Revisions to the Basel II market risk framework.
Since the financial crisis began in mid-2007, the majority of losses and most of the build up of leverage occurred in the trading book. An important contributing factor was that the current capital framework for market risk, based on the 1996 amendments to Basel I, does not capture some key risks. In response, the Committee proposes to supplement the current value-at-risk-based trading book framework with an incremental risk capital charge (IRC), which includes default risk as well as migration risk, for unsecuritised credit products. For securitised products, the capital charges of the banking book would apply. Once implemented, the IRC will reduce the incentive for regulatory arbitrage between the banking and trading books.
An additional proposed response is the introduction of a stressed value-at-risk (VaR) requirement. Losses in banks' trading books during the financial crisis have been significantly higher than the minimum capital requirements under the Pillar 1 market risk rules. The Committee therefore proposes to require banks to calculate a stressed VaR taking into account a one-year observation period relating to significant losses, which would be in addition to the VaR based on the most recent one-year observation period. The additional stressed VaR requirement will help reduce the procyclicality of the minimum capital requirements for market risk.
The Committee also proposes to discontinue the preferential treatment of a 4% capital charge for specific risk of equities that is currently applicable to portfolios that are both liquid and well-diversified. As a result, an 8% capital charge for specific risk of equities would apply in all cases.
In addition to the proposed changes noted above, the Committee will be initiating a longer-term, fundamental review of the risk-based capital framework for trading activities.
The final version of this paper was released in July 2009.
- Publication Date: January 2009
- Publication Type: Consultative
- Publication Status: Closed
- Publication Category: Market Risk
- Number of Pages: 31
- Keywords: Internal Models, Standardised Measurement, Market Risk
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