survive market risk losses. Since January 1998^33 banks in the countries that are
members of the BIS can calculate their market risk exposures in one of two ways.
The first is to use a simple standarized framework (to be discussed below). The sec-
ond, with regulatory approval, is to use their own internal models, which are similar
to the models described above. However, if an internal model is approved for use in
calculating capital requirements for the FI, it is subject to regulatory audit and cer-
tain constraints. Before looking at these constraints, we examine the BIS standard-
ized framework for, respectively, fixed-income securities, foreign exchange, and eq-
uities. Additional details of this model can be found at the BIS Website, http://www.bis.org.
(a) Fixed Income. We can examine the BIS standardized framework for measuring
the market risk on the fixed-income (or debt security) trading portfolio by using the
example for a typical FI provided by the BIS (see Exhibit 8.8). Panel A in Exhibit 8.8
lists the security holdings of an FI in its trading account. The FI holds long and short
positions in—column (3)—various quality debt issues—column 2—with maturities
ranging from one month to over 20 years—column (1). Long positions have positive
values; short positions have negative values. To measure the risk of this trading port-
folio, the BIS uses two capital charges: (1) a specific risk charge—columns (4) and
(5)—and (2) a general market risk charge —columns (6) and (7).
(i) Specific Risk Charge. The specific risk charge is meant to measure the risk of a
decline in the liquidity or credit risk quality of the trading portfolio over the FI’s
holding period. As column (4) in panel A of Exhibit 8.8 indicates, treasuries have a
zero risk weight, while junk bonds (e.g., 10–15 year nonqualifying “Non Qual” cor-
porate debt) have a risk weight of 8%. As shown in Exhibit 8.8, multiplying the ab-
solute dollar values of all the long and short positions in these instruments—column
(3)—by the specific risk weights— column (4)—produces a specific risk capital or
requirement charge for each position—column (5). Summing the individual charges
for specific risk gives the total specific risk charge of $229.^34
(ii) General Market Risk Charge. The general market risk charges or weights—
column (6)—reflect the product of the modified durations and interest rate shocks ex-
pected for each maturity.^35 The weights in Exhibit 8.8 range from zero for the 0–1
month Treasuries to 6% for the long-term (longer than 20 years to maturity) quality
corporate debt securities. The positive or negative dollar values of the positions in
each instrument—column (3)—are multiplied by the general market risk weights—
8.6 REGULATORY MODELS: THE BIS STANDARDIZED FRAMEWORK 8 • 19(^33) The requirements were introduced earlier in 1996 in the European Union.
(^34) Note that the risk weights for specific risks are not based on obvious theory, empirical research, or
past experience. Rather, the weights are based on regulators’ perceptions of what was appropriate when
the model was established.
(^35) For example, for 15–20 year Treasuries in Exhibit 8.8 the modified duration is assumed to be 8.75
years, and the expected interest rate shock is 0.60%. Thus, 8.75 ×0.6 = 5.25, which is the general mar-
ket risk weight for these securities shown in Exhibit 8.8. Multiplying 5.25 by the $1,500 long position in
these securities results in a general market risk charge of $78.75. Note that the shocks assumed for short-
term securities, such as 3-month T-bills, are larger (at 1%) than those assumed for longer maturity secu-
rities. This reflects the fact that short-term rates are more impacted by monetary policy. Finally, note that
the standardized model combines unequal rate shocks with estimated modified durations to calculate
market risk weights. Technically, this violates the underlying assumptions of the duration model which
assumes parallel yield shifts at each maturity.