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

A bank's backtesting over the last 250 trading days under the 1996 Market Risk Amendment shows 7 exceptions of its 99% one-day VaR. Which statement best describes the consequence?

Seven exceptions in 250 days falls in the yellow zone (5 to 9 exceptions). The supervisor increases the multiplier above 3, by a plus-factor in the prescribed range, rather than leaving it at 3 or automatically jumping to 4.

  1. AThe model is in the green zone and the multiplier stays at 3.0
  2. BThe model is in the yellow zone and the supervisor raises the multiplier above 3.0, with the increase set within a prescribed rangeCorrect
  3. CThe model is in the red zone and the multiplier is automatically raised to 4.0 with no discretion
  4. DThe bank must revert to the standardized method for the banking book only

Explanation

Under the 1996 traffic-light approach, 0-4 exceptions is green, 5-9 yellow, and 10 or more red. Seven exceptions is yellow, where the plus-factor is increased (0.65 for 5 up to 0.85 for 9; 7 gives 0.75). Red zone is the one with automatic 4.0 and a presumption the model is flawed.

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