Basel Norms — Set 7

Correct Answer: C. To ensure the stability of the global banking system

• **To ensure the stability of the global banking system** = Basel norms are international capital standards issued by BCBS to make banks resilient against financial shocks and prevent systemic collapse. • **Origin** — Born after the 1974 failure of Herstatt Bank (Germany), these norms require banks to hold sufficient capital to absorb unexpected losses without taxpayer bailouts. • **Scope** — They set minimum capital requirements, liquidity standards, and risk management rules adopted by 100+ countries including India via RBI. • 💡 Reducing employees has nothing to do with Basel — that is a bank's internal HR decision. Promoting online banking is a fintech/digital initiative, not a prudential standard. Increasing profits is actually constrained by Basel, since more capital must be set aside rather than lent out.

Correct Answer: C. Basel

• **Basel, Switzerland** = The Basel Committee on Banking Supervision (BCBS) is headquartered in Basel because it operates under the Bank for International Settlements (BIS), which is based there. • **Founded 1974** — Established by G10 central bank governors after the Herstatt Bank collapse; it now has 45 member institutions from 28 jurisdictions. • **Role** — BCBS sets global banking standards but has no supranational authority; countries must adopt norms voluntarily through domestic regulators like RBI. • 💡 Paris hosts OECD and FATF, not BCBS. London is the seat of the Bank of England and Financial Conduct Authority. New York hosts the Federal Reserve Bank of NY and IMF offices — none of these is the BCBS.

Correct Answer: B. Basel I

• **Basel I (1988)** = The first Basel Accord focused exclusively on credit risk — the risk that a borrower defaults on a loan — and set a simple 8% minimum capital-to-risk-weighted-assets ratio. • **Risk weights were crude** — Basel I used only five broad risk-weight buckets (0%, 10%, 20%, 50%, 100%); a sovereign loan and a corporate loan in different buckets regardless of actual creditworthiness. • **Superseded** — Basel I was replaced by Basel II (2004), which added market risk and operational risk and introduced more sophisticated IRB approaches for credit risk. • 💡 Basel II added three-pillar structure and operational risk — it went beyond credit risk. Basel III addressed capital quality and liquidity (LCR, NSFR) after the 2008 crisis. Basel IV (2017 BCBS reforms) tightened output floors and risk weight calculations — none of these was the one focused primarily on credit risk alone.

Correct Answer: B. Three

• **Three Pillars** = The Basel II/III framework rests on three pillars: Pillar 1 (Minimum Capital Requirements), Pillar 2 (Supervisory Review Process), and Pillar 3 (Market Discipline through disclosure). • **Pillar 1** covers credit, market, and operational risk capital; **Pillar 2** lets regulators demand extra capital if internal models are weak; **Pillar 3** forces banks to publicly disclose risk and capital data. • **Introduced by Basel II** — Basel I had no formal pillar structure; the three-pillar architecture was first formalised in the Basel II framework (2004). • 💡 Five and Four are incorrect — BCBS never created a fourth or fifth pillar. Two pillars (just capital + supervision, without disclosure) was never an official Basel structure.

Correct Answer: C. 8%

• **8% total capital ratio** = Basel III prescribes a minimum Total Capital Ratio (Tier 1 + Tier 2) of 8% of Risk-Weighted Assets — same as Basel I, but now with much stricter definitions of what counts as capital. • **Breakdown** — CET1 minimum is 4.5%, Additional Tier 1 brings Tier 1 to 6%, and Tier 2 adds 2% to reach the 8% floor; plus a 2.5% Capital Conservation Buffer makes effective minimum 10.5%. • **RBI requirement** — Indian banks must maintain CRAR of at least 11.5% (including CCB), which is higher than the global 8% floor. • 💡 12% is not a Basel III global minimum — some countries require this domestically. 5% has never been a Basel minimum. 10% is the PCA trigger level in India (CRAR below 10.25% triggers RBI's Prompt Corrective Action), not the basic Basel floor.

Correct Answer: D. Core capital (Equity and reserves)

• **Core capital (Equity and reserves)** = Tier 1 capital is a bank's highest-quality, permanently available capital — it absorbs losses while the bank continues operating (going-concern basis). • **Composition** — Tier 1 = Common Equity Tier 1 (CET1: paid-up equity + retained earnings + disclosed reserves) + Additional Tier 1 (AT1: perpetual bonds like Basel III-compliant debentures that can be written off). • **AT1 bonds** — India's AT1 bonds made headlines when YES Bank's AT1 bonds were written down to zero in 2020 during RBI's rescue plan, illustrating the loss-absorption feature. • 💡 Total deposits are liabilities, not capital — depositors are bank's creditors. Subordinated debt is a component of Tier 2, not Tier 1. Fixed assets (buildings, equipment) are assets on the balance sheet, not a capital category.

Correct Answer: C. Operational risk

• **Operational risk** = Basel II formally defined and required capital for operational risk — the risk of loss from failed internal processes, people, systems, or external events (fraud, system outages, legal penalties). • **Three measurement approaches** — Basic Indicator Approach (15% of gross income), Standardised Approach (varies by business line), and Advanced Measurement Approach (AMA, bank's own models); Basel IV later replaced AMA with the Standardised Approach. • **Real examples** — The 2012 JPMorgan 'London Whale' $6 billion trading loss and the 2016 Bangladesh Bank cyber heist ($81M stolen via SWIFT) are classic operational risk events. • 💡 Political risk (government instability, expropriation) is not a Basel capital category. Natural disaster risk is partly captured under operational risk but is not a standalone category. Exchange rate risk falls under market risk, which already existed before Basel II.

Correct Answer: D. Basel III

• **Basel III** = The Capital Conservation Buffer (CCB) of 2.5% CET1 was introduced in Basel III (2010) to ensure banks build a capital cushion during good times, which can be drawn down during stress. • **Restriction mechanism** — If a bank's CET1 falls below 7% (4.5% minimum + 2.5% CCB), it faces automatic restrictions on dividend payments, share buybacks, and discretionary bonuses. • **Countercyclical Buffer** — Basel III also added a Countercyclical Capital Buffer (CCyB) of 0–2.5% CET1, which regulators activate during credit booms to restrain excessive lending; RBI can activate it for India. • 💡 Basel I (1988) only addressed credit risk with an 8% capital ratio — no buffers existed. Basel II (2004) had three pillars but no conservation buffer. Basel 1988 is the same as Basel I — a distractor option.

Correct Answer: D. BIS (Bank for International Settlements)

• **BIS (Bank for International Settlements)** = The BCBS is a committee hosted by and secretariat-supported by the BIS, headquartered in Basel, Switzerland — often called the 'central bank of central banks'. • **BIS role** — BIS provides banking services to central banks, conducts research, and hosts several key committees (BCBS, CPMI for payments, FSB coordination) but does not itself regulate banks. • **Membership** — BIS has 63 member central banks representing economies accounting for about 95% of world GDP; BCBS is a subset body within this structure. • 💡 IMF lends money to countries facing balance-of-payments crises and does financial sector surveillance — it does not host BCBS. World Bank funds development projects in low/middle-income countries. WTO governs international trade in goods and services — entirely unrelated to banking prudential regulation.

Correct Answer: C. A non-risk-based capital measure

• **A non-risk-based capital measure** = The Leverage Ratio = Tier 1 Capital ÷ Total Exposure (on-balance-sheet assets + off-balance-sheet exposures), with a minimum of 3% under Basel III — it acts as a simple backstop independent of risk-weight models. • **Why needed** — Risk-weighted capital ratios can be gamed by using low risk-weight assets; the leverage ratio prevents banks from becoming excessively leveraged even if their risk-weighted ratio looks healthy. • **India** — RBI set the minimum leverage ratio at 4% for domestic systemically important banks (D-SIBs like SBI) and 3.5% for other banks, stricter than the global 3% floor. • 💡 Loans-to-deposits is the Credit-Deposit (CD) ratio, a liquidity metric unrelated to Basel leverage. Profit-to-loss ratio is not a regulatory concept. Branches-to-staff is an operational metric — none of these are the Basel Leverage Ratio.