What does the Fundamental Review of the Trading Book (FRTB) mean for banks?

"In the wake of the financial crisis, the BCBS rushed out a patch to the capital rules, known as Basel 2.5, which they hoped would make banks' trading book risk models more comprehensive. With the benefit of hindsight, regulators realised that the resulting patchwork needed a fundamental redesign. They went back to the drawing board and devised the FRTB guidelines. They are focused on ensuring banks are capitalised more consistently and better able to quantify more illiquid risks. For many banks, this radical redesign of the capital rules is also leading them to rethink their internal risk systems."


When do banks need to be ready?

"The rules stipulate 2022, which doesn’t actually give the industry much time. For banks to run daily FRTB capital in 2022, they need one year of implementation and testing in 2019, one year of model approval process in 2020, and one year of backtesting data in 2021, which means final design decisions need to made by the end of 2018."


What are the complexities keeping banks awake at night?

"There are many challenges facing banks. One of the most complex is the management of non-modellable risk factors (NMRFs). Under the FRTB text, a risk factor is only modellable if “real” prices for representative transactions are observed at least 24 times per year and with a maximum gap between observations of less than a month. Access to a rich and diversified source of transaction and pricing data will be critical to mitigate these NMRF capital charges."


How are banks tackling this complexity brought about by FRTB?

"We’re already seeing great interest from clients in deploying “parallel run" infrastructure, where they calculate capital under FRTB alongside their existing capital rules. This allows them to experiment with different scenarios for FRTB compliance in order to find the most appropriate approach.  

"This could involve choosing different trading desk structures or modeling approaches and testing risk factor proxying techniques. This agile approach provides the flexibility needed to navigate the significant regulatory uncertainty that remains and gives banks the option of revisiting these decisions if necessary."