Credit Risk Management Basel Regulatory Framework 1 — Questions and Answers
Question 1: Under Basel II, which approach allows banks to use their own estimates of PD, LGD, and EAD?
- Standardized approach
- Foundation IRB approach
- Advanced IRB approach (Correct answer)
- Basic indicator approach
Correct answer: Advanced IRB approach
The Advanced Internal Ratings-Based (A-IRB) approach permits banks to estimate all three key parameters (PD, LGD, EAD) internally, subject to supervisory approval.
Question 2: What is the minimum Tier 1 capital ratio required under Basel III?
- 2%
- 4.5%
- 6% (Correct answer)
- 8%
Correct answer: 6%
Basel III requires a minimum Tier 1 capital ratio of 6% of risk-weighted assets, strengthening capital quality requirements from Basel II.
Question 3: Under the Basel Standardized Approach for credit risk, what risk weight is applied to claims on sovereigns rated AA− to AA+?
- 0% (Correct answer)
- 20%
- 50%
- 100%
Correct answer: 0%
Sovereigns rated AA− or better receive a 0% risk weight under the Basel Standardized Approach, reflecting their very low default risk.
Question 4: What does the Basel III leverage ratio measure?
- Tier 1 capital as a percentage of risk-weighted assets
- Tier 1 capital as a percentage of total exposure (non-risk-based) (Correct answer)
- Common equity as a percentage of total deposits
- Liquid assets as a percentage of net cash outflows
Correct answer: Tier 1 capital as a percentage of total exposure (non-risk-based)
The Basel III leverage ratio is a non-risk-based backstop measure defined as Tier 1 capital divided by total exposure, with a minimum requirement of 3%.
Question 5: Which Basel III buffer requires banks to build capital during good times to draw on during stress?
- Capital conservation buffer
- Countercyclical capital buffer (Correct answer)
- G-SIB surcharge
- Pillar 2 add-on
Correct answer: Countercyclical capital buffer
The countercyclical capital buffer (CCyB) requires banks to accumulate capital during credit booms, reducing procyclicality in the financial system.
Question 6: Under Pillar 2 of Basel II/III, what is the primary responsibility of supervisors?
- Setting minimum capital ratios
- Reviewing banks' internal capital adequacy processes (ICAAP) (Correct answer)
- Requiring public disclosure of risk metrics
- Setting liquidity coverage ratios
Correct answer: Reviewing banks' internal capital adequacy processes (ICAAP)
Pillar 2 (Supervisory Review Process) requires supervisors to evaluate each bank's ICAAP and ensure capital is adequate for its specific risk profile.
Credit Risk Management Basel Regulatory Framework 1
Under Basel II, which approach allows banks to use their own estimates of PD, LGD, and EAD?