The Basel Committee on Banking Supervision (see Basel [2009 a]) released the new guidelines for Incremental Risk Charge (IRC) that are part of the new rules developed in response to the financial crisis and is a key part of a series of regulatory enhancements being rolled out by regulators.

IRC supplements existing Value-at-Risk (VaR) and captures the loss due to default and migration events at a 99.9% confidence level over a one-year capital horizon. The liquidity of position is explicitly modeled in IRC through liquidity horizon and constant level of risk (see Xiao[2017]).

The constant level of risk assumption in IRC reflects the view that securities and derivatives held in the trading book are generally more liquid than those in the banking book and may be rebalanced more frequently than once a year (see Aimone [2018]).  IRC should assume a constant level of risk over a one-year capital horizon which may contain shorter liquidity horizons. This constant level of risk assumption implies that a bank would rebalance, or rollover, its positions over the one-year capital horizon in a manner that maintains the initial risk level, as indicated by the profile of exposure by credit rating and concentration.

The current market risk capital rule is:

+ basic specific risk capital (1)

where

General market risk capital = 3 x

Basic specific risk capital = 3 x

Specific risk surcharge = (m – 3) x

where m is the specific risk capital multiplier under regulators’ guidance

The new market risk capital standard will be: