The Fundamental Review of the Trading Book & ensuring you are prepared

The Fundamental Review of the Trading Book (FRTB), published by the Basel Committee on the 14th of January, 2016, represents one of the biggest and most stringent changes to the banking industry’s existing risk management practices. According to the FRTB timeline, banks will be required to report under the new standards by year-end of 2019. This means banks need to be prepared by 2017 at the latest.

Succeeding the Basel 2.5 market risk framework, which was initially implemented as a short-term response to the financial crisis of 2008, the FRTB is designed to provide long-term stability by addressing underlying issues within the market risk framework.

The FRTB provides a consistent and standardised approach to financial market risk management, demanding that large, international banks disclose their current internal risk reporting and have sufficient risk management practices in place. The FRTB addresses the boundary between the banking book and trading book, which in the past enabled banks to shift assets between them to lower capital requirements. It achieves this by imposing intricate rules on the transfer of risk between the two, as well as providing detailed reporting guidelines, preventing capital arbitrage by banks.

The FRTB requires bank wide and trading-desk level stress-testing programs to be in place to identify and measure risk and stress factors that could result in tremendous trading book losses. Should banks fail to meet the requirements of the market risk requirements, regulatory action can be taken immediately to rectify the problem.

Banks will need to transform their existing structure and implement new data and technology to support the analysis of market risk factors. Therefore, the integration of a stress testing platform capable of running complex, risk-based scenarios, as well as managing risk, measurement and reporting, is essential if a bank is to be FRTB-ready.

The need for an FRTB-compliant stress testing solution

One of the main problems facing many banks and financial institutions is a lack of granular, firm-wide data in a centralised and easily-accessible location. This inability to quickly anticipate, mitigate and evaluate risks as they arise can potentially result in devastating consequences. For many of these banks and financial institutions, this information is collated in summaries or paper reports – and by the time that information is delivered, it is far too late to address risk forecasts.

However, with the right stress testing solution, one that includes: portfolio risk management, data quality controls in line with BCBS 239 guidelines and prebuilt models for both Standard Approach (SA) and Internal Model Approach (IMA) measures, banks and financial institutions can readily identify risks and manage risk reporting.

Furthermore, through an integrated suite of stress testing tools that work alongside existing data, banks can run revenue and loss from a single platform, giving end-to-end visibility of the stress testing process and a comprehensive view of market risk.

This will also enable them to continuously monitor the effects and influences of simulated financial models on their capital and balance sheets, as well as run multiple stress tests across various desks and compare results. With this information at their disposal, banks can then begin to optimise desk structure, reduce operational costs and support future capital planning.

But having prebuilt models is not enough. Banks need an adaptable solution that allows the customisation of model parameters in relation to changing regulations and interpretations of the FRTB. They need a stress testing solution that can incorporate third-party data from other systems and clearly portray that data in an easy-to-understand, visual hierarchy, including analytics data, reporting data and risk capital information at different levels.

Conclusion

While the Fundamental Review of the Trading Book will encourage banks to address their financial risk reporting framework to ensure compliance, the inclusion of stress testing tools will also enable operational improvements, enhanced assessment of risk organisation-wide and more effective capital management.

The FRTB should not be considered a burden, but as an opportunity to overhaul existing risk reporting frameworks and start optimising operations. Those who adopt a wait-and-see approach will undoubtedly run into complications later as their ability to measure market risk and deliver FRTB-compliant reports is affected. It is therefore vital that banks and financial institutions assess their current frameworks and lay the foundation required to ensure they are thoroughly prepared.

At SAS, we develop comprehensive, end-to-end FRTB-compliant solutions for market risk. Our solutions provide: prebuilt modules for SA, IMA and other risk measures defined by FRTB, data quality controls, integrated data management, visual workflow management, monitoring and reporting, and trading risk analysis. The end result is a holistic, firm-wide view of risk, enabling banks and financial institutions to make informed decisions based on real-time data.

To learn more about the FRTB and the emerging market risk challenges banks and financial institutions will face, download our paper for free.