Financial Institution Letter
FIL-87-2006
September 25, 2006
RISK-BASED CAPITAL RULES
Proposed Rule on Risk-Based Capital Standards: Market Risk
Federal Deposit Insurance Corporation
550 17th Street NW, Washington, D.C. 20429-9990
Summary: The federal bank and thrift regulatory agencies have jointly issued the attached notice of
proposed rulemaking (NPR) on possible modifications to the risk-based capital standards for market risk.
The proposed rule would incorporate improvements to the current trading book regime as proposed by
the Basel Committee on Bank Supervision and the International Organization of Securities Commissions
in the joint document The Application of Basel II to Trading Activities and the Treatment of Double Default
Effects, published in July 2005. The proposed rule would also apply to certain savings associations,
which currently are not covered under the rule. The FDIC will accept comments on the NPR through
January 23, 2007.
Distribution:
FDIC-Supervised Banks (Commercial and Savings)
Suggested Routing:
Chief Executive Officer
Chief Financial Officer
Chief Risk Officer
Related Topics:
Risk-Based Capital Rules
12 CFR Part 325
Basel II
Market Risk
Attachments:
. “Key Aspects of the Proposed Rule on Risk-
Based Capital Standards: Market Risk”
. Joint Notice of Proposed Rulemaking, Risk-
Based Capital Standards: Market Risk
Contact:
Jason C. Cave, Associate Director, Capital Markets
Branch, at jcave@fdic.gov or (202) 898-3548
Gloria Ikosi, Senior Quantitative Risk Analyst, at
gikosi@fdic.gov or (202) 898-3997
Note:
FDIC financial institution letters (FILs) may be
accessed from the FDIC's Web site at
www.fdic.gov/news/news/financial/2006/index.html.
To receive FILs electronically, please visit
http://www.fdic.gov/about/subscriptions/fil.html.
Paper copies of FDIC financial institution letters
may be obtained through the FDIC's Public
Information Center, 3501 Fairfax Drive, E-1002,
Arlington, VA 22226 (1-877-275-3342 or 703-562-
2200).
Highlights:
The proposed rule:
• Applies to banks with aggregate trading assets and
liabilities equal to 10 percent or more of quarter-end total
assets as reported on the most recent quarterly Call
Report or Thrift Financial Report, or equal to $1 billion or
more.
• Establishes more explicit eligibility criteria for positions
that receive market risk capital treatment; sets
requirements for prudent valuation and robust stress
testing, and for the control, oversight and validation
mechanisms for models; and expects banks to have an
internal capital assessment for market risk.
• Introduces a new minimum regulatory capital charge, the
incremental default risk requirement, which captures
default risk over a time horizon of one year, taking into
account the impact of liquidity, concentrations, hedging
and optionality.
• Updates standard specific risk capital requirements for
sub-investment grade government debt positions and
non-qualifying debt positions to conform to Basel II credit
risk weights.
• Replaces the current joint final rule on “Risk-Based
Capital Standards: Market Risk,” published in the
Federal Register on September 6, 1996 (see FIL-84-96,
dated October 10, 1996).In reply to:
FIL-87-2006
September 25, 2006
RISK-BASED CAPITAL RULES
Proposed Rule on Risk-Based Capital Standards: Market Risk
Federal Deposit Insurance Corporation
550 17th Street NW, Washington, D.C. 20429-9990
Summary: The federal bank and thrift regulatory agencies have jointly issued the attached notice of
proposed rulemaking (NPR) on possible modifications to the risk-based capital standards for market risk.
The proposed rule would incorporate improvements to the current trading book regime as proposed by
the Basel Committee on Bank Supervision and the International Organization of Securities Commissions
in the joint document The Application of Basel II to Trading Activities and the Treatment of Double Default
Effects, published in July 2005. The proposed rule would also apply to certain savings associations,
which currently are not covered under the rule. The FDIC will accept comments on the NPR through
January 23, 2007.
Distribution:
FDIC-Supervised Banks (Commercial and Savings)
Suggested Routing:
Chief Executive Officer
Chief Financial Officer
Chief Risk Officer
Related Topics:
Risk-Based Capital Rules
12 CFR Part 325
Basel II
Market Risk
Attachments:
. “Key Aspects of the Proposed Rule on Risk-
Based Capital Standards: Market Risk”
. Joint Notice of Proposed Rulemaking, Risk-
Based Capital Standards: Market Risk
Contact:
Jason C. Cave, Associate Director, Capital Markets
Branch, at jcave@fdic.gov or (202) 898-3548
Gloria Ikosi, Senior Quantitative Risk Analyst, at
gikosi@fdic.gov or (202) 898-3997
Note:
FDIC financial institution letters (FILs) may be
accessed from the FDIC's Web site at
www.fdic.gov/news/news/financial/2006/index.html.
To receive FILs electronically, please visit
http://www.fdic.gov/about/subscriptions/fil.html.
Paper copies of FDIC financial institution letters
may be obtained through the FDIC's Public
Information Center, 3501 Fairfax Drive, E-1002,
Arlington, VA 22226 (1-877-275-3342 or 703-562-
2200).
Highlights:
The proposed rule:
• Applies to banks with aggregate trading assets and
liabilities equal to 10 percent or more of quarter-end total
assets as reported on the most recent quarterly Call
Report or Thrift Financial Report, or equal to $1 billion or
more.
• Establishes more explicit eligibility criteria for positions
that receive market risk capital treatment; sets
requirements for prudent valuation and robust stress
testing, and for the control, oversight and validation
mechanisms for models; and expects banks to have an
internal capital assessment for market risk.
• Introduces a new minimum regulatory capital charge, the
incremental default risk requirement, which captures
default risk over a time horizon of one year, taking into
account the impact of liquidity, concentrations, hedging
and optionality.
• Updates standard specific risk capital requirements for
sub-investment grade government debt positions and
non-qualifying debt positions to conform to Basel II credit
risk weights.
• Replaces the current joint final rule on “Risk-Based
Capital Standards: Market Risk,” published in the
Federal Register on September 6, 1996 (see FIL-84-96,
dated October 10, 1996).In reply to:
KEY ASPECTS OF THE PROPOSED RULE ON RISK-BASED
CAPITAL STANDARDS: MARKET RISK
I. Introduction
The attached interagency NPR (Proposed Rule) explains how the U.S. banking
and thrift agencies (the Agencies) plan to adopt certain revisions to their current market
risk capital rule, as detailed in "The Application of Basel II to Trading Activities and the
Treatment of Double Default Effects," which was published by the Basel Committee on
Banking Supervision and the International Organization of Securities Commissions in
July 2005. The Proposed Rule will be applied of banks with worldwide consolidated
trading activity equal to at least 10 percent of total assets or $1 billion. Further,
regulators reserve the authority to require any bank to adopt the framework to ensure that
the bank operates in a safe and sound manner.
II. Overview
The Proposed Rule is a modification of the existing capital treatment of market
risk, which came into effect in 1997 and is based on the Market Risk Amendment of
1996 (MRA). The existing rule sets forth risk-based capital requirements for banks with
trading accounts with significant exposures to market risk to ensure that these banks
maintain adequate capital to support the risks arising from such exposures.
While the MRA framework has promoted safe and sound banking practices,
advances in risk measurement and management have set higher standards for risk control
that need to be incorporated. Modifications are also warranted because of changes in the
markets and new and innovative financial instruments that have evolved since the
adoption of the MRA in 1996. The existing rule, for example, falls short of adequately
capturing the various risks present in the relatively new and rapidly growing market for
traded structured credit. The treatment of default risk in securitization positions, such as
first loss positions that represent concentrated credit risk, is not fully captured under the
existing rules. The Proposed Rule ensures that adequate capital is held against these
positions by requiring a full deduction treatment, in line with their treatment under the
securitization framework in Basel II NPR, which has been published by the Agencies
simultaneously with this Proposed Rule.
III. Minimum Risk-Based Capital Requirements under the Proposed Rule
The Proposed Rule first defines covered positions, which are positions eligible for
treatment under the market risk framework and specifies how banks must calculate their
capital requirement for the market risk on these covered positions. The capital
requirement for market risk is determined by calculating capital requirements for general
market risk and specific risk. Additionally, the Proposed Rule requires banks to also
calculate a capital requirement for incremental default risk.
CAPITAL STANDARDS: MARKET RISK
I. Introduction
The attached interagency NPR (Proposed Rule) explains how the U.S. banking
and thrift agencies (the Agencies) plan to adopt certain revisions to their current market
risk capital rule, as detailed in "The Application of Basel II to Trading Activities and the
Treatment of Double Default Effects," which was published by the Basel Committee on
Banking Supervision and the International Organization of Securities Commissions in
July 2005. The Proposed Rule will be applied of banks with worldwide consolidated
trading activity equal to at least 10 percent of total assets or $1 billion. Further,
regulators reserve the authority to require any bank to adopt the framework to ensure that
the bank operates in a safe and sound manner.
II. Overview
The Proposed Rule is a modification of the existing capital treatment of market
risk, which came into effect in 1997 and is based on the Market Risk Amendment of
1996 (MRA). The existing rule sets forth risk-based capital requirements for banks with
trading accounts with significant exposures to market risk to ensure that these banks
maintain adequate capital to support the risks arising from such exposures.
While the MRA framework has promoted safe and sound banking practices,
advances in risk measurement and management have set higher standards for risk control
that need to be incorporated. Modifications are also warranted because of changes in the
markets and new and innovative financial instruments that have evolved since the
adoption of the MRA in 1996. The existing rule, for example, falls short of adequately
capturing the various risks present in the relatively new and rapidly growing market for
traded structured credit. The treatment of default risk in securitization positions, such as
first loss positions that represent concentrated credit risk, is not fully captured under the
existing rules. The Proposed Rule ensures that adequate capital is held against these
positions by requiring a full deduction treatment, in line with their treatment under the
securitization framework in Basel II NPR, which has been published by the Agencies
simultaneously with this Proposed Rule.
III. Minimum Risk-Based Capital Requirements under the Proposed Rule
The Proposed Rule first defines covered positions, which are positions eligible for
treatment under the market risk framework and specifies how banks must calculate their
capital requirement for the market risk on these covered positions. The capital
requirement for market risk is determined by calculating capital requirements for general
market risk and specific risk. Additionally, the Proposed Rule requires banks to also
calculate a capital requirement for incremental default risk.