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FRM Part II · FRM Exam Part II · Solvency, Liquidity and Other Regulation After the Global Financial Crisis

A bank risk officer is asked why the Basel III framework added a leverage ratio alongside the risk-based capital requirements. Which statement best describes its purpose?

The Basel III leverage ratio is a non-risk-based backstop to the risk-weighted capital requirements. It limits the build-up of leverage and protects against model risk and mismeasured risk weights, because it divides Tier 1 capital by total exposure without applying risk weights.

  1. AIt provides a non-risk-based backstop that limits balance sheet growth regardless of the risk weights assigned to assetsCorrect
  2. BIt replaces risk-weighted capital requirements for internationally active banks
  3. CIt requires banks to hold high-quality liquid assets against 30-day net cash outflows
  4. DIt sets a minimum amount of stable funding relative to long-term assets

Explanation

The leverage ratio is a simple, non-risk-based measure that constrains build-up of leverage and guards against model risk and mismeasurement of risk weights. It supplements, not replaces, risk-based requirements. Options 3 and 4 describe the LCR and NSFR.

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