The Reserve Bank of India has released draft guidelines for minimum capital requirements for market risk for consultation as part of efforts to align its regulations for banks with Basel III norms.

The capacity of banks to move instruments between the banking book and the trading book at their discretion after first designation is strictly regulated by the draught rules, subject to criteria. It is strictly forbidden to move instruments between the banking and trading books in order to engage in regulatory arbitrage. Shifting should be uncommon in practise and will only be permitted under rare circumstances.

Examples can be significant, well publicised occurrence, such as a bank reorganisation that necessitates ending the relevant business activity for the instrument or portfolio, or a change in accounting standards that permits an item to be evaluated at fair market value through P&L. Market occurrences, changes in a financial instrument’s liquidity, or a change in trading intention alone are not sufficient justifications for moving an item to a different book.

In no event or situation may a capital profit from moving be permitted. This means that the bank must ascertain its overall capital need both before and just after the shift (across the banking book and trading book). If this move results in a lower capital requirement, the bank will be required to pay a reported Pillar 1 capital surcharge equal to the difference as calculated at the time of the transition. In a way that has been agreed upon with the Department of Supervision, RBI, this fee will be permitted to run off when the positions mature or expire.

Switching between books requires approval from the bank’s board and the department of supervision.

An internal risk transfer is a record of a risk transfer made through internal derivatives trades between the banking and trading books.

Internal risk transfers from the trading book to the banking book will not be subject to regulatory capital recognition. As a result, when determining the regulatory capital requirements, a bank’s internal risk transfer from the trading book to the banking book (for instance, due to economic considerations) would not be taken into account.

Banks must compute risk-weighted assets for market risk using the standard methodology under the recently released draft.

The capital need determined by the standardised method is the simple total of the capital requirements determined by each of the three risk classes, namely interest rate risk, equity risk, and foreign exchange risk.

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