August 20, 2015 – By Kassi Assamoi, Senior Manager, Regulatory Analysis, EMEA
The industry is waiting to hear the results of the third round of consultation on the Basel Committee on Banking Supervision’s (BCBS) Fundamental Review of the Trading Book (FRTB), which concluded in February. However, it is already clear that banks will face significant challenges due to the changes that will be made to the methods they use for calculating their market risk capital charges, and they need to start planning now.
Large, well-resourced banks have become accustomed to using internal models to calculate their market risk capital charges. These internal models are usually more risk-sensitive than the standardized approach defined by the BCBS, and therefore result in lower charges for the banks. However, as part of its efforts to ensure that banks are fully capitalized, the BCBS has made it clear that from 2018 all banks that use internal models will also need to adopt the standardized approach and will need to compare the results of the two sets of calculations in order to produce their final capital charge figures.
Implementing the standardized approach promises to be a huge undertaking for banks that have previously relied only on internal models. There are fundamental differences between the standardized approach and internal models. For example, value at risk (VAR) is computed at the portfolio level, whereas the standardized approach is calculated at the transaction level. This means banks will need to redefine their data to ensure it is sufficiently granular.
Banks can significantly reduce the impact of the FRTB by partnering with an appropriate vendor. Instead of employing a large team of regulatory experts to analyze the requirements in minute detail, banks should work with an experienced vendor that will build the standardized calculations (which will be the same for all banks) and provide a data dictionary that specifies which inputs are needed. This will leave the bank free to focus on sourcing the necessary data – a process that will be different at every institution.
Working with the right vendor will provide valuable opportunities for banks to compare their interpretations of the FRTB requirements with those of their peers during client working group meetings. By adopting a standardized solution that is being used by other market participants, a bank will also reduce the likelihood that it will be viewed as an outlier and will therefore become the focus of unwanted regulatory attention.
When preparing for the FRTB, a bank should ensure their chosen vendor will provide ongoing support for the calculations and report templates they supply. The FRTB calculations and reporting requirements will inevitably be tweaked and tinkered with by the regulators. Instead of tying up resources to monitor and add all of these changes within their compliance infrastructure, a bank should be able to outsource the work to their vendor.
Banks should also check that a vendor’s FRTB solution can be used to do their impact analysis work. This is important because it will enable the bank to save its preparatory work within its solution and then move quickly from the impact analysis to production of the final results, when the regulation comes into force.
The specific requirements of the FRTB are yet to be finalized. However, now is the time for banks to establish a relationship with a vendor that will help them overcome the hurdles that lie ahead.
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