CORES Basel Framework & Capital Requirements 4 — Questions and Answers
Question 1: A bank's operational risk capital charge under the Basel III Standardized Approach (SMA) is increased by what factor for institutions with large historical losses?
- Internal Loss Multiplier (ILM), which can be greater than 1 (Correct answer)
- External Loss Factor (ELF), capped at 2.0
- Scenario Stress Add-on (SSA), set by the supervisor
- Supervisory Scaling Factor (SSF), fixed at 1.5
Correct answer: Internal Loss Multiplier (ILM), which can be greater than 1
The Internal Loss Multiplier (ILM) adjusts the SMA capital requirement upward or downward based on the bank's historical loss experience relative to the BIC.
Question 2: Under Basel market risk rules (FRTB), which approach requires banks to model non-linearities and correlations using an Expected Shortfall (ES) measure?
- Standardized Approach (SA)
- Internal Models Approach (IMA) (Correct answer)
- Basic Risk Indicator Approach (BIA)
- Simplified Alternative (SA-simplified)
Correct answer: Internal Models Approach (IMA)
The FRTB Internal Models Approach uses Expected Shortfall at a 97.5% confidence level instead of Value-at-Risk to better capture tail risk.
Question 3: Under Basel III, Tier 2 capital instruments must have a minimum original maturity of how many years?
- 1 year
- 3 years
- 5 years (Correct answer)
- 10 years
Correct answer: 5 years
Tier 2 capital instruments must have a minimum original maturity of at least 5 years to qualify.
Question 4: Which Basel concept describes the risk that a bank's model underestimates capital needs due to systematic flaws in its risk measurement methodology?
- Concentration risk
- Model risk (Correct answer)
- Residual risk
- Correlation risk
Correct answer: Model risk
Model risk refers to the potential for losses arising from errors or limitations in risk models used to estimate capital requirements.
Question 5: The Basel Committee's 'output floor' introduced in the 2017 Basel III finalization requires that IRB-based RWA cannot fall below what percentage of the standardized approach RWA?
- 50%
- 62.5%
- 72.5% (Correct answer)
- 80%
Correct answer: 72.5%
The output floor sets a minimum at 72.5% of the standardized approach RWA to limit the capital benefit banks can gain from internal models.
Question 6: In the Basel Pillar 2 Supervisory Review and Evaluation Process (SREP), which risk is specifically assessed that is NOT fully covered under Pillar 1?
- Credit risk for rated corporates
- Interest rate risk in the banking book (IRRBB) (Correct answer)
- Counterparty credit risk for derivatives
- Operational risk under the standardized approach
Correct answer: Interest rate risk in the banking book (IRRBB)
Interest rate risk in the banking book (IRRBB) is a key Pillar 2 risk because it is not captured by Pillar 1 minimum capital requirements.
Question 7: What does the 'step-in risk' concept introduced by the Basel Committee refer to?
- The risk that a bank must absorb losses from off-balance-sheet entities beyond contractual obligations due to reputational concerns (Correct answer)
- The risk that a bank steps into a troubled counterparty's position in a derivative transaction
- The risk that regulators step in and impose conservatorship on a failing institution
- The risk that a bank's capital steps below the minimum trigger before supervisors can react
Correct answer: The risk that a bank must absorb losses from off-balance-sheet entities beyond contractual obligations due to reputational concerns
Step-in risk is the risk that a bank provides financial support to sponsored entities beyond contractual obligations to protect its reputation.
CORES Basel Framework & Capital Requirements 4
A bank's operational risk capital charge under the Basel III Standardized Approach (SMA) is increased by what factor for institutions with large historical losses?