In early October, figures from the Basel Committee on Banking Supervision confirmed what banks have known for some time: the Fundamental Review of the Trading Book (FRTB) will spark a vast increase in the cost of market-making to the point that, for some products, it will no longer make sense to continue doing so.
The Basel Committee’s survey of almost 100 banks must have gone down as smoothly as a pint of icy seawater for dealers still waiting anxiously for the rules to be finalised before year-end. The largest lenders – so-called global systemically important banks, or G-Sibs – can expect their market risk capital requirements to increase by more than half under the regime; one unlucky G-Sib faces an increase of 160.5%.
For smaller lenders – those currently holding Tier 1 capital of less than €3 billion – the numbers are even more eye-watering: the average increase for this cohort is 76.4%. Dealers will probably feel a mix of pity and schadenfreude for the bank facing a 469.5% increase in market risk capital.
Little wonder then that banks in many smaller regional markets – those obliged to implement Basel standards as Group of 20 signatories, but lacking the deep and mature capital markets of other jurisdictions – have called on global watchdogs to moderate the standardised approach that most will opt for, decrying the methodology as too complex.
Basel has given some ground here: in its consultation published earlier this year, which effectively reopened the regime for further amendments, the watchdog lowered the risk weights applied to certain asset classes under the standardised sensitivities-based approach, while also clarifying and simplifying the treatment of less liquid foreign exchange pairings – a bugbear for emerging market banks.
It remains to be seen whether the Basel Committee will make adopting its simplest iteration of the rules – the reduced sensitivities-based method – an option for all but the smallest banks, as is currently the case.
On one other critical aspect of the rules, however, Basel has so far remained unmoved: the treatment of non-modellable risk factors (NMRFs). Under the rules, NMRFs that lack enough data to be priced accurately under the internal models approach, and therefore face punitive capital add-ons on top of model-generated requirements.
The aggregate impact of these add-ons is driving a large part of the increase in the minimum capital banks expect to see under the regime – perhaps a much higher proportion than many dealers have cared to admit. Where banks had previously estimated up to one-third of the increase could be driven by NMRFs, some dealers now admit more than half the jump in minimum requirements could be driven by add-ons.
That makes minimising NMRFs the top priority for banks but, unfortunately, the scope for doing so within the regulation looks limited. To qualify as modellable, a risk factor must be supported by 24 price observations during the course of a year, which cannot be more than a month apart. Banks’ biggest gripe with this definition is its failure to take account of seasonality: trading in a given market being concentrated at a particular time of year, otherwise being punctuated by long lulls over the summer period.
However, in its consultation, the Basel Committee claimed it had seen no evidence of the “materiality” of the impact of seasonality, adding it was not minded to not make any changes to the framework unless it was presented with “compelling evidence” that any were needed.
As Anna Holten Møller, senior analyst for market risk at Denmark’s Nykredit, puts it, banks still have work to do on “convincing regulators that seasonality is real”.
- Asia moves: BlackRock picks new Asia head, Credit Suisse boosts regional solutions, and more
- We need a different approach to supervisory stress-testing
- Bank risk manager of the year: UBS
- People moves: Asia hires at Credit Suisse, new UBS data role, NatWest takes UBS's Duclos, and more
- Risk solutions house of the year: HSBC