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FRM Part II · FRM Exam Part II · Range of Practices and Issues in Economic Capital Frameworks

Which practice would most strengthen the independence and effectiveness of governance over a bank's economic capital framework?

Independent validation of the EC models combined with board and senior management review of results, assumptions and limitations best strengthens governance. Front-office ownership creates conflicts of interest, withholding results from the board weakens oversight, and permanently fixed parameters ignore changing risk conditions.

  1. AHaving the front office that benefits from low EC charges own and calibrate the models
  2. BIndependent validation of EC models, with board and senior management review of results, assumptions and limitationsCorrect
  3. CDisclosing EC only to regulators and never to the board
  4. DFixing model parameters permanently to avoid inconsistent results over time

Explanation

Sound governance needs independent validation plus board and senior management oversight of results and assumptions. Front-office ownership creates conflicts, excluding the board weakens oversight, and static parameters ignore changing conditions.

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