CRD 3 and beyond
How are you left?
Simon Hills
British Bankers Association
British Bankers’ Association
Evolution of regulatory capital for the trading book
•Basel 1 - 8% capital against RWAs (1992)
•CAD 1 and basic market risk approaches (1993)
•Basel Market Risk amendments (1997)
oMarket risk on debt, FX, equities options & commodities in Trading book
oInternal VaR models
•Basel II new capital adequacy framework (2007 in EU)
oIDRC (in Europe)
•Basel trading book package = CRD 3
1 January 2011
o Stressed VaR, Incremental Risk Charge, standardised charges for securitisation, correlation
trading models
British Bankers’ Association
The construct
•
•
•
Regulatory split of assets between banking book and trading book
Banking book unless you can convince regulator otherwise
Trading book capital treatment if:
“A trading book consists of positions in financial instruments and commodities held either
with trading intent or in order to hedge other elements of the trading book. To be eligible
for trading book capital treatment, financial instruments must either be free of any
restrictive covenants on their tradability or able to be hedged completely. In addition,
positions should be frequently and accurately valued, and the portfolio should be actively
managed.”
•
Trading intent?
“Positions held with trading intent are those held intentionally for short-term resale and/or
with the intent of benefiting from actual or expected short-term price movements or to lock
in arbitrage profits, and may include for example proprietary positions, positions arising
from client servicing (e.g. matched principal broking) and market making.”
British Bankers’ Association
Banking / trading book boundary
•FX & commodity position – uniform (market risk) capital requirements
whether in trading book or banking book
•Equities/credit: trading / banking book boundary determines whether
capital held for market risk or credit risk
•Banking book (credit risk) long only regime, 1 year 99.9% calibration
•Trading book, long + short (portfolio approach) 10 99% calibration
British Bankers’ Association
What you do now.............
•Fair valuation of positions – accounting / regulatory definition
•Profits/losses taken immediately
o Losses reduce Tier 1 capital immediately
o Unrealised ‘verified’ profits can be recognised as Tier 1
•Hedging recognition depends on standard rules or modelled approach
•Market risk primary focus of regulatory capital
British Bankers’ Association
.............and the future?
“Capital required against trading book activities should be increased
significantly (e.g. several times) and a fundamental review of the
market risk capital regime (e.g. reliance on VAR measures for
regulatory purposes) should be launched”
“The BCBS should follow up its current proposals for short-term
reform of trading book capital with a fundamental review, to include
the role of VaR measures and the boundary between the trading
and banking books”
Turner Review
March 2009
British Bankers’ Association
.............and the future?
•Current regulatory boundary means some risks not properly captured:
o Credit risk in trading book
o No market risk charge for fair valued assets in banking book
•Intent vs. trading feasibility
•What about market liquidity risks?
•Is ten day capital horizon appropriate?
•Are counterparty credit risk requirements enough?
oCharge for Credit Valuation Adjustment??
•So capital requirements too low??
British Bankers’ Association
The problems
Risk management & modelling
o Does VaR modelling for regulatory purposes capture tail risk?
o Modelled capital requirements very cyclical
o Complexity and modelling don’t mix?
Valuing traded assets
o Get it right – it is the building block
o Accounting Point in Time vs. forward looking regulatory requirement
o Existing prudent valuation requirements – are they enough?
British Bankers’ Association
A regulatory response so far – specific
measures - The Proposal
July 2009 Basel Committee (CRD 3) package for implementation by January 2011
Measure
Stressed VAR
Incremental risk
charge (IRC)
Traded
securitisation
products
Additional
Additional capital
capital charge
charge based
based on
on
stressed
calibration
of
VAR
model
stressed calibration of VAR model
inputs
inputs
Impact
Increaseinincapital
capital
• • Increase
requirementfor
formodelled
modelled
requirement
positions
positions
Reductionininrelative
relativecyclicality
cyclicality
• • Reduction
VARcapital
capitalrequirement
requirement
ofofVAR
Firms must capture incremental (to
VAR) credit default and migration risk
on modelled credit products in the
trading book
• Improves risk capture on
traded credit positions
• Additional modelling standards for
portfolio” standards for
• “correlation
Additional modelling
“correlation portfolio”
• Application of banking book credit
weights to
net book credit
• risk
Application
of other
banking
securitisation
positions
risk weights to
other net
securitisation positions
•• Improves
Improves risk
risk capture
capture for
for
correlation
correlation portfolio
portfolio
• Calibrated to one year 99.9%
level
•• Reduces
Reduces scope
scope for
for regulatory
regulatory
capitalon
arbitrage
capital arbitrage
on
securitisation
products
securitisation
products
•• Expected
Expected to
to lead
lead to
to significant
significant
increase inincrease
capital in capital
requirements
requirements
British Bankers’ Association
Challenges ahead
Stressed VAR
• Doubles (at least) capital requirement
• I year period
• Implemented across multiple levels of portfolio
• Ability to perform 10 day VaR rather than scaling up
• How to combine VaR and stress testing
• Data for stressed time series?
• Duplicate models for risk management and regulatory capital
British Bankers’ Association
Challenges ahead
Credit Valuation Adjustment
• Concept OK
• Bond equivalent approach doesn't reflect economic hedges
• Needs close alignment of many internal functions
• Industry believes market implied approach better
• 2nd consultation for CVA??
British Bankers’ Association
Challenges ahead
• Overall calibration – QIS results awaited
• CCPs - reduced spreads?
• Leverage ratio
o Ignores netting
o Nominal not regulatory equivalent numbers
o Impact on strategy and appetite
•
Unrated re-securitisations = 1250% weighting or deduction
British Bankers’ Association
What to do ?
•
•
•
•
•
•
Risk and finance data integration
Coordination of market risk and regulatory reporting
Required data histories for long term analysis
Model validation quality – internal and for FSA
Identification of re-securitisations
Review trading book governance – intent vs. feasibility
British Bankers’ Association
Summary
•
•
•
•
•
•
Lots changing
Much more capital
Risk of double counting
Impact on business models
Will risk be managed better?
Lobby now
British Bankers’ Association