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

Before FRTB, a trading desk held a securitization position that was moved from the trading book to the banking book during the crisis once losses mounted. Which feature of the earlier framework most directly explains why this created a concern about capital adequacy?

The concern arises because trading and banking books had very different capital treatments, while rules for moving positions between them were weak. This let banks choose the book giving more favorable capital or avoid recognizing losses, which FRTB addressed with stricter, more objective boundary rules and reclassification limits.

  1. ATrading book positions were required to be held to maturity
  2. BBanking book positions always attracted lower capital than trading book positions
  3. CCapital depended on the book where the position sat, and the two books had very different capital treatments with weak limits on moving positions between themCorrect
  4. DBanking book positions were required to be marked to market daily

Explanation

Capital treatment differed materially between books, so the choice of book influenced capital. Without strict limits on reclassification, banks had incentives to arbitrage. It is not true that banking book always has lower capital; the arbitrage can go either way depending on the instrument. Trading book positions are not held to maturity, and banking book is not marked to market daily.

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