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FIL-12-96 Attachment

[Federal Register: March 7, 1996 (Volume 61, Number 46)]

[Proposed Rules]

[Page 9114-9119]

From the Federal Register Online via GPO Access [wais.access.gpo.gov]



 

========================================================================

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.


 

========================================================================




 

[[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.


 

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


 

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 REGS.COMMENTS@OCC.TREAS.GOV.

Board: Comments directed to the Board should refer to Docket No. R-

0884 and may be mailed to William W. Wiles, Secretary, Board of

Governors of the Federal Reserve System, 20th Street and Constitution

Avenue, N.W., Washington, D.C., 20551. Comments may also be delivered

to Room B-2222 of the Eccles Building between 8:45 a.m. and 5:15 p.m.

weekdays, or to the guard station in the Eccles Building courtyard on

20th Street, N.W., (between Constitution Avenue and C Street) at any

time. Comments may be inspected in Room MP-500 of the Martin Building

between 9 a.m. and 5 p.m. weekdays, except as provided in 12 CFR 261.8

of the Board's rules regarding availability of information.

FDIC: Written comments should be sent to Jerry L. Langley,

Executive Secretary, Attention: Room F--402, Federal Deposit Insurance

Corporation, 550 17th Street N.W., Washington, D.C. 20429. Comments may

be hand delivered to Room F--402, 1776 F Street N.W., Washington, D.C.

20429 on business days between 8:30 a.m. and 5 p.m. (Fax number (202)

898-3838; Internet address: comments@fdic.gov). Comments will be

available for inspection and photocopying in Room 7118, 550 17th

Street, N.W., Washington, D.C. 20429, between 9 a.m. and 4:30 p.m. on

business days.


 

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.


 

\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.

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


 

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.


 

\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.

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


 

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\

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

Cumulative

Adjustment to probability

Zone No. of exceptions multiplication (in

factor 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 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

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

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

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


 

* * * * *

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.


 

\13\ Back-testing includes ex post comparisons of the risk

measures generated by the model against the actual daily changes in

portfolio value.

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


 

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

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Adjustment to Cumulative\1\

Zone Level No. of exceptions) multiplication probability

factor (in 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 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\)

Last Updated: March 24, 2024