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FRM Part II · FRM Exam Part II · High-level Summary of Basel III Reforms

Which statement best describes the Basel III treatment of the input floors introduced for IRB parameters?

Input floors set minimum values for IRB parameters like PD and LGD, such as a 5 basis point PD floor, so models cannot produce unrealistically low risk weights. They complement the output floor, operate at parameter level in credit risk, and do not cap parameters or replace the output floor.

  1. AThey set minimum values for parameters such as PD and LGD to prevent excessively low model-estimated inputsCorrect
  2. BThey cap PD and LGD at maximum values to prevent excessive conservatism
  3. CThey apply only to market risk internal models
  4. DThey replace the output floor for banks with low RWA density

Explanation

Input floors set minimum levels for IRB parameters (for example a PD floor of 5 basis points and LGD floors for secured and unsecured exposures). They limit very low inputs. They are separate from and complementary to the output floor, and apply to credit risk, not market risk.

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