As the official implementation date of 1st January 2023 for FRTB approaches, are financial institutions ready for the changes? Will regulators have the rules written in time, and can those rules be applied before the deadline? In this article, we look at all things ‘FRTB-related’ and what the global impact is likely to be…

What is FRTB

Forming a significant part of Basel IV, the Fundamental Review of the Trading Book (FRTB), is a set of capital rules developed by the Basel Committee on Banking Supervision (BCBS), which will introduce international standards for banks and financial institutions on their trading activities to minimise market risk exposure.

The FRTB has been ten years in the making, with the BCBS initially launching the first consultation on the subject back in 2012 in response to the 2008 banking crisis. Unfortunately, like everything over the past two years, there have been delays due to the pandemic, but it now seems that implementation of the new rules will be sometime between 2023 and 2025.

The wide date range is attributed mainly to some jurisdictions being more prepared than others. Each region can interpret the rules to create their own set of local regulations that broadly follow the standards being introduced. 

According to recent reports, only a few jurisdictions, including Hong Kong, look ready for the 2023 deadline, with Europe close behind, having already prepared their interpretation of the rules and provided guidelines to banks intending to launch in 2024. 

However, in other areas, especially the US, there have been few official statements on rule interpretation with regulators yet to issue a formal FRTB proposal.

Purpose and impact

In basic terms, the main aim of the FRTB is to introduce a standardised means of supervision and risk assessment to allow banks to more accurately calculate their market risk and credit risk by drawing a clearer line between banking book and trading book activities. Currently, the classification of a position is determined by ‘trading intent’, but this has been said to offer too much scope for individual decision-making, which can cause issues when comparing portfolios, so the hope is that the new rules will make the process more precise.

The FRTB also focusses on introducing a regulated approach to calculating the Risk-Weighted Assets (RWA), i.e. the capital held by a bank to reduce the risk of insolvency, and also to replace Value at Risk (VaR) with a revised ‘Internal Model Method’ to calculate worst-case scenario losses. The new internal model method uses expected shortfall to enhance transparency and make more reliable comparisons between portfolios, which should be more dependable than VaR, which doesn’t account for extreme circumstances in its calculations.

The impact on banks is vast in terms of preparation as they will have to review many processes such as their trading/bank book boundaries, modelling approach and data sourcing. It could affect the entire infrastructure and business model that financial institutions operate on and may take many years to adapt to fully. This is undoubtedly one of the most significant changes to banking and financial regulation in history, but hopefully, the increased stability it will bring to the financial world will be worth all the effort.

If you’re looking for your next career move in Risk or Banking, or if you need to recruit some top-class professionals to help you through FRTB and beyond, talk to our expert recruitment team at McGregor Boyall today.