FRM Part I · FRM Exam Part I
Banks Chapter Guide for FRM Part I
The Banks chapter in FRM Part I explains how banks earn money, what risks they carry, how regulators force them to hold capital, how securitization moves loans off balance sheets, and how liquidity and funding can fail. Learn the mechanics first, then the ratios and failure cases.
What this chapter covers
This chapter covers the business of banking. You start with what banks do: take deposits, make loans, trade, and offer advisory and payment services. You then see how regulation shapes them through capital requirements, and how the originate-to-distribute model changed lending by letting banks sell loans to investors through securitization. The chapter closes with the risks banks face and the liquidity and funding problems that cause failures.
The content is mostly conceptual, but it uses simple numbers. Expect balance sheet arithmetic, capital ratios such as capital divided by risk-weighted assets, and the cash flow logic of securitization tranches. Questions often ask you to pick the correct consequence of a bank action or to spot which risk is at work in a scenario.
The chapter links to the rest of Part I. Credit, market and operational risk here become measurement topics in Valuation and Risk Models. Securitization connects to structured products in Financial Markets and Products. The failures you read about feed the case-based thinking in Foundations of Risk Management.
Banks is a chapter where careful reading earns steady marks, because most questions are conceptual and do not need long calculations. That leaves time for the quantitative sections elsewhere in a 100-question, 4-hour exam. It also supplies the vocabulary used across other topics, such as risk-weighted assets, tranches, leverage and funding gaps, so weak understanding here costs you marks in other chapters as well. GARP does not publish weightage by chapter, so treat it as a core chapter rather than a skippable one.
Banks: topics in the order to study them
- 1Structure and Functions of BanksStart here because balance sheets, banking activities and the commercial versus investment banking split are the base for everything else.
- 2Bank Regulation and Capital BasicsCapital rules only make sense once you know what is on a bank's balance sheet and which risks it carries.
- 3Originate-to-Distribute Model and SecuritizationSecuritization is a way banks manage capital and funding, so you need the capital logic first.
- 4Bank Risks, Liquidity and FundingFinish with risks and funding failures, which pull together the earlier topics and use the securitization lessons.
How to prepare Banks
Build understanding in layers, then test it with numbers and scenarios. Short, frequent sessions work well on a phone.
- Read the GARP learning objectives for this chapter in the current Study Guide, since the curriculum is revised every year, and use them as your checklist.
- Draw a simple bank balance sheet from memory: assets, liabilities and equity. Label where each type of risk sits.
- Practise capital ratio arithmetic: capital ÷ risk-weighted assets. Change one input at a time and see how the ratio moves.
- Walk through a securitization on paper: loan pool, special purpose vehicle, tranches, and who absorbs losses first.
- List the types of risk (credit, market, operational, liquidity) and write one real example of each from a bank failure.
- Do practice questions in timed blocks. For every wrong answer, write the rule you missed in one line.
- In the last week, reread your one-line notes and redo only the questions you got wrong.
Common mistakes in Banks
Confusing capital with cash or reserves
Fix: Remember that capital is the equity-like funding that absorbs losses. It sits on the liabilities and equity side, not as an asset.
Mixing up expected and unexpected losses
Fix: Link expected loss to pricing and provisions, and unexpected loss to capital.
Reading the tranche order backwards
Fix: Senior tranches are paid first and lose last. Equity tranches lose first and pay last.
Treating liquidity and solvency as the same thing
Fix: Ask two questions: does the bank have enough value in assets, and can it get cash now? A bank can fail one test and pass the other.
Ignoring incentives in the originate-to-distribute model
Fix: When a question mentions selling loans, ask who keeps the risk and how that affects lending standards.
Memorising ratios without checking the denominator
Fix: For every ratio, write the numerator and denominator in your notes and say what each one measures.
Last-day revision: Banks
- Banks take deposits and make loans, so their liabilities are mostly short-term and assets longer-term.
- Capital ratio = capital ÷ risk-weighted assets. Higher risk weights mean lower ratios for the same capital.
- Capital absorbs unexpected losses; provisions cover expected losses.
- Leverage is assets relative to equity. Higher leverage magnifies gains and losses.
- In originate-to-distribute, banks make loans, then sell them to investors instead of holding them.
- Securitization tranches pay in order of seniority; the equity tranche takes losses first.
- Weak underwriting standards are a known risk of originate-to-distribute because the originator does not keep the loss.
- Liquidity risk is being unable to meet cash obligations when due, even if the bank is solvent.
- Funding liquidity risk is about raising cash; market liquidity risk is about selling assets without a large price drop.
- Heavy reliance on short-term wholesale funding makes a bank vulnerable to runs.
- Credit, market and operational risk are the main risks; know which one a scenario describes.
Banks practice questions
- A bank has total assets of $50 billion and Tier 1 capital of $2 billion. It takes a hit of $0.5 billion to equity and, to restore its levera…
- Under the originate-to-distribute (OTD) model, a bank makes loans and then sells them to a special purpose vehicle that issues securities. W…
- Which activity best distinguishes an investment bank's operations from those of a traditional commercial bank?
- A bank's balance sheet shows available stable funding (ASF) of USD 96 billion after applying ASF factors. Required stable funding (RSF) is c…
- Under the originate-to-distribute (OTD) model, a bank makes loans and then sells them to investors, typically through securitization. Which …
- A bank has Tier 1 capital of $45 million and total leverage exposure of $1,500 million. Its RWA is $600 million. The regulator requires a mi…
- Under the originate-to-distribute model, a bank makes loans and then securitizes and sells them. Compared with the traditional originate-and…
- Under Basel III, the Net Stable Funding Ratio (NSFR) is designed primarily to address which of the following?
Banks in other exams
The same ground in other exams, if you are preparing for more than one or want another angle on it.
Banks: frequently asked questions
Is the Banks chapter calculation heavy?
Not usually. Most questions are conceptual, with some simple arithmetic such as capital ratios or tranche losses. A basic calculator is enough.
How long should I spend on this chapter?
Because it is more conceptual than the quantitative chapters, it can often be covered faster. Spend extra time only if bank balance sheets and securitization are new to you.
Does GARP publish how many questions come from Banks?
GARP publishes the topic areas and learning objectives in its annual Study Guide, but this guide does not state a question count for the chapter. Check the current Study Guide for the official structure.
Which topic in this chapter is hardest?
Many candidates find securitization hardest because of tranche structure and loss allocation. Drawing the cash flow waterfall step by step helps.
Do I need to know real bank failures?
Knowing a few well-known failures helps you link theory to scenarios. Focus on what went wrong in terms of risk type, funding or incentives rather than on dates and details.