1890 Federal Register / Vol. 76, No. 7 / Tuesday, January 11, 2011 / Proposed Rules 

DEPARTMENT OF THE TREASURY 

Office of the Comptroller of the 

Currency 

12 CFR Part 3 

[Docket ID: OCC–2010–0003] 

RIN 1557–AC99 

FEDERAL RESERVE SYSTEM 

12 CFR Parts 208 and 225 

[Regulations H and Y; Docket No. R–1401] 

RIN No. 7100–AD61 

FEDERAL DEPOSIT INSURANCE 

CORPORATION 

12 CFR Part 325 

RIN 3064–AD70 

Risk-Based Capital Guidelines: Market 

Risk 

AGENCY: Office of the Comptroller of the 

Currency, Department of the Treasury; 

Board of Governors of the Federal 

Reserve System; and Federal Deposit 

Insurance Corporation. 

ACTION: Notice of proposed rulemaking 

with request for public comment. 

SUMMARY: The Office of the Comptroller 

of the Currency (OCC), Board of 

Governors of the Federal Reserve 

System (Board), and Federal Deposit 

Insurance Corporation (FDIC) are 

requesting comment on a proposal to 

revise their market risk capital rules to 

modify their scope to better capture 

positions for which the market risk 

capital rules are appropriate; reduce 

procyclicality in market risk capital 

requirements; enhance the rules’ 

sensitivity to risks that are not 

adequately captured under the current 

regulatory measurement methodologies; 

and increase transparency through 

enhanced disclosures. The proposal 

does not include the methodologies 

adopted by the Basel Committee on 

Banking Supervision for calculating the 

specific risk capital requirements for 

debt and securitization positions due to 

their reliance on credit ratings, which is 

impermissible under the Dodd-Frank 

Wall Street Reform and Consumer 

Protection Act. The proposal, therefore, 

retains the current specific risk 

treatment for these positions until the 

agencies develop alternative standards 

of creditworthiness as required by the 

Act. The proposed rules are 

substantively the same across the 

agencies. 

DATES: Comments on this notice of 

proposed rulemaking must be received 

by April 11, 2011. 

ADDRESSES: Comments should be 

directed to: 

OCC: Because paper mail in the 

Washington, DC area and at the 

Agencies is subject to delay, 

commenters are encouraged to submit 

comments by the Federal eRulemaking 

Portal or e-mail, if possible. Please use 

the title ‘‘Risk-Based Capital Guidelines: 

Market Risk’’ to facilitate the 

organization and distribution of the 

comments. You may submit comments 

by any of the following methods: 

• Federal eRulemaking Portal— 

‘‘regulations.gov’’: Go to http://www.

regulations.gov. Select ‘‘Document 

Type’’ of ‘‘Proposed Rules,’’ and in 

‘‘Enter Keyword or ID Box,’’ enter Docket 

ID ‘‘OCC–2010–0003,’’ and click 

‘‘Search.’’ On ‘‘View By Relevance’’ tab at 

bottom of screen, in the ‘‘Agency’’ 

column, locate the proposed rule for 

OCC, in the ‘‘Action’’ column, click on 

‘‘Submit a Comment’’ or ‘‘Open Docket 

Folder’’ to submit or view public 

comments and to view supporting and 

related materials for this rulemaking 

action. 

• Click on the ‘‘Help’’ tab on the 

Regulations.gov home page to get 

information on using Regulations.gov, 

including instructions for submitting or 

viewing public comments, viewing 

other supporting and related materials, 

and viewing the docket after the close 

of the comment period. 

• E-mail: regs.comments@occ.treas.

gov. 

• Mail: Office of the Comptroller of 

the Currency, 250 E Street, SW., Mail 

Stop 2–3, Washington, DC 20219. 

• Fax: (202) 874–5274. 

• Hand Delivery/Courier: 250 E 

Street, SW., Mail Stop 2–3, Washington, 

DC 20219. 

Instructions: You must include ‘‘OCC’’ 

as the agency name and ‘‘Docket ID 

OCC–2010–0003’’ in your comment. In 

general, OCC will enter all comments 

received into the docket and publish 

them on the Regulations.gov Web site 

without change, including any business 

or personal information that you 

provide such as name and address 

information, e-mail 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 

enclose 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 

proposed rule by any of the following 

methods: 

• Viewing Comments Electronically: 

Go to http://www.regulations.gov. Select 

‘‘Document Type’’ of ‘‘Public 

Submissions,’’ in ‘‘Enter Keyword or ID 

Box,’’ enter Docket ID ‘‘OCC–2010– 

0003,’’ and click ‘‘Search.’’ Comments 

will be listed under ‘‘View By 

Relevance’’ tab at bottom of screen. If 

comments from more than one agency 

are listed, the ‘‘Agency’’ column will 

indicate which comments were received 

by the OCC. 

• Viewing Comments Personally: You 

may personally inspect and photocopy 

comments at the OCC, 250 E Street, 

SW., Washington, DC. For security 

reasons, the OCC requires that visitors 

make an appointment to inspect 

comments. You may do so by calling 

(202) 874–4700. Upon arrival, visitors 

will be required to present valid 

government-issued photo identification 

and to submit to security screening in 

order to inspect and photocopy 

comments. 

• Docket: You may also view or 

request available background 

documents and project summaries using 

the methods described above. 

Board: You may submit comments, 

identified by Docket No. R–1401 and 

RIN No. 7100–AD61, by any of the 

following methods: 

• Agency Web Site: http://www.

federalreserve.gov. Follow the 

instructions for submitting comments at 

http://www.federalreserve.gov/

generalinfo/foia/ProposedRegs.cfm. 

• Federal eRulemaking Portal: http:// 

www.regulations.gov. Follow the 

instructions for submitting comments. 

• E-mail: regs.comments@

federalreserve.gov. Include docket 

number in the subject line of the 

message. 

• Federal eRulemaking Portal: 

‘‘Regulations.gov’’: Go to http://www.

regulations.gov and follow the 

instructions for submitting comments. 

• FAX: (202) 452–3819 or (202) 452– 

3102. 

• Mail: Jennifer J. Johnson, Secretary, 

Board of Governors of the Federal 

Reserve System, 20th Street and 

Constitution Avenue, NW., Washington, 

DC 20551. 

All public comments are available 

from the Board’s Web site at http://

www.federalreserve.gov/generalinfo/

foia/ProposedRegs.cfm as submitted, 

unless modified for technical reasons. 

Accordingly, your comments will not be 

edited to remove any identifying or 

contact information. Public comments 

may also be viewed electronically or in 

paper form in Room MP–500 of the 

Board’s Martin Building (20th and C 


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Federal Register / Vol. 76, No. 7 / Tuesday, January 11, 2011 / Proposed Rules 1891 

1For simplicity, and unless otherwise indicated, 

the preamble to this notice of proposed rulemaking 

uses the term ‘‘bank’’ to include banks, savings 

associations, and bank holding companies (BHCs). 

The terms ‘‘bank holding company’’ and ‘‘BHC’’ refer 

only to bank holding companies regulated by the 

Board. 

2The BCBS is a committee of banking supervisory 

authorities, which was established by the central 

bank governors of the G–10 countries in 1975. It 

consists of senior representatives of bank 

supervisory authorities and central banks from 

Argentina, Australia, Belgium, Brazil, Canada, 

China, France, Germany, Hong Kong SAR, India, 

Indonesia, Italy, Japan, Korea, Luxembourg, Mexico, 

the Netherlands, Russia, Saudi Arabia, Singapore, 

South Africa, Spain, Sweden, Switzerland, Turkey, 

the United Kingdom, and the United States. 

Documents issued by the BCBS are available 

through the Bank for International Settlements Web 

site at http://www.bis.org. 

3The agencies’ general risk-based capital rules are 

at 12 CFR part 3, Appendix A (OCC); 12 CFR part 

208, Appendix A and 12 CFR part 225, Appendix 

A (Board); and 12 CFR part 325, Appendix A 

(FDIC). 

4 In 1997, the BCBS modified the MRA to remove 

a provision pertaining to the specific risk capital 

charge under the internal models approach (see 

http://www.bis.org/press/p970918a.htm). 

5 61 FR 47358 (September 6, 1996). The agencies’ 

market risk capital rules are 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). 

Street, NW.) between 9 a.m. and 5 p.m. 

on weekdays. 

FDIC: You may submit comments by 

any of the following methods: 

• Federal eRulemaking Portal: http:// 

www.regulations.gov. Follow the 

instructions for submitting comments. 

• Agency Web site: http://www.FDIC.

gov/regulations/laws/Federal/propose.

html. 

• Mail: Robert E. Feldman, Executive 

Secretary, Attention: Comments/Legal 

ESS, Federal Deposit Insurance 

Corporation, 550 17th Street, NW., 

Washington, DC 20429. 

• Hand Delivered/Courier: The guard 

station at the rear of the 550 17th Street 

Building (located on F Street), on 

business days between 7 a.m. and 5 p.m. 

• E-mail: comments@FDIC.gov. 

Instructions: Comments submitted 

must include ‘‘FDIC’’ and ‘‘RIN [3064– 

AD70].’’ Comments received will be 

posted without change to http://www.

FDIC.gov/regulations/laws/Federal/

propose.html, including any personal 

information provided. 

FOR FURTHER INFORMATION CONTACT: 

OCC: Roger Tufts, Senior Economic 

Advisor, Capital Policy Division, (202) 

874–4925, or Ron Shimabukuro, Senior 

Counsel, Carl Kaminski, Senior 

Attorney, or Hugh Carney, Attorney, 

Legislative and Regulatory Activities 

Division, (202) 874–5090, Office of the 

Comptroller of the Currency, 250 E 

Street, SW., Washington, DC 20219. 

Board: Anna Lee Hewko, (202) 530– 

6260, Assistant Director, Capital and 

Regulatory Policy, or Connie Horsley, 

(202) 452–5239, Senior Supervisory 

Financial Analyst, Division of Banking 

Supervision and Regulation; or April C. 

Snyder, Counsel, (202) 452–3099, or 

Benjamin W. McDonough, Counsel, 

(202) 452–2036, Legal Division. For the 

hearing impaired only, 

Telecommunication Device for the Deaf 

(TDD), (202) 263–4869. 

FDIC: Bobby R. Bean, Chief, Policy 

Section, (202) 898–6705; Karl Reitz, 

Senior Capital Markets Specialist, (202) 

898–6775; Jim Weinberger, Senior 

Policy Analyst, (202) 898–7034, 

Division of Supervision and Consumer 

Protection; or Mark Handzlik, Counsel, 

(202) 898–3990; or Michael Phillips, 

Counsel, (202) 898–3581, Supervision 

Branch, Legal Division. 

SUPPLEMENTARY INFORMATION: 

Table of Contents 

I. Introduction 

A. Background 

B. Summary of the Current Market Risk 

Capital Rule 

1. Covered Positions 

2. Capital Requirement for Market Risk 

3. Internal Models-Based Capital 

Requirement 

4. Specific Risk 

5. Calculation of the Risk-Based Capital 

Ratio 

II. Proposed Revisions to the Market Risk 

Capital Rule 

A. Objectives of the Proposed Revisions 

B. Description of the Proposed Revisions to 

the Market Risk Capital Rule 

1. Scope 

2. Reservation of Authority 

3. Modification of the Definition of 

Covered Position 

4. Requirements for the Identification of 

Trading Positions and Management of 

Covered Positions 

5. General Requirements for Internal 

Models 

Model Approval and Ongoing Use 

Requirements 

Risks Reflected in Models 

Control, Oversight, and Validation 

Mechanisms 

Internal Assessment of Capital Adequacy 

Documentation 

6. Capital Requirement for Market Risk 

Determination of the Multiplication Factor 

7. VaR-Based Capital Requirement 

Quantitative Requirements for VaR-based 

Measure 

8. Stressed VaR-Based Capital Requirement 

Quantitative Requirements for Stressed 

VaR-based Measure 

9. Revised Modeling Standards for Specific 

Risk 

10. Standardized Specific Risk Capital 

Requirement 

Debt Positions 

Equity Positions 

Securitization Positions 

11. Incremental Risk Capital Requirement 

12. Comprehensive Risk Capital 

Requirement 

13. Disclosure Requirements 

III. Regulatory Flexibility Act Analysis 

IV. OCC Unfunded Mandates Reform Act of 

1995 Determination 

V. Paperwork Reduction Act 

VI. Plain Language 

I. Introduction 

A. Background 

The first international capital 

framework for banks 1 entitled 

International Convergence of Capital 

Measurement and Capital Standards 

(1988 Capital Accord) was developed by 

the Basel Committee on Banking 

Supervision (BCBS) 2 and endorsed by 

the G–10 governors in 1988. The OCC, 

the Board, and the FDIC (collectively, 

the agencies) implemented the 1988 

Capital Accord in 1989 through the 

issuance of the general risk-based 

capital rules.3 In 1996, the BCBS 

amended the 1988 Capital Accord to 

require banks to measure and hold 

capital to cover their exposure to market 

risk associated with foreign exchange 

and commodity positions and positions 

located in the trading account (the 

Market Risk Amendment (MRA) or 

market risk framework).4 The agencies 

implemented the MRA with an effective 

date of January 1, 1997 (market risk 

capital rule).5

In June 2004, the BCBS issued a 

document entitled International 

Convergence of Capital Measurement 

and Capital Standards: A Revised 

Framework (New Accord or Basel II), 

which was intended for use by 

individual countries as the basis for 

national consultation and 

implementation. The New Accord sets 

forth a ‘‘three-pillar’’ framework that 

includes (i) risk-based capital 

requirements for credit risk, market risk, 

and operational risk (Pillar 1); (ii) 

supervisory review of capital adequacy 

(Pillar 2); and (iii) market discipline 

through enhanced public disclosures 

(Pillar 3). 

The New Accord retained much of the 

MRA; however, after its release, the 

BCBS announced that it would develop 

improvements to the market risk 

framework, especially with respect to 

the treatment of specific risk, which 

refers to the risk of loss on a position 

due to factors other than broad-based 

movements in market prices. As a 

result, in July 2005, the BCBS and the 

International Organization of Securities 

Commissions (IOSCO) published The 

Application of Basel II to Trading 

Activities and the Treatment of Double 

Default Effects. The BCBS incorporated 

the July 2005 changes into the June 2006 

comprehensive version of the New 

Accord and follow its ‘‘three-pillar’’ 

structure. Specifically, the Pillar 1 


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6 71 FR 55958, (September 25, 2006). The 2006 

proposal was issued jointly by the agencies and the 

Office of Thrift Supervision (OTS). In the proposal, 

the OTS, which had not previously adopted the 

MRA, proposed adopting a market risk capital rule. 

7The June 2010 revisions can be found, in their 

entirety, at http://bis.org/press/p100618/annex.pdf. 

8The agencies’ advanced approaches rules are at 

12 CFR part 3, Appendix C (OCC); 12 CFR part 208, 

Appendix F and 12 CFR part 225, Appendix G 

(Board); and 12 CFR part 325, Appendix D (FDIC). 

For purposes of this preamble, the term ‘‘credit risk 

capital rules’’ refers to the general risk-based capital 

rules and the advanced approaches rules (that also 

apply to operational risk), as applicable to the bank 

using the proposed rule. 

9 Idiosyncratic risk is the risk of loss in the value 

of a position that arises from changes in risk factors 

unique to that position. Event risk is the risk of loss 

on a position that could result from sudden and 

unexpected large changes in market prices or 

specific events other than the default of the issuer. 

Default risk is the risk of loss on a position that 

could result from the failure of an obligor to make 

timely payments of principal or interest on its debt 

obligation, and the risk of loss that could result 

from bankruptcy, insolvency, or similar proceeding. 

For credit derivatives, default risk means the risk 

of loss on a position that could result from the 

default of the reference exposure(s). 

10The primary Federal supervisor of a bank may 

also permit the use of alternative techniques to 

measure the market risk of de minimis exposures, 

if the techniques adequately measure associated 

market risk. 

changes narrow the types of positions 

that are subject to the market risk 

framework and revise modeling 

standards and procedures for 

calculating minimum regulatory capital 

requirements; the Pillar 2 changes 

require banks to conduct internal 

assessments of their capital adequacy 

with respect to market risk, taking into 

account the output of their internal 

models, valuation adjustments, and 

stress tests; and the Pillar 3 changes 

require banks to disclose certain 

quantitative and qualitative information, 

including their valuation techniques for 

covered positions, the soundness 

standard used for modeling purposes, 

and their internal capital adequacy 

assessment methodologies. 

In September 2006, the agencies 

issued a joint notice of proposed 

rulemaking (2006 proposal) in which 

they proposed amendments to their 

market risk capital rules that would 

implement the BCBS’s changes to the 

market risk framework.6 The BCBS 

began work on significant changes to the 

market risk framework in 2007 due to 

issues highlighted by the financial 

crisis. As a result, the agencies did not 

finalize the 2006 proposal. This joint 

notice of proposed rulemaking 

(proposed rule) incorporates aspects of 

the agencies’ 2006 proposal as well as 

further revisions to the New Accord 

(and associated guidance) published by 

the BCBS in July 2009. These 

publications include Revisions to the 

Basel II Market Risk Framework, 

Guidelines for Computing Capital for 

Incremental Risk in the Trading Book, 

and Enhancements to the Basel II 

Framework (collectively, the 2009 

revisions). 

The 2009 revisions to the market risk 

framework place additional prudential 

requirements on banks’ internal models 

for measuring market risk and require 

enhanced qualitative and quantitative 

disclosures, particularly with respect to 

banks’ securitization activities. The 

revisions also introduce an incremental 

risk capital requirement to capture 

default and credit quality migration risk 

for non-securitization credit products. 

With respect to securitizations, the 2009 

revisions require banks to apply the 

standardized measurement method for 

specific risk to these positions, except 

for ‘‘correlation trading’’ positions 

(described further below), for which 

banks may choose to model all material 

price risks. The 2009 revisions also add 

a stressed Value-at-Risk (VaR)-based 

capital requirement to banks’ VaR-based 

capital requirement under the existing 

framework. In June, 2010, the BCBS 

published additional revisions to the 

market risk framework that included 

establishing a floor on the risk-based 

capital requirement for modeled 

correlation trading positions.7

These revisions to the market risk 

framework and other proposed revisions 

are discussed more fully below. Part I.B. 

of this preamble summarizes and 

provides background on the current 

market risk capital rule. Part II describes 

the proposed revisions to the market 

risk capital rule that incorporate aspects 

of the BCBS 2005 and 2009 revisions to 

the market risk framework. 

Question 1: The agencies request 

comment on all aspects of the proposed 

rule and specifically on whether and for 

what reasons certain aspects of the 

proposed rule present particular 

implementation challenges. Responses 

should be detailed as to the nature and 

impact of such challenges. What, if any, 

specific approaches (for example, 

transitional arrangements) should the 

agencies consider to address such 

challenges and why? 

B. Summary of the Current Market Risk 

Capital Rule 

The current market risk capital rule 

supplements both the agencies’ general 

risk-based capital rules and the 

advanced capital adequacy guidelines 

(advanced approaches rules) 

(collectively, the credit risk capital 

rules) 8 by requiring any bank subject to 

the market risk capital rule to adjust its 

risk-based capital ratios to reflect market 

risk in its trading activities. The rule 

applies to a bank with worldwide, 

consolidated trading activity equal to 10 

percent or more of total assets, or $1 

billion or more. The primary Federal 

supervisor of a bank may apply the 

market risk capital rule to a bank if the 

supervisor deems it necessary or 

appropriate for safe and sound banking 

practices. In addition, the supervisor 

may exempt a bank that meets the 

threshold criteria from application of 

the rule if the supervisor determines the 

bank meets such criteria as a 

consequence of accounting, operational, 

or similar considerations, and the 

supervisor deems such an exemption to 

be consistent with safe and sound 

banking practices. 

1. Covered Positions 

The current market risk capital rule 

requires a bank to maintain regulatory 

capital against the market risk of its 

covered positions. Covered positions are 

defined as all on- and off-balance sheet 

positions in the bank’s trading account 

(as defined in the instructions to the 

Consolidated Reports of Condition and 

Income (Call Report) or to the FR Y–9C 

Consolidated Financial Statements for 

Bank Holding Companies (FR Y–9C)), 

and all foreign exchange and 

commodity positions, whether or not 

they are in the trading account. Covered 

positions exclude all positions in the 

trading account that, in form or 

substance, act as liquidity facilities that 

provide liquidity support to assetbacked commercial paper. 

2. Capital Requirement for Market Risk 

The current market risk capital rule 

defines market risk as the risk of loss 

resulting from movements in market 

prices. Market risk consists of general 

market risk and specific risk 

components. General market risk is 

defined as changes in the market value 

of positions resulting from broad market 

movements, such as changes in the 

general level of interest rates, equity 

prices, foreign exchange rates, or 

commodity prices. Specific risk is 

defined as changes in the market value 

of a position due to factors other than 

broad market movements and includes 

event and default risk, as well as 

idiosyncratic risk.9

A bank that is subject to the market 

risk capital rule is required to use an 

internal model to calculate a VaR-based 

measure of its exposure to market risk. 

A bank’s total risk-based capital 

requirement for covered positions 

generally consists of a VaR-based capital 

requirement plus an add-on for specific 

risk, if specific risk is not captured in 

the bank’s internal VaR model.10 The 

VaR-based capital requirement is based 


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11See section 5(c) of the agencies’ market risk 

capital rules for a description of this method. 

12 In addition, for futures contracts on broadly 

based indices that are matched by offsetting equity 

baskets, a bank may apply a 2.0 percent specific risk 

requirement to the futures and stock basket 

positions if the basket comprises at least 90 percent 

of the capitalization of the index. The 2.0 percent 

specific risk requirement applies to only one side 

of certain futures-related arbitrage strategies when 

either: (i) The long and short positions are in 

exactly the same index at different dates or in 

different markets; or (ii) the long and short 

positions are in different but similar indices at the 

same date. 

13Foreign exchange positions outside the trading 

account and all over-the-counter derivative 

positions, regardless of whether they are in the 

trading account, must be included in a bank’s riskweighted assets as determined under the general 

risk-based capital rules. 

on an estimate of the amount that the 

value of one or more positions could 

decline over a stated time horizon and 

at a stated confidence level. A bank may 

determine its capital requirement for 

specific risk using a standardized 

method or, with supervisory approval, 

may use internal models to measure its 

minimum capital requirement for 

specific risk. 

3. Internal Models-Based Capital 

Requirement 

In calculating the capital requirement 

for market risk, a bank is required to use 

an internal model that meets specified 

qualitative and quantitative criteria. The 

qualitative requirements reflect basic 

components of sound market risk 

management. For example, the current 

market risk capital rule requires an 

independent risk control unit that 

reports directly to senior management 

and an internal risk measurement model 

that is integrated into the daily 

management process. The quantitative 

criteria include the use of a VaR-based 

measure based on a 99.0 percent, onetailed confidence level. The VaR-based 

measure must be based on a price shock 

equivalent to a 10-business-day 

movement in rates or prices. Price 

changes estimated using shorter time 

periods must be adjusted to the 10- 

business-day standard. The minimum 

effective historical observation period 

for deriving the rate or price changes is 

one year and data sets must be updated 

at least every three months or more 

frequently if market conditions warrant. 

In all cases, under the current rule, a 

bank must have the capability to update 

its data sets more frequently than every 

three months in anticipation of market 

conditions that would require such 

updating. 

A bank need not use a single model 

to calculate its VaR-based measure. A 

bank’s internal model may use any 

generally accepted approach, such as 

variance-covariance models, historical 

simulations, or Monte Carlo 

simulations. However, the level of 

sophistication of the bank’s internal 

model must be commensurate with the 

nature and size of the positions it 

covers. The internal model must use 

risk factors sufficient to measure the 

market risk inherent in all covered 

positions. The risk factors must address 

interest rate risk, equity price risk, 

foreign exchange rate risk, and 

commodity price risk. 

The current market risk capital rule 

imposes backtesting requirements that 

must be calculated quarterly. A bank 

must compare its daily VaR-based 

measure for each of the preceding 250 

business days to its actual daily trading 

profit or loss, which typically includes 

realized and unrealized gains and losses 

on portfolio positions as well as fee 

income and commissions associated 

with trading activities. If the quarterly 

backtesting shows that the bank’s daily 

net trading loss exceeded its 

corresponding daily VaR-based 

measure, a backtesting exception has 

occurred. If a bank experiences more 

than four backtesting exceptions over 

the preceding 250 business days, it is 

generally required to apply a 

multiplication factor in excess of 3 

when it calculates its risk-based capital 

ratio (see section I.B.5 of this preamble). 

A bank subject to the market risk 

capital rule is also required to conduct 

stress tests to assess the impact of 

adverse market events on its positions. 

The market risk capital rule does not 

prescribe specific stress-testing 

methodologies. 

4. Specific Risk 

Under the current market risk capital 

rule, a bank may use an internal model 

to measure its exposure to specific risk 

if it has demonstrated to its primary 

Federal supervisor that the model 

measures the specific risk, including 

event and default risk, as well as 

idiosyncratic risk, of its debt and equity 

positions. A bank that incorporates 

specific risk in its internal model but 

fails to demonstrate that the model 

adequately measures all aspects of 

specific risk is subject to a specific risk 

add-on. In this case, if the bank can 

validly separate its VaR-based measure 

into a specific risk portion and a general 

market risk portion, the add-on is equal 

to the previous day’s specific risk 

portion. If the bank cannot separate the 

VaR-based measure into a specific risk 

portion and a general market risk 

portion, the add-on is equal to the sum 

of the previous day’s VaR-based 

measures for subportfolios of debt and 

equity positions that contain specific 

risk. 

If the bank does not model specific 

risk, it must calculate its specific risk 

capital requirement, or ‘‘add-on,’’ using 

a standardized method.11 Under this 

method, the specific risk add-on for debt 

positions is calculated by multiplying 

the absolute value of the current market 

value of each net long and net short 

position in a debt instrument by the 

appropriate specific risk-weighting 

factor in the rule. These specific riskweighting factors range from zero to 8.0 

percent and are based on the identity of 

the obligor and, in the case of some 

positions, the credit rating and 

remaining contractual maturity of the 

position. Derivative instruments are 

risk-weighted according to the market 

value of the effective notional amount of 

the underlying position. A bank may net 

long and short debt positions (including 

derivatives) in identical debt issues or 

indices. A bank may also offset a 

‘‘matched’’ position in a derivative and 

its corresponding underlying 

instrument. 

Under the standardized method, the 

specific risk add-on for equity positions 

is the sum of the bank’s net long and 

short positions in an equity, multiplied 

by a specific risk-weighting factor. A 

bank may net long and short positions 

(including derivatives) in identical 

equity issues or equity indices in the 

same market. The specific risk add-on is 

8.0 percent of the net equity position, 

unless the bank’s portfolio is both liquid 

and well-diversified, in which case the 

specific risk add-on is 4.0 percent. For 

positions that are index contracts 

comprising a well-diversified portfolio 

of equities, the specific risk add-on is 

2.0 percent of the net long or net short 

position in the index.12

5. Calculation of the Risk-Based Capital 

Ratio 

A bank subject to the current market 

risk capital rule must calculate its 

adjusted risk-based capital ratios as 

follows. First, the bank must calculate 

its adjusted risk-weighted assets, which 

equals its risk-weighted assets 

calculated under the general risk-based 

capital rule excluding the risk-weighted 

amounts of covered positions (except 

foreign exchange positions outside the 

trading account and over-the-counter 

derivative instruments) 13 and cashsecured securities borrowing receivables 

that meet the criteria of the market risk 

capital rule. 

The bank then must calculate its 

measure for market risk, which equals 

the sum of the VaR-based capital 

requirement for market risk, the specific 

risk add-on (if any), and the capital 


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14Tier 1 and tier 2 capital are defined in the 

general risk-based capital rules. Tier 3 capital is 

subordinated debt that is unsecured, is fully paid 

up, has an original maturity of at least two years, 

is not redeemable before maturity without prior 

approval by the primary Federal supervisor, 

includes a lock-in clause precluding payment of 

either interest or principal (even at maturity) if the 

payment would cause the issuing bank’s risk-based 

capital ratio to fall or remain below the minimum 

required under the credit risk capital rules, and 

does not contain and is not covered by any 

covenants, terms, or restrictions that are 

inconsistent with safe and sound banking practices. 

requirement for de minimis exposures 

(if any). The VaR-based capital 

requirement equals the greater of (i) the 

previous day’s VaR-based measure; or 

(ii) the average of the daily VaR-based 

measures for each of the preceding 60 

business days multiplied by three, or 

such higher multiplier as may be 

required under the backtesting 

requirements of the market risk capital 

rule. The measure for market risk is 

multiplied by 12.5 to calculate marketrisk-equivalent assets. The market-riskequivalent assets are added to adjusted 

risk-weighted assets to compute the 

denominator of the bank’s risk-based 

capital ratio. 

To calculate the numerator, the bank 

must allocate tier 1 and tier 2 capital 

equal to 8.0 percent of adjusted riskweighted assets, and further allocate 

excess tier 1, excess tier 2, and tier 3 14

capital equal to the measure for market 

risk. The sum of tier 2 and tier 3 capital 

allocated for market risk may not exceed 

250 percent of tier 1 capital. As a result, 

tier 1 capital must equal at least 28.6 

percent of the measure for market risk. 

The sum of tier 2 (both allocated and 

excess) and allocated tier 3 capital may 

not exceed 100 percent of tier 1 capital 

(both allocated and excess). Term 

subordinated debt and intermediateterm preferred stock and related surplus 

included in tier 2 capital (both allocated 

and excess) may not exceed 50 percent 

of tier 1 capital (both allocated and 

excess). The sum of tier 1 and tier 2 

capital (both allocated and excess) and 

allocated tier 3 capital is the numerator 

of the bank’s total risk-based capital 

ratio. 

II. Proposed Revisions to the Market 

Risk Capital Rule 

A. Objectives of the Proposed Revisions 

The key objectives of the proposed 

revisions to the current market risk 

capital rule are to enhance the rule’s 

sensitivity to risks that are not 

adequately captured by the current rule; 

to enhance modeling requirements in a 

manner that is consistent with advances 

in risk management since the initial 

implementation of the rule; to modify 

the definition of covered position to 

better capture positions for which 

treatment under the rule is appropriate; 

to address shortcomings in the modeling 

of certain risks; to address certain 

procyclicality concerns; and to increase 

transparency through enhanced 

disclosures. The objective of enhancing 

the risk sensitivity of the rule is 

particularly important because of banks’ 

increased exposure to traded credit 

products, such as credit default swaps 

(CDSs) and asset-backed securities, in 

other structured products, and in less 

liquid products. The risks of these 

products are generally not fully 

captured in current VaR models, which 

rely on a 10-business-day, one-tail, 99.0 

percent confidence level soundness 

standard. 

For example, the growth in traded 

credit products has increased default 

and credit migration risks that should be 

captured in a regulatory capital 

requirement for specific risk but have 

proved difficult to capture adequately 

within current specific risk models. The 

agencies did not contemplate risks 

associated with less liquid credit 

products when the market risk capital 

rule was first adopted. Therefore, the 

agencies propose to implement an 

incremental risk capital requirement 

that would apply to a bank that models 

specific risk for one or more portfolios 

of debt or, if applicable, equity 

positions, and to incorporate explicit 

measures of liquidity. 

In addition, to address the agencies’ 

concerns about the appropriate 

treatment of covered positions that have 

limited price transparency, the agencies 

propose to require banks to have a welldefined valuation process for all 

covered positions. The specific 

proposals are discussed below. 

B. Description of the Proposed Revisions 

to the Market Risk Capital Rule 

1. Scope 

The proposed market risk capital rule 

does not change the set of banks to 

which the rule applies. That is, the 

proposed rule continues to apply to any 

bank with aggregate trading assets and 

trading liabilities equal to 10 percent or 

more of total assets, or $1 billion or 

more. The proposed rule applies to a 

bank that meets the market risk capital 

rule applicability threshold regardless of 

whether the bank uses the general riskbased capital rules or the advanced 

approaches rules. 

The primary Federal supervisor of a 

bank that does not meet the threshold 

criteria may apply the market risk 

capital rule to the bank if the supervisor 

deems it necessary or appropriate given 

the level of market risk of the bank or 

to ensure safe and sound banking 

practices. The primary Federal 

supervisor may also exclude a bank that 

meets the threshold criteria from 

application of the rule if the supervisor 

determines that the exclusion is 

appropriate based on the level of market 

risk of the bank and is consistent with 

safe and sound banking practices. 

Question 2: The agencies seek 

comment on the appropriateness of the 

proposed applicability thresholds. 

What, if any, alternative thresholds 

should the agencies consider and why? 

2. Reservation of Authority 

The proposed rule contains a 

reservation of authority that affirms the 

authority of a bank’s primary Federal 

supervisor to require the bank to hold 

an overall amount of capital greater than 

would otherwise be required under the 

rule if the supervisor determines that 

the bank’s risk-based capital 

requirements under the rule are not 

commensurate with the market risk of 

the bank’s covered positions. In 

addition, the agencies anticipate that 

there may be instances when the 

proposed rule would generate a riskbased capital requirement for a specific 

covered position or portfolio of covered 

positions that is not commensurate with 

the risks of the covered position or 

portfolio. In these cases, a bank’s 

primary Federal supervisor may require 

the bank to assign a different risk-based 

capital requirement to the covered 

position or portfolio of covered 

positions that better reflects the risk of 

the position or portfolio. The proposed 

rule also provides authority for a bank’s 

primary Federal supervisor to require 

the bank to calculate capital 

requirements for specific positions or 

portfolios under the market risk capital 

rule or under either the general riskbased capital rules or advanced 

approaches rules, as appropriate, to 

more appropriately reflect the risks of 

the positions. 

3. Modification of the Definition of 

Covered Position 

The proposed rule modifies the 

definition of a covered position to 

include trading assets and trading 

liabilities (as reported on schedule RC– 

D of the Call Report or Schedule HC–D 

of the Consolidated Financial 

Statements for Bank Holding 

Companies) that are trading positions. 

Under the proposal, a trading position is 

defined as a position that is held by the 

bank 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. Thus, the characterization of an 


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15See 12 CFR part 3, section 3 (OCC); 12 CFR part 

208, Appendix A, section II.B and 12 CFR part 225, 

Appendix A, section II.B (Board); and 12 CFR part 

325, Appendix A, section II.B.3 (FDIC). The 

treatment of guarantees is described in sections 33 

and 34 of the advanced approaches rules. 

asset or liability as ‘‘trading’’ for 

purposes of U.S. Generally Accepted 

Accounting Principles (GAAP) will not 

necessarily determine whether the asset 

or liability is a ‘‘trading position’’ for 

purposes of the proposed rule. 

Commenters on the 2006 proposal 

expressed concerns that the proposed 

covered position definition would 

create inconsistencies between the 

regulatory capital treatment of certain 

trading assets and trading liabilities and 

the treatment of those positions under 

GAAP. The agencies, however, continue 

to believe that relying on the accounting 

definition of trading assets and trading 

liabilities, without modification, would 

not be appropriate because it includes 

positions that are not held with the 

intent or ability to trade. 

The proposed covered position 

definition includes trading assets and 

trading liabilities that hedge covered 

positions. In addition, the trading asset 

or trading liability must be free of any 

restrictive covenants on its tradability or 

the bank must be able to hedge its 

material risk elements in a two-way 

market. A trading asset or trading 

liability that hedges a trading position is 

a covered position only if the hedge is 

within the scope of the bank’s hedging 

strategy (discussed below). The agencies 

encourage the sound risk management 

of trading positions. Therefore, the 

agencies include in the definition of a 

covered position any hedges that offset 

the risk of trading positions. The 

agencies are concerned, however, that a 

bank could craft its hedging strategies in 

order to bring non-trading positions that 

are more appropriately treated under the 

credit risk capital rules into the bank’s 

covered positions. The agencies will 

review a bank’s hedging strategies to 

ensure that they are not being 

manipulated in this manner. For 

example, mortgage-backed securities 

that are not held with the intent to 

trade, but that are hedged with interest 

rate swaps to mitigate interest rate risk, 

would be subject to the credit risk 

capital rules. 

Consistent with the current definition 

of covered position, under the proposed 

rule, a covered position also includes 

any foreign exchange or commodity 

position, whether or not it is a trading 

asset or trading liability. With prior 

supervisory approval, a bank may 

exclude from its 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 bank’s tier 1 and tier 2 capital; 

or (iv) a position designed to hedge a 

bank’s capital ratios or earnings against 

the effect of adverse exchange rate 

movements on (i), (ii), or (iii). 

Also consistent with the current rule, 

the proposed definition of a covered 

position explicitly excludes any 

position that, in form or substance, acts 

as a liquidity facility that provides 

support to asset-backed commercial 

paper. In addition, the definition of 

covered position excludes all intangible 

assets, including servicing assets. 

Intangible assets are excluded because 

their risks are explicitly addressed in 

the credit risk capital rules, often 

through a deduction from capital. 

The proposed covered position 

definition excludes any equity position 

that is not publicly traded, other than a 

derivative that references a publicly 

traded equity; any direct real estate 

holding; and any position that a bank 

holds with the intent to securitize. 

Equity positions that are not publicly 

traded would include private equity 

investments, most hedge fund 

investments, and other such closelyheld and non-liquid investments that 

are not easily marketable. Direct real 

estate holdings include real estate for 

which the bank holds title, such as 

‘‘other real estate owned’’ held from 

foreclosure activities, and bank 

premises used by a bank as part of its 

ongoing business activities. With such 

real estate holdings, marketability and 

liquidity are uncertain or even 

impractical as the assets are an integral 

part of the bank’s ongoing business. 

Indirect investments in real estate, such 

as through real estate investment trusts 

or special purpose vehicles, must meet 

the definition of a trading position in 

order to be a covered position. Positions 

that a bank holds with the intent to 

securitize include a ‘‘pipeline’’ or 

‘‘warehouse’’ of loans being held for 

securitization; the agencies do not view 

the intent to securitize these positions 

as synonymous with the intent to trade 

them. Consistent with the 2009 

revisions, the agencies believe all of 

these excluded positions have 

significant constraints in terms of a 

bank’s ability to liquidate them readily 

and value them reliably on a daily basis. 

The proposed covered position 

definition excludes a credit derivative 

that the bank recognizes as a guarantee 

for purposes of calculating the amount 

of risk-weighted assets under the credit 

risk capital rules 15 if it is used to hedge 

a position that is not a covered position 

(for example, a credit derivative hedge 

of a loan that is not a covered position). 

This requires the bank to include the 

credit derivative in its risk-weighted 

assets for credit risk and exclude it from 

its VaR-based measure for market risk. 

This proposed treatment of a credit 

derivative hedge avoids the mismatch 

that arises when the hedged position 

(for example, a loan) is not a covered 

position and the credit derivative hedge 

is a covered position. This mismatch 

has the potential to overstate the VaRbased measure of market risk if only one 

side of the transaction were reflected in 

that measure. 

Question 3: The agencies request 

comment on all aspects of the proposed 

definition of covered position. 

Under the proposed rule, in addition 

to commodities and foreign exchange 

positions, covered positions include 

debt positions, equity positions and 

securitization positions. The proposal 

defines a debt position as a 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. Examples of debt 

positions include corporate and 

government bonds, certain 

nonconvertible preferred stock, certain 

convertible bonds, and derivatives 

(including written and purchased 

options) for which the underlying 

instrument is a debt position. 

The proposal defines an equity 

position as a 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. Examples of equity 

positions include voting or nonvoting 

common stock, certain convertible 

bonds, commitments to buy or sell 

equity instruments, equity indices, and 

a derivative for which the underlying 

instrument is an equity position. 

Under the proposal, a securitization is 

a transaction in which: (i) All or a 

portion of the credit risk of one or more 

underlying exposures is transferred to 

one or more third parties; (ii) the credit 

risk associated with the underlying 

exposures has been separated into at 

least two tranches that reflect different 

levels of seniority; (iii) performance of 

the securitization exposures depends 

upon the performance of the underlying 

exposures; (iv) all or substantially all of 


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16 In a synthetic securitization, a company uses 

credit derivatives or guarantees to transfer a portion 

of the credit risk of one or more underlying 

exposures to third-party protection providers. The 

credit derivative or guarantee may be collateralized 

or uncollateralized. 

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); (v) for 

non-synthetic securitizations, the 

underlying exposures are not owned by 

an operating company; 16 (vi) the 

underlying exposures are not owned by 

a small business investment company 

described in section 302 of the Small 

Business Investment Act of 1958 (15 

U.S.C. 682); and (vii) the underlying 

exposures are not owned by a firm an 

investment in which qualifies as a 

community development investment 

under 12 U.S.C. 24 (Eleventh). Further, 

a bank’s primary Federal supervisor 

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 securitization 

based on the transaction’s leverage, risk 

profile, or economic substance. 

Generally, the agencies would consider 

investment firms that can easily change 

the size and composition of their capital 

structure, as well as the size and 

composition of their assets and offbalance sheet exposures as eligible for 

exclusion from the securitization 

definition under this provision. Based 

on a particular transaction’s leverage, 

risk profile, or economic substance, a 

bank’s primary Federal supervisor may 

deem an exposure to a transaction to be 

a securitization exposure, even if the 

exposure does not meet the criteria in 

provisions (v), (vi), or (vii) above. A 

securitization position is a covered 

position that is (i) an on-balance sheet 

or off-balance sheet credit exposure 

(including credit-enhancing 

representations and warranties) that 

arises from a securitization (including a 

resecuritization); or (ii) an exposure that 

directly or indirectly references a 

securitization exposure described in 

(i) above. 

A securitization position includes 

nth-to-default credit derivatives and 

resecuritization positions. The proposal 

defines an nth-to-default credit 

derivative as a credit derivative that 

provides credit protection only for the 

nth-defaulting reference exposure in a 

group of reference exposures. In 

addition, under the proposal, a 

resecuritization is a securitization in 

which one or more of the underlying 

exposures is a securitization exposure. 

A resecuritization position is (i) an onor off-balance sheet exposure to a 

resecuritization; or (ii) an exposure that 

directly or indirectly references a 

resecuritization exposure described 

in (i). 

The proposal defines a correlation 

trading position as (i) a securitization 

position for which all or substantially 

all of the value of the underlying 

exposures is based on the credit quality 

of a single company for which a twoway market exists, or on commonly 

traded indices based on such exposures 

for which a two-way market exists on 

the indices; or (ii) a position that is not 

a securitization position and that hedges 

a position described in clause (i) above. 

Under the proposed definition, a 

correlation trading position does not 

include a resecuritization position, a 

derivative of a securitization position 

that does not provide a pro rata share in 

the proceeds of a securitization tranche, 

or a securitization position for which 

the underlying assets or reference 

exposures are retail exposures, 

residential mortgage exposures, or 

commercial mortgage exposures. 

Correlation trading positions are 

typically not rated by external credit 

rating agencies and may include CDO 

index tranches, bespoke CDO tranches, 

and nth-to-default credit derivatives. 

Standardized CDS indices and singlename CDSs are examples of instruments 

used to hedge these positions. While 

banks typically hedge correlation 

trading positions, hedging frequently 

does not reduce a bank’s net exposure 

to a position because the hedges often 

do not perfectly match the position. 

4. Requirements for the Identification of 

Trading Positions and Management of 

Covered Positions 

Section 3 of the proposal introduces 

new requirements for the identification 

of trading positions and the 

management of covered positions. The 

agencies believe that these new 

requirements are warranted based on 

the inclusion of more credit risk-related, 

less liquid, and less actively traded 

products in banks’ covered positions. 

The risks of these positions may not be 

fully reflected in the requirements of the 

market risk capital rule and may be 

more appropriately captured under 

credit risk capital rules. 

The proposed rule requires a bank to 

have clearly defined policies and 

procedures for determining which of its 

trading assets and trading liabilities are 

trading positions as well as which of its 

trading positions are correlation trading 

positions. In determining the scope of 

trading positions, the bank must 

consider (i) 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; and 

(ii) possible impairments to the liquidity 

of a position or its hedge. 

In addition, the bank must have 

clearly defined trading and hedging 

strategies. The bank’s trading and 

hedging strategies for its trading 

positions must be approved by senior 

management. The trading strategy must 

articulate the expected holding period 

of, and the market risk associated with, 

each portfolio of trading positions. The 

hedging strategy must articulate for each 

portfolio the level of market risk the 

bank is willing to accept and must detail 

the instruments, techniques, and 

strategies the bank will use to hedge the 

risk of the portfolio. The hedging 

strategy should be applied at the level 

at which trading positions are risk 

managed at the bank (for example, 

trading desk, portfolio levels). 

The proposed rule requires a bank to 

have clearly defined policies and 

procedures for actively managing all 

covered positions. In the context of nontraded commodities and foreign 

exchange positions, active management 

includes managing the risks of those 

positions within the bank’s risk limits. 

For all covered positions, these policies 

and procedures, at a minimum, must 

require (i) marking positions to market 

or model on a daily basis; (ii) assessing 

on a daily basis the bank’s ability to 

hedge position and portfolio risks and 

the extent of market liquidity; (iii) 

establishment and daily monitoring of 

limits on positions by a risk control unit 

independent of the trading business 

unit; (iv) daily monitoring by senior 

management of the information 

described in (i) through (iii) above; 

(v) at least annual reassessment by 

senior management of established limits 

on positions; and (vi) at least annual 

assessments by qualified personnel 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. 

The proposed rule introduces new 

requirements for the prudent valuation 

of covered positions that include 

maintaining policies and procedures for 

valuation, marking positions to market 

or to model, independent price 

verification, and valuation adjustments 

or reserves. The valuation process must 

consider, as appropriate, unearned 

credit spreads, close-out costs, early 

termination costs, investing and funding 


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costs, future administrative costs, 

liquidity, and model risk. These new 

valuation requirements reflect the 

agencies’ concerns about deficiencies in 

banks’ valuation of less liquid trading 

positions, especially in light of the 

historical focus of the market risk 

capital rule on a 10-business-day time 

horizon and a one-tail, 99.0 percent 

confidence level, which has proved to 

be inadequate at times to reflect the full 

extent of the risks of less liquid 

positions. 

5. General Requirements for Internal 

Models 

Model Approval and Ongoing Use 

Requirements. Under the proposed rule, 

a bank must receive the prior written 

approval of its primary Federal 

supervisor before using any internal 

model to calculate its market risk capital 

requirement. The 2006 proposal 

included a requirement that a bank 

receive prior written approval from its 

primary Federal supervisor before 

extending the use of an approved model 

to an additional business line or product 

type. Some commenters raised concerns 

that this requirement might unduly 

impede a new product launch pending 

regulatory approval. The agencies have 

not included this requirement in the 

proposed rule. Instead, the proposal 

requires that a bank promptly notify its 

primary Federal supervisor when the 

bank plans to extend the use of a model 

that the primary Federal supervisor has 

approved to an additional business line 

or product type. 

The proposed rule also requires a 

bank to notify its primary Federal 

supervisor promptly if it makes any 

change to its internal models that would 

result in a material change in the bank’s 

amount of risk-weighted assets for a 

portfolio of covered positions or when 

the bank makes any material change to 

its modeling assumptions. The bank’s 

primary Federal supervisor may rescind 

its approval, in whole or in part, of the 

use of any internal model, and 

determine an appropriate regulatory 

capital requirement for the covered 

positions to which the model would 

apply, if it determines that the model no 

longer complies with the market risk 

capital rule or fails to reflect accurately 

the risks of the bank’s covered positions. 

For example, if adverse market events or 

other developments reveal that a 

material assumption in a bank’s 

approved model is flawed, the bank’s 

primary Federal supervisor may require 

the bank to revise its model 

assumptions and resubmit the model 

specifications for review by the 

supervisor. 

Financial markets evolve rapidly, and 

internal models that were state-of-theart at the time they were approved for 

use in risk-based capital calculations 

can become less relevant as the risks of 

covered positions evolve and as the 

industry develops more sophisticated 

modeling techniques that better capture 

material risks. The proposed rule 

therefore requires a bank to review its 

internal models periodically, but no less 

frequently than annually, in light of 

developments in financial markets and 

modeling technologies, and to enhance 

those models as appropriate to ensure 

that they continue to meet the agencies’ 

standards for model approval and 

employ risk measurement 

methodologies that are most appropriate 

for the bank’s covered positions. It is 

essential that a bank continually 

improve its models to ensure that its 

market risk capital requirement reflects 

the risk of the bank’s covered positions. 

A bank’s primary Federal supervisor 

will closely scrutinize the bank’s model 

review practices as a matter of safety 

and soundness. 

To support the model review and 

enhancement requirement discussed 

above, the agencies are considering 

imposing a capital supplement in 

circumstances in which a bank’s 

internal model continues to meet the 

qualification requirements of the rule, 

but develops specific shortcomings in 

risk identification, risk aggregation and 

representation, or validation. The 

regulatory capital supplement would 

reflect the materiality of these 

shortcomings associated with the bank’s 

current model and could result in a riskweighted assets surcharge that would 

apply until such time that the bank 

enhances its model to the satisfaction of 

its primary Federal supervisor. For 

example, the capital supplement could 

take the form of a model risk multiplier 

similar to the backtesting multiplier for 

VaR-type models in section 4 of the 

proposed rule. Depending on the 

materiality of the shortcomings, the 

supervisor could increase the multiplier 

on any model above three, generally 

subject to the restriction that the 

resulting capital requirement not exceed 

the capital requirement that would 

apply under the proposed rule’s 

standardized measurement method for 

specific risk. 

Question 4: Under what 

circumstances should the agencies 

require a model-specific capital 

supplement? What criteria could the 

agencies use to apply capital 

supplements consistently across banks? 

Aside from a capital supplement or 

withdrawal of model approval, how else 

could the agencies address concerns 

about outdated models? 

Risks Reflected in Models. Under the 

proposed rule, a bank must incorporate 

its internal models into its risk 

management process and integrate the 

internal models used for calculating its 

VaR-based measure into its daily risk 

management process. The level of 

sophistication of a bank’s models must 

be commensurate with the complexity 

and amount of its covered positions. To 

measure market risk, a bank’s internal 

models may use any generally accepted 

modeling approach, including but not 

limited to variance-covariance models, 

historical simulations, or Monte Carlo 

simulations. A bank’s internal models 

must properly measure all material risks 

in the covered positions to which they 

are applied. The proposed rule requires 

that risks arising from less liquid 

positions and positions with limited 

price transparency be modeled 

conservatively under realistic market 

scenarios. The proposed rule also 

requires a bank to have a rigorous 

process for reestimating, reevaluating 

and updating its models to ensure 

continued applicability and relevance. 

Control, Oversight, and Validation 

Mechanisms. The proposed rule 

maintains the current requirement that 

a bank have a risk control unit that 

reports directly to senior management 

and is independent of its business 

trading units. In addition, the proposed 

rule provides specific model validation 

standards that are similar to those in the 

advanced approaches rules. 

Specifically, the proposal requires a 

bank to validate its internal models 

initially and on an ongoing basis. The 

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. The review personnel 

do not necessarily have to be external to 

the bank in order to achieve the 

required independence. A bank should 

ensure that individuals who perform the 

review are not biased in their 

assessment due to their involvement in 

the development, implementation, or 

operation of the models. 

Under the proposed rule, validation 

must include an evaluation of the 

conceptual soundness of the internal 

models. This evaluation should include 

evaluation of empirical evidence and 

documentation supporting the 

methodologies used; important model 

assumptions and their limitations; 

adequacy and robustness of empirical 

data used in parameter estimation and 

model calibration; and evidence of a 

model’s strengths and weaknesses. 


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Validation also must include an ongoing 

monitoring process that includes a 

review and verification of processes and 

the comparison of the bank’s model 

outputs 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 bank’s models. As part 

of this comparison, the bank should 

investigate the source of any differences 

between the model estimates and the 

relevant internal or external data or 

estimation techniques and whether the 

extent of the differences is appropriate. 

Validation of internal models must 

include an outcomes analysis process 

that includes backtesting. Consistent 

with the 2009 revisions, the proposed 

rule requires a bank’s validation process 

for internal models used to calculate its 

VaR-based measure to include an 

outcomes analysis process that includes 

a comparison of the changes in the 

bank’s portfolio value that would have 

occurred were end-of-day positions to 

remain unchanged (therefore, excluding 

fees, commissions, reserves, net interest 

income, and intraday trading) with VaRbased measures during a sample period 

not used in model development. 

The proposed rule expands upon the 

current market risk rule’s stress-testing 

requirement. Specifically, the proposal 

requires a bank to stress test the market 

risk of its covered positions at a 

frequency appropriate to each portfolio, 

and in no case less frequently than 

quarterly. The stress tests must take into 

account concentration risk, illiquidity 

under stressed market conditions, and 

other risks arising from the bank’s 

trading activities that may not be 

captured adequately in the bank’s 

internal models. For example, it may be 

appropriate for a bank to include in its 

stress testing the gapping of prices, oneway markets, nonlinear or deep out-ofthe-money products, jumps-to-default, 

and significant changes in correlation. 

Relevant types of concentration risk 

include concentration by name, 

industry, sector, country, and market. 

Market concentration occurs when a 

bank holds a position that represents a 

concentrated share of the market for a 

security, and thus requires a longer than 

usual liquidity horizon to liquidate the 

position without impacting the market. 

A bank’s primary Federal supervisor 

would evaluate the robustness and 

appropriateness of a bank’s stress tests 

through the supervisory review process. 

The proposed rule requires a bank to 

have an internal audit function 

independent of business-line 

management that at least annually 

assesses the effectiveness of the controls 

supporting the bank’s market risk 

measurement systems, including the 

activities of the business trading units 

and independent risk control unit, 

compliance with policies and 

procedures, and the calculation of the 

bank’s measure for market risk. The 

internal audit function should review 

the bank’s validation processes, 

including validation procedures, 

responsibilities, results, timeliness, and 

responsiveness to findings. Further, the 

internal audit function should evaluate 

the depth, scope, and quality of the risk 

management system review process and 

conduct appropriate testing to ensure 

that the conclusions of these reviews are 

well-founded. At least annually, the 

internal audit function must report its 

findings to the bank’s board of directors 

(or a committee thereof). 

Internal Assessment of Capital 

Adequacy. The proposed rule requires 

that a bank have a rigorous process for 

assessing its overall capital adequacy in 

relation to its market risk. The 

assessment must take into account 

market concentration and liquidity risks 

under stressed market conditions, as 

well as other risks that may not be 

captured fully in the VaR-based 

measure. 

Documentation. Under the proposal, a 

bank must document adequately all 

material aspects of its internal models, 

the management and valuation of 

covered positions, its control, oversight, 

validation and review processes and 

results, and its internal assessment of 

capital adequacy. This documentation 

would facilitate the supervisory review 

process as well as the bank’s internal 

audit or other review procedures. 

6. Capital Requirement for Market Risk 

As under the current rule, the 

proposed rule requires a bank to 

calculate its risk-based capital ratio 

denominator as the sum of its adjusted 

risk-weighted assets and market risk 

equivalent assets. To calculate market 

risk equivalent assets, a bank must 

multiply its measure for market risk by 

12.5. Under the proposed rule, a bank’s 

measure for market risk equals the sum 

of its VaR-based capital requirement, its 

stressed VaR-based capital requirement, 

any specific risk add-ons, any 

incremental risk capital requirement, 

any comprehensive risk capital 

requirement, and any capital 

requirement for de minimis exposures, 

each calculated according to the 

requirements of the proposed rule as 

discussed further below. No 

adjustments are permitted to address 

potential double counting among any of 

these components of a bank’s measure 

for market risk. 

Also, consistent with the current rule, 

under the proposed rule a bank’s VaRbased capital requirement equals the 

greater of (i) the previous day’s VaRbased measure, or (ii) the average of the 

daily VaR-based measures for each of 

the preceding 60 business days 

multiplied by three, or such higher 

multiplication factor required based on 

backtesting results determined 

according to section 4 of the proposed 

rule and discussed further below. 

Similarly, under the proposed rule, a 

bank’s stressed VaR-based capital 

requirement equals the greater of (i) the 

most recent stressed VaR-based 

measure; or (ii) the average of the 

weekly VaR-based measures for each of 

the preceding 12 weeks multiplied by 

three, or such higher multiplication 

factor as required based on backtesting 

results determined according to section 

4 of the proposed rule. The 

multiplication factor applicable to the 

stressed-VaR based measure for 

purposes of this calculation is based on 

the backtesting results for its VaR-based 

measure; there is no separate 

backtesting requirement for the stressed 

VaR-based measure for purposes of 

calculating a bank’s measure for market 

risk. 

The proposed rule requires a bank to 

include in its measure for market risk 

any specific risk add-on as required 

under section 7(c) of the proposed rule, 

determined using the standardized 

measurement method described in 

section 10 of the proposed rule. The 

proposed rule also requires a bank to 

include in its measure for market risk 

any capital requirement for de minimis 

exposures. Specifically, a bank must 

add to its measure for market risk the 

absolute value of the market value of 

those de minimis exposures that are not 

captured in the bank’s VaR-based 

measure unless the bank has obtained 

prior written approval from its primary 

Federal supervisor to calculate a capital 

requirement for the de minimis 

exposures using alternative techniques 

that appropriately measure the market 

risk associated with those exposures. 

With regard to a bank’s total risk-based 

capital numerator, the proposed rule 

eliminates tier 3 capital and the 

associated allocation methodologies. 

Determination of the Multiplication 

Factor. The proposed rule modifies the 

current rule’s regulatory backtesting 

framework for determining the 

multiplication factor based on the 

number of backtesting exceptions. 

Under the current market risk capital 

rule, a bank must compare its daily VaRbased measure to its actual daily trading 

profit or loss, which typically includes 

realized and unrealized gains and losses 


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17Using the square root of time assumes that 

daily portfolio returns are independent and 

identically distributed (IID). When the IID 

assumption is violated, the square root of time 

approximation is not appropriate. 

on portfolio positions as well as fee 

income and commissions associated 

with trading activities. Under the 

proposed rule, each quarter, a bank 

must compare each of its most recent 

250 business days’ trading losses 

(excluding fees, commissions, reserves, 

intra-day trading, and net interest 

income) with the corresponding daily 

VaR-based measure calibrated to a oneday holding period and at a one-tail, 

99.0 percent confidence level. The 

excluded components of trading profit 

and loss are not modeled as part of the 

VaR-based measure. Therefore, 

excluding them from the regulatory 

backtesting framework will improve the 

accuracy of the backtesting and provide 

a better assessment of the bank’s 

internal model. Some commenters on 

the 2006 proposal raised concerns with 

this requirement; however, the agencies 

continue to believe that banks’ trading 

and reporting systems are sufficiently 

sophisticated to allow this type of 

backtesting. 

Question 5: The agencies request 

comment on any challenges banks may 

face in formulating the measure of 

trading loss as proposed, particularly 

for smaller portfolios. More specifically, 

which, if any, of the items to be 

excluded from a bank’s measure of 

trading loss (fees, commissions, 

reserves, intra-day trading, or net 

interest income) present difficulties and 

what is the nature of such difficulties? 

7. VaR-Based Capital Requirement 

Consistent with the current rule, 

section 5 of the proposed rule requires 

a bank to use one or more internal 

models to calculate a daily VaR-based 

measure that reflects general market risk 

for all covered positions. The daily VaRbased measure also may reflect the 

bank’s specific risk for one or more 

portfolios of debt or equity positions 

and must reflect the specific risk for any 

portfolios of correlation trading 

positions that are modeled under 

section 9 of the proposed rule. 

The proposal adds credit spread risk 

to the list of risk categories required to 

be captured in a bank’s VaR-based 

measure (that is, in addition to interest 

rate risk, equity price risk, foreign 

exchange rate risk, and commodity price 

risk). The VaR-based measure may 

incorporate empirical correlations 

within and across risk categories, 

provided the bank validates and justifies 

the reasonableness of its process for 

measuring correlations. If the VaR-based 

measure does not incorporate empirical 

correlations across risk categories, the 

bank must add the separate measures 

from its internal models used to 

calculate the VaR-based measure for the 

appropriate market risk categories to 

determine the bank’s aggregate VaRbased measure. The proposed rule 

continues to require models to include 

risks arising from the nonlinear price 

characteristics of option positions or 

positions with embedded optionality. 

Consistent with the 2009 revisions, 

under the proposed rule, a bank must be 

able to justify to the satisfaction of its 

primary Federal supervisor the omission 

of any risk factors from the calculation 

of its VaR-based measure that the bank 

includes in its pricing models. In 

addition, a bank must demonstrate to 

the satisfaction of its primary Federal 

supervisor the appropriateness of any 

proxies it uses to capture the risks of the 

bank’s actual positions for which such 

proxies are used. 

Quantitative Requirements for VaRbased Measure. The proposed rule 

includes the same quantitative 

requirements for the daily VaR-based 

measure as the current market risk 

capital rule. These include the one-tail, 

99.0 percent confidence level, a tenbusiness-day holding period, and a 

historical observation period of at least 

one year. 

To calculate VaR-based measures 

using a 10-day holding period, the bank 

may calculate 10-business-day measures 

directly, or may convert VaR-based 

measures using holding periods other 

than 10 business days to the equivalent 

of a 10-business-day holding period. A 

bank that converts its VaR-based 

measure in this manner must be able to 

justify the reasonableness of its 

approach to the satisfaction of its 

primary Federal supervisor. For 

example, a bank that computes its VaRbased measure by multiplying a daily 

VaR amount by the square root of 10 

(that is, using the square root of time) 

should demonstrate that daily changes 

in portfolio value do not exhibit 

significant mean reversion, 

autocorrelation, or volatility 

clustering.17

The proposed rule requires a bank’s 

VaR-based measure to be based on data 

relevant to the bank’s actual exposures 

and of sufficient quality to support the 

calculation of risk-based capital 

requirements. The bank must update 

data sets at least monthly, or more 

frequently as changes in market 

conditions or portfolio composition 

warrant. For banks that use a weighting 

scheme or other method for identifying 

the historical observation period, the 

bank must either: (i) Use an effective 

observation period of at least one year 

in which the average time lag of the 

observations is at least six months; or 

(ii) demonstrate to its primary Federal 

supervisor that the method used is more 

effective than that described in (i) at 

representing the volatility of the bank’s 

trading portfolio over a full business 

cycle. In the latter case, a bank must 

update its data more frequently than 

monthly and in a manner appropriate 

for the type of weighting scheme. In 

general, a bank using a weighting 

scheme should update its data daily. 

Because the most recent observations 

typically are the most heavily weighted 

it is important to include these 

observations in the bank’s VaR-based 

measure. 

The proposed rule requires a bank to 

retain and make available to its primary 

Federal supervisor model performance 

information on significant subportfolios. 

Taking into account the value and 

composition of a bank’s covered 

positions, the subportfolios must be 

sufficiently granular to inform a bank 

and its supervisor about the ability of 

the bank’s VaR model to reflect risk 

factors appropriately. A bank’s primary 

Federal supervisor must approve the 

number of subportfolios it uses for 

subportfolio backtesting. While the 

proposed rule does not prescribe the 

basis for determining significant 

subportfolios, the primary Federal 

supervisor may consider the bank’s 

evaluation of certain factors such as 

trading volume, product types and 

number of distinct traded products, 

business lines, and number of traders or 

trading desks. 

The proposed rule requires a bank to 

retain and make available to its primary 

Federal supervisor, with no less than a 

60 day lag, information for each 

subportfolio for each business day over 

the previous two years (500 business 

days) that includes (i) A daily VaRbased measure for the subportfolio 

calibrated to a one-tail, 99.0 percent 

confidence level; (ii) the daily profit or 

loss for the subportfolio (that is, the net 

change in price of the positions held in 

the portfolio at the end of the previous 

business day); and (iii) the p-value of 

the profit or loss on each day (that is, 

the probability of observing a loss 

greater than reported in (ii) above, based 

on the model used to calculate the VaRbased measure described in (i) above). 

Daily information on the probability 

of observing a loss greater than that 

which occurred on any day is a useful 

metric for banks and supervisors to 

assess the quality of a bank’s VaR 

model. For example, if a bank that used 

a historical simulation VaR model using 

the most recent 500 business days 


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18See Section 2, ‘‘Definitions,’’ of the proposed 

rule for a full definition of a term repo-style 

transaction. 

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 over a given period provides 

information about the adequacy of the 

VaR model’s ability to characterize the 

whole distribution of losses, including 

information on the size and number of 

backtesting exceptions. The requirement 

to create and retain this information at 

the subportfolio level may help identify 

particular products or business lines for 

which the model is not adequately 

measuring risk. 

Question 6: The agencies request 

comment on what, if any, challenges 

exist with the proposed subportfolio 

backtesting requirements described 

above. How might banks determine 

significant subportfolios of covered 

positions that would be subject to these 

requirements? What basis could be used 

to determine an appropriate number of 

subportfolios? Is the p-value a useful 

statistic for evaluating the efficacy of a 

bank’s VaR model in gauging market 

risk? What, if any, other statistics should 

the agencies consider and why? 

The current market risk capital rule 

requires a bank to include in its VaRbased measure only covered positions. 

In contrast, the proposed rule allows a 

bank to include term repo-style 

transactions in its VaR-based measure 

even though these positions may not 

meet the definition of a covered 

position, provided the bank includes all 

such term repo-style transactions 

consistently over time. Under the 

proposed rule, a term repo-style 

transaction is a repurchase or reverse 

repurchase transaction, or a securities 

borrowing or securities lending 

transaction, including a transaction in 

which the bank acts as agent for a 

customer and indemnifies the customer 

against loss, that has an original 

maturity in excess of one business day, 

provided that it meets certain 

requirements, including being based 

solely on liquid and readily marketable 

securities or cash and subject to daily 

marking-to-market and daily margin 

maintenance requirements.18 While 

repo-style transactions typically are 

close adjuncts to trading activities, 

GAAP traditionally has not permitted 

companies to report them as trading 

assets or trading liabilities. Repo-style 

transactions included in the VaR-based 

measure will continue to be subject to 

the requirements of the credit risk 

capital rules for calculating capital for 

counterparty credit risk. 

8. Stressed VaR-based Capital 

Requirement 

Under section 6 of the proposed rule, 

a bank must calculate at least weekly a 

stressed VaR-based measure using the 

same internal model(s) used to calculate 

its VaR-based measure. The stressed 

VaR-based measure supplements the 

VaR-based measure, which, due to 

inherent limitations, proved inadequate 

in producing capital requirements 

appropriate to the level of losses 

incurred at many banks during the 

financial market crisis that began in 

mid-2007. The stressed VaR-based 

measure mitigates the procyclicality of 

the minimum capital requirements for 

market risk and contributes to a more 

appropriate measure of the risks of a 

bank’s covered positions. 

Quantitative Requirements for 

Stressed VaR-based Measure. To 

determine the stressed VaR-based 

measure, a bank must use the same 

model(s) used to calculate its VaR-based 

measure, but with model inputs 

calibrated to reflect historical data from 

a continuous 12-month period that 

reflects a period of significant financial 

stress appropriate to the bank’s current 

portfolio. The stressed VaR-based 

measure must be calculated at least 

weekly and be no less than the bank’s 

VaR-based measure. The agencies 

generally expect that a bank’s stressed 

VaR-based measure will be substantially 

greater than its VaR-based measure. 

The proposed rule requires a bank to 

have policies and procedures that 

describe how it determines the period of 

significant financial stress used to 

calculate the bank’s stressed VaR-based 

measure, and to be able to provide 

empirical support for the period used. 

These policies and procedures must 

address (i) how the bank links the 

period of significant financial stress 

used to calculate the stressed VaR-based 

measure to the composition and 

directional bias of the bank’s current 

portfolio; and (ii) the bank’s process for 

selecting, reviewing, and updating the 

period of significant financial stress 

used to calculate the stressed VaR-based 

measure and for monitoring the 

appropriateness of the 12-month period 

in light of the bank’s current portfolio. 

The bank must obtain the prior approval 

of its primary Federal supervisor for, 

and notify its primary Federal 

supervisor if the bank makes any 

material changes to, these policies and 

procedures. A bank’s primary Federal 

supervisor may require it to use a 

different period of significant financial 

stress in the calculation of the bank’s 

stressed VaR-based measure. 

9. Revised Modeling Standards for 

Specific Risk 

The proposed rule more clearly 

specifies the modeling standards for 

specific risk and eliminates the current 

option for a bank to model some but not 

all material aspects of specific risk for 

an individual portfolio of debt or equity 

positions. As under the current market 

risk capital rule, a bank may use one or 

more internal models to measure the 

specific risk of a portfolio of debt or 

equity positions with specific risk. A 

bank must also use one or more internal 

models to measure the specific risk of a 

portfolio of correlation trading positions 

with specific risk that are modeled 

under section 9 of the proposed rule. A 

bank may not, however, model the 

specific risk of securitization positions 

that are not modeled under section 9 of 

the proposed rule. This treatment 

addresses regulatory arbitrage 

opportunities as well as deficiencies in 

the modeling of securitization positions 

that became more evident during the 

course of the financial market crisis that 

began in mid-2007. 

Under the proposed rule, the internal 

models must explain the historical price 

variation in the portfolio, be responsive 

to changes in market conditions, be 

robust to an adverse environment, and 

capture all material aspects of specific 

risk for the debt and equity positions. 

Specifically, the proposed revisions 

require that a bank’s internal models 

capture event risk and idiosyncratic 

risk; capture and demonstrate 

sensitivity to material differences 

between positions that are similar but 

not identical; and capture and 

demonstrate sensitivity to changes in 

portfolio composition and 

concentrations. If a bank calculates an 

incremental risk measure for a portfolio 

of debt or equity positions under section 

8 of the proposed rule, the bank is not 

required to capture default and credit 

migration risks in its internal models 

used to measure the specific risk of 

those portfolios. 

Under the current market risk capital 

rule, if a bank incorporates specific risk 

in its internal model but fails to 

demonstrate to its primary Federal 

supervisor that its internal model 

adequately measures all aspects of 

specific risk for a portfolio of debt and 

equity positions, the bank is subject to 

an internal models-based specific risk 

add-on for that portfolio. In contrast, the 

proposed rule requires a bank that does 

not have an approved internal model 

that captures all material aspects of 

specific risk for a particular portfolio of 


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debt, equity, or correlation trading 

positions to use the standardized 

measurement method (described in 

section 10 of the proposed rule) to 

calculate a specific risk add-on for that 

portfolio. This proposed change reflects 

the agencies’ interest in creating 

incentives for more robust specific risk 

modeling. Due to concerns about the 

ability of a bank to model the specific 

risk of certain securitization positions, 

the proposed rule requires a bank to 

calculate a specific risk add-on under 

the standardized measurement method 

for all of its securitization positions that 

are not correlation trading positions 

modeled under section 9 of the 

proposed rule. The agencies note that 

not all debt, equity, or securitization 

positions have specific risk (for 

example, certain interest rate swaps). 

Under the proposed rule, there is no 

specific risk capital requirement for 

positions without specific risk. A bank 

should have clear policies and 

procedures for determining whether a 

position has specific risk. 

While the proposed rule continues to 

provide for flexibility and a 

combination of approaches to measure 

market risk, including the use of 

different models to measure the general 

market risk and the specific risk of one 

or more portfolios of debt and equity 

positions, the agencies strongly 

encourage banks to develop and 

implement models that integrate the 

measurement of VaR for general market 

risk and specific risk. A bank’s use of a 

combination of approaches would be 

subject to supervisory review to ensure 

that the overall capital requirement for 

market risk is commensurate with the 

risks of the bank’s covered positions. 

10. Standardized Specific Risk Capital 

Requirement 

The proposed rule requires a bank to 

calculate a total specific risk add-on for 

each portfolio of debt and equity 

positions for which the bank’s VaRbased measure does not capture all 

material aspects of specific risk and for 

each of its securitization positions that 

is not modeled under section 9 of the 

proposed rule. A bank must calculate 

each specific risk add-on in accordance 

with the requirements of the proposed 

rule. The bank must add the total 

specific risk add-on for each portfolio of 

positions to the bank’s measure for 

market risk. The specific risk add-on for 

an individual debt or securitization 

position that represents purchased 

credit protection is capped at the market 

value of the protection. 

For debt, equity, and securitization 

positions that are derivatives with linear 

payoffs (for example, futures, equity 

swaps), a bank must apply a risk 

weighting factor to the market value of 

the effective notional amount of the 

underlying instrument or index 

portfolio. For debt, equity, and 

securitization positions that are 

derivatives with nonlinear payoffs (for 

example, options, interest rate caps, 

tranched positions), a bank must apply 

a risk weighting factor to the market 

value of the effective notional amount of 

the underlying instrument or portfolio 

multiplied by the derivative’s delta (that 

is, the change of the derivative’s value 

relative to changes in the price of the 

reference exposure). For a standard 

interest rate derivative, the effective 

notional amount refers to the apparent 

or stated notional principal amount. If 

the contract contains a multiplier or 

other leverage enhancement, the 

apparent or stated notional principal 

amount must be adjusted to reflect the 

effect of the multiplier or leverage 

enhancement in order to determine the 

effective notional amount. A swap must 

be included as an effective notional 

position in the underlying debt, equity, 

or securitization instrument or portfolio, 

with the receiving side treated as a long 

position and the paying side treated as 

a short position. Consistent with the 

current rules, a bank may net long and 

short positions (including derivatives) 

in identical issues or identical indices. 

A bank may also net positions in 

depositary receipts against an opposite 

position in an identical equity in 

different markets, provided that the 

bank includes the costs of conversion. 

The proposed rule also expands the 

recognition of hedging effects for debt 

and securitization positions. A set of 

transactions consisting of either a debt 

position and its credit derivative hedge 

or a securitization position and its credit 

derivative hedge has a specific risk addon of zero if the debt or securitization 

position is fully hedged by a total return 

swap (or similar instrument where there 

is a matching of payments and changes 

in market value of the position) and 

there is an exact match between the 

reference obligation, the maturity, and 

the currency of the swap and the debt 

or securitization position. 

If a set of transactions consisting of 

either a debt position and its credit 

derivative hedge or a securitization 

position and its credit derivative hedge 

does not meet the criteria for no specific 

risk add-on, the specific risk add-on for 

the set of transactions is equal to 20.0 

percent of the specific risk add-on for 

the side of the transaction with the 

higher specific risk add-on, provided 

that the credit risk of the position is 

fully hedged by a credit default swap (or 

similar instrument), and there is an 

exact match between the reference 

obligation of the credit derivative hedge 

and the debt or securitization position, 

the maturity of the credit derivative 

hedge and the debt or securitization 

position, and the currency of the credit 

derivative hedge and the debt or 

securitization position. For a set of 

transactions that consists of either a 

debt position and its credit derivative 

hedge or a securitization position and 

its credit derivative hedge that does not 

meet the criteria for full offset or the 

80.0 percent offset described above (for 

example, there is mismatch in the 

maturity of the credit derivative hedge 

and that of the debt or securitization 

position), but in which all or 

substantially all of the price risk has 

been hedged, the specific risk add-on is 

equal to the specific risk add-on for the 

side of the transaction with the larger 

specific risk add-on. 

Debt and Securitization Positions. 

While most securitization positions are 

considered debt positions under the 

current market risk capital rule, the 

agencies distinguish between 

securitization positions and debt 

positions in the proposed rule because 

of new proposed requirements that are 

uniquely applicable to securitization 

positions. Under the proposed rule, the 

total specific risk add-on for a portfolio 

of debt or securitization positions is the 

sum of the specific risk add-ons for 

individual debt or securitization 

positions, which are determined by 

multiplying the absolute value of the 

current market value of each net long or 

net short debt or securitization position 

by an appropriate risk-weighting factor 

for the position. 

The 2005 revisions to the market risk 

framework incorporated changes to the 

standardized measurement method used 

for calculating the specific risk add-ons 

for debt positions. For example, the 

‘‘government’’ category was expanded to 

include all sovereign debt, and the 

specific risk-weighting factor for 

sovereign debt was changed from zero 

percent to a range from zero to 12.0 

percent based on the external rating of 

the obligor and the remaining 

contractual maturity of the debt 

position. Table 1 below provides an 

illustrative representation of the specific 

risk-weighting factors applicable to debt 

positions in the ‘‘government,’’ 

‘‘qualifying,’’ and ‘‘other’’ categories 

under the market risk framework. 


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1902 Federal Register / Vol. 76, No. 7 / Tuesday, January 11, 2011 / Proposed Rules 

TABLE 1—SPECIFIC RISK-WEIGHTING FACTORS FOR DEBT POSITIONS

Category Illustrative external rating description Remaining contractual maturity 

Specific risk 

(%) weight 

factor 

Government ................... Highest investment grade to second highest investment grade (for example, AAA to AA¥).................................................................................. 0 .00 

Third highest investment grade to lowest investment grade (for example, A+ to BBB¥).Residual term to final maturity 6 months or less ... 0 .25 

Residual term to final maturity greater than 6 and 

up to and including 24 months.

1 .00 

Residual term to final maturity exceeding 24 

months.

1 .60 

One category below investment grade to two categories below investment grade (for example, 

BB+ to B¥).

................................................................................. 8 .00 

More than two categories below investment grade ................................................................................. 12 .00 

Unrated ................................................................... ................................................................................. 8 .00 

Qualifying ....................... Not applicable ........................................................ Residual term to final maturity 6 months or less ... 0 .25 

Residual term to final maturity greater than 6 and 

up to and including 24 months.

1 .00 

Residual term to final maturity exceeding 24 

months.

1 .60 

Other .............................. One category below investment grade to two categories below investment grade (for example, 

BB+ to B¥).

................................................................................. 8 .00 

More than two categories below investment 

grade, or equivalent based on a bank’s internal 

ratings.

................................................................................. 12 .00 

Unrated ................................................................... ................................................................................. 8 .00 

The 2009 revisions to the market risk 

framework also incorporated changes to 

the specific risk-weighting factors under 

the standardized measurement method 

for rated securitization and resecuritization positions as well as other 

treatments for unrated securitization 

and re-securitization positions. For 

rated positions, the revisions apply risk 

weights according to whether the 

positions’ external rating represents a 

long-term credit rating or a short-term 

credit rating and generally apply higher 

risk weights to rated re-securitization 

positions than to other rated 

securitization positions. Tables 2 and 3 

below provide illustrative 

representations of the specific riskweighting factors applicable to rated 

securitization and re-securitization 

position under the market risk 

framework. This treatment was designed 

to address regulatory arbitrage 

opportunities as well as deficiencies in 

the modeling of securitization positions 

that became more evident during the 

course of the financial market crisis that 

began in mid-2007. This revised 

treatment also assigns a more risksensitive capital requirement to 

securitization positions than applied 

previously. 

TABLE 2—LONG-TERM CREDIT RATING SPECIFIC RISK-WEIGHTING FACTORS FOR SECURITIZATION AND RESECURITIZATION POSITIONS

Illustrative external rating description Example 

Securitization exposure (that is not a 

resecuritization 

exposure) riskweighting factor 

(%) 

Resecuritization 

exposure riskweighting factor 

(%) 

Highest investment grade rating ............................................................................. AAA .................... 1.60 3.20 

Second-highest investment grade rating ................................................................ AA ...................... 1.60 3.20 

Third-highest investment grade rating .................................................................... A ......................... 4.00 8.00 

Lowest investment grade rating .............................................................................. BBB .................... 8.00 18.00 

One category below investment grade ................................................................... BB ...................... 28.00 52.00 

Two categories below investment grade ................................................................ B ......................... 100.00 100.00 

Three categories or more below investment grade ................................................ CCC ................... 100.00 100.00 


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19See Public Law 111–203 (July 21, 2010). 

20See section 939A of the Act. 

21The agencies also note that certain other 

provisions of the Act may affect the market risk 

capital rules. For example, the credit risk retention 

requirements of the Act may affect whether a 

securitization position retained by a bank pursuant 

to the requirements meets the definition of a trading 

position or a covered position. 

22 75 FR 52283 (August 25, 2010). 

TABLE 3—SHORT-TERM CREDIT RATING SPECIFIC RISK-WEIGHTING FACTORS FOR SECURITIZATION AND RESECURITIZATION POSITIONS

Illustrative external rating description Example 

Securitization exposure (that is not a 

resecuritization 

xposure) riskweighting factor 

(%) 

Resecuritization 

exposure riskweighting factor 

(%) 

Highest investment grade rating ........................................................................................... A–1/P–1 1.60 3.20 

Second-highest investment grade rating .............................................................................. A–2/P–2 4.00 8.00 

Third-highest investment grade rating .................................................................................. A–3/P–3 8.00 18.00 

All other ratings ..................................................................................................................... N/A ....... 100.00 100.00 

As a result of the recent enactment in 

the United States of the Dodd-Frank 

Wall Street Reform and Consumer 

Protection Act 19 (the Act), the agencies 

may not reference or require reliance on 

credit ratings in the assessment of the 

creditworthiness of a security or money 

market instrument. The Act provides 

that each Federal agency, after a 

required review of its regulations, must 

remove from each of its regulations any 

reference to or requirement of reliance 

on credit ratings and substitute a 

standard of creditworthiness the agency 

determines is appropriate for the 

regulation.20

The 2005 and 2009 BCBS revisions 

include provisions that rely on credit 

ratings for determining the specific riskweighting factors for debt, 

securitization, and re-securitization 

positions. These provisions would need 

to be revised when implemented in the 

U.S. in order to conform to the Act. The 

agencies acknowledge that the specific 

risk treatment for debt, securitization 

and re-securitization positions outlined 

in Tables 1 through 3 would provide a 

more risk-sensitive treatment for these 

positions than exists under the current 

rule; however, pending the agencies’ 

development of appropriate standards of 

creditworthiness to replace use of credit 

ratings as required by the Act, the 

proposed rule retains as a placeholder 

the current rule’s method for 

determining specific risk add-ons 

applicable to debt and securitization 

positions. More specifically, the 

‘‘government,’’ ‘‘qualifying,’’ and ‘‘other’’ 

categories as described in the current 

market risk capital rule and associated 

risk-weighting factors would continue to 

apply to a bank’s debt and securitization 

positions until the agencies develop a 

substitute standard of creditworthiness 

to replace reliance on credit ratings. For 

completeness and to ensure uniformity 

of regulatory text across the agencies’ 

rules, the proposed rule includes in 

section 10(b) the current standardized 

measurement method for these 

positions. The agencies acknowledge 

the shortcomings of the current 

treatment and recognize that it will have 

to be amended in accordance with the 

requirements of the Act. To the extent 

possible, the amended treatment would 

seek to establish comparable capital 

requirements for the affected positions 

in order to ensure international 

consistency and competitive equity. At 

the same time, the agencies believe it is 

important to move forward with the 

revisions to the market risk rules 

contained in this proposal.21

When the agencies determine a 

substitute standard of creditworthiness 

for external ratings as required by the 

Act, they intend to incorporate the new 

standard into their capital rules, 

including the market risk rule. The 

agencies are currently reviewing 

alternative approaches to the use of 

credit ratings across all of the agencies’ 

regulations and requirements with the 

goal of establishing a uniform 

alternative credit-worthiness standard. 

The agencies have asked for public 

input on this process through an 

advance notice of proposed rulemaking 

(ANPR).22 The agencies noted in the 

ANPR that in evaluating any standard of 

creditworthiness for purpose of 

determining risk-based capital 

requirements, the agencies will, to the 

extent practicable and consistent with 

the other objectives, consider whether 

the standard would: 

• Appropriately distinguish the credit 

risk associated with a particular 

exposure within an asset class; 

• Be sufficiently transparent, 

unbiased, replicable, and defined to 

allow banking organizations of varying 

size and complexity to arrive at the 

same assessment of creditworthiness for 

similar exposures and to allow for 

appropriate supervisory review; 

• Provide for the timely and accurate 

measurement of negative and positive 

changes in creditworthiness; 

• Minimize opportunities for 

regulatory capital arbitrage; 

• Be reasonably simple to implement 

and not add undue burden on banking 

organizations; and 

• Foster prudent risk management. 

Question 7: What specific standards 

of creditworthiness that meet the 

agencies’ suggested criteria for a 

creditworthiness standard outlined 

above should the agencies consider for 

these positions? 

Under the proposed rule, the total 

specific risk add-on for a portfolio of 

nth-to-default credit derivatives is the 

sum of the specific risk add-ons for 

individual nth-to-default credit 

derivatives, as computed therein. A 

bank must calculate a specific risk addon for each nth-to-default credit 

derivative position regardless of 

whether the bank is a net protection 

buyer or net protection seller. 

For first-to-default credit derivatives, 

the specific risk add-on is the lesser of 

(i) the sum of the specific risk add-ons 

for the individual reference credit 

exposures in the group of reference 

exposures, and (ii) the maximum 

possible credit event payment under the 

credit derivative contract. Where a bank 

has a risk position in one of the 

reference credit exposures underlying a 

first-to-default credit derivative and this 

credit derivative hedges the bank’s risk 

position, the bank is allowed to reduce 

both the specific risk add-on for the 

reference credit exposure and that part 

of the specific risk add-on for the credit 

derivative that relates to this particular 

reference credit exposure such that its 

specific risk add-on for the pair reflects 

the bank’s net position in the reference 

credit exposure. Where a bank has 

multiple risk positions in reference 

credit exposures underlying a first-todefault credit derivative, this offset is 

allowed only for the underlying 


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reference credit exposure having the 

lowest specific risk add-on. 

For second-or-subsequent-to-default 

credit derivatives, the specific risk addon is the lesser of: (i) The sum of the 

specific risk add-ons for the individual 

reference credit exposures in the group 

of reference exposures, but disregarding 

the (n–1) obligations with the lowest 

specific risk add-ons; or (ii) the 

maximum possible credit event 

payment under the credit derivative 

contract. For second-or-subsequent-todefault credit derivatives, no offset of 

the specific risk add-on with an 

underlying reference credit exposure is 

allowed under the proposed rule. 

Equity Positions. Under the proposed 

rule, the total specific risk add-on for a 

portfolio of equity positions is the sum 

of the specific risk add-ons of the 

individual equity positions, which are 

determined by multiplying the absolute 

value of the current market value of 

each net long or short equity position by 

an appropriate risk-weighting factor. 

The proposed rule retains the specific 

risk add-ons applicable to equity 

positions under the current market risk 

capital rule, with one exception. 

Consistent with the 2009 revisions, the 

proposed rule eliminates the provision 

that allows a bank to apply a specific 

risk-weighting factor of 4.0 to an equity 

position held in a portfolio that is both 

liquid and well-diversified. Instead, a 

bank must multiply the absolute value 

of the current market value of each net 

long or short equity position by a riskweighting factor of 8.0 percent. For 

equity positions that are index contracts 

comprising a well-diversified portfolio 

of equity instruments, the absolute 

value of the current market value of 

each net long or short position is 

multiplied by a risk-weighting factor of 

2.0 percent. A portfolio is welldiversified if it contains a large number 

of individual equity positions, with no 

single position representing a 

substantial portion of the portfolio’s 

total market value. 

The proposed rule retains the specific 

risk treatment in the current market risk 

capital rule for equity positions arising 

from futures-related arbitrage strategies 

where long and short positions are in 

exactly the same index at different dates 

or in different market centers, or where 

long and short positions are in index 

contracts at the same date in different 

but similar indices. The proposed rule 

also retains the current treatment for 

futures contracts on main indices that 

are matched by offsetting positions in a 

basket of stocks comprising the index. 

Due Diligence Requirements for 

Securitization Positions. The proposed 

rule incorporates requirements from the 

2009 revisions that banks perform due 

diligence on securitization positions. 

The due diligence requirements apply to 

all securitization positions and 

emphasize the need for banks to 

conduct their own due diligence of 

borrower creditworthiness, in addition 

to any use of third-party assessments, 

and not place undue reliance on 

external credit ratings. 

In order to meet the proposed due 

diligence requirements, a bank must be 

able to demonstrate, to the satisfaction 

of its primary Federal supervisor, a 

comprehensive understanding of the 

features of a securitization position that 

would materially affect the performance 

of the bank’s securitization position. 

The bank’s analysis must be 

commensurate with the complexity of 

the securitization position and the 

materiality of the position in relation to 

capital. 

To support the demonstration of its 

comprehensive understanding, for each 

securitization position, the bank must 

conduct and document an analysis of 

the risk characteristics of a 

securitization position prior to acquiring 

the position, considering: (i) Structural 

features of the securitization that would 

materially impact the performance of 

the position, for example, the 

contractual cash flow waterfall, 

waterfall-related triggers, credit 

enhancements, liquidity enhancements, 

market value triggers, the performance 

of organizations that service the 

position, and deal-specific definitions of 

default; (ii) relevant information 

regarding the performance of the 

underlying credit exposure(s), for 

example, the percentage of loans 30, 60, 

and 90 days past due; default rates; 

prepayment rates; loans in foreclosure; 

property types; occupancy; average 

credit score or other measures of 

creditworthiness; average LTV ratio; and 

industry and geographic diversification 

data on the underlying exposure(s); (iii) 

relevant market data of the 

securitization, for example, 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 (iii) 

for resecuritization positions, 

performance information on the 

underlying securitization exposures, for 

example, the issuer name and credit 

quality, and the characteristics and 

performance of the exposures 

underlying the securitization exposures. 

On an on-going basis, but no less 

frequently than quarterly, the bank must 

also evaluate, review, and update as 

appropriate the analysis required above 

for each securitization position. 

Question 8: What, if any, specific 

challenges are involved with meeting 

the proposed due diligence 

requirements and for what types of 

securitization positions? How might the 

agencies address these challenges while 

still ensuring that a bank conducts an 

appropriate level of due diligence 

commensurate with the risks of its 

covered positions? For example, would 

it be appropriate to scale the 

requirements according to a position’s 

expected holding period? How would 

such scaling affect a bank’s ability to 

demonstrate a comprehensive 

understanding of the risk characteristics 

of a securitization position? What are 

the benefits and drawbacks of requiring 

public disclosures regarding a bank’s 

processes for performing due diligence 

on its securitization positions? 

The agencies are considering 

alternative methodologies to the 

standardized measurement method for 

determining the specific risk capital 

requirement for securitization positions 

to better recognize the risk reduction 

benefits of hedging. Conceptually, such 

a methodology could recognize some 

degree of offsetting between positions 

that reference the same pool of assets 

but have different levels of seniority, or 

between positions that reference similar 

but not identical assets. For example, it 

could use a formulaic approach to 

determine a degree of offset between 

securitization positions that are similar 

to an index. Inputs to the formula could 

include factors such as the attachment 

and detachment points of an individual 

securitization position, the aggregate 

capital requirement of its underlying 

exposures, and the percentage of 

underlying obligors common to the 

securitization exposure and the index. 

Question 9: What alternative nonmodels-based methodologies could the 

agencies use to determine the specific 

risk add-ons for securitization 

positions? Please provide specific 

details on the mechanics of and 

rationale for any suggested 

methodology. Please also describe how 

the methodology conservatively 

recognizes some degree of hedging 

benefits, yet captures the basis risk 

between non-identical positions. To 

what types of securitization positions 

would such a methodology apply and 

why? 

11. Incremental Risk Capital 

Requirement 

Under section 8 of the proposed rule, 

a bank that measures the specific risk of 

a portfolio of debt positions using 

internal models must calculate an 

incremental risk measure for that 

portfolio using an internal model 


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(incremental risk model). Incremental 

risk consists of the default risk of a 

position (that is, the risk of loss on the 

position upon an event of default (for 

example, the failure of the obligor to 

make timely payments of principal or 

interest), including bankruptcy, 

insolvency, or similar proceeding) and 

the credit migration risk of a position 

(that is, price risk that arises from 

significant changes in the underlying 

credit quality of the position). 

With the prior approval of its primary 

Federal supervisor, a bank may also 

include portfolios of equity positions in 

its incremental risk model, provided 

that it consistently includes such equity 

positions in a manner that is consistent 

with how the bank internally measures 

and manages the incremental risk for 

such positions at the portfolio level. 

Default is deemed to occur with respect 

to any equity position that is included 

in the bank’s incremental risk model 

upon the default of any debt of the 

issuer of the equity position. A bank 

may not include correlation trading 

positions or securitization positions in 

its incremental risk model. 

Under the proposed rule, a bank’s 

model to measure the incremental risk 

of a portfolio of debt positions (and 

equity positions, if applicable) must 

meet certain requirements and be 

approved by the bank’s primary Federal 

supervisor before the bank may use it to 

calculate its risk-based capital 

requirement. The model must measure 

incremental risk over a one-year time 

horizon and at a one-tail, 99.9 percent 

confidence level, either under the 

assumption of a constant level of risk, 

or under the assumption of constant 

positions. 

The liquidity horizon of a position is 

the time that would be required for a 

bank to reduce its exposure to, or hedge 

all of the material risks of, the 

position(s) in a stressed market. The 

liquidity horizon for a position may not 

be less than the lower of three months 

or the contractual maturity of the 

position. 

A position’s liquidity horizon is a key 

risk attribute for purposes of calculating 

the incremental risk measure because it 

puts a bank’s overall risk exposure to an 

actively managed portfolio into context. 

Positions with longer (that is, less 

liquid) liquidity horizons are more 

difficult to hedge and result in more 

exposure to both default and credit 

migration risk over any fixed time 

horizon. In particular, two positions 

with differing liquidity horizons but 

exactly the same amount of default risk 

if held in a static portfolio over a oneyear horizon may exhibit significantly 

different amounts of default risk if held 

in a dynamic portfolio in which hedging 

can occur in response to observable 

changes in credit quality. The position 

with the shorter liquidity horizon can be 

hedged more rapidly and with less cost 

in the event of a change in credit 

quality, which leads to a different 

exposure to default risk over a one-year 

horizon than the position with the 

longer liquidity horizon. 

A constant level of risk assumption 

assumes that the bank rebalances, or 

rolls over, its trading positions at the 

beginning of each liquidity horizon over 

a one-year horizon in a manner that 

maintains the bank’s initial risk level. 

The bank must determine the frequency 

of rebalancing in a manner consistent 

with the liquidity horizons of the 

positions in the portfolio. A constant 

position assumption assumes that a 

bank maintains the same set of positions 

throughout the one-year horizon. If a 

bank uses this assumption, it must do so 

consistently across all portfolios for 

which it models incremental risk. A 

bank has flexibility in whether it 

chooses to use a constant risk or 

constant position assumption in its 

incremental risk model; however, the 

agencies expect that the assumption will 

remain fairly constant once selected. As 

with any material change to modeling 

assumptions, the proposed rule requires 

a bank must promptly notify its primary 

Federal supervisor if the bank changes 

from a constant risk to a constant 

position assumption or vice versa. 

Further, to the extent a bank estimates 

a comprehensive risk measure under 

section 9 of the proposed rule, the 

bank’s selection of a constant position 

or a constant risk assumption must be 

consistent between the bank’s 

incremental risk model and 

comprehensive risk model. Similarly, 

the bank’s treatment of liquidity 

horizons must be consistent between a 

bank’s incremental risk model and 

comprehensive risk model. 

The proposed rule requires a bank’s 

incremental risk model to meet the 

conditions described below. The model 

must recognize the impact of 

correlations between default and credit 

migration events among obligors. In 

particular, the existence of an aggregate, 

economy-wide credit cycle implies 

some degree of correlation between the 

default and credit migration events 

across different issuers. The degree of 

correlation between default and credit 

migration events of different issuers 

may also depend on other issuer 

attributes such as industry sector or 

region of domicile. The model must also 

reflect the effect of issuer and market 

concentrations, as well as 

concentrations that can arise within and 

across product classes during stressed 

conditions. 

The bank’s incremental risk model 

must reflect netting only of long and 

short positions that reference the same 

financial instrument and must also 

reflect any material mismatch between a 

position and its hedge. Examples of 

such mismatches include maturity 

mismatches as well as mismatches 

between an underlying position and its 

hedge, (for example, the use of an index 

position to hedge a single name 

security). 

The bank’s incremental risk model 

must also recognize the effect that 

liquidity horizons have on hedging 

strategies. When a bank’s hedging 

strategy requires continual rebalancing 

of the hedge position, the constraints on 

rebalancing imposed by the liquidity 

horizon of the hedge must be 

recognized. As an example, if a position 

is being hedged with an instrument with 

a liquidity horizon of three months, no 

rebalancing of the hedge can occur 

within a three month period. 

Accordingly, any divergence in the 

value of the position and its hedge that 

occurs because the hedge cannot be 

rebalanced within the three month 

liquidity horizon must be recognized. 

Moreover, in order to reflect the effect 

of hedging in the incremental risk 

measure, the bank must (i) Choose to 

model the rebalancing of the hedge 

consistently over the relevant set of 

trading positions; (ii) demonstrate that 

the inclusion of rebalancing results in a 

more appropriate risk measurement; (iii) 

demonstrate that the market for the 

hedge is sufficiently liquid to permit 

rebalancing during periods of stress; and 

(iv) capture in the incremental risk 

model any residual risks arising from 

such hedging strategies. 

The incremental risk model must 

reflect the nonlinear impact of options 

and other positions with material 

nonlinear behavior with respect to 

default and credit migration changes. In 

light of the one-year horizon of the 

incremental risk measure and the 

extremely high confidence level 

required, it is important that 

nonlinearities be explicitly recognized. 

Price changes resulting from defaults or 

credit migrations can be large and the 

resulting nonlinear behavior of the 

position can be material. The bank’s 

incremental risk model must also 

maintain consistency with the bank’s 

internal risk management 

methodologies for identifying, 

measuring, and managing risk. 

A bank that calculates an incremental 

risk measure under section 8 of the 

proposed rule must calculate its 

incremental risk capital requirement at 


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least weekly. This capital requirement is 

the greater of: (i) The average of the 

incremental risk measures over the 

previous 12 weeks; or (ii) the most 

recent incremental risk measure. 

12. Comprehensive Risk Capital 

Requirement 

Under section 9 of the proposed rule, 

with its primary Federal supervisor’s 

prior approval, a bank may measure all 

material price risks of one or more 

portfolios of correlation trading 

positions (comprehensive risk measure) 

using a model (comprehensive risk 

model). If the bank uses a 

comprehensive risk model for a 

portfolio of correlation trading 

positions, the bank must also measure 

the specific risk of that portfolio using 

internal models that meet the 

requirements in section 7(b) of the 

proposed rule. If the bank does not use 

a comprehensive risk model to calculate 

the price risk of a portfolio of 

correlation trading positions, it must 

calculate a specific risk add-on for the 

portfolio under section 7(c) of the 

proposed rule, determined using the 

standardized measurement method for 

specific risk described in section 10 of 

the proposed rule. 

A bank’s comprehensive risk model 

must meet several requirements under 

the proposed rule. The model must 

measure comprehensive risk (that is, all 

price risk) consistent with a one-year 

time horizon and at a one-tail, 99.9 

percent confidence level, under the 

assumption of either a constant level of 

risk or constant positions. As mentioned 

under the incremental risk measure 

discussion, while a bank has flexibility 

in whether it chooses to use a constant 

risk or constant position assumption, 

the agencies expect that the assumption 

will remain fairly constant once 

selected. The bank’s selection of a 

constant position assumption or a 

constant risk assumption must be 

consistent between the bank’s 

comprehensive risk model and its 

incremental risk model. Similarly, the 

bank’s treatment of liquidity horizons 

must be consistent between the bank’s 

comprehensive risk model and its 

incremental risk model. 

The proposed rule requires that a 

bank’s comprehensive risk model 

capture all material price risk of 

included positions, including, but not 

limited to: (i) The risk associated with 

the contractual structure of cash flows 

of the position, its issuer, and its 

underlying exposures (for example, the 

risk arising from multiple defaults, 

including the ordering of defaults, in 

tranched products); (ii) credit spread 

risk, including nonlinear price risks; 

(iii) volatility of implied correlations, 

including nonlinear price risks such as 

the cross-effect between spreads and 

correlations; (iv) basis risks (for 

example, the basis between the spread 

of an index and the spread on its 

constituents and the basis between 

implied correlation of an index tranche 

and that of a bespoke tranche); (v) 

recovery rate volatility as it relates to 

the propensity for recovery rates to 

affect tranche prices; and (vi) to the 

extent the comprehensive risk measure 

incorporates benefits from dynamic 

hedging, the static nature of the hedge 

over the liquidity horizon. 

The risks above have been identified 

as risks that are particularly important 

for correlation trading positions; 

however, the comprehensive risk model 

is intended to capture all material price 

risks related to those correlation trading 

positions that are included in the 

comprehensive risk model. Accordingly, 

additional risks that are not explicitly 

discussed above but are a material 

source of price risk must be included in 

the comprehensive risk model. 

The proposed rule also requires that 

a bank have sufficient market data to 

ensure that it fully captures the material 

price risks of the correlation trading 

positions in its comprehensive risk 

measure. Moreover, the bank must be 

able to demonstrate that its model is an 

appropriate representation of 

comprehensive risk in light of the 

historical price variation of its 

correlation trading positions. The 

agencies will scrutinize the positions a 

bank identifies as correlation trading 

positions and will also review whether 

the correlation trading positions have 

sufficient market data available to 

support reliable modeling of material 

risks. If there is insufficient market data 

to support reliable modeling for certain 

positions (such as new products), the 

agencies may require the bank to 

exclude these positions from the 

comprehensive risk model and, instead, 

require the bank to calculate specific 

risk add-ons for these positions under 

the standardized measurement method 

for specific risk. Again, the proposed 

rule requires a bank to promptly notify 

its primary Federal supervisor if the 

bank plans to extend the use of a model 

that has been approved by the 

supervisor to an additional business line 

or product type. 

In addition to these requirements, a 

bank must at least weekly apply to its 

portfolio of correlation trading positions 

a set of specific, supervisory stress 

scenarios that capture changes in 

default rates, recovery rates, and credit 

spreads; correlations of underlying 

exposures; and correlations of a 

correlation trading position and its 

hedge. A bank must retain and make 

available to its primary supervisor the 

results of the supervisory stress testing, 

including comparisons with the capital 

requirements generated by the bank’s 

comprehensive risk model. A bank also 

must promptly report to its primary 

Federal supervisor any instances where 

the stress tests indicate any material 

deficiencies in the comprehensive risk 

model. 

The agencies are evaluating the 

appropriate bases for supervisory stress 

scenarios to be applied to a bank’s 

portfolio of correlation trading 

positions. There are inherent difficulties 

in prescribing stress scenarios that 

would be universally applicable and 

relevant across all banks and across all 

products contained in banks’ correlation 

trading portfolios. The agencies believe 

a level of comparability is important for 

assessing the sufficiency and 

appropriateness of banks’ 

comprehensive risk models, but also 

recognize that specific scenarios may 

not be relevant for certain products or 

for certain modeling approaches. The 

agencies are considering various options 

for stress scenarios, including an 

approach that would involve specifying 

stress scenarios based on credit spread 

shocks to certain correlation trading 

positions (for example, single-name 

CDSs, CDS indexes, index tranches), 

which may replicate historically 

observed spreads. Another approach 

would require a bank to calibrate its 

existing valuation model to certain 

specified stress periods by adjusting 

credit-related risk factors to reflect a 

given stress period. The credit-related 

risk factors, as adjusted, would then be 

used to revalue the bank’s correlation 

trading portfolio under one or more 

stress scenarios. 

Question 10: What are the benefits 

and drawbacks of the supervisory stress 

scenario requirements described above 

and what other specific stress scenario 

approaches for the correlation trading 

portfolio should the agencies consider? 

For which products and model types are 

widely applicable stress scenarios most 

appropriate, and for which product and 

model types is a more tailored stress 

scenario most appropriate? What other 

stress scenario approaches could 

consistently reflect the risks of the entire 

portfolio of correlation trading 

positions? 

The agencies have identified 

prudential challenges associated with 

relying solely on banks’ comprehensive 

risk models for determining risk-based 

capital requirements for correlation 

trading positions. For example, a bank’s 

ability to perform robust validation of 


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its comprehensive risk model using 

standard backtesting methods is limited 

in light of the proposed requirements for 

the model to measure potential losses 

on correlation trading positions due to 

all price risk at a one-year time horizon 

and high-percentile confidence level. As 

a result, banks will need to use indirect 

model validation methods, such as 

stress tests, scenario analysis or other 

methods to assess their models. The 

agencies anticipate that banks’ 

comprehensive risk model validation 

approaches will evolve over time; 

however, to address near-term modeling 

challenges while still giving 

consideration to sound risk management 

practices, the agencies are proposing a 

floor on the modeled correlation trading 

position capital requirements in the 

form of a capital surcharge as described 

below. 

A bank approved to measure 

comprehensive risk for one or more 

portfolios of correlation trading 

positions must calculate at least weekly 

a comprehensive risk measure. The 

comprehensive risk measure equals the 

sum of the output from the bank’s 

approved comprehensive risk model 

plus a surcharge on the bank’s modeled 

correlation trading positions. The 

agencies propose setting the surcharge 

equal to 15.0 percent of the total specific 

risk add-on that would apply to the 

bank’s modeled correlation trading 

positions under the standardized 

measurement method for specific risk in 

section 10 of the proposed rule. 

The agencies propose that banks 

initially be required to calculate the 

comprehensive risk measure under the 

surcharge approach while banks and 

supervisors gain experience with the 

banks’ comprehensive risk models. Over 

time, with approval from its primary 

Federal supervisor, a bank may be 

permitted to use a floor approach to 

calculate its comprehensive risk 

measure as the greater of: (1) The output 

from the bank’s approved 

comprehensive risk model; or (2) 8.0 

percent of the total specific risk add-on 

that would apply to the bank’s modeled 

correlation trading positions under the 

standardized measurement method for 

specific risk, provided the bank has met 

the comprehensive risk modeling 

requirements in the proposed rule for a 

period of at least one year and can 

demonstrate the effectiveness of its 

comprehensive risk model through the 

results of ongoing validation efforts, 

including robust benchmarking. Such 

results may incorporate a comparison of 

the banks’ internal model results to 

those from an alternative model for 

certain portfolios and other relevant 

data. The agencies may also consider a 

benchmarking approach that uses banks’ 

internal models to determine capital 

requirements for a portfolio specified by 

the supervisors to allow for a relative 

assessment of models across banks. A 

bank’s primary Federal supervisor will 

monitor the appropriateness of the floor 

approach on an ongoing basis and may 

rescind its approval of this approach if 

it determines that the bank’s 

comprehensive risk model may not 

sufficiently reflect the risks of the bank’s 

modeled correlation trading positions. 

The agencies believe the proposed 

approach provides a prudential 

backstop on modeled capital 

requirements as well as appropriate 

incentives for ongoing model 

improvement. Another potential 

approach would be a stress-test based 

floor that would, for instance, require a 

bank to value its correlation trading 

positions using prescribed 

instantaneous price and correlation 

shocks in the models it uses to price its 

correlation trading positions. For 

example, such a floor could require a 

bank’s comprehensive risk capital 

requirement to be at least as great as the 

largest loss the bank would experience 

for its correlation trading positions 

under a scenario of instantaneous price 

changes for the underlying positions 

within a range of plus and minus 15.0 

percent combined with instantaneous 

correlation changes within a range of 

plus or minus 5.0 percent. 

Question 11: What, if any, specific 

challenges exist with respect to the 

proposed modeling requirements for 

correlation trading positions? What 

additional criteria and benchmarking 

methods should the agencies consider 

that would provide an objective basis for 

evaluating whether to allow a bank to 

apply a lower surcharge percentage in 

calculating its comprehensive risk 

measure? What are the advantages and 

disadvantages of the proposed floor 

approach and the other potential floor 

approaches described above? What 

other alternatives should the agencies 

consider to address the uncertainties 

identified above while ensuring safe and 

sound risk-based capital requirements 

for correlation trading positions? 

A bank that calculates a 

comprehensive risk measure under 

section 9 of the proposed rule must 

calculate its comprehensive risk capital 

requirement at least weekly. This capital 

requirement is the greater of (i) the 

average of the comprehensive risk 

measures over the previous 12 weeks; or 

(ii) the most recent comprehensive risk 

measure. Separate from the proposed 

requirements for calculating a 

comprehensive risk measure, as 

discussed previously, the proposed rule 

contains an explicit reservation of 

authority providing that a bank’s 

primary Federal supervisor may require 

a bank to assign a different risk-based 

capital requirement than would 

otherwise apply to a covered position or 

portfolio of covered positions that better 

reflects the risk of the position or 

portfolio. For example, regardless of a 

modeled capital requirement, a primary 

Federal supervisor may require a bank 

to increase its risk-weighted asset 

amount for correlation trading positions 

to ensure that it reflects the risk to 

which the bank is exposed. Because 

banks’ comprehensive risk models use 

many different methodologies, there is 

no uniform appropriate supervisory 

adjustment to risk-weighted assets. An 

adjustment may take the form of a 

multiplier, a floor, a fixed add-on, or 

another adjustment consistent with the 

risk of the portfolio and the bank’s 

modeling practices. 

13. Disclosure Requirements 

The proposed rule imposes disclosure 

requirements designed to increase 

transparency and improve market 

discipline on the top-tier consolidated 

legal entity that is subject to the market 

risk capital rule. The disclosure 

requirements, discussed further below, 

include a breakdown of certain 

components of a bank’s market risk 

capital requirement, information on a 

bank’s modeling approaches, and 

qualitative and quantitative disclosures 

relating to a bank’s securitization 

activities. 

The agencies recognize the 

importance of market discipline in 

encouraging sound risk management 

practices and fostering financial 

stability. With enhanced information, 

market participants can better evaluate 

a bank’s risk management performance, 

earnings potential, and financial 

strength. Many of the proposed 

disclosure requirements reflect 

information already disclosed publicly 

by the banking industry. A bank is 

encouraged, but not required, to make 

these disclosures in a central location 

on its web site. 

Consistent with the advanced 

approaches rules, the proposed rule 

requires a bank to comply with the 

disclosure requirements of section 11 of 

the proposed rule unless it is a 

consolidated subsidiary of another 

depository institution or bank holding 

company that is subject to the 

disclosure requirements. A bank subject 

to section 11 is required to adopt a 

formal disclosure policy approved by its 

board of directors that addresses the 

bank’s approach for determining the 

disclosures it makes. The policy must 


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23See 5 U.S.C. 603(a). 

24See 13 CFR 121.201. 

address the associated internal controls 

and disclosure controls and procedures. 

The board of directors and senior 

management must ensure that 

appropriate verification of the bank’s 

disclosures takes place and that 

effective internal controls and 

disclosure controls and procedures are 

maintained. One or more senior officers 

is required to attest that the disclosures 

meet the requirements of the proposed 

rule, and the board of directors and 

senior management are responsible for 

establishing and maintaining an 

effective internal control structure over 

financial reporting, including the 

information required under section 11 

of the proposed rule. 

The proposed rule requires a bank, at 

least quarterly, to disclose publicly for 

each portfolio of covered positions (i) 

The high, low, median, and mean VaRbased measures over the reporting 

period and the VaR-based measure at 

period-end; (ii) the high, low, median, 

and mean stressed VaR-based measures 

over the reporting period and the 

stressed VaR-based measure at periodend; (iii) the high, low, median, and 

mean incremental risk capital 

requirements over the reporting period 

and the incremental risk capital 

requirement at period-end; (iv) the high, 

low, median, and mean comprehensive 

risk capital requirements over the 

reporting period and the comprehensive 

risk capital requirement at period-end; 

(v) separate measures for interest rate 

risk, credit spread risk, equity price risk, 

foreign exchange rate risk, and 

commodity price risk used to calculate 

the VaR-based measure; and (vi) a 

comparison of VaR-based measures with 

actual results and an analysis of 

important outliers. In addition, the bank 

must publicly disclose the following 

information at least quarterly: (i) The 

aggregate amount of on-balance sheet 

and off-balance sheet securitization 

positions by exposure type; and (ii) the 

aggregate amount of correlation trading 

positions. 

A bank is required to make qualitative 

disclosures at least annually, or more 

frequently in the event of material 

changes, of the following information 

for each portfolio of covered positions: 

(i) The composition of material 

portfolios of covered positions; (ii) the 

bank’s valuation policies, procedures, 

and methodologies for covered positions 

including, for securitization positions, 

the methods and key assumptions used 

for valuing such positions, any 

significant changes since the last 

reporting period, and the impact of such 

change; (iii) the characteristics of its 

internal models, including, for the 

bank’s incremental risk capital 

requirement and the comprehensive risk 

capital requirement, the approach used 

by the bank to determine liquidity 

horizons; the methodologies used to 

achieve a capital assessment that is 

consistent with the required soundness 

standard; and the specific approaches 

used in the validation of these models; 

(iv) a description of its approaches for 

validating the accuracy of its internal 

models and modeling processes; (v) a 

description of the stress tests applied to 

each market risk category; (vi) the 

results of a comparison of the bank’s 

internal estimates with actual outcomes 

during a sample period not used in 

model development; (vii) the soundness 

standard on which its internal capital 

adequacy assessment is based, including 

a description of the methodologies used 

to achieve a capital adequacy 

assessment that is consistent with the 

soundness standard and the 

requirements of the market risk capital 

rule; and (viii) a description of the 

bank’s processes for monitoring changes 

in the credit and market risk of 

securitization positions, including how 

those processes differ for 

resecuritization positions; and (ix) a 

description of the bank’s policy 

governing the use of credit risk 

mitigation to mitigate the risks of 

securitization and resecuritization 

positions. 

Question 12: The agencies seek 

comment on the effectiveness of the 

proposed disclosure requirements. 

What, if any, changes to these 

requirements would make the proposed 

disclosures more effective in promoting 

market discipline? 

III. Regulatory Flexibility Act Analysis 

The Regulatory Flexibility Act, 5 

U.S.C. 601 et seq. (RFA), generally 

requires that, in connection with a 

notice of proposed rulemaking, an 

agency prepare and make available for 

public comment an initial regulatory 

flexibility analysis that describes the 

impact of a proposed rule on small 

entities.23 Under regulations issued by 

the Small Business Administration,24 a 

small entity includes a commercial bank 

or bank holding company with assets of 

$175 million or less (a small banking 

organization). As of June 30, 2010, there 

were approximately 2,561 small bank 

holding companies, 690 small national 

banks, 400 small state member banks, 

and 2,706 small state nonmember banks. 

The proposed rule would apply only 

if the bank holding company or bank 

has aggregated trading assets and 

trading liabilities equal to 10 percent or 

more of quarter-end total assets, or $1 

billion or more. No small banking 

organizations satisfy these criteria. 

Therefore, no small entities would be 

subject to this rule. 

IV. OCC Unfunded Mandates Reform 

Act of 1995 Determination 

The Unfunded Mandates Reform Act 

of 1995 (UMRA) requires Federal 

agencies to prepare a budgetary impact 

statement before promulgating a rule 

that 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 (adjusted annually 

for inflation) in any one year. The 

current inflation-adjusted expenditure 

threshold is $126.4 million. If a 

budgetary impact statement is required, 

section 205 of the UMRA also requires 

an agency to identify and consider a 

reasonable number of regulatory 

alternatives before promulgating a rule. 

In conducting the regulatory analysis, 

UMRA requires each Federal agency to 

provide: 

• The text of the draft regulatory 

action, together with a reasonably 

detailed description of the need for the 

regulatory action and an explanation of 

how the regulatory action will meet that 

need; 

• An assessment of the potential costs 

and benefits of the regulatory action, 

including an explanation of the manner 

in which the regulatory action is 

consistent with a statutory mandate and, 

to the extent permitted by law, promotes 

the President’s priorities and avoids 

undue interference with State, local, 

and tribal governments in the exercise 

of their governmental functions; 

• An assessment, including the 

underlying analysis, of benefits 

anticipated from the regulatory action 

(such as, but not limited to, the 

promotion of the efficient functioning of 

the economy and private markets, the 

enhancement of health and safety, the 

protection of the natural environment, 

and the elimination or reduction of 

discrimination or bias) together with, to 

the extent feasible, a quantification of 

those benefits; 

• An assessment, including the 

underlying analysis, of costs anticipated 

from the regulatory action (such as, but 

not limited to, the direct cost both to the 

government in administering the 

regulation and to businesses and others 

in complying with the regulation, and 

any adverse effects on the efficient 

functioning of the economy, private 

markets (including productivity, 

employment, and competitiveness), 

health, safety, and the natural 

environment), together with, to the 


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25The following are the components of the 

current Market Risk Measure. Value-at-Risk (VaR) 

is an estimate of the maximum amount that the 

value of one or more positions could decline due 

to market price or rate movements during a fixed 

holding period within a stated confidence interval. 

Specific risk is the risk of loss on a position that 

could result from factors other than broad market 

movements and includes event risk, default risk, 

and idiosyncratic risk. There may also be a capital 

requirement for de minimis exposures, if any, that 

are not included in the bank’s VaR models. 

26Unless otherwise noted, the population of 

banks used in this analysis consists of all FDICinsured national banks and uninsured national 

bank and trust companies. Banking organizations 

are aggregated to the top holding company level. 

27A national banking organization is any bank 

holding company with a subsidiary national bank. 

28The report, ‘‘Analysis of the third trading book 

impact study’’, is available at http://www.bis.org/ 

publ/bcbs163.htm. The study gathered data from 43 

banks in 10 countries, including six banks from the 

United States. 

extent feasible, a quantification of those 

costs; and 

• An assessment, including the 

underlying analysis, of costs and 

benefits of potentially effective and 

reasonably feasible alternatives to the 

planned regulation, identified by the 

agencies or the public (including 

improving the current regulation and 

reasonably viable nonregulatory 

actions), and an explanation why the 

planned regulatory action is preferable 

to the identified potential alternatives. 

• An estimate of any disproportionate 

budgetary effects of the Federal mandate 

upon any particular regions of the 

nation or particular State, local, or tribal 

governments, urban or rural or other 

types of communities, or particular 

segments of the private sector. 

• An estimate of the effect the 

rulemaking action may have on the 

national economy, if the OCC 

determines that such estimates are 

reasonably feasible and that such effect 

is relevant and material. 

A. The Need for the Regulatory Action 

The proposed rule would modify the 

current market risk capital rule by 

adjusting the minimum risk-based 

capital calculation and adding public 

disclosure requirements. The proposed 

rule would also (1) modify the 

definition of covered positions to 

include assets that are in the trading 

book and held with the intent to trade; 

(2) introduce new requirements for the 

identification of trading positions and 

the management of covered positions; 

and (3) require banks to have clearly 

defined policies and procedures for 

actively managing all covered positions, 

for the prudent valuation of covered 

positions and for specific internal model 

validation standards. The proposed rule 

will generally apply to any bank with 

aggregate trading assets and liabilities 

that are at least 10 percent of total assets 

or at least $1 billion. These thresholds 

are the same as those currently used to 

determine applicability of the market 

risk rule. 

Under current rules, the measure for 

market risk is as follows: 25

Market Risk Measure = (Value-at-Risk 

based capital requirement) + 

(Specific risk capital requirement) + 

(Capital requirement for de minimis 

exposures) 

Under the proposed rule, the new 

market risk measure would be as 

follows (new risk measure components 

are underlined): 

New Market Risk Measure = (Value-atRisk based capital requirement) + 

(Stressed Value-at-Risk based 

capital requirement) + (Specific risk 

capital charge) + (Incremental risk 

capital requirement) + 

(Comprehensive risk capital 

requirement) + (Capital charge for 

de minimis exposures) 

The Basel Committee and the Federal 

banking agencies designed the new 

components of the market risk measure 

to capture key risks overlooked by the 

current market risk measure. 

B. Cost-Benefit Analysis of the Proposed 

Rule 

1. Organizations Affected by the 

Proposed Rule 26

According to September 30, 2010, Call 

Report data, 16 national banking 

organizations 27 had trading assets and 

liabilities that are at least 10 percent of 

total assets or at least $1 billion. 

2. Impact of the Proposed Rule 

The key benefits of the proposed rule 

are the following qualitative benefits: 

• Enhances sensitivity to market risk, 

• Enhances modeling requirements 

consistent with advances in risk 

management, 

• Better captures trading positions for 

which market risk capital treatment is 

appropriate, 

• Increases transparency through 

enhanced market disclosures. 

• Increased market risk capital should 

lower the probability of catastrophic 

losses to the bank occurring because of 

market risk. 

• Modified requirements should 

reduce the procyclicality of market risk 

capital. 

We derive our estimates of the 

proposed rule’s effect on the market risk 

measure from the third trading book 

impact study conducted by the Basel 

Committee on Banking Supervision in 

2009 and additional estimates of the 

capital requirement for standardized 

securitization exposures and correlation 

trading positions.28 Based on these two 

assessments, we estimate that the 

market risk measure will increase 300 

percent on average. The market risk 

measure itself acts as an estimate of the 

minimum regulatory capital 

requirement for an adequately 

capitalized bank. Thus, quadrupling the 

market risk measure suggests that 

minimum required capital will increase 

by approximately $50.7 billion under 

the proposed rule. These new capital 

requirements would lead banks to 

deleverage and lose the tax advantage of 

debt. We estimate that the loss of these 

tax benefits would be approximately 

$334 million per year. 

We estimate that new disclosure 

requirements and the implementation of 

calculations for the new market risk 

measures may involve some additional 

system costs, but because the proposed 

rule will only affect institutions already 

subject to the current market risk rule 

we expect these additional system costs 

to be de minimis. We do not anticipate 

that the proposed rule will create 

significant additional administrative 

costs for the OCC. Based on our 

assessment of the capital costs of the 

proposed rule; we estimate that the total 

cost of the proposed rule will be 

approximately $334 million in 2010 

dollars over one year. 

C. Comparison Between Proposed Rule 

and Baseline 

Under the baseline scenario, the 

current market risk rule would continue 

to apply. Thus, in the baseline scenario, 

required market risk capital would 

remain at current levels and there 

would be no additional cost associated 

with adding capital. However, the 

benefits of increased sensitivity to 

market risk, increased transparency, the 

improved targeting of trading positions, 

reduced procyclicality of market risk 

capital, and the protective advantages of 

additional capital would be lost under 

the baseline scenario. 

D. Comparison Between Proposed Rule 

and Alternatives 

The Unfunded Mandates Reform Act 

of 1995 (UMRA) requires a comparison 

between the proposed rule and 

reasonable alternatives. In this 

regulatory impact analysis, we compare 

the proposed rule with two alternatives 

that modify the size thresholds for the 

rule. 

Assessment of Alternative A 

Under Alternative A, we consider a 

rule that has the same provisions as the 


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proposed rule, but we alter the rule’s 

trading book size threshold. Because 

trading assets and liabilities are 

concentrated in six or seven 

institutions, modest changes in the size 

thresholds have little impact on the 

dollar volume of trading assets affected 

by the market risk rule and thus little 

impact on the estimated cost of the rule. 

Changing the size threshold does affect 

the number of institutions affected by 

the rule, which suggests that the 

banking agencies’ systemic concerns 

could play a role in determining the 

appropriate size threshold for 

applicability of the market risk rule. 

Assessment of Alternative B 

Under Alternative B, we consider a 

rule that has the same provisions as the 

proposed rule, but we change the 

condition of the size thresholds from 

‘‘or’’ to ‘‘and’’. With this change, the 

proposed rule would apply to 

institutions that have $1 billion or more 

in trading assets and liabilities and a 

trading book to asset ratio of at least 10 

percent. Making the applicability of the 

market risk rule contingent on meeting 

both size thresholds would reduce the 

number of banks affected by the rule to 

four using the current thresholds of $1 

billion and 10 percent. In order for the 

alternative B rule to apply to the same 

number of institutions as the current 

rule, the alternative’s joint condition 

would have to be comparable to 

thresholds of between $500 million and 

$1 billion in the trading book and a 1 

percent trading-book-to-assets ratio. 

However, under this alternative the list 

of the 16 institutions subject to the rule 

would change slightly. Not surprisingly, 

as this joint threshold alternative could 

excuse some institutions with larger 

trading books, the estimated cost of the 

alternative rule does decrease with the 

number of institutions affected by the 

rule. 

E. Overall Impact of Proposed Rule, 

Baseline and Alternatives 

Under our baseline scenario, which 

reflects the current application of the 

market risk rule, a market risk capital 

charge of approximately $16.9 billion 

applies to 16 national banks. Under the 

proposed rule, this capital charge would 

continue to apply to the same 16 banks 

but the capital charge would likely 

quadruple. We estimate that the cost of 

this additional capital would be 

approximately $334 million per year in 

2010 dollars. 

Our alternatives examine the impact 

of a market risk rule that uses different 

size thresholds in order to determine 

which institutions are subject to the 

rule. With alternative A we consider 

altering the $1 billion trading book 

threshold used currently and 

maintained under the proposed rule. 

Although varying the size threshold 

changed the number of institutions 

affected by the rule, the overall capital 

cost of the rule did not significantly 

change. This reflects the high 

concentration of trading assets and 

liabilities in seven banks with over $15 

billion in their trading books as of 

September 30, 2010. As long as the 

proposed rule applies to these seven 

institutions, the additional required 

capital and its corresponding cost will 

not change considerably. 

Alternative B did affect both the 

number of institutions subject to the 

proposed rule and the cost of the 

proposed rule by limiting the market 

risk rule to institutions that meet both 

size criteria, i.e., a $1 billion trading 

book and a trading-book-to-assets ratio 

of at least 10 percent. Only four national 

banks currently meet both of these 

criteria, and applying the proposed rule 

to these institutions would require an 

additional $36.0 billion in market risk 

capital at a cost of approximately $237 

million. Clearly, the estimated cost of 

the proposed rule would fall if the size 

thresholds determining applicability of 

the market risk rule were to increase. 

However, the current size thresholds, 

which continue to apply under the 

proposed rule, capture those institutions 

that the regulatory agencies believe 

should be subject to market risk capital 

rules. The proposed rule changes 

covered positions, disclosure 

requirements, and methods relating to 

calculating the market risk measure. 

These changes achieve the important 

objectives of enhancing the banking 

system’s sensitivity to market risk, 

increases transparency of the trading 

book and market risk, and better 

captures trading positions for which 

market risk capital treatment is 

appropriate. The proposed rule carries 

over the current thresholds used to 

determine the applicability of the 

market risk rule. The banking agencies 

have determined that these size 

thresholds capture the appropriate 

institutions; those most exposed to 

market risk. 

The large increase in required market 

risk capital, which we estimate to be 

approximately $51 billion under the 

proposed rule, will provide a 

considerable buttress to the capital 

position of institutions subject to the 

market risk rule. This additional capital 

should dramatically lower the 

likelihood of catastrophic losses from 

market risk occurring at these 

institutions, which will enhance the 

safety and soundness of these 

institutions, the banking system, and 

world financial markets. Although there 

is some concern regarding the burden of 

the proposed increase in market risk 

capital and the effect this could have on 

bank lending, in the OCC’s opinion, the 

proposed rule offers a better balance 

between costs and benefits than either 

the baseline or the alternatives. 

The OCC does not expect the revised 

risk-based capital guidelines to have any 

disproportionate budgetary effect on any 

particular regions of the nation or 

particular State, local, or tribal 

governments, urban or rural or other 

types of communities, or particular 

segments of the private sector. 

V. Paperwork Reduction Act 

A. Request for Comment on Proposed 

Information Collection 

In accordance with the requirements 

of the Paperwork Reduction Act of 1995 

(44 U.S.C. 3501–3521), the agencies may 

not conduct or sponsor, and the 

respondent is not required to respond 

to, an information collection unless it 

displays a currently valid Office of 

Management and Budget (OMB) control 

number. The information collection 

requirements contained in this joint 

notice of proposed rulemaking have 

been submitted by the OCC and FDIC to 

OMB for review and approval under 

section 3506 of the PRA and section 

1320.11 of OMB’s implementing 

regulations (5 CFR part 1320). The 

Board reviewed the proposed rule under 

the authority delegated to the Board by 

OMB. 

Comments are invited on: 

(a) Whether the collection of 

information is necessary for the proper 

performance of the agencies’ functions, 

including whether the information has 

practical utility; 

(b) The accuracy of the estimates of 

the burden of the information 

collection, including the validity of the 

methodology and assumptions used; 

(c) Ways to enhance the quality, 

utility, and clarity of the information to 

be collected; 

(d) Ways to minimize the burden of 

the information collection on 

respondents, including through the use 

of automated collection techniques or 

other forms of information technology; 

and 

(e) Estimates of capital or start up 

costs and costs of operation, 

maintenance, and purchase of services 

to provide information. 

Comments should be addressed to: 

OCC: Communications Division, 

Office of the Comptroller of the 

Currency, Public Information Room, 

Mail stop 1–5, Attention: 1557–NEW, 


kgrant on DSKGBLS3C1PROD with BILLS
Federal Register / Vol. 76, No. 7 / Tuesday, January 11, 2011 / Proposed Rules 1911 

250 E Street, SW., Washington, DC 

20219. In addition, comments may be 

sent by fax to 202–874–5274, or by 

electronic mail to 

regs.comments@occ.treas.gov. You can 

inspect and photocopy the comments at 

the OCC’s Public Information Room, 250 

E Street, SW., Washington, DC 20219. 

For security reasons, OCC requires that 

visitors make an appointment to inspect 

the comments. You may do so by calling 

202–874–4700. Upon arrival, visitors 

will be required to present valid 

government-issued photo identification 

and submit to security screening in 

order to inspect and photocopy 

comments. 

Board: You may submit comments, 

identified by the Docket number, by any 

of the following methods: 

• Agency Web Site: http:// 

www.federalreserve.gov. Follow the 

instructions for submitting comments 

on the http://www.federalreserve.gov/ 

generalinfo/foia/ProposedRegs.cfm. 

• Federal eRulemaking Portal: http:// 

www.regulations.gov. Follow the 

instructions for submitting comments. 

• E-mail: 

regs.comments@federalreserve.gov. 

Include docket number in the subject 

line of the message. 

• FAX: 202–452–3819 or 202–452– 

3102. 

• Mail: Jennifer J. Johnson, Secretary, 

Board of Governors of the Federal 

Reserve System, 20th Street and 

Constitution Avenue, NW., Washington, 

DC 20551. 

All public comments are available 

from the Board’s Web site at http:// 

www.federalreserve.gov/generalinfo/ 

foia/ProposedRegs.cfm as submitted, 

unless modified for technical reasons. 

Accordingly, your comments will not be 

edited to remove any identifying or 

contact information. Public comments 

may also be viewed electronically or in 

paper form in Room MP–500 of the 

Board’s Martin Building (20th and C 

Streets, NW) between 9 a.m. and 5 p.m. 

on weekdays. 

FDIC: You may submit written 

comments, which should refer to 3064– 

____, by any of the following methods: 

• Agency Web Site: http:// 

www.fdic.gov/regulations/laws/federal/ 

propose.html. Follow the instructions 

for submitting comments on the FDIC 

Web site. 

• Federal eRulemaking Portal: http:// 

www.regulations.gov. Follow the 

instructions for submitting comments. 

• E-mail: Comments@FDIC.gov. 

Include RIN on the subject line of the 

message. 

• Mail: Robert E. Feldman, Executive 

Secretary, Attention: Comments, FDIC, 

550 17th Street, NW., Washington, DC 

20429. 

• Hand Delivery/Courier: Guard 

station at the rear of the 550 17th Street 

Building (located on F Street) on 

business days between 7 a.m. and 5 p.m. 

Public Inspection: All comments 

received will be posted without change 

to http://www.fdic.gov/regulations/laws/ 

federal/propose/html including any 

personal information provided. 

Comments may be inspected at the FDIC 

Public Information Center, Room 100, 

801 17th Street, NW., Washington, DC, 

between 9 a.m. and 4:30 p.m. on 

business days. 

A copy of the comments may also be 

submitted to the OMB desk officer for 

the agencies: By mail to U.S. Office of 

Management and Budget, 725 17th 

Street, NW., #10235, Washington, DC 

20503 or by facsimile to 202–395–6974, 

Attention: Federal Banking Agency Desk 

Officer. 

B. Proposed Information Collection 

Title of Information Collection: RiskBased Capital Standards: Market Risk 

Frequency of Response: Varied—some 

requirements are done at least quarterly 

and some at least annually. 

Affected Public: 

OCC: National banks and Federal 

branches and agencies of foreign banks. 

Board: State member banks and bank 

holding companies. 

FDIC: Insured non-member banks, 

insured state branches of foreign banks, 

and certain subsidiaries of these 

entities. 

Abstract: The information collection 

requirements are found in sections 3, 4, 

5, 6, 7, 8, 9, 10, and 11 of the proposed 

rule. They will enhance risk sensitivity 

and introduce requirements for public 

disclosure of certain qualitative and 

quantitative information about a bank’s 

or bank holding companies’ market risk. 

The collection of information is 

necessary to ensure capital adequacy 

according to the level of market risk. 

Section-by-Section Analysis 

Section 3 sets forth the requirements 

for applying the market risk framework. 

Section 3(a)(1) requires clearly defined 

policies and procedures for determining 

which trading assets and trading 

liabilities are trading positions, which of 

its trading positions are correlation 

trading positions, and specifies what 

must be taken into account. Section 

3(a)(2) requires a clearly defined trading 

and hedging strategy for trading 

positions approved by senior 

management and specifies what each 

strategy must articulate. Section 3(b)(1) 

requires clearly defined policies and 

procedures for actively managing all 

covered positions and specifies the 

minimum that they must require. 

Sections 3(c)(4) through 3(c)(10) require 

the annual review of internal models 

and include certain requirements that 

the models must meet. Section 3(d)(4) 

requires an annual report to the board 

of directors on the effectiveness of 

controls supporting market risk 

measurement systems. 

Section 4(b) requires quarterly 

backtesting. Section 5(a)(5) requires 

institutions to demonstrate to the 

agencies the appropriateness of proxies 

used to capture risks within value-atrisk models. Section 5(c) requires 

institutions to retain value-at-risk and 

profit and loss information on 

subportfolios for two years. Section 

6(b)(3) requires policies and procedures 

for stressed value-at-risk models and 

prior approvals on determining periods 

of significant financial stress. 

Section 7(b)(1) specifies what internal 

models for specific risk must include 

and address. Section 8(a) requires prior 

written approval for incremental risk. 

Section 9(a) requires prior approval for 

comprehensive risk models. Section 

9(c)(2) requires retaining and making 

available the results of supervisory 

stress testing on a quarterly basis. 

Section 10(d) requires documentation 

quarterly for analysis of risk 

characteristics of each securitization 

position it holds. Section 11 requires 

quarterly quantitative disclosures, 

annual qualitative disclosures, and a 

formal disclosure policy approved by 

the board of directors that addresses the 

bank’s approach for determining the 

market risk disclosures it makes. 

Estimated Burden 

The burden associated with this 

collection of information may be 

summarized as follows: 

OCC 

Number of Respondents: 15. 

Estimated Burden Per Respondent: 

1,964 hours. 

Total Estimated Annual Burden: 

29,460 hours. 

Board 

Number of Respondents: 26. 

Estimated Burden Per Respondent: 

2,204 hours. 

Total Estimated Annual Burden: 

51,064 hours. 

FDIC 

Number of Respondents: 2. 

Estimated Burden Per Respondent: 

1,964. 

Total Estimated Annual Burden: 

3,928. 


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1Securities subject to repurchase and lending 

agreements are included as if they are still owned 

by the lender. 

2A position that hedges a trading position must 

be within the scope of the bank’s hedging strategy 

as described in paragraph (a)(2) of section (3) of this 

appendix. 

VI. Plain Language 

Section 722 of the GLBA required the 

agencies to use plain language in all 

proposed and final rules published after 

January 1, 2000. The agencies invite 

comment on how to make this proposed 

rule easier to understand. For example: 

• Have the agencies organized the 

material to suit your needs? If not, how 

could they present the rule more 

clearly? 

• Are the requirements in the rule 

clearly stated? If not, how could the rule 

be more clearly stated? 

• Do the regulations contain technical 

language or jargon 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 regulation 

easier to understand? If so, what 

changes would achieve that? 

• Is this section format adequate? If 

not, which of the sections should be 

changed and how? 

• What other changes can the 

agencies incorporate to make the 

regulation easier to understand? 

Text of the Proposed Common Rules 

(All Agencies) 

The text of the proposed common 

rules appears below: 

Appendix __ to Part __—Risk-Based 

Capital Guidelines; Market Risk 

Adjustment 

Section 1 Purpose, Applicability, and 

Reservation of Authority 

Section 2 Definitions 

Section 3 Requirements for Application of 

the Market Risk Capital Rule 

Section 4 Adjustments to the Risk-Based 

Capital Ratio Calculations 

Section 5 VaR-based Measure 

Section 6 Stressed VaR-Based Measure 

Section 7 Specific Risk 

Section 8 Incremental Risk 

Section 9 Comprehensive Risk 

Section 10 Standardized Measurement 

Method for Specific Risk 

Section 11 Market Risk Disclosures 

Section 1. Purpose, Applicability, and 

Reservation of Authority 

(a) Purpose. This appendix establishes riskbased capital requirements for [banking 

organizations] with significant exposure to 

market risk and provides methods for these 

[banking organizations] to calculate their 

risk-based capital requirements for market 

risk. This appendix supplements and adjusts 

the risk-based capital calculations under [the 

general risk-based capital rules] and [the 

advanced capital adequacy framework] and 

establishes public disclosure requirements. 

(b) Applicability—(1) This appendix 

applies to any [banking organization] with 

aggregate trading assets and trading liabilities 

(as reported in the [banking organization]’s 

most recent quarterly [regulatory report]), 

equal to: 

(i) 10 percent or more of quarter-end total 

assets as reported on the most recent 

quarterly [Call Report or FR Y–9C]; or 

(ii) $1 billion or more. 

(2) The [Agency] may apply this appendix 

to any [banking organization] if the [Agency] 

deems it necessary or appropriate because of 

the level of market risk of the [banking 

organization] or to ensure safe and sound 

banking practices. 

(3) The [Agency] may exclude a [banking 

organization] that meets the criteria of 

paragraph (b)(1) of this appendix from 

application of this appendix if the [Agency] 

determines that the exclusion is appropriate 

based on the level of market risk of the 

[banking organization] and is consistent with 

safe and sound banking practices. 

(c) Reservation of authority—(1) The 

[Agency] may require a [banking 

organization] to hold an amount of capital 

greater than otherwise required under this 

appendix if the [Agency] determines that the 

[banking organization]’s capital requirement 

for market risk as calculated under this 

appendix is not commensurate with the 

market risk of the [banking organization]’s 

covered positions. In making determinations 

under this paragraph, the [Agency] will apply 

notice and response procedures generally in 

the same manner as the notice and response 

procedures described in [12 CFR 3.12, 12 

CFR 263.202, 12 CFR 325.6(c), 12 CFR 

567.3(d)]. 

(2) If the [Agency] determines that the riskbased capital requirement calculated under 

this appendix by the [banking organization] 

for one or more covered positions or 

portfolios of covered positions is not 

commensurate with the risks associated with 

those positions or portfolios, the [Agency] 

may require the [banking organization] to 

assign a different risk-based capital 

requirement to the positions or portfolios that 

more accurately reflects the risk of the 

positions or portfolios. 

(3) The [Agency] may also require a 

[banking organization] to calculate risk-based 

capital requirements for specific positions or 

portfolios under this appendix, or under [the 

advanced capital adequacy framework] or 

[the general risk-based capital rules], as 

appropriate, to more accurately reflect the 

risks of the positions. 

(4) Nothing in this appendix 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. 

Section 2. Definitions 

For purposes of this appendix, the 

following definitions apply: 

Backtesting means the comparison of a 

[banking organization]’s internal estimates 

with actual outcomes during a sample period 

not used in model development. For 

purposes of this appendix, backtesting is one 

form of out-of-sample testing. 

Bank holding company is defined in 

section 2(a) of the Bank Holding Company 

Act of 1956 (12 U.S.C. 1841(a)). 

Commodity position means a position for 

which price risk arises from changes in the 

price of a commodity. 

Company means a corporation, 

partnership, limited liability company, 

depository institution, business trust, special 

purpose entity, association, or similar 

organization. 

Correlation trading position means: 

(1) A securitization position for which all 

or substantially all of the value of the 

underlying exposures is based on the credit 

quality of a single company for which a twoway market exists, or on commonly traded 

indices based on such exposures for which 

a two-way market exists on the indices; or 

(2) A position that is not a securitization 

position and that hedges a position described 

in paragraph (1) of this definition; and 

(3) 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. 

Covered position means the following 

positions: 

(1) A trading asset or trading liability 

(whether on- or off-balance sheet),1 as 

reported on Schedule RC–D of the Call 

Report or Schedule HC–D of the FR Y–9C, 

that meets the following conditions: 

(i) The position is a trading position or 

hedges another covered position 2 and 

(ii) The position is free of any restrictive 

covenants on its tradability or the [banking 

organization] is able to hedge the material 

risk elements of the position in a two-way 

market. 

(2) A foreign exchange or commodity 

position, regardless of whether the position 

is a trading asset or trading liability 

(excluding any structural foreign currency 

positions that the [banking organization] 

chooses to exclude with prior supervisory 

approval). 

(3) Notwithstanding paragraphs (1) and (2) 

of this definition, a covered position does not 

include: 

(i) An intangible asset, including any 

servicing asset; 

(ii) Any hedge of a trading position that the 

[Agency] determines to be outside the scope 

of the [banking organization]’s hedging 

strategy required in paragraph (a)(2) of 

section 3 of this appendix; 

(iii) Any position that, in form or 

substance, acts as a liquidity facility that 

provides support to asset-backed commercial 

paper; 

(iv) A credit derivative the [banking 

organization] recognizes as a guarantee for 

risk-weighted asset amount calculation 

purposes under [the advanced capital 

adequacy framework] or [the general riskbased capital rules]; 


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(v) Any equity position that is not publicly 

traded other than a derivative that references 

a publicly traded equity; 

(vi) Any position a [banking organization] 

holds with the intent to securitize; or 

(vii) Any direct real estate holding. 

Credit derivative means a financial contract 

executed under standard industry 

documentation that allows one party (the 

protection purchaser) to transfer the credit 

risk of one or more exposures (reference 

exposure(s)) to another party (the protection 

provider). 

Debt position means a 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. 

Depository institution is defined in section 

3 of the Federal Deposit Insurance Act (12 

U.S.C. 1813). 

Equity position means a 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. 

Event risk means the risk of loss on a 

position that could result from sudden and 

unexpected large changes in market prices or 

specific events other than default and credit 

migration of the issuer. 

Financial firm means a depository 

institution, a bank holding company, a 

savings and loan holding company (as 

defined in section 10(a)(1)(D) of the Home 

Owners’ Loan Act (12 U.S.C. 1467a(a)(1)(D)), 

a securities broker or dealer registered with 

the SEC, or a banking or securities firm that 

the [banking organization] has determined is 

subject to consolidated supervision and 

regulation comparable to that imposed on 

U.S. [banking organizations] or securities 

broker-dealers. 

Foreign exchange position means a 

position for which price risk arises from 

changes in foreign exchange rates. 

General market risk means the risk of loss 

that could result from broad market 

movements, such as changes in the general 

level of interest rates, credit spreads, equity 

prices, foreign exchange rates, or commodity 

prices. 

Hedge means a position or positions that 

offset all, or substantially all, of one or more 

material risk factors of another position. 

Idiosyncratic risk means the risk of loss in 

the value of a position that arises from 

changes in risk factors unique to that 

position. 

Incremental risk means the default risk and 

credit migration risk of a position. Default 

risk means the risk of loss on a position that 

could result from the failure of an obligor to 

make timely payments of principal or interest 

on its debt obligation, and the risk of loss that 

could result from bankruptcy, insolvency, or 

similar proceeding. Credit migration risk 

means the price risk that arises from 

significant changes in the underlying credit 

quality of the position. 

Investing bank means, with respect to a 

securitization, a [banking organization] that 

assumes the credit risk of a securitization 

exposure (other than an originating bank of 

the securitization). 

Market risk means the risk of loss on a 

position that could result from movements in 

market prices. 

Nth-to-default credit derivative means a 

credit derivative that provides credit 

protection only for the nth-defaulting 

reference exposure in a group of reference 

exposures. 

Originating bank, 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 asset-backed commercial 

paper (ABCP) program sponsor to the 

securitization. 

Over-the-counter (OTC) derivative means a 

derivative contract that is not traded on an 

exchange that requires the daily receipt and 

payment of cash-variation margin. 

Publicly traded means traded on: 

(1) Any exchange registered with the SEC 

as a national securities exchange under 

section 6 of the Securities Exchange Act of 

1934 (15 U.S.C. 78f); or 

(2) Any non-U.S.-based securities exchange 

that: 

(i) Is registered with, or approved by, a 

national securities regulatory authority; and 

(ii) Provides a liquid, two-way market for 

the instrument in question. 

Qualifying securities borrowing transaction 

means a cash-collateralized securities 

borrowing transaction that meets the 

following conditions: 

(1) The transaction is based on liquid and 

readily marketable securities; 

(2) The transaction is marked-to-market 

daily; 

(3) The transaction is subject to daily 

margin maintenance requirements; and 

(4)(i) The transaction is a securities 

contract for the purposes of section 555 of the 

Bankruptcy Code (11 U.S.C. 555), a qualified 

financial contract for the purposes of section 

11(e)(8) of the Federal Deposit Insurance Act 

(12 U.S.C. 1821(e)(8)), or a netting contract 

between or among financial institutions for 

the purposes of sections 401–407 of the 

Federal Deposit Insurance Corporation 

Improvement Act of 1991 (12 U.S.C. 4401– 

4407), or the Board’s Regulation EE (12 CFR 

part 231); or 

(ii) If the transaction does not meet the 

criteria in paragraph (4)(i) of this definition, 

either: 

(A) The [banking organization] has 

conducted sufficient legal review to reach a 

well-founded conclusion that: 

(1) The securities borrowing agreement 

executed in connection with the transaction 

provides the [banking organization] the right 

to accelerate, terminate, and close-out on a 

net basis all transactions under the agreement 

and to liquidate or set off collateral promptly 

upon an event of counterparty default, 

including in a bankruptcy, insolvency, or 

other similar proceeding of the counterparty; 

and 

(2) Under applicable law of the relevant 

jurisdiction, its rights under the agreement 

are legal, valid, binding, and enforceable and 

any exercise of rights under the agreement 

will not be stayed or avoided; or 

(B) The transaction is either overnight or 

unconditionally cancelable at any time by the 

[banking organization], and the [banking 

organization] has conducted sufficient legal 

review to reach a well-founded conclusion 

that: 

(1) The securities borrowing agreement 

executed in connection with the transaction 

provides the [banking organization] the right 

to accelerate, terminate, and close-out on a 

net basis all transactions under the agreement 

and to liquidate or set off collateral promptly 

upon an event of counterparty default; and 

(2) Under the law governing the agreement, 

its rights under the agreement are legal, valid, 

binding, and enforceable. 

Resecuritization means a securitization in 

which one or more of the underlying 

exposures is a securitization position. 

Resecuritization position means: 

(1) An on- or off-balance sheet exposure to 

a resecuritization; or 

(2) An exposure that directly or indirectly 

references a resecuritization exposure in 

paragraph (1) of this definition. 

SEC means the U.S. Securities and 

Exchange Commission. 

Securitization means a transaction in 

which: 

(1) All or a portion of the credit risk of one 

or more underlying exposures is transferred 

to one or more third parties; 

(2) The credit risk associated with the 

underlying exposures has been separated into 

at least two tranches that reflect different 

levels of seniority; 

(3) Performance of the securitization 

exposures depends 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) For non-synthetic securitizations, the 

underlying exposures are not owned by an 

operating company; 

(6) The underlying exposures are not 

owned by a small business investment 

company described in section 302 of the 

Small Business Investment Act of 1958 (15 

U.S.C. 682); and 

(7) The underlying exposures are not 

owned by a firm an investment in which 

qualifies as a community development 

investment under 12 U.S.C. 24(Eleventh). 

(8) The [Agency] 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 securitization based on the transaction’s 

leverage, risk profile, or economic substance. 

(9) The [Agency] may deem an exposure to 

a transaction that meets the definition of a 

securitization, notwithstanding paragraph 

(5), (6), or (7) of this definition, to be a 

securitization based on the transaction’s 

leverage, risk profile, or economic substance. 

Securitization position means a covered 

position that is: 

(1) An on-balance sheet or off-balance 

sheet credit exposure (including creditenhancing representations and warranties) 

that arises from a securitization (including a 

resecuritization); or 


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3This requirement is met where all transactions 

under the agreement are (i) executed under U.S. law 

and (ii) constitute ‘‘securities contracts’’ or 

‘‘repurchase agreements’’ under section 555 or 559, 

respectively, of the Bankruptcy Code (11 U.S.C. 555 

or 559), qualified financial contracts under section 

11(e)(8) of the Federal Deposit Insurance Act (12 

U.S.C. 1821(e)(8)), or netting contracts between or 

among financial institutions under sections 401– 

407 of the Federal Deposit Insurance Corporation 

Improvement Act of 1991 (12 U.S.C. 4407), or the 

Federal Reserve Board’s Regulation EE (12 CFR part 

231). 

(2) An exposure that directly or indirectly 

references a securitization exposure 

described in paragraph (1) of this definition. 

Sovereign entity means a central 

government (including the U.S. government) 

or an agency, department, ministry, or central 

bank of a central government. 

Specific risk means the risk of loss on a 

position that could result from factors other 

than broad market movements and includes 

event risk, default risk, and idiosyncratic 

risk. 

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 and tier 2 capital, or 

(4) A position designed to hedge a [banking 

organization]’s capital ratios or earnings 

against the effect on paragraphs (1), (2), or (3) 

of this definition of adverse exchange rate 

movements. 

Term repo-style transaction means a 

repurchase or reverse repurchase transaction, 

or a securities borrowing or securities 

lending transaction, including a transaction 

in which the [banking organization] acts as 

agent for a customer and indemnifies the 

customer against loss, that has an original 

maturity in excess of one business day, 

provided that: 

(1) The transaction is based solely on 

liquid and readily marketable securities or 

cash; 

(2) The transaction is marked-to-market 

daily and subject to daily margin 

maintenance requirements; 

(3) The transaction is executed under an 

agreement that provides the [banking 

organization] the right to accelerate, 

terminate, and close-out the transaction on a 

net basis and to liquidate or set off collateral 

promptly upon an event of default (including 

bankruptcy, insolvency, or similar 

proceeding) of the counterparty, provided 

that, in any such case, any exercise of rights 

under the agreement will not be stayed or 

avoided under applicable law in the relevant 

jurisdictions; 3 and 

(4) The [banking organization] has 

conducted and documented sufficient legal 

review to conclude with a well-founded basis 

that the agreement meets the requirements of 

paragraph (3) of this definition and is legal, 

valid, binding, and enforceable under 

applicable law in the relevant jurisdictions. 

Tier 1 capital is defined in [the general 

risk-based capital rules] or [the advanced 

capital adequacy framework], as applicable. 

Tier 2 capital is defined in [the general 

risk-based capital rules] or [the advanced 

capital adequacy framework], as applicable. 

Trading position means a position that is 

held by the [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 five business days. 

Value-at-Risk (VaR) means the estimate of 

the maximum amount that the value of one 

or more positions could decline due to 

market price or rate movements during a 

fixed holding period within a stated 

confidence interval. 

Section 3. Requirements for Application of 

the Market Risk Capital Rule 

(a) Trading positions—(1) Identification of 

trading positions. A [banking organization] 

must have clearly defined policies and 

procedures for determining which of its 

trading assets and trading liabilities are 

trading positions and which of its trading 

positions are correlation trading positions. 

These policies and procedures must take into 

account: 

(i) The extent to which a position, or a 

hedge of its material risks, can be marked-tomarket daily by reference to a two-way 

market; and 

(ii) Possible impairments to the liquidity of 

a position or its hedge. 

(2) Trading and hedging strategies. A 

[banking organization] must have clearly 

defined trading and hedging strategies for its 

trading 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 trading 

positions. 

(ii) The hedging strategy must articulate for 

each portfolio of trading positions the level 

of market risk the [banking organization] is 

willing to accept and must detail the 

instruments, techniques, and strategies the 

[banking organization] will use to hedge the 

risk of the portfolio. 

(b) Management of covered positions— 

(1) Active management. A [banking 

organization] must have clearly defined 

policies and procedures for actively 

managing all covered positions. At a 

minimum, these policies and procedures 

must require: 

(i) Marking positions to market or to model 

on a daily basis; 

(ii) Daily assessment of the [banking 

organization]’s ability to hedge position and 

portfolio risks, and of the extent of market 

liquidity; 

(iii) Establishment and daily monitoring of 

limits on positions by a risk control unit 

independent of the trading business unit; 

(iv) Daily monitoring by senior 

management of information described in 

paragraphs (b)(1)(i) through (b)(1)(iii) of this 

section; 

(v) At least annual reassessment of 

established limits on positions by senior 

management; and 

(vi) At least annual assessments by 

qualified personnel 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. 

(2) Valuation of covered positions. The 

[banking organization] must have a process 

for prudent valuation of its covered positions 

that includes policies and procedures on the 

valuation of positions, marking positions to 

market or to model, independent price 

verification, and valuation adjustments or 

reserves. The valuation process must 

consider, as appropriate, unearned credit 

spreads, close-out costs, early termination 

costs, investing and funding costs, future 

administrative costs, liquidity, and model 

risk. 

(c) Requirements for internal models. (1) A 

[banking organization] must obtain the prior 

written approval of the [Agency] before using 

any internal model to calculate its risk-based 

capital requirement under this appendix. 

(2) A [banking organization] must meet all 

of the requirements of this section on an 

ongoing basis. The [banking organization] 

must promptly notify the [Agency] when: 

(i) The [banking organization] plans to 

extend the use of a model that the [Agency] 

has approved under this appendix to an 

additional business line or product type; 

(ii) The [banking organization] makes any 

change to any internal model approved by 

the [Agency] under this appendix that would 

result in a material change in the [banking 

organization]’s risk-weighted asset amount 

for a portfolio of covered positions; or 

(iii) The [banking organization] makes any 

material change to its modeling assumptions. 

(3) The [Agency] may rescind its approval 

of the use of any internal model (in whole 

or in part) or of the surcharge applicable to 

a [banking organization]’s modeled 

correlation trading positions as determined 

under section 9(d)(2) of this appendix, and 

determine an appropriate capital requirement 

for the covered positions to which the model 

would apply, if the [Agency] determines that 

the model no longer complies with this 

appendix or fails to reflect accurately the 

risks of the [banking organization]’s covered 

positions. 

(4) The [banking organization] must 

periodically, but no less frequently than 

annually, review its internal models in light 

of developments in financial markets and 

modeling technologies, and enhance those 

models as appropriate to ensure that they 

continue to meet the [Agency]’s standards for 

model approval and employ risk 

measurement methodologies that are most 

appropriate for the [banking organization]’s 

covered positions. 

(5) The [banking organization] must 

incorporate its internal models into its risk 

management process and integrate the 

internal models used for calculating its VaRbased measure into its daily risk management 

process. 


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(6) The level of sophistication of a [banking 

organization]’s internal models must be 

commensurate with the complexity and 

amount of its covered positions. A [banking 

organization]’s internal models may use any 

of the generally accepted approaches, 

including but not limited to variancecovariance models, historical simulations, or 

Monte Carlo simulations, to measure market 

risk. 

(7) The [banking organization]’s internal 

models must properly measure all of the 

material risks in the covered positions to 

which they are applied. 

(8) The [banking organization]’s internal 

models must conservatively assess the risks 

arising from less liquid positions and 

positions with limited price transparency 

under realistic market scenarios. 

(9) The [banking organization] must have a 

rigorous and well-defined process for 

reestimating, reevaluating, and updating its 

internal models to ensure continued 

applicability and relevance. 

(10) If a [banking organization] uses 

internal models to measure specific risk, the 

internal models must also satisfy the 

requirements in paragraph (b)(1) of section 7 

of this appendix. 

(d) Control, oversight, and validation 

mechanisms. (1) The [banking organization] 

must have a risk control unit that reports 

directly to senior management and is 

independent from the business trading units. 

(2) The [banking organization] must 

validate its internal models initially and on 

an ongoing basis. 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 (including developmental 

evidence supporting) the internal models; 

(ii) 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; and 

(iii) An outcomes analysis process that 

includes backtesting. For internal models 

used to calculate the VaR-based measure, this 

process must include a comparison of the 

changes in the [banking organization]’s 

portfolio value that would have occurred 

were end-of-day positions to remain 

unchanged (therefore, excluding fees, 

commissions, reserves, net interest income, 

and intraday trading) with VaR-based 

measures during a sample period not used in 

model development. 

(3) The [banking organization] must stresstest the market risk of its covered positions 

at a frequency appropriate to each portfolio, 

and 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 its internal models. 

(4) The [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, compliance with policies and 

procedures, and calculation of the [banking 

organization]’s measure for market risk under 

this appendix. At least annually, the internal 

audit function must report its findings to the 

[banking organization]’s board of directors (or 

a committee thereof). 

(e) Internal assessment of capital 

adequacy. The [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 

in the VaR-based measure, including 

concentration and liquidity risk under 

stressed market conditions. 

(f) Documentation. The [banking 

organization] must adequately document all 

material aspects of its internal models, 

management and valuation of covered 

positions, control, oversight, validation and 

review processes and results, and internal 

assessment of capital adequacy. 

Section 4. Adjustments to the Risk-Based 

Capital Ratio Calculations 

(a) Risk-based capital ratio denominator. 

The [banking organization] must calculate its 

risk-based capital ratio denominator as 

follows: 

(1) Adjusted risk-weighted assets. The 

[banking organization] must calculate 

adjusted risk-weighted assets, which equal 

risk-weighted assets (as determined in 

accordance with [the advanced capital 

adequacy framework] or [the general riskbased capital rules], as applicable), with the 

following adjustments: 

(i) The [banking organization] must 

exclude the risk-weighted asset amounts of 

all covered positions (except foreign 

exchange positions that are not trading 

positions and over-the-counter derivative 

positions). 

(ii) A [banking organization] subject to [the 

general risk-based capital rules] may exclude 

receivables that arise from the posting of cash 

collateral and are associated with qualifying 

securities borrowing transactions to the 

extent the receivable is collateralized by the 

market value of the borrowed securities; 

(2) Measure for market risk. The [banking 

organization] must calculate the measure for 

market risk, which equals the sum of the 

VaR-based capital requirement, stressed VaRbased capital requirement, any specific risk 

add-ons, any incremental risk capital 

requirement, any comprehensive risk capital 

requirement, and any capital requirement for 

de minimis exposures as defined under this 

paragraph. 

(i) VaR-based capital requirement. The 

VaR-based capital requirement equals the 

greater of: 

(A) The previous day’s VaR-based measure 

as calculated under section 5 of this 

appendix; or 

(B) The average of the daily VaR-based 

measures as calculated under section 5 of 

this appendix for each of the preceding 60 

business days multiplied by three, except as 

provided in paragraph (b) of this section. 

(ii) Stressed VaR-based capital 

requirement. The stressed VaR-based capital 

requirement equals the greater of: 

(A) The most recent stressed VaR-based 

measure as calculated under section 6 of this 

appendix; or 

(B) The average of the stressed VaR-based 

measures as calculated under section 6 of 

this rule for each of the preceding 60 

business days multiplied by three, except as 

provided in paragraph (b) of this section. 

(iii) Any specific risk add-ons. Any specific 

risk add-ons that are required under section 

7 and are calculated in accordance with 

section 10 of this appendix. 

(iv) Any incremental risk capital 

requirement. Any incremental risk capital 

requirement as calculated under section 8 of 

this appendix. 

(v) Any comprehensive risk capital 

requirement. Any comprehensive risk capital 

requirement as calculated under section 9 of 

this appendix. 

(vi) Any capital requirement for de 

minimis exposures. The [banking 

organization] must add to its measure for 

market risk the absolute value of the market 

value of those de minimis exposures that are 

not captured in the [banking organization]’s 

VaR-based measure unless the [banking 

organization] has obtained prior written 

approval from the [Agency] to calculate a 

capital requirement for de minimis exposures 

using alternative techniques that 

appropriately measure the market risk 

associated with those exposures. 

(3) Market risk equivalent assets. The 

[banking organization] must calculate market 

risk equivalent assets as the measure for 

market risk (as calculated in paragraph (a)(2) 

of this section) multiplied by 12.5. 

(4) Denominator calculation. The [banking 

organization] must add market risk 

equivalent assets (as calculated in paragraph 

(a)(3) of this section) to adjusted riskweighted assets (as calculated in paragraph 

(a)(1) of this section). The resulting sum is 

the [banking organization]’s risk-based 

capital ratio denominator. 

(b) Backtesting. A [banking organization] 

must compare each of its most recent 250 

business days’ trading losses (excluding fees, 

commissions, reserves, intra-day trading, and 

net interest income) with the corresponding 

daily VaR-based measures calibrated to a 

one-day holding period and at a one-tail, 99.0 

percent confidence level. 

(1) Once each quarter, the [banking 

organization] must identify the number of 

exceptions (that is, the number of business 

days for which the actual daily net trading 

loss, if any, exceeds the corresponding daily 

VaR-based measure) that have occurred over 

the preceding 250 business days. 

(2) A [banking organization] must use the 

multiplication factor in Table 1 of this 

appendix that corresponds to the number of 

exceptions identified in paragraph (b)(1) of 

this section to determine its VaR-based 

capital requirement for market risk under 

paragraph (a)(2)(i) of this section and to 

determine its stressed VaR-based capital 

requirement for market risk under paragraph 


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(a)(2)(ii) of this section until it obtains the 

next quarter’s backtesting results, unless the 

[Agency] notifies the [banking organization] 

in writing that a different adjustment or other 

action is appropriate. 

TABLE 1—MULTIPLICATION FACTORS

BASED ON RESULTS OF BACKTESTING

Number of exceptions Multiplication factor 

4 or fewer ................................. 3.00 

5 ................................................ 3.40 

6 ................................................ 3.50 

7 ................................................ 3.65 

8 ................................................ 3.75 

9 ................................................ 3.85 

10 or more ................................ 4.00 

Section 5. VaR-Based Measure 

(a) General requirement. A [banking 

organization] must use one or more internal 

models to calculate daily a VaR-based 

measure of the general market risk of all 

covered positions. The daily VaR-based 

measure also may reflect the [banking 

organization]’s specific risk for one or more 

portfolios of debt and equity positions, if the 

internal models meet the requirements of 

paragraph (b)(1) of section 7. The daily VaRbased measure must also reflect the [banking 

organization]’s specific risk for any portfolio 

of correlation trading positions that is 

modeled under section 9 of this appendix. A 

[banking organization] may elect to include 

term repo-style transactions in its VaR-based 

measure, provided that the [banking 

organization] includes all such term repostyle transactions consistently over time. 

(1) The [banking organization]’s internal 

models for calculating its VaR-based measure 

must use risk factors sufficient to measure 

the market risk inherent in all covered 

positions. The market risk categories must 

include, as appropriate, interest rate risk, 

credit spread risk, equity price risk, foreign 

exchange risk, and commodity price risk. For 

material positions in the major currencies 

and markets, modeling techniques must 

incorporate enough segments of the yield 

curve—in no case less than six—to capture 

differences in volatility and less than perfect 

correlation of rates along the yield curve. 

(2) The VaR-based measure may 

incorporate empirical correlations within and 

across risk categories, provided the [banking 

organization] validates and demonstrates the 

reasonableness of its process for measuring 

correlations. If the VaR-based measure does 

not incorporate empirical correlations across 

risk categories, the [banking organization] 

must add the separate measures from its 

internal models used to calculate the VaRbased measure for the appropriate market 

risk categories (interest rate risk, credit 

spread risk, equity price risk, foreign 

exchange rate risk, and/or commodity price 

risk) to determine its aggregate VaR-based 

measure. 

(3) The VaR-based measure must include 

the risks arising from the nonlinear price 

characteristics of options positions or 

positions with embedded optionality and the 

sensitivity of the market value of the 

positions to changes in the volatility of the 

underlying rates, prices, or other material 

risk factors. A [banking organization] with a 

large or complex options portfolio must 

measure the volatility of options positions or 

positions with embedded optionality by 

different maturities and/or strike prices, 

where material. 

(4) The [banking organization] must be able 

to justify to the satisfaction of the [Agency] 

the omission of any risk factors from the 

calculation of its VaR-based measure that the 

[banking organization] uses in its pricing 

models. 

(5) The [banking organization] must 

demonstrate to the satisfaction of the 

[Agency] the appropriateness of any proxies 

used to capture the risks of the [banking 

organization]’s actual positions for which 

such proxies are used. 

(b) Quantitative requirements for VaRbased measure. (1) The VaR-based measure 

must be calculated on a daily basis using a 

one-tail, 99.0 percent confidence level, and a 

holding period equivalent to a 10-businessday movement in underlying risk factors, 

such as rates, spreads, and prices. To 

calculate VaR-based measures using a 10- 

business-day holding period, the [banking 

organization] may calculate 10-business-day 

measures directly or may convert VaR-based 

measures using holding periods other than 10 

business days to the equivalent of a 10- 

business-day holding period. A [banking 

organization] that converts its VaR-based 

measure in such a manner must be able to 

justify the reasonableness of its approach to 

the satisfaction of the [Agency]. 

(2) The VaR-based measure must be based 

on a historical observation period of at least 

one year. Data used to determine the VaRbased measure must be relevant to the 

[banking organization]’s actual exposures and 

of sufficient quality to support the 

calculation of risk-based capital 

requirements. The [banking organization] 

must update data sets at least monthly or 

more frequently as changes in market 

conditions or portfolio composition warrant. 

For a [banking organization] that uses a 

weighting scheme or other method for the 

historical observation period, the [banking 

organization] must either: 

(i) Use an effective observation period of at 

least one year in which the average time lag 

of the observations is at least six months; or 

(ii) Demonstrate to the [Agency] that its 

weighting scheme is more effective than a 

weighting scheme with an average time lag 

of at least six months at representing the 

volatility of the [banking organization]’s 

trading portfolio over a full business cycle. A 

[banking organization] using this option must 

update its data more frequently than monthly 

and in a manner appropriate for the type of 

weighting scheme. 

(c) A [banking organization] must divide its 

portfolio into a number of significant 

subportfolios approved by the [Agency] for 

subportfolio backtesting purposes. These 

subportfolios must be sufficient to allow the 

[banking organization] and the [Agency] to 

assess the adequacy of the VaR model at the 

risk factor level; the [Agency] will evaluate 

the appropriateness of these subportfolios 

relative to the value and composition of the 

[banking organization]’s covered positions. 

The [banking organization] must retain and 

make available to the [Agency] the following 

information for each subportfolio for each 

business day over the previous two years 

(500 business days), with no more than a 60 

day lag: 

(1) A daily VaR-based measure for the 

subportfolio calibrated to a one-tail, 99.0 

percent confidence level; 

(2) The daily profit or loss for the 

subportfolio (that is, the net change in price 

of the positions held in the portfolio at the 

end of the previous business day); and 

(3) The p-value 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 (c)(2) of this section based on the 

model used to calculate the VaR-based 

measure described in paragraph (c)(1) of this 

section). 

Section 6. Stressed VaR-Based Measure 

(a) General requirement. At least weekly, a 

[banking organization] must use the same 

internal model(s) used to calculate its VaRbased measure to calculate a stressed VaRbased measure. 

(b) Quantitative requirements for stressed 

VaR-based measure. (1) A [banking 

organization] must calculate a stressed VaRbased measure for its covered positions using 

the same model(s) used to calculate the VaRbased measure, subject to the same 

confidence level and holding period 

applicable to the VaR-based measure under 

section 5, but with model inputs calibrated 

to historical data from a continuous 12- 

month period that reflects a period of 

significant financial stress appropriate to the 

[banking organization]’s current portfolio. 

(2) The stressed VaR-based measure must 

be calculated at least weekly and be no less 

than the [banking organization]’s VaR-based 

measure. 

(3) A [banking organization] must have 

policies and procedures that describe how it 

determines the period of significant financial 

stress used to calculate the [banking 

organization]’s stressed VaR-based measure 

under this section and must be able to 

provide empirical support for the period 

used. The [banking organization] must obtain 

the prior approval of the [Agency] for, and 

notify the [Agency] if the [banking 

organization] makes any material changes to, 

these policies and procedures. The policies 

and procedures must address: 

(i) How the [banking organization] links 

the period of significant financial stress used 

to calculate the stressed VaR-based measure 

to the composition and directional bias of its 

current portfolio; and 

(ii) The [banking organization]’s process for 

selecting, reviewing, and updating the period 

of significant financial stress used to 

calculate the stressed VaR-based measure and 

for monitoring the appropriateness of the 

period to the [banking organization]’s current 

portfolio. 

(4) Nothing in this section prevents the 

[Agency] from requiring a [banking 

organization] to use a different period of 

significant financial stress in the calculation 

of the stressed VaR-based measure. 


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Section 7. Specific Risk 

(a) General requirement. A [banking 

organization] must use one of the methods in 

this section to measure the specific risk for 

each of its debt, equity, and securitization 

positions with specific risk. 

(b) Modeled specific risk. A [banking 

organization] may use models to measure the 

specific risk of covered positions as provided 

in paragraph (a) of section 5 (therefore, 

excluding securitization positions that are 

not modeled under section 9 of this 

appendix). A [banking organization] must use 

models to measure the specific risk of 

correlation trading positions that are 

modeled under section 9 of this appendix. 

(1) Requirements for specific risk modeling. 

(i) If a [banking organization] uses internal 

models to measure the specific risk of a 

portfolio, the internal models must: 

(A) Explain the historical price variation in 

the portfolio; 

(B) Be responsive to changes in market 

conditions; 

(C) Be robust to an adverse environment, 

including signaling rising risk in an adverse 

environment; and 

(D) Capture all material components of 

specific risk for the debt and equity positions 

in the portfolio. Specifically, the internal 

models must: 

(1) Capture event risk and idiosyncratic 

risk; 

(2) Capture and demonstrate sensitivity to 

material differences between positions that 

are similar but not identical; and 

(3) Capture and demonstrate sensitivity to 

changes in portfolio composition and 

concentrations. 

(ii) If a [banking organization] calculates an 

incremental risk measure for a portfolio of 

debt or equity positions under section 8 of 

this appendix, the [banking organization] is 

not required to capture default and credit 

migration risks in its internal models used to 

measure the specific risk of those portfolios. 

(2) Specific risk fully modeled for one or 

more portfolios. If the [banking 

organization]’s VaR-based measure captures 

all material aspects of specific risk for one or 

more of its portfolios of debt, equity, or 

correlation trading positions, the [banking 

organization] has no specific risk add-on for 

those portfolios for purposes of paragraph 

(a)(2)(iii) of section 4 of this appendix. 

(c) Specific risk not modeled. (1) If the 

[banking organization]’s VaR-based measure 

does not capture all material aspects of 

specific risk for a portfolio of debt, equity, or 

correlation trading positions, the [banking 

organization] must calculate a specific-risk 

add-on for the portfolio under the 

standardized measurement method as 

described in section 10 of this appendix. 

(2) A [banking organization] must calculate 

a specific risk add-on under the standardized 

measurement method as described in section 

10 of this appendixfor all of its securitization 

positions that are not modeled under section 

9 of this appendix. 

Section 8. Incremental Risk 

(a) General requirement. A [banking 

organization] that measures the specific risk 

of a portfolio of debt positions under section 

7(b) using internal models must calculate at 

least weekly an incremental risk measure for 

that portfolio according to the requirements 

in this section. The incremental risk measure 

is the [banking organization]’s measure of 

potential losses due to incremental risk over 

a one-year time horizon at a one-tail, 99.9 

percent confidence level, either under the 

assumption of a constant level of risk, or 

under the assumption of constant positions. 

With the prior approval of the [Agency], a 

[banking organization] may choose to include 

portfolios of equity positions in its 

incremental risk model, provided that it 

consistently includes such equity positions 

in a manner that is consistent with how the 

[banking organization] internally measures 

and manages the incremental risk of such 

positions at the portfolio level. If equity 

positions are included in the model, for 

modeling purposes default is considered to 

have occurred upon the default of any debt 

of the issuer of the equity position. A 

[banking organization] may not include 

correlation trading positions or securitization 

positions in its incremental risk measure. 

(b) Requirements for incremental risk 

modeling. For purposes of calculating the 

incremental risk measure, the incremental 

risk model must: 

(1) Measure incremental risk over a oneyear time horizon and at a one-tail, 99.9 

percent confidence level, either under the 

assumption of a constant level of risk, or 

under the assumption of constant positions. 

(i) A constant level of risk assumption 

means that the [banking organization] 

rebalances, or rolls over, its trading positions 

at the beginning of each liquidity horizon 

over the one-year horizon in a manner that 

maintains the [banking organization]’s initial 

risk level. The [banking organization] must 

determine the frequency of rebalancing in a 

manner consistent with the liquidity 

horizons of the positions in the portfolio. The 

liquidity horizon of a position or set of 

positions is the time required for a [banking 

organization] to reduce its exposure to, or 

hedge all of its material risks of, the 

position(s) in a stressed market. The liquidity 

horizon for a position or set of positions may 

not be less than the lower of three months 

or the contractual maturity of the position. 

(ii) A constant position assumption means 

that the [banking organization] maintains the 

same set of positions throughout the one-year 

horizon. If a [banking organization] uses this 

assumption, it must do so consistently across 

all portfolios. 

(iii) A [banking organization]’s selection of 

a constant position or a constant risk 

assumption must be consistent between the 

[banking organization]’s incremental risk 

model and its comprehensive risk model 

described in section 9, if applicable. 

(iv) A [banking organization]’s treatment of 

liquidity horizons must be consistent 

between the [banking organization]’s 

incremental risk model and its 

comprehensive risk model described in 

section 9, if applicable. 

(2) Recognize the impact of correlations 

between default and migration events among 

obligors. 

(3) Reflect the effect of issuer and market 

concentrations, as well as concentrations that 

can arise within and across product classes 

during stressed conditions. 

(4) Reflect netting only of long and short 

positions that reference the same financial 

instrument. 

(5) Reflect any material mismatch between 

a position and its hedge. 

(6) Recognize the effect that liquidity 

horizons have on dynamic hedging strategies. 

In such cases, a [banking organization] must: 

(i) Choose to model the rebalancing of the 

hedge consistently over the relevant set of 

trading positions; 

(ii) Demonstrate that the inclusion of 

rebalancing results in a more appropriate risk 

measurement; 

(iii) Demonstrate that the market for the 

hedge is sufficiently liquid to permit 

rebalancing during periods of stress; and 

(iv) Capture in the incremental risk model 

any residual risks arising from such hedging 

strategies. 

(7) Reflect the nonlinear impact of options 

and other positions with material nonlinear 

behavior with respect to default and 

migration changes. 

(8) Maintain consistency with the [banking 

organization]’s internal risk management 

methodologies for identifying, measuring, 

and managing risk. 

(c) Calculation of incremental risk capital 

requirement. The incremental risk capital 

requirement is the greater of: 

(1) The average of the incremental risk 

measures over the previous 12 weeks; or 

(2) The most recent incremental risk 

measure. 

Section 9. Comprehensive Risk 

(a) General requirement. (1) Subject to the 

prior approval of the [Agency], a [banking 

organization] may use the method in this 

section to measure comprehensive risk, that 

is, all price risk, for one or more portfolios 

of correlation trading positions. 

(2) A [banking organization] that measures 

the price risk of a portfolio of correlation 

trading positions using internal models must 

calculate at least weekly a comprehensive 

risk measure that captures all price risk 

according to the requirements of this section. 

The comprehensive risk measure is either: 

(i) The sum of: 

(A) The [banking organization]’s modeled 

measure of all price risk determined 

according to the requirements in paragraph 

(b) of this section; and 

(B) A surcharge for the [banking 

organization]’s modeled correlation trading 

positions equal to the total specific risk addon for such positions as calculated under 

section 10 of this appendix multiplied by 

15.0 percent; or 

(ii) With approval of the [Agency] and 

provided the [banking organization] has met 

the requirements of this section for a period 

of at least one year and can demonstrate the 

effectiveness of the model through the results 

of ongoing model validation efforts including 

robust benchmarking, the greater of: 

(A) The [banking organization]’s modeled 

measure of all price risk determined 

according to the requirements in paragraph 

(b) of this section; or 

(B) The total specific risk add-on that 

would apply to the bank’s modeled 

correlation trading positions as calculated 

under section 10 of this appendix multiplied 

by 8.0 percent. 


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(b) Requirements for modeling all price 

risk. If a [banking organization] uses an 

internal model to measure the price risk of 

a portfolio of correlation trading positions: 

(1) The internal model must measure 

comprehensive risk over a one-year time 

horizon at a one-tail, 99.9 percent confidence 

level, either under the assumption of a 

constant level of risk, or under the 

assumption of constant positions. 

(2) The model must capture all material 

price risk, including but not limited to the 

following: 

(i) The risks associated with the 

contractual structure of cash flows of the 

position, its issuer, and its underlying 

exposures; 

(ii) Credit spread risk, including nonlinear 

price risks; 

(iii) The volatility of implied correlations, 

including nonlinear price risks such as the 

cross-effect between spreads and 

correlations; 

(iv) Basis risk; 

(v) Recovery rate volatility as it relates to 

the propensity for recovery rates to affect 

tranche prices; and 

(vi) To the extent the comprehensive risk 

measure incorporates the benefits of dynamic 

hedging, the static nature of the hedge over 

the liquidity horizon must be recognized. In 

such cases, a [banking organization] must: 

(A) Choose to model the rebalancing of the 

hedge consistently over the relevant set of 

trading positions; 

(B) Demonstrate that the inclusion of 

rebalancing results in a more appropriate risk 

measurement; 

(C) Demonstrate that the market for the 

hedge is sufficiently liquid to permit 

rebalancing during periods of stress; and 

(D) Capture in the comprehensive risk 

model any residual risks arising from such 

hedging strategies; 

(3) The [banking organization] must use 

market data that are relevant in representing 

the risk profile of the [banking organization]’s 

correlation trading positions in order to 

ensure that the [banking organization] fully 

captures the material risks of the correlation 

trading positions in its comprehensive risk 

measure in accordance with this section; and 

(4) The [banking organization] must be able 

to demonstrate that its model is an 

appropriate representation of comprehensive 

risk in light of the historical price variation 

of its correlation trading positions. 

(c) Requirements for stress testing. 

(1) A [banking organization] must at least 

weekly apply specific, supervisory stress 

scenarios to its portfolio of correlation 

trading positions that capture changes in: 

(i) Default rates; 

(ii) Recovery rates; 

(iii) Credit spreads; 

(iv) Correlations of underlying exposures; 

and 

(v) Correlations of a correlation trading 

position and its hedge. 

(2) Other requirements. (i) A [banking 

organization] must retain and make available 

to the [Agency] the results of the supervisory 

stress testing, including comparisons with 

the capital requirements generated by the 

[banking organization]’s comprehensive risk 

model. 

(ii) A [banking organization] must report to 

the [Agency] promptly any instances where 

the stress tests indicate any material 

deficiencies in the comprehensive risk 

model. 

(d) Calculation of comprehensive risk 

capital requirement. The comprehensive risk 

capital requirement is the greater of: 

(1) The average of the comprehensive risk 

measures over the previous 12 weeks; or 

(2) The most recent comprehensive risk 

measure. 

Section 10. Standardized Measurement 

Method for Specific Risk 

(a) General requirement. A [banking 

organization] must calculate a total specific 

risk add-on for each portfolio of debt and 

equity positions for which the [banking 

organization]’s VaR-based measure does not 

capture all material aspects of specific risk 

and for all securitization positions that are 

not modeled under section 9 of this 

appendix. A [banking organization] must 

calculate each specific risk add-on in 

accordance with the requirements of this 

section. 

(1) The specific risk add-on for an 

individual debt or securitization position that 

represents purchased credit protection is 

capped at the market value of the protection. 

(2) For debt, equity, or securitization 

positions that are derivatives with linear 

payoffs, a [banking organization] must risk 

weight the market value of the effective 

notional amount of the underlying 

instrument or index portfolio. A swap must 

be included as an effective notional position 

in the underlying instrument or portfolio, 

with the receiving side treated as a long 

position and the paying side treated as a 

short position. For debt, equity, or 

securitization positions that are derivatives 

with nonlinear payoffs, a [banking 

organization] must risk weight the market 

value of the effective notional amount of the 

underlying instrument or portfolio 

multiplied by the derivative’s delta. 

(3) For debt, equity, or securitization 

positions, a [banking organization] may net 

long and short positions (including 

derivatives) in identical issues or identical 

indices. A [banking organization] may also 

net positions in depositary receipts against 

an opposite position in an identical equity in 

different markets, provided that the [banking 

organization] includes the costs of 

conversion. 

(4) A set of transactions consisting of either 

a debt position and its credit derivative 

hedge or a securitization position and its 

credit derivative hedge has a specific risk 

add-on of zero if the debt or securitization 

position is fully hedged by a total return 

swap (or similar instrument where there is a 

matching of payments and changes in market 

value of the position) and there is an exact 

match between the reference obligation of the 

swap and the debt or securitization position, 

the maturity of the swap and the debt or 

securitization position, and the currency of 

the swap and the debt or securitization 

position. 

(5) The specific risk add-on for a set of 

transactions consisting of either a debt 

position and its credit derivative hedge or a 

securitization position and its credit 

derivative hedge that does not meet the 

criteria of paragraph (a)(4) of this section is 

equal to 20.0 percent of the capital 

requirement for the side of the transaction 

with the higher capital requirement when the 

credit risk of the position is fully hedged by 

a credit default swap or similar instrument 

and there is an exact match between the 

reference obligation of the credit derivative 

hedge and the debt or securitization position, 

the maturity of the credit derivative hedge 

and the debt or securitization position, and 

the currency of the credit derivative hedge 

and the debt or securitization position. 

(6) The specific risk add-on for a set of 

transactions consisting of either a debt 

position and its credit derivative hedge or a 

securitization position and its credit 

derivative hedge that does not meet the 

criteria of either paragraph (a)(4) or (a)(5) of 

this section, but in which all or substantially 

all of the price risk has been hedged, is equal 

to the specific risk add-on for the side of the 

transaction with the higher specific risk addon. 

(b) Debt and securitization positions. (1) 

Unless otherwise provided in paragraph 

(b)(2) of this section, the total specific risk 

add-on for a portfolio of debt or 

securitization positions is the sum of the 

specific risk add-ons for individual debt or 

securitization positions, as computed under 

this section. To determine the specific risk 

add-on for individual debt or securitization 

positions, a [banking organization] must 

multiply the absolute value of the current 

market value of each net long or net short 

debt or securitization position in the 

portfolio by the appropriate risk-weighting 

factor in Table 2. The following definitions 

apply to this paragraph, including Table 2: 

TABLE 2—SPECIFIC RISK WEIGHTING FACTORS FOR DEBT AND SECURITIZATION POSITIONS

Category Remaining maturity 

(contractual) 

Risk-weighting 

factor 

(in percent) 

Government .............................................. N/A ............................................................................................................................... 0.00 

Qualifying .................................................. 6 months or less .......................................................................................................... 0.25 

Over 6 months to 24 months ....................................................................................... 1.00 

Over 24 months ........................................................................................................... 1.60 


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4Organization for Economic Cooperation and 

Development (OECD)-based countries is defined in 

[the general risk-based capital rules]. 

5U.S. government-sponsored agencies, 

multilateral development banks, and OECD banks 

are defined in [the general risk-based capital rules]. 

6A portfolio is well-diversified if it contains a 

large number of individual equity positions, with 

no single position representing a substantial portion 

of the portfolio’s total market value. 

TABLE 2—SPECIFIC RISK WEIGHTING FACTORS FOR DEBT AND SECURITIZATION POSITIONS—Continued 

Category Remaining maturity 

(contractual) 

Risk-weighting 

factor 

(in percent) 

Other ......................................................... N/A ............................................................................................................................... 8.00 

(i) The government category includes all 

debt instruments of central governments of 

OECD-based countries 4 including bonds, 

Treasury bills, and other short-term 

instruments, as well as local currency 

instruments of non-OECD central 

governments to the extent the bank has 

liabilities booked in that currency. 

(ii) The qualifying category includes debt 

instruments of U.S. government-sponsored 

agencies, general obligation debt instruments 

issued by states and other political 

subdivisions of OECD-based countries, 

multilateral development banks, and debt 

instruments issued by U.S. depository 

institutions or OECD-banks that do not 

qualify as capital of the issuing institution.5

This category also includes other debt 

instruments, including corporate debt and 

revenue instruments issued by states and 

other political subdivisions of OECD 

countries, that are: 

(A) Rated investment-grade by at least two 

nationally recognized credit rating services; 

(B) Rated investment-grade by one 

nationally recognized credit rating agency 

and not rated less than investment-grade by 

any other credit rating agency; or 

(C) Unrated, but deemed to be of 

comparable investment quality by the 

reporting bank and the issuer has 

instruments listed on a recognized stock 

exchange, subject to review by the [Agency]. 

(iii) The other category includes debt 

instruments that are not included in the 

government or qualifying categories. 

(2) Nth-to-default credit derivatives. The 

total specific risk add-on for a portfolio of nthto-default credit derivatives is the sum of the 

specific risk add-ons for individual nth-todefault credit derivatives, as computed under 

this paragraph. The specific risk add-on for 

each nth-to-default credit derivative position 

applies irrespective of whether a [banking 

organization] is a net protection buyer or net 

protection seller. A [banking organization] 

must calculate the specific risk add-on for 

each nth-to-default credit derivative as 

follows: 

(i) First-to-default credit derivatives. 

(A) The specific risk add-on for a first-todefault credit derivative is the lesser of: 

(1) The sum of the specific risk add-ons for 

the individual reference credit exposures in 

the group of reference exposures; or 

(2) The maximum possible credit event 

payment under the credit derivative contract. 

(B) Where a [banking organization] has a 

risk position in one of the reference credit 

exposures underlying a first-to-default credit 

derivative and this credit derivative hedges 

the [banking organization]’s risk position, the 

[banking organization] is allowed to reduce 

both the specific risk add-on for the reference 

credit exposure and that part of the specific 

risk add-on for the credit derivative that 

relates to this particular reference credit 

exposure such that its specific risk add-on for 

the pair reflects the bank’s net position in the 

reference credit exposure. Where a [banking 

organization] has multiple risk positions in 

reference credit exposures underlying a firstto-default credit derivative, this offset is 

allowed only for the underlying reference 

credit exposure having the lowest specific 

risk add-on. 

(ii) Second-or-subsequent-to-default credit 

derivatives. 

(A) The specific risk add-on for a secondor-subsequent-to-default credit derivative is 

the lesser of: 

(1) The sum of the specific risk add-ons for 

the individual reference credit exposures in 

the group of reference exposures, but 

disregarding the (n–1) obligations with the 

lowest specific risk add-ons; or 

(2) The maximum possible credit event 

payment under the credit derivative contract. 

(B) For second-or-subsequent-to-default 

credit derivatives, no offset of the specific 

risk add-on with an underlying reference 

credit exposure is allowed. 

(c) Equity positions. The total specific risk 

add-on for a portfolio of equity positions is 

the sum of the specific risk add-ons of the 

individual equity positions, as computed 

under this section. To determine the specific 

risk add-on of individual equity positions, a 

[banking organization] must multiply the 

absolute value of the current market value of 

each net long or net short equity position by 

the appropriate risk-weighting factor as 

determined under this paragraph. 

(1) The [banking organization] must 

multiply the absolute value of the current 

market value of each net long or net short 

equity position by a risk-weighting factor of 

8.0 percent. For equity positions that are 

index contracts comprising a well-diversified 

portfolio of equity instruments, the absolute 

value of the current market value of each net 

long or net short position is multiplied by a 

risk-weighting factor of 2.0 percent.6

(2) For equity positions arising from the 

following futures-related arbitrage strategies, 

a [banking organization] may apply a 2.0 

percent risk-weighting factor to one side 

(long or short) of each position with the 

opposite side exempt from an additional 

capital requirement: 

(i) Long and short positions in exactly the 

same index at different dates or in different 

market centers; or 

(ii) Long and short positions in index 

contracts at the same date in different, but 

similar indices. 

(3) For futures contracts on main indices 

that are matched by offsetting positions in a 

basket of stocks comprising the index, a 

[banking organization] may apply a 2.0 

percent risk-weighting factor to the futures 

and stock basket positions (long and short), 

provided that such trades are deliberately 

entered into and separately controlled, and 

that the basket of stocks is comprised of 

stocks representing at least 90.0 percent of 

the capitalization of the index. A main index 

refers to the Standard & Poor’s 500 Index, the 

FTSE All-World Index, and any other index 

for which the [banking organization] can 

demonstrate to the satisfaction of the 

[AGENCY] that the equities represented in 

the index have liquidity, depth of market, 

and size of bid-ask spreads comparable to 

equities in the Standard & Poor’s 500 Index 

and FTSE All-World Index. 

(d)(1) A [banking organization] must be 

able to demonstrate to the satisfaction of the 

[Agency] a comprehensive understanding of 

the features of a securitization position that 

would materially affect the performance of 

the position. The [banking organization]’s 

analysis must be commensurate with the 

complexity of the securitization position and 

the materiality of the position in relation to 

capital. 

(2) To support the demonstration of its 

comprehensive understanding, for each 

securitization position a [banking 

organization] must: 

(i) Conduct and document an analysis of 

the risk characteristics of a securitization 

position prior to acquiring the position, 

considering: 

(A) Structural features of the securitization 

that would materially impact the 

performance of the position, for example, the 

contractual cash flow waterfall, waterfallrelated triggers, credit enhancements, 

liquidity enhancements, market value 

triggers, the performance of organizations 

that service the position, and deal-specific 

definitions of default; 

(B) Relevant information regarding the 

performance of the underlying credit 

exposure(s), for example, the percentage of 

loans 30, 60, and 90 days past due; default 

rates; prepayment rates; loans in foreclosure; 

property types; occupancy; average credit 

score or other measures of creditworthiness; 

average LTV ratio; and industry and 

geographic diversification data on the 

underlying exposure(s); 

(C) Relevant market data of the 

securitization, for example, bid-ask spreads, 

most recent sales price and historical price 

volatility, trading volume, implied market 


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rating, and size, depth and concentration 

level of the market for the securitization; and 

(D) For resecuritization positions, 

performance information on the underlying 

securitization exposures, for example, the 

issuer name and credit quality, and the 

characteristics and performance of the 

exposures underlying the securitization 

exposures; and 

(ii) On an on-going basis (no less frequently 

than quarterly), evaluate, review, and update 

as appropriate the analysis required under 

paragraph (d)(1) of this section for each 

securitization position. 

Section 11. Market Risk Disclosures 

(a) Scope. A [banking organization] must 

comply with this section unless it is a 

consolidated subsidiary of a bank holding 

company 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. Quantitative 

disclosures must be made publicly 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 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. If a [banking 

organization] believes that disclosure of 

specific commercial or financial information 

would prejudice seriously its position by 

making public certain information that is 

either proprietary or confidential in nature, 

the [banking organization] need not disclose 

these specific items, but 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. 

(b) Disclosure policy. The [banking 

organization] must have a formal disclosure 

policy approved by the board of directors 

that addresses the [banking organization]’s 

approach for determining the market risk 

disclosures it makes. The policy must 

address the associated internal controls and 

disclosure controls and procedures. The 

board of directors and senior management 

must ensure that appropriate verification of 

the disclosures takes place and that effective 

internal controls and disclosure controls and 

procedures are maintained. One or more 

senior officers of the [banking organization] 

must attest that the disclosures meet the 

requirements of this appendix, and 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 section. 

(c) Quantitative disclosures. 

(1) For each portfolio of covered positions, 

the [banking organization] must publicly 

disclose the following information at least 

quarterly: 

(i) The high, low, median, and mean VaRbased measures over the reporting period and 

the VaR-based measure at period-end; 

(ii) The high, low, median, and mean 

stressed VaR-based measures over the 

reporting period and the stressed VaR-based 

measure at period-end; 

(iii) The high, low, median, and mean 

incremental risk capital requirements over 

the reporting period and the incremental risk 

capital requirement at period-end; 

(iv) The high, low, median, and mean 

comprehensive risk capital requirements over 

the reporting period and the comprehensive 

risk capital requirement at period-end, with 

the period-end requirement broken down 

into appropriate risk classifications (for 

example, default risk, migration risk, 

correlation risk); 

(v) Separate measures for interest rate risk, 

credit spread risk, equity price risk, foreign 

exchange risk, and commodity price risk 

used to calculate the VaR-based measure; and 

(vi) A comparison of VaR-based estimates 

with actual gains or losses experienced by 

the [banking organization], with an analysis 

of important outliers. 

(2) In addition, the [banking organization] 

must publicly disclose the following 

information at least quarterly: 

(i) The aggregate amount of on-balance 

sheet and off-balance sheet securitization 

positions by exposure type; and 

(ii) The aggregate amount of correlation 

trading positions. 

(d) Qualitative disclosures. 

(1) For each portfolio of covered positions, 

the [banking organization] must publicly 

disclose the following information at least 

annually, or more frequently in the event of 

material changes for each portfolio: 

(i) The composition of material portfolios 

of covered positions; 

(ii) The [banking organization]’s valuation 

policies, procedures, and methodologies for 

covered positions including, for 

securitization positions, the methods and key 

assumptions used for valuing such positions, 

any significant changes since the last 

reporting period, and the impact of such 

change; 

(iii) The characteristics of the internal 

models used for purposes of this appendix. 

For the incremental risk capital requirement 

and the comprehensive risk capital 

requirement, this must include: 

(A) The approach used by the [banking 

organization] to determine liquidity horizons; 

(B) The methodologies used to achieve a 

capital assessment that is consistent with the 

required soundness standard; and 

(C) The specific approaches used in the 

validation of these models; 

(iv) A description of the approaches used 

for validating and evaluating the accuracy of 

internal models and modeling processes for 

purposes of this appendix; 

(v) For each market risk category (that is, 

interest rate risk, credit spread risk, equity 

price risk, foreign exchange risk, and 

commodity price risk), a description of the 

stress tests applied to the positions subject to 

the factor; 

(vi) The results of the comparison of the 

[banking organization]’s internal estimates 

for purposes of this appendix with actual 

outcomes during a sample period not used in 

model development; 

(vii) The soundness standard on which the 

[banking organization]’s internal capital 

adequacy assessment under this appendix is 

based, including a description of the 

methodologies used to achieve a capital 

adequacy assessment that is consistent with 

the soundness standard; 

(2) 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 

(3) A description of the [banking 

organization]’s policy governing the use of 

credit risk mitigation to mitigate the risks of 

securitization and resecuritization positions. 

[End of Common Text] 

List of Subjects 

12 CFR Part 3 

Administrative practices and 

procedure, Capital, National banks, 

Reporting and recordkeeping 

requirements, Risk. 

12 CFR Part 208 

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. 

Adoption of Proposed Common Rule 

The adoption of the proposed 

common rules by the agencies, as 

modified by agency-specific text, is set 

forth below: 

Department of the Treasury 

Office of the Comptroller of the 

Currency 

12 CFR Chapter I 

Authority and Issuance 

For the reasons set forth in the 

common preamble, part 3 of chapter I of 

title 12 of the Code of Federal 

Regulations is 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, 3907 

and 3909. 


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2. Appendix B to part 3 is revised to 

read as set forth at the end of the 

common preamble. 

Appendix B to Part 3—Risk-Based 

Capital Guidelines; Market Risk 

Adjustment 

3. Appendix B to part 3 is further 

amended by: 

a. Removing ‘‘[the advanced capital 

adequacy framework]’’ wherever it 

appears and adding in its place 

‘‘Appendix C to this part’’; 

b. Removing ‘‘[Agency]’’ wherever it 

appears and adding in its place ‘‘OCC’’; 

c. Removing ‘‘[Agency’s]’’ wherever it 

appears and adding in its place ‘‘OCC’s’’; 

d. Removing ‘‘[banking organization]’’ 

wherever it appears and adding in its 

place ‘‘bank’’; 

e. Removing ‘‘[banking organizations]’’ 

wherever it appears and adding in its 

place ‘‘banks’’; 

f. Removing ‘‘[Call Report or FR Y– 

9C]’’ wherever it appears and adding in 

its place ‘‘Call Report’’; 

g. Removing ‘‘[regulatory report]’’ 

wherever it appears and adding in its 

place ‘‘Consolidated Reports of 

Condition and Income (Call Report)’’; 

h. Removing ‘‘[the general risk-based 

capital rules]’’ wherever it appears and 

adding in its place ‘‘Appendix A to this 

part’’. 

Board of Governors of the Federal 

Reserve System 

12 CFR Chapter II 

Authority and Issuance 

For the reasons set forth in the 

common preamble, parts 208 and 225 of 

chapter II of title 12 of the Code of 

Federal Regulations are proposed to be 

amended as follows: 

PART 208—MEMBERSHIP OF STATE 

BANKING INSTITUTIONS IN THE 

FEDERAL RESERVE SYSTEM 

(REGULATION H) 

4. 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, 1818, 1820(d)(9), 

1833(j), 1828(o), 1831, 1831o, 1831p–1, 

1831r–1, 1831w, 1831x, 1835a, 1882, 2901– 

2907, 3105, 3310, 3331–3351, and 3905– 

3909; 15 U.S.C. 78b, 78I(b), 78l(i), 780– 

4(c)(5), 78q, 78q–1, and 78w, 1681s, 1681w, 

6801, and 6805; 31 U.S.C. 5318; 42 U.S.C. 

4012a, 4104a, 4104b, 4106 and 4128. 

5. Appendix E to part 208 is revised 

to read as set forth at the end of the 

common preamble. 

Appendix E to Part 208—Capital 

Adequacy Guidelines for State Member 

Banks: Market Risk Measure 

6. Appendix E to part 208 is amended 

by: 

a. Removing ‘‘[the advanced capital 

adequacy framework]’’ wherever it 

appears and adding in its place 

‘‘Appendix F to this part’’; 

b. Removing ‘‘[Agency]’’ wherever it 

appears and adding in its place ‘‘Board’’; 

c. Removing ‘‘[Agency’s]’’ wherever it 

appears and adding in its place 

‘‘Board’s’’; 

d. Removing ‘‘[banking organization]’’ 

wherever it appears and adding in its 

place ‘‘bank’’; 

e. Removing ‘‘[banking organizations]’’ 

wherever it appears and adding in its 

place ‘‘banks’’; 

f. Removing ‘‘[Call Report or FR Y– 

9C]’’ wherever it appears and adding in 

its place ‘‘Call Report’’; 

g. Removing ‘‘[regulatory report]’’ 

wherever it appears and adding in its 

place ‘‘Consolidated Reports of 

Condition and Income (Call Report)’’; 

h. Removing ‘‘[the general risk-based 

capital rules]’’ wherever it appears and 

adding in its place ‘‘Appendix A to this 

part’’. 

PART 225—BANK HOLDING 

COMPANIES AND CHANGE IN BANK 

CONTROL (REGULATION Y) 

7. 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; 15 U.S.C. 1681s, 1681w, 6801 and 

6805. 

8. Appendix E to part 225 is revised 

to read as set forth at the end of the 

common preamble. 

Appendix E to Part 225—Capital 

Adequacy Guidelines for Bank Holding 

Companies: Market Risk Measure 

9. Appendix E is amended by: 

a. Removing ‘‘[the advanced capital 

adequacy framework]’’ wherever it 

appears and adding in its place 

‘‘Appendix G to this part’’; 

b. Removing ‘‘[Agency]’’ wherever it 

appears and adding in its place ‘‘Board’’; 

c. Removing ‘‘[Agency’s]’’ wherever it 

appears and adding in its place 

‘‘Board’s’’; 

d. Removing ‘‘[banking organization]’’ 

wherever it appears and adding in its 

place ‘‘bank holding company’’; 

e. Removing ‘‘[banking organizations]’’ 

wherever it appears and adding in its 

place ‘‘bank holding companies’’; 

f. Removing ‘‘[Call Report or FR Y– 

9C]’’ wherever it appears and adding in 

its place ‘‘FR Y–9C’’; 

g. Removing ‘‘[regulatory report]’’ 

wherever it appears and adding in its 

place ‘‘Consolidated Financial 

Statements for Bank Holding Companies 

(FR Y–9C)’’; and 

h. Removing ‘‘[the general risk-based 

capital rules]’’ wherever it appears and 

adding in its place ‘‘Appendix A to this 

part’’. 

Federal Deposit Insurance Corporation 

12 CFR Chapter III 

Authority and Issuance 

For the reasons set forth in the 

common preamble, part 325 of chapter 

III of title 12 of the Code of Federal 

Regulations is proposed to be amended 

as follows: 

PART 325—CAPITAL MAINTENANCE 

10. 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, 1835, 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, as amended by 

Pub. L. 103–325, 108 Stat. 2160, 2233 (12 

U.S.C. 1828 note); Pub. L. 102–242, 105 Stat. 

2236, 2386, as amended by Pub. L. 102–550, 

106 Stat. 3672, 4089 (12 U.S.C. 1828 note). 

11. Appendix C to part 325 is revised 

to read as set forth at the end of the 

common preamble. 

Appendix C to Part 325—Risk-Based 

Capital for State Nonmember Banks: 

Market Risk 

12. Appendix C is further amended 

by: 

a. Removing ‘‘[Agency]’’ wherever it 

appears and adding in its place ‘‘FDIC’’; 

b. Removing ‘‘[Agency’s]’’ wherever it 

appears and adding in its place 

‘‘FDIC’s’’; 

c. Removing ‘‘[banking organization]’’ 

wherever it appears and adding in its 

place ‘‘bank’’; 

d. Removing ‘‘[banking organizations]’’ 

wherever it appears and adding in its 

place ‘‘banks’’; 

e. Removing [Call Report or FR Y–9C] 

wherever it appears and adding in its 

place ‘‘Call Report’’; 

f. Removing ‘‘[the advanced capital 

adequacy framework]’’ wherever it 

appears and adding in its place 

‘‘Appendix D to this part’’; 

g. Removing ‘‘[regulatory report]’’ 

wherever it appears and adding in its 

place ‘‘Consolidated Reports of 

Condition and Income (Call Report)’’; 

h. Removing ‘‘[the general risk-based 

capital rules]’’ wherever it appears and 

adding in its place ‘‘Appendix A to this 

part’’. 


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1922 Federal Register / Vol. 76, No. 7 / Tuesday, January 11, 2011 / Proposed Rules 

Dated: December 15, 2010. 

John Walsh, 

Acting Comptroller of the Currency. 

By order of the Board of Governors of the 

Federal Reserve System, December 14, 2010. 

Robert deV. Frierson, 

Deputy Secretary of the Board. 

Dated at Washington, DC, this 14th of 

December 2010. By order of the Board of 

Directors. Federal Deposit Insurance 

Corporation. 

Robert E. Feldman, 

Executive Secretary. 

[FR Doc. 2010–32189 Filed 1–10–11; 8:45 am] 

BILLING CODE 4810–33–P; 6210–01–P; 6714–01–P; 

6720–01–P 


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