A desk's VaR has risen from Rs 12 crore to Rs 18 crore against a Rs 15 crore limit, with no change in positions, because market volatility jumped. Do you grant a temporary limit increase or cut positions, and how big a cut gets it back inside?

It is a breach, and the default answer is to cut positions by about 16.7%, not to raise the limit. VaR scales with position size for a book like this, so Rs 18 crore times (1 minus the cut) must be at most Rs 15 crore, a cut of one sixth, about Rs 100 crore of gross positions. A temporary increase is possible, but only if someone above the desk approves it, time-bound, with a reduction plan.

A driving speed limit is lower in fog. You did not change your speed, but the same speed is now more dangerous, and the rule is about the danger. A VaR limit expresses how much the bank is willing to lose on a bad day, and that appetite has not changed just because markets have. Tarsin's positions are the same, but at today's volatility they can lose more, so the risk the bank carries is Rs 18 crore against an appetite of Rs 15 crore. Treating volatility breaches as not counting would mean the limit only binds in calm markets, which is when it matters least.

For a linear equity book, cutting every position by the same share cuts VaR by that share, because VaR is a multiple of position size at a given volatility. Rs 18 crore x (1 - c) = Rs 15 crore gives c = 1/6, a cut of 16.7%, about Rs 100 crore of the Rs 600 crore book. That only reaches the limit, with no room for another volatile day. Cutting to 90% of the limit, Rs 13.5 crore, needs 25%, about Rs 150 crore. Cutting the positions that add most to VaR first, rather than everything evenly, usually gets there with less selling.

There are honest cases for one. If the jump comes from a single extreme day that will drop out of the VaR window soon, or if forced selling into a thin market would cost more than the risk it removes, a short increase can be the better choice. The test is who owns the decision: a desk head cannot raise his own limit, so the request goes to the head of market risk or the risk committee, with a reason, an expiry date and a plan to get back inside. Meanwhile stress tests and stop-loss limits still apply. What is not acceptable is the desk head's version: a month at Rs 20 crore because the breach was not his fault.

Close with a view. Here the jump came over five days, not one, and volatility regimes tend to persist for a while, so recommend a cut of about a sixth now, done over a day or two to limit market impact, and a review of whether the desk's positions are sized for the new regime. Report the breach either way; reporting is not a punishment, it is how the board learns what its limits mean in practice.