Regulatory and Capital Modelling

Question 1

what is regulatory capital?

Answer 1

the minimum amount of capital that a financial institution must hold as required by financial regulators

Question 2

what is the importance of regulatory capital?

Answer 2

• protects the financial system from insolvency
• provides a buffer against unexpected losses
• enhances confidence among stakeholders
• supports the overall stability and integrity of the financial system

Question 3

what are the 3 pillars in regards to regulatory capital?

Answer 3

pillar 1: regulatory capital requirements (for operational risk)
pillar 2: Supervisory review process
pillar 3: market discipline

Question 4

what are the regulatory frameworks that govern capital requirements?

Answer 4

• Basel accords (I-III)
  Key concepts within this include the capital adequacy ratio, the leverage ratios and liquidity coverage ratios

Question 5

what is the standardised approach to capital modelling?

Answer 5

• uses predefined risk weights for different asset classes
• simpler but less sensitive to particular institution’s risk profiles

Question 6

what is the Internal Ratings-Based (IRB) Approach to capital modelling?

Answer 6

allows banks to use their own risk models to estimate capital requirements
- more sensitive to the institution’s risk profile but requires regulatory approval

Question 7

what is the advanced measurement approach to capital modelling?

Answer 7

most sophisticated and complex option under Basel II is the advanced measurement approach (AMA). This approach allows a bank to calculate its regulatory capital charge using internal models, based on internal risk variables and profiles, and not on exposure proxies such as gross income.

Question 8

what are the different models for calculating the regulatory capital requirements for operational risk?

Answer 8

stochastic, scenario based, hybrid, and factor-based

Question 9

what are stochastic models for calculating the regulatory capital requirements for operational risk?

Answer 9

Part of the Loss Distribution Approach (LDA), purely quantitative, based on past losses. Statistical methods extrapolate future loss distributions up to the 99.9th percentile. Most widespread approach

Question 10

what are hybrid models for calculating the regulatory capital requirements for operational risk?

Answer 10

Most common and aligned with AMA regulatory expectations. Combine past incident data with scenario-based losses for operational loss distributions at 99.9% confidence. Adjust for scenario data and risk management quality

Question 11

what are factor models for calculating the regulatory capital requirements for operational risk?

Answer 11

Explain behavior of a variable based on influencing factors (e.g., size,
economic context, internal controls). Common in equity pricing

Question 12

what are the benefits of effective capital modelling?

Answer 12

• improved risk management
• regulatory compliance
• enhanced decision-making
• financial stability

Question 13

what are the challenges in capital modelling?

Answer 13

• date quality
• model risk (inaccuracies)
• regulatory changes
• complexity of advanced models

Question 14

what is the loss data approach to modelling?

Answer 14

Modelers used the LDA technique, breaking down risk events into frequency (how often they occur) and severity (their cost). This approach doubled the number of data points by decomposing each event into its frequency and severity

Question 15

what are the different types of stress testing?

Answer 15

• sensitivity (adapting the model by changing key parameters)
• scenario
• reverse
• macroeconomic

Question 16

what is wind down planning?

Answer 16

Identifies situations where the firm is no longer viable. Involves reviewing the business model, vulnerabilities, and key revenue drivers.