also materially affect the capital
requirements of Category I and II banking organizations. These include
(1) the recent eSLR changes, (2) the concurrent GSIB surcharge
proposal, and (3) the Board's proposed stress test changes for the
Board's supervisory stress test,\536\ which would inform the Board's
determination of a bank holding company's stress capital buffer
requirement.\537\ This section estimates the impact of this Stress Test
Transparency Proposal jointly with these other capital reforms.
Specifically, the stress testing component of the cumulative analysis
here incorporates the data published in the Stress Test Transparency
Proposal, which projected impacts to stress capital buffer requirement
determinations as if the proposed model changes and proposed revisions
to the global market shock scenario design had been implemented in the
2024 and 2025 stress tests, independent of other factors that affect
the determination of a banking organization's stress capital buffer
requirement.\538\ In addition, this section provides some historical
context for the overall cumulative impact of these proposals on capital
requirements.
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\536\ The ``proposed stress test changes'' refer to the proposed
model changes and revisions to the global market shock component
announced in connection with the Board's proposal to enhance the
transparency and public accountability of the Board's supervisory
stress test. See Board, Enhanced Transparency and Public
Accountability of the Supervisory Stress Test Models and Scenarios;
Modifications to the Capital Planning and Stress Capital Buffer
Requirement Rule, Enhanced Prudential Standards Rule, and Regulation
LL, 90 FR 51856 (Nov. 18, 2025) (the ``Stress Test Transparency
Proposal'').
\537\ This analysis excludes consideration of the proposal to
reduce the volatility of the stress capital buffer requirement,
which would not have any standalone impact on the determination of a
bank holding company's stress capital buffer requirement. Instead,
the proposal would reduce the volatility of the stress capital
buffer requirement by averaging the maximum common equity tier 1
capital declines projected in each of the Board's prior two annual
supervisory stress tests to inform a bank holding company's stress
capital buffer requirement. See Board, Modifications to the Capital
Plan Rule and Stress Capital Buffer Requirement, 90 FR 16843 (Apr.
22, 2025).
\538\ The estimated capital impact described in this cumulative
analysis with respect to the proposed stress test changes announced
in the Stress Test Transparency Proposal incorporates the underlying
data published by the Board in the Stress Test Transparency
Proposal, without changes to the underlying data. That proposal
included illustrative analysis that considered the potential effects
of the proposed stress test model and scenario changes, independent
of other factors and components that inform the Board's stress
capital buffer determinations for specific bank holding companies,
within the 2024 and 2025 supervisory stress tests. As stated in the
Stress Test Transparency Proposal, in aggregate, the proposed stress
test model and scenario changes are not expected to materially
change capital requirements for bank holding companies subject to
the supervisory stress test, across various stress scenarios and
jump-off conditions at the start of the test.
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In addition to capital requirements, the proposal's adjustments to
risk-weighted assets would also affect the Board's total loss absorbing
capacity (TLAC) and long-term debt requirements for U.S. GSIBs. The
estimated impact of this proposal on TLAC and long-term debt
requirements is described in the economic analysis section contained in
the Board's separate notice of proposed rulemaking for the GSIB
surcharge proposal.
I. Cumulative Impact of Recent Proposals on Capital Requirements
Table VII.3 provides estimates of the combined impact of these
revisions on Category I and II bank holding companies' aggregate common
equity tier 1 and tier 1 capital requirements. The rightmost column in
the table presents aggregate leverage requirements for these bank
holding companies as a share of aggregate tier 1 capital risk-based
requirements.\539\
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\539\ As with the estimates reported earlier, the estimates in
section VII.B reflect the GSIB surcharge that would be applicable in
early 2026.
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[[Page 15101]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.102
The combined impact of this proposal and the GSIB surcharge
proposal on GSIBs' aggregate common equity tier 1 capital requirements
would be a decrease of 2.4 percent. When combined with the proposed
stress test changes, the decrease would be 4.8 percent, based on the
average impact across 2024 and 2025 stress tests. The aggregate
combined capital impact of the proposals is close to the sum of their
standalone impact, as there are limited interactions between them.
Turning to tier 1 capital, the recent eSLR changes are projected to
reduce requirements for Category I and II bank holding companies by
about 2.3 percent. When combined with this proposal, the GSIB surcharge
proposal, and the stress testing changes, the reduction in aggregate
tier 1 capital requirements is projected to be 6.0 percent. The
estimated cumulative reduction of tier 1 capital requirements is only
about 1.2 percentage points larger than for common equity tier 1
capital requirements (6.0 percent decrease versus 4.8 percent decrease)
despite the 2.3 percent reduction due to recent eSLR changes because
tier 1 leverage requirements would become binding for two of the bank
holding companies.
The final column of Table VII.3 shows how binding the leverage and
risk-based tier 1 capital requirements are by reporting the ratio of
the aggregate leverage to risk-based requirements.\540\ Before the
recent eSLR changes, aggregate leverage and risk-based tier 1 capital
requirements were almost equal for Category I and II bank holding
companies. With the recent eSLR changes, aggregate risk-based
requirements would remain significantly higher than leverage
requirements after accounting for the cumulative effects of the
proposed changes to risk-based requirements, preserving the role of
leverage as a backstop capital requirement.
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\540\ Prior to this proposal, the denominator of this ratio is
measured using the greater of advanced approaches and standardized
approach requirements.
---------------------------------------------------------------------------
Also, while these estimates reflect an average across requirements
under 2024 and 2025 stress tests, the specific stress test
significantly affects the impact of certain of these changes in
particular. The potential impact of the proposed stress test changes
are conditional on the specific stress scenario used. In addition, the
level of the stress capital buffer requirement affects the relative
level of risk-based and leverage capital requirements, and thus the
effect of the recent eSLR changes.
While these proposals would result in a reduction relative to
current capital requirements, requirements would still remain higher
than they would be absent certain increases in capital requirements in
recent years. To illustrate this, Figure VII.1 below plots common
equity tier 1 capital requirements for Category I and II bank holding
companies under two scenarios.\541\ The black curve provides
requirements under the then-current rules. The gray curve provides a
counterfactual where past increases in capital requirements that do not
clearly respond to increasing banking system risks have been
neutralized. First, the counterfactual assumes that method 2
coefficients are indexed such that they grow at the same rate as method
1 scores beginning in Q4 2019. This date is chosen as the lack of
indexation in method 2 becomes particularly apparent as GSIBs' balance
sheets expand rapidly in response to monetary and fiscal policy actions
taken in the global COVID-19 pandemic. In addition, the counterfactual
replaces the stress capital buffer requirement, which came into effect
in late 2020, with an estimate of what capital requirements would have
been under the previous stress testing framework.\542\ The
counterfactual also neutralizes the aggregate impact on risk-weighted
assets of the introduction of the standardized approach for
counterparty credit,\543\ and reduces requirements by the estimated
amount
[[Page 15102]]
of the impact of the current expected credit losses (CECL) accounting
standard on common equity tier 1 capital.\544\ The gap between the two
curves grows in early 2020 due to CECL, in late 2020 due to the stress
capital buffer requirement, in 2022 due to SA-CCR, and gradually widens
over time due to the impact of this balance sheet growth on method 2
scores. The gap is especially large in 2023 due to the impact of the
stress capital buffer requirement under the 2022 stress test. The blue
diamond on the plot represents requirements in Q2 2025 after the
estimated cumulative reduction in requirements of 4.8 percent under the
several recently proposed revisions.\545\ In comparison, aggregate
common equity tier 1 capital requirements are lower under the
counterfactual.
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\541\ This plot is constructed using rounded stress capital
buffer requirements and threshold deductions are not included in
requirements.
\542\ Specifically, the counterfactual subtracts planned
cumulative common stock dividends and net share repurchases from
holding companies' stress CET1 capital over the whole 9-quarter
stress period, then recalculates the maximum decline in the CET1
ratio, and sets a stress requirement equal to 4.5% plus this maximum
decline of standardized risk-weighted assets. Overall CET1 capital
requirements under the counterfactual equal the greater of this
stress requirement or the greater of standardized and advances
approaches risk-weighted assets multiplied by 7.0% plus the GSIB
surcharge. The counterfactual does not account for changes in
assumed stress balance sheet growth that were part of the stress
capital buffer rule, but does account for the counterfactual's
changes to risk-weighted assets (for SA-CCR) and allowances (for
CECL). See Federal Reserve Board approves rule to simplify its
capital rules for large banks, preserving the strong capital
requirements already in place (Mar. 4, 2020), https://www.federalreserve.gov/newsevents/pressreleases/bcreg20200304a.htm.
\543\ Based on values reported in eight of the nine banking
organizations' SEC 10-Q/K filings following SA-CCR adoption (Q2 2020
for Bank of America, Q4 2021 for Goldman Sachs and Morgan Stanley,
and Q1 2022 for all others), in aggregate, at adoption, SA-CCR
increased risk-weighted assets associated with derivatives exposures
by about 15.8 percent. Consequently, in every quarter following SA-
CCR adoption, each banking organizations' risk-weighted assets for
derivative exposures under the counterfactual is scaled by 1.158.
\544\ The impact of additional allowances under CECL in each
quarter after adoption is estimated as equal to the capital impact
at adoption (January 1, 2020), multiplied by the ratio of the
current balance of allowances for loans and lease losses divided by
the sum of the balance of such allowances on December 31, 2019, plus
the impact of CECL on allowances at adoption. Data are from the FR
Y-9C, with reference codes (MDRM) as follows: capital impact at
adoption (BHCKJJ26), allowance impact at adoption (BHCKJJ28), and
allowances for loans and lease losses (BHCT3123).
\545\ The dollar amount of common equity tier 1 requirements in
this plot do not correspond with dollar requirements elsewhere in
this proposal, primarily because the analysis elsewhere uses an
average impact across 2024 and 2025 stress capital buffer
requirements and GSIB surcharges applicable in 2026.
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Figure VII.1
[GRAPHIC] [TIFF OMITTED] TP27MR26.103
2. Cumulative Impact of Recent Proposals on Common Equity Tier 1
Capital Requirements by Risk Type
The analysis now turns to the cumulative impact at the more
granular level, focusing on the specific types of risk measured under
the proposal: credit, operational, market, and CVA. The cumulative
impact on capital requirements for each risk type can differ markedly
from what is implied by the proposal's standalone impact on risk-
weighted assets.
As an example, capital requirements for trading activity are
affected not only by risk-weighted assets for market risk but also by
the overall required capital ratio, which is affected by a banking
organization's stress capital buffer requirement. As a result, capital
requirements for trading activities are also informed by the revenues
and losses such activities generate in the Board's supervisory stress
test, independent of other factors, which depend on the scenarios and
models used to project outcomes.
As the minimum capital requirements is a fixed percentage point
amount regardless of the composition of the banking organization's
risks, it can be mapped straightforwardly to risk types based on the
risks' share of risk-weighted assets. However, both the GSIB surcharge
and stress capital buffer requirement reflect a banking organization's
composition of risks, and thus attributing these requirements to risk
types is conceptually more complex. Given that the GSIB surcharge
proposal has a relatively limited impact on the composition of risks
reflected by GSIB scores, this analysis makes the simplifying
assignment of GSIB surcharge requirements to risks in proportion to
their share of risk-weighted assets as well.
As discussed in the Stress Test Transparency proposal, the proposed
stress test changes, independent of other factors, could affect the
composition of risks reflected in the modeled losses.\546\ Therefore, a
more detailed approach to attributing the stress capital buffer
requirement is undertaken in this analysis. The approach first
considers
[[Page 15103]]
whether the bank holding company's stress capital buffer requirement
has been consistently bound by the 2.5 percent floor. For holding
companies with stress capital buffer requirements consistently set at
2.5 percent, the requirement is effectively independent of the stress
losses each risk type might generate, and so the 2.5 percent buffer is
attributed to risks in proportion to each risk's share of risk-weighted
assets. For other holding companies, however, the hypothetical losses
generated by risks are reasonably likely to affect the stress capital
buffer requirement. For these remaining banking organizations, each
modelled driver of the maximum decline in the common equity tier 1
capital ratio under the stress scenario is mapped to risks. Similarly,
proposed stress test changes are mapped to risks.
---------------------------------------------------------------------------
\546\ In aggregate, the stress test model and scenario changes
are not expected to materially change capital requirements for bank
holding companies subject to the supervisory stress test, across
various stress scenarios and jump-off conditions at the start of the
test. However, notwithstanding the limited overall effect on
stressed CET1 capital ratios, there may be significant variation
across the different loss drivers. For example, the proposed changes
could result in less severe credit, market, and operational loss
estimates. See 90 Federal Register 51856, 51874-51877 (Nov. 18,
2025).
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Some of this mapping is relatively straightforward, such as mapping
losses associated with provisions to credit risk, trading losses to
market risk, counterparty losses to credit risk, and operational losses
to operational risk. Revenue sources or other losses are mapped using
blunt assumptions. Specifically, interest expenses and offsetting
account fees are attributed across market and credit risk in proportion
to the holding company's trading versus non-trading assets.
Compensation and general noninterest expenses are attributed across
risks in proportion to their estimated business-as-usual net revenues.
Potential changes in capital requirements due to reconciliation of
differences in accounting, tax and regulatory treatments are then
allocated proportionally across each risk's contributions to the common
equity tier 1 capital decline under the stress capital buffer, which is
informed by the Board's stress test results. Finally, potential
declines in the common equity tier 1 capital ratio associated with
planned distributions are attributed across risks in proportion to
their share of risk-weighted assets. Further details of this
attribution process are in section VII.D.
Table VII.4 below presents estimates of how common equity tier 1
capital requirements are cumulatively affected by the proposed
revisions to capital requirements and the proposed stress test changes.
The first two columns provide requirements under the current advanced
and standardized approaches. While the standardized approach does not
include measures of operational or CVA risk-weighted assets,
requirements for these risks in the standardized approach column result
from their contribution to the stress capital buffer requirement. The
``binding'' requirement is determined by which requirement is commonly
binding for that bank holding company. Specifically, for all but two
bank holding companies, the standardized approach requirement has been
binding over at least the past five years, so their binding
requirements are set equal to the standardized approach. For the other
two bank holding companies, where the advanced approaches have
occasionally been binding, the binding requirement reflects an average
of the standardized and advanced approaches capital requirements.\547\
The requirements under the combined proposals column represents risk-
weighted assets measured under this proposal, GSIB surcharges computed
under the corresponding GSIB surcharge proposal, and stress capital
buffer requirements recalculated when applying the proposed revisions
to the stress test, independent of other factors, to historical 2024
and 2025 stress testing scenarios.
---------------------------------------------------------------------------
\547\ For these two bank holding companies, the share of
requirements attributed to each risk stripe under standardized and
advanced approaches is averaged, and then multiplied by the maximum
of standardized and advanced approaches requirements.
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[[Page 15104]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.104
In aggregate, common equity tier 1 capital requirements would
decrease modestly--by about 5 percent--with notable differences across
risk types. The binding requirement is projected to decline from $860
billion under current rules to $818 billion under the combined
proposals.
---------------------------------------------------------------------------
\548\ The changes reported reflect the simple average of the
percentage change calculated separately using 2024 and 2025 stress
tests, and thus differ from the change computed from the dollar
amounts in the columns to the left.
\549\ Statistics used in agency calculations are from the
special data collection, FR Y-9C, and FR Y-14 forms as of June 30,
2025. See FFIEC 031 Form Statistics. For Form Y-14M, see Board of
Governors of the Federal Reserve System, Reporting Forms: FR Y-14M
(Capital Assessments and Stress Testing) (version June 2025) (``Form
FR Y-14M''), https://www.federalreserve.gov/apps/reportingforms/Report/Index/FR_Y-14M. For FR Y-14Q, see Board of Governors of the
Federal Reserve System, Reporting Forms: FR Y-14Q (Capital
Assessments and Stress Testing) (version June 2025) (``Form FR Y-
14Q''), https://www.federalreserve.gov/apps/reportingforms/Report/Index/FR_Y-14Q.
---------------------------------------------------------------------------
Credit risk capital requirements would decline by about 10.0
percent under the combined proposals. This decline occurs because the
Basel III proposal would generally reduce risk weights for credit
exposures, and the proposed stress test changes are not projected to
meaningfully modify the capital requirements applicable to credit risk.
Therefore, the combined proposals' effects on credit risk capital
requirements are more directly aligned with the changes in credit risk-
weighted assets implied by the expanded risk-based approach.
Operational risk capital requirements would increase because the
Basel III proposal includes operational risk-weighted assets in the
expanded risk-based approach. However, the proposed stress test changes
would meaningfully reduce the operational risk requirements embedded in
the stress capital buffer requirement in this analysis. Taking both the
Basel III and the proposed stress test changes together, the
requirement for operational risk would increase by about 14.9 percent.
Still, operational risk requirements would be substantially lower than
those that currently result from banking organizations' internal models
under the advanced approaches.
Cumulative market risk capital requirements are projected to
decline by approximately 5.8 percent.\550\ The increase in market risk-
weighted assets as a result of the Basel III proposal would be more
than offset by the proposed changes to the global market shock
component of the Board's stress test. The changes to the global market
shock component would better align the liquidity horizons used to
calibrate risk-factor shocks.
---------------------------------------------------------------------------
\550\ The reduction would be larger when considering the
proposed changes, independent of other factors, as implemented for
the 2024 stress test than under the 2025 stress test.
---------------------------------------------------------------------------
Finally, CVA capital requirements would increase substantially
because CVA risk-weighted assets would be included in the single risk-
based capital requirement applicable to Category I and II banking
organizations. The binding common equity tier 1 capital requirement for
CVA risk would rise about 96 percent increase. Still, CVA risk would
continue to represent a small
[[Page 15105]]
share of total risk-based capital requirements compared with credit and
operational risk. Also, the share of capital requirements for CVA risk
would remain similar to its share under the advanced approaches.
C. Impact by Banking Activities
To assess how the proposal may affect the incentives for Category I
and II banking organizations to engage in different lines of business,
this section analyzes the proposal's estimated impact on the risk-
weighted assets associated with different banking activities. The
section then turns to an analysis of the cumulative impact of the
recent and concurrent capital-related proposals considered in the
previous section, on the common equity tier 1 capital requirements of
these banking activities.
1. Impact on Risk-Weighted Assets by Banking Activity
A single banking activity can be associated with several categories
of risk-weighted assets under the expanded risk-based approach. For
example, mortgage intermediation can generate credit risk-weighted
assets associated with mortgages, mortgage-backed securities, and
mortgage servicing assets. In addition, the interest income on the
mortgages, fee income on mortgage originations or servicing, and gains
on mortgage sales or securitizations would increase risk-weighted
assets for operational risk through their inclusion in the business
indicator. Thus, all sources of risk-weighted assets need to be
considered to understand how the proposal may affect overall capital
requirements--and thereby the funding costs--associated with an
activity. Conversely, a single category of risk-weighted assets does
not generally represent a single type of banking activity. For example,
credit risk-weighted assets could represent a loan to a household to
buy a car, a line of credit to a nonbank financial company, debt
securities primarily held to preserve the banking organization's
liquidity, or an exposure to a corporate counterparty on a derivative
contract.
To assess the impact of the proposal on different banking
activities, risk-weighted assets were decomposed into three areas
intended to be broadly representative of banking organizations' high-
level functions: traditional lending, credit facilitation, and trading-
related activity. The remaining bank exposures and activities represent
banking services, such as wealth management and corporate treasury, as
well as fixed assets that could not be neatly slotted into the three
primary activity areas.
The largest category of banking activity is what is described here
as traditional lending, which primarily serves to fund the economic
activity of households and non-financial businesses. In this analysis,
traditional lending includes exposures to loans, debt securities
(including securitizations), and undrawn commitments. Traditional
lending is further subdivided into residential mortgage lending, other
retail lending, and corporate lending. Residential mortgage lending
includes loans, residential mortgage-backed securities and mortgage
securitization and servicing activity. Other retail lending captures
all other forms of credit extension to households, such as credit
cards, auto loans, installment loans, and student loans. In addition,
loans to small businesses below $1 million are included in retail
lending. Corporate lending consists of larger loans to non-financial
sector businesses and includes both commercial and industrial loans as
well as commercial real estate loans. Small business lending would fall
under a mix of retail and corporate lending, based primarily on whether
the amount borrowed exceeds $1 million.\551\
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\551\ While the banking activities of large banking
organizations are less concentrated in small business lending, they
remain significant providers of small business credit. As of Q2
2025, category I and II banking organizations account for about 18
percent of small business loans below $1 million, and 33 percent of
small business loans below $100,000. Source: FFIEC Call Report, Line
Item ``Loans to Small Businesses and Small Farms.'' This may not
capture all small business lending, as the line item only covers
exposures of $1 million or less and extensions of credit to small
businesses may fall into other categories, such as real estate
exposures, for purposes of the FFIEC Call Report.
---------------------------------------------------------------------------
Large banking organizations also engage in credit facilitation
beyond the direct lending activity discussed above. This activity
includes providing financing to other financial sector entities. It
also includes investing in Treasury securities and central bank
reserves, which enable the banking organization to meet liquidity needs
while engaging in less liquid traditional lending activity. It further
includes products, such as guarantees or letters of credit, that
facilitate business transactions by offering assurances.
In addition to providing credit, large banking organizations serve
an important intermediary role through a range of activities associated
with trading. Certain core trading activities generate market risk-
weighted assets due to their exposure to gains and losses based on
market prices or factors. Such activities include maintaining an
inventory of financial instruments when a banking organization acts as
a principal to the transactions. Additionally, market risk-weighted
assets can result from exposures that arise as part of banking
organizations' provision of derivatives or other financial products.
Derivatives and other activities that facilitate clients' trading
positions, such as securities financing transactions, also generate
counterparty credit risk, and derivatives also generate CVA risk.
The remaining risk-weighted assets are associated with ``other
banking services'' or are ``fixed or other assets.'' Other banking
services include wealth management and custody, advisory, insurance,
and cash management services. These services would generate operational
risk-weighted assets through the associated fee income, net of fee
expenses, under the proposal. Fixed or other assets include owned real
estate, investment in unconsolidated subsidiaries, and deferred tax
assets, as well as any residual uncategorized balance sheet assets.
While the attribution of risk-weighted assets for credit, market,
and CVA risks across these activities is relatively straightforward,
operational risk-weighted assets must be split across several
activities that generate income. While certain activities may have a
disproportionate effect on a banking organizations' GSIB scores, GSIB
surcharge requirements are assigned in proportion to each activity's
attributed risk-weighted assets to avoid further complexity. Details of
the methodology are covered in section VII.D.
Table VII.5 provides risk-weighted assets aggregated by banking
activity across the current standardized approach and under the
proposal. In most cases, capital requirements under the standardized
approach exceed those under the advanced approaches, so this analysis
is simplified by considering only the standardized approach here. Table
VII.6 further below provides the breakdown of risk-weighted assets of
each banking activity under the proposal across the several risk
categories.
Despite the explicit measure of operational risk when compared to
the current standardized approach, the proposal would generally reduce
the risk-weighted assets associated with traditional lending activity.
Risk-weighted assets would decrease by 10 percent for residential real
estate due to a roughly 21 percent reduction in credit risk-weighted
assets on residential mortgages, which is only partly offset by
operational risk-weighted assets. Similarly, risk-weighted assets
decrease by a significant 18 percent for corporate lending. Risk-
weighted assets increase
[[Page 15106]]
by 9 percent for retail lending due to a smaller 9 percent decrease in
credit risk-weighted assets related to the risk-weighting of
unconditionally cancelable commitments and comparatively larger
operational risk requirements associated with the higher interest
margins on most retail lending. Risk-weighted assets associated with
credit facilitation would decrease by about 10 percent.
Risk-weighted assets associated with trading-related activity would
increase by 31 percent. While more than half of these risk-weighted
assets come from counterparty credit risk on derivatives and securities
financing transactions, the increase is driven by increases in market
risk-weighted assets and operational risk associated with the
significant revenue generated by trading-related activity.
While the share of Category I and II banking organizations' risk-
weighted assets resulting from trading-related activities would
increase, traditional lending activity would still account for the
largest share of their risk-weighted assets under the proposal.
Specifically, traditional lending activity would account for 44 percent
of risk-weighted assets of Category I and II banking organizations
under the proposal, a decrease from 50 percent under the current
standardized approach. In contrast, the percentage of Category I and II
banking organizations' total risk-weighted assets arising from trading-
related activities would increase from 23 percent under the
standardized approach to 29 percent under the proposal.
Other banking services, which consist primarily of investment
management, merchant banking, advisory services and corporate treasury,
generate operational risk-weighted assets under the proposal due to
their income. Income associated with these banking activities accounts
for about 27 percent of Category I and II banking organizations'
noninterest income. Consequently, while this analysis does not assign
assets to such activities that would generate risk-weighted assets
under the standardized approach, they would account for approximately
1.8 percent of risk-weighted assets under the proposal.
---------------------------------------------------------------------------
\552\ Statistics used in agency calculations are from the
special data collection, FR Y-9C, and FR Y-14 forms as of June 30,
2025. See FFIEC 031 Form Statistics. For Form Y-14M, see Board of
Governors of the Federal Reserve System, Reporting Forms: FR Y-14M
(Capital Assessments and Stress Testing) (version June 2025) (``Form
FR Y-14M''), https://www.federalreserve.gov/apps/reportingforms/Report/Index/FR_Y-14M. For FR Y-14Q, see Board of Governors of the
Federal Reserve System, Reporting Forms: FR Y-14Q (Capital
Assessments and Stress Testing) (version June 2025) (``Form FR Y-
14Q''), https://www.federalreserve.gov/apps/reportingforms/Report/Index/FR_Y-14Q.
[GRAPHIC] [TIFF OMITTED] TP27MR26.105
[[Page 15107]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.106
2. Cumulative Impact of Recent Proposals on Common Equity Tier 1
Capital Requirements by Banking Activity
---------------------------------------------------------------------------
\553\ Includes risk-weighted asset deductions--allocated
proportionally to pre-deduction risk-weighted assets.
\554\ Statistics used in agency calculations are from the
special data collection, FR Y9-C, and FR Y-14Q forms as of June 30,
2025. For FR Y9-C, see June 2025 Form Statistics. For FR Y-14Q, see
Board of Governors of the Federal Reserve System, Reporting Forms:
FR Y-14Q (Capital Assessments and Stress Testing) (version June
2025) (``Form FR Y-14Q''), https://www.federalreserve.gov/apps/reportingforms/Report/Index/FR_Y-14Q.
---------------------------------------------------------------------------
The final analysis in this section attributes common equity tier 1
capital requirements to business activities. Due to the challenges of
attributing many sources of stress loss to a specific banking activity,
this analysis assigns the stress capital buffer requirements associated
with each risk type in proportion to each activities' share of the risk
type within the proposal's risk-weighted assets calculation. For
example, if corporate lending accounts for 15 percent of credit risk-
weighted assets at a bank, 15 percent of the portion of the banks'
stress capital buffer requirement attributed to credit risk would be
further attributed to corporate lending.
Table VII.7 presents the cumulative impact of the proposals and
proposed stress test changes on requirements by banking activity. The
cumulative impact on requirements for traditional lending and credit
facilitation roughly track the risk-weighted asset changes. However,
the 9 percent increase in common equity tier 1 capital requirements for
trading-related activities is significantly smaller than the 31 percent
risk-weighted asset impact. This difference is primarily driven by the
proposed stress test changes, which would significantly reduce
projected market risk losses (particularly in the 2024 stress test) and
projected operational losses (which are attributed in significant part
to trading-related activity) in this analysis. At the same time, the
increase in requirements for trading-related activities is
significantly larger than the 6 percent decrease in requirements for
market risk,\555\ which falls within the broader category of trading-
related activities. This follows, as trading-related activities include
significant operational risk and CVA requirements, which increase
relative to current rules, notwithstanding the proposed stress test
changes.
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\555\ See section VII.B.2.
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Further discussion of the economic implications of this proposal in
combination with other recent capital rulemakings is found in section
VIII.
[[Page 15108]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.107
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\556\ Statistics used in agency calculations are from the
special data collection, FR Y-9C, and FR Y-14 forms as of June 30,
2025. See FFIEC 031 Form Statistics. For Form Y-14M, see Board of
Governors of the Federal Reserve System, Reporting Forms: FR Y-14M
(Capital Assessments and Stress Testing) (version June 2025) (``Form
FR Y-14M''), https://www.federalreserve.gov/apps/reportingforms/Report/Index/FR_Y-14M. For FR Y-14Q, see Board of Governors of the
Federal Reserve System, Reporting Forms: FR Y-14Q (Capital
Assessments and Stress Testing) (version June 2025) (``Form FR Y-
14Q''), https://www.federalreserve.gov/apps/reportingforms/Report/Index/FR_Y-14Q.
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D. Data and Estimation Methodology
This section describes the data and methodology used to estimate
the impact of this proposal on banking organizations' risk-weighted
assets and capital requirements. Section VII.D.1 describes the
``special data collection'' used as a starting point for the risk-
weighted asset impact estimates for holding companies, and the
adjustments made to these data to reflect the current proposal. Section
VII.D.2 describes how these estimates of risk-weighted assets are
extrapolated to more recent time periods and depository institution
subsidiaries. Section VII.D.3 describes how risk-weighted assets are
attributed across banking activities under the current standardized
approach as well as under the proposal. Section VII.D.4 describes how
impacts on capital requirements are constructed from the estimated
total risk-weighted assets. Section VII.D.5 describes how stress
capital buffer capital requirements, as informed by the Board's
supervisory stress test, are attributed to risk types within the
cumulative capital impact analysis.
Question 195: The agencies request comment on all aspects of the
impact analysis in this proposal, including the estimation of risk-
weighted assets and capital requirements, the attribution of risk-
weighted assets to banking activities and the attribution of stress
capital buffer requirements to risk categories. What changes or
alternative methodologies, if any, should the agencies consider, and
why? What additional analysis or data should the agencies consider, and
why? Commenters are encouraged to provide any additional data that
would be relevant.
1. Estimation of Risk-Weighted Assets Under the Proposed Expanded Risk-
Based Approach
a. Special Data Collection
In late 2023, the Board collected data on risk-weighted assets from
32 large bank holding companies based on the specific requirements
contained in a July 27, 2023, capital proposal.\557\ The data in this
voluntary collection reflected respondents' exposures as of June 30,
2023.\558\ The differences between the current proposal and the
proposal on which the special data collection was intended to inform
are broad and material. However, the definitions of risk exposures
under the current proposal is still significantly better aligned with
the special data collection than alternative sources, making the
special data collection the
[[Page 15109]]
most suitable starting point for much of the impact analysis.\559\
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\557\ See https://www.federalreserve.gov/newsevents/pressreleases/bcreg20231020b.htm.
\558\ One banking organization submitted data as of the third
quarter of 2023, instead of as of June 30, 2023. The data provided
by this banking organization was not used for the analysis described
in this proposal. This banking organization would not be subject to
the current proposal.
\559\ The Board is releasing an aggregated form of the special
data collection in order to preserve the confidentiality of the
responses provided by individual banking organizations while also
providing additional information to the public. The aggregated form
of the special data collection will be available on the Board's
website, see: https://www.federalreserve.gov/supervisionreg/basel/basel-default.htm.
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The special data collection includes data from all nine Category I
and II bank holding companies, as well as most of the additional bank
holding companies that are expected to be subject to the proposed
market risk capital requirements, and these data were substantially
complete.\560\ In addition, the special data collection includes
estimates of market risk and CVA covering most of the additional bank
holding companies that would be subject to market risk and CVA.
However, the collection did require some limited imputation of data
points to address inconsistencies, as discussed below in section
VII.D.1.ii. In addition, significant adjustments were made to reflect
differences between the current proposal and the 2023 proposal. These
adjustments, detailed below in section VII.D.1.iii, were informed by a
combination of FR Y-14 data and industry comment letters received in
response to the 2023 proposal. For comparison with the current capital
rule, the analysis also relied on regulatory financial reports (FFIEC
Call Reports, FR Y-9C, FR Y-15, FFIEC 101, and FFIEC 102), supplemented
with data on stress capital buffer requirements.\561\
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\560\ Specifically, banking holding companies with complete
market risk estimates in the special data collection represent over
96 percent of the Q2 2025 trading assets plus liabilities of all
bank holding companies expected to be subject to market risk capital
requirements.
\561\ Reporting forms issued by the Federal Financial
Institutions Examination Council (FFIEC) are available at
www.ffiec.gov and reporting forms issued by the Federal Reserve
Board are available at www.federalreserve.gov. The ``Call Report''
collectively refers to the data from the FFIEC 031, 041, and 051
forms. Specifically, see FFIEC 031 Form Statistics and FFIEC 041
Form Statistics. For FFIEC 051 (``FFIEC 051 Form Statistics''), see
FFIEC, Reporting Forms, Consolidated Reports of Condition and Income
for a Bank with Domestic Offices Only and Total Assets Less than $5
Billion: FFIEC 051 (version June 2023). Bulk data download available
at: https://cdr.ffiec.gov/public/PWS/DownloadBulkData.aspx. Certain
financial reports filed by banking organizations, including portions
of the FFIEC 101 and FFIEC 102 reports, as well as FR Y-14 reports,
are not available publicly because they contain confidential
supervisory information and are confidential business information of
the reporting banking organizations. Where the agencies relied on
confidential information collected through these reports for
estimates in this SUPPLEMENTAL INFORMATION, the agencies have
described in detail what confidential data were used and how they
were used.
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A few important caveats remain for impact estimates included in
this section. Although the agencies and participating banking
organizations have corrected known erroneous data submissions through
extensive dialogue and resubmissions from reporting banking
organizations, some data quality issues could remain. In addition, the
adjustments detailed in section VII.D.1.iii in many cases are only
approximations and may not account for all material differences between
the current proposal and the 2023 proposal upon which the special data
collection was based. Also, the impact estimates do not reflect
potential longer-term changes in banking organizations' behavior or
changes in market conditions that may occur after implementation of the
proposal. Section VIII includes discussion of the economic implications
of the capital impact of the proposal on different banking activities
and under different economic conditions.
b. Data Imputations
The imputations fall into two categories: recalculations and
proxies. Recalculations are applied to adjust certain firm-wide totals
based on subcomponent data where a banking organization did not report
such total values or because inconsistencies were identified in a
banking organization's calculations based on its subcomponent data.
Proxies are extrapolations of missing data from one banking
organization based on submissions of similar banking organizations.
Proxies were only applied in cases where subcomponent data that could
enable a recalculation were also not provided.
There are three areas that required recalculations:
(1) CVA risk-weighted assets, where one GSIB submitted data using
an incorrect formula that was included in an early version of the data
submission instruction, before the Board issued an update to correct
the error in submission instructions. In this case, the Board used the
correct formula to recalculate CVA risk-weighted assets.
(2) Operational risk-weighted assets, where some banking
organizations' total operational risk-weighted assets were calculated
in a manner inconsistent with the formula published in the proposal. In
these cases, the agencies recalculated total operational risk-weighted
assets from their subcomponents by applying the formula in the
proposal, which had a material effect for one GSIB.
(3) Internal models approach market risk-weighted assets, where
some banking organizations provided internal models approach values for
one or more trading desks but did not follow the formula for
calculating the entity-wide market risk capital requirement using these
values. In these cases, the agencies assumed that these trading desks
are model-eligible and applied the proposed formula to recalculate
market risk weighted assets, which caps the banking organization's
entity-wide internal models-based market risk-weighted assets.\562\
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\562\ Estimates of the impact of the proposal cap the banking
organization's entity-wide internal models-based market risk capital
requirement at the capital requirement under the standardized
approach.
---------------------------------------------------------------------------
These recalculations carry through to firm-wide calculations. For
example, the agencies recalculated total risk-weighted assets to
reflect recalculated operational or market risk-weighted assets where
appropriate.
Proxies were applied where a banking organization's submission for
market risk-weighted assets was missing or equal to zero, and the
banking organization's regulatory reports suggested that it would
likely be subject to market risk under the proposal. For these few
holding companies, market risk-weighted assets under the proposal were
proxied by market risk-weighted assets under the current rule,
multiplied by (one plus) the median percentage change in market risk-
weighted assets under the proposal across peer holding companies in the
data collection. These peer groups were constructed as (i) Category I
and II holding companies, (ii) Category III and IV domestic holding
companies, and (iii) Category III and IV foreign holding companies. As
with recalculated values, the proxied value was carried through to the
calculation of total risk-weighted assets.
c. Data Adjustments To Reflect Current Proposal
The special data collection measures risk-weighted assets under the
2023 proposal, necessitating adjustments to reflect the impact of this
proposal. Where possible, the special data collection is used to
estimate these adjustments to risk-weighted assets. However, in some
cases, a sufficiently accurate estimate requires additional regulatory
data or industry estimates. The discussion below details how the
estimates used in this proposal were constructed.\563\
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\563\ The estimated risk-weighted assets do not include
adjustments for details of the current proposal not reflected in the
2023 special data collection where the impact is both expected to be
immaterial and difficult to reliably estimate.
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The current proposal would apply the Basel III risk weights for
residential real estate exposures, removing 20
[[Page 15110]]
percentage points from the set of risk weights proposed in 2023. To
reflect this, risk-weighted assets were adjusted by an amount equal to
20 percent of the estimated residential real estate exposure in the
special data collection. In calculating real estate exposure, on-
balance sheet residential real estate exposures are taken as those
reported as regulatory residential real estate under risk weights that
correspond to such exposures under the 2023 proposal.\564\ Because
there is no specific item for off-balance sheet residential real estate
exposures in the special data collection, these are estimated as the
amount of home equity loan commitments in the FR Y-9C under the
assumption that these are all unconditionally cancelable exposures with
a 10 percent credit conversion factor under the proposal.\565\
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\564\ Special data collection item 6.e under 40, 45, 50, 60, 70,
or 90 percent risk weights and item 6.f under 50, 55, 65, 80, 95,
and 125 percent risk weights.
\565\ FR Y-9C, Schedule HC-L item 1.a.
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Similarly, the current proposal would reduce retail risk weights by
10 percentage points relative to the 2023 proposal. The impact of this
modification is calculated similarly to the residential real estate
modification, with the applicable on- and off-balance sheet retail
exposure estimated using special data collection exposures reported
under 55, 85, or 110 percent risk weights in the items corresponding to
retail and unconditionally cancelable commitments, respectively.
The scope of applicability of the 65 percent risk weight for
investment grade corporate exposures has expanded significantly
relative to the 2023 proposal. Data from the special data collection
are used to estimate the impact of this change. Specifically, for each
banking organization, memo items M.6 and M.10 are used as estimates of
the amount of additional investment grade corporate exposure to which
the 65 percent risk weight would apply.\566\ Across Category I and II
banking organizations, an estimated 53 percent of balance sheet
corporate exposure and 60 percent of off-balance sheet corporate
exposure is classified as investment-grade and risk-weighted at 65
percent under the proposal, including the exposure already risk-
weighted at 65 percent under the 2023 proposal. The bank-specific
difference between this amount and the amount of corporate exposure
risk-weighted at 65 percent under the 2023 proposal is multiplied by
the negative 35-percentage-point change in risk weight to obtain the
estimated adjustment to risk-weighted assets.
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\566\ One banking organization's entry on memo item 10 is
divided by 1000 due to a likely unit error. In addition, in each of
memo items 6 and 10, there is one entry that is likely incorrect
(i.e. zero or amounts exceeding total corporate exposure risk-
weighted at 100 percent), and treated as missing. The missing values
for the (on/off-balance sheet) investment-grade corporate exposures
risk weighted at 100 percent are imputed by multiplying (on/off-
balance sheet) corporate exposures risk-weighted at 100 percent
(item 8) by the aggregate investment grade share of (on/off-balance
sheet) corporate exposures, based on those banking organizations in
the special data collection where the investment grade 100 percent
risk weighted memo item is reported.
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The treatment of equity exposures in the banking book differs
significantly under this proposal versus the special data collection.
As this proposal retains the current treatment of banking book equity
exposures, their risk-weighted assets under the current simple risk-
weight method are used as the starting point for their estimated risk-
weighted assets under the proposal.\567\ However, a downward adjustment
is applied to this amount to account for publicly traded equity
exposures that are scoped into market risk under this proposal. This
adjustment was estimated using memo item 2 of the ``Equity exposures''
template of the special data collection. For the few banking
organizations that did not provide data for this memo item, the share
of equity exposure migrating to the trading book is imputed as the
aggregate share of such exposure across the special data collection
banking organizations that did provide these data.\568\ In calculating
risk-weighted assets, it is assumed that the migrating equity exposures
would have otherwise received the 100 percent risk weight applicable to
``non-significant'' equity exposures.
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\567\ Specifically, risk-weighted assets are taken as the amount
reported in Schedule B of the FFIEC 101, item 23, column G.
\568\ The estimate of the aggregate share of equity exposures
migrating out of the equity framework is 3.79 percent.
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Risk-weighted assets in the special data collection are also
adjusted to reflect removal of the minimum haircut floor. As the
special data collection does not provide the calculation of a
standalone impact of the minimum haircut floor in the 2023 proposal on
risk-weighted assets, the impact of removing the haircut floor is
estimated by calculating the difference between the current
standardized approach and the expanded risk-based approach for
exposures that would fail the minimum haircut floor requirement.\569\
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\569\ Specifically, this difference is the sum of items 1
through 4 and 11 through 14 of column M minus the sum of those same
items in column K within the ``transacts fail hairct flrs'' sheet of
the special data collection.
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The adjustments to operational risk-weighted assets in the special
data collection are constructed in two stages. First, risk-weighted
assets for operational risk are recalculated using an internal loss
multiplier equal to one for all banking organizations. Risk-weighted
assets for operational risk are then recomputed using the business
indicator as defined in the proposal, replacing the financial and
services components with a noninterest component that also downscales
net income from investment management, investment services, and
treasury services.\570\ This noninterest component is computed
primarily from the special data collection ``Operational risk'' sheet
as the three-year average of the absolute value of net noninterest
income before operational losses (Part 2, sum of 2.a, 2.c, 3.a and 3.b,
plus Part 1, item 1, minus the sum of 2.b and 2.d), accounting for a
scaling of net noninterest income associated with investment
management, and investment and treasury services, plus the three-year
average operational losses (Part 1, item 1). To account for the scaling
of net noninterest income from historically lower operational risk
activities, the three-year average absolute value of net noninterest
income is scaled by a factor that accounts for the scaling of net
income associated with investment management and investment and
treasury services in the proposal.\571\ Due to data limitations, this
factor is based on these activities share of total, not net,
noninterest income.
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\570\ The proposal would not downscale all treasury services (as
defined in the FR Y-14Q report), but rather only certain treasury
services (see Section IV.D.1 of this Supplemental Information).
However, data on the relevant subset of treasury services is not
available to the agencies. This discrepancy implies that the
aggregate impact of the proposal would be slightly smaller than
estimated. If none of treasury services income were subject to the
scaling factor, the impact of the proposal on aggregate common
equity tier 1 capital requirements would only be about 0.3 percent
higher.
\571\ Specifically, the scaling factor equals one minus the
ratio of 70 percent of three-year average of the sum of investment
management, investment services, and treasury services noninterest
income divided by three-year average total noninterest income.
Investment management, investment services, treasury services, and
total noninterest income are items 19, 20, 21, and 26 of FR Y-14Q
Schedule G.
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The agencies used information from the special data collection to
recalculate market risk-weighted assets under the proposal.\572\ The
main changes from the 2023 proposal were to: (1) recognize full
diversification for certain non-modellable risk factors, (2) recognize
diversification between positions modeled under the standardized
approach and the internal models
[[Page 15111]]
approach, (3) use a single default risk calculation for all trading
desks rather than separate default risk calculations for modeled and
non-modeled desks, (4) cap the amount of capital required under the
internal models approach at the amount required by the standardized
approach for market risk in certain circumstances, (5) remove the
Spearman Correlation profit and loss attribution test for internally
modelled desks, and (6) clarify netting for Uniform Mortgage-Backed
Securities.\573\ In addition to the changes noted above, the estimated
impact of the proposal includes an estimated impact on risk-weighted
assets from a reduction in the scope of application of the market risk
framework of the capital rule. Due to limited data on which to base the
corresponding impact estimate for scope, it is assumed that the credit
risk-weighted assets of these currently market risk-weighted exposures
would equal the current market risk-weighted assets of these
exposures.\574\
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\572\ Due to nonlinearities in market risk formulas, firm-level
data are required to construct these estimates.
\573\ The analysis assumes that banking organizations receive
supervisory approval to cap the amount of capital required under the
internal models approach at the amount of capital required for all
trading desks under the standardized approach. For more information
on this process, see section V.A.3.b.
\574\ This conservative assumption results in the small increase
in risk-weighted assets noted in section VII.A.1, as the proposed
market risk rule would otherwise result in an overall decrease in
market risk-weighted assets for these banking organizations.
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Most market risk impact estimates are obtained by applying formulas
in the regulation. To calculate the impact of removing the Spearman
Correlation test, the agencies assume a 20 percentage point increase in
the share of modeled capital requirements and also assume that shifting
positions from the standardized approach to internal models reduces
capital requirements by 50 percent.\575\
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\575\ The 50 percent impact is derived from an analysis of the
ratio of modelled capital requirements compared to standardized
approach capital requirements for the same portfolio using
information from the special data collection.
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Additionally, due to data limitations, to reflect the impacts of
clarifying netting for Uniform Mortgage-Backed Securities, an estimate
from the joint comment letter from the International Swaps and
Derivatives Association and Securities Industry and Financial Markets
Association was used. This letter estimates an approximately nine
percent reduction in capital requirements for market risk positions
capitalized under the standardized approach across eight GSIBs.\576\
These impact estimates apply the nine percent reduction in standardized
approach capital requirements across all banking organizations.
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\576\ The nine percent figure is imputed from the comment
letter. Page 23 includes a figure indicating a $70.3 billion
reduction in risk-weighted assets from the ``GSE'' change on a base
of $801.7 billion in risk-weighted assets under the standardized
approach. $70.3 billion is approximately nine percent of $801.7
billion. See Comment Letter from International Swaps and Derivatives
Association and the Securities Industry and Financial Markets
Association, (Jan. 16, 2024), https://www.federalreserve.gov/SECRS/2024/February/20240220/R-1813/R-1813_011724_156753_496678267479_1.pdf.
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Due to data limitations, to reflect the exemption of client-facing
derivative transactions from CVA risk, an estimate from the joint
comment letter from the International Swaps and Derivatives Association
and Securities Industry and Financial Markets Association was used.
This letter estimates that such a change would reduce proposed CVA
risk-weighted assets relative to the 2023 proposal by about 9 percent
in aggregate.\577\ This 9 percent impact was applied to each bank's CVA
risk-weighted assets.
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\577\ Comment Letter from International Swaps and Derivatives
Association and the Securities Industry and Financial Markets
Association, at 103 & n. 269, 160 (Jan. 16, 2024), https://www.federalreserve.gov/SECRS/2024/February/20240220/R-1813/R-1813_011724_156753_496678267479_1.pdf.
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Lastly, to reflect a change in the securitization p-factor under
the proposal, the agencies use estimates of securitization risk-
weighted assets under a p-factor of 0.5 (memo item 1 in the
``Securitization exposures'' sheet of the data collection). This
estimate was completed by all holding companies that would be subject
to this proposal.
2. Extrapolation of Estimates to Other Time Periods and Banking
Organizations
As it has been more than two years since the as of date of the
special data collection (June 30, 2023), the analysis in this proposal
adjusts risk-weighted assets to reflect more current balance sheets.
The adjustment approach in this proposal is intended to capture not
only general growth, but also the potential effect of broad shifts in
the composition of banking organizations' balance sheets since 2023.
Specifically, the analysis in this proposal decomposes risk-weighted
assets into eleven exposure segments, and then establishes an index for
each segment and banking organization; a measure which is assumed to
change over time in proportion to the exposures' risk-weighted assets
under the proposal. The risk-weighted assets for each segment under the
proposal, as of Q2 2025, are then estimated as the segment's risk-
weighted assets under the special data collection, adjusted for
differences between the 2023 and current proposal as described above,
and then multiplied by one plus the cumulative growth in the segment's
index over the period Q2 2023 through Q2 2025. Total risk-weighted
assets under the proposal as of Q2 2025 are then taken by summing
across the segments.\578\
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\578\ In addition, total risk-weighted assets reflect a small
adjustment for an estimate of risk-weighted asset deductions as of
Q2 2025--actual deductions for allocated transfer risk reserve (FR
Y-9C HC-R Part II, item 30), plus an adjusted deduction for excess
AACL. This adjusted excess AACL deduction is estimated as zero for
holding companies reporting no excess AACL deduction in Q2 2025 (FR
Y-9C HC-R Part II, item 29), and for other holding companies it is
equal to this reported amount plus 1.25 percent of the difference in
the credit risk-weighted assets of non-equity exposures between the
proposal and the current standardized approach.
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The analysis in this proposal takes a similar approach when
estimating risk-weighted assets for the depository institution
subsidiaries of holding companies present in the special data
collection. Specifically, the index for each segment is measured at
both the depository institution and holding company levels, and the
share of risk-weighted assets at the depository institution subsidiary
is estimated to be the same as the share of the corresponding index at
the depository institution subsidiary.
The eleven exposure segments and their corresponding indices, are
described below. Given their function, the indices must exist over time
at both the holding company and depository institution levels.
Furthermore, the selected indices should bear a close conceptual
relationship with the risk-weighted assets associated with the
exposure. This improves the reliability of the estimates by ensuring
that drivers of changes in the index should generally be reflected in
changes to risk-weighted assets under the proposal. In most cases, the
chosen index is the risk-weighted assets of the exposure segment under
the standardized approach.
The eleven exposure segments include operational risk, market risk,
CVA, and eight areas of credit risk exposure. The eight segments within
credit risk are: residential real estate,\579\ retail,\580\
securitization, banking book
[[Page 15112]]
equity, SFTs,\581\ derivatives,\582\ all other balance sheet
exposures,\583\ and all other off-balance sheet exposures.\584\ For
nine of the eleven exposure segments, the chosen index represents risk-
weighted assets for the exposure segment under the standardized
approach, or a close approximation thereof.\585\ Standardized risk-
weighted assets should change similarly to risk-weighted assets under
this proposal as long as there are not large changes within the
exposure segment associated with the additional risk-drivers
incorporated within the proposal. For example, risk-weighted assets for
residential real estate should grow similarly as long as the loan-to-
value composition of the portfolio does not shift significantly.
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\579\ Includes all risk-weighted assets reported in items 6.a,
e, and f of the special data collection ``General credit risk
exposures'' sheet, plus 10 percent of the exposure amount reported
in item 1.a of FR Y-9C HC-L (i.e. home equity line of credit risk-
weighted assets when assuming a 100 percent credit risk weight and a
10 percent CCF under the proposal).
\580\ Includes all risk-weighted assets reported in item 7, plus
risk-weighted assets of exposures risk-weighted at 55, 85 or 110
percent in item 12 of the special data collection ``General credit
risk exposures'' sheet.
\581\ Includes all risk-weighted assets reported in items 18, 20
and 21 of the special data collection ``General credit risk
exposures'' sheet, plus risk-weighted assets reported in items 1
through 4 and 11 through 14 of the ``Transacts fail min hairct
flrs'' sheet.
\582\ Includes all risk-weighted assets reported in items 24 and
25 of the special data collection ``General credit risk exposures''
sheet.
\583\ Defined as all risk-weighted assets reported in part 1 of
``General credit risk exposures'' in the special data collection,
less those amounts already included within residential real estate
or retail.
\584\ Defined as all risk-weighted assets reported in part 2 of
``General credit risk exposures'' in the special data collection,
less those amounts already included within residential real estate,
retail, SFT or derivatives.
\585\ For these nine exposure segments, the standardized
approach-based index is defined by items in regulatory reports as
follows. Unless indicated otherwise, amounts represent risk-weighted
assets associated with the indicated items from the FR Y-9C, HC-R
Part II, with corresponding values from FFIEC Call reports used for
depository institution subsidiaries. Market risk--item 27.
Residential real estate--items 4.a and 5.a, amounts in columns H, I
and S. Retail--HC-C items 6.a through d (all amounts assumed risk-
weighted at 100 percent). Securitization--items 9 and 10. Banking
book equity--FFIEC 101, Schedule B, item 23. SFTs--item 16.
Derivatives--items 20 and 21. All other off-balance sheet items--
items 12 through 15, 17, and 18. All other balance sheet items--item
28, minus the amounts for the other eight standardized risk-weighted
asset exposure segments.
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Neither operational risk or CVA risk are part of current
standardized risk-weighted assets, so a different approach to indexing
is required. CVA risk-weighted assets measured under the advanced
approaches is used as the index for CVA.\586\ Lastly, for operational
risk, the agencies index the business indicator to an approximation
developed from regulatory report data items. This approximation equals
three-year average absolute modified revenue, where modified revenue
has two parts. The first part is the minimum of net interest income and
2.25 percent of interest earning assets.\587\ The second part is
modified net noninterest income, defined as noninterest income plus
realized gains or losses on securities, minus 70 percent of investment
management noninterest income and other noninterest expenses.\588\
Operational risk weighted-assets are extracted by applying the
operational risk formula to the estimated Q2 2025 business indicator,
which in turn equals the business indicator measured from the special
collection data, indexed by growth in this approximate indicator.
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\586\ Specifically, items 31.a and b of FFIEC 101 Schedule B.
\587\ Net interest income is FR Y-9C Schedule HI item 5.m and
interest earning assets are approximated as the sum of Schedule HC
items 1.b, 3, 4.a, and 4.b, Schedule HC-B item 8 (cols A and D), and
Schedule HC-D item 12. Corresponding items from FFIEC Call reports
are used for the depository institution subsidiaries.
\588\ Specific FR Y-9C data used are in Schedule HI--item 5.m
(noninterest income), item 6 (gains on securities sales), item 7.d
(other noninterest expense). Investment management noninterest
income is taken as item TPPNRS68 from the FR Y-14A.
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3. Attribution of Risk-Weighted Assets to Banking Activities
This section provides the methodology used to attribute all risk-
weighted assets under the standardized and proposed expanded risk-based
approach, to the banking activities that most likely generated them.
The sample includes the bank holding companies that participated in the
special data collection, including all that would be subject to this
proposal. The attribution of banking activity applied in this section
is chosen to distinguish the several functions that large banking
organizations serve in the U.S. economy. Banks may decide to expand or
contract the business units that perform each of these functions based
on the required capital, among other factors. These categories of
banking activity are chosen to be broad enough to allow for a mapping
of risk exposures between the FR Y-9C, which collects standardized
risk-weighted assets, and the special data collection.
Section VII.D.3.a applies this exercise to expanded total risk-
weighted assets, as reported in the special data collection and
modified to reflect the proposal. Section VII.D.3.b describes how the
agencies estimate the attribution of risk-weighted assets under the
standardized approach to these same banking activities. The total risk-
weighted assets attributed align with amounts reported within the
sections VII.C and VIII.
a. Attribution of Expanded Total Risk-Weighted Assets
When estimating risk-weighted assets by banking activity, the
agencies attribute all risk-weighted assets reported in the special
data collection under the expanded risk-based approach as well as all
adjustments (described above in section VII.D.1.c) to these figures
that were made to reflect the current proposal.
Most risk-weighted asset items in the special data collection are
attributed entirely to a specific banking activity. These comparatively
simple attributions are described below.
Traditional lending includes all credit risk-weighted assets
associated with exposures to GSEs, residential and commercial real
estate, and retail exposures, as well as all securitizations.\589\
Risk-weighted assets for equity exposures not subject to the market
risk framework are also attributed to traditional lending as, like
loans, these are typically illiquid long-term funding
arrangements.\590\ Within these traditional lending exposures,
securitization risk-weighted assets are split evenly across the
residential real estate, retail, and corporate lending categories due
to data limitations. In aggregate, securitizations account for less
than 3 percent of risk-weighted assets under the proposal. Exposures to
GSEs and residential real estate, including statutory multifamily and
``other real estate exposures,'' are attributed to residential real
estate lending, and all other exposures except for ``retail'' are
attributed to corporate lending.
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\589\ These exposures correspond to items 3, 6 and 7 of
``general credit risk exposures'' plus item 1.c of ``overview'' of
the special data collection template.
\590\ These exposures correspond to item 2 of part 1 of the
``overview'' sheet of the special data collection template, modified
to reflect the current treatment of banking book equity exposures.
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Credit facilitation includes credit risk-weighted exposures to
sovereigns, supranational entities, public-sector enterprises, and
banks.\591\ This banking activity also includes credit risk-weighted
assets associated with letters of credit, guarantees, contingent items,
and forward agreements.\592\
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\591\ Within the special data collection template, these
correspond to items 1, 2, 4 and 5 of ``general credit risk
exposures.''
\592\ Within the special data collection template, these
correspond to items 14 through 17, 19, 22 and 23 of ``general credit
risk exposures.''
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Trading-related activities include all market risk-weighted assets,
as well as credit risk-weighted assets associated with derivatives,
repo-style transactions, and exposures to unsettled transactions.\593\
In addition, CVA risk
[[Page 15113]]
and default fund contributions accompany the derivative exposures.\594\
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\593\ Within the special data collection template, market risk-
weighted assets correspond to item 4 in part 1 of ``overview'' and
the credit risk items correspond to item 1.b of overview and items
18, 20, 21, 24, 25 and 27 of ``general credit risk exposures.''
\594\ In the special data collection, default fund contributions
are item 26 of ``general credit risk exposures'' and CVA risk-
weighted assets are item 5 on part 1 of the ``overview'' sheet.
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Fixed or other assets include credit risk-weighted assets
associated with insurance and other exposures, except for mortgage
servicing assets which are included in residential real estate
lending.\595\ This segment also incorporates exposures that were
deducted from common equity tier 1 capital under the 2023 proposal, and
therefore not present in risk-weighted assets, but risk-weighted at 250
percent under this proposal.\596\
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\595\ Within the special data collection template, these
correspond to items 9 and 10 of ``general credit risk exposures.''
\596\ These exposures are mostly deferred tax assets, and thus
would be reported as other assets on the balance sheet if not
deducted.
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The remaining risk-weighted assets under the proposal are split
across several banking activities. These include credit risk associated
with commitments and corporate exposures, as well as operational risk
and deductions from risk-weighted assets for excess allowances or
allocated transfer risk reserves.
Credit risk-weighted assets associated with corporate exposures are
attributed to either traditional lending or credit facilitation based
on whether the borrower is a financial firm.\597\ This is determined
from the proportion of such exposures to non-financial firms based on
the FR Y-14Q Schedule H.1 data.\598\ The adjustment to risk-weighted
assets that is made to account for the broader applicability of the 65
percent investment grade corporate risk weight under the proposal, as
compared to the 2023 proposal, is similarly split across traditional
lending and credit facilitation based on the proportion of non-public
investment grade corporate exposures that are indicated as exposures to
highly regulated industries in the special data collection.
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\597\ The small amount of corporate exposures not reported under
either a 65 percent or 100 percent risk weight in the special data
collection (item 8) are attributed to lending and credit
facilitation. The small amount of corporate risk-weighted assets not
reported under a specific risk weight are attributed to banking
activities pro rata with all other corporate exposures across the
entire sample.
\598\ Specifically, starting from all drawn exposure in the H.1
(commercial and industrial loan data) that are reported in items
1.e.1, 3, 4, 9.a, 9.b.2 and 10.b of the FR Y-9C and have known NAICS
codes, the fraction to borrowers in NAICS starting 52 or 53 is
attributed to credit facilitation with the remainder to corporate
lending. The average share across other banking organizations is
used where NAICS are not reported for the banking organization.
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Commitments could represent exposures to counterparties that are
corporate, retail, banks, or sovereigns.\599\ The likely type of
counterparty is indicated by the risk weight assigned to the commitment
exposure. Therefore, within each risk weight, commitments are allocated
to banking activities based on the activity's share of balance sheet
exposure assigned that risk weight.\600\
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\599\ Commitments represent items 12 and 13 in the ``general
credit risk exposures'' sheet of the special data collection
template.
\600\ Balance sheet exposures are those reported in Part 1 of
``general credit risk exposures'' in the special data collection.
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Under the proposal, the operational risk-weighted assets of each
banking organization are attributed to banking activities based on
their contribution to the banking organization's business indicator.
The business indicator is comprised of an interest, lease, and dividend
component and a noninterest component. Operational risk-weighted assets
are attributed to these two components in proportion to their share of
the business indicator. The operational risk-weighted assets attributed
to each of these components are further attributed to the banking
activities as discussed below.
The interest, lease, and dividend component is proportional to the
banking organization's net interest income until it hits a cap equal to
2.25 percent of average interest-earning assets. Thus, each banking
activity's share of the net interest component equals either the
activity's share of net interest income if the banking organization is
below the cap or the activity's share of interest-earning assets if the
banking organization is above the cap. As many banking organizations
are currently near the cap, the agencies first estimate for each
banking organization the probability that it will be subject to the cap
in the long run. This estimate is equal to the fraction of the previous
ten years (2015 through 2025) in which the banking organization had a
net interest margin exceeding 2.25 percent.\601\ Then, a weight equal
to the probability of having net interest margin above the cap is
applied to the segment's share of interest-earning assets, while a
weight equal to the probability of having net interest margin below the
cap is applied to the segment's share of net interest income. To
calculate each segment's share of net interest income and interest-
earning assets, the agencies rely on data from the FR Y-14Q Schedule G
and special data collection.\602\
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\601\ The average probability of having a net interest margin
over 2.25 percent equals about 61 percent for the four GSIB
universal bank holding companies and is zero for the other five
Category I and II bank holding companies.
\602\ Net interest income in the FR Y-14Q Schedule G is
attributed to segments as follows: traditional lending--retail and
small business banking (except deposits) and commercial
lending.(items 1 and 2, except 1E); trading--sales and trading and
investment services (items 5 and 7); credit facilitation--investment
banking (item 3); other banking services--merchant banking,
investment management, insurance services, and other immaterial
segments (items 4, 6, and 9 through 11). Net interest income
associated with deposits and corporate treasury is excluded from the
calculation. Interest-bearing assets are estimated as those reported
in special data collection items 1 through 8, which are attributed
to business activities as discussed earlier in this section.
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While the noninterest income component includes historical
operational losses, these are excluded from the attribution of the
component across business segments.\603\ Furthermore, due to data
limitations and the difficulty of allocating noninterest expenses, the
agencies use each segment's share of noninterest income as a proxy for
its share of net noninterest income. Noninterest income is taken from
the FR Y-14Q Schedule G. Traditional lending is associated with
noninterest income from retail and small business banking and corporate
lending (items 14 and 15). Credit facilitation accounts for noninterest
income associated with syndicated lending (item 16D). Trading-related
activities are associated with noninterest income from equity and debt
capital markets activities as well as sales and trading and investment
services (items 16B, 16C, 18 and 20). The other banking services
segment's noninterest income includes investment banking advisory,
merchant banking, investment management, investment services, insurance
services, and other small income sources (items 16A, 17, 19, and 21
through 25).
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\603\ This approach is equivalent to an assumption that
operational losses are distributed across business segments in the
same proportion as net noninterest income.
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Each banking activity's share of both the interest, lease, and
dividend component and noninterest income component is floored at zero,
and scaled so that the sum of shares across banking activities for each
component is equal to one. To calculate the operational risk-weighted
assets for each banking activity, these component shares are multiplied
by the operational risk-weighted assets associated with that component,
and the contributions of the two components are added together.
As a final step, deductions from risk-weighted assets associated
with excess allowances and allocated transfer risk reserve are
attributed to business segments for each banking organization
[[Page 15114]]
in proportion to those segments' risk-weighted assets.\604\
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\604\ Allowance and transfer risk reserve deductions amount to
only about 0.3 percent of risk-weighted assets in aggregate, so
their attribution does not materially affect conclusions.
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b. Attribution of Risk-Weighted Assets Under the Standardized Approach
In this second part of the analysis, the agencies construct an
estimate of standardized risk-weighted assets for the same banking
activities. For credit risk exposures on the balance sheet, the
agencies extrapolate from the special data collection. Adjustments to
risk-weighted assets are applied to ensure that total standardized
risk-weighted assets equal those in the FR Y-9C. For other exposures,
the agencies take standardized risk-weighted asset amounts directly
from the FR Y-9C.
The FR Y-9C does not disaggregate balance sheet exposures
sufficiently to allow for the direct calculation of risk-weighted
assets by banking activity. Therefore, the agencies risk-weight the
balance sheet exposure amounts from the special data collection using
assumed standardized risk weights, discussed below. These assumed risk
weights apply in place of the risk weights under the proposal wherever
the risk weight in the special data collection does not exist under the
standardized approach. In addition, the assumed standardized risk
weights are applied in place of the 150 percent risk weight for all
special data collection items where a 150 percent risk weight (1) might
be applicable to non-defaulted exposures under the 2023 proposal and
(2) would be applicable only to defaulted exposures under the
standardized approach.\605\
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\605\ Specifically, the assumed risk weight is applied to
exposures to the U.S. government, supranational entities, GSEs, U.S.
public sector entities, U.S. depository institutions, ADC (not high-
volatility commercial real estate) and other real estate loans, and
corporate exposures.
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For assumed risk weights, the agencies use the most commonly
applicable standardized risk weight for the special data collection
item. This assumed risk weight is zero percent for sovereign and
supranational exposures (items 1 and 2); 20 percent for GSEs, public
sector entities, U.S. depository institutions, and self-liquidating
trade-related items (items 3, 4.a, 4.c, and 5); 50 percent for
statutory multifamily mortgages, pre-sold construction loans, and
residential real estate (items 6.a., b, e, and f); 150 percent for
high-volatility commercial real estate (item 6.c); and 100 percent for
all other balance sheet exposures. In addition, the assumed risk weight
for equity exposures not subject to the market risk framework is 100
percent, as almost all such exposures fall under the non-significant
equity exposure threshold in the standardized approach. Because the
assumed risk weights are slightly different from the actual average
risk weight, the resulting estimates of standardized risk-weighted
assets using assumed risk weights are scaled so that the total balance
sheet risk-weighted assets align with the comparable amounts in the FR
Y-9C for each banking organization.\606\
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\606\ Specifically, the agencies match the sum of standardized
risk-weighted assets associated with items 1 through 8.a in FR Y-9C
HC-R Part 2. On average, the initial estimates of standardized risk-
weighted assets using assumed risk weights are scaled down by about
2 percent.
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For the remaining off-balance sheet and counterparty credit risk
exposures, as well as securitizations and market risk, standardized
risk-weighted assets corresponding to items or small sets of items in
the special data collection can be taken directly from the FR Y-9C
Schedule HC-R Part 2. Traditional lending includes securitization
exposures and retained recourse on small business obligations (items 9,
10, and 15). Trading-related activities include all market risk-
weighted assets, as well as credit risk-weighted assets associated with
repo-style transactions, derivatives, central counterparty default fund
contributions, and exposures to unsettled transactions (items 8.b, 16,
20 through 22, and 27). The credit facilitation segment includes
letters of credit and other off-balance sheet liabilities (items 12
through 14 and 17).
Commitments (items 18 and 19) are present in multiple banking
segments. Consistent with the attribution of commitment risk-weighted
assets under the proposal discussed above, in each risk weight,
commitment exposures are attributed to banking activities pro rata
based on the activity's share of balance sheet exposures assigned to
that risk weight.\607\ This distribution of balance sheet exposures
across special data collection items is also used to estimate an
average assumed standardized risk weight for the commitment. As a final
step, the estimated risk-weighted assets for commitments summed across
banking segments are scaled to match the risk-weighted asset amount
reported in the FR Y-9C. This scaling addresses not only potential
errors in the assumed standardized risk weights, but also the change in
credit conversion factors under the proposal.\608\
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\607\ Risk-weighted assets associated with unconditionally
cancelable commitments are zero under the standardized approach.
\608\ The calculation implicitly assumes that the percentage
change in commitments' average credit conversion factors is the same
across business segments within each banking organization.
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At this stage, by construction, the standardized risk-weighted
asset amounts match with those reported in the FR Y-9C prior to
application of any deduction for excess allowances or allocated
transfer risk reserve. As was done throughout other estimates in
section VII, the agencies allocate these risk-weighted asset deductions
across banking segments in proportion to their pre-deduction total
risk-weighted assets.
4. Estimation of Capital Requirements
The capital requirements computed in this proposal include both
common equity tier 1 and tier 1 risk-based requirements under the
standardized and advanced approaches as well as tier 1 leverage and
supplemental leverage ratio requirements. Dollar amounts of
requirements are calculated by multiplying the applicable requirement
ratio by the relevant risk-weighted asset or exposure measure. In
addition, in order to capture changes to the definition of capital, the
requirements calculated in this proposal include the estimated amount
of changes in capital deductions, plus the current amount of threshold
deductions for deferred tax assets, mortgage servicing assets, or
investments.\609\ Previous sections discuss the how risk-weighted
assets are computed under the proposal, and the analysis assumes no
changes to leverage exposure measures under all proposals under
consideration. Therefore, the remainder of this section discusses how
the buffer requirements are calculated.\610\
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\609\ As of Q2 2025, only one of the bank holding companies that
would be subject to this proposal had any threshold capital
deductions, and none had deductions for mortgage servicing assets.
Therefore, this adjustment has limited impact.
\610\ The calculation of method 1 GSIB surcharge, using the
approach described below, is applicable to estimating the enhanced
supplementary leverage ratio requirement under the recently
finalized rule.
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The risk-based capital ratio requirements used within the estimates
throughout this proposal include all applicable minimum capital ratio
and buffer requirements, including the stress capital buffer
requirement and GSIB surcharge. The estimated stress capital buffer
requirement and GSIB surcharge are adjusted to reflect the mechanical
effect of risk-weighted asset changes under this proposal. In addition,
the GSIB surcharges and stress capital buffer estimates, as described
below, are linearized to avoid discontinuities in requirements that
could result in the short-run from small changes in risk-weighted
assets or GSIB scores when using bucketed GSIB surcharges or rounded
stress capital buffer requirements.
[[Page 15115]]
Under the capital plan rules, the stress capital buffer requirement
is generally calculated as (1) the difference between a banking
organization's starting and minimum projected common equity tier 1
capital under the severely adverse scenario in the Board's supervisory
stress test plus (2) the sum of the dollar amount of the banking
organization's planned common stock dividend for each of the fourth
through seventh quarters of the capital planning horizon as a
percentage of risk-weighted assets.\611\ Therefore, stress capital
buffer requirements, expressed as a ratio, would differ under the
proposal due to the proposal's impact on risk-weighted assets. To
adjust the stress capital buffer requirement to reflect the proposal,
the Board assumed that the estimated percentage difference in risk-
weighted assets between the expanded risk-based approach and the
standardized approach would have applied at the date at which the
stress capital buffer requirement was calculated. Specifically, the
estimates in this proposal adjust the actual stress capital buffer
requirements by (i) removing the 2.5 percent floor and rounding, (ii)
multiplying by the ratio of risk-weighted assets under the standardized
approach relative to risk-weighted assets under the expanded risk-based
approach in this proposal, and then (iii) reapplying the 2.5 percent
floor on the requirement. For comparability, stress capital buffer
requirements under current rules in this proposal also removes the
effect of rounding.\612\ Therefore, for bank holding companies whose
stress capital buffer requirements exceed 2.5 percent under both the
standardized and expanded risk-based approach, the change in risk-
weighted assets under the proposal has no effect on the stress capital
buffer requirement when expressed in dollar terms. However, for bank
holding companies whose stress capital buffer requirement would equal
the 2.5 percent floor under both the standardized approach and the
proposed expanded-risk based approach, the dollar amount of the stress
capital buffer requirement would change proportionally to any changes
in risk-weighted assets.
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\611\ See 12 CFR 225.8(f)(2) and 12 CFR 238.170(f)(2).
\612\ Under the current capital plan, stress capital buffer
requirements are rounded to the nearest 0.1 percent.
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Under the current rule, risk-weighted assets are an input in method
2 of the GSIB surcharge calculation.\613\ In particular, the short-term
wholesale funding score's contribution to a GSIB's method 2 score is
calculated by dividing the average of a banking organization's weighted
short-term wholesale funding amount by its average risk-weighted assets
and multiplying that amount by a fixed factor of 350.\614\ Hence,
increases (or decreases) in a banking organization's risk-weighted
assets would decrease (or increase) its method 2 score, thereby
partially offsetting in GSIB surcharge requirements the proposal's
effect on capital requirements. The standalone impact analysis in
section VII.A adjusts the short-term wholesale funding score used in
the GSIB surcharge calculation with the proposal's estimated impact on
risk-weighted assets and recalculates GSIBs' method 2 scores and
capital surcharges using the adjusted short-term wholesale funding
indicator.\615\ The GSIB score for each year is then taken as the
minimum of the method 1 and 2 score, which is then converted into a
surcharge using the following linearization which approximates the
surcharge step function: surcharge = 0.01 + 0.00005 x max[ 0, score-180
]. The same linearization is applied to scores calculated under the
GSIB surcharge proposal, noting that scores under the GSIB surcharge
proposal are independent of risk-weighted assets. In this proposal,
analyses use the linearized version of the surcharge applicable in
2026, which reflects the minimum of the surcharge based on year-end
2023 and year-end 2024 score data.
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\613\ See 12 CFR part 217, subpart H.
\614\ See 12 CFR 217.406 (calculation of the short-term
wholesale funding score).
\615\ The cumulative impact analysis in section VII.B and VII.C
does not require this adjustment as under the GSIB proposal, the
method 2 score would be unaffected by changes in risk-weighted
assets.
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5. Attribution of Stress Capital Buffer Requirement to Risk Categories
Analysis of the cumulative impact of the several changes to large
banking organizations' capital requirements at the risk or business
activity level, as described in sections VII.B and VII.C, necessitates
a mapping from the components of stress capital buffer requirements to
the risks that they reflect. This section describes the method used to
attribute stress capital buffer requirements to the four risk types
(credit, market, operational, and CVA) measured under this proposal.
The stress capital buffer requirement represents the maximum
decline in each bank holding company's common equity tier 1 capital
ratio, plus four quarters of planned common stock dividends, also
expressed as a percentage of risk-weighted assets.\616\ Thus, the
quarter in the stress scenario with the minimum capital ratio is first
identified, and the drivers of the cumulative change in capital through
that quarter are attributed to risks. In estimates reflecting changes
to the stress test, the impact (on minimum capital ratio) of several
proposed changes is also attributed to risks. Lastly, the common stock
dividends are attributed. Details of the attribution are covered below.
Note that the analysis attributing capital requirements to banking
activities, as described in section VII.C, does not require an explicit
attribution of stress capital buffer requirements to banking
activities. Instead, as discussed in section VII.C, this attribution is
extrapolated from the combination of the attribution of risk-weighted
assets by risk type to banking activities (discussed above in section
VII.D.3) and the attribution of stress capital buffer requirements to
risk types discussed here.
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\616\ Before application of the 2.5 percent floor on the
requirement.
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First, the drivers of the stress capital decline that can be
entirely attributed to a specific risk type are attributed. All credit
loss provisions are attributed to credit risk,\617\ along with losses
on loans held at fair value and private equity, gains or losses on
asset-liability hedges, changes in capital due to ``accumulated other
comprehensive income'' (AOCI), and expenses associated with other real
estate owned. Losses from the largest counterparty default in the
stress test are also attributed to credit risk. Reducing the credit-
attributed losses, interest income on all assets except trading assets
are attributed to credit risk. When changes to the stress test are
considered, those changes associated with credit losses (including
counterparty credit), assets under fair value option, securities
losses, and net interest margin models are attributed to credit risk.
Losses (or gains) attributed to market risk include those on public
equity securities, and both mark-to-market and intraday trading.
Trading revenue and interest income on trading assets are also
attributed to market risk. When considered, the impact of changes
associated with the global market shock component of the severely
adverse scenario are attributed to market risk. Counterparty losses
associated with credit valuation adjustments, net of hedges, are
attributed to CVA. Lastly, modeled operational losses are attributed to
operational risk. These
[[Page 15116]]
losses change under proposed changes to the stress test.
---------------------------------------------------------------------------
\617\ The adjustment credit for allowances held at the start of
the stress test is also attributed to credit risk.
---------------------------------------------------------------------------
Second, all interest expenses, net of income from account fees and
services charges are attributed across credit and market risk in
proportion to the trading book share of total assets. The implicit
assumption here is that the funding composition of a dollar of trading
and non-trading assets is the same.
Third, estimated changes in capital with drivers that are not
neatly associated with the specific types of measured are attributed
across credit, market, and CVA risk categories in proportion to their
share of risk-weighted assets. These drivers consist primarily of
noninterest income associated with fiduciary and investment banking
services, but also include other noninterest income, servicing fees,
changes in goodwill, and income due to minority interests. Under the
proposed stress test changes, changes in losses associated with the
proposed use of a discount path approach are also attributed in
proportion to risk-weighted asset shares.
Fourth, the major operating expense categories that cut across
banking activities are attributed across the risks in proportion to
each risk's share of an estimate of the ``business as usual'' income
associated with the risk. The operating expenses attributed in this
step include those associated with employee compensation, fixed assets
and all other non-interest expenses other than operational losses and
expenses associated with other real estate owned. When considering
requirements incorporating proposed stress test changes, the operating
expenses attributed here reflects the proposed use of efficiency ratio-
based expense projections. The estimate of ``business as usual'' income
associated with each risk type equals that risk type's share of net
interest income plus non-interest income, where these items are
attributed to risks as described above.
Fifth, accounting and regulatory capital-related adjustments that
are driven by losses in general are applied across risks in proportion
to their stress losses as attributed thus far. These adjustments
include those associated with deferred tax assets, taxes and associated
valuation allowance adjustment, and any (generally de minimus) changes
in common equity tier 1 threshold deduction amounts.
Lastly, as the stress capital buffer requirement associated with
common and preferred stock dividends is independent of the risks the
bank holding company undertakes or the gains and losses realized in the
stress test, it functions similarly to a requirement that is a fixed
percentage of risk-weighted assets. Therefore, the dividend portion of
the stress capital buffer requirement is attributed to risks in
proportion to their share of risk-weighted assets under whichever
framework (standardized or expanded risk-based) is being applied in the
given estimate.
At this point in the process, the impact of the 2.5 percent floor
on the stress capital buffer requirement is considered. Since the
introduction of the stress capital buffer in 2020, three of the nine
bank holding companies subject to this proposal have consistently had
pre-floor stress capital buffer requirements below 2.5 percent. For
these bank holding companies, the stress capital buffer requirement is
independent of the specific drivers of the stress test loss, and is
effectively proportional to risk-weighted assets. Therefore, the stress
capital buffer requirement for these three bank holding companies is
attributed proportionally to risk-weighted assets. For the other bank
holding companies, the stress capital buffer requirements is routinely
in excess of 2.5 percent, so the requirement is attributed as described
above. However, in those instances where the pre-floor requirement for
these bank holding companies is below 2.5 percent, the additional
requirement associated with the 2.5 percent floor is attributed across
risk types in proportion to their associated risk-weighted assets.
VII. Economic Analysis
This section evaluates the projected economic effect of the
proposal by analyzing its key costs and benefits. When applicable, the
analysis considers the effects of the GSIB surcharge proposal, the
standardized approach proposal, and the proposed changes to the
supervisory stress testing models and scenarios.
Section VIII.A presents an overview of the baseline of the economic
analysis by examining the current state of banking organizations and
the economy absent the combined proposals. It provides context for
subsequent analyses on changes in risk-weighted assets, capital
requirements, revenue sources, assets, and the relative importance of
bank and nonbank financial intermediation.
Section VIII.B compares the anticipated risk-weighted asset effects
of the proposal with three reasonable alternative implementations of
the Basel standards. Changes in risk-weighted assets under the proposal
would be within the range of impact of the alternatives while providing
a substantial degree of risk-sensitivity.
Section VIII.C discusses the macroeconomic effects of changes in
capital requirements. Based on the agencies' analysis, the decrease in
capital requirements stemming from the proposal combined with the GSIB
surcharge proposal and the standardized approach proposal would
maintain levels of banking organization capital that are reasonable to
achieve a safe and sound banking system based on the academic
literature. Using a variety of methods, this literature provides a wide
range of optimal capital requirements that balance the benefits of
safety and soundness against the costs of reduced banking organization
lending from higher requirements. This section also acknowledges
certain limitations in applying this literature to analyze the proposed
regulatory changes.\618\
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\618\ The literature on optimal capital levels has limitations
in its applicability to the proposed changes, as it typically
assumes fixed risk weights and focuses primarily on loan portfolios
rather than trading activities. This is particularly relevant given
the important role of capital markets in the U.S. economy.
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The proposal aims to enhance the measurement of credit,
operational, and market risk to more accurately capture the underlying
risks of covered banking organizations' activities. Improved risk
measurement helps avoid unintended inefficiencies and potential
misallocation of resources from capital regulation. Given the effects
of regulatory capital requirements on the real economy, the proposal
may improve economic efficiency. Moreover, reducing complexity in the
regulatory framework enhances transparency of capital requirements and
supports market discipline, with potential safety and soundness
benefits.
Section VIII.D presents information on the potential effects of the
proposal on banking organization lending, such as credit card,
residential mortgage, and business lending.\619\ Lending is a key
business for banking organizations and an essential method for
intermediating between savers and borrowers. The section analyzes a
range of lending products that facilitate consumption and investment
throughout the economy. The proposal's changes to risk sensitivity,
operational risk, and treatment of off-balance sheet exposures would be
the primary drivers of changes in capital requirements, potentially
encouraging banking organizations to
[[Page 15117]]
shift lending toward activities with projected reductions in risk
weights.
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\619\ While this analysis primarily relies on data for the
largest banks, the findings are also likely applicable to any
smaller banks that choose to adopt the expanded risk-based approach,
as the expected changes in risk weighted assets for lending
portfolios would be similar.
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Residential mortgage lending would incorporate LTV-based risk
weights to enhance risk sensitivity. At the same time, lower risk
weights would likely lead to a modest increase in mortgage lending by
the banking organizations. Risk-weighted assets for corporate lending
is projected to decrease due to more favorable treatment of investment-
grade borrowers and lower standardized credit conversion factors for
conditional equity and credit commitments with more than one year to
maturity, which together outweigh new operational risk requirements and
higher credit conversion factors for off-balance sheet exposures with
less than one year to maturity. Credit card portfolios would experience
mixed effects by borrower repayment behavior and utilization rates.
Depending on whether the new risk-weight on unutilized balances and the
operational risk add-ons outweigh lower risk-weights on utilized
balances, risk-weighted assets on credit card exposures under the
proposal could be higher or lower than the current standardized
approach.
Section VIII.E assesses the projected effects of the proposal on
trading activities of banking organizations and the potential impact on
their customers and on markets. The agencies expect the proposal would
help preserve the availability of intermediation and market functioning
during economic downturns by determining capital requirements based on
losses from historical stress periods, which exhibits less cyclicality
than the current approach. Also, trading products that are less liquid
or more difficult to model would require more market risk capital. This
may increase the cost of intermediation of some products but would also
better align capital requirements with risk.
Trading activity involves market risk, counterparty credit risk,
CVA risk, and operational risk. This proposal makes major revisions to
the market risk framework which would affect incentives for banking
organizations' hedging strategies and risk modelling methods. In
addition, risk-weighted assets related to trading activity would
increase from the inclusion of CVA and operational risk-weighted
assets, which are not part of the current standardized approach that
generally determines capital requirements today. The majority of
capital requirements for trading activity today comes from counterparty
credit risk-weighted assets, and this would remain true under the
proposal.
Taken together with the proposed changes to the GSIB surcharge and
supervisory stress test models, and the recent revision of the eSLR,
the cumulative effect on capital requirements related to trading
activity is expected to be about a 9 percent increase for Category I
and II banking organizations. Increases in risk-weighted assets from
changes in the market risk framework and inclusion of CVA and
operational risk are expected to be materially offset by the proposed
changes to the global market shock in supervisory stress tests. Non-
Category I and II banking organizations will see generally a small
impact to their trading activity given the relatively smaller change in
their market risk and CVA.
Section VIII.F considers the potential effects of the proposal on
competition between financial institutions. The proposed changes to
capital requirements for large U.S. banking organizations are expected
to have implications for competition both domestically and
internationally. By aligning U.S. capital requirements more closely
with international standards, the proposal may enhance Category I and
II banking organizations' ability to compete globally without
compromising their comparatively strong capital positions. The revised
risk weights, and increased certainty in capital requirements from
moving to a single set of risk-based requirements, are anticipated to
support more consistent lending and market-making activities throughout
economic cycles.
The proposal incorporates measures that maintain competitive
balance while acknowledging the business model differences between
large and small institutions. Notably, the proposal would allow banking
organizations of any size to adopt the new risk-weight framework. This
proposal preserves higher overall capital requirements for Category I
and II banking organizations which, along with the parallel proposal to
revise the U.S. standardized approach, would mitigate concerns about an
unlevel playing field. Moreover, reducing complexity in the regulatory
framework enhances transparency of capital requirements and supports
market discipline, with potential safety and soundness benefits.
The proposal would likely, in aggregate, encourage the migration of
certain activities, particularly traditional lending, back towards
banking organizations while effects on trading activities would be more
mixed. Lower risk weights for most mortgages and the removal of the
mortgage servicing assets threshold capital deduction could encourage
covered banking organizations to maintain or expand these activities
relative to nonbank financial intermediaries, directly and via
correspondent lending relationships with independent mortgage banks and
smaller depository institutions. More broadly, enhanced competition in
key lending markets could reduce the premiums that lenders can charge
above their costs, providing greater economic benefits to consumers.
For Category I and II banking organizations, heterogenous effects on
different products within the proposed market risk framework could
incentivize liquidity provision for those products to either shift
toward or away from nonbank financial intermediaries, with increases in
risk weights being offset by both reductions in the GSIB surcharge
proposal and the proposed revision to stress test scenarios.
A. Overview of the Baseline
This section discusses the current state of Category I and II
banking organizations and the economy absent the proposal (the
baseline) to help understand the potential effects of the proposal. To
help contextualize the broader macroeconomic effects of the proposal, a
discussion of the total banking system is also included.
Sections VIII.A.1 and VIII.A.2 provide context for the changes in
capital requirements under the proposal by exploring the cross-section
and time series of bank capital. Sections VIII.A.3 and VIII.A.4 help to
contextualize results presented in sections VIII.D and VIII.E that
discuss the potential effects on lending, trading, and other business
activities by breaking down the principal revenue sources and assets of
covered banking organizations. Finally, sections VIII.A.5 and VIII.A.6
document the relative dependency of the economy on bank and nonbank
sources of financial intermediation. These sections support later
analyses in section VIII.D regarding the potential macroeconomic and
financial intermediation effects of the proposal on the U.S. economy.
1. Capital Ratios of Category I and II Banking Organizations--Cross
Section
Banking organizations generally maintain capital ratios above
regulatory capital requirements, including any applicable buffer
requirements. The excess above such requirements--often called
``management buffers''--varies across banking organizations and would
likely continue to vary under the proposal as such buffers reflect
firm-specific considerations. Table VIII.1 shows the average required
and actual common equity tier 1 capital levels for Category I and II
banking organizations.
[[Page 15118]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.108
Note: This table shows aggregate required and actual common equity
tier 1 capital levels as of June 30, 2025, for the top-tier holding
companies of Category I and II banking organizations. For this purpose,
capital requirements include applicable buffer requirements, including,
as applicable, the GSIB surcharge requirement and, under the
standardized approach only, the stress capital buffer requirement.
Required capital ratios were calculated using the methodology described
in section VII.D. Source: FR Y-9C and FFIEC 101.\620\
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\620\ Statistics are calculated from the FR Y-9C and FFIEC 101,
as of June 30, 2025 (collectively, ``June 2025 Form Statistics'').
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Capital Ratios of Banking Organizations--Time Series
Observing banking organizations' capital ratios over time helps
provide another perspective on the capital in the U.S. banking
system.\621\ In this case, the agencies consider the entire banking
system to provide context for considering the potential effects of the
proposal from a broader macroeconomic perspective. Figure VIII.1 shows
that the aggregate common equity tier 1 capital ratios of the U.S.
banking system have increased slowly from around 12 percent in the
middle of the last decade to a bit above 13 percent now. Currently, the
U.S. banking system, not counting credit unions, maintains over $2.2
trillion in common equity tier 1 capital to help support approximately
$31 trillion in assets ($17 trillion in risk-weighted assets). The
proposal is expected to generally maintain the overall stability of
capital in the U.S. banking system.
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\621\ The analysis presented in section VIII.A.2 was conducted
using data from all top-level depository institution holding
companies that file the FR Y-9C, except for community banking
organizations that have opted into the community bank leverage ratio
framework and therefore do not report risk-based capital ratios.
Credit unions are not included in the analysis.
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Figure VIII.1: Aggregate U.S. Banking System Common Equity Tier 1
Capital Ratio (Percent)
[[Page 15119]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.109
3. Portfolio Characteristics of Category I and II Banking
Organizations--By Revenue
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\622\ Data from Quarterly Trends for Consolidated U.S. Banking
Organizations https://www.newyorkfed.org/research/banking_research/quarterly_trends.html (Downloaded on 1/15/26).
---------------------------------------------------------------------------
Capital requirements affect banking organizations' choice of
business model and hence the composition of their revenue. Interest
income, primarily accrued from loans and fixed-income securities, is a
key source of banking organization revenue. Across Category I and II
banking organizations, interest income constitutes nearly 69 percent of
total gross income.\623\ The remaining approximately 31 percent of
total gross income is earned from noninterest sources, such as fees and
commissions. These and other figures included in this section are based
on Y-9C data.
---------------------------------------------------------------------------
\623\ Estimates are based on data from the FR Y-9C filings of
banking organizations subject to Category I or II capital standards
as of June 30, 2025. Interest Income share is calculated as Total
Interest Income (BHCK4107) divided by the sum of Total Interest
Income and Total Noninterest Income (BHCK4079).
---------------------------------------------------------------------------
A significant share of interest income (39 percent) comes from
domestic loan portfolios, which generally include residential
mortgages; commercial mortgages; other loans to businesses; and
consumer loans such as credit cards, student loans, and auto loans.
Another 27 percent comes from interest on securities held for
investment and trading assets. The remainder of interest income comes
from foreign loans (6 percent) and other interest earning activities
(29 percent) including federal funds sold, interest on balances due
from other depository institutions, and lease financing receivables.
Roughly 36 percent of noninterest income is earned from trading
activities. Securities-related activities account for nearly 35 percent
of gross noninterest income. This category includes fees and
commissions from activities such as securities brokerage, investment
banking, and advisory activities.
While these are the broad patterns of aggregate income, there is
substantial variation across Category I and II banking organizations.
The largest universal banking organizations offer a wide array of
services, whereas other banking organizations are more specialized.
Therefore, while aggregate statistics provide an overview of
covered banking organizations subject to the proposal, each banking
organization differs in its revenue streams. Hence, the potential
effects of the proposal are likely to vary depending on each banking
organization's business model, although the overall effect is likely to
reinforce the role of banks in traditional banking activities.
Moreover, the proposed rule could also create feedback effects that
alter these metrics as banking organizations adjust their business
activities to optimize their risk-weighted assets.
4. Portfolio Characteristics of Category I and II Banking
Organizations--By Broad Asset Class
This section presents the composition of the aggregate assets of
Category I and II banking organizations. The largest asset category on
the balance sheet of these banking organizations is loans and leases
(31 percent), which are the traditional lending business of banking
organizations. Another major category is securities (19 percent), which
includes both held-to-maturity and available-for-sale debt securities,
as well as equity securities not held for trading.\624\ Debt
[[Page 15120]]
securities holdings include primarily government and corporate bonds,
and mortgage-backed securities. The trading assets category (19
percent), which includes securities that are in banking organizations'
trading portfolios as well as derivatives and other financial
instruments, is also a major asset category. Trading securities are
generally substantial for banking organizations engaged heavily in
investment banking activities, a group that includes six of the nine
Category I and II bank holding companies.
---------------------------------------------------------------------------
\624\ Estimates are based on data from schedule RC of the FR Y-
9C filings on June 30, 2025. Loans and leases consist of Loans and
Leases Held for Sale (BHCK5369) and Loans and Leases Held for
Investment (BHCKB528). Securities held for investment includes Held
to Maturity (BHCKJJ34) and Available for Sale Securities (BHCK1773).
Trading assets is BHCK3545.
---------------------------------------------------------------------------
As with the presentation of the sources of aggregate income, these
aggregate statistics mask heterogeneity across Category I and II
banking organizations. The heterogeneity in their asset compositions
exposes these banking organizations to different combinations of
credit, market, and operational risk. Therefore, the effects of the
proposal would vary based on individual banking organizations' business
models.
Balance sheet data provide an incomplete picture of risk because
they do not account for off-balance sheet exposures, including
contingent liabilities like loan commitments and letters of credit.
Banking organizations subject to Category I or II capital standards
have close to $6 trillion in total undrawn loan commitments, including
consumer credit card lines, lines of credit extended to non-financial
corporates as well as nonbank financial entities, commitments to fund
commercial real estate and other construction loans, securities
underwriting commitments, and other commitments.\625\ This total is
about a third of the size of these banking organizations' on-balance
sheet assets of $16.8 trillion. The proposal would apply different risk
weights and credit conversion factors for certain off-balance sheet
exposures, relative to the standardized approach.
---------------------------------------------------------------------------
\625\ The undrawn loan commitments calculation includes the sum
of items BHCKJ455, BHCKJ456, BHCK3816, BHCK6550, BHCK3817, BHCKJ457,
BHCKJ458, and BHCKJ459 from schedule HC-L. To provide a sense of the
relative importance of off-balance sheet exposures, the agencies use
data from Schedule HC-L of FR Y-9C reports as of June 30, 2025.
---------------------------------------------------------------------------
5. Dependency of the U.S. Economy on the Banking System
As shown in Figure VIII.2 below, U.S. businesses and households
receive a larger share of financing from nonbank entities relative to
other advanced economies due to the depth and breadth of U.S. financial
markets. The difference in bank dependence is partially due to the
United States having a more market-oriented financial system that
provides more opportunities for various forms of equity financing as
well as for nonbanks to participate in credit markets compared with the
more bank-oriented financial systems of Europe and Japan. This
difference may affect how the implementation of the Basel standards
would impact the U.S. economy when compared to the impact on the
economies of Europe and Japan. To better understand these differences,
the agencies analyzed trends in total bank credit in the United States
as a share of gross domestic product (GDP) and compared these trends
with those of the United Kingdom, Japan, and the Euro Area using data
from the Bank for International Settlements (BIS).\626\
---------------------------------------------------------------------------
\626\ Bank of International Settlements (BIS), BIS Data Portal,
Credit to the Non-Financial Sector (data flow ID: BIS,WS_TC,2.0),
``Comparative View of Advanced Economies--Credit from Banks,
Domestic to Private Non-Financial Sector at Market Value, Percentage
of GDP, Adjusted for Breaks'' (series key: Q.5R.P.B.M.770.A) (data
sets downloaded on September 29, 2025) (``BIS Data: Credit
(2025)''), https://data.bis.org/topics/TOTAL_CREDIT/BIS,WS_TC,2.0/Q.5R.P.B.M.770.A?additional_ts=BIS%2CWS_TC%2C2.0%255EQ.DE%2BFR%2BUS%2BGB.P.B.M.770.A.
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In other advanced economies, particularly in Europe and Japan,
banks are the primary source of credit for the non-financial sector. As
shown in Figure VIII.2, the share of credit to the non-financial sector
coming from banks is significantly higher in these jurisdictions than
in the United States. Moreover, the share of banking sector credit in
the United States has remained relatively constant over the past
decade.\627\ Because a smaller share of private sector credit
originates from the banking system in the United States, the proposal,
which directly affects only covered banking organizations, is likely to
have more modest macroeconomic effects than a similar regulation in a
more bank-dependent economy.
---------------------------------------------------------------------------
\627\ Over time, the share of bank credit in the United Kingdom
and the European Union has declined some, converging partway towards
the United States's level.
---------------------------------------------------------------------------
However, looking at the potential direct effects alone may
underestimate the impact of the proposal. Covered banking organizations
facilitate significant provision of credit to households and nonbank
financial institutions through their role in financial markets (these
effects are described in section VIII.D.
Figure VIII.2: Credit From the Banking Sector to the Private Non-
Financial Sector as a Share of GDP
[[Page 15121]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.110
6. Nonbank Financial Intermediaries
---------------------------------------------------------------------------
\628\ BIS Data: Credit (2025).
---------------------------------------------------------------------------
U.S. nonbank financial entity (nonbank) assets are currently three
times larger than bank assets (Figure VIII.3). This is the result of a
longstanding trend; since 1985, nonbank assets have grown much faster
than bank assets.
Figure VIII.3: Total Assets of Banks and Nonbanks
[[Page 15122]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.111
The growth in total assets discussed above is often cited to gauge
the shift in financial activity between traditional banks and nonbanks.
However, this analysis omits other linkages, such as credit lines
provided by banking organizations to nonbanks,\630\ and can also
overestimate activity by nonbanks.\631\
---------------------------------------------------------------------------
\629\ Statistics used in agency calculations are from the Board
of Governors of the Federal Reserve System, Z.1 Financial Accounts
of the United States (from Dec. 31, 1979, to June. 30, 2025),
https://www.federalreserve.gov/releases/z1/. The bank data consists
of the sum of series FL702000095.Q and FL734194005.Q. The nonbank
data consists of series FL792000095.Q less the sum of series
FL702000095.Q and FL734194005.Q.
\630\ Viral V. Acharya, Nicola Cetorelli & Bruce Tuckman,
``Where Do Banks End and NBFIs Begin?'' National Bureau of Economic
Research, Working Paper No. 32216, (March 2024) (``Acharya et al.
(2024)''), https://dx.doi.org/10.2139/ssrn.4760963.
\631\ Joshua Gallin, ``Shadow Banking and the Funding of the
Nonfinancial Sector,'' Measuring Wealth and Financial Intermediation
and Their Links to the Real Economy, Chapter 4, 89-124 (February
2015) (``Gallin (2015)''), https://doi.org/10.7208/chicago/9780226204437.003.0004.
---------------------------------------------------------------------------
The amount of credit that banks and nonbanks provide to the non-
financial private sector is another way to measure the migration of
activity out of the traditional banking sector. Figure VIII.4 shows
that the share of credit to the non-financial private sector provided
by banking organizations has been between 30 and 35 percent since the
early 2000s. This share has persisted through regulatory changes and
economic
[[Page 15123]]
events, including the U.S. implementation of Basel II and Basel III
reforms, the 2007-09 financial crisis, and the COVID-19 pandemic. The
faster growth in nonbank assets (Figure VIII.3) and (Figure VIII.4)
noting the increased role of nonbanks in the investment activity of
U.S. households and small and medium enterprises. For example, a
substantial share of mortgage origination is now primarily undertaken
by nonbanks.\632\
---------------------------------------------------------------------------
\632\ Rebucci, Alessandro; Sclip, Alex; Sapriza, Horacio; and te
Kaat, Daniel. (August 2025) ``Bank Liquidity and Financing of
Nonbank Mortgage Companies.'' Federal Reserve Bank of Richmond
Economic Brief, No. 25-33, https://www.richmondfed.org/publications/research/economic_brief/2025/eb_25-33.
---------------------------------------------------------------------------
Figure VIII.4 also shows a sharp decline in bank credit to the non-
financial private sector in the 1980s from the higher levels of the
1970s. This decline was likely driven by a combination of regulation
and financial sector innovation that reshaped the U.S. financial
system.\633\ One of these developments was the introduction of formal
leverage requirements in bank supervision and regulation in 1981.\634\
Other important changes also contributed to this decline. In the 1980s,
the financial landscape began to shift significantly, marked by the
expanded activities of government-sponsored enterprises (GSEs) and U.S.
agencies, including Fannie Mae, Freddie Mac, and Ginnie Mae. During
this period, certain housing GSEs rapidly expanded their role in the
mortgage market by securitizing a substantial share of residential
loans. Previously, the bulk of loans had generally been held on the
balance sheets of banking organizations.\635\ This expansion of
securitization allowed nonbanks to intermediate a larger share of
mortgage lending, a trend that accelerated with the creation of real
estate mortgage investment conduits in the late 1980s.\636\ As a
result, the share of credit provided by banking organizations to the
non-financial private sector began to decline sharply. This rise in GSE
activity and the broader growth of securitization markets played a
pivotal role in the long-term shift of credit provision away from
banking organizations.\637\ As described in the sections below, by
adjusting the capital framework, the proposal may support lessening of
this decline in the share of credit to the non-financial private sector
provided by banking organizations.
---------------------------------------------------------------------------
\633\ Mark A. Calabria, ``The Rise of Nonbank Mortgage
Lending,'' Regulation, 46(18) (2023) (``Calabria (2023)''), https://www.cato.org/regulation/summer-2023/rise-nonbank-mortgage-lending.
\634\ Federal Reserve Bank of St. Louis, Federal Reserve
History, ``Bank Capital Standards'' (March 2024), https://www.federalreservehistory.org/essays/bank-capital-standards;
``Capital Adequacy Guidelines,'' 68 Federal Reserve Bulletin, 33
(1982).
\635\ Dwight M. Jaffee & Kenneth T. Rosen, ``Mortgage
Securitization Trends,'' Journal of Housing Research, 1(1), 117-37
(1990) (``Jaffee and Rosen (1990)''), http://www.jstor.org/stable/24825876.
\636\ Solomon Y. Deku & Alper Kara, ``A Historical and Regional
Overview of Securitization,'' Securitization: Past, Present and
Future, 57-91 (August 2017) (``Deku and Kara (2017)''), https://doi.org/10.1007/978-3-319-60128-1_4.
\637\ See Calabria (2023).
---------------------------------------------------------------------------
Figure VIII.4: Share of Credit to Non-Financial Private Sector Provided
by Banks
[[Page 15124]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.112
The nonbank sector is diverse, comprising investment funds,
insurance providers, pensions, specialty finance companies (such as
mortgage lenders and private credit funds), and market infrastructure
providers, among other types of institutions. Nonbanks that are funded
by less stable sources of funding or are highly leveraged and nonbanks'
funding access interlinkages with wholesale capital markets,
institutional investors, and banking institutions can pose financial
stability concerns. For example, as seen during the 2007-09 financial
crisis, the suspension of redemptions by one money market mutual fund
can cause contagion as investors are incentivized to withdraw from
other funds.\639\ In addition, during the market dislocations in the
early days of the COVID-19 pandemic, principal trading firms, facing
volatile and uncertain markets, may have pulled back from providing
liquidity to U.S. Treasury markets, thus contributing to the overall
stressed market conditions.\640\ Moreover, the uneven regulatory
oversight of nonbanks, relative to banks, may increase their
vulnerability to runs, liquidity stresses, and other systemic shocks,
with potential financial stability consequences.\641\ Any potential
shifts in activity from the nonbank sector to the banking sector
stemming from this proposal may help alleviate such vulnerabilities.
---------------------------------------------------------------------------
\638\ BIS, BIS Data Portal, Credit to the Non-Financial Sector
(data flow ID: BIS,WS_TC,2.0), ``United States--Credit from All
Sectors to Private Non-Financial Sector at Market Value, U.S.
Dollar, Adjusted for Breaks'' (series key: Q.US.P.A.M.USD.A) (data
set downloaded on October 17, 2025), https://data.bis.org/topics/TOTAL_CREDIT/BIS,WS_TC,2.0/Q.US.P.A.M.USD.A.
\639\ ``Financial Crisis Inquiry Commission, The Financial
Crisis Inquiry Commission: Final Report of the National Commission
on the Causes of the Financial and Economic Crisis in the United
States,'' Featured Commission Publications, (February 2011), https://www.govinfo.gov/content/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf.
\640\ U.S. Department of the Treasury, the Board of Governors of
the Federal Reserve System, the Federal Reserve Bank of New York,
the U.S. Securities and Exchange Commission & the U.S. Commodity
Futures Trading Commission, ``Recent Disruptions and Potential
Reforms in the U.S. Treasury Market: A Staff Progress Report''
(November 2021), https://home.treasury.gov/system/files/136/IAWG-Treasury-Report.pdf.
\641\ Gary Gorton & Andrew Metrick, ``Getting Up to Speed on the
Financial Crisis: A One-Weekend-Reader's Guide,'' Journal of
Economic Literature 50(1), 128-150 (March 2012) (``Gorton and
Metrick (2012)''), https://www.doi.org/10.1257/jel.50.1.128.
---------------------------------------------------------------------------
The presence of nonbanks alongside, and in competition with,
traditional banks can also promote access to credit for households and
businesses and improve the secondary market liquidity for this credit.
Nonbanks, with business models, funding structures, and use of
technology that differ from traditional banks, can help to diversify
the financial landscape, foster innovation, and enhance the overall
efficiency of
[[Page 15125]]
financial services.\642\ These tradeoffs are discussed further when
analyzing the potential competitive effects of the proposal in section
VIII.F.
---------------------------------------------------------------------------
\642\ Stijn Claessens & Laura E. Kodres, ``The Regulatory
Responses to the Global Financial Crisis: Some Uncomfortable
Questions,'' International Monetary Fund, Working Paper No. 2014/046
(March 2014) (``Claessens and Kodres (2014)''), https://www.imf.org/external/pubs/ft/wp/2014/wp1446.pdf.
---------------------------------------------------------------------------
B. Reasonable Alternatives
This section compares the estimated consequences of the proposal on
banking organization risk-weighted assets with three reasonable
alternatives to implement the Basel standards in the United States and
achieve the objectives of the proposal. These alternatives, along with
the proposal, represent different approaches intended to promote robust
levels of capital, risk sensitivity, and a simplified capital
framework. Similar to the current capital rule, Alternative 1 would
subject Category I and II banking organizations to two sets of risk-
based capital ratio requirements: one set based on the proposed
revisions to the standardized approach, the other set based on the
proposed expanded risk-based approach (subsequently referred to as the
dual calculation implementation). Alternative 2 would replace the
current capital framework with a version of the Basel standards that
does not contain any of the U.S.-specific adjustments in the proposal
that account for factors such as the specific characteristics of U.S.
markets, practices of U.S. banking organizations, or U.S. statutory
mandates and policy objectives and, in contrast to the proposal, would
assume use of models-based approaches for credit risk (subsequently
referred to as the BCBS models-based implementation). Alternative 3
would also not contain the U.S.-specific adjustments outlined in the
proposal and would only allow use of standardized, non-modelled
approaches within the Basel standards without any U.S.-specific
adjustments (subsequently referred to as the BCBS standardized
implementation). Both Alternatives 2 and 3 would entail a single
calculation and rely on data from the quantitative impact studies
conducted by the Basel Committee on Banking Supervision.\643\ This
section discusses each alternative in turn, then presents a
quantitative comparison of their effects on the risk-weighted assets of
Category I banking organizations.
---------------------------------------------------------------------------
\643\ See, e.g., Basel Committee on Banking Supervision (2010,
2025). Basel Committee on Banking Supervision. ``Results of the
Comprehensive Quantitative Impact Study.'' Bank for International
Settlements, December 2010. https://www.bis.org/publ/bcbs186.pdf.
Basel Committee on Banking Supervision. ``Basel III Monitoring
Report.'' Bank for International Settlements, October 2025. https://www.bis.org/bcbs/publ/d599.pdf.
---------------------------------------------------------------------------
1. Alternative 1: Dual Calculation Implementation
Category I and II banking organizations are currently required to
calculate two sets of risk-based capital ratio requirements: one set
based on the standardized approach (which also applies generally to
other banking organizations), the other set based on the advanced
approaches. The binding requirement for purposes of complying with
minimum risk-based capital requirements is the lower of each ratio
calculated under the two approaches.\644\ Under the proposal, Category
I and II banking organizations would be subject to requirements based
on the expanded risk-based approach and revised market risk framework.
The standardized approach would no longer apply to these banking
organizations and the advanced approaches would be eliminated. Thus,
such banking organizations would no longer be required to calculate two
sets of risk-based capital ratios.
---------------------------------------------------------------------------
\644\ The lower of the two ratios is the stricter of the two
requirements.
---------------------------------------------------------------------------
In contrast, Alternative 1's dual calculation implementation
assumes that Category I and II banking organizations would be required
to calculate ratios under both the standardized approach (inclusive of
proposed amendments in the companion proposal to modify the
standardized approach) and the expanded risk-based approach. In the
context of comparing the proposal with the reasonable alternatives,
which focuses on comparisons of risk-weighted assets, the approach
under the dual calculation implementation that yields the higher amount
of risk-weighted assets would be considered the binding approach.
The retention of the standardized approach requirements alongside
the expanded risk-based approach for banking organizations using the
latter approach could be justified by the goal of improving
comparability in capital resulting from the proposals. As discussed in
section I.B and II.C, the proposal introduces consistent, comparable,
and robust capital requirements, without requiring two parallel sets of
requirements like in Alternative 1.
2. Alternative 2: BCBS Models-Based Implementation
In the design of this proposal, the agencies made certain
adjustments to the Basel standards to address factors such as specific
characteristics of U.S. markets, practices of U.S. banking
organizations, and U.S. policy objectives. The BCBS models-based
implementation would not include these U.S.-specific adjustments and
would assume the use of internal models for credit risk and market
risk, similar to implementation of the Basel standards in other
jurisdictions. The scope of application for mandatory use would remain
Category I and II banking organizations, consistent with the proposal
and the current advanced approaches framework.
Empirically, under the BCBS models-based implementation, modelled
risk-weighted assets would generally be higher than the Basel
standardized approach output floor.\645\ However, the Basel output
floor, which limits the benefits banking organizations can derive from
using internal models to calculate minimum capital requirements, would
be binding for a few Category I or II banking organizations.
---------------------------------------------------------------------------
\645\ The Basel standards include a floor to risk-weighted
assets, which corresponds to 72.5 percent of risk-weighted assets
calculated only using standardized approaches.
---------------------------------------------------------------------------
The key methodological difference in the treatment of credit risk
under the BCBS models-based implementation is that it continues the use
of the internal ratings-based approach for credit risk, albeit in a
constrained way.\646\ In contrast, the proposal does not allow the use
of internal models to determine risk-weighted assets for credit
portfolios. This generally causes a lower requirement, under
Alternative 2, for low-default non-sovereign exposures.
---------------------------------------------------------------------------
\646\ With credit risk, the BCBS Basel III internal rating-based
approaches remove the estimation of loss given default for lower
default portfolios (large corporates, sovereigns, banks). In
addition, the output floor constrains the degree to which those
models can reduce the contribution of risk weighted assets to risk-
weighted assets.
---------------------------------------------------------------------------
The proposal's market risk capital requirements include several
important differences relative to the BCBS models-based framework. For
example, the proposal would recognize market risk diversification
between modelled and unmodelled positions. The proposal would also
change the internal models approach to streamline testing requirements
and modify the treatment of non-modellable risk factors. Additionally,
risk weights and correlation parameters for some risk buckets in the
standardized approach to
[[Page 15126]]
market risk would be calibrated for U.S.-specific markets. The proposal
also includes a simplified partial look-through approach for
calculating fund exposures based on an appropriate index that is less
conservative than the Basel standard.
The proposal's credit valuation adjustment (CVA) risk requirements
are similar to those under the BCBS models-based implementation. One
important difference is that client-facing exposures, in connection
with client-cleared derivative transactions, are excluded from CVA risk
capital requirements under the proposal. Another important difference
is that the proposal introduces a separate counterparty credit spread
risk weight category for certain lower-risk financial institutions.
The proposal also differs in certain key respects from the
operational risk Basel standard and, therefore, from Alternative
2.\647\ Under the Basel standards, the business indicator is composed
of three components: (1) the interest, lease, and dividend component;
(2) the services component; and (3) the financial component. The
proposal retains the interest, lease, and dividend component. However,
the services and financial components are replaced with a single
noninterest component, in part to allow for netting of applicable
income and expenses.\648\ In addition, the proposal would scale the
income and expenses of the investment management business line in the
business indicator calculation while the Basel standard does not scale
any business line.
---------------------------------------------------------------------------
\647\ The proposal is consistent with the approach in the Basel
standards of setting the internal loss multiplier equal to 1.
\648\ In particular, the BCBS models-based implementation (1)
calculates the services component on a gross basis, (2) does not
allow netting across banking book and trading book activities in the
financial component, and (3) does not allow netting across
activities captured in the services component and those captured in
the financial component.
---------------------------------------------------------------------------
3. Alternative 3: BCBS Standardized Implementation
The BCBS standardized implementation under Alternative 3 modifies
Alternative 2 in two respects. First, Alternative 3 only contemplates
the use of standardized approaches for credit and market risk as
outlined in the Basel standards. Thus, Alternative 3 would remove the
option to use models to determine market risk capital requirements
compared to the proposal. Requiring the use of the market risk
standardized approach generally results in higher, less risk-sensitive
capital requirements. Second, because alternative 3 reflects only the
use of standardized approaches, it does not include the 72.5 percent
output floor.
4. Quantitative Estimates and Discussion
For each of the three alternatives, the agencies estimate aggregate
risk-weighted assets under the alternatives and contrast them with the
estimated levels under the proposal. The results for Category I banking
organizations appear in Table VIII.2.\649\
---------------------------------------------------------------------------
\649\ While Category II banking organizations are also subject
to the proposal, there is insufficient Basel quantitative impact
study data to calculate the impact for such banking organizations
under Alternative 2 and Alternative 3. Category II banking
organizations are part of the impact figures in section VII. In
addition, Table VIII.2 does not reflect RWA deductions. Therefore,
the aggregate figures for risk-weighted assets under the proposal,
in Table VIII.2, are slightly different from those reported in
Tables VII.2 and VII.5 in sections VII.A and VII.C.1, respectively.
---------------------------------------------------------------------------
Table VIII.2: Aggregate GSIB Risk-Weighted Assets under the Reasonable
Alternatives ($ billion)
[[Page 15127]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.114
Under the dual calculation implementation, aggregate risk-weighted
assets would be slightly higher than risk-weighted assets under the
proposal, and about 2 percent above current levels under the
standardized approach, which most commonly is the more binding of the
current risk-based capital requirements. The dual calculation
requirements are only slightly higher that under the proposal, as only
one of the smaller banking organizations subject to the proposal would
have higher risk-weighted assets under the standardized approach
proposal.
The BCBS models-based implementation would modestly reduce
aggregate risk-weighted assets by about 4 percent, relative to the
current standardized approach. Most Category I banking organizations
would have lower risk-weighted assets under Alternative 2 than under
the proposal.
The BCBS standardized approach would substantially increase
aggregate risk-weighted assets by 24 percent, relative to current
standardized approach. All Category I bank holding companies have
higher risk-weighted assets under Alternative 3 than under the proposal
or the other alternatives.
Despite variations in their estimated effects on total risk-
weighted assets, the proposal and alternatives maintain similar
relative contributions across risk stripes. Table VIII.2 illustrates
this composition, with credit risk contributing the majority at 70-80
percent of the total, operational risk accounting for 12-16 percent,
market risk representing 7-12 percent, and CVA comprising the smallest
portion at 3 percent. Risk-weighted assets are directly changed by the
proposal, and these alternatives do not necessarily imply equivalent
changes to capital requirements. Typically, capital requirements move
in the same direction as changes in risk-weighted assets. But changes
in capital requirements would likely be smaller in percentage terms
primarily because the capital amount required by the stress capital
buffer framework would be unaffected by changes in risk-weighted assets
for holding companies for which the 2.5 percent capital conservation
buffer requirement floor does not bind. In addition, changes in risk-
weighted assets may not translate into proportional changes in tier 1
capital requirements if leverage requirements, rather than risk-based
capital requirements, were binding for a given banking organization.
C. Macroeconomic Effects and the Analysis of the Proposal With Respect
to Estimates of Optimal Capital Levels
This section situates the proposal within the context of the
academic literature and policy analysis on the optimal capital levels
of the banking system. The proposal would change risk weights to more
closely align with the risks of covered banking organizations. These
changes in risk weights imply that the amount of required capital would
change for these banking organizations, potentially resulting in a
change to U.S. banking system capital requirements. The economic effect
of these changes can be evaluated in light of the findings of the
optimal capital research.
As noted, the proposal would mandatorily apply to Category I and II
banking organizations and banking organizations with significant
trading
[[Page 15128]]
activity. These banking organizations hold about half of the assets of
the U.S. banking system. In addition, the standardized approach
proposal would revise capital requirements for non-Category I and II
banking organizations that are subject to the risk-based framework. As
such, the analysis considers the literature on the optimal level of
capital for all banking organizations.\650\
---------------------------------------------------------------------------
\650\ This reflects the fact that the literature on optimal
capital level focuses on the banking sector of an economy, not just
the large banks.
---------------------------------------------------------------------------
As shown earlier in Figure II.1, the aggregate U.S. banking system
has more than $2.2 trillion of common equity tier 1 capital, equaling
13.4 percent of risk-weighted assets (as of June 30, 2025).
1. Impact of the Proposals
The agencies examined the impact of the proposals on capital
requirements for the U.S. banking system. This analysis includes the
proposed revisions to the calculation of risk-weighted assets and the
proposed amendments to the GSIB surcharge framework under the Board's
GSIB surcharge proposal. It also includes the proposed revisions to the
risk-weights in the U.S. standardized approach. When applicable, it
also notes the impact of the recent proposal to modify the Board's
stress tests.
Based on the estimates reported in section VII.C.2, the revisions
to the risk-weight framework and the GSIB surcharge would result in a
decrease to common equity tier 1 capital minimum plus buffer
requirements for Category I and II bank holding companies of $42.1
billion (inclusive of changes to stress capital buffer and GSIB
surcharge requirements). The estimated capital decrease is based on
balance sheets and exposures as of June 30, 2025. The actual impact may
be higher or lower depending on the future behavior of Category I and
II banking organizations.
Capital requirements for Category III and IV bank holding companies
would change due to revisions to risk-weighted assets for these banking
organizations that engage in significant trading activity, as well as
the accompanying proposal to revise the standardized approach. In
conjunction with the proposed stress test changes, these proposals are
expected to lower common equity tier 1 requirements of such bank
holding companies by $19.5 billion. Turning to bank holding companies
with assets below $100 billion, the proposals under consideration would
lower their common equity tier 1 requirements by $26.2 billion.
Altogether, these proposals would lower the common equity tier 1
requirements in the U.S. banking system by about $87.7 billion.
Excluding the effects of the stress test proposal, the three proposals
under consideration would lower common equity tier 1 requirements by
about $58.3 billion.
Using the total amount of common equity tier 1 capital in the U.S.
banking system of $2.22 trillion as a denominator and assuming affected
banking organizations would decrease their capital dollar-for-dollar
with the decrease in capital requirements--in effect maintaining the
same dollar amount of capital over requirements as they currently do--
the proposals altogether would lower aggregate capital in the U.S.
banking system by 4.0 percent.\651\ When this percentage decrease is
applied to the current common equity tier 1 capital ratio of the U.S.
banking system of 13.4 percent, the combined proposals are estimated to
decrease the common equity tier 1 capital ratio of the U.S. banking
system to an amount that is equivalent to about 12.9 percent when
measured relative to risk-weighted assets under the current rule.\652\
---------------------------------------------------------------------------
\651\ The corresponding decrease in capital requirements from
the three proposals under consideration--the Basel III proposal, the
standardized approach proposal and the G-SIB surcharge proposal--
yields an estimated decrease of 2.6 percent. The lower estimates
arises due to excluding the effects of the proposed changes to the
stress tests.
\652\ The projected common equity tier 1 capital ratio of 12.9
percent is obtained via 13.4 percent x (1-0.040).
---------------------------------------------------------------------------
To situate the proposals' effect on the quantity of capital in the
U.S. banking system in the literature on the optimal level of capital,
the agencies discuss the historical evolution of this literature as
well as more recent advances.
2. Development of the Literature on the Optimal Level of Capital in the
Banking System
The Basel Committee's long-term economic impact assessment of
capital requirements (BCBS 2010 study) represented an important
milestone in the development of the literature on the optimal capital
level in the banking system.\653\ This study was carried out in the
aftermath of the 2007-09 financial crisis and supported the increase in
capital requirements that was part of the initial phase of the Basel
III reforms.\654\ It helped spur a number of related studies by
academics and staff at regulatory agencies across the world.
---------------------------------------------------------------------------
\653\ See generally Basel Committee, ``An Assessment of the
Long-Term Economic Impact of Stronger Capital and Liquidity
Requirements'' (Aug. 2010), https://www.bis.org/publ/bcbs173.pdf
(``BCBS 2010 study'').
\654\ See, e.g., Basel Committee, ``Basel III: A Global
Regulatory Framework for More Resilient Banks and Banking Systems''
(June 2011), https://www.bis.org/publ/bcbs189.htm.
---------------------------------------------------------------------------
The BCBS 2010 study developed a framework in which the benefits of
higher capital stem from a reduced probability of a financial
crisis.\655\ These benefits can be quantified by estimating the degree
to which higher bank capital reduces the probability of a crisis and
multiplying this reduction in probability by the expected economic
output loss caused by a crisis. The cost of higher capital requirements
stems from the increased cost of funding for banks, which can lead to
higher interest rates on lending and thus lower economic activity,
depending on market structure, competition, and other factors. The
trade-off between these benefits and costs yields the optimal level of
capital in the banking system. That said, significant uncertainties and
limitations remain on how to measure these benefits and costs, and
different approaches used in various studies yield different estimates
of the optimal level of capital. Moreover, as discussed subsequently in
section VIII.C.3, the literature has since developed additional
frameworks.
---------------------------------------------------------------------------
\655\ See BCBS 2010 study.
---------------------------------------------------------------------------
The BCBS 2010 study applies this framework using several
macroeconomic models to capture a range of possible costs and benefits,
resulting in a range of possible values for the optimal level of
capital in the banking system. The study concludes that the optimal
capital requirement, measured as tangible common equity capital to
risk-weighted assets, is in the range of 10-14 percent,\656\ which
encompasses the projected new level of the common equity tier 1 capital
ratio of the U.S. banking system, under the proposals, of about 13
percent, as described in section VII.B. The fact that the projected
capital level falls within the range of optimal values suggests that
the overall proposals are consistent with the analysis of the BCBS 2010
study.
---------------------------------------------------------------------------
\656\ See BCBS 2010 study.
---------------------------------------------------------------------------
Other studies provide additional perspective. For example, Fender
and Lewrick (2016) argue that after accounting for differences in
measurement of capital and risk-weighted assets over time,\657\ the
BCBS 2010 study implies a lower optimal level for the common equity
tier 1 capital ratio of around 8-11 percent. Miles, Yang, and
Marcheggiano (2013)
[[Page 15129]]
apply a similar framework to data on global banks and find that the
optimal capital level is higher, in the range of 16-20 percent.\658\
This result stems partly from their finding that increased capital
would have a smaller adverse effect on interest rates, and thus
economic activity, than the BCBS 2010 study estimates.
---------------------------------------------------------------------------
\657\ See Ingo Fender & Ulf Lewrick, Monetary and Economic
Department, BIS, Adding it All Up: The Macroeconomic Impact of Basel
III and Outstanding Reform Issues (BIS, Working Paper No. 591, Nov.
2016) (``Fender and Lewrick (2016)''), https://www.bis.org/publ/work591.pdf.
\658\ See David Miles, Jing Yand, & Gilberto Marcheggiano,
``Optimal Bank Capital,'' 123 The Economic Journal 1, 29 Table 10
(Mar. 2013) (``Miles, Yang and Marcheggiano (2013)''), https://academic.oup.com/ej/article/123/567/1/5080596.
---------------------------------------------------------------------------
Conversely, Brooke et al. (2015) apply a similar framework and find
that, after accounting for the benefits from improvements in the
resolution framework, one would obtain a lower optimal capital level
than in the BCBS 2010 study.\659\ This study has played a key role in
informing the Bank of England's views on the optimal level of capital
in the UK banking system.\660\ Their analysis suggests that the optimal
capital level for tier 1 capital (rather than common equity tier 1
capital) ranges from 10-14 percent.\661\ In comparison, the projected
tier 1 capital in the U.S. banking system from the combined proposals
would be about 14 percent, suggesting that the proposals could result
in capital levels within the optimal range.
---------------------------------------------------------------------------
\659\ See Martin Brooke, Oliver Bush, Robert Edwards, Jas Ellis,
Bill Francis, Rashmi Harimohan, Katharine Neiss, and Caspar Siegert,
Bank of England, Measuring the Macroeconomic Costs and Benefits of
Higher UK Bank Capital Requirements (Bank of England, Financial
Stability Paper No. 35, Dec. 2015) (``Brooke et al. (2015)''),
https://www.bankofengland.co.uk/-/media/boe/files/financial-stability-paper/2015/measuring-the-macroeconomic-costs-and-benefits-of.pdf.
\660\ See Bank of England, ``Financial Stability in Focus: The
FPC's assessment of bank capital requirements'', https://www.bankofengland.co.uk/financial-stability-in-focus/2025/fsif-the-fpcs-assessment-of-bank-capital-requirements.
\661\ Tier 1 capital includes a broader set of instruments than
common equity tier 1 capital. Thus, a banking organization will
typically have a higher tier 1 capital ratio than a common equity
tier 1 capital ratio.
---------------------------------------------------------------------------
Firestone et al. (2019) apply the framework of the BCBS 2010 study
to the U.S. banking system and find that the optimal capital level for
tier 1 capital ranges from 13-26 percent.\662\ In this case, the
projected capital in the U.S. banking system would fall in the low end
of the range. The wide range stems in part from uncertainty regarding
the economic costs of financial crises, as the benefits of higher
capital levels increase with the severity of the financial crises that
are averted by the increased capital.
---------------------------------------------------------------------------
\662\ See Simon Firestone, Amy Lorenc, & Ben Ranish, ``An
Empirical Economic Assessment of the Costs and Benefits of Bank
Capital in the United States,'' 101 Federal Reserve Bank of St.
Louis Review 203, 203-30 (2019) (``Firestone et al. (2019)''),
https://doi.org/10.20955/r.101.203-30.
---------------------------------------------------------------------------
Soederhuizen et al. (2023) build on this framework and study the
optimal capital level in the Euro area.\663\ They use a more advanced
model for the costs of increased bank capital levels and obtain an
optimal level of common equity tier 1 capital relative to risk-weighted
assets of 16-31 percent, higher than the level currently maintained by
the U.S. banking system. Soederhuizen et al. (2023) also find that the
optimal capital level differs across Euro member states. This
heterogeneity, along with the range of optimal capital estimates in the
papers in this section, underlines the uncertainty in the estimated
optimal capital levels.
---------------------------------------------------------------------------
\663\ See Beau Soederhuizen, Gerrit Hugo van Heuvelen, Rob
Luginbuhl, & Bert van Stiphout-Kramer, Netherlands Bureau for
Economic Policy Analysis (CPB), ``Optimal Capital Ratios for Banks
in the Euro Area,'' 69 Journal of Financial Stability, Art. No.
101164 (Dec. 2023) (``Soederhuizen et al. (2023)''), https://doi.org/10.1016/j.jfs.2023.101164.
---------------------------------------------------------------------------
Jorda et al. (2021) challenge the underlying premise of the
literature that follows from BCBS (2010) that higher capital levels
reduce the probability of a financial crisis.\664\ Instead, they find
that higher capital levels reduce the severity of a crisis by promoting
a faster economic recovery but have no impact on the probability of a
financial crisis. Accounting for their findings could result in
different estimates of optimal capital levels than what is obtained in
the studies discussed above.\665\
---------------------------------------------------------------------------
\664\ See Oscar Jorda, Bj[ouml]rn Richter, Moritz Schularick,
and Alan Taylor, ``Bank Capital Redux: Solvency, Liquidity, and
Crisis,'' 88 The Review of Economic Studies 260, 260-268 (2021)
(``Jorda et al. (2021)''), https://doi.org/10.1093/restud/rdaa040.
\665\ The analytical framework in Jorda et al. (2021) does not
yield an estimate of the optimal level of bank capital. See Jorda et
al. (2021).
---------------------------------------------------------------------------
Admati and Hellwig (2024) provide another perspective on the level
of optimal capital in the banking system and argue that it ought to be
much higher than current capital levels.\666\ Their argument hinges on
the ability of nonbanks to provide a substitute for bank credit, thus
ameliorating the cost of higher capital requirements on bank lending.
That said, such substitution of financial services away from banks
towards nonbanks may pose other concerns, as discussed in section
VIII.F.3.
---------------------------------------------------------------------------
\666\ See Anat Admati and Martin Hellwig, The Bankers' New
Clothes: What's Wrong with Banking and What to Do About It (2024)
(``Admati and Hellwig (2024)'').
---------------------------------------------------------------------------
3. General Equilibrium Models of Optimal Capital Levels
One limitation of the above studies is that the models they employ
do not account for the optimizing behavior of agents, a key theoretical
underpinning of modern economics. As discussed below, recent
developments in modeling of optimal capital levels have turned towards
embedding optimizing behavior of agents, including households, non-
financial businesses, and banks. Notably, the cost-benefit tradeoff
examined in these models can differ from the tradeoff in the literature
based on the BCBS 2010 study discussed above.\667\
---------------------------------------------------------------------------
\667\ These models tend to be more complex than those based on
the BCBS 2010 study, and their results are obtained via matching
elements of the data to those implied by the model. As such, this
literature tends to avoid framing findings in terms of a range and
instead discusses robustness of the findings to modeling
assumptions.
---------------------------------------------------------------------------
Begenau (2020) reflects a new approach in this literature.\668\ In
particular, this study argues that higher capital requirements can spur
lending by reducing the incentives of banks to take on deposits, which
results in a lower cost of deposits and potentially a lower overall
cost of funding. In this model, households value the liquidity services
provided by deposits, and higher capital requirements can lead to lower
provision of those services. This study finds that the optimal capital
requirement equals 12.4 percent of risky assets, close to the projected
capital levels in the U.S. banking system.
---------------------------------------------------------------------------
\668\ See Juliane Begenau, ``Capital Requirements, Risk Choice,
and Liquidity Provision in a Business-Cycle Model,'' 136 Journal of
Financial Economics 355, 355-378 (May 2020) (``Begenau (2020)''),
https://doi.org/10.1016/j.jfineco.2019.10.004.
---------------------------------------------------------------------------
Begenau and Landvoigt (2022) study optimal capital ratios in a
setting with banks and unregulated nonbanks.\669\ In this setup, they
find that higher capital requirements shift activity to the unregulated
sector. However, the authors argue that such a shift can be optimal as
it moves activity away from a banking sector that is supported by
government guarantees. This study reports an optimal leverage ratio
capital requirement of 16 percent, higher than the projected capital in
the U.S. banking system.
---------------------------------------------------------------------------
\669\ Julaine Begenau and Tim Landvoigt, ``Financial Regulation
in a Quantitative Model of the Modern Banking System,'' 89 The
Review of Economic Studies 1748,1748-1784 (July 2022) (``Begenau and
Landvoigt (2022)''), https://doi.org/10.1093/restud/rdab088.
---------------------------------------------------------------------------
Elenev et al. (2021) embed financial crises into an equilibrium
macroeconomic model of households, non-financial businesses, and
banks.\670\ In this model, higher capital requirements result in a
smaller
[[Page 15130]]
financial sector and thus a smaller economy. The calibrated model
implies that welfare is maximized at a capital requirement of 6 percent
of risky assets, well below current and projected requirements.
---------------------------------------------------------------------------
\670\ Vadim Elenev, Tim Landvoigt & Stijn Van Nieuwerburgh, ``A
Macroeconomic Model With Financially Constrained Producers and
Intermediaries,'' 89 Econometrica 1361, 1361-1418 (May 2021)
(``Elenev et al. (2021)''), https://doi.org/10.3982/ECTA16438.
---------------------------------------------------------------------------
Begenau et al. (2025) examine bank capital requirements in the
context of delayed accounting for loan-loss recognition.\671\ In their
model, optimal capital requirements are lower than current values. This
decrease in optimal capital requirements arises in conjunction with an
expedited loan loss recognition relative to current practices, which
makes the banking system safer by ensuring timely accounting for non-
performing loans.
---------------------------------------------------------------------------
\671\ Juliane Begenau, Saki Bigio, Jeremy Majerovitz and Matias
Vieyra, ``A Q-Theory of Banks'', forthcoming, The Review of Economic
Studies (``Begenau et al. (2025)''), https://doi.org/doi:10.1093/restud/rdaf035.
---------------------------------------------------------------------------
Davyduik (2017) uses an equilibrium model to study how capital
requirements vary over the business cycle and finds that a
countercyclical capital requirement increases welfare.\672\ According
to the calibration in this model, the optimal level of the capital
requirement fluctuates around 6 percent over the business cycle.
---------------------------------------------------------------------------
\672\ Tetiana Davydiuk, Dynamic Bank Capital Requirements (Oct.
2017) (``Davydiuk (2017)''), https://dx.doi.org/10.2139/ssrn.3110800.
---------------------------------------------------------------------------
The agencies find that the decrease in the capital required in the
U.S. banking system under the combined proposals would result in a
level of banking organization capital that is reasonable, as informed
by the literature based on the BCBS 2010 study, as well as the more
recent studies based on the optimizing behavior of agents.
Collectively, the studies surveyed indicate uncertainty about the true
level of optimal capital requirements, providing a range of estimates
that are roughly equivalent to between 5 and 31 percent of risk-
weighted assets.\673\ Four of these 13 studies find optimal capital
requirements substantially below the projected level of capital in the
U.S. banking system under the proposal. Four studies find the projected
capital levels approximately optimal and five of the studies would
recommend higher levels of capital. Notably, more recent studies tend
towards the lower end of the above range for optimal capital
requirements, indicating the continuing evolution of this literature.
However, there are certain limitations to applying this literature to
the proposal, as detailed in the following section.
---------------------------------------------------------------------------
\673\ See also Stephen Cecchetti, Jeremy Kress and Kermit
Schoenholtz, ``Basel Endgame: Bank Capital Requirements and the
Future of International Standard Setting'', 39(3) Journal of
Economic Perspectives, 149-170. https://doi.org/10.1257/jep.20241434.
---------------------------------------------------------------------------
In the event that the Board chooses to adopt the GSIB surcharge
proposal or the agencies choose to adopt the proposals under
consideration on separate timelines, the effect on the overall level of
required capital in the banking system would be smaller than if the
three proposals were adopted together. As such, viewed through the lens
of the literature on optimal capital, the impact of each individual
proposal would also remain within the optimal range and thus achieve a
reasonable level of capital in the banking system.
4. Limitations of Applying the Academic Studies on Optimal Capital
Levels To Evaluating the Proposals
The proposals would establish risk weights applicable to banking
activities that align more closely with the risks of these activities,
relative to the current standardized approach, and improve transparency
and consistency of requirements relative to the advanced approaches
framework. Part of the changes in the proposed capital requirements
stem from these differences in risk weights.\674\ The literature on
optimal capital levels, however, takes the assignment of risk weights
as given and examines the optimal level of capital given equilibrium
levels of safe and risky assets. As such, this literature may be less
suitable for analyzing a change in capital requirements resulting from
changes in risk weights, as opposed to a direct change in the required
capital for a certain quantity of risky assets.
---------------------------------------------------------------------------
\674\ Capital requirements for large banking organizations would
also change due to the companion proposal to reform the G-SIB
surcharge.
---------------------------------------------------------------------------
A related measurement challenge stems from the broad range of loss-
absorbing instruments that banking organizations use to meet the
different capital requirements. While there are a few exceptions, such
as Brooke et al. (2015), many of the studies do not distinguish between
these different capital instruments.\675\ This makes it challenging to
determine which capital ratio is most applicable to mapping the results
of a given study to the U.S. banking system.
---------------------------------------------------------------------------
\675\ See Brooke et al. (2015).
---------------------------------------------------------------------------
As noted in section VII.C.1, the proposal would increase total
risk-weighted assets applicable to trading-related activities by 31
percent while reducing total risk-weighted assets relating to lending
by about 10 percent.\676\ The optimal capital level literature,
including the studies based on optimizing macroeconomic agents,
primarily focuses on capitalizing for the risks posed by banks' loan
portfolios. The literature neither considers the risk associated with
trading activity nor the potential macroeconomic effect of changes in
the provision of trading activity. This reduces the applicability of
the optimal capital levels literature to the proposal, given the
prominent role that capital markets play in the financing of economic
activity in the United States.\677\
---------------------------------------------------------------------------
\676\ As discussed subsequently in section VIII.E, the changes
to the GMS in the stress testing proposal would significantly offset
the capital impact of this increase in trading related risk-weighted
activities.
\677\ See supra Figure VIII.4--Share of Credit to Non-Financial
Private Sector Provided by Banks.
---------------------------------------------------------------------------
One additional limitation is that the optimal level of capital can
differ across jurisdictions. For example, Stavrekeva (2020) finds that
jurisdictions with a higher fiscal capacity may have a lower optimal
capital level as the fiscal authorities may be better positioned to
absorb shocks by bailing out the financial system.\678\ However, the
agencies note that one function of the regulatory capital framework is
to reduce the probability of a crisis and the need for extraordinary
government support in the event of stress. Conversely, a small open
economy may wish to have a higher capital level to reduce the
likelihood of banking stress that subsequently triggers a sovereign
debt crisis.\679\ Differences in the degree to which an economy uses a
bank-based system of finance versus a market-based system may also
affect the optimal level of capital in the banking system.
---------------------------------------------------------------------------
\678\ See Vania Stavrakeva, ``Optimal Bank Regulation and Fiscal
Capacity,'' 87 The Review of Economic Studies 1034, 1034-89 (Mar.
2020) (``Stavrakeva (2020)''), https://doi.org/10.1093/restud/rdz012.
\679\ Alter and Beyer (2014) provides an empirical analysis of
spillovers between banks and sovereign debt. See Adrian Alter and
Andreas Beyer, ``The Dynamics of Spillover Effects During the
European Sovereign Debt Turmoil,'' 42 Journal of Banking & Finance
134, 134-153 (May 2024) (``Alter and Beyer (2014)''), https://doi.org/10.1016/j.jbankfin.2014.01.030.
---------------------------------------------------------------------------
5. Differences Across U.S. Households
The literature on the optimal capital level typically considers
macroeconomic benefits and costs through the lens of an economic agent
that represents the household sector.\680\ As such, these models
typically look past heterogeneity across U.S. households. However, the
economic situation of different households may influence their costs
and benefits from banking organization capital requirements.
---------------------------------------------------------------------------
\680\ Such models are typically referred to as ``representative
agent'' models.
---------------------------------------------------------------------------
[[Page 15131]]
Commenters on previous capital proposals have raised concerns that
certain increased risk weights may increase costs and impede access to
credit for members of disadvantaged communities. Economic theories link
net worth to the cost of external finance.\681\ Specifically, members
of disadvantaged communities would likely have lower net worth and thus
be more adversely affected by an increased cost of borrowing. For
example, Fairlie et al. (2022) find that borrowers from certain
disadvantaged communities face higher interest rates and exhibit more
reluctance to seek bank debt.\682\ The reduction in capital
requirements stemming from the proposals may encourage banking
organizations to introduce new banking products and expand the
availability of products to more customers, facilitating financial
inclusion.
---------------------------------------------------------------------------
\681\ See Ben S. Bernanke and Mark Gertler, ``Inside the Black
Box: The Credit Channel of Monetary Policy Transmission'' 9 Journal
of Economic Perspectives 27, 27-48 (Fall 1995) (``Bernanke and
Gertler (1995)''), https://www.aeaweb.org/articles?id=10.1257/jep.9.4.27; Ben S. Bernanke, Mark Gertler, and Simon Gilchrist,
``The Financial Accelerator in a Quantitative Business Cycle
Framework,'' Handbook of Macroeconomics, Vol. 1, Ch. 21 (John B.
Taylor & Michael Woodford eds., 1999) (``Bernanke et al. (1999)''),
https://doi.org/10.1016/S1574-0048(99)10034-X.
\682\ See Robert Fairlie, Frank M. Fossen, Reid Johnsen, &
Gentian Droboniku, ``Were Small Businesses More Likely to
Permanently Close in the Pandemic?,'' 60 Small Business Economics
1613, 1613-1629 (2023) (``Fairlie et al. (2023)''), https://doi.org/10.1007/s11187-022-00662-1.
---------------------------------------------------------------------------
Conversely, members of disadvantaged communities may be at higher
risk of suffering losses during financial stress. For example, Bayer et
al. (2016) find that members of such communities had higher rates of
delinquency and default on their mortgage debt during the 2007-09
financial crisis.\683\ In addition, Contreras et al. (2023) show that
bank failures can increase income inequality.\684\
---------------------------------------------------------------------------
\683\ See Patrick Bayer, Fernando Ferreira, & Stephen L. Ross,
``The Vulnerability of Minority Homeowners in the Housing Boom and
Bust,'' 8 American Economic Journal: Economic Policy 1, 1-27 (Feb.
2016) (``Bayer et al. (2016)''), https://www.aeaweb.org/articles?id=10.1257/pol.20140074.
\684\ Salvador Contreras, Amit Ghosh, & Iftekhar Hasan, ``The
Effect of Bank Failures on Small Business Loans and Income
Inequality,'' 146 Journal of Banking & Finance, Art. No. 106690
(Jan. 2023) (``Contreras et al. (2023)''), https://doi.org/10.1016/j.jbankfin.2022.106690.
---------------------------------------------------------------------------
Question 196: What alternative approaches, if any, should the
agencies consider for assessing the macroeconomic benefits and costs of
the changes in the level of required capital that would result from the
proposals, and why?
6. Benefits From Improved Risks Measurement
The proposal's changes to the measurement of credit risk, market
risk, and operational risk aim to improve how regulatory capital ratios
capture the underlying economic riskiness of covered banking
organizations' balance sheets and activities. Improving the measurement
of key policy inputs and reducing complexity in the regulatory
framework contributes to enhancing and consistency while avoiding
potential deadweight losses in the banking sector associated with
miscalibrated capital requirements.
While capital requirements figure prominently in banking
organizations' intermediation decisions, pinning down their optimal
level to foster economic activity and to increase welfare is
challenging. Deposit insurance is viewed in the literature as one of
the rationales for the existence of capital requirements.\685\ The use
of capital requirements to mitigate moral hazard induced by government
guarantees and contribute to financial stability depends on appropriate
calibration to avoid excessive risk-taking behavior by banking
organizations.\686\ By improving the measurement of risks that banking
organizations are subject to, the proposal contributes to avoiding
potential deadweight losses resulting from the deviation of capital
requirements from their socially optimal level.
---------------------------------------------------------------------------
\685\ John H. Kareken & Neil Wallace, ``Deposit Insurance and
Bank Regulation: A Partial-Equilibrium Exposition,'' The Journal of
Business, 51(3), 413-438 (July 1978) (``Kareken and Wallace
(1978)''), https://www.jstor.org/stable/2352275; Skander J. Van den
Heuvel, ``The Welfare Cost of Bank Capital Requirements,'' The
Journal of Monetary Economics, 55(2), 298-320 (March 2008) (``Van
den Heuvel (2008)''), https://doi.org/10.1016/j.jmoneco.2007.12.001.
\686\ Caterina Mendicino, Kalin Nikolov, Javier Suarez & Dominik
Supera, ``Optimal Dynamic Capital Requirements,'' The Journal of
Money, Credit and Banking, 50(6), 1271-297 (September 2018)
(``Mendicino et al. (2018)''), https://doi.org/10.1111/jmcb.12490;
Vadim Elenev, Tim Landvoigt & Stijn Van Nieuwerburgh, ``A
Macroeconomic Model With Financially Constrained Producers and
Intermediaries,'' Econometrica, 89(3), 1361-1418 (May 2021)
(``Elenev et al. (2021)''), https://doi.org/10.3982/ECTA16438.
---------------------------------------------------------------------------
Given the far-reaching effects of banking policies on the real
economy,\687\ the proposal aims to reduce the unintended consequences
of capital regulation by improving the measurement of risks to which
covered banking organizations are exposed. For instance, migration of
certain lending activity from depository institutions to nonbanks, as
described in section VIII.A.6, may be mitigated by improving risk
measurement inside of the banking sector.
---------------------------------------------------------------------------
\687\ Jose M. Berrospide & Rochelle M. Edge, ``Bank capital
buffers and lending, firm financing and spending: What can we learn
from five years of stress test results?'', The Journal of Financial
Intermediation, 57 (January 2024) (``Berrospide and Edge (2024)''),
https://doi.org/10.1016/j.jfi.2023.101061.
---------------------------------------------------------------------------
Reducing complexity in the regulatory framework enhances
transparency of capital requirements and supports market discipline. As
financial innovation made the banking system more complex, financial
regulation has been strengthened to preserve the safety and soundness
of the banking sector.\688\ Increased regulatory burden and complexity
stemming from this more restrictive environment may have contributed to
the increase in noninterest expenses faced by covered banking
organizations through higher compliance costs.\689\ Overly complex
banking regulation could also contribute to systemic risk by
incentivizing regulatory arbitrage and encouraging migration of
activities toward nonbanks.\690\ By making the regulatory framework
simpler, the proposal aims to reduce compliance burdens while
preserving the financial stability benefits of banking regulation.
---------------------------------------------------------------------------
\688\ Richard J. Herring, ``The Evolving Complexity of Capital
Regulation,'' The Journal of Financial Services Research, 53, 183-
205 (April 2018) (``Herring (2018)''), https://doi.org/10.1007/s10693-018-0295-8.
\689\ Thomas L. Hogan & Scott Burns, ``Has Dodd-Frank affected
bank expenses?'' The Journal of Regulatory Economics, 55, 214-236
(April 2019) (``Hogan and Burns (2019)''), https://doi.org/10.1007/s11149-019-09379-8; Adrien Alvero, Sakai Ando & Kairong Xiao,
``Watch What They Do, Not What They Say: Estimating Regulatory Costs
from Revealed Preferences,'' The Review of Financial Studies, 36(6),
2224-2273 (June 2023) (``Alvero et al. (2023)''), https://doi.org/10.1093/rfs/hhac089; Jean-Edouard Colliard & Co-Pierre Georg,
``Measuring regulatory complexity,'' The Journal of Financial
Economics, 174, 104186 (December 2025) (``Colliard and Georg
(2025)''), https://doi.org/10.1016/j.jfineco.2025.104186.
\690\ Prasanna Gai, Malcolm Kemp, Antonio Sanchez Serrano &
Isabel Schnabel, ``Regulatory complexity and the quest for robust
regulation,'' SUERF Policy Note, 86 (July 2019) (``Gai et al.
(2019)''), https://www.suerf.org/publications/suerf-policy-notes-and-briefs/regulatory-complexity-and-the-quest-for-robust-regulation/.
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7. Microprudential Consequences of the Proposals
As discussed in section VII.B.1, the proposed revisions to the
calculation of risk-weighted assets and the G-SIB surcharge are
projected to reduce the capital requirements of Category I and II
banking organizations by about 2.7%. This projected change is primarily
from the GSIB surcharge proposal, while the proposed changes to the
calculation of risk-weighted assets leaves capital requirements
approximately unchanged. When combined with the effects of the proposed
changes to stress test model
[[Page 15132]]
and scenarios, common equity tier 1 requirements for Category I and II
banking organizations are projected to decline by a moderate 5.1%.
Furthermore, the proposed changes to risk weights are expected to lower
common equity tier 1 requirements for Category I and II depository
institutions by about 5.3%.
These lower capital requirements could moderately reduce these
banking organizations' ability to withstand financial stress,
marginally increasing their risk of failure. Specifically, reducing
capital requirements could increase the size and likelihood of losses,
thereby shifting losses from shareholders to creditors and the Deposit
Insurance Fund in the event that the FDIC is required to resolve the
insured depository institution. Category I and II depository
institutions remain subject to heightened supervisory and regulatory
standards. Additionally, the parent GSIBs remain subject to resolution
planning requirements, designed to facilitate rapid and orderly
resolution under the U.S. Bankruptcy Code. The resolution plans of
GSIBs envision a single-point-of entry strategy, under which parent
GSIBs would enter resolution while material subsidiaries, including
insured depository institutions, continue to operate on a going-concern
basis and therefore would not enter FDIC receivership requiring the use
of Deposit Insurance Fund resources. Finally, as the tier 1 leverage
ratio is included in the pricing methodology for large banks,
assessments paid by Category I and II depository institutions may
increase if tier 1 capital declines as a result of the proposal,
partially offsetting any additional losses to the Fund that might
occur. While the combined proposals maintain a strong level of capital
in the regulatory framework and the proposed changes are expected to
support financial intermediation by covering banking organizations,
these microprudential effects are a potential cost of the combined
proposals.
D. Effects on Lending (Including Credit Cards, Residential Mortgages,
and Business Lending)
Lending is a cornerstone of banking and an essential source of
financing to households and businesses through which banking
organizations fulfill their fundamental economic role of intermediating
between savers and borrowers. For Category I and II banking
organizations, lending encompasses a diverse range of products
including consumer loans such as credit cards, auto loans, student
loans, and personal loans; commercial loans to corporations, small
businesses, and financial institutions; as well as residential
mortgages, exposures to GSEs, and commercial real estate loans. Lending
supports economic growth by enabling capital formation, business
expansion, and household wealth-building through homeownership and
other forms of credit access. Given the importance of lending to the
broader economy, this section analyzes the potential economic effects
of the proposal on lending by Category I and II banking organizations.
The agencies provided the overall impact of the proposal on lending
activity and the marginal effects of other proposals in section VII.C.
In this section, the agencies examine specific lending segments--
including credit cards, residential mortgages, and corporate loans to
provide additional insights on the costs and benefits of the proposal
for these segments.
1. Credit Cards
As explained in section IV.A.3.b, the proposal's impact on credit
card exposures varies by borrower repayment history and credit line
utilization. The current standardized approach applies a 100 percent
risk weight to the drawn, on-balance sheet portion of all credit card
exposures, while generally a zero percent credit conversion factor
(CCF) would apply to the undrawn portion of the exposure. The proposal
differs in three ways (see sections IV.A.2.d and IV.A.3). First, risk
weights would vary by the obligor's repayment history: 45 percent for
transactor exposures and 75 percent for non-transactor exposures
(revolvers). Second, a 10 percent CCF would apply to the unutilized
portion of all credit lines that are unconditionally cancelable
commitments. Third, operational risk capital requirements would reflect
interest-earning assets, net interest income, fee income, and fee
expenses associated with credit cards.\691\
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\691\ As discussed in detail in section VII.D, operational risk
capital requirements would result from interest-earning assets, net
interest income, fee income, and fee expenses associated with credit
cards. Based on the figures presented in Table VII.6 of section
VII.D, the agencies estimate that operational risk capital
requirements for credit card exposures, which are a subset of retail
lending, would be equivalent to approximately 20 percentage points
when expressed as an add-on to credit risk weights. This estimate
reflects the ratio of operational risk RWAs to credit risk RWAs for
retail exposures ($172 billion/$840 billion).
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The proposal's differential treatment of credit cards that are
retail exposures reflects a more risk-sensitive approach compared with
the current standardized approach's uniform 100 percent risk weight:
Non-transactor exposures: The proposal's impact depends on
utilization rates. Accounts with lower utilization would generally face
higher capital requirements because applying a 10 percent credit
conversion factor to the large unused portion of the credit line,
combined with operational risk-weighted assets, more than offsets the
benefit of the reduced credit risk weight. Accounts with higher
utilization may face lower capital requirements, as the reduced credit
risk weight (75 percent compared with the current 100 percent) applied
to the large drawn portion more than offsets the capitalization of the
small unused portion, although operational-risk add-ons would partially
offset this reduction.
Transactor exposures: Similarly, the proposal's impact varies
significantly by utilization rates. Transactor exposures with lower
utilization could still face higher capital requirements despite the
reduced credit risk weight (45 percent compared with the current 100
percent), primarily because capitalizing their substantial unused
commitments dominates the calculation. Accounts with higher utilization
would benefit from lower capital requirements, as the substantially
reduced credit risk weight more than offsets the capitalization of
unused commitments and operational-risk add-ons.
The proposal would align capital requirements more closely with the
underlying credit risk across borrower types and usage patterns. This
risk-sensitive framework would provide incentives for banking
organizations to differentiate among credit card exposures based on
repayment behavior, enhancing the risk-responsiveness of regulatory
capital requirements for retail exposures.
2. Residential Mortgages
The proposal includes several provisions that may impact mortgage
lending activities, such as traditional originate-to-hold lending,
originate-to-distribute lending, investing in mortgage-backed
securities, funding nonbank mortgage lenders and servicers, and
servicing of loans both held in portfolio and in mortgage-backed
security pools. In this section, the agencies analyze how the proposal
could affect mortgage activities.
The proposal would enhance risk sensitivity in the treatment of
residential mortgage loans, whether originated by the banking
organization or purchased from another lender. Under the current
standardized approach, a prudently underwritten first lien residential
mortgage on a property that is either owner-occupied or rented
[[Page 15133]]
generally receives a 50 percent risk weight; other mortgages receive a
100 percent risk weight. The proposal would assign risk weights to the
former category (generally regulatory residential real estate exposures
under the proposal) based on the LTV ratio of the mortgage, among other
factors.\692\
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\692\ The proposal would also assign risk weights for
residential mortgage exposures based on whether the residential real
estate loan is dependent on cash flows from the property for
repayment of the loan. For purposes of this analysis, the agencies
have restricted the sample to primary residence loans (HMDA
occupancy field = 1), excluding any investment properties from the
sample.
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To better understand which types of borrowers are more reliant on
mortgages with high LTV ratios, the agencies conducted an analysis of
Home Mortgage Disclosure Act (HMDA) data collected by the Federal
Financial Institutions Examination Council (FFIEC) and the Consumer
Financial Protection Bureau.\693\ The institutions reporting these data
include the universe of depository and non-depository mortgage lenders
that extend more than a minimal number of loans in any metro area. The
data are at the applicant level, and the analysis focuses on originated
first-lien purchase mortgages. The data include information about both
the institutions that originated the loans and whether a loan was sold
or securitized.\694\
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\693\ Data represent the most comprehensive available source of
loan-level information on U.S. mortgage market activity. Originally
enacted by Congress in 1975 and implemented through Regulation C,
HMDA requires many financial institutions to maintain, report, and
publicly disclose detailed mortgage lending information. The dataset
serves three primary purposes: (1) assessing whether lenders
adequately serve their communities' housing needs, (2) providing
public officials with data-driven insights for policy decisions, and
(3) identifying potentially discriminatory lending patterns. To
protect applicant and borrower privacy, the publicly available data
are modified before release. See Consumer Financial Protection
Bureau & FFIEC, ``Home Mortgage Disclosure Act: HMDA Data
Publication'' (downloaded on October 1, 2025; most recent available
loan data sets from Jan. to Oct. 2023) (``HMDA Data (2023)''),
https://ffiec.cfpb.gov/data-publication/2023.
\694\ The data also include information on loan size,
origination LTV ratio, borrower income and race/ethnicity, and the
income and racial composition of the borrower's neighborhood. While
a version of the data is public, the analysis utilized a
confidential version to better identify which loans were sold. See
Consumer Financial Protection Bureau & FFIEC, ``Home Mortgage
Disclosure Act: Public HMDA--LAR Data Fields'' (accessed on October
1, 2025), https://ffiec.cfpb.gov/documentation/publications/loan-level-datasets/lar-data-fields.
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The results of this analysis are presented below in Table VIII.4.
The discussion of results to follow focuses mainly on Panel A. Panel B
of Table VIII.4 reproduces the analysis using loan dollar volumes as
opposed to loan counts, with broadly consistent results. The first
column presents the total number of loans originated. The second column
shows average LTV ratios at origination by borrower or loan type.
Columns three through five present origination market shares by
Category I and II banking organizations, other banking organizations
(including credit unions solely for this purpose), and nonbank lenders,
respectively. Column six shows the share of mortgages held in
portfolio, meaning whole loans funded long-term on the balance sheet,
by Category I and II banking organizations.\695\ The last column
applies the proposal's LTV-based risk weights to all originated loans
extended to each borrower or loan type, as though they were all held on
these banking organizations' balance sheets.\696\ These reflect credit
risk-weighted assets only. The rows break down results by borrower
income and loan type. Below, the agencies make comparisons
incorporating implied operational risk-weighted assets.
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\695\ The agencies estimated borrower characteristics for loans
purchased by Category I and II banking organizations from loan
origination records. This was necessary as records of loan purchases
by covered banking organizations from other lenders typically do not
include borrower demographic data. This allows a breakdown of the
share of whole loans held longer term on covered banking
organization balance sheets in the second to last column. To
estimate demographic data for purchased loans, the agencies sorted
both originated and purchased loans into 96 bins based on three
characteristics: loan-to-value ratio (LTV), census tract median
income relative to the loan's MSA or MD median income, and the
percentile of a loan's property value relative to other loans in the
same MSA or MD. Specifically, loans were categorized using six LTV
tranches (0 to 50 percent, greater than 50 to 60 percent, greater
than 60 to 80 percent, greater than 80 to 90 percent, greater than
90 to 100 percent, and greater than 100 to 120 percent); four MSA-
based income tranches (census tract income less than 0.5 times MSA/
MD median income, 0.5 to less than 0.8 times, 0.8 to less than 1.2
times, and 1.2 times or greater); and four MSA-based home price
tranches based on property value percentiles within each MSA or MD
(0 to 25th percentile, greater than 25th to 50th percentile, greater
than 50th to 75th percentile, and greater than 75th percentile). For
originated loans in each bin, the agencies calculated the share that
ended up funded as portfolio loans of Category I and II banking
organizations. This share was then applied as the probability that
purchased loans in the same bin would be funded as portfolio loans
by these banking organizations. Additionally, all loans in the
sample--both originated and purchased--were limited to first-lien,
home-purchase loans for one-unit, owner-occupied, one- to four-
family housing (excluding manufactured homes), and excluded open-end
lines of credit and reverse mortgages.
\696\ This approach implicitly assumes that changes in risk
weights affect all issuance, regardless of whether a particular loan
will be held on balance sheet.
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The rows of the table break out the results by different borrower
and loan types. Rows two and three divide mortgages into those taken by
low-to-moderate income (LMI) and higher income borrowers. Rows four and
five divide mortgages by loan size, specifically into jumbo (that is,
those above the loan size limits set by the GSEs for their loan
purchases and securitizations) and non-jumbo. Rows six and seven
segment conventional loans from non-conventional, where the latter are
loans available only to specific borrowers as specified by various
sponsor agencies.\697\ These mortgages are frequently extended with
ultra-low down payments and securitized into Ginnie Mae mortgage-backed
securities.\698\
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\697\ The sponsor agencies are predominantly the Federal Housing
Administration, Department of Veterans Affairs, and the United
States Department of Agriculture.
\698\ See Government National Mortgage Association (Ginnie Mae),
``Programs and Products,'' https://www.ginniemae.gov/about_us/what_we_do/Pages/programs_products.aspx (accessed [1/6/2026]).
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[GRAPHIC] [TIFF OMITTED] TP27MR26.115
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[GRAPHIC] [TIFF OMITTED] TP27MR26.116
Although Category I and II banking organizations extend a large
number of mortgages, their market share is low both in absolute terms
and particularly in comparison to their overall footprint in the
banking sector. From Table VIII.4 Panel A, Category I and II banking
organizations originate only 4 percent of mortgages and fund only 3
percent of mortgages as portfolio loans (as seen in row one of columns
three and six), compared to the 30 percent for the other banking
organizations (column four). As seen in row four in Panel A (or 7
percent relative to 31 percent by dollars of loan volume in Panel B),
Category I and II banking organizations originate and fund a much
larger share of jumbo loans. Comparing column two of rows two and three
indicates that higher- and lower-income borrowers obtain mortgages with
similar LTV ratios on average.
---------------------------------------------------------------------------
\699\ See HMDA Data Publication, https://ffiec.cfpb.gov/data-publication. HMDA data are published with a significant delay. The
data used in the analysis are the most recent data available at the
time of this analysis.
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The last column of Table VIII.4 shows the average credit risk
weight that would apply to each segment of loans under the expanded
risk-based approach. For example, in Panel A, the 42 percent average
risk weight in row two of column seven for low-to-moderate income
borrowers is calculated based on the distribution of LTV ratios for all
mortgages extended to low-to-moderate income borrowers in the data,
whether they were originated by Category I and II banking
organizations, other banking organizations, or nonbanks.
To characterize the total impact of the proposal, the agencies also
convert the operational risk-weighted assets attributable to these
loans into an effective additional risk weight. More specifically, as
described in section VII.D, the agencies estimate operational risk-
weighted assets based on exposures' contribution to each component of
the operational risk business indicator. These estimated operational
risk-weighted assets are then divided by the total balance sheet
exposures in the residential mortgage market to determine the effective
additional risk weight. This methodology yields an implied interest
income operational risk weight add-on of around 4 percent on average
across Category I and II banking organizations.\700\
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\700\ As noted above for credit cards, the operational risk
weight add-on does vary across Category I and II banking
organizations and over time for the same organization depending on
whether recent net interest margins are above or below the 2.25
percent ceiling. When below, the effective operational risk weight
depends on the net interest margin of the particular activity, which
for mortgages is relatively moderate.
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In line with the decline in aggregate risk-weighted assets for
residential mortgages under the proposal, estimated
[[Page 15136]]
effective risk weights, inclusive of operational risk, would be stable
or falling for almost all types of mortgage borrowers relative to the
50 percent risk weight in the current standardized approach. For
instance, for low-to-moderate income borrowers (second row), the total
equivalent risk weight under the proposal would be 46 percent (42
percent from credit risk and 4 percent from operational risk).
Therefore, effective risk weights would be lower than the 50 percent
risk weight applicable under the current standardized approach for most
types of borrowers. Jumbo loans would see the largest reduction, with
average risk weights more than 10 percentage points lower than the
current standardized approach. Non-conventional loans would see an
increase in average risk weights. However, because these loans are for
the most part not originated by Category I and II banking
organizations, this change would have limited practical impact.
In addition to lowering average risk weights at origination for
portfolio mortgages, the expanded risk-based approach would also
include additional risk sensitivity relative to the current
standardized approach as the LTV-based tables allow further decreases
in risk weights over time as mortgages are paid down. That is, the
proposal better accounts for amortization through reduced risk weights
as mortgages migrate to lower LTV ratio buckets over time. These
amortization provisions would support mortgage lending, particularly
under the originate-to-hold model.
The agencies supervise banking organizations' mortgage underwriting
in accordance with the Interagency Guidelines for Real Estate
Lending.\701\ These guidelines assist banking organizations in
formulating and maintaining a real estate lending policy that satisfies
supervisory expectations and is appropriate to the banking
organization. For mortgages with an LTV ratio at or above 90 percent at
origination, the guidelines recommend that banking organizations
require appropriate credit enhancements, including private mortgage
insurance or readily marketable collateral. Under both the current
standardized approach and the proposed expanded risk-based approach,
mortgages that do not meet the standards in the guidelines receive a
100 percent risk weight, while prudently underwritten mortgages receive
lower risk weights, which would vary by LTV ratio under the proposal.
Therefore, the proposal would not lower risk weights for higher-risk
mortgages.
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\701\ See Interagency Guidelines for Real Estate Lending, 12 CFR
part 34 subpart D app. A (OCC); Interagency Guidelines for Real
Estate Lending Policies, 12 CFR part 208 app. C (Board); Interagency
Guidelines for Real Estate Lending Policies, 12 CFR part 365 subpart
A app. A (FDIC).
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Many banking organizations that would be subject to the expanded
risk-based approach extend mortgages under an originate-to-distribute
business model. The introduction of operational risk-weighted assets
for these activities under the proposal could lead these banking
organizations to reduce this activity if, for example, such
requirements lead to higher funding costs and these banking
organizations are unable to raise mortgage margins to compensate in
what is a competitive market. In the originate-to-distribute business
model, the banking organization underwrites a loan following the
standards of the GSEs, Ginnie Mae sponsor agencies, or private label
mortgage-backed securities issuers and sells the mortgage to a
securitizer, holding it on balance sheet for a short period, often only
a matter of weeks. Profits in this business line are largely
attributable to the prices offered by mortgage-backed security
investors, origination fees, and the valuation of the servicing rights
generated by the origination and sale of the mortgage. Under the
proposal, this noninterest income would generate operational risk-
weighted assets. Fuster et al. (2013) develop a methodology to measure
average originator profits and use it to produce a monthly series. Over
the past 10 years, the measure has averaged 2.75 percent of originate-
to-distribute loan volumes.\702\ Although a lack of granular data on
noninterest expenses prevents a precise quantification, the agencies
expect residential real estate lending activities to generate about
$100 billion in aggregate operational risk-weighted assets at Category
I and II banking organizations, with about $26 billion of that
attributable to noninterest income.\703\
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\702\ See Andreas Fuster, Laurie Goodman, David Lucca, Laurel
Madar, Linsey Molloy, & Paul Willen, ``The Rising Gap Between
Primary and Secondary Mortgage Rates,'' 19 Federal Reserve Bank of
New York Economic Policy Review 17, 17-39 (Dec. 2013) (``Fuster et
al. (2013)''), https://www.newyorkfed.org/research/epr/2013/execsum_fust.html. The Fuster et al. (2013) methodology remains
valid under Basel III as it measures originator margins using
observable market prices rather than regulatory models. The authors
explicitly tested the framework's robustness to Basel III capital
treatment changes (see Fuster et al. 2013, section 4.1, pp. 31-32).
\703\ See sections VII.C and VII.D for further discussion and
detail on the attribution of risk-weighted assets by banking
activity and for detail on the methodology, respectively.
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Lax underwriting standards in the pre-financial crisis period
resulted in the GSEs requiring originating banking organizations to
repurchase large quantities of non-performing mortgages.\704\ The risks
posed to banking organizations by so-called putback requests, along
with legal actions, including for potential fair lending violations,
are risks of the originate-to-distribute business model. Even though
these mortgages are only briefly held on balance sheet, they entail
ongoing risk of operational losses throughout their term. Because risk
weights on portfolio mortgages under the proposal would tend to be
lower than under the current standardized approach while income from
mortgage securitization activities would now generate an operational
risk requirement, Category I and II banking organizations may tilt
their mortgage exposures somewhat towards portfolio lending and away
from originate-to-distribute lending, depending on the strength of this
incentive.\705\
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\704\ See Laurie S. Goodman and Jun Zhu, ``Reps and Warrants:
Lessons from the GSEs Experience,'' 24 Journal of Fixed Income 29,
29-41 (June 2014) (``Goodman and Zhu (2014)''), https://www.pm-research.com/content/iijfixinc/24/1/29.
\705\ See section VII.D. for a description of how operational
risk-weighted assets are attributed across banking activities.
Noninterest income associated with mortgage securitization activity
is within items 14E through N of FR Y14Q Schedule G.
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Banking organizations are significant funders of nonbank mortgage
lenders via warehouse lines of credit.\706\ The impact of the proposal
on warehouse lending depends on several factors, including the
application of the securitization framework to the exposures. On the
one hand, this lending could be affected by proposed changes to the
risk weights for certain corporate borrowers and credit conversion
factors for off-balance sheet commitments.\707\ To that end, the
proposal's effects on warehouse lending could vary depending on the
creditworthiness of the nonbank
[[Page 15137]]
borrowers and the structure of the lending arrangements. If warehouse
lending counterparties qualify as investment-grade borrowers, they
would receive more favorable risk weights under the proposal compared
to non-investment-grade counterparties.
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\706\ See Erica Xuewei Jiang, ``Financing competitors: Shadow
banks' funding and mortgage market competition,'' The Review of
Financial Studies 36, no. 10 (2023): 3861-3905, https://doi.org/10.1093/rfs/hhad031.
\707\ The expanded risk-based approach would apply lower risk
weights, relative to the current standardized approach, for
investment grade corporate counterparties (65 percent vs. 100
percent). It would also apply a different treatment to commitments,
where the standardized approach applies a 20 percent credit
conversion factor to commitments with an original maturity of one
year or less that are not unconditionally cancellable by the banking
organization and a 50 percent credit conversion factor to
commitments with an original maturity of more than one year that are
not unconditionally cancellable by the banking organization. The
expanded risk-based approach would apply a uniform 40 percent credit
conversion factor to these exposures regardless of their maturity.
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On the other hand, both under the current framework and the
proposal, mortgage warehouse lending can be treated as a securitization
exposure rather than a corporate exposure when the structure meets the
relevant criteria--typically based on the level of
overcollateralization and the use of special-purpose entities. Further,
the proposed securitization framework would generally require less
capital under the credit risk framework and so the proposal would
likely continue to incentivize extension of credit by banking
organization to mortgage warehouse lenders using such structures.
In a lender's decision to make a mortgage loan, the profitability
from a mortgage servicing asset, which is generated when a mortgage is
securitized, is part of the economic consideration. With performing
loans, mortgage servicers collect borrowers' monthly payments and
handle escrow for property tax and insurance payments. For non-
performing loans, servicers must both work with borrowers to
potentially amend payment plans and continue making tax and insurance
payments and, in some cases, continue forwarding expected loan payments
to mortgage-backed securities investors that, in the event of
foreclosure, may not be recouped for some time.
Under the current standardized approach, Category I and II banking
organizations must deduct MSAs from CET1 capital when they exceed 10
percent of CET1 capital individually or 15 percent in aggregate with
other threshold items, with any non-deducted portions receiving a 250
percent risk weight. The proposal would eliminate this deduction
requirement, instead applying a 250 percent risk weight to all MSAs.
The removal of capital deductions for mortgage servicing rights
would incentivize Category I and II banking organizations to expand
mortgage servicing activity. Eliminating the deduction requirement
would significantly reduce the regulatory disincentives for maintaining
such assets, which may contribute to a more active secondary market for
mortgage servicing rights as banking organizations face fewer capital
constraints when holding these assets.
While maintaining the 250 percent risk weight acknowledges MSAs'
inherent risk due to interest rate sensitivity and complexity, the
proposed treatment could alter capital allocation decisions. This would
create opportunities for deployment of capital that would otherwise be
restricted under the current framework; the agencies would continue
monitoring MSA concentration and market value volatility during periods
of economic stress.\708\
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\708\ See the 2016 agencies report available at: https://www.federalreserve.gov/publications/other-reports/files/effect-capital-rules-mortgage-servicing-assets-201606.pdf.
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Taken together, the proposal would enhance risk sensitivity in
residential mortgage lending by implementing more granular risk weights
based on loan characteristics like LTV ratios and credit quality. The
proposal is also expected to have a positive impact on the availability
of mortgage credit relative to the current standardized approach. In
part, the limited expected impact comes from Category I and II banking
organizations originating fewer than 10 percent of residential
mortgages and holding less than that as portfolio loans. The proposal
would decrease funding costs for most portfolio lending operations
undertaken by Category I and II banking organizations, by increasing
risk sensitivity of capital requirements for mortgages compared to the
current standardized approach. Category I and II banking organizations
may consider these shifts in incentives among other factors when
deciding their future participation in these activities.
3. Corporate Loans
The current standardized approach requires banking organizations to
assign a 100 percent risk weight to all corporate loan exposures. Off-
balance-sheet exposures, substantially consisting of unutilized
portions of credit lines, are subject to requirements through credit
conversion factors.
The application of credit conversion factors under the current
standardized approach varies based on the nature and duration of the
commitment. For commitments that are not unconditionally cancelable,
the credit conversion factor depends on the original maturity: those
with an original maturity of one year or less are assigned a 20 percent
credit conversion factor, while those exceeding one year receive a 50
percent credit conversion factor. Commitments that are unconditionally
cancellable receive a zero percent credit conversion factor.
The proposed expanded risk-based approach would enhance risk
sensitivity by allowing banking organizations to assign lower risk
weights (65 percent versus current 100 percent) to loans to investment-
grade corporate borrowers based on internal ratings. Further, the
proposal would apply a 10 percent credit conversion factor to
unconditionally cancellable commitments, and apply a flat 40 percent
credit conversion factor to commitments that are not unconditionally
cancellable regardless of maturity. As mentioned above, the proposal
would also introduce operational risk-weighted assets attributed to the
interest and fee income associated with loans and credit lines.
Applying differentiated risk weights to investment-grade and non-
investment-grade exposures increases the risk sensitivity of the
framework by distinguishing between varying exposure risks. Banking
organizations can leverage their existing risk management frameworks
through internal ratings systems for determining investment-grade
status. This more granular risk assessment approach could better align
capital with actual risk exposures.
Since differentiation would be based on individual organizations'
internal credit risk models, there could be variability in requirements
for similar risks. The proposal addresses this by setting expectations
for investment-grade determinations when applying the 65 percent risk
weight. Robust supervisory oversight would help ensure appropriate
application of investment-grade criteria and prevent banking
organizations from using this framework to grant lower risk weights to
riskier loans.
The internal ratings systems used for determining investment-grade
status undergo ongoing refinement and validation, helping ensure
appropriate capital levels through different economic conditions. The
agencies estimate a meaningful reduction in capital requirements for
affected institutions, based on applying a 35 percentage point reduced
risk weight to applicable investment-grade exposures.
As described in section VII.D.1.c, based on data from the special
data collection, an estimated 53 percent of balance-sheet corporate
exposure and 60 percent of off-balance-sheet corporate exposure is
classified as investment-grade and would be risk-weighted at 65 percent
under the proposal for Category I and II banking organizations. This
expanded scope would likely result in a more efficient allocation of
capital, with the potential for banks to pass some capital relief to
borrowers in the form of reduced borrowing costs or
[[Page 15138]]
increased credit availability for investment-grade corporations. The
more targeted approach to risk weighting may encourage lending to
financially sound corporations, supporting productive economic activity
while still maintaining appropriate capital buffers against potential
losses.
The proposed changes to credit conversion factors present a mixed
impact on capital requirements for individual loans. The implementation
of a flat 40 percent credit conversion factor for commitments that are
not unconditionally cancellable would decrease capital requirements for
longer-term commitments (previously at 50 percent) while increasing
requirements for shorter-term commitments (previously at 20 percent).
This change would likely encourage banks to provide more long-term
credit compared with the current framework, potentially benefiting
businesses seeking stable, longer-term financing arrangements. The
standardization could also simplify regulatory compliance while
providing incentives for longer-duration lending that may better match
the funding needs of many corporate borrowers. The introduction of a 10
percent credit conversion factor for unconditionally cancellable
commitments would increase capital requirements for these exposures,
which currently receive a 0 percent factor. While this change better
recognizes the inherent risk in such commitments, it could also lead to
adjusted pricing or terms for certain credit products, particularly
revolving credit facilities.
In sum, the proposed expanded risk-based approach represents an
enhancement to the current standardized approach by improving risk
sensitivity through differentiated treatment of corporate exposures
based on creditworthiness. It also streamlines the approach to off-
balance-sheet exposures and incorporates operational risk requirements.
The agencies' analysis suggests that Category I and II banking
organizations would experience a decrease in their overall capital
requirements for these exposures, potentially leading to increased
lending activity. The proposal also creates incentives for longer-term
lending by equalizing credit conversion factors across maturity bands.
These changes, implemented within the existing supervisory framework,
aim to create a more risk-sensitive capital regime that supports
economic activity.
E. Effects on Trading
This part of the economic analysis studies the potential effects of
the proposal on the trading businesses of banking organizations and the
resulting potential effects on end users and markets. On a standalone
basis, this proposal would raise the capital required for trading.
Taken together with the proposals to change to the GSIB surcharge and
supervisory stress test models, the combined impact is estimated to be
a 9.2 percent increase in common equity tier 1 capital for Category I
and II banking organizations (see table VII.7) and a small impact on
non-Category I and II banking organizations (see discussion in section
VII.A.1).
Trading activity exposes banking organizations to market risk,
counterparty credit risk, CVA risk, and operational risk. This proposal
makes changes to how each of these risks are capitalized. There are
major revisions to the market risk framework which would affect
incentives for banking organizations' hedging strategies and risk
modelling methods. Proposed changes to the credit risk framework would
somewhat reduce counterparty credit risk-weighted assets. CVA and
operational risk-weighted assets would be required for many banking
organizations, whereas these are currently not part of the standardized
approach that generally determines capital requirements today.
The proposal would have different impacts on banking organizations
depending on their size. Category I and II banking organizations are
key participants in the capital markets and conduct the majority of
trading among banking organizations. These banking organizations have
diversified trading businesses, which can provide substantial
diversification benefits even in stress periods. The proposed market
risk framework intentionally limits the recognition of diversification
across risk classes and adds a layer of conservatism for non-modellable
risk factors. Due primarily to these two features, this proposal would
increase market risk-weighted assets for Category I and II banking
organizations by 20 percent (see table VII.2 in section VII.A).
However, the cumulative effect inclusive of the GSIB surcharge proposal
and stress test changes is projected to be a 5.8 percent decrease in
the common equity tier 1 capital requirements associated with market
risk (see table VII.4 in section VII.B.2). The reduction is largely due
to changes to the global market shock that would reduce the liquidity
horizons used to calibrate risk-factor shocks and offset the increase
in market risk-weighted assets. This change to the global market shock
would be expected to increase banking organizations' incentives to
participate in trading.
This proposal also makes significant changes to the frameworks for
CVA and operational risk-weighted assets. These are currently
explicitly included in the advanced approaches calculation, but not in
the standardized approaches calculation which is most often the binding
constraint. Under the proposal, all Category I and II banking
organizations would be required to include them. The CVA and
operational risk-weighted assets associated with trading activity can
be seen in table VII.6. The impact due to their inclusion is
significantly larger than the proposed changes in market risk-weighted
assets. Overall risk-weighted assets for trading-related activities of
Category I and II banking organizations would rise 30.9 percent (see
table VII.5). Despite this significant increase in risk-weighted
assets, when considering the other proposals, in particular the
proposed changes to the global market shock, the combined impact on
capital requirements would be a moderate 9.2 percent.
In contrast, this proposal will have a smaller impact on non-
Category I and II banking organizations. Some of these have significant
trading activity and must calculate market risk-weighted assets. The
proposed changes to the market risk framework would result in a 39
percent decrease in market risk-weighted assets for non-Category I and
II banking organizations.\709\ This decrease is likely attributable to
increased recognition of credit and equity hedges in the proposal
relative to the current standardized specific risk charge, which is
highly conservative and typically used by relatively smaller banking
organizations . However, a few non-Category I and II banking
organizations also have substantial exposure to over-the-counter
derivatives, and under the proposal they would begin to include CVA
risk-weighted assets. Not every banking organization would be subject
to both requirements, but in the aggregate they offset each other.
Finally, some non-Category I and II banking organizations might elect
to use the expanded risk-based approach, in which case they would be
required to also calculate operational risk-weighted assets for trading
activity.
---------------------------------------------------------------------------
\709\ These impacts of changes to market and CVA risk-weighted
assets for non-Category I and II banking organizations are not
stated separately in section VII.A.1, but are calculated using the
same underlying bank-specific impacts and methodology.
---------------------------------------------------------------------------
Under the proposal, total risk-weighted assets related to trading
activity by non-Category I and II
[[Page 15139]]
banking organizations would increase by 0.9 percent (see discussion in
section VII.A.1). The proposed change to the GSIB surcharge does not
affect these banking organizations. The impact of the proposed
revisions to the supervisory stress is expected to be small since most
non-Category I and II banking organizations are not subject to the
global market shock.
The post-implementation change in trading-related capital
requirements could be lower than these estimates as banking
organizations could optimize requirements under the proposal, including
by changing their trading activities and modeling approaches.
The agencies expect the proposal would increase the resilience of
banking organizations by better aligning capital requirements with risk
in several ways. Replacing the Value at Risk (VaR)-based measure of
market risk with an expected shortfall-based measure better reflects
the tail risk of extreme events, especially for portfolios with non-
normal return distributions. Replacing the current uniform 10-day
liquidity horizon with varying horizons would better account for market
illiquidity during stress periods and the risk that difficult-to-trade
positions may lose more value as they remain on balance sheets longer.
The more conservative recognition of diversification within the
proposed framework would aim to capture the risk that historical
correlations between risk factors may not hold in stress periods. The
inclusion of equities within the default risk capital requirement would
account for the possibility of the value of an equity falling to zero.
Finally, the proposed framework would better address model risk
relative to the current framework. The proposal would hold the internal
models used by banking organizations to a higher standard by
introducing new tests of model performance while explicitly recognizing
that some risk factors are not modellable. In addition, the proposal's
introduction of a standardized approach would offer a conservative
alternative for banking organizations that choose not to use internal
models and serves as a fallback method when internal models perform
poorly.
The agencies expect that capital requirements under the proposed
framework would be substantially less procyclical, which would help to
preserve the availability of intermediation during periods of financial
stress. The current market risk framework is more procyclical because
current period VaR is a substantial component of capital requirements
and it generally rises during market stress, increasing market risk
capital requirements and the cost of intermediation. The proposed
market risk framework is calibrated based on historic stressed market
conditions and, therefore, will tend to increase less under new
stressed conditions, resulting in a less procyclical capital
requirements.\710\
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\710\ While the structure of the proposed framework avoids
direct procyclicality, some components might indirectly contribute a
degree of procyclicality for banking organizations using the models-
based method. Stressed market conditions could cause these banking
organizations to fail backtests or the profit and loss attribution
test, which could potentially increase the banking organization's
backtesting multiplier or force some modeled desks to revert to the
standardized approach (or add a surcharge). Such market conditions
might also increase the number of non-modellable risk factors.
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The following sections focus on how capital requirements are likely
to change on average across different trading activities, and how
changes in capital requirements for trading activities would generally
affect banking organizations, end users, and markets.
1. Changes in Capital Requirements Across Different Trading Activities
Because banking organizations engage in a broad range of trading
activities, this section takes a high-level view of how general
categories of trading activities would be affected under the proposal.
The agencies expect substantial heterogeneity in the capital impacts
across both banking organizations and trading activities. Different
products and portfolios receive different treatments, which could lead
to capital requirements rising for some banking organizations and
falling for others depending on their trading portfolios. Capital
impacts would also depend on banking organizations' use of models, both
under the current framework and the proposal.
Broadly, the agencies expect that capital requirements would be
relatively higher for products that are exposed to risk factors that
are less liquid, lack transaction data, or have complex payoff
structures. Highly liquid and simple products would likely receive
relatively lower capital requirements. Portfolios that are diversified
across risk classes would receive less recognition of diversification
compared to the current framework, which does not limit recognition of
diversification between risk classes. Cross-asset-class hedges would
also receive less recognition, likely leading to increases in risk-
weighted assets for trading strategies that make substantial use of
them.
a. Illiquid Risk Factors
Products with illiquid risk factors would be particularly affected
by the proposal's introduction of variable liquidity horizons. Under
the current framework, banking organizations estimate their risk over a
10-day horizon, based on the assumption that they can trade or hedge
the exposure within that time period (liquidity horizon). The proposal
would introduce liquidity horizons that vary across risk factors and
assign longer liquidity horizons to less liquid risk factors to better
reflect the time needed to sell or hedge the exposure to such risk
factors. These liquidity horizons are explicitly in the models-based
measure and are implicitly used to calibrate risk weights in the
standardized approach. Highly liquid risk factors, such as linear U.S.
dollar interest rate risk exposure, would maintain a 10-day liquidity
horizon, while less liquid risk factors, such as those reflecting
volatility exposures, would have higher liquidity horizons that could
reach a maximum of 120 days.
The most liquid risk factors, with 10-day liquidity horizons, are
generally interest rates for major currencies, foreign exchange rates
for major currency pairs, and large cap equities. Products whose
valuations are primarily affected by these risk factors would likely
see limited impact from the proposed liquidity horizon revisions.\711\
The least liquid risk factors are implied volatilities, credit spreads,
and many commodity prices. Thus, products whose valuations depend
heavily on these risk factors, for example volatility swaps, would
likely see larger capital requirement increases.
---------------------------------------------------------------------------
\711\ Examples include vanilla interest rate and foreign
exchange swaps as well as cash equities.
---------------------------------------------------------------------------
b. Market Data Availability
Risk factors lacking sufficient reliable data on transaction prices
would likely see an increase in capital requirements for banking
organizations using the models-based approach due to the non-modellable
risk factor framework.
Within the models-based approach, a risk factor is modellable if it
passes a qualitative test of data quality and a quantitative test of
whether there is sufficient data from traded prices. If a risk factor
passes the qualitative test, but fails the quantitative test, it is a
Type A non-modellable risk factor. Otherwise, the risk factor is a Type
B non-modellable risk factor.
Non-modellable risk factors are capitalized by first computing
standalone losses and then aggregating them based on a formula that
imposes
[[Page 15140]]
assumptions about the correlations of those risk factors. Type A non-
modellable risk factors are included in the internal model capital
charge, but are assumed to have zero correlation in the stressed
expected shortfall to capture their inherently higher risks associated
with model risk and illiquidity. Type B non-modellable risk factors are
only included in the stressed expected shortfall, but are assumed to
have a higher correlation of 0.36 with other Type B non-modellable risk
factors. In most cases, non-modellable risk factors are expected to
contribute to higher capital requirements.
The non-modellable risk factor framework would have the largest
impact on asset markets for which there is limited trade data, whether
due to market illiquidity or limited access to transaction details. The
agencies expect that highly liquid products with easily-available data,
such as large cap stocks, would not be materially affected. Less liquid
products, such as certain fixed income products, would likely see a
bigger impact. Products whose values are sensitive to illiquid parts of
curves or surfaces, such as implied volatilities that are far away from
current implied volatility, would also likely be more affected.
c. Specific Risk
The agencies expect that products with substantial exposures to
specific risk would have reduced capital requirements, but only for
banking organizations that currently use the standardized approach for
calculating specific risk capital charges. Such organizations tend to
be smaller. Specific risk accounts for risks that are not covered by
systematic market factors, such as idiosyncratic equity or credit
spread risk. The standardized approach for capturing specific risk in
the current framework makes highly conservative assumptions that are
not included in the proposed framework. In particular, the current
standardized approach only recognizes the netting of idiosyncratic risk
from the same issuer if the offsetting positions are in identical
instruments. The proposal would recognize offsetting of risks to the
same issuer across different issuances based on a correlation parameter
that takes into account the issuer name, tenor differences, and curve
basis risk. This change in the treatment of specific risk is likely one
of the major reasons why non-Category I and II banking organizations
that remain subject to market risk are projected to see market risk-
weighted assets decrease by 35 percent.\712\
---------------------------------------------------------------------------
\712\ However, the proposed inclusion of CVA risk-weighted
assets for banking organizations with over $1 trillion in OTC
derivatives will offset the reduction in market risk-weighted assets
for many of the non-Category I and II banking organizations. As
noted above, the impacts of changes to market and CVA risk-weighted
assets for non-Category I and II banking organizations are not
stated separately in section VII.A.1, but are calculated using the
same underlying bank-specific impacts and methodology based on the
special collection.
---------------------------------------------------------------------------
d. Operational Risk
Trading strategies with higher profits would likely see an increase
in their capital requirements due to operational risk capital
requirements. The noninterest component of operational risk capital
requirements would depend on a formula that includes the absolute value
of a measure that combines trading profits with profits from other
sources. Typically, higher trading profits would increase operational
risk capital requirements.
e. Risk Class Diversification
The reduced recognition of diversification across risk classes
under the proposal would likely raise capital requirements for
portfolios containing exposures to risk factors from multiple risk
classes. Currently, the market risk framework does not restrict
recognition of diversification across risk classes, which means that
the current market risk capital requirement reflects that banking
organization's estimated diversification benefit based on the empirical
correlation it uses for different risk classes. The proposal would
entirely eliminate recognition of diversification across risk classes
in the standardized non-default capital requirement and reduce the
diversification benefit in the models-based non-default capital
requirement.\713\ Reducing the recognition of diversification across
risk classes would likely raise risk-weighted assets, which has been
noted by Viegas de Carvalho, et al. (2024) for a representative
portfolio under the models-based non-default capital requirement.\714\
While the models-based non-default capital requirement would recognize
greater diversification across risk classes than the standardized non-
default capital requirement, both approaches would reduce recognition
of diversification compared to the current market risk framework. This
more conservative treatment of cross-risk-class diversification
addresses the possibility that correlations between risk classes change
between stress periods; one prominent example is how the correlation
between nominal bonds and equities has changed signs over time.\715\
---------------------------------------------------------------------------
\713\ Specifically, in the standardized non-default capital
requirement, the sensitivities-based method capital requirements are
simply added across risk classes, which implicitly assumes that
losses across risk classes are perfectly correlated. In the models-
based non-default capital requirement, the internally modelled
capital calculation places a weight of 50 percent on a measure that
assumes losses are perfectly correlated and 50 percent on a measure
that is based on their empirical relationships.
\714\ See Viegas de Carvalho, Paulo, et al. ``The Impact of the
Fundamental Review of the Trading Book: Evaluation on a Stylized
Portfolio.'' Journal of Risk, 23 Jan. 2024, https://doi.org/10.21314/jor.2023.014.
\715\ For empirical evidence on bond-stock comovements, see
Campbell, John, et al. Bond-Stock Comovements. Working paper. 1 Oct.
2025. Accessible at www.nber.org/papers/w34323.
---------------------------------------------------------------------------
f. Other Effects
There are many other changes within the proposal that would affect
the market risk capital requirements for particular products. The
residual risk add-on within the standardized non-default capital
requirement would increase capital requirements associated with exotic
positions and those with residual risk not captured by the
sensitivities-based method.\716\ The inclusion of equities in the
default risk capital requirement might raise requirements associated
with equities to capture risks associated with companies rapidly
failing, although other changes, such as revisions to the treatment of
specific risk, may counteract that increase. Within the models-based
non-default capital requirement, the switch from VaR, which measures
loss at a specific percentile, to expected shortfall, which measures
expected loss beyond a specific percentile, would likely raise capital
requirements for products with greater tail risk.
---------------------------------------------------------------------------
\716\ Examples of exotic positions include those referencing
longevity risk, weather, or natural disasters.
---------------------------------------------------------------------------
Changes to the standardized approach to counterparty credit risk
would recognize diversification between derivative transactions and
non-cleared repo-style transactions within a netting set when
calculating exposure at default. These changes would reduce capital
requirements associated with combining both types of transactions
within a single netting set, such as engaging in Treasury repo and
Treasury futures transactions with the same counterparty. There is
limited empirical evidence on the magnitude of the change in capital
requirements to expect with respect to these changes.
2. Impact on Banking Organizations
This section considers how changes in capital requirements for
trading
[[Page 15141]]
activities could affect the behavior of covered banking organizations.
Because the proposal would better capture certain risks, the agencies
expect that covered banking organizations would become more resilient.
Banking organizations would also likely reduce the quantity of
intermediation and raise fees for trading activities with increased
capital requirements, and similarly increase the quantity and reduce
the cost for trading activities with reduced capital requirements,
although the magnitudes are uncertain. The agencies also expect that
banking organizations would likely adjust their trading strategies to
reduce capital requirement impacts, such as by hedging more risks or
holding fewer positions. The agencies also expect that the reduced
procyclicality of the proposed market risk capital requirements would
lead to more stable provision of financial intermediation during market
stress periods as compared to the current framework.
a. Supply of Intermediation Services
Increased capital requirements may lead banking organizations to
reduce the scale of their trading activities or increase their fees,
commissions, or bid-ask spreads--the costs they charge to their
customers for intermediation services--although the magnitudes of any
potential impact are difficult to estimate. Changes in the volume of
trading and to its cost are intimately connected, as suggested by a
standard supply-demand framework.
The intersection of supply and demand establishes the equilibrium
price and quantity of intermediation for a particular type of trading.
An increase in capital requirements would shift the supply curve
upward, which would increase the cost of intermediation and reduce the
quantity. A decrease in capital requirements would similarly reduce the
cost of intermediation and increase the quantity. The magnitudes of
quantity versus price changes would depend on the elasticities of
supply and demand (that is, how responsive the quantity of
intermediation is to changes in its price). There is limited empirical
evidence on the magnitude of the impact of capital requirements on
trading activity and it is difficult to obtain such an estimate.
Another consideration is that banking organizations are not the
only companies engaging in these trading activities. To the extent that
higher costs only apply to banking organizations, intermediation
activity may flow outside the banking system. This effect on markets
will be considered in section VIII.E.3.
b. Trading and Hedging Strategies
Another possible effect of the proposal is that banking
organizations may switch to trading or modeling strategies that result
in lower capital requirements. Some possible approaches include (1)
changing hedging strategies, (2) changing the number of positions held
directly, (3) improving their models or gathering additional data, and
(4) increasing central clearing.
First, banking organizations may adjust hedging strategies in
response to the proposed requirements. These adjustments could take
many forms. For example, if a banking organization were leaving an
exposure unhedged in the current framework and its standalone capital
requirements would rise under the proposed framework, then the banking
organization might use hedges to reduce the capital impact. To the
extent that the proposed framework is more risk sensitive, banking
organizations would have greater incentives to hedge economically
meaningful risk exposures. Evidence from Lu and Wallen (2024) indicates
that large dealer banking organizations are already hedging most market
risk, suggesting that the scope for additional hedging may be
limited.\717\
---------------------------------------------------------------------------
\717\ See Wallen, Jonathan, and Lina Lu. ``What Do Bank Trading
Desks Do?'' Working paper. November 6, 2024. Available at https://doi.org/10.2139/ssrn.4898830.
---------------------------------------------------------------------------
Second, banking organizations may change how many positions they
hold directly. For example, one approach to market making is to buy and
sell products as needed by customers and to hold a product inventory
plus any trade imbalances. Another approach is to directly match buyers
and sellers together, which does not require the banking organization
to hold any position. If capital requirements associated with holding
inventory were to rise, a banking organization might start directly
matching buyers and sellers more frequently or decide to limit the size
of its inventory. Conversely, if capital requirements were to fall, a
banking organization might increase the size of its inventory.
Bessembinder et al. (2018) document how bank-affiliated dealers were
less likely to hold customer order imbalances on their own balance
sheets following the 2008 financial crisis relative to other
dealers.\718\ The evidence is consistent with post-crisis capital
regulations affecting trading inventories, although it is difficult to
disentangle other effects.
---------------------------------------------------------------------------
\718\ See Bessembinder, Hendrik, et al. ``Capital commitment and
illiquidity in corporate bonds.'' The Journal of Finance 73.4
(2018): 1615-1661.
---------------------------------------------------------------------------
Third, banking organizations using the models-based approach might
respond to the proposed capital framework by gathering additional data
to reduce the impacts of non-modellable risk factors. Gathering
additional data could help a non-modellable risk factor to become
modellable, which would generally reduce capital requirements. However,
there are indications that there is reluctance among banking
organizations to share data and that purchasing the data from vendors
can be expensive, although greater adoption of internal models by
banking organizations could mitigate these problems.\719\
---------------------------------------------------------------------------
\719\ See Wilkes, S. (2023, November 20). ``FRTB managers face
hard facts about risk factors''. Available at Risk.net. https://www.risk.net/regulation/7958192/frtb-managers-face-hard-facts-about-risk-factors.
---------------------------------------------------------------------------
Fourth, banking organizations may centrally clear more of their
derivatives. Such exposures are exempt from the CVA framework due to
their substantially reduced risk profiles. Evidence from Canada, which
has already implemented its version of the new market risk standards,
indicates an increase in derivatives clearing.\720\ Increased clearing
would have the benefit of reducing counterparty-related risks.
---------------------------------------------------------------------------
\720\ See Migliorato, L. (2024, March 13). ``Canada's top
dealers boost derivatives clearing as FRTB kicks in''. Available at
Risk.net. https://www.risk.net/risk-quantum/7959098/canadas-top-dealers-boost-derivatives-clearing-as-frtb-kicks-in.
---------------------------------------------------------------------------
c. Stability
Banking organizations would likely provide more stable
intermediation during market stress due to the reduced procyclicality
of the proposed market risk framework. The inclusion of current period
VaR within the current framework means that capital requirements are
more likely to increase sharply during market stress, which can lead
banking organizations to reduce their intermediation activity.\721\ The
proposed framework would instead rely on estimates of losses during
past stressed conditions, which would reduce the likelihood of spikes
in capital requirements. The agencies expect this change to lead to
more stable
[[Page 15142]]
provision of intermediation during market stress.
---------------------------------------------------------------------------
\721\ During the COVID-19 crash, banking organizations
experienced simultaneous backtesting exceptions that, without
intervention, would have increased their backtesting multipliers and
raised market risk capital requirements by $3.3 billion. See Abboud,
Alice, Chris Anderson, Aaron Game, Diana Iercosan, Hulusi Inanoglu,
and David Lynch (2021). ``Banks' Backtesting Exceptions during the
COVID-19 Crash: Causes and Consequences,'' FEDS Notes. Washington:
Board of Governors of the Federal Reserve System, July 08, 2021,
https://doi.org/10.17016/2380-7172.2939.
---------------------------------------------------------------------------
d. Impacts on End Users
The proposal would likely change the cost of financial
intermediation for end users, with effects that differ by the type of
trading activity. Trading activities with increased capital
requirements may become less profitable for banking organizations
unless they can increase revenue by charging higher fees and
commissions on transactions or by widening bid-ask spreads. Banking
organizations often focus on return on equity as an essential measure
of profitability.\722\ Return on equity for trading is likely to
decrease if risk-weighted assets increase, and the proposal is expected
to increase overall risk-weighted assets for trading activities for
Category I and II banking organizations, unless they adjust their
portfolios, which would require changes in either trading or hedging
strategies.
---------------------------------------------------------------------------
\722\ Pennacchi and Santos (2018) document banks' emphasis on
return on equity and explore banks' motivation in preferring this
metric.
---------------------------------------------------------------------------
Some banking organizations may exit some markets or reduce the
variety of their offerings if they cannot maintain an acceptable return
on equity. It is widely accepted that banking organizations attempt to
shift resources from activities with low capital efficiency towards
activities with higher capital efficiency. However, Ding and Sickles
(2018) document that return on equity for banking organizations has
fluctuated significantly over time.\723\ Moreover, a survey conducted
by Federal Reserve supervision staff of Category I banking
organizations showed significant dispersion in the capital efficiency
of different trading activities. This was true when comparing similar
business lines at different banking organizations and when comparing
different business lines within the same banking organization. The
observation that less capital efficient business lines continue to
operate suggests that banking organizations may not entirely abandon
low capital efficiency trading activity.
---------------------------------------------------------------------------
\723\ See Ding, Dong, and Robin C. Sickles. ``Frontier
Efficiency, Capital Structure, and Portfolio Risk: An Empirical
Analysis of U.S. Banks.'' BRQ Business Research Quarterly, vol. 21,
no. 4, Oct. 2018, pp. 262-277. Ding and Sickles (2018) also find
that banking organizations with lower operating costs also hold
higher capital buffers above their minimums and take on more risk.
---------------------------------------------------------------------------
The trading businesses of banking organizations serve a wide
variety of clients, including commercial end users, institutional
investors such as pension funds and insurance companies, governments,
other banking organizations, and nonbank financial organizations such
as hedge funds. Banking organizations also serve households indirectly
through securitization of loans and by supporting mutual funds and
retail brokerages. Each type of trading customer has different
intermediation needs. For example, commercial end users may be
interested in accessing capital markets, and in hedging the foreign
exchange or commodity price risk arising from their business and
hedging interest rate risk on their debt. Any change in the cost or
availability of these services may have a significant effect on the
real economy.
The benefit to society from enabling hedging by commercial end
users is difficult to ascertain, so the proposal's impacts from
changing hedging behavior are difficult to estimate. Classic finance
theory dating back to Modigliani and Miller holds that risk management
does not increase firm value because it is irrelevant to a firm's
shareholders who can themselves hedge by holding a diversified
portfolio.\724\ Regardless, commercial firms themselves have a strong
demand for hedging instruments. A number of theories have been proposed
to explain this behavior. For example, Froot, Scharfstein and Stein
(1993) suggest firms that manage risk reduce the chance of not being
able to take advantage of growth opportunities.\725\ There is some
empirical evidence that risk management increases firm value. Allayanis
and Weston (2015) find that, among nonfinancial firms that are exposed
to exchange rate risk from their foreign operations, the use of
derivatives to hedge foreign currency risk increases firm value by 4
percent.\726\
---------------------------------------------------------------------------
\724\ See Modigliani, Franco, and Merton H. Miller. ``The Cost
of Capital, Corporation Finance and the Theory of Investment.'' The
American Economic Review, vol. 48, no. 3, June 1958, pp. 261-297.
\725\ See Froot, Kenneth A., David S. Scharfstein, and Jeremy C.
Stein. ``Risk management: Coordinating corporate investment and
financing policies.'' the Journal of Finance 48.5 (1993): 1629-1658.
\726\ See Allayannis, George, and James P. Weston. ``The use of
foreign currency derivatives and firm market value.'' The Review of
Financial Studies 14.1 (2001): 243-276.
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The impact of the proposal on end users would differ depending on
the type of customer relationships end users have with banking
organizations of different sizes. The largest banking organizations
offer a broad variety of intermediation services, including some that
require sophisticated risk management. Category I and II banking
organizations generally have well-hedged and diversified portfolios,
but also have the capacity to warehouse the risks that arise from their
intermediation and are difficult to hedge. Mixon and Onur (2020)
document how commodities swaps dealers, many of which are banking
organizations,\727\ offer their customers bespoke contracts which they
then hedge with standard, liquid instruments, leaving the dealer
holding residual basis risk.\728\ Category I and II banking
organizations tend to optimize their trading and hedging strategies and
their risk management, including the models used to calculate required
capital, to maximize return on capital while not exceeding their
appetite for risk. Category I and II banking organizations serve the
entire gamut of investment banking clients and are also market makers,
generally in multiple markets.
---------------------------------------------------------------------------
\727\ See list of registered swaps dealers at https://www.cftc.gov/LawRegulation/DoddFrankAct/registerswapdealer.html.
\728\ See Mixon, Scott, and Esen Onur. ``Risk appetite and
intermediation by swap dealers.'' Available at SSRN 3566003 (2020).
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In contrast, smaller banking organizations (those not in Categories
I and II) are more likely to focus on a few lines of trading business.
Customers may be commercial end users with whom the banking
organization already has a lending relationship and provides other
commercial banking services. For such banking organizations, trading
strategy focuses on client facilitation. As a result, non-category I or
II banking organizations are less likely to rely on sophisticated risk
management and more likely to offer services for which the risks are
straightforward to hedge. This also suggests that these banking
organizations have generally invested less in risk models, and may
intentionally compensate for this by erring on the side of conservatism
when calculating required capital.
The introduction of a standardized approach for market risk capital
requirements is likely to expand the intermediation services offered by
non-Category I or II banking organizations for two reasons. First, the
proposed standardized approach for market risk would reduce the
regulatory compliance and operational costs of offering new products.
The current rule requires banking organizations to receive regulatory
approval for the models used in market risk capital calculations prior
to trading a new product. This approval process takes time and involves
overhead in ensuring that the risk models comply with the rule. Banking
organizations that use the proposal's standardized approach would avoid
this delay and overhead of regulatory pre-approval and may reduce other
costs
[[Page 15143]]
associated with modelling risk.\729\ This may eliminate a current
disincentive for accommodating customer requests for particular trading
products that a banking organization does not already trade.
---------------------------------------------------------------------------
\729\ Note that it is expected that banking organizations will
continue to use internal models for their risk management,
regardless of whether those models are used to calculate market risk
capital requirements. See Sec. [thinsp]__.203 (c)(4) of the
proposal, which requires daily monitoring of risk-management
measurements including VaR. However, if banking organizations'
internal risk management models are not the same as those used to
calculate capital requirements, then banking organizations may
invest fewer resources in their internal risk management models,
which could mean reducing data quality, computational capacity, or
quality of model risk management. For example, the generation of
historical risk factor scenarios required for stressed-VaR can be
particularly costly for products that a banking organization did not
trade or products that did not exist during a banking organization's
stress-VaR window.
---------------------------------------------------------------------------
Second, the new standardized approach is likely to result in lower
capital requirements for some types of trading activity of smaller
banking organizations. The current rule requires internal models for
general market risk but applies a standardized add-on unless a banking
organization receives supervisory approval for their risk model's
treatment of specific risk.\730\ Modelling specific risk is complex,
and supervisors have set a high bar for model approval. As a result,
while Category I and II banking organizations often have approved
specific risk models, many other banking organizations with significant
trading activity do not. The current standardized specific risk add-on
is conservative. Moreover, it does not recognize any hedging benefit
from offsetting credit exposures to the same obligor unless there is an
exact match on the reference obligation.\731\ This treatment encourages
banking organizations that do not have specific risk approval to focus
on agency and riskless principal trading, making back-to-back trades
with customers offset by trades with other banking organizations. This
allows banking organizations to facilitate access to capital markets
for their relationship clients, but it constrains their market
offerings to liquid, readily tradable products.
---------------------------------------------------------------------------
\730\ Specific risk is the risk that is not attributable to
broad market movements and includes event risk, default risk, and
idiosyncratic risk.
\731\ However, the current rule avoids double counting of the
specific risk add-on for an exposure and its credit derivative hedge
that does not meet the ``same obligation'' criterion but in which
all or substantially all of the price risk has been hedged.
---------------------------------------------------------------------------
The proposal's standardized approach does not have separate
treatments for general and specific risk. Both the sensitivities-based
method and the default risk capital requirement would apply risk
weights to net exposures at the issuer level. For a banking
organization currently applying the specific risk add-on, this
recognition of netting at the issuer level rather than the issuance
level may result in significantly lower risk-weighted assets for
portfolios with risk that is economically small but not perfectly
offset. Moreover, both the proposed sensitivities-based method and the
default risk capital requirement would recognize some hedge benefit
across exposures to different issuers in the same bucket, and the
proposed sensitivities-based method would recognize some
diversification between buckets.
Lower market risk-weighted assets, and the option to reduce
operational and regulatory overhead by choosing the standardized
approach for market risk, will likely increase the capital efficiency
of non-Category I or II banking organizations, particularly for trading
businesses in which the banking organization retains some specific
risk. Examples include market making in less liquid corporate bonds and
more bespoke customer facilitation. This may reduce a barrier to entry
into new markets for some banking organizations. As such, customers of
non-Category I or II banking organizations may find more choice of
trading products for hedging credit spread risk and equity price risk.
An expected benefit of the proposal is that it would likely reduce
costs and increase availability of intermediation during times of
financial stress, relative to the current rule. This is for two
reasons. First, distressed banking organizations may be unable or
unwilling to undertake trading activity that adds risk. The proposal is
intended to make banking organizations less likely to become distressed
by more accurately reflecting their exposure to losses during extreme
stress in their market risk capital requirement. Second, if the capital
requirement for a given trading activity fluctuates over time, then
banking organizations may be less willing to provide intermediation at
times when the capital requirement is high or may charge more for
intermediation to maintain an acceptable return on capital. Capital
requirements under the proposal are based on through-the-cycle risk
measures and should be less pro-cyclical than the current rule, as
capital requirements would not increase as much during financial
downturns. With less cyclical fluctuation in capital requirements, the
costs to end users should also fluctuate less.
3. Impacts on Markets
To understand how the proposal could affect market liquidity, it is
informative to understand how markets reacted to the higher capital
requirements that were implemented after the 2008 financial crisis.
Literature exploring the impact of post-2008 capital requirements
on the corporate bond market generally shows limited impacts on bid-ask
spreads, but also that customers waited longer before making
transactions. The papers also indicate that dealers reduced their
inventory imbalances and charged higher prices for providing immediate
liquidity. Broadly, there is evidence that the cost of immediate
liquidity rose in the corporate bond market and that bank-affiliated
dealers reduced their willingness to bear inventory imbalances,
although it is difficult to isolate how much is due to higher capital
requirements compared to other factors.732 733
---------------------------------------------------------------------------
\732\ Dick-Nielsen and Rossi (2018) show that the cost of
immediate trades, reflected by index trackers that must trade
quickly after a bond falls out of an index, has risen more than
twofold and Bao, et al. (2018) show greater costs from trading
following bond rating downgrades. Furthermore, Bessembinder (2018)
and Dick-Nielsen and Rossi (2018) provide evidence that bank-
affiliated dealers reduced the extent of inventory imbalances that
they accommodated. In more recent times, Anderson, et al. (2023) and
Kargar, et al. (2021) show that dealers did not substantially change
their net positions in corporate bonds during the COVID-related
market turmoil around March 2020. See Trebbi, Francesco, and Kairong
Xiao. ``Regulation and market liquidity.'' Management Science 65.5
(2019): 1949-1968; Bessembinder, Hendrik, et al. ``Capital
commitment and illiquidity in corporate bonds.'' The Journal of
Finance 73.4 (2018): 1615-1661; Dick-Nielsen, Jens, and Marco Rossi.
``The cost of immediacy for corporate bonds.'' The Review of
Financial Studies 32.1 (2019): 1-41; Bao, Jack, Maureen O'Hara, and
Xing Alex Zhou. ``The Volcker Rule and corporate bond market making
in times of stress.'' of Financial Economics 130.1 (2018): 95-113;
Anderson, Christopher S., David C. McArthur, and Ke Wang. ``Internal
risk limits of dealers and corporate bond market making.'' Journal
of Banking & Finance 147 (2023): 106653; and Kargar, Mahyar, et al.
``Corporate bond liquidity during the COVID-19 crisis.'' The Review
of Financial Studies 34.11 (2021): 5352-5401. Dick-Nielsen and Rossi
(2018) show that the cost of immediate trades, reflected by index
trackers that must trade quickly after a bond falls out of an index,
has risen more than twofold and Bao, et al. (2018) show greater
costs from trading following bond rating downgrades. Furthermore,
Bessembinder (2018) and Dick-Nielsen and Rossi (2018) provide
evidence that bank-affiliated dealers reduced the extent of
inventory imbalances that they accommodated. In more recent times,
Anderson, et al. (2023) and Kargar, et al. (2021) show that dealers
did not substantially change their net positions in corporate bonds
during the COVID-related market turmoil around March 2020. See
Trebbi, Francesco, and Kairong Xiao. ``Regulation and market
liquidity.'' Management Science 65.5 (2019): 1949-1968;
Bessembinder, Hendrik, et al. ``Capital commitment and illiquidity
in corporate bonds.'' The Journal of Finance 73.4 (2018): 1615-1661;
Dick-Nielsen, Jens, and Marco Rossi. ``The cost of immediacy for
corporate bonds.'' The Review of Financial Studies 32.1 (2019): 1-
41; Bao, Jack, Maureen O'Hara, and Xing Alex Zhou. ``The Volcker
Rule and corporate bond market making in times of stress.'' Journal
off
\733\ Several papers, including Trebbi and Xiao (2017) and
Bessembinder (2018), have documented that standard measures of
market liquidity, such as bid-ask spreads, did not change
substantially following the financial crisis or even improved
relative to before. However, some literature argues that customers
have shifted away from demanding immediate liquidity from dealers,
which is more expensive, to instead being willing to wait longer
before transacting, which is cheaper. In that case, it would be
possible for average transaction costs to fall, even if the cost of
immediate liquidity would have risen.
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[[Page 15144]]
Wu (2024) specifically considers the impact of post-crisis capital
regulations, which in the case of market risk are informally known as
Basel 2.5.\734\ The paper argues that the size of the liquidity premium
embedded within corporate bonds increased after the 2008 financial
crisis.\735\ Wu (2024) shows that immediately after the release of the
Basel 2.5 NPR in June 2012, there was an abrupt increase in the
liquidity premium for more volatile bonds, which would likely receive
higher capital requirements under Basel 2.5, compared to less volatile
bonds. The paper estimates an approximately 0.3 percentage point
difference in yield spreads between the most and least volatile bonds,
controlling for other characteristics.
---------------------------------------------------------------------------
\734\ See Wu, Botao. ``Increasing corporate bond liquidity
premium and post-crisis regulations.'' NYU Stern School of Business
Working Paper (2020).
\735\ The liquidity premium is the component of a corporate
bond's yield that compensates investors for difficulty in
transacting in that bond.
---------------------------------------------------------------------------
Extrapolating from evidence in the corporate bond market to
potential broader impacts, higher capital requirements on certain
products would likely incentivize banking organizations to hold smaller
inventories and accommodate fewer imbalances, although magnitudes are
unclear. There would likely be a reduction in banking organizations
providing immediate liquidity (i.e., entering into a trade with a
customer immediately rather than waiting), although the magnitude would
likely vary across markets. More illiquid products, such as corporate
bonds, would likely see larger effects. Additionally, because market
risk capital requirements are typically based on end-of-day
inventories, accommodating intraday imbalances for more liquid products
would likely not be as costly. Similarly, lower capital requirements on
other products would likely incentivize banking organizations to
accommodate more imbalances and provide greater immediate liquidity to
their customers.
Another consideration is the migration of activity to nonbanks.
Bessembinder (2018) provides evidence that nonbank-affiliated dealers
expanded their intermediation in the corporate bond market as bank-
affiliated dealers pulled back.\736\ This evidence suggests that
nonbank-affiliated dealers might step in to mitigate reduced liquidity
provision of bank-affiliated dealers in other markets as well.
---------------------------------------------------------------------------
\736\ Bessembinder (2018) show that only bank-affiliated dealers
reduced the inventory imbalances they would accommodate, while the
nonbank-affiliated dealers took on greater imbalances, although not
enough to offset changes by the bank-affiliated dealers. However, it
is difficult to disentangle the impacts of capital regulation from
those of other regulations. Bao, et. al (2018) find limited
difference in the inventory imbalances held by dealers passing the
CCAR stress test compared to those not passing, they interpret as
evidence of capital requirements not being a likely driver.
---------------------------------------------------------------------------
There are both benefits and drawbacks to nonbanks potentially
increasing intermediation if banking organizations pull back. One clear
benefit is that nonbanks could mitigate any potential reductions in
market liquidity. Also, given that nonbanks do not benefit from deposit
insurance, a shift toward nonbanks might reduce costs to the
government. One drawback is that nonbanks may take on excessive
leverage or risk, in part due to lack of prudential regulation
comparable to bank regulation. If important nonbank intermediaries were
to fail during extreme stress, there could be substantial negative
effects on financial stability and market liquidity, which could impose
costs on the government and the economy.
Some aspects of the proposal could also have impacts on markets
beyond the effects of a change in the average level of capital
requirements.
First, the reduced procyclicality of capital requirements for
banking organizations may encourage relatively more market liquidity
during periods of stress. Both the proposed standardized and models-
based approaches are substantially less sensitive to changes in current
market conditions and are calibrated instead to historical periods of
stress, in contrast to the current market risk framework that includes
VaR based on current market data.
Second, the decrease in capital requirements for non-Category I and
II banking organizations could potentially reduce their trading costs,
which may encourage market making to be relatively less concentrated
among the largest banking organizations. One of the key channels would
be the removal of the standardized approach for specific risk, which
tends to have a larger impact on smaller banking organizations.
Third, there may be greater use of central clearing for certain
derivatives. As central clearing becomes more common, there could
possibly be spillover effects whereby other market participants not
directly affected by the proposal choose to centrally clear as well,
which could potentially enhance the efficiency and stability of
markets.
Fourth, if banking organizations hedge more in aggregate due to the
proposed capital framework, some nonbank counterparties would likely
have to take on that risk instead. While there is uncertainty over
exactly how risk is distributed throughout the U.S. financial system,
it is possible that entities such as pension funds, insurance
companies, or investment funds would step in to purchase more of that
risk from banking organizations. These could create new opportunities
for such trading counterparties, but also potential avenues for
financial instability outside the banking system.
To summarize, there would likely be heterogenous effects on
markets, depending on whether capital requirements would rise or fall
for products in a given market under the proposal. The markets where
the proposal would result in a larger increase in banking organization
capital requirements would likely see banking organizations
accommodating smaller inventory imbalances. Average transaction costs
would not necessarily rise, but the cost of conducting immediate trades
would likely rise. Nonbanks would likely step in to provide more
intermediation, although growing reliance on nonbanks for market
intermediation raises its own potential concerns. Similarly, the areas
in which the proposal would result in a decrease in banking
organization capital requirements would likely see larger inventory
imbalances, lower costs of immediate trades, and a greater share of
activity conducted by banking organizations. Various features of the
proposal could also have other impacts on markets, such as reducing the
procyclicality of intermediation and encouraging relatively more
trading activity by smaller banking organizations.
F. Effect on Competitiveness
The proposed changes to risk-based capital requirements of the
largest U.S. banking organizations could potentially affect competition
of those banking organizations with international peers, smaller
banking organizations in the United States, and nonbank financial
entities. This section highlights the
[[Page 15145]]
anticipated potential effects expected to be the most economically
important for the United States.
An overall moderate lowering of required capital for Category I and
II banking organizations, moving closer in line with the requirements
for internationally active foreign banks, could somewhat increase U.S.
banking organizations' ability to compete for business internationally.
Lower risk weights relative to the current standardized approach in
certain lending areas could advantage covered banking organizations in
attracting domestic customers, though other changes, like ending
capital deduction for excess mortgage servicing assets, could also help
them support smaller banking organizations through correspondence
lending relationships, growing aggregate lending. At the same time, the
concurrent standardized approach proposal and the option available to
smaller banking organizations to use the expanded risk-based approach
under this proposal would help ensure continued robust competition
between domestic banking organizations. The proposal may induce some
lower-risk traditional lending activities to flow back into the banking
sector in a way that would enhance competition and financial stability
in the United States. Finally, the analysis discusses how key lending
areas could see improved pricing and service quality as increased
competition reduces applicable interest rates, and how regulatory
barriers to entry into the largest bank tiers would be reduced through
a shift to lower, less complex, and more certain capital requirements.
1. On Internationally Active Banks
Benefits of the Basel framework include the promotion of global
financial stability by strengthening the resilience of the global
banking system and preventing a regulatory race-to-the-bottom for
internationally active banks. International banking integration can
increase competition, boosting productivity and growth, with particular
importance for international trade and global liquidity
management.\737\ The agencies project the combined impact of this
proposal and the GSIB surcharge proposal to yield lower required
capital levels on average and for most individual banking organizations
subject to the rules. As detailed further below, internationally active
banks from other jurisdictions are generally bound by capital
requirements based on a calculation of risk-weighted assets which rely
heavily on internally modelled risk weights. While Category I and II
banking organizations currently also compute risk weights for their
exposures based on internal models, most of these organizations are
bound by the U.S. standardized approach in most quarters, which
generally sets higher, fixed risk weights to compensate for the reduced
risk sensitivity of the approach.\738\ In practice, this means
internationally active foreign banks are applying lower risk weights
and have lower minimum capital requirements than their U.S.
counterparts.\739\
---------------------------------------------------------------------------
\737\ See Claudia M. Buch & Linda S. Goldberg, ``Global banking:
Toward an assessment of benefits and costs,'' Annual Review of
Financial Economics, 12.1 (2020): 141-175, available at: https://doi.org/10.1146/annurev-financial-021920-112021.
\738\ See, e.g., Joasia E. Popwicz, ``All top US banks below
Collins floor,'' risk.net (January 2022), available at: https://www.risk.net/risk-quantum/7922981/all-top-us-banks-below-collins-floor.
\739\ See Online Appendix of Elizabeth Duncan, Akos Horvath,
Diana Iercosan, Bert Loudis, Alice Maddrey, Francis Martinez,
Timothy Mooney, Ben Ranish, Ke Wang, Missaka Warusawitharana & Carlo
Wix, ``COVID-19 as a stress test: Assessing the bank regulatory
framework,'' Journal of Financial Stability, Volume 61, (2022),
available at: https://doi.org/10.1016/j.jfs.2022.101016.
---------------------------------------------------------------------------
The proposed expanded risk-based approach risk weights are
generally calibrated at a lower level than the current standardized
approach, and are more granular to enhance risk sensitivity, reducing
incentives to disengage from relatively lower risk lending activities.
While important, lower capital requirements are not the sole
determinant of long-run profitability, as illustrated by return on
equity at U.S. GSIBs following the 2007-09 global financial crisis
which averaged around 5 to 6 percentage points higher than their
counterparts in the Euro Area.\740\ That said, the lower requirements
that proposed revisions to the GSIB surcharge would deliver, and that
would remain within the generally accepted optimal level of capital, as
discussed in section VIII.C, should promote the global competitiveness
of internationally active U.S. banking organizations.
---------------------------------------------------------------------------
\740\ See Luca Di Vito, Natalia Fuentes, Natalia & Joao Matos
Leite, ``Understanding the profitability gap between euro area and
US global systemically important banks,'' ECB Occasional Paper, No.
327, (2023), available at: https://doi.org/10.2866/51151.
---------------------------------------------------------------------------
The BIS collects anonymized data on large, internationally active
banks in Basel member jurisdictions. These data are analyzed and
compiled in a semi-annual monitoring report that describes the average
asset holdings and concomitant risk weight density, risk-weighted
assets divided by exposure amounts, by exposure category. These reveal
that the effective average risk weights used by foreign banks subject
to the Basel standards as implemented in other jurisdictions are
materially lower than the risk weights that Category I and II banking
organizations currently apply across several exposure categories. For
example, for internationally active banks in all Basel jurisdictions at
the end of 2024, average risk weight density for corporate exposures
was around 56 percent and for retail exposures around 29 percent.\741\
Category I and II banking organizations, when bound by the current
standardized approach as is typically the case, apply 100 percent risk
weights to both types of exposures. While the proposed risk weights in
those exposure types would still exceed global averages, the downward
calibrations would bring them much closer in line, reducing anti-
competitive disparities with global competitors while still maintaining
the comparatively stronger levels of capital at Category I and II
banking organizations that have resulted in greater resilience relative
to their global peers.
---------------------------------------------------------------------------
\741\ See Basel Committee on Banking Supervision, ``Basel III
Monitoring Report,'' (March 2025), available at: https://www.bis.org/bcbs/publ/d592.pdf.
---------------------------------------------------------------------------
Increased competition in international banking can lower individual
and systemic risk. Faia et al. (2021) develops a model of global
banking competition that predicts cross-border expansion of banks into
retail activities like lending and deposit-taking can actually lower
individual risk taking and systemic risk through a competition driven
compression of loan-deposit spreads. They find empirical evidence that
supports this prediction using data from 2005 to 2014 on the foreign
expansion, profit margins, and market and accounting risk metrics of 15
European G-SIBs headquartered in eight different countries.\742\
---------------------------------------------------------------------------
\742\ See Ester Faia, S[eacute]bastien Laffitte, Maximilian
Mayer, & Gianmarco Ottaviano, ``Global banking: Endogenous
competition and risk taking,'' European Economic Review, Volume 133,
2021, available at: https://doi.org/10.1016/j.euroecorev.2021.103661.
---------------------------------------------------------------------------
This proposal would obviate the need for U.S. banking organizations
to internally model credit and operational risk for regulatory capital
calculations, which could yield more certainty in capital requirements,
which could support investment, lending, and trading activities through
the economic cycle. As noted above, Category I and II banking
organizations, in recent years, have been predominantly bound by
standardized or leverage capital requirements. During the height of the
shock from the COVID-19 pandemic beginning in early 2020, a number of
these banking organizations became unexpectantly bound by rising
modelled
[[Page 15146]]
capital requirements as expected defaults rose. Behn, Haselmann, and
Wachtel (2016) exploit an upward shock to modelled capital requirements
at German banks following the failure of Lehman Brothers in 2008 to
show how unexpected swings in capital requirements can lead to a
procyclical drag on lending.\743\ The proposed removal of modelling for
credit and operational risk, and proposed changes to the modelling of
market risk capital requirements, would reduce uncertainty in future
capital requirements, particularly during times of stress, allowing
Category I and II banking organizations to continue lending and market
making during such periods.\744\
---------------------------------------------------------------------------
\743\ See Markus Behn, Rainer Haselmann, & Paul Wachter,
``Procyclical Capital Regulation and Lending,'' The Journal of
Finance, Volume 71, Issue 2, April 2016, Pages 919-956, available
at: https://doi.org/10.1111/jofi.12368.
\744\ See section VIII.E.2.c for discussion of the expected
reduction in the procyclicality of requirements for trading
activities resulting from this proposal.
---------------------------------------------------------------------------
2. On Smaller Banks
As mentioned previously, Category I and II banking organizations
are currently predominantly bound by the standardized approach that
also applies to smaller banking organizations, while also being subject
to additional buffer requirements. While these proposals are projected
to lower aggregate capital requirements at Category I and II banking
organizations, these requirements would still exceed those applied to
smaller banking organizations. Further, Category I and II banking
organizations would continue to have more stringent requirements
relative to Category III and IV banking organizations, reflecting the
former group's greater size, complexity, and systemic risk. On an
exposure-by-exposure basis, the proposed revised capital requirements
would sometimes be lower than those in the standardized approach, even
inclusive of associated operational risk requirements. A number of
factors help though to mitigate any concern that the proposal would
create competitive inequity overall between Category I and II banking
organizations and smaller banks. These include the companion
standardized approach proposal, the proposed option for any banking
organization to adopt the expanded risk-based approach as discussed in
section II.A, the proposed operational risk requirements included in
the expanded risk-based approach, and the differing nature of large and
small banking organization business models. Smaller lenders could also
benefit from potential enhanced interest from the largest banking
organizations in correspondent lending relationships, given the
proposed reduction in risk weights in some lending areas under the
expanded risk-based approach.
The proposal would address potential concerns around competitive
imbalances by allowing banking organizations of any size to elect to
use the expanded risk-based approach.
Broader concerns about impacts of the proposal on the competition
between large and small banking organizations are diminished more
generally by the differences in their typical business models. For one,
Category I and II banking organizations tend to have significant
trading operations, an area where smaller banking organizations do not
participate. Second, smaller banking organizations tend to rely more
heavily on relationship lending models that entail the cultivation of
qualitative information about their customers' credit-worthiness and
monitoring via geographic proximity. The largest banking organizations
tend to engage in more transactional lending that relies heavily on
data collection and verification for underwriting and that is backed by
tangible collateral.\745\
---------------------------------------------------------------------------
\745\ See Allen N. Berger & Lamont K. Black, ``Bank size,
lending technologies, and small business finance,'' Journal of
Banking & Finance, no. 35(3) (2011), https://doi.org/10.1016/j.jbankfin.2010.09.004.
---------------------------------------------------------------------------
Aspects of the proposal, as discussed in sections III and IV.A, may
also indirectly support smaller banking organizations by increasing the
attractiveness of correspondent lending models and other forms of loan
participation agreements.\746\ Smaller lenders can cultivate customers
via their superior local knowledge while turning to larger banking
organizations for funding and for their facility with securitization
markets.\747\ This could allow larger banking organizations to
essentially downstream the reduced risk weights under the expanded
risk-based approach in areas like real estate, retail, and corporate
lending to the smaller banking organizations originating the loans. The
proposed removal of the mortgage servicing assets deduction treatment
could also make mortgage lending relationships under these types of
models more attractive, particularly for Ginnie Mae securitizations
where lenders must pool together multiple loans themselves.
---------------------------------------------------------------------------
\746\ See Michael Poprik, ``Loan Participations: Lessons Learned
During a Period of Economic Malaise,'' Federal Reserve Bank of
Richmond Community and Regional Supervision (2013), https://www.communitybankingconnections.org/articles/2013/q2/loan-participations.
\747\ See Richard Stanton, Johan Walden, & Nancy Wallace, ``The
Industrial Organization of the US Residential Mortgage Market,''
Annual Review of Financial Economics, no. 6 (2014), available at:
https://doi.org/10.1146/annurev-financial-110613-034324 and David
Benson, You Suk Kim, & Karen Pence, ``Bank Aggregator Exit, Nonbank
Entry, and Credit Supply in the Mortgage Industry,'' Working Paper
(2023), https://www.fdic.gov/system/files/2024-07/kim-paper.pdf.
---------------------------------------------------------------------------
3. On Nonbank Financial Intermediaries
The proposal would likely drive expansion in bank lending that
could partially reverse the ongoing migration of activity to the
nonbank financial sector in a manner that could support financial
stability. Heightened capital requirements have been identified as one
factor in nonbanks' increased share of financial market activity. The
proposal reduces requirements in certain areas, particularly for
traditional lending activities such as mortgages and corporate loans,
in a way that would support bank competitiveness relative to nonbanks.
Given the greater willingness and capacity for lending that banks
demonstrate during periods of stress, this could generate stability
benefits.
The migration of activities from banking organizations to nonbanks
has been a longstanding trend for the financial system. It can have
heterogeneous effects on financial stability. Certain nonbanks operate
with very low leverage and are well-positioned to manage large economic
downturns.\748\ However, many nonbanks rely on fragile, confidence-
sensitive sources of funding, partly from banking organizations, making
them vulnerable during times of stress. Moreover, more resilient
banking organizations are better positioned to lend in the face of
economic downturns, in part compensating for the potential reduction in
lending from more vulnerable nonbanks. Thus, the impact of migration on
financial stability and lending over the business cycle is influenced
by numerous factors, including the specific characteristics of the
nonbanks that assume these activities and their interdependencies with
banks.
---------------------------------------------------------------------------
\748\ Anat Admati and Martin Hellwig, ``The Bankers' New
Clothes: What's Wrong with Banking and What to Do About It''
Princeton University Press (2024) (``Admati and Hellwig (2024)''),
https://press.princeton.edu/books/paperback/9780691251707/the-bankers-new-clothes.
---------------------------------------------------------------------------
a. Effects of Capital Regulations on Migration of Activity to Nonbanks
Capital regulation has been linked to the migration of activity to
nonbanks, though the effects through the entire economic cycle are less
certain. On the one hand, tighter regulations, including stricter
capital requirements, might induce banking organizations to reduce
[[Page 15147]]
their lending, creating opportunities for nonbanks to fill the gap. For
example, Buchak et al. (2018) found that more stringent capital
requirements and tighter regulations pushed mortgage origination to
nonbanks, which expanded their mortgage origination market share.\749\
On the other hand, well-capitalized banking organizations are better
positioned to extend credit, especially during times of economic
stress.\750\ Buchak et al. (2018) note that resilient banking
organizations, supported by robust regulatory frameworks, can act as
stabilizing forces during crises where banking organizations with
strong capital buffers can provide essential liquidity, supporting
investment and economic recovery.\751\
---------------------------------------------------------------------------
\749\ Greg Buchak, Gregor Matvos, Tomasz Piskorski & Amit Seru,
``Fintech, Regulatory Arbitrage, and the Rise of Shadow Banks,''
Journal of Financial Economics, 130(3), 453-483 (December 2018)
(``Buchak et al. (2018)''), https://doi.org/10.1016/j.jfineco.2018.https:03.011.
\750\ Allen N. Berger & Christa H.S. Bouwman, ``How Does Capital
Affect Bank Performance During Financial Crises?'' Journal of
Financial Economics, 109(1), 146-176 (July 2013) (``Berger and
Bouwman (2013)''), https://doi.org/10.1016/j.jfineco.2013.https:02.008; Admati and Hellwig (2024).
\751\ Buchak et al. (2018).
---------------------------------------------------------------------------
The differential effects of the proposal across business
activities, as well as differences across nonbanks, may contribute to
reversing the migration of some activities toward banking
organizations. For example, the proposed lower risk weights for most
mortgages may encourage banking organizations to hold more of these
loans in their portfolios, while the proposed removal of the MSA
deduction treatment may lead them to expand their originate-to-
distribute lending operations. Conversely, the proposed increase in
risk-weighted assets for market risk, as well as an increase in some
credit conversion factors and operational risk-weighted assets
attributed to the interest and fee income associated with credit lines,
may incentivize some liquidity provision in financial markets to shift
towards nonbanks.
b. Impact of Migration of Activity to Nonbanks on Financial Stability
The proposal's contribution to slowing or partially reversing the
migration of financial activities toward nonbanks would have
implications for financial stability. While some nonbanks are less
leveraged than banking organizations, making them better positioned to
absorb losses, they often rely on less stable sources of funding
compared to banks. \752\ Besides, not all nonbank financial entities
are equally prone to runs. Private equity funds manage long-term
capital through funding structures that permit less frequent redemption
and corporate bond mutual funds operate with little or no leverage.
Some studies, though, argue that their fragile funding structures still
make them vulnerable.\753\ Disorderly withdrawals have forced the
closure of corporate bond mutual funds at Credit Suisse and Third
Avenue Management,\754\ and it is common for private equity funds to
face withdrawals when lock-up periods expire.\755\
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\752\ Gorton and Metrick (2012); Erica Xuewei Jiang, Gregor
Matvos, Tomasz Piskorski & Amit Seru, ``Monetary Tightening and U.S.
Bank Fragility in 2023: Mark-to-Market Losses and Uninsured
Depositor Runs?'' Journal of Financial Economics, 159, 103899
(September 2024) (``Jiang et al. (2024)''), https://doi.org/10.1016/j.jfineco.2024.103899.
\753\ Itay Goldstein, Hao Jiang & David T. Ng, ``Investor Flows
and Fragility in Corporate Bond Funds,'' Journal of Financial
Economics 126(3), 592-613 (December 2017) (``Goldstein et al
(2017)''), https://doi.org/10.1016/j.jfineco.2016.11.007.
\754\ Jeffrey Ptak & Sarah Bush, ``Third Avenue Focused Credit
Abruptly Shuttered,'' Morningstar (December 2015) (``Ptak and Bush
(2015)''), https://www.morningstar.com/funds/third-avenue-focused-credit-abruptly-shuttered; Tim McLaughlin, Ross Kerber & Svea
Herbst-Bayliss, ``Hidden in Plain Sight: Big Risks at Failed Third
Avenue Fund Were Clear to Some,'' Reuters (December 2015)
(``McLaughlin et al. (2015)''), https://www.reuters.com/article/business/hidden-in-plain-sight-big-risks-at-failed-third-avenue-fund-were-clear-to-some-idUSKBN0U627V.
\755\ As another example of U.S. government support of nonbanks
in a period of stress, during the COVID-19 pandemic, the Federal
Reserve established the Primary Market Corporate Credit Facility and
the Secondary Market Corporate Credit Facility to alleviate stress
in the corporate bond market. Before that, the Federal Reserve
established several financial crisis era facilities including the
Money Market Investor Funding Facility, the Asset-Backed Commercial
Paper Money Market Mutual Fund Liquidity Facility, Commercial Paper
Funding Facility, and the Term Asset-Backed Securities Loan
Facility.
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In aggregate, by encouraging the migration of certain activities
back towards banking organizations, the proposal is expected to support
financial stability. Nonbanks are typically less regulated and are not
subject to the same comprehensive federal prudential regulation and
supervision as banking organizations. Gorton and Metrick (2012) argue
that the lack of regulatory oversight makes nonbanks more vulnerable to
runs and liquidity crises.\756\ Some of these risks are discussed
further in the Federal Reserve Board's Financial Stability Report of
April 2025.\757\ Nonbanks do not have access to the same protections as
banking organizations through deposit insurance or other central bank
facilities. Finally, nonbanks may amplify shocks during times of stress
by reducing lending to a larger extent compared to banking
organizations.\758\
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\756\ Gorton and Metrick (2012).
\757\ ``Financial Stability Report,'' Board of Governors of the
Federal Reserve System (April 2025), https://www.federalreserve.gov/publications/files/financial-stability-report-20250425.pdf.
\758\ I[ntilde]aki Aldasoro, Sebastian Doerr & Haonan Zhou,
``Non-Bank Lending During Crises,'' Bureau of International
Settlements, Working Paper No. 1074 (August 2025) (``Aldasoro et al.
(2025)''), https://www.bis.org/publ/work1074.pdf.
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4. On Consumer Welfare and Barriers to Entry
The proposal would generally lower risk weights, particularly for
safer portfolios, while also enhancing the risk sensitivity of capital
requirements. Doing so would likely encourage more lending, thereby
heightening competition, with end users seeing the benefits in improved
pricing and increased consumer surplus. While certain financial
markets, like large corporate lending, are already quite competitive,
others persist with pricing that includes significant markups above
marginal cost.\759\ For example, in the mortgage space, Bhutta, Fuster,
and Hizmo (2024) combine rate lock and loan offer data and find that
borrowers with similar credit profiles see significant dispersion in
the prices they pay for loans, which they link to lender market power.
Importantly, they demonstrate through lender income and expense data
and borrower surveys that more expensive loans are indicative of higher
markups rather than better service.\760\
---------------------------------------------------------------------------
\759\ See Thomas Flanagan, ``The Value of Bank Lending,''
Journal of Finance, 80: 2017-2061 (May 2025), available at https://doi.org/10.1111/jofi.13465.
\760\ See Neil Bhutta, Andreas Fuster, & Aurel Hizmo, ``Paying
Too Much? Borrower Sophistication and Overpayment in the US Mortgage
Market,'' Federal Reserve Bank of Philadelphia Working Paper, no.
24-11 (June 2024), available at: https://doi.org/10.21799/frbp.wp.2024.11.
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In addition to promoting activity at current Category I and II
banking organizations, the proposals could also encourage growth in the
number of banking organizations in these categories. More Category I
and II banking organizations, rather than just a few that continually
get bigger, could constitute a safer and more competitive financial
landscape.
Besides dampening lending in general, overly complex, or uncertain,
capital requirements can introduce barriers to entry that enshrine
incumbents, reducing overall competition and incentivizing banking
organizations that may pose systemic risk to bunch below the regulatory
thresholds at which they would be
[[Page 15148]]
formally recognized as such. While other jurisdictions have seen some
churn in which institutions are systemically important enough to be
deemed GSIBs, the eight U.S. bank holding companies identified as GSIBs
by the Financial Stability Board in 2012 remain the only U.S. GSIBs
today, and no additional Category II banking organizations have emerged
following the creation of the current tier definitions.\761\ The
proposed rules, through a potential reduction in the overall level of
required capital, removal of complexity and burden from the requirement
to simultaneously internally model credit and operational risk, and
increased certainty from a single set of risk-based requirements,
should lessen the extent to which becoming a Category I or II banking
organization may be seen as undesirable. While somewhat paradoxical,
the growth and consolidation of some large regional banks into Category
I or II banking organizations could actually provide more competition
in the lending and trading markets that can only be contended by
banking organizations of the largest scale.
---------------------------------------------------------------------------
\761\ See ``2025 List of Global Systemically Important Banks (G-
SIBs),'' (November 2025), available at: https://www.fsb.org/2025/11/2025-list-of-global-systemically-important-banks-g-sibs/#g-sibs-2012-2025. Some Category III banking organizations are approaching
the Category II thresholds for either Total Assets or Cross-
Jurisdictional Activity.
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Larger banking organizations can also reduce risk in some
dimensions and temper local economic shocks through greater depositor
base diversification.\762\ Indicatively, Caglio, Dlugosz, and Rezende
(2025) found, using confidential data on bank balance sheets, that
during the period of heightened stress following the regional banking
organizations failures of March 2023, GSIBs saw notable upticks in
uninsured deposit flows, even relative to other large non-GSIB
banks.\763\ That highlights the benefits to financial market stability
of promoting the emergence of competitors to the current Category I and
II banking organizations. Importantly, should the proposed rule changes
in these proposals lead more Category I or II banking organizations to
emerge, they would become subject to key provisions around capital,
augmented liquidity, detailed resolution planning, and enhanced
supervisory oversight to formally allay concerns over whether such
institutions were too big to fail.
---------------------------------------------------------------------------
\762\ See Sebastian Doerr, ``Deposit Diversification and Funding
Stability,'' (September 2025), available at: http://dx.doi.org/10.2139/ssrn.4788627. They leverage a gravity model of firm
expansion trends away from their headquarters, along with the
staggered repeal of interstate branching limitations across states,
to assess the impact of exogenous increases in a bank's deposit-base
geographical diversification. They find that it increases a bank's
funding stability, through a greater reliance on insured demand
deposits, and empowers banks to increase liquidity creation and
better continue lending when exposed to a negative localized shock
like a natural disaster.
\763\ See Cecilia Caglio, Jennifer Dlugosz, & Marcelo Rezende,
``Flight to Safety in the Regional Bank Stress of 2023,'' SSRN
Working Paper (February 25, 2025), available at: https://doi.org/10.2139/ssrn.4457140.
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Question 197: What, if any, alternative approaches should the
agencies consider for assessing the proposal's effect on
competitiveness, and why?
G. Conclusion
The agencies have conducted a thorough economic analysis of the
proposal, examining its potential effects on the U.S. banking system
and the broader economy. This assessment encompassed proposed changes
in risk-weighted assets, capital requirements and their potential
effects on lending and trading activities, market liquidity, and
competition among financial institutions. The analysis suggests that
the proposal would improve the measurement of various risks faced by
banking organizations, increasing the risk sensitivity of the
regulatory capital framework. Furthermore, the proposed changes to risk
weights are broadly expected to support enhanced financial
intermediation by covered banking organizations. The analysis also
suggests that the cumulative change in capital under the combined
proposals (or of each proposal on a standalone basis) is expected to
maintain a level of capital that is within range of estimates for
optimal capital in the U.S. banking system, and thus reasonable.
Furthermore, by aligning more closely with international standards,
the proposed revisions to risk weights aim to enhance Category I and II
banking organizations' global competitiveness without compromising
their strong capital positions. Based on this economic analysis, the
agencies conclude that the benefits of the proposal justify its costs.
The agencies invite comment on all aspects of this economic analysis.
IX. 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 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 as 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. __.1, the proposal would clarify the application of notice
and response procedures for reservation of authority actions, would
clean up expired effective date provisions, and would clarify the when
standards apply to banking organizations that change from one category
to another. The proposal would introduce a severability provision to
clarify the agencies' intent with respect to the ongoing effectiveness
of the proposal in the event that any particular provision or
application of the rule is stayed or determined to be invalid. The
proposed severability provision reflects the agencies' view that
invalidation of a particular provision or application of the capital
rule would not render the entire regulation or regulatory scheme
unworkable.
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,\764\ the definition of qualifying master
netting agreement 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
[[Page 15149]]
OCC finalized the restrictions in the qualified financial contracts
stay rule (\765\ and made conforming amendments to the capital rule,
certain paragraphs related to a walkaway clause in the definition of
qualifying master netting agreement were removed in error. The Board
and OCC propose to correct the error by inserting back these
paragraphs.
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\764\ See 78 FR 62018 (Oct. 11, 2013).
\765\ See 82 FR 42882 (Sept. 12, 2017).
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In Sec. __.10(c)(2)(i) of the capital rule, the proposal would
clarify in the definition of total leverage exposure that total
leverage exposure amount could be reduced by any AACL for on-balance
sheet assets. The capital rule defines total leverage exposure to
include the carrying value of on-balance sheet assets without any
adjustment for AACL. The definition of carrying value does not allow
for the reduction in the on-balance sheet amount by any credit loss
allowances, except for allowances related to AFS securities and
purchased credit deteriorated assets. In the numerator of the
supplementary leverage ratio, the AACL flows through earnings and is
reflected in Tier 1 capital. To align the numerator and the denominator
of the SLR, the proposed change would allow banking organizations to
net the AACL from the denominator of the SLR.
The proposal would 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.\766\ 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).
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\766\ See 84 FR 61804 (Nov. 13, 2019).
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Sec. __.303 of the capital rule covers a temporary exclusion from
total leverage exposure that ended March 31, 2021. Consistent with the
community bank leverage ratio proposed rule, the proposal would remove
Sec. __.304 of the capital rule, which covers temporary changes to the
community bank leverage ratio framework that applied until December 31,
2021.\767\ 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.
---------------------------------------------------------------------------
\767\ See 90 FR 55048 (Dec. 1, 2025).
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On November 12, 2025, the Financial Accounting Standards Board
(FASB) issued Accounting Standards Update (ASU) 2025-08, ``Financial
Instruments--Credit Losses (Topic 326): Purchased Loans,'' which amends
the guidance on accounting for purchased loans. Upon adoption of ASU
2025-08, the population of acquired financial assets subject to the
``gross-up approach'' will be expanded to include purchased seasoned
loans. The ``gross-up approach'' under U.S. GAAP requires a banking
organization to record an allowance for credit losses on purchased
credit deteriorated assets \768\ as well as purchased seasoned loans as
of the date of acquisition with an offsetting gross-up adjustment to
the purchase price of the assets or loans.
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\768\ Purchase credit deteriorated assets are acquired
individual financial assets (or acquired groups of financial assets
with shared risk characteristics) that, as of the date of
acquisition and as determined by an acquirer's assessment, have
experienced a more-than-insignificant deterioration in credit
quality since origination.
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In the agencies' final rule implementing the current expected
credit losses (CECL) methodology in 2019 (CECL final rule), the
agencies amended the capital rule to identify which allowance for
credit losses under the new CECL accounting standard would be eligible
for inclusion in a banking organization's tier 2 capital.\769\ The CECL
final rule addressed the treatment of allowance for credit losses
related to purchase credit deteriorated assets. As ASU 2025-08 requires
banking organizations to apply the gross approach to both purchase
credit deteriorated assets and purchased seasoned loans, the agencies
are proposing to apply the capital rule's treatment of allowance for
credit losses on purchase credit deteriorated assets to allowance for
credit losses on purchased seasoned loans. In particular, the proposal
would modify the term adjusted allowance for credit losses (AACL)
adopted in the CECL final rule to exclude credit loss allowances on
purchased seasoned loans in addition to those on purchase credit
deteriorated assets and available-for-sale (AFS) debt securities. A
banking organization would continue to be able to include AACL in its
tier 2 capital up to 1.25 percent of the banking organization's total
credit risk weighted assets. The proposal would also amend the
definition of carrying value to require the carrying value of purchased
seasoned loans to be calculated net of ACLs like the capital rule's
current treatment of PCD assets.
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\769\ See 86 FR 4224 (Feb. 14, 2019).
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In defining AACL, the agencies intend to include only those ACLs
that have been fully charged against earnings or retained earnings.
Including in tier 2 capital ACLs that have not been charged against
earnings would diminish the quality of regulatory capital. Since the
initial ACL amount for a PSL recorded on a banking organization's
balance sheet would not be established through a charge to earnings,
the agencies believe the treatment currently applied to the initial ACL
for purchase credit deteriorated assets also would be appropriate for
the ACL on purchased seasoned loans. Due to concerns of undue
complexity and burden on banking organizations, the agencies are not
proposing a bifurcated approach for the treatment of purchased seasoned
loans whereby a banking organization could include post-acquisition
ACLs on PSLs in tier 2 capital when the banking organization's
purchased seasoned loan balances exceed a materiality threshold. The
agencies believe that requiring banking organizations to calculate the
carrying value of purchased seasoned loans net of ACLs appropriately
offsets the effects of excluding post-acquisition ACLs on PSLs in the
calculation of regulatory capital. Therefore, the agencies are
proposing to exclude the entire ACL on PSLs from AACL, even though
post-acquisition increases in ACLs for PSLs would be established
through a charge against earnings.
In addition, the agencies are proposing to amend the definitions of
AACL and carrying value to provide the same treatment as purchase
credit deteriorated assets to other assets that may in the future
become subject to the gross approach following a change to GAAP by
FASB.
The agencies are also proposing a technical amendment to the
current
[[Page 15150]]
capital rule to remove the definition of allowance for loan and lease
losses (ALLL) from section __.2 of the capital rule. The definition of
ALLL in the current capital rule is no longer meaningful given the
introduction and adoption of the current expected credit loss (CECL)
methodology by the FSAB under ASU 2016-13, ``Financial Instruments--
Credit Losses (Topic 326).''
A. Additional OCC Technical Amendments
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. The FDIC also proposes to
merge the definition of ``bank'' into the definition of ``FDIC-
supervised institution'' and to remove ``bank'' as a defined term in
the FDIC's capital rule. 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.
X. Related Proposals and Proposed Amendments to Related Rules
A. Related Proposals
The agencies are also issuing a proposal that would modify certain
aspects of the capital requirements applicable to banking organizations
not covered by the expanded risk-based approach. That proposal would
revise the risk-based capital treatment of certain exposure categories
under the standardized approach, focusing on improving the calibration
and risk sensitivity of risk weights that are particularly material to
lending activities. Consistent with this proposal, the standardized
approach proposal would modify the definition of regulatory capital by
removing the threshold-based deduction for mortgage servicing assets,
including for banking organizations subject to the community bank
leverage ratio framework. In addition, the standardized approach
proposal would require Category III and IV banking organizations to
recognize most elements of accumulated other comprehensive income in
their regulatory capital.
The Board is separately issuing 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 proposal would modify certain coefficients used to calculate
GSIB surcharges under method 2 of the GSIB surcharge framework and
provide for annual adjustments of these coefficients going forward. The
proposal would modify the measurement and weighting of the weighted
short-term wholesale funding systemic indicator in method 2. For
certain systemic indicators currently measured only as of a single date
each year, the proposal would change to reporting of average values to
reduce the effects of temporary changes to indicator values around
measurement dates. The proposal would reduce cliff effects and enhance
the sensitivity of the surcharge to changes in the method 2 score by
calculating surcharges based on narrower score band ranges. To improve
risk capture, the proposal would also make improvements to the
measurement of some systemic indicators used in the GSIB surcharge
framework and the framework for determining prudential standards for
large banking organizations. The proposal would also make several
additional amendments to the FR Y-15 to improve the consistency of data
reporting and streamline the reporting process.
As discussed in section IV.A.3. of this SUPPLEMENTARY INFORMATION,
the proposal would modify the credit conversion factors applicable to
large banking organizations. The proposal would introduce a 40 percent
conversion factor for all conditional equity and credit commitments
regardless of maturity, which would replace the current capital rule's
20 percent and 50 percent conversion factors for conditional equity and
credit commitments. The proposal would also introduce a 5 percent
credit conversion for certain low-utilization retail exposures and a
treatment for retail commitments with no pre-set limit. To account for
this aspect of the proposal with the agencies supplementary leverage
ratio framework, the supplementary leverage ratio framework would
incorporate these conversion factors for banking organizations that are
subject to the expanded risk-based approach to ensure alignment between
the two frameworks.
Question 198: What modifications, if any, should the agencies
consider to this proposal due to related proposals and why?
B. OCC Amendments
Lending Limits Rule
The OCC's lending limit rule \770\ includes a definition of
eligible credit derivative, which references the definition of eligible
guarantee in the capital rule.\771\ This proposed rule would revise the
definition of eligible guarantee in 12 CFR part 3 to add a requirement
that an eligible guarantee must be provided by an eligible guarantor,
also as defined in 12 CFR part 3. To avoid imposing this additional
requirement of an eligible guarantor for eligible credit derivatives,
as defined for lending limit purposes, the OCC is proposing to revise
the definition of eligible credit derivative in 12 CFR part 32 to scope
out the new proposed requirement of an eligible guarantor.
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\770\ 12 CFR part 32.
\771\ See 12 CFR 32.2(m)(1).
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C. 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
[[Page 15151]]
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 199: What modifications, if any, should the Board consider
to this proposal or to other Board rules indirectly affected by this
proposal?
XI. Administrative Law Matters
A. Paperwork Reduction Act
Certain provisions of the proposal contain ``collections of
information'' within the meaning of the Paperwork Reduction Act of 1995
(PRA). 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 proposal 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 section 1320.11 of
OMB's implementing regulations (5 CFR part 1320). The Board reviewed
the proposal under the authority delegated to the Board by OMB.
The proposal 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). These
information collections are also being revised by the standardized
approach proposal. For ease of reference, the proposed revisions to
these information collections by this proposal as well as the
standardized approach proposal will be addressed in a separate Federal
Register notice.
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 proposed revisions to these Board reports will be addressed
in one or more separate Federal Register notices.
Finally, 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). The proposed revisions to
these FFIEC reports will be addressed in one or more separate Federal
Register notices.
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 (NAICS Code:
522110) and $47 million for trust companies (NAICS Code: 523991)) 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 609 small entities.\772\
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\772\ Consistent with the General Principles of Affiliation 13
CFR 121.103(a), OCC staff count the assets of affiliated financial
institutions when determining whether to classify an OCC-supervised
institution as a small entity. OCC staff use December 31, 2024, 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 footnote 8 of the
U.S. Small Business Administration's Table of Size Standards.
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The OCC estimates that the proposed rule would impact none of these
small entities, as the scope of the rule only applies to large national
banks and FSAs and their subsidiaries. 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
\773\ (RFA) requires an agency to consider whether the rule it proposes
will have a significant economic impact on a substantial number of
small entities.\774\ 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.\775\
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\773\ 5 U.S.C. 601 et seq.
\774\ Under regulations issued by the U.S. 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 the second quarter of 2025, there
were approximately 2,796 small bank holding companies and
approximately 157 small savings and loan holding companies, and
approximately 443 small state member banks.
\775\ 5 U.S.C. 603(b)-(c).
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The Board has considered the potential impact of the proposed rule
on small entities in accordance with the RFA. Based on its analysis and
for the reasons stated below, the Board believes that this proposed
rule will not have a significant economic impact on a substantial
number of small entities. Nevertheless, the Board is publishing and
inviting comment on this initial regulatory flexibility analysis. The
proposal would also make
[[Page 15152]]
corresponding changes to the Board's reporting forms.
As discussed in detail in sections I through X 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, change the definition of capital, amend certain dollar-
based regulatory thresholds, 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.
Requirements under the proposal would generally be consistent with
international capital standards issued by the Basel Committee.
Congress has authorized the agencies to establish risk-based
capital requirements and standards for banking organizations subject to
this proposal. Section 165 of the Dodd-Frank Wall Street Reform and
Consumer Protection Act (Dodd-Frank Act),\776\ as amended by section
401 of the Economic Growth, Regulatory Relief, and Consumer Protection
Act,\777\ requires the Board to establish enhanced prudential standards
that include risk-based capital requirements for bank holding companies
with $250 billion or more in total consolidated assets.\778\ The prompt
corrective action framework in section 38 of the Federal Deposit
Insurance Act (FDI Act) requires the agencies to prescribe capital
standards for insured depository institutions that include a risk-based
capital requirement and provides that the agencies may establish any
additional relevant capital measures to carry out the purpose of that
section.\779\ Various other statutory authorities provide the agencies
with broad discretionary authority to set capital requirements and
standards for banking organizations supervised by the agencies,
including national banking associations, state-chartered banks, savings
associations, and depository institution holding companies.\780\
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\776\ Dodd-Frank Wall Street Reform and Consumer Protection Act,
Public Law 111-203, 124 Stat. 1376 (2010).
\777\ Economic Growth, Regulatory Relief, and Consumer
Protection Act, Public Law 115-174, 132 Stat. 1296 (2018).
\778\ See 12 U.S.C. 5365(a)(1), (b)(1)(A)(i). Section 165 of the
Dodd-Frank Act also provides that the Board may apply any prudential
standard established under section 165 to any bank holding company
with $100 billion or more in total consolidated assets to which the
prudential standard does not otherwise apply, under certain
circumstances. 12 U.S.C. 5365(a)(2)(C). Section 165, in relevant
part, also applies to foreign banks or companies that are treated as
a bank holding company for purposes of the Bank Holding Company Act.
See 12 U.S.C. 3106(a), 5311(a)(1). See also section 401(g) of the
Economic Growth, Regulatory Relief, and Consumer Protection Act
(regarding the Board's authority to establish enhanced prudential
standards for foreign banking organizations with total consolidated
assets of $100 billion or more). 12 U.S.C. 5365 note.
\779\ See 12 U.S.C. 1831o(c)(1)(A), (c)(1)(B)(i).
\780\ See 12 U.S.C. 93a (national banking associations); 12
U.S.C. 248(i), 324, 327, 329 (state member banks); 12 U.S.C. 1463
(savings associations); 12 U.S.C. 1467a(g)(1) (savings and loan
holding companies); 12 U.S.C. 1844(b) (bank holding companies); 12
U.S.C. 3106 (certain U.S. operations of foreign banking
organizations); 12 U.S.C. 3902(1)-(2), 3907(a), 3909(a), (c)(1)-(2)
(depository institutions; affiliates of depository institutions,
including holding companies; and certain U.S. operations of foreign
banking organizations); 12 U.S.C. 5371 (insured depository
institutions, depository institution holding companies, and nonbank
financial companies supervised by the Board). Additional statutory
authorities relevant to the agencies' capital rule can be found in
the authority citations in the capital rule. See 12 CFR part 3
(OCC); 12 CFR part 217 (Board); 12 CFR part 324 (FDIC).
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As discussed in more detail in section II of this SUPPLEMENTARY
INFORMATION, the proposed rule would apply to Category I and II banking
organizations, 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.
Additionally, the proposal would allow other banking organizations to
opt into the expanded risk-based approach. Banking organizations that
choose this option would also be subject to the definition of capital
that applies to Category I and II banking organizations. Accordingly,
essentially all banking organizations to which the proposed rule would
apply exceed the SBA's $850 million total asset threshold, except for
small entities that opt into the framework set out in the proposed
rule. A small entity could choose not to opt into the framework set out
in this proposal and would not be required to make any changes to its
current reporting, recordkeeping, or compliance systems in order to
elect not to adopt this framework; the proposed rule, therefore, would
not impose mandatory requirements or costs on any small entities.
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.\781\
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.\782\
[[Page 15153]]
For the reasons described below, the FDIC certifies that the proposed
rule would not have a significant economic impact on a substantial
number of small entities.
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\781\ 5 U.S.C. 601 et seq.
\782\ The SBA defines a small banking organization as having
$850 million or less in assets, where an organization's ``assets are
determined by averaging the assets reported on its four quarterly
financial statements for the preceding year.'' See 86 FR 69118 which
amends 13 CFR 121.201, (effective December 19, 2022.). In its
determination, the ``SBA counts the receipts, employees, or other
measure of size of the concern whose size is at issue and all of its
domestic and foreign affiliates.'' See 13 CFR 121.103. Following
these regulations, the FDIC uses a covered entity's affiliated and
acquired assets, averaged over the preceding four quarters, to
determine whether the covered entity is ``small'' for the purposes
of RFA.
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As discussed in section IV, the proposed rule, if enacted, would
revise the risk-based capital requirements applicable to Category I and
II holding companies and their subsidiary Depository Institutions
(DIs).\783\ Specifically, these banking organizations would be subject
to a single set of risk-based capital ratio requirements based on the
expanded risk-based approach, as defined in section III. According to
Call Reports, there are 2,802 FDIC-supervised DIs that report risk-
based capital.\784\ Of these, approximately 2,085 would be considered
small entities for the purposes of the RFA.\785\ As of June 30, 2025,
there were 9 top-tier U.S. depository institution holding companies and
22 U.S.-based depository institutions that report risk-based capital
figures and are subject to Category I or II standards.\786\ As of June
30, 2025, the FDIC supervised one DI that is a subsidiary of a holding
company subject to the Category I capital standards and no DIs that are
subsidiaries of holding companies subject to the Category II capital
standards.\787\ This FDIC-supervised DI is not considered a small
entity for the purposes of the RFA because it is a subsidiary of a
holding company with over $850 million in total assets. Therefore, no
FDIC-supervised small entities would be subject to the expanded risk-
based approach should the proposed rule be enacted.
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\783\ Covered banking organizations surpassing certain trading
asset thresholds would also be subject to the proposal.
\784\ Call Reports data, June 30, 2025. The count of potential
covered entities excludes six insured, domestic branches of foreign
banks.
\785\ Call Reports data, June 30, 2025.
\786\ 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 June 2025 Call Reports, FR Y-9C data, and FR Y-
15 data.
\787\ Counts are based on June 30, 2025 Call Reports, FR Y-9C
data, and FR Y-15 data.
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As discussed in section II.A, the proposed rule would allow any
non-Category I or II covered banking organization to elect to use the
expanded risk-based approach. Electing the expanded risk-based approach
would entail compliance with other requirements, notably the need to
capitalize separately for operational risk and ineligibility to elect
the AOCI filter for banking organizations below the Category IV
threshold. Banking organizations electing to use the expanded risk-
based approach would be required to fully implement its applicable
provisions, including the capital, operational risk, recordkeeping,
reporting, and disclosure elements. Further, they would be required to
reflect most elements of AOCI in regulatory capital even if they
subsequently change to the standardized approach.
Banking organizations that qualify as small entities have simpler
business models with risk management and reporting systems designed for
their size and activities. If they elect the requirements under the
proposal, they may be required to set up, operate, maintain, and keep
records on more granular systems that would not likely yield benefits
that would warrant the additional costs to these small entities.
As mentioned, the agencies are concurrently publishing a separate
proposal that revises the standardized approach risk-based capital
requirements. Small entities that use the proposed standardized
approach or elect to use the CBLR framework would avoid the expanded
risk-based approach requirements designed for larger, more complex
banking organizations.\788\
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\788\ The CBLR criteria currently require a banking organization
to have less than $10 billion in total assets, meet a minimum
required ratio of tangible equity capital to its average total
consolidated assets of 9 percent, hold off-balance sheet exposures
of 25 percent or less of total consolidated assets, and hold total
trading assets plus trading liabilities of 5 percent or less of
total consolidated assets. As of June 30, 2025, over 1,000 FDIC-
supervised DI elect to use the CBLR framework. A recent proposal
would reduce the required leverage ratio from 9 percent to 8
percent, and extend the grace period for an eligible banking
organization that fails to meet the qualifying criteria after opting
into the CBLR framework. 90 FR 55048 (Dec. 1, 2025).
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Under the scenario in which all three frameworks are finalized as
proposed, the agencies believe that FDIC-supervised small entities are
most likely to choose as their required capital framework either (1)
the concurrently proposed revised standardized approach or (2) the
recently proposed revised CBLR, as these two frameworks are better
suited to the size and complexity of small entities than is the
proposed expanded risk-based approach. For eligible small entities, the
two options present a basic tradeoff between lower required capital
under the proposed revised standardized approach and simpler reporting
requirements under proposed revised CBLR.\789\
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\789\ See the Economic Impact section of the Regulatory Capital
and Standardized Approach for Risk-weighted Assets Notice of
Proposed Rulemaking for more information on small banking
organizations' incentives to select between the standardized
approach and the CBLR.
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For these reasons, the FDIC does not expect a substantial number of
small entities to elect to use the proposed expanded risk-based
approach.
Some effects of the proposal on small entities would occur
regardless of whether the entities adopt the expanded-risk based
approach. First, aspects of the proposal discussed in sections III and
IV.A may indirectly support small entities by increasing the
attractiveness of correspondent lending models and other forms of loan
participation agreements.\790\ Smaller lenders can cultivate customers
via their superior local knowledge while turning to larger banking
organizations for funding and for their facility with securitization
markets.\791\ The proposed removal of the mortgage servicing assets
deduction treatment would also make mortgage lending relationships
under these types of models more attractive, particularly for Ginnie
Mae securitizations where lenders must pool together multiple loans
themselves. Second, the proposed reduction in capital requirements in
the expanded risk-based approach, in principle, could have
competitiveness impacts in certain lending markets that may indirectly
affect small entities. However, the agencies designed this proposal and
the standardized approach proposal concurrently, in part to mitigate
potential competitiveness impacts on smaller banking organizations.
Several changes in proposed risk weights applicable to Category I and
II banking organizations through the expanded risk-based approach have
corresponding changes to proposed risk weights applicable to smaller
banking organizations (including small entities) through the
standardized approach proposal. Therefore, the agencies believe
indirect competitiveness effects on small entities generally would be
[[Page 15154]]
small. The agencies do not have the data necessary to estimate the
magnitudes of these additional effects on small entities, but believe
that these effects do not rise to a significant level for a substantial
number of small entities.
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\790\ See Michael Poprik, ``Loan Participations: Lessons Learned
During a Period of Economic Malaise,'' Federal Reserve Bank of
Richmond Community and Regional Supervision (2013), https://www.communitybankingconnections.org/articles/2013/q2/loan-participations.
\791\ See Richard Stanton, Johan Walden, & Nancy Wallace, ``The
Industrial Organization of the US Residential Mortgage Market,''
Annual Review of Financial Economics, no. 6 (2014), available at:
https://doi.org/10.1146/annurev-financial-110613-034324 and David
Benson, You Suk Kim, & Karen Pence, ``Bank Aggregator Exit, Nonbank
Entry, and Credit Supply in the Mortgage Industry,'' Working Paper
(2023), https://www.fdic.gov/system/files/2024-07/kim-paper.pdf.
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For the reasons outlined above, the FDIC certifies that the
proposed rule, if adopted, would not have a significant economic effect
on a substantial number of small entities.
C. Plain Language
Section 722 of the Gramm-Leach Bliley Act \792\ requires the
Federal banking agencies \793\ to use plain language in all proposed
and final rules published after January 1, 2000. The agencies have
sought to present the proposal in a simple and straightforward manner
and invite comments on the use of plain language and whether any part
of the proposal could be more clearly stated. For example:
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\792\ Public Law 106-102, section 722, 113 Stat. 1338, 1471
(1999).
\793\ The Federal banking agencies are the OCC, Board, and FDIC.
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Have the agencies presented the material in an organized
manner that meets your needs? If not, how could this material be better
organized?
Are the requirements in the notice of proposed rulemaking
clearly stated? If not, how could the proposed rule be more clearly
stated?
Does the proposed rule contain language that is not clear?
If so, which language requires clarification?
Would a different format (grouping and order of sections,
use of headings, paragraphing) make the proposed rule easier to
understand? If so, what changes to the format would make the proposed
rule easier to understand?
What else could the agencies do to make the proposed rule
easier to understand?
D. Riegle Community Development and Regulatory Improvement Act of 1994
Pursuant to section 302(a) of the Riegle Community Development and
Regulatory Improvement Act (RCDRIA),\794\ in determining the effective
date and administrative compliance requirements for new regulations
that impose additional reporting, disclosure, or other requirements on
insured depository institutions, each Federal banking agency must
consider, consistent with principles 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 insured
depository institutions 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.\795\
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\794\ 12 U.S.C. 4802(a).
\795\ 12 U.S.C. 4802.
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The agencies note that comment on these matters has been solicited
in other sections of this SUPPLEMENTARY INFORMATION section, and that
the requirements of RCDRIA will be considered as part of the overall
rulemaking process. In addition, the agencies also invite any other
comments that further will inform the agencies' consideration of
RCDRIA.
E. OCC Unfunded Mandates Reform Act of 1995 Determination
The OCC has analyzed the proposed rule under the factors in the
Unfunded Mandates Reform Act of 1995 (UMRA) (2 U.S.C. 1532). Under this
analysis, the OCC considered whether the proposed rule includes a
Federal mandate that may result in the expenditure by State, local, and
tribal governments, in the aggregate, or by the private sector, of $100
million or more in any one year, adjusted annually for inflation
(currently $187 million \796\).
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\796\ OCC staff estimate the UMRA inflation adjustment using the
change in the annual average of the U.S. GDP Implicit Price Deflator
between 1995 and 2024, which are the most recent annual data
available. According to Bureau of Economic Analysis data released on
March 27, 2025, the deflator was 66.939 in 1995 and 125.230 in 2024,
resulting in an inflation adjustment factor of 1.87 (125.230/66.939
= 1.87 rounded to the nearest hundredth, and $100 million x 1.87 =
$187 million).
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To estimate the compliance costs of the proposal, OCC staff
reviewed the new mandates that affect OCC-supervised banks, and then
considered costs that may arise from compliance with these mandates,
including the total hours needed per bank, on average, for systems
development, data acquisition, data aggregation and reporting,
calculation and verification, training, and risk management. Based on
internal discussions with OCC subject matter experts, OCC staff
estimate a one-time implementation cost of approximately $110
million.\797\ Thus, the OCC concludes that the expenditures imposed by
the rule will be less than $187 million. Accordingly, the UMRA does not
require that a written statement accompany this rule.
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\797\ These compliance cost estimates are subject to
considerable uncertainty. They should be interpreted as approximate,
order-of-magnitude estimates rather than precise measures of the
actual costs individual banks will incur.
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F. Executive Orders 12866, 13563 and 14192
Executive Order 12866 (Regulatory Planning and Review) \798\ and
Executive Order 13563 (Improving Regulation and Regulatory Review)
\799\ direct agencies to assess the costs and benefits of available
regulatory alternatives and, if regulation is necessary, to select
regulatory approaches that maximize net benefits. This proposed rule
was drafted and reviewed in accordance with Executive Order 12866 and
Executive Order 13563. Within OMB, the Office of Information and
Regulatory Affairs (OIRA) has determined that this rulemaking is `an
economically significant regulatory action' under section 3(f)(1) of
Executive Order 12866. Accordingly, the draft rule was submitted to
OIRA for review. As noted in other sections of the SUPPLEMENTARY
INFORMATION of this document, the agencies have assessed the costs and
benefits of this rulemaking and have made a reasoned determination that
the benefits of this rulemaking justify its costs. The proposal, if
finalized as proposed, is not expected to be an Executive Order 14192
regulatory action.
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\798\ E.O. 12866, 58 FR 51735 (Oct. 4, 1993).
\799\ E.O. 13563, 76 FR 3821 (Jan. 21, 2011).
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G. Providing Accountability Through Transparency Act of 2023
The Providing Accountability Through Transparency Act of 2023 (5
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, the bank regulatory agencies request comment on a
proposal to revise the risk-based capital requirements that apply to
the largest, most internationally active firms to substantially
simplify the framework, better align minimum requirements with risk,
improve the consistency of requirements across U.S. firms, consider
overlaps with the stress capital buffer requirement, and align
requirements with international standards while ensuring the framework
accounts for specific features of U.S. markets.
[[Page 15155]]
The proposal and such a summary can be found at https://www.regulations.gov by searching for Docket ID OCC-2026-0265 and
https://occ.gov/topics/laws-and-regulations/occ-regulations/proposed-issuances/index-proposed-issuances.html, https://www.federalreserve.gov/supervisionreg/reglisting.htm, and https://www.fdic.gov/federal-register-publications.
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 Category I [BANKING ORGANIZATION],
any Category II [BANKING ORGANIZATION], and any [BANKING ORGANIZATION]
that elects to use this subpart under Sec. __.10(b).
(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 (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.
Dependent on the cash flows generated by the real estate means, for
a real estate exposure, that the underwriting, at the time of
origination, considers 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.
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 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 broadly 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 broadly 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.
Investment management means asset management, wealth management and
private banking, including professional management of mutual funds and
institutional accounts, and professional portfolio management and
advisory services for individuals.
Investment services means asset servicing (which include custody,
fund services, securities lending, liquidity services, collateral
management, and other asset servicing; as well as recording keeping
services for 401K and employee benefit plans, but exclude funding or
guarantee products offered to such clients), issuer services (which
include corporate trust, shareowner services, depository receipts, and
other issuer services), and other investment services (which include
clearing and other investment services).
Noninterest expense for BI means other noninterest expense, based
on the consolidated financial statements of the
[[Page 15156]]
[BANKING ORGANIZATION], excluding expenses that relate to non-financial
services received by the [BANKING ORGANIZATION] and operational losses.
Noninterest expense for BI does not include salaries and employee
benefits, expenses of premises and fixed assets, goodwill impairment
losses, or amortization expense and impairment losses for other
intangible assets.
Non-lending treasury services means cash management, global
payments, and deposit services (and excludes any lending or card
activities).
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 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 risk).
Other real estate exposure means a real estate exposure that is not
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 the project, 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 those related to 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) An exposure that is primarily 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.
Regulatory commercial real estate exposure means a real estate
exposure that is not a regulatory residential 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;
(5) The property must be valued in accordance with Sec. __.5; and
(6) Involves a loan that has not been restructured or modified.
Regulatory residential real estate exposure means a real estate
exposure that is a first-lien residential mortgage exposure, that is
not an ADC exposure, a pre-sold construction loan, a statutory
[[Page 15157]]
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) Involves a loan, for which the [BANKING ORGANIZATION] 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, during underwriting of the loan;
(iv) Is secured by property that is valued in accordance with Sec.
__.5; and
(v) Involves a loan that has not been restructured or modified,
provided that a loan modified or restructured solely pursuant to the
U.S. Treasury's Home Affordable Mortgage Program is not modified or
restructured for purposes of this section.
(2) When a [BANKING ORGANIZATION] holds the first-lien and junior-
lien(s) 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 both
of the following criteria:
(1) Product criterion. The exposure is a revolving credit or line
of credit or a term loan or lease; and
(2) Aggregate limit. The sum of the notional amount of the exposure
and the notional amounts of all other retail exposures to the obligor
and to its affiliates does not exceed $1 million, as adjusted pursuant
to Sec. __.4.
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 (2) 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 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, as adjusted
pursuant to Sec. __.4, for the most recent fiscal year.
Subordinated exposure means an exposure that is a corporate
exposure, a bank exposure, or an exposure to a GSE that is subordinated
by its terms or separate intercreditor agreement to the general
creditors of the obligor, including an exposure to preferred stock that
is not an equity exposure.
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.
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 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. __.117;
(ii) A cleared transaction subject to Sec. __.116;
(iii) A default fund contribution subject to Sec. __.116;
(iv) A securitization exposure subject to Sec. Sec. __.130 through
__.134;
(v) An equity exposure (other than an equity 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
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.
[[Page 15158]]
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(3) Certain sovereign exposures. Notwithstanding paragraph (a)(2)
of this section, a [BANKING ORGANIZATION] may assign to a sovereign
exposure a risk weight that is lower than the applicable risk weight in
Table 1 to Sec. __.111 if:
(i) The exposure is denominated in the sovereign's currency;
(ii) The [BANKING ORGANIZATION] has at least an equivalent amount
of liabilities in that currency; and
(iii) The risk weight is not lower than the risk weight that the
home country supervisor allows an organization engaged in the business
of banking under its jurisdiction to assign to the same exposures to
the sovereign.
(4) Exposures to a non-OECD member sovereign with no CRC. Except as
provided in paragraphs (a)(3), (5) and (6) of this section, a [BANKING
ORGANIZATION] must assign a 100 percent risk weight to an exposure to a
sovereign if the sovereign does not have a CRC.
(5) Exposures to an OECD member sovereign with no CRC. Except as
provided in paragraph (a)(6) of this section, a [BANKING ORGANIZATION]
must assign a 0 percent risk weight to an exposure to a sovereign that
is a member of the OECD if the sovereign does not have a CRC.
(6) Sovereign default. A [BANKING ORGANIZATION] must assign a 150
percent risk weight to a sovereign exposure immediately upon
determining that an event of sovereign default has occurred, or if an
event of sovereign default has occurred during the previous five years.
(b) Specified supranational entities and multilateral development
banks (MDBs). A [BANKING ORGANIZATION] must assign a zero percent risk
weight to exposures to a specified supranational entity 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) A subordinated exposure.
(2) A [BANKING ORGANIZATION] must assign a 150 percent risk weight
to a subordinated exposure to a GSE, unless a different risk weight is
provided under paragraph (c)(3) of this section.
(3) A [BANKING ORGANIZATION] must assign a 20 percent risk weight
to a subordinated exposure to a Federal Home Loan Bank or the Federal
Agricultural Mortgage Corporation (Farmer Mac).
(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)(3) or (d)(4) of this section.
[[Page 15159]]
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(2) A [BANKING ORGANIZATION] must assign a 30 percent risk weight
to a Grade A bank exposure for which the obligor is:
(i) A qualifying community banking organization (as defined in 12
CFR 3.12, 12 CFR 217.12, or 12 CFR 324.12, as applicable) that is
subject to the community bank leverage ratio framework (as defined in
12 CFR 3.12, 12 CFR 217.12, or 12 CFR 324.12, as applicable); or
(ii) A depository institution, foreign bank, or credit union not
described in paragraph (d)(2)(i) of this section and whose most recent
capital ratios or net worth ratio, as applicable, meet or exceed the
following:
(A) For a depository institution that is a Category I, II, or III
banking organization, a common equity tier 1 capital ratio of 14
percent and a supplementary leverage ratio of 5 percent;
(B) For a depository institution not described in paragraph
(d)(2)(ii)(A) of this section, a common equity tier 1 capital ratio of
14 percent and a tier 1 leverage ratio of 5 percent;
(C) For a credit union, a net worth ratio of 9 percent; or
(D) For a foreign bank, a common equity tier 1 capital ratio of 14
percent and a leverage ratio of 5 percent, each under the capital
requirements imposed by the home country supervisor on that foreign
bank.
(3) Notwithstanding paragraphs (d)(1) and (2) 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.
(4) Notwithstanding paragraph (d)(1), (d)(2), or (d)(3) 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 a
subordinated exposure 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.
[[Page 15160]]
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[GRAPHIC] [TIFF OMITTED] TP27MR26.120
(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.
(2) Pre-sold construction loans. A [BANKING ORGANIZATION] must
assign a 50 percent risk weight to a pre-sold construction loan, 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.
(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.
(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.
[[Page 15161]]
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[GRAPHIC] [TIFF OMITTED] TP27MR26.122
(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 risk weight of the borrower is 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] TP27MR26.123
[GRAPHIC] [TIFF OMITTED] TP27MR26.124
(7) Other real estate exposures. A [BANKING ORGANIZATION] must
assign an other 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) Past due real estate exposures. Notwithstanding any other
provision of this subpart, a [BANKING ORGANIZATION] must assign a 150
percent risk weight to a real estate exposure that is 90 days past due
or on nonaccrual, unless the exposure is a
[[Page 15162]]
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.
(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 75 percent risk weight to a regulatory retail exposure that is not a
transactor exposure.
(ii) Transactor exposures. A [BANKING ORGANIZATION] must assign a
45 percent risk weight to a transactor exposure.
(2) Other retail exposures. A [BANKING ORGANIZATION] must assign a
100 percent risk weight to retail exposures that are not regulatory
retail exposures.
(h) Corporate exposures. A [BANKING ORGANIZATION] must assign a 100
percent risk weight to a corporate exposure unless the corporate
exposure receives a different risk weight under paragraphs (h)(1)
through (5) of this section.
(1) Unless the corporate exposure receives a different risk weight
under paragraphs (h)(2) through (5) of this section, a [BANKING
ORGANIZATION] may assign a 65 percent risk weight to a corporate
exposure to a company that is investment grade, if the exposure is not
a subordinated exposure. For the purposes of this paragraph (h)(1), a
[BANKING ORGANIZATION] may determine that a company is investment grade
only by relying on one or more internal credit risk rating systems that
meet the requirements in paragraphs (h)(1)(i) through (v) of this
section.
(i) The internal credit risk rating system must be used to inform
material business and risk management decisions of the [BANKING
ORGANIZATION], such as those related to accounting, regulatory
reporting, risk management and measurement, loan loss reserve
estimation, capital planning, loan pricing, or board decision making.
(ii) The internal credit risk rating system must define which
obligor rating grades resulting from that system are considered to be
investment grade, as that term is defined in Sec. __.2.
(iii) The internal credit risk rating system must:
(A) Assign accurate and timely obligor rating grades based on
clearly defined criteria; and
(B) Assign a rating grade for each obligor at least annually and
whenever the [BANKING ORGANIZATION] receives new material information
regarding the creditworthiness of the obligor.
(iv) The internal credit risk rating system does not solely rely on
third-party assessments of credit risk and incorporates quantitative
and qualitative factors relating to the historical and projected
patterns of payment behaviors of similar obligors or products,
financial situation and performance of each obligor, and any relevant
developments that affect the investment grade determination.
(v) At least annually, the [BANKING ORGANIZATION] must validate the
robustness, consistency, and reliability of the internal credit risk
rating system, using data from at least one full credit cycle, and
update the internal credit risk rating system to address any
deficiencies exposed as part of the validation. As part of the
validation required by this paragraph (h)(1)(v), the [BANKING
ORGANIZATION] must:
(A) Evaluate whether the performance of obligors identified by the
internal credit risk rating system as investment grade is consistent
with the definition of investment grade in Sec. __.2, including by
benchmarking the ratings resulting from the internal credit risk rating
system with external information relating to the creditworthiness of
obligors;
(B) Assess the reliability, accuracy, completeness, timeliness, and
appropriateness of the data sources and other information used as part
of the investment grade determinations;
(C) Incorporate available information, including information
regarding the performance of companies that have ceased operations or
that have been sold to a third party, that is reasonably expected to
support a robust evaluation of the internal credit risk rating system;
(D) Ensure the validation process is independent of the internal
credit risk rating system's development, implementation, and operation,
or subject the validation process to an independent review of its
adequacy and effectiveness;
(E) Incorporate default data covering at least the preceding five
years, or a longer period as necessary to reflect at least one period
of economic downturn conditions, provided that if the [BANKING
ORGANIZATION] has relevant and material reference data that span a
longer period of time, the [BANKING ORGANIZATION] must incorporate such
data in its validation; and
(F) Not place undue weight on data from periods of favorable or
benign economic conditions relative to periods of economic downturn
conditions.
(2) Unless the corporate exposure receives a different risk weight
under paragraphs (h)(3) through (5) of this section, a [BANKING
ORGANIZATION] must assign a 100 percent risk weight to 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.
(3) Unless the corporate exposure receives a different risk weight
under paragraphs (h)(4) through (5) of this section, a [BANKING
ORGANIZATION] must assign risk weights to certain project finance
exposures as follows:
(i) A [BANKING ORGANIZATION] must assign a 100 percent risk weight
to a project finance operational phase exposure, and
(ii) A [BANKING ORGANIZATION] must assign a 130 percent risk weight
to a project finance exposure that is not a project finance operational
phase exposure.
(4) Unless the corporate exposure receives a different risk weight
under paragraph (h)(5) of this section, 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. __.116(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.
__.116(b)(3)(i)(B); and
(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. __.116(c)(3)(i).
(5) A [BANKING ORGANIZATION] must assign a 150 percent risk weight
to a corporate exposure that is a subordinated exposure or an exposure
to a covered debt instrument.
(i) Past due exposures. Notwithstanding any other provision of this
subpart, a [BANKING ORGANIZATION] must assign a 150 percent risk weight
to any exposure that is not a sovereign exposure or a real estate
exposure and that is 90 days past due or on nonaccrual, provided that:
[[Page 15163]]
(1) A [BANKING ORGANIZATION] may assign a risk weight to the
guaranteed portion of a past due exposure based on the risk weight that
applies under Sec. __.120 if the guarantee or credit derivative meets
the requirements of that section; and
(2) A [BANKING ORGANIZATION] may assign a risk weight to the
collateralized portion of a past due exposure or the protected portion
of a past due exposure covered by a prepaid credit protection
arrangement based on the risk weight that applies under Sec. __.121 if
the collateral or prepaid credit protection arrangement meets the
requirements of that section.
(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:
(i) MSAs; and
(ii) The portion of DTAs arising from temporary differences that
the [BANKING ORGANIZATION] could not realize through net operating loss
carrybacks to the extent such DTAs are not deducted from common equity
tier 1 capital pursuant to Sec. __.22(d).
(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 calculate the exposure
amount by multiplying the committed but undrawn amount of the
commitment 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 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 that is a retail
exposure does not have an express contractual maximum amount that can
be drawn, the committed but undrawn amount of the commitment is equal
to the highest total drawn amount over the period since the commitment
was created or the prior 24 months, whichever period is shorter, 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 reflect in expanded
total risk-weighted assets either:
(i) The exposure amount under this section 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]; or
(ii) The exposure for counterparty credit risk according to
Sec. Sec. __.113 through __.115.
(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 cancelable 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 the following off-balance-sheet items and
[[Page 15164]]
other similar transactions, regardless of whether a lower CCF would
otherwise apply under paragraphs (b)(1) through (3) of this section:
(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 Counterparty Credit Risk
(a) General. (1) To determine the exposure amount for transactions
with counterparty credit risk, a [BANKING ORGANIZATION]:
(i) Must use the standardized approach for counterparty credit risk
(SA-CCR) in Sec. __.114 for a derivative contract or netting set that
only includes derivative contracts;
(ii) May use SA-CCR in Sec. __.114 for a netting set of
transactions that are not cleared transactions and that are subject to
a qualifying cross-product master netting agreement that includes one
or more derivative contracts and one or more repo-style transactions,
subject to paragraph (b) of this section; and
(iii) May use the collateral haircut approach in Sec. __.115 for a
repo-style transaction, eligible margin loan, or a netting set of repo-
style transactions or eligible margin loans.
(b) Qualifying cross-product master netting agreements. (1) For
purposes of determining the exposure amount for a netting set of
transactions subject to a qualifying cross-product master netting
agreement under Sec. __.114, a [BANKING ORGANIZATION] may elect to
treat any repo-style transaction that is not a cleared transaction
subject to the qualifying cross-product master netting agreement as a
derivative contract.
(2) The exposure amount of a set of transactions subject to a
qualifying cross-product master netting agreement for purposes of
(b)(1), , must be calculated as follows:
Exposure AmountNSCP = (1-MRNSCP) * (Exposure Amountrepo-style
transactions + Exposure Amountderivatives) + MRNSCP * Extended SA--CCR
Exposure Amount
Where:
(i) Exposure Amountrepo-style transactions is the exposure amount
for repo-style transactions in the netting set that is subject to a
qualifying cross-product master netting agreement, calculated using
the collateral haircut approach, under Sec. __.115;
(ii) Exposure Amountderivatives is the exposure amount for
derivatives in the netting set that is subject to a qualifying
cross-product master netting agreement, calculated using the
standardized approach for counterparty credit risk, under Sec.
__.114;
(iii) Extended SA--CCR Exposure Amount is the exposure amount for
both repo-style transactions and derivatives that are in the netting
set that is subject to a qualifying cross-product master netting
agreement, calculated using the standardized approach for
counterparty credit risk, under Sec. __.114; and
(iv) MRNSCP is the Maturity Ratio for a given netting set that is
subject to a qualifying cross-product master netting agreement,
calculated as follows:
[GRAPHIC] [TIFF OMITTED] TP27MR26.125
Where:
(A) [Sigma]NAWM of the repo-style transactioni is the
notional average weighted maturity of all i repo-style transactions
subject to the qualifying cross-product master netting agreement,
subject to a minimum maturity of 10 business days and a maximum
maturity of one year for purposes of this calculation.
(B) [Sigma]NAWM of the derivative transactioni is the
notional average weighted maturity of all i derivative transactions
subject to the qualifying cross-product master netting agreement
subject to a minimum maturity of 10 business days and a maximum
maturity of one year for purposes of this calculation.
Sec. __.114 Derivative Contracts: Standardized Approach
(a)(1) 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 paragraph (a) of this section, 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. A [BANKING ORGANIZATION] may determine the exposure
amount for a repo-style transaction using the SA-CCR under this
section, as provided in Sec. __.113(b), subject to paragraph (a)(2) of
this section.
(2) Exposure amount for repo-style transactions. If a [BANKING
ORGANIZATION] is using the SA-CCR for a repo-style transaction as
described in Sec. __.113(b), the [BANKING ORGANIZATION] must make the
adjustments described in paragraphs (a)(2)(i) through (iii) of this
section.
(i) For purposes of this section, the [BANKING ORGANIZATION] must:
(A) Treat a repo-style transaction that has multiple underlying
instruments as separate repo-style transactions for each distinct
underlying instrument;
(B) Treat a repo-style transaction with a debt instrument as the
underlying instrument as either a credit derivative that references the
underlying debt instrument or an interest rate derivative that
references the interest rate of the underlying debt instrument, based
on the primary risk factor of the repo-style transaction;
(C) Treat a repo-style transaction with an equity instrument as the
underlying instrument as an equity derivative that references the
underlying equity instrument;
(D) Not apply paragraph (d) of this section to a repo-style
transaction with
[[Page 15165]]
an equity instrument as the underlying instrument; and
(E) Treat a repo-style transaction as a client-facing derivative
transaction where the [BANKING ORGANIZATION] is either acting as a
financial intermediary and enters into an offsetting transaction with a
qualifying central counterparty (QCCP) or where the [BANKING
ORGANIZATION] provides a guarantee on the performance of a client on a
transaction between the client and a QCCP.
(ii) For purposes of the supervisory delta under paragraph (i)(3)
of this section, a [BANKING ORGANIZATION] must use a supervisory delta
of 1 for a repurchase transaction or a securities lending transaction,
and must use a supervisory delta of -1 for a reverse repurchase
transaction or a securities borrowing transaction;
(iii) For purposes of the maturity factor under paragraph (i)(4) of
this section, MPOR cannot be less than five business days plus the
periodicity of re-margining expressed in business days minus one
business day.
(b) Definitions. For purposes of this section, the following
definitions apply:
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.
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.
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 (i) through (v) of this
definition.
(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 (i) through (v) of this definition.
(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
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. Sec. __.140 through __.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. Sec. __.140
through __.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. Sec. __.140
through __.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
[[Page 15166]]
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 or a client-facing
derivative transaction and 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] TP27MR26.126
(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 (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] TP27MR26.127
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
[[Page 15167]]
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:
[GRAPHIC] [TIFF OMITTED] TP27MR26.128
(ii) Formula 2 is as follows:
[GRAPHIC] [TIFF OMITTED] TP27MR26.129
Where in paragraphs (h)(1)(i) and (ii) of this section:
[GRAPHIC] [TIFF OMITTED] TP27MR26.130
(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] TP27MR26.327
Where:
k is each reference entity within the hedging set.
K is the number of reference entities within the hedging set.
[[Page 15168]]
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.
[rho]k equals the applicable supervisory correlation
factor, as provided in Table 2 to Sec. __.114.
(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] TP27MR26.328
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.
[rho] equals the applicable supervisory correlation factor, as
provided in Table 2 to Sec. __.114.
(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) of this section 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 Sec. __.114.
(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] TP27MR26.131
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
[[Page 15169]]
formulas in Table 1 to Sec. __.114, as applicable:
[GRAPHIC] [TIFF OMITTED] TP27MR26.132
(B) As used in the formulas in Table 1 Sec. __.114:
(1) [phis] is the standard normal cumulative distribution function;
(2) P 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 [lambda] 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. [lambda]
equals zero for all derivative contracts except those option contracts
where it is possible for P to have negative values. For option
contracts where it is possible for P to have negative values, to
determine the value of [lambda] for a given risk factor or instrument,
a [BANKING ORGANIZATION] must find the lowest value, L, of P 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
P and K of all interest rate option contracts in a given currency, that
the [BANKING ORGANIZATION] has with all counterparties. Then, [lambda]
is set as follows: when the underlying risk factor is an interest rate,
[lambda] = max{-L + 0.1%,0{time} ; otherwise, [lambda] = max{-
1.1[middot]L,0{time} ; and
(6) [sigma] equals the supervisory option volatility, as provided
in Table 2 to Sec. __.114.
(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 [lambda] 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
[lambda] 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 [lambda]
in accordance with this paragraph for an option contract must assign
the same value for [lambda] 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] TP27MR26.133
(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;\1\
(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 by the [BANKING
ORGANIZATION] to purchase credit protection and is designated with a
negative sign if the collateralized debt obligation tranche was used by
the [BANKING ORGANIZATION] to sell credit protection.
(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:
[[Page 15170]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.134
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 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] TP27MR26.135
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] TP27MR26.136
[[Page 15171]]
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
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.
[[Page 15172]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.137
Sec. __.115 Collateral Haircut Approach for Repo-Style Transactions
and Eligible Margin Loans
(a) Collateral haircut approach--Exposure amount for eligible
margin loans and repo-style transactions. 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 eligible margin loans or repo-style 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 (b) of this section.
(b) Exposure amount calculation. For purposes of the collateral
haircut approach, a [BANKING ORGANIZATION] must determine the exposure
amount for an eligible margin loan, repo-style transaction, or netting
set of eligible margin loans or repo-style transactions according to
the following formula:
[GRAPHIC] [TIFF OMITTED] TP27MR26.138
Where:
(1) E* is the exposure amount of the eligible margin loan, repo-
style transaction, or netting set after credit risk mitigation;
(2) 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;
(3) 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;
(4) netexposure = [verbar][Sigma]sEsHs[verbar];
(5) grossexposure = [Sigma]sEs[verbar]Hs[verbar];
(6) 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;
[[Page 15173]]
(7) Hs is the haircut appropriate to Es as described in Table 1 to
Sec. __.115, 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;
(8) 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 eligible margin
loan, repo-style transaction, or 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 eligible margin loan, repo-style transaction, or netting set
are not included in the count or gold, with any amount of gold given
a value of one;
(9) Efx is the absolute value of the net position in each currency
fx different from the settlement currency;
(10) Hfx is the haircut appropriate for currency mismatch of
currency fx.
(c) Market price volatility and currency mismatch haircuts. (1) A
[BANKING ORGANIZATION] must use the haircuts for market price
volatility (Hs) in Table 1 to Sec. __.115, as adjusted in certain
circumstances as provided in paragraphs (c)(3) through (5) of this
section.
[[Page 15174]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.139
(2) 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 (b)(3) and (4) of
this section.
[[Page 15175]]
(3) For repo-style transactions, a [BANKING ORGANIZATION] may
multiply the haircuts provided in paragraphs (b)(1) and (2) of this
section by the square root of \1/2\ (which equals 0.707107).
(4) A [BANKING ORGANIZATION] must adjust the haircuts provided in
paragraphs (c)(1) and (2) of this section upward on the basis of a
holding period longer than ten business days for 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)(1) and (2) 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. __.116. If a netting set contains one or more trades
involving illiquid collateral, a [BANKING ORGANIZATION] must adjust the
haircuts provided in paragraphs (c)(1) and (2) 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)(1) and (2) 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] TP27MR26.140
Where:
(i) 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;
(ii) Hs equals the market price volatility haircut provided in Table
1 to Sec. __.115 or to the foreign exchange rate volatility haircut
provided in paragraph (c)(2) of this section; and
(iii) Ts equals 10 business days for eligible margin loans or 5
business days for repo-style transactions.
(5) 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).
Sec. __.116 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.
(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. __.114,
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
Sec. __.115, 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) Two 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) Four 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
[[Page 15176]]
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. __.114, 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. __.115, 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 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] TP27MR26.141
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
DFpref CCPCM 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:
[[Page 15177]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.142
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. __.114 (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. __.114(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.
__.115, 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. __.115, 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. __.115 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 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. __.115 for repo-style transactions and
to Sec. __.114 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. __.117 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).
(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)
[[Page 15178]]
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. __.117.
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(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 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. 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
[[Page 15179]]
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:
Pm = E x (t-0.25)/(T-0.25),
where:
(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
(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:
(i) 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
(ii) 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:
Pr = Pm x 0.60,
where:
(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:
Pc = Pr x (1- HFX),
where:
(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:
[[Page 15180]]
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Sec. __.121 Collateralized Transactions and Prepaid Credit Protection
Arrangements
(a) Financial Collateral. To recognize the risk-mitigating effects
of financial collateral, a [BANKING ORGANIZATION] may use the simple
approach in paragraph (b) of this section for any exposure for which
the [BANKING ORGANIZATION] does not use Sec. Sec. __.113 through
__.115 to calculate the exposure amount for counterparty credit risk. A
[BANKING ORGANIZATION] must use the same approach to recognize the
risk-mitigating effects of financial collateral for similar exposures
or transactions.
(b) The simple approach--(1) General requirements. To qualify for
the simple approach under this paragraph (b), the financial collateral
must meet the following requirements:
(i) The collateral must be revalued at least every six months;
(ii) The legal mechanism by which financial collateral is pledged
or transferred must be enforceable in the relevant jurisdictions and
ensure that the [BANKING ORGANIZATION] has the contractual right, as
applicable to the characteristics of the financial collateral and
exposure, to liquidate or take legal possession of the financial
collateral, setoff amounts owed to the obligor against amounts owed to
the [BANKING ORGANIZATION] and close out any transaction giving rise to
the secured exposure, in a timely manner, in the event of the default,
insolvency or bankruptcy (or one or more otherwise-defined credit
events set out in the transaction documentation) of the obligor;
(iii) If the financial collateral has been pledged or transferred
by a party other than the obligor of the secured exposure, the
bankruptcy or insolvency of the pledgor or transferor must not
terminate or impair the enforceability of the legal mechanism that
establishes the [BANKING ORGANIZATION]'s rights in respect of the
financial collateral; and
(iv) The [BANKING ORGANIZATION] must be able to reasonably
demonstrate the ability to protect and enforce its rights in respect of
any financial collateral.
(2) Risk weight substitution. (i) A [BANKING ORGANIZATION] may
apply a risk weight to the portion of an exposure that is secured by
financial collateral that meets the requirements of paragraph (b) of
this section, up to the protection amount of the financial collateral
as adjusted by paragraph (d) 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 portion of the exposure secured by
financial collateral may not be less than 20 percent.
(ii) A [BANKING ORGANIZATION] must apply a risk weight to the
amount of an exposure in excess of the protection amount of financial
collateral securing 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 up to the
protection amount of the financial collateral 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) Eligible prepaid credit protection arrangements. (1) Scope. A
[BANKING ORGANIZATION] may recognize the credit risk mitigation
benefits of an eligible prepaid credit protection arrangement as
provided under this paragraph.
(2) Application. This paragraph applies to exposures, including
securitization exposures, for which:
(i) Credit risk is fully covered by an eligible prepaid credit
protection arrangement; 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 prepaid credit protection
arrangement.
(3) Tranching of credit risk. 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) Multiple eligible prepaid credit protection arrangements. If
multiple eligible prepaid credit protection arrangements cover a single
exposure, a [BANKING ORGANIZATION] may treat the hedged exposure as
multiple separate exposures each covered by a single eligible credit
protection arrangement and may calculate a separate risk-weighted asset
amount for each separate exposure as described in paragraph (c)(6) of
this section.
(5) Single eligible credit protection arrangements. If a single
eligible credit protection arrangement covers multiple hedged
exposures, a [BANKING ORGANIZATION] must treat each hedged exposure as
covered by a separate eligible credit protection arrangement and must
calculate a separate risk-weighted asset amount for each exposure as
described in paragraph (c)(6) of this section.
(6) Prepaid credit protection arrangements--The substitution
approach. (i) Full coverage. If an eligible prepaid credit protection
arrangement meets the conditions in paragraphs (c)(1) through (5) of
this section and the protection amount (P) of the prepaid credit
protection arrangement is greater than or equal to the exposure amount
of the reference exposure, a [BANKING ORGANIZATION] may assign a zero
percent risk weight to the reference exposure.
(ii) Partial coverage. If an eligible prepaid credit protection
arrangement meets the conditions in paragraphs (c)(1) through (5) of
this section and the protection amount (P) of the prepaid credit
protection arrangement is less than the exposure amount of the
reference exposure, the [BANKING ORGANIZATION] must treat the reference
exposure as two separate exposures (protected and unprotected) in order
to recognize the credit risk mitigation benefit of the prepaid credit
protection arrangement.
(A) The [BANKING ORGANIZATION] may apply a risk-weight of zero
percent for the protected exposure.
(B) 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
reference exposure.
[[Page 15181]]
(C) The treatment provided in this section is applicable when the
credit risk of a reference 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 prepaid credit protection arrangement under
paragraph (d) of this section.
(d) Required adjustments--(1) Maturity mismatch adjustment. (i) A
[BANKING ORGANIZATION] that recognizes the credit risk mitigation
benefits of financial collateral under paragraph (b) of this section or
of an eligible prepaid credit protection arrangement under paragraph
(c) of this section must adjust the amount of credit risk mitigation
recognized to reflect any maturity mismatch.
(ii) A maturity mismatch occurs when:
(A) The residual maturity of the legal mechanism by which financial
collateral is pledged is less than that of the secured exposure(s); or
(B) The residual maturity of an eligible prepaid credit protection
arrangement is less than that of the reference exposure.
(iii) The residual maturity of a secured exposure under paragraph
(b) of this section or a reference exposure under paragraph (c) of this
section is the longest possible remaining time before the obligated
party of the secured exposure or reference exposure is scheduled to
fulfil its obligation on the exposure. For purposes of this paragraph
(d)(1)(iii):
(A) For an eligible prepaid credit protection arrangement, if the
terms of the arrangement include embedded options that may reduce its
term, the [BANKING ORGANIZATION] (protection purchaser) must adjust the
residual maturity. If a call is at the discretion of the protection
provider, the residual maturity 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 contain a
positive incentive for the [BANKING ORGANIZATION] to cancel the
arrangement before contractual maturity, the remaining time to the
first call date is the residual maturity.
(B) For financial collateral that is not cash on deposit at the
[BANKING ORGANIZATION], but including cash held for the [BANKING
ORGANIZATION] by a third-party custodian or trustee, the residual
maturity of any amount of such financial collateral is the earliest
date on which the [BANKING ORGANIZATION]'s rights in respect of such
amount of financial collateral may be terminated without the pledgor
being subject to a contemporaneous requirement to pledge additional
financial collateral. For financial collateral that is cash on deposit
at the [BANKING ORGANIZATION], the residual maturity of any amount of
such cash collateral is the earliest date on which a depositor may
withdraw such amount, notwithstanding any notice requirements or early
withdrawal fees or penalties.
(iv) The credit risk mitigation benefits of financial collateral or
an eligible prepaid credit protection arrangement with a maturity
mismatch may be recognized only if the original maturity of the legal
mechanism by which financial collateral is pledged or the eligible
prepaid credit protection arrangement is greater than or equal to one
year and its residual maturity is greater than three months.
(v) When a maturity mismatch exists, the [BANKING ORGANIZATION]
must apply the following adjustment to reduce the protection amount:
Pm = E x (t-0.25)/(T-0.25),
where:
(A) Pm = fair value of the financial collateral or effective
notional amount of the eligible prepaid credit protection
arrangement, adjusted for maturity mismatch;
(B) E = fair value of the financial collateral or effective notional
amount of the eligible prepaid credit protection arrangement;
(C) t = the lesser of T or the residual maturity of the arrangement,
expressed in years; and
(D) T = the lesser of five or the residual maturity of the secured
exposure or reference exposure, expressed in years.
(2) Currency mismatch adjustment. (i) If a [BANKING ORGANIZATION]
recognizes the credit risk mitigation benefits of financial collateral
under paragraph (b) of this section or of an eligible prepaid credit
protection arrangement under paragraph (c) of this section that is
denominated in a currency different from that in which the secured or
reference exposure is denominated, the [BANKING ORGANIZATION] must
apply the following formula to the fair value of the financial
collateral or the effective notional amount of the eligible prepaid
credit protection arrangement:
Pc = Pr x (1- HFX),
where:
(A) Pc = fair value of the financial collateral or the effective
notional amount of the eligible prepaid credit protection
arrangement, adjusted for currency mismatch (and maturity mismatch,
if applicable);
(B) Pr = fair value of the financial collateral or the effective
notional amount of the eligible prepaid credit protection
arrangement (adjusted for maturity mismatch, if applicable); and
(C) HFX = haircut appropriate for the currency mismatch between the
financial collateral and the secured exposure or the eligible
prepaid credit protection arrangement and the reference exposure, as
determined under paragraphs (d)(2)(ii) through (iii) of this
section.
(ii) Subject to paragraph (d)(2)(iii) of this section, a [BANKING
ORGANIZATION] must set HFX equal to eight percent.
(iii) A [BANKING ORGANIZATION] must increase HFX as
determined under paragraph (d)(2)(ii) of this section if the [BANKING
ORGANIZATION] revalues the financial collateral or eligible prepaid
credit protection arrangement less frequently than once every 10
business days using the following formula:
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[[Page 15182]]
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 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 securitization 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 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;
(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; or
(iv) A prepaid credit protection arrangement that meets all
criteria as set forth in the definition of eligible prepaid credit
protection arrangement in Sec. __.2, except for the criteria in
paragraph (3) of that definition.
(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;
(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
[[Page 15183]]
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 accordance with Sec. Sec. __.113 through
__.115 or Sec. __.112, 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. __.116.
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. 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 (such as when a [BANKING
ORGANIZATION] provides a program-wide credit enhancement and multiple
pool-specific liquidity facilities to an ABCP program), the [BANKING
ORGANIZATION] is not required to hold duplicative risk-based capital
against the overlapping position. Instead, the [BANKING ORGANIZATION]
may apply to the overlapping position the applicable risk-based capital
treatment that results in the highest risk-based capital requirement.
(2) If a [BANKING ORGANIZATION] has two or more securitization
exposures that partially overlap with each other, the [BANKING
ORGANIZATION] may treat the exposures as overlapping and apply the
treatment under paragraph (d)(1). For purposes of such a treatment
under this paragraph (d)(2), the [BANKING ORGANIZATION] must include in
expanded total risk-weighted assets the risk-weighted asset amount for
a hypothetical securitization exposure that would fully overlap with
all of the partially overlapping exposures.
(3) If a [BANKING ORGANIZATION] has a securitization exposure under
this subpart that is an overlapping exposure 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
securitization exposure the applicable risk-based 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
[[Page 15184]]
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 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-or-later-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-or-later-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 purchased protection in the form of an 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. Sec. __.113 through __.114.
(j) Guarantees, credit derivatives other than nth-to-default credit
derivatives, and prepaid credit protection arrangements--(1) Protection
provider. For a guarantee, credit derivative (other than an nth-to-
default credit derivative), or prepaid credit protection arrangement
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, credit
derivative, or prepaid credit protection arrangement under paragraph
(a) of this section as if it held the portion of the securitization
exposure covered by the guarantee, credit derivative, or prepaid credit
protection arrangement.
(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. Sec. __.113 through __.114.
(ii) If a [BANKING ORGANIZATION] cannot, or chooses not to,
recognize protection purchased in the form of a credit derivative as a
credit risk mitigant under Sec. __.134, the [BANKING ORGANIZATION]
must determine the exposure amount of the credit derivative under Sec.
__.114.
(A) If the [BANKING ORGANIZATION] purchases credit protection from
a counterparty the activities of which are limited to those appropriate
for the specific purpose of
[[Page 15185]]
holding the underlying exposures of a securitization, 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 the activities of which are limited to those appropriate
for the specific purpose of holding the underlying exposures of a
securitization, 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, calculated without reference
to, or use of, the risk weight under Sec. __.141(b)(3)(iii), 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 nonrefundable purchase price discount for the NPL
securitization is greater than or equal to 50 percent of the
outstanding balance of the pool of exposures at inception of the
transaction, 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 assigned to a securitization
exposure, or portion of a securitization exposure, is calculated
according to the following formula:
[GRAPHIC] [TIFF OMITTED] TP27MR26.146
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 current
dollar amount of underlying exposures that are subordinated to the
exposure of the [BANKING ORGANIZATION] to the current dollar amount
of the underlying exposures, as adjusted in accordance with
paragraph (a)(6) of this section;
(3) D (detachment point) equals the greater of zero and the sum of
parameter A and the ratio, expressed as a decimal value between zero
and one, of the current dollar amount of the securitization
exposures that are pari passu with the exposure (that is, have equal
seniority with respect to credit risk) to the current dollar amount
of the underlying exposures, 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] TP27MR26.147
Where:
(i) a equals
[GRAPHIC] [TIFF OMITTED] TP27MR26.148
(as kA is defined in this paragraph (a)), where [rho] equals 1.5 for
a resecuritization exposure and 0.5 for all other securitization
exposures;
(ii) m equals D-KA (as D and KA are defined in paragraph (a) of
this section);
(iii) l equals max(A-KA, 0) (as A and KA are defined in
paragraph (a) of this section); and
(iv) e equals the base of the natural logarithm.
(6) A [BANKING ORGANIZATION] must include in the calculation of and
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 and . If the securitization exposure includes a
nonrefundable purchase price discount, the nonrefundable purchase price
discount must be included in the numerator and denominator of and 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 dollar amounts of any underlying
exposures of the securitization that are not securitization
exposures and that meet any of the criteria in paragraphs (b)(1)(i)
through (vii) 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
[[Page 15186]]
based on changes in the creditworthiness of the borrower; or
(vi) Is in default; and
(vii) Notwithstanding paragraphs (1)(i) through (vi) of this
paragraph, an exposure that is directly and unconditionally
guaranteed by the U.S. Government, its central bank, or a U.S.
Government agency may be excluded from the calculation of W up to
the amount of the guarantee; and
(2) KG equals the weighted average (with unpaid principal used as
the weight for each credit exposure and fair value used for each
equity 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 this paragraph (b)(2). For purposes of KG, the determination of
the capital requirement associated with an underlying exposure that
is an equity exposure cannot use the risk weight under Sec.
__.141(b)(3)(iii). 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.
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. Sec. __.120 or
__.121 for any hedged securitization exposure. In the context of a
synthetic securitization, when a credit risk mitigant described in
Sec. __.130(b)(1)(ii) through (iv) 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) Calculation of risk-weighted asset amounts. 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) Separate accounts. 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. 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 Simple Risk-Weight Approach (SRWA)
(a) General. A [BANKING ORGANIZATION]'s total risk-weighted 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 or the
effective portion and ineffective portion of a hedge pair (as defined
in paragraph (c) of this section) by the lowest applicable risk weight
in this paragraph (b).
(1) Zero percent risk weight equity exposures. An equity exposure
to a
[[Page 15187]]
sovereign, a specified supranational entity, 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,
excluding equity exposures to an unconsolidated small business
investment company and equity exposures held through a consolidated
small business investment company described in section 302 of the Small
Business Investment Act.
(ii) The effective portion of a hedge pair; and
(iii) Equity exposures, excluding significant investments in the
capital of an unconsolidated institution in the form of common stock
and exposures to an investment firm that would meet the definition of a
traditional securitization were it not for the [AGENCY]'s application
of paragraph (8) of that definition in Sec. __.2 and has greater than
immaterial leverage, to the extent that the aggregate adjusted carrying
value of the exposures does not exceed 10 percent of the [BANKING
ORGANIZATION]'s total capital.
(A) To compute the aggregate adjusted carrying value of a [BANKING
ORGANIZATION]'s equity exposures for purposes of this section, the
[BANKING ORGANIZATION] may exclude equity exposures described in
(b)(1), (2), (3)(i), (3)(ii), and (3)(iii) of this section, the equity
exposure in a hedge pair with the smaller adjusted carrying value, and
a proportion of each equity exposure to an investment fund equal to the
proportion of the assets of the investment fund that are not equity
exposures or that meet the criterion of paragraph (b)(3)(i) of this
section. If a [BANKING ORGANIZATION] does not know the actual holdings
of the investment fund, the [BANKING ORGANIZATION] may calculate the
proportion of the assets of the fund that are not equity exposures
based on the terms of the prospectus, partnership agreement, or similar
contract that defines the fund's permissible investments. If the sum of
the investment limits for all exposure classes within the fund exceeds
100 percent, the [BANKING ORGANIZATION] must assume for purposes of
this section that the investment fund invests to the maximum extent
possible in equity exposures.
(B) When determining which of a [BANKING ORGANIZATION]'s equity
exposures qualifies for a 100 percent risk weight under this section, a
[BANKING ORGANIZATION] first must include equity exposures to
unconsolidated small business investment companies or held through
consolidated small business investment companies described in section
302 of the Small Business Investment Act, then must include publicly
traded equity exposures (including those held indirectly through
investment funds), and then must include non-publicly traded equity
exposures (including those held indirectly through investment funds).
(4) 250 percent risk weight. 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) must
be assigned a 250 percent risk weight.
(5) 300 percent risk weight. An equity exposure that is publicly
traded (other than an equity exposure described in paragraph (b)(7) of
this section and including the ineffective portion of a hedge pair)
must be assigned a 300 percent risk weight.
(6) 400 percent risk weight. An equity exposure that is not
publicly traded and is not described in paragraph (b)(7) of this
section must be assigned a 400 percent risk weight.
(7) 600 percent risk weight. An equity exposure to an investment
firm must be assigned a 600 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.
(c) Hedge transactions--
(1) Hedge pair. A hedge pair comprises two equity exposures that
form an effective hedge so long as each equity exposure is publicly
traded or has a return that is primarily based on a publicly traded
equity exposure.
(2) Effective hedge. Two equity exposures form an effective hedge
if the exposures either have the same remaining maturity or each has a
remaining maturity of at least three months; the hedge relationship is
formally documented in a prospective manner (that is, before the
[BANKING ORGANIZATION] acquires at least one of the equity exposures);
the documentation specifies the measure of effectiveness (E) the
[BANKING ORGANIZATION] will use for the hedge relationship throughout
the life of the transaction; and the hedge relationship has an E
greater than or equal to 0.8. A [BANKING ORGANIZATION] must measure E
at least quarterly and must use one of three alternative measures of E
as set forth in this paragraph (c)(2).
(i) Under the dollar-offset method of measuring effectiveness, the
[BANKING ORGANIZATION] must determine the ratio of value change (RVC).
The RVC is the ratio of the cumulative sum of the changes in value of
one equity exposure to the cumulative sum of the changes in the value
of the other equity exposure. If RVC is positive, the hedge is not
effective and E equals 0. If RVC is negative and greater than or equal
to -1 (that is, between zero and -1), then E equals the absolute value
of RVC. If RVC is negative and less than -1, then E equals 2 plus RVC.
(ii) Under the variability-reduction method of measuring
effectiveness:
[GRAPHIC] [TIFF OMITTED] TP27MR26.149
Where:
(A) Xt = At - Bt
(B) At = the value at time t of one exposure in a hedge pair;
(C) Bt = the value at time t of the other exposure in a hedge pair;
(iii) Under the regression method of measuring effectiveness, E
equals the coefficient of determination of a regression in which the
change in value of one exposure in a hedge pair is the dependent
variable and the change in value of the other exposure in a hedge
pair is the independent variable. However, if the estimated
regression coefficient is positive, then E equals zero.
(3) The effective portion of a hedge pair is E multiplied by the
greater of the adjusted carrying values of the equity exposures forming
a hedge pair.
(4) The ineffective portion of a hedge pair is (1-E) multiplied by
the greater of the adjusted carrying values of the equity exposures
forming a hedge pair.
Sec. __.142 Equity Exposures to Investment Funds
(a) Available approaches.
(1) Unless the exposure meets the requirements for a community
development equity exposure in Sec. __.141(b)(3)(i), a [BANKING
ORGANIZATION] must determine the risk-weighted asset amount of an
equity exposure to an investment fund under the full look-through
approach
[[Page 15188]]
described in paragraph (b) of this section, the simple look-through
approach described in paragraph (c), or the alterative modified look-
through approach described in paragraph (d) of this section, provided,
however, that the minimum risk weight that may be assigned to an equity
exposure under this section is 20 percent.
(2) The risk-weighted asset amount of an equity exposure to an
investment fund that meets the requirements for a community development
equity exposure in Sec. __.141(b)(3)(i) is its adjusted carrying
value.
(3) If an equity exposure to an investment fund is part of a hedge
pair and the [BANKING ORGANIZATION] does not use the full look-through
approach, the [BANKING ORGANIZATION] must use the ineffective portion
of the hedge pair as determined under Sec. __.141(b)(4)(i) as the
adjusted carrying value for the equity exposure to the investment fund.
The risk-weighted asset amount of the effective portion of the hedge
pair is equal to its adjusted carrying value.
(b) Full look-through approach. A [BANKING ORGANIZATION] that is
able to calculate a risk-weighted asset amount for its proportional
ownership share of each exposure held by the investment fund (as
calculated under this subpart E of this part as if the proportional
ownership share of each exposure were held directly by the [BANKING
ORGANIZATION]) may set the risk-weighted asset amount of the [BANKING
ORGANIZATION]'s exposure to the fund equal to the product of:
(1) The aggregate risk-weighted asset amounts of the exposures held
by the fund as if they were held directly by the [BANKING
ORGANIZATION]; and
(2) The [BANKING ORGANIZATION]'s proportional ownership share of
the fund.
(c) Simple modified look-through approach. Under the simple
modified look-through approach, the risk-weighted asset amount for a
[BANKING ORGANIZATION]'s equity exposure to an investment fund equals
the adjusted carrying value of the equity exposure multiplied by the
highest risk weight that applies to any exposure the fund is permitted
to hold under its prospectus, partnership agreement, or similar
contract that defines the fund's permissible investments (excluding
derivative contracts that are used for hedging rather than speculative
purposes and that do not constitute a material portion of the fund's
exposures).
(d) Alternative modified look-through approach. Under the
alternative modified look-through approach, a [BANKING ORGANIZATION]
may assign the adjusted carrying value of an equity exposure to an
investment fund on a pro rata basis to different risk weight categories
under this subpart based on the investment limits in the fund's
prospectus, partnership agreement, or similar contract that defines the
fund's permissible investments. The risk-weighted asset amount for the
[BANKING ORGANIZATION]'s equity exposure to the investment fund equals
the sum of each portion of the adjusted carrying value 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 fund exceeds 100 percent, the [BANKING ORGANIZATION] must
assume that the 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 order of
the exposure type with the next highest 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. A [BANKING ORGANIZATION] may
exclude derivative contracts held by the fund that are used for hedging
rather than for speculative purposes and do not constitute a material
portion of the fund's exposures.
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 product of the business indicator
component, as calculated pursuant to paragraph (b) of this section,
multiplied by 12.5.
(b) Business indicator component. A [BANKING ORGANIZATION]'s
business indicator component is calculated as follows:
(1) If the [BANKING ORGANIZATION]'s business indicator is less than
or equal to $1 billion, as adjusted pursuant to Sec. __.4, the
business indicator component equals the product of the business
indicator and 0.12.
(2) If the [BANKING ORGANIZATION]'s business indicator is greater
than $1 billion, as adjusted pursuant to Sec. __.4, and less than or
equal to $30 billion, as adjusted pursuant to Sec. __.4, the business
indicator component equals $120 million, as adjusted pursuant to Sec.
__.4, plus the product of:
(i) The business indicator less $1 billion, as adjusted pursuant to
Sec. __.4; and
(ii) 0.15.
(3) If the [BANKING ORGANIZATION]'s business indicator is greater
than $30 billion, as adjusted pursuant to Sec. __.4, the business
indicator component equals $4.47 billion, as adjusted pursuant to Sec.
__.4 plus the product of:
(i) The business indicator less $30 billion, as adjusted pursuant
to Sec. __.4; and
(ii) 0.18.
(c) Business indicator.
(1) A [BANKING ORGANIZATION]'s business indicator equals the sum of
the interest, lease, and dividend component and the noninterest
component.
(i) The interest, lease, and dividend component is calculated using
the following formula:
Interest, lease, and dividend component = min(Avg3y(Abs(total
interest income-total interest expense)), 0.0225*Avg3y(interest earning
assets)) + Avg3y(dividend income)
where Avg3y refers to the three-year average of the expression in
parenthesis; Abs refers to the absolute value of the expression in
parenthesis; and total interest income, total interest expense,
interest earning assets, and dividend income are the amounts determined
in accordance with paragraph (c)(2) of this section.
(ii) The noninterest component is calculated using the following
formula:
Noninterest component = Avg3y(Abs(total noninterest income + realized
gains (losses) on held-to-maturity securities + realized gains (losses)
on available-for-sale debt securities--noninterest expense for BI-
0.7*(total noninterest income from investment management, investment
services, and non-lending treasury services--noninterest expense for BI
from investment management, investment services, and non-lending
treasury services)) + total operational losses)
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 noninterest income, realized gains (losses) on
held-to-maturity securities, realized gains (losses) on available-for-
sale debt securities, noninterest expense for BI, total noninterest
income from investment management, investment services, and non-lending
treasury
[[Page 15189]]
services, noninterest expense for BI from investment management,
investment services, and non-lending treasury services, and total
operational losses are the amounts determined in accordance with
paragraph (c)(2) of this section.
(2) For purposes of paragraph (c)(1) of this section, to calculate
the three-year average of the Abs(total interest income-total interest
expense), dividend income, Abs(total noninterest income + realized
gains (losses) on held-to-maturity securities + realized gains (losses)
on available-for-sale debt securities-noninterest expense for BI-
0.7*(total noninterest income from investment management, investment
services, and non-lending treasury services-noninterest expense for BI
from investment management, investment services, and non-lending
treasury services)), and total operational losses, 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. The total operational losses for a four-calendar quarter
period equals the sum of all operational losses for each quarter in
that period. To calculate the three-year average of interest-earning
assets, a [BANKING ORGANIZATION] must divide by 12 the sum of the
quarter-end 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 (c)(1) of this section, a [BANKING
ORGANIZATION] must exclude loss provisions and reversals of provisions,
except for those relating to operational loss events, from the
calculation of the business indicator.
(4) For purposes of paragraph (c)(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, noninterest income, realized gains (losses) on
held-to-maturity securities, realized gains (losses) on available-for-
sale debt securities, noninterest expense for BI, noninterest income
from investment management, investment services, and non-lending
treasury services, noninterest expense for BI from investment
management, investment services, and non-lending treasury services, and
operational losses 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.
(d) 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 (d)(2) of this section and for overseeing the
processes that implement paragraph (d)(1)(ii);
(ii) 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, as adjusted pursuant to Sec. __.4, (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 (d)(2)(ii) of this section and the processes in (d)(2)(iii)
of this section to regular independent reviews by internal or external
audit functions.
Disclosures
Sec. __.160 Purpose and Scope
Sections __.160 through __.162 establish public disclosure
requirements related to the capital requirements for a [BANKING
ORGANIZATION] that calculates expanded total risk-weighted assets
pursuant to this subpart E, 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, except as provided in paragraph
(d) of this section. 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
[[Page 15190]]
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.
(d) A [BANKING ORGANIZATION] described in Sec. __.160 is required
to make the disclosures in Table 4 of Sec. __.162 only if the [BANKING
ORGANIZATION] is subject to Sec. __.11(b).
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 13 to Sec. __.162. 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 4810-33-6210-01-6714-01-P
Table 1 to Sec. __.162--Scope of Application
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(b) Risk management-related disclosure requirements. (1) The
[BANKING ORGANIZATION] must describe its risk management objectives and
policies for the organization overall, in particular:
(i) How the business model determines and interacts with the
overall risk profile (for example, the key risks related to the
business model and how each of these risks is reflected and described
in the risk disclosures) and how this risk profile aligns with the
parameters of the risk tolerance approved by the [BANKING
ORGANIZATION]'s board of directors;
(ii) The risk governance structure, including: responsibilities
attributed throughout the [BANKING ORGANIZATION] (for example,
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 (for example, 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] (for example, code of conduct;
manuals containing operating limits or procedures to treat violations
or breaches of risk thresholds; procedures to raise and share risk
issues 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 (for example,
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 13 to 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.
[[Page 15192]]
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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 13 to Sec. __.162. 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 13 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 13 to Sec. __.162. 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 13 to Sec. __.162. A
global systemically important BHC also must disclose the full terms and
conditions of all eligible debt securities.
[[Page 15197]]
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[[Page 15198]]
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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, and establishes public disclosure requirements.
(b) Applicability--(1) Market risk. The market risk capital
requirements and related reporting and public disclosure requirements
specified in Sec. Sec. __.203 through __.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 depository institution holding
company that is either a Category I [BANKING ORGANIZATION] or a
Category II [BANKING ORGANIZATION]; 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, [as adjusted pursuant to Sec. __.4], 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. Sec. __.220 through __.225 and related reporting and public
disclosure requirements specified in Sec. __.217 apply to any [BANKING
ORGANIZATION] that is:
(i) A depository institution holding company that is a Category I
[BANKING ORGANIZATION] or a Category II [BANKING ORGANIZATION];
(ii) A depository institution subsidiary of an institution
described in paragraph (b)(2)(i) of this section where such subsidiary
is subject to the market risk framework pursuant to Sec. __.201(b)(1);
or
(iii) A [BANKING ORGANIZATION] that is subject to the market risk
framework pursuant to Sec. __.201(b)(1) and engages in OTC derivative
contracts with an aggregate gross notional value, as reported on the
[BANKING ORGANIZATION]'s [REGULATORY REPORT]s of $1 trillion[, as
adjusted pursuant to 12 CFR 217.4,] or more on average for the prior
four quarters.
(3) Initial applicability. A [BANKING ORGANIZATION] must satisfy
the requirements of this subpart beginning [on the first day of] 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 (i) its aggregate trading assets and trading
liabilities to determine the applicability of this subpart F in
accordance with paragraph (b)(1) of this section; and (ii) the
aggregate gross notional value of the OTC derivative contracts the
[BANKING ORGANIZATION] engages in to determine the applicability of
this subpart F in accordance with paragraph (b)(2) of this section.
(5) Ongoing applicability. (i) A [BANKING ORGANIZATION] that is
subject to the market risk capital requirements and related reporting
and public disclosure requirements of this subpart F shall remain
subject to those requirements unless and until it does not meet any of
the standards in paragraph (b)(1) of this section, applying the
adjusted thresholds specified in paragraph (b)(1)(ii)(B) of this
section effective on the date of comparison.
[[Page 15199]]
(ii) A [BANKING ORGANIZATION] that is subject to the CVA risk-based
capital requirements and related reporting and public disclosure
requirements of this subpart F shall remain subject to those
requirements unless and until it does not meet any of the standards in
paragraph (b)(2) of this section, applying the adjusted thresholds
specified in paragraph (b)(2)(iii) of this section effective on the
date of comparison.
(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 in paragraph (b)(2) of this section from application of
Sec. Sec. __.203 through __.217 or Sec. Sec. __.220 through __.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) or gross notional value of OTC derivatives must
calculate the average in paragraph (b)(1)(ii) or paragraph (b)(2)(iii)
of this section, respectively, 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. Sec. __.203 through __.217 or Sec. Sec. __.220 through __.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(f).
(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.
(d) In making determinations under paragraphs (b)(6), (b)(7), and
(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)].
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 and net interest income 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. Sec. __.204(g) and __.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.
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 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
[[Page 15200]]
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 (2)(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 or a client-facing
derivative 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.
Default risk position means a market risk covered position,
including a defaulted market risk covered position, that is subject to
default risk.
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. Sec. __.207 and __.208 for purposes of calculating the
sensitivities-based capital requirement and Sec. Sec. __.224 and
__.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
that:
(i) For purposes of calculating the basic CVA approach capital
requirement, is 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, 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;
(iii) A correlation trading position; and
(iv) A CVA hedge at a [BANKING ORGANIZATION] that is not required
to apply the CVA risk-based capital requirements, pursuant to Sec.
__.201(b)(2).
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 the risk classes under the sensitivities-based capital
requirement or is not captured by the default risk capital requirement,
which includes, but is not limited to, longevity risk, weather risk,
and natural disaster risk.
[[Page 15201]]
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, as specified in Sec. __.215.
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, and intraday trading 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, [as adjusted pursuant to Sec. __.4].
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),\800\ 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; \801\ and
---------------------------------------------------------------------------
\800\ Securities subject to repurchase and lending agreements
are included as if they are still owned by the lender.
\801\ 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) A CVA hedge; 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, [as adjusted pursuant
to Sec. __.4], or more;
(E) An embedded derivative on instruments issued by the [BANKING
ORGANIZATION] that relates to the [BANKING ORGANIZATION]'s credit or
equity risk that the [BANKING ORGANIZATION] either:
(1) Bifurcates for accounting purposes; or
(2) Elects the fair value option for purposes of financial
reporting;
(F) With prior approval from the [AGENCY], an entire instrument
with an embedded derivative issued by the [BANKING ORGANIZATION] that
relates to credit or equity risk, for which the [BANKING ORGANIZATION]
elects the fair value option for purposes of financial reporting;
[[Page 15202]]
(G) The trading desk segment of an eligible internal risk transfer
of credit risk as described in Sec. __.205(g)(1)(i);
(H) The trading desk segment of an eligible internal risk transfer
of interest rate risk as described in Sec. __.205(g)(1)(ii);
(I) A position arising from a transaction between a trading desk
and an external party conducted as part of an internal risk transfer
that meets the criteria described in Sec. __.205(g);
(J) The trading desk segment of an eligible internal risk transfer
of CVA risk as described in Sec. __.205(g); and
(K) Instruments resulting from securities underwriting commitments,
where the securities are expected to be purchased by the [BANKING
ORGANIZATION] on the settlement date but are not securities expected to
be purchased by the [BANKING ORGANIZATION] for held to maturity (HTM)
or available for sale (AFS) purposes.
(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 market risk capital requirements
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) Real estate directly held by the [BANKING ORGANIZATION] or
an affiliate;
(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) An equity position arising from a deferred compensation plan,
or bank owned life insurance or corporate owned life insurance owned by
an affiliate of [BANKING ORGANIZATION] that is consistent with the
requirements of [Volcker Rule Sec. __.10(c)(7)];
(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(d)(2), as applicable;
(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 (xi) of this definition;
(xiii) A CVA hedge;
(xiv) An equity position in an investment fund that the [BANKING
ORGANIZATION] or an affiliate organizes and offers, which the [BANKING
ORGANIZATION] acquired for the purpose of providing such fund with
sufficient initial equity for investment to permit the fund to attract
unaffiliated investors and which the [BANKING ORGANIZATION] has held
for fewer than five years from the date on which the investment adviser
or similar entity to the fund begins making investments pursuant to the
written investment strategy for the fund; and
(xv) Hedges that are effective hedges, pursuant to the treatment in
Sec. __.52(c) or Sec. __.141(c), as applicable.
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 position means a market risk covered position on a
model-eligible trading desk that is not a model-ineligible position.
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 position means an equity position in an investment
fund where the [BANKING ORGANIZATION] is not able to identify the
underlying positions held by an investment fund on a quarterly basis, a
securitization position, or a correlation trading position.
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 both the
risk factor qualitative test in Sec. __.214(b)(2) and the risk factor
quantitative test in Sec. __.214(b)(3), consistent with Sec.
__.214(b)(1).
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:\802\
---------------------------------------------------------------------------
\802\ 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(g)(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 type A non-modellable risk
factor or a type B non-modellable risk factor.
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
[[Page 15203]]
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 issued by the [BANKING
ORGANIZATION] that relate to credit or equity risk that the [BANKING
ORGANIZATION] either bifurcates for accounting purposes or elects the
fair value option for purposes of financial reporting, instruments with
an embedded derivative issued by the [BANKING ORGANIZATION] that relate
to credit or equity risk, for which the [BANKING ORGANIZATION] elects
the fair value option for purposes of financial reporting, 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).
Pension fund means:
(1) An employee benefit plan (as defined in 29 U.S.C. 1002(3)) that
is not exempt from ERISA, under 29 U.S.C. 1003(b), and that complies
with the tax deferral qualification requirements provided in the
Internal Revenue Code;
(2) A governmental plan (as defined in 29 U.S.C. 1002(32)) that
complies with the tax deferral qualification requirements provided in
the Internal Revenue Code; or
(3) A fund for employee benefit plans subject to ERISA that is
exempt from the definition of an investment company under section
3(c)(11) of the Investment Company Act (15 U.S.C. 80a-1 et seq.).
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).
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 price provided by a regulated exchange, a qualifying central
counterparty, a sovereign entity, or a specified supranational entities
and multilateral development banks (MDBs);
(3) A verifiable price for an actual transaction between other
arm's-length parties or a bona fide competitive bid or offer by a party
transacting at arm's length either made to or received by the [BANKING
ORGANIZATION] itself or obtained from a third-party provider, provided
that, for any transaction, bid, or offer obtained from a third-party
provider:
(i) The transaction, bid, or offer has been processed through a
third-party provider; or
(ii) The third-party provider agrees to provide evidence of the
transaction, bid, or offer 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.
Residential mortgage-backed security (RMBS) means a prime RMBS,
mid-prime RMBS, or sub-prime RMBS.
Risk class means:
(1) For the purpose of calculating the sensitivities-based capital
requirement, one of the classes specified in Sec. __.206(a)(1);
(2) For the purpose of calculating the models-based non-default
capital requirement, one of the following: interest rate risk, equity
risk, foreign exchange risk, commodity risk, credit risk, and any other
risk class established by the agency; and
(3) For the purpose of calculating the standardized CVA approach
capital requirement, one of the classes relevant to the capital
requirement 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-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 that
can be included in the [BANKING ORGANIZATION]'s internal risk
management models.
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, as adjusted pursuant to Sec. __.4.
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.
[[Page 15204]]
Term repo-style transaction means a repo-style transaction that has
an original maturity in excess of one business day.
Time effects means the effects on the profit and loss solely due to
the passage of time.
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.
Type A non-modellable risk factor means a risk factor that
satisfies the risk factor qualitative test in Sec. __.214(b)(2) but
not the risk factor quantitative test in Sec. __.214(b)(3), consistent
with Sec. __.214(b)(1).
Type B non-modellable risk factor means a risk factor that is not a
modellable risk factor or a type A non-modellable risk factor,
consistent with Sec. __.214(b)(1).
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. Sec. __.207 and __.208 for purposes of calculating the
sensitivities-based capital requirement and Sec. Sec. __.224 and
__.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
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(g), embedded derivatives on
instruments issued by the [BANKING ORGANIZATION] that relate to credit
or equity risk that the [BANKING ORGANIZATION] either bifurcates for
accounting purposes or elects the fair value option for purposes of
financial reporting, and instruments with an embedded derivative issued
by the [BANKING ORGANIZATION] that relate to credit or equity risk, for
which the [BANKING ORGANIZATION] elects the fair value option for
purposes of financial reporting;
(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
[[Page 15205]]
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; and
(iv) A business strategy that includes regular reports on the
revenue, costs, and market risk capital requirements of the trading
desk.
(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 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, 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;
(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
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
[[Page 15206]]
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:
(i) The risk factor qualitative and quantitative tests, including
the description of the mapping of real price observations to risk
factors, as described in Sec. Sec. __.214(b)(2) and (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)(1) and any empirical correlations
recognized with respect to risk classes.
Sec. __.204 Measure for Market Risk
(a) General requirements. (1) 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.
(2) Notwithstanding paragraph (a)(1) of this section, when a
[BANKING ORGANIZATION] is required to calculate market risk capital for
a trading desk on a stand-alone basis, the [BANKING ORGANIZATION] must
calculate its measure for market risk as the sum of:
(i) The primary measure, calculated by applying the provisions of
paragraph (a)(1) of this section to all market risk covered positions
that are not included in a stand-alone measure for market risk in
paragraph (a)(2)(ii) of this section; and
(ii) The stand-alone measure for each trading desk that is required
to calculate market risk capital on a stand-alone basis, calculated by
applying the provisions of paragraph (a)(1) of this section to the
positions on that trading desk as if those positions were the entire
portfolio of market risk covered positions.
(b) Standardized measure for market risk. The standardized measure
for market risk equals the sum of the standardized non-default capital
requirement as defined in this paragraph (b), the default risk capital
requirement as defined in paragraph (d) of this section, the fallback
capital requirement as defined in paragraphs (e)(1) and (2) of this
section, and the capital add-ons for re-designations as defined in
paragraph (f) of this section. The standardized non-default capital
requirement equals the sum of the sensitivities-based 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. Sec. __.206
through __.209 for market risk covered positions.
(2) 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(c) for market
risk covered positions.
(c) Models-based measure for market risk. The models-based measure for
market risk equals:
Models-based measure for market risk = NDCR + DRC + fallback capital
requirement + capital add-on for redesignations
Where:
(1) NDCR is the non-default capital requirement under the models-
based measure and is calculated as follows, except that, with
supervisory approval, the non-default capital requirement under the
models-based measure can instead be equal to SAall desks:
NDCR = IMAG,A + (SAall desks - SAG,A)
Where:
(i) IMAG,A is the models-based non-default capital requirement
calculated for model-eligible positions on model-eligible trading
desks and is calculated as follows:
[[Page 15207]]
IMAG,A = max ((IMCCt-1 + SESt-1), ((mc x IMCCaverage) + SESaverage)) +
PLA add-on
Where:
(A) IMCC is the internally modelled capital calculation, which is
the aggregate capital measure for modellable risk factors and type A
non-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, 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;
(C) The capital multiplier mc equals 1.5 unless otherwise specified
in paragraph (g) of this section; and
(D) 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);
(ii) SAall desks equals the standardized non-default capital
requirement as defined in paragraph (b) of this section for market
risk covered positions on all trading desks;
(iii) SAG,A equals the standardized non-default capital requirement
as defined in paragraph (b) of this section for model-eligible
positions on model-eligible trading desks;
(2) DRC is the default risk capital requirement as defined in
paragraph (d) of this section;
(3) Fallback capital requirement is defined in paragraph (e) of this
section; and
(4) Capital add-on for redesignations is defined in paragraph (f) of
this section.
(d) Default risk capital requirement. A [BANKING ORGANIZATION]'s
default risk capital requirement equals the sum of the 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.
(e) Fallback capital requirement--(1) Calculation of the fallback
capital requirement. Unless the [BANKING ORGANIZATION] receives prior
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 non-default capital requirement and the default
risk capital requirement for any market risk covered positions
described by paragraph (e)(3)(ii)(A) for which the [BANKING
ORGANIZATION] is able to calculate all parts of those capital
requirements; and
(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 (e)(2)(ii) and
(e)(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 default risk capital requirement for a market risk
covered position, that position must be excluded from the calculation
of the standardized non-default capital requirement and the default
risk 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 under paragraph (e)(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. Notwithstanding paragraph
(c) of this section, for a [BANKING ORGANIZATION] that calculates the
models-based measure for market risk: in cases where, for any reason, a
[BANKING ORGANIZATION] is unable to calculate any portion of SAall
desks, IMAG,A, SAG.A, SAi as part of the calculation of the PLA add-on,
or the default risk capital requirement for a market risk covered
position subject to that calculation, that market risk covered position
must be excluded from the calculation of IMAG,A, SAall desks, SAG,A,
SAi, and the default risk capital requirement, unless the [BANKING
ORGANIZATION] receives prior approval from the [AGENCY].
(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 model-eligible positions excluded from the calculation of
IMAG,A under paragraph (e)(3)(i) of this section; and
(B) All market risk covered positions excluded from the calculation of
SAall desks under paragraph (e)(3)(i) of this section; and
(C) All market risk covered positions excluded from the default risk
capital requirement under paragraph (e)(3)(i) of this section.
(f) 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 provisions 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
F 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 may decrease over time,
proportionate to the decrease in the balance sheet value of the
position from the time of re-designation.
(v) Notwithstanding paragraphs (f)(2)(i) through (iv) of this section,
with
[[Page 15208]]
prior notification to 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 approval of the [AGENCY].
(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 model-
eligible trading desks, subject to Sec. __.212(b)(1)(iii)(B) of this
part. Time effects must be treated in a consistent manner in the
hypothetical profit and loss used for backtesting.
(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;
(B) The [BANKING ORGANIZATION] can demonstrate that one or more non-
modellable risk factors caused the relevant loss, and the portion of
the aggregate stressed expected shortfall, as described in paragraph
(c)(2)(ii) of this section, that can be attributed to these non-
modellable risk factors for that business day exceeds the difference
between the [BANKING ORGANIZATION]'s VaR-based measure and the actual
or hypothetical loss for that business day; or
(C) The [BANKING ORGANIZATION] can demonstrate that one or more model-
ineligible positions caused the relevant loss, and the portion of the
aggregate non-default capital requirement under the models-based
measure, as described in paragraph (c)(2)(ii) of this section, that can
be attributed to these model-ineligible positions for that business day
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 to Sec. __.204 that corresponds to the overall number of
exceptions identified in paragraph (g)(3) of this section to determine
the multiplication factor for the models-based non-default capital
requirement under paragraph (c)(2)(iii) 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.
[[Page 15209]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.165
(h) Maximum loss. Notwithstanding any other paragraph of this
section, a [BANKING ORGANIZATION] may cap the market risk capital
requirements of a market risk covered position at the maximum loss of
that market risk covered position.
Sec. __.205 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; Defaulted and
Distressed Positions; Hybrid Instruments; Index Instruments and Multi-
Underlying Options; Equity Positions in an Investment Fund; Certain
Term Repo-Style Transactions; and Internal Risk Transfers.
(a) Net short risk positions. A [BANKING ORGANIZATION] must
calculate its net short risk positions on a quarterly basis.
(b) Treatment of defaulted and distressed market risk covered
positions.
(1) For purposes of calculating the default risk capital
requirement, a [BANKING ORGANIZATION] must include defaulted market
risk covered positions. Notwithstanding Sec. __.204, a [BANKING
ORGANIZATION] is not required to include defaulted and distressed
market risk covered positions in the standardized non-default capital
requirement or the models-based non-default capital requirement.
(2) A [BANKING ORGANIZATION] may treat a distressed position as a
defaulted position for the purpose of calculating market risk capital
requirements.
(c) Treatment of hybrid instruments that are market risk covered
positions. For purposes of calculating the standardized non-default
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 default
risk capital requirement, a [BANKING ORGANIZATION] must decompose a
hybrid instrument into a non-securitization position and an equity
position and calculate the default risk capital requirement for each
position respectively.
(d) Index instruments and multi-underlying options. For a market
risk covered position that is an index instrument or a multi-underlying
option, the [BANKING ORGANIZATION] must apply:
(1) For purposes of calculating the standardized non-default
capital requirement,
(i) One of the following approaches to calculate the delta capital
requirement and the curvature capital requirement:
(A) The look-through approach; or
(B) The single-sensitivity approach, whereby a single sensitivity
is calculated to the index and assigned to the relevant bucket in Sec.
__.209, in accordance with:
(1) For an equity or credit index where at least 75 percent of the
market or notional value, respectively, of the underlying constituents,
taking into account the weightings of such index, relate to the same
sector, the sensitivity must be assigned to the corresponding sector
bucket, otherwise the sensitivity must be mapped to an index bucket;
(2) For an equity index that is not described in paragraph
(d)(1)(i)(B)(1) of this section, if at least 75 percent of the market
value of the constituents in the index, taking into account the
weightings of such index, is invested in large market cap and liquid
market economy, then the sensitivity must be assigned to bucket 12 in
Table 8 to Sec. __.209; otherwise, the sensitivity must be assigned to
bucket 13 in Table 8 to Sec. __.209;
(3) For a credit index that is not described in paragraph
(d)(1)(i)(B)(1) of this section, if at least 75 percent of the notional
value of the constituents in the index taking into account the
weightings of such index, is invested in investment grade positions,
the sensitivity must be assigned to bucket 19 in Table 3 to Sec.
__.209; otherwise, the sensitivity must be assigned to bucket 20 in
Table 3 to Sec. __.209;
(4) For an index that is not described in paragraphs
(d)(1)(i)(B)(1) through (3) of this section, the [BANKING ORGANIZATION]
must allocate the index proportionately to the relevant risk classes
following the methodology in paragraphs (d)(1)(i)(B)(1) through (3) of
this section;
(5) For credit indices, the [BANKING ORGANIZATION] may calculate
the delta sensitivity for interest rate risk specified in Sec.
__.207(b)(1) or the delta sensitivity for any credit spread risk
specified in Sec. __.207(b)(2) as delta sensitivity for equity risk
specified in Sec. __.207(b)(3) multiplied by effective duration; and
(6) For options on credit indices, the [BANKING ORGANIZATION] must
calculate curvature capital requirement specified in Sec. __.206(d)
for interest rate risk and credit spread risk for non-securitization
positions using the risk weights specified in Sec. __.209(d)
multiplied by the duration of the fund; and
(ii) One of the following approaches to calculate the vega capital
requirement:
[[Page 15210]]
(A) The look-through approach;
(B) For an index, the vega capital requirement with respect to the
implied volatility based on the appropriate sector specific bucket or
index bucket, which is the same sector specific bucket or index bucket
used to calculate the delta capital requirement and the curvature
capital requirement in paragraph (d)(1)(i)(B) of this section if the
[BANKING ORGANIZATION] calculates the delta capital requirement and the
curvature capital requirement under paragraph (d)(1)(i)(B) of this
section; or
(C) For a multi-underlying option, the vega capital requirement
based on the implied volatility of the option; and
(2) For purposes of calculating the models-based non-default
capital requirement, one of the following approaches:
(i) The look-through approach;
(ii) The hypothetical portfolio approach, consistent with paragraph
(e)(3)(ii) of this section; or
(iii) After receiving prior approval of the [AGENCY], an
alternative modelling approach; and
(3) For purposes of calculating the default risk capital
requirement, one of the following approaches:
(i) The look-through approach provided that 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 and
assuming the LGD for the single name is the appropriate LGD specified
in Sec. __.210(b)(1)(iv) and the value of the instrument assuming none
of the single names referenced by the instrument default;
(ii) A single exposure mapped to an appropriate bucket, provided
that the index or option substantially meets the criteria for that
bucket; or
(iii) A single sub-speculative exposure.
(e) Treatment of equity positions in an investment fund. For an
equity position in an investment fund that is a market risk covered
position, the [BANKING ORGANIZATION] must apply the following
provisions.
(1) A [BANKING ORGANIZATION] must determine whether it is able to
use the look-through approach to calculate market risk capital
requirements for its proportional ownership share of all or a portion
of the underlying positions in the fund. If a [BANKING ORGANIZATION] is
able to use the look-through approach to calculate market capital
requirements for only a portion of the underlying positions in the
fund, the [BANKING ORGANIZATION] must treat the equity position in the
investment fund as two separate market risk covered positions: one
market risk covered position for which the [BANKING ORGANIZATION] is
able to apply the look-through approach and one market risk covered
position for which the [BANKING ORGANIZATION] is not able to apply the
look-through approach, with each position representing the proportional
amount of the original position corresponding to the portion of the
investment fund that the [BANKING ORGANIZATION] is able to use the
look-through approach or not able to use the look-through approach,
respectively.
(2) With respect to a position subject to this paragraph (e) for
which the [BANKING ORGANIZATION] is able to use the look-through
approach to calculate market risk capital requirements, the [BANKING
ORGANIZATION] must apply the treatment specified in paragraph (d) of
this section.
(3) With respect to a position subject to this paragraph (e) for
which the [BANKING ORGANIZATION] is not able to use the look-through
approach to calculate market risk capital requirements, the [BANKING
ORGANIZATION] must apply one of the following three methods in
paragraphs (e)(3)(i) through (e)(3)(iii) of this section, provided that
the [BANKING ORGANIZATION] must not include such market risk covered
positions in the calculation of the models-based non-default capital
requirement:
(i) Tracked index method. For an investment fund that closely
tracks an index benchmark, the [BANKING ORGANIZATION] treats the
investment fund as the tracked index and calculates the standardized
non-default capital requirement by applying the treatment specified in
paragraphs (d)(1)(i)(B) and (d)(1)(ii)(B) of this section, and the
default risk capital requirement by applying the treatment specified in
paragraph (d)(3) of this section.
(ii) Hypothetical portfolio approach. The [BANKING ORGANIZATION]
decomposes the investment fund into a hypothetical portfolio for the
standardized non-default capital requirement and the default risk
capital requirement, provided that the hypothetical portfolio either:
(A) Assumes the fund invests to the maximum extent permitted under
the fund's investment limits in the exposure types subject to the
highest applicable risk weights, provided that if more than one risk
weight can be applied to a given exposure, the maximum risk weight
applicable must be used, that cause the fund to be fully invested; or
(B) Is based on the most recent quarterly disclosure of the
investment fund's holdings of underlying positions.
(iii) Backstop fund method. (A) For purposes of calculating the
standardized non-default capital requirement, a [BANKING ORGANIZATION]
may allocate the equity position in an investment fund to the other
sector bucket 11 in Table 8 to Sec. __.209. If an investment fund's
investment mandate permits the investment fund to maintain exposure
types as described in Sec. __.211(a), the [BANKING ORGANIZATION] must
apply the residual risk add-on to the portion of the fund permitted to
be invested in such exposure types, assuming the fund would invest in
such exposure types to the maximum extent permitted under the mandate.
(B) For purposes of calculating the default risk capital
requirement, the [BANKING ORGANIZATION] must calculate the default risk
capital requirement based on either:
(1) A hypothetical portfolio, as described in paragraph (e)(3)(ii)
of this section; or
(2) A single sub-speculative equity exposure.
(f) Term repo-style transactions that the [BANKING ORGANIZATION]
elects to include in market risk. A [BANKING ORGANIZATION] may elect to
include a term repo-style transaction in market risk, provided that the
[BANKING ORGANIZATION]:
(1) Includes all such term repo-style transactions consistently
over time;
(2) Marks the transaction to market;
(3) Captures the market price risk and the issuer-default risk of
the transaction by:
(i) Including the risk factor sensitivity to each applicable risk
factor pursuant to Sec. __.208; and
(ii) Calculating the default risk capital requirement under Sec.
__.210 using:
(A) For the calculation of Expanded Total Risk-Weighted Assets, the
exposure amount that would apply to the transaction under Sec. Sec.
__.113 through __.115 multiplied by 8 percent; or
(B) 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;
(4) Recognizes:
(i) For the calculation of Expanded Total Risk-Weighted Assets, the
credit risk mitigation benefits of collateral pursuant to Sec. __.115;
or
(ii) For the calculation of Standardized Total Risk-Weighted
[[Page 15211]]
Assets, the credit risk mitigation benefits of collateral pursuant to
Sec. __.37(c); and
(5) Treats the term repo-style transactions the [BANKING
ORGANIZATION] elects to include in market risk as market risk covered
positions for the purposes of calculations under this part.
(g) 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 (g).
(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 at trade
initiation; 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. For interest rate risk, an eligible
internal risk transfer means an internal risk transfer:
(A) For which the documentation of the internal risk transfer
identifies the exposure being hedged and its source(s) of interest rate
risk;
(B) If the position is on a dedicated notional trading desk, that
desk calculates market risk capital on a stand-alone basis, pursuant to
Sec. __.204(a)(2)(ii); and
(C) 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.
(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 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;
and
(B) The documentation of the internal risk transfer of CVA risk
identifies the CVA risk being hedged and the source(s) of such 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
[[Page 15212]]
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 paragraph
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
paragraph Sec. __.209(b).
(2) Within bucket aggregation. For each bucket, b, specified in
paragraph 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. Sec. __.206(e) and __.209(b), as follows:
[GRAPHIC] [TIFF OMITTED] TP27MR26.166
(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 gbc as specified in Sec. Sec. __.206(e) and __.209(b), as
follows:
[GRAPHIC] [TIFF OMITTED] TP27MR26.167
Where:
(i) Sb = [Sigma]k WSk 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
[GRAPHIC] [TIFF OMITTED] TP27MR26.324
[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]kWSkKb),-Kb) for all risk factors in
bucket b; and
(B) Sc = max(min([Sigma]kWSkKc),-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 factork, 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. Sec. __.206(e) and __.209(c), as
follows:
[GRAPHIC] [TIFF OMITTED] TP27MR26.168
[[Page 15213]]
(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. Sec. __.206(e) and __.209(c),
as follows:
[GRAPHIC] [TIFF OMITTED] TP27MR26.169
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]bK2b + [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. Sec.
__.207 and __.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 position for the
portfolio is calculated as,
[GRAPHIC] [TIFF OMITTED] TP27MR26.170
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
(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, [gamma]kl, as specified in Sec. Sec.
__.206(e) and __.209(d) as follows:
Kb = max(K+b, K-b)
[[Page 15214]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.171
and
(i) The bucket-level capital requirement, Kb, is calculated as the
greater of the capital requirement under the upward scenario,
K+b, or the capital requirement under the downward scenario,
K-b;
(ii) In the specific case where K+b = K-b, if
[Sigma]kCVR+k > [Sigma]kCVR-k, the upward
scenario is selected, otherwise the downward scenario is selected; and
(iii) C (CVRk, CVRl) = 0 if CVRk and CVRl both have negative signs;
and C (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, , as specified in Sec. Sec. __.206(e) and __.209(d), as
follows:
[GRAPHIC] [TIFF OMITTED] TP27MR26.172
Where:
(i) Sb = [Sigma]kCVR+k for all risk factors in bucket b
when the upward scenario has been selected for bucket b, and Sb =
[Sigma]kCVR-k otherwise; and
(ii) C(Sb, Sc) = 0, if Sb and Sc both have negative signs, and c
(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 (correlation
between risk factors within a bucket) and (correlation across buckets
within a risk class) as specified below:
(1) For the medium correlation scenario, the correlation parameters
and specified in Sec. __.209 apply;
(2) For the high correlation scenario, the specified correlation
parameters and are uniformly multiplied by 1.25, with and subject to a
cap at 100 percent; and
(3) For the low correlation scenario, the specified correlation
parameters and are replaced by,
[GRAPHIC] [TIFF OMITTED] TP27MR26.325
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 in this section.
(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 pricing 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 the models specified in paragraph (a)(3) of this
section. With prior approval from the [AGENCY], a [BANKING
ORGANIZATION] may calculate delta sensitivities, vega sensitivities,
and
[[Page 15215]]
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 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 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 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, by 0.0001 as follows:
[GRAPHIC] [TIFF OMITTED] TP27MR26.174
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
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 by one basis point (0.0001 in absolute terms)
and dividing the resulting change in the value of the market risk
covered position, by 0.0001 as follows:
[GRAPHIC] [TIFF OMITTED] TP27MR26.175
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
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, , by 0.01 as
follows:
[GRAPHIC] [TIFF OMITTED] TP27MR26.176
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 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:
[[Page 15216]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.177
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 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] TP27MR26.178
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 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] TP27MR26.179
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 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 si, which can
be represented as
[GRAPHIC] [TIFF OMITTED] TP27MR26.180
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.
(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
[[Page 15217]]
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 paragraph (b)(2)(iii)(A) of this section;
(ii) The implied volatilities of cross-currency basis risk-
sensitive options as defined along paragraph (b)(2)(iii)(A) of this
section; and
(iii) The implied volatilities of interest rate risk-sensitive
options as defined along paragraphs (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.
(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. 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.
[[Page 15218]]
(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.
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
to Sec. __.209.
[GRAPHIC] [TIFF OMITTED] TP27MR26.181
(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.
[[Page 15219]]
(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 [rho]kl 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.
(B) The correlation parameter [rho]kl 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 to Sec.
__.209.
[GRAPHIC] [TIFF OMITTED] TP27MR26.182
(C) The correlation parameter [rho]kl between risk-weighted delta
sensitivities WSk and WSl within the same bucket, with different tenors
and different interest rate curves equals the correlation parameter
[rho]kl specified in Table 2 to Sec. __.209 multiplied by 99.9
percent.
(D) The correlation parameter [rho]kl between risk-weighted delta
sensitivities WSk and WSl to different inflation curves within the same
bucket equals 99.9 percent.
(E) The correlation parameter [rho]kl 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 [rho]kl 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 Ybc 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 to
Sec. __.209. 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 to Sec. __.209. Delta sensitivities that a [BANKING
ORGANIZATION] cannot assign to a sector must be assigned to the other
sector, bucket 18 in Table 3 to Sec. __.209.
(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 to Sec. __.209. The risk weights are the
same for all tenors within a bucket.
BILLING CODE 4810-33-6210-01-6714-01-P
[[Page 15220]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.183
[[Page 15221]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.184
BILLING CODE 4810-33-6210-01-6714-01-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 17, the correlation parameter [rho]kl between
risk weighted delta sensitivities WSk and WSl equals:
[GRAPHIC] [TIFF OMITTED] TP27MR26.185
Where:
(1) [rho](name)kl equals 100 percent if the two names of the delta
sensitivities to risk factors k and l are identical, and 35 percent
otherwise;
(2) [rho](tenor)kl 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](basis)kl equals 100 percent if the two delta sensitivities
are related to the same curve, and 99.9 percent otherwise.
(B) For bucket 18, 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] TP27MR26.186
(C) For buckets 19 and 20, the correlation parameter [rho]kl
between risk weighted delta sensitivities WSk and WSl equals:
[GRAPHIC] [TIFF OMITTED] TP27MR26.187
Where:
[GRAPHIC] [TIFF OMITTED] TP27MR26.188
(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:
[GRAPHIC] [TIFF OMITTED] TP27MR26.189
Where:
[[Page 15222]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.190
[GRAPHIC] [TIFF OMITTED] TP27MR26.191
(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 to Sec. __.209. 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 to Sec. __.209. Delta sensitivities that
a [BANKING ORGANIZATION] cannot assign to a sector must be assigned to
the other sector, bucket 16 in Table 5 to Sec. __.209.
(ii) For calculating risk weighted delta sensitivities for credit
spread risk for correlation trading positions, a [BANKING ORGANIZATION]
must use
[[Page 15223]]
the risk weights in Table 5 to Sec. __.209. The risk weights are the
same for all tenors within a bucket.
[GRAPHIC] [TIFF OMITTED] TP27MR26.192
(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 15, the correlation parameter rkl between risk
weighted delta sensitivities WSk and WSl equals:
[GRAPHIC] [TIFF OMITTED] TP27MR26.193
Where:
[[Page 15224]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.194
(B) For bucket 16, 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] TP27MR26.195
(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 Ybc
as follows:
[GRAPHIC] [TIFF OMITTED] TP27MR26.196
Where:
[GRAPHIC] [TIFF OMITTED] TP27MR26.197
[GRAPHIC] [TIFF OMITTED] TP27MR26.198
[[Page 15225]]
(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 to Sec. __.209. 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 to Sec. __.209.
[[Page 15226]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.199
(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:
[[Page 15227]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.200
Where:
[GRAPHIC] [TIFF OMITTED] TP27MR26.201
(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] TP27MR26.202
(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 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 to Sec. __.209. 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 to
Sec. __.209.
[[Page 15228]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.203
(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 pkl between two risk weighted delta sensitivities WSk and WSl
is as follows:
(1) pkl equals 99.9 percent, where one delta sensitivity is to an
equity spot
[[Page 15229]]
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, pkl equals:
(i) 15 percent between delta sensitivities assigned to buckets 1,
2, 3, and 4 of Table 8 to Sec. __.209 (large market cap, emerging
market economy);
(ii) 25 percent between delta sensitivities assigned to buckets 5,
6, 7, or 8 of Table 8 to Sec. __.209 (large market cap, liquid market
economy);
(iii) 7.5 percent between delta sensitivities assigned to bucket 9
of Table 8 to Sec. __.209 (small market cap, emerging market economy);
(iv) 12.5 percent between delta sensitivities assigned to bucket 10
of Table 8 to Sec. __.209 (small market cap, liquid market economy);
and
(v) 80 percent between delta sensitivities assigned to buckets 12
or 13 of Table 8 to Sec. __.209 (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 pkl, 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] TP27MR26.204
(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 ybc equals:
(A) 15 percent if bucket b and bucket c fall within buckets 1 to 10
of Table 8 to Sec. __.209;
(B) Zero percent if either of bucket b and bucket c is bucket 11 of
Table 8 to Sec. __.209;
(C) 75 percent if bucket b and bucket c are buckets 12 and 13 of
Table 8 to Sec. __.209 (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 to Sec. __.209.
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 to Sec. __.209.
[[Page 15230]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.205
(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 15231]]
(A) For buckets 1 through 12, the correlation parameter pkl between
two risk weighted delta sensitivities WSk and WSl equals:
[GRAPHIC] [TIFF OMITTED] TP27MR26.206
Where:
[GRAPHIC] [TIFF OMITTED] TP27MR26.207
[GRAPHIC] [TIFF OMITTED] TP27MR26.208
(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 ybc equals:
(A) 20 percent if bucket b and bucket c fall within buckets 1 to 10
or 12 of Table 10 to Sec. __.209; and
(B) Zero percent if either bucket b or bucket c is bucket number 11
of Table 10 to Sec. __.209.
(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 the [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
[[Page 15232]]
class, the cross-bucket correlation parameter gbc equals 60 percent.
(c) Vega capital requirement--(1) Vega buckets. For each risk
class, a [BANKING ORGANIZATION] must use the same buckets as specified
in paragraph (b) of this section for the calculation of the vega
capital requirement.
(2) Vega risk weights. For calculating risk weighted sensitivities
for vega risk as described in Sec. __.206(c)(1), a [BANKING
ORGANIZATION] must use the corresponding risk weight for each risk
class specified in Table 11 to Sec. __.209.
(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 to
Sec. __.209.
(ii) Equity risk (small market cap and other sector) applies to
vega risk factors that correspond to buckets 9 to 11 of Table 8 to
Sec. __.209.
[GRAPHIC] [TIFF OMITTED] TP27MR26.209
(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:
[GRAPHIC] [TIFF OMITTED] TP27MR26.210
Where:
[[Page 15233]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.211
(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 to
Sec. __.209), the correlation parameter rkl equals:
[GRAPHIC] [TIFF OMITTED] TP27MR26.212
Where:
[GRAPHIC] [TIFF OMITTED] TP27MR26.213
[[Page 15234]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.214
(iii) For purposes of aggregating risk weighted vega sensitivities
within the other sector buckets (for credit spread risk for non-
securitizations, bucket 18 in Table 3 to Sec. __.209, for credit
spread risk for correlation trading positions, bucket 16 in Table 5 to
Sec. __.209, for credit spread risk for securitization positions non-
CTP, bucket 25 in Table 7 to Sec. __.209, and for equity risk, bucket
11 in Table 8 to Sec. __.209), 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 gbc as specified for delta risk in paragraph (b)
of this section.
(d) The curvature capital requirement--(1) Curvature buckets. For
each risk class, a [BANKING ORGANIZATION] must use the same buckets as
specified in paragraph (b) of this section for the calculation of the
curvature capital requirement.
(2) Curvature risk weights. (i) For calculating the net curvature
risk 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
CVR+k and CVR-kfor 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 consistent,
relative shock to all tenor points 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, rkl, equals 99.8 percent where risk factors k and l relate
to different interest rate curves and 100 percent otherwise;
(ii) Except as noted in paragraph (d)(3)(vi) of this section, for
the risk classes of credit spread risk for non-securitization positions
and credit spread risk for correlation trading positions, the curvature
risk correlation parameter, rkl, equals the corresponding delta
correlation parameter,
[GRAPHIC] [TIFF OMITTED] TP27MR26.215
as specified in paragraphs (b)(2)(iii)(A)(1) and (b)(3)(iii)(A)(1) of
this section, respectively, squared.
(iii) Except as noted in paragraph (d)(3)(vi) of this section, for
the risk class of credit spread risk for securitization positions non-
CTP, the curvature risk correlation parameter, rkl, equals the
corresponding delta correlation parameter,
[[Page 15235]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.216
as specified in paragraph (b)(4)(iii)(A) of this section, squared;
(iv) Except as noted in paragraph (d)(3)(vi) of this section, for
the risk class of commodity risk, the curvature risk correlation
parameter, rkl, equals the corresponding delta correlation parameter,
[GRAPHIC] [TIFF OMITTED] TP27MR26.217
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
equals the corresponding delta correlation parameters, rkl, as
specified in paragraph (b)(5)(iii)(A)(2) of this section, squared;
(vi) For purposes of aggregating the net curvature risk positions
within the other sector buckets (for credit spread risk for non-
securitizations, bucket 18 in Table 3 to Sec. __.209, for credit
spread risk for correlation trading positions, bucket 16 in Table 5 to
Sec. __.209, for credit spread risk for securitization positions non-
CTP, bucket 25 in Table 7 to Sec. __.209, and for equity risk, bucket
11 in Table 8 to Sec. __.209), the curvature bucket-level risk
position equals:
[GRAPHIC] [TIFF OMITTED] TP27MR26.218
(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 [ggr]bc for curvature risk by squaring the
corresponding delta correlation parameters [ggr]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 rkl as
calculated in paragraph (d)(3) of this section and the cross-bucket
correlation parameter [ggr]bc as calculated in paragraph (d)(4) of this
section.
Sec. __.210 Default Risk Capital Requirement
(a) Overview of the default risk capital requirements. (1) A
[BANKING ORGANIZATION] must calculate default risk capital requirements
for its default risk positions across the following default risk
categories:
(i) Non-securitization debt or equity positions, other than U.S.
sovereign exposures, specified supranational entities, or MDBs;
(ii) Securitization positions non-CTP; and
(iii) Correlation trading positions.
(2) For each default risk category, the 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
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:
[[Page 15236]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.219
Where:
(1) Net default exposure(long) equals the aggregate net long default
exposure, calculated as the simple sum of the net long default
exposures across obligors;
(2) Net default 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 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.
(3) The 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, provided that such positions
may be decomposed into single positions, applying the appropriate loss
given default rates and risk weights for non-securitization debt or
equity positions, specified below.
(4) A [BANKING ORGANIZATION] may not recognize any diversification
benefits across default risk categories. The overall default risk
capital requirement is the sum of the default risk capital requirement
for each default risk category.
(b) 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 national amount +
P&L), 0),
Gross default exposure(short) = max((LGD rate x national amount +
P&L), 0),
(iv) A [BANKING ORGANIZATION] must assign LGD rates to non-
securitization debt or equity positions as follows:
(A) 100 percent for equity, non-senior debt and defaulted
positions;
(B) 75 percent for senior debt, unless a lower LGD is assigned;
(C) 75 percent for GSE debt issued, but not guaranteed, by GSEs;
(D) 50 percent for positions in a PSE that is organized under the
laws of the United States or any state or political subdivision
thereof;
(E) 25 percent for GSE debt guaranteed by GSEs;
(F) 25 percent for covered bonds; and
(G) Zero percent if the value of the non-securitization debt or
equity position is not linked to the recovery rate of the defaulter.
(v) For credit derivatives, a [BANKING ORGANIZATION] must use the
LGD rate of the reference exposure.
(vi) 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.
(vii) 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 exposure. 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
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] 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 default risk capital requirement for non-
securitization debt or equity positions. (i) To calculate the 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 exposures;
(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:
[[Page 15237]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.329
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 to Sec. __.210:
[GRAPHIC] [TIFF OMITTED] TP27MR26.330
(iii) The default risk capital requirement for non-securitization
debt or equity positions equals the sum of the four bucket-level
default risk capital requirements.
(c) Default risk capital requirement for securitization positions
non-CTP--(1) Gross default exposure. 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) and (ii) 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 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 short
securitization positions non-CTP may offset.
(3) Calculation of the default risk capital requirement for
securitization positions non-CTP. (i) To calculate the 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
[[Page 15238]]
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, for each DRCb, bucket, b, for
securitization positions non-CTP as follows:
[GRAPHIC] [TIFF OMITTED] TP27MR26.331
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)(3)(i) 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 default risk
capital requirement for an individual cash securitization position
non-CTP at its fair value.
(iv) The default risk capital requirement for securitization
positions non-CTP equals the sum of the bucket-level default risk
capital requirements.
(d) 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) and (ii) 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] TP27MR26.332
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 listed in paragraphs
(d)(2)(i) and (ii) through decomposition of a correlation trading
position, including an equivalent exposure that arises from
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 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.
[[Page 15239]]
(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] TP27MR26.333
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 or
decomposed single name exposures, the same loss given default rates
and risk weights as for non-securitization debt or equity positions,
provided that such hedges or decomposed single exposures must be
excluded from the calculation of the default risk capital
requirement for non-securitization debt or equity positions.
(v) A [BANKING ORGANIZATION] must calculate the default risk
capital requirement for correlation trading positions by aggregating
the bucket-level capital requirements as follows:
[GRAPHIC] [TIFF OMITTED] TP27MR26.334
Sec. __.211 Residual Risk Add-On
(a) Included positions. 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, but are not
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 subject to
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) The portion of the exposure amount resulting from an equity
position in an investment fund required to be included in the residual
risk add-on under Sec. __.205(e)(3)(iii); and
(4) 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.
(b) Excluded positions. (1) 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
(iii) Market risk covered position that are options without path
dependent pay-offs or with two or fewer underlyings.
(2) 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.
(c) 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
[[Page 15240]]
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.
Models-Based Non-Default Capital Requirement
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 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 model-ineligible positions; and
(iii) For any trading desk that includes de minimis amounts of
model-ineligible positions:
(A) Not consider model-ineligible positions on model-eligible
trading desks to be model-eligible positions for the calculations in
Sec. __.215; and
(B) Exclude model-ineligible 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 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, beginning [THREE YEARS AFTER EFFECTIVE DATE], PLA test
results for the trading desk to the [AGENCY];
(B) Provide at least 125 business days of trading desk level
backtesting and, beginning [THREE YEARS AFTER EFFECTIVE DATE], 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, beginning [THREE YEARS AFTER EFFECTIVE DATE],
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,
beginning [THREE YEARS AFTER EFFECTIVE DATE], PLA test results to the
[AGENCY]; or
(D) Beginning [THREE YEARS AFTER EFFECTIVE DATE], 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 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 requirements 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 requirements 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 approval of the [AGENCY] to use an internal model for the
ES-based measure in Sec. __.215(b), and the stressed expected
shortfall methodologies in Sec. __.215(d). 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 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 and stressed expected shortfall
methodologies. (i) A [BANKING ORGANIZATION] must receive prior 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 ES-based measure for a trading desk, the [BANKING
ORGANIZATION]'s IMCC, or the [BANKING ORGANIZATION]'s stressed expected
shortfall.
(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 ES-based measure
for a trading desk, the [BANKING ORGANIZATION]'s IMCC, or the [BANKING
ORGANIZATION]'s stressed expected shortfall.
[[Page 15241]]
(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 one or more specified model-eligible trading desks
as if that trading desk were a stand-alone regulatory portfolio, as
directed by the [AGENCY].
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. Time effects must be
treated in a consistent manner in the hypothetical profit and loss used
for backtesting.
(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 portion
of the stressed expected shortfall, as defined in Sec.
__.204(c)(2)(ii), that can be attributed to these non-modellable risk
factors on that business day exceeds the difference between the
[BANKING ORGANIZATION]'s VaR-based measure 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 a model-ineligible trading desk,
upon the completion of the [AGENCY]'s quarterly review of the relevant
backtesting data.
(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.
[[Page 15242]]
(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 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 and, beginning [THREE YEARS AFTER
EFFECTIVE DATE], the trading desk produces results in the PLA test
green zone or PLA test amber zone; 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 metric. (i) A [BANKING ORGANIZATION] must calculate
the Kolmogorov-Smirnov 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) 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.
(iii) 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.
(iv) 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 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 to Sec. __.213.
[GRAPHIC] [TIFF OMITTED] TP27MR26.335
(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) Beginning [THREE YEARS AFTER EFFECTIVE DATE], 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) Beginning [THREE YEARS AFTER EFFECTIVE DATE], 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
[[Page 15243]]
this section, Sec. __.212(b)(2)(ii)(D), or Sec. __.212(b)(4), equals:
[GRAPHIC] [TIFF OMITTED] TP27MR26.336
(A) SAi denotes the standardized non-default capital requirement for
market risk covered positions on trading desk, i;
(B) [Sigma]i[egr]ASAi equals the sum of the standardized non-default
capital requirement, calculated separately, for each trading desk i
that is subject to the PLA add-on; and
(C) [Sigma]i[egr]G,ASAi equals the sum of the standardized non-
default capital requirement, calculated separately, for each model-
eligible trading desk i (including trading desks subject to the PLA
add-on); and
(ii) All other terms have the meaning specified in Sec.
__.204(c)(2).
Sec. __.214 Risk Factor Identification
(a) Identification of risk factors. A [BANKING ORGANIZATION] must
identify an appropriate set of risk factors to be used for purposes of
calculating the internally modelled capital calculation, IMCC, and the
stressed expected shortfall, 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, unless
the [BANKING ORGANIZATION] is able to support the omission of specific
risk classes to the satisfaction of the [AGENCY].
(b) Risk factor eligibility tests. (1) Conduct of tests and
classification of risk factors. A [BANKING ORGANIZATION] must classify
each risk factor according to the risk factor qualitative test
specified in paragraph (b)(2) of this section and the risk factor
quantitative test specified in paragraph (b)(3) of this section as
follows:
(i) A risk factor that passes both the risk factor quantitative
test and the risk factor qualitative test is a modellable risk factor;
(ii) A risk factor that passes the risk factor qualitative test but
fails the risk factor quantitative test is a type A non-modellable risk
factor; and
(iii) A risk factor that is not a modellable risk factor or a type
A non-modellable risk factor is a type B non-modellable risk factor.
(2) Risk factor qualitative test. To pass the risk factor
qualitative test, the data that a [BANKING ORGANIZATION] uses to
calculate the models-based non-default capital requirement
corresponding to a risk factor must be consistent with each of the
standards in this paragraph (b)(2).
(i) The data must allow the internal models used to calculate the
ES-based measure to capture both idiosyncratic risk and systematic
risk, if applicable.
(ii) 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.
(iii) 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.
(iv) The data must be updated at a sufficient frequency to
adequately reflect the performance of the risk factor, 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 and for
updating the sources of data used.
(v) 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 specified in Sec. __.215(b)(5). 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.
(vi) 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) The proxies have sufficiently similar characteristics to the
[[Page 15244]]
transactions they represent in terms of volatility level and
correlations; and
(C) The proxies are appropriate for the region, credit spread,
quality and type of instrument they are intended to represent.
(vii) The [AGENCY] has not determined that the data is unsuitable
to calibrate the [BANKING ORGANIZATION]'s ES-based measure.
(3) Risk factor quantitative test. To conduct the risk factor
quantitative test, a [BANKING ORGANIZATION] must identify real price
observations that meet the requirements set forth in paragraph
(b)(3)(i) and allocate each real price observation into a bucket for a
risk factor, as specified in paragraph (b)(3)(ii). To pass the risk
factor quantitative test, a [BANKING ORGANIZATION] must identify real
price observations in the bucket corresponding to the risk factor over
the prior 12 months equal to or greater than the minimum number of real
price observations specified in paragraph (b)(3)(iii).
(i) Requirements for real price observations.
(A) 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.
(B) The [BANKING ORGANIZATION] must not count more than one real
price observation in a single day.
(C) When a [BANKING ORGANIZATION] uses real prices from a third-
party provider:
(1) 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;
(2) The third-party provider that is not a U.S. Government agency,
an exchange, or a QCCP 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 quantitative
test; and
(3) When the real price observations are provided with a time lag,
the period used for the risk factor quantitative 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.
(ii) Bucketing approaches. For the risk factor quantitative test, a
[BANKING ORGANIZATION] must allocate real price observations into
buckets corresponding to risk factors 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 quantitative test. To
allocate real price observations into buckets, the [BANKING
ORGANIZATION] must group risk factors on a curve or surface level. Real
price observations may be mapped to more than one risk factor. Each
bucket may be defined by using either of the bucketing approaches
specified in this paragraph (b)(3)(ii).
(A) 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].
(B) Standard bucketing approach. Under this approach, the [BANKING
ORGANIZATION] must use the standard buckets as set out as follows:
(1) 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 to Sec. __.214 must be used.
(2) For interest rate, foreign exchange and commodity risk factors
with several maturity dimensions (excluding implied volatilities) (,
where is measured in years), the buckets corresponding to the t values
in row (B) of Table 1 to Sec. __.214 must be used.
(3) Credit spread and equity risk factors with one or several
maturity dimensions (excluding implied volatilities) (, where is
measured in years), the buckets corresponding to the t values in row
(C) of Table 1 to Sec. __.214 must be used.
(4) For any risk factors with one or several strike dimensions (the
probability that an option is ``in the money'' at maturity, [delta]),
the buckets corresponding to the [delta] values in row (D) of Table 1
to Sec. __.214 must be used.
(5) For expiry and strike dimensions of implied volatility risk
factors (excluding those of interest rate swaptions), only the buckets
corresponding to the t or [delta] values in rows (C) and (D),
respectively, of Table 1 to Sec. __.214 must be used.
(6) For maturity, expiry and strike dimensions of implied
volatility risk factors from options on swaps, only the buckets
corresponding to the t or [delta] values in row (B), (C) and (D),
respectively, of Table 1 to Sec. __.214 must be used.
(7) 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.
[[Page 15245]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.220
(C) For purposes of the risk factor quantitative 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, provided that real price observations
that have been identified within the prior 12 months must be either:
(1) Counted in the maturity bucket to which they were initially
allocated; or
(2) Re-allocated to the shorter maturity bucket that reflects the
market risk covered position's remaining maturity.
(D) 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 movements for a given
economy, region or sector.
(iii) Minimum sufficient number of real price observations.
(A) The minimum sufficient number of real price observations is 24
if the liquidity horizon is 10 or 20 days, and 16 otherwise.
(B) Notwithstanding other provisions of this paragraph (b)(3), for
new issuances, the observation period for the risk factor quantitative
test may begin on the issuance date and the number of real price
observations required to pass the risk factor quantitative test may be
prorated until 12 months after the issuance date.
(c) Calibration. The [BANKING ORGANIZATION] must choose the most
appropriate data for modellable risk factors and type A non-modellable
risk factors to calibrate the ES-based measure. For the calibration of
the ES-based measure, the [BANKING ORGANIZATION] may use different data
than the data used to pass the risk factor quantitative test.
Sec. __.215 The Models-Based Non-Default Capital Requirement
(a) A [BANKING ORGANIZATION] that calculates the models-based non-
default capital requirement must calculate the ES-based measure, the
internally modelled capital calculation, IMCC, and the stressed
expected shortfall, 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.
(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] TP27MR26.221
Where:
(i) ES is the liquidity horizon-adjusted ES-based measure;
(ii) T is the length of the base liquidity horizon, 10 days;
(iii) EST(P) is ES at base liquidity horizon T of a portfolio with
market risk covered positions P;
(iv) EST(P,J) is the at base liquidity horizon T of a portfolio with
market risk covered positions T for all risk factors whose liquidity
horizon is at least as long as the liquidity horizon corresponding
to the index value j, LH,j as specified in Table 1 to Sec. __.215;
(v) LH,j is the liquidity horizon corresponding to the index value,
j, specified in Table 1 to Sec. __.215.
[[Page 15246]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.222
(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.
(5) Stress period. A [BANKING ORGANIZATION] must identify a 12-
month period of stress over the observation horizon in which the
[BANKING ORGANIZATION]'s model-eligible positions would experience the
largest loss, pursuant to policies and procedures approved by the
[AGENCY]. Such policies and procedures must:
(i) Base the identification of the period of stress using either
the full set of risk factors or a reduced set of risk factors;
(ii) Provide that when using a reduced set of risk factors to
identify the period of stress the [BANKING ORGANIZATION] must:
(A) Specify a reduced set of risk factors for which there is a
sufficiently long history of observations that meet requirements of the
risk factor qualitative test specified in Sec. __.214(b)(2) and for
which:
(1) The [BANKING ORGANIZATION] uses data that are reflective of
market prices observed or quoted in the historical stress period used
by the expected shortfall model and sourced from the historical stress
period, when possible;
(2) Where the market prices used for the historical stress period
in the expected shortfall calculation differ from the market prices
actually observed for that period, the [BANKING ORGANIZATION]
empirically justifies the selection of the stress period; and
(3) For model-eligible positions that did not exist during the
historical stress period, the [BANKING ORGANIZATION] demonstrates that
the prices used match changes in the prices or spreads of instruments
that traded during that period and that are similar to the model-
eligible positions;
(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, on
date t, the variation explained equals
[GRAPHIC] [TIFF OMITTED] TP27MR26.223
Where:
(1) ESF,C,h 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 calculated at date h,
which ranges from one day prior to date t to 60 days prior to date
t;
(2) ESR,C,h is the current liquidity horizon-adjusted ES-based
measure using the reduced set of risk factors calculated at date h,
which ranges from one day prior to date t to 60 days prior to date
t; and
(3) Mean(ESF,C) is the mean of ESF,C over the previous 60 business
days.
(iii) Consider 12-month periods going back to, at a minimum, 2007;
(iv) Equally weight observations within the 12-month period; and
(v) Provide for updating, as appropriate, the 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 model-
eligible positions 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)(2)(vi).
(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:
[[Page 15247]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.224
Where:
(1) ESR,C is the liquidity horizon-adjusted ES-based measure for the
[BANKING ORGANIZATION]'s model-eligible positions using the reduced
set of risk factorscalculated 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 liquidity horizon-adjusted ES-based measure for the
[BANKING ORGANIZATION]'s model-eligible positions using the reduced
set of risk factors.
(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.
(9) Empirical correlations. A [BANKING ORGANIZATION] may recognize
empirical correlations within risk classes. Empirical correlations
across risk 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 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 map each of its risk factors to
one of the risk factor categories and corresponding liquidity horizons,
n, in Table 2 to Sec. __.215 and must assign a liquidity horizon of
10, 20, 40, 60, or 120 days to each of its risk factors, in accordance
with the requirements of this paragraph (b)(11).
(i) A [BANKING ORGANIZATION] must assign a liquidity horizon to a
risk factor on a particular trading desk, which must be greater than or
equal to the minimum liquidity horizon corresponding to the value, n,
for the risk factor category in Table 2 to Sec. __.215, 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 to Sec. __.215, 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 to Sec. __.215 of each individual
underlying by its weight in the index and summing the weighted
liquidity horizons across all underlyings.
---------------------------------------------------------------------------
\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 specified by the [AGENCY] under Sec.
__.209(b)(7)(ii).
---------------------------------------------------------------------------
[[Page 15248]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.337
(c) Internally modelled capital calculation. A [BANKING
ORGANIZATION] must calculate an internally modelled capital
calculation, IMCC, on each business day in accordance with the below:
(1) For all model-eligible trading desks, a [BANKING ORGANIZATION]
must include in its internal models used to calculate the aggregate
liquidity horizon-adjusted ES-based measure all modellable risk factors
and type A non-modellable risk factors.
(2) The [BANKING ORGANIZATION] must calculate its aggregate
liquidity horizon-adjusted ES-based measure,
[[Page 15249]]
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 classes held constant) for each risk 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 class ES-based measure. The stress period used to
calculate IMCC(C) and IMCC(Ci) must be the same.
(4) The internally modelled capital calculation, IMCC, must be
calculated as the weighted average of the constrained and unconstrained
ES-based measures as follows:
[GRAPHIC] [TIFF OMITTED] TP27MR26.338
Where:
(i) w equals 0.5;
(ii) i is the index of risk classes, which are the following:
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) Stressed expected shortfall. (1) General. A [BANKING
ORGANIZATION] must calculate a stressed expected shortfall, SES, that
meets 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 conservative as the ES-based measure, as
described in paragraph (b), used for the internally modelled capital
calculation, as described in paragraph (c), provided that:
(A) 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 class,
(B) In determining the stress scenario, a [BANKING ORGANIZATION]
may use proxies, provided the proxies meet the standards in Sec.
__.214(b)(2)(vi),
(C) Methodologies used to calculate any stressed expected shortfall
must address non-linearities, as well as correlation and relevant basis
risks, such as basis risk between credit default swaps and bonds; and
(D) 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)(1) of this section
and (2) 20 days; and
(E) When the [BANKING ORGANIZATION] cannot determine a stress
scenario capital measure for any risk factor under paragraph (d)(1)(i)
of this section, the [BANKING ORGANIZATION] must use the scenario
capital requirement that produces the maximum possible loss for each
risk factor as the stress scenario capital requirement, for purposes of
calculating the stressed expected shortfall.
(ii) Notwithstanding paragraph (d)(i) of this section, with
approval of the [AGENCY], a [BANKING ORGANIZATION] also may use an
alternative approach to determine the stress scenario.
(2) Stressed expected shortfall calculation. A [BANKING
ORGANIZATION] must calculate the stressed expected shortfall, SES, for
all non-modellable risk factors, as follows:
[GRAPHIC] [TIFF OMITTED] TP27MR26.339
Where:
(i) SESNM,k is the stress scenario capital measure for the type A
non-modellable risk factor k;
(ii) K is the number of type A non-modellable risk factors;
(iii) rb is 0.36;
(iv) SESNM,j is the stress scenario capital measure for the type B
non-modellable risk factor j; and
(v) J is the number of type B non-modellable risk factors.
Sec. __.216 [RESERVED]
Sec. __.217 Market Risk Reporting and Disclosures
(a) Scope. Paragraphs (b) through (f) of this section apply to
[BANKING ORGANIZATIONS] subject to the market risk capital requirements
as described in Sec. __.201(b)(1) and paragraphs (b) through (e) and
(g) of this section apply to [BANKING ORGANIZATIONS] subject to the CVA
risk-based capital requirements as described in Sec. __.201(b)(2),
provided that 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 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 paragraphs (f) or (g)
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
[[Page 15250]]
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 and CVA 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) Market risk 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 models-based non-default 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
models-based non-default 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 category;
(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;
(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
[[Page 15251]]
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).
(g) CVA risk disclosures and reports--(1) Risk management-related
disclosure requirements. Except as provided in paragraphs (a) and (d)
of this section, a [BANKING ORGANIZATION] subject to the CVA risk-based
capital requirements as described in Sec. __.201(b)(2) must make the
disclosures described in Tables 1 and 2 to Sec. __.217. 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
F of this part.
[GRAPHIC] [TIFF OMITTED] TP27MR26.340
[GRAPHIC] [TIFF OMITTED] TP27MR26.341
CVA Risk-Based Capital Requirements
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 ineligible 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.
[[Page 15252]]
(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 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);
(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.
(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] TP27MR26.342
Where:
(i) The correlation parameter, [rho], equals 50 percent;
(ii) Sc( ) refers to a summation across all counterparties, c, of
CVA risk covered positions;
(iii) SCVAc is equal to:
[GRAPHIC] [TIFF OMITTED] TP27MR26.226
Where:
(A) a equals:
(1) 1 for counterparties for which the [BANKING ORGANIZATION]
calculates exposure amount under Sec. __.114(e)(4); and
[[Page 15253]]
(2) 1.4 for all other counterparties.
(B) SNS( ) 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, which must be determined
using the same methodology it uses to calculate the exposure amount for
counterparty credit risk for its OTC derivative contracts under Sec.
__.34 or Sec. Sec. __.113 through __.114, as applicable;
[GRAPHIC] [TIFF OMITTED] TP27MR26.225
(F) RWc is the risk weight for counterparty c, based on the sector and
credit quality of the counterparty, as specified in Table 1 to Sec.
__.222.
[GRAPHIC] [TIFF OMITTED] TP27MR26.229
(3) Khedged is calculated as follows:
[GRAPHIC] [TIFF OMITTED] TP27MR26.228
Where:
(i) The correlation parameter, r, is defined in paragraph (a)(2)(i) of
this section;
(ii) Sc( ) 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:
[[Page 15254]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.227
Where:
(A) She( ) 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 to Sec. __.222;
(C) RWh is the risk weight of single-name hedge, h, as prescribed
in Table 1 to Sec. __.222, for the sector and credit quality of the
reference name of the hedge;
[GRAPHIC] [TIFF OMITTED] TP27MR26.232
[GRAPHIC] [TIFF OMITTED] TP27MR26.231
(iv) IH is calculated as follows:
[GRAPHIC] [TIFF OMITTED] TP27MR26.230
Where:
(A) Si( ) refers to a summation across all eligible CVA hedges that are
index hedges, i, that the [BANKING ORGANIZATION] uses to hedge CVA
risk;
(B) RWi is the risk weight of the index hedge, i, as follows:
(1) For an index hedge where all index constituents belong to the same
sector and are of the same credit quality, the value in Table 1 to
Sec. __.222 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 to Sec.
__.222 corresponding to the sectors and credit qualities of the
constituents, multiplied by 0.7;
[[Page 15255]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.234
(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] TP27MR26.233
(b) [Reserved]
Sec. __.223 Requirements for the Standardized Measure for CVA Risk
(a) Eligibility requirements. (1) A [BANKING ORGANIZATION] must
receive 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 determine the EAD for
derivative contracts using the standardized approach for counterparty
credit risk as specified in Sec. __.114; and
(iv) 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.
(2) 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.
(3) 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 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
[[Page 15256]]
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:
[GRAPHIC] [TIFF OMITTED] TP27MR26.343
(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
[[Page 15257]]
weighted delta sensitivities for each risk factor in a bucket, b ,
using the buckets and correlation parameters, rkl, applicable to each
risk class as specified in Sec. __.225(a), as follows:
[GRAPHIC] [TIFF OMITTED] TP27MR26.344
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, gbc,
applicable to each risk class as specified in Sec. __.225(a), as
follows:
[GRAPHIC] [TIFF OMITTED] TP27MR26.345
Where:
(i) Sb is defined for bucket, b, as:
[GRAPHIC] [TIFF OMITTED] TP27MR26.346
(ii) Sc is defined for bucket c as:
[GRAPHIC] [TIFF OMITTED] TP27MR26.347
(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:
[[Page 15258]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.348
(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, rkl, applicable to each risk class
as specified in Sec. __.225(b), as follows:
[GRAPHIC] [TIFF OMITTED] TP27MR26.349
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, for
each bucket in the risk class using the correlation parameters, Ybc,
applicable to each risk class as specified in Sec. __.225(b), as
follows:
[GRAPHIC] [TIFF OMITTED] TP27MR26.350
Where:
(i) Sb is defined for bucket b as:
Sb = max (min ([Sigma]k[egr]b WSk, Kb), -Kb)
(ii) Sc is defined for bucket c as:
Sc = max (min ([Sigma]k[egr]c WSk, Kc), -Kc)
(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:
[[Page 15259]]
(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 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. Sec. __.113 through __.114 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 all 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 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, , 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, ,
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
[[Page 15260]]
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, , must be
calculated by applying the shift of risk factor, , to all index
constituents that depend on this risk factor and recalculating the
aggregate regulatory CVA or the market value of the standardized CVA
hedge.
(7) Notwithstanding paragraph (e)(6) of this section, for credit
and equity indices:
(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 the indices (index risk factors);
(ii) If a [BANKING ORGANIZATION] chooses to introduce such
additional risk factors, a [BANKING ORGANIZATION] must calculate CVA
sensitivities to the index risk factors in addition to sensitivities to
the other index risk factors; and
(iii) For a standardized CVA risk covered position or a
standardized CVA hedge whose underlying is an 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 equity indices where at least 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 credit indices where at least 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
[[Page 15261]]
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 to Sec. __.225.
[GRAPHIC] [TIFF OMITTED] TP27MR26.351
(C) Delta within-bucket correlation parameter for interest rate
risk, specified currencies. The correlation parameters, rkl, related to
the specified currencies are set out in Table 2 to Sec. __.225.
[GRAPHIC] [TIFF OMITTED] TP27MR26.352
(iii) For currencies not specified in paragraph (a)(2)(ii) of this
section:
(A) Delta risk factors for interest rate risk, other currencies.
The delta risk factors for interest rate risk equal the absolute change
of the inflation rate and the parallel shift of the entire risk-free
yield curve for a given currency;
(B) Delta risk weights for interest rate risk, other currencies.
The delta risk weights, RWk, for both the risk-free yield curve and the
inflation rate equal 1.58 percent; and
(C) Delta within-bucket correlation parameter for interest rate
risk, other currencies. The correlation parameter, rkl, between the
risk-free yield curve and the inflation rate equals 40 percent.
(iv) Delta cross-bucket correlation parameter for interest rate
risk. The delta cross-bucket correlation parameter, gbc, 50 percent for
all currency pairs.
(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, gbc, 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 to Sec. __.225. Delta buckets 1 to
7 represent the non-index risk factors and bucket 8 is available for
the optional treatment of indices. Under the optional treatment of
indices, only standardized CVA hedges of counterparty credit spread
risk and reference 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- 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 indices (under the optional treatment of 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 to Sec. __.225. The same risk weight for a given bucket
and given credit quality applies to all tenors.
[[Page 15262]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.353
(iv) Delta within-bucket correlation parameters, rkl, for
counterparty credit spread risk. The delta correlation parameters, rkl,
for counterpart credit spread risk must be defined as follows:
(A) For buckets 1 through 7 of Table 3 to Sec. __.225, a [BANKING
ORGANIZATION] must calculate the correlation parameter, rkl, between
two weighted sensitivities WSk and WSl as follows:
[[Page 15263]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.354
(B) For bucket 8 of Table 3 to Sec. __.225, a [BANKING
ORGANIZATION] must calculate the correlation parameter, , between two
weighted sensitivities and as follows:
[GRAPHIC] [TIFF OMITTED] TP27MR26.355
(v) Delta cross-bucket correlation parameters for counterparty
credit spread risk. The delta cross-bucket correlation parameters, ,
for counterparty credit spread risk are set out in Table 4 to Sec.
__.225.
[[Page 15264]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.356
(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 to Sec. __.225.
(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 to Sec. __.225.
[[Page 15265]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.357
(iv) Delta cross-bucket correlation parameters for reference credit
spread risk. The delta cross-bucket correlation parameter, gbc, for
reference credit spread risk equals:
(A) The cross-bucket correlation parameters, gbc, between buckets
of the same credit quality (where speculative and sub-speculative grade
is treated as one credit quality category) are set out in Table 6 to
Sec. __.225.
[[Page 15266]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.358
(B) The cross-bucket correlation parameters, gbc, between buckets 1
to 14 of different credit quality (where speculative and sub-
speculative grade is treated as one credit quality category), are set
out in Table 7 to Sec. __.225.
[GRAPHIC] [TIFF OMITTED] TP27MR26.359
(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 to Sec. __.225. 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.
[[Page 15267]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.360
(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.
(iii) Delta risk weights for equity risk. The delta risk weights,
RWk, for equity risk are set out in Table 8 to Sec. __.225.
(iv) Delta cross-bucket correlation parameters for equity risk. The
delta cross-bucket correlation parameter, gbc, for equity risk equals
15 percent for all cross-bucket pairs in Table 8 to Sec. __.225
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 in Table 8 to Sec. __.225 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 Sec. __.225.
(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 to Sec.
__.225.
[[Page 15268]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.361
(iv) Delta cross-bucket correlation parameters for commodity risk.
The delta cross-bucket correlation, gbc, for commodity risk equals 20
percent for all cross-bucket pairs in Table 9 to Sec. __.225 assigned
to bucket numbers 1
[[Page 15269]]
to 10 or 12 and zero percent for all cross-bucket pairs that include
bucket 11.
(b) CVA vega capital requirement--(1) Interest rate risk.
(i) Vega buckets for interest rate risk. A [BANKING ORGANIZATION]
must establish a separate vega interest rate risk bucket for each
currency.
(ii) Vega risk factors for interest rate risk. The vega risk
factors for interest rate risk for all currencies equal a simultaneous
relative change of all inflation rate volatilities for each currency
and a simultaneous relative change of all interest rate volatilities
for each currency.
(iii) Vega risk weights for interest rate risk. The vega risk
weights, RWk, for interest rate risk equal 100 percent.
(iv) Vega within-bucket correlation parameters for interest rate
risk. The vega within-bucket correlation parameter, rkl, for interest
rate risk equals 40 percent.
(v) Vega cross-bucket correlation parameter for interest rate risk.
The vega cross-bucket correlation parameter, gbc, for interest rate
risk equals 50 percent for all currency pairs.
(2) Foreign exchange risk--(i) Vega buckets for foreign exchange
risk. A [BANKING ORGANIZATION] must establish a separate vega foreign
exchange risk bucket for each currency, except for a [BANKING
ORGANIZATION]'s own reporting currency.
(ii) Vega risk factors for foreign exchange risk. The vega risk
factors for foreign exchange risk equal the simultaneous, relative
change of all volatilities for the exchange rate between a [BANKING
ORGANIZATION]'s reporting currency or base currency and each other
currency.
(iii) Vega risk weights for foreign exchange risk. The vega risk
weights, , for foreign exchange risk equal 100 percent.
(iv) Vega cross-bucket correlation parameter for foreign exchange
risk. The vega cross-bucket correlation parameter, , 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 Sec. __.225.
(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, , 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, , 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, ,
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, , for equity risk equals 15
percent for all cross-bucket pairs within Table 8 to Sec. __.225 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, in Table 8 to Sec. __.225, 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 are 100 percent.
(iv) Vega cross-bucket correlation parameters for commodity risk.
The vega cross-bucket correlation parameter, , for commodity risk
equals 20 percent for all cross-bucket pairs in Table 9 to Sec. __.225
that fall within bucket numbers 1 to 10 or 12 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 association.
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:
[[Page 15270]]
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 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), and add paragraph (g) to read as follows:
Sec. 3.1 Purpose, applicability, reservations of authority, and
timing.
* * * * *
(c) * * *
(3) * * *
(i) Each national bank or Federal savings association subject to
subpart D of this part must use the methodologies in subpart D (and
subpart F of this part if the national bank or Federal savings
association meets the trading activity threshold to be a market risk
national bank or Federal savings association) to calculate standardized
total risk-weighted assets.
(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 if the national bank or Federal savings
association meets the trading activity threshold to be 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.
(g) Severability. If any provision of this part, or the application
thereof to any person or circumstances, is held invalid, such
invalidity shall not affect the validity of other provisions or the
application of such provision to other persons or circumstances that
can be given effect without the invalid provision or application.
0
3. In Sec. 3.2:
0
a. Revise the definition of ``Adjusted allowances for credit losses
(AACL)'';
0
b. Remove the definitions for ``Advanced approaches national bank or
Federal savings association'', ``Advanced approaches total risk-
weighted assets'', ``Advanced market risk-weighted assets'', and
``Allowances for loan and lease losses (ALLL)'';
0
c. Revise the definition for ``Carrying value'';
0
d. Add, in alphabetical order, the definition for ``Category I national
bank or Federal savings association'';
0
e. Revise the definitions for ``Category II national bank or Federal
savings association'' and ``Category III national bank or Federal
savings association'';
0
f. Add, in alphabetical order, the definition for ``Category IV
national bank or Federal savings association'';
0
g. Revise footnote 3 to the definition for ``Cleared transaction'';
0
h. Revise the definition for ``Commitment'';
0
i. Revise the definition for ``Corporate exposure'';
0
j. Remove the definition for ``Credit-risk-weighted assets'';
0
k. Add, in alphabetical order, the definition for ``CVA risk-weighted
assets'';
0
l. Add, in alphabetical, order the definition for ``Dependent on the
cash flows generated by the real estate'';
0
m. Revise the definition for ``Effective notional amount'';
0
n. Revise the definition for ``Eligible clean-up call'';
0
o. Remove the definition for ``Eligible credit reserves'';
0
p. Revise the definition for ``Eligible guarantee'';
0
q. Add, in alphabetical order, the definition for ``Eligible prepaid
credit protection arrangement'';
0
r. Add, in alphabetical, order the definition for ``Expanded total
risk-weighted assets'';
0
s. Remove the definition for ``Expected credit loss (ECL)'';
0
t. Revise the definition for ``Exposure amount'';
0
u. Revise paragraph (4)(i)(A) in the definition of ``Financial
institution'';
0
v. Revise the definition for ``Market risk national bank or Federal
savings association'';
0
w. Add, in alphabetical, order the definition for ``Market risk-
weighted assets'';
0
x. Revise the definitions for ``Net independent collateral amount'' and
``Netting set'';
0
y. Add, in alphabetical order, the definitions for ``Non-performing
loan securitization (NPL securitization)'' and ``Nonrefundable purchase
price discount (NRPPD)'';
0
z. Revise the definition for ``Non-significant investment in the
capital of an unconsolidated financial institution'';
0
aa. Add, in alphabetical, order the definition for ``Prepaid credit
protection arrangement'';
0
bb. Revise the definition for ``Protection amount (P)'';
0
cc. Add, in alphabetical order, the definition of ``Qualifying cross-
product master netting agreement'';
0
dd. Revise paragraphs (3) and (4) of the definition for ``Qualifying
master netting agreement'';
0
ee. 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 paragraph (2) (as redesignated), remove the words ``family;
and'' and add, in their place, the word ``family.'';
0
ff. Remove the definition for ``Securitization special purpose entity
(securitization SPE)'';
0
gg. Revise the definition for ``Significant investment in the capital
of an unconsolidated financial institution'';
0
hh. Remove the definition for ``Specific wrong-way risk'';
0
ii. Add, in alphabetical order, the definition of ``Specified
supranational entity'';
0
jj. Revise the definitions for ``Speculative grade'' and ``Standardized
market risk-weighted assets'';
0
kk. Revise the definitions for ``Standardized total risk-weighted
assets'', ``Sub-speculative grade'', and ``Synthetic securitization'';
[[Page 15271]]
0
ll. Add, in alphabetical order, the definition for ``Synthetic excess
spread'';
0
mm. Add, in alphabetical order, the definition for ``Total credit risk-
weighted assets'';
0
nn. Revise the definition for ``Traditional securitization'' ;
0
oo. Remove the definition for ``Value-at-risk (VaR)'';
0
pp. Revise the definition for ``Variation margin amount''; and
0
qq. Remove the definition for ``Unconditionally cancelable''.
The additions and revisions read as follows:
Sec. 3.2 Definitions
* * * * *
Adjusted allowances for credit losses (AACL) means valuation
allowances that have been established through a charge against earnings
or retained earnings for expected credit losses on financial assets
measured at amortized cost and a lessor's net investment in leases that
have been established to reduce the amortized cost basis of the assets
to amounts expected to be collected as determined in accordance with
GAAP. For purposes of this part, adjusted allowances for credit losses
include allowances for expected credit losses on off-balance sheet
credit exposures not accounted for as insurance as determined in
accordance with GAAP. Adjusted allowances for credit losses exclude
allocated transfer risk reserves and allowances created that reflect
credit losses on purchased credit deteriorated assets, purchased
seasoned loans, assets required to record an allowance for credit
losses through a gross-up adjustment to the purchase price of the
asset, and available-for-sale debt securities.
* * * * *
Carrying value means, with respect to an asset, the value of the
asset on the balance sheet of the national bank or Federal savings
association as determined in accordance with GAAP. For all assets other
than available-for-sale debt securities, purchased credit deteriorated
assets, purchased seasoned loans, or assets required to record an
allowance for credit losses through a gross-up adjustment to the
purchase price of the asset, the carrying value is not reduced by any
associated credit loss allowance that is determined in accordance with
GAAP.
* * * * *
Category I national bank or Federal savings association means a
national bank or Federal savings association that is a subsidiary of a
global systemically important BHC, as defined pursuant to 12 CFR 252.5.
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-
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 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 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 $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 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 $250
billion. 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 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 Call Report or
[[Page 15272]]
equivalent reporting form, minus the total consolidated assets of the
national bank or Federal savings association, 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 a 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 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. 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 (4)(iii) 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) * *\3\
* * * * *
Commitment means a contractual arrangement under which a national
bank or Federal savings association and an obligor agree to terms
applicable to one or more future extensions of credit, purchases of
assets, or issuances of credit substitutes by the national bank or
Federal savings association, whether or not such arrangement is
unconditionally cancelable. A commitment is unconditionally cancelable
if, by its terms, it either: (a) provides that a national bank or
Federal savings association is not obligated to extend credit, purchase
assets, or issue credit substitutes; or (b) permits a national bank or
Federal savings association, at any time, with or without cause, to
refuse to extend credit, purchase assets, or issue credit substitutes
under the arrangement (to the extent permitted under applicable law).
* * * * *
Corporate exposure means an exposure to a company that is not:
(1) An exposure to a sovereign, a specified supranational entity, 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. 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.
* * * * *
Dependent on the cash flows generated by the real estate means, for
a real estate exposure, 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.
* * * * *
Effective notional amount means for an eligible guarantee, eligible
credit derivative, or eligible prepaid credit protection arrangement,
the lesser of the contractual notional amount of the credit risk
mitigant and the exposure amount of the hedged exposure, multiplied by
the percentage coverage of the credit risk mitigant.
* * * * *
Eligible clean-up call means a clean-up call that:
(1) Is exercisable solely at the discretion of the originating
national bank or Federal savings association or servicer;
(2) Is not structured to avoid allocating losses to securitization
exposures held by investors or otherwise structured to provide credit
enhancement to the securitization; and
(3) Is only exercisable:
(i) For a traditional securitization, when 10 percent or less of
the principal amount of the underlying exposures or securitization
exposures (determined as of the inception of the securitization) is
outstanding;
(ii) For a synthetic securitization, when 10 percent or less of the
principal amount of the reference portfolio of underlying exposures
(determined as of the inception of the securitization) is outstanding;
[[Page 15273]]
(iii) Upon the occurrence of a regulatory event that significantly
changes the risk-weighted asset amount for the securitization exposure
under this part; or
(iv) Upon the occurrence of a tax event that significantly changes
the tax treatment of the securitization exposure under applicable tax
laws.
* * * * *
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 national bank or Federal
savings association, unless the affiliate is an insured depository
institution, foreign bank, securities broker or dealer, or insurance
company that:
(i) Does not control the national bank or Federal savings
association; 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.
* * * * *
Eligible prepaid credit protection arrangement means a prepaid
credit protection arrangement that:
(1) Is written;
(2) Is unconditional;
(3) Covers all or a pro rata portion of all contractual payments
due to be paid on the reference exposure or reference exposures;
(4) Provides that the amount and timing of payments due from the
protection purchaser to the protection provider are incorporated into
the arrangement and the arrangement only allows these terms to change
in the event of a breach of the arrangement by the protection
purchaser;
(5) Provides that entry of the protection provider into
receivership, insolvency, liquidation, conservatorship, or similar
proceeding does not change the amounts or timing of payments due to be
paid by the protection purchaser under the arrangement;
(6) Is legally valid and enforceable under applicable law of the
relevant jurisdictions;
(7) Upon a failure by the obligor on the one or more reference
exposures to make a contractually required payment, or the occurrence
of other credit events as described in the arrangement, allows the
protection purchaser promptly to reduce the outstanding balance of the
initial principal amount due to the protection provider by the loss of
the protection purchaser on the reference exposures without input from
the protection provider; and
(8) Does not increase the protection purchaser's cost of credit
protection in response to deterioration in the credit quality of any of
the reference exposures.
* * * * *
Expanded total risk-weighted assets means:
(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, if applicable; and
(v) CVA risk-weighted assets, if applicable; 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.
* * * * *
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)); a 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, Sec. Sec. 3.113 through 3.115 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.
(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
national bank or Federal savings association has made an AOCI opt-out
election (as defined in Sec. 3.22(b)(2)), the national bank's or
Federal savings association'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 national bank or Federal savings association
has made an AOCI opt-out election (as defined in Sec. 3.22(b)(2)), the
national bank's or Federal savings association'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 national bank's
or Federal savings association's regulatory capital components.
(4) For the off-balance sheet component of an exposure (other than
a 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 a derivative contract (other than a
cleared transaction), the exposure amount determined under Sec. 3.34
or Sec. Sec. 3.113 through 3.114, as applicable.
(6) For an exposure that is a cleared transaction, the exposure
amount determined under Sec. 3.35 or Sec. 3.116, as applicable.
[[Page 15274]]
(7) For an exposure that is an eligible margin loan or repo-style
transaction (other than a cleared transaction) for which the bank
calculates the exposure amount as provided in Sec. 3.37 or Sec. Sec.
3.113 through 3.115, as applicable, the exposure amount determined
under Sec. 3.37 or Sec. Sec. 3.113 through 3.115, 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 institution means:
* * * * *
(4) * * *
(i) * * *
(A) An investment in GAAP equity instruments of the company with an
adjusted carrying value or exposure amount equal to or greater than $10
million, as adjusted pursuant to Sec. 3.4; or
* * * * *
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: a group of transactions with a single
counterparty that are subject to a qualifying master netting agreement.
For derivative contracts, netting set also includes a single derivative
contract between a national bank or Federal savings association and a
single counterparty.
* * * * *
Non-performing loan securitization (NPL securitization) means a
traditional securitization, that is not a resecuritization, where
parameter W (as defined in Sec. 3.133(b)(1)) for the underlying
exposures is greater than or equal to 90 percent at the origination
cut-off date and at any subsequent date on which exposures are added to
or removed from the pool of underlying exposures due to replenishment
or restructuring.
Nonrefundable purchase price discount (NRPPD) means the difference
between the outstanding principal balance of the underlying exposures
at the time of sale and the price at which these exposures are sold by
the originator to a company the activities of which are limited to
those appropriate for the specific purpose of holding the underlying
exposures of a securitization, when neither originator nor the original
lender are reimbursed for this difference. In cases where the
originator underwrites tranches of an NPL securitization for subsequent
sale, the NRPPD may include the differences between the outstanding
principal balance of the underlying exposures at the time of sale and
the price at which all of the 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 of a securitization tranche are not considered.
* * * * *
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 and
outstanding common stock of the unconsolidated financial institution.
* * * * *
Prepaid credit protection arrangement means a contractual
arrangement under which a protection purchaser transfers the credit
risk of one or more reference exposures to a protection provider where:
(1) The protection provider pays an initial principal amount in
cash to the protection purchaser at the inception of the transaction;
and
(2) The protection purchaser is obligated to repay the initial
principal amount to the protection provider on or before the maturity
date of the transaction, less any losses that the protection purchaser
realizes or otherwise recognizes due to nonpayment of all contractual
payments due to be paid on the reference exposure or reference
exposures by the obligors.
* * * * *
Protection amount (P) means, with respect to an exposure hedged by
an eligible guarantee, eligible credit derivative, or eligible prepaid
credit protection arrangement, or secured by financial collateral, the
effective notional amount of the guarantee, credit derivative, or
prepaid credit protection arrangement, or the fair value of the
financial collateral, reduced to reflect any currency mismatch,
maturity mismatch, or lack of restructuring coverage (as provided in
Sec. Sec. 3.36-3.37 or Sec. Sec. 3.120-3.121, as appropriate).
* * * * *
Qualifying cross-product master netting agreement means a
qualifying master netting agreement that provides for termination and
close-out netting across multiple types of financial transactions or
qualifying master netting agreements in the event of a counterparty's
default, provided that the underlying financial transactions are
derivative contracts or repo-style transactions that are not cleared
transactions. In order to treat an agreement as a qualifying cross-
product master netting agreement, a national bank or Federal savings
association must comply with the requirements of Sec. 3.3(c) of this
part with respect to that agreement.
* * * * *
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 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.
* * * * *
[[Page 15275]]
Specified supranational entity means the Bank for International
Settlements, the European Central Bank, the European Commission, the
International Monetary Fund, the European Stability Mechanism, or the
European Financial Stability Facility.
* * * * *
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) The sum of:
(i) Total risk-weighted assets for general credit risk as
calculated under Sec. 3.31;
(ii) Total risk-weighted assets for cleared transactions and
default fund contributions as calculated under Sec. 3.35;
(iii) Total risk-weighted assets for unsettled transactions as
calculated under Sec. 3.38;
(iv) Total risk-weighted assets for securitization exposures as
calculated under Sec. 3.42;
(v) Total risk-weighted assets for equity exposures as calculated
under Sec. 3.52 and Sec. 3.53; and
(vi) For a market risk national bank or federal savings association
only, market risk-weighted assets; less
(2) Any amount of the national bank's or Federal savings
association's 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 securitization means a transaction in which:
(1) All or a portion of the credit risk of one or more underlying
exposures is retained or transferred to one or more third parties
through the use of one or more credit derivatives, or guarantees (other
than a guarantee that transfers only the credit risk of an individual
retail exposure) or prepaid credit protection arrangements;
(2) The credit risk associated with the underlying exposures has
been separated into at least two tranches reflecting different levels
of seniority;
(3) Performance of the securitization exposures depends solely upon
the performance of the underlying exposures; and
(4) All or substantially all of the underlying exposures are
financial exposures with credit risk (such as loans, commitments,
credit derivatives, guarantees, receivables, asset-backed securities,
mortgage-backed securities, other debt securities, or equity
securities).
* * * * *
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. 3.116;
(3) Total risk-weighted assets for unsettled transactions as
calculated under Sec. 3.117; and
(4) Total risk-weighted assets for securitization exposures as
calculated under Sec. 3.132.
* * * * *
Traditional securitization means a transaction in which:
(1) All or a portion of the credit or equity risk of one or more
underlying exposures is transferred to one or more third parties other
than through the use of credit derivatives, guarantees, or prepaid
credit protection arrangements;
(2) The credit risk associated with the underlying exposures has
been separated into at least two tranches reflecting different levels
of seniority;
(3) Performance of the securitization exposures depends solely upon
the performance of the underlying exposures;
(4) All or substantially all of the underlying exposures are
financial exposures (such as loans, commitments, credit derivatives,
guarantees, receivables, asset-backed securities, mortgage-backed
securities, other debt securities, or equity securities);
(5) The underlying exposures are not owned by an operating company;
(6) The underlying exposures are not owned by a small business
investment company defined in section 302 of the Small Business
Investment Act;
(7) The underlying exposures are not owned by a firm an investment
in which qualifies as a community development investment under section
24(Eleventh) of the National Bank Act;
(8) The OCC may determine that a transaction in which the
underlying exposures are owned by an investment firm that exercises
substantially unfettered control over the size and composition of its
assets, liabilities, and off-balance sheet exposures is not a
traditional securitization based on the transaction's leverage, risk
profile, or economic substance;
(9) The OCC may deem a transaction that meets the definition of a
traditional securitization, notwithstanding paragraph (5), (6), or (7)
of this definition, to be a traditional securitization based on the
transaction's leverage, risk profile, or economic substance; and
(10) The transaction is not:
(i) An investment fund;
(ii) A collective investment fund (as defined in 12 CFR 9.18
(national banks), 12 CFR 151.40 (Federal saving associations));
(iii) An employee benefit plan (as defined in paragraphs (3) and
(32) of section 3 of ERISA), a ``governmental plan'' (as defined in 29
U.S.C. 1002(32)) that complies with the tax deferral qualification
requirements provided in the Internal Revenue Code, or any similar
employee benefit plan established under the laws of a foreign
jurisdiction;
(iv) A synthetic exposure to the capital of a financial institution
to the extent deducted from capital under Sec. 3.22; or
(v) Registered with the SEC under the Investment Company Act of
1940 (15 U.S.C. 80a-1) or foreign equivalents thereof.
* * * * *
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.
* * * * *
[[Page 15276]]
Footnotes--3.2
\3\ 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 treatment of these exposures under
subpart E, see Sec. 3.113.
* * * * *
0
4. In Sec. 3.3, revise paragraph (c) to read as follows:
Sec. 3.3 Operational requirements for counterparty credit risk.
* * * * *
(c) Qualifying cross-product master netting agreement. In order to
recognize an agreement as a qualifying cross-product master netting
agreement as defined in Sec. 3.2, a national bank or Federal savings
association must obtain a written legal opinion verifying the validity
and enforceability of the agreement under applicable law of the
relevant jurisdictions if the counterparty fails to perform upon an
event of default, including upon receivership, insolvency, liquidation,
or similar proceeding.
* * * * *
0
5. Add a new section Sec. 3.4 to read as follows:
Sec. 3.4 Threshold Indexing.
(a) Methodology. The dollar thresholds specified in paragraph (c)
of this section shall be adjusted by multiplying the baseline threshold
values specified in paragraph (c) of this section by one plus the
cumulative percent change in the non-seasonally adjusted Consumer Price
Index for Urban Wage Earners and Clerical Workers, measured from the
effective date of this rule, as further described in paragraph (b) of
this section, and shall be rounded in accordance with paragraph (d) of
this section.
(b) Frequency. (1) In general--biennial adjustments. Except as
otherwise provided in paragraph (b)(2) and (b)(3) of this section, the
adjustments described in paragraph (a) of this section shall be
effective on October 1 following each consecutive two year period
ending August 30, and using the non-seasonally adjusted Consumer Price
Index for Urban Wage Earners and Clerical Workers as of August 30 of
that year.
(2) Off-year adjustments. In the event that the OCC determines,
during a year where no adjustment would be made under paragraph (b)(1),
that the non-seasonally adjusted Consumer Price Index for Urban Wage
Earners and Clerical Workers, measured over the twelve month period
ending August 30 of that year, is such that an adjustment under this
section would be appropriate for that year, the OCC may make an
adjustment under this section for that year.
(3) Periods of negative inflation. Notwithstanding paragraph (b)(1)
or (b)(2) of this section, if an adjustment of dollar thresholds using
the cumulative percent change of the non-seasonally adjusted Consumer
Price Index for Urban Wage Earners and Clerical Workers from the
effective date of this rule or the most recent adjustment, as
applicable, would not result in an increase from the current dollar
thresholds, no adjustment will be made pursuant to paragraph (a) of
this section.
(c) Specified thresholds. The thresholds in the following sections
shall be adjusted in accordance with paragraph (a) of this section
relative to the baseline threshold values as specified below.
(1) Sec. 3.2, definition of Financial institution, paragraph
(4)(i)(A), baseline threshold value $10 million;
(2) Sec. 3.101, definition of Regulatory retail exposure,
paragraph (2), baseline threshold value $1 million;
(3) Sec. 3.101, definition of Small or medium-sized entity (SME),
baseline threshold value $50 million;
(4) Sec. 3.150(b)(1), baseline threshold value $1 billion;
(5) Sec. 3.150(b)(2), baseline threshold values $1 billion, $30
billion, and $120 million;
(6) Sec. 3.150(b)(2)(i), baseline threshold value $1 billion;
(7) Sec. 3.150(b)(3), baseline threshold values $30 billion and
$4.47 billion
(8) Sec. 3.150(b)(3)(i), baseline threshold value $30 billion;
(9) Sec. 3.150(d)(2)(i)(A), baseline threshold value $20,000;
(10) Sec. 3.201(b)(1)(ii)(B), baseline threshold value $5 billion;
(11) Sec. 3.201(b)(2)(ii), baseline threshold value $1 trillion;
(12) Sec. 3.202 ``Large market cap'', baseline threshold value $2
billion;
(13) Sec. 3.202, ``Market risk covered position'' (1)(ii)(D),
baseline value $20 million;
(14) Sec. 3.202, ``Small market cap'', baseline threshold value $2
billion.
(d) Rounding. When adjusting thresholds under this section, each
threshold shall be rounded based on the size of the threshold (e.g.,
thousands, millions, billions) to the nearest number with two
significant digits.
(e) Effective date of threshold adjustments. The OCC shall announce
the thresholds adjusted in accordance with this section by publication
in the Federal Register. Such adjusted thresholds shall be effective on
October 1 of the year during which an adjustment is made.
(f) Failure to publish in the Federal Register. In the event, for
any reason, the thresholds adjusted in accordance with this section are
not published in the Federal Register in a year in which an adjustment
is made under this section, the thresholds specified in paragraph (c)
of this section will adjust as provided in this section and be
effective on October 1, notwithstanding the lack of publication in the
Federal Register.
* * * * *
0
6. Add a new section Sec. 3.5 to read as follows:
Sec. 3.5 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 12 CFR part
34, appendix A to subpart D, that secures the extension of credit,
subject to the following:
(i) For exposures subject to 12 CFR part 34, subpart C, the market
value of property is a valuation that meets all requirements of that
rule.
(ii) For exposures not subject to 12 CFR part 34, subpart C:
(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 national
bank's or Federal savings association'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
[[Page 15277]]
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 OCC requires a national bank or Federal savings association
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 12 CFR part 34, appendix A to subpart D, must be
appropriately discounted by the national bank or Federal savings
association consistent with the national bank's or Federal savings
association's usual practices for making loans secured by such
collateral.
* * * * *
0
7. In Sec. 3.10:
0
a. Revise paragraph (a)(1)(v);
0
b. Revise paragraph (b);
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. 3.10 Minimum capital requirements.
(a) * * *
(1) * * *
(v) For a Category I national bank or Federal savings association,
a Category II national bank or Federal Savings association, and a
Category III national bank or Federal savings association, a
supplementary leverage ratio of 3 percent.
* * * * *
(b) Standardized capital ratio calculations. For a national bank or
Federal savings association that is not a Category I national bank or
Federal savings association or a Category II national bank or Federal
savings association:
(1) Common equity tier 1 capital ratio. The national bank's or
Federal savings association's common equity tier 1 capital ratio is the
ratio of the national bank's or Federal savings association's common
equity tier 1 capital to selected total risk-weighted assets;
(2) Tier 1 capital ratio. The national bank's or Federal savings
association's tier 1 capital ratio is the ratio of the national bank's
or Federal savings association's tier 1 capital to selected total risk-
weighted assets;
(3) Total capital ratio. The national bank's or Federal savings
association's total capital ratio is the ratio of the national bank's
or Federal savings association's total capital to selected total risk-
weighted assets; and
(4) Leverage ratio. The national bank's or Federal savings
association's leverage ratio is the ratio of the national bank's or
Federal savings association's tier 1 capital to the national bank's or
Federal savings association's average total consolidated assets as
reported on the national bank's or Federal savings association's Call
Report, minus amounts deducted from tier 1 capital under Sec. 3.22(a),
(c) and (d).
(5) Selected total risk-weighted assets. A national bank's or
Federal savings association's selected total risk-weighted assets is
either the national bank's or Federal savings association's
standardized total risk-weighted assets or expanded total risk-weighted
assets, as selected by the national bank or Federal savings
association. A national bank or Federal savings association may change
its choice for selected total risk-weighted assets by providing the OCC
with prior notice of the change at least four full calendar quarters
before the calendar quarter in which the change will take effect.
(c) Supplementary leverage ratio. (1) The supplementary leverage
ratio of a Category I national bank or Federal savings association, a
Category II national bank or Federal Savings association, or a Category
III national bank or Federal savings association 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 custody bank:
(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, for a national bank or Federal savings
association that uses the Standardized approach for counterparty credit
risk (SA-CCR) Sec. 3.114 for its standardized total risk-weighted
assets or expanded total risk-weighted assets, less the fair value of
any derivative contracts;
(ii) (A) For a national bank or Federal savings association that
uses the current exposure methodology under Sec. 3.34(b) for its
standardized total risk-weighted assets, the potential future credit
exposure (PFE) for each derivative contract or each single-product
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 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), to
which the national bank or Federal savings association is a
counterparty as determined under Sec. 3.34, but without regard to
Sec. 3.34(c), provided that:
(1) 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. 3.34, but without regard to Sec. 3.34(c), provided that it
does not adjust the net-to-gross ratio (NGR); and
(2) A national bank or Federal savings association that chooses to
exclude the PFE of credit derivatives or other similar instruments
through which it provides credit protection pursuant to paragraph
(c)(2)(ii)(A) of this section must do so consistently over time for the
calculation of the PFE for all such instruments; or
(B) (1) For a national bank or Federal savings association that
uses SA-CCR under Sec. 3.114 for its standardized total risk-weighted
assets or expanded total risk-weighted assets, the PFE under SA-CCR for
each derivative contract or single product netting set to which the
national bank or Federal savings association is a counterparty
(including cleared transactions except as provided in paragraph
(c)(2)(ix) of this section and, at the discretion of the national
[[Page 15278]]
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. 3.114(g), in which the term C in Sec. 3.114(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.
3.114(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
(2) 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. 3.114, provided that it does so consistently over time for
the calculation of the PFE for all such instruments;
(iii)(A)(1) For a national bank or Federal savings association that
uses the current exposure methodology under Sec. 3.34(b) for its
standardized total risk-weighted assets, the amount of cash collateral
that is received from a counterparty to a derivative contract and that
has offset the mark-to-fair value of the derivative asset, or cash
collateral that is posted to a counterparty to a derivative contract
and that has reduced the national bank's or Federal savings
association's on-balance sheet assets, unless such cash collateral is
all or part of variation margin that satisfies the conditions in
paragraphs (c)(2)(iii)(C) through (G) of this section; and
(2) The variation margin is used to reduce the current credit
exposure of the derivative contract, calculated as described in Sec.
3.34(b), and not the PFE; and
(3) For the purpose of the calculation of the NGR described in
Sec. 3.34(b)(2)(ii)(B), variation margin described in paragraph
(c)(2)(iii)(A)(2) of this section may not reduce the net current credit
exposure or the gross current credit exposure; or
(B)(1) For a national bank or Federal savings association that uses
Standardized approach for derivative contracts under Sec. 3.114 for
its standardized total risk-weighted assets or expanded total risk-
weighted assets, the replacement cost under Sec. 3.114 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)(ix) 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)(C) through (G) 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)(C) through (G) 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 national bank or Federal savings association must apply
the formula for replacement cost provided in Sec. 3.114(j)(1), in
which the term CMA may only include cash collateral that satisfies the
conditions in paragraphs (c)(2)(iii)(C) through (G) of this section;
and
(3) For purposes of paragraph (c)(2)(iii)(A)(1) 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. 3.114(e)(6);
(C) 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);
(D) Variation margin is calculated and transferred on a daily basis
based on the mark-to-fair value of the derivative contract;
(E) 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;
(F) 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)(F), 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
(G) 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;
(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
[[Page 15279]]
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:
(A) For a national bank or Federal savings association that elects
to calculate its standardized total risk-weighted assets under Sec.
3.10(b), the applicable credit conversion factor under Sec. 3.33(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; or
(B) For a national bank or Federal savings association that elects
to
[[Page 15280]]
calculate its expanded total risk-weighted assets under Sec. 3.10(b),
a Category I national bank or Federal savings association, or a
Category II national bank or Federal savings association, the
applicable credit conversion factor under Sec. 3.112(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 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) 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;
(E) Notwithstanding paragraphs (c)(2)(ix)(A) through (C) of this
section, 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; and
(F) Notwithstanding paragraph (c)(2)(ix)(A), a national bank or
Federal savings association that has elected under Sec. 3.113(c) to
treat any repo-style transactions subject to a qualifying cross-product
master netting agreement as derivative contracts must treat any such
repo-style transactions as a derivative contract for purposes of this
paragraph (c).
(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. A Category I national bank
or Federal savings association, or a Category II national bank or
Federal savings association, or a national bank or Federal savings
association that elects to use expanded total risk-weighted assets for
purposes of Sec. 3.10(a)(5) must determine its regulatory capital
ratios as described in paragraphs (d)(1) through (4) of this section.
(1) Common equity tier 1 capital ratio. The national bank's or
Federal savings association's common equity tier 1 capital ratio is the
ratio of the national bank's or Federal savings association's common
equity tier 1 capital to expanded total risk-weighted assets;
(2) Tier 1 capital ratio. The national bank's or Federal savings
association's tier 1 capital ratio is the ratio of the national bank's
or Federal savings association's tier 1 capital to expanded total risk-
weighted assets;
(3) Total capital ratio. The national bank's or Federal savings
association's total capital ratio is the ratio of the national bank's
or Federal savings association's total capital to expanded total risk-
weighted assets; and
(4) Leverage ratio. The national bank's or Federal savings
association's leverage ratio is the ratio of the national bank's or
Federal savings association's tier 1 capital to the national bank's or
Federal savings association's average total consolidated assets as
reported on the national bank's or Federal savings association's Call
Report, minus amounts deducted from tier 1 capital under Sec. 3.22(a),
(c) and (d).
* * * * *
0
8. In Sec. 3.11, revise paragraphs (a)(2)(iv), (b)(1), (b)(1)(ii), and
(b)(1)(iii) to read as follows:
Sec. 3.11 Capital conservation buffer and countercyclical capital
buffer amount.
* * * * *
(a) * * *
(2) * * *
(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, a specified supranational entity, a MDB, a PSE, or a
GSE.
* * * * *
(b) * * *
(1) General. A Category I or Category II national bank or Federal
savings association, and a Category III national bank or Federal
savings association, must calculate a countercyclical capital buffer
amount in accordance with paragraphs (b)(1)(i) through (iv) of this
section for purposes of determining its maximum payout ratio under
Table 1 to this section.
(i) * * *
(ii) Amount. A Category I or Category II national bank or Federal
savings association, and a Category III national bank or Federal
savings association, 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
9. In Sec. 3.12, revise paragraph (a)(2) and remove paragraph (a)(4).
The revision reads as follows:
[[Page 15281]]
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 Category I national bank or Federal savings association, or a
Category II national bank or savings association, and that satisfies
all of the following criteria:
* * * * *
0
10. In Sec. 3.20, revise paragraphs (c)(1)(xiv) and (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 Category I national bank or Federal savings
association, or a Category II national bank or Federal savings
association, or a national bank or Federal savings association that
uses expanded total risk-weighted assets for purposes of Sec.
3.10(a)(5), the governing agreement, offering circular, or prospectus
of an instrument issued after the date upon which the national bank or
Federal savings association becomes a Category I national bank or
Federal savings association, or a Category II national bank or Federal
savings association, or a national bank or Federal savings association
that uses expanded total risk-weighted assets for purposes of Sec.
3.10(a)(5), 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.
* * * * *
(d) * * *
(1) * * *
(xi) For a Category I national bank or Federal savings association,
a Category II national bank or Federal savings association, or a
national bank or Federal savings association that uses expanded total
risk-weighted assets for purposes of Sec. 3.10(a)(5), the governing
agreement, offering circular, or prospectus of an instrument issued
after the date on which the national bank or Federal savings
association becomes a Category I national bank or Federal savings
association, or a Category II national bank or Federal savings
association, or a national bank or Federal savings association that
uses expanded total risk-weighted assets for purposes of Sec.
3.10(a)(5), 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) AACL up to 1.25 percent of a national bank's or Federal savings
association's standardized total risk-weighted assets or total credit
risk-weighted assets, as applicable, not including any amount of AACL
(and excluding, in the case of a market risk national bank or Federal
savings association, its market risk weighted assets).
* * * * *
0
11. 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 ``Category I national bank or Federal savings association,
Category II national bank or Federal savings association, or national
bank or Federal savings association that uses expanded total risk-
weighted assets for purposes of Sec. 3.10(a)(5)'';
0
b. Revise paragraph (b):
The revision reads as follows:
Sec. 3.21 Minority interest.
* * * * *
(b)(1) Applicability. For purposes of Sec. 3.20, a Category I
national bank or Federal savings association, a Category II national
bank or Federal savings association or a national bank or Federal
savings association that uses expanded total risk-weighted assets for
purposes of Sec. 3.10(a)(5), is subject to the minority interest
limitations in this paragraph (b) if:
(i) A consolidated subsidiary of the national bank or Federal
savings association has issued regulatory capital that is not owned by
the national bank or federal savings association; 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 national
bank or Federal savings association, the national bank or Federal
savings association must assume that the capital adequacy standards of
the national bank or Federal savings association apply to the
subsidiary.
(3) Common equity tier 1 minority interest includable in the common
equity tier 1 capital of the national bank or Federal savings
association. For each consolidated subsidiary of a national bank or
Federal savings association, the amount of common equity tier 1
minority interest the national bank or Federal savings association 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 national bank or Federal savings
association, 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. 3.11 or equivalent standards established by the
subsidiary's home country supervisor; or
(B)(1) The expanded total risk-weighted assets of the national bank
or Federal savings association 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. 3.11 or equivalent standards established by the
subsidiary's home country supervisor.
(4) Tier 1 minority interest includable in the tier 1 capital of
the national bank or Federal savings association. For each consolidated
subsidiary of the national bank or Federal savings association, the
amount of tier 1 minority interest the national bank or Federal savings
association 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 national bank or Federal savings association 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. 3.11 or equivalent standards established by the subsidiary's home
country supervisor, or
(B)(1) The expanded total risk-weighted assets of the national bank
or
[[Page 15282]]
Federal savings association 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. 3.11 or equivalent standards established by the subsidiary's home
country supervisor.
(5) Total capital minority interest includable in the total capital
of the national bank or Federal savings association. For each
consolidated subsidiary of the national bank or Federal savings
association, the amount of total capital minority interest the national
bank or Federal savings association 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 national bank or Federal savings association 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. 3.11 or equivalent standards established by the subsidiary's home
country supervisor, or
(B) (1) The expanded total risk-weighted assets of the national
bank or Federal savings association 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. 3.11 or equivalent standards established by the subsidiary's home
country supervisor.
* * * * *
0
12. In Sec. 3.22:
0
a. Revise paragraphs (a)(1) and (a)(4);
0
b. Remove paragraph (a)(6);
0
c. Redesignate paragraph (a)(7) as new paragraph (a)(6), and
redesignate paragraph (a)(8) and the new paragraph (a)(7);
0
d. In paragraph (b)(2)(i) and (b)(2)(iv), remove the words ``an
advanced approaches national bank or Federal savings association'' and
add in their place the words ``a Category I national bank or Federal
savings association, a Category II national bank or Federal savings
association, or a national bank or Federal savings association that
uses expanded total risk-weighted assets for purposes of Sec.
3.10(a)(5),'';
0
e. Revise paragraph (b)(2)(ii);
0
f. In paragraph (b)(2)(iii) and (b)(2)(iv), remove the words ``an
advanced approaches national bank or Federal savings association'' and
add in their place the words ``a Category I national bank or Federal
savings association or a Category II national bank or Federal savings
association or a national bank or Federal savings association that uses
expanded total risk-weighted assets for purposes of Sec. 3.10(a)(5)'';
0
g. In footnote 21, in paragraph (b)(2)(iii), remove the words ``12 CFR
part 225 (Board); 12 CFR part 325, and 12 CFR part 390'' and add in
their place ``12 CFR part 217 (Board); and 12 CFR part 325 (FDIC)'';
0
h. In footnote 22, in paragraph (b)(2)(iv)(A), remove the words ``12
CFR part 225 (Board); 12 CFR part 325, and 12 CFR part 390'' and add in
their place ``12 CFR part 217 (Board); and 12 CFR part 325 (FDIC)'';
0
i. In footnote 23, in paragraph (c), remove the words ``ALLL or AACL,
as applicable,'' and add in its places ``AACL'';
0
j. Revise paragraphs (c)(2);
0
k. In paragraph (c)(4), remove the words ``an advanced approaches
national bank or Federal savings association'' and replace them with a
Category I national bank or Federal savings association or a Category
II national bank or Federal savings association or a national bank or
Federal savings association that uses expanded total risk-weighted
assets for purposes of Sec. 3.10(a)(5);
0
l. Revise paragraphs (c)(5)(i) through (iv);
0
m. Revise paragraphs (c)(6);
0
n. Revise paragraph (d)(1).
0
o. Remove and reserve paragraph (d)(1)(iii);
0
p. Revise paragraph (d)(2);
0
q. Revise paragraph (f); and
0
r. Revise paragraph (g).
The revisions 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) Any gain-on-sale in connection with a securitization
exposure; and
(ii) For a Category I national bank or Federal savings association
or a Category II national bank or Federal savings association or a
national bank or Federal savings association that uses expanded total
risk-weighted assets for purposes of Sec. 3.10(a)(5), the portion of
any CEIO that does not constitute an after-tax gain-on-sale;
* * * * *
(b) * * *
(2) * * *
(i) A national bank or Federal savings association that is not a
Category I national bank or Federal savings association, or a Category
II national bank or Federal savings association, or a national bank or
Federal savings association that uses expanded total risk-weighted
assets for purposes of Sec. 3.10(a)(5), 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 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 a
Category I national bank or Federal savings association, a Category II
national bank or Federal savings association, or a national bank or
Federal savings association that uses expanded total risk-weighted
assets for purposes of Sec. 3.10(a)(5) 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 a Category I national bank or Federal
savings association, a Category II
[[Page 15283]]
national bank or Federal savings association, or a national bank or
Federal savings association that used expanded total risk-weighted
assets for purposes of Sec. 3.10(a)(5), the national bank or Federal
savings association may not make an AOCI opt-out election under this
paragraph (b)(2)(ii).
* * * * *
* * * * *
(c) * * * 23
(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 Category I national bank or Federal savings
association, a Category II national bank or Federal savings
association, and a national bank or Federal savings association that
uses expanded total risk-weighted assets for purposes of Sec.
3.10(a)(5) also must deduct an investment in the national bank's or
Federal savings association's own covered debt instruments, as follows:
* * * * *
(iv) A Category I national bank or Federal savings association or a
Category II national bank or Federal savings association or a national
bank or Federal savings association that uses expanded total risk-
weighted assets for purposes of Sec. 3.10(a)(5) 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 national bank or Federal savings
association 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 a Category I
national bank or Federal savings association, or a Category II national
bank or Federal savings association, or a national bank or Federal
savings association that uses expanded total risk-weighted assets for
purposes of Sec. 3.10(a)(5) (as described in paragraph (c)(4) of this
section), non-significant investments in the capital of unconsolidated
financial institutions for a Category I national bank or Federal
savings association, or a Category II national bank or Federal savings
association, or a national bank or Federal savings association that
uses expanded total risk-weighted assets for purposes of Sec.
3.10(a)(5) (as described in paragraph (c)(5) of this section), and non-
common stock significant investments in the capital of unconsolidated
financial institutions for a Category I national bank or Federal
savings association or a Category II national bank or Federal savings
association or a national bank or Federal savings association that uses
expanded total risk-weighted assets for purposes of Sec. 3.10(a)(5)
(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 Category I national bank or Federal savings association
or a Category II national bank or Federal savings association or a
national bank or Federal savings association that uses expanded total
risk-weighted assets for purposes of Sec. 3.10(a)(5), a tier 2 capital
instrument if it is a covered debt instrument.
* * * * *
(3) * * *
(ii) A Category I national bank or Federal savings association or a
Category II national bank or Federal savings association or a national
bank or Federal savings association that uses expanded total risk-
weighted assets for purposes of Sec. 3.10(a)(5) 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 a Category I national bank or Federal savings association or a
Category II national bank or Federal savings association or a national
bank or Federal savings association that uses expanded total risk-
weighted assets for purposes of Sec. 3.10(a)(5) 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.\24\ 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.\25\
(5) * * *
(i) A Category I national bank or Federal savings association or a
Category II national bank or Federal savings association or a national
bank or Federal savings association that uses expanded total risk-
weighted assets for purposes of Sec. 3.10(a)(5) 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.\26\ The deductions described in this
paragraph
[[Page 15284]]
are net of associated DTLs in accordance with paragraph (e) of this
section. In addition, with the prior written approval of the OCC, a
Category I national bank or Federal savings association or a Category
II national bank or Federal savings association or a national bank or
Federal savings association that uses expanded total risk-weighted
assets for purposes of Sec. 3.10(a)(5) 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.\27\ For
any calculation under this paragraph (c)(5)(i), a Category I national
bank or Federal savings association or a Category II national bank or
Federal savings association or a national bank or Federal savings
association that uses expanded total risk-weighted assets for purposes
of Sec. 3.10(a)(5) 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 Category I national bank or Federal savings association
or a Category II national bank or Federal savings association or a
national bank or Federal savings association that uses expanded total
risk-weighted assets for purposes of Sec. 3.10(a)(5), 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-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 Category II national bank or Federal
savings association, or a national bank or Federal savings association
that uses expanded total risk-weighted assets for purposes of Sec.
3.10(a)(5), 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.
(iv) Prior to applying the deduction under paragraph (c)(5)(i) of
this section:
(A) A Category I national bank or Federal savings association may
designate any investment in a covered debt instrument as an excluded
covered debt instrument, as defined in Sec. 3.2.
(B) A Category I national bank or Federal savings association must
deduct, according to the corresponding deduction approach in paragraph
(c)(2) of this section, its gross long position, calculated in
accordance with paragraph (h)(2) of this section, in a covered debt
instrument that was originally designated as an excluded covered debt
instrument, in accordance with paragraph (c)(5)(iv)(A) of this section,
but no longer qualifies as an excluded covered debt instrument.
(C) A Category I national bank or Federal savings association must
deduct according to the corresponding deduction approach in paragraph
(c)(2) of this section the amount of its gross long position,
calculated in accordance with paragraph (h)(2) of this section, in a
direct or indirect investment in a covered debt instrument that was
originally designated as an excluded covered debt instrument, in
accordance with paragraph (c)(5)(iv)(A) of this section, and has been
held for more than thirty business days.
(D) A Category I national bank or Federal savings association must
deduct according to the corresponding deduction approach in paragraph
(c)(2) of this section its gross long position, calculated in
accordance with paragraph (h)(2) of this section, of its aggregate
position in excluded covered debt instruments that exceeds 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
Category I national bank or Federal savings association, or a Category
II national bank or Federal savings association, or a national bank or
Federal savings association that uses expanded total risk-weighted
assets for purposes of Sec. 3.10(a)(5) 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.\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 OCC,
for the period of time stipulated by the OCC, a Category I national
bank or Federal savings association or a Category II national bank or
Federal savings association or a national bank or Federal savings
association that uses expanded total risk-weighted assets for purposes
of Sec. 3.10(a)(5) 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) Certain DTAs subject to common equity tier 1 capital deduction
thresholds.
(1) A national bank or Federal savings association that is not a
Category I national bank or Federal savings association, or a Category
II national bank or Federal savings association, or a national bank or
Federal savings association that uses expanded total risk-weighted
assets for purposes of Sec. 3.10(a)(5) must make deductions from
regulatory capital as described in this paragraph (d)(1).
* * * * *
(2) A Category I national bank or Federal savings association, or a
[[Page 15285]]
Category II national bank or Federal savings association, or a national
bank or Federal savings association that uses expanded total risk-
weighted assets for purposes of Sec. 3.10(a)(5) must make deductions
from regulatory capital as described in this paragraph (d)(2).
(i) A Category I national bank or Federal savings association, or a
Category II national bank or Federal savings association, or a national
bank or Federal savings association that uses expanded total risk-
weighted assets for purposes of Sec. 3.10(a)(5) 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 Category I
national bank or Federal savings association or a Category II national
bank or Federal savings association or a national bank or Federal
savings association that uses expanded total risk-weighted assets for
purposes of Sec. 3.10(a)(5) 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) 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 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 Category I national bank or
Federal savings association, or a Category II national bank or Federal
savings association, or a national bank or Federal savings association
that uses expanded total risk-weighted assets for purposes of Sec.
3.10(a)(5) 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 Category I national bank or Federal savings association, or
a Category II national bank or Federal savings association, or a
national bank or Federal savings association that uses expanded total
risk-weighted assets for purposes of Sec. 3.10(a)(5) 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.\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
Category I national bank or Federal savings association or a Category
II national bank or Federal savings association or a national bank or
Federal savings association that uses expanded total risk-weighted
assets for purposes of Sec. 3.10(a)(5) may exclude DTAs and DTLs
relating to adjustments made to common equity tier 1 capital under
paragraph (b) of this section. A Category I national bank or Federal
savings association or a Category II national bank or Federal savings
association or a national bank or Federal savings association that uses
expanded total risk-weighted assets for purposes of Sec. 3.10(a)(5)
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 Category I national bank or Federal savings
association or a Category II national bank or Federal savings
association or a national bank or Federal savings association that uses
expanded total risk-weighted assets for purposes of Sec. 3.10(a)(5)
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 Category I
national bank or Federal savings association, or a Category II national
bank or Federal savings association, or a national bank or Federal
savings association that uses expanded total risk-weighted assets for
purposes of Sec. 3.10(a)(5) 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.
* * * * *
Footnotes--3.22
* * * * *
\23\ 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
[[Page 15286]]
AACL includable in tier 2 capital under Sec. 3.20(d)(3).
\24\ 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.
\25\ 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.
\26\ With the prior written approval of the OCC, for the period
of time stipulated by the OCC, a Category I national bank or Federal
savings association or a Category II national bank or Federal
savings association or a national bank or Federal savings
association that uses expanded total risk-weighted assets for
purposes of Sec. 3.10(a)(5) 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.
\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 OCC, for the period of
time stipulated by the OCC, a Category I national bank or Federal
savings association or a Category II national bank or Federal
savings association or a national bank or Federal savings
association that uses expanded total risk-weighted assets for
purposes of Sec. 3.10(a)(5) 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.
* * * * *
\30\ With the prior written approval of the OCC, for the period
of time stipulated by the OCC, a Category I national bank or Federal
savings association or a Category II national bank or Federal
savings association or a national bank or Federal savings
association that uses expanded total risk-weighted assets for
purposes of Sec. 3.10(a)(5) 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.
\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
Category I national bank or Federal savings association or the
Category II national bank or Federal savings association or a
national bank or Federal savings association that uses expanded
total risk-weighted assets for purposes of Sec. 3.10(a)(5) and
assigned the appropriate risk weight for the investment under
subpart E of this part for purposes of expanded total risk-weighted
assets.
* * * * *
0
13. In Sec. 3.30
0
a. Revise paragraph (a);
0
b. In paragraph (b), remove the words ``covered positions'' and add in
their place the words ``market risk covered positions''.
The revisions read as follows:
Sec. 3.30 Applicability.
(a) This subpart sets forth methodologies for determining
standardized total risk-weighted assets. This subpart applies to any
national bank or Federal savings association that elects to use this
subpart under Sec. 3.10(b).
* * * * *
0
14. In Sec. 3.34, revise paragraph (a) to read as follows:
Sec. 3.34 Derivative contracts.
(a) Exposure amount for derivative contracts. A national bank or
Federal savings association 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)(2) of this section.
(2) 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. 3.114 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. 3.116 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.
* * * * *
0
15. Revise Sec. 3.35(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 has
elected to use SA-CCR under Sec. 3.34(a), must apply Sec. 3.116 to
its derivative contracts that are cleared transactions rather than this
section.
* * * * *
Sec. 3.37 [Amended]
0
16. In Sec. 3.37, revise paragraph (c)(1) to read as follows:
(c) Collateral haircut approach--(1) General. A national bank or
Federal savings association 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 national
bank's or Federal savings association's measure for market risk under
subpart F of this part by using the collateral haircut approach in this
section. A national bank or Federal savings association may use the
standard supervisory haircuts in paragraph (c)(3) of this section or,
with prior written approval of the OCC, its own estimates of haircuts
according to paragraph (c)(4) of this section.
* * * * *
0
17. 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 a national bank or Federal
savings association subject to subpart E 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-
[[Page 15287]]
end Call Report that is not subject to subpart E 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
18. 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 and Federal savings
associations described in Sec. 3.61.
* * * * *
Table 3 to Sec. 3.63--Capital Adequacy
Table 3 to Sec. 3.63--Capital Adequacy
------------------------------------------------------------------------
------------------------------------------------------------------------
* * * * * * *
(c) Market risk-weighted
assets as calculated
under subpart F of this
part 3.
* * * * * * *
------------------------------------------------------------------------
* * * * *
0
19. Subparts E and F are amended as follows:
Subparts E and F [Amended]
0
a. Remove subparts E and F and replace with 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 ORGANIZATIONS]'' and add ``national banks or
Federal savings associations'' in its place wherever it appears;
0
e. Remove ``[BANKING ORGANIZATION]'s'' and add ``national bank's or
Federal savings association's'' in its place, wherever it appears;
0
f. Remove ``[REAL ESTATE LENDING GUIDELINES]'' and add ``12 CFR part
34, appendix A to subpart D'' in its place wherever it appears; and
0
g. Remove ``[APPRAISAL RULE]'' and add ``12 CFR part 34, subpart C'' in
its place wherever it appears.
0
20. 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 paragraph (k).
0
21. In Sec. 3.300:
0
a. Revise paragraph (a);
0
b. Remove paragraphs (b), (c), and (d);
0
c. Redesignate paragraph (e) as paragraph (b); and
0
d. Remove paragraphs (f), (g), and (h).
The revision reads as follows:
Sec. 3.300 Transitions.
(a) Transition adjustments for AOCI. Beginning [January 1, 2027], a
national bank or Federal savings association that uses expanded total
risk-weighted assets for purposes of Sec. 3.10(a)(5) that had made an
AOCI opt-out election under Sec. 3.22(b)(2) effective [December 31,
2026] 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.
Table 1 to Sec. 3.300
----------------------------------------------------------------------------------------------------------------
Transition AOCI adjustment
-----------------------------------------------------------------------------------------------------------------
Percentage applicable to transition AOCI
Transition period adjustment amount
----------------------------------------------------------------------------------------------------------------
January 1, 2027 to December 31, 2027................................. 100
January 1, 2028 to December 31, 2028................................. 80
January 1, 2029 to December 31, 2029................................. 60
January 1, 2030 to December 31, 2030................................. 40
January 1, 2031 to December 31, 2031................................. 20
January 1, 2032 and thereafter....................................... 0
----------------------------------------------------------------------------------------------------------------
* * * * *
0
22. Remove and reserve Sec. 3.301
0
23. 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''.
0
24. Remove and reserve Sec. Sec. 3.303 and 3.304.
0
25. 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''.
[[Page 15288]]
PART 6--PROMPT CORRECTIVE ACTION
0
26. The authority citation for part 6 continues to read as follows:
Authority: 12 U.S.C. 93a, 1831o, 5412(b)(2)(B).
0
27. 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 Category I national
bank or Federal savings association;
0
c. Add, in alphabetical order, the definition for Category II national
bank or Federal savings association;
0
d. Add, in alphabetical order, the definition for Category III national
bank or Federal savings association;
0
e. Add, in alphabetical order, the definition for ``National bank or
Federal savings association subject to part 3, subpart E of this
chapter''; and
0
f. Revise the definition for ``Total risk-weighted assets''.
The addition and revision read as follows:
Sec. 6.2 Definitions.
* * * * *
Category I national bank or Federal savings association means a
bank that is a Category I Board-regulated institution as defined in 12
CFR 3.2.
Category II national bank or Federal savings association means a
bank that is a Category II Board-regulated institution as defined in 12
CFR 3.2.
Category III national bank or Federal savings association means a
bank that is a Category III Board-regulated institution as defined in
12 CFR 3.2.
* * * * *
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
28. In Sec. 6.4, revise paragraphs (a)(1)(iv)(B), (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 Category I national bank or Federal savings
association or a Category II national bank or Federal savings
association; and
* * * * *
(b) * * *
(2) * * *
(iv) * * *
(B) With respect to a Category I national bank or Federal savings
association, a Category II national bank or Federal savings
association, or a Category III national bank or Federal savings
association, the national bank or Federal savings association has a
supplementary leverage ratio of 3.0 percent or greater;
* * * * *
(3) * * *
(iv) * * *
(B) With respect to a Category I national bank or Federal savings
association, a Category II national bank or Federal savings
association, or a Category III national bank or Federal savings
association, the national bank or Federal savings association has a
supplementary leverage ratio of less than 3.0 percent.
* * * * *
PART 32--LENDING LIMITS
0
29. 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
30. In Sec. 32.2, remove the designations for paragraphs (a) through
(ee) and arrange the definitions in alphabetical order and in the
definition for ``Eligible credit derivative'', revise paragraph (1).
The revision reads as follows:
Sec. 32.2 Definitions
* * * * *
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;
* * * * *
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
31. 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
32. 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).
Category I bank means a bank that is a Category I Board-regulated
institution as defined in 12 CFR 217.2.
Category II bank means a bank that is a Category II Board-regulated
institution as defined in 12 CFR 217.2.
Category III bank means a bank that is a Category III Board-
regulated institution as defined in 12 CFR 217.2.
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) or Sec. 217.10(d) 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.
[[Page 15289]]
(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.
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) or Sec. 217.10(d) 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) or Sec. 217.10(d) of this chapter, as applicable.
Total risk-weighted assets means standardized total risk-weighted
assets or expanded total risk-weighted assets, each as defined in Sec.
217.2 of this chapter.
Subpart D [Amended]
0
33. In Sec. 208.43, remove the words ``an advanced approaches 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 words ``a Category I bank, Category II bank, or Category III
bank.''
Subpart G--Financial Subsidiaries of State Member Banks
0
34. 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
35. 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
36. 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
37. Revise subparts E and F of part 217 as set forth at the end of the
common preamble.
0
38. 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; and
0
c. Remove ``__.'' and add ``217.'' in its place wherever it appears.
Subpart A--General Provisions
0
39. In Sec. 217.1:
0
a. Revise paragraph (c)(4);
0
b. Add paragraph (c)(6);
0
c. Revise paragraphs (e) and (f); and
0
d. Add paragraph (h).
The addition and revision read as follows:
Sec. 217.1 Purpose, applicability, reservations of authority, and
timing.
* * * * *
(c) * * *
(4) Risk-weighted assets. Each Board-regulated institution must
calculate either standardized total risk-weighted assets or expanded
total risk-weighted assets, as necessary to satisfy the requirements of
Sec. 217.10(b) or (d), as applicable.
* * * * *
(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.
* * * * *
(e) Notice and response procedures. In making a determination under
this part, unless more specifically provided for, the Board will apply
notice and response procedures in the same manner and to the same
extent as the notice and response procedures in 12 CFR 263.202.
(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.
* * * * *
(h) Severability. If any provision of this part, or the application
thereof to any person or circumstances, is held invalid, such
invalidity shall not affect the validity of other provisions or the
application of such provision to other persons or circumstances that
can be
[[Page 15290]]
given effect without the invalid provision or application.
* * * * *
0
40. In Sec. 217.2:
0
a. Revise the definition of ``Adjusted allowances for credit losses
(AACL)'';
0
b. Remove the definitions for ``Advanced approaches Board-regulated
institution'', ``Advanced approaches total risk-weighted assets'', and
``Advanced market risk-weighted assets'';
0
c. Remove the definition of ``Allowances for loan and lease losses
(ALLL)'';
0
d. Revise the definition for ``Carrying value'';
0
e. Add, in alphabetical order, the definition for ``Category I Board-
regulated institution'';
0
f. 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 redesignated 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
g. In the definition of ``Category III Board-regulated institution'':
0
i. Remove paragraph (3);
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
h. Add, in alphabetical order, the definition for ``Category IV Board-
regulated institution'';
0
i. Revise footnote 3 to paragraph (2) of the definition for ``Cleared
transaction.''
0
j. Revise the definition for ``Commitment'';
0
k. Revise the definition for ``Corporate exposure'';
0
l. Remove the definition for ``Credit-risk-weighted assets'';
0
m. Add, in alphabetical order, the definitions for ``CVA risk-weighted
assets'' and ``Dependent on the cash flows generated by the real
estate'';
0
n. Revise the definitions for ``Effective notional amount'' and
``Eligible clean-up call'';
0
o. Remove the definition for ``Eligible credit reserves'';
0
p. Revise the definition for ``Eligible guarantee'';
0
q. Add, in alphabetical order, the definitions for ``Eligible prepaid
credit protection arrangement'' and ``Expanded total risk-weighted
assets'';
0
r. Remove the definition for ``Expected credit loss (ECL)'';
0
s. Revise the definition for ``Exposure amount'';
0
t. Revise paragraph (4)(i)(A) in the definition of ``Financial
institution'';
0
u. Revise the definition of ``Market risk Board-regulated
institution'';
0
v. Add, in alphabetical order, the definition for ``Market risk-
weighted assets'';
0
w. Revise the definitions for ``Net independent collateral amount'' and
``Netting set'';
0
x. Add, in alphabetical order, the definitions for ``Non-performing
loan securitization (NPL securitization)'' and ``Nonrefundable purchase
price discount (NRPPD)'';
0
y. Revise the definition for ``Non-significant investment in the
capital of an unconsolidated financial institution'';
0
z. Add, in alphabetical order, the definition for ``Prepaid credit
protection arrangement'';
0
aa. Revise the definition for ``Protection amount (P)'';
0
bb. Add, in alphabetical order, the definition for ``Qualifying Cross
Product Master Netting Agreement'';
0
cc. Revise paragraphs (3) and (4) of the definition for ``Qualifying
master netting agreement'';
0
dd. 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
ee. Remove the definition for ``Securitization special purpose entity
(securitization SPE)'';
0
ff. Revise the definition for ``Significant investment in the capital
of an unconsolidated financial institution'';
0
gg. Remove the definition for ``Specific wrong-way risk'';
0
hh. Add, in alphabetical order, the definition for ``Specified
supranational entity'';
0
ii. Revise the definitions for ``Speculative grade'', ``Standardized
market risk-weighted assets'', ``Standardized total risk-weighted
assets'' and ``Sub-speculative grade'';
0
jj. Add, in alphabetical order, the definition for ``Synthetic excess
spread'';
0
kk. Revise the definition for ``Synthetic securitization'';
0
ll. Add, in alphabetical order, the definition for ``Total credit risk-
weighted assets'';
0
mm. Revise the definition for ``Traditional securitization'';
0
nn. Remove the definition for ``Value-at-risk (VaR)'';
0
oo. Revise the definition for ``Variation margin amount''; and
0
pp. Remove the definition of ``Unconditionally cancelable''.
The additions and revisions read as follows:
Sec. 217.2 Definitions.
* * * * *
Adjusted allowances for credit losses (AACL) means valuation
allowances that have been established through a charge against earnings
or retained earnings for expected credit losses on financial assets
measured at amortized cost and a lessor's net investment in leases that
have been established to reduce the amortized cost basis of the assets
to amounts expected to be collected as determined in accordance with
GAAP. For purposes of this part, adjusted allowances for credit losses
include allowances for expected credit losses on off-balance sheet
credit exposures not accounted for as insurance as determined in
accordance with GAAP. Adjusted allowances for credit losses exclude
allocated transfer risk reserves and allowances created that reflect
credit losses on purchased credit deteriorated assets, purchased
seasoned loans, assets required to record an allowance for credit
losses through a gross-up adjustment to the purchase price of the
asset, and available-for-sale debt securities.
* * * * *
Carrying value means, with respect to an asset, the value of the
asset on the balance sheet of the Board-regulated institution as
determined in accordance with GAAP. For all assets other than
available-for-sale debt securities, purchased credit deteriorated
assets, purchased seasoned loans, or assets required to record an
allowance for credit losses through a gross-up adjustment to the
purchase price of the asset, the carrying value is not reduced by any
associated credit loss allowance that is determined in accordance with
GAAP.
Category I Board-regulated institution means:
(1) A global systemically important BHC; or
(2) A state member bank that is a subsidiary of a global
systemically important BHC.
* * * * *
[[Page 15291]]
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 most recent consecutive 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.
* * * * *
Commitment means a contractual arrangement, under which a Board-
regulated institution and an obligor agree to terms applicable to one
or more future extensions of credit, purchases of assets, or issuances
of credit substitutes by the Board-regulated institution, whether or
not such arrangement is unconditionally cancelable. A commitment is
unconditionally cancelable if, by its terms, it either: (a) provides
that a Board-regulated institution is not obligated to extend credit,
purchase assets, or issue credit substitutes; or (b) permits a Board-
regulated institution, at any time, with or without cause, to refuse to
extend credit, purchase assets, or issue credit substitutes under the
arrangement (to the extent permitted under applicable law).
* * * * *
Corporate exposure means an exposure to a company that is not:
(1) An exposure to a sovereign, a specified supranational entity, 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.
* * * * *
Dependent on the cash flows generated by the real estate means, for
a real estate exposure, 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.
* * * * *
Effective notional amount means for an eligible guarantee, eligible
credit derivative, or eligible prepaid credit protection arrangement,
the lesser of the contractual notional amount of the credit risk
mitigant and the exposure amount of the hedged exposure, multiplied by
the percentage coverage of the credit risk mitigant.
* * * * *
Eligible clean-up call means a clean-up call that:
(1) Is exercisable solely at the discretion of the originating
Board-regulated institution or servicer;
(2) Is not structured to avoid allocating losses to securitization
exposures held by investors or otherwise structured to provide credit
enhancement to the securitization; and
(3) Is only exercisable:
(i) For a traditional securitization, when 10 percent or less of
the principal amount of the underlying exposures or securitization
exposures (determined as of the inception of the securitization) is
outstanding;
(ii) For a synthetic securitization, when 10 percent or less of the
principal amount of the reference portfolio of underlying exposures
(determined as of the inception of the securitization) is outstanding;
(iii) Upon the occurrence of a regulatory event that significantly
changes the risk-weighted asset amount for the securitization exposure
under this part; or
(iv) Upon the occurrence of a tax event that significantly changes
the tax treatment of the securitization exposure under applicable tax
laws.
* * * * *
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
[[Page 15292]]
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.
* * * * *
Eligible prepaid credit protection arrangement means a prepaid
credit protection arrangement that:
(1) Is written;
(2) Is unconditional;
(3) Covers all or a pro rata portion of all contractual payments
due to be paid on the reference exposure or reference exposures;
(4) Provides that the amount and timing of payments due from the
protection purchaser to the protection provider are incorporated into
the arrangement and the arrangement only allows these terms to change
in the event of a breach of the arrangement by the protection
purchaser;
(5) Provides that entry of the protection provider into
receivership, insolvency, liquidation, conservatorship, or similar
proceeding does not change the amounts or timing of payments due to be
paid by the protection purchaser under the arrangement;
(6) Is legally valid and enforceable under applicable law of the
relevant jurisdictions;
(7) Upon a failure by the obligor on the one or more reference
exposures to make a contractually required payment, or the occurrence
of other credit events as described in the arrangement, allows the
protection purchaser promptly to reduce the outstanding balance of the
initial principal amount due to the protection provider by the loss of
the protection purchaser on the reference exposures without input from
the protection provider; and
(8) Does not increase the protection purchaser's cost of credit
protection in response to deterioration in the credit quality of any of
the reference exposures.
* * * * *
Expanded total risk-weighted assets means the sum of:
(1) Total credit risk-weighted assets;
(2) Total risk-weighted assets for equity exposures as calculated
under Sec. 217.141 and 217.142;
(3) Risk-weighted assets for operational risk as calculated under
Sec. 217.150;
(4) Market risk-weighted assets, if applicable; and
(5) CVA risk-weighted assets, if applicable; minus
(6) 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)); a 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, Sec. Sec. 217.113
through 217.115, 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
a 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 a derivative contract (other than a
cleared transaction), the exposure amount determined under Sec. 217.34
or Sec. Sec. 217.113 through 217.114, as applicable.
(6) For an exposure that is a cleared transaction, the exposure
amount determined under Sec. 217.35 or Sec. 217.116, as applicable.
(7) For an exposure that is an eligible margin loan or repo-style
transaction (other than a cleared transaction) for which the bank
calculates the exposure amount as provided in Sec. 217.37 or
Sec. Sec. 217.113 through 217.115, as applicable, the exposure amount
determined under Sec. 217.37 or Sec. Sec. 217.113 through 217.115, 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.
* * * * *
Financial institution means:
* * * * *
(4) * * *
(i) * * *
(A) An investment in GAAP equity instruments of the company with an
[[Page 15293]]
adjusted carrying value or exposure amount equal to or greater than $10
million, as adjusted pursuant to Sec. 217.4; or
* * * * *
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 a group of transactions with a single
counterparty that are subject to a qualifying master netting agreement.
For derivative contracts, netting set also includes a single derivative
contract between a Board-regulated institution and a single
counterparty.
* * * * *
Non-performing loan securitization (NPL securitization) means a
traditional securitization, that is not a resecuritization, where
parameter W (as defined in Sec. 217.133(b)(1)) for the underlying
exposures is greater than or equal to 90 percent at the origination
cut-off date and at any subsequent date on which exposures are added to
or removed from the pool of underlying exposures due to replenishment
or restructuring.
Nonrefundable purchase price discount (NRPPD) means the difference
between the outstanding principal balance of the underlying exposures
at the time of sale and the price at which these exposures are sold by
the originator to a company the activities of which are limited to
those appropriate for the specific purpose of holding the underlying
exposures of a securitization, when neither originator nor the original
lender are reimbursed for this difference. In cases where the
originator underwrites tranches of an NPL securitization for subsequent
sale, the NRPPD may include the differences between the outstanding
principal balance of the underlying exposures at the time of sale and
the price at which all of the 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 of a securitization tranche are not considered.
Non-significant investment in the capital of an unconsolidated
financial institution means an investment by a Category I Board-
regulated institution or a Category II Board-regulated institution in
the capital of an unconsolidated financial institution where the
Category I Board-regulated institution or Category II Board-regulated
institution owns 10 percent or less of the issued and outstanding
common stock of the unconsolidated financial institution.
* * * * *
Prepaid credit protection arrangement means a contractual
arrangement under which a protection purchaser transfers the credit
risk of one or more reference exposures to a protection provider where:
(1) The protection provider pays an initial principal amount in
cash to the protection purchaser at the inception of the transaction;
and
(2) The protection purchaser is obligated to repay the initial
principal amount to the protection provider on or before the maturity
date of the transaction, less any losses that the protection purchaser
realizes or otherwise recognizes due to nonpayment of all contractual
payments due to be paid on the reference exposure or reference
exposures by the obligors.
* * * * *
Protection amount (P) means, with respect to an exposure hedged by
an eligible guarantee, eligible credit derivative, or eligible prepaid
credit protection arrangement, or secured by financial collateral, the
effective notional amount of the guarantee, credit derivative, or
prepaid credit protection arrangement, or the fair value of the
financial collateral, reduced to reflect any currency mismatch,
maturity mismatch, or lack of restructuring coverage (as provided in
Sec. 217.36-217.37 or Sec. 217.120-121, as applicable).
* * * * *
Qualifying cross-product master netting agreement means a
qualifying master netting agreement that provides for termination and
close-out netting across multiple types of financial transactions or
qualifying master netting agreements in the event of a counterparty's
default, provided that the underlying financial transactions are
derivative contracts or repo-style transactions that are not cleared
transactions. In order to treat an agreement as a qualifying cross-
product master netting agreement, a Board-regulated institution must
comply with the requirements of Sec. 217.3(c) of this part with
respect to that agreement.
* * * * *
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.
* * * * *
Significant investment in the capital of an unconsolidated
financial institution means an investment by a Category I Board-
regulated institution or a Category II Board-regulated institution in
the capital of an unconsolidated financial institution where the
Category I Board-regulated institution or a Category II Board-regulated
institution owns more than 10 percent of the issued and outstanding
common stock of the unconsolidated financial institution.
* * * * *
Specified supranational entity means the Bank for International
Settlements, the European Central Bank, the European Commission, the
International Monetary Fund, the European Stability Mechanism, or the
European Financial Stability Facility.
* * * * *
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.
[[Page 15294]]
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 adjusted
allowance for credit losses 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.
* * * * *
Synthetic securitization means a transaction in which:
(1) All or a portion of the credit risk of one or more underlying
exposures is retained or transferred to one or more third parties
through the use of one or more credit derivatives, guarantees (other
than a guarantee that transfers only the credit risk of an individual
retail exposure), or prepaid credit protection arrangements;
(2) The credit risk associated with the underlying exposures has
been separated into at least two tranches reflecting different levels
of seniority;
(3) Performance of the securitization exposures depends solely upon
the performance of the underlying exposures; and
(4) All or substantially all of the underlying exposures are
financial exposures (such as loans, commitments, credit derivatives,
guarantees, receivables, asset-backed securities, mortgage-backed
securities, other debt securities, or equity securities).
* * * * *
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. 217.116;
(3) Total risk-weighted assets for unsettled transactions as
calculated under Sec. 217.117; and
(4) Total risk-weighted assets for securitization exposures as
calculated under Sec. 217.132.
* * * * *
Traditional securitization means a transaction in which:
(1) All or a portion of the credit or equity risk of one or more
underlying exposures is transferred to one or more third parties other
than through the use of credit derivatives, guarantees, or prepaid
credit protection arrangements;
(2) The credit risk associated with the underlying exposures has
been separated into at least two tranches reflecting different levels
of seniority;
(3) Performance of the securitization exposures depends solely upon
the performance of the underlying exposures;
(4) All or substantially all of the underlying exposures are
financial exposures (such as loans, commitments, credit derivatives,
guarantees, receivables, asset-backed securities, mortgage-backed
securities, other debt securities, or equity securities);
(5) The underlying exposures are not owned by an operating company;
(6) The underlying exposures are not owned by a small business
investment company defined in section 302 of the Small Business
Investment Act;
(7) The underlying exposures are not owned by a firm an investment
in which qualifies as a community development investment under section
24(Eleventh) of the National Bank Act;
(8) The Board may determine that a transaction in which the
underlying exposures are owned by an investment firm that exercises
substantially unfettered control over the size and composition of its
assets, liabilities, and off-balance sheet exposures is not a
traditional securitization based on the transaction's leverage, risk
profile, or economic substance;
(9) The Board may deem a transaction that meets the definition of a
traditional securitization, notwithstanding paragraph (5), (6), or (7)
of this definition, to be a traditional securitization based on the
transaction's leverage, risk profile, or economic substance; and
(10) The transaction is not:
(i) An investment fund;
(ii) A collective investment fund (as defined in 12 CFR 208.34);
(iii) An employee benefit plan (as defined in paragraphs (3) and
(32) of section 3 of ERISA), a ``governmental plan'' (as defined in 29
U.S.C. 1002(32)) that complies with the tax deferral qualification
requirements provided in the Internal Revenue Code, or any similar
employee benefit plan established under the laws of a foreign
jurisdiction;
(iv) A synthetic exposure to the capital of a financial institution
to the extent deducted from capital under Sec. 217.22; or
(v) Registered with the SEC under the Investment Company Act of
1940 (15 U.S.C. 80a-1) or foreign equivalents thereof.
* * * * *
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.
* * * * *
0
41. In Sec. 217.3, revise paragraph (c) to read as follows:
Sec. 217.3 Operational requirements for counterparty credit risk.
* * * * *
(c) Qualifying cross-product master netting agreement. In order to
recognize an agreement as a qualifying cross-product master netting
agreement as defined in Sec. 217.2, a Board-regulated institution must
obtain a written legal opinion verifying the validity and
enforceability of the agreement under applicable law of the relevant
jurisdictions if the counterparty fails to perform upon an event of
default, including upon receivership, insolvency, liquidation, or
similar proceeding
* * * * *
0
42. Add a new section Sec. 217.4 to read as follows:
Sec. 217.4 Threshold Indexing.
(a) Methodology. The dollar thresholds specified in paragraph (c)
of this section shall be adjusted by multiplying the baseline threshold
values specified in paragraph (c) of this section by one plus the
cumulative percent change in the non-seasonally
[[Page 15295]]
adjusted Consumer Price Index for Urban Wage Earners and Clerical
Workers, measured from the effective date of this rule, as further
described in paragraph (b) of this section, and shall be rounded in
accordance with paragraph (d) of this section.
(b) Frequency. (1) In general--biennial adjustments. Except as
otherwise provided in paragraph (b)(2) and (b)(3) of this section, the
adjustments described in paragraph (a) of this section shall be
effective on October 1 following each consecutive two year period
ending August 30, and using the non-seasonally adjusted Consumer Price
Index for Urban Wage Earners and Clerical Workers as of August 30 of
that year.
(2) Off-year adjustments. In the event that the Board determines,
during a year where no adjustment would be made under paragraph (b)(1),
that the non-seasonally adjusted Consumer Price Index for Urban Wage
Earners and Clerical Workers, measured over the twelve month period
ending August 30 of that year, is such that an adjustment under this
section would be appropriate for that year, the Board may make an
adjustment under this section for that year.
(3) Periods of negative inflation. Notwithstanding paragraph (b)(1)
or (b)(2) of this section, if an adjustment of dollar thresholds using
the cumulative percent change of the non-seasonally adjusted Consumer
Price Index for Urban Wage Earners and Clerical Workers from the
effective date of this rule or the most recent adjustment, as
applicable, would not result in an increase from the current dollar
thresholds, no adjustment will be made pursuant to paragraph (a) of
this section.
(c) Specified thresholds. The thresholds in the following sections
shall be adjusted in accordance with paragraph (a) of this section
relative to the baseline threshold values as specified below.
(1) Sec. 217.2, definition of Financial institution, paragraph
(4)(i)(A), baseline threshold value $10 million;
(2) Sec. 217.101, definition of Regulatory retail exposure,
paragraph (2), baseline threshold value $1 million;
(3) Sec. 217.101, definition of Small or medium-sized entity
(SME), baseline threshold value $50 million;
(4) Sec. 217.150(b)(1), baseline threshold value $1 billion;
(5) Sec. 217.150(b)(2), baseline threshold values $1 billion, $30
billion, and $120 million;
(6) Sec. 217.150(b)(2)(i), baseline threshold value $1 billion;
(7) Sec. 217.150(b)(3), baseline threshold values $30 billion and
$4.47 billion
(8) Sec. 217.150(b)(3)(i), baseline threshold value $30 billion;
(9) Sec. 217.150(d)(2)(i)(A), baseline threshold value $20,000;
(10) Sec. 217.201(b)(1)(ii)(B), baseline threshold value $5
billion;
(11) Sec. 217.201(b)(2)(ii), baseline threshold value $1 trillion;
(12) Sec. 217.202 ``Large market cap'', baseline threshold value
$2 billion;
(13) Sec. 217.202, ``Market risk covered position'' (1)(ii)(D),
baseline value $20 million;
(14) Sec. 217.202, ``Small market cap'', baseline threshold value
$2 billion.
(d) Rounding. When adjusting thresholds under this section, each
threshold shall be rounded based on the size of the threshold (e.g.,
thousands, millions, billions) to the nearest number with two
significant digits.
(e) Effective date of threshold adjustments. The [AGENCY] shall
announce the thresholds adjusted in accordance with this section by
publication in the Federal Register. Such adjusted thresholds shall be
effective on October 1 of the year during which an adjustment is made.
(f) Failure to publish in the Federal Register. In the event, for
any reason, the thresholds adjusted in accordance with this section are
not published in the Federal Register in a year in which an adjustment
is made under this section, the thresholds specified in paragraph (c)
of this section will adjust as provided in this section and be
effective on October 1, notwithstanding the lack of publication in the
Federal Register.
* * * * *
0
43. Add Sec. 217.5 ``Calculation of loan-to-value (LTV) ratio.''
The addition reads as follows:
Sec. 217.5 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 12 CFR part
208, appendix C, that secures the extension of credit, subject to the
following:
(i) For exposures subject to 12 CFR 208 subpart E or 12 CFR 225
subpart G, as applicable, the market value of property is a valuation
that meets all requirements of that rule.
(ii) For exposures not subject to 12 CFR 208 subpart E or 12 CFR
225 subpart G, as applicable:
(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 account for 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 includes the financing to
purchase the property, the value of the property is the lower of the
market value obtained under paragraph (c)(1)(i) or (c)(1)(ii) of this
section, 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 12 CFR part 208, appendix C, must be appropriately
discounted by the [BANKING ORGANIZATION] consistent with the [BANKING
ORGANIZATION]'s usual practices for making loans secured by such
collateral.
Subpart B--Capital Ratio Requirements and Buffers
0
44. In Sec. 217.10:
0
a. Revise paragraph (a)(1)(v);
0
b. Revise paragraph (b);
0
c. Revise paragraph (c);
0
d. Revise paragraph (d) introductory text; and
[[Page 15296]]
0
e. Revise paragraph (d)(3)(ii).
The revisions read as follows:
Sec. 217.10 Minimum capital requirements.
(a) * * *
(1) * * *
(v) For a Category I Board-regulated institution, Category II
Board-regulated institution, or Category III Board-regulated
institution, a supplementary leverage ratio of 3 percent.
* * * * *
(b) Standardized capital ratio calculations. For a Board-regulated
institution that is not a Category I Board-regulated institution or
Category II Board regulated institution:
(1) Common equity tier 1 capital ratio. The Board-regulated
institution's common equity tier 1 capital ratio is the ratio of the
Board-regulated institution's common equity tier 1 capital to selected
total risk-weighted assets;
(2) Tier 1 capital ratio. The Board-regulated institution's tier 1
capital ratio is the ratio of the Board-regulated institution's tier 1
capital to selected total risk-weighted assets;
(3) Total capital ratio. The Board-regulated institution's total
capital ratio is the ratio of the Board-regulated institution's total
capital to selected total risk-weighted assets; and
(4) Leverage ratio. The Board-regulated institution's leverage
ratio is the ratio of the Board-regulated institution's tier 1 capital
to the Board-regulated institution's average total consolidated assets
as reported on the Board-regulated institution's Call Report, for a
state member bank, or the Consolidated Financial Statements for Bank
Holding Companies (FR Y-9C), for a bank holding company or savings and
loan holding company, as applicable minus amounts deducted from tier 1
capital under Sec. 217.22(a), (c) and (d).
(5) Selected total risk-weighted assets. A Board-regulated
institution's selected total risk-weighted assets is either the Board-
regulated institution's standardized total risk-weighted assets or
expanded total risk-weighted assets, as selected by the Board-regulated
institution. A Board-regulated institution may change its choice for
selected total risk-weighted assets by providing the Board with prior
notice of the change at least four full calendar quarters before the
calendar quarter in which the change will take effect.
(c) Supplementary leverage ratio. (1) The supplementary leverage
ratio of a Category I Board-regulated institution, Category II Board-
regulated institution, or Category III Board-regulated institution 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, for a Board-regulated
institution that uses the standardized approach for counterparty credit
risk (SA-CCR) under Sec. 217.114 for its standardized total risk-
weighted assets or expanded total risk-weighted assets, less the fair
value of any derivative contracts;
(ii) (A) For a Board-regulated institution that uses the current
exposure methodology under Sec. 217.34(b) for its standardized total
risk-weighted assets, the potential future credit exposure (PFE) for
each derivative contract or each single-product 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), to which the Board-
regulated institution is a counterparty as determined under Sec.
217.34, but without regard to Sec. 217.34(c), provided that:
(1) 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. 217.34,
but without regard to Sec. 217.34(c), provided that it does not adjust
the net-to-gross ratio (NGR); and
(2) A Board-regulated institution that chooses to exclude the PFE
of credit derivatives or other similar instruments through which it
provides credit protection pursuant to paragraph (c)(2)(ii)(A) of this
section must do so consistently over time for the calculation of the
PFE for all such instruments; or
(B) (1) For a Board-regulated institution that uses SA-CCR under
Sec. 217.114 for its standardized total risk-weighted assets or
expanded total risk-weighted assets, the PFE under SA-CCR for each
derivative contract or single product netting set of derivative
contracts to which the Board-regulated institution is 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. 217.114(g), in
which the term C in Sec. 217.114(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. 217.114(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
(2) 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.
217.114, provided that it does so consistently over time for the
calculation of the PFE for all such instruments;
(iii)(A)(1) For a Board-regulated institution that uses the current
exposure methodology under Sec. 217.34(b) for its standardized total
risk-weighted assets, the amount of cash collateral that is received
from a counterparty to a derivative contract and that has offset the
mark-to-fair value of the derivative asset, or cash collateral that is
posted to a counterparty to a derivative contract and that has reduced
the Board-regulated institution's on-balance sheet assets, unless such
cash collateral is all or part of variation margin that satisfies the
conditions in
[[Page 15297]]
paragraphs (c)(2)(iii)(C) through (G) of this section; and
(2) The variation margin is used to reduce the current credit
exposure of the derivative contract, calculated as described in Sec.
217.34(b), and not the PFE; and
(3) For the purpose of the calculation of the NGR described in
Sec. 217.34(b)(2)(ii)(B), variation margin described in paragraph
(c)(2)(iii)(A)(2) of this section may not reduce the net current credit
exposure or the gross current credit exposure; or
(B)(1) For a Board-regulated institution that uses SA-CCR under
Sec. 217.114 for its standardized total risk-weighted assets or
expanded total risk-weighted assets, the replacement cost under Sec.
217.114 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)(C) through (G) 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)(C) through (G) 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. 217.114(j)(1), in which the term CMA
may only include cash collateral that satisfies the conditions in
paragraphs (c)(2)(iii)(C) through (G) 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. 217.114(e)(6);
(C) 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);
(D) Variation margin is calculated and transferred on a daily basis
based on the mark-to-fair value of the derivative contract;
(E) 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;
(F) 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)(F), 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
(G) 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 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
[[Page 15298]]
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:
(A) For a Board-regulated institution that elects to calculate its
standardized total risk-weighed assets under Sec. 217.10(b), the
applicable credit conversion factor under Sec. 217.33(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; or
(B) For a Board-regulated institution that elects to calculate its
expanded total risk-weighted assets under Sec. 217.10(b), a Category I
Board-regulated institution, or a Category II Board-regulated
institution, 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;
(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; and
(F) Notwithstanding paragraph (c)(2)(ix)(A), a Board-regulated
[[Page 15299]]
institution that has elected under Sec. 217.113(c) to treat any repo-
style transactions subject to a qualifying cross-product master netting
agreement as derivative contracts must treat any such repo-style
transactions as a derivative contract for purposes of this paragraph
(c).
(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. For a Category I Board-
regulated institution or a Category II Board-regulated institution:
(1) Common equity tier 1 capital ratio. The Board-regulated
institution's common equity tier 1 capital ratio is the ratio of the
Board-regulated institution's common equity tier 1 capital to expanded
total risk-weighted assets;
(2) Tier 1 capital ratio. The Board-regulated institution's tier 1
capital ratio is the ratio of the Board-regulated institution's tier 1
capital to expanded total risk-weighted assets;
(3) Total capital ratio. The Board-regulated institution's total
capital ratio is the ratio of the Board-regulated institution's total
capital to expanded total risk-weighted assets; and
(4) Leverage ratio. The Board-regulated institution's leverage
ratio is the ratio of the Board-regulated institution's tier 1 capital
to the Board-regulated institution's average total consolidated assets
as reported on the Board-regulated institution's Call Report, for a
state member bank, or the Consolidated Financial Statements for Bank
Holding Companies (FR Y-9C), for a bank holding company or savings and
loan holding company, as applicable minus amounts deducted from tier 1
capital under Sec. 217.22(a), (c) and (d).
* * * * *
0
45. 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,
and that is not a state member bank that is a subsidiary of a globally
systemically important BHC, 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. For a Board-regulated institution
that is subject to 12 CFR 225.8 or 238.170 or that is a state member
bank that is a subsidiary of a global systemically important BHC, 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, a specified supranational entity, a MDB, a PSE, or a
GSE.
(v) Leverage buffer requirement. (A) A global systemically
important BHC's leverage buffer requirement is 50 percent of the most
recent method 1 surcharge (expressed as a percentage) that the Board-
regulated institution was required to calculate pursuant to Sec.
217.403(b), subject to the effective date provisions of Sec.
217.403(d).
(B) The leverage buffer requirement of a state member bank that is
a subsidiary of a global systemically important BHC is equal to the
lesser of 1.0 percent or 50 percent of the most recent method 1
surcharge (expressed as a percentage) that the global systemically
important BHC that controls the state member bank was required to
calculate pursuant to Sec. 217.403(b), subject to the effective date
provisions of Sec. 217.403(d).
(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,
[[Page 15300]]
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 making such a determination, the Board
will consider the nature and extent of the request and the particular
circumstances giving rise to the request.
Table 1 to Sec. 217.11--Calculation of Maximum Payout Amount
------------------------------------------------------------------------
Capital conservation buffer Maximum payout ratio
------------------------------------------------------------------------
Greater than 2.5 percent plus 100 percent of the No payout ratio
Board-regulated institution's applicable limitation applies.
countercyclical capital buffer amount.
Less than or equal to 2.5 percent plus 100 60 percent.
percent of the Board-regulated institution's
applicable countercyclical capital buffer
amount, and greater than 1.875 percent plus 75
percent of the Board-regulated institution's
applicable countercyclical capital buffer
amount.
Less than or equal to 1.875 percent plus 75 40 percent.
percent of the Board-regulated institution's
applicable countercyclical capital buffer
amount, and greater than 1.25 percent plus 50
percent of the Board-regulated institution's
applicable countercyclical capital buffer
amount.
Less than or equal to 1.25 percent plus 50 20 percent.
percent of the Board-regulated institution's
applicable countercyclical capital buffer
amount and greater than 0.625 percent plus 25
percent of the Board-regulated institution's
applicable countercyclical capital buffer
amount.
Less than or equal to 0.625 percent plus 25 0 percent.
percent of the Board-regulated institution's
applicable countercyclical capital buffer
amount.
------------------------------------------------------------------------
(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 Category
I Board-regulated institution, Category II Board-regulated institution,
or Category III Board-regulated institution 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 section and, if applicable, Table 2 to Sec. 217.11.
(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 Category I Board-regulated institution, Category II
Board-regulated institution, or Category III Board-regulated
institution 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\
\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
[[Page 15301]]
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, or that is a
state member bank that is a subsidiary of a global systemically
important BHC, 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, or
that is a state member bank that is a subsidiary of a globally
systemically important BHC, 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.
(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. A
Board-regulated institution that is a state member bank subsidiary of a
global systemically important BHC has a capital conservation buffer
requirement equal to 2.5 percent.
(iv) No maximum payout amount limitation. A Board-regulated
institution that is subject to 12 CFR 225.8 or 238.170, or that is a
state member bank that is a subsidiary of a global systemically
important BHC, 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, or that is a state member
bank that is a subsidiary of a global systemically important BHC, 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, or
that is a state member bank that is a subsidiary of a global
systemically important BHC, 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, or that is a state member bank that is a subsidiary of a
global systemically important BHC, 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, or that is a state member bank that is a subsidiary of a
global systemically important BHC, 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,
[[Page 15302]]
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 Category I Board-regulated institution 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 a
Category I Board-regulated institution's supplementary leverage ratio
is less than or equal to 3 percent, the Category I Board-regulated
institution's leverage buffer is zero.
Table 2 to Sec. 217.11--Calculation of Maximum Payout Ratio
------------------------------------------------------------------------
Capital buffer \1\ Payout ratio
------------------------------------------------------------------------
Greater than the Board-regulated institution's buffer No payout
requirement \2\........................................ ratio
limitation
applies.
Less than or equal to 100 percent of the Board-regulated 60 percent.
institution's buffer requirement, and greater than 75
percent of the Board-regulated institution's buffer
requirement............................................
Less than or equal to 75 percent of the Board-regulated 40 percent.
institution's buffer requirement, and greater than 50
percent of the Board-regulated institution's buffer
requirement............................................
Less than or equal to 50 percent of the Board-regulated 20 percent.
institution's buffer requirement, and greater than 25
percent of the Board-regulated institution's buffer
requirement............................................
Less than or equal to 25 percent of the Board-regulated 0 percent.
institution's buffer requirement.......................
------------------------------------------------------------------------
\1\ A Board-regulated institution's ``capital buffer'' means each of, as
applicable, its capital conservation buffer and leverage buffer.
\2\ A Board-regulated institution's ``buffer requirement'' means each
of, as applicable, its capital conservation buffer requirement and
leverage buffer requirement.
(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.
Subpart C--Definition of Capital
0
46. 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 Category I Board-regulated institution, a Category II
Board-regulated institution, or a Board-regulated institution that uses
expanded total risk-weighted assets for purposes of Sec. 217.10(a)(5),
the governing agreement, offering circular, or prospectus of an
instrument issued after the date upon which the Board-regulated
institution becomes a Category I Board-regulated institution, a
Category II Board-regulated institution, or a Board-regulated
institution that uses expanded total risk-weighted assets for purposes
of Sec. 217.10(a)(5) 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 Category I Board-regulated institution, a Category II
Board-regulated institution, or a Board-regulated institution that uses
expanded total risk-weighted assets for purposes of Sec. 217.10(a)(5),
the governing agreement, offering circular, or prospectus of an
instrument issued after the date on which the Board-regulated
institution becomes a Category I Board-regulated institution, a
Category II Board-regulated institution, or a Board-regulated
institution that uses expanded total risk-weighted assets for purposes
of Sec. 217.10(a)(5) 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) AACL up to 1.25 percent of the Board-regulated institution's
standardized total risk-weighted assets or total credit risk-weighted
assets, as applicable, not including any amount of the AACL (and
excluding the case of a market risk Board-regulated institution, its
market risk weighted assets).
* * * * *
0
47. 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 ``a
Category I Board-regulated institution, a Category II Board-regulated
institution, or a Board-regulated institution that uses expanded total
risk-weighted assets for purposes of Sec. 217.10(a)(5)'' ; 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 Category I
Board-regulated institution, a Category II Board-regulated institution,
or a Board-regulated institution that uses expanded total risk-weighted
assets for purposes of Sec. 217.10(a)(5) 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
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
[[Page 15303]]
established by the subsidiary's home country supervisor; or
(B)(1) The expanded 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 expanded 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 expanded 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
48. 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. Revise paragraphs (b)(2)(i) and (b)(2)(ii);
0
e. In paragraph (b)(2)(iii), remove the words ``an advanced approaches
Board-regulated institution'' and add in their place the words ``a
Category I Board-regulated institution, a Category II Board-regulated
institution, or a Board-regulated institution that uses expanded total
risk-weighted assets for purposes of Sec. 217.10(a)(5)'';
0
f. In paragraph (b)(2)(iv), remove the words ``or FR Y-9SP'';
0
g. 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
h. In footnote 23, in paragraph (c), remove the words ``ALLL or AACL,
as applicable,'' and add in its places ``AACL'';
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 ``a
Category I Board-regulated institution, a Category II Board-regulated
institution, or a Board-regulated institution that uses expanded total
risk-weighted assets for purposes of Sec. 217.10(a)(5)'';
0
k. Revise paragraphs (c)(5)(i) through (iv); and
0
l. Revise paragraphs (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 Category I Board-regulated institution, a Category II
Board-regulated institution, or a Board-regulated institution that uses
expanded total risk-weighted assets for purposes of Sec. 217.10(a)(5),
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) Any gain-on-sale in connection with a securitization
exposure;
(ii) For a Category I Board-regulated institution, a Category II
Board-regulated institution, or a Board-regulated institution that uses
expanded total risk-weighted assets for purposes of Sec. 217.10(a)(5),
the portion of any CEIO that does not constitute an after-tax gain-on-
sale;
(b) * * *
(2) AOCI opt-out election.
(i) A Board-regulated institution that is not a Category I Board-
regulated institution, a Category II Board-regulated institution, or a
Board-regulated institution that uses the expanded total risk-weighted
assets for purposes of Sec. 217.10(a)(5) 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 Board-regulated
institution 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 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 Board-regulated institution'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 Board-regulated institution that is not a Category I Board-
regulated institution, a Category II Board-regulated institution, or a
Board-regulated institution that uses expanded
[[Page 15304]]
total risk-weighted assets for purposes of Sec. 217.10(a)(5) must make
its AOCI opt-out election in the Call Report, for a state member bank,
or FR Y-9C, for a bank holding company or savings and loan holding
company, 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 a Category I Board-regulated
institution, a Category II Board-regulated institution, or a Board-
regulated institution that uses expanded total risk-weighted assets for
purposes of Sec. 217.10(a)(5), the Board-regulated institution may not
make an AOCI opt-out election under this paragraph (b)(2)(ii).
* * * * *
(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 a Category I Board-regulated
institution, a Category II Board-regulated institution, or a Board-
regulated institution that uses expanded total risk-weighted assets for
purposes of Sec. 217.10(a)(5) (as described in paragraph (c)(4) of
this section), non-significant investments in the capital of
unconsolidated financial institutions for a Category I Board-regulated
institution, a Category II Board-regulated institution, or a Board-
regulated institution that uses expanded total risk-weighted assets for
purposes of Sec. 217.10(a)(5) (as described in paragraph (c)(5) of
this section), and non-common stock significant investments in the
capital of unconsolidated financial institutions for a Category I
Board-regulated institution, a Category II Board-regulated institution,
or a Board-regulated institution that uses expanded total risk-weighted
assets for purposes of Sec. 217.10(a)(5) (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 Category I Board-regulated institution, a Category II Board-
regulated institution, or a Board-regulated institution that uses
expanded total risk-weighted assets for purposes of Sec. 217.10(a)(5)
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 Category I
Board-regulated institution, a Category II Board-regulated institution,
or a Board-regulated institution that uses expanded total risk-weighted
assets for purposes of Sec. 217.10(a)(5) 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 Category I Board-
regulated institution, a Category II Board-regulated institution, or a
Board-regulated institution that uses expanded total risk-weighted
assets for purposes of Sec. 217.10(a)(5) 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 Category I Board-regulated institution, a Category II
Board-regulated institution, or a Board-regulated institution that uses
expanded total risk-weighted assets for purposes of Sec. 217.10(a)(5),
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.
(iii) For purposes of applying the deduction under paragraph
(c)(5)(i) of this section, a Category II Board-regulated institution or
a Board-regulated institution that uses expanded total risk-weighted
assets for purposes of Sec. 217.10(a)(5) may exclude from the
deduction the amount of the Board-regulated institution's gross long
position, in accordance with Sec. 217.22(h)(2), in investments in
covered debt instruments issued by financial institutions in which the
Board-regulated institution 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 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,
net of associated DTLs in accordance with paragraph (e) of this
section.
(iv) Prior to applying the deduction under paragraph (c)(5)(i) of
this section:
(A) A Category I Board-regulated institution may designate any
investment in a covered debt instrument as an excluded covered debt
instrument, as defined in Sec. 217.2.
(B) A Category I Board-regulated institution must deduct, according
to the corresponding deduction approach in paragraph (c)(2) of this
section, its gross long position, calculated in accordance with
paragraph (h)(2) of this section, in a covered debt instrument that was
originally designated as an excluded covered debt instrument, in
accordance with paragraph (c)(5)(iv)(A) of this section, but no longer
qualifies as an excluded covered debt instrument.
[[Page 15305]]
(C) A Category I Board-regulated institution must deduct according
to the corresponding deduction approach in paragraph (c)(2) of this
section the amount of its gross long position, calculated in accordance
with paragraph (h)(2) of this section, in a direct or indirect
investment in a covered debt instrument that was originally designated
as an excluded covered debt instrument, in accordance with paragraph
(c)(5)(iv)(A) of this section, and has been held for more than thirty
business days.
(D) A Category I Board-regulated institution must deduct according
to the corresponding deduction approach in paragraph (c)(2) of this
section its gross long position, calculated in accordance with
paragraph (h)(2) of this section, of its aggregate position in excluded
covered debt instruments that exceeds 5 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, 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
Category I Board-regulated institution, a Category II Board-regulated
institution, or a Board-regulated institution that uses expanded total
risk-weighted assets for purposes of Sec. 217.10(a)(5) 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 Category I
Board-regulated institution, a Category II Board-regulated institution,
or a Board-regulated institution that uses expanded total risk-weighted
assets for purposes of Sec. 217.10(a)(5) 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 Category I Board-regulated institution, a Category II Board-
regulated institution, or a Board-regulated institution that uses
expanded total risk-weighted assets for purposes of Sec. 217.10(a)(5)
must make deductions from regulatory capital as described in this
paragraph (d)(2).
(i) A Category I Board-regulated institution, a Category II Board-
regulated institution, or a Board-regulated institution that uses
expanded total risk-weighted assets for purposes of Sec. 217.10(a)(5)
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 Category I Board-
regulated institution, a Category II Board-regulated institution, or a
Board-regulated institution that uses expanded total risk-weighted
assets for purposes of Sec. 217.10(a)(5) 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) 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 Category I Board-regulated institution, a
Category II Board-regulated institution, or a Board-regulated
institution that uses expanded total risk-weighted assets for purposes
of Sec. 217.10(a)(5) 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 Category I Board-regulated institution, a Category II Board-
regulated institution, or a Board-regulated institution that uses
expanded total risk-weighted assets for purposes of Sec. 217.10(a)(5)
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
Category I Board-regulated institution, a Category II Board-regulated
institution, or a Board-regulated institution that uses expanded total
risk-weighted assets for purposes of Sec. 217.10(a)(5) may exclude
DTAs and DTLs relating to adjustments made to common equity tier 1
capital under paragraph (b) of this section. A Category I Board-
regulated institution, a Category II Board-regulated institution, or a
Board-regulated institution that uses expanded total risk-weighted
assets for purposes of Sec. 217.10(a)(5) that elects to exclude DTAs
relating to adjustments under paragraph (b) of this section also
[[Page 15306]]
must exclude DTLs and must do so consistently in all future
calculations. A Category I Board-regulated institution, a Category II
Board-regulated institution, or a Board-regulated institution that uses
expanded total risk-weighted assets for purposes of Sec. 217.10(a)(5)
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 Category I Board-regulated
institution, a Category II Board-regulated institution, or a Board-
regulated institution that uses expanded total risk-weighted assets
for purposes of Sec. 217.10(a)(5) 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 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 Category I Board-regulated
institution, a Category II Board-regulated institution, or a Board-
regulated institution that uses expanded total risk-weighted assets
for purposes of Sec. 217.10(a)(5) 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 Category I Board-regulated
institution, a Category II Board-regulated institution, or a Board-
regulated institution that uses expanded total risk-weighted assets
for purposes of Sec. 217.10(a)(5) 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
Category I Board-regulated institution, a Category II Board-
regulated institution, or a Board-regulated institution that uses
expanded total risk-weighted assets for purposes of Sec.
217.10(a)(5) 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
49. In Sec. 217.30
0
a. Revise paragraph (a);
0
b. In paragraph (b), remove the words ``covered positions'' and add in
their place the words ``market risk covered positions''.
The revisions read as follows:
* * * * *
(a) This subpart sets forth methodologies for determining
standardized total risk-weighted assets. This subpart applies to any
Board-regulated institution that elects to use this subpart under Sec.
__.10(b).
* * * * *
Sec. 217.34 Derivative Contracts.
0
50. In Sec. 217.34, revise paragraph (a) to read as follows:
* * * * *
(a) Exposure amount for derivatives contracts--(1) A Board-
regulated institution 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 Board-regulated
institution makes the election provided in paragraph (a)(2) of this
section.
(2) A Board-regulated institution 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.
217.114 by notifying the Board, rather than calculating the exposure
amount for all its derivative contracts using CEM. A Board-regulated
institution that elects under this paragraph (a)(2) to calculate the
exposure amount for its OTC derivative contracts under SA-CCR must
apply the treatment of cleared transactions under Sec. 217.116 to its
derivative contracts that are cleared transactions and to all default
fund contributions associated with such derivative contracts, rather
than applying Sec. 217.35. A Board-regulated institution must use the
same methodology to calculate the exposure amount for all its
derivative contracts and, if a Board-regulated institution has elected
to use SA-CCR under this paragraph (a)(2), the Board-regulated
institution may change its election only with prior approval of the
Board.
* * * * *
Sec. 217.35 Cleared transactions.
0
51. In Sec. 217.35, revise paragraph (a)(3) to read as follows:
(a) * * *
(3) Alternate requirements. Notwithstanding any other provision of
this section, a Board-regulated institution that has elected to use SA-
CCR under Sec. 217.34(a) must apply Sec. 217.116 to its derivative
contracts that are cleared transactions rather than this section.
* * * * *
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. 217.61217. 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
[[Page 15307]]
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.
* * * * *
Table 3 to Sec. 217.63--Capital Adequacy
------------------------------------------------------------------------
------------------------------------------------------------------------
* * * * * * *
(c) Market risk-weighted
assets as calculated
under subpart F of this
part 217.
* * * * * * *
------------------------------------------------------------------------
* * * * *
Subpart E--Risk-Weighted Assets--Expanded Risk-Based Approach
Sec. 217.141 Simple risk-weight approach (SRWA).
0
55. In Sec. 217.141, revise paragraph (b)(3)(i) to read as follows:
(b) * * *
(3) * * *
(i) Community development equity exposures.
(A) For state member banks and bank holding companies, an equity
exposure that qualifies as a community development investment under 12
U.S.C. 24 (Eleventh), excluding equity exposures to an unconsolidated
small business investment company and equity exposures 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).
(B) For savings and loan holding companies, an equity exposure that
is designed primarily to promote community welfare, including the
welfare of low- and moderate-income communities or families, such as by
providing services or employment, and excluding equity exposures to an
unconsolidated small business investment company and equity exposures
held through a small business investment company described in section
302 of the Small Business Investment Act of 1958 (15 U.S.C. 682).
* * * * *
Subpart G--Transition Provisions
0
56. In Sec. 217.300:
0
a. Revise paragraph (a);
0
b. Remove and reserve paragraphs (f) through (i).
The revision and addition read as follows:
Sec. 217.300 Transitions.
(a) Transition adjustments for AOCI. Beginning [January 1, 2027], a
Board-regulated institution that uses expanded total risk-weighted
assets for purposes of Sec. 217.10(a)(5) that had made an AOCI opt-out
election under Sec. 217.22(b)(2) effective [December 31, 2026] 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.
Table 1 to Sec. 217.300
----------------------------------------------------------------------------------------------------------------
Transition AOCI Adjustment
-----------------------------------------------------------------------------------------------------------------
Percentage applicable to transition AOCI
Transition period adjustment amount
----------------------------------------------------------------------------------------------------------------
January 1, 2027 to December 31, 2027................................. 100
January 1, 2028 to December 31, 2028................................. 80
January 1, 2029 to December 31, 2029................................. 60
January 1, 2030 to December 31, 2030................................. 40
January 1, 2031 to December 31, 2031................................. 20
January 1, 2032 and thereafter....................................... 0
----------------------------------------------------------------------------------------------------------------
* * * * *
Sec. 217.301 [Removed and Reserved]
0
57. Remove and reserve Sec. 217.301.
* * * * *
Sec. 217.303 [Removed and Reserved]
0
58. Remove and reserve Sec. 217.303.
Sec. 217.304 [Removed and Reserved]
0
59. Remove and reserve Sec. 217.304.
Sec. Sec. 217.1, 217.2, 217.10, 217.12, 217.22, 217.35, 217.61,
217.300, 217.302, 217.305, Appendix A to Part 217 [Amended]
0
60. 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:
[[Page 15308]]
------------------------------------------------------------------------
Remove the Add the following
Sections: following words: words:
------------------------------------------------------------------------
217.1........................... ``an advanced ``a Category I
217.2........................... approaches Board- Board-regulated
217.12(a)(2) introductory text.. regulated institution, a
217.22(b)(1)(ii), (b)(1)(iii), institution''. Category II Board-
(c)(1), (c)(2)(ii)(D), regulated
(c)(3)(ii), footnote [24] of institution, or a
(c)(4), (c)(5)(iii), (d)(1), Board-regulated
and (f);. institution that
uses expanded
total risk-
weighted assets
for purposes of
Sec.
217.10(a)(5).''
217.61
217.300(c)
217.1(c)(5)(iii)................ ``advanced ``Category I Board-
217.2........................... approaches Board- regulated
217.22(b)(1)(ii), (b)(1)(iii), regulated institution, a
(c)(1), (c)(2)(ii)(D), institution''. Category II Board-
(c)(3)(ii), (c)(5)(iii), regulated
(d)(1), and (f); and. institution, or a
Board-regulated
institution that
uses expanded
total risk-
weighted assets
for purposes of
Sec.
217.10(a)(5).''
217.1........................... ``advanced ``expanded total
217.10(d);...................... approaches total risk-weighted
217.22(g);...................... risk-weighted assets''.
217.302; and.................... assets''.
217.305.........................
217.22(b)(1)(ii) and (b)(1)(iii) ``an advanced ``a Category I
approaches Board- Board-regulated
regulated institution, a
institution''. Category II Board-
regulated
institution, or a
Board-regulated
institution that
uses expanded
total risk-
weighted assets
for purposes of
Sec.
217.10(a)(5)''.
217.2, in the definition of
``qualifying central
counterparty (QCCP)''.
217.35(a)(3).................... ``Sec. 217.133'' ``Sec.
217.114''.
Part 217 Appendix A............. ``advanced ``Category I-II
approaches institutions and
institutions''. institutions the
elect to use the
expanded risk-
based approach''.
``advanced ``Category I-II
approaches banking
banking organizations and
organizations''. institutions that
elect to use the
expanded risk-
based approach''.
Part 217 Appendix A, paragraph ``(FDIC)''........ ``(FDIC, and
1.(a). together with the
Board and OCC,
the agencies)''.
------------------------------------------------------------------------
0
61. 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 Category I-III
banking organizations. See, e.g., 12 CFR 217.100(b).
* * * * *
\4\ The CcyB was subject to a phase-in arrangement between 2016
and 2019.
* * * * *
0
62. Redesignate the footnotes in part 217, as follows:
----------------------------------------------------------------------------------------------------------------
Section Current footnote number New footnote number
----------------------------------------------------------------------------------------------------------------
217.2--``Cleared transaction''............................... 3 1
217.2--``Collateral agreement''.............................. 4 2
217.2--``Eligible margin loan''.............................. 5 3
217.2--``Eligible margin loan''.............................. 6 4
217.2--``Qualifying master netting agreement''............... 7 5
217.2--``Repo-style transaction''............................ 8 6
217.2--``Statutory multifamily mortgage''.................... 9 7
217.20(b)(3)................................................. 11 1
217.20(c)(1)(v)(C)........................................... 12 2
217.20(c)(1)(xiii)........................................... 13 3
217.20(c)(3)(i).............................................. 14 4
217.20(c)(3)(i).............................................. 15 5
217.20(c)(3)(ii)............................................. 16 6
217.20(d)(1)(iv)............................................. 16 7
217.20(d)(1)(v)(C)........................................... 17 8
217.20(d)(1)(ix)............................................. 18 9
217.20(d)(4)(i).............................................. 19 10
217.20(d)(4)(i).............................................. 20 11
217.20(d)(4)(ii)............................................. 21 12
217.22(b)(2)(iv)(A).......................................... 22 1
217.22(c) paragraph heading.................................. 23 2
217.22(c)(4)................................................. 24 3
217.22(c)(4)................................................. 25 4
217.22(c)(5)(i).............................................. 26 5
217.22(c)(5)(i).............................................. 27 6
217.22(c)(6)................................................. 28 7
217.22(d)(1)(i).............................................. 29 8
217.22(d)(2)(i)(C)........................................... 30 9
[[Page 15309]]
217.22(d)(2)(ii)............................................. 31 10
----------------------------------------------------------------------------------------------------------------
PART 225--BANK HOLDING COMPANIES AND CHANGE IN BANK CONTROL
(REGULATION Y)
0
63. 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
64. 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); and
0
d. 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.
* * * * *
(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
65. 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
66. 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.
* * * * *
Subpart P--Company-Run Stress Test Requirements for Savings and
Loan Holding Companies
0
67. 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.
* * * * *
Subpart Q--Single Counterparty Credit Limits for Covered Savings
and Loan Holding Companies
0
68. In Sec. 238.151:
0
a. 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. 217.37 of this chapter or in table 1 to Sec. 217.121 of this
chapter, as applicable'';
0
b. Remove the words ``(12 CFR part 217, subpart D)'' in paragraph
(e)(4) and add in their place the words ``(12 CFR part 217, subpart D
or E, as applicable)''; and
0
c. Revise paragraph (q).
The revisions read as follows:
Sec. 238.151 Definitions.
* * * * *
(q) Exempt counterparty means an entity that is identified as
exempt from the requirements of this subpart under Sec. 252.77, or
that is otherwise excluded from this subpart, including any sovereign
entity assigned a zero percent risk weight under the standardized
approach or the expanded risk-based approach in the Board's Regulation
Q, as applicable (12 CFR part 217, subpart D or E, as applicable).
* * * * *
Sec. 238.153 [Amended]
0
69. 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 ``any of
the methods that the covered company is authorized to use under 12 CFR
part 217, subparts D or E, as applicable''.
Sec. 238.154 [Amended]
0
70. Remove the words ``the currency mismatch adjustment approach of
Sec. 217.37(c)(3)(ii) of the Board's Regulation Q (12 CFR
217.37(c)(3)(ii))'' in paragraph (h)(1) and add in their place ``the
currency mismatch adjustment approach of Sec. 217.37(c)(3)(ii) or
Sec. 217.115(c)(2), as applicable, of the Board's Regulation Q (12 CFR
217.37(c)(3)(ii) or 217.115(c)(2), as applicable)''.
[[Page 15310]]
Subpart S--Capital Planning and Stress Capital Buffer Requirement
0
71. 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); and
0
d. 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 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.
* * * * *
(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
72. 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
73. 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.
* * * * *
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
74. 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.
* * * * *
Subpart F--Company-Run Stress Test Requirements for Certain U.S.
Bank Holding Companies and Nonbank Financial Companies Supervised
by the Board
0
75. 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.
* * * * *
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
76. In Sec. 252.61:
0
a. Revise the definition of ``Common equity tier 1 capital ratio'';
0
b. Revision the definition of ``Supplementary leverage ratio'';
0
c. Revise the definition of ``Total leverage exposure''; and
0
d. Revise the definition of ``Total risk-weighted assets''.
The revisions read as follows:
Sec. 252.61 Definitions.
* * * * *
Common equity tier 1 capital ratio has the same meaning as in 12
CFR 217.10(b)(1) and 12 CFR 217.10(d)(1).
* * * * *
Supplementary leverage ratio has the same meaning as in 12 CFR
217.10(c)(1).
* * * * *
Total leverage exposure has the same meaning as in 12 CFR
217.10(c)(2).
Total risk-weighted assets means standardized total risk-weighted
assets or expanded total risk-weighted assets, as applicable under part
217 of this chapter.
* * * * *
Subpart H--Single-Counterparty Credit Limits
0
77. In Sec. 252.71:
0
a. 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)'';
0
b. Remove the words ``(12 CFR part 217, subpart D)'' in paragraph
(e)(4) and add in their place the words ``(12 CFR part 217, subpart D
or E, as applicable)''; and
0
c. Revise paragraph (q).
The revisions read as follows:
[[Page 15311]]
Sec. 252.71 Definitions.
* * * * *
(q) Exempt counterparty means an entity that is identified as
exempt from the requirements of this subpart under Sec. 252.77, or
that is otherwise excluded from this subpart, including any sovereign
entity assigned a zero percent risk weight under the standardized
approach or the expanded risk-based approach in the Board's Regulation
Q, as applicable (12 CFR part 217, subpart D or E, as applicable).
* * * * *
Sec. 252.73 [Amended]
0
78. 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 ``any of the methods that the covered company is
authorized to use under the Board's Regulation Q (12 CFR part 217,
subparts D or E, as applicable)''.
Sec. 272.74 [Amended]
0
79. In Sec. 252.74, remove the words ``the currency mismatch
adjustment approach of Sec. 217.37(c)(3)(ii) of the Board's Regulation
Q (12 CFR 217.37(c)(3)(ii))'' in paragraph (h)(1) and add in their
place ``the currency mismatch adjustment approach of Sec.
217.37(c)(3)(ii) or Sec. 217.115(c)(2), as applicable, of the Board's
Regulation Q (12 CFR 217.37(c)(3)(ii) or 217.115(c)(2), as
applicable)''.
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
80. 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
81. 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 P--Covered IHC Long-Term Debt Requirement, Covered IHC
Total Loss Absorbing Capacity Requirement and Buffer, and
Restrictions on Corporate Practices for Intermediate Holding
Companies of Global Systemically Important Foreign Banking
Organizations
0
82. In Sec. 252.161:
0
a. Revise the definition of ``Common equity tier 1 capital ratio'';
0
b. Remove the definition of ``Standardized total risk-weighted
assets'';
0
c. Revise the definition of ``Supplementary leverage ratio'';
0
d. Revise the definition of ``Total leverage exposure''; and
0
e. Revise the definition of ``Total risk-weighted assets''.
The revisions read as follows:
Sec. 252.161 Definitions.
* * * * *
Common equity tier 1 capital ratio has the same meaning as in 12
CFR 217.10(b)(1) and 12 CFR 217.10(d)(1).
* * * * *
Supplementary leverage ratio has the same meaning as in 12 CFR
217.10(c)(1).
* * * * *
Total leverage exposure has the same meaning as in 12 CFR
217.10(c)(2).
Total risk-weighted assets means standardized total risk-weighted
assets or expanded total risk-weighted assets, as applicable under part
217 of this chapter.
* * * * *
Subpart Q--Single Counterparty Credit Limits
0
83. In Sec. 252.171:
0
a. 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)'';
0
b. Remove the words ``(12 CFR part 217, subpart D)'' in paragraph
(f)(4) and add in their place the words ``(12 CFR part 217, subpart D
or E, as applicable)''; and
0
c. Revise paragraph (r).
The revisions read as follows:
Sec. 252.171 Definitions.
* * * * *
(r) Exempt counterparty means an entity that is identified as
exempt from the requirements of this subpart under Sec. 252.177, or
that is otherwise excluded from this subpart, including any sovereign
entity assigned a zero percent risk weight under the standardized
approach or the expanded risk-based approach in the Board's Regulation
Q, as applicable (12 CFR part 217, subpart D or E, as applicable).
* * * * *
Sec. 252.173 [Amended]
0
84. 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 ``any of the methods that the covered company is
authorized to use under the Board's Regulation Q (12 CFR part 217,
subparts D or E, as applicable)''.
Sec. 252.174 [Amended]
0
85. In Sec. 252.174, remove the words ``the currency mismatch
adjustment approach of Sec. 217.37(c)(3)(ii) of the Board's Regulation
Q (12 CFR 217.37(c)(3)(ii))'' in paragraph (h)(1) and add in their
place ``the currency mismatch adjustment approach of Sec.
217.37(c)(3)(ii) or Sec. 217.115(c)(2), as applicable, of the Board's
Regulation Q (12 CFR 217.37(c)(3)(ii) or 217.115(c)(2), as
applicable)''.
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
86. 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),
[[Page 15312]]
1828(n), 1828(o), 1831o, 1835, 3907, 3909, 4808; 5371; 5412; Public
Law 102-233, 105 Stat. 1761, 1789, 1790 (12 U.S.C. 1831n note);
Public Law 102-242, 105 Stat. 2236, 2355, as amended by Public Law
103-325, 108 Stat. 2160, 2233 (12 U.S.C. 1828 note); Public Law 102-
242, 105 Stat. 2236, 2386, as amended by Public Law 102-550, 106
Stat. 3672, 4089 (12 U.S.C. 1828 note); Public Law 111-203, 124
Stat. 1376, 1887 (15 U.S.C. 78o-7 note), Public Law 115-174; section
4014 Sec. 201, Public Law 116-136, 134 Stat. 281 (15 U.S.C. 9052).
0
87. Revise subpart E and subpart F of part 324 as set forth at the end
of the common preamble.
0
88. 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 ``[REAL ESTATE LENDING GUIDELINES]'' and add ``12 CFR part
365, Subpart A, Appendix A'' in its place wherever it appears;
0
e. Remove ``[APPRAISAL RULE]'' and add ``12 CFR part 323, Subpart A''
in its place wherever it appears;
0
f. Remove ``__.'' and add ``324.'' in its place wherever it appears;
0
g. Remove ``[REGULATORY REPORT]'' and add ``Call Report'' in its place
wherever it appears.
Subpart A--General Provisions
0
89. In Sec. 324.1:
0
a. Revise paragraph (c)(3);
0
b. Revise paragraph (e);
0
c. Revise paragraph (f); and
0
d. Add paragraph (g).
The additions and revisions read as follows:
Sec. 324.1 Purpose, applicability, reservations of authority, and
timing.
* * * * *
(c) * * *
(3) Risk-weighted assets. Each FDIC-supervised institution must
calculate either standardized total risk-weighted assets or expanded
total risk-weighted assets, as necessary to satisfy the requirements of
Sec. 324.10(b) or (d), as applicable.
* * * * *
(e) Notice and response procedures. In making a determination under
this part, unless more specifically provided for, the FDIC will apply
notice and response procedures in the same manner and to the same
extent as the notice and response procedures in 12 CFR 324.7(c).
* * * * *
(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.
* * * * *
(g) Severability. If any provision of this part, or the application
thereof to any person or circumstances, is held invalid, such
invalidity shall not affect the validity of other provisions or the
application of such provision to other persons or circumstances that
can be given effect without the invalid provision or application.
* * * * *
0
90. Amend Sec. 324.2 as follows:
0
a. Redesignate footnotes 3 through 9 as footnotes 1 through 7,
respectively;
0
b. Revise the definition of ``Adjusted allowances for credit losses
(AACL)'';
0
c. Remove the definitions for ``Advanced approaches FDIC-supervised
institution'', ``Advanced approaches total risk-weighted assets'', and
``Advanced market risk-weighted assets'';
0
d. Remove the definition of ``Allowances for loan and lease losses
(ALLL)'';
0
e. Remove the definition for ``Bank'';
0
f. Revise the definition for ``Carrying value'';
0
g. Add, in alphabetical order, the definition for ``Category I FDIC-
supervised institution'';
0
h. Revise the definitions for ``Category II FDIC-supervised
institution'' and ``Category III FDIC-supervised institution'';
0
i. Add the definition for ``Category IV FDIC-supervised institution''
in alphabetical order;
0
j. Revise newly redesignated footnote 1 to paragraph (2) of the
definition for ``Cleared transaction'';
0
k. Revise the definition for ``Commitment'';
0
l. Revise the definition for ``Corporate exposure'';
0
m. Remove the definition for ``Credit-risk-weighted assets'';
0
n. Add the definition for ``CVA risk-weighted assets'' in alphabetical
order;
0
o. Add the definition of ``Dependent on the cash flows generated by the
real estate'' in alphabetical order;
0
p. Revise the definitions for ``Effective notional amount'' and
``Eligible clean-up call'';
0
q. Remove the definition for ``Eligible credit reserves'';
0
r. Revise the definition for ``Eligible guarantee'';
0
s. Add the definitions for ``Eligible prepaid credit protection
arrangement'', ``ERBA FDIC-supervised institution'', and ``Expanded
total risk-weighted assets'' in alphabetical order;
0
t. Remove the definition for ``Expected credit loss (ECL)'';
0
u. Revise the definitions for ``Exposure amount'', ``FDIC-supervised
institution'', paragraphs (4)(i)(A) and (5)(i) of ``Financial
institution'', and ``Market risk FDIC-supervised institution'';
0
v. Add the definition for ``Market risk-weighted assets'' in
alphabetical order;
0
w. Revise the definitions for ``Net independent collateral amount'' and
``Netting set'';
0
x. Add, in alphabetical order, the definitions for ``Non-performing
loan securitization (NPL securitization)'' and ``Nonrefundable purchase
price discount (NRPPD)'';
0
y. Revise the definition for ``Protection amount (P)'';
0
z. Add the definition for ``Prepaid credit protection arrangement'' and
``Qualifying cross-product master netting agreement'' in alphabetical
order;
0
aa. 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 redesignated paragraph (2), remove the words ``family;
and'' and add, in their place, the word ``family.'';
0
bb. Remove the definition for ``Securitization special purpose entity
(securitization SPE)'';
0
cc. Remove the definition for ``Specific wrong-way risk'';
0
dd. Add the definition of ``Specified supranational entity'' in
alphabetical order;
0
ee. Revise the definitions for ``Speculative grade'', ``Standardized
market risk-weighted assets'', ``Standardized total risk-weighted
assets'', and ``Sub-speculative grade'';
0
ff. Add, in alphabetical order, the definition for ``Synthetic excess
spread'';
0
gg. Revise the definition of ``Synthetic securitization'';
[[Page 15313]]
0
hh. Add the definition for ``Total credit risk-weighted assets'' in
alphabetical order;
0
ii. Revise the definition for ``Traditional securitization'';
0
jj. Remove the definition for ``Value-at-Risk (VaR)'';
0
kk. Revise the definition for ``Variation margin amount''; and
0
ll. Remove the definition of ``Unconditionally cancelable''.
The additions and revisions read as follows:
Sec. 324.2 Definitions
* * * * *
Adjusted allowances for credit losses (AACL) means valuation
allowances that have been established through a charge against earnings
or retained earnings for expected credit losses on financial assets
measured at amortized cost and a lessor's net investment in leases that
have been established to reduce the amortized cost basis of the assets
to amounts expected to be collected as determined in accordance with
GAAP. For purposes of this part, adjusted allowances for credit losses
include allowances for expected credit losses on off-balance sheet
credit exposures not accounted for as insurance as determined in
accordance with GAAP. Adjusted allowances for credit losses exclude
allocated transfer risk reserves and allowances created that reflect
credit losses on purchased credit deteriorated assets, purchased
seasoned loans, assets required to record an allowance for credit
losses through a gross-up adjustment to the purchase price of the
asset, and available-for-sale debt securities.
* * * * *
Carrying value means, with respect to an asset, the value of the
asset on the balance sheet of the FDIC-supervised institution as
determined in accordance with GAAP. For all assets other than
available-for-sale debt securities, purchased credit deteriorated
assets, purchased seasoned loans, or assets required to record an
allowance for credit losses through a gross-up adjustment to the
purchase price of the asset, the carrying value is not reduced by any
associated credit loss allowance that is determined in accordance with
GAAP.
Category I FDIC-supervised institution means an FDIC-supervised
institution that is a subsidiary of a global systemically important
BHC, as defined pursuant to 12 CFR 252.5.
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 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 the FDIC-supervised institution's total
exposure, calculated in accordance with the instructions to the FR Y-15
or equivalent reporting form, minus the FDIC-supervised institution's
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, an FDIC-supervised institution continues to be a Category
III FDIC-supervised institution until the FDIC-supervised institution:
(A) Has:
[[Page 15314]]
(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 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 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\
\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.
* * * * *
Commitment means a contractual arrangement, under which an FDIC-
supervised institution and an obligor agree to terms applicable to one
or more future extensions of credit, purchases of assets, or issuances
of credit substitutes by the FDIC-supervised institution, whether or
not such arrangement is unconditionally cancelable. A commitment is
unconditionally cancelable if, by its terms, it either: (a) provides
that an FDIC-supervised institution is not obligated to extend credit,
purchase assets, or issue credit substitutes; or (b) permits a FDIC-
supervised institution, at any time, with or without cause, to refuse
to extend credit, purchase assets, or issue credit substitutes under
the arrangement (to the extent permitted under applicable law).
* * * * *
Corporate exposure means an exposure to a company that is not:
(1) An exposure to a sovereign, a specified supranational entity, 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. 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.
* * * * *
Dependent on the cash flows generated by the real estate means, for
a real estate exposure, 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.
* * * * *
Effective notional amount means for an eligible guarantee, eligible
credit derivative, or eligible prepaid credit protection arrangement,
the lesser of the contractual notional amount of the credit risk
mitigant and the exposure amount of the hedged exposure, multiplied by
the percentage coverage of the credit risk mitigant.
* * * * *
Eligible clean-up call means a clean-up call that:
(1) Is exercisable solely at the discretion of the originating
FDIC-supervised institution or servicer;
(2) Is not structured to avoid allocating losses to securitization
exposures held by investors or otherwise structured to provide credit
enhancement to the securitization; and
(3) Is only exercisable:
(i) For a traditional securitization, when 10 percent or less of
the principal amount of the underlying exposures or securitization
exposures (determined as of the inception of the securitization) is
outstanding;
(ii) For a synthetic securitization, when 10 percent or less of the
principal amount of the reference portfolio of underlying exposures
(determined as of the inception of the securitization) is outstanding;
(iii) Upon the occurrence of a regulatory event that significantly
changes the risk-weighted asset amount for the securitization exposure
under this part; or
(iv) Upon the occurrence of a tax event that significantly changes
the tax treatment of the securitization exposure under applicable tax
laws.
* * * * *
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);
[[Page 15315]]
(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.
* * * * *
Eligible prepaid credit protection arrangement means a prepaid
credit protection arrangement that:
(1) Is written;
(2) Is unconditional;
(3) Covers all or a pro rata portion of all contractual payments
due to be paid on the reference exposure or reference exposures;
(4) Provides that the amount and timing of payments due from the
protection purchaser to the protection provider are incorporated into
the arrangement and the arrangement only allows these terms to change
in the event of a breach of the arrangement by the protection
purchaser;
(5) Provides that entry of the protection provider into
receivership, insolvency, liquidation, conservatorship, or similar
proceeding does not change the amounts or timing of payments due to be
paid by the protection purchaser under the arrangement;
(6) Is legally valid and enforceable under applicable law of the
relevant jurisdictions;
(7) Upon a failure by the obligor on the one or more reference
exposures to make a contractually required payment, or the occurrence
of other credit events as described in the arrangement, allows the
protection purchaser promptly to reduce the outstanding balance of the
initial principal amount due to the protection provider by the loss of
the protection purchaser on the reference exposures without input from
the protection provider; and
(8) Does not increase the protection purchaser's cost of credit
protection in response to deterioration in the credit quality of any of
the reference exposures.
* * * * *
ERBA FDIC-supervised institution means an FDIC-supervised
institution that is described in Sec. 324.100(b).
* * * * *
Expanded total risk-weighted assets means the sum of:
(1) Total credit risk-weighted assets;
(2) Total risk-weighted assets for equity exposures as calculated
under Sec. Sec. 324.141 and 324.142;
(3) Risk-weighted assets for operational risk as calculated under
Sec. 324.150;
(4) Market risk-weighted assets, if applicable; and
(5) CVA risk-weighted assets, if applicable; minus
(6) 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)); a derivative contract; a repo-style transaction or
an eligible margin loan for which the FDIC-supervised institution
determines the exposure amount under Sec. 324.37, Sec. Sec. 324.113
through 324.115, 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
a 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 a derivative contract (other than a
cleared transaction), the exposure amount determined under Sec. 324.34
or Sec. Sec. 324.113 through 324.114, as applicable.
(6) For an exposure that is a cleared transaction, the exposure
amount determined under Sec. 324.35 or Sec. 324.116, as applicable.
(7) For an exposure that is an eligible margin loan or repo-style
transaction (other than a cleared transaction) for which the FDIC-
supervised institution calculates the exposure amount as provided in
Sec. 324.37 or Sec. Sec. 324.113 through 324.115, as applicable, the
exposure amount determined under Sec. 324.37 or Sec. 324.113 through
324.115, 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.
* * * * *
FDIC-supervised institution means an FDIC-insured, state-chartered
commercial or savings bank that is not a member of the Federal Reserve
System
[[Page 15316]]
and for which the FDIC is the appropriate Federal banking agency
pursuant to section 3(q) of the Federal Deposit Insurance Act (12
U.S.C. 1813(q)), or a state savings association.
* * * * *
Financial institution * * *
(4) * * *
(i) * * *
(A) An investment in GAAP equity instruments of the company with an
adjusted carrying value or exposure amount equal to or greater than $10
million, as adjusted pursuant to Sec. 217.4; or
* * * * *
(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 an 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 a group of transactions with a single
counterparty that are subject to a qualifying master netting agreement.
For derivative contracts, netting set also includes a single derivative
contract between an FDIC-supervised institution and a single
counterparty.
* * * * *
Non-performing loan securitization (NPL securitization) means a
traditional securitization, that is not a resecuritization, where
parameter W (as defined in Sec. 324.133(b)(1)) for the underlying
exposures is greater than or equal to 90 percent at the origination
cut-off date and at any subsequent date on which exposures are added to
or removed from the pool of underlying exposures due to replenishment
or restructuring.
Nonrefundable purchase price discount (NRPPD) means the difference
between the outstanding principal balance of the underlying exposures
at the time of sale and the price at which these exposures are sold by
the originator to a company the activities of which are limited to
those appropriate for the specific purpose of holding the underlying
exposures of a securitization, when neither originator nor the original
lender are reimbursed for this difference. In cases where the
originator underwrites tranches of an NPL securitization for subsequent
sale, the NRPPD may include the differences between the outstanding
principal balance of the underlying exposures at the time of sale and
the price at which all of the 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 of a securitization tranche are not considered.
* * * * *
Prepaid credit protection arrangement means a contractual
arrangement under which a protection purchaser transfers the credit
risk of one or more reference exposures to a protection provider where:
(1) The protection provider pays an initial principal amount in
cash to the protection purchaser at the inception of the transaction;
and
(2) The protection purchaser is obligated to repay the initial
principal amount to the protection provider on or before the maturity
date of the transaction, less any losses that the protection purchaser
realizes or otherwise recognizes due to nonpayment of all contractual
payments due to be paid on the reference exposure or reference
exposures by the obligors.
* * * * *
Protection amount (P) means, with respect to an exposure hedged by
an eligible guarantee, eligible credit derivative, or eligible prepaid
credit protection arrangement, or secured by financial collateral, the
effective notional amount of the guarantee, credit derivative, or
prepaid credit protection arrangement, or the fair value of the
financial collateral, reduced to reflect any currency mismatch,
maturity mismatch, or lack of restructuring coverage (as provided in
Sec. 324.36-324.37 or Sec. 324.120-121, as applicable).
* * * * *
Qualifying cross-product master netting agreement means a
qualifying master netting agreement that provides for termination and
close-out netting across multiple types of financial transactions or
qualifying master netting agreements in the event of a counterparty's
default, provided that the underlying financial transactions are
derivative contracts or repo-style transactions that are not cleared
transactions. In order to treat an agreement as a qualifying cross-
product master netting agreement, an FDIC-supervised institution must
comply with the requirements of Sec. 324.3(c) of this part with
respect to that agreement.
* * * * *
Specified supranational entity means the Bank for International
Settlements, the European Central Bank, the European Commission, the
International Monetary Fund, the European Stability Mechanism, or the
European Financial Stability Facility.
* * * * *
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 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. 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 adjusted
[[Page 15317]]
allowance for credit losses 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 issuer or the
reference entity likely would default on its financial commitments.
* * * * *
Synthetic securitization means a transaction in which:
(1) All or a portion of the credit risk of one or more underlying
exposures is retained or transferred to one or more third parties
through the use of one or more credit derivatives, guarantees (other
than a guarantee that transfers only the credit risk of an individual
retail exposure), or prepaid credit protection arrangements;
(2) The credit risk associated with the underlying exposures has
been separated into at least two tranches reflecting different levels
of seniority;
(3) Performance of the securitization exposures depends solely upon
the performance of the underlying exposures; and
(4) All or substantially all of the underlying exposures are
financial exposures (such as loans, commitments, credit derivatives,
guarantees, receivables, asset-backed securities, mortgage-backed
securities, other debt securities, or equity securities).
* * * * *
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. 324.116;
(3) Total risk-weighted assets for unsettled transactions as
calculated under Sec. 324.117; and
(4) Total risk-weighted assets for securitization exposures as
calculated under Sec. 324.132.
* * * * *
Traditional securitization means a transaction in which:
(1) All or a portion of the credit or equity risk of one or more
underlying exposures is transferred to one or more third parties other
than through the use of credit derivatives, guarantees, or prepaid
credit protection arrangements;
(2) The credit risk associated with the underlying exposures has
been separated into at least two tranches reflecting different levels
of seniority;
(3) Performance of the securitization exposures depends solely upon
the performance of the underlying exposures;
(4) All or substantially all of the underlying exposures are
financial exposures (such as loans, commitments, credit derivatives,
guarantees, receivables, asset-backed securities, mortgage-backed
securities, other debt securities, or equity securities);
(5) The underlying exposures are not owned by an operating company;
(6) The underlying exposures are not owned by a small business
investment company defined in section 302 of the Small Business
Investment Act;
(7) The underlying exposures are not owned by a firm an investment
in which qualifies as a community development investment under section
24 (Eleventh) of the National Bank Act;
(8) The FDIC may determine that a transaction in which the
underlying exposures are owned by an investment firm that exercises
substantially unfettered control over the size and composition of its
assets, liabilities, and off-balance sheet exposures is not a
traditional securitization based on the transaction's leverage, risk
profile, or economic substance;
(9) The FDIC may deem a transaction that meets the definition of a
traditional securitization, notwithstanding paragraph (5), (6), or (7)
of this definition, to be a traditional securitization based on the
transaction's leverage, risk profile, or economic substance; and
(10) The transaction is not:
(i) An investment fund;
(ii) A collective investment fund (as defined in 12 CFR 344.3
(state nonmember bank), and 12 CFR 390.203 (state savings association);
(iii) An employee benefit plan (as defined in paragraphs (3) and
(32) of section 3 of ERISA), a ``governmental plan'' (as defined in 29
U.S.C. 1002(32)) that complies with the tax deferral qualification
requirements provided in the Internal Revenue Code, or any similar
employee benefit plan established under the laws of a foreign
jurisdiction;
(iv) A synthetic exposure to the capital of a financial institution
to the extent deducted from capital under Sec. 324.22; or
(v) Registered with the SEC under the Investment Company Act of
1940 or foreign equivalents thereof.
* * * * *
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.
* * * * *
0
91. In Sec. 324.3, revise paragraph (c) to read as follows:
Sec. 324.3 Operational requirements for counterparty credit risk.
* * * * *
(c) Qualifying cross-product master netting agreement. In order to
recognize an agreement as a qualifying cross-product master netting
agreement as defined in Sec. 324.2, an FDIC-supervised institution
must obtain a written legal opinion verifying the validity and
enforceability of the agreement under applicable law of the relevant
jurisdictions if the counterparty fails to perform upon an event of
default, including upon receivership, insolvency, liquidation, or
similar proceeding
* * * * *
Sec. 324.4 [Redesignated as Sec. 324.6]
0
92. Redesignate Sec. 324.4 as Sec. 324.6.
0
a. Redesignate footnote 10 as footnote 1.
0
b. Revise newly redesignated footnote 1.
The revision reads as follows:
Sec. 324.6 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).
Sec. 324.5 [Redesignated as Sec. 324.7]
0
93. Redesignate Sec. 324.5 as Sec. 324.7.
0
a. In paragraph (a), remove the reference ``Sec. Sec. 324.4 and
324.10'' and adding in its place the reference ``Sec. Sec. 324.6 and
324.10''.
0
94. Add section Sec. 324.4 to read as follows:
Sec. 324.4 Threshold Indexing.
(a) Methodology. The dollar thresholds specified in paragraph (c)
of this section shall be adjusted by multiplying the baseline threshold
values specified in paragraph (c) of this section by one plus the
cumulative percent change in the non-seasonally adjusted Consumer Price
Index for Urban Wage Earners and Clerical Workers, measured from the
effective
[[Page 15318]]
date of this rule, as further described in paragraph (b) of this
section, and shall be rounded in accordance with paragraph (d) of this
section.
(b) Frequency. (1) In general--biennial adjustments. Except as
otherwise provided in paragraph (b)(2) and (b)(3) of this section, the
adjustments described in paragraph (a) of this section shall be
effective on October 1 following each consecutive two year period
ending August 30, and using the non-seasonally adjusted Consumer Price
Index for Urban Wage Earners and Clerical Workers as of August 30 of
that year.
(2) Off-year adjustments. In the event that the FDIC determines,
during a year where no adjustment would be made under paragraph (b)(1),
that the non-seasonally adjusted Consumer Price Index for Urban Wage
Earners and Clerical Workers, measured over the twelve month period
ending August 30 of that year, is such that an adjustment under this
section would be appropriate for that year, the FDIC may make an
adjustment under this section for that year.
(3) Periods of negative inflation. Notwithstanding paragraph (b)(1)
or (b)(2) of this section, if an adjustment of dollar thresholds using
the cumulative percent change of the non-seasonally adjusted Consumer
Price Index for Urban Wage Earners and Clerical Workers from the
effective date of this rule or the most recent adjustment, as
applicable, would not result in an increase from the current dollar
thresholds, no adjustment will be made pursuant to paragraph (a) of
this section.
(c) Specified thresholds. The thresholds in the following sections
shall be adjusted in accordance with paragraph (a) of this section
relative to the baseline threshold values as specified below.
(1) Sec. 324.2, definition of Financial institution, paragraph
(4)(i)(A), baseline threshold value $10 million;
(2) Sec. 324.101, definition of Regulatory retail exposure,
paragraph (2), baseline threshold value $1 million;
(3) Sec. 324.101, definition of Small or medium-sized entity
(SME), baseline threshold value $50 million;
(4) Sec. 324.150(b)(1), baseline threshold value $1 billion;
(5) Sec. 324.150(b)(2), baseline threshold values $1 billion, $30
billion, and $120 million;
(6) Sec. 324.150(b)(2)(i), baseline threshold value $1 billion;
(7) Sec. 324.150(b)(3), baseline threshold values $30 billion and
$4.47 billion
(8) Sec. 324.150(b)(3)(i), baseline threshold value $30 billion;
(9) Sec. 324.150(d)(2)(i)(A), baseline threshold value $20,000;
(10) Sec. 324.201(b)(1)(ii)(B), baseline threshold value $5
billion;
(11) Sec. 324.201(b)(2)(ii), baseline threshold value $1 trillion;
(12) Sec. 324.202 ``Large market cap'', baseline threshold value
$2 billion;
(15) Sec. 324.202, ``Market risk covered position'' (1)(ii)(D),
baseline value $20 million;
(16) Sec. 324.202, ``Small market cap'', baseline threshold value
$2 billion.
(d) Rounding. When adjusting thresholds under this section, each
threshold shall be rounded based on the size of the threshold (e.g.,
thousands, millions, billions) to the nearest number with two
significant digits.
(e) Effective date of threshold adjustments. The FDIC shall
announce the thresholds adjusted in accordance with this section by
publication in the Federal Register. Such adjusted thresholds shall be
effective on October 1 of the year during which an adjustment is made.
(f) Failure to publish in the Federal Register. In the event, for
any reason, the thresholds adjusted in accordance with this section are
not published in the Federal Register in a year in which an adjustment
is made under this section, the thresholds specified in paragraph (c)
of this section will adjust as provided in this section and be
effective on October 1, notwithstanding the lack of publication in the
Federal Register.
* * * * *
0
95. Add Sec. 324.5 ``Calculation of loan-to-value (LTV) ratio.''
The addition reads as follows:
Sec. 324.5 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 12 CFR part
365, subpart A, Appendix A, that secures the extension of credit,
subject to the following:
(i) For exposures subject to 12 CFR part 323, subpart A, the market
value of property is a valuation that meets all requirements of that
rule.
(ii) For exposures not subject to 12 CFR part 323, subpart A:
(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 FDIC-
supervised institution'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 account for 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 includes the financing to
purchase the property, the value of the property is the lower of the
market value obtained under paragraph (c)(1)(i) or (c)(1)(ii) of this
section, 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 FDIC requires an FDIC-supervised institution 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 12 CFR part 365, subpart A, Appendix A, must be
appropriately discounted by the FDIC-supervised institution consistent
with the FDIC-supervised institution's usual practices for making loans
secured by such collateral.
Subpart B--Capital Ratio Requirements and Buffers
0
96. In Sec. 324.10:
0
a. Revise paragraphs (a)(1)(v), (b), (c), (d); and
0
b. Add paragraph (b)(6).
The revisions read as follows:
Sec. 324.10 Minimum capital requirements.
* * * * *
(a) * * *
[[Page 15319]]
(1) * * *
(v) For an Category I FDIC-supervised institution, Category II
FDIC-supervised institution, or Category III FDIC-supervised
institution, a supplementary leverage ratio of 3 percent.
* * * * *
(b) Standardized capital ratio calculations. For an FDIC-supervised
institution that is not a Category I FDIC-supervised institution or
Category II FDIC-supervised institution:
(1) Common equity tier 1 capital ratio. The FDIC-supervised
institution's common equity tier 1 capital ratio is the ratio of the
FDIC-supervised institution's common equity tier 1 capital to selected
total risk-weighted assets;
(2) Tier 1 capital ratio. The FDIC-supervised institution's tier 1
capital ratio is the ratio of the FDIC-supervised institution's tier 1
capital to selected total risk-weighted assets;
(3) Total capital ratio. The FDIC-supervised institution's total
capital ratio is the ratio of the FDIC-supervised institution's total
capital to selected total risk-weighted assets; and
(4) Leverage ratio. The FDIC-supervised institution's leverage
ratio is the ratio of the FDIC-supervised institution's tier 1 capital
to the FDIC-supervised institution's average total consolidated assets
as reported on the FDIC-supervised institution's Call Report, minus
amounts deducted from tier 1 capital under Sec. 324.22(a), (c) and
(d).
(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).
(6) Selected total risk-weighted assets. An FDIC-supervised
institution's selected total risk-weighted assets is either the FDIC-
supervised institution's standardized total risk-weighted assets or
expanded total risk-weighted assets, as selected by the FDIC-supervised
institution. An FDIC-supervised institution may change its choice for
selected total risk-weighted assets by providing the FDIC with prior
notice of the change at least four full calendar quarters before the
calendar quarter in which the change will take effect.
(c) Supplementary leverage ratio. (1) The supplementary leverage
ratio of a Category I FDIC-supervised institution, Category II FDIC-
supervised institution, or Category III FDIC-supervised institution 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, for an FDIC-supervised
institution that uses the standardized approach for counterparty credit
risk (SA-CCR) under Sec. 324.114 for its standardized total risk-
weighted assets or expanded total risk-weighted assets, less the fair
value of any derivative contracts;
(ii) (A) For an FDIC-supervised institution that uses the current
exposure methodology under Sec. 324.34(b) for its standardized total
risk-weighted assets, the potential future credit exposure (PFE) for
each derivative contract or each single-product 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), to which the FDIC-
supervised institution is a counterparty as determined under Sec.
324.34, but without regard to Sec. 324.34(c), provided that:
(1) 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. 324.34,
but without regard to Sec. 324.34(c), provided that it does not adjust
the net-to-gross ratio (NGR); and
(2) An FDIC-supervised institution that chooses to exclude the PFE
of credit derivatives or other similar instruments through which it
provides credit protection pursuant to paragraph (c)(2)(ii)(A) of this
section must do so consistently over time for the calculation of the
PFE for all such instruments; or
(B) (1) For an FDIC-supervised institution that uses SA-CCR under
Sec. 324.114 for its standardized total risk-weighted assets or
expanded total risk-weighted assets, the PFE under SA-CCR each
derivative contract or single product netting set of derivative
contracts 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. 324.114(g), in
which the term C in Sec. 324.114(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. 324.114(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
(2) 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.
324.114, provided that it does so consistently over time for the
calculation of the PFE for all such instruments;
(iii)(A)(1) For an FDIC-supervised institution that uses the
current exposure methodology under Sec. 324.34(b) for its standardized
total risk-weighted assets, the amount of cash collateral that is
received from a counterparty to a derivative contract and that has
offset the mark-to-fair value of the derivative asset, or cash
collateral that is posted to a counterparty to a derivative contract
and that has reduced the FDIC-supervised institution's on-balance sheet
assets, unless such cash collateral is all or part of variation margin
that satisfies the conditions in
[[Page 15320]]
paragraphs (c)(2)(iii)(C) through (G) of this section; and
(2) The variation margin is used to reduce the current credit
exposure of the derivative contract, calculated as described in Sec.
324.34(b), and not the PFE; and
(3) For the purpose of the calculation of the NGR described in
Sec. 324.34(b)(2)(ii)(B), variation margin described in paragraph
(c)(2)(iii)(A)(2) of this section may not reduce the net current credit
exposure or the gross current credit exposure; or
(B)(1) For an FDIC-supervised institution that uses SA-CCR under
Sec. 324.114 for its standardized total risk-weighted assets or
expanded total risk-weighted assets, the replacement cost under Sec.
324.114 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)(C) through (G) 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)(C) through (G) 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, an FDIC-supervised institution must apply the formula for
replacement cost provided in Sec. 324.114(j)(1), in which the term CMA
may only include cash collateral that satisfies the conditions in
paragraphs (c)(2)(iii)(C) through (G) of this section; and
(3) For purposes of paragraph (c)(2)(iii)(A) of this section, an
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. 324.114(e)(6);
(C) 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);
(D) Variation margin is calculated and transferred on a daily basis
based on the mark-to-fair value of the derivative contract;
(E) 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;
(F) 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)(F), 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
(G) 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
[[Page 15321]]
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 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:
(A) For an FDIC-supervised institution that elects to calculate its
standardized total risk-weighted assets under Sec. 324.10(b), the
applicable credit conversion factor under Sec. 324.33(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; or
(B) For an FDIC-supervised institution that elects to calculate its
expanded total risk-weighted assets under Sec. 324.10(b), a Category I
FDIC-supervised institution, a Category II FDIC-supervised institution,
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 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;
(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; and
[[Page 15322]]
(F) Notwithstanding paragraph (c)(2)(ix)(A), an FDIC-supervised
institution that has elected under Sec. 324.113(c) to treat any repo-
style transactions subject to a qualifying cross-product master netting
agreement as derivative contracts must treat any such repo-style
transactions as a derivative contract for purposes of this paragraph
(c).
(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. For a Category I FDIC-
supervised institution, a Category II FDIC-supervised institution, or
an ERBA FDIC-supervised institution:
(1) Common equity tier 1 capital ratio. The FDIC-supervised
institution's common equity tier 1 capital ratio is the ratio of the
FDIC-supervised institution's common equity tier 1 capital to expanded
total risk-weighted assets;
(2) Tier 1 capital ratio. The FDIC-supervised institution's tier 1
capital ratio is the ratio of the FDIC-supervised institution's tier 1
capital to expanded total risk-weighted assets;
(3) Total capital ratio. The FDIC-supervised institution's total
capital ratio is the ratio of the FDIC-supervised institution's total
capital to expanded total risk-weighted assets; and
(4) Leverage ratio. The FDIC-supervised institution's leverage
ratio is the ratio of the FDIC-supervised institution's tier 1 capital
to the FDIC-supervised institution's average total consolidated assets
as reported on the FDIC-supervised institution's Call Report, minus
amounts deducted from tier 1 capital under Sec. 324.22(a), (c) and
(d).
(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, the term total assets shall have the
meaning provided in 12 CFR 324.401(g).
* * * * *
0
97. In Sec. 324.11:
0
a. Revise paragraph (a)(2)(iv);
0
b. In paragraph (b)(1), remove the words ``An advanced approaches FDIC-
supervised institution or a Category III FDIC-supervised institution''
and add in their place the words ``A Category I FDIC-supervised
institution, a Category II FDIC-supervised institution, or a Category
III FDIC-supervised institution'';
0
c. Revise paragraph (b)(1)(iii); and
0
d. In paragraph (b)(2)(ii), redesignate footnote 11 as footnote 1.
The revision reads as follows:
Sec. 324.11 Capital conservation buffer and countercyclical capital
buffer amount
* * * * *
(a) * * *
(2) * * *
(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, a specified supranational entity, a MDB, a PSE, or a
GSE.
(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 capital requirement as determined under Sec.
324.210 multiplied by 12.5.
* * * * *
Sec. 324.12 [Amended]
0
98. In Sec. 324.12, remove paragraph (a)(4).
Subpart C--Definition of Capital
0
99. 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 ERBA FDIC-supervised institution, the governing
agreement, offering circular, or prospectus of an instrument issued
after the date upon which the FDIC-supervised institution becomes
subject to this part 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 ERBA FDIC-supervised institution, the governing
agreement, offering circular, or prospectus of an instrument issued
after the date on which the FDIC-supervised institution becomes subject
to this part 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) AACL up to 1.25 percent of the FDIC-supervised institution's
standardized total risk-weighted assets or total credit risk-weighted
assets, as applicable, not including any amount of the AACL (and
excluding the case of a market risk FDIC-supervised institution, its
market risk weighted assets).
* * * * *
0
100. In Sec. 324.21:
0
a. Revise paragraph (b).
The revision reads as follows:
Sec. 324.21 Minority interest.
* * * * *
(b) (1) Applicability. For purposes of Sec. 324.20, an ERBA FDIC-
supervised institution 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
[[Page 15323]]
calculations in this section, if the consolidated subsidiary issuing
the capital is not subject to capital adequacy standards similar to
those of the ERBA FDIC-supervised institution, the ERBA FDIC-supervised
institution 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 ERBA FDIC-supervised institution, 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 expanded 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. For each consolidated subsidiary of
the ERBA FDIC-supervised institution, 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 expanded 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 ERBA FDIC-supervised institution, 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 expanded total risk-weighted assets of the FDIC-
supervised 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
101. In Sec. 324.22:
0
a. Redesignate footnotes 22 through 31 as footnotes 1 through 10,
respectively;
0
b. Revise newly redesignated footnotes 1, 5, 6, 7, 9, and 10;
0
c. Revise paragraph (a)(4);
0
d. Remove and reserve paragraph (a)(6);
0
e. Revise paragraph (b)(1)(ii);
0
f. Revise paragraphs (b)(2)(i), (b)(2)(ii), (b)(2)(iii), and (b)(2)(iv)
introductory text, and (c)(2) introductory text; and
0
g. Revise paragraphs (c)(5), (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) Any gain-on-sale in connection with a securitization
exposure;
(ii) For an ERBA FDIC-supervised institution, the portion of any
CEIO that does not constitute an after-tax gain-on-sale;
* * * * *
(b) * * *
(1) * * *
(ii) An ERBA FDIC-supervised institution, and an 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) AOCI opt-out election.
(i) An FDIC-supervised institution that is not an ERBA FDIC-
supervised institution 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:
(A) Subtract any net unrealized gains and add any net unrealized
losses on available-for-sale 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 FDIC-supervised institution'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) An FDIC-supervised institution that is not an ERBA 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 required to comply with subpart A of this part. If
[[Page 15324]]
the FDIC-supervised institution was previously an ERBA FDIC-supervised
institution, the FDIC-supervised institution may not make an AOCI opt-
out election under this paragraph (b)(2)(ii).
(iii) With respect to an FDIC-supervised institution that is not an
ERBA FDIC-supervised institution, each of its subsidiary banking
organizations that is subject to regulatory capital requirements issued
by the Federal Reserve, the FDIC, or the OCC1 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 and that
is not an ERBA FDIC-supervised institution 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 an ERBA FDIC-supervised
institution (as described in paragraph (c)(4) of this section), non-
significant investments in the capital of unconsolidated financial
institutions for an ERBA FDIC-supervised institution (as described in
paragraph (c)(5) of this section), and non-common stock significant
investments in the capital of unconsolidated financial institutions for
an ERBA FDIC-supervised institution (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 ERBA FDIC-supervised institution 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 ERBA FDIC-
supervised institution 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 ERBA FDIC-supervised institution 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 ERBA FDIC-supervised institution, the 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.
* * * * *
(iii) For purposes of applying the deduction under paragraph
(c)(5)(i) of this section, an ERBA FDIC-supervised institution that is
not a Category I FDIC-supervised institution may exclude from the
deduction the amount of the FDIC-supervised institution's gross long
position, in accordance with Sec. 324.22(h)(2), in investments in
covered debt instruments issued by financial institutions in which the
FDIC-supervised institution 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 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,
net of associated DTLs in accordance with paragraph (e) of this
section.
(iv) Prior to applying the deduction under paragraph (c)(5)(i) of
this section:
(A) A Category I FDIC-supervised institution may designate any
investment in a covered debt instrument as an excluded covered debt
instrument, as defined in Sec. 324.2.
(B) A Category I FDIC-supervised institution must deduct, according
to the corresponding deduction approach in paragraph (c)(2) of this
section, its gross long position, calculated in accordance with
paragraph (h)(2) of this section, in a covered debt instrument that was
originally designated as an excluded covered debt instrument, in
accordance with paragraph (c)(5)(iv)(A) of this section, but no longer
qualifies as an excluded covered debt instrument.
(C) A Category I FDIC-supervised institution must deduct according
to the corresponding deduction approach in paragraph (c)(2) of this
section the amount of its gross long position, calculated in accordance
with paragraph (h)(2) of this section, in a direct or indirect
investment in a covered debt instrument that was originally designated
as an excluded covered debt instrument, in accordance with paragraph
(c)(5)(iv)(A) of this section, and has been held for more than thirty
business days.
(D) A Category I FDIC-supervised institution must deduct according
to the corresponding deduction approach in paragraph (c)(2) of this
section its gross long position, calculated in accordance with
paragraph (h)(2) of this section, of its aggregate position in excluded
covered debt instruments that exceeds 5
[[Page 15325]]
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, 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 an
ERBA FDIC-supervised institution 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
ERBA FDIC-supervised institution 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) Certain DTAs subject to common equity tier 1 capital deduction
thresholds.
(1) An FDIC-supervised institution that is not an ERBA FDIC-
supervised institution must make deductions from regulatory capital as
described in this paragraph (d)(1).
* * * * *
(2) An ERBA FDIC-supervised institution must make deductions from
regulatory capital as described in this paragraph (d)(2).
(i) An ERBA FDIC-supervised institution 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 ERBA FDIC-supervised
institution 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) 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 ERBA FDIC-supervised institution 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) An ERBA FDIC-supervised institution 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, an
ERBA FDIC-supervised institution may exclude DTAs and DTLs relating to
adjustments made to common equity tier 1 capital under paragraph (b) of
this section. An ERBA FDIC-supervised institution 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. An ERBA FDIC-supervised institution 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 an
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 an ERBA FDIC-supervised institution 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. 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 ERBA FDIC-supervised institution
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
[[Page 15326]]
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 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 ERBA FDIC-supervised institution 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 ERBA FDIC-supervised institution
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
ERBA FDIC-supervised institution 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
102. In Sec. 324.30
0
a. Revise paragraph (a);
0
b. In paragraph (b), remove the words ``covered positions'' and add in
their place the words ``market risk covered positions''.
The revision reads as follows:
* * * * *
(a) This subpart sets forth methodologies for determining
standardized total risk-weighted assets. This subpart applies to any
FDIC-supervised institution that elects to use this subpart under Sec.
324.10(b).
* * * * *
Sec. 324.34 Derivative contracts.
0
103. In Sec. 324.34, revise paragraph (a) to read as follows:
* * * * *
(a) Exposure amount for derivative contracts--(1) An FDIC-
supervised institution 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)(2) of this
section.
(2) An FDIC-supervised institution 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.
324.114 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)(2) to calculate the
exposure amount for its OTC derivative contracts under SA-CCR must
apply the treatment of cleared transactions under Sec. 324.116 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 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)(2), the FDIC-supervised
institution may change its election only with prior approval of the
FDIC.
* * * * *
0
104. 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 has elected to use
SA-CCR under Sec. 324.34(a) must apply Sec. 324.116 to its derivative
contracts that are cleared transactions rather than this section.
* * * * *
0
105. 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
106. 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
107. 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.
* * * * *
Table 3 to Sec. 324.63--Capital Adequacy
------------------------------------------------------------------------
------------------------------------------------------------------------
* * * * * * *
(c) Market risk-weighted
assets as calculated
under subpart F of this
part.
* * * * * * *
------------------------------------------------------------------------
[[Page 15327]]
* * * * *
Subpart E--Risk-Weighted Assets--Expanded Risk-Based Approach
Sec. 324.111 [Amended]
0
108. 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
109. 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
an 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 an FDIC-supervised institution is
adequately capitalized, undercapitalized, significantly
undercapitalized, or critically undercapitalized under subpart H of
this part; and
* * * * *
0
110. In Sec. 324.162:
0
a. Revise paragraph (c) as follows; and
0
b. Revise the heading of Table 13 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. An FDIC-
supervised institution described in Sec. 324.160 must provide a
description of the main features of its regulatory capital instruments,
in accordance with table 13 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 13 to paragraph (c). An
FDIC-supervised institution also must disclose the full terms and
conditions of all instruments included in regulatory capital.
Table 13 to Paragraph (c)--Main Features of Regulatory Capital Instruments and of Other TLAC-Eligible
Instruments
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
Qualitative Disclosures................ (a) For each regulatory capital instrument and any
other instrument that is an eligible debt
security as defined in 12 CFR 252.61, the FDIC-
supervised institution must provide the following
information:
------------------------------------------------------------------------
................ (1) The issuer's legal entity.
................ (2) The unique identifier.
................ (3) The governing law(s) of the instrument.
................ (4) The regulatory capital treatment.
................ (5) The level(s) within the FDIC-supervised
institution at which the instrument is included
in capital.
................ (6) The instrument type.
................ (7) The amount recognized in regulatory capital.
................ (8) The par value of the instrument.
................ (9) The accounting classification as debt or
equity.
................ (10) The original date of issuance.
................ (11) Whether perpetual or dated.
................ (12) The original maturity date.
................ (13) Whether an issuer call option subject to
prior supervisory approval exists.
................ (14) For an instrument with an issuer call option:
(i) the first date of call if the instrument has
a call option on a specific date (day, month, and
year); (ii) the instrument has a tax and/or
regulatory event call; and (iii) the redemption
price.
................ (15) Whether there are subsequent call option
dates and, if so, their frequency.
................ (16) Whether the coupon or dividend is fixed over
the life of the instrument, floating over the
life of the instrument, currently fixed but will
move to a floating rate in the future, or
currently floating but will move to a fixed rate
in the future.
................ (17) The coupon rate of the instrument and any
related index that the coupon or dividend rate
references.
................ (18) Whether the non-payment of a coupon or
dividend on the instrument prohibits the payment
of dividends on common shares.
................ (19) Whether the issuer has full, partial, or no
discretion over whether a coupon or dividend is
paid.
................ (20) Whether there is a step-up or other incentive
to redeem.
................ (21) Whether the dividends or coupons are
cumulative or non-cumulative.
................ (22) Whether the instrument is convertible or non-
convertible.
................ (23) If the instrument is convertible, the
conditions under which the instrument will
convert, including point of non-viability. Where
one or more authorities have the ability to
trigger conversion, the authorities should be
listed. For each of the authorities, state
whether the legal basis for the authority to
trigger conversion is provided by the terms of
the contract of the instrument (a contractual
approach) or statutory means (a statutory
approach).
................ (24) If the instrument is convertible, whether the
instrument will: (i) always convert fully; (ii)
may convert fully or partially; or (iii) will
always convert partially.
................ (25) If the instrument is convertible, the rate of
conversion into the more loss-absorbent
instrument.
................ (26) If the instrument is convertible, whether
conversion is mandatory or optional.
................ (27) If the instrument is convertible, the
instrument type into which it is convertible.
................ (28) If the instrument is convertible, the issuer
of the instrument into which it converts.
................ (29) Whether a write-down feature exists.
................ (30) If there is a write-down feature, the trigger
at which write-down occurs, including point of
non-viability. Where one or more authorities have
the ability to trigger write-down, the
authorities should be listed. For each of the
authorities it should be stated whether the legal
basis for the authority to trigger conversion is
provided by the terms of the contract of the
instrument or statutory means.
[[Page 15328]]
................ (31) If there is a write-down feature, for each
write-down trigger separately, whether the
instrument will: (i) always be written down
fully; (ii) may be written down partially; or
(iii) will always be written down partially.
................ (32) If there is a write-down feature, whether the
write-down is permanent or temporary.
................ (33) For instruments that have a temporary write-
down, a description of the writeup mechanism.
................ (34) The type of subordination.
................ (35) A description of the position in
subordination hierarchy in liquidation, including
by specifying the instrument type immediately
senior to instrument in the insolvency creditor
hierarchy of the legal entity concerned.
----------------------------------------------------------------------------------------------------------------
Subpart F--Risk-weighted Assets--Market Risk and Credit Valuation
Adjustment (CVA)
0
111. In Sec. 324.201:
0
a. Revise paragraphs (b)(1) and (b)(2); and
0
b. In paragraph (d), remove ``[12 CFR 3.404, 263.202, and 324.5(c)]''
and add ``12 CFR 324.7(c)'' in its place wherever it appears.
The revisions are as follows:
Sec. 324.201 Purpose, applicability, and reservation of authority.
* * * * *
(b) * * *
(1) Market risk. The market risk capital requirements and related
reporting and public disclosure requirements specified in Sec. Sec.
__.203 through __.217 apply to an FDIC-supervised institution that has
aggregate trading assets and trading liabilities, excluding customer
and proprietary broker-dealer reserve bank accounts, equal to:
(i) 10 percent or more of quarter-end total assets as reported on
the most recent quarterly Call Report; or
(ii) $5 billion, as adjusted pursuant to Sec. 324.4, or more, on
average for the four most recent quarters as reported in the FDIC-
supervised institution's Call Reports.
* * * * *
(2) CVA Risk. The CVA risk-based capital requirements specified in
Sec. Sec. 324.220 through 324.225 apply to any FDIC-supervised
institution that is:
(i) A subsidiary of a global systemically important BHC or a
Category II depository institution holding company and subject to the
market risk framework pursuant to Sec. 324.201(b)(1); or
(ii) An FDIC-supervised institution that is subject to the market
risk framework pursuant to Sec. 324.201(b)(1) and engages in OTC
derivative contracts with an aggregate gross notional value, as
reported on the FDIC-supervised institution's Call Reports of $1
trillion [, as adjusted pursuant to Sec. 324.4,] or more on average
for the prior four quarters.
* * * * *
* * * * *
Subpart G--Transition Provisions
0
112. In Sec. 324.300:
0
a. Revise paragraph (a); and
0
b. Remove and reserve paragraphs (f) through (h).
The revision and addition read as follows:
Sec. 324.300 Transitions.
(a) Transition adjustments for AOCI. Beginning [January 1, 2027],
an FDIC-supervised institution that uses expanded total risk-weighted
assets for purposes of Sec. 324.10(a)(5) and that had made an AOCI
opt-out election under Sec. 324.22(b)(2) effective [December 31, 2026]
must subtract from the sum of its common equity tier 1 elements, before
making deduction 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
(4) Net unrealized holding gains or losses on held-to-maturity
securities that are included in AOCI.
Table 1 to Sec. 324.300
----------------------------------------------------------------------------------------------------------------
Transition AOCI adjustment
-----------------------------------------------------------------------------------------------------------------
Percentage applicable to transition AOCI
Transition period adjustment amount
----------------------------------------------------------------------------------------------------------------
January 1, 2027 to December 31, 2027................................. 100
January 1, 2028 to December 31, 2028................................. 80
January 1, 2029 to December 31, 2029................................. 60
January 1, 2030 to December 31, 2030................................. 40
January 1, 2031 to December 31, 2031................................. 20
January 1, 2032 and thereafter....................................... 0
----------------------------------------------------------------------------------------------------------------
* * * * *
Sec. 324.301 Current expected credit losses (CECL) transition.
0
113. Remove and reserve Sec. 324.301.
Sec. 324.303 [Removed and Reserved]
0
114. Remove and reserve Sec. 324.303.
Sec. 324.304 [Removed and Reserved]
0
115. Remove and reserve Sec. 324.304.
Subpart H--Prompt Corrective Action
0
116. In Sec. 324.401, revise paragraphs (c), (f), and (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
[[Page 15329]]
to all insured depository institutions that are deemed critically
undercapitalized.
* * * * *
(f) Timing. The calculation of the definitions of common equity
tier 1 capital, the common equity tier 1 risk-based capital ratio, the
leverage ratio, the supplementary leverage ratio, tangible equity, tier
1 capital, the tier 1 risk-based capital ratio, total assets, total
leverage exposure, the total risk-based capital ratio, and total risk-
weighted assets under this subpart H is subject to the timing
provisions at 12 CFR 324.1(f) and the transitions at 12 CFR part 324,
subpart G.
(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
117. 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 a Category I FDIC-supervised institution,
Category II FDIC-supervised institution, or Category III FDIC-
supervised institution, the supplementary leverage ratio.
* * * * *
(b) * * *
(2) * * *
(vi) A Category I FDIC-supervised institution, Category II FDIC-
supervised institution, or Category III FDIC-supervised institution
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) A Category I FDIC-supervised institution, Category II FDIC-
supervised institution, or Category III FDIC-supervised institution
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
118. 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:
------------------------------------------------------------------------
Remove the Add the following
Sections: following words: words:
------------------------------------------------------------------------
324.1........................... ``advanced ``ERBA FDIC-
324.2........................... approaches FDIC- supervised
324.12(a)(2) introductory text.. supervised institution.''
324.21(a)(1).................... institution''.
324.22 (a)(1)(ii), (b)(1)(iii),
(c)(2)(ii)(D), (c)(3)(ii), and
(c)(4), and.
324.61..........................
324.22(g)....................... ``advanced ``expanded total
324.302, and.................... approaches total risk-weighted
324.305......................... risk-weighted assets.''
assets''.
324.2, in the definition of ``Sec. 324.133'' ``Sec.
``qualifying central 324.114.''
counterparty (QCCP)''.
------------------------------------------------------------------------
* * * * *
Jonathan V. Gould,
Comptroller of the Currency.
By order of the Board of Governors of the Federal Reserve
System.
Benjamin W. McDonough,
Secretary of the Board.
Federal Deposit Insurance Corporation.
By order of the Board of Directors,
Dated at Washington, DC, on March 19, 2026.
Jennifer M. Jones,
Deputy Executive Secretary.
[FR Doc. 2026-05959 Filed 3-26-26; 8:45 am]
BILLING CODE 4810-33-6210-01-6714-01-P