Chapter 13: Risk Regulations in the Banking Industry (CAIIB – Paper 2)
1. What is the primary goal of banking regulations?
A. To maximize bank profits
B. To promote international trade only
C. To ensure stability, protect depositors, and maintain financial system integrity
D. To encourage competition among banks
Banking regulations aim to maintain financial stability, protect depositors' funds, and ensure the smooth functioning of the banking system.
2. Why is risk-based regulation important in modern banking?
A. It focuses only on liquidity risk
B. It ensures banks identify, measure, and manage risks proportional to their size and complexity
C. It eliminates all types of risks
D. It applies only to international banks
Risk-based regulation requires banks to manage risks according to their business model, complexity, and risk profile, rather than applying uniform rules for all.
3. Which of the following is a necessity for regulation in the banking industry?
A. Protection of depositors and prevention of systemic failures
B. Reducing bank profits
C. Encouraging banks to take higher risks
D. Limiting foreign investment in banks
Regulation ensures depositor protection and prevents systemic instability by monitoring and controlling banking practices.
4. Which of the following is a key objective of risk-based banking regulation?
A. To guarantee profits for banks
B. To regulate only credit risk
C. To impose penalties without guidance
D. To align regulatory requirements with the bank’s risk profile and business complexity
Risk-based regulation adapts rules based on the bank’s size, risk exposure, and complexity to promote sound risk management practices.
5. The changing global environment has increased the need for risk-based regulation because:
A. Financial markets are more interconnected and banks face diverse and complex risks
B. Banks now have fewer clients
C. Risk management is no longer relevant
D. Central banks have become less active
Globalization and financial innovation have exposed banks to multiple types of risks, making traditional one-size-fits-all regulation insufficient.
6. Which of the following best describes the goal of risk regulation in banks?
A. Maximizing shareholder dividends only
B. Ensuring financial stability while promoting prudent risk-taking
C. Eliminating all financial risks completely
D. Focusing only on market expansion
Risk regulation balances financial stability with the bank’s operational and growth needs, promoting safe and prudent risk management.
7. A key necessity of banking regulation is to:
A. Reduce competition among banks
B. Encourage excessive risk-taking
C. Protect the financial system and depositors from potential failures
D. Limit international transactions
Banking regulation is essential to prevent bank failures, safeguard depositor funds, and maintain public confidence in the financial system.
8. What was the primary objective of the Basel I Capital Accord?
A. To ensure banks maintain adequate capital to cover credit risk
B. To regulate interest rates in international banking
C. To standardize banking technology globally
D. To prevent mergers between international banks
Basel I was introduced in 1988 to ensure banks hold sufficient capital to absorb potential losses from credit risk, promoting financial stability.
9. Basel I classified bank assets into different risk categories. What was the purpose of this classification?
A. To determine lending limits
B. To calculate interest income accurately
C. To assign risk weights and determine minimum capital requirements
D. To standardize accounting practices
Basel I assigned risk weights to different asset classes, enabling banks to calculate the minimum capital needed to cover potential credit losses.
10. The 1996 amendment to Basel I introduced capital requirements for which type of risk?
A. Credit risk only
B. Market risk, including trading book exposures
C. Operational risk
D. Liquidity risk
The 1996 amendment extended Basel I to include market risk for banks’ trading book positions, requiring them to hold capital against potential losses from market fluctuations.
11. Under Basel I, what is the minimum capital adequacy ratio (CAR) banks are required to maintain?
A. 6%
B. 8.5%
C. 10%
D. 8%
Basel I required banks to maintain a minimum CAR of 8% of risk-weighted assets to ensure sufficient capital buffer against credit risk.
12. Which of the following assets had a 0% risk weight under Basel I?
A. Corporate loans
B. Residential mortgages
C. Cash and claims on sovereign governments
D. Bank deposits
Under Basel I, sovereign claims and cash were considered risk-free and assigned a 0% risk weight, requiring no capital allocation.
13. Why was the 1996 amendment considered significant for international banking?
A. It introduced a standardized approach to market risk capital charges for banks worldwide
B. It eliminated the need for banks to hold capital against credit risk
C. It restricted foreign investment in banking sectors
D. It mandated mergers between large banks
The 1996 amendment standardized capital requirements for market risk across international banks, promoting consistent risk management globally.
14. What was the main reason for introducing the Basel II Accord?
A. To reduce capital requirements for all banks
B. To improve risk sensitivity and strengthen banking supervision
C. To eliminate the need for market risk management
D. To standardize global interest rates
Basel II was introduced to make capital requirements more risk-sensitive and to strengthen supervisory oversight of banks globally.
15. Basel II Accord is built on how many pillars?
A. One
B. Two
C. Three
D. Four
Basel II is based on three pillars: (1) Minimum Capital Requirements, (2) Supervisory Review, and (3) Market Discipline.
16. Which of the following is a key goal of Basel II?
A. Align regulatory capital more closely with actual risk exposure
B. Remove all regulatory oversight
C. Standardize bank profits globally
D. Limit lending to government projects only
Basel II aims to make capital requirements more sensitive to the actual risks faced by banks, improving stability and efficiency.
17. The first pillar of Basel II deals with:
A. Market discipline only
B. Supervisory review only
C. Operational efficiency
D. Minimum capital requirements for credit, market, and operational risks
The first pillar sets out minimum capital requirements for banks covering credit, market, and operational risks.
18. Which pillar of Basel II emphasizes the role of supervisors in evaluating a bank’s risk management?
A. Pillar 1
B. Pillar 2
C. Pillar 3
D. Pillar 4
Pillar 2 (Supervisory Review Process) emphasizes the importance of supervisory evaluation of banks’ internal risk management and capital adequacy.
19. The third pillar of Basel II focuses on:
A. Reducing capital requirements
B. Credit risk management only
C. Market discipline through public disclosure
D. Operational risk elimination
Pillar 3 aims to enhance transparency and market discipline by requiring banks to publicly disclose key risk and capital information.
20. Basel II improved on Basel I mainly by:
A. Incorporating operational risk and more risk-sensitive capital requirements
B. Eliminating market risk requirements
C. Mandating fixed capital for all banks regardless of size
D. Limiting international banking operations
Basel II introduced operational risk and more risk-sensitive approaches for credit and market risks, enhancing the risk management framework beyond Basel I.
21. What is the primary objective of Basel III?
A. To strengthen bank capital, improve risk management, and enhance financial system stability
B. To eliminate capital requirements entirely
C. To standardize interest rates globally
D. To restrict international banking operations
Basel III was introduced to address weaknesses revealed during the global financial crisis, strengthening capital adequacy, liquidity, and overall risk management.
22. Under Basel III, what is the minimum Common Equity Tier 1 (CET1) capital ratio?
A. 6%
B. 4.5%
C. 8%
D. 10%
Basel III requires banks to maintain a minimum CET1 ratio of 4.5% of risk-weighted assets, along with additional capital buffers.
23. Which of the following is a method of credit risk mitigation?
A. Reducing interest rates only
B. Increasing bank branches
C. Collateral, guarantees, and netting agreements
D. Limiting deposits from customers
Credit risk mitigation techniques reduce potential loss by using collateral, guarantees, or netting arrangements, thereby lowering capital requirements.
24. Capital charge for credit risk under Basel III is calculated based on:
A. Risk-weighted assets after considering mitigation techniques
B. Total assets without risk adjustment
C. Operational expenses
D. Customer deposits only
Credit risk capital charge is based on the risk-weighted assets of a bank, adjusted for eligible credit risk mitigation techniques.
25. Which of the following is included in the capital charge for market risk?
A. Operational failures only
B. Losses from trading book exposures due to interest rate, equity, and currency movements
C. Depositor withdrawals
D. Loan defaults only
Market risk capital charge covers potential losses from trading book exposures, including interest rate, equity, and foreign exchange risks.
26. Which of the following statements is true about Credit Risk Mitigation (CRM) techniques?
A. CRM techniques are not recognized under Basel III
B. CRM can only be applied to market risk
C. CRM increases capital requirement
D. CRM reduces the effective risk-weighted assets, lowering capital requirements
CRM techniques such as collateral, guarantees, and netting reduce the bank’s exposure, thereby lowering the risk-weighted assets and capital charge.
27. Basel III introduced additional capital buffers primarily to:
A. Reduce credit risk only
B. Increase bank profits
C. Absorb losses during periods of financial stress and improve resilience
D. Standardize banking operations globally
Capital buffers under Basel III, like the conservation buffer, help banks absorb losses during stress, maintaining solvency and confidence in the system.
28. Capital charge for operational risk under Basel II/III is intended to cover:
A. Losses arising from internal processes, people, systems, or external events
B. Market fluctuations only
C. Credit defaults only
D. Liquidity shortages only
Operational risk includes losses due to failed internal processes, human errors, system failures, or external events. Basel II/III requires banks to hold capital against these potential losses.
29. Which of the following is a method for calculating operational risk capital?
A. Risk-weighted asset method only for credit risk
B. Basic Indicator Approach, Standardized Approach, and Advanced Measurement Approach
C. Market risk exposure calculation
D. Supervisory review process only
Banks can calculate operational risk capital using the Basic Indicator Approach (BIA), Standardized Approach (SA), or Advanced Measurement Approach (AMA), depending on complexity and regulatory approval.
30. Pillar 2 of Basel II/III primarily focuses on:
A. Minimum capital requirements only
B. Market discipline through disclosures
C. Supervisory review of internal risk management and capital adequacy
D. Operational risk elimination
Pillar 2 emphasizes the supervisory review process, ensuring banks have sound internal processes to assess capital adequacy relative to risks and manage them prudently.
31. Under Pillar 2, supervisors may require banks to:
A. Ignore operational risks
B. Standardize all bank profits
C. Reduce market risk exposures only
D. Hold additional capital if internal assessment shows higher risk
Supervisors can require banks to hold extra capital if internal risk assessments indicate potential exposures not fully captured by Pillar 1.
32. Which of the following is true about the Supervisory Review Process under Pillar 2?
A. It eliminates the need for Pillar 1 capital
B. It complements minimum capital requirements by assessing bank-specific risks and governance
C. It focuses only on market risk
D. It replaces Pillar 3 disclosures
Pillar 2 complements Pillar 1 by evaluating bank-specific risk exposures, risk management processes, and governance practices, ensuring overall capital adequacy.
33. Operational risk differs from credit and market risk because:
A. It arises from customer defaults
B. It depends solely on market movements
C. It arises from failures in internal processes, people, or systems rather than market or credit events
D. It is regulated only under Pillar 3
Operational risk is caused by internal process failures, human errors, system failures, or external events, unlike credit or market risk.
34. What is the main purpose of Pillar 3 under Basel II/III?
A. To reduce credit risk
B. To calculate operational risk capital
C. To enhance market discipline through disclosure of risk, capital, and risk management information
D. To eliminate regulatory oversight
Pillar 3 promotes transparency and market discipline by requiring banks to publicly disclose detailed information on risks, capital adequacy, and risk management practices.
35. The Capital Conservation Buffer (CCB) is designed to:
A. Replace minimum capital requirements
B. Ensure banks build up capital above minimum requirements to absorb losses during stress periods
C. Reduce regulatory supervision
D. Focus only on market risk exposures
The Capital Conservation Buffer requires banks to hold additional CET1 capital (typically 2.5% of RWA) above minimum requirements to maintain financial stability during economic stress.
36. Which of the following is true regarding disclosures under Pillar 3?
A. Disclosures are optional and internal only
B. Only credit risk disclosures are required
C. Only operational risk disclosures are required
D. Banks must publicly disclose risk exposure, capital adequacy, and risk management practices
Pillar 3 requires banks to publicly disclose comprehensive information on all major risk exposures, capital, and risk management to strengthen market discipline.
37. The Capital Conservation Buffer is primarily composed of which type of capital?
A. Common Equity Tier 1 (CET1) capital
B. Tier 2 capital only
C. Hybrid debt instruments only
D. Subordinated debt only
The Capital Conservation Buffer must be held in Common Equity Tier 1 (CET1) capital to ensure maximum loss-absorbing capacity.
38. If a bank’s CET1 ratio falls into the Capital Conservation Buffer zone, what action is required?
A. Increase lending to meet profitability targets
B. Ignore the buffer as it is only advisory
C. Restrict dividends, share buybacks, and discretionary bonuses to conserve capital
D. Increase operational risk exposure
Banks falling into the CCB zone must conserve capital by limiting dividends, share repurchases, and discretionary bonuses, ensuring adequate capital buffers remain.
39. Market discipline under Pillar 3 helps to:
A. Replace Pillar 1 capital requirements
B. Encourage banks to improve risk management due to transparency and investor scrutiny
C. Eliminate operational risk
D. Standardize profits for all banks
By requiring banks to disclose detailed risk and capital information, Pillar 3 enhances market discipline, incentivizing better risk management practices.
40. What is the primary purpose of the leverage ratio under Basel III?
A. To replace the risk-weighted capital requirements
B. To limit excessive leverage by ensuring banks hold sufficient capital relative to total exposures
C. To calculate operational risk only
D. To determine dividend payout ratios
The leverage ratio is a non-risk-based measure that limits the build-up of excessive leverage in banks, complementing risk-weighted capital requirements.
41. How is the leverage ratio calculated?
A. Tier 1 capital divided by total exposure (on- and off-balance sheet)
B. Risk-weighted assets divided by total capital
C. Operational risk divided by total assets
D. CET1 capital divided by net income
The leverage ratio is calculated by dividing Tier 1 capital by the bank’s total exposure, including both on-balance sheet and off-balance sheet items.
42. The Countercyclical Capital Buffer (CCyB) is designed to:
A. Replace the minimum capital requirement
B. Eliminate operational risk
C. Require banks to build additional capital during periods of excessive credit growth
D. Standardize interest rates
The CCyB is designed to protect the banking system from periods of excessive credit growth by requiring banks to hold extra CET1 capital, which can be released during downturns.
43. When is the Countercyclical Capital Buffer typically activated?
A. During recessions only
B. When market risk falls below threshold
C. Only for operational risk exposures
D. During periods of excessive credit growth to protect against future stress
Regulators activate the CCyB when credit growth is high to build a capital buffer that can absorb potential losses in economic downturns.
44. Which type of capital is primarily used for the Countercyclical Capital Buffer?
A. Tier 2 capital
B. Common Equity Tier 1 (CET1) capital
C. Hybrid debt instruments only
D. Subordinated debt only
The CCyB must be met using CET1 capital because it provides the highest loss-absorbing capacity, ensuring resilience in stress periods.
45. The leverage ratio under Basel III complements which other regulatory requirement?
A. Pillar 3 disclosures only
B. Countercyclical capital buffer only
C. Risk-weighted capital requirements under Pillar 1
D. Market discipline under Pillar 3 only
The leverage ratio is a non-risk-based measure that complements Pillar 1 risk-weighted capital requirements, preventing excessive leverage build-up.
46. What defines a Systemically Important Financial Institution (SIFI)?
A. A bank with high operational efficiency only
B. A financial institution whose failure could trigger widespread disruption in the financial system
C. Any bank with international operations
D. A bank with the largest number of branches
SIFIs are institutions deemed “too big to fail” because their collapse could severely impact the broader financial system and economy.
47. What is the primary regulatory focus for SIFIs under Basel III?
A. Operational efficiency only
B. Standardizing interest rates globally
C. Higher capital surcharges, enhanced supervision, and resolution planning
D. Limiting foreign investments
SIFIs are required to maintain higher capital buffers, undergo stricter supervision, and prepare resolution plans to reduce systemic risk.
48. Risk-Based Supervision (RBS) primarily focuses on:
A. Supervising all banks with equal intensity
B. Eliminating Pillar 1 requirements
C. Focusing only on market risk
D. Allocating supervisory resources based on the risk profile and systemic importance of banks
RBS prioritizes supervisory attention to banks with higher risk profiles and systemic importance, ensuring efficient use of regulatory resources.
49. Which of the following is an advantage of Risk-Based Supervision?
A. Treats all banks equally regardless of risk
B. Focuses regulatory efforts on institutions with higher potential impact on financial stability
C. Eliminates the need for capital requirements
D. Standardizes profitability across banks
RBS enhances supervision efficiency by concentrating on institutions whose failure would pose the greatest risk to the financial system.
50. Supervisors under Risk-Based Supervision typically assess which aspects of a bank?
A. Only liquidity position
B. Only capital adequacy
C. Capital adequacy, risk management, governance, and overall systemic impact
D. Only profitability ratios
RBS involves comprehensive evaluation, including capital, risk management practices, governance standards, and potential systemic impact of banks.
51. What regulatory measure is often applied to domestic SIFIs in addition to Basel III standards?
A. Reduced capital requirements
B. Standardized interest rate mandates
C. Elimination of operational risk capital charge
D. Additional capital surcharges and stricter supervisory oversight
Domestic SIFIs are subject to additional capital surcharges and enhanced supervision to reduce systemic risk and enhance resilience.
52. A bank has Tier 1 capital of ₹500 crore and total risk-weighted assets (RWA) of ₹4000 crore. What is its CET1 ratio?
A. 12%
B. 12.5%
C. 11%
D. 13%
CET1 ratio = (Tier 1 Capital / Risk-Weighted Assets) × 100 = (500 / 4000) × 100 = 12.5%.
53. A bank has total exposures of ₹6000 crore and Tier 1 capital of ₹450 crore. Calculate the leverage ratio.
A. 7.5%
B. 6%
C. 8%
D. 10%
Leverage ratio = (Tier 1 Capital / Total Exposure) × 100 = (450 / 6000) × 100 = 7.5%.
54. A bank has total high-quality liquid assets (HQLA) of ₹1200 crore and net cash outflows over 30 days of ₹1500 crore. Calculate the Liquidity Coverage Ratio (LCR).
55. A bank has a credit exposure of ₹1000 crore to a corporate borrower. The exposure is secured by collateral worth ₹400 crore. What is the effective exposure after credit risk mitigation?
58. A bank has a capital conservation buffer of 2.5% on RWA of ₹4000 crore. What is the required buffer in ₹?
A. ₹80 crore
B. ₹85 crore
C. ₹100 crore
D. ₹90 crore
Capital Conservation Buffer = 2.5% × 4000 = ₹100 crore.
59. What is the primary objective of the Liquidity Coverage Ratio (LCR)?
A. To measure profitability of a bank
B. To calculate risk-weighted assets
C. To ensure banks maintain sufficient high-quality liquid assets to survive a 30-day stress scenario
D. To determine capital adequacy ratio
The LCR ensures banks hold enough high-quality liquid assets (HQLA) to cover net cash outflows over a 30-day stress period, strengthening short-term resilience.
60. Which assets qualify as High-Quality Liquid Assets (HQLA) under Basel III?
A. Any loan or receivable
B. Cash, central bank reserves, and marketable securities with low credit and market risk
C. Equity shares of private companies
D. Intangible assets and goodwill
HQLA includes cash, central bank reserves, and high-quality marketable securities that can be easily converted to cash with little or no loss in value during stress periods.
61. What is the minimum required LCR under Basel III for banks?
A. 80%
B. 85%
C. 90%
D. 100%
Basel III requires banks to maintain an LCR of at least 100%, ensuring sufficient liquidity to withstand a 30-day stress scenario.
62. What is the main purpose of the Net Stable Funding Ratio (NSFR)?
A. To measure short-term profitability
B. To ensure banks maintain a stable funding profile relative to their assets over a one-year horizon
C. To calculate operational risk capital
D. To determine dividend payout ratio
The NSFR ensures banks have stable funding sources for their long-term assets, promoting resilience over a one-year time horizon.
63. Which of the following best describes the NSFR calculation?
A. HQLA divided by net cash outflows over 30 days
B. Tier 1 capital divided by total exposure
C. Available stable funding (ASF) divided by required stable funding (RSF) >= 100%
D. Risk-weighted assets divided by total capital
NSFR = ASF / RSF ≥ 100%, ensuring that banks’ stable funding covers the required stable funding of their assets, contingent liabilities, and off-balance-sheet activities over one year.
64. Which of the following is classified as Required Stable Funding (RSF) under NSFR?
A. Cash and central bank reserves
B. High-quality liquid securities
C. Short-term borrowings
D. Loans with maturity greater than one year
RSF includes assets that require stable funding, such as loans and other illiquid assets with maturities beyond one year.
65. Which of the following statements is correct regarding LCR and NSFR?
A. LCR and NSFR both measure capital adequacy
B. LCR focuses on short-term liquidity, NSFR on long-term funding stability
C. NSFR is a component of CET1 capital
D. LCR and NSFR are only relevant for SIFIs
LCR ensures short-term liquidity resilience over 30 days, while NSFR ensures banks maintain stable funding for long-term assets over a one-year horizon.
66. What minimum NSFR must banks maintain under Basel III?
A. 90%
B. 95%
C. 100%
D. 105%
Basel III requires banks to maintain NSFR ≥ 100%, ensuring that available stable funding is sufficient to cover required stable funding for one year.
