Basel committee: we are focused on market risk framework

Author: John Crabb | Published: 25 Apr 2018
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Although it has been 10 years in the making the Basel Committee on Banking Supervision has yet to finalise its post-crisis reform agenda, specifically market risk structure aspects, secretary general Bill Coen told delegates during his keynote address at Isda's annual general meeting in Miami.

Coen’s speech addressed three specific questions: why has the committee revised the market risk framework; why has it taken so long to complete and how can it get the framework finished in a timely manner.

The global financial crisis exposed fault lines in the Basel II market risk framework, Coen suggested. The framework’s low capital requirement for market risk was far eclipsed by the market risk losses of many banks, and as a stop-gap response, the committee introduced a set of revisions that are conveniently dubbed the Basel 2.5 framework.

“The committee recognised at the time that Basel 2.5 did not fully address the framework’s shortcomings and as a result, the committee undertook a fundamental review of the trading book regime [BCBS (2012)],” he said. 

The review sought to address shortcomings in the regime’s design as well as weaknesses in risk measurement under both the internal models-based and standardised approaches.

coen speech
Coen was the keynote speaker at the Isda AGM in Miami

Coen outlined that the committee intends to improve the following shortcomings; trading book/banking book boundary, incorporating the risk of market illiquidity, enhancing the robustness and risk sensitivity of the standardised approach and capitalising against tail risk.

“In short, the pre-crisis market risk framework was in need of major repair. The weaknesses exposed by the crisis were also a stark reminder of the shortcomings in banks’ own risk management practices and the limitations of models in general,” he said.

Reiterating the importance of market risk, Coen outlined that it was a major source of loss for banks during the global financial crisis and episodes of market risk-related stress can often catalyse credit risk and liquidity risk concerns, and vice versa.

“Many of the activities captured in the trading book, such as market-making and capital-raising, help support the real economy,” he said. “So it is important that the prudential regulatory framework for market risk is calibrated to ensure the safety and soundness of the banking system, and, subject to achieving this objective, that it mitigates any unintended impacts on socially useful market activities.”

In summary, Coen suggested that an important consideration for the committee is whether the framework adequately balances simplicity, comparability and risk sensitivity and asked if the committee needs to consider if a simpler and more robust approach should be included in the revised market risk framework.

“There is a clear expectation for full, timely and consistent implementation of the Basel III standards,” he said. “This includes the January 1 2022 implementation date of the market risk framework, as reaffirmed last month by the G20 Finance Ministers and Central Bank Governors.”


Isda chairman Eric Litvack, who is also managing director and head of regulatory strategy at Société Générale agreed that it is important to continue to focus on sensitivity. You only get the right balance of efficiency and resiliency available if you get the balance right, he said, during a press briefing at the event.

“It is down to us, or the computer, to make the case for sensitivity to bring to the table and where possible to take costs out. We must also drill down not just to the global capital requirements at each bank level," he added.

"The pre-crisis market risk framework was in need of major repair"

Coen discussed the impact of market risk structure on bank capital in terms of the impact on the overall number. When a firm becomes capital constrained by a given measure, that is how it pilots its allocation and assign activity, whether it is more complex structured derivatives or not. 

“If it becomes relatively more costly than the actual risk inherent in the activity, then there is an issue where we start allocating capital away from those businesses,” said Litvack. “That is why we need to drill down to the activity level to ensure that we are getting risk sensitivity right through the process.”

See also 

FRTB meeting regulatory objectives not a priority for banks

IFLR's EU Capital markets Forum 2018: key takeaways