Minimum Capital Requirements for Market Risk

Besides a higher capital requirement for any outcomes that place the bank in the backtesting amber zone, in the case of severe problems with the basic integrity of the model, SAMA may consider whether to disallow the bank’s use of the model for market risk capital requirement purposes altogether. 12.15 If a bank’s model falls into the backtesting red zone, SAMA will automatically increase the multiplication factor applicable to the bank’s model or may disallow use of the model. Backtesting at the trading desk level 12.16 The performance of a trading desk’s risk management model will be tested through daily backtesting. 12.17 The backtesting assessment is considered to be complementary to the PLA assessment when determining the eligibility of a trading desk for the IMA. 12.18 At the trading desk level, backtesting must compare each desk’s one-day VaR measure (calibrated to the most recent 12 months’ data, equally weighted) at both the 97.5th percentile and the 99th percentile, using at least one year of current observations of the desk’s one-day P&L. (1) An exception or an outlier occurs when either the actual or hypothetical loss of the trading desk registered in a day of the backtesting period exceeds the corresponding daily VaR measure determined by the bank’s model. Exceptions for actual losses are counted separately from exceptions for hypothetical losses; the overall number of exceptions is the greater of these two amounts. (2) In the event either the P&L or the risk measure is not available or impossible to compute, it will count as an outlier. Volatility scaling of returns for VaR calculation at the discretion of the bank that result in a shorter observation period being used is not allowed. A bank may scale up the volatility of all observations for a selected (group of) risk factor(s) to reflect a recent stress period. The bank may use this scaled data to calculate future VaR and expected shortfall estimates only after ex ante notification of such a scaling to SAMA. 12.19 If any given trading desk experiences either more than 12 exceptions at the 99th percentile or 30 exceptions at the 97.5th percentile in the most recent 12-month period, the capital requirement for all of the positions in the trading desk must be determined using the standardised approach. 47 47 Desks with exposure to issuer default risk must pass a two-stage approval process. First, the market risk model must pass backtesting and PLA. Conditional on approval of the market risk model, the desk may then apply for approval to model default risk. Desks that fail either test must be capitalised under the standardised approach. PLA Test Requirements 12.20 The PLA test compares daily risk-theoretical P&L (RTPL) with the daily HPL for each trading desk. It intends to: (1) measure the materiality of simplifications in a banks’ internal models used for determining market risk capital requirements driven by missing risk factors and differences in the way positions are valued compared with their front office systems; and (2) prevent banks from using their internal models for the purposes of capital requirements when such simplifications are considered material. 12.21 The PLA test must be performed on a standalone basis for each trading desk in scope for use of the IMA. Definition of profits and losses used for the PLA test and backtesting