FRM (Financial Risk Manager) Treasury, Regulation and Current Issues (Part II) Syllabus

Treasury, Regulation and Current Issues (Part II) syllabus — full chapter and topic list

Expand any chapter to see its topics and sub-topics. This is the whole examinable outline for Treasury, Regulation and Current Issues (Part II) in FRM (Financial Risk Manager), not a summary of it.

1. 1

   Basel Accords and Regulatory Capital

   4 topics

   • Evolution of Basel Frameworks
     • Basel I, II, and III pillars
     • Basel III endgame and finalization
   • Capital Adequacy Requirements
     • CET1, Tier 1, and Tier 2 capital
     • Risk-weighted assets calculation
   • Leverage and Liquidity Standards
     • Leverage ratio
     • Capital buffers and countercyclical measures
   • Systemically Important Institutions
     • G-SIBs and additional loss absorbency
     • TLAC requirements
2. 2

   Treasury and Balance Sheet Management

   3 topics

   • Interest Rate Risk in the Banking Book (IRRBB)
     • Repricing and gap analysis
     • Economic value of equity
   • Capital Planning
     • Internal capital adequacy assessment (ICAAP)
     • Earnings-at-risk
   • Asset-Liability Management
     • Net interest margin management
     • Deposit modeling and behavioral assumptions
3. 3

   Current Issues in Financial Markets

   4 topics

   • Climate and Environmental Risk
     • Physical and transition risk
     • Climate stress testing and TCFD disclosures
   • Artificial Intelligence in Risk
     • Machine learning model risk
     • Generative AI and explainability
   • Digital Assets and FinTech Risk
     • Cryptocurrency and stablecoin risk
     • DeFi and distributed ledger risk
   • Liquidity and Systemic Events
     • Lessons from recent banking turmoil
     • Reference rate transition (LIBOR to SOFR)

Treasury, Regulation and Current Issues (Part II) flashcards for FRM (Financial Risk Manager)

25 of 50 cards from the Treasury, Regulation and Current Issues (Part II) deck — real questions with worked answers.

1. What is the Basel Accords' overarching purpose, and which body issues them?

   The Basel Accords are a set of international banking regulatory standards aimed at strengthening the regulation, supervision, and risk management of banks. They are issued by the Basel Committee on Banking Supervision (BCBS), housed at the Bank for International Settlements (BIS) in Basel, Switzerland.

2. Trace the chronological evolution of the Basel frameworks.

   Basel I (1988, market debut focused on credit risk capital), Basel II (2004, three-pillar risk-sensitive framework), Basel 2.5 (2009, enhanced market-risk/trading-book rules post-crisis), Basel III (2010-2017, capital quality, leverage, and liquidity), and the Basel III 'endgame'/finalization (2017 reforms, phasing in toward 2028).

3. What was the single headline capital requirement introduced by Basel I (1988)?

   A minimum total capital ratio of $8\%$ of risk-weighted assets, i.e. $\frac{\text{Capital}}{\text{RWA}} \geq 8\%$, focused primarily on credit risk with a simple risk-weighting scheme (0%, 20%, 50%, 100%).

4. What are the three pillars of Basel II?

   Pillar 1: Minimum capital requirements (credit, market, and operational risk). Pillar 2: Supervisory review process (including ICAAP and SREP). Pillar 3: Market discipline through public disclosure requirements.

5. Which risk type did Basel II add to Pillar 1 capital that Basel I did not explicitly cover?

   Operational risk. Basel II added an explicit Pillar 1 capital charge for operational risk (alongside credit and market risk), with approaches such as Basic Indicator, Standardized, and Advanced Measurement Approaches (AMA).

6. What were the main weaknesses of Basel II exposed by the 2007-2009 financial crisis?

   Insufficient quantity and quality of capital, excessive leverage, inadequate liquidity buffers, procyclicality, and underestimation of trading-book and securitization risks. These prompted Basel 2.5 and Basel III.

7. What three broad areas did Basel III (2010) reform relative to Basel II?

   (1) Capital — higher quality and quantity of capital plus new buffers; (2) Leverage — a non-risk-based leverage ratio backstop; (3) Liquidity — the Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR).

8. What is meant by the 'Basel III endgame' (Basel III finalization)?

   The 2017 final reforms completing Basel III: revised standardized approaches for credit and operational risk, constraints on internal models, the Standardized Approach for Counterparty Credit Risk (SA-CCR), a revised CVA framework, the Fundamental Review of the Trading Book (FRTB), and an output floor. Phase-in runs through 2028.

9. What is the Basel III output floor, and what level does it ultimately reach?

   The output floor caps the capital benefit a bank can gain from internal models: RWAs computed with internal models cannot fall below $72.5\%$ of the RWAs computed under the standardized approaches. It phases in to the full $72.5\%$ level.

10. Define capital adequacy in the Basel context.

    Capital adequacy is the requirement that a bank hold sufficient regulatory capital relative to its risk-weighted assets to absorb unexpected losses and remain solvent. It is measured by capital ratios such as CET1/RWA, Tier 1/RWA, and Total Capital/RWA.

11. What is Common Equity Tier 1 (CET1) capital composed of?

    The highest-quality, most loss-absorbing capital: common shares, stock surplus (share premium), retained earnings, accumulated other comprehensive income, and qualifying minority interest, less regulatory deductions (e.g., goodwill, intangibles, certain DTAs).

12. Distinguish Tier 1 capital from Tier 2 capital.

    Tier 1 (going-concern capital) absorbs losses while the bank operates; it equals CET1 plus Additional Tier 1 (AT1). Tier 2 (gone-concern capital) absorbs losses in liquidation/resolution and includes subordinated debt with original maturity $\geq 5$ years and certain general loan-loss provisions.

13. What instruments qualify as Additional Tier 1 (AT1) capital?

    Perpetual instruments (no maturity date) such as non-cumulative perpetual preferred shares and contingent convertible bonds (CoCos), with fully discretionary, non-cumulative coupons and a principal loss-absorption mechanism (write-down or conversion to equity).

14. State the three minimum Basel III capital ratios (before buffers).

    CET1 ratio $\geq 4.5\%$ of RWA, Tier 1 ratio $\geq 6.0\%$ of RWA, and Total capital ratio $\geq 8.0\%$ of RWA.

15. How are risk-weighted assets (RWA) calculated under the standardized approach (basic idea)?

    Each exposure is multiplied by a regulatory risk weight reflecting its credit quality, then summed: $$\text{RWA} = \sum_{i} w_{i} \cdot E_{i}$$ where $w_i$ is the risk weight and $E_i$ the exposure amount. Total RWA also adds market-risk and operational-risk components.

16. Under Basel's standardized approach, what risk weight is applied to cash and to claims on a bank's own sovereign in domestic currency?

    A $0\%$ risk weight, meaning such exposures generate no credit RWA (e.g., cash, and claims on the central government/central bank in domestic currency).

17. In the IRB approach, what are the four key risk parameters used to compute credit RWA?

    Probability of Default (PD), Loss Given Default (LGD), Exposure at Default (EAD), and effective Maturity (M). Expected loss is $EL = PD \times LGD \times EAD$; the capital charge is based on unexpected loss via the regulatory risk-weight function.

18. What is the Basel III leverage ratio and its minimum requirement?

    A non-risk-based backstop: $$\text{Leverage Ratio} = \frac{\text{Tier 1 Capital}}{\text{Total Exposure Measure}} \geq 3\%$$ The exposure measure includes on-balance-sheet assets, derivatives, securities-financing transactions, and off-balance-sheet items (no risk weighting).

19. Why is the leverage ratio described as a 'backstop' to risk-based capital requirements?

    Because it is not risk-weighted, it guards against model risk and the understatement of RWAs, constraining the build-up of excessive leverage that risk-based ratios might miss. It binds when a bank's assets are very low-risk-weighted yet large.

20. What does the Liquidity Coverage Ratio (LCR) require, and what is its formula?

    It ensures banks hold enough high-quality liquid assets (HQLA) to survive a 30-day stress: $$\text{LCR} = \frac{\text{HQLA}}{\text{Total net cash outflows over 30 days}} \geq 100\%$$

21. What does the Net Stable Funding Ratio (NSFR) measure, and what is its formula?

    It promotes stable funding over a one-year horizon: $$\text{NSFR} = \frac{\text{Available Stable Funding (ASF)}}{\text{Required Stable Funding (RSF)}} \geq 100\%$$ ASF weights liabilities/equity by stability; RSF weights assets by their liquidity/funding need.

22. What is the Capital Conservation Buffer (CCB) and what happens if a bank dips into it?

    A $2.5\%$ CET1 buffer above the minimum, intended to be drawn down in stress. Breaching it triggers automatic constraints on distributions (dividends, buybacks, discretionary bonuses) via the Maximum Distributable Amount (MDA) restrictions, but is not an outright breach of minimums.

23. What is the Countercyclical Capital Buffer (CCyB), and what range can it take?

    A macroprudential CET1 buffer (0% to 2.5% of RWA) set by national regulators. It is raised during periods of excess credit growth to build resilience and released in downturns to support lending, dampening procyclicality.

24. Adding the conservation buffer, what is the effective CET1 requirement for a non-systemic bank?

    $4.5\%$ minimum CET1 plus the $2.5\%$ capital conservation buffer equals an effective $7.0\%$ CET1 requirement (before any countercyclical or systemic surcharge).

25. What are SIFIs, and what is the rationale for treating them differently?

    Systemically Important Financial Institutions are banks/firms whose failure could threaten the broader financial system ('too big to fail'). Because of the systemic externality and moral hazard, they face additional capital surcharges, higher supervision, and resolution planning requirements.

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