The Fundamental Review of the Trading Book, also known as the FRTB, is a set of guidelines from the international banking supervision authority, the Basel Committee. It was first published in 2016, and it underwent a revision in 2019.
The Basel Committee is set to oversee constituent banks’ compliance by January of 2023. This gives financial institutions about a year and a half to meet the FRTB guidelines for minimum capital requirements for market risk.
At this point in time, you might be wondering whether FRTB compliance is worth prioritizing and how much legwork you should get done. You may also be looking for justification to make large investments for FRTB compliance, such as the purchase of regulatory reporting software.
This article is a primer on becoming an early implementer of FRTB standards for your bank, as your compliance may serve as a competitive advantage in the future. Below is a recap of what FRTB entails and the context in which this set of standards operates.
In addition, you’ll find some valuable tips on kickstarting an early FRTB compliance journey for your bank.
A Briefer on FRTB: What Banks Need to Know
FRTB is among the “Basel IV” standards for global bank capital requirements that are to be implemented in 2023. In response to the financial crisis of 2007–2008, the Basel Committee sought to strengthen the banking system by standardizing banks’ capital and liquidity requirements. Four things that distinguish FRTB are its emphasis on the following:
- What separates the trading book (assets available for sale and ready for trading) and the banking book (assets that are held to maturity, like customer loans);
- Key revisions to both the internal models’ approach (IMA) and standardized approach (SA) for calculating market risk;
- The usage of expected shortfall as opposed to value-at-risk as the constituent bank’s measure of risk under stress, which puts tail risk events into perspective;and;
- The acknowledgment of market illiquidity risk and the introduction of liquidity horizons in the updated IMA and SA models.
The rationale behind complying with FRTB is that it will enjoin banks to be more deliberate in determining the relationships between their capital requirements and their imminent risks. Ultimately, the goal is for banks to adhere to these guidelines in order to use their capital more efficiently, especially in hard times.
An Action Plan for FRTB Compliance: Four Things Your Bank Can Do
It’s no secret that FRTB compliance at the granular level will pose a challenge for banks. But the earlier your financial institution aligns its capital requirements with FRTB, the smoother the road to 2023 will be. Here is a four-step plan for beginning your FRTB compliance journey.
Invest in New Regulatory Reporting Software
First, consider upgrading your tech stack to achieve up-to-the-minute, hiccup-free compliance to FRTB. For the next year and a half, you will depend on daily computations related to your expected shortfall, your sensitivities, and the like. It will be good to invest in high-performing software that can quickly dispatch these calculations under IMA or SA.
Develop a Computation Strategy That Gives You a Bird’s-Eye View of Risks and Sensitivities
Next, adopt a computation strategy for your risks and sensitivities and orient your FRTB compliance team about your expectations. Learn about the problems you may initially encounter when subscribing to this framework, like dealing with extreme values when calculating expected shortfall.
Use Your Mastery of IMA or SA To Make Better Decisions at Your Trading Desk
Under FRTB, your bank will have two choices of modeling approach: the directly implementable but capital-intensive SA or the complex but less capital-reliant IMA. Whichever it is you choose, find out how you can use this method to follow a more sustainable trading structure at your bank’s trading desk.
Prevent Costly Issues in Ongoing FRTB Compliance by Becoming an Early Adopter
Lastly, be conscientious about your compliance efforts for practical purposes. It’s true that becoming an early adopter of FRTB may seem cumbersome and expensive now. But the earlier you set the groundwork for full FRTB compliance, the less you spend on compliance-related errors or long and drawn-out issues with your regulators. This will result in valuable savings for your bank, and in turn, grant you more power over your capital.
Conclusion: Making the First Move in Your Industry’s Compliance to FRTB
Due to the economic fallout of the COVID-19 pandemic, tough times lie ahead for the banking industry. That gives financial institutions all the more reason to think out of the box when it comes to determining their competitive advantages.
One concrete initiative that your bank can take on is to speed up your compliance with FRTB. In doing so, you can do more than check off the task of compliance. You can bolster your decision-making capabilities with regard to your capital requirements, become wiser about your spending, and ensure longevity for your institution amidst challenging times for the global economy.
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