New Basel Regulations Will Increase Capital Constraints for Banks

• The upcoming Fundamental Review of the Trading Book (FRTB) regulation will impact the ability of EU-based banks to continue to operate principal-centric, front-office business and trading models for all asset classes.
• GreySpark analysis demonstrates the significant increase in capital banks will have to hold against their operations as a result of the regulation.

London – 5 May 2017 – GreySpark Partners presents a new report examining the impact of the FRTB on EU-based banks. Set for implementation in 2019, the new Basel regulation will ultimately hinder the ability of the sellside to maintain its regular scope of operations across all asset classes.

The report, The Fundamental Review of the Trading Book in the EU, provides analysis and guidelines on how to comply with the new regulation’s requirements to:

• separate banking and trading capitalisation and funding functions;
• establish global standards for the calculation of risk through the creation of two risk assessment models; and
• recalibrate the amount of time assets can be held onto within the banks.

The new risk assessment models will require every asset class and trading desk affected by the regulation to increase the amount of capital held against their operations. GreySpark believes that banks will be forced to review and reconfigure their business models to determine which trading desks will remain profitable and which should be closed outright.

In order to better assess the cost constraints that the FRTB will place on bank front-office business and trading models, GreySpark ran a series of hypothetical scenarios for a portfolio amounting to approximately USD 1bn in value using both risk assessment models to demonstrate the impact of the FRTB. The results indicated that:

• the portfolio would be required to increase the amount of capital held by USD 87mn, of which roughly 83% would be new charges under the FRTB;
• the amount of capital held against operations are 60% and 126% higher under the new risk assessment models; and
• while one risk assessment model – the Internal Models Approach – results in a lower capital requirement, it is hard to maintain the regulatory approval required for its use.

GreySpark anticipates that banks will shed their riskier assets and decrease their risk-taking behaviour in the attempt to remain profitable.

Aliana Greenberg, GreySpark analyst consultant, said: “The implementation of the FRTB and its impact on sellside business and trading models means that many banks may no longer be able to take risk in the marketplaces for key asset classes. As a result, algorithmic or high-frequency trading hedge funds that currently compete with Tier I and Tier II banks for client market share in those asset classes could soon take advantage of the opportunity to pick up the mantle of risk-taking that banks will leave behind and position themselves as leading market-makers.”