Basel Committee on Banking Supervision

1 Basel Committee on Banking Supervision STANDARDS minimum capital requirements for market risk January 2016 Note: Basel III revisions published in December 2017 affect the implementation date of this standard. This publication is available on the BIS website ( ). Bank for International Settlements 2015. All rights reserved. Brief excerpts may be reproduced or translated provided the source is stated. ISBN 978-92-9197-399-6 (print) ISBN 978-92-9197-416-0 (online) Note: Basel III revisions published in December 2017 affect the implementation date of this standard. capital requirements for market Risk iii minimum capital requirements for market Risk Contents Preamble.

2 5 minimum capital requirements for market risk .. 5 A. The boundary between the trading book and Banking book and the scope of application of the minimum capital requirements for market risk .. 5 1. Scope of application and methods of measuring market risk .. 5 2. Definition of the trading book .. 6 3. Risk management policies for trading book instruments .. 7 4. Definition of the trading desk .. 9 5. Restrictions on moving instruments between the regulatory books .. 10 6. Treatment of internal risk transfers .. 11 7. Treatment of counterparty credit risk in the trading book .. 13 8. Transitional arrangements .. 13 B. market Risk The Standardised Approach.

3 13 1. General provisions .. 13 2. Structure of the standardised approach .. 14 (i) Overview of the structure of the standardised approach .. 14 (ii) Sensitivities-based Method: main definitions .. 14 (iii) Sensitivities-based Method: instruments subject to delta, vega and curvature risks .. 15 (iv) Sensitivities-based Method: delta and vega .. 15 (v) Sensitivities-based Method: curvature .. 16 (vi) Sensitivities-based Method: correlation scenarios and aggregation of risk charges .. 18 (vii) The Default Risk Charge .. 18 (viii) The Residual Risk Add-On .. 19 3. Sensitivities-based Method: risk factor and sensitivity definitions .. 20 (i) Risk factor 20 (ii) Sensitivity definitions.

4 25 (iii) Treatment of index instruments and multi-underlying options .. 27 (iv) requirements on sensitivity computations .. 28 4. Sensitivities-based Method: delta risk weights and 28 (i) Delta GIRR .. 28 (ii) Delta CSR non-S ecuritisations .. 30 Note: Basel III revisions published in December 2017 affect the implementation date of this standard. minimum capital requirements for market Risk (iii) Delta CSR Securitisations (correlation trading portfolio) .. 32 (iv) Delta CSR Securitisations (non-correlation trading portfolio) .. 33 (v) Equity risk .. 35 (vi) Commodity risk .. 37 (vii) Foreign exchange risk .. 40 5. Sensitivities-based Method: vega risk weights and correlations.

5 40 6. Sensitivities-based Method: curvature risk weights and correlations .. 42 7. The Default Risk Charge .. 42 (i) Default Risk Charge for non-securitisations .. 43 (ii) Default Risk Charge for securitisations (non-correlation trading portfolio) .. 46 (iii) Default Risk Charge for securitisations (correlation trading portfolio) .. 47 C. market risk The Internal Models Approach .. 50 1. General criteria .. 50 2. Qualitative standards .. 50 3. Quantitative standards .. 52 4. Model validation standards .. 55 5. Determining the eligibility of trading activities .. 56 6. Interaction with the standardised approach methodology .. 58 7. Specification of market risk factors.

6 59 8. Default risk .. 60 9. Capitalisation of risk factors .. 63 10. Stress testing .. 65 11. External validation .. 66 Appendix A: Trading desk definitions .. 68 Appendix B: Supervisory framework for the use of backtesting and profit and loss attribution in conjunction with the internal models approach to market risk capital requirements .. 70 D. Treatment for illiquid positions .. 80 1. Prudent valuation guidance .. 80 2. Adjustment to the current valuation of less liquid positions for regulatory capital 82 E. Supervisory Review Process The Second Pillar .. 83 Glossary .. 86 Note: Basel III revisions published in December 2017 affect the implementation date of this standard.

7 capital requirements for market Risk 1 minimum capital requirements for market Risk Executive Summary This document sets out revised standards for minimum capital requirements for market Risk by the Basel Committee on Banking Supervision ( the Committee ). The text herein is intended to replace the existing minimum capital requirements for market risk in the global regulatory framework, including amendments made after the June 2006 publication of Basel II: International Convergence of capital Measurement and capital Standards - Comprehensive Version. Consistent with the policy rationales underpinning the Committee s three consultative papers on the Fundamental Review of the Trading Book,1 the revised market risk framework consists of the following key enhancements: A revised internal models-approach (IMA).

8 The new approach introduces a more rigorous model approval process that enables supervisors to remove internal modelling permission for individual trading desks, more consistent identification and capitalisation of material risk factors across banks, and constraints on the capital -reducing effects of hedging and diversification. A revised standardised approach (SA). The revisions fundamentally overhaul the standardised approach to make it sufficiently risk- sensitive to serve as a credible fallback for, as well as a floor to, the IMA, while still providing an appropriate standard for banks that do not require a sophisticated treatment for market risk.

9 A shift from Value-at-Risk (VaR) to an Expected Shortfall (ES) measure of risk under stress. Use of ES will help to ensure a more prudent capture of tail risk and capital adequacy during periods of significant financial market stress. Incorporation of the risk of market illiquidity. Varying liquidity horizons are incorporated into the revised SA and IMA to mitigate the risk of a sudden and severe impairment of market liquidity across asset markets. These replace the static 10-day horizon assumed for all traded instruments under VaR in the current framework. A revised boundary between the trading book and Banking book.

10 Establishment of a more objective boundary will serve to reduce incentives to arbitrage between the regulatory Banking and trading books, while still being aligned with banks' risk management practices. Overview of the revised internal models approach for market risk An illustration of the process and policy design of the internal models-based approaches (IMA) is set out in the diagram below. For a bank that has bank-wide internal model approval for capital requirements 1 Basel Committee on Banking Supervision : Fundamental review of the trading book, consultative document, May 2012, Fundamental review of the trading book: A revised market risk framework, consultative document, October 2013, Fundamental review of the trading book: Outstanding issues, consultative document, December 2014, Note: Basel III revisions published in December 2017 affect the implementation date of this standard.