FRTB Standarlized Approach
The Fundamental Review of the Trading Book (FRTB) is a new Basel committee framework for the next generation market risk regulatory capital rules. It is inspired by the undercapitalisation of trading book exposures witnessed during the financial crisis. FRTB aims to address shortcoming of the current Basel 2.5 market risk capital framework.
FRTB provides a clear definition of the boundary between the trading book and the banking book. It consists of an overhaul of the internal model approach (IMA) to focus on tail risk and an overhaul of the standardized approach (SA) to make it more risk sensitive. Each approach also explicitly captures default risk and other residual risks. Liquidity risk is explicitly included for different asset classes via liquidity horizons.
FRTB has an interanl model approach and a standardized approach: the overhaul of the internal model approach (IMA) to focus on tail risk, while the overhaul of the standardized approach (sa) to make it more risk sensitive and explicitly capture default risk and other residual risks. It includes liquidity horizons explicitly for different asset classes.
The standardized approach (SA)is a regulator-set approach. It contains the sensitivity-based risk charge (SBRC), the default risk charge (DRC-SA), and the residual add-on (RAD).
The standardized Approach defines three risk measures. They are Delta measure, Vega measure, and Curvature measure. The calculation is based on seven risk classes: General interest rate (GII), Credit spread risk, Credit spread risk with non-correlated securitisation, Credit spread risk with correlated securitisation, Equity, Commodity, Foreign exchange.
The sensitivity based risk charge should be calculated separately for each risk class and each risk measure. The reporting hierarchy is portfolio, desk, bank. Total risk charge = sensitivity-based risk charge + default risk charge +residual add-on For example, an equity desk has only equity and interest rate risk, Total risk charge = equity Delta charge + equity Vega charge + equity Curvature charge + GII charge + DRC + RAD
The FRTB Default risk charge covers Debt instruments, Equity products, and Securitisation. The Calculation procedure is: First, determine jump-to-default (JTD) loss amount; second, offset the JTD amounts of long and short exposures with respect to the same obligor; third, discount the net short exposures by a hedge benefit ratio. Finally, apply default risk weights to exposures to arrive at the DRC.
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