Trading Book

What Is a Trading Book?

A trading book is the portfolio of financial instruments held by a brokerage or bank. Financial instruments in a trading book are purchased or sold because of multiple factors. For instance, they may be bought or sold to work with trading activities for customers or to profit from trading spreads between the bid and ask prices, or to hedge against various forms of risk. Trading books can go in size from a huge number of dollars to several billions relying upon the size of the institution.

Fundamentals of a Trading Book

Most institutions utilize sophisticated risk metrics to oversee and alleviate risk in their trading books. Trading books function as a form of accounting ledger by tracking the securities held by the institution that are routinely bought and sold. Moreover, trading history information is followed inside the trading book by making a simple method for evaluating the institution's previous activities of associated securities. This contrasts from a banking book as securities in a trading book are not planned to be held until maturity while the securities in the banking book will be held long-term.

Securities held in a trading book must be eligible for active trading.

Trading books are subject to gains and losses as prices of the included securities change. Since these securities are held by the financial institution, and not by individual investors, these gains and losses impact the financial wellness of the institution straightforwardly.

Impact of Trading Book Losses

The trading book can be a source of huge losses inside a financial institution. Losses emerge due to the very high degrees of leverage employed by an institution to build the trading book. One more source of trading book losses is lopsided and highly focused bets on specific securities or market sectors by deviant or rogue traders.

Trading book losses can have a flowing, global effect when they hit various financial institutions simultaneously, for example, during the Long-Term Capital Management, LTCM, Russian debt crisis of 1998, and the Lehman Brothers bankruptcy in 2008. The global credit crunch and financial crisis of 2008 was fundamentally owing to the many billions of losses supported by global investment banks in the mortgage-backed securities portfolios held inside their trading books. During that crisis, Value at Risk (VaR) models were utilized to evaluate trading risks in trading books. Banks moved their risk from the banking book to trading books since VaR values are low.

Endeavors to camouflage mortgage-backed security trading book losses during the financial crisis eventually brought about criminal charges being brought against a former vice leader of Credit Suisse Group. In 2014, Citigroup Inc. purchased the commodity trading books held by Credit Suisse. Credit Suisse partook in the sale in response to regulatory pressure and their intent to lower their association in commodities investing.

Highlights

• Losses in a bank's trading book can affect the global economy, like those that happened during the 2008 financial crisis.
• Trading books are subject to gains and losses that influence the financial institution straightforwardly.
• Trading books are a form of accounting ledger that contains records of all tradeable financial assets of a bank.