Basel propose tougher boundary between trading and banking books. What is the difference between the trading book and the banking book of a bank. Arpit is the global head of financial solutions at mathworks. Strict limits on the movement of instruments between the. For example, banks could move assets between the banking book and the trading book to minimise the capital charge. The eu published a proposal to amend the existing crr rules to meet the new bcbs standard in november 2016. How assets in the trading book and banking book are. Reassignments are more difficult, so it is critical that banks get it right the first time. The trading book is required under basel ii and iii to be marked to market daily. May 03, 2012 measures designed to improve trading book capital requirements basel propose tougher boundary between trading and banking books investment executive ce corner. Measures designed to improve trading book capital requirements.
Banks have to prove, that fair valued positions are not held with trading intent or do not hedge positions held with trading intent. A financial instrument is any contract that gives rise to both a. Basel capital rules for banks trading books will shift. The basel committee on banking supervision bcbs wants to make banks treat the assets in their trading books more like those in their banking books by forcing them to hold increased capital against assets designated for trading historically, lower capital requirements for trading book assets had encouraged banks to shift assets from the more expensive. Regardless of where they are booked, all repostyle transactions are subject to a banking book counterparty credit risk. Basel iv revised trading and banking book boundary for. Any deviation will be subject to supervisor approval and. Here is an analysis of the governance, position transfer and risk transfer provisions, comparing the existing eu rules with the bcbs standard and eu.
The difference between the trading and banking book blogger. Market risk is defined as the risk of losses arising from movements in market prices. Through the frtb rules, bcbs is seeking, for example, to establish a more objective boundary between the trading book and the banking book, and to eliminate capital arbitrage between the regulatory banking and trading books. Basel propose tougher boundary between trading and banking. A key new concept is the regulatory trading desk, a standalone unit which will be run by a head trader with its own strategy and risk management. The boundary between the banking book and trading book has been revised to reduce incentives for a bank to arbitrage its regulatory capital requirements between the two regulatory books, with the boundary based on the banks intent to trade or hold a position to maturity. The primary issue with the above framework has been a lack of clear demarcation of boundary between the two books, which in the past enabled banks to shift assets to the trading book from the banking book prior to the financial crisis due to lower capital requirements and then do the reverse post financial crisis due to massive loss in. The valueatrisk var for assets in the trading book is measured on a 10day time horizon under basel ii. The boundary between the trading book and banking book. Arpit narain global head of financial solutions mathworks linkedin. Jan 14, 2016 standards minimum capital requirements for market risk effective from 1 january 2019 a. Internal asset transfers between books need to meet stringent rules in order to limit the ability of banks to move assets from the trading book to the banking book, and vice versa.
The boundary between the trading book and banking book needs to be tightly defined. For this purpose, tradingrelated repostyle transactions are defined as only those that meet the requirements of rbc25. In summary, the frtb involves a meaningful reorganization of the trading bookbanking book boundary, with a redefinition of some existing concepts and the creation of several new ones. What is the difference between a banking book and a. The revised boundary between the banking book and the trading book. While the frtb has been finalized, it is important that the revised framework is fully tested and continuously monitored to ensure the calibrations are appropriate and risk sensitive. Managing capital and stress testing for traded book assets. Frtb requires that business be allocated to either the trading or banking book, and not jump the boundary in an arbitrary way. Revised trading and banking book boundary for market risk. This ability to arbitrage the boundary between the banking. Trading book risks cannot be moved to the banking book for regulatory capital purposes. The frtb will tighten desk management standards, trading. Banks face tougher rules on how they differentiate between assets they keep in their banking and trading books, making it harder to dodge capital rules, under proposals published by the basel. Consistency and crossover with other regulations mifid, bcbs 239, ifrs 9.
Capital requirements for market risk protiviti united states. The change strongly restricts the current discretionary approach in the assignment and future reallocation of an instrument between the banking book and the trading book. In general, trading book boundary rules restrict banks to transfer instruments between trading and banking book, specially for the regulatory arbitrage purposes. Bcbs is seeking, for example, to establish a more objective boundary between. A more sophisticated standardized approach sa based on risk factor sensitivities to adequately capture. Basel seeks tougher boundary between banking, trading. The revised requirements will lead to increased demands on the availability of. Basel seeks tougher boundary between banking, trading books. All other instruments must be included in the banking book. Implementing the frtb in the european union financial. This chapter sets out the instruments to be included in the trading book which are subject to market risk capital requirements and those to be.
For this purpose, trading related repostyle transactions are defined as only those that meet the requirements of rbc25. The basel committee published in may 2012 a consultation paper proposing a more robust boundary between trading and banking books to avoid regulatory arbitrage, capture market illiquidity more effectively, strengthen the risk measurement and valuation requirements under both standardised and internal model based approaches along with. There has been a lot of discussion on how frtb will define whether a book is a banking book or a trading book. Basel iv revised trading and banking book boundary for market. A trading book consists of positions in financial instruments and commodities held either with trading intent or in order to hedge other elements.
Following the 200708 global financial crisis gfc, bcbs and other regulatory bodies studied the global regulatory framework in an effort to understand what caused or contributed to systemic breakdowns in markets during that period. A new definition of the regulatory boundary between the banking book and trading book. Frtb new market risk framework polarizes regulators and. Under volcker, therefore, trading accounts are not identified as such if the account aligns with the trading book or banking book within the bank. The boundary between the trading book and banking book and the scope of application of the minimum capital requirements for market risk. Therefore, in addition to transparency requirements and reclassification burdens, a presumptive list for each book was published. Rbc25 boundary between the banking book and the trading. A trading book is the portfolio of financial instruments held by a brokerage or bank. Position paper crd vcrr ii international swaps and.
The precise answer is both complex and involves considerable latitude for opinion. May 03, 2012 banks face tougher rules on how they differentiate between assets they keep in their banking and trading books, making it harder to dodge capital rules, under proposals published by the basel. What are the issues with the classification of the trading book and banking book boundary. The boundary between trading and banking books under frtb. So far, the banks have been deciding if a book was a trading book or a banking book, and there was an. A revised boundary between the trading book and banking book. A revised boundary between the trading book and banking book the final rules establish a more objective boundary that serves to reduce incentives to arbitrage between the banking book and trading book, especially arbitrage in regulatory capital requirements between the two books. Positions arising from internal hedges are eligible for trading book capital treatment, provided that they are held with trading intent and that the general criteria on trading intent and prudent valuation specified in bipru 1. If a bank does an interest rate swap with a customer, thats trading book. Operating model, data management and system challenges. A fundamental objective of frtb is creating a high, impermeable wall that separates the trading and banking books. Rbc25 boundary between the banking book and the trading book. The boundary between the trading book and the banking book.
Capital requirements for market risk protiviti united. Definitions have been tightened and new restrictions introduced on transfers and hedges between the trading book and the banking book a key new concept is the regulatory trading desk, a standalone unit which will be run by a head trader with its own strategy and risk management structure. Criteria for trading banking book boundary include instrument structure, accounting treatment, availability of prices, portfolio, desk, hedge. Deviation requires explicit approval from supervisor. One of the most immediate issues, from the eus perspective, is addressing capital requirements for market. Traditionally, analysis of trading book and banking book is viewed as distinct from the analysis of the different nature and dynamics of risks. Differences between interest rate risk irr in the banking and. What you need to know about the new trading boundary. A trading book consists of all instruments that meet the specifications for trading book instruments set out in rbc25. Implications and actions for banks nevertheless, a number of banks have expressed the concern that frtb will lead to a significant increase in capital requirements which, combined with higher. Boundary trading book banking book definition of the boundary on an instrument basis tradingintent presumptive lists accounting trading asset or liability trading book marketmaking trading book real estate holdings banking book eg switching limits capital arbitrage mitigation supervisory redesignation.
The trading book of the banks refers to assets held by a bank that are regularly traded by the bank. Revised trading and banking book boundary for market risk 7 frtb still builds on the intent based criteria for tradingbanking book assignment but supplements it with essential prescriptive rules in order to provide more objectiveness. What you need to know about the new trading boundary frtb. One of the most visible updates to the trading book regime is the revised trading banking book boundary.
Scope of application and methods of measuring market risk. It seeks to bettercapture tail risk, to redraw the boundary between banking and trading books, and to raise the bar for internal models. Home news from the regulators basel propose tougher boundary between trading and banking books. The final rules establish a more objective boundary that serves to reduce incentives to. On larger view below methodology gets followed to classify the book as banking and trading. Financial instruments in a trading book are purchased or sold for reasons including to. Aug 31, 2015 revised boundary definition and internal risk transfers. As per the bcbs rules, the revised boundary has been strengthened to discourage regulatory arbitrage.
Before bcbs come with defined rules for banking book and trading book boundary, currently different banks have setup their on policy to do the same. However, some joint dynamics are required to capture the emergence of collateral risk exploring both regulatory and internal risk capital concentration and correlation affects for concentration risk. In its previous form, the boundary between the trading book and the banking book was unclear. The boundary between banking and trading book should be adapted in a way that should lead to a more objective allocation of positions. The boundary between the trading book and banking book and. Aug 07, 2016 in general, trading book boundary rules restrict banks to transfer instruments between trading and banking book, specially for the regulatory arbitrage purposes. So far, the banks have been deciding if a book was a trading book or a banking book, and there was an incentive to arbitrage from this determination, as there was a difference in the capital requirements for these books. What the basel proposals on bank tradingbook rules mean. Regulatory boundary between trading and banking book new defined list of instruments presumed to be included in the trading book or banking book. This would prevent lenders from shifting assets between books to try to lower their capital. Program issues and impacts impact of the trading bookbanking book boundary regulators are establishing a more objective boundary to mitigate capital arbitrage between the regulatory trading.
In this context, stricter limits as well as capital disincentives. Definitions have been tightened and new restrictions introduced on transfers and hedges between the trading book and the banking book. Instruments comprise financial instruments, foreign exchange fx, and commodities. Thinking strategically both from investment and capital perspective. Switching require approval from senior management as well as regulators. Data from the european banking authority eba published this autumn, assessing the potential impact of basel iii reforms on eu banks, underlined the importance of the eus forthcoming implementation of global regulatory standards on the capital banks must hold for certain activities. Strict limits on the movement of instruments between the books after initial designation. The valueatrisk for assets in the trading book is measured on a 10day time horizon under basel ii norms in order to determine the capital requirement.
So far, the banks have been deciding if a book was a trading book or a banking book, and there was an incentive to arbitrage from this determination, as. The trading book is an accounting term that refers to assets held by a bank that are regularly traded. So here are the definitions on how to treat a position either as a banking book or as a trading book. In summary, the frtb involves a meaningful reorganization of the trading book banking book boundary, with a redefinition of some existing concepts and the creation of several new ones. It offered a degree of choice over how banks would like their assets to be classified and subsequently regulated. It was generally agreed that permeability across the tradingbanking book boundary created the opportunity for extreme mismatches between. Tougher boundary between a banks trading book and its banking book to reduce regulatory arbitrage. A partial list of these boundaryrelated concerns from the bcbs includes. A partial list of these boundary related concerns from the bcbs includes.