What is trading book?

A trading book is a term used in the financial industry to refer to a collection of securities that are actively traded by a financial institution. It usually comprises various types of financial instruments such as stocks, bonds, commodities, derivatives, and foreign currencies.

The trading book is held by financial institutions, including commercial banks, investment banks, and hedge funds, as part of their trading activities. The main objective of the trading book is to generate profits through short-term buying and selling of financial assets.

The trading book is different from the banking book, which consists of assets held by a financial institution for the purpose of investment or long-term holding. The trading book is marked-to-market regularly, meaning that the value of the assets is calculated based on their current market prices. This allows for the determination of daily trading profits or losses.

Financial institutions have specific risk management processes in place to monitor the trading book's exposure to market risks. This includes measuring and managing various risks such as market risk, credit risk, liquidity risk, and operational risk. These risk management practices ensure that the trading book's activities are aligned with the overall risk appetite and strategy of the institution.

Regulatory authorities, such as central banks and financial regulatory bodies, closely monitor and regulate the trading book activities of financial institutions to ensure market stability and the prevention of financial crises. These regulations include capital requirements, stress testing, and reporting obligations to ensure the prudent management of risks associated with trading book activities.

Overall, the trading book plays a significant role in the financial industry by facilitating active trading and providing liquidity to the markets. It allows financial institutions to generate profits through the efficient buying and selling of financial instruments, while also carrying certain risks that need to be managed effectively.