The Fundamental Review of the Trading Book (FRTB) is a new Basel committee framework for the next generation market risk regulatory capital rules. It is inspired by the undercapitalisation of trading book exposures witnessed during the financial crisis. FRTB aims to address shortcoming of the current Basel 2.5 market risk capital framework

Tim Xiao

Humanities Commons

FRTB: Standardised ApproachFRTB SASummary◆ FRTB Definition◆ FRTB vs Basel 2.5◆ FRTB Main Features◆ FRTB Approaches◆ FRTB Standardised Approach (SA)◆ FRTB SA: Sensitivity Based Risk Charge◆ FRTB SA: Default Risk Charge◆ FRTB SA: Residual Risk Add-onFRTB SAFRTB definition◆ The Fundamental Review of the Trading Book (FRTB) is a new Basel committee framework for the next generation market risk.◆ FRTB is inspired by the undercapitalisation of trading book exposures witnessed during the financial crisis.◆ It aims to address shortcoming of the current Basel 2.5 market risk capital framework.FRTB SAFRTB vs Basel 2.5◆ Standardised Approach◆ FRTB➢ Sensitivity based risk charge + Default risk charge + Residual risk add-on◆ Basel 2.5➢ Standardised capital charge◆ Internal Model Approach◆ FRTB➢ Expected shortfall + Default risk charge + Non-modellable risk factors◆ Basel 2.5➢ VaR + Stress VaR + Incremental Risk Charge (IRC)FRTB SAFRTB Main Features◆ Clear definition of the boundary between the trading book and the banking book◆ An overhaul of the internal model approach (IMA) to focus on tail risk◆ An overhaul of the standardized approach (sa) to make it more risk sensitive and explicitly capture default risk and other residual risks◆ Inclusion of liquidity horizons explicitly for different asset classes.FRTB SAFRTB approaches◆ Standardized approach (SA): a regulator-set approach◆ Sensitivity-based risk charge (SBRC)◆ Default risk charge (DRC-SA)◆ Residual add-on (RAD)◆ Internal model approach (IMA): a bank’s own approach◆ Expected shortfall (ES)◆ Default risk charge (DRC-IMA)◆ Non-modellable risk factors (NMRF)This presentation focuses on standardized approachFRTB SAFRTB Standardized Approach◆ 3 risk measures: Delta, Vega and Curvature◆ 7 risk classes◆ General interest rate risk (GII)◆ Credit spread risk◆ Credit spread risk: non-correlated securitisation◆ Credit spread risk: correlated securitisation◆ Equity risk◆ Commodity risk ◆ Foreign exchange risk◆ Sensitivity based risk charge should be calculated separately for each risk class and each risk measure.FRTB SAFRTB Standardized Approach (cont’d)◆ Reporting hierarchy: portfolio, desk, bank◆ Total risk chargeTotal = sensitivity-based risk charge + default risk charge + residual add-on◆ For exampleAn equity desk has equity risk and interest rate risk only, the total risk charge is given byTotal = equity Delta risk charge + equity Vega risk charge+ equity Curvature risk charge + general interest rate Delta risk charge+ default risk charge + residual add-onFRTB SAFRTB SA: Sensitivity Based Risk Charge◆ Required sensitivities◆ Delta: the first order derivative with respect to underlying price◆ Vega: the first order derivative with respect to implied volatility◆ Curvature: equivalent to the sum of all high-order derivatives with respect to underlying price◆ Sensitivity notes◆ Delta: all trading products have Deltas.◆ Vega and Curvature: only non-linear products (e.g., options) have Vega and Curvature.FRTB SAFRTB SA: Sensitivity Based Risk Charge (cont’d)◆ Sensitivity calculation◆ Clearly define all Delta and Curvature calculation but not Vega. ◆ Interest rate deltas are computed based on yield rates (or zero coupon rates) rather than liquid instrument quotes (e.g., swap rates, futures).◆ Curvature is a new measurement that is equal to shocked value change minus Delta. ◆ Bucket and risk factor◆ Sensitivities should be divided into buckets and risk factors within each risk measure and each risk class.◆ Risk weight: a risk weight is defined for each risk factor.◆ Risk correlation: correlations are specified between risk factors and between buckets.FRTB SAFRTB SA: Sensitivity Based Risk Charge (cont’d)◆ Calculation◆ Sum all sensitivities belonging to the same risk factor and then multiply by the risk weight ➔ risk charge 𝑊𝑖𝑆𝑖 per risk factor◆ Within one bucket, two risk factor charges can be added as𝐾𝑏 = (𝑊𝑖𝑆𝑖)2+(𝑊𝑗𝑆𝑗)2+𝜌𝑖𝑗𝑊𝑖𝑆𝑖)(𝑊𝑖𝑆𝑖)◆ Within each class and each measure, two bucket charges can be added as a correlated sum➢ For example, an equity Delta risk charge has two buckets only, the Delta risk charge is given by𝐷𝑒𝑙𝑡𝑎𝑅𝑖𝑠𝑘𝐶ℎ𝑎𝑟𝑔𝑒 = 𝐾𝑏2 + 𝐾𝑐2 + 𝛾𝑏𝑐𝐾𝑏2𝐾𝑐2FRTB SAFRTB SA: Default Risk Charge◆ Scope◆ Debt instruments◆ Equity products◆ Securitisation products◆ Calculation procedure◆ Determine jump-to-default (JTD) loss amount◆ Offset the JTD amounts of long and short exposures with respect to the same obligor◆ Discount the net short exposures by a hedge benefit ratio◆ Apply default risk weights to exposures to arrive at the DRCFRTB SAFRTB SA: Residual Add-on◆ The following trade types bearing residual risk◆ Traded in incomplete markets◆ Gap risk: such as path dependent options (barrier, Asian, digital, Bermudan, etc.)◆ Correlation risk: such as multiple underlying options (basket, best, spread, basis, quote, etc.)◆ Behavioural risk: such as mortgage◆ Calculation◆ RAD = notional * factor (1% or 0.1%) Thanks!You can find more online presentations athttps://finpricing.com/lib/EqSwap.html

FRTB Standardized Approach

https://hcommons.org/deposits/download/hc:33098/CONTENT/frtbsa-6.pdf/

FRTB Standardized Approach

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