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FRM Part II · FRM Exam Part II · Capital Regulation Before the Global Financial Crisis

A bank has 250 days of backtesting data for its 99% 1-day VaR and records 7 exceptions. Under the Basel traffic-light framework used with the 1996 Amendment, how should the bank and its supervisor respond?

Seven exceptions in 250 days falls in the yellow zone (5 to 9). The multiplier is raised by a plus factor, which is 0.65 for seven exceptions, with supervisors using discretion based on the cause. The model is not automatically rejected, which happens only in the red zone with ten or more.

  1. AGreen zone: the multiplier stays at 3 and the model is accepted
  2. BYellow zone: the multiplier is increased, with the increase at the supervisor's discretion within the specified range, and the model is not automatically rejectedCorrect
  3. CRed zone: the model is automatically rejected and the bank must use the standardised method
  4. DYellow zone: the multiplier must be set at exactly 4

Explanation

Green is 0-4 exceptions, yellow 5-9, red 10 or more. In yellow, the plus factor rises from 0.40 at 5 to 0.85 at 9 (7 gives 0.65), but it is applied at supervisory discretion depending on cause. So the multiplier is not fixed at 4 and the model is not automatically rejected.

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