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

A risk manager explains why FRTB removed securitizations from the internal models approach while the revised CVA framework also limited internal modelling. Which rationale best reflects the Basel Committee's reasoning?

Basel limited internal models for securitizations and CVA because model risk, scarce data and hard-to-validate tail behaviour produced excessive variability in risk-weighted assets across banks. The aim was greater comparability and robustness, not identical capital for every exposure or because these exposures are immaterial.

  1. ASecuritization and CVA exposures are too small to justify the cost of internal models
  2. BModelling risks, data limitations and the complexity of tail behaviour in these exposures made internal model outputs hard to validate and led to excessive variability in risk-weighted assetsCorrect
  3. CInternal models cannot capture any credit spread risk
  4. DSupervisors wanted all banks to hold identical capital for the same exposures

Explanation

The Committee cited model risk, limited data, and unreliable tail estimation as reasons for restricting internal models for these exposures, aiming to reduce unwarranted variability in risk-weighted assets. The claims that exposures are small or that models cannot capture any credit spread risk are incorrect. The goal is comparability, not identical capital for all.

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