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FRM Exam Part II · Risk, Regulation and Organizational Structure

Systemic Risk and Post-Crisis Regulation for FRM Part II

Updated 11 October 2026 · Fact-checked

Systemic risk is the risk that the failure or distress of one institution or market spreads and damages the wider financial system and real economy. Post-crisis rules respond with extra capital for G-SIBs, loss-absorbing debt (TLAC), living wills and resolution regimes, and laws like Dodd-Frank. Match each rule to the problem it fixes.

Understand Systemic Risk and Post-Crisis Regulation

Systemic risk is the risk of a breakdown in the whole financial system, not just one firm. It spreads through three channels: direct exposures between firms (interconnectedness), fire sales and funding runs that hit many firms at once (common exposures and liquidity), and loss of confidence. It is a negative externality: a bank does not bear the full cost its failure imposes on others.

Too big to fail (TBTF) means a firm is so large, connected or critical that authorities feel forced to rescue it. This creates moral hazard: creditors expect support, so they lend cheaply and the bank takes more risk. Post-crisis reform tries to make failure possible without a bailout.

The Basel Committee and the FSB identify G-SIBs (global systemically important banks) using an indicator-based approach with five categories: size, interconnectedness, substitutability or financial institution infrastructure, complexity, and cross-jurisdictional activity. Each bank gets a score and is placed in a bucket. A higher bucket means a higher CET1 capital surcharge on top of the Basel III minimum and buffers. D-SIBs are the domestic equivalent, set by national authorities.

G-SIBs must also hold TLAC (total loss-absorbing capacity): capital plus eligible long-term debt that can be written down or converted to equity in resolution. This is bail-in: losses fall on investors, not taxpayers. The FSB Total Loss-Absorbing Capacity standard sets a minimum of 18% of risk-weighted assets and 6.75% of the Basel III leverage ratio denominator, excluding buffers.

Resolution planning means preparing an orderly wind-down. Banks write living wills (recovery and resolution plans) showing how they could be resolved without systemic damage. Authorities choose a resolution strategy: single point of entry (the parent is resolved, subsidiaries keep operating) or multiple point of entry (separate parts resolved in different jurisdictions).

The Dodd-Frank Act (US, 2010) is the main legislative reform. Key provisions: the Financial Stability Oversight Council (FSOC) to monitor systemic risk; enhanced prudential standards for large banks; the Volcker Rule limiting proprietary trading and certain fund investments; OTC derivatives reform with central clearing, exchange or platform trading and reporting; living-will requirements; Orderly Liquidation Authority for failing systemic firms; and stress testing (DFAST and CCAR).

Key formulas to remember

G-SIB indicator categories
Size, Interconnectedness, Substitutability, Complexity, Cross-jurisdictional activity
Five categories. Each carries equal weight in the score (20% each in the Basel methodology). Score decides the bucket and surcharge.
G-SIB total capital requirement
CET1 requirement = 4.5% minimum + 2.5% conservation buffer + G-SIB surcharge (+ countercyclical buffer if any)
Surcharge is met with CET1. Buckets run from 1.0% up to 3.5% in the Basel framework.
TLAC minimum
TLAC ≥ 18% of RWA and ≥ 6.75% of leverage ratio exposure
Both must be met, excluding buffers. The higher of the two binds.
Surcharge cost to the bank
Extra CET1 = surcharge % × RWA
Use RWA, not total assets, for risk-based requirements.

How to solve Systemic Risk and Post-Crisis Regulation questions

Most questions ask you to match a rule to a risk, compute a requirement, or judge whether a policy reduces TBTF.

  1. 1Identify what is asked: definition, requirement calculation, or policy evaluation.
  2. 2Name the problem the rule targets: externality, moral hazard, interconnectedness, or lack of orderly failure.
  3. 3For a G-SIB, recall the five indicator categories and that a higher bucket means a higher CET1 surcharge.
  4. 4For calculations, find the right base (RWA for risk-based ratios, leverage exposure for leverage-based ones) and add components.
  5. 5For TLAC, test both the RWA test and the leverage test and use the stricter.
  6. 6For resolution questions, decide whether the answer points to bail-in, living wills, or entry strategy (SPE or MPE).
  7. 7Eliminate options that put losses on taxpayers or ignore moral hazard.

Quickest way: Rule-to-problem matching

When to use it: Use for conceptual MCQs on regulation when time is short.

  1. Spot the keyword: surcharge, TLAC, living will, Volcker, clearing, FSOC.
  2. Link it to one purpose: more capital, loss absorption, orderly failure, less speculation, less counterparty risk, or monitoring.
  3. For numbers, multiply the percentage by the stated base and add buffers.
  4. Pick the option that shifts losses to shareholders and creditors.

Common mistakes in Systemic Risk and Post-Crisis Regulation

  • Applying the G-SIB surcharge to total assets

    Students forget risk-based capital uses risk-weighted assets.

    Fix: Always multiply the surcharge by RWA unless the question names a leverage measure.

  • Thinking G-SIB score depends only on size

    Size is the most obvious category.

    Fix: Remember all five categories: size, interconnectedness, substitutability, complexity, cross-jurisdictional activity.

  • Treating TLAC as the same as Basel III capital

    Both are loss-absorbing and both are percentages of RWA.

    Fix: TLAC adds eligible long-term debt on top of regulatory capital and is a separate, additional requirement for G-SIBs.

  • Confusing bail-in with bailout

    The words sound similar.

    Fix: Bail-in uses the firm's own creditors and shareholders. Bailout uses public money.

  • Assigning the Volcker Rule to derivatives clearing

    Both are Dodd-Frank topics.

    Fix: Volcker limits proprietary trading and certain fund investments. Derivatives reform covers clearing, trading and reporting.

  • Assuming the surcharge replaces the conservation buffer

    Buffers are listed together and blur.

    Fix: The surcharge is additional. Add it to the minimum and the conservation buffer.

Worked examples

Example 1

A G-SIB has risk-weighted assets of USD 400 billion. It sits in a bucket with a 2.0% surcharge. Using a 4.5% CET1 minimum and a 2.5% conservation buffer, with no countercyclical buffer, what CET1 capital must it hold?

Show the solution
  1. Add the CET1 components: 4.5% + 2.5% + 2.0% = 9.0%.
  2. Apply to RWA: 9.0% × USD 400 billion = USD 36 billion.

Answer: USD 36 billion of CET1.

Example 2

A G-SIB has RWA of EUR 500 billion and leverage ratio exposure of EUR 1,600 billion. What is the minimum TLAC it must hold, excluding buffers?

Show the solution
  1. RWA test: 18% × 500 = EUR 90 billion.
  2. Leverage test: 6.75% × 1,600 = EUR 108 billion.
  3. Both must be met, so take the higher: EUR 108 billion.

Answer: EUR 108 billion, because the leverage test binds.

Exam tips

  • Expect numeric questions that add the minimum, conservation buffer and surcharge, so memorize the structure.
  • Know the five G-SIB categories and the idea of buckets, not the exact scoring weights beyond equal weighting.
  • Read carefully whether the base is RWA or leverage exposure.
  • For policy questions, the correct answer usually reduces moral hazard or moves losses to private investors.
  • Link Dodd-Frank provisions to their purpose in one phrase each.

Practice questions from Risk, Regulation and Organizational Structure

Systemic Risk and Post-Crisis Regulation: frequently asked questions

What is a G-SIB capital surcharge?

It is extra CET1 capital that a global systemically important bank must hold above the standard Basel III requirement. The size depends on the bucket from its systemic importance score. It aims to lower the chance of failure and offset the externality of its distress.

What is a living will?

A living will is a resolution plan a large bank prepares to show how it could fail in an orderly way without taxpayer support. Authorities review it and can require changes to structure or operations if the firm is not resolvable.

What is the difference between bail-in and bailout?

In a bail-in, shareholders and eligible creditors absorb losses through write-down or conversion to equity. In a bailout, the government injects public funds. TLAC is designed to make bail-in workable.

Which Dodd-Frank provisions matter most for FRM?

Focus on FSOC, enhanced prudential standards, the Volcker Rule, OTC derivatives clearing and reporting, living wills, Orderly Liquidation Authority and stress testing. Know the purpose of each.