After receiving extensive comment on a concept paper describing a “fundamental review” of the capital rules governing the trading book at banking organizations, the Basel Committee has decided to proceed with an overhaul of the “Basel II.5” trading-book standards finalized in 2009. Reflecting Basel’s increased focus on simplicity and comparability, the rewrite of the trading-book rules seeks a far more standardized framework that would limit reliance on internal models and facilitate supervisory and market risk assessment. The new approach would scrap the long-established approach to market risk-based capital, the value-at-risk (VaR) model, in favor of a new, “expected-shortfall” (ES) framework designed not only to improve simplicity and comparability, but also better to capture low-probability, high-risk market events. The revised approach also seeks better to address liquidity risk, which occurred during the crisis as markets froze, and to reduce reliance on internal models. The proposal does not put a standardized floor under models or add a surcharge to them, but Basel continues to consider this to prevent gamesmanship. In the interim, new disclosures for model-users would be required that might force de facto reliance on the new standardized approach. While this and the revised model-based standards reflect many industry concerns in the initial consultation, both standards are complex and each would sharply hike regulatory capital for market risk. As a result, significant operational burden would result and there could be significant changes in competitiveness and market liquidity, albeit with the hoped-for benefit of greater stability in bank trading activities and, thus, less systemic risk.
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