The RBI has released a new circular on Minimum Capital Requirements for Market Risk. Market risk is the risk of loss to a bank because the market value of its financial assets or liabilities changes due to movements in market prices.
A bank should not reclassify an instrument between the trading book and the banking book with the intention of reducing its capital requirement or for regulatory arbitrage. If an instrument is reclassified between the two books, whether the decision is made by the bank or happens due to circumstances beyond the bank’s control, such as delisting of an equity, the bank must calculate its total capital requirement immediately before and after the reclassification. If the reclassification results in a reduction in the total capital requirement, the bank must maintain the difference as a disclosed Pillar 1 capital surcharge, in addition to the normal capital requirement applicable to the book where the instrument has been reclassified. The bank is not required to calculate this Pillar 1 capital surcharge on an ongoing basis.
When a bank hedges the interest rate risk of its banking book using an internal risk transfer with its trading book, the trading book part of the transfer will be treated as a trading book instrument under the market risk framework only when certain conditions are met. First, the bank must properly document the internal risk transfer, including the banking book interest rate risk being hedged and the sources of that risk. Second, the internal risk transfer must be carried out through a dedicated “GIRR internal risk transfer desk” that has been specifically approved by the Department of Supervision, RBI for this purpose. Third, this dedicated desk must meet the trading book capital requirements under the market risk framework on a standalone basis. Its capital requirements must be calculated separately from other GIRR and other market risks arising from the bank’s trading book activities.
A bank may enter into internal risk transfers between the CVA portfolio and the trading book. Such a transfer has two parts: the CVA portfolio side and the non-CVA portfolio side. If the CVA portfolio side is recognised under the CVA risk capital requirement, it will not be included in the market risk capital requirement. However, the non-CVA portfolio side will be included in the market risk capital requirement. For such an internal CVA risk transfer to receive regulatory capital recognition, the bank must properly document the transfer. The documentation should clearly mention the CVA risk being hedged and the sources of that risk.
A bank should not calculate foreign exchange risk capital requirements for any position that has already been deducted from its regulatory capital. This also applies to any position used to hedge such a deducted position. While calculating market risk capital requirements, the bank should not include capital instruments that have already been deducted from regulatory capital or have been assigned a 1250% risk weight. This includes the bank’s own eligible regulatory capital instruments, as well as eligible regulatory capital instruments of other banks and financial entities and intangible assets that have been deducted from regulatory capital. A bank should also not apply market risk capital requirements to securities that have already matured but remain unpaid, or securities that have been classified as non-performing assets or investments. Such securities will attract capital requirements only for credit risk.
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