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

A bank wishes to use the Advanced Measurement Approach (AMA) for operational risk under Basel II. Which of the following best describes a supervisory soundness standard for the AMA's risk measure?

The AMA risk measure must capture potentially severe tail events, comparable to a 99.9% confidence level over a one-year holding period. The other options describe the Basic Indicator Approach, the Standardised Approach, or a much weaker standard that does not meet the requirement.

  1. AIt must capture potentially severe tail loss events at a 99.9% confidence level over a one-year horizonCorrect
  2. BIt must equal 15% of average gross income
  3. CIt must be based on the bank's expected loss only, at a 95% confidence level
  4. DIt must use fixed regulatory betas applied to eight business lines

Explanation

Basel II requires the AMA measure to be comparable to a 99.9% one-year soundness standard, capturing severe tail events. The 15% of gross income is the BIA and fixed betas are the Standardised Approach. Expected loss alone at 95% does not meet the standard.

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