The fundamental review of the trading book: implications for portfolio and risk management in the banking sector

The Fundamental Review of the Trading Book (FRTB) is the promised overhaul of bank market risk regulation. FRTB retains the authorised use of proprietary risk models, however, it introduces two additional criteria: (i) P&L attribution (PLA) tests, and (ii) desk-level backtests. We examine empirically whether these additional criteria influence risk management and portfolio management practice, specifically portfolio construction and choice of risk model. We find that the PLA tests demand significant alignment with risk factors, however, the backtests do not incentivise use of superior risk models. This has important implications for the efficacy of the capital-based regulatory system.