FRTB Standardised Approach: AI-Supported Basel III Standardised Approach Optimisation and Market Risk Capital Calculation

The FRTB Standardised Approach (SA) is the new framework for calculating own-funds requirements for market risk in the trading book. Developed by the Basel Committee on Banking Supervision (BCBS) under the Fundamental Review of the Trading Book, it replaces the previous net-position-based standard method.

The key difference lies in the calculation methodology: instead of flat net positions, the FRTB SA uses a Sensitivities-Based Method (SbM). Banks compute the sensitivities of their trading book positions to defined risk factors — delta, vega and curvature — and aggregate them across seven risk classes.

The three pillars of the capital requirement are:

In the EU, the FRTB SA is implemented through CRR III (Regulation 2024/1623) and has been mandatory since January 2025.

The Sensitivities-Based Method (SbM) forms the core of the FRTB Standardised Approach. It calculates the capital charge based on the sensitivities of each trading book position to prescribed risk factors.

The three risk measures of the SbM:

1. Delta sensitivities: Measure the linear price change of a position for a small move in a risk factor (e.g. interest rate, spread, equity price). They are calculated per risk factor and bucket, then multiplied by regulatory risk weights.

2. Vega sensitivities: Capture the volatility risk of options and option-like instruments. Vega measures the value change when implied volatility shifts.

3. Curvature sensitivities: Capture non-linear risks beyond delta — such as gamma risk for options. Calculated through full revaluation of the position under large upward and downward risk factor moves.

The seven risk classes are: General Interest Rate Risk (GIRR), Credit Spread Risk (CSR) non-securitised, CSR securitised (non-CTP), CSR securitised (CTP), Equity, Commodity and Foreign Exchange (FX).

Aggregation uses three correlation scenarios (low, medium, high), with the maximum result taken as the capital requirement.

Delta, vega and curvature are the three risk measures of the Sensitivities-Based Method in the FRTB Standardised Approach:

Delta risk describes the linear sensitivity of a position to small movements in the risk factor. For a bond, the delta to the interest rate is the modified duration. For equities, it is typically the market value itself. Delta sensitivities are calculated per risk-factor bucket and scaled by regulatory risk weights.

Vega risk measures sensitivity to changes in implied volatility. It primarily affects options and structured products with embedded optionality. The calculation uses the value change when implied volatility shifts by one relative unit.

Curvature risk captures non-linear effects that delta does not cover — such as gamma risk for options. It is calculated through full revaluation of the position under large upward and downward risk factor shifts. The curvature risk amount equals the difference between the actual value change and the delta-approximated change.

Each risk measure has specific risk weights, bucket assignments and correlation parameters prescribed by the Basel Committee and CRR III.

The Default Risk Charge (DRC) is the second pillar of the capital requirement under the FRTB Standardised Approach. It covers the default risk of credit and equity positions in the trading book that is not fully captured by the Sensitivities-Based Method.

The DRC calculation covers three categories:

1. DRC for non-securitised positions: Based on Jump-to-Default (JTD) losses, weighted by regulatory risk weights per rating category. Netting within the same obligor is permitted under certain conditions.

2. DRC for securitisations (non-CTP): Also uses JTD amounts with adjusted risk weights reflecting the tranche structure.

3. DRC for the Correlation Trading Portfolio (CTP): Separate rules for index tranches and single-name CDS, accounting for correlation effects.

DRC risk weights range from 0.5% (AAA) to 100% (defaulted). A hedging benefit is recognised when long and short positions exist against the same obligor.

ADVISORI implements the DRC calculation including the correct JTD netting logic and supervisory risk weight tables.

The Residual Risk Add-On (RRAO) is the third pillar of the FRTB Standardised Approach. It provides a flat capital surcharge for instruments whose risk profiles are not adequately captured by either SbM or DRC.

The RRAO applies to two categories:

1. Instruments with exotic underlyings: Including weather derivatives, longevity risk and instruments whose underlying cannot be assigned to any of the seven risk classes. Risk weight: 1.0% of gross notional.

2. Instruments with other residual risks: Including instruments with gap risk (e.g. barrier options, digital options), correlation risk or behavioural uncertainty (e.g. prepayment risk in MBS). Risk weight: 0.1% of gross notional.

Supervisors may exempt institutions from the RRAO on application, provided the residual risk is demonstrably covered by internal models. In practice, this exemption is rarely granted.

ADVISORI assists with the identification of RRAO-liable instruments, notional amount calculation and supervisory documentation.

The FRTB Standardised Approach defines seven risk classes across which all sensitivities are calculated and aggregated:

1. GIRR (General Interest Rate Risk): General interest rate risk. Buckets by currency, risk factors by tenor nodes (0.25Y to 30Y) and inflation/cross-currency basis.

2. CSR non-sec (Credit Spread Risk, non-securitised): Credit spread risk for bonds, CDS and other non-securitised credit instruments. Buckets by sector (sovereigns, financials, corporates etc.).

3. CSR sec non-CTP: Credit spread risk for securitisations outside the Correlation Trading Portfolio. Buckets by tranche type and underlying.

4. CSR sec CTP: Credit spread risk for the Correlation Trading Portfolio (index tranches, bespoke CDOs). Separate bucket structure and correlation parameters.

5. Equity: Equity risk. Buckets by market capitalisation and economic sector. Sensitivities to spot price and repo rate.

6. Commodity: Commodity risk. Buckets by commodity group (energy, metals, agriculture etc.). Sensitivities to spot price and basis spreads.

7. FX (Foreign Exchange): Foreign exchange risk. Sensitivities to FX spot rates against the reporting currency.

Each risk class has its own risk weights, bucket definitions and correlation matrices. The final capital requirement results from aggregation across all classes.

ADVISORI guides banks and investment firms through the complete implementation of the FRTB Standardised Approach — from regulatory gap analysis to ongoing reporting.

Our services include:

As an advisory firm focused on regulatory implementation, we combine deep subject matter expertise with project experience at banks of all sizes.