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FRM Part II · FRM Exam Part II · Capital Planning at Large Bank Holding Companies: Supervisory Expectations and Range of Current Practice

During a capital plan review, supervisors find that a bank's loss projections for its trading book use historical loss rates from benign years, with no adjustment for the stress scenario. Which supervisory concern is most directly raised?

The main concern is that projection methods are not sensitive to the stress scenario. Losses based on benign historical averages ignore the scenario's conditions, so stressed losses and capital needs are likely understated, weakening the capital plan's reliability.

  1. AProjection methodologies are not sensitive to scenario conditions, so stressed losses are likely understatedCorrect
  2. BThe bank holds too much Tier 1 common equity
  3. CThe bank's dividend payout is too low
  4. DThe bank has too many scenarios

Explanation

Loss estimates must respond to the macro and market variables in the scenario. Using benign-period averages disconnects results from the stress, understating losses. The other options do not follow from the facts.

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