Banking book & Trading book

"Book" in banking is very widely used term. Book is nothing but smallest trades organizing entity that holds some particular trades. Books gets created based on different criteria such as trader, accounting treatment, risk methodology treatment , legal entity and etc. All books are normally arranged in hierarchy.
Classification of banking book and trading book is very important for risk and accounting treatment. BCBS committee guidelines have different risk computation treatment for banking and trading book.

Trading book should contains all trades that are traded with intent of making profit through market price movement, hold for short term resale, lock in arbitrage profit or to hedge other trading book positions. Trading books needs to be valued at fair value daily, mark to market daily.Under BCBS guidelines capital charge for trading book gets calculated using VaR, SVaR and IRC.The value-at-risk for assets in the trading book is calculated at a 99% confidence level based on a 10-day time horizon.
Banking book should contains all positions that have been taken with intent of holding them till m

aturity. Banking books does not need to be valued at fair value daily, no mark to market daily. Assets can be on balance sheet at their historic values. Capital charge for banking book gets calculated from RWA (risk weighted assets).The value-at-risk for assets in the banking book are calculated at a 99.9% confidence level on a one-year horizon.

Currently there are no specific rules are defined to classify trades into banking and trading books. It has been left to banks to decide the intent of trading and classify the trade accordingly. Until Basel 2 guidelines there was a huge capital advantage in keeping trade in trading book instead of banking book. It is like shifting the banking book loan to trading book bond and reducing capital. But after IRC requirement in Basel 2.5 guidelines it has come significantly down. A detailed comparison of baking book and trading book capital charges are compared using one sample portfolio in Swing Basel document.

BCBS is reviewing the trading book framework. It has released updated consultative document on the same, Fundamental review of the trading book.

Before BCBS come with  defined rules for banking book and trading book boundary, currently different banks have setup their on policy to do the same. On larger view below methodology gets followed to classify the book as banking and trading.

Banking Book or Trading Book decision