ement and (2) a market, or systematic, risk element. The BIS charges for unsystem-
atic risk by adding the long and short positions in any given stock and applying a 4%
charge against the gross position in the stock (called the xfactor). Suppose stock num-
ber 2, in Exhibit 8.10, is IBM. The FI has a long $100 million and short $25 million
position in that stock. Its gross position that is exposed to unsystematic (firm-specific)
risk is $125, which is multiplied by 4% to give a capital charge of $5 million.
Market or systematic risk is reflected in the net long or short position (the so-
calledyfactor). In the case of IBM, this risk is $75 million ($100 long minus $25
short). The capital charge would be 8% against the $75 million, or $6 million. The
total capital charge (xfactor + yfactor) is $11 million for this stock.
This approach is very crude, basically assuming the same systematic risk factor
() for every stock. It also does not fully consider the benefits from portfolio diver-
sification (i.e., that unsystematic risk is not diversified away).
8.7 BIS REGULATIONS AND LARGE BANK INTERNAL MODELS. As discussed pre-
viously, the BIS capital requirement for market risk exposure introduced in January
1998 allows large banks (subject to regulatory permission) to use their own internal
models to calculate market risk instead of the standardized framework. However, the
required captial calculation has to be relatively conservative compared to that pro-
duced internally. A comparison of the BIS requirement for large banks using their in-
ternal models with RiskMetrics indicates the following in particular.
- In calculating DEAR, the FI must define an adverse change in rates as being in
the 99th percentile rather than in the 95th percentile (multiply by 2.33 rather
than by 1.65 as under RiskMetrics). - The FI must assume the minimum holding period to be 10 days (this means that
RiskMetrics’ daily DEAR would have to be multiplied by ).
The FI must consider its proposed captial charge or requirement as the higherof:- The previous day’s VAR (value at risk or DEAR × ).
- The average daily VAR over the previous 60 days times a multiplication factor
2102108.7 BIS REGULATIONS AND LARGE BANK INTERNAL MODELS 8 • 23Once a bank has calculated its net position in each foreign currency, it converts each posi-
tion into its reporting currency and calculates the risk (capital) measure as in the following
example, in which the position in the reporting currency (dollars) has been excluded:
Yen* DM GB Fr fr SW fr
+50 +100 +150 –20 –180+300 –200The capital charge would be 8 percent of the higher of the longs and shorts (i.e., 300).
*All currencies in $ equivalents.
Source:BIS, 1993. http://www.bis.org.
Exhibit 8.9. Example of the BIS Standardized Framework Measure of Foreign Exchange
Risk (in millions of dollars).