CAIIB Paper 2 Module D Quiz 2

Pillar 1 sets minimum capital requirements for specified risks. Pillar 2 is supervisory review and Pillar 3 is market discipline through disclosure.

Pillar 2 is the Supervisory Review Process. It assesses whether banks have sound internal processes to evaluate capital adequacy relative to their risk profile and whether supervisors should require remedial action.

Pillar 3 promotes market discipline through meaningful disclosures of capital, risk exposures, risk assessment processes and related information.

Capital adequacy ratio = eligible regulatory capital ÷ risk-weighted assets × 100 = ₹120 crore ÷ ₹1,000 crore × 100 = 12%. Applicable minimums and buffers depend on current RBI rules and the bank category.

Risk weights reflect regulatory assessments of relative risk across exposures. Risk-weighted assets provide a denominator for capital requirements that is more risk-sensitive than unweighted total assets.

CET1 consists primarily of common shares and retained earnings, subject to regulatory adjustments. It has the strongest ability to absorb losses while the bank remains a going concern.

Basel III Tier 1 capital comprises CET1 plus eligible Additional Tier 1 capital after applicable deductions and adjustments. Tier 2 is separate and contributes to total capital, not Tier 1.

The capital conservation buffer is an additional layer of capital intended to absorb losses during periods of stress. Falling into the buffer range can trigger restrictions on distributions under applicable rules.

The countercyclical buffer addresses systemic risk associated with excessive aggregate credit growth. Authorities can activate or release it as conditions change, subject to the applicable framework.

The leverage ratio is a non-risk-based backstop, comparing Tier 1 capital with a broad exposure measure. Risk-based capital ratios instead use risk-weighted assets.

Regulatory adjustments seek to ensure capital is genuinely available to absorb losses. Some intangible assets may have limited loss-absorbing value in a resolution or stress scenario and are therefore deducted under rules.

For applicable off-balance-sheet items, a credit conversion factor converts the commitment into a credit-equivalent exposure. The relevant risk weight is then applied, subject to the current regulatory rules and exposure type.

ICAAP is part of the Pillar 2 framework. It should be proportionate to the bank’s nature, scale and complexity and assess capital needs for material risks, including risks not fully captured by Pillar 1.

Capital planning should consider projected earnings, growth, distributions, regulatory changes and stress outcomes. It helps determine whether the bank can maintain adequate capital under plausible adverse conditions.

The ratio is capital divided by RWA. If the numerator remains constant and the denominator increases, the ratio falls.

A management buffer provides resilience against volatility, unexpected losses and RWA growth. The appropriate buffer depends on risk appetite, supervisory expectations, business plans and market conditions.

Market risk includes potential losses from movements in interest rates, foreign-exchange rates, equity prices and commodity prices for relevant positions. The precise scope and methods depend on applicable regulations.

The Basel operational-risk concept covers loss from inadequate or failed internal processes, people and systems or external events, including legal risk. Strategic and reputational risks are treated differently in the Basel definition.

Pillar 3 disclosures should be accurate, timely and comparable so market participants can evaluate a bank’s capital adequacy and risk profile. Confidential customer credentials are never appropriate disclosures.

Capital is a loss-absorbing cushion; liquidity is the ability to meet obligations as they fall due. Strong capital does not automatically ensure adequate liquidity, so both need separate management.