Minimum Capital Requirements for Market Risk

A bank must assume constant positions over the one-year horizon, or 60 days in the context of designated equity sub-portfolios. The concept of constant positions has changed in the market risk framework because the capital horizon is now meant to always be synonymous with the new definition of liquidity horizon and no new positions are added when positions expire during the capital horizon. For securities with a maturity under one year, a constant position can be maintained within the liquidity horizon but, any maturity of a long or short position must be accounted for when the ability to maintain a constant position within the liquidity horizon cannot be contractually assured. 13.24 Default risk must be measured for each obligor. (1) Probabilities of default (PDs) implied from market prices are not acceptable unless they are corrected to obtain an objective probability of default. 51 (2) PDs are subject to a floor of 0.03%. 13.25 A bank’s model may reflect netting of long and short exposures to the same obligor. If such exposures span different instruments with exposure to the same obligor, the effect of the netting must account for different losses in the different instruments (eg differences in seniority). 13.26 The basis risk between long and short exposures of different obligors must be modelled explicitly. The potential for offsetting default risk among long and short exposures across different obligors must be included through the modelling of defaults. The pre-netting of positions before input into the model other than as described in [13.25] is not allowed. 13.27 The DRC requirement model must recognise the impact of correlations between defaults among obligors, including the effect on correlations of periods of stress as described below. (1) These correlations must be based on objective data and not chosen in an opportunistic way where a higher correlation is used for portfolios with a mix of long and short positions and a low correlation used for portfolios with long only exposures. (2) A bank must validate that its modelling approach for these correlations is appropriate for its portfolio, including the choice and weights of its systematic risk factors. A bank must document its modelling approach and the period of time used to calibrate the model. (3) These correlations must be measured over a liquidity horizon of one year. (4) These correlations must be calibrated over a period of at least 10 years. (5) Banks must reflect all significant basis risks in recognising these correlations, including, for example, maturity mismatches, internal or external ratings, vintage etc. 13.28 The bank’s model must capture any material mismatch between a position and its hedge. With respect to default risk within the one-year capital horizon, the model must account for the risk in the timing of defaults to capture the relative risk from the maturity mismatch of long and short positions of less than one-year maturity. 13.29 The bank’s model must reflect the effect of issuer and market concentrations, as well as concentrations that can arise within and across product classes during stressed conditions. 13.30 As part of this DRC requirement model, the bank must calculate, for each and every position subjected to the model, an incremental loss amount relative to the current valuation that the bank would incur in the event that the obligor of the position defaults. 13.31 Loss estimates must reflect the economic cycle; for example, the model must incorporate the dependence of the recovery on the systemic risk factors.