Skip to content

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

Which of the following is a recognised weakness of the 1996 Market Risk Amendment that later motivated the Basel 2.5 and Fundamental Review of the Trading Book reforms?

A key weakness was reliance on 10-day 99% VaR, which ignored losses beyond the cutoff and assumed positions could be exited quickly. It also underweighted default, migration and illiquidity risks in credit-related trading positions, prompting Basel 2.5 and the FRTB reforms.

  1. AIt required banks to hold equity against all trading book positions using a flat 8% charge
  2. BIt relied on 10-day 99% VaR, which did not capture tail losses, illiquidity, and default and migration risk of credit-sensitive trading positions adequatelyCorrect
  3. CIt prohibited the use of internal models for any trading activity
  4. DIt applied the credit risk weights of the banking book to all derivative positions

Explanation

The crisis showed that VaR at 99% understated losses on securitisation and credit positions, whose liquidity horizons were far longer than 10 days and whose risks included default and migration. This led to stressed VaR and the incremental risk charge in Basel 2.5, and to Expected Shortfall and liquidity horizons in the FRTB. The other options misdescribe the Amendment.

Did you get it right without looking?

One question tells you little. A timed set on Capital Regulation Before the Global Financial Crisis shows your real accuracy, how long you take and where you lose marks.

Practise Capital Regulation Before the Global Financial CrisisFree diagnostic mock

More Capital Regulation Before the Global Financial Crisis questions