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Home > News & Events > Financial Institution Letters




Financial Institution Letters


[Federal Register: April 19, 1999 (Volume 64, Number 74)]
[Rules and Regulations]               
[Page 19034-19039]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr19ap99-4]

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DEPARTMENT OF THE TREASURY

Office of the Comptroller of the Currency

12 CFR Part 3

[Docket No. 99-04]
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 final rule.

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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 
adopting as a final rule an interim rule amending their respective 
risk-based capital standards for market risk applicable to

[[Page 19035]]

certain banks and bank holding companies with significant trading 
activities. The interim rule implemented a revision to the Basle Accord 
adopted in 1997. Prior to the revision, an institution that measured 
specific risk with an internal model that adequately measured such risk 
was subject to a minimum capital charge. An institution's capital 
charge for specific risk had to be at least as large as 50 percent of a 
specific risk charge calculated using the standardized approach. The 
rule will finalize the interim rule, which reduced regulatory burden 
for institutions with qualifying internal models because they no longer 
must calculate a standardized specific risk capital charge.

EFFECTIVE DATE: This final rule is effective on July 1, 1999.

FOR FURTHER INFORMATION CONTACT: OCC: Margot Schwadron, Risk Expert 
(202/874-5070), Amrit Sekhon, Risk Specialist (202/874-5070), Capital 
Policy Division; or Ronald Shimabukuro, Senior Attorney (202/874-5090), 
Legislative and Regulatory Activities Division, Office of the 
Comptroller of the Currency, 250 E Street, S.W., Washington, DC 20219.
    Board: James Houpt, Deputy Associate Director (202/452-3358), 
Barbara Bouchard, Manager (202/452-3072), T. Kirk Odegard, Financial 
Analyst (202/530-6225), Division of Banking Supervision; or Stephanie 
Martin, Senior Counsel (202/452-3198), Mark E. Van Der Weide, Attorney 
(202/452-2263), Legal Division. For the hearing impaired only, 
Telecommunication Device for the Deaf (TDD), Diane Jenkins (202/452-
3544), Board of Governors of the Federal Reserve System, 20th and C 
Streets, N.W., Washington, DC 20551.
    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; for legal issues, Jamey Basham, Counsel (202/
898-7265), Legal Division, Federal Deposit Insurance Corporation, 550 
17th Street, N.W., Washington, DC 20429.

SUPPLEMENTARY INFORMATION:

I. 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 (Basle 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 
general counterparty credit risk.1 In December 1995, the G-
10 Governors endorsed the Basle Committee's amendment to the Accord 
(effective by year-end 1997) to incorporate a measure for exposure to 
market risk (market risk amendment) into the capital adequacy 
assessment. On September 6, 1996, the agencies issued revisions to 
their risk-based capital standards implementing the Basle Committee's 
market risk amendment (market risk rules) (61 FR 47358). In September 
1997, the Basle Committee modified the market risk amendment and on 
December 30, 1997, the agencies issued an interim rule implementing 
that modification (62 FR 68064).
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    \1\ The G-10 countries are Belgium, Canada, France, Germany, 
Italy, Japan, Netherlands, Sweden, Switzerland, the United Kingdom, 
and the United States. The Basle Committee is comprised of 
representatives of the central banks and supervisory authorities 
from the G-10 countries and Luxembourg.
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    Under the agencies' market risk rules, banks and bank holding 
companies (institutions) with significant trading activities must 
measure and hold capital for exposure to both general market risk and 
specific risk. General market risk refers to changes in the market 
value of on-and off-balance-sheet items resulting from broad market 
movements in interest rates, equity prices, foreign exchange rates, and 
commodity prices. An institution must measure its general market risk 
using its internal risk measurement model, subject to certain 
qualitative and quantitative criteria, to calculate a capital charge 
based on the model-determined value-at-risk (VAR).2
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    \2\ The 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 of three. Beginning no later than one year after becoming 
subject to 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.
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    Specific risk refers to changes in the market value of individual 
debt and equity positions in a trading portfolio due to factors other 
than broad market movements. Under the agencies' market risk rules, an 
institution may measure its specific risk by using either the 
standardized approach 3 or its own internal model, if the 
institution can demonstrate to the appropriate banking agency that the 
model adequately measures specific risk. When the agencies initially 
adopted the market risk rules, an institution using its internal model 
to measure specific risk was required to hold capital for specific risk 
equal to at least 50 percent of the specific risk charge calculated 
using the standardized approach (the minimum specific risk charge). If 
the portion of the institution's VAR attributable to specific risk did 
not equal the minimum specific risk charge, the institution's VAR-based 
capital charge was subject to an add-on charge of the difference 
between the two. In practice, this required an institution employing an 
internal model to measure specific risk to also calculate the specific 
risk charge using the standardized approach.
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    \3\ The standardized approach applies a risk-weighting process 
developed by the Basle Committee to individual financial 
instruments. Under this approach, debt and equity instruments in the 
institution's trading account are assessed a category-based fixed 
capital charge.
---------------------------------------------------------------------------

    When the agencies included the minimum specific risk charge as part 
of the market risk rules, they recognized that dual calculations of 
specific risk--that is, calculating specific risk with internal models 
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 Basle Committee's belief that a minimum charge was necessary 
to ensure that modeling techniques for specific risk adequately 
measured that risk. After the Basle Committee adopted the market risk 
amendment, many institutions improved their modeling techniques and, in 
particular, their modeling of specific risk. Recognizing these 
improvements, in September 1997 the Basle Committee decided to 
eliminate the use of the minimum specific risk charge and the burden of 
a separate calculation. The Basle Committee revised the market risk 
amendment so that an institution using a valid internal model to 
measure specific risk could use the VAR measures generated by the model 
without comparing the model-generated results to the minimum specific 
risk charge calculated under the standardized approach.4 The 
revisions specified that the specific risk elements of internal models 
would be assessed consistently with the assessment of the general 
market risk elements of such models through backtesting and review by 
the relevant agency.
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    \4\ The 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.
---------------------------------------------------------------------------

    To implement this revision to the market risk amendment, the 
agencies

[[Page 19036]]

issued an interim rule with a request for comment (62 FR 68064) in 
December 1997. As discussed in the interim rule, the agencies found 
sufficient good cause to make the amendments effective immediately, 
without prior opportunity for public comment or a delayed effective 
date. The interim rule applied only to the calculation of specific risk 
under the market risk rules, and all other aspects of the market risk 
rules remained unchanged.

II. Comments Received

    The agencies received a total of three public comments on the 
interim rule (two from industry trade associations and one from a 
financial institution). All three commenters supported the interim 
rule, primarily because of its reduction of regulatory burden. None of 
the commenters suggested any changes to the interim rule.

III. Final Rule

    The agencies are adopting in final form, without substantive 
change, the interim rule eliminating 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. This final rule does not apply 
to institutions that use the standardized method to calculate specific 
risk.
    For those institutions using internal models to calculate their 
specific risk charges, the agencies will continue to review the 
internal models to determine whether or not they adequately measure 
specific risk. In reviewing these internal models, the agencies will 
evaluate the extent to which the internal models adequately capture 
idiosyncratic price variations of debt and equity instruments due to 
circumstances unique to the issuer, as well as the instruments' 
exposure to event and default risk. In order to capture specific risk 
adequately, an institution's internal model must explain the historical 
price variation in the portfolio. Internal models must also be 
sensitive to changes in portfolio concentrations (both magnitude and 
changes in composition), and require additional capital for greater 
concentrations. The agencies likewise will take into account whether an 
internal model is sensitive to an adverse environment. If an 
institution's internal model adequately captures specific risk, the 
institution may base its specific risk capital charge on the internal 
model's estimates.
    If an institution's internal model does not adequately measure 
specific risk, the institution must continue to calculate the standard 
specific risk capital charge and add that charge to its VAR-based 
capital charge for general market risk to produce its total regulatory 
capital requirement for market risk. If an institution's internal model 
adequately addresses idiosyncratic risk but does not adequately capture 
all other aspects of specific risk, including event and default risk, 
the institution may use its internal model to calculate specific risk, 
but it will have a ``specific risk add-on.'' The specific risk add-on 
may be calculated using either one of two approaches, both of which 
have the effect of subjecting the modeled specific risk to a minimum 
multiplier of four.5
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    \5\ The 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.
---------------------------------------------------------------------------

    Under the first approach, an institution whose internal model is 
able to separate its VAR measure into general market risk and specific 
risk components must use as its measure for market risk 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. Under the second 
approach, an institution whose internal model does not separately 
identify the specific and general market risk components of its VAR 
measure must use as its measure for market risk the total VAR-based 
capital charge, plus an add-on consisting of the VAR measures of the 
subportfolios of debt and equity positions that contain specific risk. 
An institution using the second approach may not alter its subportfolio 
structures for the sole purpose of decreasing its VAR measure.
    An institution using its internal model for specific risk capital 
purposes must backtest the model to assess whether the model accurately 
explains observed price variations arising from both general market 
risk and specific risk. To assist in internal model validation, the 
institution should perform backtests on its traded debt and equity 
subportfolios that contain specific risk. 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 modeled accurately. If subportfolio backtests indicate 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 expect institutions to continue improving their 
internal models, particularly with respect to 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 methods are improved and become accepted 
within the industry as effective measurement techniques for event and 
default risk, the agencies will consider permitting such models to be 
applied without any add-on charge. The Basle 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.

IV. Changes From the Interim Rule

    In adopting the final rule, the Board and FDIC made certain wording 
changes. These changes do not alter the effect or substance of the 
final rule, and only conform or clarify the language.
    First, both the Board and the FDIC changed their language which 
states that a bank that incorporates specific risk into its internal 
model but fails to demonstrate that its internal model adequately 
measures all aspects of specific risk may use its internal model to 
calculate specific risk subject to a ``specific risk add-on.'' This 
change was made to make the agencies' language more consistent. Second, 
the Board and the FDIC conformed their definition of ``specific risk'' 
to be more consistent with the OCC's language. Third, the FDIC has 
changed paragraph (c) of Appendix C of Part 325 Section 5 to clarify 
that, when an institution models the specific risk of either its 
covered debt positions or its covered equity positions, but not both 
components, the capital treatment specified for modeled specific risk 
will apply as to the modeled component, and the standardized approach 
will apply as to the non-modeled component. The add-on charge will 
consist of the specific risk charge determined under the

[[Page 19037]]

standardized approach for the non-modeled component, plus the specific 
risk add-on, if any, for the modeled component (because the model does 
not adequately measure event and default risk). The FDIC's change in 
this regard is technical. The language of the interim rule also 
effectuated this approach, but the changes make it clearer to the 
reader.

V. Regulatory Flexibility Act Analysis

    Pursuant to section 603 of the Regulatory Flexibility Act (RFA), 
RFA does not apply if any agency is not required to issue a Notice of 
Proposed Rulemaking. Nevertheless, the agencies have considered the 
impact of this final rule and determined that it will 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 final rule will rarely, if ever, apply to small entities. 
Moreover, this final rule reduces 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.

VI. Paperwork Reduction Act

    The agencies have determined that the 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.).

VII. Small Business Regulatory Enforcement Fairness Act

    The Small Business Regulatory Enforcement Fairness Act of 1996 
(SBREFA) (Title II, Pub. L. 1004-121) provides generally for agencies 
to report rules to Congress for review. The reporting requirement is 
triggered when a federal agency issues a final rule. Accordingly, the 
agencies filed the appropriate reports with Congress as required by 
SBREFA.
    The Office of Management and Budget has determined that these final 
rules do not constitute ``major rules'' as defined by SBREFA.

VIII. OCC Executive Order 12866 Determination

    The OCC has determined that the final rule does not constitute a 
``significant regulatory action'' for the purpose of Executive Order 
12866.

IX. OCC Unfunded Mandates Reform Act of 1995 Determination

    Section 202 of the Unfunded Mandates Reform Act of 1995, Pub. L. 
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 final rule eliminates the minimum specific risk charge for 
institutions that use internal models that adequately capture specific 
risk. The effect of this final 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 final 
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 addressed the regulatory alternatives 
considered.

X. FDIC Assessment of Impact of Federal Regulation on Families

    The FDIC has determined that this final rule will not affect family 
well-being within the meaning of section 654 of the Treasury and 
General Government Appropriations Act of 1999 (Pub. Law 105-277).

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, the OCC's portion of 
the joint interim rule with request for comment amending 12 CFR part 3 
titled Risk-Based Capital Standards: Market Risk, published on December 
30, 1997, at 62 FR 68067 is adopted as final without change.

    Dated: March 24, 1999.
John D. Hawke, Jr.,
Comptroller of the Currency.

Federal Reserve System

12 CFR Chapter II

    For the reasons set forth in the joint preamble, the Board's 
portion of the joint interim rule with request for comment, amending 12 
CFR parts 208 and 225, published on December 30, 1997, at 62 FR 68067 
is adopted as final with the following changes:

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, 92a, 93a, 248(a), 248(c), 321-338a, 
371d, 461, 481-486, 601, 611, 1814, 1816, 1818, 1823(j), 1828(o), 
1831o, 1831p-1, 1831r-1, 1835a, 1882, 2901-2907, 3105, 3310, 3331-
3351, and 3906-3909; 15 U.S.C. 78b, 78l(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, the appendix heading is revised to 
read as follows:

Appendix E to Part 208--Capital Adequacy Guidelines for State 
Member Banks; Market Risk Measure

    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 and 
includes event and default risk as well as idiosyncratic variations.
* * * * *
    4. In Appendix E to part 208, section 5., paragraphs (a), (b), and 
the

[[Page 19038]]

introductory text of paragraph (c) 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 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) Partially modeled specific risk. (1) A bank that 
incorporates specific risk in its internal model but fails to 
demonstrate to the Federal Reserve that its internal model 
adequately measures all aspects of specific risk for covered debt 
and equity positions, including event and default risk, as provided 
by section 5(a), of this appendix must calculate its specific risk 
add-on in accordance with one of the following methods:
    (i) 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.
    (ii) 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 equity positions that contain 
specific risk.
    (2) If a bank models the specific risk of covered debt positions 
but not covered equity positions (or vice versa), then the bank may 
determine its specific risk charge for the included positions under 
section 5(a) or 5(b)(1) of this appendix, as appropriate. The 
specific risk charge for the positions not included equals the 
standard specific risk capital charge under paragraph (c) of this 
section.
    (c) Specific risk not modeled. If a bank does not model specific 
risk in accordance with section 5(a) or 5(b) of this appendix, then 
the bank's specific risk capital charge shall equal the standard 
specific risk capital charge, calculated as follows:
* * * * *

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 to 
read as follows:

Appendix E to Part 225--Capital Adequacy Guidelines for Bank 
Holding Companies: Market Risk Measure

    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 and 
includes event and default risk as well as idiosyncratic variations.
* * * * *
    4. In appendix E to part 225, section 5., paragraphs (a), (b), and 
the introductory text of paragraph (c) 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 organization 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 organization 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) Partially modeled specific risk. (1) A bank holding company 
that incorporates specific risk in its internal model but fails to 
demonstrate to the Federal Reserve that its internal model 
adequately measures all aspects of specific risk for covered debt 
and equity positions, including event and default risk, as provided 
by section 5(a) of this appendix, must calculate its specific risk 
add-on in accordance with one of the following methods:
    (i) 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.
    (ii) 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 equity positions that contain 
specific risk.
    (2) If a bank holding company models the specific risk of 
covered debt positions but not covered equity positions (or vice 
versa), then the bank holding company may determine its specific 
risk charge for the included positions under section 5(a) or 5(b)(1) 
of this appendix, as appropriate. The specific risk charge for the 
positions not included equals the standard specific risk capital 
charge under paragraph (c) of this section.
    (c) Specific risk not modeled. If a bank holding company does 
not model specific risk in accordance with section 5(a) or 5(b) of 
this appendix, then the organization's specific risk capital charge 
shall equal the standard specific risk capital charge, calculated as 
follows:
* * * * *
    By order of the Board of Governors of the Federal Reserve 
System, April 7, 1999.
Jennifer J. Johnson,
Secretary of the Board.

Federal Deposit Insurance Corporation

12 CFR Chapter III

    For the reasons set forth in the joint preamble, FDIC's portion of 
the joint interim final rule with request for comment amending 12 CFR 
part 325, published December 30, 1997, at 62 FR 66068 is adopted as 
final with the following changes:

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, the appendix heading is revised to 
read as follows:

Appendix C to Part 325--Risk-Based Capital for State Non-Member 
Banks: Market Risk

    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 and 
includes event and default risk as well as idiosyncratic variations.
* * * * *
    4. In appendix C to part 325, section 5., paragraphs (a), (b), and 
(c) introductory text are revised to read as follows:
* * * * *

[[Page 19039]]

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 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. A bank that 
incorporates specific risk in its internal model but fails to 
demonstrate to the FDIC that its internal model adequately measures 
all aspects of specific risk for covered debt and equity positions, 
including event and default risk, as provided by section 5(a) of 
this appendix, must calculate the bank's specific risk add-on for 
purposes of section 3(a)(2)(ii) of this appendix as follows:
    (1) If the model is capable of 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 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 add-on charge for purposes 
of section 3(a)(2)(ii) of this appendix equals the sum of the 
components for covered debt and equity positions. If a bank models, 
in accordance with paragraph (a) or (b) of this section, the 
specific risk of covered debt positions but not covered equity 
positions (or vice versa), then the bank's specific risk add-on 
charge for the positions not modeled is the component for covered 
debt or equity positions as appropriate:
* * * * *
    Dated at Washington, D.C. this 23rd day of March, 1999.

    By order of the Board of Directors.

Federal Deposit Insurance Corporation.
Robert E. Feldman,
Executive Secretary.
[FR Doc. 99-9185 Filed 4-16-99; 8:45 am]
BILLING CODES 4810-33-P; 6210-01-P; 6714-01-P


Last Updated 07/17/1999 communications@fdic.gov