FRM Part II · FRM Exam Part II · Range of Practices and Issues in Economic Capital Frameworks
A bank's treasury function proposes to evaluate business-line performance using economic capital allocated to each unit. Which of the following is the primary management purpose of allocating economic capital to business lines in the range of practices described by the Basel Committee's economic capital report?
The main purpose is to support risk-adjusted performance measurement, pricing and strategic decisions. Allocated economic capital lets management compare each unit's return with the risk it consumes. It does not replace regulatory capital, require segregated liquid assets, or remove the need for stress testing.
- ATo replace regulatory capital requirements with an internal figure for reporting to supervisors
- BTo support risk-adjusted performance measurement and pricing, so returns can be compared against the risk each unit consumesCorrect
- CTo guarantee that each business line holds a separate pool of liquid assets equal to its allocation
- DTo eliminate the need for stress testing at the business-line level
Explanation
Banks use allocated economic capital as the denominator in risk-adjusted performance measures and for pricing and limit setting. It does not replace regulatory capital, nor does it create physically segregated assets. Stress testing remains a separate complementary tool.
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