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FRM Part II · FRM Exam Part II · Solvency, Liquidity and Other Regulation After the Global Financial Crisis

A regulator is considering the purpose of the Basel III leverage ratio relative to risk-based capital requirements. Which statement best reflects its role?

The leverage ratio is a simple, non-risk-based backstop that supplements, rather than replaces, risk-based capital requirements. It limits the build-up of leverage and protects against model risk and mismeasurement of risk weights, applying across the whole balance sheet and off-balance-sheet exposures.

  1. AIt is a non-risk-based backstop that constrains balance sheet growth and limits model risk and measurement error in risk-weighted assetsCorrect
  2. BIt replaces risk-weighted capital ratios because risk weights proved unreliable
  3. CIt is risk-sensitive and assigns higher capital to riskier assets than the risk-based framework
  4. DIt applies only to the trading book and excludes loans

Explanation

The leverage ratio is a simple, non-risk-based backstop supplementing risk-based requirements, guarding against excessive leverage and model risk in risk weights. It does not replace them and is not risk-sensitive. It covers the whole balance sheet including off-balance-sheet items.

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