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FRM Part II · FRM Exam Part II · High-level Summary of Basel III Reforms

A bank's CFO asks why the Basel III reforms include a leverage ratio alongside risk-based capital requirements. Which response is most accurate?

The leverage ratio is a simple, non-risk-based backstop that constrains the build-up of leverage and protects against model risk and measurement error in risk-weighted capital requirements. It uses Tier 1 capital over total exposure. It is not a liquidity measure, which is the role of the LCR.

  1. AThe leverage ratio is a non-risk-based backstop that limits the build-up of leverage and mitigates model risk and measurement error in risk-weighted requirementsCorrect
  2. BThe leverage ratio replaces risk weights for trading book positions only
  3. CThe leverage ratio is a liquidity measure that compares high-quality liquid assets to net outflows
  4. DThe leverage ratio measures the ratio of Tier 2 capital to total assets for resolution planning

Explanation

The Basel III leverage ratio is a simple, transparent, non-risk-based measure of Tier 1 capital to exposure that backstops risk-based requirements, constraining leverage and guarding against model risk. Option C describes the LCR. Options B and D misstate its scope and the capital used.

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