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

A risk officer is explaining why the revised Basel III CVA framework was changed from the Basel II.5 approach. Which of the following was a main motivation?

The reform aimed to make CVA capital reflect the exposure component as well as credit spreads, and to line up with accounting CVA and the way banks hedge it. The old framework captured only spread risk, so the first option is correct.

  1. ATo capture exposure-driven CVA variability by including exposure component sensitivity, and to align with accounting CVA and hedging practicesCorrect
  2. BTo eliminate the capital charge for CVA on all centrally cleared transactions and on all corporate counterparties
  3. CTo replace CVA with a leverage-ratio-only treatment of derivatives
  4. DTo require that CVA be measured using only credit spread movements and ignore exposure changes

Explanation

The old framework captured credit spread risk but ignored exposure variability, and did not align well with accounting CVA. The revised framework also incorporates exposure sensitivities (in SA-CVA) and recognises eligible hedges. The option ignoring exposure is wrong, since that was the old weakness.

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