Financial Risk Management Regulatory Capital and Basel

Question 1

Under Basel III, what is the minimum Common Equity Tier 1 (CET1) capital ratio requirement?

Accepted Answer

4.5%

Answer

Basel III raised the minimum CET1 ratio to 4.5% of risk-weighted assets, with an additional 2.5% capital conservation buffer, making the effective minimum 7% CET1 for most banks.

Question 2

What is the 'capital conservation buffer' under Basel III and what happens when a bank breaches it?

Accepted Answer

A 2.5% CET1 buffer above the 4.5% minimum; breaching it restricts dividend payments and discretionary bonuses

Answer

The 2.5% conservation buffer acts as a cushion; when a bank dips into it, escalating restrictions on capital distributions (dividends, buybacks, bonuses) are triggered to help rebuild the buffer.

Question 3

What is the 'countercyclical capital buffer' (CCyB) under Basel III?

Accepted Answer

A variable buffer (0–2.5%) that national regulators increase during credit booms and release during downturns to dampen pro-cyclicality

Answer

The CCyB is a macroprudential tool: regulators build it up when credit growth is excessive (preventing overheating) and release it during stress to support lending.

Question 4

What is the 'leverage ratio' under Basel III and what problem does it address?

Accepted Answer

Tier 1 capital / total exposure ≥ 3%; acts as a backstop against excessive leverage regardless of risk-weighting

Answer

The 3% Tier 1 leverage ratio is a non-risk-sensitive backstop that prevents banks from gaming risk-weighted capital ratios by holding low-risk-weighted but highly leveraged exposures.

Question 5

What does 'risk-weighted assets' (RWA) mean in the context of bank capital?

Accepted Answer

Bank assets adjusted by risk weights assigned to different exposure types, so riskier assets require more capital support

Answer

Under Basel, each asset class gets a risk weight (e.g., sovereign bonds = 0%, mortgages = 35–50%, unsecured retail = 75%, unrated corporates = 100%), and capital must be 8% of total RWA.

Financial Risk Management Practice Test

Financial Risk Management Practice Test

Financial Risk Management Regulatory Capital and Basel