Module: | MODULE B: RISK MANAGEMENT
Q317: Scenario: A commercial bank expands into a highly controversial sector facing massive public backlash, creating severe reputational risk. Simultaneously, it struggles with severe liquidity asset mismatches. Based on the Basel II and III frameworks, consider the following statements regarding the regulatory capital treatment of these specific risks:
1. The bank must allocate capital explicitly for reputational risk under the Pillar 1 standardized approach.
2. The bank is required to identify and assess these non-Pillar 1 risks (liquidity and reputational) under its internal ICAAP framework.
3. The regulator can impose a Pillar 2 capital add-on if it finds the bank's internal assessment of these specific risks inadequate.
Which of the statements given above is/are correct?
2. The bank is required to identify and assess these non-Pillar 1 risks (liquidity and reputational) under its internal ICAAP framework.
3. The regulator can impose a Pillar 2 capital add-on if it finds the bank's internal assessment of these specific risks inadequate.
Which of the statements given above is/are correct?
✅ Correct Answer: B
The correct answer is B. Statement 1 is incorrect: Pillar 1 provides explicit mathematical capital charge calculations only for Credit, Market, and Operational risks.
It does not provide standardized formulas for allocating capital for reputational risk, strategic risk, or liquidity risk.
Statement 2 is correct: The primary purpose of the Internal Capital Adequacy Assessment Process (ICAAP) under Pillar 2 is to capture "Non-Pillar 1 risks." The bank is strictly required to identify, measure, and allocate internal capital for risks like reputational and liquidity mismatches.
Statement 3 is correct: During the Supervisory Review and Evaluation Process (SREP), if the regulator determines that the bank's ICAAP has failed to adequately provision for these reputational or liquidity risks, the regulator has the authority to impose a Pillar 2 capital add-on.
It does not provide standardized formulas for allocating capital for reputational risk, strategic risk, or liquidity risk.
Statement 2 is correct: The primary purpose of the Internal Capital Adequacy Assessment Process (ICAAP) under Pillar 2 is to capture "Non-Pillar 1 risks." The bank is strictly required to identify, measure, and allocate internal capital for risks like reputational and liquidity mismatches.
Statement 3 is correct: During the Supervisory Review and Evaluation Process (SREP), if the regulator determines that the bank's ICAAP has failed to adequately provision for these reputational or liquidity risks, the regulator has the authority to impose a Pillar 2 capital add-on.