FRM Part I · FRM Exam Part I · Stress Testing
A bank's stress test shows that a severe scenario would reduce its CET1 ratio from 12.0% to 8.5%. Its internal risk appetite sets a management buffer trigger at 9.0% and a regulatory minimum of 4.5%. Which action is most consistent with using stress testing as a risk management tool?
Management should consider mitigating actions such as cutting exposures, raising capital or restricting distributions. The stressed CET1 ratio of 8.5% falls below the internal trigger of 9.0%, even though it exceeds the 4.5% regulatory minimum. Moving the trigger to avoid the breach would undermine risk appetite.
- ATake no action because the stressed ratio remains above the regulatory minimum
- BDismiss the scenario as implausible because it breaches no regulatory limit
- CConsider actions such as reducing risk exposures, raising capital or restricting distributions, since the stressed ratio breaches the internal triggerCorrect
- DRecalibrate the internal trigger to 8.0% so the scenario produces no breach
Explanation
The stressed CET1 of 8.5% is below the 9.0% internal trigger, so management should evaluate and decide on mitigating actions. Comparing only with the regulatory minimum ignores the bank's own risk appetite, and lowering the trigger merely to avoid a breach defeats the purpose of the test.
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