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P2.T7.806. Capital planning practices at large bank holding companies (BHC)

Nicole Seaman

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Learning objectives: Describe the Federal Reserve’s Capital Plan Rule and explain the seven principles of an effective capital adequacy process for bank holding companies (BHCs) subject to the Capital Plan Rule. Describe practices that can result in a strong and effective capital adequacy process for a BHC in the following areas: Risk identification; Internal controls, including model review and validation; Corporate governance; Capital policy, including setting of goals and targets and contingency planning; Stress testing and stress scenario design; Estimating losses, revenues, and expenses, including quantitative and qualitative methodologies; Assessing the impact of capital adequacy, including risk-weighted asset (RWA) and balance sheet projections.


806.1. Each of the following is true about capital planning at large bank holding companies supervised by the Federal Reserve EXCEPT which is inaccurate?

a. Large bank holding companies (BHCs) in the United States are subject to an annual assessment by the Federal Reserve that includes two related programs: Dodd-Frank act supervisory stress testing, and the Comprehensive Capital Analysis and Review (CCAR)
b. Under the U.S. supervisory stress tests, three macroeconomic scenarios are required by the Dodd-Frank Act: baseline, adverse and severely adverse (itself characterized by a severe global recession accompanied by a global aversion to long-term fixed-income assets)
c. Once a BHC has reached the minimum regulatory capital requirements (common equity tier 1, tier 1, or total capital) during normal and non-stressed times, the Federal Reserve cannot limit the bank's freedom to pay dividends or re-purchase shares
d. The seven principles of an effective capital adequacy process are: sound foundational risk management; effective loss-estimation methodologies; solid resource-estimation methodologies; sufficient capital adequacy impact assessment; comprehensive capital policy and capital planning; robust internal controls; and effective governance

806.2. In regard to practices that can result in a strong and effective capital adequacy process, according to "Capital Planning at Large Bank Holding Companies: Supervisory Expectations and Range of Current Practice," each of the following is true EXCEPT which is false?

a. Most BHCs use some forms of expert judgment for some purposes, often as a management adjustment overlay to modeled outputs
b. With respect to Expected Loss Approaches, BHCs with leading practices were able to break down losses into PD, LGD, and EAD components, separately identifying key risk drivers for each of those components
c. Although best practices in operational-risk models are still evolving, common approaches to operational-loss-estimation for stress scenarios include regression models, modified loss-distribution-approach (LDA) and scenario analysis
d. With respect to Market and Counterparty Credit Risk, the Federal Reserve much prefers probabilistic approaches to deterministic approaches because deterministic approaches do not link stress scenarios to risk factor shocks

806.3. Betaplanet International is a large bank holding company (BHC) with a high dependence on customer deposits. Betaplanet recently submitted its capital plan and stress scenarios to the Federal Reserve with the following features:

I. Betaplanet projected estimated revenue and expenses forward over a nine-quarter planning horizon
II. Betaplanet separately estimated losses, revenues, and expenses under hypothetical stressed conditions for business lines that are sensitive to different risk drivers
III. The adverse scenarios assume that Betaplanet will gain, respectively, +2.0% and +5.0% market share due to its competitive advantage and reputation for safety
IV. For some portfolios where it has limited expertise, Betaplanet relied on a commercial, third-party models
V. For its wholesale portfolios where it has limited history, Betaplanet supplemented internal data with external data
VI. Betaplanet projected net interest income (NII) and its components, but (due to its high dependence on deposits) excluded projections of non-interest income and non-interest expense

Which of the features above are UNLIKELY to meet the regulatory expectations of the capital planning process?

a. None, all of the mentioned features are explicitly permitted
b. III. and VI., Betaplanet should not assume market share gains under stress scenario, nor should it exclude non-interest income and expenses in projections
c. II. and IV, Betaplanet should not separate losses/revenues/expenses by business line, nor should rely on third-party models whatsoever (versus internal models)
d. I. and V, Betaplanet must project revenue and expenses at least five years, and it cannot rely on external data

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