Basel Norms — Set 1

Correct Answer: C. Switzerland

• **Switzerland** = BCBS is headquartered at the Bank for International Settlements (BIS) in Basel, Switzerland — its secretariat is hosted by BIS. • **1974 founding** — BCBS was created by G10 central bank governors in 1974 after the failure of Germany's Herstatt Bank exposed gaps in cross-border bank supervision. • BCBS now has 28 member jurisdictions; its guidelines are not legally binding — each country must enact its own laws to adopt them; India has implemented all three Basel accords. • 💡 United Kingdom is wrong — the Bank of England and FCA regulate UK banks, not BCBS; Germany is wrong — Herstatt's failure triggered BCBS formation, but the committee is based in Switzerland; United States is wrong — the Federal Reserve regulates US banks nationally.

Correct Answer: B. Basel Committee on Banking Supervision

• **Basel Committee on Banking Supervision** = BCBS is the full form; it is the primary global standard-setter for prudential regulation of banks, seated at BIS in Basel, Switzerland. • **28 member jurisdictions** — membership includes major financial centres; the committee issues guidelines (not binding laws) covering capital adequacy, liquidity, and risk management. • BCBS issued Basel I (1988), Basel II (2004), and Basel III (2010) — each progressively strengthened global banking standards. • 💡 Board for Central Banking Standards is wrong — no such body exists; Banking Council for Better Stability is a fabricated name; Bureau of Credit and Banking Security is wrong — BCBS is a supervisory committee, not a bureau or credit agency.

Correct Answer: A. 1988

• **1988** = Basel I (the Basel Capital Accord) was published in 1988; it focused exclusively on credit risk and set the first internationally agreed minimum Capital Adequacy Ratio (CAR) at 8%. • **Two tiers** — Basel I introduced Tier 1 (core equity capital + disclosed reserves) and Tier 2 (supplementary capital like subordinated debt); together they must meet the 8% CAR against risk-weighted assets. • Basel I had a simple risk-weight framework with just five categories (0%, 10%, 20%, 50%, 100%); it was later criticised for ignoring market risk and operational risk — weaknesses Basel II addressed. • 💡 1974 is wrong — that is the year BCBS itself was established, not when Basel I was published; 1992 is wrong — that is when G10 countries were expected to comply with Basel I, not its introduction; 2004 is wrong — that is when Basel II was released.

Correct Answer: C. 2008 Global Financial Crisis

• **2008 Global Financial Crisis** = Basel III was developed by BCBS in 2010 directly in response to the 2007–08 financial crisis, which exposed severe weaknesses in bank capital quality and liquidity management. • **Phased 2013–2019** — Basel III was rolled out gradually; key reforms included higher CET1 requirements, liquidity ratios (LCR and NSFR), leverage ratio, and capital buffers (CCB and CCyB). • The crisis revealed that banks held insufficient high-quality capital and were dangerously dependent on short-term wholesale funding — both problems Basel III directly targets. • 💡 Dot-com bubble burst (2000) is wrong — it caused equity market losses but did not trigger systemic banking reform; The Great Depression (1929) is wrong — it preceded BCBS by 45 years; 1997 Asian Financial Crisis is wrong — it prompted IMF reforms, not Basel III.

Correct Answer: D. 8%

• **8%** = The global Basel III minimum CAR (Total Capital Ratio) is 8% of risk-weighted assets — composed of CET1 ≥4.5%, AT1 ≥1.5%, and Tier 2 ≥2%. • **Effective minimum 10.5%** — adding the mandatory Capital Conservation Buffer (CCB) of 2.5% raises the effective floor to 10.5% CET1 for banks operating without restrictions on dividends. • India's RBI has set a stricter minimum CAR of 9% (vs 8% global) for Scheduled Commercial Banks, plus the CCB of 2.5%, making India's effective minimum 11.5%. • 💡 10% is wrong — it is not the global Basel III floor (it resembles India's effective minimum with CCB); 9% is wrong globally — it is India's RBI-specific minimum, not the BCBS standard; 11% is wrong — no Basel accord sets 11% as a standalone minimum.

Correct Answer: A. Pillar 2

• **Pillar 2** = Pillar 2 (Supervisory Review Process) requires national regulators to evaluate whether a bank's internal capital assessment is adequate for its risk profile and to impose additional capital if needed. • **ICAAP** — under Pillar 2 banks must conduct an Internal Capital Adequacy Assessment Process (ICAAP); supervisors then review it in the Supervisory Review and Evaluation Process (SREP). • Pillar 2 gives regulators the power to intervene — they can require a bank to hold capital above the Pillar 1 minimum if risks such as concentration risk or interest rate risk in the banking book are under-captured. • 💡 Pillar 4 is wrong — Basel has only three pillars; there is no Pillar 4; Pillar 3 is wrong — it deals with Market Discipline through public disclosure, not supervisory review; Pillar 1 is wrong — it covers Minimum Capital Requirements for credit, market, and operational risk.

Correct Answer: B. Pillar 3

• **Pillar 3** = Pillar 3 (Market Discipline) requires banks to publicly disclose detailed information about their capital structure, risk exposures, and risk management practices so that market participants can assess a bank's soundness. • **Transparency tool** — Pillar 3 disclosures include CET1 ratios, leverage ratios, liquidity metrics, and credit risk data; this reduces information asymmetry and lets creditors, investors, and depositors price risk accurately. • Pillar 3 complements Pillar 1 (minimum capital rules) and Pillar 2 (supervisory review) by adding external market pressure on banks to maintain sound practices. • 💡 Pillar 4 is wrong — no such pillar exists in the Basel framework; Pillar 1 is wrong — it sets minimum capital requirements for credit, market, and operational risk; Pillar 2 is wrong — it is the Supervisory Review Process conducted by regulators, not public disclosure.

Correct Answer: A. Capital to Risk-weighted Assets Ratio

• **Capital to Risk-weighted Assets Ratio** = CRAR (also called CAR) measures a bank's total eligible capital divided by its total risk-weighted assets (RWAs); it indicates a bank's ability to absorb losses while protecting depositors. • **Formula** — CRAR = (Tier 1 Capital + Tier 2 Capital) ÷ Risk-Weighted Assets × 100; RBI mandates CRAR ≥ 9% for Indian Scheduled Commercial Banks. • A higher CRAR means a more solvent and safer bank; banks with low CRAR face regulatory action including restrictions on dividend payments and branching. • 💡 Central Reserve and Assets Register is wrong — it is a fabricated term with no banking meaning; Credit Risk Assessment Report is wrong — this describes a document, not a capital ratio; Corporate Rate and Annual Revenue is wrong — it mixes unrelated financial terms with no connection to Basel norms.

Correct Answer: A. Paid-up share capital and free reserves

• **Paid-up share capital and free reserves** = Tier 1 capital is the highest quality, 'going-concern' capital; it is fully available to absorb losses while the bank continues to operate; core components are paid-up equity shares and retained earnings (free reserves). • **CET1 sub-category** — within Tier 1, Basel III further distinguishes Common Equity Tier 1 (CET1 ≥ 4.5%) — comprising ordinary shares and retained profits — and Additional Tier 1 (AT1 ≥ 1.5%) which includes perpetual non-cumulative preference shares and contingent convertible bonds (CoCos). • Tier 1 capital is loss-absorbing without the bank needing to cease operations, unlike Tier 2 capital which absorbs losses mainly in liquidation. • 💡 Revaluation reserves are wrong — they are part of Tier 2 (supplementary) capital because their value is uncertain and not freely distributable; Hybrid debt instruments are wrong — they qualify as AT1 only if they meet strict Basel III criteria; Subordinated debt is wrong — it is a Tier 2 instrument, subordinated to depositors and senior creditors.

Correct Answer: B. Supplementary Capital

• **Supplementary Capital** = Tier 2 capital is formally called supplementary capital because it provides an additional, secondary layer of protection beyond Tier 1 but is of lower quality and less readily available to absorb losses on a going-concern basis. • **Components** — Tier 2 includes undisclosed reserves, revaluation reserves, general provisions/loan loss reserves (up to 1.25% of RWA), hybrid debt instruments that do not qualify as AT1, and subordinated debt with original maturity ≥5 years. • Under Basel III, Tier 2 must be at least 2% of RWA; total CAR = CET1 (4.5%) + AT1 (1.5%) + Tier 2 (2%) = 8% minimum globally. • 💡 Primary Capital is wrong — that is an informal synonym for Tier 1, not Tier 2; Core Capital is wrong — core capital refers to Tier 1 (equity and retained earnings); Working Capital is wrong — it is an accounting/finance concept (current assets minus current liabilities) completely unrelated to Basel capital tiers.