GARP 2016-FRR - Financial Risk and Regulation (FRR) Series

The change in equity value per 1% change in yield can be calculated using the formula:

ΔE=(Dl×MDl−Dd×MDd)×Δy\Delta E = (D_l \times \text{MD}_l - D_d \times \text{MD}_d) \times \Delta yΔE=(Dl​×MDl​−Dd​×MDd​)×Δy

Where DlD_lDl​ and DdD_dDd​ are the dollar amounts of loans and deposits, respectively, and MDl\text{MD}_lMDl​ and MDd\text{MD}_dMDd​ are their modified durations. For Gamma Bank:

ΔE=(300×2−200×1)×0.01=600−200=400×0.01=−2 million\Delta E = (300 \times 2 - 200 \times 1) \times 0.01 = 600 - 200 = 400 \times 0.01 = -2 \text{ million}ΔE=(300×2−200×1)×0.01=600−200=400×0.01=−2 milli

Planning for the operational risk framework generally involves setting clear goals, realistic milestones, and achievable deliverables that add value. Strong project management skills are applied to the design and implementation of each new element to manage the complexity and evolution of the framework. Once the elements are operational, they need to be monitored to ensure their integrity over time. Short-term planning and immediate benefits are not preferred over long-term planning in this context.

When operating in a heavily traded currency, a commercial and retail bank's treasury focuses on cover operations to mitigate risks. A cover operation involves taking actions to offset potential losses from the bank's business activities by hedging these risks in the market. This ensures that any adverse movements in exchange rates or interest rates do not negatively impact the bank's financial position.

Comprehensive and Detailed In-Depth Explanation:

Key Risk Indicators (KRIs) are metrics used to monitor operational, credit, or market risks, providing early warnings of potential issues. Basel II’s operational risk framework and GARP’s FRR guidelines specify that KRIs require:

Method of calculation:Defines how the KRI is computed (e.g., number of failed transactions).

Owner of the KRI:Assigns responsibility for monitoring and acting on the indicator.

Method of reporting:Specifies how and to whom the KRI is communicated (e.g., dashboards).

Red flag threshold:While critical for actionability, it is an outcome of KRI design, not a mandatory criterion for compliance with KRI standards. Thresholds vary by institution and risk appetite, making C the exception.Options A, B, and D are foundational to KRI establishment, whereas C is a subsequent application.

Exact Extract from Official Source:

BCBS, "Basel II: International Convergence of Capital Measurement and Capital Standards," June 2006, para. 664: "A bank’s operational risk measurement system must include the use of key risk indicators… These should include clear definitions, ownership, and reporting mechanisms, tailored to the bank’s risk profile."

GARP FRR Study Notes, Operational Risk Section: "KRIs require a calculation methodology, an assigned owner, and a reporting structure. Thresholds, such as red flags, are set based on risk tolerance but are not a universal requirement for KRI definition."

Comprehensive and Detailed In-Depth Explanation:

Loan loss reserves (LLR) are provisions set aside from earnings to cover expected credit losses (ECL), reflecting anticipated defaults under accounting standards (e.g., IFRS 9, CECL). Capital (B) and equity (D) absorb unexpected losses per Basel rules, while deposits (C) are a funding source, not a loss buffer. GARP’s FRR and Basel distinguish LLR for expected losses versus capital for unexpected losses.

Risk Adjusted Return on Capital (RAROC) is the ratio of profitability to the risk of a trading portfolio or bank business unit. This measure helps in assessing how much return is generated per unit of risk, allowing banks to compare the performance of different business units and investment opportunities on a risk-adjusted basis.

Securitization is a financial process used by banks to improve their liquidity and manage risk. The process involves the following steps:

I.Issuing Bonds:Banks issue bonds where the payment of interest and repayment of principal on the bonds depend on the cash flow generated by a pool of bank assets. This means that the assets (like loans) are used to back the bonds, and the revenue from these assets is used to pay bondholders.

II.Transfer of Legal Rights:When banks issue these bonds, they transfer their legal right to payment of interest and repayment of principal to bondholders. This transfer ensures that bondholders have a claim on the cash flows generated by the pooled assets, reducing the bank's risk exposure.

III.Selling Illiquid Assets:By securitizing assets, banks can sell off illiquid assets (like loans) and convert them into liquid securities (like bonds) that can be traded in the financial markets. This improves the bank's liquidity position by turning assets that are difficult to sell individually into marketable securities.

Statement I:DeltaFin can develop a control scoring method that assesses both the design and the performance of the control.

Verified and correct. It is essential to assess both design and performance to ensure that controls are not only well-designed but also effectively implemented.

Statement II:DeltaFin can combine the design and performance scores for each control to produce an overall control effectiveness score.

Verified and correct. Combining both scores provides a comprehensive measure of control effectiveness.

Statement III:DeltaFin can use the control performance scores to compute an overall risk severity score.

This is not accurate as the risk severity score typically considers the inherent risk and the residual risk after considering the controls, not just the performance scores.

Statement IV:DeltaFin can determine its own appropriate control scoring method.

Verified and correct. Organizations have the flexibility to develop their own scoring methods that best fit their operational risk profiles and needs.

As of April 2007, the three most widely traded currencies on the global foreign exchange market in decreasing order of market share were the United States dollar (USD), the European euro (EUR), and the Japanese yen (JPY). This ranking reflects the liquidity and trading volume associated with each currency, with the USD being the most traded, followed by the EUR and then the JPY.

A currency swap typically involves four components: an initial exchange of notional amounts in different currencies, periodic exchange of interest payments in different currencies, and a final exchange of notional amounts at maturity. The denomination of the original notional amount into a foreign currency is not a standalone component of a currency swap; it is part of the initial and final exchanges.