Anybody that runs a business must pay close attention to financial issues. You need to understand how changes in banking are likely to affect the future of your company.
One of the biggest changes that business owners have to be aware of is the Fundamental Review of the Trading Book or FRTB. This is going to change many aspects of your business, particularly in regards to managing your bank account. You will either need to prepare for these changes or start using an offshore bank if you don’t like them.
What Business Owners Must Understand About the FRTB
Among the regulatory compliance headaches that your bank may be anticipating in the near future, none may be as formidable as those related to the FRTB. FRTB is a regulation rolled out by the Basel Committee on Banking Supervision, or simply the Basel Committee, in 2016. It contains a set of standards that, when taken together, dictates how banks must measure their market risk exposure and adjust their capital requirements accordingly.
As of this writing, the current deadline for FRTB adoption is in January of 2023. In light of the race to meet FRTB requirements, you may be asking yourself: what’s the point of compliance, why should your bank prepare for the earliest possible adoption, and why should you invest in solutions like financial risk management software?
To answer your questions, here’s a quick briefer on the standard and what the Basel Committee hopes to achieve in its implementation across the global banking industry. The driving force behind FRTB, which is a more stringent and granular approach to measuring risk, may be extremely relevant to banks given past events—and given similar events that will likely impact the future of financial institutions.
As a business owner, there are a lot of ways that this can affect you. It can make it harder to get loans or mean that you have to pay more attention to banks that are meeting regulatory standards such as liquidity standards.
Also Read
What is the Rationale Behind FRTB, and What Does It Involve?
In launching FRTB, the Basel Committee aims to prevent a dark past from repeating itself. The catastrophe that inspired the drafting of FRTB proposals is none other than the global financial crisis of 2007–2008, which was driven in part by excessive risk-taking on the part of global financial institutions.
Previous measures from the Basel Committee, such as Basel II, were not enough to save banks on the verge of collapse due to their risk-taking behaviors. Cognizant of this, the Committee has since launched FRTB as a universal standard for capital and liquidity requirements. Implementation of the standard involves the following:
- That banks will engage in the computation of their capital requirements by the day, instead of by the month. In other words, banks will need an accurate view of both their capital requirements and imminent risks to their assets on a daily, near-real-time basis.
- That there will be a solid distinction between banking books and trading books. As a consequence, banks will have less flexibility in moving assets from one book to another. They will also be required to keep account of which assets belong to either book of business.
- That banks pay more attention to the capital reduction that may come out of their diversification and hedging activities.
- That banks shift to measuring expected shortfall instead of value-at-risk, given that the latter is a more coherent and more conservative measure of risk under stress. This means that banks will be more cognizant of—and ideally, better prepared for—the worst outcomes when they incur losses.
- That banks come to terms with the prospect of market illiquidity, or volatile liquidity horizons in challenging times.
- That banks use either a Standardized Approach (SA) or Internal Models Approach (IMA) to calculate their capital. Whichever approach they choose, banks are expected to meet the Committee’s strict criteria on the quality of their data and the thoroughness of their calculations.
The simplest way to understand FRTB is that it is a measure to help banks strive towards more credible capital outcomes, especially in times of uncertainty. And while full compliance will definitely be a challenge, it’s one that’s worth undertaking as soon as possible.
How Your Bank Can Prepare for Full FRTB Compliance
At the heart of your FRTB compliance program should be a deep understanding of the relationship between risk and your bank’s finances. Your overall goal should be to align your day-to-day comprehension of the two, even outside of your FRTB regulatory requirements.
One of the first steps you can take is to upgrade your current repertoire of technology for regulatory compliance, as it will allow you a full vantage point and full flexibility over the data you’ll be using to make computations. A reliable solution can improve your data architecture for FRTB compliance, automate key processes that are involved in compiling reports, and handle the complex numbers that govern your risk sensitivity, expected shortfall, and the like. After investing in a new tech stack, you’ll be poised to clear a number of obstacles in your FRTB compliance journey.
Next, you’ll want to determine whether you’ll be using SA or IMA to make decisions at your bank’s trading desk. The former may be easier to implement, but it’s also quite capital-intensive. The latter is less capital-reliant, but choosing it will mean that your bank has to submit additional regulatory requirements in order to prove the internal model’s accuracy. In particular, you will have to meet certain quantitative profit and loss attribution and back testing criteria from your regulators. The choice between SA and IMA will really depend on what your bank is better equipped for.
Lastly, you will need to pay special attention to the task of data governance for your FRTB compliance. This means following all the metrics, standards, and policies your bank has set for managing FRTB-related data assets. Instituting the right protocols for data governance, and designating the right people to take charge of oversight, will be crucial to the success of your compliance program.
Businesses Must Prepare for the Changes Brought on by the FRTB
A number of new financial regulations could affect your business. One of the biggest changes that business owners have to prepare for is the FRTB.
FRTB was conceptualized in the wake of the 2007–2008 financial crisis. At the time, it was hard for anyone to wrap their heads around something even more cataclysmic happening to the financial sector. But as everyone knows, a financial crisis of a wholly different tenor has been brought about by the COVID-19 pandemic. The industry is still reeling from the ongoing impact, which underscores the value of being proactive about future market risk exposure.
Take a leaf from the Basel Committee’s book and prepare for hard times before the fallout ruptures your bank’s financial situation. Be more responsive to your bank’s present and future risk situations, and don’t delay in complying with FRTB.