The three pillars of Basel II are minimum capital requirements, supervisory review and which third pillar?

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, 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.