The Basel Committee on Banking Supervision issued a revised capital framework to purportedly better account for market risk by banks. In doing so, the Committee proposed changes to the requirements for internal models that might be utilized by banks to calculate risk, as well as changes to a standardized model that is used by default by banks not using internal models. Among other things, internal models would be required to utilize a new measure of risk – Expected Shortfall – instead of the traditional Value at Risk and stressed Value at Risk models. Expected Shortfall, according to BCBS, “measures the riskiness of a position by considering both the size and the likelihood of losses above a certain confidence level” – better capturing tail risks (i.e., extraordinarily unlikely risks) that BCBS argues are not adequately captured in current VaR measures. In addition, the new framework provides for a more “granular” internal model review process, requires approval “down to the level of the regulatory trading desk,” and limits the capital-reducing impact of hedging and diversification. BCBS estimates that, overall, its new framework will cause the amount of bank’s risk weighted assets attributed to market risk to increase to 10 percent from 6 percent. According to a statement issued by the International Swaps and Derivatives Association, Inc. and two other industry organizations, “Overall, we are concerned that despite the BCBS’s reiteration not to significantly increase overall capital requirements, trading book capital will increase by 40 percent under the new rules based on the BCBS’s impact assessment. We worry that the rules may have a negative effect on banks’ capital markets activities and reduce market liquidity.” (Click here to access ISDA’s statement.)