The Fundamental Review of Trading Book: New standard approach and risk management impacts

Abstract

With the aim of reducing the excessive variability of risk-weighted assets (RWA) and improving the comparability and transparency of banks’ risk-based capital ratios, the European Banking Authority restructured the regulatory market risk framework. The long-awaited final version of the FRTB Market Risk Framework was published by the Basel Committee on Banking Supervision (BCBS) in January 2019. This paper aims to analyse the main reasons that led the regulators to formulate the new Market Risk Framework named Fundamental Review of Trading Book (FRTB) and the consequent risk management impacts. The first FRTB impact assessments conducted by the same European authorities suggest important increases in capital charges for banks that use either the standardised or internal models approach. Beyond the impact on capital charges, the FRTB framework will have a deep impact on market risk management activity, analytics, data collection, market risk limits, control systems, market risk procedures and policies. From this perspective, the FRTB represents a great change in the market risk management paradigms. It requires not only new measurement, management and control tools but also new financial skills and knowledge for the European banking sector. This is for all banks and those that, in the current regulatory context, use the standardised approach for the calculation of the capital requirement.