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FRM Part II Updated
What is country risk beyond sovereign default, and how do banks measure transfer and convertibility risk?
Country risk goes beyond sovereign default to include transfer and convertibility risk, political risk, and economic risk. Banks use proprietary scorecards, set country exposure limits, and employ mitigation techniques like political risk insurance and offshore escrow accounts.
How does business process mapping support operational risk management?
Business process mapping decomposes each core banking activity into sequential steps, identifying at each step the inputs, outputs, controls, risk events, and owners...
Why does regulatory capital target unexpected loss and not expected loss?
EL is covered by credit spreads and provisions (normal cost of lending). Capital covers only UL (tail losses) to avoid double-counting. Basel deducts provision shortfall from CET1...
What is the third-party risk management lifecycle and why is it critical for banks?
The TPRM lifecycle has five phases: planning and risk assessment, due diligence and selection, contract negotiation, ongoing monitoring, and termination with exit planning. Critical vendors require board approval, enhanced due diligence, and continuous monitoring.
What are recovery and resolution plans ('living wills'), and how do they differ from each other?
Recovery and resolution planning is a cornerstone of the post-crisis 'too big to fail' reform agenda. Recovery plans are the bank's own playbook for self-rescue, while resolution plans are prepared by regulators for when recovery fails.
What are Key Risk Indicators (KRIs) and how are they designed?
Key Risk Indicators (KRIs) are forward-looking metrics that signal rising levels of operational risk exposure before losses materialize...
What is the IRB formula for Expected Loss and how does it differ from Unexpected Loss?
EL = PD × LGD × EAD — covered by provisions. UL = 99.9% loss minus EL — covered by capital. Basel IRB formula uses ASRF model to compute K per unit exposure...
What is the TCFD framework and how do financial institutions apply it to climate risk disclosures?
The TCFD framework has four pillars: Governance, Strategy, Risk Management, and Metrics & Targets. Banks must disclose how climate risks affect their portfolios through scenario analysis, integration into credit underwriting, and quantitative measures like financed emissions.
What are CoVaR, SRISK, and MES, and how do they measure systemic risk differently?
Systemic risk measures attempt to quantify how much a single institution's distress contributes to system-wide risk. CoVaR, MES, and SRISK each answer a different question about the relationship between institutions and the financial system.
How do banks conduct operational risk scenario analysis?
Operational risk scenario analysis is a structured process where subject-matter experts construct plausible-but-severe loss scenarios to capture tail risks that historical data alone cannot reveal...
How do banks estimate A-IRB parameters PD, LGD, EAD under Basel?
A-IRB lets banks estimate PD, LGD, EAD internally. PD from rating grades with 5+ yr data; LGD downturn with 7+ yr data; EAD via CCF on undrawn commitments. Subject to floors and use test...
What is the difference between transition risk and physical risk in climate finance?
Transition risk arises from the shift to a low-carbon economy (carbon taxes, technology disruption, market shifts), while physical risk comes from direct climate impacts (hurricanes, flooding, sea level rise). They affect different sectors, operate over different time horizons, and have a paradoxical inverse relationship.
What does resolution planning require and how do recovery and resolution plans differ?
Recovery plans describe how banks restore themselves in stress; resolution plans describe how authorities would resolve a failed bank.
How does bail-in work and what is the creditor hierarchy during resolution?
Bail-in is statutory power to write down or convert liabilities following a strict creditor hierarchy to avoid taxpayer bailouts.
How do I calculate the benefit of close-out netting for a counterparty?
Netting benefit = gross positive MTM minus max(0, sum of all MTMs). For Farringham Meridian Trust with 140 trades, $68M gross positive vs $22M net = $46M benefit (68% reduction). Legal enforceability is critical.
How does variation margin frequency affect residual exposure?
VM frequency sets the MPR floor. Daily (10-day MPR) vs weekly (20-day MPR) roughly cuts residual exposure in half due to sqrt-of-time diffusion. For Brightmoor Continental, moving to daily saves $3-5M in annual capital. Often regulatory-mandated.
How does MREL differ from TLAC and apply to European banks?
MREL is the EU resolution capacity regime calibrated to loss absorption plus recapitalization, applying to all EU banks.
What is TLAC and why must G-SIBs hold it in addition to regulatory capital?
TLAC is the additional loss-bearing resource G-SIBs must hold so shareholders and creditors — not taxpayers — absorb resolution losses.
SIMM vs grid approach for IM — which should we use?
SIMM uses risk sensitivities and recognizes netting (typically 30-60% lower IM) but requires complex infrastructure. Grid uses notional percentages — simple but higher IM. For Argent Stonehill's multi-product book, SIMM saves $35M annually.
How is initial margin calculated for uncleared bilateral trades?
IM covers 10-day 99% PFE of a replacement portfolio, posted gross and segregated, not netted against VM. Choose SIMM or standardized grid. For $250M netting set with Sylvaris, SIMM might give $14M vs grid $22M. UMR threshold is $50M bilateral.
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