Basel Committee adjusts market risk framework

The Basel Committee on Banking Supervision has adjusted parts of its new market risk framework, six months after the end of a quantitative impact (QIS) study on the measures.

The most significant amendment is the setting of a floor on the capital held for correlation trading. When the revisions to the market risk framework were published last July, the Basel Committee declared that banks would be able to use their own internal models to calculate the capital charge for correlation books, covering incremental default and migration risks and specific price risks. The Basel Committee said at the time it would determine a minimum floor for the new internally modelled charge after an impact study.

Under the revisions announced today, the floor is set at 8% of the capital charge for specific risk based on the standardised measurement approach.

The 8% floor was widely expected, and attracted significant criticism from banks during the QIS, which ended in January this year. Some have argued the floor is arbitrary and prevents banks from benefiting from investments in internal models, and so should be removed. Others claim the rules on correlation trading are too punitive and led to capital charges being higher than the floor in many cases anyway (Risk February 2010, page 8).

Correlation traders concede the rules are a significant improvement on the original proposals published in January 2009. In that draft, the Basel Committee stated that securitisation positions would be excluded from incremental risk charge models and subjected to a stricter banking book charge based on credit ratings. The loose definition of securitisation exposures meant correlation trading would have become uneconomical, dealers claimed.

Meanwhile, the Basel Committee has implemented a transition period of two years for a capital charge on non-correlation trading securitisation positions. Rather than basing the capital charge on the sum of the charges for net long and net short positions, the charge can be based on the larger of the capital levels for net long and net short positions until December 31, 2013.

The Basel Committee also reaffirmed its intention for the new rules to increase market risk capital requirements by an average of three to four times. However, it extended the deadline for implementation by one year, from December 31, 2010 to December 31, 2011.

This article first appreared on Risk.net