Basel Committee Tightens Capital Requirements for Market Risk

The Basel Committee on Banking Supervision ("BCBS") published its revised Minimum Capital Requirements for Market Risk. The revised and standardized requirements are intended to replace the existing minimum capital requirements for market risk in the global regulatory framework.

The Executive Summary of the BCBS Standards publication identified the following "key enhancements":

• "A revised internal models approach ("IMA"): A more rigorous model approval process that enables (i) supervisors to remove internal modeling permissions for individual trading desks, (ii) more consistent identification and capitalization of material risk factors across banks, and (iii) constraints on the capital-reducing effects of hedging and diversification."

• "A revised standardized approach ("SA"): An overhaul of the standardized approach that renders it sufficiently risk-sensitive to serve as a fallback and floor for the IMA while providing an appropriate standard for banks that do not require market risk to be tested in sophisticated ways."

• "A shift from Value-at-Risk ("VaR") to an Expected Shortfall ("ES") measure of risk under stress: Usage of ES will ensure a more prudent capture of "tail risk" and capital adequacy during periods of significant financial market stress."

• "Incorporation of the risk of market illiquidity: Varying liquidity horizons (i) replace the static 10-day horizon that was assumed for all traded instruments under VaR in the unrevised framework, and (ii) are incorporated into the revised SA and IMA to mitigate the risk of a sudden and severe impairment of market liquidity across asset markets."

• "A revised boundary between the trading book and banking book: The establishment of a more objective boundary that will reduce incentives to arbitrage between the regulatory banking and trading books while maintaining an alignment with banks' risk management practices."