Revisions to the Basel II market risk framework - updated as of 31 December 2010

Since the financial crisis began in mid-2007, an important source of losses and of the build up of leverage occurred in the trading book. A main contributing factor was that the current capital framework for market risk, based on the 1996 Amendment to the Capital Accord to incorporate market risks, does not capture some key risks. In response, the Basel Committee on Banking Supervision (the Committee) supplements the current value-at-risk based trading book framework with an incremental risk capital charge, which includes default risk as well as migration risk, for unsecuritised credit products. For securitised products, the capital charges of the banking book will apply with a limited exception for certain so-called correlation trading activities, where banks may be allowed by their supervisor to calculate a comprehensive risk capital charge subject to strict qualitative minimum requirements as well as stress testing requirements. These measures will reduce the incentive for regulatory arbitrage between the banking and trading books.

An additional response to the crisis is the introduction of a stressed value-at-risk requirement. Losses in most banks' trading books during the financial crisis have been significantly higher than the minimum capital requirements under the former Pillar 1 market risk rules. The Committee therefore requires banks to calculate a stressed value-at-risk taking into account a one-year observation period relating to significant losses, which must be calculated in addition to the value-at-risk based on the most recent one-year observation period. The additional stressed value-at-risk requirement will also help reduce the procyclicality of the minimum capital requirements for market risk.

The document has been updated as of 31 December 2010 to reflect the adjustments to the Basel II market risk framework announced by the Basel Committee in its 18 June 2010 press release and the stress testing guidance for the correlation trading portfolio referred to in paragraph 9 of the July 2009 version of this document. Changes introduced by the Basel III framework are not yet reflected in the text.

In the separate document "Interpretive issues with respect to the revisions to the market risk framework" (latest version from November 2011), the Committee provides responses to interpretive issues regarding the Revisions to the Basel II market risk framework and the Guidelines for computing capital for incremental risk in the trading book. Updated versions of this document will be published on the Committee's website if and when additional interpretive issues arise.