Basel Norms — Set 5

Correct Answer: B. They can be converted to equity or written off if capital falls below a threshold

AT1 bonds are perpetual debt instruments that have specific loss-absorption features. If a bank's capital levels drop dangerously low, these bonds can be converted to equity to save the bank. They are considered riskier than traditional bonds but offer higher yields.

Correct Answer: A. Pillar 2

Pillar 2 allows regulators to evaluate a bank's specific risk profile and demand higher capital if they deem the bank's internal risks are high. This process is known as the Supervisory Review and Evaluation Process (SREP). It adds a customized layer of security to the uniform rules of Pillar 1.

Correct Answer: C. Risk of a total financial system collapse triggered by an event

Systemic risk refers to the risk of collapse of an entire financial system or market, as opposed to risk associated with any one individual entity. Basel III focuses heavily on mitigating systemic risk to prevent another 2008-style crisis. It identifies 'too big to fail' institutions as major systemic risks.

Correct Answer: A. To ensure banks have enough cash to meet short-term obligations

The liquidity standards (LCR and NSFR) are designed to ensure that banks can survive a period of market stress without relying on government bailouts. Liquidity is the ability to meet cash needs as they arise. Many banks failed in 2008 because they had capital but lacked liquidity.

Correct Answer: A. Group of Central Bank Governors and Heads of Supervision

The GHOS is the governing body of the Basel Committee. It oversees the committee's work and approves its major decisions and standards. It consists of the heads of central banks and supervisory authorities from member countries.

Correct Answer: D. Capital / RWA = Capital Adequacy Ratio

The Capital Adequacy Ratio (CAR) is calculated by dividing a bank's capital by its risk-weighted assets. This percentage indicates if the bank has enough 'buffer' to cover the risk of its assets. A higher ratio means a safer bank.

Correct Answer: D. Basel II

Basel II allowed sophisticated banks to use their own internal rating systems to calculate their capital requirements. This made the capital requirement more sensitive to the actual risks managed by the bank. However, it was later criticized for being too complex and allowing banks to game the system.

Correct Answer: C. Tier 1

Retained earnings are part of Common Equity Tier 1 (CET1) within Tier 1 capital. They represent the profits that a bank keeps for itself rather than paying out as dividends. This is the highest quality capital for absorbing losses.

Correct Answer: C. Enhance financial stability

The ultimate goal of Basel norms is to enhance global financial stability by ensuring banks have enough capital to handle crises. This prevents contagion, where the failure of one bank leads to the failure of others. Stable banks are essential for a healthy global economy.

Correct Answer: B. The ability of capital to cover losses and keep the bank operational

Loss absorbency refers to the quality of capital that allows it to 'soak up' financial losses. Common equity is the best at this because it does not need to be repaid. Basel norms prioritize loss-absorbing capital to protect depositors.