3 FRTBs Standardized Approach

FRTB’S STANDARDIZED APPROACH
• Focuses on sensitivities of risk positions in the

trading book
• Key risk sensitivities are delta, vega and curvature
• Summary of separate steps required to compute SA
capital charge
FRTB’S • Example of calculating delta risk charge for simple
FX portfolio
STANDARDIZED • Vega Risk Charge
APPROACH • Curvature Risk Charge
• Default Risk Charge example
• Residual Risk Add-on charge
Information Classification: General

Method for calculating capital requirements for banks that
do not require sophisticated measurement of market risk.
Designed by the BCBS to provide consistent and comparable

reporting of market risk across banks and jurisdictions
FRTB – the
Standardized All banks must compute the standardized approach capital
requirement on a daily basis
Approach
(SA) SA capital charge can be used to construct a “floor” on the
minimum capital charge for banks approved for IMA
BCBS decided that SA should capture market risks from

securitisation exposures and from Correlation Trading
Portfolios (CTP) - not permitted to use IMA
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• Greater reliance on risk sensitivities as inputs into capital
charge calculations
• Captures three risk sensitivities - delta, vega and
curvature
• Uses BCBS specified risk weights and correlation
Key elements of parameters
• Default Risk Charge - calibrated to the credit risk
Standardized treatment in the banking book (replaces the IRC from
Basel 2.5)
Approach • Residual Risk Add-on - sum of gross notional amounts of
the instruments bearing residual risks
• Risk weight of 1.0% for instruments with an exotic
underlying
• 10 bps for instruments bearing any other residual
risks

Capital charge under the SA
• The SA minimum capital requirement is the sum of:
• Sensitivities Based Charge
• Default Risk Charge
• Residual Risk Add-on
Source: www.bis.org/bcbs/publ/d352.pdf 5
6
• Instruments are mapped to a set of regulatory

prescribed risk factors to which shocks (i.e., risk weights)
are applied
• These sensitivities are then aggregated within each
Sensitivity Based bucket
Methodology • This step uses regulator-prescribed correlations applied
within a regulator-prescribed aggregation formula
Step by step
• The resulting bucket-level capital charges are then
approach from BCBS aggregated
document d352 • This step determines the risk class-level capital charge
• The aggregate sensitivities based capital charge is the
simple sum of each risk-class level capital charge

Sensitivity Based Methodology
Source: Percentile – FRTB OVERVIEW & IMPLEMENTATION NOTES

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Sensitivity Based Methodology
Treatment for Foreign Exchange
• For FX spot positions the delta is simply the current exchange rate against the
reporting currency for the bank
• The risk weights are seen below from the BCBS documentation
• To calculate the delta risk charge of an FX portfolio the risk weights are applied in
conjunction with a correlation matrix where the coefficient for all FX pairs is set at a
single common value of 0.6
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SA risk classification system
Buckets and risk weights for Equity
positions
9
• Vega is the sensitivity of an instrument to the
implied volatility.
• During periods of stress – as in 2008 - there was
high realized volatility for most assets
• Market participants were anxious to hedge
Vega risk portfolios
• Implied volatilities in option premiums increased
charge greatly
• As an example, much increased risk exposure for
banks with short gamma portfolios
• Capital charge for vega sensitivity is now
considered essential by BCBS to reflect greater
market risk during financial stress.

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• Aim is to calculate capital charge for the second order

risk inherent in non-linear instruments.
• Delta charge is computed using a sensitivity that
assumes a relatively low change in the underlying risk
factor.
• During periods of stress, assets can move by drastic
Curvature risk amounts
• CVR is additional charge to compensate for lack of
charge (CVR) coverage by the delta charge
• CVR is calculated by applying upward and downward
stress shocks to each risk factor
• Uses the worst loss scenario from each directional
change in aggregating within buckets and across
buckets.

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• Quantifies loss that would be suffered by the bank if an

issuer of a financial instrument defaults
• BCBS states that is intended to capture stress events in
the tail of the default distribution which may not be
captured by changes in credit spreads on a simple MtM
basis
• Requires banks to use a Jump to Default (JTD) approach
Default Risk • JTD calculation steps:
• Calculate gross JTD risk positions (Gross JTD)
Charge (DRC) • Through offsetting calculate net JTD risk positions
(Net JTD)
• Recognize any applicable hedging instruments
• Apply the default risk weights – prescribed by the
BCBS

Default Risk Charge
(DRC)
• Example – what is the DRC for bank which

is short CDS protection on BBB rated
corporate – notional $40m?
• Equity instruments and non-senior
debt instruments are assigned an
LGD of 100%.
• Senior debt instruments are
assigned an LGD of 75%.
• Covered bonds are assigned an LGD
of 25%.
• LGD is 75%
• JTD is $30m
• DRW is 6%
• DRC = $1.8m
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FRTB Implementation issues
from EY Executive Summary on FRTB (2016)
• Changes that must be made to banks’ infrastructure to implement the FRTB

standards are transformational
• Standardized approach requirements to use granular risk factor sensitivities will
require an overhaul of current market risk capital calculations and processes
• Increased communication and engagement with senior management regarding
FRTB implementation
• Increased awareness of supervisory rule-making status
• Focus on the anticipated RWA impacts…
• Awareness of the scale of the bank’s FRTB program and related resource
needs
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FRTB’S STANDARDIZED APPROACH

• Focuses on sensitivities of risk positions in the

Information Classification: General

Designed by the BCBS to provide consistent and comparable

BCBS decided that SA should capture market risks from

Information Classification: General

• Instruments are mapped to a set of regulatory

Information Classification: General

Source: Percentile – FRTB OVERVIEW & IMPLEMENTATION NOTES

Information Classification: General

• Aim is to calculate capital charge for the second order

Information Classification: General

• Quantifies loss that would be suffered by the bank if an

Information Classification: General

• Example – what is the DRC for bank which

• Changes that must be made to banks’ infrastructure to implement the FRTB

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