The Basel Committee’s fundamental review of the trading book is an immensely complicated task, and tight deadlines have the banks in a panic.

What's happening?

The Basel Committee on Banking Supervision (BCBS) began its fundamental review of the trading book (FRTB) with a consultation in May 2012. The plan was to complete the review in time to seek endorsement from the G20 finance ministers’ meeting in November 2014, but this was postponed by a year to the next G20 meeting in Turkey. The postponement was necessary owing to the sheer complexity of the project: Basel is completely redesigning the framework for calculating risk weights for banks’ market risk assets using both the standardised approach and internal models.

Moreover, after trade associations warned that the proposed standardised approach was unworkable, the BCBS worked with the industry to devise an entirely new method called the sensitivities-based approach (SBA), which was only formulated in 2014 and has not yet been fully field-tested.

What are the implications?

Although the BCBS has indicated that simply raising the capital banks will need to hold against the trading book is not the primary intention, bankers believe the FRTB could have profound effects on capital charges for certain types of assets. In particular, banks must shift their internal models from value-at-risk calculations to expected shortfall. This new measure incorporates tail-risk events, and consequently assets that experienced high volatility during the 2008 financial crisis are likely to end up with higher risk weights. Moreover, the BCBS has incorporated liquidity horizons into the models, which means higher risk weights for positions that would take longer to liquidate.

Both of these changes point to higher charges specifically for fixed-income trading assets. One global bank has apparently calculated that the capital treatment of credit under the SBA could be 10 times more penal than that of foreign exchange, although this is not necessarily a consensus view in the market. Moreover, the recently designed SBA has taken on added significance, because the BCBS is now also consulting on the possibility of using the standardised approach as a floor for internal models.

Reg rage anxiety

“In the past, the BCBS has expressed a desire not to alter the total amount of capital in the system, but modified this by saying that the potential capital requirements for certain asset classes may change,” says Martyn Brush, head of risk for corporate and institutional banking at RBS. “This could translate into potentially large differences opening up between asset classes, with foreign exchange and interest rate risk benefiting under the SBA to market risk, while credit and securitisations are potentially heading toward higher capital charges. Unless thoughtfully calibrated, using the SBA as a floor could trigger a further exit by banks from credit trading inventories.”

What happens next?

The BCBS will conduct a new set of quantitative impact studies (QIS) in mid-2015. What concerns the industry is that the tight timeline for completion may not allow adequate integration of the QIS results into the final version of the FRTB. In a joint letter to the BCBS trading book group, the Global Financial Markets Association, International Swaps and Derivatives Association and Institute of International Finance called for a rethink of the timetable.

“An aggressive implementation timeline that does not provide adequate time to iteratively incorporate testing outcomes may limit the success of this review,” the associations wrote. “We strongly advocate on the need to incorporate the next firm-wide QIS in the policy finalisation process given that new concepts and methodologies that have been recently introduced require adequate testing. In our view, the QIS outcomes may be incorporated into the framework build phase without affecting the ‘go-live’ date for implementation, and will help assure that the framework design is right the first time. We would also encourage the trading book group to adopt flexible wording where the framework components have not been fully assessed, so that amendments can be accommodated at a later stage.”

What do regulators say?

At least publicly, regulators are holding to the November 2015 deadline for the FRTB. But there seems to be less agreement about the concept of using the standardised approach as a floor for internal models, a project which is also scheduled for completion by the end of 2015.

Sweden has already imposed a 25% risk weight floor on domestic mortgages to take into account new characteristics in the local mortgage market that might not be reflected by models based on historic default data. But Uldis Cerps, executive director for banks at Sweden’s financial supervisor, Finansinspektionen, is uncertain how much this experience applies to the much broader Basel proposals.

“It remains to be seen whether the calibration in the standardised approach, which will apply to all Basel Committee member states including emerging markets, is also appropriate for mature markets in western Europe,” he says.  

PLEASE ENTER YOUR DETAILS TO WATCH THIS VIDEO

All fields are mandatory

The Banker is a service from the Financial Times. The Financial Times Ltd takes your privacy seriously.

Choose how you want us to contact you.

Invites and Offers from The Banker

Receive exclusive personalised event invitations, carefully curated offers and promotions from The Banker



For more information about how we use your data, please refer to our privacy and cookie policies.

Terms and conditions

Join our community

The Banker on Twitter