Capital Adequacy – Basel Norms MCQ: CAIIB BFM Unit 27 Module D

Correct Answer: B. Minimum Capital Requirements, Supervisory Review Process, Market Discipline. The Basel III framework is structured around these three core pillars to strengthen banking regulations.

Correct Answer: C. To improve the stability and soundness of the banking system. Basel III aims to enhance the overall resilience of the banking sector and encourage better risk management.

Correct Answer: B. The 1988 Basel Accord (Basel I). Basel III is an update and replacement for the earlier Basel Accord to address its limitations.

Correct Answer: C. Operational Risk. A key innovation in Basel III was the introduction of specific minimum capital requirements for operational risk, which was not explicitly covered in the same way before.

Correct Answer: C. Flexible and risk-sensitive options. Basel III provides different approaches for calculating capital, allowing methods that are more sensitive to a bank’s actual risk profile.

Correct Answer: D. Credit risk, market risk, and operational risk. Pillar 1 specifically sets out the minimum capital requirements covering these three major risk categories faced by banks.

Correct Answer: C. Standardised Approach (using external ratings). Basel III offers the Standardised Approach, Foundation IRB, and Advanced IRB for calculating credit risk capital.

Correct Answer: A. Standardised Approach (e.g., Duration-Based Method). Pillar 1 provides the Standardised Approach (with methods like Maturity Ladder or Duration) and Internal Models Approach for market risk.

Correct Answer: D. Basic Indicator Approach (BIA). The BIA calculates operational risk capital as a percentage of a bank’s average gross income over a period.

Correct Answer: B. To ensure banks have enough capital beyond Pillar 1 and improve their risk management. Pillar 2 involves supervisors assessing if a bank’s capital is adequate for its overall risk profile, beyond just Pillar 1 rules.

Correct Answer: B. Internal Capital Adequacy Assessment Process (ICAAP). Pillar 2 requires banks to perform their own assessment (ICAAP) of their capital needs relative to their risks.

Correct Answer: C. Risks not fully captured or not covered at all by Pillar 1, and external risks. The ICAAP is meant to be comprehensive, covering residual Pillar 1 risks, risks outside Pillar 1 (like concentration risk), and external factors.

Correct Answer: C. To improve market discipline through required public disclosures. Pillar 3 aims to use transparency and disclosure to allow market forces to encourage prudent bank behaviour.

Correct Answer: B. It allows them to assess a bank’s risk profile and capital adequacy. The disclosures under Pillar 3 provide necessary information for the market to evaluate a bank’s financial health and risk management.

Correct Answer: C. Information on capital structure, risk exposures, and assessment processes. Pillar 3 mandates disclosures covering scope, capital, risk exposures (like credit, market, operational), and the methods used to assess these risks.

Correct Answer: C. Commercial Banks. Basel III regulations are specifically designed for and applied to commercial banks.

Correct Answer: D. Cooperative Banks, Local Area Banks (LABs), and Regional Rural Banks (RRBs). These types of banks are typically excluded from the direct application of the Basel III framework in many jurisdictions.

Correct Answer: C. Both at the individual bank (solo) and banking group (consolidated) levels. Basel III is intended to be applied comprehensively, considering both the individual entity and the entire group it belongs to.

Correct Answer: C. Capital to Risk-weighted Assets Ratio (CRAR). A central requirement of Basel III is maintaining a minimum CRAR, which compares a bank’s capital to its risk-adjusted assets.

Correct Answer: C. Potentially lower required capital charges under certain approaches. Using advanced internal models (like IRB or AMA), which require sophisticated risk systems, can potentially lead to lower capital requirements compared to standardised approaches.

Correct Answer: C. Internationally active banks. While applicable broadly to commercial banks, Basel III was initially developed with a focus on setting standards for banks operating across borders.

Correct Answer: B. Yes, regulators can impose stricter standards if they deem it necessary. Basel III provides a minimum floor, but national authorities have the discretion to enforce higher capital requirements.

Correct Answer: C. Cooperation between the bank’s home country supervisor and host country supervisors. Effective cross-border implementation requires coordination and information sharing between the regulators in the different countries where the bank operates.

Correct Answer: C. Regulatory Capital / Risk-Weighted Assets (RWA). The capital ratio measures the bank’s eligible capital in proportion to its risk-weighted assets.

Correct Answer: B. 8%. Basel III established a global minimum requirement of 8% for the total capital ratio.

Correct Answer: C. 9%. While the global minimum is 8%, regulators in India require banks to maintain a higher minimum total capital ratio of 9%.

Correct Answer: C. Tier-I (Core Capital) and Tier-II (Supplementary Capital). Regulatory capital is primarily divided into these two tiers based on quality and loss-absorption capacity.

Correct Answer: C. Paid-up capital and free reserves. Tier-I capital consists of the highest quality capital, including equity like paid-up capital and retained earnings like free reserves.

Correct Answer: B. Revaluation reserves. Indian banking regulations allow revaluation reserves (arising from revaluing assets like property) to be included in Tier-I capital, subject to certain conditions.

Correct Answer: C. Subordinated debt with maturity greater than 5 years. Tier-II capital includes items like long-term subordinated debt and certain reserves that supplement Tier-I capital.

Correct Answer: B. Tier-II cannot exceed 100% of Tier-I Capital. To maintain the quality of total capital, the amount of Tier-II capital is capped at the same amount as Tier-I capital.

Correct Answer: C. It was phased out and is no longer used. Tier-III capital, which existed under Basel II for market risk, was eliminated under Basel III.

Correct Answer: D. Credit Risk, Market Risk, and Operational Risk. RWA under Basel III comprehensively reflects a bank’s exposure by weighting assets according to these three main risk categories.

Correct Answer: C. RWA = RWA credit risk + (12.5 × Capital for market risk) + (12.5 × Capital for operational risk). The formula adds RWA for credit risk to the capital charges for market and operational risk, multiplied by 12.5 to convert them into equivalent RWAs.

Correct Answer: D. The reciprocal of the minimum capital requirement (1 / 8% or 1 / 0.08). Multiplying the capital charge by 12.5 converts it into an RWA equivalent based on the 8% minimum capital ratio.

Correct Answer: C. Tier-I and Tier-II capital. The primary loss-absorbing capital (Tier-I and Tier-II) must be used to cover requirements for credit and counterparty credit risks.

Correct Answer: C. Basel III is designed to be more risk-sensitive than Basel I. Basel III incorporates more sophisticated methods for measuring risks (credit, market, operational) making capital requirements more aligned with a bank’s actual risk profile compared to the simpler Basel I.

Correct Answer: B. To ensure banks hold adequate capital above Pillar 1 minimums and have strong risk management. Pillar 2 focuses on ensuring that banks identify and hold capital for all their material risks, not just those covered by Pillar 1, and maintain effective risk practices.

Correct Answer: B. To cover risks that are underestimated or not included in Pillar 1 calculations. Pillar 2 acts as a supplement to Pillar 1, ensuring capital adequacy for the bank’s entire risk profile.

Correct Answer: C. Credit Concentration Risk. Pillar 2 explicitly considers risks like concentration risk (too much exposure to one borrower or sector), which are not adequately addressed by Pillar 1’s minimum requirements.

Correct Answer: B. Internal Capital Adequacy Assessment Process. ICAAP refers to the bank’s own internal procedure for evaluating its risks and determining the necessary capital levels.

Correct Answer: C. To assess its total risk exposure internally and decide how much capital it needs. The ICAAP is the bank’s self-assessment mechanism for ensuring it holds sufficient capital for all its risks.

Correct Answer: C. The bank’s Board of Directors. The ultimate responsibility for the bank’s capital adequacy rests with the Board, hence they must approve the ICAAP.

Correct Answer: D. Forward-looking elements like capital projections and strategies. The ICAAP should not only look at the current situation but also anticipate future capital needs and plans.

Correct Answer: C. Banks are primarily responsible for assessing their own capital adequacy (through ICAAP). Principle 1 of SRP emphasizes the bank’s own responsibility in the assessment process.

Correct Answer: B. To develop its own comprehensive ICAAP. Banks must proactively conduct their internal assessment process.

Correct Answer: D. Maintain it above the regulatory minimums. Banks are expected to operate with a buffer above the bare minimum capital requirements, as assessed through the ICAAP and reviewed by supervisors.

Correct Answer: C. To review and evaluate the bank’s ICAAP and overall compliance. Supervisors oversee the bank’s internal process and assess if it is adequate and if the bank holds sufficient capital.

Correct Answer: B. They can require the bank to hold capital above the Pillar 1 minimum. If the supervisor deems the Pillar 1 minimum insufficient for a specific bank’s risk profile, they can mandate higher capital levels.

Correct Answer: C. Early, to prevent capital from falling below minimum levels. Principle 4 of SRP emphasizes proactive and early intervention by supervisors if capital adequacy is threatened.

Correct Answer: C. The Board of Directors and senior management. Effective ICAAP requires strong governance, with oversight from the highest levels of the bank.

Correct Answer: C. The complexity of the ICAAP should match the complexity of the bank’s operations. A large, complex bank needs a more sophisticated ICAAP than a small, simple bank.

Correct Answer: B. It must be risk-based. A core feature is that the capital adequacy assessment is driven by the specific risks the bank actually faces.

Correct Answer: C. Stress testing. ICAAP must include stress tests to see how the bank’s capital would hold up under adverse economic or financial conditions.

Correct Answer: B. To act as the official record of the bank’s assessment for Board and RBI review. The document formally records the process, analysis, and conclusions of the ICAAP for internal governance and supervisory review.

Correct Answer: B. It acts as a market-based check, encouraging banks to maintain adequate capital (Pillar 1) and strong risk management (Pillar 2). Market scrutiny incentivizes banks to adhere to the spirit of the regulations beyond just minimum compliance.

Correct Answer: C. Meaningful. The principles (Clear, Comprehensive, Meaningful, Consistent, Comparable) aim to ensure disclosures are useful and understandable for market participants.

Correct Answer: C. At the top consolidated level of the entire group. Disclosures generally provide a view of the risk profile and capital adequacy of the banking group as a whole.

Correct Answer: B. No, individual disclosures are generally not required unless specific conditions apply (e.g., significant subsidiary). The primary focus is on the consolidated group, but individual disclosures might be needed in specific cases.

Correct Answer: C. Half-yearly (every six months). Banks must make comprehensive Pillar 3 disclosures at least twice a year.

Correct Answer: B. Quarterly (every three months). Specific important disclosures related to capital adequacy and credit risk require more frequent publication (quarterly).

Correct Answer: C. Concurrently (at the same time) with the bank’s financial results. Pillar 3 disclosures are meant to be read alongside the financial statements for a complete picture.

Correct Answer: C. Included in published financial statements or on the bank’s official website. Disclosures must be publicly accessible, typically through the bank’s standard reporting channels.

Correct Answer: C. A common template format mandated by regulators. To improve comparability, standardized templates are required for certain key disclosures, especially regulatory capital.

Correct Answer: C. The bank itself, through its internal processes. Banks are responsible for having controls and validation procedures to ensure their disclosures are accurate.

Correct Answer: B. No, external audit is generally not required, but the data should align with audited financials where relevant. While not typically audited themselves, the information should be consistent with audited financial statements.

Correct Answer: C. If leaving it out or misstating it could influence users’ decisions. Materiality means disclosing information that is important enough to potentially affect the judgment of someone relying on the disclosures.

Correct Answer: C. Yes, if the information is proprietary (competitively sensitive) or confidential, provided it doesn’t hide the bank’s overall risk. There are limited exceptions for sensitive information, but not if the omission misleads about risk or capital.

Correct Answer: C. A formal disclosure policy approved by the Board of Directors. Banks need a documented policy outlining their approach and controls for Pillar 3 disclosures.

Correct Answer: B. Details about the disclosures, internal controls, validation, and frequency. The policy should cover the governance and process surrounding the disclosures.