Tuesday, May 15, 2012

Basel Seeks Input on Trading Book Capital Requirements

The Basel Committee on Banking Supervision is seeking comment on initial policy proposals emerging from the Committee's fundamental review of trading book capital requirements The consultation paper contemplates a revised market risk framework and proposes specific measures intended to improve trading book capital requirements. These proposals also reflect the Committee’s increased focus on achieving a regulatory framework that can be implemented consistently by supervisors and which achieves comparable levels of capital across jurisdictions.

The Committee's review focuses on six major areas:

  1. A more objective boundary between the trading book and the banking book that materially reduces the scope for regulatory arbitrage - feedback is sought on two alternative approaches;

  2. Moving from value-at-risk to expected shortfall, a risk measure that better captures "tail risk";

  3. Calibrating the revised framework in both the standardized and internal models-based approaches to a period of significant financial stress, consistent with the stressed value-at-risk approach adopted in Basel 2.5;

  4. Comprehensively incorporating the risk of market illiquidity, again consistent with the direction taken in Basel 2.5;

  5. Measures to reduce model risk in the internal models-based approach, including a more granular models approval process and constraints on diversification; and

  6. A revised standardized approach that is intended to be more risk-sensitive and act as a credible fallback to internal models.
The Committee is also proposing to strengthen the relationship between the models-based and standardized approaches by establishing a closer link between the calibration of the two approaches, requiring mandatory calculation of the standardized approach by all banks, and considering the merits of introducing the standardized approach as a floor or surcharge to the models-based approach. Furthermore, the treatment of hedging and diversification will be more closely aligned between the two approaches.

Notably, the review does not cover interaction of market and counterparty risks or interest rates in the banking book.

Comments on this consultation paper are due by September 7, 2012.
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