I. Introduction This guidance provides the Federal Reserve’s
core capital planning expectations for Large and Noncomplex Firms,
building upon the capital planning requirements included in the Board’s
capital plan rule and stress test rules. This guidance outlines capital
planning expectations
1 for these firms in the following areas:
- Governance
- Risk management
- Internal controls
- Capital policy
- Incorporating stressful conditions and events
- Estimating impact on capital positions
Further, this guidance provides detailed supervisory
expectations on a firm’s capital planning process in the following
appendices:
A.
Use of Models and Other Estimation Approaches
B.
Model Overlays
C.
Use
of Benchmark Models in the Capital Planning Process
D.
Sensitivity
Analysis and Assumptions Management
E.
Role of the Internal Audit Function in the Capital Planning Process
F.
Capital Policy
G.
Scenario
Design
H.
Risk-Weighted
Asset (RWA) Projections
I.
Operational Loss Projections
This guidance applies to U.S. bank holding companies and
intermediate holding companies of foreign banking organizations that
have total consolidated assets of at least $50 billion but less than
$250 billion, have consolidated total on-balance sheet foreign exposure
of less than $10 billion, and are not otherwise subject to the Federal
Reserve’s Large Institution Supervision Coordinating Committee (LISCC)
framework
2 (referred to in this guidance as a “Large and Noncomplex Firm”).
34 The guidance
is effective immediately for bank holding companies that are subject
to the capital plan rule as of January 1, 2016. The guidance will
become effective for intermediate holding companies beginning on January
1, 2017, which is the date on which the capital plan rule applies
to these firms.
The Federal Reserve has different expectations for sound
capital planning and capital adequacy depending on the size, scope
of operations, activities, and systemic importance of a firm. Concurrently
with issuance of this guidance, the Federal Reserve is issuing separate
guidance for U.S. bank holding companies and intermediate holding
companies that are subject to the LISCC framework (referred to as
a “LISCC Firm”) or that otherwise have total consolidated assets of
$250 billion or more or consolidated total on-balance sheet foreign
exposure of $10 billion or more (referred to as a “Large and Complex
Firm”). This separate guidance clarifies that expectations for LISCC
Firms and Large and Complex Firms are higher than the expectations
for Large and Noncomplex Firms.
II. Regulatory Requirements for Capital Positions and PlanningSound capital planning for any firm begins
with adherence to all applicable rules and regulations relating to
capital adequacy. Three Federal Reserve regulations form the basis
of the regulatory framework for capital positions and capital planning:
1.
Regulation
Q (12 CFR part 217 [at
3-2100]), Capital Adequacy Requirements for
Board-regulated Institutions;
2.
Regulation
YY (12 CFR part 252 [subparts E and F at
4-787 and
4-788]), Enhanced Prudential Standards; and
3.
Section
225.8 of Regulation Y (12 CFR 225.8 [at
4-017.5], also known as the
capital plan rule).
Regulation Q establishes minimum capital requirements
and overall capital adequacy standards for Federal Reserve-regulated
institutions. Among other things, Regulation YY establishes capital
stress testing requirements for bank holding companies with total
consolidated assets of $50 billion or more, including requirements
to participate in the Federal Reserve’s annual supervisory stress
test and conduct their own internal capital stress tests. The capital
plan rule establishes general capital planning requirements for a
bank holding company with total consolidated assets of $50 billion
or more and requires a bank holding company to develop an annual capital
plan that is approved by its board of directors.
This guidance provides the Federal Reserve’s
core capital planning expectations for firms subject to this guidance,
building upon the capital planning requirements in the Federal Reserve’s
capital plan rule and stress test rules.
5Capital is central to a firm’s ability
to absorb unexpected losses and continue to lend to creditworthy businesses
and consumers. A firm’s capital planning processes are critical to
its financial strength and resiliency.
SR letter 12-17/CA letter 12-14, “Consolidated Supervision
Framework for Large Financial Institutions,” outlines core expectations
for sound capital planning for bank holding companies with total consolidated
assets of $50 billion or more. This capital planning and positions
guidance provides additional details around the Federal Reserve’s
core capital planning expectations for Large and Noncomplex Firms,
building on the capital planning requirements included in the capital
plan rule and the Board’s stress test rules.
6 A firm
should maintain a sound capital planning process on an ongoing basis,
including in between submissions of its annual capital plan.
7The Federal Reserve expects a firm to have sound
governance over its capital planning process. In general, senior management
should establish the capital planning process and the board of directors
should review and periodically approve that process.
1. Board of directors
A firm’s board of
directors is ultimately responsible and accountable for the firm’s
capital-related decisions and for capital planning. The firm’s capital
planning should be consistent with the strategy and risk appetite
set by the board and with the firm’s risk levels, including how risks
at the firm may emerge and evolve under stress. The board must annually
review and approve the firm’s capital plan.
8The board should direct senior management to provide a
briefing on their assessment of the firm’s capital adequacy at least
quarterly, and whenever economic, financial, or firm-specific conditions
warrant a more frequent update. The briefing should describe whether
current capital levels and planned capital distributions remain appropriate
and consistent with capital goals (see section III.D, “Capital
Policy”). In their briefing, senior management should also highlight
for the board any problem areas related to capital planning identified
by senior management, internal audit, or supervisors.
The board should hold senior management accountable
for providing sufficient information on the firm’s material risks
and exposures to inform board decisions on capital adequacy
and actions, including capital distributions. Information provided
to the board should be clear, accurate, and timely. The board should
direct senior management to provide this information at least quarterly
and whenever economic, financial, or firm-specific conditions warrant
a more frequent update. The information presented to the board should
include consideration of a number of factors, such as:
- macroeconomic conditions and relevant market events;
- current capital levels relative to budgets and forecasts;
- post-stress capital goals and targeted real time
capital levels (see section III.D, “Capital Policy”);
- enterprise-wide and line-of-business performance;
- expectations from stakeholders (including shareholders,
regulators, investors, lenders, counterparties, and rating agencies);
- potential sources of stress to the firm’s operating
performance; and
- risks that may emerge only under stressful conditions.
After receiving the information, the board should
be in a position to understand the major drivers of the firm’s projections
under a range of conditions, including baseline and stress scenarios.
The board should direct senior management to provide information
about the firm’s estimation approaches, model overlays, and assessments
of model performance (see Appendix A: Use of Models and Other
Estimation Approaches and Appendix B: Model Overlays). The board should
also receive information about uncertainties around projections of
capital needs or limitations within the firm’s capital planning process
to understand the impact of these weaknesses on the process. This
information should include key assumptions and the analysis of sensitivity
of a firm’s projections to changes in the assumptions (see Appendix
D: Sensitivity Analysis and Assumptions Management). The board should
incorporate uncertainties in projections and limitations in the firm’s
capital planning process into its decisions on capital adequacy and
capital actions. It should also review and approve mitigating steps
to address capital planning process weaknesses.
The board should direct senior management to
establish sound controls for the entire capital planning process.
The board should approve policies related to capital planning, and
review them annually. The board should also approve capital planning
activities and strategies. The board of directors should maintain
an accurate record of its meetings pertaining to the firm’s capital
planning process.
2. Senior management
Senior management should direct staff to implement
board-approved capital policies, capital planning activities, and
strategies in an effective manner. Senior management should make informed
recommendations to the board regarding the firm’s capital planning
and capital adequacy, including post-stress capital goals and capital
distribution decisions. Senior management’s proposed capital goals
and capital distributions should have analytical support and take
into account the expectations of important stakeholders, including
shareholders, rating agencies, counterparties, depositors, creditors,
and supervisors.
Senior management should design and oversee the implementation
of the firm’s capital planning process; identify and assess material
risks and use appropriate firm-specific scenarios in the firm’s stress
test; monitor and assess capital planning practices to identify limitations
and uncertainties and develop remediation plans; understand key assumptions
used throughout a firm’s capital planning process and assess the sensitivity
of the firm’s projections to those assumptions (see Appendix
D: Sensitivity Analysis and Assumptions Management); and review the
capital planning process at least semi-annually.
Senior management should establish a process
for independent review of the firm’s capital planning process, including
the elements outlined in this guidance. The independent review process
should be designed to identify the weaknesses and limitations of the
capital planning process and the potential impact of those weaknesses
on the process. Senior management should also develop remediation plans
for any identified weaknesses affecting the reliability of capital
planning results. Both the specific identified weaknesses and the
remediation plans should be reported to the board of directors in
a timely manner.
Differences in Expectations
for LISCC Firms and Large and Complex Firms, as Compared to Large
and Noncomplex Firms
The Federal Reserve
expects senior management of a LISCC Firm and a Large and Complex
Firm to have a higher level of engagement in the capital planning
process than the senior management of a Large and Noncomplex Firm.
Specifically, senior management of a LISCC Firm and a Large and Complex
Firm should review the capital planning process quarterly, whereas
senior management of a Large and Noncomplex Firm should review the
capital planning process at least semi-annually.
B. Risk Management A firm should have a risk-management infrastructure that
appropriately identifies, measures, and assesses material risks and
provides a strong foundation for capital planning.
9 This risk-management infrastructure
should be supported by comprehensive policies and procedures, clear
and well-established roles and responsibilities, and strong and independent
internal controls. In addition, the risk-management infrastructure
should be built upon sound information technology and management information
systems. The Federal Reserve’s supervisory assessment of the sufficiency
of a firm’s capital planning process will depend in large part on
the effectiveness of the firm’s risk-management infrastructure and
the strength of its process to identify unique risks under normal
and stressful conditions, as well as on the strength of its overall
governance and internal control processes.
1. Risk
identification and assessment process
A firm’s
risk-identification process should include a comprehensive assessment
of risks stemming from its unique business activities and associated
exposures. The assessment should include on-balance sheet assets and
liabilities, off-balance sheet exposures, vulnerability of the firm’s
earnings, and other major firm-specific determinants of capital adequacy
under normal and stressed conditions. This assessment should also
capture those risks that only materialize or become apparent under
stressful conditions.
The specifics of the risk-identification process will
differ across firms given differences in organizational structure,
business activities, and size and complexity of operations. However,
the risk-identification process at all firms subject to this guidance
should be dynamic, inclusive, and comprehensive, and drive the firm’s
capital adequacy analysis. A firm should:
- evaluate material risks across the enterprise to ensure
comprehensive risk capture on an ongoing basis;
- actively monitor its material risks; and
- use identified material risks to inform key aspects
of the firm’s capital planning, including the development of stress
scenarios, the assessment of the adequacy of post-stress capital levels,
and the appropriateness of potential capital actions in light of the
firm’s capital objectives.
A firm should be able to demonstrate how material risks
are accounted for in its capital planning process. For risks not well
captured by scenario analysis, the firm should clearly articulate
how the risks are otherwise captured and addressed in the capital
planning process and factored into decisions about capital needs and
distributions.
2. Risk measurement and risk
materiality
A firm should have a sound risk-measurement
process that informs senior management about the size and risk characteristics
of exposures and business activities under both normal and stressful
operating conditions. A firm should employ risk measurement approaches
that are appropriate for its size, complexity, and risk profile.
Identified weaknesses, limitations, biases, and assumptions
in the firm’s risk-measure
ment processes should be assessed for their
potential impact on the integrity of a firm’s capital planning process
(
see Appendix D: Sensitivity Analysis and Assumptions Management).
A firm should have a process in place for determining materiality
in the context of material risk identification and capital planning.
This process should include a sound analysis of relevant quantitative
and qualitative considerations, including, but not limited to, the
firm’s risk profile, size, and complexity, and their effects on the
firm’s projected regulatory capital ratios in stressed scenarios.
10A firm should identify how and where its material risks
are accounted for within the capital planning process. The firm should
be able to specify material risks that are captured in its scenario
design, the approaches used to estimate the impact on capital, and
the risk drivers associated with each material risk.
Differences in Expectations for LISCC Firms and Large and Complex
Firms, as Compared to Large and Noncomplex Firms
The Federal Reserve expects a LISCC Firm and a Large
and Complex Firm to have a more formal risk-identification process
with quarterly updates, identify difficult-to-quantify risks, segment
risks at more granular levels, involve multiple stakeholders across
the firm in identifying material risks, critically assess risk transfer
techniques, and use quantitative approaches supported by expert judgment
for risk management. In contrast, the Federal Reserve expects a Large
and Noncomplex Firm to have a less formal risk-identification process,
has lower expectations regarding identification of difficult-to-quantify
risks, segmentation, engagement with stakeholders, and assessment
of risk transfer techniques, and provides the option for a Large and
Noncomplex Firm to use either qualitative or quantitative risk measurement
approaches for risk management.
C. Internal Controls A firm should
have a sound internal control framework that helps ensure that all
aspects of the capital planning process are functioning as designed
and result in sound assessments of the firm’s capital needs. The framework
should include:
- an independent internal audit function;
- independent review and validation practices; and
- integrated management information systems, effective
reporting, and change control processes.
A firm’s internal control framework should support its
entire capital planning process, including the sufficiency of and
adherence to policies and procedures; risk identification, measurement,
and management practices and systems used to produce input data; and
the models, management overlays, and other methods used to generate
inputs to post-stress capital estimates. Any part of the capital planning
process that relies on manual procedures should receive heightened
attention. The internal control framework should also assess the aggregation
and reporting process used to produce reports to senior management
and to the board of directors and the process used to support capital
adequacy recommendations to the board.
1. Comprehensive
policies, procedures, and documentation for capital planning
A firm should have policies and procedures that
support consistent and repeatable capital planning processes.
11 Policies and procedures should describe the capital planning
process in a manner that informs internal and external stakeholders
of the firm’s expectations for internal practices, documentation,
and business line controls. The firm’s documentation should be sufficient
to provide relevant information to those making decisions about capital
ac
tions. The documentation should also allow parties unfamiliar with
a process or model to understand generally how it operates, as well
as its main limitations, key assumptions, and uncertainties.
Policies and procedures should also
clearly identify roles and responsibilities of staff involved in capital
planning and provide accountability for those responsible for the
capital planning process. A firm should also have an established process
for policy exceptions. Such exceptions should be approved by the appropriate
level of management based upon the gravity of the exception. Policies
and procedures should reflect the firm’s current practices, and be
reviewed and updated as appropriate, but at least annually.
2. Model validation and independent review of estimation
approaches
Models used in the capital planning
process should be reviewed for suitability for their intended uses.
A firm should give particular consideration to the validity of models
used for calculating post-stress capital positions. In particular,
models designed for ongoing business activities may be inappropriate
for estimating losses, revenue, and expenses under stressed conditions.
If a firm identifies weaknesses or uncertainties in a material model,
the firm should make adjustments to model output if the findings would
otherwise result in the material understatement of capital needs (see Appendix B: Model Overlays). If the deficiencies are critical,
the firm should restrict the use of the model, apply overlays, or
avoid using the model entirely.
A firm should independently validate or otherwise conduct
effective challenge of models used in internal capital planning, consistent
with supervisory guidance on model risk management, with priority
given to more material models.
12 The model review
and validation process should include an evaluation of conceptual
soundness of models and ongoing monitoring of the model performance.
The firm’s validation staff should have the necessary technical competencies,
sufficient stature within the organization, and appropriate independence
from model developers and business areas to provide a critical and
unbiased evaluation of the estimation approaches.
A firm should maintain an inventory of all
estimation approaches used in the capital planning process, including
models used to produce projections or estimates used by the models
that generate final loss, revenue, expense, and capital projections.
13 Material models
should receive greater attention.
14 The intensity and frequency
of validation work should be a function of the importance of those
models in generating estimates of post-stress capital.
Not all models can be fully validated
prior to use in capital planning. However, a firm should make efforts
to conduct a conceptual soundness review of its material models prior
to their use in capital planning. If such a conceptual soundness review
is not possible, the absence of that review should be made transparent
to users of model output and the firm should determine whether the
use of compensating controls (such as conservative adjustments) are
warranted.
Further, a firm should treat output from material models
for which there are model risk management shortcomings with caution.
3. Management information systems and change control
processes
A firm should have internal controls
that ensure the integrity of reported results and that make certain
the firm is identifying, documenting, reviewing, and tracking all
material changes to the capital planning process and its components.
The firm should ensure that such controls exist at all levels of the
capital planning process. Specific controls should ensure:
- sufficiently sound management information systems
to support the firm’s capital planning process;
- comprehensive reconciliation and data integrity processes
for key reports;
- the accurate and complete presentation of capital
planning process results, including a description of adjustments made
to compensate for identified weaknesses; and
- that information provided to senior management and
the board is accurate and timely.
Many of the processes used to assess capital adequacy,
including models, data, and management information systems, are tightly
integrated and interdependent. As a result, a firm should ensure consistent
change control oversight across the entire firm, in line with existing
supervisory guidance.
15 A firm should establish
and maintain a policy describing minimum internal control standards
for managing change in capital planning process policies and procedures,
model development, information technology, and data. Control standards
for these areas should address risk, testing, authorization and approval,
timing of implementation, and post-installation verification.
4. Internal audit function
Internal audit should play a key role in evaluating capital planning
and the elements described in this guidance to ensure that the entire
process is functioning in accordance with supervisory expectations
and the firm’s policies and procedures. Internal audit should review
the manner in which deficiencies are identified, tracked, and remediated.
Furthermore, internal audit should ensure appropriate independent
review and challenge is occurring at all key levels within the capital
planning process.
As discussed further in Appendix E: Role of the Internal
Audit Function in the Capital Planning Process, internal audit staff
should have the appropriate competence and influence to identify and
escalate key issues. All deficiencies, limitations, weaknesses, and
uncertainties identified by the internal audit function that relate
to the firm’s capital planning process should be reported to senior
management, and material deficiencies should be reported to the board
of directors (or the audit committee of the board) in a timely manner.
16Differences in Expectations for LISCC
Firms and Large and Complex Firms, as Compared to Large and Noncomplex
Firms
The Federal Reserve expects a
LISCC Firm and a Large and Complex Firm to complete a conceptual soundness
review of all models prior to use, maintain comprehensive documentation
of its capital planning process, and have compensating controls for
known model uncertainties. In contrast, the Federal Reserve expects
a Large and Noncomplex Firm to make an effort to review its material
models prior to use; further, the Federal Reserve has lower expectations
regarding documentation and compensating controls.
In addition, the Federal Reserve
expects a LISCC Firm and a Large and Complex Firm to subject benchmark
models to validation, to the extent the models contribute to post-stress
capital estimates. In contrast, a Large and Noncomplex Firm is not
expected to use benchmark models in its capital planning process.
The Federal Reserve expects that the change control
process of a LISCC Firm and a Large and Complex Firm would take into
account recovery plans, whereas the Federal Reserve does not have
this expectation for Large and Noncomplex Firms.
Last, the Federal Reserve expects a LISCC
Firm and a Large and Complex Firm to more clearly integrate the separate
components of the capital planning process at the enterprise-wide
level, as compared to a Large and Noncomplex Firm.
D. Capital Policy A capital policy is a firm’s written assessment of the
principles and guidelines used for capital planning, issuance, usage,
and distribu
tions.
17 This includes internal post-stress
capital goals (as discussed in more detail below and in Appendix F:
Estimating Impact on Capital Positions) and real-time targeted capital
levels; guidelines for dividend payments and stock repurchases; strategies
for addressing potential capital shortfalls; and internal governance
responsibilities and procedures for the capital policy. The capital
policy must be approved by the firm’s board of directors or a designated
committee of the board.
18The capital policy should be reevaluated at least annually
and revised as necessary to address changes to the firm’s business
strategy, risk appetite, organizational structure, governance structure,
post-stress capital goals, real-time targeted capital levels, regulatory
environment, and other factors potentially affecting the firm’s capital
adequacy.
A capital policy should describe the firm’s capital adequacy
decision-making process, including the decision-making process for
common stock dividend payments or stock repurchases.
19 The policy should incorporate actionable protocols, including
governance and escalation, in the event a post-stress capital goal,
real-time targeted capital level, or other early warning metric is
breached.
1. Post-stress capital goals
A firm should establish post-stress capital goals
that are aligned with its risk appetite and risk profile, its ability
to act as a financial intermediary in times of stress, and the expectations
of internal and external stakeholders. Post-stress capital goals should
be calibrated based on the firm’s own internal analysis, independent
of regulatory capital requirements, of the minimum level of post-stress
capital the firm has deemed necessary to remain a going concern over
the planning horizon. A firm should also determine targets for real-time
capital ratios and capital levels that ensure that capital ratios
and levels would not fall below the firm’s internal post-stress capital
goals (including regulatory minimums) under stressful conditions at
any point over the planning horizon. For more details, see Appendix
F: Capital Policy.
Differences in Expectations
for LISCC Firms and Large and Complex Firms, as Compared to Large
and Noncomplex Firms
The Federal Reserve
expects the capital policy of a LISCC Firm and a Large and Complex
Firm to cover a broader set of topics, including roles and responsibilities
of key parties and metrics influencing capital distributions, than
the capital policies of a Large and Noncomplex Firm.
See Appendix F: Capital Policy,
for additional differentiated expectations for a firm’s capital policy.
E. Incorporating Stressful
Conditions and Events As part of its
capital planning process, a firm should incorporate appropriately
stressful conditions and events that could adversely affect the firm’s
capital adequacy into its capital planning. As part of its capital
plan, a firm must use at least one scenario that stresses the specific
vulnerabilities of the firm’s activities and associated risks, including
those related to the company’s capital adequacy and financial condition.
201. Scenario
design
A firm should either develop a complete
internal scenario or adjust the Federal Reserve’s supervisory scenarios
for the specific vulnerabilities of the firm’s risk profile and operations,
as needed, to appropriately capture the firm’s risks (see Appendix
G: Scenario Design).
2. Scenario narrative
A firm’s stress scenario should be supported
by a brief narrative describing how the scenario addresses the firm’s
particular material risks and vulnerabilities, and how the paths
of the scenario variables relate to each other.
Differences in Expectations for LISCC Firms and Large and Complex
Firms, as Compared to Large and Noncomplex Firms
The Federal Reserve has elevated expectations for a
LISCC Firm and a Large and Complex Firm relating to scenario design.
Specifically, the Federal Reserve expects a LISCC Firm and a Large
and Complex Firm to develop a scenario that is directly linked to
the firm’s risk-identification process and its risk assessment, and
engage a broad range of stakeholders. In contrast, a Large and Noncomplex
Firm is expected to either develop a firm-specific scenario or adjust
the Federal Reserve’s scenario to reflect the firm’s own risk profile.
In addition, a LISCC Firm and a Large and Complex Firm
should use multiple firm-specific scenarios as part of its ongoing
efforts to assess a broad range of risks, stressful conditions, or
events that could impact the firm’s capital adequacy. A Large and
Noncomplex Firm is not expected to use multiple firm-specific scenarios
in its capital adequacy assessment.
Further, the Federal Reserve has higher expectations
for the scenario narrative of a LISCC Firm and a Large and Complex
Firm and expects these firms to articulate how risks not captured
by scenario analysis are otherwise addressed in the capital planning
process.
F. Estimating
Impact on Capital Positions A firm should
employ estimation approaches that allow it to project the impact on
capital positions of various types of stressful conditions and events.
The firm’s stress testing practices should capture the potential increase
in losses or decrease in pre-provision net revenue (PPNR) that could
result from the firm’s risks, exposures, and activities under stressful
scenarios. A firm should estimate losses, revenues, expenses, and
capital using a sound method that relates macroeconomic and other
risk drivers to its estimates. The firm should be able to identify
the manner in which key variables, factors, and events in a scenario
affect losses, revenue, expenses, and capital over the planning horizon.
The firm may use simple approaches for their non-material portfolios
or business lines, such as application of loss or revenue rates during
the prior stress periods or other conservative assumptions.
1. Loss estimation
A firm should
provide support for the assumed relationship between risk drivers
and losses. A firm is expected to estimate losses by type of business
activity.
a. Credit risk losses on loans and securities
A firm should develop sound methods to estimate
credit losses under stress that take into account the type and size
of portfolios, risk characteristics, and data availability. A firm
should understand the key characteristics of its loss estimation approach.
In addition, a firm’s reserves for each quarter of the planning horizon,
including the last quarter, should be sufficient to cover estimated
loan losses consistent with generally accepted accounting standards.
A firm should test credit-sensitive securities for potential
other-than-temporary impairment (OTTI) regardless of current impairment
status. The threshold for determining OTTI for structured products
should be based on cash-flow analysis and credit analysis of underlying
obligors.
b. Operational-risk losses
A firm should maintain a sound process for estimating
operational risk losses in its capital planning process. Operational
losses can rise from various sources, including inadequate or failed
internal processes, people, and systems, or from external events (see Appendix I: Operational Loss Projections).
2. PPNR
In projecting PPNR, a firm should
take into account not only its current positions, but also how its
activities, business strategy, and revenue drivers may evolve over
time under the varying circumstances and operating environments. The
firm should ensure that the various PPNR components, including net
interest in come, non-interest income and non-interest
expense, and other key items projected by the firm such as balance
sheet positions, RWA, and losses, are projected in a manner that is
internally consistent.
The ability to effectively project net interest income
is dependent upon the firm’s ability to identify and aggregate current
positions and their attributes; project future changes in accruing
balances due to a variety of factors; and appropriately translate
the impact of these factors and relevant interest rates into net interest
income based on assumed conditions. Accordingly, a firm’s current
portfolio of interest-bearing assets and liabilities should serve
as the foundation for its forward-looking estimates of net interest
income.
Non-interest income is derived from a diverse set of sources,
including fees and certain realized gains and losses. Non-interest
income generally is more susceptible to rapid changes than net interest
income, especially if certain market measures move sharply. A firm’s
projections should incorporate material factors that could affect
the generation of non-interest income under stress, including the
firm’s business strategy, the competitive landscape, and changing
regulations.
Non-interest expenses include both expenses that are likely
to vary with certain stressful conditions and those that are not.
Projections of expenses that are closely linked to revenues or balances
should vary with projected changes in revenue or balance sheet levels.
3. Aggregating estimation results
A firm should have well-documented processes for projecting
the size and composition of on- and off-balance sheet positions and
RWAs over the planning horizon that feed in to the wider capital planning
process (see Appendix H: Risk-Weighted Asset (RWA) Projections).
A firm should have a consistently executed process for
aggregating enterprise-wide stress test projections of losses, revenues,
and expenses, including estimating on- and off-balance sheet exposures,
and RWAs, and for calculating post-stress capital positions and ratios.
The aggregation system should be able to bring together data and information
across business lines, portfolios, and risk types and should include
the data systems and sources, data reconciliation points, data quality
checks, and appropriate internal control points to ensure accurate
and consistent projection of financial data within enterprise-wide
scenario analysis. Internal processes for aggregating projections
from all relevant systems and regulatory templates should be identified
and documented. In addition, the beginning points for projections
and scenario variables should align with the end of the historical
reference period.
Differences in Expectations
for LISCC Firms and Large and Complex Firms, as Compared to Large
and Noncomplex Firms
The Federal Reserve
has elevated expectations for a LISCC Firm and a Large and Complex
Firm regarding its use of models in loss and revenue estimation. As
noted above, a LISCC Firm and a Large and Complex Firm is generally
expected to use quantitative approaches in estimating losses and PPNR,
whereas a Large and Noncomplex Firm may use either quantitative or
qualitative approaches. In addition, a LISCC Firm and a Large and
Complex Firms are expected to project losses and PPNR at a greater
level of granularity and are held to higher expectations regarding
their estimations in other areas, including with respect to setting
reserves, modeling operational risk, and identifying key risk drivers.
In addition, a LISCC Firm and a Large and Complex Firm
are held to expectations for estimation approaches for certain exposures,
such as fair value option loans and market risks for trading exposures,
that do not apply to a Large and Noncomplex Firm.
See Appendix A: Use of Models
and Other Estimation Approaches, for additional differentiated expectations
for a firm’s estimation approaches.
Appendix A: Use of Models and Other Estimation
Approaches Projections of losses and
PPNR under various scenarios are key components of enterprise-wide
stress testing and capital planning. The firm should ensure that its
material projection approaches, including any specific processes
or methodologies employed, are well supported, transparent, and repeatable
over time.
A firm may use either quantitative methods or qualitative
approaches for generating projections. A firm is not expected to employ
a sophisticated modeled approach, particularly if the firm can demonstrate
that a simpler approach, combined with well-supported expert judgment,
produces credible and transparent output. A firm can apply simple
assumptions to generate losses or PPNR for its non-material portfolios
or business lines.
A firm should adhere to supervisory guidance on model
risk management (SR-11-7) when using models, and should have sound
internal controls around both quantitative and qualitative approaches.
1. Quantitative approaches
If a firm decides to employ quantitative approaches, it is not expected
to use any specific quantitative estimation method. Any quantitative
approach should be appropriate for the type and materiality of the
portfolio or activity for which it is used and the granularity and
length of available data. The firm should also ensure that the quantitative
approach selected generates credible estimates that are consistent
with assumed scenario conditions. A firm should separately estimate
losses and PPNR for portfolios or business lines that are either sensitive
to different risk drivers or sensitive to risk drivers in a markedly
different way, particularly during periods of stress.
a. Use of data
A firm may use either
internal or external data to estimate losses and PPNR as part of its
enterprise-wide stress testing and capital planning practices.
21 If a firm uses external
data to estimate its losses or PPNR, the firm should ensure that the
external data reasonably approximate underlying risk characteristics
of the firm’s portfolios or business lines. Further, the firm should
make adjustments to estimation methods or outputs, as appropriate,
to account for identified differences in risk characteristics and
performance reflected in internal and external data. If internal data
are not available, a firm should strive to collect internal data over
time to augment its projections.
For material portfolios and business lines, a firm should
generally include all available data in its analysis, unless the firm
no longer engages in a line of business or its activities have changed
such that the firm is no longer exposed to a particular risk. The
firm should not selectively exclude data for material portfolios and
business lines based on the changing nature of the ongoing business
or activity without strong empirical support. For example, excluding
certain loans only on the basis that they were underwritten to standards
that no longer apply or on the basis that the loans were acquired
by the firm is not sound practice.
b. Use of vendor
models
22A firm should have
processes to confirm that any vendor or other third-party models it
uses are sound, appropriate for the given task, and implemented properly.
A firm should clearly outline limitations and uncertainties associated
with vendor models.
2. Assessing model performance
A firm should use measures to assess model performance
that are appropriate for the type of model being used. The firm should
outline how each performance measure is evaluated and used. A firm
should also assess the sensitivity of material model estimates to
key assumptions (see Appendix D: Sensitivity Analysis and Assumptions
Management).
For models used for material portfolios and business lines,
a firm should provide supporting information about the models to users
of their output, including descriptions of known measurement problems,
simplifying assumptions, model limitations, or other ways in which
the model exhibits weaknesses in capturing the relationships being
modeled. Providing such qualitative information is critical when
certain quantitative criteria or tests measuring model performance
are lacking.
3. Qualitative approaches
A firm may use a qualitative approach to project
losses and PPNR. When using a qualitative approach for material portfolios
and business lines, the firm should substantiate assumptions and estimates
using analysis of current and past risk drivers and performance, internal
risk identification, forward-looking risk assessments, external analysis
or other available information. The firm should conduct an initial
and ongoing assessment of the performance and viability of the qualitative
approach. The processes used in qualitative projection approaches
should be transparent and repeatable. The firm should also clearly
document material qualitative approaches and key assumptions used.
Qualitative approaches should be subject to independent
review, although the review may differ from the review of quantitative
approaches or models. The level of independent review should be commensurate
with:
- the materiality of the portfolio or business line
for which the qualitative approach is used;
- the impact of the approach’s output on the overall
capital results; and
- the complexity of the approach.
Firm staff conducting the independent review of the qualitative
approaches should not be involved in developing, implementing or using
the approach. However, this staff can be different than the staff
that conducts validation of quantitative approaches or models.
Differences in Expectations for LISCC Firms
and Large and Complex Firms, as Compared to Large and Noncomplex Firms
The Federal Reserve expects a LISCC Firm
and a Large and Complex Firm to base their projections on internal
data, include all available data in its analysis, and estimate losses
and PPNR at a disaggregated level. In contrast, the Federal Reserve
expects a Large and Noncomplex Firm to use either internal or external
data in its projections, use all available data in analyzing material
portfolios and business lines, and estimate losses and PPNR at a less
granular level.
In addition, the Federal Reserve has heightened expectations
for a LISCC Firm and a Large and Complex Firm regarding the variable
selection process, controls around the use of vendor models, and measures
for assessing model performance. In addition, the Federal Reserve
expects a LISCC Firm and a Large and Complex Firm to have strong controls
related to all qualitative approaches, whereas the Federal Reserve
holds a Large and Noncomplex Firm to this standard only with respect
to material qualitative approaches.
See section F, “Estimating Impact on Capital Positions,”
of the core guidance document for additional differentiated expectations
for a firm’s estimation approaches
Appendix B: Model Overlays A firm may need to rely on overrides or adjustments
to model output (model overlay) to compensate for model, data, or
other known limitations.
23 If well-supported, use of a model overlay can
represent a sound practice.
A model overlay may be appropriate to address cases of
identified weaknesses or limitations in the firm’s models that cannot
be otherwise addressed, or for select portfolios that have unique
risks that are not well captured by the model used for those exposures
and activities.
24 In contrast, a model overlay that functions as a general “catch
all” buffer on top of targeted capital levels to account for model
weaknesses generally would not represent sound practice.
25As part of its overall documentation of methodologies
used in stress testing, a firm should document its use of model overlays.
1. Process for applying overlays
A firm should establish a consistent firm-wide process
for applying model overlays and for controls around model overlays.
The process can vary by model type and portfolio, but should contain
some key elements, as described below. This process should be outlined
in the firm’s policies and procedures and include a specific exception
process for the use of overlays that do not follow the firm’s standards.
As part of model development, implementation, and use, overlays for
material portfolios and business lines should be well documented,
supported, and communicated to senior management. Model overlays should
be applied in an appropriate, systematic, and transparent manner.
Model results should also be reported to senior management with and
without overlay adjustments.
Model overlays (including those based solely on expert
or management judgment) should be subject to validation or some other
type of effective challenge.
26 Consistent with the
materiality principle in SR-11-7, the intensity of model risk management
for overlays should be a function of the materiality of the model
and overlay. A firm should make efforts to conduct effective challenge
of its material overlays prior to their use in capital planning. If
such validation or effective challenge is not possible, those instances
should be made transparent to users of the model and overlay.
Validation or other type of effective
challenge of model overlays may differ from quantitative model validation.
Staff responsible for effective challenge should not also be
setting the overlay itself or providing significant input to the level
or type of overlay. For example, a committee that develops an overlay
should not also be responsible for the effective challenge of the
overlay. In addition, staff engaging in the effective challenge of
model overlays should meet supervisory expectations relating to incentives,
competence, and influence (as outlined in SR-11-7).
2. Governance of overlays
Overlays and
adjustments used by a firm should be reviewed and approved at a level
within the organization commensurate with the materiality of that
overlay or adjustment to overall pro forma results. In general, the
purpose and impact of material overlays should be communicated to
senior management in a manner that facilitates an understanding of
the issues by the firm’s senior management. Material overlays to the
model—either in isolation or in combination—should receive a heightened
level of support and scrutiny, up to and including review by the firm’s
board of directors (or a designated committee), in instances where
the impact on pro forma results is material.
Differences in Expectations for LISCC Firms and Large and Complex
Firms, as Compared to Large and Noncomplex Firms
The Federal Reserve has elevated expectations for
a LISCC Firm and a Large and Complex Firm regarding its use of model
overlays. The Federal Reserve expects a LISCC Firm and a Large and
Complex Firms to use overlays in sparing and targeted manner, subject
overlays to validation or effective challenge before use, and conduct
sensitivity analysis on an overlay. In contrast, a Large and Noncomplex
Firm may use overlays to a greater extent, should make an effort to
validate or conduct effective challenge for material overlays before
use, and is not expected to conduct sensitivity analysis on an overlay.
In addition, the Federal Reserve expects a LISCC Firm
and a Large and Complex Firm to have strong controls over all overlays,
whereas the Federal Reserve holds a Large and Noncomplex Firm to this
standard only with respect to material qualitative approaches. Last,
the Federal Reserve has heightened expectations for LISCC Firm and
a Large and Complex Firm relating to governance of overlays.
Appendix C: Use of Benchmark
Models in the Capital Planning Process As noted in Appendix A: Use of Models and Other Estimation Approaches,
a firm should use a variety of methods to assess performance of material
models and gain comfort with material model estimates. However, a
firm is not expected to use benchmark models in its capital planning
process.
Differences in Expectations for
LISCC Firms and Large and Complex Firms, as Compared to Large and
Noncomplex Firms
The Federal Reserve
expects a LISCC Firm and a Large and Complex Firm to use benchmark
models in capital planning; a Large and Noncomplex Firm is not held
to this expectation.
Appendix
D: Sensitivity Analysis and Assumptions Management A firm should understand the sensitivity of its stress
testing estimates used in capital planning to the various inputs and
assumptions. In addition, sensitivity analysis should be used to test
the robustness of material quantitative approaches and models and
enhance reporting to the firm’s senior management, board of directors,
and supervisors. A firm should ensure that it identifies, documents,
and manages the use of all key assumptions used in capital planning.
1. Sensitivity analysis
Understanding and documenting a range of potential outcomes provides
insight into the inherent uncertainty and imprecision around pro forma
results. A firm should assess the sensitivity of its estimates of
capital ratios, losses, revenues, and RWAs to key assumptions and
uncertainty across the entire firm’s projections under stress. Through
this assessment, a firm should calculate a range of potential estimates
based on changes to assumptions and inputs.
A firm should also evaluate the sensitivity of material
models to key assumptions to evaluate model performance, assess the
appropriateness of assumptions, and understand uncertainty associated
with model output.
Sensitivity analysis for capital planning models should
be applied in a manner consistent with the expectations outlined in
the Federal Reserve’s supervisory guidance on model risk management
(refer to SR-11-7). Sensitivity analysis should be conducted during
model development and during model validation to provide information
about how models respond to changes in key inputs and assumptions,
and how those models perform in stressful conditions. In addition,
sensitivity analysis should be applied to understand the range of
possible results from material vendor-provided models and vendor-provided
scenario forecasts that have opaque or proprietary elements. Sensitivity
analysis should be used to provide information to help users of model
output interpret results, but does not have to result in changes to
models or model outputs. Changes made based on sensitivity analysis
should be clearly documented and justified.
A firm should ensure that the key sensitivities are presented
to senior management and the board in advance of decision-making around
the firm’s capital plan and capital actions. Sensitivity analysis
should also be used to inform senior management, and, as appropriate,
the board of directors about the potential uncertainty associated
with models employed of the firm’s projections under stress.
2. Assumptions management
A firm should clearly document assumptions when estimating losses,
PPNR, and balance sheet, and RWA components. Documentation should
include the rationale and empirical support for assumptions and specifically
address how those assumptions are consistent with and appropriate
under the firm’s scenario conditions.
A firm’s rationale for assumptions used in capital planning
should be consistent with the different effects of scenario conditions,
shifts in portfolio mix, and growth or decline in balances projected
over the planning horizon. For example, the firm should scrutinize
and support any assumptions about sizeable loan growth during a severe
economic downturn.
A firm should generally use conservative assumptions,
particularly in areas of high uncertainty. The firm should provide
greater support for assumptions that appear optimistic or otherwise
appear to benefit the firm (such as loss reduction or revenue enhancement).
A firm should not assume that senior management will be able to realize
favorable strategic actions that cannot be reasonably assured in stress
scenarios given the high level of uncertainty around market conditions.
Further, a firm should not assume that it would have the perfect foresight
that would allow it, for example, to make significant expense reductions
in the first quarter of the forecast horizon in anticipation of the
forthcoming economic deterioration described in the scenario.
A firm should confirm that key assumptions
used in material vendor or other third-party products are transparent
and have sufficient support before using the products in stress testing.
The firm should limit use of material vendor products whose assumptions
are not fully transparent or supported or use those products only
in conjunction with another approach or compensating controls (e.g.,
overlays).
Differences in Expectations for
LISCC Firms and Large and Complex Firms, as Compared to Large and
Noncomplex Firms
The Federal Reserve
expects a LISCC Firm and a Large and Complex Firm to apply sensitivity
analysis, including assumptions used in vendor models, to all approaches
and assumptions used in capital planning. In contrast, a Large and
Noncomplex Firm is expected to use sensitivity analysis only for material
approaches and assumptions used in material vendor models.
In addition, the Federal Reserve expects a LISCC Firm
and a Large and Complex Firm to subject a greater range of assumptions
to sensitivity analysis and subject assumptions based on historical
patterns to greater scrutiny.
Appendix E: Role of the Internal Audit Function in the Capital
Planning Process A firm’s internal
audit function should play a key role in evaluating the adequacy of
the firm’s capital planning process and in assessing whether the risk
management and internal control practices supporting that process
are comprehensive and effective. A firm should establish an audit
program around its capital planning process that is consistent with
SR letter 13-1, “Supplemental Policy Statement on the Internal Audit
Function and Its Outsourcing.”
1. Responsibilities
of audit function
The internal audit function
should identify all auditable processes related to capital planning
and develop an associated audit plan. The audit function should also
perform substantive testing to ascertain the effectiveness of the
control framework supporting the firm’s capital planning process,
communicate identified limitations and deficiencies to senior management,
and communicate material limitations and deficiencies to the board
of directors (or the audit committee of the board). The audit function
should comprehensively cover the firm’s capital planning process.
The internal audit function should perform periodic reviews
of all aspects of the internal control framework supporting the capital
planning process to ensure that all individual components as well
as the entire process are functioning in accordance with supervisory
expectations and the firm’s policies and procedures. The internal
audit function should also review the manner in which deficiencies
are identified, tracked, and remediated. Furthermore, the internal
audit function should ensure appropriate independent review is occurring
at various levels within the capital planning process.
A firm’s internal audit staff should
have the appropriate competence and stature to identify and escalate
key issues when necessary. The internal audit function may also rely
on an independent third party external to the firm to complete some
of the substantive testing as long as the internal audit function
can demonstrate proper independence of the third party from the area
being assessed and provide oversight over the execution and quality
of the work.
2. Development of audit plan
The internal audit function should have a documented
plan describing its strategy to assess the processes and controls
supporting the firm’s capital planning process. When defining the
annual audit universe and audit plan, the internal audit function of
a firm should focus on the most significant risks relating to the
capital planning process. The firm may leverage existing or regularly
scheduled audits to ensure coverage of all the capital planning process
components; however, the findings and conclusions of these audits
should be incorporated into the overall summary of audit activities
and conclusions regarding the firm’s capital planning process.
3. Briefings to senior management and board
On an annual basis, the internal audit function
should report to senior management and the board of directors on the
capital planning process to inform recommendations and decisions on
the firm’s capital plan. The report should provide an opinion of the
capital planning process, a statement of the effectiveness of the
controls and processes employed, a status update on previously identified
issues and remediation plans, and any open issues or uncertainties
related to the firm’s capital plan. Any key processes that are not
comprehensively reviewed and tested, due to timing or significant
changes in processes, should be clearly documented and identified
as areas with potential heightened risk.
The internal audit function should track responses to
its material findings and report to the board any cases in which senior
management is not implementing required changes related to audit findings
or is doing so with insufficient intensity.
Differences in Expectations for LISCC Firms and Large and Complex
Firms, as Compared to Large and Noncomplex Firms
The expectations for internal audit at a LISCC Firm
and a Large and Complex Firm are more specific and detailed than the
expectations for a Large and Noncomplex Firm. For example, the internal
audit function of a LISCC Firm and a Large and Complex Firm is expected
to conduct a deeper, more detailed assessment of the firm’s model
inventory, procedures for updating processes and change and version
controls, adherence to documentation standards, operational systems,
and work conducted by external parties. In addition, internal audit
at a LISCC Firm and a Large and Complex Firm should have more explicit
procedures for updating its audit plans. Last, a LISCC Firm and a
Large and Complex Firm should brief the board of directors at least
quarterly about key findings related to the capital planning process
(in addition to the formal annual audit report, which is an expectation
for a LISCC Firm, a Large and Complex Firm, and a Large and Noncomplex
Firm).
Appendix F: Capital
Policy A firm’s capital policy should
describe how the firm manages, monitors, and makes decisions regarding
capital planning.
27 The policy should include internal post-stress
capital goals and real-time targeted capital levels; guidelines for
dividends and stock repurchases; and strategies for addressing potential
capital shortfalls.
A firm’s capital policy should describe the manner in
which consolidated estimates of capital positions are presented to
senior management and the board of directors. The capital policy should
require staff with responsibility for developing capital estimates
to clearly identify and communicate to senior management and board
of directors the key assumptions affecting various components that
feed into the aggregate estimate of capital positions and ratios.
The capital policy should require that aggregated results be directly
compared against the firm’s stated post-stress capital goals, and
that those comparisons are included within the standard reporting
to senior management and the board of directors.
1. Post-stress capital goals
Post-stress
capital goals should provide specific minimum thresholds for the level
and composition of capital that the firm intends to maintain during
a stress period. Post-stress capital goals should include any capital
measures that are relevant to the firm.
The firm should be able to demonstrate through its own
internal analysis, independently of regulatory capital requirements,
that remaining at or above its internal post-stress capital goals will
allow the firm to continue to operate.
The capital policy should describe how senior management
and the board concluded that the firm’s post-stress capital goals
are appropriate, sustainable in different conditions and environments,
and consistent with its strategic objectives, business model, and
capital plan. In addition, the capital policy should describe the
process by which the firm establishes its post-stress capital goals,
and include the supporting analysis underpinning the goals chosen
by the firm.
A firm should annually review its capital goals, evaluate
whether its post-stress capital goals are still appropriate based
on changes in operating environment, business mix, or other conditions,
and adjust those goals as needed.
A firm should adjust its real-time capital targets (that
is the amount of current capital it holds above its post-stress capital
goals to ensure it does not fall below those goals under stress) more
frequently than it adjusts capital goals, based on changes in the
business mix, operating environment or other current conditions and
circumstances.
2. Dividends and stock repurchases
A firm’s capital policy should describe the processes
relating to common stock dividend and repurchase decisions, including
the processes to determine the timing, form, and amount of all planned
distributions. The capital policy should also specify the analysis
and metrics that senior management and the board use to make capital
distribution decisions. The analysis should include strategic considerations
such as new business initiatives, potential acquisitions, and the
other relevant factors.
3. Contingency plans
for capital shortfalls
A firm’s capital policy
should include specific capital contingency actions the firm would
take to remedy any current or prospective deficiencies in its capital
position. The firm’s capital contingency plan should reflect strategies
for identifying and addressing potential capital shortfalls and specify
circumstances under which the board of directors and senior management
will revisit planned capital actions or otherwise institute contingency
measures. A contingency plan should include a set of thresholds for
metrics or events that provide early warning signs of capital deterioration
and that trigger management action or scrutiny.
28Capital contingency plans should include options for actions
that a firm would consider taking to remedy any current or prospective
deficiencies in its capital position, such as reducing or ceasing
capital distributions, raising additional capital, reducing risk,
or employing other means to preserve existing capital. Contingency
options in the firm’s capital policy should be consequential, realistic,
actionable, and comprehensive.
Differences
in Expectations for LISCC Firms and Large and Complex Firms, as Compared
to Large and Noncomplex Firms
The Federal
Reserve expects a LISCC Firm and a Large and Complex Firm to include
quantitative payout ratios in its distribution decision-making process,
but does not have this expectation for Large and Noncomplex Firms.
The Federal Reserve also expects a LISCC Firm and a Large and Complex
Firm to provide more support for its post-stress capital goals than
a Large and Noncomplex Firm.
In addition, the Federal Reserve expects a LISCC Firm
and a Large and Complex Firm to include additional detail on contingency
options in its capital contingency plan and to integrate its capital
contingency plan with the firm’s broader crisis management framework.
In contrast, the Federal Reserve does not have these expectations
for Large and Noncomplex Firms.
See section D, “Capital Policy,” for additional differentiated
expectations for a firm’s capital policy.
Appendix G: Scenario Design As part of its capital plan, a firm must use at
least one scenario that stresses the specific
vulnerabilities
of the firm’s risk profile and operations, including those related
to the company’s capital adequacy and financial condition.
29 The firm’s
stress scenario should be at least as severe as the Federal Reserve’s
severely adverse supervisory scenario, measured in terms of its effect
on net income and other elements that affect capital.
30As noted in the core document, a firm should create its
stress scenario, either by developing a complete internal scenario,
or using the Federal Reserve’s supervisory scenarios, adjusted for
the firm’s idiosyncratic risk profile.
The stress scenario should include stressful circumstances
and events that could, on a standalone basis or in combination, reduce
the firm’s capital levels and ratios and potentially impede the firm’s
ability to operate as a going concern, and cover material risks to
which the firm is exposed over the course of an annual planning cycle.
A firm’s scenario should include factors that capture economy- or
market-wide stresses and idiosyncratic risks that can put a strain
on the firm. A firm should also take into account conditions and events
that have not previously occurred, but that may pose a significant
threat to the firm given its exposures, risk profile, and business
strategy.
Differences in Expectations for
LISCC Firms and Large and Complex Firms, as Compared to Large and
Noncomplex Firms
The Federal Reserve
has elevated expectations for a LISCC Firm and a Large and Complex
Firm relating to scenario design. Specifically, a LISCC Firm and a
Large and Complex Firm is expected to develop a scenario that is directly
linked to the idiosyncratic risks of the firm, as determined by its
risk-identification process and risk assessment. In contrast, a Large
and Noncomplex Firm is expected to either develop a firm-specific
scenario or adjust the Federal Reserve’s scenario to reflect the firm’s
own risk profile.
In addition, a LISCC Firm and a Large and Complex Firm
should use multiple internally-designed scenarios as part of its efforts
to assess a broad range of risks, stressful conditions, or events
that could impact the firm’s capital adequacy. A Large and Noncomplex
Firm is not expected to use multiple scenarios in its capital planning
process.
Appendix H: Risk-Weighted
Asset (RWA) Projections A firm should
maintain a sound process for projecting RWAs over the planning horizon.
The firm’s initial and projected RWA calculations should be consistent
with applicable regulatory capital requirements.
Starting balances for both on- and off-balance
sheet exposures and applicable risk weights form the foundation for
estimates of post-stress capital ratios. Therefore, firms should verify
carefully the accuracy of these starting balances. Moreover, deficiencies
in starting RWA calculations are generally compounded in RWA projections
over the planning horizon. A firm should ensure that it has sound
controls around its RWA calculation and regulatory reporting processes
as part of the firm’s broader data governance program.
A firm should ensure that RWA projections
are consistent with a given scenario and incorporate the impact of
projected changes in exposure amounts and risk characteristics of
on- and off-balance sheet exposures under the scenario. A firm should
demonstrate that assumptions associated with RWA projections are clearly
conditioned on a given scenario and are consistent with stated internal
and external business strategies. For example, the firm should demonstrate
how projected credit RWAs over the planning horizon are related to
projected loan growth under the scenario. A firm should provide documented
evidence for the appropriateness of key assumptions used to project
RWAs.
Differences in
Expectations for LISCC Firms and Large and Complex Firms, as Compared
to Large and Noncomplex Firms
The Federal
Reserve has elevated expectations for a LISCC Firm and a Large and
Complex Firm relating to RWAs projections. For instance, a LISCC Firm
and a Large and Complex Firm should provide more detailed support
and documentation for assumptions regarding RWA projections, and implement
an independent review of RWA projections. In contrast, a Large and
Noncomplex Firm is not held to the heightened expectations regarding
RWA projections, and is not expected to implement an independent review
of RWA projections.
In addition, this appendix sets forth expectations
for market RWA projections, which would apply only to a LISCC Firm
and a Large and Complex Firm.
Appendix I: Operational Loss Projections A firm faces a wide range of operational risk in conducting
its business operations. Operational losses can arise from various
sources, including inadequate or failed internal processes, people,
and systems, or from external events, and can differ in frequency
and severity. For example, some operational loss events, such as credit
card fraud, are often more predictable as they occur at high frequency,
but generally have low loss severity. The outcome of other events,
such as major litigation, are less certain and can result in outsized
losses.
Risk-identification process
A firm should maintain a sound process for estimating
operational risk losses in its capital planning process, taking into
account the differences in loss characteristics of different operational
loss event types. A firm’s risk-identification process should include
the evaluation of the type of operational risk loss events to which
the firm is exposed and the sensitivity of those events to internal
and external operating environments. The firm-specific scenario submitted
in a firm’s capital plan should capture the firm’s material operational
risks.
Approaches to operational loss estimation
A firm can use a variety of estimation approaches
to project operational losses for its enterprise-wide stress testing
program, but should not rely on unstable or unintuitive correlations
to project operational losses. The firm can use a simple, conservative
approach based on historical loss data, such as applying average historical
losses, or maximum historical losses, to project operational losses.
A firm should also consider the use of scenario analysis to evaluate
the effect of material operational risk events, especially those which
are less certain or can result in outsized losses.
Use of data
The firm’s operational loss
projection approaches should make appropriate use of relevant reference
data. The firm should supplement its internal data with relevant external
data if the internal data lacks sufficient operational loss history
or granularity.
Differences in Expectations
for LISCC Firms and Large and Complex Firms, as Compared to Large
and Noncomplex Firms
The Federal Reserve
has elevated expectations for a LISCC Firm and a Large and Complex
Firm relating to operational loss projections. For example, a LISCC
Firm and a Large and Complex Firm should use scenario analysis in
its operational loss projections, use both internal and external operational
risk data, have greater support for its assumptions, and solicit input
from senior management on operational risk events. In contrast, a
Large and Noncomplex Firm is not expected to use scenario analysis,
may use external data if internal data are lacking, and is not held
to the same expectations related to assumptions or engagement with
senior management. Issued by the Board
Dec. 18, 2015 (SR-15-19).
