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

A bank wants to use the Basel II Advanced Measurement Approach (AMA) and plans to use insurance to reduce its operational risk capital. Which statement is consistent with Basel II requirements?

Under Basel II, AMA banks may recognise insurance only up to 20% of the total operational risk capital charge, and the insurer must have a high claims-paying ability rating. It is not available under the Basic Indicator Approach and is not unlimited.

  1. AInsurance recognition is capped at 20% of the total operational risk capital charge, and the insurer must have a sufficiently high claims-paying ability ratingCorrect
  2. BInsurance recognition is unlimited if the policy is renewable annually
  3. CInsurance may be recognised under the Basic Indicator Approach if the premium exceeds 15% of gross income
  4. DInsurance recognition is capped at 50% of the charge provided the insurer is domestic

Explanation

Basel II allows AMA banks to recognise insurance mitigation up to a cap of 20% of the total operational risk capital charge, subject to criteria such as insurer claims-paying ability, a policy term of at least one year with haircuts for shorter terms, and no exclusions for regulatory action. Recognition is not available under the simpler approaches, and no domestic-insurer rule or 50% cap exists.

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