Finance Watch has responded to the European Commission’s Consultation on the implementation of the new market risk framework under Basel III standards. After last year’s postponement, it is now time to finalise implementation and strengthen the resilience of EU financial institutions – and, by extension, the EU financial market – against impending financial volatility.
The Fundamental Review of the Trading Book (FRTB) has been designed to address inherent limitations of the current market risk internal models, notably the Value-at-Risk (VaR) and Stressed Value-at-Risk (SVaR) approaches. These models fail to adequately capture tail risks and liquidity risks, leading to an underestimation of market risk in times of stressed market conditions for institutions using the Internal Models Approach (IMA).
Given escalating geopolitical tensions, we are likely to experience more stressed market conditions. The EU Commission’s role is crucial in ensuring the sustainability of the EU financial system. As we navigate potentially volatile times, a robust market risk framework is indispensable. While the FRTB may appear conservative in certain aspects, it is essential to safeguard society from another financial crisis. Considering the essential investment needs of the EU related to its climate objectives, innovation, and defence, ensuring the stability of the financial system and its ability to keep financing the economy should be a political priority. The EU cannot afford to repeat a taxpayer-sponsored bailout of private banks due to the underestimation of risk.
The decision by other jurisdictions to delay the FRTB implementation at the risk of financial instability is a gamble that the EU should not take. The foreseen implementation of the FRTB has already provided banks with the lead time to enhance their risk management frameworks, including transparency, data pipelines, automation, simplification and consistency between front office and risk modelling. Embracing the FRTB should be viewed as an opportunity for improvement, not merely a cost.
