In his speech, William Coen, Secretary General of the Basel Committee on Banking Supervision, will focus on the issue of market risk. First, some perspective. Ten years have passed since the start of the global financial crisis. During this period, the Basel Committee has finalised its wide-ranging and comprehensive set of post-crisis reforms. These greatly improve the quality of regulatory capital, increase capital requirements, enhance risk capture, while specifying a minimum leverage ratio requirement, adding a macroprudential overlay, and introducing international liquidity standards (BCBS (2010), (2015a), (2017)).
One element of the Committee’s post-crisis reform agenda has yet to be fully finalised: the market risk framework. Consider the following excerpt from a Basel Committee document on the market risk framework: “A common response…has been that the frameworks developed by the Committee for measuring market risk are at the same time complex and inaccurate…the frameworks are further criticised for incorporating a methodology which banks [do not] use…”.
This may sound familiar. But it may surprise you to learn that this excerpt is from a 1994 Basel Committee document summarising the comments received on a 1993 consultation paper on “the prudential supervision of netting, market risk and interest rate risk” (Goodhart (2011)).
So, a full quarter-century later, must we lament the finalisation of the market risk framework as one of those never-ending stories? My speech today will try to answer three questions:
- why has the Committee revised the market risk framework?
- why has it taken so long to complete? and
- how do we get the framework finished in a timely manner?
Why revise the market risk framework?
Trading book instruments have existed since the beginning of history. Some say that the 48th law in Hammurabi’s Code makes the first reference to them (Kummer and Pauletto (2012)). Under this Babylonian legislation, dating from around 1754 BC, farmers could renege on their debt if their crops failed. This is much akin to a put option: in the event of a poor harvest, the farmer could exercise a right to stop making debt repayments (Whaley (2006)). Similarly but somewhat later, Aristotle recounts the story of the Greek philosopher Thales, who expected an unusually large olive harvest and secured the right, but not the obligation, to use all the olive presses in the ancient Greek city of Miletus for the following year (Aristotle (2000)). So, in a sense, market risk has been with us for millennia.
Moving to the present day, the global financial crisis exposed fault lines in the Basel II market risk framework. The framework’s low capital requirement for market risk was far eclipsed by the market risk losses of many banks. As a stop-gap response, the Committee introduced a set of revisions (the so-called “Basel 2.5” framework). These sought to reduce the framework’s cyclicality and increase the overall level of capital. There was a particular focus on instruments exposed to credit risk (including securitisations), where the previous regime had been found especially lacking.
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Why has it taken so long to complete the market risk framework?
After several years of work that included multiple consultations and quantitative impact studies (QIS), the Committee published a revised standard for the market risk framework in January 2016 (BCBS (2016)). As part of finalising the Basel III framework last year (BCBS (2017)), ongoing challenges in implementing certain bank capital reforms were acknowledged by the Group of Governors and Heads of Supervision (GHOS), the Committee’s oversight body. Accordingly, the GHOS endorsed the Committee’s proposal to extend the implementation date of the revised market risk framework from 2019 to 1 January 2022 (for both the implementation and first regulatory reporting date for the revised framework).
Deferring its implementation will also align the framework’s starting date with those of the Basel III revisions for credit risk and operational risk. It will give banks more time to develop the systems needed to apply it.
More recently, the Committee issued a consultation paper in March proposing changes to the revised market risk framework. These include revisions to the calibration of certain elements of the standardised approach, and to the assessment process that determines whether a bank’s internal risk management models appropriately reflect the risks of individual trading desks (BCBS (2018b)).
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Where do we go from here?
So where does this leave us, 25 years since the Committee’s initial consultation on market risk? I’ll make three concluding remarks:
- The revised market risk framework will represent a major improvement to the pre-crisis regulatory framework. The framework will address many of the fault lines exposed by the global financial crisis. The main elements of the revised framework finalised in 2016 are in a stable shape, and the Committee is focused on finalising the few remaining outstanding issues in a timely manner this year.
- In doing so, an important consideration for the Committee is whether the framework adequately balances simplicity, comparability and risk sensitivity. Will the Committee need to consider whether simpler and more robust approaches should be included in the revised market risk framework?
- There is a clear expectation for full, timely and consistent implementation of the Basel III standards. This includes the 1 January 2022 implementation date of the market risk framework, as reaffirmed last month by the G20 Finance Ministers and Central Bank Governors (G20 (2018)). So the Committee will increasingly be focused on meeting this expectation.
You can read the full version of the speech on the website of the BIS.
Source: https://www.bis.org/
