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FRM Part II · FRM Exam Part II · Basel III: Finalising Post-crisis Reforms

A bank in the second BI bucket has a Business Indicator Component of €2.0 billion and a loss component of €3.0 billion, based on ten years of loss data. How does the SMA treat this bank's operational risk capital relative to its BIC?

Capital is higher than the BIC. Because the loss component of €3.0bn exceeds the BIC of €2.0bn, the ratio is above one and the internal loss multiplier formula produces a value greater than one. Operational risk capital is BIC times ILM, so heavier past losses raise the requirement.

  1. AThe internal loss multiplier exceeds 1, so capital is higher than the BICCorrect
  2. BThe internal loss multiplier is below 1, so capital is lower than the BIC
  3. CThe multiplier is fixed at 1, so capital equals the BIC
  4. DThe multiplier is capped at 1, so the excess loss history is ignored

Explanation

ILM = ln(e − 1 + (LC/BIC)^0.8). With LC/BIC = 1.5 > 1, the term (1.5)^0.8 is above 1, so the argument exceeds e and the ILM exceeds 1. Capital = BIC × ILM, which is above the BIC. An ILM below 1 arises only when losses are lower than the BIC-implied level, and the ILM is not capped at 1.

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