Fundamental Review of the Trading Book

The Fundamental Review of the Trading Book (FRTB), is a set of proposals by the Basel Committee on Banking Supervision for a new market risk-related capital requirement for banks.[1][2]

Background

The reform, which is part of Basel III, is one of the initiatives taken to strengthen the financial system, noting that the previous proposals (Basel II) did not prevent the financial crisis of 2007–2008.[3][4] It was first published as a Consultative Document in October 2013.[5] Following feedback received on the consultative document, an initial proposal was published in January 2016,[6] which was revised in January 2019.[7]

Key features

The FRTB revisions address deficiencies relating to the existing Standardised approach[8] and Internal models approach[8][9] and particularly revisit the following:

Implementation

FRTB sets a "higher bar" for banks to use their own, internal models for calculating capital, as opposed to the standardised approach.[2] The rationale is that the standardised approach is directly implementable, but, at the same time, carries more capital; whereas the internal models approach, by contrast, carries less capital, but the modelling is more complex, requiring that expected shortfall is applied, together with add-ons for the "non-modellable risk factors" that lack sufficient data. Given this complexity, for a desk to qualify for the internal models approach, its model must pass two tests: a profit and loss attribution test and a backtest.[11]

References

  1. Minimum Capital Requirements for Market-Risk. International Monetary Fund, 2016
  2. Fundamental Review of the Trading Book (FRTB). risk.net
  3. "The Basel Committee - overview". The Basel Committee on Banking Supervision. 28 June 2011. Retrieved 5 April 2019.
  4. Explanatory note on the minimum capital requirements for market risk (PDF). Basel Committee on Banking Supervision. 2019. ISBN 978-92-9259-236-3.
  5. "Fundamental review of the trading book: A revised market risk framework - consultative document" (PDF). www.bis.org. BIS. Retrieved 17 April 2022.
  6. Minimum capital requirements for market risk (PDF). Basel Committee on Banking Supervision. 2016. ISBN 978-92-9197-416-0.
  7. Minimum capital requirements for market risk (PDF). Basel Committee on Banking Supervision. 2019. ISBN 978-92-9259-237-0.
  8. International Convergence of Capital Measurement and Capital Standards. Basel Committee on Banking Supervision, 2006
  9. An internal model-based approach to market risk capital requirements. Basel Committee on Banking Supervision, 1995
  10. Banking book, bankpedia.org
  11. "Explaining The Two Key FRTB Frameworks | Quantifi". 2017-06-28. Retrieved 2023-03-10.

Bibliography

  • Ioannis Akkizidis, Lampros Kalyvas (2018). Basel III Modelling: Implementation, Impact and Implications. Palgrave Macmillan. ISBN 978-3319704241
  • Sanjay Sharma, John Beckwith (2018). The FRTB: Concepts, Implications and Implementation. Risk Books. ISBN 9781782723240
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