JOINT FINAL RULE--AMENDMENT TO RISK-BASED CAPITAL STANDARDS FOR MARKET RISK.

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 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 July 1, 1999, 12 C.F.R. Parts 3, 208, 225, and 325 are amended as follows.

Part 3--Risk-Based Capital Standards: Market Risk

For the reasons set out in the joint preamble, the OCC's portion of the joint interim rule with request for comment amending 12 C.F.R. parts titled Risk-Based Capital Standards: Market Risk, published on December 30, 1997, at 62 Federal Register 68,067 is adopted as final without change.

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), 18310, 1831p-1, 1831r-1, 1835a, 1882, 2901-2907, 3105, 3310, 3331-3351, and 3906-3909; 15 U.S.C. 78b, 781(b), 781(g), 781(i), 780-4(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 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 the 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: 12U. 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:

Part 325--Capital Maintenance

1. The authority citation for Part 325 continues to read as follows:

Authority: 12U. 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:

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:3