Market risk

Pursuant to the Capital Requirements Regulation (CRR), credit institutions are required to hold own funds for market risk to cover foreign exchange risk and commodities risk in their non-trading and trading books as well as position risk (risk of positions in debt and equity instruments) in their trading book. They can use either the standardised approach or internal risk models to calculate their market risk.

The capital requirements under the standardised approach are regulated by Articles 326 to 361 of CRR. These provisions describe the calculation methods used to determine the capital charge for instruments of every risk category. Furthermore, there are regulatory technical standards, implementing technical standards, and guidelines for individual topics (see below).

The rules for the capital requirements for internal market risk models can be found in Articles 362 to 377 of CRR. Only with permission from the competent authorities may institutions use internal risk models for one or more risk categories alongside or instead of the standardised approaches.

Credit institutions permitted to use their own market risk models

The following institutions have been granted permission to use an internal risk model to calculate capital charges or partial capital charges for market risk positions pursuant to Article 363 of CRR:

  • Commerzbank AG
  • Deka Bank Deutsche Girozentrale
  • Deutsche Bank AG
  • DZ Bank AG
  • HSBC Trinkaus & Burkhardt AG
  • Landesbank Baden-Württemberg
  • Landesbank Hessen-Thüringen Girozentrale
  • Norddeutsche Landesbank - Girozentrale
  • UniCredit Bank AG

Last updated: 30 June 2019

The procedure to be followed when models are changed or extended is set forth in a regulatory technical standard. Material extensions or changes to internal models need to be approved. If a non-material change or an extension needs to be made to an approved risk model, the authorities must be notified and separate permission by the competent authorities may be necessary.

The own funds requirements under an internal model approach are composed of various elements which each have to be determined according to certain calculation rules. Credit institutions are always expected to calculate value-at-risk (VaR) and stressed VaR figures (stressed VaR). Institutions that model the specific risk of debt instruments are additionally required to calculate the capital charge for default and migration risk (incremental risk charge, or IRC). They can choose to include all listed equity positions and derivatives positions based on listed equities in the calculation of the capital charge for default and migration risk. Institutions also have the option of determining their capital charge for the correlation trading portfolio using an internal model (comprehensive risk measure, or CRM).

Institutions are required to carry out daily back-testing on hypothetical and actual changes in the portfolio value and count the overshootings as described in Article 366 of CRR. The number of overshootings is used to generate a (quantitative) addend on the multiplication factor for the VaR and stressed VaR figures. The multiplication factor amounts to at least three, but it can be higher if there are any qualitative flaws. The addend derived from the number of overshootings identified during back-testing takes a value between 0 and 1 as defined per Table 1 in Article 366 of CRR.

The introduction of Stressed VaR and the modelling of default and migration risk (IRC, see above) were part of a more comprehensive overhaul of the framework for measuring market risk (“Basel 2.5”) introduced by the Basel Committee on Banking Supervision 2009 in response to the financial crisis.

In February 2017, the ECB initiated a project for a targeted review of internal models (Targeted Review of Internal Models, or TRIM). Goal of TRIM is to assess adequacy of internal models used within the SSM with a consistent guide and to reduce the non-risk driven variability of model-based capital requirements.

After the planned investigations in the area of market risk models had been conducted, the guide was adjusted to reflect insights, publicly consulted and published in its final version by ECB on 8 July 2019.

Since then, the Basel Committee has fundamentally revised the concepts and methods in both the standardised approach and the internal models-based approach and refined the trading book definition. The resulting new Basel framework for market risk – the Fundamental Review of the Trading Book (FRTB) – was published in January 2016. Modifications to the FRTB were published for consultation in the second quarter of 2018 and changes were published in January 2019.

In the EU, the new FRTB regulations are implemented in a phased manner. As a first step, the application of the FRTB by institutions will start in the form of a reporting obligation for the FRTB standardised approach one year after the adoption of a delegated act of the European Commission (deadline for this is 31.12.2019, Article 461a CRR2). The internal models-based approach will be introduced three years after the publication of the last of the four Core RTS in the EU Official Journal (in accordance with Article 430b (3) CRR2). However, for a certain transitional period, the own funds will continue to be calculated on the basis of the rules currently in force. The concrete form of the new own funds requirement will be the subject of a legislative proposal which the European commission is expected to present by mid-2020.

Note on backtesting according to Art. 366 CRR

For the purposes of the interpretation of Art. 366 CRR, BaFin and Bundesbank generally refer to the ECB guide to internal models. 

The guide was prepared in close cooperation with the national competent authorities of the Single Supervisory Mechanism and takes on board experience made in the targeted review of internal models (TRIM) project. The guide aims to ensure a common understanding of the existing legal framework on internal models. The final version was published by the ECB on 8 July 2019 following a public consultation. In particular when it comes to aspects of the determination of hypothetical and actual changes in value, the calculation of the supervisory addend and the business days for supervisory back-testing, which were previously described in the guidance notice concerning supervisory backtesting of internal models (rescinded), BaFin and Bundesbank now refer to the ECB guide to internal models instead - this also applies to institutions classified as less significant and investment firms which are not directly supervised by the ECB. Requirements relative to other aspects previously described in the guidance notice, such as the quarterly delivery of the time series, the reporting process and the notification and analysis of overshootings, are communicated to the less significant institutions concerned in an individual letter.