FRTB Desk Approval, Expected Shortfall Eligibility, and SA Capital

Summary

The document clarifies how risk-factor eligibility for the internal expected shortfall model relates to approval of a trading desk for the Fundamental Review of the Trading Book internal models approach. The apparent sequencing problem is that a desk needs production model results to demonstrate profit-and-loss attribution and backtesting performance, yet the quoted rule describes eligibility after desk approval.

The answer explains that desks pursuing or holding internal-model approval operate internal models alongside the standardized approach. During the period used to establish profit-and-loss attribution evidence, a desk can run its models in production while calculating regulatory capital under the standardized approach. A desk already using the internal models approach may also need to revert to standardized capital calculations if its attribution test falls into the red zone, until it returns to the green zone. The note is a short procedural explanation; it does not detail all approval steps or regulatory criteria.

Key ideas

• Internal-model desks also maintain standardized-approach calculations under the described Basel III framework.
• A desk can run production models to build profit-and-loss attribution evidence while capital is calculated under the standardized approach.
• A desk with a red-zone attribution result may have to use standardized capital calculations until its status improves.
• Model operation and regulatory capital treatment can therefore occur at different stages.

Tags

# FRTB model eligibility of risk factors


# FRTB model eligibility of risk factors












Item 31.12 from FRTB's documentation states the following regarding risk factor eligibility for the expected shortfall model:

> A bank must determine which risk factors within its trading desks that have received approval to use the internal models approach as set out in [MAR32] are eligible to be included in the bank’s internal expected shortfall (ES) model for regulatory capital requirements as set out in [MAR33].

From this paragraph, I understand that it is only after getting a desk approved for the use of IMA that the risk factors can be deemed eligible for the expected shortfall model.

How is it possible given that the internal model needs to be up and running so to pass the P&L attribution test and backtesting, which are both necessary in order to be approved?

I think I'm a bit confused regarding the steps involved in that process.

## Answer by Frank Cho (score 2)

https://quant.stackexchange.com/a/76283

Desks approved for IMA will always need to run both internal models and SA calculations under Basel III, which is different to B2.5 where they can be on either internal models or SA. For getting IMA accreditation, there will need to be a period when a desk runs internal models in production to establish PLA evidence but would calculate capital under SA. Another example is when a desk is on IMA but its PLA status falls in the red zone, then they will have to calculate capital under SA until their PLA test is back into the green zone.

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.