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Risk-based Capital Guidelines: Market Risk

Proposed Rule

Score: 16 / 60

RULE SUMMARY

The Office of the Comptroller of the Currency (OCC), Board of Governors of the Federal Reserve System (Board), and Federal Deposit Insurance Corporation (FDIC) are requesting comment on a proposal to revise their market risk capital rules to modify their scope to better capture positions for which the market risk capital rules are appropriate; reduce procyclicality in market risk capital requirements; enhance the rules’ sensitivity to risks that are not adequately captured under the current regulatory measurement methodologies; and increase transparency through enhanced disclosures. The proposal does not include the methodologies adopted by the Basel Committee on Banking Supervision for calculating the specific risk capital requirements for debt and securitization positions due to their reliance on credit ratings, which is impermissible under the Dodd-Frank Wall Street Reform and Consumer Protection Act.

MONETIZED COSTS & BENEFITS (AS REPORTED BY AGENCY)

Dollar Year
2010
 
Time Horizon (Years)
1
 
Discount Rates
NA
 
Expected Costs (Annualized)  
Expected Benefits (Annualized)  
Expected Costs (Total)
$334 Million
 
Expected Benefits (Total)
NA (Qualitative)
 
Net Benefits (Annualized)
NA
 
Net Benefits (Total)  

METHODOLOGY

There are twelve criteria within our evaluation within three broad categories: Openness, Analysis and Use. For each criterion, the evaluators assign a score ranging from 0 (no useful content) to 5 (comprehensive analysis with potential best practices). Thus, each analysis has the opportunity to earn between 0 and 60 points.

CriterionScore

Openness

1. How easily were the RIA , the proposed rule, and any supplementary materials found online?
The NPRM is available on regulations.gov via a RIN or keyword search. The only regulatory analysis is apparently a very brief section labeled the Unfunded Mandates Reform Act analysis. The NPRM does not even mention Executive Order 12866, even though reginfo.gov classifies the regulation as economically significant. A RIN search on the Comptroller of the Currency web site turns up a link to the NRPM via a press release.
4/5
2. How verifiable are the data used in the analysis?
Virtually no data are used. A single attempt to estimate the effect on capital requirements cites a Basel Committee study and unspecified "additional estimates."
0/5
3. How verifiable are the models and assumptions used in the analysis?
The analysis was based on a few assertions and not very well documented calculations. No theoretical literature or models were cited that aid in analysis of the regulation's effects.
1/5
4. Was the analysis comprehensible to an informed layperson?
The analysis assumes specialized knowledge, especially familiarity with jargon. It is hard to follow the reasoning and evidence to the conclusions since there is very little of either.
2/5

Analysis

5. How well does the analysis identify the desired outcomes and demonstrate that the regulation will achieve them?
1/5
Does the analysis clearly identify ultimate outcomes that affect citizens’ quality of life?
General purpose of the rule is to promote "safety and soundness" in banking by adjusting regulations to cover risks not currently covered and incorporate advances in risk modeling. Although it is not directly stated, the proposed rule's main outcome is an increased sensitivity to market risk within the banking system which will lower the "probability of catastrophic losses to the banks occurring because of market risk." The analysis section claims that the ultimate impact is "the safety and soundness of banking institutions and world financial markets." The closest the analysis comes to naming an outcome is a claim that the regulation will reduce the risk of catastrophic losses to banks. The relationship between this outcome and citizens' quality of life is never explained, even though it should not have been difficult to do so.
2/5
Does the analysis identify how these outcomes are to be measured?
Six benefits are listed. None are measured.
0/5
Does the analysis provide a coherent and testable theory showing how the regulation will produce the desired outcomes?
The analysis claims that by changing the capital risk guidelines and the risk modeling requirements, banking institutions will have more buttress against market risk, which could not be as effectively (or at all) achieved by the other alternatives presented. Although the analysis mentions these findings are direct recommendations of the Basel Committee and the OCC, FDIC and the Fed, there could be more clear explanations as to how the proposed rule will produce the desired outcome without causing any other unintended consequences.
2/5
Does the analysis present credible empirical support for the theory?
No empirical research cited to support the claim that changing the risk model and approaches will make banks safer. Readers are expected to take the regulators' judgment on faith.
0/5
Does the analysis adequately assess uncertainty about the outcomes?
Benefits are presumed to occur with certainty, and there is no analysis of uncertainty.
0/5
6. How well does the analysis identify and demonstrate the existence of a market failure or other systemic problem the regulation is supposed to solve?
1/5
Does the analysis identify a market failure or other systemic problem?
The agencies claim that the current rule fails to include some forms of risk and needs to be updated to reflect advances in risk modeling. The analysis assumes, rather than proves, the existence of a systemic problem or a significant systemic risk. It does, however, quote the Basel findings which were adopted as a result of the current global financial crisis and it argues that the proposed changes will help strengthen banking institutions against market risk. It could be inferred that the market failure/systemic problem is the recent global financial crisis; however, the analysis does not mention this directly.
2/5
Does the analysis outline a coherent and testable theory that explains why the problem (associated with the outcome above) is systemic rather than anecdotal?
The deficiencies in the current regulation are asserted with very little explanation. Analysis simply states that the new market risk measure is more complete. No theory is presented showing why the financial health of a bank is a systemic issue rather than just a concern for the bank's shareholders.
1/5
Does the analysis present credible empirical support for the theory?
The only empirical support the analysis offers is the Basel Committee findings in 2009.
1/5
Does the analysis adequately assess uncertainty about the existence or size of the problem?
No uncertainty about the need for the regulation or size of the problem is acknowledged.
0/5
7. How well does the analysis assess the effectiveness of alternative approaches?
2/5
Does the analysis enumerate other alternatives to address the problem?
Two alternatives (plus the baseline) are considered: an unspecified change in the size of the bank's trading book that triggers the regulation, and a combined bank size/trading book size threshold that would reduce the number of banks subject to the regulation.
4/5
Is the range of alternatives considered narrow (e.g., some exemptions to a regulation) or broad (e.g., performance-based regulation vs. command and control, market mechanisms, nonbinding guidance, information disclosure, addressing any government failures that caused the original problem)?
The alternatives involve no change in the substance of the regulation, just the banks to which it applies.
2/5
Does the analysis evaluate how alternative approaches would affect the amount of the outcome achieved?
There is no substantial analysis of outcomes produced under the alternatives. Instead, the analysis asserts, "[T]he current size thresholds, which continue to apply under the proposed rule, capture those institutions that the regulatory agencies believe should be subject to market risk capital rules." So, the chosen approach will produce better outcomes than the alternatives because it applies to the institutions the regulators believe it should apply to. Broader applicability or tighter requirements are assumed to produce more/better outcomes.
1/5
Does the analysis adequately address the baseline? That is, what the state of the world is likely to be in the absence of federal intervention not just now but in the future?
Analysis says the baseline scenario is the current regulation, and it asserts that market risk capital would remain at current levels under the baseline. This presumes no changes would occur in the market that might alter capital requirements under the current regulation. The agencies simply assert that the desired benefits of the proposed rule will not occur under the baseline scenario.
1/5
8. How well does the analysis assess costs and benefits?
1/5
Does the analysis identify and quantify incremental costs of all alternatives considered?
The only monetary cost estimated is the reduction in tax benefit to banks associated with making them hold more equity and less debt. This is calculated only for the alternative chosen. It is not clear if this calculation is even correct, since debt and equity may have different costs apart from the tax consequences. For one proposed alternative, the analysis simply asserts "that the estimated costs of the alternative rule decreases with the number of institutions affected by the rule."
2/5
Does the analysis identify all expenditures likely to arise as a result of the regulation?
The analysis asserts that the regulation will not create any additional significant administrative costs. Paperwork burden of the chosen alternative is estimated, but only in hours. It does not identify the expenditures for complying with the new enhanced disclosure requirements.
1/5
Does the analysis identify how the regulation would likely affect the prices of goods and services?
The RIA does not discuss how the regulation will likely affect the prices of goods and services. The agencies only assert they will not expect to have any disproportionate effect on any segment of the private sector; and that there is "some concern regarding the burden of the proposed increase in market risk capital and the effect this could have on bank lending." The rule does, however, ask for comments on this issue.
1/5
Does the analysis examine costs that stem from changes in human behavior as consumers and producers respond to the regulation?
No relevant content.
0/5
If costs are uncertain, does the analysis present a range of estimates and/or perform a sensitivity analysis?
No discussion of cost uncertainty.
0/5
Does the analysis identify the alternative that maximizes net benefits?
Benefits were not calculated and hardly any costs were calculated, so net benefits could not be calculated.
0/5
Does the analysis identify the cost-effectiveness of each alternative considered?
Benefits were not calculated, so net benefits could not be calculated.
0/5
Does the analysis identify all parties who would bear costs and assess the incidence of costs?
The analysis of alternatives revealed that most of the trading assets and risks are concentrated in seven large banks, and they would bear most of the costs. No further discussion of how these costs would affect depositors, borrowers, etc. The analysis also asserts that the enforcement agencies will not incur "significant additional administrative costs" and that there will not be any budgetary effects at various government levels or in the private sector.
3/5
Does the analysis identify all parties who would receive benefits and assess the incidence of benefits?
Most language seems to imply that the banks themselves will benefit and these regulations are for their own good. There are one or two assertions that the regulations improve the "safety and soundness" of the banking system and improve financial market stability, but no explanation of who benefits from this.
1/5

Use

9. Does the proposed rule or the RIA present evidence that the agency used the analysis?
The NPRM does not claim to have used the analysis. The analysis reads like an add-on to fulfill the Unfunded Mandates Reform Act requirements after the regulatory decisions were already made.
1/5
10. Did the agency maximize net benefits or explain why it chose another alternative?
Net benefits could not be determined from the information in the analysis. The analysis claimed that the chosen alternative "offers a better balance between costs and benefits," but the factual basis for this claim is not very clear.
1/5
11. Does the proposed rule establish measures and goals that can be used to track the regulation's results in the future?
The rule does not explicitly establish measures or goals that can be used to track the regulation's results in the future. The rule goes partway toward retrospective analysis by requiring banks to compare outputs of their risk models with their actual financial results. This is not a full retrospective evaluation of the regulation, but it amounts to retrospective analysis of the models required by the regulation.
1/5
12. Did the agency indicate what data it will use to assess the regulation's performance in the future and establish provisions for doing so?
Banks must make performance information available to examiners, which in theory gives the regulators some data that could be used for retrospective analysis.
1/5
 
Total16 / 60

Additional details

Agency
Joint Banking Regulators
Regulatory Identification Number
1557-AC99
Agency Name
Joint Banking Regulators
Rule Publication Date
01/11/2011
Comment Closing Date
04/11/2011
Dollar Year
2010
Time Horizon (Years)
1