Revised framework for market risk capital requirements issued by the Basel Committee
14 January 2016
The Basel Committee on Banking Supervision has today issued the revised minimum capital requirements for market risk as agreed by its oversight body - the Group of Governors and Heads of Supervision (GHOS). The revised market risk framework is a key component of the Basel Committee's overall efforts to reform global regulatory standards in response to the global financial crisis.
The 2007-08 period of severe market stress exposed weaknesses in the framework for capitalising risks from trading activities. In 2009, the Committee introduced a set of revisions to the Basel II market risk framework to address the most pressing deficiencies. A fundamental review of the trading book was also initiated to tackle a number of structural flaws in the framework that were not addressed by those revisions.
The purpose of the revised market risk framework is to ensure that the standardised and internal model approaches to market risk deliver credible capital outcomes and promote consistent implementation of the standards across jurisdictions. The final standard incorporates changes that have been made following two consultative documents published in October 2013 and December 2014 and several quantitative impact studies.
The key features of the revised framework include:
A revised boundary between the trading book and banking book. A better defined boundary will serve to reduce incentives to arbitrage between the regulatory banking and trading books, while still respecting banks' risk management practices.
A revised internal models approach for market risk. The new approach introduces a more rigorous model approval process that lets supervisors remove internal modelling approval for individual trading desks. It also allows a more consistent identification and capitalisation of material risk factors across banks, and sets constraints on the capital-reducing effects of hedging and diversification.
A revised standardised approach for market risk. The standardised approach has been overhauled to make it sufficiently risk-sensitive to serve as a credible fallback as well as a floor to the internal models approach, while still providing an appropriate standard for banks that do not require a sophisticated treatment for market risk.
A shift from value-at-risk to an expected shortfall measure of risk under stress. Use of expected shortfall will help to ensure prudent capture of "tail risk" and so maintain capital adequacy during periods of significant market stress.
- Incorporation of the risk of market illiquidity. Varying liquidity horizons are incorporated into the revised standardised and internal model approaches to mitigate the risk of a sudden and severe impairment of market liquidity across asset markets. These replace the static 10-day horizon assumed under VaR for all traded instruments in the current framework.
The Committee has conducted impact analysis using data provided by banks and assuming the revised market risk framework was fully in force as of end-June 2015. The revised framework produces market risk risk-weighted assets (RWAs) that account for less than 10% of total RWAs, compared to approximately 6% under the current framework. Compared with the current market risk framework, the revised market risk standard would result in a median (weighted mean) increase of approximately 22% (40%) in total market risk capital requirements. These impact estimates take account of the calibration refinements endorsed by the Committee in December 2015.
The revised market risk framework comes into effect on 1 January 2019. Over the implementation period, the Committee will continue to monitor the capital impact of the revised standard in order to ensure consistency in the overall calibration of the Basel capital framework.