Journal of Risk

The impact of the Fundamental Review of the Trading Book: evaluation on a stylized portfolio

Paulo Viegas de Carvalho, Carlos Manuel Pinheiro and Marta Sofia Rodrigues

  • For a representative trading portfolio the expected shortfall (ES) is higher than the sum of VaR and SVaR measures.
  • Portfolios more focused on bond positions could lead to a higher market risk capital requirement.
  • We assess the impact on banks’ capital requirements for market risk under the internal model approach (IMA) resulting from the FRTB
  • We compute the capital requirement for both the current and proposed frameworks, focusing on the market risk component.

We investigate the impact of the Basel Fundamental Review of the Trading Book (FRTB) on banks’ market risk capital requirements under the internal models approach. To do this, we take a stylized portfolio sensitive to the risk factors affected by the FRTB, representative of a typical trading book. Our assessment spans the period 2007–19. We find that the FRTB will entail sizable increases in the regulatory capital intended to absorb market shocks. These increases originate not only from the change in the risk measure and taking longer liquidity horizons (the latter having a greater impact on portfolios more focused on bonds) but also from the strict limitation of portfolio diversification benefits. Our study should be of interest to bank supervisors and regulators, risk managers and other decision makers within the banking industry.

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