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

Orla McCullagh, Mark Cummins, Sheila Killian

Research output: Contribution to journalArticlepeer-review

Abstract

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.
Original languageEnglish
JournalJournal of Money, Credit and Banking
Early online date28 Feb 2023
DOIs
Publication statusE-pub ahead of print - 28 Feb 2023

Keywords

  • Basel III
  • fundamental review of the trading book
  • risk management
  • portfolio management
  • value-at-risk
  • P&L attribution tests

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