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 for reasons including to facilitate trading for the institution's customers, to profit from trading spreads between the bid and ask prices, or to hedge against various types of risk. Trading books can range in size from hundreds of thousands of dollars to tens of billions depending on the size of the institution.
BREAKING DOWN 'Trading Book'Most institutions employ sophisticated risk metrics to manage and mitigate risk in their trading books. Trading books function as a form of accounting ledger by tracking the securities held by the institution that are regularly bought and sold. Additionally, trading history information is tracked within the trading book creating a simple way to review the institution's previous trading activities of the associated securities. This differs from a banking book as securities in a trading book are not intended to be held until maturity while the securities in the banking book are going to 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 the prices of the included securities change. Since these securities are held by the financial institution, and not be individual investors, these gains and losses impact the financial health of the institution directly.
Trading Book Losses
The trading book can be a source of massive losses within a financial institution. Losses arise due to the extremely high degrees of leverage employed by an institution to build the trading book. Another source of trading book losses is disproportionate and highly concentrated wagers on specific securities or market sectors by errant or rogue traders.
Impact of Trading Book Losses
Trading book losses can have a cascading, global effect when they hit numerous financial institutions at the same time, such as 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 significantly attributable to the hundreds of billions of losses sustained by global investment banks in the mortgage-backed securities portfolios held within their trading books.
Attempts to disguise mortgage-backed security trading book losses during the financial crisis ultimately resulted in criminal charges being brought against a former vice president of Credit Suisse Group. In 2014, Citigroup Inc. purchased the commodity trading books held by Credit Suisse. Credit Suisse participated in the sale in response to regulatory pressure and their intent to lower their involvement in commodities investing.