Module: | MODULE B: RISK MANAGEMENT
Q392: Consider the following statements regarding the eligibility criteria for On-Balance Sheet Netting under the Basel Credit Risk Mitigation (CRM) framework:
1. The bank must have a legally enforceable netting agreement with the counterparty that spans across applicable jurisdictions.
2. Successful netting allows the bank to calculate capital requirements strictly on the net exposure rather than the gross exposure.
3. Loans and deposits can be netted even if the bank does not possess the legal right to set off the respective amounts at any given time.
Which of the statements given above is/are correct?
2. Successful netting allows the bank to calculate capital requirements strictly on the net exposure rather than the gross exposure.
3. Loans and deposits can be netted even if the bank does not possess the legal right to set off the respective amounts at any given time.
Which of the statements given above is/are correct?
✅ Correct Answer: A
The correct answer is A. Statement 1 is correct: To qualify for On-Balance Sheet Netting under Basel norms, the bank must have a well-founded, legally enforceable netting agreement covering all included transactions, ensuring it stands up in court across relevant jurisdictions.
Statement 2 is correct: The primary mathematical benefit of netting is capital relief.
It allows the bank to offset mutual claims (e.g., a 100 loan and a 40 deposit from the same client) and calculate risk weights strictly on the net exposure (60), reducing the capital burden.
Statement 3 is incorrect: The core prerequisite for netting is that the bank must have an unconditional legal right to set off the amounts owed to the counterparty against the amounts owed by the counterparty at any given time, especially in the event of default, bankruptcy, or liquidation.
Without this right, netting is strictly prohibited.
Statement 2 is correct: The primary mathematical benefit of netting is capital relief.
It allows the bank to offset mutual claims (e.g., a 100 loan and a 40 deposit from the same client) and calculate risk weights strictly on the net exposure (60), reducing the capital burden.
Statement 3 is incorrect: The core prerequisite for netting is that the bank must have an unconditional legal right to set off the amounts owed to the counterparty against the amounts owed by the counterparty at any given time, especially in the event of default, bankruptcy, or liquidation.
Without this right, netting is strictly prohibited.