Module: | MODULE B: RISK MANAGEMENT
Q305: Consider the following statements regarding the paradigm shift from the Basel I Accord to the Basel II framework:
1. Basel II completely abolished the 8 percent minimum capital requirement ratio established by Basel I.
2. Basel II shifted from a crude one-size-fits-all risk weighting method to a highly risk-sensitive approach using external and internal credit ratings.
3. It introduced a comprehensive Three Pillar framework encompassing Minimum Capital, Supervisory Review, and Market Discipline.
Which of the statements given above is/are correct?
2. Basel II shifted from a crude one-size-fits-all risk weighting method to a highly risk-sensitive approach using external and internal credit ratings.
3. It introduced a comprehensive Three Pillar framework encompassing Minimum Capital, Supervisory Review, and Market Discipline.
Which of the statements given above is/are correct?
✅ Correct Answer: B
The correct answer is B. Statement 1 is incorrect: Basel II did not abolish the fundamental minimum capital requirement.
The baseline 8% Capital to Risk-Weighted Assets Ratio (CRAR) established in Basel I was retained and carried forward into Basel II (and later Basel III), serving as the foundation of the calculation.
Statement 2 is correct: The primary motivation for Basel II was to correct the crude risk-weighting of Basel I (which assigned a flat 100% risk weight to all corporate loans regardless of credit quality). Basel II introduced risk-sensitive approaches, allowing banks to use external credit rating agencies (Standardised Approach) or their own internal historical data (IRB Approach) to align capital closer to actual risk.
Statement 3 is correct: Basel II revolutionized banking regulation by moving beyond just capital arithmetic.
It introduced the comprehensive Three Pillar framework: Pillar 1 (Minimum Capital Requirements for Credit, Market, and Operational Risk), Pillar 2 (Supervisory Review Process, including ICAAP and SREP), and Pillar 3 (Market Discipline via enhanced public disclosures).
The baseline 8% Capital to Risk-Weighted Assets Ratio (CRAR) established in Basel I was retained and carried forward into Basel II (and later Basel III), serving as the foundation of the calculation.
Statement 2 is correct: The primary motivation for Basel II was to correct the crude risk-weighting of Basel I (which assigned a flat 100% risk weight to all corporate loans regardless of credit quality). Basel II introduced risk-sensitive approaches, allowing banks to use external credit rating agencies (Standardised Approach) or their own internal historical data (IRB Approach) to align capital closer to actual risk.
Statement 3 is correct: Basel II revolutionized banking regulation by moving beyond just capital arithmetic.
It introduced the comprehensive Three Pillar framework: Pillar 1 (Minimum Capital Requirements for Credit, Market, and Operational Risk), Pillar 2 (Supervisory Review Process, including ICAAP and SREP), and Pillar 3 (Market Discipline via enhanced public disclosures).