Critical appraisal of the Basel fundamental review of the trading book regulations

J. Orgeldinger

Journal of Risk Management in Financial Institutions, 2017, vol. 10, issue 3, 257-275

Abstract: In its October 2013 consultative paper for a revised market risk framework (Fundamental Review of the Trading Book, FRTB) and subsequent versions published thereafter, the Basel committee suggested new ways of dealing with market risk in banks’ trading and banking books. The Basel committee estimates that the new rules will result in an approximate median capital increase of 22 per cent and a weighted average capital increase of 40 per cent, compared with the current framework. Key changes are found in the internal model approach (IMA), the standard rules and the scope/approval process. Among the significant changes that are being introduced by the FRTB is a stricter separation of the trading book and banking book. Regardless of whether they use standardised or internal models, banks will need to review their portfolios to determine if existing classifications of instruments and desks as trading book or banking book are still applicable or whether a revision of desk structure is needed. In this article, the theoretical foundations of the IMA are explained, which are the stressed expected shortfall, liquidity adjustments, default and migration risk, and non-modellable risk factors. The various approaches for IMA and the introduction of a standardised floor, the sensitivity based approach (SBA) with delta, vega and curvature, shock scenarios and the aggregation with asymmetric correlation and reflection of basis/default risk are elaborated.

Keywords: fundamental review of the trading book (FRTB); internal model approach (IMA); revised standardised model; factor models; risk contribution (search for similar items in EconPapers)
JEL-codes: E5 G2 (search for similar items in EconPapers)
Date: 2017
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