What Is FRTB?

The Fundamental Review of the Trading Book (FRTB) framework was introduced in 2016 by the Basel Committee on Banking Supervision (BCBS) to establish minimum capital requirements for market risk. FRTB aimed to address flaws in the BASEL 2.5 Market Risk Capital framework by more accurately capturing trading risks and reducing variability in capital outcomes, ensuring that banks are sufficiently capitalized to absorb potential trading losses, even in stressed conditions.

Key changes introduced in FRTB included a new Standardized Approach (SA), an Internal Models Approach (IMA), revised boundaries between trading and banking books, and new supervisory tests.

Overview of FRTB Requirements

FRTB introduced several key changes to the risk management framework for banks:

• Expected shortfall (ES): FRTB introduced ES as a more robust measure of tail risk, replacing value-at-risk (VaR).
• Revised SA: FRTB introduced a risk-sensitive SA with specific risk weights for asset classes.
• Revised trading book definition: FRTB imposes stricter rules for instrument classification between trading and banking books.
• IMA: FRTB requires regulatory approval of IMA at the trading desk level.
• Non-modelable risk factors (NMRFs): FRTB requires proof that the risk factors used in the model are derived from sufficiently liquid instruments (known as modelability).
• P&L attribution test (PLAT) and backtesting: To use the FRTB IMA method, a trading desk must pass both the PLAT and backtesting.

FRTB Implementation Challenges

Achieving FRTB compliance demands significant resources and effort. While the goal is to create a more stable banking system, the process is complex and banks must perform FRTB calculations and monitoring on an ongoing basis. Key implementation challenges include:

• Data governance: FRTB compliance requires high-quality data to ensure data integrity and consistency across multiple trading desks and risk factors.
• Model development and validation: Developing and validating risk models for IMA under FRTB require both accuracy and the ability to withstand regulatory scrutiny.
• Infrastructure overhaul: FRTB compliance necessitates investment in new technology and systems to handle higher processing demands and integrate diverse data sources.
• Global consistency and local regulations: Banks must balance global FRTB standards with local regulations, ensuring compliance across multiple jurisdictions.

FRTB Compliance: Key Areas of Focus

Successfully implementing FRTB requires a multifaceted approach that addresses key aspects of risk management, technology, and regulatory engagement. Critical focus areas include:

• Assessment of existing risk systems: Assess current risk systems to identify gaps and develop a remediation plan that aligns with FRTB compliance requirements.
• Data integrity: Ensure access to high-quality, accurate data with robust data governance.
• Model development and validation: Develop robust risk models for IMA and perform extensive model validation to align with the regulatory expectations for risk factors and liquidity horizon.
• Model and system testing and reporting: Conduct rigorous model and system testing and implement regulatory reporting with automated processes to enhance efficiency and ensure consistent FRTB compliance.
• Technology infrastructure enhancement: Invest in upgraded IT infrastructure to manage data and analytics and support improved risk measurement and reporting capabilities.
• Regulatory engagement: Maintain open communication with regulators during FRTB implementation to clarify expectations and ensure alignment with compliance requirements.

Assessing your current systems, investing in the necessary technology, and engaging with regulators are important steps toward ensuring FRTB compliance and managing market risk effectively.

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