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

A bank's loss component is high relative to its BI component because of a history of large operational losses over the past ten years. How does the Basel III standardised approach treat this bank's operational risk capital, compared with a bank whose loss component equals its BI component?

Capital is higher, because the internal loss multiplier rises above 1 when the loss component exceeds the BI component. The multiplier scales the BI component up for banks with heavy historical losses and down for banks with light loss experience.

  1. ACapital is lower because the internal loss multiplier falls below 1
  2. BCapital is the same because internal losses are ignored for banks above EUR 1 billion BI
  3. CCapital is higher because the internal loss multiplier exceeds 1Correct
  4. DCapital is unchanged but Pillar 2 add-ons are prohibited

Explanation

The internal loss multiplier is based on the ratio of loss component to BI component. When the ratio exceeds 1, the multiplier exceeds 1 and raises capital. Option A reverses the direction, which applies when losses are low relative to BI.

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