FRTB Overview

In January 2016, the Basel Committee on Banking Supervision (BCBS) released revised minimum capital requirements for market risk following their 8-year-long Fundamental Review of the Trading Book (FRTB). This framework represents an overarching view of how risks from banks’ trading activities and portfolios should be assessed and quantified through a credible and intuitive relationship with capital requirements. Principal components of the new guidelines include: a clear and impermeable boundary between banking and trading books; replacement of value-at-risk (VaR) by expected shortfall (ES) as a risk measure; a revised sensitivity-based standardized approach (SA); and a revised ES-based internal models approach (IMA) with differentiated liquidity horizons. The principal objectives of BCBS for FRTB are to achieve consistency across jurisdictions, for its standardized approach to serve as a credible fallback and a floor for the internal models approach, and to address existing weaknesses in the internal models approach – with the overarching motivation of not significantly increasing bank capital requirements. In January 2019 BCBS published the final revised FRTB document.

Recall how we arrived here. These risks still exist

• Intentional arbitrage between trading book and banking book in order to improve capital and/or P&L treatment
• Differential treatment of similar risks held in different books (e.g. CDS vs. loan)
• Subjective boundary definition driven by “intent to trade” principals
• Enforcement challenges including subjective metrics and “all-or-nothing” enforcement tools
• Embedded liquidity risks hidden until the advent of a stress event
• Jump to default risks which were not adequately captured in the trading book