FRTB capital levels, model risk and Korean linkers

Revealed: FRTB impact three times higher than expected

Undisclosed Isda study finds capital hike outweighs previous Basel Committee estimate

Complex op risk models open to high error, study finds

Measuring 1-in-1,000 year loss events ‘unrealistic’, researchers say

Korean regulator likely to probe issuers of rate-linked products

Mis-selling enquiry may extend to structuring banks as global rates plunge threatens retail notes

COMMENTARY: Confidence intervals

This week saw some unsettling news for banks preparing for the reform of market capital rules: a study by the International Swaps and Derivatives Association revealed the Fundamental Review of the Trading Book (FRTB) could have a capital impact three times higher than its authors predicted, potentially doubling risk-weighted assets.

The study, unfortunately, raises more questions than it answers. For a start, the Basel Committee on Banking Supervision put its impact study out in the public eye at the start of this year (here; the impact assessment is on page 18). Isda hasn’t. All we have to go on are the remarks of bank risk managers – themselves constrained by non-disclosure agreements – and these are not always clear.

The Basel impact study predicted a median FRTB market risk capital increase of 16%; the weighted average increase is 22%. Against that, one risk manager says the Isda study shows risk-weighted assets (RWA) would double on average for European banks; another says the estimates are “more than three times” the Basel estimates.

Now, with a bit of a shove, all of these could be true, meaning European banks would take a far bigger hit than banks elsewhere if the global average is 22%, but banks in the EU are seeing rises of at least 66%, but that isn’t impossible. There are certainly good reasons to think Europe’s treatment of internal models has been less severe than the US regulatory approach, for instance. 

The Basel Committee’s study showed a great deal of variation in impact from bank to bank; several will see market risk drop as a share of total RWAs, while others will see it increase by as much as nine percentage points (for a comparison, at present under the Basel 2.5 rules market risk represents an average 4.4% of total RWAs). Unfortunately, but understandably, it didn’t go into detail about which banks – large, small, European, non-European – would see the biggest changes.

In the next couple of months, fortunately, this may all become moot: the next Basel impact study, using data up to December 2018 – the same period as the Isda study – will appear before the end of October, and that should answer many questions. However, it has also been pointed out that this study will be vulnerable to condemnation as being out of date – last December, institutions had not yet fully updated to the latest version of FRTB. On this argument, we’ll need to wait for June 2019 data to be submitted (this month) and published (not before February 2020). But the next study will at least answer some questions by providing a like-for-like comparison that will (to a degree) be publicly available for analysis and criticism. If the Basel numbers look as bad as the numbers Isda has reportedly calculated, we can start worrying. If not, then Isda and Basel together need to do some explaining.

STAT OF THE WEEK

Deutsche Bank has steadily cut the share of its liquidity portfolio held in cash, as it seeks to deploy excess liquidity into higher-yielding investments. As of the second quarter of this year, Deutsche had 64% of its €246 billion ($270 billion) liquidity reserve as cash in central banks, down from 70.8% at end-2018 and 79.3% at end-2017. In its Q2 interim report, the bank said it was taking “active measure to reduce and redeploy excess liquidity” – In liquidity buffer shake-up, Deutsche shuns cash

QUOTE OF THE WEEK

“Total remuneration for us is a function of initial margin (IM), as we often charge clients basis points on the IM figure. Secondly, it reduces our risk because it cuts down our economic credit valuation adjustment equivalent, and thirdly, it reduces our cost of capital. But all this creates an appropriate tension between central counterparties and futures commission merchants” – a capital and risk expert on the CME’s new Span 2 margin framework