Basel Norms — Set 8

Correct Answer: D. Supplementary Capital

• **Supplementary Capital** = Tier 2 capital supplements Tier 1 by providing gone-concern loss absorption — it protects depositors and senior creditors only after the bank fails, not while it still operates. • **Components** — Tier 2 includes general loan-loss provisions, revaluation reserves, hybrid instruments, and subordinated debt with original maturity of at least 5 years. • **Cap** — Under Basel III, Tier 2 capital cannot exceed Tier 1 capital; total capital = Tier 1 + Tier 2, and the 8% CRAR requirement allows Tier 2 to cover only up to 2% of RWAs. • 💡 Primary Capital is an informal term for Tier 1 (core capital) — not Tier 2. Reserve Capital is not a defined Basel term. Fixed Capital refers to long-term business assets (machinery, buildings) — an accounting concept, not a banking capital tier.

Correct Answer: A. Pillar 3

• **Pillar 3** = Market Discipline requires banks to publicly disclose their risk exposures, capital adequacy, risk management practices, and remuneration — enabling investors, depositors, and analysts to assess bank safety. • **Disclosure items** — Under Pillar 3, banks publish data on CRAR breakdowns, credit risk exposures, securitisation, liquidity, and leverage; RBI mandates quarterly/annual disclosures for Indian banks. • **Logic** — Transparency creates market pressure: a bank with weak capital or high NPAs faces higher borrowing costs and falling share price, incentivising management to stay prudent without regulator intervention. • 💡 Pillar 1 covers Minimum Capital Requirements (credit, market, operational risk). Pillar 2 is the Supervisory Review Process where regulators assess ICAAP. Pillar 4 does not exist in the Basel framework.

Correct Answer: D. 4.5%

• **4.5% CET1** = Basel III mandates a minimum CET1 ratio of 4.5% of Risk-Weighted Assets — CET1 is the highest quality capital (paid-up equity + retained earnings + disclosed reserves, net of deductions). • **Full capital stack** — CET1 (4.5%) + Additional Tier 1 (1.5%) = Tier 1 (6%) + Tier 2 (2%) = Total Capital (8%); add Capital Conservation Buffer 2.5% → effective CET1 requirement 7%, total 10.5%. • **D-SIB surcharge** — Banks like SBI (D-SIB bucket 3) must hold an additional 0.60% CET1 surcharge, raising their effective CET1 minimum above 7%. • 💡 7.0% is the CET1 including the Conservation Buffer (4.5% + 2.5%) — not the standalone minimum. 9.0% is not a Basel III global CET1 minimum; RBI requires Indian banks to maintain 8% CET1 (including CCB). 2.5% is the Capital Conservation Buffer add-on, not the base CET1 ratio.

Correct Answer: C. LCR (Liquidity Coverage Ratio)

• **LCR (Liquidity Coverage Ratio)** = LCR = High Quality Liquid Assets (HQLA) ÷ Total Net Cash Outflows over 30 days ≥ 100%; it ensures a bank can survive a severe short-term liquidity stress without central bank support. • **HQLA composition** — Level 1 assets (cash, central bank reserves, govt securities — 0% haircut) and Level 2 assets (certain corporate bonds, covered bonds — 15–50% haircut); Indian banks hold mainly G-Secs as HQLA. • **Introduced** — Basel III (2010), mandatory in India from 2015; RBI gradually increased the minimum from 60% to 100% by January 2019. • 💡 CRAR (Capital Adequacy Ratio) measures capital against risk-weighted assets — it addresses solvency, not short-term liquidity. NSFR measures structural funding stability over one year, not 30 days. Interest Ratio is not a defined regulatory metric under Basel norms.

Correct Answer: A. One year

• **One year** = NSFR = Available Stable Funding (ASF) ÷ Required Stable Funding (RSF) ≥ 100% over a one-year horizon; it ensures banks fund long-term illiquid assets with stable funding sources, not short-term volatile deposits. • **Contrast with LCR** — LCR is a 30-day short-term survival metric; NSFR is a structural, long-term metric ensuring the bank's funding model is sustainable over 12 months even in a prolonged stress scenario. • **India** — RBI introduced NSFR guidelines for scheduled commercial banks in 2021; banks with excessive reliance on overnight/call-money funding fail the NSFR test. • 💡 One month (30 days) is the LCR time horizon, not NSFR. Five years is not the horizon for any Basel liquidity ratio. One day is relevant for intra-day liquidity monitoring under BCBS 248, a separate framework — not NSFR.

Correct Answer: D. Reserve Bank of India (RBI)

• **Reserve Bank of India (RBI)** = RBI is India's central bank and the statutory banking regulator under the Banking Regulation Act, 1949; it translates BCBS guidelines into binding Master Circulars for all scheduled commercial banks. • **Stricter than Basel** — RBI often imposes higher requirements: minimum CRAR 11.5% vs Basel's 10.5%, leverage ratio 4% for D-SIBs vs Basel's 3%, and designated SBI/ICICI/HDFC as D-SIBs with extra CET1 surcharges. • **PCA framework** — RBI's Prompt Corrective Action (PCA) framework penalises banks that breach CRAR, GNPA, or ROA thresholds, an example of RBI enforcing capital discipline domestically. • 💡 LIC is an insurance company regulated by IRDAI — it is not a banking regulator. The Finance Ministry sets fiscal policy and owns public sector banks but does not issue prudential banking regulations. SEBI regulates capital markets (equities, mutual funds) — not the banking sector.

Correct Answer: B. Risk-weighted Assets

• **Risk-Weighted Assets (RWA)** = CAR = (Tier 1 + Tier 2 Capital) ÷ Risk-Weighted Assets × 100%; RWAs adjust the nominal value of assets by multiplying each asset by its assigned risk weight. • **Risk weights** — Cash and govt securities: 0% (very safe); residential mortgages: 35–75%; corporate loans: 100%; high-risk assets: 125–150%; off-balance-sheet exposures: converted via Credit Conversion Factor before risk-weighting. • **Why not total assets?** — Using raw total assets ignores risk differences; a bank holding only G-Secs is far safer than one with only corporate loans even if both have the same total assets, so RWAs provide a fairer capital benchmark. • 💡 Total Capital is the numerator, not the denominator — getting this right is critical for the formula. Net Profit is an income statement item, not used in CAR. Total Deposits are liabilities — Basel capital ratios are asset-side risk metrics, not liability comparisons.

Correct Answer: B. Banking institutions

• **Banking institutions** = Basel norms (I, II, III, IV) are specifically designed by BCBS for banks and banking groups — they set capital, liquidity, and risk management standards for deposit-taking, lending institutions. • **Scope in India** — RBI applies Basel III norms to all scheduled commercial banks (public sector, private sector, foreign banks operating in India); cooperative banks and NBFCs have separate prudential frameworks. • **Other sectors** — Insurance companies are governed by Solvency II (EU) or IRDAI regulations in India. Hospitals and manufacturing companies follow accounting standards and sector-specific regulations — not BCBS prudential norms. • 💡 Hospitals deal in healthcare services — no deposit-taking or systemic financial risk. Manufacturing companies are non-financial corporates subject to Companies Act and SEBI disclosure norms if listed. Insurance companies have their own capital adequacy norms (solvency margin under IRDAI) distinct from Basel.

Correct Answer: D. Pillar 2

• **Pillar 2** = The Supervisory Review Process requires regulators to review a bank's Internal Capital Adequacy Assessment Process (ICAAP) and intervene if capital or risk management is deemed insufficient. • **ICAAP** — Banks prepare ICAAP annually to self-assess all risks not fully captured in Pillar 1 (concentration risk, interest rate risk in banking book, pension risk, strategic risk); RBI then reviews and may mandate additional capital (SREP — Supervisory Review and Evaluation Process). • **Powers** — Under Pillar 2, RBI can require a bank to hold capital above the Pillar 1 minimum, impose lending restrictions, or trigger PCA if internal controls are weak. • 💡 Pillar 1 sets the minimum quantitative capital requirements for credit, market, and operational risk. Pillar 3 is Market Discipline (public disclosure). Pillar 4 does not exist — any option suggesting a fourth pillar is a distractor.

Correct Answer: C. Riskier assets

• **Riskier assets** = Risk-weighting assigns higher risk weights to assets with greater probability of default or loss, forcing banks to hold more capital against those positions — a corporate unsecured loan (100% weight) requires more capital than a G-Sec (0% weight). • **Key weights** — Government securities: 0%; claims on banks: 20–50%; residential mortgages: 35–75%; personal loans/credit cards: 100–125%; substandard/doubtful assets: 150%. • **Basel vs Standardised vs IRB** — Under Standardised Approach, risk weights come from RBI/BCBS tables; under IRB, banks use internal models to estimate Probability of Default (PD), Loss Given Default (LGD), and Exposure at Default (EAD) to compute their own risk weights. • 💡 Fixed deposits placed by a bank (as assets) with other banks carry a 20% risk weight — not the highest. Government bonds carry 0% risk weight because sovereign default is considered negligible — they require the least capital, not more. Small banks are an institutional category, not an asset type subject to risk-weighting.