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

A bank's internal models produce much lower risk weights than the standardised approach for similar portfolios. Under the Basel III finalisation, which measure is specifically intended to limit the capital benefit from such internal models?

The output floor, set at 72.5% of risk-weighted assets calculated under the standardised approaches, limits how far internal models can reduce capital. It ensures model-based RWA cannot fall below that proportion of standardised RWA.

  1. AAn aggregate output floor set at 72.5% of the standardised approaches' risk-weighted assetsCorrect
  2. BA cap on the leverage ratio at 3%
  3. CA requirement that all banks use internal models for operational risk
  4. DA ban on the standardised approach for credit risk

Explanation

The output floor requires total RWA from internal models to be no lower than 72.5% of RWA computed under the standardised approaches. This limits the benefit of internal models. The leverage ratio is a minimum, not a cap, and the other options are contrary to the reforms.

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