FRTB and the Fixed Income Desk

Even with the revised 2023 deadline, banks are heavily involved in FRTB and one interesting challenge is what is known as Heisenberg’s Uncertainty Principle (yes, Walter White’s alias lol). Initially for quantum mechanics, we can broadly apply it to view Basel’s Fundamental Review of the Trading Book regulations’ impact on Fixed Income.

Heisenberg states that you cannot know both a particle’s position and momentum at the same time, in other words, the more precisely the position is determined, the less precisely momentum can be determined.

Now let’s apply this to asset class. When you think fixed income-anything, generally, you’d imagine less risky than its equities counterpart which would occupy the other end of the riskiness spectrum. But for capital purposes, under the Standardised Approach, this assumed lack of risk must be measured directly.

While FRTB was not intended to increase the bank’s capital costs, the December 2020 Basel Monitoring Report suggests that the weighted average overall capital increase will be significant: 47.9% for Group 1 banks, 53.1% for G-SIBs and 30.9% for Group 2 banks (i.e. banks that have Tier 1 capital of less than €3 billion or are not internationally active).

The ICMA suggests that much of the capital increase is due to FRTB requirements and will impact the banks’ intermediation services for bonds and other securities. Unless the bank can give at least some indication of what’s in the fund (FI), FRTB-SA treats the fund as a generic equity holding, with the highest possible risk weight.