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FRM Part II · FRM Exam Part II · Stress Testing Banks

A bank's stress testing team is building a framework to project capital under a severely adverse scenario. Which of the following components is the most appropriate to project in order to arrive at the post-stress CET1 ratio?

The post-stress CET1 ratio requires projecting pre-provision net revenue, credit and market losses, and changes in risk-weighted assets together. Capital changes through net income after losses, and the denominator changes through stressed RWA, so omitting revenue or RWA gives an incomplete and misleading result.

  1. AOnly credit losses on the loan book, holding revenue and risk-weighted assets constant at current levels
  2. BPre-provision net revenue, credit and market losses, and changes in risk-weighted assets, then the resulting effect on capitalCorrect
  3. COnly the change in the bank's share price under the scenario
  4. DOnly the regulatory minimum capital requirement under the scenario

Explanation

Post-stress capital is built from the full income path: pre-provision net revenue less provisions and losses (credit, market, operational), taxes and distributions, giving capital, and from stressed RWA for the denominator. Projecting only credit losses and freezing revenue and RWA ignores key drivers and would misstate the ratio.

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