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

A bank has a trading book position in a corporate bond. Under the 1996 Amendment, which statement correctly describes how the capital for this position is determined when the bank uses the internal models approach?

Under the 1996 Amendment, trading book capital must cover general market risk via the VaR-based charge and also specific risk. Specific risk is captured by the bank's model if it meets supervisory standards, otherwise through a standardized add-on charge.

  1. AMarket risk capital covers only general market risk; specific risk is ignored
  2. BCapital covers general market risk through the VaR-based charge, and specific risk (issuer-related risk) must be captured either by the model meeting supervisory criteria or by a standardized specific-risk chargeCorrect
  3. CCapital is the same as for banking book loans, at 8% of 100% risk-weighted exposure
  4. DCapital is set at the 10-day 95% VaR multiplied by 1.0

Explanation

The Amendment required capital for both general market risk and specific risk. Banks whose models did not satisfy supervisory criteria for specific risk had to add a standardized specific-risk charge. The 99%, 10-day VaR is used, not 95%, and trading book positions are not treated as banking book loans.

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