Regulatory Risk Capital & CCAR Measurement

Regulatory Risk Capital & CCAR Measurement

In the wake of 2007-09 financial crisis, Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). The Dodd-Frank Act requires the Federal Reserve to conduct an annual stress test of large bank holding companies and all non-bank financial companies designated by the Financial Stability Oversight Council (FSOC) for Federal Reserve supervision. The Federal Reserve is to evaluate whether these companies have sufficient capital to absorb losses resulting from stressful economic and financial market conditions in annual stress tests. Regulators have set up yearly banking capital adequacy tests for banks to perform and report back to the regulators.

These reports, called Comprehensive Capital Analysis and Review reports (CCAR), are required by regulators for these banks to implement. Gateway Partners provides comprehensive services for CCAR measurement.

CCAR is a detailed capital adequacy test based on prescriptive market,credit, and liquidity stress tests along with stress VaR to measure the capital drawdown requirements for a bank. These tests determine if banks can survive such capital drawdowns during these conditions.

Regulatory risk capital measurement includes the following risk types:

  • Credit Risk Capital
  • Market Risk Capital
  • Liquidity Risk Capital
  • Operational Risk Capital

In general these risks, especially market, credit, and liquidity risk, are not independent, and in severely adverse conditions are highly coupled. A crisis condition in one risk can lead to a crisis in additional risk conditions. However, these risks tend to be measured separately and then added together, making an assumption of high correlation between the risk types. Regulators provide two different approaches for the measurements of these risks, and in most cases banks have the choice to use the one they feel is appropriate for their institution:

  • Standard Approach
  • Advanced Approach Using Internal Capital Models