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Preamble

Table of Contents
          - Introduction 
          - Scope 
          - Qualification 
          - Calculation of Tier 1 Capital and Total Qualifying Capital 
          - Calculation of Risk-Weighted Assets 
          - Operational Risk 
          - Disclosure 

List of Acronyms

Regulatory Flexibility Act Analysis

Paperwork Reduction Act

Plain Language

OCC Executive Order 12866

OTS Executive Order 12866 Determination

OCC Unfunded Mandates Reform Act of 1995 Determination

OTS Unfunded Mandates Reform Act of 1995 Determination

Proposed Regulatory Text

Table of Contents
        - Part I
        - General Provisions
        - Part II
        - Qualifying Capital
        - Part III
        - Qualification
        - Part IV
        - Risk-Weighted Assets for General Credit Risk
        - Part V 
        - Risk-Weighted Assets for Securitization Exposures
        - Part VI
        - Risk-Weighted Assets for Equity Exposures
        - Part VII
        - Risk-Weighted Assets for Operational Risk
        - Part VIII
        - Disclosure

List of Subjects

Authority and Issuance

OCC

Federal Reserve

FDIC

OTS

OCC

Federal Reserve

FDIC

OTS

Billing Codes

(a) Timing. (1) A [bank] that is described in paragraph (b)(1)       of section 1 must adopt a written implementation plan no later than       six months after the later of the effective date of this appendix or the       date the [bank] meets a criterion in that section. The plan must incorporate       an explicit first floor period start date no later than 36 months after       the later of the effective date of this appendix or the date the [bank] meets       at least one criterion under paragraph (b)(1) of section 1. [AGENCY]       may extend the first floor period start date.

(2) A [bank] that elects to be subject to this appendix under paragraph (b)(2)       of section 1 must adopt a written implementation plan and notify the       [AGENCY] in writing of its intent at least 12 months before it proposes       to begin its first floor period.

(b) Implementation plan. The [bank]�s implementation plan must address       in detail how the [bank] complies, or plans to comply, with the qualification       requirements in section 22. The [bank] also must maintain a comprehensive       and sound planning and governance process to oversee the implementation       efforts described in the plan. At a minimum, the plan must:

(1) Comprehensively address the qualification requirements in section 22       for the [bank] and each consolidated subsidiary (U.S. and foreign-based)       of the [bank] with respect to all portfolios and exposures of the [bank] and       each of its consolidated subsidiaries;

(2) Justify and support any proposed temporary or permanent exclusion of       business lines, portfolios, or exposures from application of the advanced       approaches in this appendix (which business lines, portfolios, and exposures       must be, in the aggregate, immaterial to the [bank]);

(3) Include the [bank]�s self-assessment of:

(i) The [bank]�s current status in meeting the qualification requirements       in section 22; and

(ii) The consistency of the [bank]�s current practices with the [AGENCY]�s       supervisory guidance on the qualification requirements;

(4) Based on the [bank]�s self-assessment, identify and describe the areas       in which the [bank] proposes to undertake additional work to comply with       the qualification requirements in section 22 or to improve the consistency       of the [bank]�s current practices with the [AGENCY]�s supervisory guidance       on the qualification requirements (gap analysis);

(5) Describe what specific actions the [bank] will take to address the areas       identified in the gap analysis required by paragraph (b)(4) of this       section;

(6) Identify objective, measurable milestones, including delivery dates       and a date when the [bank]�s implementation of the methodologies described       in this appendix will be fully operational;

(7) Describe resources that have been budgeted and are available to implement       the plan; and

(8) Receive board of directors approval.

(c) Parallel run. Before determining its risk-based capital requirements       under this appendix and following adoption of the implementation plan,       the [bank] must conduct a satisfactory parallel run. A satisfactory parallel       run is a period of no less than four consecutive calendar quarters       during which the [bank] complies with all of the qualification requirements       in section 22 to the satisfaction of [AGENCY]. During the parallel       run, the [bank] must report to the [AGENCY] on a calendar quarterly basis       its risk-based capital ratios using [the general risk-based capital rules]       and the risk-based capital requirements described in this appendix. During       this period, the [bank] is subject to [the general risk-based capital rules].    

(d) Approval to calculate risk-based capital requirements under this       appendix. The [AGENCY] will notify the [bank] of the date that the [bank]       may begin its first floor period following a determination by the [AGENCY]       that: 

(1) The [bank] fully complies with the qualification requirements in section 22;

(2) The [bank] has conducted a satisfactory parallel run under paragraph (c)       of this section; and

(3) The [bank] has an adequate process to ensure ongoing compliance with       the qualification requirements in section 22.

(e) Transitional floor periods. Following a satisfactory parallel       run, a [bank] is subject to three transitional floor periods.

(1) Risk-based capital ratios during the transitional floor periods       - (i) Tier 1 risk-based capital ratio. During a [bank]�s transitional       floor periods, a [bank]�s tier 1 risk-based capital ratio is equal to       the lower of:

(A) The [bank]�s floor-adjusted tier 1 risk-based capital ratio; or

(B) The [bank]�s advanced approaches tier 1 risk-based capital ratio.

(ii) Total risk-based capital ratio.  During a [bank]�s transitional floor periods, a [bank]�s total risk-based capital ratio is equal to the lower of:

(A) The [bank]�s floor-adjusted total risk-based capital ratio; or

(B) The [bank]�s advanced approaches total risk-based capital ratio.

(2) Floor-adjusted risk-based capital ratios. (i) A [bank]�s floor-adjusted       tier 1 risk-based capital ratio during a transitional floor period       is equal to the [bank]�s tier 1 capital as calculated under [the general       risk-based capital rules], divided by the product of:

(A) The [bank]�s total risk-weighted assets as calculated under [the general       risk-based capital rules]; and

(B) The appropriate transitional floor percentage in Table 1.

(ii) A [bank]�s floor-adjusted total risk-based capital ratio during a transitional floor period is equal to the sum of the [bank]�s tier 1 and tier 2 capital as calculated under [the general risk-based capital rules], divided by the product of:

(A) The [bank]�s total risk-weighted assets as calculated under [the general risk-based capital rules]; and

(B) The appropriate transitional floor percentage in Table 1.

(iii) A [bank] that meets the criteria in paragraph (b)(1) or (b)(2)       of section 1 as of the effective date of this rule must use [the general       risk-based capital rules] effective immediately before this rule became       effective during the parallel run and as the basis for its transitional       floors.

| Transitional floor period | Transitional floor percentage |
|---------------------------|-------------------------------|
| First floor period        | 95 percent               |
| Second floor period       | 90 percent               |
| Third floor period        | 85 percent               |

(3) Advanced approaches risk-based       capital ratios. (i) A [bank]�s advanced approaches tier 1 risk-based       capital ratio equals the [bank]�s tier 1 risk-based capital ratio as       calculated under this appendix (other than this section on transitional       floor periods).

(ii) A [bank]�s advanced approaches total risk-based capital ratio equals       the [bank]�s total risk-based capital ratio as calculated under this appendix       (other than this section on transitional floor periods).

(4) Reporting. During the transitional floor periods, a [bank] must       report to the [AGENCY] on a calendar quarterly basis both floor-adjusted       risk-based capital ratios and both advanced approaches risk-based capital       ratios.

(5) Exiting a transitional floor period. A [bank] may not exit a transitional       floor period until the [bank] has spent a minimum of four consecutive calendar       quarters in the period and the [AGENCY] has determined that the [bank] may       exit the floor period. The [AGENCY]�s determination will be based on an       assessment of the [bank]�s ongoing compliance with the qualification requirements       in section 22.

(a) Process and systems requirements. (1) A [bank] must have a rigorous       process for assessing its overall capital adequacy in relation to its risk       profile and a comprehensive strategy for maintaining an appropriate level       of capital.

(2) The systems and processes used by a [bank] for risk-based capital purposes       under this appendix must be consistent with the [bank]�s internal risk management       processes and management information reporting systems.

(3) Each [bank] must have an appropriate infrastructure with risk measurement       and management processes that meet the qualification requirements of this       section and are appropriate given the [bank]�s size and level of complexity.       Regardless of whether the systems and models that generate the risk parameters       necessary for calculating a [bank]�s risk-based capital requirements are       located at any affiliate of the [bank], the [bank] itself must ensure that       the risk parameters and reference data used to determine its risk-based       capital requirements are representative of its own credit risk and operational       risk exposures.

(b) Risk rating and segmentation systems for wholesale and retail exposures.       (1) A [bank] must have an internal risk rating and segmentation system       that accurately and reliably differentiates among degrees of credit risk       for the [bank]�s wholesale and retail exposures.

(2) For wholesale exposures, a [bank] must have an internal risk rating system       that accurately and reliably assigns each obligor to a single rating grade       (reflecting the obligor�s likelihood of default). The [bank]�s wholesale       obligor rating system must have at least seven discrete rating grades for       non-defaulted obligors and at least one rating grade for defaulted obligors.       Unless the [bank] has chosen to directly assign ELGD and LGD estimates to       each wholesale exposure, the [bank] must have an internal risk rating system       that accurately and reliably assigns each wholesale exposure to loss severity       rating grades (reflecting the [bank]�s estimate of the ELGD and LGD of the       exposure). A [bank] employing loss severity rating grades must have a sufficiently       granular loss severity grading system to avoid grouping together exposures       with widely ranging ELGDs or LGDs.

(3) For retail exposures, a [bank] must have a system that groups exposures       into segments with homogeneous risk characteristics and assigns accurate       and reliable PD, ELGD, and LGD estimates for each segment on a consistent       basis. The [bank]�s system must group retail exposures into the appropriate       retail exposure subcategory and must group the retail exposures in each       retail exposure subcategory into separate segments. The [bank]�s system must       identify all defaulted retail exposures and group them in segments by subcategories       separate from non-defaulted retail exposures. 

(4) The [bank]�s internal risk rating policy for wholesale exposures must       describe the [bank]�s rating philosophy (that is, must describe how wholesale       obligor rating assignments are affected by the [bank]�s choice of the range       of economic, business, and industry conditions that are considered in the       obligor rating process).

(5) The [bank]�s internal risk rating system for wholesale exposures must       provide for the review and update (as appropriate) of each obligor rating       and (if applicable) each loss severity rating whenever the [bank] receives       new material information, but no less frequently than annually. The [bank]�s       retail exposure segmentation system must provide for the review and update       (as appropriate) of assignments of retail exposures to segments whenever       the [bank] receives new material information, but no less frequently than       quarterly. 

(c) Quantification of risk parameters for wholesale and retail exposures.       (1) The [bank] must have a comprehensive risk parameter quantification       process that produces accurate, timely, and reliable estimates of the risk       parameters for the [bank]�s wholesale and retail exposures.

(2) Data used to estimate the risk parameters must be relevant to the [bank]�s       actual wholesale and retail exposures, and of sufficient quality to support       the determination of risk-based capital requirements for the exposures.

(3) The [bank]�s risk parameter quantification process must produce conservative       risk parameter estimates where the [bank] has limited relevant data, and       any adjustments that are part of the quantification process must not result       in a pattern of bias toward lower risk parameter estimates.

(4) PD estimates for wholesale and retail exposures must be based on at       least 5 years of default data. ELGD and LGD estimates for wholesale       exposures must be based on at least 7 years of loss severity data,       and ELGD and LGD estimates for retail exposures must be based on at least       5 years of loss severity data. EAD estimates for wholesale exposures       must be based on at least 7 years of exposure amount data, and EAD estimates       for retail exposures must be based on at least 5 years of exposure       amount data.

(5) Default, loss severity, and exposure amount data must include periods       of economic downturn conditions, or the [bank] must adjust its estimates       of risk parameters to compensate for the lack of data from periods of economic       downturn conditions.

(6) The [bank]�s PD, ELGD, LGD, and EAD estimates must be based on the definition       of default in this appendix.

(7) The [bank] must review and update (as appropriate) its risk parameters       and its risk parameter quantification process at least annually.

(8) The [bank] must at least annually conduct a comprehensive review and       analysis of reference data to determine relevance of reference data to       [bank] exposures, quality of reference data to support PD, ELGD, LGD, and       EAD estimates, and consistency of reference data to the definition of default       contained in this appendix.

(d) Counterparty credit risk model. A [bank] must obtain the prior       written approval of [AGENCY] under section 32 to use the internal       models methodology for counterparty credit risk.

(e) Double default treatment. A [bank] must obtain the prior written       approval of [AGENCY] under section 34 to use the double default treatment.

(f) Securitization exposures. A [bank] must obtain the prior written       approval of [AGENCY] under section 44 to use the internal assessment       approach for securitization exposures to ABCP programs.

(g) Equity exposures model. A [bank] must obtain the prior written       approval of [AGENCY] under section 53 to use the internal models approach       for equity exposures.

(h) Operational risk - (1) Operational risk management processes.       A [bank] must:

(i) Have an operational risk management function that:    

(A) Is independent of business line management; and

(B) Is responsible for designing, implementing, and overseeing the [bank]�s       operational risk data and assessment systems, operational risk quantification       systems, and related processes; 

(ii) Have and document a process to identify, measure, monitor, and control       operational risk in [bank] products, activities, processes, and systems (which       process must capture business environment and internal control factors       affecting the [bank]�s operational risk profile); and

(iii) Report operational risk exposures, operational loss events, and other       relevant operational risk information to business unit management, senior       management, and the board of directors (or a designated committee of the       board).

(2) Operational risk data and assessment systems.  A [bank] must have operational risk data and assessment systems that capture operational risks to which the [bank] is exposed.  The [bank]�s operational risk data and assessment systems must:

(i) Be structured in a manner consistent with the [bank]�s current business       activities, risk profile, technological processes, and risk management       processes; and

(ii) Include credible, transparent, systematic, and verifiable processes       that incorporate the following elements on an ongoing basis:

(A) Internal operational loss event data. The [bank] must have a systematic       process for capturing and using internal operational loss event data in       its operational risk data and assessment systems. 

(1) The [bank]�s operational risk data and assessment systems must       include a historical observation period of at least five years for internal       operational loss event data (or such shorter period approved by [AGENCY]       to address transitional situations, such as integrating a new business       line). 

(2) The [bank] may refrain from collecting internal operational loss       event data for individual operational losses below established dollar threshold       amounts if the [bank] can demonstrate to the satisfaction of the [AGENCY]       that the thresholds are reasonable, do not exclude important internal operational       loss event data, and permit the [bank] to capture substantially all the dollar       value of the [bank]�s operational losses. 

(B) External operational loss event data. The [bank] must have a systematic       process for determining its methodologies for incorporating external operational       loss data into its operational risk data and assessment systems.

(C) Scenario analysis. The [bank] must have a systematic process for       determining its methodologies for incorporating scenario analysis into       its operational risk data and assessment systems. 

(D) Business environment and internal control factors. The [bank]       must incorporate business environment and internal control factors into       its operational risk data and assessment systems. The [bank] must also periodically       compare the results of its prior business environment and internal control       factor assessments against its actual operational losses incurred in the       intervening period.

(3) Operational risk quantification systems. (i) The [bank]�s       operational risk quantification systems:

(A) Must generate estimates of the [bank]�s operational risk exposure using       its operational risk data and assessment systems; and

(B) Must employ a unit of measure that is appropriate for the [bank]�s range       of business activities and the variety of operational loss events to which       it is exposed, and that does not combine business activities or operational       loss events with different risk profiles within the same loss distribution.

(C) May use internal estimates of dependence among operational losses within       and across business lines and operational loss events if the [bank] can demonstrate       to the satisfaction of [AGENCY] that its process for estimating dependence       is sound, robust to a variety of scenarios, and implemented with integrity,       and allows for the uncertainty surrounding the estimates. If the [bank] has       not made such a demonstration, it must sum operational risk exposure estimates       across units of measure to calculate its total operational risk exposure.

(D) Must be reviewed and updated (as appropriate) whenever the [bank] becomes       aware of information that may have a material effect on the [bank]�s estimate       of operational risk exposure, but no less frequently than annually.

(ii) With the prior written approval of [AGENCY], a [bank] may generate an       estimate of its operational risk exposure using an alternative approach       to that specified in paragraph (h)(3)(i) of this section.      A [bank] proposing to use such an alternative operational risk quantification       system must submit a proposal to [AGENCY]. In considering a [bank]�s proposal       to use an alternative operational risk quantification system, [AGENCY]       will consider the following principles:

(A) Use of the alternative operational risk quantification system will       be allowed only on an exception basis, considering the size, complexity,       and risk profile of a [bank];

(B) The [bank] must demonstrate that its estimate of its operational risk       exposure generated under the alternative operational risk quantification       system is appropriate and can be supported empirically; and

(C) A [bank] must not use an allocation of operational risk capital requirements       that includes entities other than depository institutions or the benefits       of diversification across entities.

(i) Data management and maintenance. (1) A [bank] must have data management       and maintenance systems that adequately support all aspects of its advanced       systems and the timely and accurate reporting of risk-based capital requirements.

(2) A [bank] must retain data using an electronic format that allows timely retrieval of data for analysis, validation, reporting, and disclosure purposes.

(3) A [bank] must retain sufficient data elements related to key risk drivers to permit adequate monitoring, validation, and refinement of its advanced systems.

(j) Control, oversight, and validation mechanisms.  (1) The [bank]�s senior management must ensure that all components of the [bank]�s advanced systems function effectively and comply with the qualification requirements in this section.

(2) The [bank]�s board of directors (or a designated committee of the board)       must at least annually evaluate the effectiveness of, and approve, the       [bank]�s advanced systems.

(3) A [bank] must have an effective system of controls and oversight that:

(i) Ensures ongoing compliance with the qualification requirements in this       section; 

(ii) Maintains the integrity, reliability, and accuracy of the [bank]�s advanced       systems; and

(iii) Includes adequate governance and project management processes.

(4) The [bank] must validate, on an ongoing basis, its advanced systems.       The [bank]�s validation process must be independent of the advanced systems�       development, implementation, and operation, or the validation process must       be subjected to an independent review of its adequacy and effectiveness.       Validation must include:

(i) The evaluation of the conceptual soundness of (including developmental       evidence supporting) the advanced systems;

(ii) An on-going monitoring process that includes verification of processes       and benchmarking; and

(iii) An outcomes analysis process that includes back-testing. 

(5) The [bank] must have an internal audit function independent of business-line       management that at least annually assesses the effectiveness of the controls       supporting the [bank]�s advanced systems and reports its findings to the       [bank]�s board of directors (or a committee thereof).

(6) The [bank] must periodically stress test its advanced systems. The stress       testing must include a consideration of how economic cycles, especially       downturns, affect risk-based capital requirements (including migration       across rating grades and segments and the credit risk mitigation benefits       of double default treatment).

(k) Documentation. The [bank] must adequately document all material       aspects of its advanced systems.

(a) Changes to advanced systems. A [bank] must meet all the qualification       requirements in section 22 on an ongoing basis. A [bank] must notify       the [AGENCY] when the [bank] makes any change to an advanced system that       would result in a material change in the [bank]�s risk-weighted asset amount       for an exposure type, or when the [bank] makes any significant change to       its modeling assumptions.

(b) Mergers and acquisitions - (1) Mergers and acquisitions of       companies without advanced systems. If a [bank] merges with or acquires       a company that does not calculate its risk-based capital requirements using       advanced systems, the [bank] may use [the general risk-based capital rules]       to determine the risk-weighted asset amounts for, and deductions from capital       associated with, the merged or acquired company�s exposures for up to 24 months       after the calendar quarter during which the merger or acquisition consummates.       [AGENCY] may extend this transition period for up to an additional 12 months.       Within 30 days of consummating the merger or acquisition, the [bank]       must submit to [AGENCY] an implementation plan for using its advanced systems       for the acquired company. During the period when [the general risk-based       capital rules] apply to the merged or acquired company, any ALLL, net of       allocated transfer risk reserves established pursuant to 12 U.S.C. 3904,       associated with the merged or acquired company�s exposures may be included       in the [bank]�s tier 2 capital up to 1.25 percent of the acquired       company�s risk-weighted assets. All general reserves of the merged or acquired       company must be excluded from the [bank]�s eligible credit reserves. In addition,       the risk-weighted assets of the merged or acquired company are not included       in the [bank]�s credit-risk-weighted assets but are included in total risk-weighted       assets. If a [bank] relies on this paragraph, the [bank] must disclose publicly       the amounts of risk-weighted assets and qualifying capital calculated under       this appendix for the acquiring [bank] and under [the general risk-based       capital rules] for the acquired company.

(2) Mergers and acquisitions of companies with advanced systems.       If a [bank] merges with or acquires a company that calculates its risk-based       capital requirements using advanced systems, the acquiring [bank] may use       the acquired company�s advanced systems to determine the risk-weighted       asset amounts for, and deductions from capital associated with, the merged       or acquired company�s exposures for up to 24 months after the calendar       quarter during which the acquisition or merger consummates. [AGENCY] may       extend this transition period for up to an additional 12 months. Within       30 days of consummating the merger or acquisition, the [bank] must submit       to [AGENCY] an implementation plan for using its advanced systems for the       merged or acquired company.

(c) Failure to comply with qualification requirements. If [AGENCY]       determines that a [bank] that is subject to this appendix and has conducted       a satisfactory parallel run fails to comply with the qualification requirements       in section 22, [AGENCY] will notify the [bank] in writing of the [bank]�s       failure to comply. The [bank] must establish a plan satisfactory to the [AGENCY]       to return to compliance with the qualification requirements and must disclose       to the public its failure to comply with the qualification requirements       promptly after receiving notice from the [AGENCY]. In addition, if the       [AGENCY] determines that the [bank]�s risk-based capital requirements are       not commensurate with the [bank]�s credit, market, operational, or other       risks, the [AGENCY] may require such a [bank] to calculate its risk-based       capital requirements:

(1) Under [the general risk-based capital rules]; or

(2) Under this appendix with any modifications provided by the [AGENCY].

Basel II Capital AccordNotice of Proposed Rulemaking (NPR)

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