FRTB recognizes that differences in capital requirements between the trading book and banking book may give rise to regulatory arbitrage, but it does not propose harmonization of these requirements as a way to mitigate this risk. Instead, FRTB attempts to establish a clearer boundary between the two books to make it difficult for banks to misallocate assets. A, B, and D are all true.

Things to Remember

• Regulatory arbitrage refers to the practice where financial institutions take advantage of regulatory differences between different jurisdictions to reduce their overall regulatory burden and increase profits.
• The trading book consists of positions that are actively traded and are marked-to-market, while the banking book consists of assets that are held to maturity and are accounted for at historical cost.
• FRTB stands for Fundamental Review of the Trading Book, which is a set of global regulations developed by the Basel Committee on Banking Supervision to address shortcomings in the current market risk framework.
• Credit spread risk refers to the risk of losses due to changes in credit spreads, while jump-to-default risk refers to the risk of losses due to a sudden default of a counterparty.
• FRTB aims to improve the consistency and comparability of capital requirements for market risk across jurisdictions and enhance the overall stability of the financial system.