Research Discussion Paper – RDP 9408 The Supervisory Treatment of Banks’ Market Risk
December 1994
Abstract
In April 1993, the Basle Committee on Banking Supervision released a series of consultative papers relating to the supervisory treatment of market risk within banks' trading portfolios. The papers proposed a method of allocating capital to cover risk from banks' trading positions in debt securities and equities, as well as exposure to foreign exchange risk across the entire bank. This study assesses the efficacy of the proposed methods for measuring risk and allocating capital to exposures from traded debt securities, traded equities and foreign exchange. The analysis draws on actual portfolio data from banks, as well as random hypothetical portfolios, measured against historical movements in debt and equity prices and exchange rates. The conclusions drawn are broadly that the capital charges generated under the proposed methods are conservative, when measured against historical changes in portfolio values. In the case of the debt securities and foreign exchange proposals, the capital charges are reasonably well correlated with risk in portfolios; higher risk portfolios attract higher capital charges. However, in the case of the equity risk proposal, this relationship is not as strong.