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2000 - Rules and Regulations
Appendix C to Part 325Risk-Based Capital for State Non-Member
Banks: Market Risk
Section 1. Purpose, Applicability, Scope, and Effective Date
(a) Purpose. The purpose of this appendix is to ensure
that banks with significant exposure to market risk maintain adequate
capital to support that
exposure. 1
This appendix supplements and adjusts the risk-based capital ratio
calculations under appendix A of this part with respect to those
organizations.
(b) Applicability. (1) This appendix applies to any
insured state nonmember bank whose trading
activity 2
(on a worldwide consolidated basis) equals:
(i) 10 percent or more of total
assets; 3
or
(ii) $1 billion or more.
(2) The FDIC may additionally apply this appendix to any insured
state nonmember bank if the FDIC deems it necessary or appropriate for
safe and sound banking practices.
(3) The FDIC may exclude an insured state nonmember bank
otherwise meeting the criteria of paragraph (b)(1) of this section from
coverage under this appendix if it determines the bank meets such
criteria as a consequence of accounting, operational, or similar
considerations, and the FDIC deems it consistent with safe and sound
banking practices.
(c) Scope. The capital requirements of this appendix
support market risk associated with a bank's covered
positions.
{{2-28-06 p.2262.14}}
(d) Effective date. This appendix is effective as of
January 1, 1997. Compliance is not mandatory until January 1, 1998.
Subject to supervisory approval, a bank may opt to comply with this
appendix as early as January 1,
1997. 4
Section 2. Definitions
For purposes of this appendix, the following definitions apply:
(a) Covered positions means all positions in a bank's
trading account, and all foreign
exchange 5
and commodity positions, whether or not in the trading
account. 6
Positions include on-balance-sheet assets and liabilities and
off-balance-sheet items. Securities subject to repurchase and lending
agreements are included as if they are still owned by the lender.
Covered positions exclude all positions in a bank's trading account
that, in form or in substance, act as liquidity facilities that provide
liquidity support to asset-backed commercial paper. Such excluded
positions are subject to the risk-based capital requirements set forth
in appendix A of this part.
(b) Market risk means the risk of loss resulting from
movements in market prices. Market risk consists of general market risk
and specific risk components.
(1) General market risk means changes in the market
value of covered positions resulting from broad market movements, such
as changes in the general level of interest rates, equity prices,
foreign exchange rates, or commodity prices.
(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.
(c) Tier 1 and Tier 2 capital are defined in
appendix A of this part.
(d) Tier 3 capital is subordinated debt that is
unsecured; is fully paid up; has an original maturity of at least two
years; is not redeemable before maturity without prior approval by the
FDIC; includes a lock-in clause precluding payment of either interest
or principal (even at maturity) if the payment would cause the issuing
bank's risk-based capital ratio to fall or remain below the minimum
required under appendix A of this part; and does not contain and is not
covered by any covenants, terms, or restrictions that are inconsistent
with safe and sound banking practices.
(e) Value-at-risk (VAR) means the estimate of the
maximum amount that the value of covered positions could decline during
a fixed holding period within a stated confidence level, measured in
accordance with section 4 of this appendix.
Section 3. Adjustments to the Risk-Based Capital Ratio Calculations
(a) Risk-based capital ratio denominator. A bank subject
to this appendix shall calculate its risk-based capital ratio
denominator as follows:
(1) Adjusted risk-weighted assets. Calculate adjusted
risk-weighted assets, which equals risk-weighted assets (as determined
in accordance with
appendix A of this
part) excluding the risk-weighted amounts of all covered
positions (except foreign exchange positions outside the trading
account and over-the-counter derivative
positions) 7
and receivables arising from the posting of cash collateral that is
associated with securities borrowing transactions to the extent the
receivables are collateralized by the market value of the borrowed
securities, provided that the following conditions are met:
(i) The transaction is based on securities includable in the
trading book that are liquid and readily marketable,
(ii) The transaction is marked to market daily,
(iii) The transaction is subject to daily margin maintenance
requirements, and
{{2-28-06 p.2262.14-A}}
(iv) (A) The transaction is a securities contract for the
purposes of section 555 of the Bankruptcy Code (11 U.S.C. 555), a
qualified financial contract for the purposes of section 11(e)(8) of
the Federal Deposit Insurance Act (12
U.S.C. 1821(e)(8)), or a netting contract between or among
financial institutions for the purposes of sections 401--407 of the
Federal Deposit Insurance Corporation Improvement Act of 1991
(12 U.S.C. 4401--4407), or the
Board's Regulation EE (12 CFR Part 231); or
(B) If the transaction does not meet the criteria set forth in
paragraph (iv)(A) of this section, then either:
(1) The bank has conducted sufficient legal review to
reach a well-founded conclusion that:
(i) The securities borrowing agreement executed in
connection with the transaction provides the bank the right to
accelerate, terminate, and close-out on a net basis all transactions
under the agreement and to liquidate or set off collateral promptly
upon an event of counterparty default, including in a bankruptcy,
insolvency, or other similar proceeding of the counterparty; and
(ii) Under applicable law of the relevant
jurisdiction, its rights under the agreement are legal, valid, binding,
and enforceable and any exercise of rights under the agreement will not
be stayed or avoided; or
(2) The transaction is either overnight or
unconditionally cancelable at any time by the bank, and the bank has
conducted sufficient legal review to reach a well-founded conclusion
that:
(i) The securities borrowing agreement executed in
connection with the transaction provides the bank the right to
accelerate, terminate, and close-out on a net basis all transactions
under the agreement and to liquidate or set off collateral promptly
upon an event of counterparty default; and
(ii) Under the law governing the agreement, its rights
under the agreement are legal, valid, binding, and enforceable.
(2) Measure for market risk. Calculate the measure for
market risk, which equals the sum of the VAR-based capital charge, the
specific risk add-on (if any), and the capital charge for de minimis
exposures (if any).
(i) VAR-based capital charge. The VAR-based capital
charge equals the higher of:
(A) The previous day's VAR measure; or
(B) The average of the daily VAR measures for each of the
preceding 60 business days multiplied by three, except as provided in
section 4(e) of this appendix;
(ii) Specific risk add-on. The specific risk add-on is
calculated in accordance with section 5 of this appendix;
and
{{10-31-96 p.2262.15}}
(iii) Capital charge for de minimis exposure. The
capital charge for de minimis exposure is calculated in accordance with
section 4(a) of this appendix.
(3) Market risk equivalent assets. Calculate market
risk equivalent assets by multiplying the measure for market risk (as
calculated in paragraph (a)(2) of this section) by 12.5.
(4) Denominator calculation. Add market risk
equivalent assets (as calculated in paragraph (a)(3) of this section)
to adjusted risk-weighted assets (as calculated in paragraph (a)(1) of
this section). The resulting sum is the bank's risk-based capital ratio
denominator.
(b) Risk-based capital ratio numerator. A bank subject
to this appendix shall calculate its risk-based capital ratio numerator
by allocating capital as follows:
(1) Credit risk allocation. Allocate Tier 1 and Tier 2
capital equal to 8.0 percent of adjusted risk-weighted assets (as
calculated in paragraph (a)(1) of this
section). 8
(2) Market risk allocation. Allocate Tier 1, Tier 2,
and Tier 3 capital equal to the measure for market risk as calculated
in paragraph (a)(2) of this section. The sum of Tier 2 and Tier 3
capital allocated for market risk must not exceed 250 percent of Tier 1
capital allocated for market risk. (This requirement means that Tier 1
capital allocated in this paragraph (b)(2) must equal at least 28.6
percent of the measure for market risk.)
(3) Restrictions. (i) The sum of Tier 2 capital (both
allocated and excess) and Tier 3 capital (allocated in paragraph (b)(2)
of this section) may not exceed 100 percent of Tier 1 capital (both
allocated and excess). 9
(ii) Term subordinated debt (and intermediate-term preferred
stock and related surplus) included in Tier 2 capital (both allocated
and excess) may not exceed 50 percent of Tier 1 capital (both allocated
and excess).
(4) Numerator calculation. Add Tier 1 capital (both
allocated and excess), Tier 2 capital (both allocated and excess), and
Tier 3 capital (allocated under paragraph (b)(2) of this section). The
resulting sum is the bank's risk-based capital ratio numerator.
Section 4. Internal Models
(a) General. For risk-based capital purposes. a bank
subject to this appendix must use its internal model to measure its
daily VAR, in accordance with the requirements of this
section. 10
The FDIC may permit a bank to use alternative techniques to measure the
market risk of de minimis exposures so long as the techniques
adequately measure associated market risk.
(b) Qualitative requirements. A bank subject to this
appendix must have a risk management system that meets the following
minimum qualitative requirements:
(1) The bank must have a risk control unit that reports directly
to senior management and is independent from business trading units.
(2) The bank's internal risk measurement model must be integrated
into the daily management process.
(3) The bank's policies and procedures must identify, and the
bank must conduct, appropriate stress tests and
backtests. 11
The bank's policies and procedures must identify the procedures to
follow in response to the results of such tests.
{{10-31-96 p.2262.16}}
(4) The bank must conduct independent reviews of its risk
measurement and risk management systems at least annually.
(c) Market risk factors. The bank's internal model must
use risk factors sufficient to measure the market risk inherent in all
covered positions. The risk factors must address interest rate
risk, 12
equity price risk, foreign exchange rate risk, and commodity price
risk.
(d) Quantitative requirements. For regulatory capital
purposes, VAR measures must meet the following quantitative
requirements:
(1) The VAR measures must be calculated on a daily basis using a
99 percent, one-tailed confidence level with a price shock equivalent
to a ten-business day movement in rates and prices. In order to
calculate VAR measures based on a ten-day price shock, the bank may
either calculate ten-day figures directly or convert VAR figures based
on holding periods other than ten days to the equivalent of a ten-day
holding period (for instance, by multiplying a one-day VAR measure by
the square root of ten).
(2) The VAR measures must be based on an historical observation
period (or effective observation period for a bank using a weighting
scheme or other similar method) of at least one year. The bank must
update data sets at least once every three months or more frequently as
market conditions warrant.
(3) The VAR measures must include the risks arising from the
non-linear price characteristics of options positions and the
sensitivity of the market value of the positions to changes in the
volatility of the underlying rates or prices. A bank with a large or
complex options portfolio must measure the volatility of options
positions by different maturities.
(4) The VAR measures may incorporate empirical correlations
within and across risk categories, provided that the bank's process for
measuring correlations is sound. In the event that the VAR measures do
not incorporate empirical correlations across risk categories, then the
bank must add the separate VAR measures for the four major risk
categories to determine its aggregate VAR measure.
(e) Backtesting. (1) Beginning one year after a bank
holding company starts to comply with this appendix, it must conduct
backtesting by comparing each of its most recent 250 business days'
actual net trading profit or loss 13
with the corresponding daily VAR measures generated for internal risk
measurement purposes and calibrated to a one-day holding period and a
99 percent, one-tailed confidence level.
(2) Once each quarter, the bank must identify the number of
exceptions, that is, the number of business days for which the
magnitude of the actual daily net trading loss, if any, exceeds the
corresponding daily VAR measures.
(3) A bank must use the multiplication factor indicated in Table
1 of this appendix in determining its capital charge for market risk
under section 3(a)(2)(i)(B) of this appendix until it obtains the next
quarter's backtesting results, unless the FDIC determines that a
different adjustment or other action is appropriate.
{{4-30-99 p.2262.17}}
Table 1.Multiplication Factor Based on Results of
Backtesting
Number of exceptions |
Multiplication factor
|
4 or fewer |
3.00 |
5 |
3.40 |
6 |
3.50
|
7 |
3.65 |
8 |
3.75 |
9 |
3.85 |
10 or
more |
4.00
|
Section 5. 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:
(1) Covered debt positions. (i) For purposes of this
section 5, covered debt positions means fixed-rate or floating-rate
debt instruments located in the trading account and instruments located
in the trading account with values that react primarily to changes in
interest rates, including certain non-convertible preferred stock,
convertible bonds, and instruments subject to repurchase and lending
agreements. Also included are derivatives (including written and
purchased options) for which the underlying instrument is a covered
debt instrument that is subject to a non-zero specific risk capital
charge.
(A) For covered debt positions that are derivatives, a bank must
risk-weight (as described in paragraph (c)(1)(iii) of this section) the
market value of the effective notional amount of the underlying debt
instrument or index portfolio. Swaps must be included as the notional
position in the underlying debt instrument or index portfolio, with a
receiving side treated as a long position and a paying side treated as
a short position; and
{{4-30-99 p.2262.18}}
(B) For covered debt positions that are options, whether long or
short, a bank must risk-weight (as described in paragraph (c)(1)(iii)
of this section) the market value of the effective notional amount of
the underlying debt instrument or index multiplied by the option's
delta.
(ii) A bank may net long and short covered debt positions
(including derivatives) in identical debt issues or indices.
(iii) A bank must multiply the absolute value of the current
market value of each net long or short covered debt position by the
appropriate specific risk weighting factor indicated in Table 2 of this
appendix. The specific risk capital charge component for covered debt
positions is the sum of the weighted values.
Table 2.Specific Risk Weighting Factors for Covered Debt
Positions
Category |
Remaining maturity (contractual) |
Weighting
factor (in percent) |
Government |
N/A |
0.00
|
Qualifying |
6 months or less |
0.25 |
|
Over 6
months to 24 months |
1.00 |
|
Over 24 months |
1.60
|
Other |
N/A |
8.00
|
(A) The government category includes all debt
instruments of central governments of OECD-based
countries 14
including bonds, Treasury bills, and other short-term instruments, as
well as local currency instruments of non-OECD central governments to
the extent the bank has liabilities booked in that currency.
(B) The qualifying category includes debt instruments
of U.S. government-sponsored agencies, general obligation debt
instruments issued by states and other political subdivisions of
OECD-based countries, multilateral development banks, and debt
instruments issued by U.S. depository institutions or OECD-banks that
do not qualify as capital of the issuing
institution. 15
This category also includes other debt instruments, including corporate
debt and revenue instruments issued by states and other political
subdivisions of OECD countries, that are:
(1) Rated investment-grade by at least two nationally
recognized credit rating services;
(2) Rated investment-grade by one nationally
recognized credit rating agency and not rated less than
investment-grade by any other credit rating agency; or
(3) Unrated, but deemed to be of comparable investment
quality by the reporting bank and the issuer has instruments listed on
a recognized stock exchange, subject to review by the FDIC.
(C) The other category includes debt instruments that
are not included in the government or qualifying categories.
(2) Covered equity positions. (i) For purposes of this
section 5, covered equity positions means equity instruments located in
the trading account and instruments located in the trading account with
values that react primarily to changes in equity prices, including
voting or non-voting common stock, certain convertible bonds, and
commitments to buy or sell equity instruments. Also included are
derivatives (including written or purchased options) for which the
underlying is a covered equity position.
(A) For covered equity positions that are derivatives, a bank
must risk weight (as described in paragraph (c)(2)(iii) of this
section) the market value of the effective notional amount of the
underlying equity instrument or equity portfolio. Swaps must
be
{{12-31-07 p.2262.19}}included as the notional
position in the underlying equity instrument or index portfolio, with a
receiving side treated as a long position and a paying side treated as
a short position; and
(B) For covered equity positions that are options, whether long
or short, a bank must risk weight (as described in paragraph
(c)(2)(iii) of this section) the market value of the effective notional
amount of the underlying equity instrument or index multiplied by the
option's delta.
(ii) A bank may net long and short covered equity positions
(including derivatives) in identical equity issues or equity indices in
the same market. 16
(iii)(A) A bank must multiply the absolute value of the current
market value of each net long or short covered equity position by a
risk weighting factor of 8.0 percent, or by 4.0 percent if the equity
is held in a portfolio that is both liquid and
well-diversified. 17
For covered equity positions that are index contracts comprising a
well-diversified portfolio of equity instruments, the net long or short
position is multiplied by a risk weighting factor of 2.0 percent.
(B) For covered equity positions from the following
futures-related arbitrage strategies, a bank may apply a 2.0 percent
risk weighting factor to one side (long or short) of each position with
the opposite side exempt from charge, subject to review by the FDIC:
(1) Long and short positions in exactly the same index
at different dates or in different market centers; or
(2) Long and short positions in index contracts at the
same date in different but similar indices.
(C) For futures contracts on broadly-based indices that are
matched by offsetting positions in a basket of stocks comprising the
index, a bank may apply a 2.0 percent risk weighting factor to the
futures and stock basket positions (long and short), provided that such
trades are deliberately entered into and separately controlled, and
that the basket of stocks comprises at least 90 percent of the
capitalization of the index.
(iv) The specific risk capital charge component for covered
equity positions is the sum of the weighted values.
[Codified to 12 C.F.R. Part 325, Appendix C]
[Appendix C added at 61 Fed. Reg. 47376, September
6, 1996, effective January 1, 1997; amended at 62 Fed. Reg. 68068,
December 30, 1997, effective December 31, 1997; 64 Fed. Reg. 19038,
April 19, 1999, effective July 1, 1999; 65 Fed. Reg. 75859, December 5,
2000, effective January 4, 2001; 69 Fed. Reg. 44924, July 28, 2004,
however, any banking organization may elect to adopt, as of July 28,
2004, the capital treatment described in this final rule for assets in
ABCP programs that are consolidated onto the balance sheets of
sponsoring banking organizations as a result of FIN 46-R. All liquidity
facilities that provide support to ABCP will be treated as "eligible
ABCP liquidity facilities," regardless of their compliance with the
definition of "eligible ABCP liquidity facilities" in the final
rule, until September 30, 2005. On that date and thereafter, liquidity
facilities that do not meet the final rule's definition of
"eligible ABCP liquidity facility" will be treated as recourse
obligations or direct credit substitutes; 71 Fed. Reg. 8937, February
22, 2006.]
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. Go Back to Text
2Trading activity means the gross sum of trading assets and
liabilities as reported in the bank's most recent quarterly
Consolidated Report of Condition and Income (Call Report). Go Back to Text
3Total assets means quarter-end total assets as reported in the
bank's most recent Call Report. Go Back to Text
4A bank that voluntarily complies with the final rule prior to
January 1, 1998, must comply with all of its provisions. Go Back to Text
5Subject to FDIC review, a bank may exclude structural
positions in foreign currencies from its covered positions. Go Back to Text
6The term trading account is defined in the instructions to the
Call Report. Go Back to Text
7Foreign exchange positions outside the trading account and all
over-the-counter derivative positions, whether or not in the trading
account, must be included in the adjusted risk weighted assets as
determined in appendix A of this part. Go Back to Text
8A bank may not allocate Tier 3 capital to support credit risk
(as calculated under appendix A of this part). Go Back to Text
9Excess Tier 1 capital means Tier 1 capital that has not been
allocated in paragraphs (b)(1) and (b)(2) of this section. Excess Tier
2 capital means Tier 2 capital that has not been allocated in paragrph
(b)(1) and (b)(2) of this section, subject to the restrictions in
paragraph (b)(3) of this section. Go Back to Text
10A bank's internal model may use any generally accepted
measurement techniques, such as variance-covariance models, historical
simulations, or Monte Carlo simulations. However, the level of
sophistication and accuracy of a bank's internal model must be
commensurate with the nature and size of its covered positions. A bank
that modifies its existing modeling procedures to comply with the
requirements of this appendix for risk-based capital purposes should,
nonetheless, continue to use the internal model it considers most
appropriate in evaluating risk for other purposes. Go Back to Text
11Stress tests provide information about the impact of adverse
market events on a bank's covered positions. Backtests provide
information about the accuracy of an internal model by comparing a
bank's daily VAR measures to its corresponding daily trading profits
and losses. Go Back to Text
12For material exposures in the major currencies and markets,
modeling techniques must capture spread risk and must incorporate
enough segments of the yield curve--at least six--to capture
differences in volatility and less than perfect correlation of rates
along the yield curve. Go Back to Text
13Actual net trading profits and losses typcially include such
things as realized and unrealized gains and losses on portfolio
positions as well as fee income and commissions associated with trading
activities. Go Back to Text
14Organization for Economic Cooperation and Development
(OECD)-based countries is defined in appendix A of this part. Go Back to Text
15U.S. government-sponsored agencies, multilateral development
banks, and OECD banks are defined in appendix A of this part. Go Back to Text
16A bank may also net positions in depository receipts against
an opposite position in the underlying equity or identical equity in
different markets, provided that the bank includes the costs of
conversion. Go Back to Text
17A portfolio is liquid and well-diversified if: (1) it is
characterized by a limited sensitivity to price changes of any single
equity issue or closely related group of equity issues held in the
portfolio; (2) the volatility of the portfolio's value is not
dominated by the volatility of any individual equity issue or by equity
issues from any single industry or economic sector; (3) it contains a
large number of individual equity positions, with no single position
representing a substantial portion of the portfolio's total market
value; and (4) it consists mainly of issues traded on organized
exchanges or in well-established over-the-counter markets. Go Back to Text
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