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FRM Part II · FRM Exam Part II · Capital Regulation Before the Global Financial Crisis

Under the Basel II Standardised Approach for operational risk, a bank has the following gross income in one year: retail banking USD 200 million (beta 12%), trading and sales USD 100 million (beta 18%), and corporate finance USD 50 million (beta 18%). Ignoring the three-year averaging, what is the charge for that year, and what is the treatment if the aggregate result is negative in a year?

The charge is USD 51 million: 24 + 18 + 9 from the three business lines. Basel II lets negative business-line charges offset positive ones in a year, but if the year's aggregate is negative, it is set to zero in the three-year average.

  1. AUSD 51 million; negative aggregate business-line charges may offset positive ones in the year, but a negative total is set to zero in the three-year averageCorrect
  2. BUSD 51 million; negative business-line charges may never offset positive ones
  3. CUSD 52.5 million; negative totals are carried forward to later years
  4. DUSD 51 million; negative totals are used as negative values in the average

Explanation

Charge = 0.12x200 + 0.18x100 + 0.18x50 = 24 + 18 + 9 = USD 51 million. Under the Standardised Approach, negative charges in one business line can offset positive ones across lines, but if the total across lines in a year is negative, that year's input is set to zero. The 52.5 million option wrongly applies 15% to total income (350 x 15%).

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