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         IV. The standardised methodology


Proposal To Issue A Supplement To The Basel Capital Accord To Cover Market Risk

IV. The standardised methodology

14. Alongside the work on models, the Committee has reviewed its April 1993 proposal as a basis for setting capital requirements for the market risks of those banks not using comprehensive internal models (the "standardised measurement method"). The way in which it plans to introduce the requirements is set out in detail in Part A of the attached Supplement.

15. The April 1993 proposal was intended to introduce specific capital charges to be applied: (i) to the current market value of open positions (including derivative positions) in debt securities and equities in banks' trading books, and (ii) to banks' total currency positions in respect of foreign exchange risk. The proposals for debt securities and equities were based upon the so-called "building-block" approach which differentiates requirements for specific risk (i.e. the risk of loss caused by an adverse price movement of a security due principally to factors related to the issuer of the security) from those for general market risk (i.e. the risk of loss arising from adverse changes in market prices).

16. Two changes of substance have been made to the April 1993 proposal. One arises from the fact that banks' trading in commodities and particularly in commodity derivatives have been growing rapidly in recent years. The Committee now sees the omission of any capital charges for commodities risk for banks as a potentially serious gap in the April 1993 framework. A proposal for measuring and applying capital requirements to commodities risk is therefore contained in Section A.4 of the attached Supplement. Since this is the first time the market has seen a proposal to measure commodities risk and it is not an easy risk to measure, comments are specially invited in this area.

17. The second significant change concerns the treatment of options. A number of alternative suggestions for measuring the price risk in options were flagged in the April 1993 paper, together with an invitation for specific comments on this matter. The Committee is conscious that measurement of options risk is a complex matter in which banks have at present very different capabilities, but it believes that banks which are trading even modestly in options should have the capability to measure the risks accurately. After careful review of the views expressed by the industry, the Committee has concluded that a number of different alternatives should be permitted within the standardised methodology at supervisors' discretion. Three of these alternatives are described in A.5 of the Supplement to the Accord. However, banks which are significant traders in options will be expected over time to move to a comprehensive options risk management model under the terms of Part B of the Supplement for their options positions and the associated underlyings. The Committee is willing to work with the industry to develop improved measurement of options risk.

18. In addition, a number of minor changes have been made to the proposal for the standardised method. One of these is purely cosmetic in that the provisions for the use of comprehensive risk factor models for foreign exchange have been moved to the models section, so that all banks using comprehensive models will be subject to the same qualitative and quantitative standards. Another relatively minor point is that, in order to take account of the criticism that greater accuracy is not being recognised, those using the so-called "duration method" in measuring general market risk for traded debt securities will now have vertical disallowances of half the size of the "maturity" method. Details of the other minor changes to the building-block framework set out in the April 1993 proposals can be found in Part A of the Supplement.


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