FRTB survey: banks fear high bar for P&L test

One bank expects all of its desks to fail the P&L attribution test

High bar
Tall order: passing the P&L attribution test will be a challenge for banks

This is the second companion piece to's forthcoming 2016 FRTB implementation survey. The full results will be published shortly.

More than half the banks in's inaugural Fundamental review of the trading book (FRTB) implementation survey fear a significant number of their desks will lose approval to use the internal model approach (IMA) under the new regime. Six banks fear at least 20% of their trading desks will fail to gain IMA approval; two of them said a fail rate of 80% or more was likely.

The FRTB was finalised by the Basel Committee on Banking Supervision on January 14. The rules allow banks to calculate their capital requirement using either IMA or a more punitive standardised approach. In order to be able to use the IMA, each desk that matches the FRTB's definition of a trading desk must pass two tests: a P&L attribution test and a backtest. Many banks consider the former to be extremely difficult to pass.

This was evident in the survey responses. Of the 11 banks that participated, six said that 20% or more of their desks would likely fail the P&L attribution test. Only two banks believed that less than 20% of their desks would lose model approval.

"I think there is always an aspiration from our point of view [to seek internal model approval], so we will not preclude any possibility of getting on the IMA for at least some desks. But if you put in the money, the people and the work, it looks like we will still fail – so what's the point of doing it?" says one risk manager at an Asian bank that responded to the survey.

On a given desk you may trade a mix of products – and one product can make the whole desk fail
Risk manager at a European bank

Banks are eager to get on to the IMA because of the punitive nature of the standardised approach. Industry studies suggest using the latter could result in a capital hit of between two to 6.2 times that of current levels. The IMA, on the other hand, would apply a smaller 1.5 times jump.

The P&L attribution test requires two different measures to be compared: a hypothetical P&L and a risk-theoretical P&L. One is based on front-office pricing systems and the other on internal model-generated risk measures. To pass the test, banks must compare the measures in two different ways without finding significant differences. Some say the test has significant design flaws, which makes it extremely difficult to pass in most cases.

"It's an interactive work. The first time you try [passing the P&L test], three desks out of four may fail. Then you try to rationalise: on a given desk you may trade a mix of products – and one product can make the whole desk fail. Then you think 'I'm going to move that product to another desk,' and suddenly [that will let] you pass," says one market risk manager at a European bank.

The likelihood of failure also depends on where the Basel Committee sets the threshold for passing the test. Regulators will need data from dealers in order to calibrate the threshold – but many claim a lot of their desks currently lack sufficient data since they are still in the middle of implementing the rules.

None of the surveyed banks said they were happy with the regulator calibrating the thresholds based on data submitted this year. Four dealers said they needed at least a year to develop and test their internal models, whereas three others felt they would need at least two years to do the same – which would mean cutting it too close to the implementation date of January 1, 2019.

Further clouding preparations, regulators have given mixed signals over whether a stricter version of the P&L attribution test, proposed in the glossary of the final rules, will prevail over an easier-to-pass version in the main text. As a result, some banks have chosen to wait for a final decision on the matter before moving ahead with implementation.

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