Apr 17, 2015

Basel III Implementation: What's Next? Tackling Liquidity, Stress Testing & Fundamental Review of the Trading Book

While many of the objectives — such as tackling capital adequacy, collateral and liquidity challenges — behind Basel III are well understood by now, how to go about implementing these goals still remains perplexing.  From liquidity management to the growing scope of stress testing requirements and overlapping responsibilities across the banking enterprise, market practitioners are increasingly asking themselves: What now? What’s next?

Keeping all of this in mind, we are also noticing a shifting focus towards optimizing business lines and trade activity, along with meeting regulatory requirements. Looking ahead, we see a flurry of activity surrounding the development of robust enterprise-wide analytic frameworks, along with market participants leveraging technology advancements to serve risk analytics.

Moreover, as institutions continue to embark on implementing the necessary changes related to Basel III, there is the distant hum of what many market participants anticipate to be the genesis of ‘Basel IV’ in the background.

So what should market participants be looking out for as the year progresses, in 2015 and beyond? From a market risk perspective, all eyes are on the draft Fundamental Review of the Trading Book: A Revised Market Risk Framework (FRTB) guidelines which could bring significant change to both Internal and Standardized models.1

FRTB is expected to be finalized this year and implemented in 2017/2018, though we may see some delays.  In this context, below is a high level summary of what we believe market participants should start thinking about in the coming months.

FRTB – A Summary of What to Expect
Fundamental Review of Trading Book:  A Revised Market Risk Framework – Target to finalize in 2015 & implementation by 2017/8

EXPECTED SHORTFALL VS. VAR
  • VaR becomes Expected Shortfall (ES)
  • Move from Stressed VaR to Stressed ES
  • Might require additional scenarios for meaningful results
LIQUIDITY HORIZONS
  • Integration of Market Liquidity Risk
  • Incorporate Liquidity horizons from 10d to 250d
  • Measuring and calibrating liquidity horizons can be complex, potentially additional form of basis risk
METHODOLOGY
  • Trading / Banking book boundary changes – based on risk factors & positions

 

Overall, we believe one of the key issues and biggest challenges related to FRTB will be the focus on expected shortfall, which may result in the need for additional scenarios and methodological changes in order to produce stable Capital measures. Another key issue would likely be related to measuring liquidity risk, with varying measurement horizons —from 10 days to 250 days.  In addition, the need for comparable capital across the Internal Model Approach and Standardized Approach could result in significant changes to the Standardized Approach.

For a more detailed analysis of key issues and challenges to look out for in 2015 when it comes to Basel III, FRTB and beyond, view our on-demand webinar hosted by Numerix and Chartis, Basel III Implementation: Tackling Capital, Collateral, Liquidity, Stress Testing and Enterprise Consistency Challenges in 2015 and Beyond.

 

1Basel Committee on Banking Supervision (BCBS 265)

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