FRTB under Basel IV - New required Market Risk capital calculation methodology – Regulatory Backdrop - How did we get here?

This series of posts from Risks Explained Limited will cover all key issues on Basel IV and FRTB. Subsequent to Basel I’s issuance in 1988, there was a 1996 Amendment to Basel I in order to incorporate market risks. After the 2008-2009 financial crisis, many banking supervisors were of the view that that the regulatory capital for market risk was not adequate to fully cover market risks. As a result, in July 2009 Basel 2.5 was issued as a revision to the market risk framework. Since then, many have thought that Basel 2.5 was deficient.

The result is Basel IV for Market Risk, which is also known as the Fundamental Review of the Trading Book (FRTB). It is intended to harmonize the treatment of market risk across national jurisdictions and is anticipated to generally result in higher global capital requirements. Given its size, the focus was firstly (and rightly) on Credit Risk and then the next piece in the Basel IV jigsaw was to address the myriad of changes in market risk. This is why it is called the “Fundamental Review”. There were many challenges in drafting FRTB. For example, there was unprecedented push back due to Non-Modellable Risk Factors (NMRF) as well as for P&L attribution as these tests were seen as unworkable and impossible for many desks to pass.

While some believe that the FRTB revisions did not go far enough in some areas they are still viewed as much improved over Basel 2.5.

Basel IV Market Risk/FRTB’s implementation date varies based on the jurisdiction. For details, see posting # 1 entitled “FRTB under Basel IV - New required Market Risk capital calculation methodology - A confused and staggered Global Timeline”          

Conclusion

Basel IV and FRTB is the most wide-raging comprehensive reformation package especially in the context of data management challenges in the history of the Basel regulations and all-encompassing preparatory work will be required for all areas of the financial institution.

By: Mark Dougherty, CPA/CMA