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FRM Part II · FRM Exam Part II · Solvency, Liquidity and Other Regulation After the Global Financial Crisis

A risk manager is explaining the purpose of the Basel III leverage ratio to the board of a large international bank. Which statement best describes its role in the post-crisis framework?

The Basel III leverage ratio is a simple, non-risk-based backstop. It divides Tier 1 capital by total exposure without risk weights, constraining balance sheet growth and limiting the impact of model risk and risk-weight gaming in the risk-based capital framework.

  1. AIt is a risk-sensitive capital measure that weights exposures by internal model outputs to reward good risk management
  2. BIt is a simple, non-risk-based backstop that limits balance sheet growth and reduces model risk in the risk-weighted capital frameworkCorrect
  3. CIt is a short-term liquidity metric requiring sufficient high-quality liquid assets to cover 30 days of stressed outflows
  4. DIt is a stable funding metric that compares available stable funding with required stable funding over one year

Explanation

The leverage ratio uses Tier 1 capital over a non-risk-weighted exposure measure. It acts as a backstop to risk-based requirements and mitigates model risk and measurement error in risk weights. The liquidity and funding descriptions refer to the LCR and NSFR, and risk-sensitive weighting is the opposite of the leverage ratio's design.

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