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investments. Granting the request, moreover, would result in inequitable treatment with
respect to other bank holding companies that hold similar exposures. Accordingly, the
Board declines to grant the relief requested.

These determinations are specifically conditioned on compliance by GSGI and
Bank with all the commitments and representations made to the Board in connection with
the requests for exemptions. These commitments and representations are deemed to be
conditions imposed in writing by the Board in connection with granting the requests and,
as such, may be enforced in proceedings under applicable law. These determinations are
based on the specific facts and circumstances of GSGI and Bank. Any material change in
those facts or circumstances or any failure by GSGI and Bank to observe any of their
commitments or representations may result in different determinations or in revocation of
the exemptions.

Please contact Homer C. Hill, II of the Federal Reserve Bank of New York at
(212) 720-2164 if you have any questions.

Sincerely yours,

RheT lv, Fore —

Robert deV. Frierson
Deputy Secretary of the Board

ce: Homer C. Hill, II
Federal Reserve Bank of New York


BOARD OF GOVERNORS
OF THE

FEDERAL RESERVE SYSTEM

WASHINGTON, O. C. 20551

ADORESS OFFICIAL CORRESPONDENCE
TO THE BOARD

February 5, 2009

Ms. Sarah Smith

Chief Accounting Officer

The Goldman Sachs Group, Inc.
85 Broad Street

New York, New York 10004

Dear Ms. Smith:

This letter is in response to the requests from The Goldman Sachs Group, Inc.
(“GSGI”) and Goldman Sachs Bank USA (“Bank”), both of New York, New York, for
temporary exemptions from the application of certain aspects of the Board’s market risk
rules for state member banks and bank holding companies (together, the
“Market Risk Rules”)! and the Board’s general risk-based capital rules for bank holding
companies (the “Credit Risk Capital Rules”)?

On September 21, 2008, the Board approved the application by GSGI to become a
bank holding company,? and on September 25, 2008, the Board approved the application
by Bank for membership in the Federal Reserve System.’ To facilitate the orderly
transition of GSGI and Bank to the Board’s Market Risk Rules and Credit Risk Capital
Rules, GSGI has requested that (1) through December 31, 2009, GSGI and Bank be
permitted to use certain Value-at-Risk (“VaR”) models approved by the SEC, as
supplemented by supervisory add-ons approved by the SEC (together, “SEC-approved
models”), to determine their capital requirements for specific risk under the Market Risk
Rules; (2) through December 31, 2009, GSGI and Bank be permitted to use methods
approved by the SEC to determine their capital requirements under the Market Risk
Rules for those trading assets, including distressed debt and restricted stock investments,
that the SEC did not require to be included in the VaR-based models of GSGI and Bank;
and (3) GSGI be allowed to use methods approved by the SEC to calculate risk-based

"12 CER parts 208 and 225, Appendix E.
? 12 CER part 225, Appendices A and F.

> The Goldman Sachs Group, Inc., 94 Federal Reserve Bulletin C101 (2008). GSGI was
previously subject to the consolidated supervised entity capital requirements established
by the U.S. Securities and Exchange Commission (“SEC”) and subject to market risk
capital requirements similar to the Market Risk Rules. See Appendix E to

17 CFR 240.15c¢3-1.

4 Board letter to Michael T. Escue, Esq., dated September 25, 2008.



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capital requirements for its nonfinancial equity investments (“merchant banking
investments”) that are subject to the Board’s Credit Risk Capital Rules.

Market Risk Rules Requests

Under the Market Risk Rules, an institution with significant exposure to market
risk must maintain adequate capital to support that exposure.° In addition to the
requirement for an institution subject to the Market Risk Rules to have a VaR model to
measure general market risk, the institution also must capture its exposure to
idiosyncratic or specific market risk either through a model approved by the
Federal Reserve or by applying standard specific risk charges.’ The Board has authority
to provide exemptions from the Market Risk Rules.*

With respect to the requests by GSGI and Bank for a transition period to come
into full compliance with the Market Risk Rules, the Board concludes that the limited and
temporary relief described above would permit GSGI and Bank to complete the transition
to the Market Risk Rules in a safe, sound, and orderly manner.

To allow an appropriate amount of time for Federal Reserve staff to conduct in-
depth reviews of all relevant market risk models, the Board has decided that GSGI and
Bank may use certain SEC-approved models to calculate their risk-based capital
requirements for specific risk under the Market Risk Rules, provided that in no case shall
GSGI or Bank use the SEC-approved models to calculate any capital requirements under
the Market Risk Rules after the December 31, 2009, reporting date. Based on the
Board’s preliminary review, the risk-based capital requirements for specific risk
produced by the SEC-approved models used by GSGI and Bank appear to be sufficiently
conservative for the transition to the Board’s Market Risk Rules. During 2009, Federal
Reserve staff will, among other things, review the existing specific risk models of GSGI
and Bank on a model-by-model basis. After Federal Reserve staff completes its review
of each model, GSGI and Bank may continue to use that model to calculate the specific
tisk of covered positions under the Market Risk Rules only if GSGI and Bank have
demonstrated to the Federal Reserve that the model adequately measures the specific risk
of covered positions. If GSGI and Bank have not made such a demonstration, they must
begin applying the standard specific risk capital requirements in the Market Risk Rules to

> See 12 CFR part 225, Appendix A, § II.B.5.

612 CFR parts 208 and 225, Appendix E, § 1(a). Positions covered by the Market Risk
Rules (“covered positions”) generally include all assets, liabilities, and off-balance-sheet
items in an organization’s trading account, and all foreign exchange and commodity
positions both in and outside the trading account. Most covered positions are excluded
from the Credit Risk Capital Rules.

7 See 12 CFR parts 208 and 225, Appendix E, § 5. If an institution has not demonstrated
to the Federal Reserve that its model measures the specific risk of covered positions, it
must use the standard specific risk capital requirements in the Market Risk Rules.

5 See 12 CFR parts 208 and 225, Appendix E, § 1(b)(3).


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all covered positions that are covered by the model immediately after Federal Reserve
staff completes its review of the model.?

In addition, GSGI and Bank may continue to use methods approved by the SEC to
determine their capital requirements under the Market Risk Rules for those trading assets,
including distressed debt and restricted stock investments, that the SEC did not require to
be included in the VaR-based models of GSGI and Bank, until the December 31, 2009,
teporting date. After that time, all the requirements in the Market Risk Rules will apply
to these assets as follows: they must be included in the general VaR of GSGI and Bank,
and GSGI and Bank must either have a specific risk model approved by Federal Reserve
staff for these investments or apply the standard specific risk capital requirements in the
Market Risk Rules to them.

During and after the transition period to full implementation of the Board’s
Market Risk Rules, GSGI and Bank must maintain the accounting controls surrounding
their computation of capital requirements for market risk. These controls are a critical
element supporting the reliability of reported capital requirements. !°

Credit Risk Capital Rules Request

For merchant banking investments that are not covered positions, bank holding
companies must use the approach described in the Credit Risk Capital Rules to determine
the risk-based capital requirements for those investments. Under the Credit Risk Capital
Rules, a bank holding company must deduct a percentage of the adjusted carrying value
of merchant banking investments from tier 1 capital based on the aggregate percentage of
the holding company’s tier 1 capital represented by the investments.'! The Board has
broad authority to provide exemptions from the Credit Risk Capital Rules.’

GSGI has requested that it be allowed to use the approach approved by the SEC
for its merchant banking investments. GSGI has not indicated that it is unable to perform
the capital calculations required under the Credit Risk Capital Rules for its merchant
banking investments, and the Board believes that the risk-based capital requirements
under the Credit Risk Capital Rules are more appropriate for merchant banking

° See 12 CFR parts 208 and 225, Appendix E, § 5.

10 In addition, GSGI and Bank may not use internal models approved by the SEC to
calculate their risk-based capital requirements for counterparty credit risk and instead
must use the approach in the Credit Risk Capital Rules to calculate their capital
requirements arising from counterparty credit risk. See 12 CFR parts 208 and 225,
Appendix A, § III-E. Furthermore, all the qualitative requirements in section 4(b) of the
Market Risk Rules will apply immediately to GSGI and Bank’s covered positions with
capital requirements that are determined based on VaR models. See 12 CFR parts 208
and 225, Appendix E, § 4(b).

1 See 12 CFR parts 208 and 225, Appendix A, § IIL.B.5.c.
"2 See 12 CFR parts 208 and 225, Appendix A, § III.A.