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Release Date: July 1, 1999

For immediate release

The Federal Reserve today issued a supervisory letter which emphasizes the growing need for large and complex banking organizations to maintain strong internal processes to assure that their capital is fully sufficient to support the underlying risks they face as well as to meet minimum regulatory standards.

Capital adequacy is a critical element of a bank's safety and soundness. With the growing scope and complexity of business activities and ongoing financial innovation, simple ratios - including risk-based capital ratios - and traditional rules of thumb no longer suffice in assessing the overall capital adequacy of many banking organizations.

The supervisory letter directs examiners to evaluate internal capital management processes to judge whether they meaningfully tie the identification, monitoring, and evaluation of risk to the determination of the institution's capital needs. To support that evaluation, this letter describes the fundamental elements of a sound and comprehensive internal capital adequacy analysis and the key areas of risk it should encompass.

This letter grows in part from a recent supervisory review of internal capital management processes at several large complex banking organizations. This review suggests that these processes could be significantly improved, in particular to become better integrated with internal risk measurement and analysis. In providing guidance to examiners and supervisors, this supervisory letter is also intended to encourage such banking organizations to strengthen their risk measurement capabilities as well as to integrate these capabilities more fully in evaluating their own capital adequacy.

The practices described in this letter extend in some cases beyond those currently followed by most large banking organizations. Examiners should generally expect these institutions to make steady and meaningful progress towards implementation of a comprehensive internal process for assessing capital adequacy in relation to risk, rather than immediate and full implementation. However, examiners should expect those banking organizations actively involved in complex securitizations or other similar transfers of risk to have in place or immediately implement a comprehensive internal capital analysis that fully reflects all risks.

Supervisory letters are the primary means by which the Federal Reserve communicates key policy directives to its examiners, supervisory staff, and the banking industry. The long-term goal of this supervisory letter is to encourage broader adoption of sound practices in internal analysis of capital adequacy, to promote further innovation and enhancements by the industry in this area, and to integrate better such internal analysis into the supervisory process.

The supervisory letter is attached.

1999 Banking and consumer regulatory policy

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Last update: July 1, 1999