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Fundamental Review of the Trading Book: outstanding issues

Basel Committee on Banking Supervision

The BCBS has published a series of consultative documents reviewing the capitalization of trading activities and proposing measures to strengthen the regulatory capital framework for market risk established in BIS II and revisited in BIS 2.5 and BIS III.

In May 2012, the BCBS published the first consultative document in which it specified a series of measures to improve capital requirements for the trading book. The overall objective of the Committee was to design a new regulatory framework that would mitigate the weaknesses in risk measurement present in the internal models and the standardized approach for market risk. It also sought a more consistent implementation of capital requirements in order for them to be comparable across jurisdictions.

Later, in October 2013 the BCBS issued a second consultative document. It included further detail of the measures in the first document and a draft text which would be the new revised framework for market risk.
With the same aim as the previous two texts, the Committee has published a third consultative paper on the Fundamental Review of the Trading Book: outstanding issues. This paper takes into account the comments made by the entities, as well as the results of the Quantitative Impact Study (QIS). The adjustments it introduced a can be divided into three broad sections:

  • Specific treatment of Internal Risk Transfers (IRTs) for credit risk, equity and interest rate between the trading and the banking book.
  • Revised standardized method, based on changes in the value of an instrument due to its sensitivity to underlying risk factors.
  • Simpler method for incorporating the liquidity horizon concept in the internal market risk models

The new regulation is aimed at solving issues not adequately addressed in the previous regulation in terms of exposure to market risk in the trading book.

The paper analyzes the main aspects of the BCBS document and the implications derived from implementation of the new framework by financial institutions.

Executive Summary

The third consultative document of the BCBS introduced a specific treatment for IRTs, a review of the standardized approach and the concept of liquidity horizon in internal models.

 

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