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Market risk positions

Market risk

14.09.2018

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: 14 September 2018

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 Basel Committee on Banking Supervision responded to the financial crisis by introducing a more comprehensive framework for measuring market risk in 2009 (“Basel 2.5”), which saw the rollout of stressed VaR and IRC modelling, amongst other things.

The Basel Committee has since fundamentally revised the concepts and methods in both the standardised approach and the internal models-based approach and has 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. The finalised Basel framework is to be incorporated into the forthcoming review of the CRR.

To assess the internal models currently used by banks, the ECB launched its targeted review of internal models (TRIM) in February 2017. The objective of TRIM is to assess, with the aid of a uniform guide, whether internal models within the Single Supervisory Mechanism (SSM) are being used appropriately and to reduce unwarranted variability in the capital requirements calculated by internal models.

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