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FRM Part II · FRM Exam Part II · High-level Summary of Basel III Reforms

A risk manager at a large bank is briefing the board on the Basel III post-crisis reforms. Which statement best describes the purpose of the aggregate output floor?

The output floor requires a bank's total risk-weighted assets from internal models to be at least a set percentage of the RWA computed under the standardised approaches. It limits how far models can lower capital requirements and improves comparability across banks.

  1. AIt sets a minimum leverage ratio for all internationally active banks regardless of risk
  2. BIt requires that total RWA from internal models be no lower than a set percentage of RWA under the standardised approachesCorrect
  3. CIt caps the amount of Tier 2 capital that can count towards total capital
  4. DIt limits the share of a bank's assets that can be risk-weighted under the standardised approach

Explanation

The output floor sets a lower bound on RWA calculated with internal models, equal to a percentage of the RWA that standardised approaches would produce. This limits model-driven capital reductions and improves comparability. The leverage ratio is a separate non-risk-based backstop.

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