Trading Book

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Trading Book

What Is a Trading Book?

A trade book is a brokerage or bank’s portfolio of financial products. Financial instruments in a trading book are bought and sold for a variety of reasons. They may be purchased or sold, for example, to expedite trading operations for clients, to benefit from trade spreads between bid and ask prices, or to hedge against various types of risk. Depending on the size of the organization, trading books may vary from hundreds of thousands of dollars to tens of billions of dollars.

Basics of a Trading Book

To monitor and minimize risk in their trading books, most institutions use sophisticated risk measures. Trading books serve as a kind of accounting ledger by monitoring the securities owned by the institution that are purchased and sold on a regular basis. Furthermore, trading history information is maintained inside the trading book by providing an easy method to evaluate the institution’s earlier activity with related securities. This varies from a banking book in that securities in a trading book are not designed to be maintained until maturity, while securities in a banking book are intended to be retained for a lengthy period of time.

Securities in a trading book must be open to active trade.

Trading books experience profits and losses when the values of the securities contained vary. Because these assets are owned by the financial institution rather than private investors, the profits and losses have a direct influence on the institution’s financial health.

Key Takeaways

  • Trading books are a kind of accounting ledger that includes details of all a bank’s tradeable financial assets.
  • Trading books are vulnerable to profits and losses that have a direct impact on the financial organization.
  • Losses in a bank’s trading book, such as those seen during the 2008 financial crisis, may have a cascade impact on the global economy.
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Impact of Trading Book Losses

A financial institution’s trading book may be a source of significant losses. Losses occur as a result of an institution’s use of exceptionally high levels of leverage to expand its trading book. Errant or rogue traders’ excessive and highly focused bets on certain securities or market sectors are another cause of trading book losses.

When multiple financial institutions are attacked at the same time, such as during the Long-Term Capital Management, LTCM, Russian debt crisis of 1998 and the Lehman Brothers collapse in 2008, trading book losses may have a cascading, worldwide impact. The worldwide credit crunch and financial crisis of 2008 were heavily influenced by hundreds of billions of dollars in losses incurred by global investment banks in mortgage-backed securities portfolios housed in their trading books. Value at Risk (VaR) models were employed to estimate trade risks in trading books during that crisis. Because VaR values are low, banks moved their risk from the banking book to the trading book.

Attempts to conceal mortgage-backed securities trading book losses during the financial crisis led in the filing of criminal charges against a former vice president of Credit Suisse Group. Citigroup Inc. bought Credit Suisse’s commodities trading books in 2014. Credit Suisse took part in the transaction in response to regulatory pressure and their desire to reduce their engagement in commodities investment.

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