Learning Objectives: Describe the BIS recommendations that supervisors should consider to make effective use of internal risk measures, such as economic capital, that are not designed for regulatory purposes. Describe best practices and assess key concerns for the governance of an economic capital framework.
Questions:
24.8.1. Q-Capita Bank has implemented an economic capital model to better understand its capital adequacy and support strategic decision-making. During a supervisory review, the bank's board of directors is questioned about their awareness of how the economic capital model impacts business decisions. Which of the following responses would most likely satisfy the supervisor's expectations regarding the use of economic capital models?
a. We focus primarily on regulatory capital requirements, and our risk department only uses the economic capital model for internal risk measurement purposes.
b. Our economic capital model helps guide key decisions, such as capital allocation, by assessing the difference between standalone and diversified risk
c. While we use the economic capital model for assessing capital adequacy, its results do not significantly influence our business strategies or risk management practices.
d. Our board does not directly engage with the economic capital model; instead, we rely entirely on external consultants to ensure its proper application.
24.8.2. Zedra Bank uses internal Value at Risk (VaR) models to manage its economic capital, focusing on credit risk and counterparty credit risk. During a BIS supervisory review, the bank is asked to demonstrate how it ensures the effectiveness of these internal risk measures. Based on BIS recommendations, which of the following actions would best align with effective use of economic capital models that are not designed purely for regulatory purposes?
a. The bank performs backtesting over a 250-day period and implements stress testing to identify potential vulnerabilities in its VaR models.
b. The bank integrates dependency structures into its economic capital models for credit risk and uses supplementary methods like sensitivity analysis to address model limitations.
c. The bank conducts periodic reviews of its counterparty credit risk models but focuses primarily on meeting minimum regulatory requirements.
d. The bank emphasizes market risk in its economic capital models, with plans to incorporate credit and counterparty risks at a later stage.
24.8.3. DEF Bank has implemented an economic capital framework to manage its risk and capital adequacy. To align with best practices in governance, senior management is reviewing the governance structure to ensure it supports strategic decision-making and risk management. Which of the following actions would most likely reflect best practices for the governance of an economic capital framework, according to BIS recommendations?
a. Assigning economic capital oversight to the finance department, with minimal involvement from senior management.
b. Establishing governance controls, including formalized change processes and active senior management engagement.
c. Performing economic capital calculations annually, with senior management reviewing the results at year-end.
d. Focusing on regulatory capital requirements and using economic capital models only for internal reporting.
Answers here:
Questions:
24.8.1. Q-Capita Bank has implemented an economic capital model to better understand its capital adequacy and support strategic decision-making. During a supervisory review, the bank's board of directors is questioned about their awareness of how the economic capital model impacts business decisions. Which of the following responses would most likely satisfy the supervisor's expectations regarding the use of economic capital models?
a. We focus primarily on regulatory capital requirements, and our risk department only uses the economic capital model for internal risk measurement purposes.
b. Our economic capital model helps guide key decisions, such as capital allocation, by assessing the difference between standalone and diversified risk
c. While we use the economic capital model for assessing capital adequacy, its results do not significantly influence our business strategies or risk management practices.
d. Our board does not directly engage with the economic capital model; instead, we rely entirely on external consultants to ensure its proper application.
24.8.2. Zedra Bank uses internal Value at Risk (VaR) models to manage its economic capital, focusing on credit risk and counterparty credit risk. During a BIS supervisory review, the bank is asked to demonstrate how it ensures the effectiveness of these internal risk measures. Based on BIS recommendations, which of the following actions would best align with effective use of economic capital models that are not designed purely for regulatory purposes?
a. The bank performs backtesting over a 250-day period and implements stress testing to identify potential vulnerabilities in its VaR models.
b. The bank integrates dependency structures into its economic capital models for credit risk and uses supplementary methods like sensitivity analysis to address model limitations.
c. The bank conducts periodic reviews of its counterparty credit risk models but focuses primarily on meeting minimum regulatory requirements.
d. The bank emphasizes market risk in its economic capital models, with plans to incorporate credit and counterparty risks at a later stage.
24.8.3. DEF Bank has implemented an economic capital framework to manage its risk and capital adequacy. To align with best practices in governance, senior management is reviewing the governance structure to ensure it supports strategic decision-making and risk management. Which of the following actions would most likely reflect best practices for the governance of an economic capital framework, according to BIS recommendations?
a. Assigning economic capital oversight to the finance department, with minimal involvement from senior management.
b. Establishing governance controls, including formalized change processes and active senior management engagement.
c. Performing economic capital calculations annually, with senior management reviewing the results at year-end.
d. Focusing on regulatory capital requirements and using economic capital models only for internal reporting.
Answers here:
