Fundamental Review of the Trading Book (FRTB)
The Fundamental Review of the Trading Book (FRTB) is a set of regulatory standards developed by the Basel Committee on Banking Supervision (BCBS) as a part of its broader Basel III framework. FRTB aims to address shortcomings in the existing trading book framework, enhance risk management practices, and ensure that banks hold sufficient capital against their risk exposures. In this paper, we will be addressing the new FRTB rule, what it is, and its impact on organisations.
Following consultation with HM Treasury, on 17th January 2025, the Prudential Regulation Authority (PRA) announced its decision to delay the implementation of Basel 3.1 by a year, pushing back the proposed effective date to 1st January 2027.
A smooth transition to the new framework and mitigating potential compliance risks associated with the new regulatory environment is critical for affected firms.
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Fundamental Review of the Trading Book (FRTB)
FRTB is an international standard that lays out rules on the minimum capital banks must hold against market risk exposures. This requires clear demarcation of trading activity and banking book activity. The rules also set a higher bar for banks to use their own internal models for calculating capital, as opposed to the standardised approach.
The communication issued to the financial firms outlined a timeline for pre-applications related to the Internal Models Approach (IMA) and Standardised Approach (SA) for market risk. The January 2027 implementation date of makes it crucial for firms to complete pre-application procedures and align their internal models with the revised capital standards in the FRTB near-final rules.
The FRTB revisions address key deficiencies in both the Standardised Approach (SA) and Internal Models Approach (IMA), concentrating on:
Defining the boundary between the 'trading book' and the 'banking book,' distinguishing assets held for active trading from those held to maturity (such as customer loans and deposits).
Introducing stronger measures for market illiquidity risk, ensuring that banks account for disruptions in liquidity and their impact on capital adequacy.
Replacing the traditional Value at Risk (VaR) with the Expected Shortfall (ES) metric as a measure of risk under stress, which ensures banks properly account for tail risk events. Expected Shortfall is preferred over VaR for regulatory capital requirements because it captures the size and likelihood of extreme losses, offering a more accurate risk assessment, particularly during periods of severe market stress.
FRTB represents a radical shift in the calculation of methodologies for both the Standardised Approach (SA) and the Internal Models Approach (IMA). This transformation is prompting banks to reassess their business models, trading desk structures, desk viability, and underlying technology.
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