Title 12

SECTION 3.208

3.208 Incremental risk.

§ 3.208 Incremental risk.

(a) General requirement. A national bank or Federal savings association that measures the specific risk of a portfolio of debt positions under § 3.207(b) using internal models must calculate at least weekly an incremental risk measure for that portfolio according to the requirements in this section. The incremental risk measure is the national bank's or Federal savings association's measure of potential losses due to incremental risk over a one-year time horizon at a one-tail, 99.9 percent confidence level, either under the assumption of a constant level of risk, or under the assumption of constant positions. With the prior approval of the OCC, a national bank or Federal savings association may choose to include portfolios of equity positions in its incremental risk model, provided that it consistently includes such equity positions in a manner that is consistent with how the national bank or Federal savings association internally measures and manages the incremental risk of such positions at the portfolio level. If equity positions are included in the model, for modeling purposes default is considered to have occurred upon the default of any debt of the issuer of the equity position. A national bank or Federal savings association may not include correlation trading positions or securitization positions in its incremental risk measure.

(b) Requirements for incremental risk modeling. For purposes of calculating the incremental risk measure, the incremental risk model must:

(1) Measure incremental risk over a one-year time horizon and at a one-tail, 99.9 percent confidence level, either under the assumption of a constant level of risk, or under the assumption of constant positions.

(i) A constant level of risk assumption means that the national bank or Federal savings association rebalances, or rolls over, its trading positions at the beginning of each liquidity horizon over the one-year horizon in a manner that maintains the national bank's or Federal savings association's initial risk level. The national bank or Federal savings association must determine the frequency of rebalancing in a manner consistent with the liquidity horizons of the positions in the portfolio. The liquidity horizon of a position or set of positions is the time required for a national bank or Federal savings association to reduce its exposure to, or hedge all of its material risks of, the position(s) in a stressed market. The liquidity horizon for a position or set of positions may not be less than the shorter of three months or the contractual maturity of the position.

(ii) A constant position assumption means that the national bank or Federal savings association maintains the same set of positions throughout the one-year horizon. If a national bank or Federal savings association uses this assumption, it must do so consistently across all portfolios.

(iii) A national bank's or Federal savings association's selection of a constant position or a constant risk assumption must be consistent between the national bank's or Federal savings association's incremental risk model and its comprehensive risk model described in section 209 of this subpart, if applicable.

(iv) A national bank's or Federal savings association's treatment of liquidity horizons must be consistent between the national bank's or Federal savings association's incremental risk model and its comprehensive risk model described in section 209, if applicable.

(2) Recognize the impact of correlations between default and migration events among obligors.

(3) Reflect the effect of issuer and market concentrations, as well as concentrations that can arise within and across product classes during stressed conditions.

(4) Reflect netting only of long and short positions that reference the same financial instrument.

(5) Reflect any material mismatch between a position and its hedge.

(6) Recognize the effect that liquidity horizons have on dynamic hedging strategies. In such cases, a national bank or Federal savings association must:

(i) Choose to model the rebalancing of the hedge consistently over the relevant set of trading positions;

(ii) Demonstrate that the inclusion of rebalancing results in a more appropriate risk measurement;

(iii) Demonstrate that the market for the hedge is sufficiently liquid to permit rebalancing during periods of stress; and

(iv) Capture in the incremental risk model any residual risks arising from such hedging strategies.

(7) Reflect the nonlinear impact of options and other positions with material nonlinear behavior with respect to default and migration changes.

(8) Maintain consistency with the national bank's or Federal savings association's internal risk management methodologies for identifying, measuring, and managing risk.

(1) The average of the incremental risk measures over the previous 12 weeks; or

(2) The most recent incremental risk measure.