Basel Norms — Set 3

Correct Answer: D. Voluntary guidelines and recommendations

• **Voluntary guidelines and recommendations** = Basel norms are guidelines issued by BCBS — they are not international treaties or legally binding standards; each member country must pass its own domestic legislation or regulatory rules to enforce them. • **Adoption in practice** — despite being voluntary, virtually all G20 countries and major financial centres adopt Basel norms because non-compliance signals weakness to international investors and counterparties; RBI enacted Basel III via Master Circulars, making them legally binding on Indian banks. • BCBS has 28 member jurisdictions but the norms apply only as domestic law, not through a supranational enforcement mechanism — countries can deviate if they choose. • 💡 Binding international laws is wrong — BCBS has no legal enforcement authority; it cannot fine or sanction banks directly; Penalties for non-performing assets is wrong — NPA management is governed by RBI's IRAC norms and IBC, not by Basel norms; Only applicable to US banks is wrong — BCBS standards apply globally across all 28 member jurisdictions including India.

Correct Answer: D. Risk of loss due to changes in market prices

• **Risk of loss due to changes in market prices** = Market risk is the risk of losses in on-balance sheet and off-balance sheet positions arising from adverse movements in market variables — primarily interest rates, equity prices, foreign exchange rates, and commodity prices. • **Trading book focus** — market risk primarily applies to a bank's trading book (held-for-trading instruments); Basel II formalised capital requirements for market risk building on the 1996 Market Risk Amendment to Basel I. • Banks can calculate market risk capital using the Standardised Approach or the Internal Models Approach (Value-at-Risk models); Basel III's FRTB (Fundamental Review of the Trading Book) further refined market risk measurement. • 💡 Bank robbery is wrong — physical security losses are not a Basel-defined risk category; they may fall under operational risk but are not market risk; Borrower default is wrong — that is credit risk (the risk of a counterparty failing to meet its obligations); Faulty computer systems is wrong — losses from IT failures, fraud, or system breakdowns are classified as operational risk under Basel II.

Correct Answer: A. 4.5%

• **4.5%** = Basel III mandates a minimum CET1 ratio of 4.5% of risk-weighted assets; CET1 is the highest quality capital — comprising ordinary paid-up shares and retained earnings — able to absorb losses on a going-concern basis. • **Full Basel III capital stack** — CET1 4.5% + AT1 1.5% = Tier 1 6%; + Tier 2 2% = Total CAR 8%; add CCB 2.5% → effective CET1 floor for unrestricted operations = 7%; India's RBI sets CET1 ≥ 5.5%. • CET1 was introduced as a distinct category in Basel III (it did not exist in Basel I or II) because the 2008 crisis showed that Tier 1 capital often included instruments that could not absorb losses in a going-concern scenario. • 💡 6.0% is wrong — that is the minimum Tier 1 Capital ratio (CET1 4.5% + AT1 1.5%), not the CET1-alone requirement; 8.0% is wrong — that is the total minimum CAR (Tier 1 + Tier 2), not the CET1 floor; 2.5% is wrong — that is the Capital Conservation Buffer (CCB), not the CET1 minimum.

Correct Answer: A. 2021

• **2021** = RBI originally planned to complete Basel III implementation by March 2019 (aligned with global phasing), but granted multiple extensions; the full implementation deadline was finally set as March 31, 2021. • **Phased rollout** — RBI began phasing in Basel III from April 1, 2013; extensions were granted partly due to the economic impact of COVID-19 (the CCB phasing was also deferred during 2020–21). • As of 2021, all Scheduled Commercial Banks in India must comply with full Basel III norms including CET1 ≥ 5.5%, Total CAR ≥ 9%, CCB 2.5%, and LCR/NSFR requirements as per RBI's Master Circulars. • 💡 2010 is wrong — that is when BCBS published the Basel III framework internationally, not when India completed its implementation; 2017 is wrong — RBI had set interim milestones by 2017 but the full deadline was later; 2015 is wrong — the LCR minimum requirement was introduced in India in 2015, but overall Basel III compliance was not complete until 2021.

Correct Answer: B. Government Savings and Investment Boards

• **Government Savings and Investment Boards** = This term does not exist in the Basel III framework or in banking regulation; it is a fabricated option. • **Real Basel III systemic importance terms** — G-SIBs (Global Systemically Important Banks) are large international banks whose failure would cause global financial disruption; D-SIBs (Domestic Systemically Important Banks) are national equivalents; SIFIs (Systemically Important Financial Institutions) is the broader term covering both banks and non-bank financial firms. • In India, RBI designates D-SIBs annually; current D-SIBs are SBI, ICICI Bank, and HDFC Bank — they face an additional CET1 surcharge of 0.2%–0.8% above standard requirements. • 💡 Domestic Systemically Important Banks (D-SIBs) is a real and valid Basel III concept — it is not the wrong answer; Systemically Important Financial Institutions (SIFIs) is a real term used by FSB and Basel frameworks; Global Systemically Important Banks (G-SIBs) is explicitly defined in Basel III with additional loss absorbency requirements — also valid.

Correct Answer: A. G10

• **G10** = BCBS was established in 1974 by the central bank governors of the Group of Ten (G10) countries — Belgium, Canada, France, Germany, Italy, Japan, Netherlands, Sweden, Switzerland, United Kingdom, and the United States (11 actual members despite the name). • **Trigger** — the committee was formed after the 1974 failure of Herstatt Bank (Germany) and Franklin National Bank (USA) caused cross-border banking disruptions; BIS in Basel, Switzerland provides its secretariat. • BCBS membership has since expanded to 28 jurisdictions (including India, China, Brazil, Australia) to better reflect the global banking system; but the founding body was the G10. • 💡 BRICS is wrong — Brazil, Russia, India, China, South Africa did not exist as a formal group in 1974; BRICS formed as a concept in 2001 and as a formal body later; G7 is wrong — G7 is a political grouping; BCBS was founded by G10 central banks, not the political G7; G20 is wrong — G20 was formed in 1999, 25 years after BCBS was established in 1974.

Correct Answer: B. A percentage reduction in the market value of collateral to account for risk

• **A percentage reduction in the market value of collateral to account for risk** = A haircut is the difference between an asset's current market value and the value a lender attributes to it as collateral; it accounts for price volatility, liquidity risk, and forced-sale discounts. • **Basel application** — BCBS specifies standardised haircuts for different collateral types; for example, government bonds with >5-year maturity may attract a 4%–8% haircut; equities may carry 15%–25%; lower-quality assets face higher haircuts, requiring borrowers to pledge more collateral. • Haircuts directly affect Credit Risk Mitigation (CRM) calculations under Basel II/III — a lower effective collateral value means higher net exposure, requiring more regulatory capital against that position. • 💡 Physical security in bank vaults is wrong — haircut is a financial valuation concept, not a vault security method; Fee for opening an account is wrong — account-opening fees are commercial banking charges with no connection to Basel collateral rules; Reducing bank staff salary is wrong — the term 'haircut' in this context is a financial valuation term, not a compensation concept.

Correct Answer: D. Corporate loans and bonds

• **Corporate loans and bonds** = Under the Standardised Approach for credit risk in Basel II/III, risk weights for corporate exposures are determined by external credit ratings from recognised rating agencies (e.g., CRISIL, ICRA in India; Moody's, S&P, Fitch globally). • **Rating-to-risk-weight mapping** — AAA to AA-rated corporates: 20% risk weight; A+ to A-: 50%; BBB+ to BB-: 100%; below BB-: 150%; unrated: typically 100%; higher-rated firms require less capital per rupee of lending. • External ratings are used for corporates, banks, and sovereigns; they are not applied to physical assets like buildings or furniture which use fixed regulatory risk weights or deductions. • 💡 Bank furniture is wrong — fixed assets like furniture have a standardised 100% risk weight and no external rating applies; Bank's own buildings are wrong — they are treated as fixed assets with standard risk weights; Cash in hand is wrong — cash has a 0% risk weight (no credit risk), so no rating is needed or applicable.

Correct Answer: D. Master Circular on Prudential Norms

• **Master Circular on Prudential Norms** = RBI issues Master Circulars (typically updated annually on July 1) that consolidate all instructions on Basel implementation for Indian banks — covering CRAR calculation, capital tiers, risk weights, LCR, NSFR, and disclosure requirements. • **Legal binding** — while Basel norms are globally voluntary guidelines, RBI's Master Circulars are legally binding on all Scheduled Commercial Banks in India under the Banking Regulation Act, 1949; non-compliance invites RBI enforcement action. • The Master Circular on Basel III Capital Regulations is the key document; RBI also issues supplementary circulars for specific topics like D-SIB surcharges, LCR updates, and leverage ratio requirements. • 💡 Gazette of India is wrong — the Gazette publishes central government legislative notifications, not RBI's regulatory instructions to banks; Annual Budget is wrong — it is the Union government's fiscal policy document, not a banking prudential norm; Press Trust of India report is wrong — PTI is a news agency, not a regulatory body; it has no role in issuing banking standards.

Correct Answer: C. Pillar 1

• **Pillar 1** = The Leverage Ratio (Tier 1 Capital ÷ Total Exposure ≥ 3%) serves as a non-risk-based backstop to the risk-based capital requirements of Pillar 1 (Minimum Capital Requirements); it acts as a floor that cannot be gamed by risk model manipulation. • **Why Pillar 1 needs a backstop** — Pillar 1 uses risk-weighted assets; banks can use sophisticated internal models (IRB approach) to assign low risk weights and thus report high CARs with little actual capital; the Leverage Ratio prevents this by ignoring risk weights entirely. • Pre-2008, banks in some countries had leverage ratios exceeding 30:1 (assets 30× their equity) despite complying with risk-based Pillar 1 rules; the Leverage Ratio directly addresses this systemic vulnerability. • 💡 All pillars simultaneously is wrong — the Leverage Ratio specifically targets Pillar 1's risk-weighting loophole; it does not serve as a backstop to supervisory review (Pillar 2) or disclosure (Pillar 3); Pillar 3 is wrong — Pillar 3 is about market discipline through disclosure; the Leverage Ratio supplements capital measurement, not transparency; Pillar 2 is wrong — Pillar 2 is the supervisory review process; the Leverage Ratio is a Pillar 1 capital metric, not a supervisory tool.