FR4201_20121231_omb

Supporting Statement for the Risk-Based Capital Guidelines: Market Risk
(FR 4201; OMB No. 7100-0314)
Risk-Based Capital Guidelines: Market Risk
(Docket No. R-1401) (RIN 7100-AD61)
Summary
The Board of Governors of the Federal Reserve System, under delegated authority from
the Office of Management and Budget (OMB), proposes to reinstate, with revision, the RiskBased Capital Guidelines: Market Risk (FR 4201; OMB No. 7100-0314). The Paperwork
Reduction Act (PRA) classifies reporting, recordkeeping, or disclosure requirements of a
regulation as an information collection.1 This information collection is included in proposed
amendments to Regulations H and Y.
The Office of the Comptroller of the Currency (OCC), the Board of Governors of the
Federal Reserve System (Federal Reserve), and the Federal Deposit Insurance Corporation
(FDIC) (the agencies) published a joint final rule (77 FR 53060) on August 30, 2012, to revise
the market risk capital rule, which was effective January 1, 1997. This final rule would revise
the market risk capital rule to better capture positions for which the market risk capital rule is
appropriate, reduce procyclicality, enhance the rule’s sensitivity to risks that are not adequately
captured under the current methodologies, and increase transparency through enhanced
disclosures. The final rule does not include all of the methodologies adopted by the Basel
Committee on Banking Supervision (BCBS) for calculating the standardized specific risk capital
requirements for debt and securitization positions due to their reliance on credit ratings, which is
impermissible under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.
Instead, the final rule includes alternative methodologies for calculating standardized specific
risk capital requirements for debt and securitization positions. The final rule is effective on
January 1, 2013.
The final rule contains requirements subject to the PRA. The reporting, recordkeeping,
and disclosure requirements are found in sections 3, 4, 5, 6, 7, 8, 9, 10, and 12. These
requirements would enhance risk sensitivity and introduce requirements for public disclosure of
certain qualitative and quantitative information about a financial institution’s market risk. The
Federal Reserve’s total annual burden for this information collection is estimated to be 51,064
hours for the 26 financial institutions it supervises that are deemed respondents for purposes of
the PRA. There are no required reporting forms associated with this information collection.
Background and Justification
The first international capital framework for banks2 entitled International Convergence of
Capital Measurement and Capital Standards (1988 Capital Accord) was developed by the BCBS
and endorsed by the G–10 governors in 1988. The agencies implemented the 1988 Capital
Accord in 1989 through the issuance of the general risk-based capital rules. In 1996, the BCBS
1
2

See 44 U.S.C. § 3501 et seq.
The term bank includes banks, savings associations, and bank holding companies.

amended the 1988 Capital Accord to require banks to measure and hold capital to cover their
exposure to market risk associated with foreign exchange and commodity positions and positions
located in the trading account (the Market Risk Amendment (MRA) or market risk framework).
The agencies implemented the MRA with an effective date of January 1, 1997 (market risk
capital rule).
In June 2004, the BCBS issued a document entitled International Convergence of Capital
Measurement and Capital Standards: A Revised Framework (New Accord or Basel II), which
was intended for use by individual countries as the basis for national consultation and
implementation. The New Accord sets forth a “three-pillar” framework that includes (1) riskbased capital requirements for credit risk, market risk, and operational risk (Pillar 1); (2)
supervisory review of capital adequacy (Pillar 2); and (3) market discipline through enhanced
public disclosures (Pillar 3). The New Accord retained much of the MRA; however, after its
release, the BCBS announced that it would develop improvements to the market risk framework,
especially with respect to the treatment of specific risk, which refers to the risk of loss on a
position due to factors other than broad-based movements in market prices. As a result, in July
2005, the BCBS and the International Organization of Securities Commissions (IOSCO)
published The Application of Basel II to Trading Activities and the Treatment of Double Default
Effects. The BCBS incorporated the July 2005 changes into the June 2006 comprehensive
version of the New Accord and follow its “three-pillar” structure. Specifically, the Pillar 1
changes narrowed the types of positions that are subject to the market risk framework and revise
modeling standards and procedures for calculating minimum regulatory capital requirements; the
Pillar 2 changes required banks to conduct internal assessments of their capital adequacy with
respect to market risk, taking into account the output of their internal models, valuation
adjustments, and stress tests; and the Pillar 3 changes required banks to disclose certain
quantitative and qualitative information, including their valuation techniques for covered
positions, the soundness standard used for modeling purposes, and their internal capital adequacy
assessment methodologies.
On September 25, 2006, the agencies issued a joint notice of proposed rulemaking (2006
proposal) (71 FR 55958) in which they proposed amendments to their market risk capital rules
that would implement the BCBS’s changes to the market risk framework. The BCBS began
work on significant changes to the market risk framework in 2007 due to issues highlighted by
the financial crisis. As a result, the agencies did not finalize the 2006 proposal. The January
2011 notice of proposed rulemaking incorporates aspects of the agencies’ 2006 proposal as well
as further revisions to the New Accord (and associated guidance) published by the BCBS in July
2009. These publications include Revisions to the Basel II Market Risk Framework, Guidelines
for Computing Capital for Incremental Risk in the Trading Book, and Enhancements to the Basel
II Framework (collectively, the 2009 revisions).
In June 2010, the BCBS published additional revisions to the market risk framework that
included establishing a floor on the risk-based capital requirement for modeled correlation
trading positions. On January 11, 2011, the agencies issued a joint notice of proposed
rulemaking (2011 proposal) (76 FR 1890) to revise their market risk capital rules to modify their
scope to better capture positions for which the market risk capital rules are appropriate; reduce
procyclicality in market risk capital requirements; enhance the rules’ sensitivity to risks that are

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not adequately captured under the current regulatory measurement methodologies; and increase
transparency through enhanced disclosures. On December 21, 2011, the agencies published an
amendment (76 FR 79380) to the 2011 proposal to incorporate into the proposed market risk
capital rules certain alternative methodologies for calculating specific risk capital requirements
for debt and securitization positions that do not rely on credit ratings.
The collection of information contained in the final rule is necessary to ensure banks’
capital adequacy according to their level of market risk.
Description of Information Collection
The final rule would apply to any bank with aggregate trading assets and trading
liabilities equal to (1) 10 percent or more of quarter-end total assets or (2) $1 billion or more.
The proposed revisions would apply to a bank meeting the market risk capital rule applicability
threshold regardless of whether the institution would adopt the proposed advanced capital
adequacy framework or remain under the general risk-based capital rule.
The Federal Reserve may apply the final rule to any bank if the Federal Reserve deems it
necessary or appropriate because of the level of market risk of the bank or to ensure safe and
sound banking practices. Also, the Federal Reserve may exclude a bank that meets the threshold
criteria from the rule if the Federal Reserve determines that the exclusion is appropriate based on
the level of market risk of the bank or to ensure safe and sound banking practices.
The final rule includes certain reporting, recordkeeping, and disclosure requirements.
These requirements are described in sections 3, 4, 5, 6, 7, 8, 9, 10, and 12 of the final rule.
Details of the information collection requirements of each section are provided below.
Reporting Requirements
Prior Written Approvals (Sections 8 and 9). Section 8(a) requires prior written
approvals for models measuring incremental risk. With the prior approval of the Federal
Reserve, a bank may choose to include portfolios of equity positions in its incremental risk
model, provided that it consistently includes such equity positions in a manner that is consistent
with how the bank internally measures and manages the incremental risk of such positions at the
portfolio level.
Section 9(a) requires prior approval of the Federal Reserve so that a bank may use the
method in this section to measure comprehensive risk, that is, all price risk, for one or more
portfolios of correlation trading positions.
Recordkeeping Requirements
Policies and Procedures (Sections 3 and 6). Section 3(a)(1) requires clearly defined
policies and procedures for determining which trading assets and trading liabilities are trading
positions and which trading positions are correlation trading positions. These policies and
procedures must take into account (1) the extent to which a position, or a hedge of its material

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risks, can be marked-to-market daily by reference to a two-way market and (2) possible
impairments to the liquidity of a position or its hedge.
Section 3(b)(1) requires clearly defined policies and procedures for actively managing all
covered positions and ,at a minimum, these policies and procedures must require (1) marking
positions to market or to model on a daily basis; (2) daily assessment of the bank’s ability to
hedge position and portfolio risks, and of the extent of market liquidity; (3) establishment and
daily monitoring of limits on positions by a risk control unit independent of the trading business
unit; (4) daily monitoring by senior management of certain information; (5) at least annual
reassessment of established limits on positions by senior management; and (6) at least annual
assessments by qualified personnel of the quality of market inputs to the valuation process, the
soundness of key assumptions, the reliability of parameter estimation in pricing models, and the
stability and accuracy of model calibration under alternative market scenarios.
Section 6(b)(3) requires policies and procedures that describe how the bank determines
the period of significant financial stress used to calculate its stressed VaR-based measure under
this section and must be able to provide empirical support for the period used. The policies and
procedures must address (1) how the bank links the period of significant financial stress used to
calculate the stressed VaR-based measure to the composition and directional bias of its current
portfolio and (2) the bank’s process for selecting, reviewing, and updating the period of
significant financial stress used to calculate the stressed VaR-based measure and for monitoring
the appropriateness of the period to the bank’s current portfolio.
Trading and Hedging Strategy (Section 3). Section 3(a)(2) requires clearly defined
trading and hedging strategies for trading positions approved by senior management of the bank.
The trading strategy must articulate the expected holding period of, and the market risk
associated with, each portfolio of trading positions. The hedging strategy must articulate for
each portfolio of trading positions the level of market risk the bank is willing to accept and must
detail the instruments, techniques, and strategies the bank will use to hedge the risk of the
portfolio.
Internal Models (Sections 3, 5, and 7). Sections 3(c)(4) through 3(c)(10) requires the
annual review of internal models and include certain requirements that the models must meet.
The bank must periodically, but no less frequently than annually, review its internal models in
light of developments in financial markets and modeling technologies, and enhance those models
as appropriate to ensure that they continue to meet the Federal Reserve’s standards for model
approval and employ risk measurement methodologies that are most appropriate for the bank’s
covered positions. The bank must incorporate its internal models into its risk management
process and integrate the internal models used for calculating its VaR-based measure into its
daily risk management process. The level of sophistication of a bank’s internal models must be
commensurate with the complexity and amount of its covered positions. A bank’s internal
models may use any of the generally accepted approaches, including but not limited to variancecovariance models, historical simulations, or Monte Carlo simulations, to measure market risk.
The bank’s internal models must properly measure all of the material risks in the covered
positions to which they are applied. The bank’s internal models must conservatively assess the
risks arising from less liquid positions and positions with limited price transparency under

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realistic market scenarios. The bank must have a rigorous and well-defined process for reestimating, re-evaluating, and updating its internal models to ensure continued applicability and
relevance. If a bank uses internal models to measure specific risk, the internal models must also
satisfy the requirements in paragraph (b)(1) of section 7 of the final rule.
Section 3(d)(4) requires at least an annual report to the bank’s board of directors on the
effectiveness of controls supporting the bank’s market risk measurement systems, including the
activities of the business trading units and of the independent risk control unit, compliance with
policies and procedures, and the calculation of the bank’s measure for market risk.
Section 5(a)(5) requires the bank to demonstrate to the satisfaction of the Federal Reserve
the appropriateness of any proxies used to capture the risks of the bank’s actual positions for
which such proxies are used.
Section 7(b)(1) requires either the use of internal models or the standard method set forth
in section 5 to measure the specific risk of each of its portfolios of covered debt and equity
positions. If a bank uses internal models to measure the specific risk of a portfolio of covered
debt or equity positions, the internal models must (1) explain the historical price variation in the
portfolio; (2) be responsive to changes in market conditions; (3) be robust to an adverse
environment, including signaling rising risk in an adverse environment; and (4) capture all
material components of specific risk for the debt and equity positions in the portfolio.
Specifically, the internal models must (a) capture event risk and idiosyncratic risk and (b)
capture and demonstrate sensitivity to material differences between positions that are similar but
not identical and to changes in portfolio composition and concentrations.
Backtesting and Stress Testing (Sections 4, 5 and 9). Section 4(b) requires a bank to
compare each of its most recent 250 business days’ trading losses (excluding fees, commissions,
reserves, net interest income, and intraday trading) with the corresponding daily VaR-based
measures. Once each quarter, the bank must identify the number of exceptions (that is, the
number of business days for which the actual daily net trading loss, if any, exceeds the
corresponding daily VaR-based measure) that have occurred over the preceding 250 business
days. A bank must use a multiplication factor that corresponds to the number of exceptions
identified to determine its VaR-based capital requirement and its stressed VaR-based capital
requirement for market risk until it obtains the next quarter’s backtesting results, unless the
Federal Reserve notifies the bank in writing that a different adjustment or other action is
appropriate.
Section 5(c) requires a bank to divide its portfolio into a number of significant
subportfolios approved by the Federal Reserve for subportfolio backtesting purposes. These
subportfolios must be sufficient to allow the bank and the Federal Reserve to assess the adequacy
of the VaR model at the risk factor level; the Federal Reserve will evaluate the appropriateness
of these subportfolios relative to the value and composition of the bank’s covered positions. The
bank must retain and make available to the Federal Reserve the following information for each
subportfolio for each business day over the previous two years (500 business days), with no more
than a 60-day lag: (1) a daily VaR-based measure for the subportfolio calibrated to a one-tail,
99.0 percent confidence level; (2) the daily profit or loss for the subportfolio (that is, the net

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change in price of the positions held in the portfolio at the end of the previous business day); and
(3) the probability of observing a profit that is less than, or a loss that is greater than, the amount
projected for each day.
Section 9(c) requires that a bank must at least weekly apply specific, supervisory stress
scenarios to its portfolio of correlation trading positions that capture changes in (1) default rates,
(2) recovery rates, (3) credit spreads, (4) correlations of underlying exposures, and
(5) correlations of a correlation trading position and its hedge. A bank must retain and make
available to the Federal Reserve the results of the supervisory stress testing, including
comparisons with the capital requirements generated by the bank’s comprehensive risk model. A
bank must report to the Federal Reserve promptly any instances where the stress tests indicate
any material deficiencies in the comprehensive risk model.
Securitizations (Section 10). Section 10(f) requires that a bank must demonstrate to the
satisfaction of the Federal Reserve a comprehensive understanding of the features of a
securitization position that would materially affect the performance of the position. The bank’s
analysis must be commensurate with the complexity of the securitization position and the
materiality of the position in relation to capital. To support the demonstration of its
comprehensive understanding, for each securitization position a bank must (1) conduct and
document an analysis of the risk characteristics of a securitization position prior to acquiring the
position, considering (a) structural features of the securitization that would materially impact the
performance of the position, (b) relevant information regarding the performance of the
underlying credit exposure(s), (c) relevant market data of the securitization, and (d) for
resecuritization positions, performance information on the underlying securitization exposures;
and (2) on an on-going basis (no less frequently than quarterly), evaluate, review, and update as
appropriate the analysis required above for each securitization position.
Disclosure Policy (Section 12). Section 12(b) requires that the bank must have a formal
disclosure policy approved by the board of directors that addresses the bank’s approach for
determining the market risk disclosures. The policy must address the associated internal controls
and disclosure controls and procedures. The board of directors and senior management must
ensure that appropriate verification of the disclosures takes place and that effective internal
controls and disclosure controls and procedures are maintained. One or more senior officers of
the bank must attest that the disclosures meet the requirements of the final rule and the board of
directors and senior management are responsible for establishing and maintaining an effective
internal control structure over financial reporting, including the disclosures required by this
section.
Disclosure Requirements
Disclosures (Section 12). Section 12(c) requires certain quantitative disclosures be made
public each calendar quarter. For each material portfolio of covered positions, the bank must
publicly disclose the following at least quarterly: (1) the high, low, and mean VaR-based
measures over the reporting period and the VaR-based measure at period-end; (2) the high, low,
and mean stressed VaR-based measures over the reporting period and the stressed VaR-based
measure at period-end; (3) the high, low, and mean incremental risk capital requirements over

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the reporting period and the incremental risk capital requirement at period-end; (4) the high, low,
and mean comprehensive risk capital requirements over the reporting period and the
comprehensive risk capital requirement at period-end, with the period-end requirement broken
down into appropriate risk classifications; (5) separate measures for interest rate risk, credit
spread risk, equity price risk, foreign exchange risk, and commodity price risk used to calculate
the VaR-based measure; and (6) a comparison of VaR-based estimates with actual gains or losses
experienced by the bank, with an analysis of important outliers. The bank must also disclose the
following at least quarterly: (1) the aggregate amount of on-balance sheet and off-balance sheet
securitization positions by exposure type; and (2) the aggregate amount of correlation trading
positions.
Section 12(d) requires the following qualitative disclosures annually, with any significant
changes disclosed in the interim: (1) the composition of material portfolios of covered positions;
(2) the bank’s valuation policies, procedures, and methodologies for covered positions including,
for securitization positions, the methods and key assumptions used for valuing such positions,
any significant changes since the last reporting period, and the impact of such change; (3) the
characteristics of the internal models used for purposes of this final rule; (4) a description of the
approaches used for validating and evaluating the accuracy of internal models and modeling
processes for purposes of this final rule; (5) for each market risk category (that is, interest rate
risk, credit spread risk, equity price risk, foreign exchange risk, and commodity price risk), a
description of the stress tests applied to the positions subject to the factor; (6) the results of the
comparison of the bank’s internal estimates for purposes of this final rule with actual outcomes
during a sample period not used in model development; (7) the soundness standard on which the
bank’s internal capital adequacy assessment under this final rule is based, including a description
of the methodologies used to achieve a capital adequacy assessment that is consistent with the
soundness standard; (8) a description of the bank’s processes for monitoring changes in the credit
and market risk of securitization positions, including how those processes differ for
resecuritization positions; and (9) a description of the bank’s policy governing the use of credit
risk mitigation to mitigate the risks of securitization and resecuritization positions.
Time Schedule for Information Collection
This information collection contains reporting, recordkeeping, and disclosure
requirements, as mentioned above. The creation of policies and procedures, a trading and
hedging strategy, internal models, and a disclosure policy are mandatory one-time recordkeeping
requirements, with mandatory updates that are on-occasion. The remaining recordkeeping
requirements are quarterly, annually, and on-occasion. The prior written approvals are all
required on-occasion. The disclosures are required quarterly, annually, and on-occasion.
Legal Status
The Board’s Legal Division has determined that 12 U.S.C. § 324 and 12 U.S.C. § 1844(c)
authorize the Board to require the information collection. Under the Freedom of Information Act
(FOIA), 5 U.S.C. § 552, Board records generally must be disclosed unless they are determined to
fall, in whole or in part, within the scope of one or more of the FOIA exemptions from
disclosure. See 5 U.S.C. § 552(b)(1)-(9). The exempt categories include, but are not limited to,

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“trade secrets and commercial or financial information obtained from a person and privileged or
confidential” (exemption 4). A submitter of information to the Board may request confidential
treatment for any portion of the information collected that the reporter believes is exempt from
disclosure under FOIA. The submitter must follow the steps outlined in the Board’s Rules
Regarding Availability of Information. See 12 CFR § 261. Additionally, to the extent that such
information may be contained in an examination report such information maybe also be withheld
from the public. See 5 U.S.C. § 552 (b)(8).
Consultation Outside the Agency
On September 25, 2006, the agencies published a joint notice of proposed rulemaking in
the Federal Register (71 FR 55958) in which they proposed amendments to their market risk
capital rules that would implement the BCBS’s changes to the market risk framework. The
BCBS began work on significant changes to the market risk framework in 2007 due to the issues
highlighted by the financial crisis. As a result, the agencies did not finalize the 2006 proposal.
The 2011 notice of proposed rulemaking incorporated aspects of the 2006 proposal as well as
further revisions to the New Accord (and associated guidance) published by the BCBS in July
2009. On January 11, 2011, the agencies published the 2011 proposed rule in the Federal
Register (76 FR 1890) requesting public comment for 90 days. The comment period for this
notice expired on April 11, 2011. On December 21, 2011, the agencies published an amendment
to the 2011 proposed rule in the Federal Register (76 FR 79380) requesting public comment for
45 days. The comment period for this notice expired on February 3, 2012. No comments
concerning PRA were received in response to the notice of proposed rulemaking. On August 30,
2012, the agencies published the final rule in the Federal Register (77 FR 53060) and is effective
on January 1, 2013.
Estimate of Respondent Burden
The total annual burden for the FR 4201 is 51,064 hours, as shown in the table below.
The Federal Reserve estimates that it will take each of the 26 respondents 96 hours to create its
policies and procedures, 16 hours to define its trading and hedging strategy, 128 hours to specify
what the internal models must include, and 40 hours to develop a disclosure policy. Most of the
burden associated with these parts of the information collection will only occur during the first
year of implementation or once a bank meets the qualification criteria.
The Federal Reserve estimates each respondent will take 16 hours per quarter to complete
the backtesting required under section 4(b) and 104 hours annually to complete the backtesting
and stress testing under Sections 5(c) and 9(c). The Federal Reserve also estimates the
securitizations analysis will take each respondent 120 hours per quarter. In addition, the Federal
Reserve estimates respondents will take 960 hours to submit prior written approvals annually.
Finally, the Federal Reserve estimates the quantitative disclosures will take respondents 16 hours
per quarter and the qualitative disclosures will take respondents 12 hours per year. Note that all
of these estimates represent an average across all respondents and represent the incremental
burden above and beyond any usual and customary business requirements. This burden
represents less than 1 percent of the total Federal Reserve System paperwork burden.

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Number of
respondents3

Annual
frequency

Estimated
average
hours
per response

26

1

960

24,960

Policies and Procedures

26

1

96

2,496

Trading and Hedging Strategy

26

1

16

416

Internal Models

26

1

128

3,328

Section 4(b)

26

4

16

1,664

Sections 5(c) and 9(c)

26

1

104

2,704

Securitizations

26

4

120

12,480

Disclosure Policy

26

1

40

1,040

Quantitative

26

4

16

1,664

Qualitative

26

1

12

312

Estimated
annual burden
hours

Reporting
Prior Written Approvals
Recordkeeping

Backtesting and Stress Testing

Disclosure

51,064

Total

The total annual cost to the public for this information collection is estimated to be $2,290,220.4
Sensitive Questions
This collection of information contains no questions of a sensitive nature, as defined by
OMB guidelines.
Estimate of Cost to the Federal Reserve System
The cost to the Federal Reserve System is negligible.

3

Of these respondents, none are small entities as defined by the Small Business Administration (i.e., entities with
less than $175 million in total assets) www.sba.gov/content/table-small-business-size-standards.
4
Total cost to the public was estimated using the following formula: percent of staff time, multiplied by annual
burden hours, multiplied by hourly rate (30% Office & Administrative Support @ $17, 45% Financial Managers @
$52, 15% Legal Counsel @ $55, and 10% Chief Executives @ $81). Hourly rate for each occupational group are
the median hourly wages (rounded up) from the Bureau of Labor and Statistics (BLS), Occupational Employment
and Wages 2011, www.bls.gov/news.release/ocwage.nr0.htm. Occupations are defined using the BLS Occupational
Classification System, www.bls.gov/soc/.

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