Basel Committee Refors

The Basel Committee on Banking Supervision introduced the Fundamental Review of the Trading Book (FRTB) in January 2016 to address weaknesses in the market risk capital framework.

FRTB introduced stricter rules for defining the boundary between the Trading Book and Banking Book to prevent banks from shifting risky assets to reduce capital requirements.

The Trading Book contains assets that banks actively trade in financial markets, including stocks, bonds, and derivatives.

The Banking Book generally contains assets and liabilities held for longer-term banking activities, such as loans and deposits.

VaR does not capture the size or average severity of losses beyond its threshold, so it can fail to adequately capture tail risk.

Expected Shortfall, also called Conditional VaR, measures the average loss in extreme cases beyond the VaR threshold.

Expected Shortfall considers the entire tail of the loss distribution by measuring average losses beyond the VaR threshold.

Market illiquidity risk is the risk that a bank cannot sell assets quickly without suffering significant losses because there may be few buyers or selling may sharply reduce the asset price.

FRTB categorizes assets based on liquidity horizons, which reflect how long it may take to sell an asset without significantly affecting its price.

FRTB aims to strengthen market risk management by improving risk measurement and ensuring banks maintain adequate capital for potential market losses.