The Federal Reserve Board on Friday advised large financial institutions to carefully evaluate transactions intended to reduce risk to ensure that, if risks are shifted to a thinly capitalized counterparty or affiliated entity of the firm, any residual risk is effectively captured in the firm's internal capital adequacy assessment. Examiners will closely consider such transactions, and potential residual risks, when evaluating an institution's capital adequacy.
Following inquiries from banking institutions and investors, the Board issued the guidance to clarify that while efforts to reduce risk can be positive, certain transactions can result in residual risks to the firm that may not be accounted for in risk-based capital measures. Institutions should be able to demonstrate that the residual risks are fully reflected in their internal assessment of capital adequacy and that they maintain sufficient capital to account for such risks.
Supervisors will closely scrutinize risk-transfer transactions that result in substantial reductions in risk-weighted assets when assessing capital adequacy, including during the annual Comprehensive Capital Analysis and Review of the 30 largest financial institutions.