Continuing its “fundamental review of the trading book” (FRTB) that dramatically revises the current market-risk rules known as Basel II.5, the Basel Committee has adopted final standards that take a far more stringent view of the internal-models approach (IMA), mandating a revised and more stringent standardized approach (SA) that is now not just an alternative but also a floor under the IMA. The rules also include a shift from the value-at-risk (VaR) methodology to one based on expected shortfall (ES) under stress, new standards addressing illiquidity risk replacing static time horizons under VaR, and a revised boundary between the banking and trading books to prevent regulatory arbitrage. Taken together, all of these changes lead to significant increases in trading-book capital that will result in strategic changes at banks now active in affected lines of business. Demand for assets frequently used in trading operations (e.g., sovereigns and agency obligations) could also suffer despite provisions designed to reduce capital for instruments with low credit and liquidity risk. However, higher-risk assets not captured by the SA could become a greater focus for banks that remain on the IMA.
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