FRM Part II · FRM Exam Part II · Capital Planning at Large Bank Holding Companies: Supervisory Expectations and Range of Current Practice
A bank's stress test shows a minimum post-stress Tier 1 common ratio of 7.0% against an internal target of 6.0%. Supervisors note the bank assumed it would keep paying planned dividends and could freely issue new equity in the stress period, while its pre-provision net revenue was projected using baseline growth. Which statement best assesses the 1.0% cushion?
The 1.0% cushion is likely overstated. Assuming easy equity issuance and baseline revenue growth under stress is unrealistic, since markets may be closed and income falls. Credible capital plans use conservative, scenario-consistent assumptions about management actions and earnings.
- AIt is likely overstated because management actions and revenue assumptions are not credible under stressCorrect
- BIt is understated because dividends reduce capital needs
- CIt is accurate because the target is exceeded
- DIt is irrelevant because only Tier 2 matters
Explanation
Assuming equity issuance may be unavailable in stress and baseline revenue growth is inconsistent with the scenario. Both inflate the post-stress ratio. Dividends being paid actually lower capital, but the key flaw is unrealistic favorable assumptions, so the cushion is overstated.
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