LO 50.1: Describe the Federal Reserves Capital Plan Rule and explain the seven

LO 50.1: Describe the Federal Reserves Capital Plan Rule and explain the seven principles of an effective capital adequacy process for bank holding companies (BHCs) subject to the Capital Plan Rule.
Bank holding companies (BHCs) must have adequate and sufficient capital for their survival and growth. Capital provides a cushion against unexpected losses and allows BHCs to continue to operate. The failure of BHCs (i.e., liabilities exceed assets, resulting in negative capital) would most likely be a burden on taxpayers and deposit insurance funds. An effective and sound capital management policy is critical for the health of BHCs, as well as the smooth functioning and stability of the entire financial system.
The Federal Reserve maintains its interest in survivability and smooth functioning BHCs through its Capital Plan Rule and the annual Comprehensive Capital Analysis and Review (CCAR). The CCAR is the Federal Reserves supervisory program for evaluating capital plans.
The Capital Plan Rule mandates that BHCs develop and put in place a capital plan and a process to evaluate and monitor their capital adequacy. The capital plan covers all U.S. domiciled BHCs with total consolidated assets equal to $50 billion or more.
The Capital Plan Rule lists the principles that the Federal Reserve uses to evaluate the adequacy and appropriateness of a BHCs internal capital planning processes and practices.
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2018 Kaplan, Inc.
Topic 50 Cross Reference to GARP Assigned Reading – Board o f Governors o f the Federal Reserve System
The principles on which the Federal Reserve assesses BHCs for managing and allocating their capital resources is referred to as the capital adequacy process (CAP). The seven principles of the CAP are as follows: 1. Risk management foundation. A BHC has an effective capital risk management plan
to encompass all key risk exposures on a firm-wide basis in terms of identification, evaluation, measurement, and control.
2. Resource estimation methods. A BHC has a capital resource estimation plan to clearly
define and estimate available capital resources over a stress scenario time horizon.
3. Loss estimation methods. A BHC has a process for estimating potential losses and
aggregating them on a firm-wide basis over a given stress scenario time horizon.
4. Impact on capital adequacy. A BHC has a process to evaluate the combined impact on capital adequacygiven loss estimates and capital resources combinedin light of the stated goals with respect to capital level and composition.
5. Capital planning policy. A BHC has a sound capital policy to develop capital goals, determine appropriate capital levels and composition as well as capital distributions (actions) and contingency plans.
6. Internal controls. A BHC has a vigorous internal controls policy in place for
independent review, model validation, documentation, and internal audit of the capital adequacy process.
7. Effective oversight. A BHC has a board and senior management responsible for an effective and thorough oversight of multiple dimensions of the internal capital risk plan, including methods, processes, assessments, validations, reviews, documentation, infrastructure, resources, goals, limitations, and approval of capital decisions.
2018 Kaplan, Inc.
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Topic 50 Cross Reference to GARP Assigned Reading – Board o f Governors o f the Federal Reserve System
C a p i t a l A d e q u a c y P r o c e s s
Internal controls, including model review and valuation

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