Skip to content

FRM Part II · FRM Exam Part II · Stress Testing Banks

A supervisor reviews a bank's stress-test model for pre-provision net revenue and finds that fee income and expenses were projected using historical averages unrelated to the scenario variables. What is the principal weakness?

The weakness is that revenue and expenses are not conditioned on the scenario's macroeconomic variables. Historical averages ignore how stressed activity, volatility and funding costs would affect earnings, so projected capacity to absorb losses may be misstated.

  1. AThe projections are too conservative because averages always overstate stress losses
  2. BThe model fails to link revenue and expense lines to the scenario's macroeconomic paths, so projected earnings capacity may not reflect the stressCorrect
  3. CThe model overstates capital because taxes are applied twice
  4. DThe model is invalid because revenue should never be included in a stress test

Explanation

Stress testing requires revenue and expense projections to respond to scenario conditions such as lower activity, market volatility and funding costs. Using unconditional historical averages disconnects earnings from the stress and can misstate capital depletion.

Did you get it right without looking?

One question tells you little. A timed set on Stress Testing Banks shows your real accuracy, how long you take and where you lose marks.

Practise Stress Testing BanksFree diagnostic mock

More Stress Testing Banks questions