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FRM Part II · FRM Exam Part II · The Evolution of Stress Testing Counterparty Exposures

A bank's stress test shows a stressed potential exposure to Counterparty X of USD 120 million against a board-approved stress exposure limit of USD 100 million. Counterparty X's exposure was USD 80 million in the base case. Which action is most consistent with using stress results effectively?

The breach should be escalated and either mitigated through exposure reduction, collateral or hedging, or formally approved as a documented exception. Adjusting the limit or excluding the counterparty defeats the purpose, and base-case compliance does not remove the USD 20 million stress excess.

  1. AIgnore the breach because the base case exposure is within limits
  2. BEscalate the breach, then decide on reducing exposure, adding collateral or hedging, or formally approve an exception with documented rationaleCorrect
  3. CRaise the stress limit to USD 120 million so no breach is reported
  4. DRemove Counterparty X from the stress test sample

Explanation

A stress limit breach of USD 20 million (120 minus 100) must be escalated and addressed through mitigation or a documented, authorized exception. Raising the limit to hide the breach or excluding the name undermines the control, and base-case compliance does not cancel the stress breach.

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