FRTB - Fundamental Review of the Trading Book

Definition

The Fundamental Review of the Trading Book (FRTB) is a regulatory framework developed by the Basel Committee on Banking Supervision aimed at improving the resilience of banks' trading activities by enhancing risk management and capital requirements. It seeks to address the shortcomings of the previous framework by providing more robust methods for calculating market risk capital, incorporating changes in market dynamics, and ensuring that banks hold adequate capital against their trading activities.

5 Must Know Facts For Your Next Test

1. FRTB introduces two approaches for calculating capital requirements: the Standardized Approach and the Internal Models Approach, allowing banks to choose between using standardized methods or their own internal risk models.
2. One of the key aspects of FRTB is the incorporation of liquidity horizons into the capital calculation, which takes into account how quickly positions can be liquidated in stressed market conditions.
3. FRTB requires banks to use a more granular approach to risk factors, leading to improved sensitivity in measuring potential risks associated with trading activities.
4. Under FRTB, banks are required to assess the non-linear risks associated with complex derivatives more accurately, leading to a better understanding of potential losses.
5. The implementation of FRTB aims to create a more consistent and transparent approach to market risk management across different jurisdictions, enhancing comparability among banks.

Review Questions

• How does FRTB improve upon previous frameworks for managing market risk in banks?
  • FRTB enhances previous frameworks by introducing more rigorous methodologies for calculating capital requirements, such as the Standardized Approach and Internal Models Approach. It emphasizes liquidity horizons and a more granular approach to risk factors, which allows for better sensitivity in measuring risks. This improvement helps banks better manage their trading activities while ensuring they hold adequate capital against potential losses.
• Discuss the role of liquidity horizons in the FRTB framework and why they are important for assessing market risk.
  • Liquidity horizons play a crucial role in the FRTB framework as they determine how quickly positions can be liquidated under stressed market conditions. By considering liquidity horizons, banks can better estimate the potential impact of market fluctuations on their trading portfolios. This ensures that capital requirements are aligned with realistic scenarios that reflect actual market behavior during times of stress, thus promoting overall financial stability.
• Evaluate how the FRTB's requirement for banks to assess non-linear risks associated with derivatives impacts their trading strategies and overall risk management practices.
  • The requirement under FRTB for banks to assess non-linear risks associated with complex derivatives fundamentally impacts their trading strategies by pushing them to adopt more sophisticated risk management techniques. Banks must develop models that accurately reflect these risks, which can lead to changes in portfolio construction and hedging strategies. As a result, this evaluation fosters a deeper understanding of potential losses and encourages more proactive measures in managing market risks, ultimately enhancing the resilience of banks' trading operations.

Related terms

Market Risk: The risk of losses in positions arising from movements in market prices, including equity prices, interest rates, foreign exchange rates, and commodity prices.

Capital Requirements: The minimum amount of capital a bank must hold as required by financial regulators to absorb potential losses and ensure stability.

VaR - Value at Risk: A statistical measure used to assess the potential loss in value of a portfolio over a defined period for a given confidence interval.