In our previous blog, we described the three major data issues facing banks as they plan the implementation of the Fundamental Review of Trading Book (FRTB), the Basel Committee on Banking Supervision (BCBS) rules aimed at strengthening banks’ capital positions and reducing their exposure to trading risk.

We shall discuss the first issue “Risk Sensitivities Sourcing” in this blog.

Capital requirements using a revised standardized approach (SA) are now mandatory for all banks and have to be reported for all trading desks and at a firm-wide, consolidated level to enable a like-for-like comparison.  Compared to previous standardized models, the SA under FRTB rules makes use of risk sensitivities to capture both linear and non-linear risk in the trading desk.1  

Added complexity comes along with the mandatory requirements for calculating risk charge using SA, as banks to calculate Delta, Vega and Curvature sensitivities across all risk classes.  The rules specify the maturity buckets for each risk class and sensitivity combination in order to arrive at a final sensitivity value per bucket using netting rules. This should lead to a comprehensive calculation of risk using SA, adding to the computation complexity not required under earlier rules.2  

To highlight this complexity, the number of buckets for each sensitivity and risk class combination under a sensitivities-based method for SA appears in Table 1.

Table 1. Number of buckets for sensitivities calculation

Source: “Minimum capital requirements for market risk.” Basel Committee on Banking Supervision, January 2016.

A bank now has to compute at least 79 different calculation inputs (excluding GIRR and Foreign Exchange (FX) risk, also assuming that the market portfolio has assets across the buckets) for each sensitivity class for risk computation under SA.  For example, the new prescribed risk factors and liquidity computation complexity may lead to as many as 12,000 calculations per trade compared to the current 250 – 500 calculations per trade.3

The SA has introduced the concept of curvature risk to capture nonlinear risk, which is not captured by delta of the instruments with optionality. Curvature risk is not a second order approximation, but rather a full revaluation which is needed for every instrument affected.4 We believe this means that banks should change infrastructure, data availability and (IT) capacity to run the revaluation for all products with optionality.

The new rules specify that the sensitivities should be calculated on the prices of instruments or on pricing models which are used for P&L reporting or market risk management within the bank. This calls for consistency between the calculations used for computing sensitivities and the valuation models being used by the front office for trading purposes.5

In our next blog, we will look at challenges posed by the second of three FRTB-related issues, market data sourcing. 

For more information see SlideShare deck: “Fundamental Review of the Trading Book (FRTB) – Data Challenges

References

  1. “Minimum capital requirements for market risk.” Basel Committee on Banking Supervision, January 2016. Access at: http://www.bis.org/bcbs/publ/d352.htm
  2. Ibid
  3. Accenture estimate based upon discussions with clients, May 2016
  4. “Minimum capital requirements for market risk.” Basel Committee on Banking Supervision, January 2016. Access at: http://www.bis.org/bcbs/publ/d352.htm
  5. Ibid

 

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