FRM Part 2 Schweser Notes 2023 Book 3

Readings and Learning Objectives Reading 35 Introduction to Operational Risk and Resilience Exam Focus Module 35.1: Operational Risk Categories Operational Risk Management Framework Event-Driven Risk Categories Types of Risks Within the ORM Framework Module 35.2: Operational Risk Characteristics Heterogeneous Idiosyncratic Heavy Tailed Interconnected Dynamic Operational Resilience Regulatory Expectations U.K. Regulations U.S. Regulations Basel Committee on Banking Supervision (BCBS) Other Regulators Key Concepts LO 35.a LO 35.b LO 35.c LO 35.d Answer Key for Module Quizzes Reading 36 Risk Governance Exam Focus Module 36.1: Operational Risk Regulation and Governance Basel II Operational Risk Pillar 1: Principles for the Sound Management of Operational Risk Pillar 1: Capital Calculation Pillar 2: Operational Risk Capital Regulatory Expectations Risk Committee Structure Governance and Risk Documentation Board of Directors Role (Operational Risk) Board of Directors Role (Operational Resilience) Module 36.2: Three Lines of Defense, Risk Appetite, and Risk Culture The Three Lines of Defense Model Delineation of the Lines of Defense First Line of Defense Risk Specialists Second Line of Defense Third Line of Defense Risk Appetite (Regulatory Expectations) Risk Appetite (Best Practices) Risk Culture Key Concepts LO 36.a LO 36.b LO 36.c LO 36.d Answer Key for Module Quizzes Reading 37 Risk Identification Exam Focus Module 37.1: Identifying Operational Risks Scope of Risk Identification Top-Down Approach Bottom-Up Approach Top-Down Risk Identification Tools Exposures and Vulnerabilities Risk Wheel Emerging Risks Bottom-Up Risk Identification Tools Event and Loss Data Analysis Risk and Control Self-Assessment Process Mapping Scenario Analysis Best Practices Regulatory Guidance Brainstorming Methods Module 37.2: Operational Risk Taxonomies Basel Taxonomy Custom Taxonomies Operational Riskdata eXchange (ORX) Taxonomy Taxonomies for Causes, Impacts, and Controls Causes Impacts Controls Key Concepts LO 37.a LO 37.b LO 37.c LO 37.d Answer Key for Module QUIZZES Reading 38 Risk Measurement and Assessment Exam Focus Module 38.1: Operational Loss Data and Qualitative Risk Assessment Regulatory Requirements for Operational Loss Data Data Collection Process Comprehensive Data Incident Dates Boundary Events Data Quality Requirements Operational Risk Data Risk and Control Self-Assessments Impact Scales Likelihood Assessment Scales Heatmaps Module 38.2: Key Indicators and Quantitative Risk Assessment Key Risk Indicators (KRIs) Key Performance Indicators (KPIs) Key Control Indicators (KCIs) Fault Tree Analysis (FTA) Factor Analysis of Information Risk (FAIR) Swiss Cheese Model Root-Cause Analysis Module 38.3: Operational Risk Capital and Resilience Loss Distribution Approach (LDA) Extreme Value Theory (EVT) Internal and External Loss Data Capital Modeling Operational Resilience Key Concepts LO 38.a LO 38.b LO 38.c LO 38.d LO 38.e LO 38.f LO 38.g Answer Key for Module QUIZZES Reading Risk Mitigation Exam Focus Module 39.1: Risk Mitigation With Internal Controls and Process Design Risk Mitigation Characteristics Risk Response Types of Internal Controls Key Controls Automated Controls Control Testing Process Design and Categories of Human Errors Lean Six Sigma and Quality Improvement Module 39.2: Operational Risk Mitigation Measures and Management Assessing New Products and Initiatives Mergers and Acquisitions Contingency Planning Business Continuity Management Event and Crisis Management Risk Transfer External Insurance Outsourcing Managing Reputational Risk Key Concepts LO 39.a LO 39.b LO 39.c LO 39.d LO 39.e LO 39.f Answer Key for Module Quizzes Reading 40 Risk Reporting Exam Focus Module 40.1: Organizational Committees Risk Committee (Within the Board of Directors) Audit Committee (Within the Board of Directors) Executive Committee (Within the Board of Directors) Central Operational Risk Function (And Operational Risk Committee) Business Line Managers (And Risk Champions) Module 40.2: Operational Risk Reporting Components Prioritized Risks and Outlook Heatmap and Risk Register Risk Appetite Metrics KRIs and Issue Monitoring Risk Events and Near Misses Action Plans and Remediation Emerging Risks and Horizon Scanning Risk Software Module 40.3: Operational Risk Reporting Challenges Operational Risk Event Data Asymmetry Large Risk Event Escalation Small, Frequent Losses Operational Loss Benchmarking Operational Risk Distributions Concentrations, Outliers, and Scenarios Qualitative Risk Data Aggregation Combined Assurance Module 40.4: External Reporting Best Practices Key Concepts LO 40.a LO 40.b LO 40.c LO 40.d Answer Key for Module QUIZZES Reading 41 Integrated Risk Management Exam Focus Module 41.1: Enterprise Risk Management (ERM) Introduction to ERM Structure of ERM Risk Governance Risk Culture Risk Appetite Capital Elements of the ERM Framework Regulatory Capital Economic Capital Risk-Adjusted Return on Capital Capital Assessment Risk Aggregation Module 41.2: Stress Testing Fundamentals of Stress Testing Taxonomy Stress Testing Approaches Stress Testing Operational Risk Operational Risk Stress Testing Models Key Concepts LO 41.a LO 41.b LO 41.c LO 41.d Answer Key for Module QUIZZES Reading 42 Cyber-Resilience: Range of Practices Exam Focus Module 42.1: Cyber Risks, Governance, and Supervision Cyber-Resilience Standards and Guidelines Cyber-Governance Cybersecurity Strategy Management Roles and Responsibilities Awareness Architecture and Standards Workforce Approaches to Cyber Risk Management and Incident Response and Recovery Supervision of Cyber-Resilience Information Security Controls Incident Response and Recovery Cybersecurity and Resilience Metrics Module 42.2: Cybersecurity Information Sharing Between Institutions and Third-Party Risk Sharing Cybersecurity Information Between Institutions Sharing Among Banks Sharing From Banks to Regulators Sharing Among Regulators Sharing From Regulators to Banks Sharing with Security Agencies Risks of Third-Party Service Providers Governance of Third-Party Interconnections Business Continuity and Availability Information Confidentiality and Integrity Expectations and Practices Around Visibility of Third-Party Interconnections Auditing and Testing Resources and Skills Key Concepts LO 42.a LO 42.b LO 42.c LO 42.d LO 42.e Answer Key for Module Quizzes Reading 43 Case Study: Cyberthreats and Information Security Risks Exam Focus Module 43.1: Information Security Risks and Frameworks Information Security Risk Typology Cybersecurity Risk Frameworks and Standards NIST CSF CIS ISO 27001 Cybersecurity Protection and Monitoring Equifax Case Study Key Concepts LO 43.a LO 43.b Answer Key for Module Quiz Reading 44 Sound Management of Risks Related to Money Laundering and Financing of Terrorism Exam Focus Module 44.1: Management of Money Laundering and Financial Terrorism Risks Risk Assessment Risk Management Risk Mitigation Risk Monitoring Customer Acceptance Customer Verification Customer Identification ML/FT Risk Management for Cross-Border Banks Role of Supervisors Key Concepts LO 44.a LO 44.b LO 44.c Answer Key for Module Quiz Reading 45 Case Study: Financial Crime and Fraud Exam Focus Module 45.1: Financial Crime and Fraud Risk Management Definitions of Financial Crime, Internal Fraud, and External Fraud Definitions of Money Laundering and Terrorism Financing Financial Crime Risk Management Internal Fraud Management External Fraud Management AML Risk Management USAA Federal Savings Bank Case Study Key Concepts LO 45.a LO 45.b Answer Key for Module Quiz Reading 46 Guidance on Managing Outsourcing Risk Exam Focus Module 46.1: Managing Outsourcing Risk Risks of Outsourcing Activities to Third-Party Service Providers Effective Program to Manage Outsourcing Risk Due Diligence on Service Providers Business Background, Reputation, and Strategy Financial Performance and Condition Operations and Internal Controls Contract Provisions Key Concepts LO 46.a LO 46.b LO 46.c Answer Key for Module Quiz Reading 47 Case Study: Third-Party Risk Management Exam Focus Module 47.1: Third-Party Risk Management and Responsibilities Overview of Third-Party Risk Management The TPRM Life Cycle Third-Party Case Studies Capital One Morgan Stanley Key Concepts LO 47.a LO 47.b Answer Key for Module Quiz Reading 48 Case Study: Investor Protection and Compliance Risks in Investment Activities Exam Focus Module 48.1: Investor Protection Regulations Markets in Financial Instruments Directive Dodd-Frank: Investor Protection Act Compliance Risk Management Investor Protection Case Studies Key Concepts LO 48.a LO 48.b Answer Key for Module Quiz Reading 49 Supervisory Guidance on Model Risk Management Exam Focus Module 49.1: Model Risk Management Effective Model Risk Management Elements Best Practices for Model Development and Implementation Module 49.2: Model Validation Process Evaluation of Conceptual Soundness Ongoing Monitoring Outcomes Analysis Vendor and Other Third-Party Products Key Concepts LO 49.a LO 49.b LO 49.c LO 49.d Answer Key for Module QUIZZES Reading 50 Case Study: Model Risk and Model Validation Exam Focus Module 50.1: Model Risk and Model Validation Model Risk Exposure Model Risk Management Model Risk Case Studies Gaussian Copula and CDO Pricing The Barclays Acquisition of Lehman Brothers’ Assets and Spreadsheet Error NASA Mars Orbiter Key Concepts LO 50.a LO 50.b LO 50.c Answer Key for Module Quiz Reading 51 Stress Testing Banks Exam Focus Module 51.1: Stress Testing Supervisory Capital Assessment Program (SCAP) Challenges in Designing Stress Tests Module 51.2: Challenges in Modeling Losses and Revenues Challenges in Modeling the Balance Sheet Stress Test Comparisons Key Concepts LO 51.a LO 51.b LO 51.c Answer Key for Module QUIZZES Reading 52 Risk Capital Attribution and Risk-Adjusted Performance Measurement Exam Focus Module 52.1: Risk-Adjusted Return on Capital Risk Capital, Economic Capital, and Regulatory Capital Using Economic Capital Approaches Risk-Adjusted Return on Capital Module 52.2: RAROC, Hurdle Rate, and Adjusted RAROC RAROC for Performance Measurement Time Horizon Default Probability Confidence Level Hurdle Rate for Capital Budgeting Decisions Adjusted RAROC Module 52.3: Diversification Benefits and RAROC Best Practices Risk Capital and Diversification RAROC Best Practices Senior Management Communication and Education Ongoing Consultation Data Quality Control Complement RAROC With Qualitative Factors Active Capital Management Key Concepts LO 52.a LO 52.b LO 52.c LO 52.d LO 52.e LO 52.f LO 52.g LO 52.h Answer Key for Module QUIZZES Reading 53 Range of Practices and Issues in Economic Capital Frameworks Exam Focus Module 53.1: Risk Measures and Risk Aggregation Defining and Calculating Risk Measures Standard Deviation VaR (The Most Commonly Used Measure) Expected Shortfall Spectral and Distorted Risk Measures Risk Aggregation Module 53.2: Validation, Dependency, Counterparty Credit Risk, and Interest Rate Risk Validation of Models Dependency Modeling in Credit Risk Evaluating Counterparty Credit Risk Market-Risk-Related Challenges to Counterparty Exposure at Default (EAD) Estimation Credit-Risk-Related Challenges to PD and LGD Estimation Interaction Between Market Risk and Credit Risk—Wrong-Way Risk Operational-Risk-Related Challenges in Managing Counterparty Credit Risk Differences in Risk Profiles Between Margined and Non-Margined Counterparties Aggregation Challenges Assessing Interest Rate Risk in the Banking Book Optionality in the Banking Book Banks’ Pricing Behavior The Choice of Stress Scenarios Module 53.3: BIS Recommendations, Constraints and Opportunities, and Best Practices and Concerns BIS Recommendations for Supervisors Economic Capital Constraints and Opportunities Credit Portfolio Management Constraints Imposed Opportunities Offered Risk-Based Pricing Constraints Imposed Opportunities Offered Customer Profitability Analysis Constraints Imposed Opportunities Offered Management Incentives Constraints Imposed Opportunities Offered Best Practices and Concerns for Economic Capital Governance Key Concepts LO 53.a LO 53.b LO 53.c LO 53.d Answer Key for Module QUIZZES Reading 54 Capital Planning at Large Bank Holding Companies: Supervisory Expectations and Range of Current Practice Exam Focus Module 54.1: The Federal Reserve’s Capital Plan Rule Module 54.2: Capital Adequacy Process Risk Identification Internal Controls Governance Capital Policy Stress Testing and Stress Scenario Design Estimating Losses, Revenues, and Expenses Quantitative and Qualitative Basis Loss Estimation Methods Module 54.3: Assessing the Impact of Capital Adequacy Operational Risk Market Risk and Counterparty Credit Risk PPNR Projection Methodologies Generating Projections Key Concepts LO 54.a LO 54.b Answer Key for Module QUIZZES Reading 55 Capital Regulation Before the Global Financial Crisis Exam Focus Module 55.1: Basel I Regulations and Revisions Capital and Risk-Weighted Assets The 1995 Amendment: Netting The 1996 Amendment: Market Risk and Trading Activities Standardized Measurement Method Internal Model-Based Approach Backtesting Module 55.2: Basel II Regulations Pillars of Sound Bank Management Pillar 1: Minimum Capital Requirements Pillar 2: Supervisory Review Pillar 3: Market Discipline Credit Risk Capital Requirements The Standardized Approach Collateral Adjustments The Internal Ratings-Based (IRB) Approach Foundation IRB Approach Advanced IRB Approach Foundations IRB Approach and Advanced IRB Approach for Retail Exposures Operational Risk Capital Requirements Basic Indicator Approach (BIA) Standardized Approach Advanced Measurement Approach (AMA) Solvency II Framework Standardized Approach Internal Models Approach Key Concepts LO 55.a LO 55.b LO 55.c LO 55.d LO 55.e LO 55.f LO 55.g LO 55.h Answer Key for Module Quizzes Reading 56 Solvency, Liquidity, and Other Regulation After the Global Financial Crisis Exam Focus Module 56.1: Stressed VAR, Incremental Risk Capital Charge, and Comprehensive Risk Charge Stressed VaR Incremental Risk Charge Comprehensive Risk Charge Module 56.2: Basel III Capital Requirements, Buffers, and Liquidity Risk Management Basel III Capital Requirements Capital Conservation Buffer and Countercyclical Buffer Liquidity Risk Management Module 56.3: Contingent Convertible Bonds and Dodd-Frank Reform Contingent Convertible Bonds Reforms After the Global Financial Crisis Key Concepts LO 56.a LO 56.b LO 56.c LO 56.d LO 56.e LO 56.f LO 56.g LO 56.h Answer Key for Module QUIZZES Reading 57 High-Level Summary of Basel III Reforms Exam Focus Module 57.1: High-Level Summary of Basel III Reforms Standardized Approach (SA) for Credit Risk Internal Ratings-Based (IRB) Approaches for Credit Risk Credit Valuation Adjustment (CVA) Risk Framework Operational Risk Framework Leverage Ratio Framework Key Concepts LO 57.a LO 57.b LO 57.c Answer Key for Module Quiz Reading 58 Basel III: Finalizing Post-Crisis Reforms Exam Focus MODULE 58.1: Basel III: Finalizing Post-Crisis Reforms The Standardized Approach The Business Indicator Internal Loss Multiplier Standardized Approach Capital Requirement The Standardized Approach vs. Earlier Approaches Identification, Collection, and Treatment of Operational Loss Data Key Concepts LO 58.a LO 58.b LO 58.c Answer Key for Module Quiz Formulas Reading 52 Reading 55 Reading 56 Reading 58 Index