The Boundary Between Trading and Banking Books Under FRTB

Sanjay Sharma and John Beckwith

“The boundaries which divide Life from Death are at best shadowy and vague. Who shall say where one ends, and the other begins?” – Edgar Allan Poe

HISTORICAL PERSPECTIVE TO THE BOUNDARY

A fundamental objective of FRTB is creating a high, impermeable wall that separates the trading and banking books. Following the 2007–08 global financial crisis (GFC), BCBS and other regulatory bodies studied the global regulatory framework in an effort to understand what caused or contributed to systemic breakdowns in markets during that period. It was generally agreed that permeability across the trading/banking book boundary created the opportunity for extreme mismatches between risk models designed for one paradigm but applied to another. Some of these mismatches were exploited intentionally by professional traders; others were simply hidden until the right stress event appeared; but all were contributing factors to the systemic events of the GFC. A partial list of these boundary-related concerns from the BCBS includes:

• • intentional arbitrage between trading book and banking book to improve capital and/or P&L treatment;
• • differential treatment of similar risks held