FRTB: A Revolution Toward Transparency

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Regulators rarely ask the banks they supervise to tell them a “story”. But within the vast chain of interlocking global financial regulations that banks are required to meet, that is precisely what regulators are seeking – in the form of data transparency.

Flying blind with a solution that coughs up regulatory reports on cue without any analytical capabilities not only leaves you vulnerable to risk but invites regulatory scrutiny.

The Basel III Standardized Approach to the Fundamental Review of the Trading Book (FRTB) is one instance where a deep analytical dive is particularly needed.

ActiveViam’s FRTB solution serves as a guide for the complex FRTB calculations and allows users to change risk factor inputs, test scenarios and interpret a capital charge before it’s reported to regulators – all without losing performance.

A “black box” solution that does not allow you to see granular-level data and perform “What-If” scenarios also does not give you a firm grasp of your risk. This lack of transparency can lead to holding too much capital against risky assets – or not enough.

FRTB Challenges

The list of FRTB requirements include:

  • Calculating the default risk charge (DRC)
  • Performing fund decomposition (the need to measure risk for each constituent of an index)
  • Reporting each bank entity as if it were a standalone

Default Risk Charge

The DRC is meant as a “catch-all” to account for risk related to the potential decline in the creditworthiness of the underlying value of a security wrapped in another financial instrument, as an example. A bank would need to calculate the risk of a possible default by the issuer of that underlying security. This is known as the “jump-to-default” (JTD) risk.

Using train-of-thought analysis to adjust scenarios and test the resilience of certain investments affords a user the ability to see the impact on the bank’s capital charge. For the DRC, this means creating ‘What-If’ scenarios to change, for example, a ratings downgrade or maturity of a security and scale the gross JTD risk and see the results.

Below is a screenshot from the FRTB Accelerator showing the default risk charge for non-securitized loans by bucket and risk weights with jump-to-default risk and the total DRC in yellow:

Fund Decomposition

Basel regulations require that banks analyze and set appropriate risk weights against individual stock names within an index. If a bank holds investments in the S&P 500, the risk methodology would have to include a risk profile for each of the underlying constituents in the index.  Sweeping stock market volatility and chatter about “frothy” tech stocks may signal the need to map out individual stock risks anyway.

Once index decomposition is complete, ActiveViam’s FRTB solution aggregates the risks to offset the investment profile. Risk managers can calculate capital and perform ‘What-If’ analyses on aggregate exposures computed in different ways or classify them differently and test the impact on the portfolio and capital charge. The more precise the classification, the better for properly weighting risk and the less chance of incurring higher capital charges. This assures regulators that you are in complete control of the bank’s investment profile, and its impact on risk.

Below is a screenshot from the FRTB Accelerator showing the equity delta risk charge per desk (left) and, in a pie chart (right), broken out by economy type and capitalization:

Standalone Reporting

Last but most certainly not all, the FRTB regulation requires banks to report all of their entities as standalones, which means they need to perform mass currency conversions in every geography in which they operate as well as aggregate all entities in the currency in which their home office is located.

In sum, the FRTB challenge does not only reside in crunching numbers on a larger scale than before. The ability to have a clear view of the underlying trends and report them precisely is just as essential – and can be just as hard without the right tools.

ActiveViam has helped Erste Bank and other clients meet the FRTB requirements by providing multi-jurisdictional support across regions. Read more about how ActiveViam implemented an FRTB project at Erste Bank.

And read our FRTB Accelerator white paper.