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January 31, 2019

Parsing the final FRTB rules

Creating next-generation risk models for banks

On January 14, 2019, the Basel Committee on Banking Supervision (BCBS)published1 the final standards, or the revised market risk framework, which setsthe final rules for establishing the market risk capital requirement.


In response to the standards published in January 20162, the investment bankingindustry raised many concerns and sought clarifications on various clauses. TheBCBS acknowledged these, and published a consultative document in March20183 with clarifications and revisions to address the issues, while simultaneouslyinviting industry feedback. After these consultations and based on the results ofQuantitative Impact Study (QIS) submitted by banks, the BCBS released the finalstandards on January 14, 2019.


The key changes focus on the Standardised Approach (SA), trading and bankingbook boundary, non-modellable risk factors (NMRF) and Profit & Loss Attribution(PLA) test. However, the revised market risk rules might be subject to subsequentminor tweaks and clarifications before it comes into effect in 2022.


The BCBS has recognised that risk weights used in the sensitivity-based SA needto be recalibrated for certain risk classes, and has reduced them for generalinterest rate risk (GIRR) and foreign exchange (FX) risk significantly. The creditspread (CS) risk weights for high-yield sovereign and covered bonds have alsobeen revised. The cliff effect of curvature risk has also been addressed, along withremediating the double counting of FX curvature risk.


The NMRF framework was penalising in the previous standard, which could havesignificantly discouraged banks from building internal models and providingliquidity in products that would be most impacted by it. Recognising this, the BCBShas relaxed the modellability criteria for risk factors. The PLA test metrics havebeen finalised with revised thresholds from those introduced in March 2018 toreduce the chances of portfolios with highly correlated Hypothetical P&L (HPL) andRisk Theoretical P&L (RTPL) falling into the red zone. This will potentially enablebanks to clear more desks for the Internal Model Approach (IMA).


Banks which haven’t started implementation of Fundamental Review of TradingBook (FRTB) in a big way may have to speed up as earlier timelines have beenretained for Pillar 1, starting with an overall assessment of their firm-wide riskcapital model. January 1, 2022, has been set as the deadline to comply with thenew standards and start Pillar II supervisory process and reporting.


This document highlights the major changes compared with the previous standardand clarifications made in the latest publication, and what banks should do tocomply with the revised standard.


1Minimum capital requirements for market risk, published in January 2019 https://www.bis.org/bcbs/publ/d457.pdf
2Minimum capital requirements for market risk, published in January 2016 https://www.bis.org/bcbs/publ/d352.pdf
3Revisions to the minimum capital requirements for market risk https://www.bis.org/bcbs/publ/d436.pdf