Compliance with Basel 2.5: banks’ approaches to implementing stressed VaR

Author:Lukasz Prorokowski, Hubert Prorokowski
Position:Rogue Consulting, Lukas Biosurgery, London, UK; University of San Francisco, San Francisco, California, USA
Pages:339-348
SUMMARY

Purpose - The purpose of this paper is to outline how banks are coping with the new regulatory challenges posed by stressed value at risk (SVaR). The Basel Committee has introduced three measures of capital charges for market risk: incremental risk charge (IRC), SVaR and comprehensive risk measure (CRM). This paper is designed to analyse the methodologies for SVaR deployed at different banks to highlight the... (see full summary)

 
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Compliance with Basel 2.5:
banks’ approaches to
implementing stressed VaR
Lukasz Prorokowski
Rogue Consulting, Lukas Biosurgery, London, UK, and
Hubert Prorokowski
University of San Francisco, San Francisco, California, USA
Abstract
Purpose – The purpose of this paper is to outline how banks are coping with the new regulatory
challenges posed by stressed value at risk (SVaR). The Basel Committee has introduced three measures
of capital charges for market risk: incremental risk charge (IRC), SVaR and comprehensive risk measure
(CRM). This paper is designed to analyse the methodologies for SVaR deployed at different banks to
highlight the SVaR-related challenges stemming from complying with Basel 2.5. This revised market
risk framework comes into force in Europe in 2012. Among the wide range of changes is the requirement
for banks to calculate SVaR at a 99 per cent condence interval over a period of signicant stress.
Design/methodology/approach The current research project is based on in-depth, semi-
structured interviews with nine universal banks and one nancial services company to explore the
strides major banks are taking to implement SVaR methodologies while complying with Basel 2.5.
Findings – This paper focuses on strengths and weaknesses of the SVaR approach while reviewing
peer practices of implementing SVaR modelling. Interestingly, the surveyed banks have not indicated
signicant challenges associated with implementation of SVaR, and the reported problems boil down to
dealing with the poor quality of market data and, as in cases of IRC and CRM, the lack of regulatory
guidance. As far as peer practices of implementing SVaR modelling are concerned, the majority of the
surveyed banks utilise historical simulations and apply both the absolute and relative measures of
volatility for different risk factors.
Originality/value The academic studies that explicitly analyse challenges associated with
implementing the stressed version of VaR are scarce. Filling in the gap in the existing academic
literature, this paper aims to shed some explanatory light on the issues major banks are facing when
calculating SVaR. In doing so, this study adequately bridges theory and practice by contributing to the
erce debate on compliance with Basel 2.5.
Keywords Banks, Basel 2.5, Market risk capital charge, Stressed VaR
Paper type Research paper
1. Introduction
The global nancial crisis has reinforced the need to improve the existing regulatory
framework for credit institutions to strengthen risk management frameworks. In the
light of many weaknesses in these frameworks exposed by the nancial crisis, the Basel
Committee on Banking Supervision has implemented several amendments to the
regulatory framework governing the trading book. The committee introduced three new
measures to capture movements in the market risk prole because of credit deterioration
and stressed environments:
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1358-1988.htm
Banks’
approaches to
implementing
stressed VaR
339
Journal of Financial Regulation and
Compliance
Vol. 22 No. 4, 2014
pp. 339-348
© Emerald Group Publishing Limited
1358-1988
DOI 10.1108/JFRC-10-2013-0038

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