A Review of the Fundamentals of the Fundamental Review of the Trading Book II: Asymmetries, Anomalies, and Simple Remedies

Abstract

In this paper we highlight some anomalies in both the standardized approach (SA) and the internal models approach (IMA) of the FRTB that may not be well-known. These anomalies may be unintentional and simply require clarification or rewording of the FRTB text. Alternatively they may be aspects that were not fully considered from certain angles. We here wish to highlight the potential for unintended consequences of ignoring them. They vary in the the degree to which they impact capital, and they can grossly misstate risk in either direction. Indeed, we demonstrate in many cases that the framework can record high risk when there is none, or record zero risk when the risk is high. We offer simple adjustments to eliminate these problems. None of our suggestions require new calibration or a material change to the framework, but merely minor modifications to the wording of the text, that can restore logical consistency. It is our hope that this paper will assist both regulators and practitioners in a productive dialog.

Keywords: FRTB, market risk, Standardized Approach, Fundamental Review, Trading Book, Internal Models Approach

JEL Classification: G28, G01, G21, C00, C02, C54