# 77 FR 594: Enhanced Prudential Standards and Early Remediation Requirements for Covered Companies

> Federal · Regulations · In force

URL: https://www.frixlaw.com/law-library/statutes/FR_PRORULE_2011-33364

## Section

- **Citation:** 77 FR 594
- **Heading:** Enhanced Prudential Standards and Early Remediation Requirements for Covered Companies
- **Jurisdiction:** Federal
- **Kind:** Regulations
- **Status:** In force
- **Text as of:** August 14, 2026
- **Source:** Compiled text
- **Location:** Federal Register / Vol. 77 / 77 FR 594

## Text

FEDERAL RESERVE SYSTEM 12 CFR Part 252 [Regulation YY; Docket No. 1438] RIN 7100-AD-86 Enhanced Prudential Standards and Early Remediation Requirements for Covered Companies AGENCY:
Board of Governors of the Federal Reserve System (Board).

ACTION:
Proposed rule; request for public comment.

SUMMARY:
The Board is requesting comment on proposed rules that would implement the enhanced Prudential standards required to be established under section 165 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act or Act) and the early remediation requirements established under section 166 of the Act. The enhanced standards include risk-based capital and leverage requirements, liquidity standards, requirements for overall risk management (including establishing a risk committee), single-counterparty credit limits, stress test requirements, and a debt-to-equity limit for companies that the Financial Stability Oversight Council has determined pose a grave threat to financial stability.

DATES:
Comments: Comments should be received on or before March 31, 2012.

ADDRESSES:
You may submit comments, identified by Docket No. 1438 and RIN 7100-AD-86 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.
• Email: regs.comments@federalreserve.gov. Include docket and RIN numbers 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 http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm as submitted, unless modified for technical reasons
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 http://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 form in Room MP-500 of the Board's Martin Building (20th and C Streets NW.) between 9 a.m. and 5 p.m. on weekdays.
FOR FURTHER INFORMATION CONTACT:
Mark Van Der Weide, Senior Associate Director, (202) 452-2263, or Molly E. Mahar, Senior Supervisory Financial Analyst, (202) 973-7360, Division of Banking Supervision and Regulation; or Laurie Schaffer, Associate General Counsel, (202) 452-2272, or Dominic A. Labitzky, Senior Attorney, (202) 452-3428, Legal Division.
Risk-Based Capital Requirements and Leverage Limits: Anna Lee Hewko, Assistant Director, (202) 530-6260, or Meg Donovan, Supervisory Financial Analyst, (202) 872-7542, Division of Banking Supervision and Regulation; or April C. Snyder, Senior Counsel, (202) 452-3099, or Benjamin W. McDonough, Senior Counsel, (202) 452-2036, Legal Division.
Liquidity Requirements: Mary Aiken, Manager, (202) 721-4534, or Chris Powell, Financial Analyst, (202) 921-4353, Division of Banking Supervision and Regulation; or April C. Snyder, Senior Counsel, (202) 452-3099, Legal Division.
Single-Counterparty Credit Limits: Mark Van Der Weide, Senior Associate Director, (202) 452-2263, or Molly E. Mahar, Senior Supervisory Financial Analyst, (202) 973-7360, Division of Banking Supervision and Regulation; or Pamela G. Nardolilli, Senior Counsel, (202) 452-3289, Patricia P. Yeh, Counsel, (202) 912-4304, or Anna M. Harrington, Attorney, (202) 452-6406, Legal Division
Legal Division.
Single-Counterparty Credit Limits: Mark Van Der Weide, Senior Associate Director, (202) 452-2263, or Molly E. Mahar, Senior Supervisory Financial Analyst, (202) 973-7360, Division of Banking Supervision and Regulation; or Pamela G. Nardolilli, Senior Counsel, (202) 452-3289, Patricia P. Yeh, Counsel, (202) 912-4304, or Anna M. Harrington, Attorney, (202) 452-6406, Legal Division.
Risk Management and Risk Committee Requirements: Pamela A. Martin, Senior Supervisory Financial Analyst, (202) 452-3442, Division of Banking Supervision and Regulation; or Jonathan D. Stoloff, Senior Counsel, (202) 452-3269, or Jeremy C. Kress, Attorney, (202) 872-7589, Legal Division.
Stress Test Requirements: Tim Clark, Senior Adviser, (202) 452-5264, Lisa Ryu, Assistant Director, (202) 263-4833, Constance Horsley, Manager, (202) 452-5239 or David Palmer, Senior Supervisory Financial Analyst, (202) 452-2904, Division of Banking Supervision and Regulation; Dominic A. Labitzky, Senior Attorney, (202) 452-3428, or Christine E. Graham, Senior Attorney, (202) 452-3005, Legal Division.
Debt-to-Equity Limits for Certain Covered Companies: Robert Motyka, Senior Project Manager, (202) 452-5231, Division of Banking Supervision and Regulation; or April C. Snyder, Senior Counsel, (202) 452-3099, or Benjamin W. McDonough, Senior Counsel, (202) 452-2036, Legal Division.
Early Remediation Framework: Barbara J. Bouchard, Senior Associate Director, (202) 452-3072, or Molly E. Mahar, Senior Supervisory Financial Analyst, (202) 973-7360, Division of Banking Supervision and Regulation; or Paul F. Hannah, Counsel, (202) 452-2810, or Jay R. Schwarz, Counsel, (202) 452-2970, Legal Division.

SUPPLEMENTARY INFORMATION:

Table of Contents
I. Introduction II. Overview of the Proposal A. Scope of Application B. Risk-Based Capital Requirements and Leverage Limits C. Liquidity Requirements D. Single-Counterparty Credit Limits E. Risk Management and Risk Committee Requirements F. Stress Testing Requirements G
2) 452-2810, or Jay R. Schwarz, Counsel, (202) 452-2970, Legal Division.

SUPPLEMENTARY INFORMATION:

Table of Contents
I. Introduction II. Overview of the Proposal A. Scope of Application B. Risk-Based Capital Requirements and Leverage Limits C. Liquidity Requirements D. Single-Counterparty Credit Limits E. Risk Management and Risk Committee Requirements F. Stress Testing Requirements G. Debt-to-Equity Limits for Certain Covered Companies H. Early Remediation Framework I. Transition Arrangements and Ongoing Compliance J. Reservation of Authority K. Common Definitions III. Risk-Based Capital Requirements and Leverage Limits A. Background B. Overview of the Proposed Rule 1. Capital Planning and Minimum Capital Requirements 2. Quantitative Risk-Based Capital Surcharge IV. Liquidity Requirements A. Background B. Overview of the Proposed Rule 1. Key Definitions 2. Corporate Governance Provisions 3. Liquidity Requirements V. Single Counterparty Exposure Limits A. Background B. Overview of the Proposed Rule VI. Risk Management and Risk Committee Requirements A. Background B. Overview of the Proposed Rule 1. Risk Committee Requirements 2. Additional Enhanced Risk Management Standards for Covered Companies VII. Stress Test Requirements A. Background B. Overview of the Proposed Rule 1. Annual Supervisory Stress Tests Conducted by the Board 2. Annual and Additional Stress Tests Conducted by the Companies C. Request for Comments VIII. Debt-to-Equity Limit for Certain Covered Companies A. Background B. Overview of the Proposed Rule IX. Early Remediation A. Background B. Overview of the Proposed Rule 1. Early Remediation Requirements 2. Early Remediation Triggering Events X. Administrative Law Matters A. Solicitation of Comments and Use of Plain Language B. Paperwork Reduction Act Analysis C. Regulatory Flexibility Act Analysis I
Debt-to-Equity Limit for Certain Covered Companies A. Background B. Overview of the Proposed Rule IX. Early Remediation A. Background B. Overview of the Proposed Rule 1. Early Remediation Requirements 2. Early Remediation Triggering Events X. Administrative Law Matters A. Solicitation of Comments and Use of Plain Language B. Paperwork Reduction Act Analysis C. Regulatory Flexibility Act Analysis I. Introduction
The recent financial crisis showed that some financial companies had grown so large, leveraged, and interconnected that their failure could pose a threat to overall financial stability. The sudden collapses or near-collapses of major financial companies were among the most destabilizing events of the crisis. The crisis also demonstrated weaknesses in the existing framework for supervising, regulating and otherwise constraining the risks of major financial companies, as well as deficiencies in the government's toolkit for managing their failure.
As a result of the imprudent risk taking of major financial companies and the severe consequences to the financial system and the economy associated with the disorderly failure of these interconnected companies, the U.S. government (and many foreign governments in their home countries) intervened on an unprecedented scale to reduce the impact of, or prevent, the failure of these companies and the attendant consequences for the broader financial system. Market participants before the crisis had assumed some probability that major financial companies would receive government assistance if they became troubled. But the actions taken by the government in response to the crisis, although necessary, have solidified that market view.
The market perception that some companies are “too big to fail” poses threats to the financial system. First, it reduces the incentives of shareholders, creditors and counterparties of these companies to discipline excessive risk-taking
ment assistance if they became troubled. But the actions taken by the government in response to the crisis, although necessary, have solidified that market view.
The market perception that some companies are “too big to fail” poses threats to the financial system. First, it reduces the incentives of shareholders, creditors and counterparties of these companies to discipline excessive risk-taking. Second, it produces competitive distortions because companies perceived as “too big to fail” can often fund themselves at a lower cost than other companies. This distortion is unfair to smaller companies, damaging to competition, and tends to artificially encourage further consolidation and concentration in the financial system.
A major thrust of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act or Act) 1 is mitigating the threat to financial stability posed by systemically important financial companies. The Dodd-Frank Act addresses this problem with a multi-pronged approach: a new orderly liquidation authority for financial companies (other than banks and insurance companies); the establishment of the Financial Stability Oversight Council (Council) empowered with the authority to designate nonbank financial companies for Board oversight; stronger regulation of major bank holding companies and nonbank financial companies designated for Board oversight; and enhanced regulation of over-the-counter (OTC) derivatives, other core financial markets, and financial market utilities.
1 Public Law 111-203, 124 Stat. 1376 (2010).
Overview of Statutory Requirements
The focus of this proposal is stronger regulation of major bank holding companies and nonbank financial companies designated by the Council for Board supervision
gnated for Board oversight; and enhanced regulation of over-the-counter (OTC) derivatives, other core financial markets, and financial market utilities.
1 Public Law 111-203, 124 Stat. 1376 (2010).
Overview of Statutory Requirements
The focus of this proposal is stronger regulation of major bank holding companies and nonbank financial companies designated by the Council for Board supervision. In particular, sections 165 and 166 of the Dodd-Frank Act require the Board to impose a package of enhanced prudential standards on bank holding companies with total consolidated assets of $50 billion or more 2 and nonbank financial companies the Council has designated, pursuant to section 113 of the Dodd-Frank Act, 3 for supervision by the Board (together, covered companies and each a covered company). By their terms, sections 165 and 166 of the Act apply to any foreign nonbank financial company designated by the Council for supervision by the Board 4 and any foreign banking organization with total consolidated assets of $50 billion or more that is or is treated as a bank holding company for purposes of the Bank Holding Company Act of 1956 pursuant to section 8(a) of the International Banking Act of 1978. 5 However, as explained in greater detail below, this proposal does not apply to foreign banking organizations, and the Board expects to issue a separate proposal shortly that would apply the enhanced standards of sections 165 and 166 of the Act to foreign banking organizations. The definition of “covered company” for purposes of the proposal would nonetheless include a foreign banking organization's U.S.-based bank holding company subsidiary that on its own has total consolidated assets of $50 billion or more. 6 This proposal would not extend to the U.S. operations of a foreign banking organization that are conducted outside of a U.S.-based bank holding company subsidiary
he definition of “covered company” for purposes of the proposal would nonetheless include a foreign banking organization's U.S.-based bank holding company subsidiary that on its own has total consolidated assets of $50 billion or more. 6 This proposal would not extend to the U.S. operations of a foreign banking organization that are conducted outside of a U.S.-based bank holding company subsidiary.
2 The Board, pursuant to a Council recommendation, may raise the $50 billion asset threshold for bank holding companies with respect to the application of certain enhanced standards. See 12 U.S.C. 5365(a)(2)(B).
3 See 12 U.S.C. 5323. The Council proposed rules to implement its authority under section 113 in January 2011 and October 2011. See 76 FR 4555 (January 26, 2011) and 76 FR 64264 (October 18, 2011).
4 See 12 U.S.C. 5323(b). Section 102(c) limits the application of section 165 to only the U.S. activities and subsidiaries of a foreign nonbank financial company. 12 U.S.C. 5311(c).
5 See 12 U.S.C. 5311(a)(1) (defining the term “bank holding company” for purposes of Title I of the Dodd-Frank Act). A foreign banking organization is treated as a bank holding company pursuant to section 8(a) of the International Banking Act if the foreign banking organization operates a branch, agency or commercial lending company in the United States.
6 With the exception of the proposed liquidity and enterprise-wide risk management requirements and the debt-to-equity limit for covered companies that the Council has determined pose a grave threat, the proposed rule would not apply to any bank holding company subsidiary of a foreign banking organization that has relied on Supervision and Regulation Letter SR 01-01 issued by the Board of Governors (as in effect on May 19, 2010) until July 21, 2015. This is consistent with the phase-in period for the imposition of minimum risk-based and leverage capital requirements established in section 171 of the Dodd-Frank Act
ld not apply to any bank holding company subsidiary of a foreign banking organization that has relied on Supervision and Regulation Letter SR 01-01 issued by the Board of Governors (as in effect on May 19, 2010) until July 21, 2015. This is consistent with the phase-in period for the imposition of minimum risk-based and leverage capital requirements established in section 171 of the Dodd-Frank Act.
The prudential standards for covered companies required under section 165 of the Dodd-Frank Act must include enhanced risk-based capital and leverage requirements, enhanced liquidity requirements, enhanced risk management and risk committee requirements, a requirement to submit a resolution plan, single-counterparty credit limits, stress tests, and a debt-to-equity limit for covered companies that the Council has determined pose a grave threat to financial stability. In general, the Act directs the Board to implement enhanced prudential standards that strengthen existing micro-prudential supervision 7 and regulation of individual companies and incorporate macro-prudential considerations so as to reduce threats posed by covered companies to the stability of the financial system as a whole. Section 166 of the Act requires the Board to establish a regulatory framework for the early remediation of financial weaknesses of covered companies in order to minimize the probability that such companies will become insolvent and the potential harm of such insolvencies to the financial stability of the United States. 8
7 Micro-prudential supervision focuses on surveillance of the safety and soundness of individual companies, whereas macro-prudential supervision focuses on the surveillance of systemic risk posed by individual companies and systemic risks posed by interconnectedness among companies.
8 See 12 U.S.C. 5366(b)
e potential harm of such insolvencies to the financial stability of the United States. 8
7 Micro-prudential supervision focuses on surveillance of the safety and soundness of individual companies, whereas macro-prudential supervision focuses on the surveillance of systemic risk posed by individual companies and systemic risks posed by interconnectedness among companies.
8 See 12 U.S.C. 5366(b).
In addition to the required standards, the Act authorizes but does not require the Board to establish additional enhanced standards for covered companies relating to (i) contingent capital; (ii) public disclosures; (iii) short-term debt limits; and (iv) such other prudential standards as the Board 9 The Board is not proposing any of these supplemental standards at this time but continues to consider whether adopting any of these standards would be appropriate.
9 See 12 U.S.C. 5365(b)(1)(B).
The Act requires the enhanced standards established by the Board for covered companies under section 165 to be more stringent than those standards applicable to other bank holding companies and nonbank financial companies that do not present similar risks to U.S. financial stability. 10 Section 165 also requires that the enhanced standards established pursuant to that section increase in stringency based on the systemic footprint and risk characteristics of individual covered companies. 11
10 See 12 U.S.C. 5365(a)(1)(A).
11 See 12 U.S.C. 5365(a)(1)(B). Under section 165(a)(1)(B), the enhanced standards must increase in stringency, based on the considerations listed in section 165(b)(3). These considerations are summarized in note 13, infra.
In prescribing prudential standards under section 165(b)(1) 12 to covered companies, the Board is required to take into account differences among bank holding companies covered by the rule and nonbank financial companies supervised by the Board, based on certain considerations
ingency, based on the considerations listed in section 165(b)(3). These considerations are summarized in note 13, infra.
In prescribing prudential standards under section 165(b)(1) 12 to covered companies, the Board is required to take into account differences among bank holding companies covered by the rule and nonbank financial companies supervised by the Board, based on certain considerations. 13 The Board also has authority under section 165 to tailor the application of the standards, including differentiating among covered companies on an individual basis or by category. 14 When differentiating among companies for purposes of applying the standards established under section 165, the Board may consider the companies' size, capital structure, riskiness, complexity, financial activities, and any other risk-related factor the Board deems appropriate.
12 12 U.S.C. 5365(b)(1). The Board is separately required to issue regulations to implement the risk committee and stress test enhanced standards pursuant to sections 165(h) and 165(i), respectively.
13 See 12 U.S.C. 5365(b)(3). The factors the Board must consider include—(i) The factors described in sections 113(a) and (b) of the Dodd-Frank Act (12 U.S.C. 5313(a) and (b)); (ii) whether the company owns an insured depository institution; (iii) nonfinancial activities and affiliations of the company; and (iv) any other risk-related factors that the Board determines appropriate. 12 U.S.C. 5365(b)(3)(A). The Board must, as appropriate, adapt the required standards in light of any predominant line business of a nonbank financial company for which particular standards may not be appropriate. 12 U.S.C. 5365(b)(3)(D). Section 165(b)(3) also requires the Board, to the extent possible, to ensure that small changes in the factors listed in sections 113(a) and 113(b) of the Dodd-Frank Act would not result in sharp, discontinuous changes in the prudential standards established by the Board under section 165(b)(1). 12 U.S.C. 5365(b)(3)(B)
for which particular standards may not be appropriate. 12 U.S.C. 5365(b)(3)(D). Section 165(b)(3) also requires the Board, to the extent possible, to ensure that small changes in the factors listed in sections 113(a) and 113(b) of the Dodd-Frank Act would not result in sharp, discontinuous changes in the prudential standards established by the Board under section 165(b)(1). 12 U.S.C. 5365(b)(3)(B). The statute also directs the Board to take into account any recommendations made by the Council pursuant to its authority under section 115 of the Dodd-Frank Act. 12 U.S.C. 5365(b)(3)(C).
14 See 12 U.S.C. 5365(a)(2)(A).
II. Overview of the Proposal
The Board is requesting comment on proposed rules to implement certain requirements of sections 165 and 166 of the Dodd-Frank Act. 15 The Board consulted with the Council, including by providing periodic updates to members of the Council and their staff on the development of the proposed enhanced standards. The proposal reflects comments provided to the Board as a part of this consultation process. The Board also intends, before imposing prudential standards or any other requirements pursuant to section 165 that are likely to have a significant impact on a functionally regulated subsidiary or depository institution subsidiary of a covered company, to consult with each Council member that primarily supervises any such subsidiary. 16
15 12 U.S.C. 5365 and 5366.
16 See 12 U.S.C. 5365(b)(4).
This proposal includes rules to implement the requirements under section 165 related to (i) risk-based capital and leverage; (ii) liquidity; (iii) single-counterparty credit limits; (iv) overall risk management and risk committees; (v) stress tests; and (vi) a debt-to-equity limit for covered companies that the Council has determined pose a grave threat to financial stability
U.S.C. 5365(b)(4).
This proposal includes rules to implement the requirements under section 165 related to (i) risk-based capital and leverage; (ii) liquidity; (iii) single-counterparty credit limits; (iv) overall risk management and risk committees; (v) stress tests; and (vi) a debt-to-equity limit for covered companies that the Council has determined pose a grave threat to financial stability. The proposal also includes rules to implement the early remediation requirements in section 166 of the Act related to establishing measures of financial condition and remediation requirements that increase in stringency as the financial condition of a covered company declines.
Section 165(d) of the Act also establishes requirements that each covered company submit periodically to the Board and Federal Deposit Insurance Corporation (FDIC) a plan for rapid and orderly resolution under the Bankruptcy Code in the event of its material financial distress or failure, as well as a periodic report regarding credit exposures between each covered company and other significant financial companies. The Board and FDIC jointly issued a final rule to implement the resolution plan requirement that became effective on November 30, 2011 and expect to implement periodic reporting of credit exposures at a later date. 17
17 See 76 FR 67323 (November 1, 2011). In response to significant concerns expressed by commenters about the clarity of key definitions and the scope of the reporting requirement of the proposed credit exposure reporting requirement, the Board and FDIC postponed finalizing the credit exposure reporting requirement. The Board believes that robust reporting of a covered company's credit exposures to other significant bank holding companies and financial companies is critical to ongoing risk management by covered companies, as well as to the Board's ongoing supervision of covered companies and financial stability responsibilities, and the FDIC's responsibility to resolve failed covered companies
ng requirement. The Board believes that robust reporting of a covered company's credit exposures to other significant bank holding companies and financial companies is critical to ongoing risk management by covered companies, as well as to the Board's ongoing supervision of covered companies and financial stability responsibilities, and the FDIC's responsibility to resolve failed covered companies. However, the agencies also recognize that these reports would be most useful and complete if developed in conjunction with the Dodd-Frank Act's single counterparty credit exposure limits. See 12 U.S.C. 5365(e).
By setting forth comprehensive enhanced prudential standards and an early remediation framework for covered companies, the proposal would create an integrated set of requirements that seeks to meaningfully reduce the probability of failure of systemically important companies and minimize damage to the financial system and the broader economy in the event such a company fails. The proposed rules, which increase in stringency with the level of systemic risk posed by and the risk characteristics of the covered company, would provide incentives for covered companies to reduce their systemic footprint and encourage covered companies to consider the external costs that their failure or distress would impose on the broader financial system, thus helping to offset any implicit subsidy they may have enjoyed as a result of market perceptions of implicit government support.
This proposal provides a core set of concrete rules to complement the Federal Reserve's existing efforts to enhance the supervisory framework for covered companies. The Federal Reserve, since before the passage of the Dodd-Frank Act, has been taking steps to strengthen its supervision of the largest, most complex banking companies. For example, the Federal Reserve created a centralized multidisciplinary body called the Large Institution Supervision Coordinating Committee (LISCC) to oversee the supervision of these companies
ry framework for covered companies. The Federal Reserve, since before the passage of the Dodd-Frank Act, has been taking steps to strengthen its supervision of the largest, most complex banking companies. For example, the Federal Reserve created a centralized multidisciplinary body called the Large Institution Supervision Coordinating Committee (LISCC) to oversee the supervision of these companies. This committee uses horizontal, or cross-company, evaluations to monitor interconnectedness and common practices among companies that could lead to greater systemic risk. The committee also uses additional and improved quantitative methods for evaluating the financial condition of companies and the risks they might pose to each other and to the broader financial system.
A. Scope of Application
The Dodd-Frank Act requires the Board to apply enhanced standards established under section 165(b)(1) and early remediation requirements under
Under section 165(i)(2), the requirements to conduct annual stress tests apply to any financial company with more than $10 billion in total consolidated assets and that is regulated by a primary federal financial regulatory agency. 18 The Board, as the primary Federal financial regulatory agency for bank holding companies, savings and loan holding companies, and state member banks, proposes to apply the annual company-run stress test requirements to any bank holding company, savings and loan holding company, 19 and state member bank with more than $10 billion in total consolidated assets. Moreover, the requirement to establish a risk committee under section 165(h) of the Act applies to any publicly traded bank holding company with $10 billion or more in total consolidated assets. 20
18 12 U.S.C. 5365(i)(2). The Dodd-Frank Act defines primary financial regulatory agency in section 2 of the Act. See 12 U.S.C. 5301(12). The Board, Office of the Comptroller of the Currency, and Federal Deposit Insurance Corporation have consulted on rules implementing section 165(i)(2)
applies to any publicly traded bank holding company with $10 billion or more in total consolidated assets. 20
18 12 U.S.C. 5365(i)(2). The Dodd-Frank Act defines primary financial regulatory agency in section 2 of the Act. See 12 U.S.C. 5301(12). The Board, Office of the Comptroller of the Currency, and Federal Deposit Insurance Corporation have consulted on rules implementing section 165(i)(2).
19 As discussed below, the Board proposes to delay the effective date of the portion of the proposal implementing section 165(i)(2) for savings and loan holding companies until such time as the Board has implemented consolidated capital rules for savings and loan holding companies.
20 12 U.S.C. 5365(h).
For purposes of the definition of a covered company, a bank holding company is deemed to have met the $50 billion asset criterion based on the average of the company's total consolidated assets as reported on its four most recent quarterly reports to the Board, i.e., the Consolidated Financial Statements for Bank Holding Companies (Federal Reserve Form FR Y-9C). 21 This calculation will be effective as of the due date of the bank holding company's most recent FR Y-9C. 22 Under the proposal, a bank holding company that becomes a covered company would remain a covered company until its total consolidated assets, as reported to the Board on a quarterly basis on the FR Y-9C, fall and remain below $50 billion for four consecutive quarters.
21 With respect to a company that has been a bank holding company for less than four quarters, the Board would refer to the company's financial statements from quarters preceding the time that it began reporting on the FR Y-9C. For example, if a bank holding company had been reporting on the FR Y-9C for only one quarter, the Board would refer to its GAAP financial statements for the prior three quarters for purposes of calculating its average total consolidated assets
ss than four quarters, the Board would refer to the company's financial statements from quarters preceding the time that it began reporting on the FR Y-9C. For example, if a bank holding company had been reporting on the FR Y-9C for only one quarter, the Board would refer to its GAAP financial statements for the prior three quarters for purposes of calculating its average total consolidated assets.
22 For purposes of subpart E of the proposed rule, the same calculation approach would be applied to any bank holding company in determining when it becomes an over $10 billion bank holding company. For purposes of subpart G of the proposed rule, the same calculation approach would be applied to any bank holding company, savings and loan holding company, or state member bank in determining when it becomes an over $10 billion company.
This proposal would apply the same set of enhanced prudential standards to covered companies that are bank holding companies and covered companies that are nonbank financial companies. As noted above, however, in applying the enhanced prudential standards to covered companies, the Board may determine, on its own or in response to a recommendation by the Council, to tailor the application of the enhanced standards to different companies on an individual basis or by category, taking into consideration their capital structure, riskiness, complexity, financial activities, size, and any other risk-related factors that the Board deems appropriate. 23
23 12 U.S.C. 5365(a)(2).
The Board notes that this authority will be particularly important in applying the enhanced standards to specific nonbank financial companies designated by the Council that are organized and operated differently from banking organizations
tructure, riskiness, complexity, financial activities, size, and any other risk-related factors that the Board deems appropriate. 23
23 12 U.S.C. 5365(a)(2).
The Board notes that this authority will be particularly important in applying the enhanced standards to specific nonbank financial companies designated by the Council that are organized and operated differently from banking organizations. 24 Under the Act, 25 the Council generally may determine that a nonbank financial company, i.e., a company predominantly engaged in financial activities, should be subject to supervision by the Board and the enhanced standards established pursuant to section 165 and the early remediation requirements established pursuant to section 166, if material financial distress at such company, or the nature, scope, size, scale, concentration, interconnectedness, or mix of the activities of the nonbank financial company, could pose a threat to the financial stability of the United States. As such, the types of business models, capital structures, and risk profiles of companies that would be subject to designation by the Council could vary significantly.
24 To date, the Council has not designated any nonbank financial company for supervision by the Board.
25 See 12 U.S.C. 5315. See also 76 FR 64264 (Oct. 18, 2011) (proposing to implement the Council's authority under section 113 of the Dodd-Frank).
While this proposal was largely developed with large, complex bank holding companies in mind, some of the standards nonetheless provide sufficient flexibility to be readily implemented by covered companies that are not bank holding companies. In prescribing prudential standards under section 165(b)(1), the Board would to take into account differences among bank holding companies and nonbank financial companies supervised by the Board
oped with large, complex bank holding companies in mind, some of the standards nonetheless provide sufficient flexibility to be readily implemented by covered companies that are not bank holding companies. In prescribing prudential standards under section 165(b)(1), the Board would to take into account differences among bank holding companies and nonbank financial companies supervised by the Board. 26 Following designation of a nonbank financial company by the Council, the Board would thoroughly assess the business model, capital structure, and risk profile of the designated company to determine how the proposed enhanced prudential standards and early remediation requirements should apply. The Board may, by order or regulation, tailor the application of the enhanced standards to designated nonbank financial companies on an individual basis or by category, as appropriate. 27
26 See 12 U.S.C. 5365(b)(3). The factors the Board must take into consideration in prescribing the enhanced standards under section 165(b)(1) are described above. See supra note 13. Under section 171 of the Dodd-Frank Act, the Board is required to impose the same minimum risk-based and leverage capital requirements on bank holding companies and nonbank covered company as it imposes on insured depository institutions. 12 U.S.C. 5371.
27 Following designation of nonbank financial companies by the FSOC, the Board also would consider the appropriate risk-based capital treatment of asset types with no explicit treatment under the current risk-based capital rules. See generally 76 FR 37620 (June 28, 2011).
The Board solicits comment on alternative approaches for applying the enhanced prudential standards and the early remediation requirements the Dodd-Frank Act requires to nonbank covered companies
he Board also would consider the appropriate risk-based capital treatment of asset types with no explicit treatment under the current risk-based capital rules. See generally 76 FR 37620 (June 28, 2011).
The Board solicits comment on alternative approaches for applying the enhanced prudential standards and the early remediation requirements the Dodd-Frank Act requires to nonbank covered companies.
Question 1: What additional characteristics of a nonbank covered company—in addition to its business model, capital structure, and risk profile—should the Board consider when determining how to apply the enhanced standards and the early remediation requirements to such a company?
Question 2: What are the potential unintended consequences and burdens associated with subjecting a nonbank covered company to the enhanced prudential standards and the early remediation requirements?
The current proposal would apply only to U.S.-based bank holding companies that are covered companies and to nonbank covered companies, and would not apply to foreign banking 28 of $50 billion or more are subject to sections 165 and 166 of the Dodd-Frank Act. Section 165 instructs the Board, in applying the enhanced prudential standards of section 165 to foreign financial companies, to give due regard to the principle of national treatment and equality of competitive opportunity, and to take into account the extent to which the foreign company is subject, on a consolidated basis, to home country standards that are comparable to those applied to financial companies in the United States.
28 For a foreign banking organization subject to section 165 of the Dodd-Frank Act, total consolidated assets would be based on the foreign banking organization's Capital and Asset Reports for Foreign Banking Organizations (Federal Reserve Form FR Y-7Q)
is subject, on a consolidated basis, to home country standards that are comparable to those applied to financial companies in the United States.
28 For a foreign banking organization subject to section 165 of the Dodd-Frank Act, total consolidated assets would be based on the foreign banking organization's Capital and Asset Reports for Foreign Banking Organizations (Federal Reserve Form FR Y-7Q).
Determining how to apply the enhanced prudential standards and early remediation framework established by the Dodd-Frank Act to foreign banking organizations in a manner consistent with the purposes of the statute and the Board's existing framework of supervising foreign banking organizations is difficult. The scope of enhanced prudential standards required under sections 165 and 166 extends beyond the set of prudential standards that are part of existing international agreements, and foreign banking organizations are subject to home country regulatory and supervisory regimes that employ a wide variety of approaches to prudential regulation. Further, foreign banking organizations operate in the United States through diverse structures, complicating the consistent application of the enhanced standards to the U.S. operations of a foreign banking organization. Finally, the risk posed to U.S. financial stability by foreign banking organizations that are subject to sections 165 and 166 varies widely. The Board is actively developing a proposed framework for applying the Act's enhanced prudential standards and early remediation requirement to foreign banking organizations, and expects to issue this framework for public comment shortly.
While sections 165 and 166 generally do not apply to savings and loan holding companies, section 165(i)(2) requires the Board to issue regulations pursuant to which any financial company for which the Board is the primary federal financial regulatory agency and that has more than $10 billion in total consolidated assets must conduct an annual stress test
his framework for public comment shortly.
While sections 165 and 166 generally do not apply to savings and loan holding companies, section 165(i)(2) requires the Board to issue regulations pursuant to which any financial company for which the Board is the primary federal financial regulatory agency and that has more than $10 billion in total consolidated assets must conduct an annual stress test. 29 Thus, the proposal would apply annual company-run stress test requirements to any savings and loan holding company with more than $10 billion in consolidated assets. However, because the annual stress test requirement, as proposed, is predicated on a company being subject to consolidated capital requirements, this proposal would delay the effective date of the company-run stress test requirements for savings and loan holding companies until the Board has established risk-based capital requirements for savings and loan holding companies.
29 Among entities covered by this part of the Dodd-Frank are state member banks, bank holding companies, and savings and loan holding companies with total consolidated assets of $10 billion or more.
While the remaining parts of section 165 and section 166 do not specifically apply to savings and loan holding companies, the Board, as the primary supervisor of savings and loan holding companies, has the authority under the Home Owners' Loan Act to apply the enhanced standards to savings and loan holding companies to ensure their safety and soundness
consolidated assets of $10 billion or more.
While the remaining parts of section 165 and section 166 do not specifically apply to savings and loan holding companies, the Board, as the primary supervisor of savings and loan holding companies, has the authority under the Home Owners' Loan Act to apply the enhanced standards to savings and loan holding companies to ensure their safety and soundness. 30 The Board intends to issue a separate proposal for notice and comment to initially apply the enhanced standards and early remediation requirements to all savings and loan holding companies with substantial banking activities—i.e., any savings and loan holding company that (i) has total consolidated assets of $50 billion or more; and (ii)(A) has savings association subsidiaries which comprise 25 percent or more of such savings and loan holding company's total consolidated assets, or (B) controls one or more savings associations with total consolidated assets of $50 billion or more. The Board believes that applying the enhanced prudential standards of this proposal to savings and loan holding companies that satisfy these criteria is an important aspect of ensuring their safety and soundness. The Board also may determine to apply the enhanced standards to any savings and loan holding company, if appropriate to ensure the safety and soundness of such company, on a case-by-case basis.
30 See 12 U.S.C. 1467a(g) (authorizing the Board to issue such regulations and orders as the Board deems necessary or appropriate to administer and carry out the purposes of section 10 of the Home Owners' Loan Act).
As is the case with stress testing, many of the other enhanced standards are predicated on a covered company being subject to consolidated capital requirements
case-by-case basis.
30 See 12 U.S.C. 1467a(g) (authorizing the Board to issue such regulations and orders as the Board deems necessary or appropriate to administer and carry out the purposes of section 10 of the Home Owners' Loan Act).
As is the case with stress testing, many of the other enhanced standards are predicated on a covered company being subject to consolidated capital requirements. Therefore, similar to the approach with respect to applying the annual company-run stress test requirement to savings and loan holding companies, the Board intends to impose enhanced prudential standards and early remediation requirements on savings and loan holding companies with substantial banking activities once the Board has established risk-based capital requirements for savings and loan holding companies.
Question 3: The Board seeks comment on its proposed approach to the application of the company-run stress test requirements, including the delayed effective date, to savings and loan holding companies. Also, what additional or alternative criteria should the Board consider for determining which savings and loan holding companies initially would be subject to the enhanced prudential standards and early remediation requirements?
B. Risk-Based Capital Requirements and Leverage Limits
The recent financial crisis exposed significant weaknesses in the regulatory capital requirements for large banking companies. The amount of capital held by many large, complex banking companies proved to be inadequate to cover the risks that had accumulated in the companies. For certain exposure types, such as trading positions, OTC derivatives, and securitization and re-securitization exposures, it became evident that capital requirements did not adequately cover the risk of loss from those activities. In addition, it became apparent that some of the instruments that qualified as tier 1 capital for banking companies, the core measure of capital adequacy, were not truly loss absorbing
ure types, such as trading positions, OTC derivatives, and securitization and re-securitization exposures, it became evident that capital requirements did not adequately cover the risk of loss from those activities. In addition, it became apparent that some of the instruments that qualified as tier 1 capital for banking companies, the core measure of capital adequacy, were not truly loss absorbing.
Section 165(b)(1)(A)(i) of the Act directs the Board to establish enhanced risk-based capital and leverage standards for covered companies to address these weaknesses. The Board plans to meet this statutory requirement with a two-part effort. Under this proposal, the Board would subject all covered companies to the Board's capital plan rule, which currently requires all bank holding companies with $50 billion or more in consolidated assets to submit an annual capital plan to the Board for review (capital plan rule). 31 Under the capital plan rule, covered companies would have to demonstrate to the Board that they have robust, forward-looking capital planning processes that account for their unique risks and that permit continued operations during times of economic 32 The Board expects that a covered company will integrate into its capital plan, as one part of the underlying analysis, the results of the company-run stress tests conducted in accordance with section 165(i)(2) of the Dodd-Frank Act and the Board's proposed implementing rules. The results of those stress tests, as well as the annual supervisory stress test conducted by the Board under section 165(i)(1) of the Dodd-Frank, will be considered in the evaluation of a covered company's capital plan.
31 12 CFR 225.8.
32 In June 2011, the Board, along with the OCC and FDIC, issued for comment proposed supervisory guidance on stress testing for banking organizations with more than $10 billion in total assets. 76 FR 35072 (June 15, 2011)
isory stress test conducted by the Board under section 165(i)(1) of the Dodd-Frank, will be considered in the evaluation of a covered company's capital plan.
31 12 CFR 225.8.
32 In June 2011, the Board, along with the OCC and FDIC, issued for comment proposed supervisory guidance on stress testing for banking organizations with more than $10 billion in total assets. 76 FR 35072 (June 15, 2011). That proposed guidance contains principles for an effective stress testing framework that would cover an organization's various stress testing activities, including capital and liquidity stress testing. The agencies issued the proposed guidance for comment separately from this proposal because the proposed guidance is intended to apply broadly to organizations' use of stress testing in overall risk management, not just to capital and liquidity stress testing, as is the case for the requirements of this proposed rule. The agencies are considering comments on the proposed guidance and expect to issue a final version shortly. The Board expects that companies would follow the principles set forth in the final stress testing guidance—as well as with other relevant supervisory guidance—when conducting capital and liquidity stress testing in accordance with requirements in this proposed rule.
Under the capital plan rule, covered companies would be required to demonstrate to the Board their ability to maintain capital above existing minimum regulatory capital ratios and above a tier 1 common ratio of 5 percent under both expected and stressed conditions over a minimum nine-quarter planning horizon. 33 Covered companies with unsatisfactory capital plans would face limits on their ability to make capital distributions.
33 Under the capital plan rule, tier 1 common is defined as tier 1 capital less non-common elements in tier 1 capital, including perpetual preferred stock and related surplus, minority interest in subsidiaries, trust preferred securities and mandatory convertible preferred securities
red companies with unsatisfactory capital plans would face limits on their ability to make capital distributions.
33 Under the capital plan rule, tier 1 common is defined as tier 1 capital less non-common elements in tier 1 capital, including perpetual preferred stock and related surplus, minority interest in subsidiaries, trust preferred securities and mandatory convertible preferred securities. Specifically, non-common elements include the following items captured in the FR Y-9C reporting form: Schedule HC, line item 23 net of Schedule HC-R, line item 5; and Schedule HC-R, line items 6a, 6b, and 6c.
The Board intends to supplement the enhanced risk-based capital and leverage requirements included in this proposal with a subsequent proposal to implement a quantitative risk-based capital surcharge for covered companies or a subset of covered companies. Over the past few years, the Federal Reserve and other U.S. federal banking agencies have worked together with other members of the Basel Committee on Banking Supervision (BCBS) to strengthen the regulatory capital regime for internationally active banks and develop a framework for a risk-based capital surcharge for the world's largest, most interconnected banking companies. The new regime for internationally active banks, known as Basel III, 34 materially improves the quality of regulatory capital and introduces a new minimum common equity requirement. Basel III also raises the numerical minimum capital requirements and introduces capital conservation and countercyclical buffers to induce banking organizations to hold capital in excess of regulatory minimums. In addition, Basel III establishes for the first time an international leverage standard for internationally active banks. The Board is working with the other U.S. banking regulators to implement the Basel III capital reforms in the United States
rements and introduces capital conservation and countercyclical buffers to induce banking organizations to hold capital in excess of regulatory minimums. In addition, Basel III establishes for the first time an international leverage standard for internationally active banks. The Board is working with the other U.S. banking regulators to implement the Basel III capital reforms in the United States.
34 See Basel Committee on Banking Supervision, Basel III: A global regulatory framework for more resilient banks and banking systems (revised June 2011), available at http://www.bis.org/publ/bcbs189.htm (hereinafter Basel III framework). See also Basel Committee on Banking Supervision, Basel III: International framework for liquidity risk measurement, standards and monitoring (December 2010), available at www.bis.org/publ/bcbs188.htm (hereinafter Basel III liquidity framework); Enhancements to the Basel II framework (July 2009), available at www.bis.org/publ/bcbs157.htm; and Revisions to the Basel II market risk framework (July 2009), available at www.bis.org/publ/bcbs158.htm.
Building on the Basel III reforms, the BCBS published a document in November 2011 entitled Global systemically important banks: Assessment methodology and the additional loss absorbency requirement (BCBS framework), which set forth an additional capital requirement for global systemically important banks (G-SIBs). 35
35 See Basel Committee on Banking Supervision, Global systemically important banks: Assessment methodology and the additional loss absorbency requirement (November 2011), available at http://www.bis.org/publ/bcbs207.htm (hereinafter BCBS capital surcharge framework)
equirement (BCBS framework), which set forth an additional capital requirement for global systemically important banks (G-SIBs). 35
35 See Basel Committee on Banking Supervision, Global systemically important banks: Assessment methodology and the additional loss absorbency requirement (November 2011), available at http://www.bis.org/publ/bcbs207.htm (hereinafter BCBS capital surcharge framework).
The Basel III and BCBS frameworks, once implemented in the United States, are expected to significantly enhance risk-based capital and constrain the leverage of covered companies and will be a key part of the Board's overall approach to enhancing the risk-based capital and leverage standards applicable to these companies in accordance with section 165 of the Dodd-Frank Act. The Board intends to propose a quantitative risk-based capital surcharge in the United States based on the BCBS approach consistent with the BCBS's implementation timeframe. The forthcoming proposal would contemplate adopting implementing rules in 2014, and requiring G-SIBs to meet the capital surcharges on a phased-in basis from 2016-2019.
C. Liquidity Requirements
The financial crisis revealed significant weaknesses in liquidity buffers and liquidity risk management practices throughout the financial system that directly contributed to the failure or near failure of many companies and exacerbated the crisis. Section 165(b)(1)(A)(ii) addresses inadequacies in the existing regulatory liquidity requirements by directing the Board to establish liquidity standards for covered companies. Similar to enhanced risk-based capital and leverage requirements, the Federal Reserve intends to implement this statutory requirement through a multi-stage approach.
This proposal would subject covered companies to a set of enhanced liquidity risk management standards, including liquidity stress testing. 36 The proposal builds on guidance previously adopted by the Board and other U.S
companies. Similar to enhanced risk-based capital and leverage requirements, the Federal Reserve intends to implement this statutory requirement through a multi-stage approach.
This proposal would subject covered companies to a set of enhanced liquidity risk management standards, including liquidity stress testing. 36 The proposal builds on guidance previously adopted by the Board and other U.S. federal banking agencies and proposes higher liquidity risk management standards for covered companies. 37
36 See supra note 32.
37 Supervision and Regulation Letter SR 10-6, Interagency Policy Statement on Funding and Liquidity Risk Management (March 17, 2010), available at http://www.federalreserve.gov/boarddocs/srletters/2010/sr1006.pdf; 75 FR 13656 (March 22, 2010). The Board, the Office of the Comptroller of the Currency (OCC), the FDIC, the Office of Thrift Supervision, the National Credit Union Administration, and the Conference of State Bank Supervisors jointly issued the Interagency Liquidity Risk Policy Statement. The Interagency Liquidity Risk Policy Statement incorporates principles of sound liquidity risk management that the agencies have issued in the past, and supplements them with the principles of sound liquidity risk management established by the Basel Committee on Bank Supervision (Basel Committee) in its document entitled “Principles for Sound Liquidity Management and Supervision.” Principles for Sound Liquidity Risk Management and Supervision (September 2008), available at https://ww.bis.org/publ/bcbs144.htm.
The proposal would require covered companies to conduct internal stress tests at least monthly to measure their liquidity needs at 30-day, 90-day and one-year intervals during times of instability in the financial markets and to hold liquid assets that would be sufficient to cover 30-day stressed net cash outflows under their internal stress scenarios
able at https://ww.bis.org/publ/bcbs144.htm.
The proposal would require covered companies to conduct internal stress tests at least monthly to measure their liquidity needs at 30-day, 90-day and one-year intervals during times of instability in the financial markets and to hold liquid assets that would be sufficient to cover 30-day stressed net cash outflows under their internal stress scenarios. Covered companies also would be required to meet specified corporate governance requirements around liquidity risk management, to project cash flow needs over various time horizons, to establish internal limits on certain liquidity metrics, and
In addition to the enhanced liquidity risk management standards included in this proposal, the Federal Reserve and other U.S. federal banking agencies have been working with the BCBS over the past few years to develop quantitative liquidity requirements to increase the capacity of internationally active banking firms to absorb shocks to funding relative to the liquidity risks they face. The BCBS approved two new liquidity rules as part of the Basel III reforms in December 2010. The first rule is a Liquidity Coverage Ratio (LCR), which would require banks to hold an amount of high-quality liquid assets sufficient to meet expected net cash outflows over a 30-day time horizon under a supervisory stress scenario. The second rule is the Net Stable Funding Ratio (NSFR), which would require banks to enhance their liquidity risk resiliency out to one year. Under the terms of Basel III, global banks are required to comply with the LCR by 2015 and with the NSFR by 2018.
The Basel III liquidity rules are currently in an international observation period as the U.S. federal banking agencies and other BCBS members assess the potential impact of the rules on banks and various financial markets. The Board intends, in conjunction with other federal banking agencies, to implement these standards in the United States through one or more separate rulemakings
SFR by 2018.
The Basel III liquidity rules are currently in an international observation period as the U.S. federal banking agencies and other BCBS members assess the potential impact of the rules on banks and various financial markets. The Board intends, in conjunction with other federal banking agencies, to implement these standards in the United States through one or more separate rulemakings. Through implementation of these standards in the United States, the Board anticipates that the Basel III liquidity rules would then become a central component of the enhanced liquidity requirements for covered companies, or a subset of covered companies, under section 165 of the Dodd-Frank Act.
D. Single-Counterparty Credit Limits
As demonstrated in the crisis, interconnectivity among major financial companies poses risks to financial stability. The effects of one large financial company's failure or near collapse may be transmitted and amplified by the bilateral credit exposures between large, systemically important companies. The financial crisis also revealed inadequacies in the structure of the U.S. regulatory framework for single-counterparty credit limits. Although banks were subject to single-borrower lending and investment limits, these limits did not apply to bank holding companies on a consolidated basis and did not adequately cover credit exposures generated by derivatives and some securities financing transactions. 38
38 Section 610 of the Dodd-Frank Act amends the term “loans and extensions of credit” for purposes of the lending limits applicable to national banks to include any credit exposure arising from a derivative transaction, repurchase agreement, reverse repurchase agreement, securities lending transaction, or securities borrowing transaction. See Dodd-Frank Act, Public Law 111-203, § 610, 124 Stat. 1376, 1611 (2010). As discussed in more detail below, these types of transactions are also all made subject to the single counterparty credit limits of section 165(e). 12 U.S.C. 5365(e)(3)
ng from a derivative transaction, repurchase agreement, reverse repurchase agreement, securities lending transaction, or securities borrowing transaction. See Dodd-Frank Act, Public Law 111-203, § 610, 124 Stat. 1376, 1611 (2010). As discussed in more detail below, these types of transactions are also all made subject to the single counterparty credit limits of section 165(e). 12 U.S.C. 5365(e)(3).
In an effort to address concentration risk among large financial institutions, section 165(e) of the Dodd-Frank Act directs the Board to establish single-counterparty credit limits for covered companies in order to limit the risks that the failure of any individual company could pose to a covered company. 39 This section directs the Board to prescribe regulations that prohibit covered companies from having credit exposure to any unaffiliated company that exceeds 25 percent of the capital stock and surplus of the covered company. 40 This section also authorizes the Board to lower the 25 percent threshold if necessary to mitigate risks to the financial stability of the United States. 41
39 See 12 U.S.C. 5365(e)(1).
40 12 U.S.C. 5365(e)(2).
41 See id.
Credit exposure to a company is defined broadly in section 165(e) of the Act to cover all extensions of credit to the company; all repurchase and reverse repurchase agreements, and securities borrowing and lending transactions, with the company; all guarantees and letters of credit issued on behalf of the company; all investments in securities issued by the company; counterparty credit exposure to the company in connection with derivative transactions; and any other similar transaction that the Board determines to be a credit exposure for purposes of section 165(e). 42 Section 165(e) also grants authority to the Board to exempt transactions from the definition of the term “credit exposure” if the Board finds that the exemption is in the public interest and consistent with the purposes of the subsection. 43
42 See 12 U.S.C. 5365(e)(3).
43 See 12 U.S.C
ther similar transaction that the Board determines to be a credit exposure for purposes of section 165(e). 42 Section 165(e) also grants authority to the Board to exempt transactions from the definition of the term “credit exposure” if the Board finds that the exemption is in the public interest and consistent with the purposes of the subsection. 43
42 See 12 U.S.C. 5365(e)(3).
43 See 12 U.S.C. 5365(e)(5)-(6).
The proposal implements these statutory provisions by defining key terms, such as covered company, unaffiliated counterparty, and capital stock and surplus. The proposal also targets the mutual interconnectedness of the largest financial companies by setting a stricter 10 percent limit for credit exposure between a covered company and a counterparty that each either have more than $500 billion in total consolidated assets or are a nonbank covered company. In addition, the proposal provides rules for measuring the amount of credit exposure generated by the various types of credit transactions. Notably, the proposal would allow covered companies to reduce their credit exposure to a counterparty for purposes of the limit by obtaining credit risk mitigants such as collateral, guarantees, and credit derivative hedges. The proposal describes the types of collateral, guarantees and derivative hedges that are eligible under the rule and provides valuation rules for reflecting such credit risk mitigants.
E. Risk Management and Risk Committee Requirements
Sound, enterprise-wide risk management by covered companies reduces the likelihood of their material distress or failure and thus promotes financial stability
The proposal describes the types of collateral, guarantees and derivative hedges that are eligible under the rule and provides valuation rules for reflecting such credit risk mitigants.
E. Risk Management and Risk Committee Requirements
Sound, enterprise-wide risk management by covered companies reduces the likelihood of their material distress or failure and thus promotes financial stability. In addition to adopting enhanced risk management standards for covered companies, the Board is directed by section 165(h) to require publicly traded covered companies and publicly traded bank holding companies with $10 billion or more in total consolidated assets to establish a risk committee of the board of directors that is responsible for oversight of enterprise-wide risk management, is comprised of an appropriate number of independent directors, and includes at least one risk management expert.
The proposal would require all covered companies to implement robust enterprise-wide risk management practices that are overseen by a risk committee of the board of directors and chief risk officer with appropriate levels of independence, expertise and stature. The proposal also would require any publicly traded bank holding company with $10 billion or more in total consolidated assets and that is not a covered company to establish a risk committee.
F. Stress Testing Requirements
The crisis also revealed weaknesses in the stress testing practices of large banking organizations, as well as gaps in the regulatory community's approach to assessing capital adequacy
l also would require any publicly traded bank holding company with $10 billion or more in total consolidated assets and that is not a covered company to establish a risk committee.
F. Stress Testing Requirements
The crisis also revealed weaknesses in the stress testing practices of large banking organizations, as well as gaps in the regulatory community's approach to assessing capital adequacy. During the height of the crisis, the Federal Reserve began stress testing the capital adequacy of large, complex bank holding companies as a forward-looking exercise designed to estimate losses, revenues, regulatory capital ratios, and reserve needs under various macroeconomic 44 By looking at the broad needs of the financial system and the specific needs of individual companies, these stress tests provided valuable information to market participants and had an overall stabilizing effect.
44 In early 2009, the Federal Reserve led the Supervisory Capital Assessment Program (SCAP) as a key element of the plan to stabilize the U.S. financial system. Building on SCAP and other supervisory work coming out of the crisis, the Federal Reserve initiated the Comprehensive Capital Analysis and Review (CCAR) in late 2010 to evaluate the internal capital planning processes of large, complex bank holding companies. The CCAR represented a substantial strengthening of previous approaches to ensuring that large firms have thorough and robust processes for managing and allocating their capital resources. The CCAR also focused on the risk measurement and management practices supporting firms' capital adequacy assessments, including their ability to deliver credible inputs to their loss estimation techniques
nies. The CCAR represented a substantial strengthening of previous approaches to ensuring that large firms have thorough and robust processes for managing and allocating their capital resources. The CCAR also focused on the risk measurement and management practices supporting firms' capital adequacy assessments, including their ability to deliver credible inputs to their loss estimation techniques.
Section 165(i)(1) directs the Board to implement rules requiring the Federal Reserve, in coordination with the appropriate primary Federal regulatory agencies and the Federal Insurance Office, to conduct an annual evaluation of whether each covered company has sufficient capital to absorb losses as a result of adverse economic conditions (supervisory stress tests). The Board is also required to publish a summary of the results of the supervisory stress tests. In addition, section 165(i)(2) directs the Board to implement rules requiring each covered company to conduct its own semi-annual stress tests and any state member bank, bank holding company or savings and loan holding company with more than $10 billion in total consolidated assets (that is not a covered company) to conduct its own annual stress tests (company-run stress tests). Companies must also publish a summary of the results of the company-run stress tests.
The proposal would implement these statutory provisions by requiring the Federal Reserve to conduct annual supervisory stress tests of covered companies under baseline, adverse, and severely adverse scenarios and by requiring companies that are subject to company-run stress test requirements to conduct their own capital adequacy stress tests on an annual or semi-annual basis, as applicable. Under the proposal, the Board would publicly disclose information on the company-specific results of the supervisory stress tests.
G
sts of covered companies under baseline, adverse, and severely adverse scenarios and by requiring companies that are subject to company-run stress test requirements to conduct their own capital adequacy stress tests on an annual or semi-annual basis, as applicable. Under the proposal, the Board would publicly disclose information on the company-specific results of the supervisory stress tests.
G. Debt-to-Equity Limits for Certain Covered Companies
Section 165(j) of the Dodd-Frank Act provides that the Board must require a covered company to maintain a debt-to-equity ratio of no more than 15-to-1, upon a determination by the Council that (i) such company poses a grave threat to the financial stability of the United States and (ii) the imposition of such a requirement is necessary to mitigate the risk that the company poses to U.S. financial stability. The proposal establishes procedures to notify a covered company that the Council has made a determination under section 165(j) that the company must comply with the 15-to-1 debt-to-equity ratio requirement, defines “debt” and “equity” for purposes of calculating compliance with the ratio, and provides an affected company with a transition period to come into compliance with the ratio.
H. Early Remediation Framework
The financial crisis revealed that the condition of large banking organizations can deteriorate rapidly even during periods when their reported regulatory capital ratios are well above minimum requirements. The crisis also revealed that financial companies that addressed incipient financial problems swiftly and decisively performed much better than companies that delayed remediation work.
Section 166 of the Dodd-Frank Act directs the Board to prescribe regulations to provide for the early remediation of financial distress at covered companies so as to minimize the probability that the company will become insolvent and to reduce the potential harm of the insolvency of a covered company to the financial stability of the United States
er than companies that delayed remediation work.
Section 166 of the Dodd-Frank Act directs the Board to prescribe regulations to provide for the early remediation of financial distress at covered companies so as to minimize the probability that the company will become insolvent and to reduce the potential harm of the insolvency of a covered company to the financial stability of the United States. The regulation must use measures of the financial condition of a covered company, including regulatory capital ratios, liquidity measures, and other forward-looking indicators as triggers for remediation actions. Remediation requirements must increase in stringency as the financial condition of a covered company deteriorates. Remedies must include, in the initial stages of financial decline of the covered company, limits on capital distributions, acquisitions, and asset growth. Remedies in the later stages of financial decline of the covered company must include a capital restoration plan and capital-raising requirements, limits on transactions with affiliates, management changes, and asset sales.
The proposed rule implementing section 166 establishes a regime for the early remediation of financial distress at covered companies that includes several forward-looking triggers designed to identify emerging or potential issues before they develop into larger problems. In addition to regulatory capital triggers, the proposed rule includes triggers based on supervisory stress test results, market indicators and weaknesses in enterprise-wide and liquidity risk management. The proposed rule also describes the regulatory restrictions that a covered company must comply with in each remedial stage.
I. Transition Arrangements and Ongoing Compliance
Another important aspect of the proposal is the timing of initial compliance and ongoing reporting to the Board in conjunction with the proposed enhanced standards
knesses in enterprise-wide and liquidity risk management. The proposed rule also describes the regulatory restrictions that a covered company must comply with in each remedial stage.
I. Transition Arrangements and Ongoing Compliance
Another important aspect of the proposal is the timing of initial compliance and ongoing reporting to the Board in conjunction with the proposed enhanced standards. In order to reduce the burden on covered companies of coming into initial compliance with the standards, the Board is proposing to provide meaningful phase-in periods. In general, a company that is a covered company on the effective date of the final rule would be subject to the enhanced prudential standards beginning on the first day of the fifth quarter following the effective date of the final rule. A company that becomes a covered company after the effective date of the final rule generally would become subject to the enhanced standards beginning on the first day of the fifth quarter following the date that it became a covered company. For a variety of reasons, the proposed rule provides different transition arrangements for enhanced risk-based capital and leverage requirements, single-counterparty credit limits and stress testing requirements. Transition arrangements for these standards are discussed in the relevant sections of the preamble below.
To reduce the burden of ongoing compliance with the enhanced standards, the Board is also proposing to sequence the timing of required submissions. For example, the requirement that covered companies conduct stress tests is specifically timed to coordinate with the reporting requirements associated with the capital plan, and the capital plan and stress test requirements are specifically timed to minimize overlap with resolution plan update requirements. 45
45 See 12 CFR 243.3
is also proposing to sequence the timing of required submissions. For example, the requirement that covered companies conduct stress tests is specifically timed to coordinate with the reporting requirements associated with the capital plan, and the capital plan and stress test requirements are specifically timed to minimize overlap with resolution plan update requirements. 45
45 See 12 CFR 243.3.
Question 4: Are there alternative approaches the Board should consider to phase in the proposed enhanced prudential standards for either bank holding companies or nonbank financial companies?
J. Reservation of Authority
To address situations where compliance with the requirements of the proposed rule would not sufficiently mitigate the risks to U.S. financial 46 The proposed rule also specifies that the Board may determine that a bank holding company that is not a covered company shall be subject to one or more of the standards established under the proposed rule if the Board determines that doing so is necessary or appropriate to protect the safety and soundness of the company or to promote financial stability.
46 12 U.S.C. 5365(b)(1)(B)(iv).
In addition, the proposed rule would specifically state that nothing in the rule would limit the authority of the Board under any other provision of law or regulation to take supervisory or enforcement action, including action to address unsafe and unsound practices or conditions, deficient capital or liquidity levels, or violations of law.
K. Common Definitions
A number of terms are used throughout the proposed rule. Some of these terms are generally given the same meaning as their definitions under other regulations issued by the Board. For example, under the proposal, the term “company” would be defined as a corporation, partnership, limited liability company, depository institution, business trust, special purpose entity, association, or similar organization
r of terms are used throughout the proposed rule. Some of these terms are generally given the same meaning as their definitions under other regulations issued by the Board. For example, under the proposal, the term “company” would be defined as a corporation, partnership, limited liability company, depository institution, business trust, special purpose entity, association, or similar organization. The term “bank holding company” generally would have the same meaning as in section 2 of the Bank Holding Company Act, as amended (12 U.S.C. 1841), and the Board's Regulation Y (12 CFR part 225). 47 Additional common definitions are detailed in the proposed rule.
47 Control would have a different meaning under the proposed rules concerning single-counterparty credit limits.
The Board solicits comment on these proposed definitions.
III. Risk-Based Capital Requirements and Leverage Limits
A. Background
Section 165 of the Dodd-Frank Act directs the Board to establish risk-based capital and leverage standards for covered companies that are more stringent than the risk-based capital and leverage standards applicable to nonbank financial companies and bank holding companies that do not present similar risks to the financial stability of the United States and increase in stringency based on the systemic footprint of the company.
As discussed above, in addition to implementing the broader Basel III capital reforms, the Board seeks to implement enhanced risk-based capital and leverage standards for covered companies in a two-stage process: (i) In this proposal, the application of the Board's capital plan rule to covered companies, including the requirement for covered companies to maintain capital above 5 percent tier 1 common risk-based capital ratio under both expected and stressed conditions; and (ii) in a separate future proposal, the introduction of a quantitative risk-based capital surcharge for covered companies or a subset of covered companies based on the BCBS capital surcharge framework for G-SIBs.
B
companies, including the requirement for covered companies to maintain capital above 5 percent tier 1 common risk-based capital ratio under both expected and stressed conditions; and (ii) in a separate future proposal, the introduction of a quantitative risk-based capital surcharge for covered companies or a subset of covered companies based on the BCBS capital surcharge framework for G-SIBs.
B. Overview of the Proposed Rule
1. Capital Planning and Minimum Capital Requirements
Under the proposal, all covered companies would be required to comply with, and hold capital commensurate with, the requirements of any regulations adopted by the Board relating to capital plans and stress tests. Thus, in addition to the stress testing requirements that are part of this proposal, this subpart would require all covered companies to comply with the capital plan rule recently adopted by the Board. 48 In addition, the Board is proposing that nonbank covered companies be subject to the same minimum risk-based and leverage capital requirements that apply to covered companies that are bank holding companies.
48 12 CFR 225.8. See 76 FR 74631 (December 1, 2011). The capital plan rule currently applies to all U.S. bank holding companies with $50 billion or more in total consolidated assets (large bank holding companies).
As discussed further below, the capital plan rule would enhance minimum capital standards for covered companies in several dimensions, including requiring firms to demonstrate capital adequacy over a minimum nine-quarter planning horizon under both expected and stressed conditions. 49 The Board believes that the safety and soundness rationale that underlies the capital plan rule's enhanced risk-based capital and leverage standards for bank holding companies is also applicable to nonbank covered companies, and that compliance with this rule by such companies would help to promote their ongoing financial stability
r planning horizon under both expected and stressed conditions. 49 The Board believes that the safety and soundness rationale that underlies the capital plan rule's enhanced risk-based capital and leverage standards for bank holding companies is also applicable to nonbank covered companies, and that compliance with this rule by such companies would help to promote their ongoing financial stability. By requiring covered companies to have robust capital plans and to hold capital commensurate with the risks they would face under stressful financial conditions, and by limiting capital distributions under certain circumstances, the proposed rule would reduce the probability of the failure of a covered company.
49 At present, the Board's rules for calculating minimum capital requirements are found at 12 CFR part 225, appendix A (general risk-based capital rule), 12 CFR part 225, appendix D (leverage rule), 12 CFR part 225, appendix E (market risk rule), and 12 CFR part 225, appendix G (advanced approaches risk-based capital rule). A firm that met the applicability thresholds under the market risk rule or the advanced approaches risk-based capital rule would be required to use those rules to calculate its minimum risk-based capital requirements in addition to the general risk-based capital requirements and the leverage rule.
The current capital plan rule imposes enhanced risk-based and leverage requirements on large bank holding companies in several ways. The rule requires such companies to submit board-approved annual capital plans to the Federal Reserve in which they demonstrate their ability to maintain capital above the Board's minimum risk-based capital ratios (total capital ratio of 8 percent, tier 1 capital ratio of 4 percent) and tier 1 leverage ratio (4 percent) under both baseline and stressed conditions over a minimum nine-quarter, forward-looking planning horizon
anies to submit board-approved annual capital plans to the Federal Reserve in which they demonstrate their ability to maintain capital above the Board's minimum risk-based capital ratios (total capital ratio of 8 percent, tier 1 capital ratio of 4 percent) and tier 1 leverage ratio (4 percent) under both baseline and stressed conditions over a minimum nine-quarter, forward-looking planning horizon. Each such plan must include a discussion of the bank holding company's sources and uses of capital reflecting the risk profile of the firm over the planning horizon. In addition, these bank holding companies must demonstrate the ability to maintain a minimum tier 1 common risk-based capital ratio of 5 percent over the same planning horizon (under both baseline and stressed conditions). 50 The stressed scenarios must include any scenarios provided by the Federal Reserve (such as those discussed in section VII of this preamble) as well as at least one stressed scenario developed by the bank holding company appropriate to its business model. A capital plan must
50 Under the capital plan rule, tier 1 common is defined as tier 1 capital less non-common elements in tier 1 capital, including perpetual preferred stock and related surplus, minority interest in subsidiaries, trust preferred securities and mandatory convertible preferred securities. Specifically, non-common elements include the following items captured in the FR Y-9C reporting form: Schedule HC, line item 23 net of Schedule HC-R, line item 5; and Schedule HC-R, line items 6a, 6b, and 6c.
In its capital plan, a large bank holding company must provide a detailed description of its process for assessing capital adequacy, including a description of how it will, under stressful conditions, maintain capital commensurate with its risks and continue its operations by maintaining ready access to funding, meeting its obligations to creditors and other counterparties, and continuing to serve as a credit intermediary
rge bank holding company must provide a detailed description of its process for assessing capital adequacy, including a description of how it will, under stressful conditions, maintain capital commensurate with its risks and continue its operations by maintaining ready access to funding, meeting its obligations to creditors and other counterparties, and continuing to serve as a credit intermediary. A large bank holding company that is unable to satisfy these requirements generally may not make any capital distributions until it provides a satisfactory capital plan to the Federal Reserve. 51
51 See section VII supra on the enhanced prudential requirement that a covered company conduct certain stress tests for explanation of the relation between this enhanced prudential capital requirement and the stress test requirement under section 165.
In addition, a large bank holding company must obtain prior approval from the Federal Reserve before making a capital distribution in certain circumstances where the Federal Reserve had provided a non-objection to the large bank holding company's capital plan. The bank holding company would be required to include certain information in the request, which may include, among other things, an assessment of the bank holding company's capital adequacy under a revised stress scenario provided by the Federal Reserve, a revised capital plan, and supporting data.
As stated above, a nonbank covered company would be subject to the capital plan rule under this proposal. While a bank holding company that becomes a covered company over time is subject to the requirements of the capital plan rule as provided for in that rule, 52 a nonbank covered company would become subject to the requirements of the capital plan rule in the calendar year that it was designated by the Council, if the nonbank covered company was designated by the Council more than 180 days before September 30 of that calendar year.
52 See generally 12 CFR 225.8(b)
e is subject to the requirements of the capital plan rule as provided for in that rule, 52 a nonbank covered company would become subject to the requirements of the capital plan rule in the calendar year that it was designated by the Council, if the nonbank covered company was designated by the Council more than 180 days before September 30 of that calendar year.
52 See generally 12 CFR 225.8(b). The final capital plan rule provides that a bank holding company that becomes subject to the final rule by operation of the asset threshold after the 5th of January of a calendar year will not be subject until January 1 of the next calendar year to the final rule's requirement to file a capital plan with the Federal Reserve, resubmit a capital plan under certain circumstances, or to obtain prior approval of capital distributions in excess of those described in the firm's capital plan. A bank holding company would be subject to all other requirements under the capital plan rule immediately upon becoming subject to that rule.
In addition, 180 days following its designation by the Council, a nonbank covered company would be subject to minimum risk-based capital and leverage requirements. A nonbank covered company would be required to calculate its minimum risk-based and leverage capital requirements as if it were a bank holding company in accordance with any minimum capital requirements established by the Board for bank holding companies. 53 Accordingly, the nonbank covered company would be required to hold capital sufficient to meet (i) a tier 1 risk based capital ratio of 4 percent and a total risk-based capital ratio of 8 percent, as calculated according to the Board's risk-based capital rules, 54 and (ii) a tier 1 leverage ratio of 4 percent as calculated under the leverage rule. 55 Finally, each nonbank covered company would be required to report to the Board on a quarterly basis its risk-based capital and leverage ratios
(i) a tier 1 risk based capital ratio of 4 percent and a total risk-based capital ratio of 8 percent, as calculated according to the Board's risk-based capital rules, 54 and (ii) a tier 1 leverage ratio of 4 percent as calculated under the leverage rule. 55 Finally, each nonbank covered company would be required to report to the Board on a quarterly basis its risk-based capital and leverage ratios. Upon ascertaining that it had failed to meet any of its minimum risk-based or leverage requirements, a nonbank covered company would be required to notify the Board immediately. 56
53 See supra note 49.
54 12 CFR part 225, appendix A and G.
55 12 CFR part 225, appendix D, section II.
56 Under section 171 of the Dodd-Frank Act, the Board is required to impose minimum risk-based and leverage capital requirements on bank holding companies and nonbank covered companies that are not less than the generally applicable capital requirements it imposes on insured depository institutions. 12 U.S.C. 5371. The Board recognizes that some aspects of its capital requirements may not take into account the characteristics of activities and assets of nonbank covered companies that are impermissible for banks and bank holding companies. When a nonbank covered company is designated by the Council, the Board may consider whether any adjustments to the minimum capital requirements applicable to the nonbank covered company may be appropriate, within the limits of section 171 of the Dodd-Frank Act.
Under the proposed rules' reservation of authority, the Board may require any covered company to hold additional capital or be subject to other requirements or restrictions if it determines that compliance with the requirements of the proposal does not sufficiently mitigate risks to U.S. financial stability posted by the failure or material financial distress of the covered company.
The Board seeks comment on all aspects of the proposed enhanced risk-based capital and leverage requirements
hold additional capital or be subject to other requirements or restrictions if it determines that compliance with the requirements of the proposal does not sufficiently mitigate risks to U.S. financial stability posted by the failure or material financial distress of the covered company.
The Board seeks comment on all aspects of the proposed enhanced risk-based capital and leverage requirements.
In particular, the Board seeks comment on the appropriateness of requiring nonbank covered companies to have the same capital planning and stress testing, and regulatory capital requirements as bank holding companies.
Question 5: What factors should the Board consider in deciding whether to impose different capital planning or stress testing requirements on nonbank covered companies?
Question 6: What alternative enhanced capital requirements for nonbank covered companies should the Board consider? Should the Board consider a longer or shorter phase-in period for capital requirements for nonbank covered companies?
Conforming Amendment to Section 225.8 of Regulation Y
To make the applicability of the Board's capital plan rule consistent with the applicability of the proposed enhanced capital standards under this proposed rule, the Board is considering whether to amend the capital plan rule to provide that a bank holding company subject to that rule would remain subject to that rule until its total consolidated assets fall below $50 billion for four consecutive calendar quarters.
2. Quantitative Risk-Based Capital Surcharge
In November 2011, the BCBS agreed to require G-SIBs to hold an additional amount of common equity above the regulatory minimums to enhance their resiliency and ability to absorb losses under difficult economic conditions. The recently finalized BCBS framework establishes five capital surcharge categories, ranging from 100 to 350 basis points, 57 and allocates G-SIBs to a specific surcharge category based on a twelve-factor formula
to require G-SIBs to hold an additional amount of common equity above the regulatory minimums to enhance their resiliency and ability to absorb losses under difficult economic conditions. The recently finalized BCBS framework establishes five capital surcharge categories, ranging from 100 to 350 basis points, 57 and allocates G-SIBs to a specific surcharge category based on a twelve-factor formula. The formula includes measures of size, interconnectedness, complexity, lack of substitutes and cross-border activity. The capital surcharge must be met with common equity only and would operate to expand the Basel III capital conservation buffer. The BCBS framework would phase-in the G-SIB surcharge requirement in equal increments from 2016 to 2019, in parallel with the capital conservation buffer.
57 Initially, G-SIBs would be placed in 1 of 4 categories, with surcharges ranging from 100 to 250 basis points and the fifth category, with an associated surcharge of 350 basis points, would be left empty in order to leave room to apply higher surcharges to G-SIBs that increase their systemic footprint further over time.
Approximately 30 global banks would be subject initially to the G-SIB surcharge under the BCBS framework. The BCBS has noted that the number of banks subject to the framework, and the surcharge category associated with different banks, would evolve over time as the systemic risk profiles of different
The Board and other U.S. federal banking agencies worked closely with other members of the BCBS to develop the BCBS framework and the Board believes that it is consistent with the financial stability objectives of section 165 of the Dodd-Frank Act, including minimizing the threat to U.S. financial stability posed by systemically important financial companies. The Board believes that a U.S. capital surcharge framework based on the BCBS framework would meaningfully reduce the probability of failure of the largest, most complex financial companies and would minimize losses to the U.S
al stability objectives of section 165 of the Dodd-Frank Act, including minimizing the threat to U.S. financial stability posed by systemically important financial companies. The Board believes that a U.S. capital surcharge framework based on the BCBS framework would meaningfully reduce the probability of failure of the largest, most complex financial companies and would minimize losses to the U.S. financial system and the economy if such a company should fail. A capital surcharge would help require that these companies account for the costs they impose on the broader financial system and would reduce the implicit subsidy they enjoy due to market perceptions of their systemic importance. The Board intends to issue a concrete proposal for implementation of a quantitative risk-based capital surcharge for covered companies, or a subset thereof, based on the BCBS approach consistent with the BCBS's implementation timeframe. The forthcoming proposal would contemplate adopting implementing rules in 2014, and requiring G-SIBs to meet the capital surcharges on a phased-in basis from 2016-2019.
Question 7: How should the Board implement the BCBS framework discussed above, or are there alternatives to the BCBS framework the Board should consider?
Question 8: What is the appropriate scope of application of a quantitative capital surcharge in the United States in light of section 165 of the Dodd-Frank Act? What adaptations to the BCBS framework, or alternative surcharge assessment methodologies, would be appropriate for determining a quantitative capital surcharge for covered companies that are not identified as global systemically important banks in the BCBS framework?
Question 9: If the BCBS framework were to be applied to nonbank covered companies, how should the framework be modified to capture the systemic footprint of those companies?
IV. Liquidity Requirements
A
ethodologies, would be appropriate for determining a quantitative capital surcharge for covered companies that are not identified as global systemically important banks in the BCBS framework?
Question 9: If the BCBS framework were to be applied to nonbank covered companies, how should the framework be modified to capture the systemic footprint of those companies?
IV. Liquidity Requirements
A. Background
During the financial crisis that began in 2007, many solvent financial companies experienced significant financial stress because they did not manage their liquidity in a prudent manner. In some cases, these companies had difficulty in meeting their obligations as they became due because sources of funding became severely restricted. These events followed several years of ample liquidity in the financial system, during which liquidity risk management did not receive the same level of priority and scrutiny as management of other sources of risk. The rapid reversal in market conditions and availability of liquidity during the crisis illustrated how quickly liquidity can evaporate, and that illiquidity can last for an extended period, leading to a company's insolvency before its assets experience significant deterioration in value.
Many of the liquidity-related difficulties experienced by financial companies were due to lapses in basic principles of liquidity risk management. This problem was evident from the horizontal reviews of financial companies conducted by the Senior Supervisors Group (“SSG”), which comprises senior financial supervisors from seven countries. 58 The SSG found that failure of liquidity risk management practices contributed significantly to the financial crisis. In particular, the SSG noted that firms' inappropriate reliance on short-term sources of funding and in some cases, the repo market, as well as inaccurate measurements of funding needs and lack of effective contingency funding were key factors in the liquidity crises many firms faced
he SSG found that failure of liquidity risk management practices contributed significantly to the financial crisis. In particular, the SSG noted that firms' inappropriate reliance on short-term sources of funding and in some cases, the repo market, as well as inaccurate measurements of funding needs and lack of effective contingency funding were key factors in the liquidity crises many firms faced. 59
58 See Senior Supervisors Group, Observations on Risk Management Practices During the Recent Market Turbulence (March 2008), available at http://www.newyorkfed.org/newsevents/news/banking/2008/SSG_Risk_Mgt_doc_final.pdf (hereinafter 2008 SSG Report).
59 See Senior Supervisors Group, Risk Management Lessons from the Global Banking Crisis of 2008 (October 2009), available at http://www.newyorkfed.org/newsevents/news_archive/banking/2009/SSG_report.pdf (hereinafter 2009 SSG Report).
Given the direct link between liquidity risk management failures and the many strains on firms and the financial system experienced during the recent crisis, the Board believes that strong liquidity risk management is crucial to ensuring a company's resiliency during periods of financial market stress and that covered companies should be held to the highest liquidity standards, as well as capital standards.
The Board also believes establishing minimum quantitative liquidity standards will improve the capacity of firms to remain viable during a liquidity stress. The Basel III Liquidity Framework establishes minimum requirements for funding liquidity that are designed to promote the resilience of a banking organization's liquidity risk profile. 60 These minimum requirements are imposed through two ratios:
60 Basel Committee on Bank Supervision, Basel III: International Framework for Liquidity Risk Measurement, Standards, and Monitoring (December 20, 2010), available at www.bis.org/publ/bcbs188.htm
s minimum requirements for funding liquidity that are designed to promote the resilience of a banking organization's liquidity risk profile. 60 These minimum requirements are imposed through two ratios:
60 Basel Committee on Bank Supervision, Basel III: International Framework for Liquidity Risk Measurement, Standards, and Monitoring (December 20, 2010), available at www.bis.org/publ/bcbs188.htm.
• A liquidity coverage ratio (LCR), which is designed to promote the short-term resiliency of a banking organization's liquidity risk profile by ensuring that it has sufficient high quality liquid resources to survive an acute stress scenario lasting for one month; and
• A net stable funding ratio (NSFR), which is designed to promote liquidity risk resilience over a longer time period and to create incentives for a banking organization to fund its activities with medium- and longer-term funding sources. The NSFR has a time horizon of one year, and is designed to provide a sustainable maturity structure of assets and liabilities.
Under the terms of Basel III, the LCR and NSFR are to be implemented by Basel Committee member countries by 2015 and 2018, respectively.
The Board intends to institute a liquidity regime for covered companies through a multi-stage process that would include a regulatory framework for strong liquidity risk management and quantitative liquidity requirements based on the Basel III liquidity ratios. In the first stage, covered companies would be subject to enhanced liquidity risk management standards under this proposal. The proposal builds on the core provisions of the Board's Supervision and Regulation (SR) letter 10-6, Interagency Policy Statement on Funding and Liquidity Risk Management issued in March 2010 (Interagency Liquidity Risk Policy Statement). 61 As discussed in detail below, the proposed rules would require a covered company to take a number of prudential steps to manage liquidity risk
his proposal. The proposal builds on the core provisions of the Board's Supervision and Regulation (SR) letter 10-6, Interagency Policy Statement on Funding and Liquidity Risk Management issued in March 2010 (Interagency Liquidity Risk Policy Statement). 61 As discussed in detail below, the proposed rules would require a covered company to take a number of prudential steps to manage liquidity risk. Significantly, the proposed rules introduce liquidity stress test requirements for covered companies and require them to maintain liquid assets sufficient to meet projected net cash flows under the stress tests. The proposed rules would also require a covered company to generate comprehensive cash flow projections, to establish and monitor its liquidity risk tolerance, and maintain contingency plans for funding where normal sources of funding may not be available.
61 See supra note 37.
The Board believes liquidity requirements are vitally important to the
The requirements of the proposed rule are also designed to increase in stringency based on the systemic footprint of a company. For example, a covered company's capital structure, risk profile, complexity, activities, size, and other appropriate risk related factors would be considered in: (i) Setting the liquidity risk tolerance of the covered company; (ii) determining the amount of detail provided in cash flow projections; (iii) tailoring liquidity stress testing to the covered company; (iv) setting the size of the liquidity buffer; (v) formulating the contingency funding plan; and (vi) setting the size of the specific limits on potential sources of liquidity risk. In addition, the Board would reserve its authority to require a covered company to be subject to additional or further enhanced prudential standards if it determines that compliance with the rule does not sufficiently mitigate the risks to U.S. financial stability posed by the failure or material financial distress of the covered company
the specific limits on potential sources of liquidity risk. In addition, the Board would reserve its authority to require a covered company to be subject to additional or further enhanced prudential standards if it determines that compliance with the rule does not sufficiently mitigate the risks to U.S. financial stability posed by the failure or material financial distress of the covered company.
In addition to the enhanced liquidity risk management requirements of this proposal, the Board intends to implement the second stage of establishing a regulatory liquidity framework for covered companies through one or more future proposals that would require covered companies (or a subset of covered companies) to satisfy specific quantitative liquidity requirements that are derived from, or consistent with, the international liquidity standards incorporated into Basel III. The Board believes that the eventual introduction of the Basel III liquidity standards will be important to establish a rigorous liquidity framework and should further the important goal of buttressing systemically important companies from the possibility of failure due to liquidity shortfalls. These metrics are currently undergoing observation by the BCBS and may be modified depending on the results of that observation. The Board and other federal banking agencies have been working with banking organizations and other members of the BCBS to gather data and study the impact of the proposed standards on the banking system. The Board is carefully considering what changes to the standards it may recommend to the BCBS based on the results of this observation. The Board also is currently considering, along with the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation, one or more joint rulemakings that would implement the Basel Liquidity Framework in the United States
e banking system. The Board is carefully considering what changes to the standards it may recommend to the BCBS based on the results of this observation. The Board also is currently considering, along with the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation, one or more joint rulemakings that would implement the Basel Liquidity Framework in the United States.
Question 10: Is the Board's approach to enhanced liquidity standards for covered companies appropriate? Why or why not?
Question 11: Are there other approaches that would effectively enhance liquidity standards for covered companies? If so, provide detailed examples and explanations.
Question 12: The Dodd-Frank Act contemplates additional enhanced prudential standards, including a limit on short-term debt. Should the Board adopt a short-term debt limit in addition to or in place of the LCR and NSFR? Discuss why or why not?
B. Overview of the Proposed Rule
1. Key Definitions
Under the proposed rule, liquidity is defined as a covered company's capacity to efficiently meet its expected and unexpected cash flows and collateral needs at a reasonable cost without adversely affecting the daily operations or the financial condition of the covered company. Liquidity risk is defined as the risk that a covered company's financial condition or safety and soundness will be adversely affected by its inability or perceived inability to meet its cash and collateral obligations.
2. Corporate Governance Provisions
A critical element of sound liquidity risk management is effective corporate governance, consisting of oversight of the covered company's liquidity risk management by its board of directors, as well as senior management, and an independent review function. The proposed rule includes provisions addressing these aspects of a covered company's corporate governance with respect liquidity risk management.
a
cal element of sound liquidity risk management is effective corporate governance, consisting of oversight of the covered company's liquidity risk management by its board of directors, as well as senior management, and an independent review function. The proposed rule includes provisions addressing these aspects of a covered company's corporate governance with respect liquidity risk management.
a. Board of Directors and Risk Committee Responsibilities (§ 252.52)
A covered company's board of directors is ultimately responsible for the liquidity risk assumed by the covered company. Accordingly, the proposed rule at § 252.52(a) would require that the board of directors (or the risk committee) 62 must oversee the covered company's liquidity risk management processes, and must review and approve the liquidity risk management strategies, policies, and procedures established by senior management.
62 The risk committee would be defined as the enterprise-wide committee established by a covered company's board of directors under proposed section 252.126 of the risk management rules subpart of this proposal.
The proposed rule would impose several specific duties on the board of directors. First, the board of directors would be required to establish the covered company's liquidity risk tolerance at least annually. The proposed rule would define liquidity risk tolerance as the acceptable level of liquidity risk the covered company may assume in connection with its operating strategies. In determining the liquidity risk tolerance, the board of directors would be required to consider the covered company's capital structure, risk profile, complexity, activities, size, and other appropriate risk related factors. These considerations should help to ensure that the established liquidity risk tolerance will be appropriate for the business strategy of the covered company and its role in the financial system, and will reflect the covered company's financial condition and funding capacity on an ongoing basis
pital structure, risk profile, complexity, activities, size, and other appropriate risk related factors. These considerations should help to ensure that the established liquidity risk tolerance will be appropriate for the business strategy of the covered company and its role in the financial system, and will reflect the covered company's financial condition and funding capacity on an ongoing basis.
The liquidity risk tolerance should reflect the board of directors' assessment of tradeoffs between the costs and benefits of liquidity. That is, inadequate liquidity can expose the covered company to significant financial stress and endanger its ability to meet contractual obligations. Conversely, too much liquidity can entail substantial opportunity costs and have a negative impact on the covered company's profitability. In establishing the covered company's liquidity risk tolerance, the Board would expect a covered company's board of directors to articulate the liquidity risk tolerance in such a way that all levels of management clearly would: (i) Understand the board of director's policy for managing the trade-offs between the risk of insufficient liquidity and generating profit; and (ii) properly apply this approach to all aspects of 63 To ensure that a covered company is managed in accordance with the liquidity risk tolerance, the proposed rule would require the board of directors to review information provided by senior management at least semi-annually to determine whether the covered company is managed in accordance with the established liquidity risk tolerance.
63 Under the proposed rule, the established liquidity risk tolerance would be considered in assessing new business strategies and products (proposed § 252.52(b)(2)), in setting the size of the liquidity buffer (proposed § 252.57(b)), in developing the CFP (proposed § 252.58(a)), and in setting the specific limits on sources of liquidity (proposed § 252.59(b))
stablished liquidity risk tolerance.
63 Under the proposed rule, the established liquidity risk tolerance would be considered in assessing new business strategies and products (proposed § 252.52(b)(2)), in setting the size of the liquidity buffer (proposed § 252.57(b)), in developing the CFP (proposed § 252.58(a)), and in setting the specific limits on sources of liquidity (proposed § 252.59(b)).
Second, the risk committee or a designated subcommittee of the risk committee would be required to review and approve the liquidity costs, benefits, and risk of each significant new business line and each significant new product before the covered company may implement the line or offer the product. In connection with this review, the risk committee or a designated subcommittee would be required to consider whether the liquidity risk of the new strategy or product under current conditions and under a liquidity stress is within the established liquidity risk tolerance. At least annually, the risk committee or a designated subcommittee would be required to review approved significant business lines and products to determine whether each line or product has created any unanticipated liquidity risk, and to determine whether the liquidity risk of each line or product continues to be within the established liquidity risk tolerance.
Third, the proposed rule would require the board of directors to review and approve the covered company's CFP at least annually and whenever the covered company materially revises the plan. As discussed below, the CFP is the covered company's compilation of policies, procedures, and action plans for managing liquidity stress events.
Fourth, the risk committee or a designated subcommittee would be required to conduct the following reviews and approvals at least quarterly:
prove the covered company's CFP at least annually and whenever the covered company materially revises the plan. As discussed below, the CFP is the covered company's compilation of policies, procedures, and action plans for managing liquidity stress events.
Fourth, the risk committee or a designated subcommittee would be required to conduct the following reviews and approvals at least quarterly:
(i) A review of cash flow projections produced under section 252.55 of the proposed rule that use time periods in excess of 30 days to ensure that the covered company's liquidity risk is within the covered company's established liquidity risk tolerance;
(ii) A review and approval of the liquidity stress testing described in section 252.56 of the proposed rule, including the covered company's stress testing practices, methodologies, and assumptions. The risk committee or a designated subcommittee would also be required to conduct this review and approval whenever the covered company materially revises its liquidity stress testing;
(iii) A review of the liquidity stress testing results produced under section 252.56 of the proposed rule;
(iv) Approval of the size and composition of the liquidity buffer established under section 252.57 of the proposed rule;
(v) A review and approval of the specific limits on potential sources of liquidity risk established under section 252.59 of the proposed rule, and a review of the covered company's compliance with those limits; and
results produced under section 252.56 of the proposed rule;
(iv) Approval of the size and composition of the liquidity buffer established under section 252.57 of the proposed rule;
(v) A review and approval of the specific limits on potential sources of liquidity risk established under section 252.59 of the proposed rule, and a review of the covered company's compliance with those limits; and
(iv) A review of liquidity risk management information necessary to identify, measure, monitor, and control liquidity risk and to comply with the new liquidity rules.
In addition, the risk committee or a designated subcommittee would be required to periodically review the independent validation of the stress tests produced under section 252.56(c)(2)(ii) of the proposed rule.
The proposed rule establishes minimum requirements governing the frequency of certain reviews and approvals. It also would require the board of directors (or the risk committee) to conduct more frequent reviews and approvals as market and idiosyncratic conditions warrant. 64 The risk committee or a designated subcommittee would also be required to establish procedures governing the content of senior management reports on the liquidity risk profile of the covered company and other information described in the senior management responsibilities section below.
64 As used in this preamble, idiosyncratic conditions or events refer to conditions or events that are unique to the covered company. Market conditions or events refer to conditions or events that are market-wide.
b. Senior Management Responsibilities (§ 252.53)
Under the proposed rule, senior management of a covered company would be required to establish and implement liquidity risk management strategies, policies and procedures
ratic conditions or events refer to conditions or events that are unique to the covered company. Market conditions or events refer to conditions or events that are market-wide.
b. Senior Management Responsibilities (§ 252.53)
Under the proposed rule, senior management of a covered company would be required to establish and implement liquidity risk management strategies, policies and procedures. This would include overseeing the development and implementation of liquidity risk measurement and reporting systems, the cash flow projections, the liquidity stress testing, the liquidity buffer, the CFP, the specific limits, and the monitoring procedures required under the proposed rule.
Senior management would also be required to report regularly to the risk committee or designated subcommittee thereof on the liquidity risk profile of the covered company, and to provide other relevant and necessary information to the board of directors (or risk committee) to facilitate its oversight of the liquidity risk management process. As noted above, the proposed rule would require the risk committee or a designated subcommittee to establish procedures governing the content of management reports on the liquidity risk profile of the covered company and other information regarding compliance with the proposed rule. The Board expects that management would be required under these procedures to report as frequently as conditions warrant, but no less frequently than quarterly.
c. Independent Review (§ 252.54)
Under the proposed rule, a covered company would be required to establish and maintain an independent review function to evaluate its liquidity risk management. Under the proposal, this review function must be independent of management functions that execute funding (the treasury function). The independent review function would be required to review and evaluate the adequacy and effectiveness of the covered company's liquidity risk management processes regularly, but no less frequently than annually
view function to evaluate its liquidity risk management. Under the proposal, this review function must be independent of management functions that execute funding (the treasury function). The independent review function would be required to review and evaluate the adequacy and effectiveness o

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- [77 FR 770 Proposed Revocation of Class E Airspace; Southport, NC, and Proposed Establishment of Class E Airspace; Oak Island, NC](https://www.frixlaw.com/law-library/statutes/FR_PRORULE_2012-56.md)
- [77 FR 960 National Emission Standards for Hazardous Air Pollutants From Petroleum Refineries; National Uniform Emission Standards for Heat Exchange Systems](https://www.frixlaw.com/law-library/statutes/FR_PRORULE_2011-31530.md)
- [77 FR 1429 Proposed Amendment of Class E Airspace; Springfield, CO](https://www.frixlaw.com/law-library/statutes/FR_PRORULE_2012-244.md)
- [77 FR 1654 Airworthiness Directives; Agusta S.p.A. Helicopters](https://www.frixlaw.com/law-library/statutes/FR_PRORULE_2012-367.md)
- [77 FR 2234 Airworthiness Directives; DG Flugzeugbau GmbH Gliders](https://www.frixlaw.com/law-library/statutes/FR_PRORULE_2012-744.md)
- [77 FR 2481 United States Standards for Condition of Food Containers](https://www.frixlaw.com/law-library/statutes/FR_PRORULE_2012-833.md)
- [77 FR 2493 Special Local Regulations for Marine Events; Spa Creek and Annapolis Harbor, Annapolis, MD](https://www.frixlaw.com/law-library/statutes/FR_PRORULE_2012-784.md)
- [77 FR 2676 Competitive Postal Products](https://www.frixlaw.com/law-library/statutes/FR_PRORULE_2012-851.md)
- [77 FR 2830 Energy Conservation Program: Test Procedure for Television Sets](https://www.frixlaw.com/law-library/statutes/FR_PRORULE_2012-687.md)
- [77 FR 2928 Airworthiness Directives; Airbus Airplanes](https://www.frixlaw.com/law-library/statutes/FR_PRORULE_2012-1131.md)
- [77 FR 2932 Airworthiness Directives; Rolls-Royce plc (RR) Turbofan Engines](https://www.frixlaw.com/law-library/statutes/FR_PRORULE_2012-1128.md)

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Source: Frix Law Library, https://www.frixlaw.com/law-library/statutes/FR_PRORULE_2011-33364. Check the current official text before relying on it. Not legal advice.