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Nicole Seaman

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Learning objectives: Describe changes to the Basel regulations made as part of Basel II, including the three pillars. Compare the standardized IRB approach, the Foundation Internal Ratings-Based (IRB) approach and the advanced IRB approach for the calculation of credit risk capital under Basel II. Compare the basic indicator approach, the standardized approach and the Advanced Measurement Approach for the calculation of operational risk capital under Basel II. Summarize elements of the Solvency II capital framework for insurance companies.

Questions:

20.8.1. Peter is studying for the Financial Risk Manager (FRM) exam and he thinks the historical evolution of the Basel regulations is confusing. In particular, he wants to better understand the difference between the original Basel I accord (aka, the 1988 Basel Accord that was implemented by 1992) and Basel II, which was finally published over ten years later in 2004. His colleague Mary explains that, in comparison to the original accord, Basel II contained four significant innovations. Specifically, in comparison to the original Basel I accord (which do include the 1995/1996 Amendments) that came before, Mary says that significant innovations in Basel II included the following:

I. In addition to credit risk and market risk, Basel II required capital for operational risk
II. Basel II eliminated risk weights and risk-weighed assets (RWA) and replaced them with direct calculation of risk charges
III. Basel II contained specific requirements for supervision related to capital and risk management (Pillar 2) and required public disclosures (Pillar 3)
IV. To fine-tune the accord's design, Basel II made repeated use of Quantitative Impact Studies (QIS) to which banks contributed data (i.e., feedback) that was analyzed by supervisors

Is Mary correct?

a. Yes, all four statements are correct
b. I. and II. are correct but III and IV are inaccurate
c. Only II. is inaccurate but I, III, and IV are correct
d. Unfortunately, none of her statements are correct


20.8.2. Which of the following statements is TRUE about Basel II?

a. Under the Internal Ratings Based (IRB) approach to credit risk, default probability (PD) increases as the correlation parameter increases
b. Expected losses are included in the credit risk charge but excluded from the operational risk charge
c. Two popular approaches to the operational risk Advanced Measurement Approach (AMA) are Scenario Analysis and the Loss Distribution Approach (LDA; i.e., parametric and Monte Carlo)
d. The operational risk Advanced Measurement Approach (AMA) was one of Basel II's most successful features such that it persisted into Basel III and IV


20.8.3. Solvency II is a risk-based regulatory capital requirement that applies to (i.e., has jurisdiction over) insurance companies in the European Union. GARP explains, "In Europe, regulation of insurance companies is done by the European Union’s (EU) European Insurance and Occupational Pensions Authority (EIOPA; see https://www.eiopa.europa.eu/). The first capital regulations at the EU level were known colloquially as Solvency I, which has recently been replaced by Solvency II. More than 10 years in the making, Solvency II resembles Basel II in that many elements of its capital requirements are based on a one-year VaR concept (at the 99.5th percentile) ..." (Source: GARP's 2020 FRM Part II: Operational Risk and Resiliency, 10th Edition. Pearson Learning Solutions)

In regard to a comparison between Solvency II and Basel II, which of the following statements is TRUE?

a. Similar to Basel II, Solvency II is an international regulatory standard
b. Similar to Basel II, Solvency II has three Pillars and three tiers of capital
c. Similar to Basel II, Solvency II considers three risks: credit, market risk, and operational risk
d. Similar to Basel II, Solvency II ignores balance sheet liabilities but requires a minimum percentage of risk-weighted assets

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