At the heart of post global financial crisis reforms was the Basel III framework, a globally agreed set of standards to strengthen the regulation, supervision and risk management of banks.
As Basel III has been developed and implemented over the past 15 years, challenges have emerged. Key jurisdictions have moved at different speeds, interpreting and implementing the global standards in their own way. Today, banks must navigate a complex web of requirements, with significant implications for competition, risk and the functioning of global capital markets.
In a recent paper, the International Swaps and Derivatives Association (ISDA) presents some of the key areas where it’s been focusing advocacy in relation to the Basel III market risk framework. The Fundamental Review of the Trading Book (FRTB) is a central component of the Basel III framework that sets capital requirements for market risk.
In many respects, the FRTB represents a step forward, bringing greater clarity to the boundary between the trading and banking books, setting higher standards for model validation and encouraging more granular measurement of risk. However, the new framework has considerable operational complexity and for many banks, the costs and technical demands of compliance are exceptionally onerous.
The capital treatment of certain exposures, including funds and non-modellable risk factors (NMRFs), has been a source of frustration, with rules that are often seen as excessively conservative and not sufficiently aligned with the realities of risk management.
“The stakes couldn’t be higher – for the preservation of deep and liquid markets, we need a risk-appropriate and robust capital framework. Poorly calibrated capital rules are damaging to market liquidity and will compromise economic activity,” said Scott O’Malia, chief executive officer at ISDA, cited in the report.