Financial Risk Management Regulatory Capital and Basel 2

Question 1

What is the 'Liquidity Coverage Ratio' (LCR) under Basel III?

Accepted Answer

High Quality Liquid Assets / Net Cash Outflows over 30 days ≥ 100%

Answer

The LCR requires banks to hold enough High Quality Liquid Assets (HQLA) to survive a 30-day stress scenario of combined retail and wholesale funding outflows, ensuring short-term liquidity resilience.

Question 2

What is the 'Net Stable Funding Ratio' (NSFR) under Basel III?

Accepted Answer

Available Stable Funding / Required Stable Funding ≥ 100%

Answer

The NSFR requires banks to fund long-term, illiquid assets with stable, long-term funding sources, addressing structural funding mismatches that contributed to the 2008 crisis.

Question 3

What is the 'Fundamental Review of the Trading Book' (FRTB) under Basel IV?

Accepted Answer

A comprehensive revision to trading book capital rules replacing VaR with Expected Shortfall, imposing stricter boundary rules, and introducing desk-level model approval

Answer

FRTB (Basel IV) replaces 99% 10-day VaR with 97.5% ES, tightens the banking/trading book boundary to prevent regulatory arbitrage, and introduces granular desk-level internal model approval.

Question 4

What is 'Pillar 2' in the Basel framework?

Accepted Answer

The supervisory review process where regulators assess bank-specific risks not fully captured in Pillar 1 and can impose additional capital requirements

Answer

Pillar 2 gives supervisors the authority to require banks to hold capital above the Pillar 1 minimum if their risk profile (concentration risk, interest rate risk in the banking book, etc.) warrants it.

Question 5

What is 'Pillar 3' of the Basel framework?

Accepted Answer

Market discipline through mandatory public disclosure of capital, risk exposures, and risk management practices to enable external stakeholders to assess a bank's risk profile

Answer

Pillar 3 harnesses market forces by requiring standardized disclosures so that investors, analysts, and counterparties can compare bank risk profiles and discipline excessive risk-taking through pricing.

Financial Risk Management Practice Test

Financial Risk Management Practice Test

Financial Risk Management Regulatory Capital and Basel 2