Financial Risk Management Regulatory Capital and Basel 3

Question 1

What are 'contingent convertible bonds' (CoCos) and what is their role in Basel III?

Accepted Answer

Hybrid instruments that automatically convert to equity or are written down when a bank's capital falls below a trigger level, absorbing losses on a going-concern basis

Answer

Bonds convertible at the issuer's option for tax optimization purposes

Answer

Government-issued bonds used to recapitalize failed banks

Answer

Interest rate derivatives used to hedge bank funding costs

Question 2

What is the purpose of the 'Internal Capital Adequacy Assessment Process' (ICAAP)?

Accepted Answer

A bank's own internal process to assess whether its capital is adequate for all material risks it faces, including those not covered in Pillar 1

Answer

A regulatory audit conducted by the Federal Reserve of all US banks annually

Answer

A standardized stress test prescribed by regulators with fixed scenarios

Answer

A process for calculating minimum regulatory capital requirements under the standardized approach

Question 3

What is 'stress testing' under the Dodd-Frank Act (DFAST) for US banks?

Accepted Answer

A regulatory framework requiring large US banks to annually project their capital levels under baseline, adverse, and severely adverse macroeconomic scenarios

Answer

An internal bank process for reviewing credit underwriting standards quarterly

Answer

A requirement for all US banks to conduct quarterly VaR backtests

Answer

A voluntary program where banks share stress results with the Federal Reserve

Question 4

Under the Basel standardized approach for credit risk, what risk weight is typically applied to unrated corporate exposures?

Accepted Answer

100%

Answer

0%

Answer

50%

Answer

150%

Question 5

What is the 'output floor' introduced in Basel IV (Basel III finalization)?

Accepted Answer

A requirement that RWA calculated under internal models must be at least 72.5% of the RWA calculated under the standardized approach, limiting capital savings from internal models

Answer

A minimum threshold for bank leverage ratios at 3% regardless of internal model results

Answer

A floor on operational risk capital equal to 10% of total regulatory capital

Answer

A minimum LCR of 100% that cannot be reduced below even in a government-declared stress period

Question 6

What is 'resolution planning' (living wills) under the Dodd-Frank Act?

Accepted Answer

A mandatory plan submitted by large financial institutions detailing how they could be wound down in an orderly manner without taxpayer support if they fail

Answer

A succession plan for bank CEOs and senior management during a crisis

Answer

An annual review of a bank's merger and acquisition strategy by the FDIC

Answer

A capital plan demonstrating that a bank can survive a severe two-year recession