Test: Banking Sector Reforms in India - UGC NET MCQ

Under the Basel I framework, assets are classified according to their risk levels, which means that different types of assets have different weights when calculating risk-weighted assets. This differentiation allows banks to recognize that not all assets pose the same level of risk and thus require varying amounts of capital to cover potential losses. For example, government bonds are typically considered low-risk, while unsecured loans carry higher risk and therefore require more capital. A noteworthy aspect of this risk-weighting system is that it encourages banks to adopt safer lending practices, ultimately promoting a more stable financial system.

• The Assertion is true as Basel III aims to enhance the overall quality of banks, which can lead to better financial performance in the long run.
• The Reason is false because while higher capital adequacy improves stability, it does not inherently allow banks to take on more risks; rather, it limits the risks they can take.
• Since the Reason is not correct, it does not explain the Assertion, making Option C the correct choice.

The Basel norms were created primarily to enhance the stability of the banking system. This objective is crucial, especially in ensuring that banks maintain sufficient capital to cover their risks and protect depositors. By coordinating banking regulations internationally, the Basel accords aim to reduce the likelihood of banking crises, which can have severe economic consequences. An interesting fact is that the Basel Committee was formed in response to the financial crises of the 1970s, highlighting the need for a cooperative approach to banking regulations.

Basel I introduced a standardized framework for measuring banks' capital adequacy. This accord established minimum capital requirements for banks based on the risk-weighted assets they held, marking a significant step towards ensuring that banks maintained adequate capital buffers to absorb potential losses. Basel II and Basel III later built upon these concepts, introducing more sophisticated risk assessment metrics and stricter capital standards to further enhance financial stability. An interesting note is that Basel I was implemented in 1988 and was the first international agreement of its kind, setting a precedent for future banking regulations.

Statement 1 is correct as Basel II indeed mandates that banks maintain a minimum capital adequacy ratio of 8% of their risk-weighted assets, which was a refinement over Basel I. However, Statement 2 is incorrect because Basel II explicitly encourages banks to enhance their risk management practices, making it a significant aspect of the framework. Therefore, the only correct statement is Statement 1.

Statement 1 is correct as Basel III indeed introduced a minimum leverage ratio requirement to mitigate excessive leverage in banks. Statement 2 is incorrect because while the LCR and NSFR are critical components of Basel III, they are primarily focused on liquidity risk management rather than enhancing the quality of regulatory capital. Therefore, the correct answer is Option A: 1 Only.

The Basel I framework was designed primarily to enhance the capital ratios of banks, ensuring they maintain adequate reserves to cover potential credit risks. This means that banks must hold a minimum of 8% of their risk-weighted assets as capital. The focus on capital adequacy was crucial in stabilizing the banking system and protecting depositors in the event of borrower defaults. An interesting fact is that Basel I laid the groundwork for subsequent Basel agreements, including Basel II and Basel III, which introduced more comprehensive risk management practices.

• The Assertion is true because the Basel norms indeed aim to strengthen the banking system globally by ensuring that banks can withstand financial stress.
• The Reason is also true as one of the key components of the Basel norms is to impose higher capital requirements on banks.
• The Reason correctly explains the Assertion because maintaining higher capital reserves directly contributes to the resilience of the banking system.

• Assertion (A) is true; delays in regulatory frameworks can lead to a perception of weakness in banking institutions.
• Reason (R) is also true; compliance is indeed a crucial factor for investors.
• Reason (R) serves as a correct explanation for Assertion (A) as it highlights why the delays could tarnish the banks' reputations.

• Assertion (A) is true; the pandemic significantly influenced the decision to extend the deadline.
• Reason (R) is also true; the RBI indeed sought to ease the financial strain on banks.
• Furthermore, Reason (R) correctly explains Assertion (A) because the economic context provided a rationale for the extension.