A comparison of the original and revised Basel market risk frameworks for regulating bank capital

Recognizing that many banks suffered trading losses that notably exceeded their minimum capital requirements during the recent crisis, the Basel Committee on Banking Supervision (2011) revised its regulatory framework for trading portfolios. In this paper, we compare: (1) the relative effectiveness of risk management systems based on the original and revised frameworks in controlling tail risk; and (2) the relative adequacy of these frameworks in setting minimum capital requirements. Our main findings are as follows. First, both systems allow the selection of portfolios with substantive tail risk, but one based on the revised framework tends to be less effective in controlling tail risk. Second, the minimum capital requirements set by the revised framework are much less likely to be wiped out by trading losses than those set by the original framework. Hence, on balance, the revised framework improves upon the original framework. We also suggest further improvements for consideration by bank regulators.

► We compare the original and revised frameworks for regulating bank trading portfolios. ► Both frameworks base minimum capital requirements on portfolio tail risk. ► The revised framework tends to be less effective in controlling portfolio tail risk. ► Minimum capital required by revised framework provides more protection from losses. ► On balance the revised framework improves upon the original framework.