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

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.

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.

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.

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).

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.

What are the five categories of the BCBS G-SIB assessment methodology?

(1) Size, (2) Interconnectedness, (3) Substitutability/financial-institution infrastructure, (4) Complexity, and (5) Cross-jurisdictional activity. Each is equally weighted (20%) to produce a score that maps a bank into a G-SIB bucket.

What is the G-SIB additional loss-absorbency requirement?

An extra CET1 surcharge (a 'higher loss absorbency' bucket) ranging from $1.0\%$ to $3.5\%$ of RWA depending on the bank's systemic-importance bucket. It sits on top of minimums and the conservation buffer.

What does TLAC stand for, and what is its purpose?

Total Loss-Absorbing Capacity. For G-SIBs, TLAC ensures enough loss-absorbing and recapitalization capacity in resolution so that a failing G-SIB can be recapitalized without taxpayer bailout, supporting an orderly 'bail-in.'

State the TLAC minimum requirements as risk-weighted and leverage-based measures.

TLAC must be at least $18\%$ of RWA and at least $6.75\%$ of the leverage-ratio exposure measure (from 2022). These are minimums in addition to applicable regulatory capital buffers.

How does TLAC differ from regulatory capital?

Regulatory capital (CET1, AT1, Tier 2) absorbs going/gone-concern losses, while TLAC is a broader resolution concept that also includes eligible senior subordinated 'bail-in' debt. TLAC capacity exceeds capital because it adds long-term unsecured debt that can be written down or converted in resolution.

Define Interest Rate Risk in the Banking Book (IRRBB).

IRRBB is the current or prospective risk to a bank's capital and earnings arising from adverse movements in interest rates that affect its banking-book (non-trading) positions, through changes in the value of assets/liabilities and in net interest income.

Under what Basel pillar is IRRBB primarily addressed, and how?

Pillar 2 (supervisory review). IRRBB is managed via internal measurement, governance, and the supervisory outlier test rather than a standardized Pillar 1 capital charge, with enhanced Pillar 3 disclosures of EVE and NII sensitivities.

What are the three main sub-types of interest rate risk in the banking book?

(1) Gap/repricing risk (timing mismatches in asset/liability repricing), (2) Basis risk (imperfect correlation between rates on instruments with similar repricing), and (3) Option risk (embedded optionality such as prepayments and early withdrawals).

What is repricing (gap) analysis?

A technique that buckets rate-sensitive assets (RSA) and liabilities (RSL) by their repricing dates and computes the gap in each time band: $$\text{GAP} = \text{RSA} - \text{RSL}$$ to assess exposure of net interest income to rate changes.

How does a repricing gap translate into a change in net interest income (NII)?

Approximately: $$\Delta NII \approx \text{GAP} \times \Delta r$$ A positive gap (RSA > RSL) benefits from rising rates and is hurt by falling rates; a negative gap is the reverse.

Define Economic Value of Equity (EVE).

EVE is the present value of all expected banking-book asset cash flows minus the present value of all expected liability cash flows (often excluding equity): $$EVE = PV(\text{Assets}) - PV(\text{Liabilities})$$ It captures the long-run, value-based impact of interest-rate changes.

Contrast the EVE perspective with the earnings (NII) perspective of IRRBB.

EVE is a value-based, long-term measure of the change in the economic value of equity under a rate shock; NII/earnings-at-risk is a short-term (typically 1-year) measure of the change in net interest income. EVE captures full-maturity effects, NII focuses on near-term profitability.

What is the Basel IRRBB supervisory outlier test threshold for EVE?

A bank is flagged as an outlier if the maximum decline in EVE under the prescribed standardized interest-rate shock scenarios exceeds $15\%$ of its Tier 1 capital.

How many standardized interest-rate shock scenarios does the Basel IRRBB framework prescribe for EVE?

Six scenarios: parallel up, parallel down, steepener (short rates down, long rates up), flattener (short rates up, long rates down), short-rate up, and short-rate down.

What is capital planning in a banking context?

A forward-looking process by which a bank assesses its current and projected capital needs against its risk profile and strategy, sets capital targets above regulatory minimums, and ensures it can maintain adequate capital through normal and stressed conditions (including stress testing and distribution planning).

What does ICAAP stand for, and under which Basel pillar does it fall?

Internal Capital Adequacy Assessment Process. It falls under Pillar 2 and requires banks to identify, measure, and hold capital for all material risks — including those not fully captured in Pillar 1 (e.g., IRRBB, concentration, liquidity, business/strategic risk).

What is the supervisory counterpart to a bank's ICAAP?

The Supervisory Review and Evaluation Process (SREP), through which regulators assess the adequacy of a bank's ICAAP, risk management, and capital, and may impose additional (Pillar 2) capital requirements or other measures.

List key risks an ICAAP typically captures beyond Pillar 1.

Concentration risk, interest rate risk in the banking book (IRRBB), liquidity and funding risk, strategic/business risk, reputational risk, residual credit risk, model risk, pension risk, and the impact of stress scenarios.

Define Earnings-at-Risk (EaR).

Earnings-at-Risk is the potential reduction in net interest income (or net earnings) over a defined horizon (commonly 12 months) due to adverse interest-rate movements, given the bank's repricing structure. It is the earnings-perspective measure of IRRBB.

How does Earnings-at-Risk differ from Economic Value of Equity sensitivity?

EaR measures the short-term impact of rate changes on accrual earnings (NII) over a fixed horizon, whereas EVE sensitivity measures the long-term impact on the present value of equity across the full life of positions. EaR is flow-based; EVE is stock/value-based.

Why can a bank simultaneously have low Earnings-at-Risk but high EVE sensitivity?

Because short-dated repricing may keep near-term NII stable (low EaR) while long-duration assets funded by shorter liabilities create large present-value swings under rate shocks (high EVE sensitivity). The two perspectives capture different time horizons of the same rate exposure.

What is the Maximum Distributable Amount (MDA) concept?

When a bank's capital falls into its combined buffer (conservation + countercyclical + systemic buffers), automatic limits on the percentage of earnings it can pay out (dividends, AT1 coupons, bonuses) take effect. The deeper the breach, the smaller the permitted distribution.

Under Basel III, how is the combined buffer requirement built up on top of CET1 minimum?

Combined buffer = Capital Conservation Buffer ($2.5\%$) + Countercyclical Buffer (0%-2.5%) + G-SIB/D-SIB surcharge (e.g., 1.0%-3.5%), all met with CET1 and stacked above the $4.5\%$ CET1 minimum (and above the $6\%$ Tier 1 / $8\%$ Total minimums).

What change to market-risk capital was introduced by the Fundamental Review of the Trading Book (FRTB)?

FRTB replaced VaR with an Expected Shortfall (ES) measure for the internal models approach, introduced a more risk-sensitive sensitivities-based standardized approach, sharpened the boundary between trading and banking books, and added the non-modellable risk factor (NMRF) and P&L attribution tests.

What is the difference between going-concern and gone-concern loss absorption in the Basel capital stack?

Going-concern capital (CET1 + AT1, i.e., Tier 1) absorbs losses while the institution remains a viable operating entity; gone-concern capital (Tier 2, and broader TLAC instruments) absorbs losses only at the point of non-viability, in resolution or liquidation, to protect senior creditors and depositors.