RDP 9408: The Supervisory Treatment of Banks' Market Risk 7. Conclusion

The greatest impact of the new requirements will fall on those banks which are active in the equities, debt securities and foreign exchange markets. However, despite growth in banks' market-related activities, the size of banks' market exposures appears to be very small relative to traditional credit-related exposures. The size of any additional capital requirements to cover market risk is, therefore, likely to be correspondingly small. Further, with capital ratios of Australian banks currently averaging around 12 per cent, there would appear to be a large buffer of excess capital to meet any additional capital charges arising from market risk exposures.

However, there are two qualifications which should be made to that conclusion:

• as the size of market-related exposures increases relative to traditional credit-related risks, the important issue becomes not how much capital is generated by the proposals but whether these simple proposals represent an accurate measurement of the risks involved. In cases where banks conduct a wide range of market-related transactions, risk may be better measured by techniques which take into account correlations across products and currencies. Such complexities have not been introduced into this set of proposals. An additional factor to be considered is the extent to which the risk associated with more complex or exotic financial instruments can be captured within the relatively simple framework set out in the proposal; and
• interpretation of the empirical results has suggested that the proposed capital charges are conservative. This conclusion should be assessed in terms of the benchmark against which the charges are tested; 95 per cent confidence intervals of two-weekly movements (monthly for debt securities) in portfolio values based on historical market rates. The losses which would be incurred under exceptional market conditions (equivalent to the 1987 stockmarket crash) fall outside the 95 per cent confidence band. The proposed capital charges may be inadequate to cover such extreme market movements.