68064 Federal Register / Vol. 62, No. 249 / Tuesday, December 30, 1997 / Rules and Regulations

1The G–10 countries are Belgium, Canada,

France, Germany, Italy, Japan, Netherlands,

Sweden, Switzerland, the United Kingdom, and the

United States. The Committee is comprised of

representatives of the central banks and supervisory

authorities from the G–10 countries and

Luxembourg.

2The VAR-based capital charge is the higher of

(i) the previous day’s VAR measure, or (ii) the

average of the daily VAR measures for each of the

preceding 60 business days multiplied by a factor

DEPARTMENT OF THE TREASURY

Office of the Comptroller of the

Currency

12 CFR Part 3

[Docket No. 97–25]

RIN 1557–AB14

FEDERAL RESERVE SYSTEM

12 CFR Parts 208 and 225

[Regulations H and Y; Docket No. R–0996]

FEDERAL DEPOSIT INSURANCE

CORPORATION

12 CFR Part 325

RIN 3064–AC14

Risk-Based Capital Standards: Market

Risk

AGENCIES: Office of the Comptroller of

the Currency, Treasury; Board of

Governors of the Federal Reserve

System; and Federal Deposit Insurance

Corporation.

ACTION: Joint interim rule with request

for comment.

SUMMARY: The Office of the Comptroller

of the Currency (OCC), the Board of

Governors of the Federal Reserve

System (Board), and the Federal Deposit

Insurance Corporation (FDIC)

(collectively, the Agencies) are

amending their respective risk-based

capital standards for market risk

applicable to certain banks and bank

holding companies with significant

trading activities. The amendment

eliminates the requirement that when an

institution measures specific risk using

its internal model, the total capital

charge for specific risk must equal at

least 50 percent of the standard specific

risk capital charge. The amendment

implements a revision to the Basle

Accord that permits such treatment for

an institution whose internal model

adequately measures specific risk. The

rule will reduce regulatory burden for

institutions with qualifying internal

models because they will no longer be

required to calculate a standard specific

risk capital charge.

DATES: This interim rule is effective

December 31, 1997. Comments must be

received by March 2, 1998.

ADDRESSES: Comments should be

directed to:

OCC: Comments may be submitted to

Docket No. 97–25, Communications

Division, Third Floor, Office of the

Comptroller of the Currency, 250 E

Street, S.W., Washington DC 20219.

Comments will be available for

inspection and photocopying at that

address. In addition, comments may be

sent by facsimile transmission to FAX

number (202) 874–5274, or by electronic

mail to regs.comment@occ.treas.gov.

Board: Comments directed to the

Board should refer to Docket No. R–

0996 and may be mailed to Mr. William

W. Wiles, Secretary, Board of Governors

of the Federal Reserve System, 20th

Street and Constitution Avenue, N.W.,

Washington DC 20551. Comments

addressed to the attention of Mr. Wiles

may also be delivered to Room B–2222

of the Eccles Building between 8:45 a.m.

and 5:15 p.m. weekdays, or the security

control room in the Eccles Building

courtyard on 20th Street, N.W. (between

Constitution Avenue and C Street) at

any time. Comments may be inspected

in Room MP–500 of the Martin Building

between 9:00 a.m. and 5:00 p.m.

weekdays, except as provided in 12 CFR

261.8 of the Board’s Rules Regarding

Availability of Information.

FDIC: Send written comments to

Robert E. Feldman, Executive Secretary,

Attention: Comments/OES, Federal

Deposit Insurance Corporation, 550 17th

Street, N.W., Washington, DC 20429.

Comments may be hand-delivered to the

guard station at the rear of the 17th

Street Building (located on F Street), on

business days between 7:00 a.m. and

5:00 p.m. (FAX number (202) 898–3838;

Internet address: comments@fdic.gov).

Comments may be inspected and

photocopied in the FDIC Public

Information Center, Room 100, 801 17th

Street, N.W., Washington, DC 20429,

between 9:00 a.m. and 4:30 p.m. on

business days.

FOR FURTHER INFORMATION CONTACT:

OCC: Roger Tufts, Senior Economic

Advisor (202/874–5070), Capital Policy

Division; Margot Schwadron, Financial

Analyst (202/874–5670), Treasury and

Market Risk; or Ronald Shimabukuro,

Senior Attorney (202/874–5090),

Legislative and Regulatory Activities

Division.

Board: Roger Cole, Associate Director

(202/452–2618), James Houpt, Deputy

Associate Director (202/452–3358),

Barbara Bouchard, Senior Supervisory

Financial Analyst (202/452–3072),

Division of Banking Supervision; or

Stephanie Martin, Senior Attorney (202/

452–3198), Legal Division. For the

hearing impaired only,

Telecommunication Device for the Deaf

(TDD), Diane Jenkins (202/452–3544).

FDIC: William A. Stark, Assistant

Director (202/898–6972), Miguel

Browne, Manager (202/898–6789), John

J. Feid, Chief (202/898–8649), Division

of Supervision; Jamey Basham, Counsel

(202/898–7265), Legal Division, Federal

Deposit Insurance Corporation, 550 17th

Street, N.W., Washington DC 20429.

SUPPLEMENTARY INFORMATION:

Background

The Agencies’ risk-based capital

standards are based upon principles

contained in the July 1988 agreement

entitled ‘‘International Convergence of

Capital Measurement and Capital

Standards’’ (Accord). The Accord,

developed by the Basle Committee on

Banking Supervision (Committee) and

endorsed by the central bank governors

of the Group of Ten (G–10) countries

(G–10 Governors), provides a framework

for assessing an institution’s capital

adequacy by weighting its assets and

off-balance-sheet exposures on the basis

of counterparty credit risk.1 In

December 1995, the G–10 Governors

endorsed the Committee’s amendment

to the Accord (effective by year-end

1997) to incorporate a measure for

exposure to market risk into the capital

adequacy assessment. On September 6,

1996, the Agencies issued revisions to

their risk-based capital standards

implementing the Committee’s market

risk amendment (61 FR 47358).

Under the Agencies’ market risk rules,

banks and bank holding companies

(institutions) with significant trading

activities must measure and hold capital

for exposure to general market risk

arising from fluctuations in interest

rates, equity prices, foreign exchange

rates, and commodity prices and

exposure to specific risk associated with

debt and equity positions in the trading

portfolio. General market risk refers to

changes in the market value of onbalance-sheet assets and off-balancesheet items resulting from broad market

movements. Specific risk refers to

changes in the market value of

individual positions due to factors other

than broad market movements and

includes such risks as the credit risk of

an instrument’s issuer.

Under the Agencies’ current rules, an

institution must measure its general

market risk using its internal risk

measurement model, subject to certain

qualitative and quantitative criteria, to

calculate a value-at-risk (VAR) based

capital charge.2 An institution may
Federal Register / Vol. 62, No. 249 / Tuesday, December 30, 1997 / Rules and Regulations 68065

of three. Beginning no later than one year after

adopting the market risk rules, an institution is

required to backtest its internal model. An

institution may be required to apply a higher

multiplication factor, up to a factor of four, based

on backtesting results.

3The revisions are described in the Committee’s

document entitled ‘‘Explanatory Note: Modification

of the Basle Capital Accord of July 1988, as

Amended January 1996’’ and is available through

the Board’s and the OCC’s Freedom of Information

Office and the FDIC’s Public Information Center.

4The multiplier applicable to the modeled

general market risk elements will not be affected.

Thus, the multiplier for general market risk will

continue to be three, unless a higher multiplier is

indicated by virtue of the institution’s backtesting

results for general market risk, or unless no

multiplier is applied because the previous day’s

VAR for general market risk is higher than the 60-

day average times the multiplier.

measure its specific risk through a valid

internal model or by the so-called

standardized approach. The

standardized approach uses a riskweighting process developed by the

Committee that is applied to individual

instruments and through which debt

and equity positions in the institution’s

trading account are assessed a categorybased fixed capital charge. However, the

Agencies’ current rules provide that an

institution using an internal model to

measure specific risk must hold capital

for specific risk at least equal to 50

percent of the specific risk charge

calculated using the standardized

approach (referred to as the minimum

specific risk charge). If the portion of the

institution’s VAR which is attributable

to specific risk does not equal the

minimum specific risk charge, the

institution’s VAR-based capital charge is

subject to an add-on charge for the

difference. The sum of these capital

charges is factored into an institution’s

risk-based capital ratio.

When the Agencies included the

minimum specific risk charge as part of

the market risk rules, the Agencies

recognized that dual calculations of

specific risk—that is, calculating

specific risk in the internal model as

well as using the standardized approach

to establish the minimum specific risk

charge—would be burdensome.

However, the Agencies’ decision to

include the minimum specific risk

charge was consistent with the

Committee’s conviction, at the time the

Committee adopted its market risk

amendment, that a floor was necessary

to ensure that modeling techniques for

specific risk adequately measured that

risk.

Since the Committee adopted the

market risk amendment, many

institutions have significantly improved

their modeling techniques and, in

particular, their modeling of specific

risk. In September 1997 the Committee

determined that sufficient progress had

been made to eliminate the use of the

minimum specific risk charge and the

burden of a separate calculation.

Accordingly, the Committee revised the

market risk amendment to the Accord so

that an institution using a valid internal

model to measure specific risk may use

the VAR measures generated by the

model without being required to

compare the model-generated results to

the minimum specific risk charge as

calculated under the standardized

approach.3 The revisions specify that

the specific risk elements of internal

models will be assessed consistently

with the assessment of the general

market risk elements of such models

through review by the relevant

supervisor and backtesting.

To implement this revision to the

market risk amendment, the Agencies

are issuing an interim rule with a

request for comment. As discussed in

the section entitled ‘‘Interim

Effectiveness of the Rule,’’ the Agencies

have found that good cause necessitates

making the amendments herein effective

immediately, without opportunity for

public comment or a delayed effective

date. Effectiveness of the amendments

herein is on an interim basis, until the

Agencies issue a final rule, following

public comment on this interim rule, in

accordance with the procedures

specified in section 553 of the

Administrative Procedure Act, 5 U.S.C.

553. The interim rule applies only to the

calculation of specific risk under the

market risk rules. All other aspects of

the market risk rules remain unchanged.

Description of the Interim Rule

An institution whose internal model

does not adequately measure specific

risk must continue to calculate the

standard specific risk capital charge and

add that charge to its VAR-based capital

charge to produce its total regulatory

capital requirement for market risk. An

institution whose internal model

adequately captures specific risk may

base its specific risk capital charge on

the model’s estimates.

The Agencies will review an

institution’s internal model to ensure

that the model adequately measures

specific risk. In order to clarify the risks

that must be assessed in this regard, the

rule contains a new definition that

states that specific risk means the

changes in market value of specific

positions due to factors other than broad

market movements, including such risks

as idiosyncratic variation as well as

event and default risk. In order to

adequately capture specific risk, an

institution’s internal model must

explain the historical price variation in

the portfolio and be sensitive to changes

in portfolio concentrations (both

magnitude and changes in composition),

requiring additional capital for greater

concentrations. The Agencies will also

take into account whether an internal

model is robust to an adverse

environment. The model’s ability to

capture specific risk must be validated

through backtesting aimed at assessing

whether specific risk is adequately

captured. In addition, the institution

must be able to demonstrate that its

methodologies adequately capture event

and default risk. An institution that has

been able to demonstrate to its

supervisor that its internal model

adequately captures specific risk

consistent with the preceding

discussion may use its VAR-based

capital charge as its measure for market

risk. Such an institution will have no

specific risk add-on.

An institution whose model addresses

idiosyncratic risk but does not

adequately capture event and default

risk will continue to have a specific risk

add-on. The specific risk add-on for

such an institution may be calculated

using either one of two approaches, both

of which have the effect of subjecting

the modeled specific risk elements of

the institution’s internal risk model to a

multiplier of four.4

Under the first approach, an

institution’s internal model must be able

to separate its VAR measure into general

market risk and specific risk

components. The institution’s measure

for market risk would equal the sum of

the total VAR-based capital charge

(typically three times the internal

model’s general and specific risk

measure), plus an add-on consisting of

the isolated specific risk component of

the VAR measure. Alternatively, an

institution whose internal model does

not separately identify the specific and

general market risk of its VAR measure,

may use as its measure for market risk

the sum of the total VAR-based capital

charge, plus an add-on consisting of the

VAR measure(s) of the subportfolios of

debt and equity positions that contain

specific risk. An institution using this

approach normally would identify its

sub-portfolio structures prior to

calculating market risk capital charges

and may not alter those sub-portfolio

structures without supervisory

consultation.

An institution using its internal

model for specific risk capital purposes

must backtest its internal model to

assess whether observed price variation

arising from both general market risk

and specific risk are accurately
68066 Federal Register / Vol. 62, No. 249 / Tuesday, December 30, 1997 / Rules and Regulations

explained by the model. To assist in

model validation, the institution should

perform backtests on subportfolios

containing specific risk, i.e., traded debt

and equity positions. The institution

should conduct these backtests with the

understanding that subportfolio

backtesting is a productive mechanism

for assuring that instruments with

higher levels of specific risk, especially

event or default risk, are being

accurately modeled. If backtests of

subportfolios reflect an unacceptable

internal model, especially for

unexplained price variation that may be

arising from specific risk, the institution

should take immediate action to

improve the internal model and ensure

that it has sufficient capital to protect

against associated risks.

The Agencies, based on information

available to them, presently feel that the

industry is making significant progress

in developing methodologies for

modeling specific risk, although

progress relating to measurement of

event and default risk lags somewhat.

The Agencies’ consultation over the past

two years with other national

supervisors on the Committee has

supported this view. The Agencies

expect institutions to continue

improving their internal models and

particularly to make substantial progress

in measuring event and default risk for

traded debt and equity instruments. The

Agencies intend to work with the

industry in these efforts and believe

that, over time, market standards for

measuring event and default risk will

emerge. As individual modeling

methodologies are improved and

become accepted within the industry as

effective measurement techniques for

event and default risk, the Agencies will

consider permitting all internal models

based on that methodology to be applied

without any add-on charge. The Basle

Supervisors Committee may issue

general guidance for capturing event

and default risk for trading book

instruments. Until such time as

standards for measuring event and

default risk are established within the

industry, the Agencies intend to

cooperate with each other and

communicate extensively with other

international supervisors to ensure that

the market risk capital requirements are

implemented in an appropriate and

consistent manner.

The Agencies request comment on all

aspects of these amendments to their

market risk rules.

Interim Effectiveness of the Rule

The Agencies’ amendments to their

market risk rules are effective on

December 31, 1997, but only on an

interim basis during the Agencies’ full

notice and comment rulemaking

process. Section 553 of the

Administrative Procedure Act permits

the Agencies to issue a rule without

public notice and comment when the

agency, for good cause, finds (and

incorporates the finding and a brief

statement of reasons therefore in the

rules issued) that notice and public

procedure thereon are impracticable,

unnecessary, or contrary to the public

interest. 5 U.S.C. 553(b)(B). Section 553

also permits the Agencies to issue a rule

without delaying its effectiveness for

thirty days from the publication if the

agency finds good cause and publishes

it with the rule. 5 U.S.C. 553(d)(3). In

addition, section 302 of the Riegle

Community Development and

Regulatory Improvement Act of 1994, 12

U.S.C. 4802(b), permits the Agencies to

issue a regulation which takes effect

before the first day of a calendar quarter

beginning on or after the date on which

the regulations are published in final

form when the agency determines for

good cause published with the

regulation that the regulation should

become effective before such time. The

Agencies have found that good cause

exists, for several reasons.

First, the amendments are extremely

limited in scope. The number of

institutions subject to the Agencies’

market risk rules, and consequently to

the amendments, is very small, in both

absolute and relative terms. The

amendments will serve only to reduce

regulatory burden, by eliminating the

need for institutions that model specific

risk to make dual calculations under the

standardized approach in order to

determine their minimum specific risk

charge. Such calculations, while not

necessarily difficult from an analytical

standpoint, are a voluminous and

detailed operation to execute.

Second, immediate effectiveness of

the amendments is necessary. The

market risk rules become mandatory for

certain institutions in January of 1998,

and the Agencies will not be able to

complete the full rulemaking process by

that time. Institutions covered by the

market risk rule that model specific risk

would be needlessly forced to commit

significant internal resources to

implement the dual calculation

approach potentially on a temporary

basis. Contrary to the public interest,

they could also be placed at a

competitive disadvantage vis a vis their

competitors (internationally-active

banks in other G–10 countries) who,

because of the recent G–10 Governors’

endorsement of the Committee’s new

approach, will not be subject to any

dual calculation requirement.

Regulatory Flexibility Act Analysis

Pursuant to section 605(b) of the

Regulatory Flexibility Act, the Agencies

have determined that this interim final

rule would not have a significant

economic impact on a substantial

number of small entities within the

meaning of the Regulatory Flexibility

Act (5 U.S.C. 601 et seq.). The Agencies’

comparison of the applicability section

of the rule to which these amendments

pertain to Consolidated Reports of

Condition and Income (Call Report) data

on all existing institutions shows that

the rule will rarely, if ever, apply to

small entities. Accordingly, a regulatory

flexibility analysis is not required.

Paperwork Reduction Act

The Agencies have determined that

the interim final rule does not involve

a collection of information pursuant to

the provisions of the Paperwork

Reduction Act of 1995 (44 U.S.C. 3501

et seq.).

OCC Executive Order 12866

Determination

The OCC has determined that the

interim final rule does not constitute a

‘‘significant regulatory action’’ for the

purpose of Executive Order 12866.

OCC Unfunded Mandates Reform Act of

1995 Determination

Section 202 of the Unfunded

Mandates Reform Act of 1995, Public

Law 104–4 (Unfunded Mandates Act)

requires that an agency prepare a

budgetary impact statement before

promulgating a rule that includes a

Federal mandate that may result in

expenditure by State, local, and tribal

governments, in the aggregate, or by the

private sector, of $100 million or more

in any one year. If a budgetary impact

statement is required, section 205 of the

Unfunded Mandates Act also requires

an agency to identify and consider a

reasonable number of regulatory

alternatives before promulgating a rule.

As discussed in the preamble, this

interim rule eliminates the minimum

specific risk charge for institutions that

use internal models that adequately

capture specific risk. The effect of this

rule is to reduce regulatory burden by

no longer requiring institutions to make

dual calculations under both the

institution’s internal model and the

standardized specific risk model. The

OCC therefore has determined that the

effect of the interim rule on national

banks as a whole will not result in

expenditures by State, local, or tribal

governments or by the private sector of

$100 million or more. Accordingly, the

OCC has not prepared a budgetary

impact statement or specifically
Federal Register / Vol. 62, No. 249 / Tuesday, December 30, 1997 / Rules and Regulations 68067

1This appendix is based on a framework

developed jointly by supervisory authorities from

the countries represented on the Basle Committee

on Banking Supervision and endorsed by the Group

of Ten Central Bank Governors. The framework is

described in a Basle Committee paper entitled

‘‘Amendment to the Capital Accord to Incorporate

Market Risks,’’ January 1996. Also see

modifications issued in September 1997.

addressed the regulatory alternatives

considered.

List of Subjects

12 CFR Part 3

Administrative practice and

procedure, Capital, National banks,

Reporting and recordkeeping

requirements, Risk.

12 CFR Part 208

Accounting, Agriculture, Banks,

banking, Confidential business

information, Crime, Currency, Federal

Reserve System, Mortgages, Reporting

and recordkeeping requirements,

Securities.

12 CFR Part 225

Administrative practice and

procedure, Banks, banking, Federal

Reserve System, Holding companies,

Reporting and recordkeeping

requirements, Securities.

12 CFR Part 325

Bank deposit insurance, Banks,

banking, Capital adequacy, Reporting

and recordkeeping requirements,

Savings associations, State non-member

banks.

Authority and Issuance

Office of the Comptroller of the

Currency

12 CFR Chapter I

For the reasons set out in the joint

preamble, part 3 of chapter I of title 12

of the Code of Federal Regulations is

amended as set forth below:

PART 3—MINIMUM CAPITAL RATIOS;

ISSUANCE OF DIRECTIVES

1. The authority citation for part 3

continues to read as follows:

Authority: 12 U.S.C. 93a, 161, 1818,

1828(n), 1828 note, 1831n note, 1835, 3907,

and 3909.

2. Section 2 of Appendix B to part 3

is amended by revising paragraph (b)(2)

to read as follows:

Appendix B To Part 3—Risk-Based

Capital Guidelines; Market Risk

Adjustment

* * * * *

Section 2. Definitions

* * * * *

(b) * * *

(2) Specific risk means changes in the

market value of specific positions due to

factors other than broad market movements

and includes default and event risk as well

as idiosyncratic variations.

* * * * *

3. Section 5 of appendix B to part 3

is amended by revising paragraphs (a)

and (b) to read as follows:

* * * * *

Section 5. Specific Risk

(a) Specific risk surcharge. For purposes of

section 3(a)(2)(ii) of this appendix, a bank

shall calculate its specific risk surcharge as

follows:

(1) Internal models that incorporate

specific risk. (i) No specific risk surcharge

required for qualifying internal models. A

bank that incorporates specific risk in its

internal model has no specific risk surcharge

for purposes of section 3(a)(2)(ii) of this

appendix if the bank demonstrates to the

OCC that its internal model adequately

measures all aspects of specific risk,

including default and event risk, of covered

debt and equity positions. In evaluating a

bank’s internal model the OCC will take into

account the extent to which the internal

model:

(A) Explains the historical price variation

in the trading portfolio; and

(B) Captures concentrations.

(ii) Specific risk surcharge for modeled

specific risk that fails to adequately measure

default or event risk. A bank that

incorporates specific risk in its internal

model but fails to demonstrate that its

internal model adequately measures all

aspects of specific risk, including default and

event risk, as provided by this section 5(a)(1),

must calculate its specific risk surcharge in

accordance with one of the following

methods:

(A) If the bank’s internal model separates

the VAR measure into a specific risk portion

and a general market risk portion, then the

specific risk surcharge equals the previous

day’s specific risk portion.

(B) If the bank’s internal model does not

separate the VAR measure into a specific risk

portion and a general market risk portion,

then the specific risk surcharge equals the

sum of the previous day’s VAR measure for

subportfolios of covered debt and equity

positions.

(2) Specific risk surcharge for specific risk

not modeled. If a bank does not model

specific risk in accordance with section

5(a)(1) of this appendix, then the bank shall

calculate its specific risk surcharge using the

standard specific risk capital charge in

accordance with section 5(c) of this

appendix.

(b) Covered debt and equity positions. If a

model includes the specific risk of covered

debt positions but not covered equity

positions (or vice versa), then the bank may

reduce its specific risk charge for the

included positions under section 5(a)(1)(ii) of

this appendix. The specific risk charge for

the positions not included equals the

standard specific risk capital charge under

paragraph (c) of this section.

* * * * *

Dated: December 19, 1997.

Eugene A. Ludwig,

Comptroller of the Currency.

Federal Reserve System

12 CFR Chapter II

For the reasons set forth in the joint

preamble, parts 208 and 225 of chapter

II of title 12 of the Code of Federal

Regulations are amended as follows:

PART 208—MEMBERSHIP OF STATE

BANKING INSTITUTIONS IN THE

FEDERAL RESERVE SYSTEM

(REGULATION H)

1. The authority citation for part 208

continues to read as follows:

Authority: 12 U.S.C. 24, 36, 92(a), 93(a)

248(a), 248(c), 321–338a, 371d, 461, 481–486,

601, 611, 1814, 1816, 1818, 1820(d)(9),

1823(j), 1828(o), 1831, 1831o, 1831p–1,

1831r–1, 1835(a), 1882, 2901–2907, 3105,

3310, 3331–3351, and 3906–3909; 15 U.S.C.

78b, 781(b), 781(g), 781(i), 78o–4(c)(5), 78q,

78q–1, and 78w; 31 U.S.C. 5318; 42 U.S.C.

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

2. In appendix E to part 208, section

1., paragraph (a), footnote 1 is revised to

read as follows:

Appendix E to Part 208—Capital

Adequacy Guidelines for State Member

Banks; Market Risk Measure

Section 1. Purpose, Applicability, Scope, and

Effective Date

(a) * * * 1 * * *

* * * * *

3. In appendix E to part 208, section

2., paragraph (b)(2) is revised to read as

follows:

* * * * *

Section 2. Definitions

* * * * *

(b) * * *

(2) Specific risk means changes in the

market value of specific positions due to

factors other than broad market

movements. Specific risk includes such

risk as idiosyncratic variation, as well as

event and default risk.

* * * * *

4. In appendix E to part 208, section

5., paragraphs (a), (b), and (c)

introductory text are revised to read as

follows:

* * * * *
68068 Federal Register / Vol. 62, No. 249 / Tuesday, December 30, 1997 / Rules and Regulations

1 This appendix is based on a framework

developed jointly by supervisory authorities from

the countries represented on the Basle Committee

on Banking Supervision and endorsed by the Group

of Ten Central Bank Governors. The framework is

described in a Basle Committee paper entitled

‘‘Amendment to the Capital Accord to Incorporate

Market Risks,’’ January 1996. Also see

modifications issued in September 1997.

1This appendix is based on a framework

developed jointly by supervisory authorities from

the countries represented on the Basle Committee

on Banking Supervision and endorsed by the Group

of Ten Central Bank Governors. The framework is

described in a Basle Committee paper entitled

‘‘Amendment to the Capital Accord to Incorporate

Market Risks,’’ January 1996. Also see

modifications issued in September 1997.

Section 5. Specific Risk

(a) Modeled specific risk A bank may use

its internal model to measure specific risk. If

the bank has demonstrated to the Federal

Reserve that its internal model measures the

specific risk, including event and default risk

as well as idiosyncratic variation, of covered

debt and equity positions and includes the

specific risk measures in the VAR-based

capital charge in section 3(a)(2)(i) of this

appendix, then the bank has no specific risk

add-on for purposes of section 3(a)(2)(ii) of

this appendix. The model should explain the

historical price variation in the trading

portfolio and capture concentration, both

magnitude and changes in composition. The

model should also be robust to an adverse

environment and have been validated

through backtesting which assesses whether

specific risk is being accurately captured.

(b) Add-on charge for modeled specific

risk. If a bank’s model measures specific risk,

but the bank has not been able to

demonstrate to the Federal Reserve that the

model adequately measures event and default

risk for covered debt and equity positions,

then the bank’s specific risk add-on is

determined as follows:

(1) If the model is susceptible to valid

separation of the VAR measure into a specific

risk portion and a general market risk

portion, then the specific risk add-on is equal

to the previous day’s specific risk portion.

(2) If the model does not separate the VAR

measure into a specific risk portion and a

general market risk portion, then the specific

risk add-on is the sum of the previous day’s

VAR measures for subportfolios of covered

debt and covered equity positions.

(c) Add-on charge if specific risk is not

modeled. If a bank does not model specific

risk in accordance with paragraph (a) or (b)

of this section, then the bank’s specific risk

add-on charge equals the components for

covered debt and equity positions as

appropriate:

* * * * *

PART 225—BANK HOLDING

COMPANIES AND CHANGE IN BANK

CONTROL (REGULATION Y)

1. The authority citation for part 225

continues to read as follows:

Authority: 12 U.S.C. 1817(j)(13), 1818,

1828(o), 1831i, 1831p-1, 1843(c)(8), 1844(b),

1972(1), 3106, 3108, 3310, 3331–3351, 3907,

and 3909.

2. In appendix E to part 225, the

appendix heading is revised and in

section 1., paragraph (a), footnote 1 is

revised to read as follows:

Appendix E To Part 225—Capital

Adequacy Guidelines For Bank Holding

Companies: Market Risk Measure

Section 1. Purpose, Applicability, Scope, and

Effective Date

(a) * * * 1 * * *

* * * * *

3. In appendix E to part 225, section

2., paragraph (b)(2) is revised to read as

follows:

* * * * *

Section 2. Definitions

* * * * *

(b) * * *

(2) Specific risk. means changes in the

market value of specific positions due to

factors other than broad market movements.

Specific risk includes such risk as

idiosyncratic variation, as well as event and

default risk.

* * * * *

4. In appendix E to part 225, section

5., paragraphs (a), (b), and (c)

introductory text are revised to read as

follows:

* * * * *

Section 5. Specific Risk

(a) Modeled specific risk. A bank holding

company may use its internal model to

measure specific risk. If the institution has

demonstrated to the Federal Reserve that its

internal model measures the specific risk,

including event and default risk as well as

idiosyncratic variation, of covered debt and

equity positions and includes the specific

risk measures in the VAR-based capital

charge in section 3(a)(2)(i) of this appendix,

then the institution has no specific risk addon for purposes of section 3(a)(2)(ii) of this

appendix. The model should explain the

historical price variation in the trading

portfolio and capture concentration, both

magnitude and changes in composition. The

model should also be robust to an adverse

environment and have been validated

through backtesting which assesses whether

specific risk is being accurately captured.

(b) Add-on charge for modeled specific

risk. If a bank holding company’s model

measures specific risk, but the institution has

not been able to demonstrate to the Federal

Reserve that the model adequately measures

event and default risk for covered debt and

equity positions, then the institution’s

specific risk add-on is determined as follows:

(1) If the model is susceptible to valid

separation of the VAR measure into a specific

risk portion and a general market risk

portion, then the specific risk add-on is equal

to the previous day’s specific risk portion.

(2) If the model does not separate the VAR

measure into a specific risk portion and a

general market risk portion, then the specific

risk add-on is the sum of the previous day’s

VAR measures for subportfolios of covered

debt and covered equity positions.

(c) Add-on charge if specific risk is not

modeled. If a bank holding company does not

model specific risk in accordance with

paragraph (a) or (b) of this section, then the

institution’s specific risk add-on charge

equals the components for covered debt and

equity positions as appropriate:

* * * * *

By order of the Board of Governors of the

Federal Reserve System, December 19, 1997.

William W. Wiles,

Secretary of the Board.

Federal Deposit Insurance Corporation

12 CFR Chapter III

For the reasons set forth in the joint

preamble, part 325 of chapter III of title

12 of the Code of Federal Regulations is

amended as follows:

PART 325—CAPITAL MAINTENANCE

1. The authority citation for part 325

continues to read as follows:

Authority: 12 U.S.C. 1815(a), 1815(b),

1816, 1818(a), 1818(b), 1818(c), 1818(t),

1819(Tenth), 1828(c), 1828(d), 1828(i),

1828(n), 1828(o), 1831o, 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, 2386 (12 U.S.C.

1828 note).

2. In appendix C to part 325, section

1(a), footnote 1 is revised to read as

follows:

Appendix C to Part 325—Risk-Based

Capital For State Non-Member Banks;

Market Risk

Section 1. Purpose, Applicability, Scope, and

Effective Date

(a) * * * 1 * * *

* * * * *

3. In appendix C to part 325, section

2., paragraph (b)(2) is revised to read as

follows:

* * * * *

Section 2. Definitions

* * * * *

(b) * * *

(2) Specific risk means changes in the

market value of specific positions due to

factors other than broad market movements.

Specific risk includes such risk as

idiosyncratic variation, as well as event and

default risk.

* * * * *

4. In appendix C to part 325, section

5., paragraphs (a), (b), and (c)

introductory text are revised to read as

follows:

* * * * *

Section 5. Specific Risk

(a) Modeled specific risk. A bank may use

its internal model to measure specific risk. If
Federal Register / Vol. 62, No. 249 / Tuesday, December 30, 1997 / Rules and Regulations 68069

the bank has demonstrated to the FDIC that

its internal model measures the specific risk,

including event and default risk as well as

idiosyncratic variation, of covered debt and

equity positions and includes the specific

risk measure in the VAR-based capital charge

in section 3(a)(2)(i) of this appendix, then the

bank has no specific risk add-on for purposes

of section 3(a)(2)(ii) of this appendix. The

model should explain the historical price

variation in the trading portfolio and capture

concentration, both magnitude and changes

in composition. The model should also be

robust to an adverse environment and have

been validated through backtesting which

assesses whether specific risk is being

accurately captured.

(b) Add-on charge for modeled specific

risk. If a bank’s model measures specific risk,

but the bank has not been able to

demonstrate to the FDIC that the model

adequately measures event and default risk

for covered debt and equity positions, then

the bank’s specific risk add-on for purposes

of section 3(a)(2)(ii) of this appendix is as

follows:

(1) If the model is susceptible to valid

separation of the VAR measure into a specific

risk portion and a general market risk

portion, then the specific risk add-on is equal

to the previous day’s specific risk portion.

(2) If the model does not separate the VAR

measure into a specific risk portion and a

general market risk portion, then the specific

risk add-on is the sum of the previous day’s

VAR measures for subportfolios of covered

debt and covered equity positions.

(c) Add-on charge if specific risk is not

modeled. If a bank does not model specific

risk in accordance with paragraph (a) or (b)

of this section, the bank’s specific risk addon charge for purposes of section 3(a)(2)(ii)

of this appendix equals the components for

covered debt and equity positions as

appropriate:

* * * * *

Dated at Washington, D.C. this 9th day of

December, 1997.

By order of the Board of Directors.

Federal Deposit Insurance Corporation.

Robert E. Feldman,

Executive Secretary.

[FR Doc. 97–33653 Filed 12–29–97; 8:45 am]

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