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FRM Part II · FRM Exam Part II · Capital Planning at Large Bank Holding Companies: Supervisory Expectations and Range of Current Practice

A bank projects pre-provision net revenue (PPNR) under stress using a model fitted to the last eight years of data, which contained no severe recession. Which supervisory concern is most directly raised?

The concern is that a model calibrated on benign history may not capture non-linear revenue deterioration in severe stress. Banks should recognize this limitation, use well-documented overlays or judgmental adjustments, and run sensitivity analyses rather than rely on the model output mechanically.

  1. AThe model may not capture non-linear revenue behavior in severe stress, so overlays and sensitivity analysis are neededCorrect
  2. BThe model will overstate fee income because of mandatory regulatory add-ons
  3. CPPNR should never be modeled because it is not a risk measure
  4. DHistorical data should be ignored in favor of a one-year forecast

Explanation

Models estimated on benign data may understate revenue declines in severe stress. Supervisors expect banks to recognize limitations, apply overlays or judgment, and test sensitivity. The other options are not supervisory positions.

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