Today, the Federal Reserve issued a Supervision and Regulation letter (SR letter) entitled Risk Transfer Considerations When Assessing Capital Adequacy – Supplemental Guidance on Consolidated Supervision Framework for Large Financial Institutions.
The SR letter applies to U.S. bank holding companies and savings and loan holding companies with consolidated assets of $50 billion or more as well as foreign banking organizations with combined assets of U.S. operations of $50 billion or more (collectively, “large banking organizations”).
The purpose of the SR letter is to provide guidance on how certain risk transfer transactions affect assessments of capital adequacy at large banking organizations. The guidance advises large banking organizations to carefully evaluate transactions intended to reduce risk to ensure that, if risks are shifted to a thinly capitalized counterparty or an affiliated entity, any residual risk is effectively captured in the banking organization’s internal capital adequacy assessment.
The Federal Reserve noted that supervisors will strongly scrutinize risk transfer transactions that result in substantial reductions in risk-weighted assets, including in supervisors’ assessment of a large banking organization’s overall capital adequacy, capital planning and risk management through the Comprehensive Capital Analysis and Review (CCAR).
Based on an assessment of the risks retained by the banking organization, the Federal Reserve may in particular cases determine not to recognize a transaction as a risk mitigant for risk-based capital purposes. Banking organizations should bring these types of risk transfer transactions to the attention of their senior management and supervisors. Supervisors will evaluate whether a banking organization can adequately demonstrate that it has taken into account any residual risks in connection with the transaction.
Federal Reserve, Risk Transfer Considerations When Assessing Capital Adequacy – Supplemental Guidance on Consolidated Supervision Framework for Large Financial Institutions (SR letter 12-17/CA letter 12-14) (Dec. 20, 2013) available here: http://federalreserve.gov/bankinforeg/srletters/sr1323.pdf