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

A risk manager at a mid-sized bank is briefing the board on the Basel III reforms finalised in December 2017. Which statement best describes the purpose of the output floor, which is phased in over a multi-year transitional period?

The output floor requires a bank's risk-weighted assets, calculated using internal models, to be at least a set percentage of those calculated under the standardised approaches. It limits excessive model-driven capital reductions and is phased in gradually, unlike the leverage ratio or liquidity measures.

  1. AIt sets a minimum leverage ratio that applies to all internationally active banks
  2. BIt requires banks' total risk-weighted assets calculated with internal models to be no lower than a set percentage of the amount calculated under the standardised approachesCorrect
  3. CIt limits the maximum amount of Tier 2 capital a bank may include in total capital
  4. DIt requires banks to hold a minimum amount of high-quality liquid assets against net cash outflows

Explanation

The output floor constrains the benefit of internal models by setting RWAs at no less than a percentage of the standardised-approach RWAs. The leverage ratio and LCR are separate measures, and the Tier 2 limit is not the floor's purpose.

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