Risk Management and Financial Institutions, 4th Edition

CHAPTER 17 Fundamental Review of the Trading Book

In May 2012, the Basel Committee on Banking Supervision issued a consultative document proposing major revisions to the way capital is calculated for the trading book. This is referred to as the Fundamental Review of the Trading Book (FRTB).¹ Once comments had been received from market participants, the Basel Committee followed up with a second consultative paper in October 2013.² Once further comments had been received and Quantitative Impact Studies had been carried out, the rules were refined in December 2014.³

The FRTB will lead to a totally new approach to determining capital for market risk. It is therefore something with which all risk managers and students of risk management need to familiarize themselves. This chapter summarizes some of the main changes that are expected.

17.1 NEW MARKET RISK MEASURES

The Basel I calculations of market risk capital were based on a value at risk (VaR) calculated for a 10-day horizon with a 99% confidence level. The VaR was current in the sense that calculations were based on the behavior of market variables during a recent period of time (typically one to four years). Basel II.5 required banks to calculate a stressed VaR measure in addition to the current measure. As explained in Sections 13.1 and 16.1, this is VaR where calculations are based on the behavior of market variables during a 250-day period of stressed market conditions. To determine the stressed period, banks were required ...