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On Tuesday, the Basel Committee on Banking Supervision (BCBS), in conjunction with the International Organization of Securities Commissions (IOSCO), proposed changes in the way risk in the trading book is to be treated and issued Guidelines for Computing Capital for Incremental Risk in the Trading Book for public comment.
The BCBS have been consulting on how to calculate regulatory capital for incremental default risk (the excess risk over default risk already reflected in the VaR model) since last October. However they now view that a simple incremental default risk charge would not have avoided the recent credit crisis losses which resulted from credit migrations, the widening of credit spreads and the loss of liquidity. The BCBS are proposing expanding the scope of the regulatory capital charge with an incremental risk charge (IRC) that captures defaults, credit migrations, liquidity risks and significant changes in credit spreads and equity prices. The BCBS also plans to run an impact quantitative impact study of the IRC on firms' capital requirements.
"Major banking organisations have experienced significant losses over the last year, most of which were sustained in banks' trading books" stated Nout Wellink, Chairman of the Basel Committee and President of the Netherlands Bank. "Against this backdrop, the Basel Committee's incremental risk proposal will better align regulatory capital requirements with the risk exposure of banks' trading book positions."
Christopher Cox, chairman of IOSCO's Technical Committee and Chairman of the SEC said "The market turmoil has had a severe impact on many commercial and investment banks. The incremental risk guidelines and related changes to the Basel II Framework will contribute to a safer and sounder financial system."
Comments were invited by 15th October 2008 and it is proposed to implement changes by 1st January 2010 with an additional year for firms to incorporate all the proposed risks into their IRC models. However an interim requirement is planned to fill the gap till end 2010 and this will be issued later this year.
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