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FRM Part II · FRM Exam Part II · Basel III: Finalising Post-crisis Reforms

A risk manager is explaining why the output floor was calibrated against the standardised approaches in the finalised Basel III reforms. Which statement best describes its purpose?

The output floor limits how much lower a bank's internally modelled RWA can be than the standardised-approach RWA. By capping the capital benefit from internal models, it improves comparability across banks, reduces RWA variability and mitigates model risk, working as a risk-sensitive backstop alongside the leverage ratio.

  1. AIt limits the capital benefit banks can obtain from internal models relative to standardised approaches, supporting comparability and reducing model riskCorrect
  2. BIt replaces the leverage ratio as the backstop to risk-based requirements
  3. CIt requires banks to hold liquid assets equal to 72.5% of net outflows
  4. DIt sets a minimum risk weight of 72.5% on every exposure

Explanation

The floor constrains how far modelled RWA can fall below standardised RWA, addressing excessive variability in RWA and model risk. It operates at the aggregate RWA level, not per exposure, and is separate from the leverage ratio and liquidity rules.

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