New standards for market risk capital requirements released alongside Fundamental Review of the Trading Book.
After much iteration since the first consultation back in 2012, the Basel Committee has finally concluded its work on the Fundamental Review of the Trading Book and has issued its new standards for market risk capital requirements.
The framework – which is due to come into effect in 2019 – is broadly similar to the July 2015 proposals, but reflects material downward adjustments to certain risk weights.
These adjustments have lowered the expected increase in capital requirements compared with the previous proposals, with total market risk capital requirements estimated to increase by 22 percent on a median basis or 40 percent, on a weighted average basis. In particular, securitised assets and credit exposures have benefitted most from the changes in parameterisation in the final standards.
In making these changes, the Basel Committee have clearly recognised the concerns flagged by the banking industry. However, the impact on capital is still significant and in a world with low returns on equity the inevitable question of the viability of certain trading businesses will be posed.
It remains to be seen how the revised Basel Committee standards will be translated into EU and other national requirements, but in the EU this could require amendments to the legislation.
Summary of the new market risk standards
The revisions focus on three main areas:
The revisions to the internal models approach aim to:
The revised standardized approach continues the Committee's focus on enhancing the risk sensitivity of standardized calculations. The approach is intended to remain suitable for banks with limited trading activity, while also serving as a credible fallback for, as well as a floor to, the internal models approach.
Key revisions include:
While the final standards provide some relief for banks, there are still many challenges ahead:
Higher capital requirements: The Basel Committee estimates that, using data at end-June 2015, the revised framework would increase total market risk capital requirements by 40 percent (on a weighted average basis). For most banks this would have only a limited impact on total capital requirements, since even on this revised basis market risk risk-weighted assets would account for less than 10 percent of total risk-weighted assets (up from 6 percent under the current framework). However, banks with large trading books would face much larger increases in capital requirements.
Higher costs: The Basel Committee has changed the basis of the internal models approach and has added to the complexity of the standardised approach, which will impose significant implementation costs. KPMG estimates these implementation costs to be in excess of £100 million for G-SIFIs.
Reduced incentives to develop internal models: Banks will have less incentive to develop internal models, which may in turn lead to them not taking opportunities to improve their risk management.
Reduction in market liquidity: Some banks may run smaller trading books, with an adverse impact on market liquidity and more heavily concentrated markets dominated by the major investment banks. This would in turn have an adverse impact on the wider economy if markets became less liquid (as has already occurred in the corporate bond market).
Wider context: Banks also face restrictions on their use of internal models for other risks. The Basel Committee has announced that it will consult on removing the use of internal models for calculating regulatory capital requirements for operational risk and on limiting the extent to which the use of internal models for credit and market risk can reduce capital requirements below the capital required under the standardised approaches.