Banking and Finance Law Daily Fed, OCC address question about capital implications as result of market conditions
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Monday, May 4, 2020

Fed, OCC address question about capital implications as result of market conditions

By Colleen M. Svelnis, J.D.

The federal banking agencies answer a frequently asked question about capital implication under the market risk capital rule in light of the coronavirus pandemic.

The Office of the Comptroller of the Currency and the Federal Reserve Board have issued a Bulletin giving an answer to a question about a capital implication under the market risk capital rule, in light of the current financial conditions due to the coronavirus pandemic. Concern about the impact of COVID-19 has led to a significant repricing of global financial markets, an increase in market volatility, and a deterioration in market liquidity. The FAQ involves the capital implications under the market risk capital rule if a banking organization reported an increase in the number of backtesting exceptions in the first quarter of 2020, as part of its Pillar 3 disclosures for market risk.

The bulletin applies to banks subject to market risk capital rule, which generally applies to banking organizations with aggregate trading assets and trading liabilities equal to at least 10 percent or more of quarter-end total assets or $1 billion.

The market risk capital rule requires that a banking organization identify, once each quarter, the number of business days for which the actual daily net trading loss, if any, exceeds the corresponding daily Value at Risk (VaR)-based measure that have occurred over the preceding 250 business days. The question asks about the capital implications under the market risk capital rule if a banking organization reported an increase in the number of backtesting exceptions as part of its Pillar 3 disclosures for market risk. The answer involves the capital implications under 12 CFR Part 3, subpart F, 12 CFR Part 217, subpart F, and 12 CFR Part 324, subpart F.

According to the bulletin, additional time may be required in order to evaluate the root cause of recent backtesting exceptions, which otherwise result in a capital requirement for market risk that is not commensurate with the firm’s covered positions. As a result of the impact of COVID-19 on financial markets, the agencies took action in March and April 2020 to allow certain banks the option to adjust a banking organization’s VaR-based and stressed VaR-based capital requirements for market risk. These banks may apply the multiplication factor that applied as of Dec. 31, 2019, rather than applying a higher multiplier based on the most recent exceptions in order to determine VaR-based capital requirements for market risk.

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