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Recent market turmoil has compelled regulators to introduce new measures to help financial institutions meet the challenges of globalized financial markets. And firms themselves are looking for new ways to improve and tighten risk management. A close examination of the Basel Committee's new trading book requirements reveals how these new rules will have an impact on the way banks assign assets to both their trading and banking books. A key component of the new requirements is the Incremental Risk Charge (IRC). The inclusion of CDOs, CDSs and other structured and exotic products in the trading book inevitably produces a rise in default risk, correlation and skew risk. These are risks that ought to be captured in specific risk models.
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