In July 2005, the Basel Committee on Banking Supervision (Basel Committee) and the International Organization of Securities Commissions reached an agreement which contained several improvements to the capital regime for trading book positions. The agreement was entitled The Application of Basel II to trading activities and the treatment of double default effects. Among the revisions was a new requirement for banks that model specific risk to measure and hold capital against default risk that is incremental to any default risk captured in the bank’s value-at-risk (VaR) model. The incremental default risk charge was incorporated into the trading book capital regime in response to the increasing amount of exposure in banks’ trading books to credit-risk related products (which are often illiquid) whose risk is not reflected in VaR.
In October 2007, the Basel Committee released for public comment guidelines for computing capital incremental default risk.
At its meeting in March 2008 the Basel Committee reviewed the comments it received on its guidelines and expanded the scope of the capital charge to capture not only price changes due to defaults but also other sources of price risk, such as those reflecting credit migrations and significant moves in credit spreads and equity prices.
There has now been published a Commission Services Staff Working Document that looks at possible changes to the trading book capital requirements.
The Commission Services is of the opinion that updating European capital requirements to broaden the scope of a capital requirement for incremental risks in institutions’ trading books is desireable. In particular in light of the recent market turmoil, institutions’ current VaR models have not performed as well as expected in periods of stressed markets.
The deadline for comments is 15 October 2008.
View Commission Services Staff Working Document - Possible changes to the trading book capital requirements, (PDF 67.5KB), 20 August 2008