What RBI’s new market risk framework means for banks

The Reserve Bank of India (RBI) has issued the Directions on Minimum Capital Requirements for Market Risk 2026, introducing a revised market risk capital framework for commercial banks effective April 1, 2027. The framework brings India closer to Basel standards and provides a more standardised and transparent approach to measuring and capitalising trading-book risks under the Simplified Standardised Approach (SSA).

A key feature of the framework is its alignment with the Investment Directions, 2025, which provide a clearer definition of Held for Trading (HFT) assets. For investment book exposures, only positions classified as HFT fall within the trading book and attract market risk capital requirements. HTM (Held to Maturity), AFS (Available for Sale), non-HFT FVTPL (Fair Value Through Profit or Loss) exposures, and investments in subsidiaries, joint ventures, and associates remain in the banking book and are generally excluded from market risk capital calculations, except where specific requirements such as foreign exchange risk apply.

The Directions also reinforce the boundary between the trading and banking books. Reclassifications cannot be used to reduce regulatory capital requirements. Where positions are transferred between books, banks must compare pre- and post-transfer capital requirements and retain any resulting capital benefit as a Pillar 1 surcharge for the life of the position.

While global standards permit banks to calculate market risk capital using advanced internal models, the RBI has opted for a simplified standardised framework that is better aligned to the scale and complexity of most Indian banks while placing emphasis on the integrity of the trading book and banking book boundary, governance and documentation of internal risk transfers.

Key changes to market risk capital calculations

The revised framework updates the treatment of net open positions, foreign exchange risk, interest rate specific risk, and investment funds held in the trading book.

Internal risk transfers receive tighter regulatory treatment. Transfers from the trading book to the banking book are not recognised for capital purposes. For general interest rate risk (GIRR), however, the trading-book leg may be recognised where transactions are properly documented and routed through a dedicated internal risk transfer desk.

One of the most significant changes relates to equity risk. Equity positions attract a 9% specific-risk charge on the gross position and a 9% general market risk charge on the net position. Combined with the revised 3.5 scalar, the effective capital charge on a standalone net equity position increase to 63%, representing a substantial rise relative to the existing framework. Short positions remain prohibited except through approved derivatives or Government Securities.

The treatment of foreign exchange risk has also been expanded. FX risk, including gold positions, now applies to both trading-book and banking-book exposures and includes overseas capital and surplus positions. Banks may exclude qualifying structural foreign currency positions held for non-dealing purposes, subject to prescribed conditions including a minimum six-month holding period.

AT1 and Tier 2 instruments will now attract a flat 12% specific-risk charge, irrespective of issuer credit rating, replacing the current maturity- and rating-based methodology. This may increase capital requirements for exposures to stronger issuers while reducing them for certain weaker ones.

Debt mutual funds and ETFs may be treated as debt exposures only where they are open-ended, invest at least 90% of assets in debt instruments, publish monthly constituent-level information, and provide daily NAV disclosures. Funds that do not satisfy these conditions must be treated entirely as equity exposures.

Equity and fund exposures likely to drive impact

The capital impact is expected to vary significantly across institutions. For banks with predominantly debt-based trading portfolios and limited equity exposures, where interest rate risk is the primary driver of market risk, the overall increase in capital requirements is likely to be modest. However, portfolios containing complex multi-underlier instruments or investment funds that cannot satisfy look-through requirements may face materially higher capital charges under the revised rules.

Banks with significant overseas operations may also experience higher foreign exchange capital requirements as overseas capital and unremitted surplus will now form part of the net open position unless institutions establish qualifying structural FX exclusion frameworks, supported by appropriate policies, documentation, and quarterly currency-level assessments.

The most pronounced impact is likely to be on equity-intensive portfolios, where higher scalars significantly increase effective capital requirements. The framework also strengthens controls against regulatory capital arbitrage by tightening requirements governing book classification, internal risk transfers, and position reclassifications.

What it means for banks

Banks that begin implementation planning early are likely to be better positioned for the transition. Key priorities include:

• Reassessing trading-book vs. banking-book classifications and tightening controls against capital-driven reclassification

• Quantifying capital impacts arising from equity positions, investment funds, and AT1/Tier 2 holdings

• Enhancing governance over internal risk transfers, including documentation and operational arrangements for GIRR transfers

• Developing fund look-through capabilities to support debt treatment and identify exposures that may default to equity treatment

• Establishing structural FX exclusion frameworks and supporting processes for daily capital calculations on both solo and consolidated bases

• Reviewing portfolio strategy and capital allocation, including limits, pricing, and RWA-adjusted returns across affected asset classes

• Strengthening management reporting, controls, and disclosures to support supervisory expectations under the revised framework

The road ahead

With implementation scheduled for April 1, 2027, the framework provides banks an opportunity to align the capital allocation more closely with underlying market risks while strengthening the governance and discipline surrounding trading-book activities. As major regulators such as the PRA, Federal Reserve/OCC, and ECB move towards revised market risk frameworks over 2027-28, the RBI’s reforms position Indian banks to remain broadly aligned with evolving global regulatory standards.

(The author Partner – Financial Services Risk Consulting, EY India. Views are personal.)