RISK MANAGEMENT MODULE E QUIZ 2

Regulatory capital is calculated under prudential rules and may include qualifying instruments beyond accounting equity, while requiring deductions and adjustments for items such as certain intangible assets or deferred tax assets. Therefore accounting equity and regulatory capital are related but not identical.

Tier 1 capital is intended to absorb losses on a going-concern basis and includes CET1 and qualifying Additional Tier 1 instruments. Tier 2 is supplementary capital that generally absorbs losses on a gone-concern basis, subject to eligibility criteria and applicable rules.

The leverage ratio is a non-risk-based backstop that limits excessive leverage and complements risk-weighted capital ratios. It compares Tier 1 capital with a broad exposure measure that includes on-balance-sheet and specified off-balance-sheet items under the applicable rules.

Counterparty credit risk is the risk that the other party to a transaction defaults before final settlement of the transaction‘s cash flows, leaving a replacement-cost or other exposure. Exposure can vary with market values and may be mitigated by netting and collateral if legally enforceable and recognised.

Recognised external credit assessments may be mapped to regulatory risk weights under the applicable framework, subject to eligibility, due diligence and rules on use of ratings. A rating does not remove the bank‘s responsibility for credit assessment and ongoing monitoring.

An issue-specific rating may reflect the terms, seniority, security and structural features of a particular instrument, while an issuer rating assesses the general creditworthiness of the issuer. Applying an issue rating to other claims is permitted only as provided by applicable regulatory rules and rating methodology.

Credit-equivalent amount = nominal commitment × credit conversion factor = ₹50 crore × 20% = ₹10 crore. The applicable risk weight is then applied to the credit-equivalent exposure to calculate the RWA contribution, subject to the relevant rules.

Market-risk capital requirements cover losses arising from movements in market prices, including interest rates and equity prices in the trading book, foreign exchange and commodity prices, according to the applicable framework. The precise scope and calculation depend on regulatory definitions and rules.

For fixed-income instruments, bond prices generally move inversely to yields. Trading-book interest-rate risk capital is intended to cover adverse movements in market rates and related price effects, measured under the applicable standardised or approved internal approach.

A payment-processing outage caused by a system failure is an operational-risk event because it arises from failed systems or processes. Credit losses from borrower default and market losses from price movements are different risk categories, although one event can have multiple consequences.

Under the Basel II Basic Indicator Approach, the operational-risk capital charge was based on a fixed percentage (alpha, 15%) of positive annual gross income averaged over the prescribed three-year period, subject to the framework‘s detailed rules. Basel reforms later revised the operational-risk framework, so exam answers should distinguish Basel II methodology from newer implementations.

Basel II included business-line-based approaches such as the Standardised Approach and Advanced Measurement Approaches. Basel III reforms consolidated the framework into the Standardised Measurement Approach (SMA) for operational-risk capital, subject to implementation by national authorities. Terminology and applicable dates matter.

ICAAP requires a bank to assess its overall capital adequacy in relation to its risk profile, strategy and internal controls, including risks that may not be fully captured by Pillar 1. Supervisors review the process and may require remedial action or additional capital where appropriate.

Stress testing assesses the impact of severe but plausible adverse conditions on capital, liquidity, earnings and risk concentrations. It complements normal forecasts and historical models and can inform capital planning, contingency actions and supervisory dialogue.

Pillar 3 promotes transparency by requiring disclosures that enable market participants to assess a bank‘s risk profile, capital adequacy and risk-management practices. It complements minimum capital rules and supervisory review rather than replacing them.

The LCR is a short-term liquidity standard designed to ensure an adequate stock of unencumbered high-quality liquid assets to cover net cash outflows over a 30-calendar-day stress scenario, subject to the applicable regulatory framework and national implementation.

The NSFR is a structural liquidity standard intended to promote a stable funding profile over a one-year horizon. It compares available stable funding with required stable funding, reducing excessive reliance on unstable short-term funding for longer-term assets.

PCA frameworks establish supervisory triggers and graduated actions when a bank‘s financial indicators—often capital and other prudential measures—deteriorate. The exact trigger metrics and restrictions depend on the applicable national framework and current supervisory rules.

Risk-based supervision allocates supervisory attention according to the nature, scale and potential impact of risks at an institution. It focuses more intensively on material risks and the quality of controls while considering the bank‘s systemic importance and risk profile.

Risk-based internal audit plans its work according to the risk significance of activities, controls and exposures. Higher-risk areas receive greater audit attention, while the function maintains independence and provides assurance on governance, risk management and internal controls.