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FRM Part II · FRM Exam Part II · Risk Capital Attribution and Risk-Adjusted Performance Measurement

A bank's CRO compares economic capital with regulatory capital for the trading business. Which situation most clearly shows why a bank would hold economic capital above its regulatory minimum for a business line?

A bank may hold economic capital above regulatory minimums when its internal model reveals risks, such as concentrations or fat-tail exposures, that the regulatory formula does not capture. Economic capital is tailored to the bank's actual risk profile and target solvency standard.

  1. AThe internal model shows tail risks, such as concentration, that the regulatory formula does not captureCorrect
  2. BThe regulatory ratio is calculated using risk-weighted assets
  3. CThe bank pays dividends from retained earnings
  4. DThe business line has a positive expected return

Explanation

Economic capital captures risks specific to the bank's portfolio, such as concentrations or model-specific tail exposures, that standardized regulatory formulas may miss, so it can exceed the regulatory requirement. The other options do not bear on a gap between the two measures.

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