Basel III is the global framework for bank capital regulation, developed by the Basel Committee on Banking Supervision in response to the 2008 financial crisis. Its core purpose is ensuring banks hold enough capital to absorb losses without requiring taxpayer bailouts. For the markets business, Basel III shapes the cost of every trade through its impact on how much capital the bank must set aside against its derivatives, bond, and securities positions.
What regulatory capital is
Regulatory capital is the equity buffer that absorbs losses before depositors and creditors are affected. The Basel III framework requires banks to hold minimum levels of capital relative to their risk-weighted assets — the bank's assets adjusted by risk weights that reflect their probability and severity of loss.
The framework distinguishes between tiers of capital by quality. Common Equity Tier 1 (CET1) — ordinary shares and retained earnings — is the highest quality and most loss-absorbing. Tier 2 capital — subordinated debt and certain other instruments — is lower quality. The minimum requirements apply at each tier and in aggregate.
The impact on the markets business
Every trading book position consumes regulatory capital. Market risk capital covers the risk of loss from market moves on the bank's trading positions. Counterparty credit risk capital covers the risk of loss from a derivatives counterparty defaulting. CVA capital covers the risk of loss from mark-to-market changes in CVA itself.
When a trader executes a trade, the regulatory capital cost of that trade is real and material. This cost must be recovered in pricing — through the bid-offer spread or through explicit XVA charges. Trades that consume more capital (illiquid instruments, long-dated derivatives with large potential exposures, positions in high-risk counterparties) must generate more revenue to justify their capital consumption.
FRTB: the next generation
The Fundamental Review of the Trading Book (FRTB) is a major overhaul of the market risk capital framework, introducing more risk-sensitive approaches to capital calculation and tighter limits on internal model use. FRTB has materially raised capital requirements for complex trading book positions, reshaping which products banks can profitably offer.
The specific minimum capital ratios, the G-SIB surcharge framework, and the detailed mechanics of FRTB's Internal Models Approach and Standardised Approach are covered in Market Mechanics — the complete plain-English guide to how a bank's markets business works.