FRTB: A Revolution Toward Transparency

ActiveViam |
January 28, 2021

Regulators almost never request a narrative from banks they monitor. However, in the complex network of international banking laws which must be followed, regulators seek more insight into the banks’ information – in the form of data transparency.

Flying without any visibility into the accuracy and completeness of regulatory reports, as well as without any analytical capabilities to help ensure regulatory compliance, leaves you vulnerable to financial, legal, and reputational risks. Additionally, operating in such a manner can invite unwanted regulatory scrutiny and increase the chance of not meeting the requirements of the Fundamental Review of the Trading Book (FRTB) regulations.

The Basel III Standardized Approach to the Fundamental Review of the Trading Book (FRTB) is one instance where a deep analytical dive is particularly needed.

A “black box” solution that does not allow you to see granular-level data and perform “What-If” scenarios also does not give you a firm grasp of your risk. This lack of transparency can lead to too much capital against risky assets – or not enough.

FRTB Challenges

The list of FRTB Regulation requirements includes:

  • Calculating the default risk charge (DRC)
  • Performing fund decomposition (the need to measure risk for each constituent of an index)
  • Reporting each bank entity as if it were a standalone

Default Risk Charge

The DRC is meant as a “catch-all” to account for risk related to the potential decline in the creditworthiness of the underlying value of security wrapped in another financial instrument.  For example, a bank would need to calculate the risk of a possible default by the issuer of that underlying security. This is known as the “jump-to-default” (JTD) risk.

Using train-of-thought analysis to adjust scenarios and test the resilience of certain investments affords a user the ability to see the impact on the bank’s capital charge. For the DRC, this means creating ‘What-If’ scenarios to change, for example, a ratings downgrade or maturity of a security, and scale the gross JTD risk and see the results.

ActiveViam FRTB Accelerator showing default risk charge for non-securitized loans by bucket and risk weights with jump-to-default risk and the total DRC in yellow:

FRTB Default Risk Charge

Fund Decomposition

Basel regulations require that banks analyze and set appropriate risk weights against individual stock names within an index. If a bank holds investments in the S&P 500, the risk methodology would have to include a risk profile for each of the underlying constituents in the index. Sweeping stock market volatility and chatter about “frothy” tech stocks may signal the need to map out individual stock risks anyway.

Once index decomposition is complete, ActiveViam’s FRTB solution aggregates the risks to offset the investment profile. Risk managers can calculate capital and perform ‘What-If’ analyses on aggregate exposures computed in different ways or classify them differently and test the impact on the portfolio and capital charge. The more precise the classification, the better for properly weighting risk and the less chance of incurring higher capital charges. This assures regulators you are in complete control of the bank’s investment profile and its impact on risk.

ActiveViam’s FRTB Accelerator broken out by economy type and capitalization:

FRTB Fund Decomposition

Standalone Reporting

One other requirement to point out is that the FRTB regulation requires banks to report all of their entities as standalones, which means they need to perform mass currency conversions in every geography in which they operate as well as aggregate all entities in the currency in which their home office is located.

In conclusion, the challenge posed by the Fundamental Review of the Trading Book (FRTB) goes beyond the need to process numerical data on a larger scale than ever before. The FRTB regulation requires financial institutions to make changes in how they measure, analyze and manage their trading activities from both a quantitative and qualitative perspective. 

Being FRTB compliant entails a thorough review of all existing processes, systems, and controls that are used to measure, analyze and manage trading activity, as well as the implementation of new procedures and technologies for data collection, storage, and analysis. Moreover, financial institutions must ensure that their risk management activities meet the stringent requirements of the Basel III FRTB regulation. The ability to have a clear view of the underlying trends and report them precisely is just as essential – and can be just as hard without the right tools.

We have helped Erste Bank and other clients meet the FRTB requirements by providing multi-jurisdictional support across regions. Read more about how ActiveViam implemented an FRTB project at Erste Bank.

ActiveViam’s FRTB solution serves as a guide for complex FRTB calculations and allows users to change risk factor inputs, test scenarios, and interpret a capital charge before it’s reported to regulators – all without losing performance.  If you would like to learn more about how our FRTB Accelerator can be used to build or replace your risk analysis and reporting system top to bottom, or simply complement your existing reporting capabilities with much-improved analytics read our FRTB Accelerator white paper.

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