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FRM Part II · FRM Exam Part II · Range of Practices and Issues in Economic Capital Frameworks

A bank's economic capital framework measures credit risk, market risk and operational risk separately. Which statement best describes a common feature of how banks, according to the BCBS range-of-practices report, measure credit risk economic capital?

Most banks use internal portfolio credit risk models that capture default correlation and name or sector concentration, calibrated to a confidence level consistent with the bank's target solvency standard, rather than flat asset percentages or purely regulatory risk weights.

  1. AMost banks use a portfolio model that captures default correlation and concentration, calibrated to a target solvency confidence levelCorrect
  2. BMost banks apply a flat percentage of total assets with no distinction between obligors
  3. CMost banks measure credit risk capital only from the regulatory standardised risk weights without any internal modelling
  4. DMost banks ignore concentration risk because it is captured by operational risk models

Explanation

Banks commonly use internal portfolio credit models that reflect default correlation, concentration and a chosen confidence level tied to a target rating. A flat percentage of assets or only standardised weights would ignore obligor-level risk, and concentration is a credit risk matter, not operational.

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