This document outlines the minimum capital requirements for market risk, effective January 1, 2022, replacing those set by Basel II. It describes the changes made compared to the January 2016 publication and organizes the chapters in a new modular format to enhance the accessibility of Basel standards. The sections cover standardized approaches and internal models for calculating capital requirements.
This document, published by the Basel Committee on Banking Supervision in January 2019 (revised February 2019), presents the minimum capital requirements for market risk, applicable from January 1, 2022. It replaces previous requirements defined in Basel II and the January 2016 publication. The scope covers capital requirement calculation methods for market risk, including the definition of trading books, standardized and internal model approaches, as well as rules for managing financial instruments, credit risk, interest rate risk, foreign exchange, equity, commodities, and option-related risks. The document is 136 pages long, but only the first 43 pages are provided for this synthesis (p. 1-43).
The document details the new international standard for minimum regulatory capital requirements related to market risk, effective January 1, 2022. This standard aims to strengthen banks' resilience against potential losses due to market price fluctuations, replacing previous rules deemed insufficient after the 2008 financial crisis. The framework introduces a clear distinction between the trading book, subject to market risk, and the banking book, subject to credit risk, with strict criteria for instrument allocation (p. 3-6). Two main capital calculation methods are proposed: the standardized approach, based on a sensitivity method (delta, vega, curvature) with risk aggregation according to defined correlations, and the internal model approach, subject to validation and rigorous testing (p. 19-24). The standardized approach also includes capital for default risk (DRC) and a residual risk add-on (RRAO) not captured by the main method (p. 25-26). The precise definition of trading desks, the risk measurement unit, is framed to ensure consistency and supervision (p. 22-24). The document emphasizes the need for continuous and rigorous risk management, with internal controls and close supervision, notably for internal risk transfers between books (p. 6-15). Banks must calculate capital requirements under the standardized approach at minimum, even if they use internal models, to ensure a comparison base and prudential floor (p. 21). Finally, the framework provides variable correlation scenarios to account for financial stress conditions (p. 31). These rules aim to better align capital requirements with actual risks, improve comparability between banks, and strengthen global financial system stability.
This document was developed to update and strengthen minimum capital requirements related to market risk, in response to shortcomings revealed by the 2007-2008 global financial crisis. The previous framework, stemming from Basel II and amended in 2016, did not sufficiently capture certain risks, notably those related to trading books and internal models. The objective is to improve banks' robustness against financial market fluctuations, ensure better transparency and comparability of capital requirements, and limit regulatory arbitrage opportunities. The scope covers financial instruments, market risks (interest rate, credit, equity, foreign exchange, commodities), calculation methods (standardized and internal models), as well as associated governance and supervisory rules. The document's limitations notably concern the lack of coverage beyond page 43, excluding details on some advanced methods and transitional provisions (p. 1-2, 7-8).
Definition of banking and trading books:
- The trading book includes instruments held for short-term resale, arbitrage, profit from price movements, or hedging these risks. Instruments not allocated for these purposes belong to the banking book (p. 3-6).
- Trading book instruments must be measured at fair value daily with impact on profit and loss (P&L) (p. 4).
- Strict rules govern transfers of instruments between books, limiting arbitrary movements and requiring senior and regulatory approval, as well as a capital surcharge if capital needs are reduced by transfer (p. 11-13).
- Internal risk transfers between books are subject to precise conditions to be recognized in capital, notably the need for exact external hedging (p. 13-15).
Key terminology and definitions:
- Market risk encompasses losses related to price variations on financial instruments, currencies, and commodities (p. 16-18).
- Concepts of sensitivity (delta, vega, curvature), risk factors, buckets, risk classes are defined to structure capital calculation (p. 16-18).
- CVA (Credit Valuation Adjustment) and its associated risk are integrated into the framework (p. 18).
Market risk measurement methods:
- Two approaches are possible: standardized (mandatory at minimum) and internal models (subject to approval) (p. 20-21).
- The standardized approach consists of three elements: sensitivity method (delta, vega, curvature), default risk capital (DRC), and residual risk add-on (RRAO) (p. 25).
- The sensitivity method calculates exposures to risk factors, applies risk weights, and aggregates results considering correlations, with three correlation scenarios (average, high, low) to reflect variability under stress (p. 27-32).
- Risk factors are detailed by class (interest rate, credit, equity, commodities, foreign exchange) with precise rules for curve construction and tenor definition (p. 32-33).
Definition and governance of trading desks:
- A trading desk is a group of traders or accounts with a clear strategy, defined reporting, risk limits, and a risk management structure approved by the supervisor (p. 22-24).
- FX and commodity positions in the banking book are treated as if held in fictitious desks for capital calculation (p. 24).
Findings:
- The standard enforces a strict separation between banking and trading books, with precise criteria for instrument allocation (p. 3-6).
- The standardized approach relies on a sensitivity method to risk factors, with detailed rules for calculating delta, vega, and curvature, and aggregation considering correlations (p. 27-32).
- Default risk capital (DRC) and residual risk add-on (RRAO) complement the standardized method (p. 25-26).
- Banks must calculate capital requirements under the standardized approach even if they use internal models, to ensure a floor and comparability (p. 21).
Assumptions:
- Correlations between risk factors may vary under stress, justifying calculation under three scenarios (p. 31).
- Instruments with optionality require specific consideration of curvature and volatility risk (vega) (p. 27-28).
Interpretations:
- The modularity of the framework facilitates integration into the consolidated Basel framework and improves readability and implementation (p. 1-2).
- Rigor in defining desks and documenting policies aims to limit regulatory arbitrage and strengthen supervision (p. 22-24).
Uncertainties:
- Precise implementation modalities of internal models and their validation are detailed in pages not provided, limiting full understanding of the framework (p. 1).
- The practical impact of requirements on banks, notably in terms of capital cost and system adaptation, will depend on national interpretations and supervisory practices.
The Basel Committee concludes that implementing this enhanced minimum capital framework for market risk is essential to improve overall financial stability. It recommends banks comply with strict rules for instrument classification between banking and trading books, implement documented and controlled policies for managing internal risk transfers, and calculate capital requirements under the standardized approach at minimum, even if they have an approved internal model. Supervisors must exercise increased vigilance over desk definitions, transfers between books, and model validation. The framework provides mechanisms to limit regulatory arbitrage and ensure comprehensive risk coverage, notably via the residual risk add-on. The modular publication facilitates access and standards updates. The Committee foresees a forthcoming publication of the consolidated framework integrating these standards. No detailed action plan is given in the provided pages, but key deadlines include the effective date of January 1, 2022, and the need for annual updates of internal policies (p. 1-2, 7, 11-13, 21).
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