Basel Norms and Capital Adequacy: Pillars and Ratios

The correct answer is B, the Basel Committee on Banking Supervision. It was set up in 1974 by the central bank governors of the Group of Ten countries and has its secretariat at the Bank for International Settlements in Basel, Switzerland. Its standards are recommendations and bind banks only once a national regulator adopts them. Option A is wrong because the International Monetary Fund looks after exchange rate stability and balance of payments support, not bank capital standards. Option C is wrong because the World Bank lends for development projects and poverty reduction and has no supervisory role over commercial banks. Option D is wrong because the Financial Action Task Force sets standards against money laundering and terrorist financing, a different subject that examiners often place beside Basel as a distractor. Remember the city, the committee and the Bank for International Settlements together.

The correct answer is B, market discipline. The third pillar works through disclosure: a bank must publish enough about its risk profile, capital and risk management for depositors, investors and rating agencies to judge it, so that the market itself exerts pressure for prudent behaviour. Option A is wrong because deposit insurance in India is handled by the Deposit Insurance and Credit Guarantee Corporation and is not part of the Basel pillars. Option C is wrong because liquidity coverage came in with Basel III in the form of the Liquidity Coverage Ratio and was not one of the three Basel II pillars. Option D is wrong because asset classification into standard, substandard, doubtful and loss categories is a Reserve Bank prudential norm rather than a Basel pillar. Recite the order: minimum capital, supervisory review, market discipline.

The correct answer is B, nine per cent. The Reserve Bank has deliberately set the Indian minimum one percentage point above the Basel figure, so Indian banks must maintain a capital to risk weighted assets ratio of nine per cent, of which Common Equity Tier one must be at least five and a half per cent and total Tier one at least seven per cent. Option A is wrong because eight per cent is the Basel minimum applied internationally, not the Indian one. Option C is wrong because ten and a half per cent is the Basel III requirement once the capital conservation buffer of two and a half per cent is added to the global eight; the comparable Indian figure is eleven and a half per cent. Option D is wrong because twelve per cent is not prescribed. Remember the Indian pair: nine per cent plus a buffer of two and a half.

The correct answer is C, paid up equity capital and statutory reserves. Common Equity Tier one is the purest form of going concern capital, able to absorb losses while the bank continues to trade, and it is made up of paid up equity capital, share premium, statutory reserves and retained earnings. Option A is wrong because subordinated debt is a Tier two instrument: it ranks below depositors and protects them only in liquidation. Option B is wrong because revaluation reserves, which arise from writing up the value of property, are also counted in Tier two and not in core equity. Option D is wrong because general provisions held against standard assets are likewise a Tier two item. The simple test is whether the money can absorb losses with the bank still running; only then is it Common Equity Tier one.

The correct answer is B, the global financial crisis of 2008. The crisis showed that banks had too little capital of genuinely loss absorbing quality and no cushion of liquid assets, so the Basel Committee issued Basel III in 2010 with stricter definitions of capital, the capital conservation and countercyclical buffers, a leverage ratio and the two liquidity standards. Option A is wrong because the Asian crisis of 1997 prompted reforms of exchange rate and reserve management rather than a new Basel accord. Option C is wrong because the collapse of Bankhaus Herstatt in 1974 is the event that led to the creation of the Basel Committee itself, not to Basel III. Option D is wrong because the European sovereign debt troubles came after Basel III was already framed. Match each event to its outcome carefully.

The correct answer is C, Common Equity Tier one capital. The buffer of two and a half per cent of risk weighted assets is meant to be built up in good years and drawn down in bad ones, so it must consist of the highest quality capital, that is common equity. A bank that lets the buffer fall faces curbs on dividends, share buybacks and bonus payments until it is rebuilt. Option A is wrong because Tier two capital protects depositors only in liquidation and cannot serve as a usable cushion for a bank still trading. Option B is wrong because Additional Tier one instruments, though they are going concern capital, are not accepted for the buffer. Option D is wrong because no combination is allowed; the requirement is specific. In India the buffer takes the effective requirement to eleven and a half per cent.

The correct answer is B, thirty days. The Liquidity Coverage Ratio is a short term standard: a bank must hold enough high quality liquid assets, mainly cash, central bank reserves and sovereign securities, to survive the net cash outflows of a thirty day stress scenario, and the ratio must be at least a hundred per cent. Option A is wrong because no Basel standard uses a seven day horizon. Option C is wrong because ninety days is not the measurement window for either liquidity standard. Option D is wrong because one year is the horizon of the other Basel III liquidity rule, the Net Stable Funding Ratio, which compares available stable funding with required stable funding. Keep the pair straight: thirty days for the Liquidity Coverage Ratio, one year for the Net Stable Funding Ratio, both at a hundred per cent.

The correct answer is A, the Bank for International Settlements. The Bank is located in Basel, Switzerland, was established in 1930 and is the oldest international financial institution in the world; it is often described as the bank for central banks because its members are central banks rather than private customers. The Basel Committee sits within it, which is how the accords took the city's name. Option B is wrong because the European Central Bank, based in Frankfurt, conducts monetary policy for the euro area. Option C is wrong because the Swiss National Bank is simply the central bank of Switzerland and does not host the committee. Option D is wrong because the Organisation for Economic Co operation and Development, based in Paris, works on economic policy research and tax matters.

The correct answer is B, State Bank of India, ICICI Bank and HDFC Bank. The Reserve Bank issued its framework for Domestic Systemically Important Banks in 2014 and has since placed these three in the list, on the view that their size, interconnectedness and complexity make their failure a danger to the whole system. Each is put in a bucket and must hold an additional Common Equity Tier one surcharge, and the leverage ratio required of them is four per cent against three and a half for other banks. Option A is wrong because Punjab National Bank and Bank of Baroda, though large public sector banks, are not on the list. Option C is wrong because Axis Bank and Kotak Mahindra Bank have not been designated. Option D is wrong for the same reason regarding Canara Bank and Union Bank of India.

The correct answer is C, credit risk. The first accord was a simple framework that asked banks to hold capital equal to at least eight per cent of their risk weighted assets, with risk weights of zero, twenty, fifty and a hundred per cent assigned according to the creditworthiness of the borrower. India adopted it in 1992. Option A is wrong because operational risk, the risk of loss from failed processes, people, systems or external events, was brought into the capital charge only with Basel II in 2004. Option B is wrong because market risk, arising from movements in interest rates, exchange rates and prices, was added through an amendment after Basel I and formalised under Basel II. Option D is wrong because liquidity risk was addressed only in Basel III through the Liquidity Coverage Ratio and the Net Stable Funding Ratio.