The banking book is a term for assets on a banks balance sheet that are expected to be held to maturity, usually consisting of customer loans to and deposits. Market risk can be defined as the risk of losses in on and offbalance sheet positions arising from adverse movements in market prices. For conciseness, we set the lgd rate to 100% for each position of the two portfolio types. Close the loop hole of capital arbitrage between the trading book and the banking book calculate the capital for the trading book and the banking book as if the banks are in stressed market conditions calculate capital using the continue reading trading book and banking book. What is the difference between a banking book and a. One of the issues extensively addressed in frtb has much to do with regulatory modifications with respect to the trading book and banking book.
Those instruments which fall outside the banking book definition of eligible collateral shall be subject to a haircut at the level applicable to nonmain index equities listed on recognised exchanges as noted in cre22. Jun 07, 2017 the precise answer is both complex and involves considerable latitude for opinion. Banks are strictly prohibited from reallocating an instrument in the trading book into the banking book for regulatory arbitrage benefits. The trading book should be used by banks ideally only to incorporate assets which are held for trading as opposed to being held till maturity for example, any derivative instrument used as a speculative or. Current rules have allowed banks to allocate transactions to trading book largely based on the intent to trade or to hedge. The banking book is also an accounting term that refers to assets on a banks balance sheet that are expected to be held to maturity. Revised trading and banking book boundary for market risk. Under volcker, therefore, trading accounts are not identified as such if the account aligns with the trading book or banking book within the bank. Banks are required to divide their balance sheets between banking and trading books both from regulatory and accounting perspective. The paper comprises a detailed set of proposals for a comprehensive revision of the market risk framework. Internal risk transfer is the transfer of risk between the books say banking and trading books via an internal trade. Rbc25 boundary between the banking book and the trading book. I can not understand whether basel iii in the part of market risk applies both to trading book and banking book or just to the first one. However under frtb this principles based approach will go away and will.
The capital treatment is identical to the situation where the credit or equity risk is hedged directly in the banking book. Say you have credit risk exposure in the banking book, and you book a hedging trade with the trading book, then this would be an internal risk transfer. May 23, 2012 the trading book is an accounting term that refers to assets held by a bank that are regularly traded. Revise the boundary between the trading book and the banking book. The report assesses the impact of proposed revisions to the market risk framework set out in two consultative documents published in october 20 and december 2014. The bcbss objective was to address shortcomings in basel 2. There has been a lot of discussion on how frtb will define whether a book is a banking book. The trading book of the banks refers to assets held by a bank that are regularly traded by the bank. The valueatrisk var for assets in the trading book. Trading book banking book boundaryevidencebased approach. Real estate holdings and retail and small business lending must go in the banking book. Inconsistencies in the allocation of individual financial instruments to the trading book or the banking book have been resolved by a new system. In light of the perils of material undercapitalization of trading book exposures, the basel committee on banking supervision bcbs introduced the basel 2. The reallocation of securities between trading and banking book should be considered a reassignment of securities and is governed by rbc25.
Under the internalrating based irb approach, the rwas in the banking book measure the exposure of a bank granting loans by applying a weight according to. Given the many infrastructure and workflow changes needed to implement frtb, banks need to move quickly in order to meet these. The banking book refers to assets on a bank s balance sheet that are expected to be held to maturity. If a bank makes a fiveyear corporate loan it intends to keep on its books, thats banking book. Calculate capital using the standardized approach, even though trading desks calculate the capital charge using internal models approach for the trading book what are the issues with the classification of the trading book and banking book boundary. Market risk trading and banking book in light of basel iii. The valueatrisk for assets in the trading book is measured on a 10day time horizon.
Revised trading and banking book boundary for market risk presumed assignment to the trading book alternative allocation possible through explicit supervisory approval there is a general presumption that any of the following instruments are being held for. The banking book refers to assets on a banks balance sheet that are expected to be held to maturity. The basel committee on banking supervision bcbs wants to make banks treat the assets in their trading books more like those in their banking books by forcing them to hold increased capital against assets designated for trading historically, lower capital requirements for trading book assets had encouraged banks to shift assets from the more expensive. It has been left to banks to decide the intent of trading and classify the trade accordingly. Basel capital rules for banks trading books will shift. The basel committee on banking supervision bcbs wants to make banks treat the assets in their trading books more like those in their banking books by forcing them to hold increased capital against assets designated for trading.
Nov 28, 2016 the trading book is required under basel ii and iii to be markedtomarket on a daily basis. The asset value on the balance sheet net of reserve will only change. The precise answer is both complex and involves considerable latitude for opinion. Basel iv revised trading and banking book boundary for. Trading book and credit risk twofactor model for incremental default risk charge impact on the risk. How assets in the trading book and banking book are. What is the difference between a banking book and a trading book. Banks transferred their risk from the banking book to trading books because var values are low. Market risk trading and banking book in light of basel. So far, the banks have been deciding if a book was a trading book or a banking book, and there was an incentive to arbitrage from this determination, as there was a difference in the capital. From a regulatory perspective, market risk stems from all the positions included in banks trading book as well as from commodity and foreign exchange risk positions in the whole balance sheet.
Frtb builds on the intent based criteria for trading banking book assignment as set out in basel ii. Trading book and banking book treatment in frtb can be summarized in three lines as follows. Banks face riskmodel clampdown in basel tradingbook. We are looking forward to you presenting at the risk emea summit where you will be focusing on the trading book and banking book. Majority of trading book positions will comprise derivatives. The major overhaul of market risk capital regime is. Can you give us a very brief overview of the trading book and banking book revisions within the revised basel market risk framework. As a global professional services company, we offer financial. Basel iv revised trading and banking book boundary for market. The trading book is required under basel ii and iii. All the books held in capital markets or investment banking division of a bank. Financial instruments in a trading book are purchased or sold for reasons including to. Securities underwritings are only included in the trading book if the bank expects to purchase the security on the settlement date. The banking book can also include those derivatives that are used to hedge exposures arising from the banking book activity, including interest rate risk.
Trading book vs banking book banks are required to divide their balance sheets between banking and trading books both from regulatory and accounting perspective. I have read that for what concerns banking book you only compute credit, change in commodity price and exchange rate. Feb 15, 2016 frtb builds on the intent based criteria for trading banking book assignment as set out in basel ii. Regulatory arbitrage can occur if institutions take advantage of the ability to lower their capital requirements by shifting assets between the banking book and. There is no shifting of risk from the banking book to the trading book, with the latter effectively acting only as an agent for the banking book for the external rehedge. A trading book is the portfolio of financial instruments held by a brokerage or bank. However, it clarifies these criteria through more prescriptive rules. Revised trading and banking book boundary for market risk presumed assignment to the trading book alternative allocation possible through explicit supervisory approval there is a general presumption that any of the following instruments are being held for at least one of the above. Securities and financial contracts that a bank intends to trade, resell or profit from on. Aug 07, 2016 regulators have seen principles based approach to allocate transactions to a trading or a banking book as a source of capital arbitrage for the banks. The rule, which takes effect january 2022, is focused on strengthening capital standards and creating a more resilient banking sector.
An internal risk transfer is an internal written record of a transfer of risk within the banking book, between the banking and the trading book or within the trading book between different desks. Cre55 counterparty credit risk in the trading book. The valueatrisk var for assets in the trading book is measured on a 10day time horizon under basel ii. Historically, the trading book consists of instruments that the bank intends to trade, while the banking book. Differences between interest rate risk irr in the banking. Insight and strategies for entering the frtb era disclaimer.
The trading book is an accounting term that refers to assets held by a bank that are regularly traded. The distinction parallels the one between the banking book, containing notably longcredit loans, and the trading book, usually including long and short positions e. Frtb removes nearly all of a firms ability to move assets between the banking book and trading book. Recently the committee made revisions to the basel 2. The trading book is required under basel ii and iii to be markedtomarket on a daily basis. If a bank does an interest rate swap with a customer, thats trading book. This reform, often referred to as basel iv, is one of the initiatives taken to strengthen the financial system, noting that the previous proposals did not prevent the. In general, trading book boundary rules restrict banks to transfer instruments between trading and banking book, specially for the regulatory arbitrage purposes. The trading book is required under basel ii and iii to be marked to market daily. What is the difference between a banking book and a trading. Hence, it is analysed if the market risk charge mrc of the trading book increases under the requirements of basel iii, relative to basel ii. A trading book is defined as positions which the bank holds for the purpose of short term gain and which it can close when markets conditions are favourable.
It is like shifting the banking book loan to trading book bond and reducing capital. May 16, 2014 it has been left to banks to decide the intent of trading and classify the trade accordingly. In the trading book, for repostyle transactions, all instruments, which are included in the trading book, may be used as eligible collateral. Basel committee on banking supervision consultative document. The difference between the trading and banking book. Differences between interest rate risk irr in the banking and. There are two prescribed approaches to calculate the market risk. Through the frtb rules, bcbs is seeking, for example, to establish a more objective boundary between the trading book and the banking book, and. The allocation of assets into the trading book has a significant impact on a firms regulatory risk capital requirements. The banking book is a term for assets on a banks balance sheet that are expected to be held to maturity, usually consisting of customer loans to and deposits from retail and corporate customers. Basel committee on banking supervision, october 20 trading book banking book boundary treatment of credit risk in the trading book banking booktrading book boundary to be more objective additional tools for supervision 1 weaknesses of var approach hedging and diversification. Until basel 2 guidelines there was a huge capital advantage in keeping trade in trading book instead of banking book.
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