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FRM Part II · FRM Exam Part II · Fundamental Review of the Trading Book

A risk manager at a bank is explaining to the board why the Basel Committee launched the Fundamental Review of the Trading Book (FRTB) after the Basel 2.5 changes had already been introduced. Which of the following was a key weakness in the pre-FRTB framework that FRTB was designed to address?

FRTB addressed the weak, intent-based trading book/banking book boundary, which let banks arbitrage capital requirements by shifting positions between books. FRTB replaced it with a more objective boundary and strict limits on reclassification, whereas the other options describe features the earlier framework did not have.

  1. AThe boundary between the trading book and banking book relied on management intent and could be exploited for regulatory arbitrageCorrect
  2. BThe framework required all positions to be valued at historical cost, ignoring market prices
  3. CThe framework prohibited the use of internal models for any market risk capital calculation
  4. DThe framework applied capital charges only to credit risk in the banking book and ignored trading activities

Explanation

The pre-FRTB boundary was based on trading intent, which allowed banks to move positions between books to reduce capital. FRTB introduced a more objective boundary with restrictions on reclassification. The other options misdescribe the earlier framework, which did permit internal models and fair-value trading positions.

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