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FRM Part II · FRM Exam Part II · Fundamental Review of the Trading Book

A bank's internal risk transfer (IRT) from a banking book desk to a trading desk hedges the banking book's interest rate risk. Under FRTB, how is this treated for capital purposes?

For interest rate risk, the internal risk transfer is recognized for the banking book only when the trading desk offsets it with an external hedge to an eligible third party that matches the IRT. Without that external hedge, the transfer is not recognized, limiting arbitrage between the books.

  1. AThe IRT is ignored entirely and both books are charged as if no hedge existed
  2. BThe banking book recognizes the hedge only if the trading desk enters an external hedge with an eligible third party that exactly matches the IRT; otherwise the trading desk's positions are treated on a standalone basis in the trading book without banking book recognitionCorrect
  3. CThe trading desk is exempt from capital requirements on the IRT
  4. DThe IRT is automatically recognized in the banking book and the trading book charge is eliminated

Explanation

For IRTs of interest rate risk, the banking book hedge is recognized only if the trading desk transfers the risk to the market via an external hedge that matches the IRT. Without an external match, the trading book desk cannot net out the IRT, so the trading desk is capitalized on a standalone basis as though unhedged. Ignoring the IRT or exempting capital would conflict with the anti-arbitrage purpose.

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