[Federal Register Volume 61, Number 46 (Thursday, March 7, 1996)]
[Proposed Rules]
[Pages 9114-9119]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-5235]
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Proposed Rules
Federal Register
________________________________________________________________________
This section of the FEDERAL REGISTER contains notices to the public of
the proposed issuance of rules and regulations. The purpose of these
notices is to give interested persons an opportunity to participate in
the rule making prior to the adoption of the final rules.
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Federal Register / Vol. 61, No. 46 / Thursday, March 7, 1996 /
Proposed Rules
[[Page 9114]]
DEPARTMENT OF THE TREASURY
Office of the Comptroller of the Currency
12 CFR Part 3
[Docket No. 96-05]
RIN 1557-AB14
FEDERAL RESERVE SYSTEM
12 CFR Parts 208 and 225
[Regulations H and Y; Docket No. R-0884]
FEDERAL DEPOSIT INSURANCE CORPORATION
12 CFR Part 325
RIN 3064-AB72
Risk-Based Capital Standards; Market Risk; Internal Models
Backtesting
AGENCIES: Office of the Comptroller of the Currency, Treasury; Board of
Governors of the Federal Reserve System; and Federal Deposit Insurance
Corporation.
ACTION: Joint notice of proposed rulemaking.
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SUMMARY: The Office of the Comptroller of the Currency (OCC), the Board
of Governors of the Federal Reserve System (Board), and the Federal
Deposit Insurance Corporation (FDIC) (Agencies) are proposing to amend
their July 25, 1995, proposal to incorporate a measure for market risk
into their respective risk-based capital standards. The proposed
amendment would provide additional guidance to an institution about how
the multiplication factor used to calculate capital requirements for
market risk under the internal models approach would be adjusted if
comparisons of its internal model's previous estimates with actual
trading results indicate that the internal model is inaccurate. The
proposed amendment would increase the market risk capital charge for an
institution with an inaccurate model.
DATES: Comments must be received on or before April 5, 1996.
ADDRESSES: Comments should be directed to:
OCC: Comments may be submitted to Docket No. 96-05, Communications
Division, Third Floor, Office of the Comptroller of the Currency, 250 E
Street, S.W., Washington, D.C., 20219. Comments will be available for
inspection and photocopying at that address. In addition, comments may
be sent by facsimile transmission to FAX number (202) 874-5274, or by
electronic mail to [email protected]
Board: Comments directed to the Board should refer to Docket No. R-
0884 and may be mailed to William W. Wiles, Secretary, Board of
Governors of the Federal Reserve System, 20th Street and Constitution
Avenue, N.W., Washington, D.C., 20551. Comments may also be delivered
to Room B-2222 of the Eccles Building between 8:45 a.m. and 5:15 p.m.
weekdays, or to the guard station in the Eccles Building courtyard on
20th Street, N.W., (between Constitution Avenue and C Street) at any
time. Comments may be inspected in Room MP-500 of the Martin Building
between 9 a.m. and 5 p.m. weekdays, except as provided in 12 CFR 261.8
of the Board's rules regarding availability of information.
FDIC: Written comments should be sent to Jerry L. Langley,
Executive Secretary, Attention: Room F--402, Federal Deposit Insurance
Corporation, 550 17th Street N.W., Washington, D.C. 20429. Comments may
be hand delivered to Room F--402, 1776 F Street N.W., Washington, D.C.
20429 on business days between 8:30 a.m. and 5 p.m. (Fax number (202)
898-3838; Internet address: comments@fdic.gov). Comments will be
available for inspection and photocopying in Room 7118, 550 17th
Street, N.W., Washington, D.C. 20429, between 9 a.m. and 4:30 p.m. on
business days.
FOR FURTHER INFORMATION CONTACT:
OCC: Margot Schwadron, Financial Analyst, or Christina Benson,
Capital Markets Specialist (202/874-5070), Office of the Chief National
Bank Examiner. For legal issues, Ronald Shimabukuro, Senior Attorney,
or Andrew Gutierrez, Attorney (202/874-5090), Legislative and
Regulatory Activities Division.
Board: Roger Cole, Deputy Associate Director (202/452-2618), James
Houpt, Assistant Director (202/452-3358), Barbara Bouchard, Supervisory
Financial Analyst (202/452-3072), Division of Banking Supervision and
Regulation; or Stephanie Martin, Senior Attorney (202/452-3198), Legal
Division. For the Hearing impaired only, Telecommunication Device for
the Deaf, Dorothea Thompson (202/452-3544).
FDIC: William A. Stark, Assistant Director, (202/898-6972), Miguel
D. Browne, Deputy Assistant Director, (202/898-6789), or Kenton Fox,
Senior Capital Markets Specialist, (202/898-7119), Division of
Supervision; Jamey Basham, Counsel, (202/898-7265) Legal Division,
FDIC, 550 17th Street N.W., Washington, D.C. 20429.
SUPPLEMENTARY INFORMATION:
Background
The Agencies' risk-based capital standards are based upon
principles contained in the agreement on International Convergence of
Capital Measurement and Capital Standards (Accord) issued in July 1988.
The Accord, proposed by the Basle Committee on Banking Supervision
(Committee) and endorsed by the central bank governors of the Group of
Ten (G-10) countries,1 assesses an institution's capital adequacy
by weighting its assets and off-balance-sheet exposures on the basis of
credit risk. In April 1995, the Committee issued a consultative
proposal to supplement the Accord to cover market risk, specifically
market risk in foreign exchange and commodity activities and in debt
and equity instruments held in trading portfolios, in addition to
credit risk.2 On July 25, 1995, the Board, the OCC, and the FDIC
issued a joint proposal to amend their respective risk-based capital
standards in accordance
[[Page 9115]]
with the consultative proposal (60 FR 38082) (July 1995 proposal).
Under the July 1995 proposal, an institution with relatively large
trading activities would calculate a capital charge for market risk
using either its own internal value-at-risk (VAR) 3 model
(internal models approach) or, alternatively, risk measurement
techniques that were developed by the Committee (standardized
approach). The institution would integrate the market risk capital
charge into its risk-based capital ratios.
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\1\ The Committee is composed of representatives of the central
banks and supervisory authorities from the G-10 countries (Belgium,
Canada, France, Germany, Italy, Japan, Netherlands, Sweden,
Switzerland, the United Kingdom, and the United States) and
Luxembourg. The Agencies each adopted risk-based capital standards
implementing the Accord in 1989.
\2\ The Committee's document is entitled ``Proposal to issue a
Supplement to the Basle Capital Accord to cover market risk.'' On
December 11, 1995, the G-10 Governors endorsed a final supplement to
the Accord incorporating a measure for market risk, subject to the
completion of rulemaking procedures in countries that require such
action. The final supplement is entitled ``Amendment to the Capital
Accord to incorporate market risks.'' The proposal and the final
supplement are available through the Board's and the OCC's Freedom
of Information Office and the FDIC's Reading Room.
\3\ Generally, the VAR is an estimate of the maximum amount that
could be lost on a set of positions due to general market movements
over a given holding period, measured with a specified confidence
level.
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Under the internal models approach, an institution would calculate
a VAR amount using its internal model, subject to certain qualitative
and quantitative regulatory parameters. The institution's capital
charge for market risk would equal the greater of (1) its previous
day's VAR amount (calculated based upon a 99 percent confidence level
and a ten-day holding period); or (2) an average of the daily VAR
amounts over the preceding 60 business days multiplied by a minimum
multiplication factor of three.
The July 1995 proposal also provides that the Agencies could adjust
the multiplication factor to increase an institution's capital
requirement based on an assessment of the quality and historical
accuracy of the institution's risk management system. One of the
proposal's qualitative criteria, which supervisors would use to
evaluate the quality and accuracy of a risk management system, is that
an institution would have to conduct regular backtesting. Backtesting
involves comparing the VAR amounts generated by the institution's
internal model against its actual daily profits and losses (outcomes).
Supervisory Framework for the Use of Backtesting
Since issuing its consultative proposal, the Committee developed a
framework that more explicitly incorporates backtesting into the
internal models approach and directly links backtesting results to
required capital levels.4 This framework recognizes that
backtesting can be useful in evaluating the accuracy of an
institution's internal model, and also acknowledges that even accurate
models (i.e., models whose true coverage level is 99 percent) can
perform poorly under certain conditions.
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\4\ The Committee sets out this framework in a document entitled
``Supervisory framework for the use of `backtesting' in conjunction
with the internal models approach to market risk capital
requirements,'' which accompanies the document entitled ``Amendment
to the Capital Accord to incorporate market risks,'' supra note 2.
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The Agencies agree with the Committee that backtesting can be a
useful tool in evaluating the performance of an institution's internal
model but recognize that backtesting techniques are still evolving and
that they differ among institutions. The Agencies believe that the
framework for backtesting developed by the Committee adequately
recognizes the limitations of backtesting, while providing incentives
for institutions to improve the efficiency of their internal models.
The Agencies, therefore, are proposing to amend their July 1995
proposal to incorporate a backtesting framework similar to the one
endorsed by the G-10 Governors, as described later in the supplementary
information.
Under the supervisory framework for backtesting, an institution
must compare its internal model's daily VAR amount with the following
day's trading outcome. The institution must use the daily VAR amount
generated for internal risk measurement purposes, not the daily VAR
amount generated for supervisory capital purposes. Moreover, when
making this comparison, the institution must first adjust the VAR
amount, if necessary, to correspond to an assumed one-day holding
period and a 99 percent confidence level.
An institution must count the number of times that the magnitude of
trading losses on a single day, if any, exceeds the corresponding day's
adjusted VAR amount during the most recent 250 business days
(approximately one year) to determine the number of exceptions. The
number of exceptions, in turn, will determine whether and how much an
institution must adjust the multiplication factor it would use when
calculating capital requirements for market risk. However, if the
institution demonstrates to its supervisor's satisfaction that an
exception resulted from an accurate model affected by unusual events,
the supervisor may allow the institution to disregard that exception.
The Agencies recognize that there may be several explanations for
exceptions. For example, an exception may result when an institution's
internal model does not capture the risk of certain positions or when
model volatilities or correlations are not calculated correctly. This
type of exception reflects a problem with the basic integrity of the
model. In other cases, the model may not measure market risk with
sufficient precision, implying the need to refine the model. Other
types of exceptions, on the other hand, may occur occasionally even
with accurate models, such as exceptions resulting from unexpected
market volatility or large intra-day changes in the institution's
portfolio.
Backtesting results also could prompt the supervisor to require
improvements in an institution's risk measurement and management
systems or additional capital for market risk. When considering
supervisory responses, the Agencies would take into account the extent
to which trading losses exceed the VAR amounts, since exceptions that
greatly exceed VAR amounts are of greater concern than are exceptions
that exceed them only slightly. The Agencies also could consider, for
example, other statistical test results provided by the institution,
documented explanations for individual exceptions, and the
institution's compliance with applicable qualitative and quantitative
internal model standards. The first backtesting for regulatory capital
purposes is scheduled to begin in January 1999, using VAR amounts and
trading outcomes beginning in January 1998.
Framework for Interpreting Backtesting Results
This framework attempts to balance the possibility that an accurate
risk model would be determined inaccurate (Type I error) and the
possibility that an inaccurate model would be determined accurate (Type
II error). Consequently, it divides the number of possible exceptions
into three zones:
(1) The green zone (four or fewer exceptions)--Backtest results do
not themselves suggest a problem with the quality or accuracy of the
institution's internal model. In these cases, backtest results are
viewed as acceptable, given the supervisors' concerns of committing a
Type I error. Within this zone, there is no presumed increase to an
institution's multiplication factor.
(2) The yellow zone (five through nine exceptions)--Backtest
results raise questions about a model's accuracy, but could be
consistent with either an accurate or inaccurate model. If the number
of exceptions places an institution into the yellow zone, then it must
adjust its multiplication factor. Because a larger number of exceptions
carries a stronger presumption that the model is inaccurate, the
adjustment to an institution's multiplication factor increases with the
number of exceptions. Accordingly, the institution would adjust its
multiplication factor by the amount corresponding to the number of
exceptions as shown in Table 1.
(3) The red zone (ten or more exceptions)--Backtest results
indicate a
[[Page 9116]]
problem with the institution's internal model, and the probability that
the model is accurate is remote. Unless the high number of exceptions
is attributed to a regime shift involving dramatic changes in financial
market conditions that result in a number of exceptions for the same
reason in a short period of time, the institution must increase its
multiplication factor from three to four, and improve its risk
measurement and management system.
The presumed adjustments to an institution's multiplication factor
based on the number of exceptions follow:
Table 1--Adjustment in Multiplication Factor From Results of Backtesting Based on 250 Trading Outcomes \1\
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Cumulative
Adjustment to probability
Zone No. of exceptions multiplication (in
factor percent)
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Green Zone...................................... 4 or fewer....................... 0.00 89.22
5................................ 0.40 95.88
6................................ 0.50 98.63
Yellow Zone..................................... 7................................ 0.65 99.60
8................................ 0.75 99.89
9................................ 0.85 99.97
Red Zone........................................ 10 or more....................... 1.00 99.99
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\1\ The zones are defined according to the cumulative probability of obtaining up to a given number of
exceptions in a sample of 250 independent observations when the true level of coverage is 99 percent. The
yellow zone begins where the cumulative probability equals or exceeds 95 percent, and the red zone begins
where the cumulative probability equals or exceeds 99.99 percent.
The Agencies urge institutions to continue working on improving the
accuracy of backtests that use actual trading outcomes and to develop
the capability to perform backtests based on the hypothetical changes
in portfolio value that would occur if there were no intra-holding
period changes (e.g., from fee income or intra-holding period changes
in portfolio composition).
Questions on Which the Agencies Specifically Request Comment
1. Some industry participants have argued that VAR measures cannot
be compared against actual trading outcomes because the actual outcomes
will be contaminated by intra-day trading and the inclusion of fee
income booked in connection with the sale of new products. The results
of intra-day trading, they believe, will tend to increase the
volatility of trading outcomes while the inclusion of fee income may
mask problems with the internal model. Others have argued that the
actual trading outcomes experienced by the bank are the most important
and relevant figures for risk management and backtesting purposes.
What are the merits and problems associated with performing
backtesting on the basis of hypothetical outcomes (e.g., the changes in
portfolio values that would occur if end-of-day positions remained
unchanged with no intra-day trading or fee income)?
What are the merits and problems associated with performing
backtesting on the basis of actual trading profits and losses?
2. What, if any, operational problems may institutions encounter in
implementing the proposed backtesting framework? What changes, if any,
should the Agencies consider to alleviate those problems?
3. What type of events or regime shifts might generate exceptions
that the Agencies should view as not warranting an increase in an
institution's multiplication factor? How should the Agencies factor in
or exclude the effects of regime shifts from subsequent backtesting
exercises?
4. The adjustments to the multiplication factor set forth in Table
1 of the proposal are based on the number of exceptions in a sample of
250 independent observations. Should the Agencies permit institutions
to use other sample sizes and, if so, what degree of flexibility should
be provided?
5. The Agencies recognize that an institution may utilize different
parameters (e.g., historical observation period) for the VAR model that
it employs for its own risk management purposes than for the VAR model
that determines its market risk capital requirements (as specified in
the July 1995 proposal). Should the adjustment to an institution's
multiplication factor be determined using trading outcomes backtested
against the institution's VAR amounts generated for internal risk
management purposes or against the VAR amounts generated for market
risk capital requirements? Should the Agencies permit an institution to
choose? Should backtesting be required against both sets of VAR
amounts?
Regulatory Flexibility Act Analysis
OCC Regulatory Flexibility Act Analysis
Pursuant to section 605(b) of the Regulatory Flexibility Act, the
Comptroller of the Currency certifies that this proposal would not have
a significant impact on a substantial number of small business entities
in accord with the spirit and purposes of the Regulatory Flexibility
Act (5 U.S.C. 601 et seq.). Accordingly, a regulatory flexibility
analysis is not required. The impact of this proposal on banks
regardless of size is expected to be minimal. Further, this proposal
generally would apply to larger banks with significant trading
activities and would cover only trading activities and foreign exchange
and commodity positions throughout the bank.
Board Regulatory Flexibility Act Analysis
Pursuant to section 605(b) of the Regulatory Flexibility Act, the
Board does not believe this proposal would have a significant impact on
a substantial number of small business entities in accord with the
spirit and purposes of the Regulatory Flexibility Act (5 U.S.C. 601 et
seq.). Accordingly, a regulatory flexibility analysis is not required.
In addition, because the risk-based capital standards generally do not
apply to bank holding companies with consolidated assets of less than
$150 million, this proposal would not affect such companies.
FDIC Regulatory Flexibility Act Analysis
Pursuant to section 605(b) of the Regulatory Flexibility Act (Pub.
L. 96-354, 5 U.S.C. 601 et seq.), it is certified that the proposal
would not have a significant impact on a substantial number of small
entities.
Paperwork Reduction Act
The Agencies have determined that this proposal would not increase
the regulatory paperwork burden of banking organizations pursuant to
the provisions
[[Page 9117]]
of the Paperwork Reduction Act (44 U.S.C. 3501 et seq.).
OCC Executive Order 12866 Determination
The OCC has determined that this proposal is not a significant
regulatory action under Executive Order 12866.
OCC Unfunded Mandates Reform Act of 1995 Determination
The OCC has determined that this proposal would not result in
expenditures by state, local, and tribal governments, or by the private
sector, of $100 million or more in any one year. Accordingly, a
budgetary impact statement is not required under section 202 of the
Unfunded Mandates Reform Act of 1995.
List of Subjects
12 CFR Part 3
Administrative practice and procedure, Capital, National banks,
Reporting and recordkeeping requirements, Risk.
12 CFR Part 208
Accounting, Agriculture, Banks, banking, Confidential business
information, Crime, Currency, Federal Reserve System, Mortgages,
Reporting and recordkeeping requirements, Securities.
12 CFR Part 225
Administrative practice and procedure, Banks, banking, Federal
Reserve System, Holding companies, Reporting and recordkeeping
requirements, Securities.
12 CFR Part 325
Administrative practice and procedure, Banks, banking, Capital
adequacy, Reporting and recordkeeping requirements, Savings
associations, State non-member banks.
Authority and Issuance
Office of the Comptroller of the Currency
12 CFR CHAPTER I
For the reasons set out in the preamble, part 3 of title 12 of
chapter I of the Code of Federal Regulations, as proposed to be amended
at 60 FR 38082, is further proposed to be amended as follows:
PART 3--MINIMUM CAPITAL RATIOS; ISSUANCE OF DIRECTIVES
1. The authority citation for part 3 continues to read as follows:
Authority: 12 U.S.C. 93a, 161, 1818, 1828(n), 1828 note, 1831n
note, 3907, and 3909.
2. Appendix B to part 3 as proposed to be added at 60 FR 38095
would be amended by revising paragraph (a)(2) of section 4 and by
adding a new paragraph (d) to section 5 to read as follows:
Appendix B to Part 3--Market Risk
* * * * *
Section 4. Market Risk Exposure
* * * * *
(a) * * *
(2) The average of the daily value-at-risk amounts for each of
the preceding 60 business days times a multiplication factor of
three, except as provided in section 5(d).
* * * * *
Section 5. Qualifying Internal Market Risk Model
* * * * *
(d) Backtesting. A bank using an internal market risk model
shall conduct backtesting as follows:
(1) The bank shall conduct backtesting quarterly;
(2) For each backtesting, the bank shall compare the previous
250 business days' trading outcomes with the corresponding daily
value-at-risk measurements generated for its internal risk
measurement purposes, calibrated to a one-day holding period and a
99 percent confidence level;
(3) The bank shall consider each business day for which the
trading loss, if any, exceeds the daily value-at-risk measurement as
an exception; however, the OCC may allow the bank to disregard an
exception if it determines that the exception does not reflect an
inaccurate model; and
(4) Depending on the number of exceptions, a bank shall adjust
the multiplication factor of three described in section 4(a)(2) of
this appendix B by the corresponding amount indicated in Section
5(d)(4) Table, and shall use the adjusted multiplication factor when
determining its market risk capital requirements until it obtains
the next quarter's backtesting results, unless the OCC determines
that a different adjustment or other action is appropriate:
Section 5(d)(4) Table.--Adjustment to Multiplication Factor From Results
of Backtesting Based on 250 Trading Outcomes
------------------------------------------------------------------------
Adjustment to
No. of exceptions multiplication
factor
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4 or fewer.............................................. 0.00
5....................................................... 0.40
6....................................................... 0.50
7....................................................... 0.65
8....................................................... 0.75
9....................................................... 0.85
10 or more.............................................. 1.00
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* * * * *
Dated: February 26, 1996.
Eugene A. Ludwig,
Comptroller of the Currency.
Federal Reserve Board
12 CFR CHAPTER II
For the reasons set forth in the preamble, parts 208 and 225 of
title 12 of chapter II of the Code of Federal Regulations, as proposed
to be amended at 60 FR 38082 (July 25, 1995) are further proposed to be
amended as follows:
PART 208--MEMBERSHIP OF STATE BANKING INSTITUTIONS IN THE FEDERAL
RESERVE SYSTEM (REGULATION H)
1. The authority citation for part 208 continues to read as
follows:
Authority: 12 U.S.C. 36, 248(a), 248(c), 321-338a, 371d, 461,
481-486, 601, 611, 1814, 1823(j), 1828(o), 1831o, 1831p-1, 3105,
3310, 3331-3351, and 3906-3909; 15 U.S.C. 78b, 78l(b), 78l(g),
78l(i), 78o-4(c)(5), 78q, 78q-1, and 78w; 31 U.S.C. 5318; 42 U.S.C.
4012a, 4104a, 4104b, 4106, and 4128.
2. In appendix E to part 208 as proposed to be added at 60 FR
38103, section III.B. would be amended by revising paragraph 2.a. and
adding a new paragraph 3 to read as follows:
Appendix E to Part 208--Capital Adequacy Guidelines for State Member
Banks: Market Risk Measure
* * * * *
III. The Internal Models Approach
* * * * *
B. * * *
2. * * *
a. A bank must have a risk control unit that is independent from
its business trading units and reports directly to senior management
of the bank. The unit must be responsible for designing and
implementing the bank's risk management system and analyzing daily
reports on the output of the bank's risk measurement model in the
context of trading limits. The unit must conduct regular backtesting
13 and adjust its multiplication factor, if appropriate, in
accordance with section III.B.3. of this appendix E.
* * * * *
c. * * *
3. In addition to any backtesting the bank may conduct as part
of its internal risk management system, the bank must conduct, for
regulatory capital purposes, backtesting that meets the following
criteria:
a. The backtesting must be conducted quarterly, using the most
recent 250 trading days' outcomes and VAR measures, which encompass
approximately twelve months. The VAR measures must be calibrated to
a one-day holding period and a 99 percent confidence level.
b. The bank should identify the number of exceptions (that is,
cases where the
[[Page 9118]]
magnitude of the daily trading loss, if any, exceeds the previous
day's VAR measure) to determine its appropriate zone and level
within a zone, as set forth in Table A of section III.B.3.c. of this
appendix E.
c. A bank should adjust its multiplication factor by the amount
indicated in Table A of this paragraph c., unless the Federal
Reserve determines that a different adjustment or other action is
appropriate:
Table A.--Adjustment to Multiplication Factor from Results of Backtesting Based on 250 Trading Outcomes
----------------------------------------------------------------------------------------------------------------
Cumulative
Adjustment to 1
Zone Level (No. of exceptions) multiplication probability
factor (in
-------------------------------------------------------------------------------------------------------percent)-
Green Zone...................................... 4 or fewer....................... 0.00 89.22
5................................ 0.40 95.88
6................................ 0.50 98.63
Yellow Zone..................................... 7................................ 0.65 99.60
8................................ 0.75 99.89
9................................ 0.85 99.97
Red Zone........................................ 10 or more....................... 1.00 99.99
----------------------------------------------------------------------------------------------------------------
\1\ The zones are defined according to the cumulative probability of obtaining up to a given number of
exceptions in a sample of 250 independent observations when the true coverage level is 99 percent. The yellow
zone begins where cumulative probability equals or exceeds 95 percent, and the red zone begins where the
cumulative probability equals or exceeds 99.99 percent.
* * * * *
PART 225--BANK HOLDING COMPANIES AND CHANGE IN BANK CONTROL
(REGULATION Y)
1. The authority citation for part 225 continues to read as
follows:
Authority: 12 U.S.C. 1817(j)(13), 1818, 1828(o), 1831i, 1831p-1,
1843(c)(8), 1844(b), 1972(1), 3106, 3108, 3310, 3331-3351, 3907, and
3909.
2. In appendix E to part 225 as proposed to be added at 60 FR
38116, section III.B. would be amended by revising paragraph 2.a. and
adding a new paragraph 3 to read as follows:
Appendix E to Part 225--Capital Adequacy Guidelines for Bank Holding
Companies: Market Risk Measure
* * * * *
III. The Internal Models Approach
* * * * *
B. * * *
2. * * *
a. A institution must have a risk control unit that is
independent from its business trading units and reports directly to
senior management of the bank holding company. The unit must be
responsible for designing and implementing the institution's risk
management system and analyzing daily reports on the output of the
institution's risk measurement model in the context of trading
limits. The unit must conduct regular backtesting 13 and adjust
its multiplication factor, if appropriate, in accordance with
section III.B.3. of this appendix E.
* * * * *
c. * * *
3. In addition to any backtesting the bank holding company may
conduct as part of its internal risk management system, the bank
holding company must conduct, for regulatory capital purposes,
backtesting that meets the following criteria:
a. The backtesting must be conducted quarterly, using the most
recent 250 trading days' outcomes and VAR measures, which encompass
approximately twelve months. The VAR measures must be calibrated to
a one-day holding period and a 99 percent confidence level.
b. The bank holding company should identify the number of
exceptions (that is, cases where the magnitude of the daily trading
loss, if any, exceeds the previous day's VAR measure) to determine
its appropriate zone and level within a zone, as set forth in Table
A of section III.B.3.c. of this appendix E.
c. An institution should adjust its multiplication factor by the
amount indicated in Table A of this paragraph c., unless the Federal
Reserve determines that a different adjustment or other action is
appropriate:
Table A.--Adjustment to Multiplication Factor From Results of Backtesting Based on 250 Trading Outcomes
----------------------------------------------------------------------------------------------------------------
Adjustment to Cumulative
Zone Level (No. of exceptions) multiplication \1\
factor probability
----------------------------------------------------------------------------------------------------(in percent)
Green Zone..................................... 4 or fewer...................... 0.00 89.22
5............................... 0.40 95.88
6............................... 0.50 98.63
Yellow Zone.................................... 7............................... 0.65 99.60
8............................... 0.75 99.89
9............................... 0.85 99.97
Red Zone....................................... 10 or more...................... 1.00 99.99
----------------------------------------------------------------------------------------------------------------
\1\ The zones are defined according to the cumulative probability of obtaining up to a given number of
exceptions in a sample of 250 independent observations when the true coverage level is 99 percent. The yellow
zone begins where cumulative probability equals or exceeds 95 percent, and the red zone begins where the
cumulative probability equals or exceeds 99.99 percent.
[[Page 9119]]
* * * * *
By order of the Board of Governors of the Federal Reserve
System, February 9, 1996.
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\13\ Back-testing includes ex post comparisons of the risk
measures generated by the model against the actual daily changes in
portfolio value.
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William W. Wiles,
Secetary of the Board.
Federal Deposit Insurance Corporation
12 CFR CHAPTER III
For the reasons set forth in the preamble, part 325 of title 12 of
chapter III of the Code of Federal Regulations, as proposed to be
amended at 60 FR 38082 (July 25, 1995), is further proposed to be
amended as follows:
PART 325--CAPITAL MAINTENANCE
1. The authority citation for part 325 continues to read as
follows:
Authority: 12 U.S.C. 1815(a), 1815(b), 1816, 1818(a), 1818(b),
1818(c), 1818(t), 1819(Tenth), 1828(c), 1828(d), 1828(i), 1828(n),
1828(o), 1831o, 3907, 3909, 4808; Pub. L. 102-233, 105 Stat. 1761,
1789, 1790 (12 U.S.C. 1831n note); Pub. L. 102-242, 105 Stat. 2236,
2355, 2386 (12 U.S.C. 1828 note).
2. In appendix C to part 325 as proposed to be added at 60 FR
38129, section III.B.2. introductory text and section III.B.2.a. would
be revised and section III.B.3. would be added to read as follows:
Appendix C to Part 325--Risk-Based Capital for State Non-Member Banks:
Market Risk
* * * * *
III. The Internal Models Approach
* * * * *
B. * * *
1. * * *
2. A bank must meet the following minimum qualitative criteria
before using its internal model to measure its exposure to market
risk.\13\
a. A bank must have a risk control unit that is independent from
its business trading units and reports directly to senior management
of the bank. The unit must be responsible for designing and
implementing the bank's risk management system and analyzing daily
reports on the output of the bank's risk measurement model in the
context of trading limits. The unit must conduct regular backtesting
\14\ and adjust its multiplication factor, if appropriate, in
accordance with section III.B.3. of this appendix C.
* * * * *
3. In addition to any backtesting the bank may conduct as part
of its internal risk management system, the bank must conduct, for
regulatory capital purposes, backtesting that meets the following
criteria:
a. The backtesting must be conducted quarterly, using the most
recent 250 trading days' outcomes and VAR measures, which encompass
approximately twelve months. The VAR measures must be calibrated to
a one-day holding period and a 99 percent confidence level.
b. The bank should identify the number of exceptions (that is,
cases where the magnitude of the daily trading loss, if any, exceeds
the previous day's VAR measure) to determine its appropriate zone
and level within a zone, as set forth in Table A of section
III.B.3.c. of this appendix C.
c. A bank should adjust its multiplication factor by the amount
indicated in Table A, unless the FDIC determines that a different
adjustment or other action is appropriate.
Table A.--Adjustment to Multiplication Factor From Results of Backtesting Based on 250 Trading Outcomes
----------------------------------------------------------------------------------------------------------------
Adjustment to Cumulative\1\
Zone Level No. of exceptions) multiplication probability
factor (in percent)
----------------------------------------------------------------------------------------------------------------
Green Zone..................................... 4 or fewer...................... 0.00 89.22
5............................... 0.40 95.88
6............................... 0.50 98.63
Yellow Zone.................................... 7............................... 0.65 99.60
8............................... 0.75 99.89
9............................... 0.85 99.97
Red Zone....................................... 10 or more...................... 1.00 99.99
----------------------------------------------------------------------------------------------------------------
\1\ The zones are defined according to the cumulative probability of obtaining up to a given number of
exceptions in a sample of 250 independent observations when the true coverage level is 99 percent. The yellow
zone begins where cumulative probability equals or exceeds 95 percent, and the red zone begins where the
cumulative probability equals or exceeds 99.99 percent.
* * * * *
By order of the Board of Directors.
---------------------------------------------------------------------------
\13\ If the FDIC is not satisfied with the extent to which a
bank meets these criteria, the FDIC may adjust the multiplication
factor used to calculate market risk capital requirements or
otherwise increase capital requirements.
\14\ Back-testing includes ex post comparisons of the risk
measures generated by the model against the actual daily changes in
portfolio value.
Dated at Washington, D.C., this 27th day of February 1996.
Jerry L. Langley,
Executive Secretary.
[FR Doc. 96-5235 Filed 3-6-96; 8:45 am]
BILLING CODE 4810-33-P (\1/3\), 6210-01-P (\1/3\), 6714-01-P (\1/3\)
