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

A risk manager at a bank is summarizing for the board why the Basel Committee launched the Fundamental Review of the Trading Book after the 2007-2009 crisis, even though Basel 2.5 had already been implemented. Which of the following best describes a weakness of the pre-FRTB framework that FRTB sought to correct?

The intent-based boundary between the trading and banking books was a key weakness. Banks could shift positions to the book with lower capital, producing arbitrage. FRTB responded with a more objective boundary, presumptive lists and restrictions on moving positions between books after initial designation.

  1. AThe boundary between the banking book and trading book relied on a bank's stated intent to trade, creating scope for regulatory capital arbitrageCorrect
  2. BThe framework required all trading positions to be capitalized using only the standardized approach
  3. CThe framework used Expected Shortfall for all risk factors, which understated tail risk
  4. DThe framework prohibited banks from using internal models for market risk capital

Explanation

Under the earlier regime the trading book was defined largely by trading intent, so banks could move positions between books to obtain lower capital. FRTB introduced a more objective boundary with presumptive lists and limits on reclassification. The other options misdescribe the earlier framework: internal models were allowed and VaR, not ES, was used.

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