DEPARTMENT OF THE TREASURY pub 9/25/06 Office of the Comptroller of the Currency 12 CFR Part 3 [Docket No. 06-09] RIN 1557-AC91 FEDERAL RESERVE SYSTEM 12 CFR Parts 208 and 225 [Regulations H and Y; Docket No. R-1261 FEDERAL DEPOSIT INSURANCE CORPORATION 12 CFR Part 325 RIN 3064-AC73 DEPARTMENT OF THE TREASURY Office of Thrift Supervision 12 CFR Part 566 RIN 1550-AB56 Risk-Based Capital Standards: Advanced Capital Adequacy Framework AGENCIES: Office of the Comptroller of the Currency, Treasury; Board of Governors of the Federal Reserve System; Federal Deposit Insurance Corporation; and Office of Thrift Supervision, Treasury. ACTION: Joint notice of proposed rulemaking. SUMMARY: The Office of the Comptroller of the Currency (OCC), the Board of Governors of the Federal Reserve System (Board), the Federal Deposit Insurance Corporation (FDIC), and the Office of Thrift Supervision (OTS) (collectively, the agencies) are proposing a new risk-based capital adequacy framework that would require some and permit other qualifying banks1 to use an internal ratings-based approach to calculate regulatory credit risk capital requirements and advanced measurement approaches to calculate regulatory operational risk capital requirements. The proposed 1 For simplicity, and unless otherwise indicated, this notice of proposed rulemaking (NPR) uses the term “bank” to include banks, savings associations, and bank holding companies (BHCs). The terms “bank holding company” and “BHC” refer only to bank holding companies regulated by the Board and do not include savings and loan holding companies regulated by the OTS. 1 rule describes the qualifying criteria for banks required or seeking to operate under the proposed framework and the applicable risk-based capital requirements for banks that operate under the framework. DATES: Comments must be received on or before [INSERT DATE 120 DAYS AFTER PUBLICATION IN THE FEDERAL REGISTER]. ADDRESSES: Comments should be directed to: OCC: You should include OCC and Docket Number 06-09 in your comment. You may submit comments by any of the following methods: • Federal eRulemaking Portal: http://www.regulations.gov. Follow the instructions for submitting comments. • OCC Web Site: http://www.occ.treas.gov. Click on "Contact the OCC," scroll down and click on "Comments on Proposed Regulations." • E-mail address: [email protected]. • Fax: (202) 874-4448. • Mail: Office of the Comptroller of the Currency, 250 E Street, SW, Mail Stop 1- 5, Washington, DC 20219. • Hand Delivery/Courier: 250 E Street, SW, Attn: Public Information Room, Mail Stop 1-5, Washington, DC 20219. Instructions: All submissions received must include the agency name (OCC) and docket number or Regulatory Information Number (RIN) for this notice of proposed rulemaking. In general, OCC will enter all comments received into the docket without 2 change, including any business or personal information that you provide. You may review comments and other related materials by any of the following methods: • Viewing Comments Personally: You may personally inspect and photocopy comments at the OCC's Public Information Room, 250 E Street, SW, Washington, DC. You can make an appointment to inspect comments by calling (202) 874-5043. Board: You may submit comments, identified by Docket No. R-1261, by any of the following methods: • Agency Web Site: http://www.federalreserve.gov. Follow the instructions for submitting comments at http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm. • Federal eRulemaking Portal: http://www.regulations.gov. Follow the instructions for submitting comments. • E-mail: [email protected]. Include docket number in the subject line of the message. • FAX: 202/452-3819 or 202/452-3102. • Mail: Jennifer J. Johnson, Secretary, Board of Governors of the Federal Reserve System, 20th Street and Constitution Avenue, NW, Washington, DC 20551. All public comments are available from the Board’s web site at www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm as submitted, unless modified for technical reasons. Accordingly, your comments will not be edited to remove any identifying or contact information. Public comments may also be viewed electronically or in paper in Room MP-500 of the Board’s Martin Building (20th and C Streets, NW) between 9:00 a.m. and 5:00 p.m. on weekdays. 3 FDIC: You may submit comments, identified by RIN number, by any of the following methods: • Federal eRulemaking Portal: http://www.regulations.gov. Follow the instructions for submitting comments. • Agency Web Site: http://www.fdic.gov/regulations/laws/federal/propose.html. • Mail: Robert E. Feldman, Executive Secretary, Attention: Comments, Federal Deposit Insurance Corporation, 550 17th Street, NW, Washington, D.C. 20429. • Hand Delivery/Courier: Guard station at rear of the 550 17th Street Building (located on F Street) on business days between 7:00 a.m. and 5:00 p.m. • E-mail: [email protected]. • Public Inspection: Comments may be inspected at the FDIC Public Information Center, Room E-1002, 3502 Fiarfax Drive, Arlington, VA, 22226, between 9 a.m. and 5:00 p.m. on business days. Instructions: Submissions received must include the agency name and RIN for this rulemaking. Comments received will be posted without change to http://www.fdic.gov/regulations/laws/federal/propose.html including any personal information provided. OTS: You may submit comments, identified by No. 2006-33, by any of the following methods: • Federal eRulemaking Portal: http://www.regulations.gov. Follow the instructions for submitting comments. 4 • E-mail address: [email protected]. Please include No. 2006-33 in the subject line of the message and include your name and telephone number in the message. • Fax: (202) 906-6518. • Mail: Regulation Comments, Chief Counsel’s Office, Office of Thrift Supervision, 1700 G Street, NW, Washington, DC 20552, Attention: No. 2006-33. • Hand Delivery/Courier: Guard’s Desk, East Lobby Entrance, 1700 G Street, NW, from 9:00 a.m. to 4:00 p.m. on business days, Attention: Regulation Comments, Chief Counsel’s Office, Attention: No. 2006-33. Instructions: All submissions received must include the agency name and docket number or Regulatory Information Number (RIN) for this rulemaking. All comments received will be posted without change to the OTS Internet Site at http://www.ots.treas.gov/pagehtml.cfm?catNumber=67&an=1, including any personal information provided. Docket: For access to the docket to read background documents or comments received, go to http://www.ots.treas.gov/pagehtml.cfm?catNumber=67&an=1. In addition, you may inspect comments at the Public Reading Room, 1700 G Street, NW, by appointment. To make an appointment for access, call (202) 906-5922, send an e-mail to [email protected], or send a facsimile transmission to (202) 906-7755. (Prior notice identifying the materials you will be requesting will assist us in serving you.) We schedule appointments on business days between 10:00 a.m. and 4:00 p.m. In most cases, appointments will be available the next business day following the date we receive a request. 5 FOR FURTHER INFORMATION CONTACT: OCC: Roger Tufts, Senior Economic Advisor, Capital Policy (202-874-4925) or Ron Shimabukuro, Special Counsel, Legislative and Regulatory Activities Division (202- 874-5090). Office of the Comptroller of the Currency, 250 E Street, SW, Washington, DC 20219. Board: Barbara Bouchard, Deputy Associate Director (202-452-3072 or [email protected]) or Anna Lee Hewko, Senior Supervisory Financial Analyst (202-530-6260 or [email protected]), Division of Banking Supervision and Regulation; or Mark E. Van Der Weide, Senior Counsel (202-452-2263 or [email protected]), Legal Division. For users of Telecommunications Device for the Deaf (“TDD”) only, contact 202-263-4869. FDIC: Jason C. Cave, Associate Director, Capital Markets Branch, (202) 898- 3548, Bobby R. Bean, Senior Quantitative Risk Analyst, Capital Markets Branch, (202) 898-3575, Kenton Fox, Senior Capital Markets Specialist, Capital Markets Branch, (202) 898-7119, Division of Supervision and Consumer Protection; or Michael B. Phillips, Counsel, (202) 898-3581, Supervision and Legislation Branch, Legal Division, Federal Deposit Insurance Corporation, 550 17th Street, NW, Washington, DC 20429. OTS: Michael D. Solomon, Director, Capital Policy, Supervision Policy (202) 906-5654; David W. Riley, Senior Analyst, Capital Policy (202) 906-6669; or Karen Osterloh, Special Counsel, Regulations and Legislation Division (202) 906-6639, Office of Thrift Supervision, 1700 G Street, NW, Washington, DC 20552. SUPPLEMENTARY INFORMATION: Table of Contents 6 I. Introduction A. Background B. Conceptual Overview 1. The IRB framework for credit risk 2. The AMA for operational risk C. Overview of Proposed Rule D. Structure of Proposed Rule E. Quantitative Impact Study 4 and Overall Capital Objectives 1. Quantitative Impact Study 4 2. Overall capital objectives F. Competitive Considerations II. Scope A. Core and Opt-In Banks B. U.S. Depository Institution Subsidiaries of Foreign Banks C. Reservation of Authority III. Qualification A. The Qualification Process 1. In general 2. Parallel run and transitional floor periods B. Qualification Requirements 1. Process and systems requirements 2. Risk rating and segmentation systems for wholesale and retail exposures Wholesale exposures Retail exposures Definition of default Rating philosophy Rating and segmentation reviews and updates 3. Quantification of risk parameters for wholesale and retail exposures Probability of default (PD) Loss given default (LGD) and expected loss given default (ELGD) Exposure at default (EAD) General quantification principles 4. Optional approaches that require prior supervisory approval 5. Operational risk Operational risk data and assessment system 7 Operational risk quantification system ` 6. Data management and maintenance 7. Control and oversight mechanisms Validation Internal audit Stress testing 8. Documentation C. Ongoing Qualification IV. Calculation of Tier 1 Capital and Total Qualifying Capital V. Calculation of Risk-Weighted Assets A. Categorization of Exposures 1. Wholesale exposures 2. Retail exposures 3. Securitization exposures 4. Equity exposures 5. Boundary between operational risk and other risks 6. Boundary between the proposed rule and the market risk amendment B. Risk-Weighted Assets for General Credit Risk (Wholesale Exposures, Retail Exposures, On-Balance Sheet Assets that are not Defined by Exposure Category, and Immaterial Credit Exposures) 1. Phase 1 – Categorization of exposures 2. Phase 2 – Assignment of wholesale obligors and exposures to rating grades and retail exposures to segments Purchased wholesale receivables Wholesale lease residuals 3. Phase 3 – Assignment of risk parameters to wholesale obligors and exposures and retail segments 4. Phase 4 – Calculation of risk-weighted assets 5. Statutory provisions on the regulatory capital treatment of certain mortgage loans C. Credit Risk Mitigation Techniques 1. Collateral 2. EAD for counterparty credit risk EAD for repo-style transactions and eligible margin loans Collateral haircut approach Standard supervisory haircuts Own estimates of haircuts Simple VaR methodology 3. EAD for OTC derivative contracts Current exposure methodology 8 4. Internal models methodology Maturity under the internal models methodology Collateral agreements under the internal models methodology Internal estimate of alpha Alternative models 5. Guarantees and credit derivatives that cover wholesale exposures Eligible guarantees and eligible credit derivatives PD substitution approach LGD adjustment approach Maturity mismatch haircut Restructuring haircut Currency mismatch haircut Example Multiple credit risk mitigants Double default treatment 6. Guarantees and credit derivatives that cover retail exposures D. Unsettled Securities, Foreign Exchange, and Commodity Transactions E. Securitization Exposures 1. Hierarchy of approaches Exceptions to the general hierarchy of approaches Servicer cash advances Amount of a securitization exposure Implicit support Operational requirements for traditional securitizations Clean-up calls 2. Ratings-based approach (RBA) 3. Internal assessment approach (IAA) 4. Supervisory formula approach (SFA) General requirements Inputs to the SFA formula 5. Eligible disruption liquidity facilities 6. Credit risk mitigation for securitization exposures 7. Synthetic securitizations Background Operational requirements for synthetic securitizations First-loss tranches Mezzanine tranches Super-senior tranches 8. Nth-to-default credit derivatives 9. Early amortization provisions Background Controlled early amortization Noncontrolled early amortization 9 F. Equity Exposures 1. Introduction and exposure measurement Hedge transactions Measures of hedge effectiveness 2. Simple risk-weight approach (SRWA) Non-significant equity exposures 3. Internal models approach (IMA) IMA qualification Risk-weighted assets under the IMA 4. Equity exposures to investment funds Full look-through approach Simple modified look-through approach Alternative modified look-through approach VI. Operational Risk VII. Disclosure 1. Overview Comments on ANPR 2. General requirements Frequency/timeliness Location of disclosures and audit/certification requirements Proprietary and confidential information 3. Summary of specific public disclosure requirements 4. Regulatory reporting I. Introduction A. Background On August 4, 2003, the agencies issued an advance notice of proposed rulemaking (ANPR) (68 FR 45900) that sought public comment on a new risk-based regulatory capital framework based on the Basel Committee on Banking Supervision (BCBS)2 April 2003 consultative paper entitled “The New Basel Capital Accord” (Proposed New Accord). The Proposed New Accord set forth a “three pillar” framework encompassing risk-based capital requirements for credit risk, market risk, and operational risk (Pillar 1); 2 The BCBS is a committee of banking supervisory authorities, which was established by the central bank governors of the G-10 countries in 1975. It consists of senior representatives of bank supervisory authorities and central banks from Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, the Netherlands, Spain, Sweden, Switzerland, the United Kingdom, and the United States. 10