FRTB meets Barbenhiemer, “Now I am become death, destroyer of desks”

How can banks embrace complex Basel III regulations as a source of competitive advantage?

This year not only not brought gave us the Barbie and the Oppenheimer film, which gave birth to the meme, Barnenheimer, where watching both movies, often back-to-back, became a trend; this has parallels with banks having to run multiple Market Risk capital models on the same trading desk to satisfy.

Better Liquidity, Capital and Risk Management

Fifteen years after the 2008 global financial crisis, that shock sent atomic shock waves across every financial corner of the world. Banks regarded as “too big to fail” collapsed the relationship between banks changed forever. The GFC centred around the combination of the following factors:

1.?????? Banks had too much leverage

2.?????? Banks held inadequate liquidity buffers

3.?????? Poor governance

4.?????? Poor risk management

5.?????? Inadequate incentives across product lines

Lessons were learnt, and the new principles for strengthening the stability of the banking system were set with closer working between regulators and banks, particularly in times of crisis under the revised Basel III framework strengthening the three Pillars introduced in Basel II. The focus on good compliance by large and medium-sized banks now extended to all banks due to the interconnected nature of global markets.

Focus on Pillar 1, Capital calculations included a complete overhaul of the market risk framework, known as the Fundamental Review of the Trading Book, FRTB, which resulted in some of the most complex and controversial aspects of the Basel III framework with the original Jan 2016 standard being revised due to industry push back in Jan 2019. ?

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FRTB is a fantastic example of the difficulty in setting and implementing regulatory change for regulators and banks.

The complexity is conveyed in the different regulatory standards required for banks depending on their size and importance to the stability of the financial markets.

The complexity of FRTB lies in new models for Market Risk capital and the fact that it affects the bank at every level, from the boardroom to specific risk factors with trades. ?Subject to regulatory approval, small banks can use the simplified approach as a carry-through of the standardised approach from Basel II. All other banks must produce sensitivity-based Standardised Approach (FRTB-SA) calculations for every trading desk based on sensitivities delta, vega and curvature across all asset classes. Banks can nominate desks for internal model (IMA) treatment subject to approval based if they demonstrate stringent P&L alignment (PLAT) between risk and Front Office; Backtesting at the bank (VaR) and quality of risk factors, with additional stressed capital add-ons for Non Modellable Risk Factors (NMRF), gaps in the risk factor time-series.

Protecting the franchise – setting risk appetite and trading strategies

The legendary American physicist Julius Robert Oppenheimer became known as the “father of the atomic bomb” due to his role in the Manhattan Project at the Los Alamos Laboratory in the US where nuclear bombs were developed. On seeing the first nuclear explosion on July 16th, 1945, Oppenheimer noted the reactions of those around him: a few laughed, a few cried but most were silent. ?On reading the FRTB regulations for the first time: a few laughed, a few cried but most were not silent!

Oppenheimer was interested in Sanskrit and the sacred Hindu scripture, the Bhagavad Gita. On seeing the brightness and power of the nuclear explosion reminded him of the words of Lord Krishna’s (Vishnu) call to arms to his warrior prince, Arjuna. Lord Krishna revealed his true form and power before battle, citing:

“Now, I am become death, destroyer of worlds.”

Equally, like Oppenheimer on first reading the FRTB regulations, I came to the realisation:

“FRTB: Now, I am become death, destroyer of desks.”

The regulatory focus moved from the Bank legal entity level to include more frequent ongoing regulatory scrutiny affecting every trading desk in the bank at the trade and risk factor level

This has a profound effect on the bank's business and hedging strategies as the executive management team and trading heads will have to balance the profitability of the trading desk against the cost of the additional regulatory burden required. Diversification in trading is crucial to sound trading principles.

Jurisdictional Variance and Target Operating Model Impacts

July 2023, the US Basel III rules were finally released, including FRTB. The Jurisdictional variance between different regulatory implementations of the same Basel III FRTB principles presents further challenges for banks.

Banks need to review who does what and when regarding people, processes and technology required considering the impact of FRTB. The extent they embrace implementing this complex regulation will dictate the competitive advantage achieved. FRTB is not for the faint hearted.

Multi-year, multi-year global programs requiring 100s of people worldwide can be used as a catalyst for positioning the bank into a strategically better place. The build v buy decision will be made based on the complexity and resources available for the bank. In some cases, banks may decide to implement a simpler business model. This is the challenge of balancing innovation v regulation.

1.?????? FRTB requires the ability of the trading infrastructure to support parallel running as part of the model approval process.

2.?????? FRTB needs to exploit existing in-flight regulatory programs such as BCBS 239 to fix data gaps in trade, market, and reference data to reduce punitive capital charges for gaps in data.

3.?????? FRTB needs scalable storage to handle the volume of trade and risk factor data required for a production environment that supports excellent granularity. This is an opportunity to move to Cloud-based solutions and review silo data pain points.

4.?????? FRTB requires the necessary computing power to support new capital calculators for generating market risk capital across each asset class and existing VaR-based back-testing processes. ?

5.?????? FRTB requires reviewing resources considering automation, agile methods and more efficient processes to meet additional regulatory burdens within the same trading day or reporting cycle.?

Like the Barbie and Oppenheimer films, banks must decide their world view; Simplicity or complexity. Implemented correctly, FRTB can be a source of real competitive advantage. It all depends on the pain and the price they are prepared to get there.

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IBAM Consulting provides strategic, regulatory and technical consulting resources with in depth expertise to ensure a smooth transition to achieve that goal from program inception to model approval we are here to help.

For more details about our services and capabilities please contact Jonathan Astbury? + 44 7809226922 email: [email protected]

This article is a summarised extract of the forthcoming book, Delivery Regulatory Change by Satinder Jandu.