Over the past decade, banks have devoted many resources to developing internal risk models for the purpose of better quantifying the risks they face and allocating economic capital. These efforts have been recognized and encouraged by bank regulators. For example, the 1997 Market Risk Amendment (MRA) to the Basel Capital Accord formally incorporates banks ’ internal, market risk models into regulatory capital calculations. That is, the regulatory capital requirements for banks ’ market risk exposures are explicitly a function of the banks ’ own value-at-risk estimates. A key component in the design and implementation of the MRA was the development of qualitative and quantitative standards that must be satisfied in order for banks ’ models to be used for regulatory capital purposes. In this paper, we examine the MRA and recent regulatory experience to draw out lessons for the design and implementation of internal models-based capital regimes for other types of risk. Note: The views expressed in this paper are those of the authors and not necessarily those of the Federal Reserve Bank of New York, the Federal Reserve Bank of San Francisco or the Federal Reserve System. I
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