CRR III

What does CRR III mean for banks' market-risk capital requirements?

CRR III and Market Risk Capital Requirements: The FRTB in Practice

CRR III – formally Regulation (EU) 2024/1623 – entered into force on 1 January 2025 and is, without exaggeration, the most significant overhaul of the EU's bank capital framework since CRR I in 2013. For trading desks and capital markets businesses, the centrepiece is the Fundamental Review of the Trading Book (FRTB) – the Basel Committee's wholesale redesign of how market risk attracts regulatory capital, now codified in CRR III Articles 325 ff.

Why FRTB Matters: The Core Problem It Solves

The predecessor framework (the "Basel 2.5" rules still embedded in the original CRR) had well-documented weaknesses: the boundary between trading book and banking book was porous, Value-at-Risk as a risk measure failed to capture tail events properly, and internal models faced no consistent supervisory discipline across firms. FRTB addresses all three.

The Two-Track Approach: SA and IMA

Standardised Approach (SA) – now the mandatory baseline

The new SA is no longer the simple, blunt instrument of old. It is built around a Sensitivity-Based Approach (SBA) with three components:

  • Delta risk – captures the first-order price sensitivity across prescribed risk factors (interest rates, equity, FX, commodities, credit spreads)
  • Vega risk – covers option volatility exposure
  • Curvature risk – catches the non-linear component that delta misses for options books

On top of the SBA, two additional charges apply:

  • Residual Risk Add-On (RRAO): a surcharge for instruments with hard-to-model risks – gap risk, correlation risk, and exotic payoffs
  • Default Risk Charge (DRC): captures jump-to-default exposure for bonds and equities, separate from the spread-risk component in the SBA

Critically, the SA is now mandatory for all banks – even those approved for internal models must compute it, because it serves as a floor for the IMA output.

Internal Model Approach (IMA) – granular approval, tighter scrutiny

The IMA overhaul is equally fundamental:

  • Expected Shortfall (ES) replaces Value-at-Risk: ES at the 97.5th percentile looks at the average loss in the tail beyond the confidence level – it is inherently more sensitive to extreme events than the old 99th-percentile VaR
  • Liquidity horizons are instrument-specific, ranging from 10 trading days (for liquid large-cap equities) up to 120 trading days for illiquid positions; this alone significantly increases capital requirements for less liquid books compared to the uniform 10-day VaR horizon
  • Desk-level approval: there is no longer such a thing as a bank-wide IMA approval. Supervisors now approve (or reject) individual trading desks separately. A desk that fails can lose its IMA status and revert to the SA – creating strong internal incentives for model quality maintenance
  • P&L Attribution Test (PLAT): a regular statistical test comparing the risk-theoretical P&L from the model to the actual hypothetical P&L. Desks that fail the PLAT risk losing IMA approval
  • Backtesting: daily monitoring with a red/amber/green traffic-light scheme on the number of exceedances

The Boundary Question: Trading Book vs. Banking Book

This is perhaps the most operationally complex aspect of FRTB. CRR III sharpens the criteria for trading book assignment dramatically:

  • Clear classification rules: instruments must meet specific criteria – held with trading intent, actively managed, marked to market daily – to qualify for the trading book
  • Reclassifications are restricted: moving positions between books to manage capital costs is explicitly constrained; supervisory approval is required for any such reclassification, and additional capital charges apply
  • Practical implication: banks with structured products or illiquid derivatives that were sitting in the trading book under the old rules now face a binary choice – accept substantially higher market risk RWA under FRTB, or move positions to the banking book (which may trigger credit risk and IRRBB charges instead)

Capital Impact: How Much More?

The numbers are material:

Driver Estimated RWA Impact
Shift to ES + liquidity horizons Significantly higher for illiquid positions
Structural products / exotics (RRAO) Additional surcharge on top of SBA
Desk-level IMA fragmentation Desks without approval fall to SA – typically higher
Overall market risk RWA (G-SIBs) Deutlich höhere Anforderungen, especially structured products

For G-SIBs with significant trading operations, industry estimates put FRTB IT infrastructure costs alone at EUR 100–500 million per institution – reflecting the need for entirely new sensitivity calculation engines, desk-level P&L attribution systems, and data pipelines. Branchenverbände schätzen die gesamten CRR III-Umsetzungskosten für EU-Banken auf EUR 5–15 billion across capital models, IT, and reporting collectively.

Related Market Risk Reforms: CVA and SA-CCR

CRR III also brings two closely related capital charges that interact directly with trading book exposures:

  • CVA reform (Credit Valuation Adjustment): revised methodology for OTC derivative counterparty credit risk, moving away from internal models towards standardised approaches; particularly impactful for derivatives-heavy banks
  • SA-CCR (Standardised Approach for Counterparty Credit Risk): replaces the old Current Exposure Method (CEM) for non-cleared derivatives and repo-style transactions; generally results in higher capital consumption for derivatives-intensive institutions

The EU Timeline and Transition Rules

CRR III started with phased transition provisions for FRTB. The Output Floor phase-in (50% in 2025, rising to 72.5% by 2030) runs in parallel, and its interaction with market risk RWA adds further complexity to capital planning for trading-intensive banks.

The EBA has a mandate for approximately 100 new RTS/ITS/Guidelines under CRR III – many of them directly relevant to FRTB calibration, reporting templates, and the P&L attribution test criteria. Banks working through implementation are essentially running parallel streams: build the systems, navigate the EBA technical standards, and maintain capital adequacy throughout.

International Divergence: A Genuine Concern

The EU's FRTB implementation is broadly on track. The UK (PRA) is implementing its own version under Basel 3.1 with certain adjustments. The US remains the outlier: the Basel III Endgame proposal was fundamentally revised after industry pushback, with FRTB being subject to separate US-specific rules and a significantly delayed timeline. This creates genuine regulatory arbitrage risk – US banks with large EU-facing trading operations face different capital charges than their European competitors, which is a live issue for levelling competitive conditions in cross-border markets.

What Needs to Happen Internally

For a trading-intensive bank, the FRTB/CRR III market risk workstream requires action across multiple dimensions simultaneously:

  • Risk systems: sensitivity calculation infrastructure capable of producing the full SBA decomposition (delta/vega/curvature per risk class and bucket)
  • Desk structure: mapping of legal trading desks to FRTB desk definitions; decisions on which desks to run under IMA vs. SA
  • P&L Attribution: new daily PLAT process with governance and remediation procedures for amber/red desks
  • Data: clean, complete, and timely market data for all instruments in scope, including liquidity horizon classifications
  • Reporting: updated COREP market risk templates under the revised ITS
  • Capital planning: interaction between FRTB RWA, the Output Floor, and overall capital stack needs to be modelled across the full 2025–2030 phase-in path

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