Banking: Chapter test

The Basel Committee on Banking Supervision (BCBS) was set up in 1974 by the central bank governors of the G10 countries after the failure of Germany's Herstatt Bank disturbed currency markets. Its secretariat is at the Bank for International Settlements (BIS) in Basel, Switzerland, which gives the accords their name: Basel I (1988), Basel II (2004) and Basel III (from 2010, after the global financial crisis). The Committee has no legal powers; its standards are minimums that national regulators, like the RBI, put into their own rules. India has been a member since 2009.

Risk weights reflect how likely an exposure is to cause a loss. Claims on the Central Government in rupees, such as G-secs and Treasury Bills, carry a 0% risk weight, because the sovereign can always service debt in its own currency. That is why banks can hold large amounts of government securities, including those kept for the SLR, without needing extra capital for credit risk. Unrated corporate loans generally attract a 100% or higher risk weight, and unsecured consumer credit such as personal loans and credit card receivables carries some of the highest weights; in November 2023 the RBI raised them further, for example to 125% for many personal loans and to 150% for credit card receivables of banks. Note that G- secs still carry market risk, which needs separate capital.

Only statement 1 is correct. The 2008 crisis showed that banks with adequate capital could still fail because they ran out of cash. Basel III therefore added two liquidity standards. The LCR requires a stock of unencumbered high-quality liquid assets, such as government securities, at least equal to the bank's net cash outflows over the next 30 days under stress; in India it has been 100% since January 2019. Statement 2 is wrong: the NSFR is also a liquidity standard, not a capital ratio. It requires available stable funding to be at least equal to required stable funding over a one-year horizon, so that long-term assets are not financed by short-term money; the RBI applied it from October 2021. Neither ratio is part of the CRAR.

Statements 1 and 3 are correct. The Finance Act 2022 amended section 22 of the RBI Act so that 'bank notes' include a digital form. The e₹-R, piloted from 1 December 2022, is therefore legal tender and, like cash, a liability of the RBI and not of the bank that distributes the wallet. Statement 2 is wrong: the RBI designed the digital rupee to be non-interest-bearing, mirroring physical cash. If it paid interest, people might shift money out of bank deposits on a large scale, shrinking banks' ability to lend; this risk is called disintermediation. In 2024 the RBI extended the pilot with programmability, which lets money be restricted to specific uses (for example, a government benefit that can be spent only on certain items), and an offline mode for areas with weak connectivity. Unlike UPI, which moves bank deposits between accounts, e₹ is the money itself.

Statements 1 and 3 are correct. The PCA framework lets the RBI step in early and require a weak bank to take corrective steps, such as limits on dividends, branch expansion or risky lending, before it fails. The revised framework announced on 2 November 2021 tracks three areas: capital (CRAR or CET1 ratio), asset quality (net NPA ratio) and leverage (Tier 1 leverage ratio). Statement 2 is wrong: profitability measured by return on assets was a trigger under the 2017 framework but was dropped in the 2021 revision. The circular is addressed to all scheduled commercial banks excluding SFBs, payments banks and RRBs, so statement 3 is correct. It applies to foreign banks operating through branches or subsidiaries.

Statement-I is correct but Statement-II is incorrect. The CRAR divides a bank's regulatory capital by its risk-weighted assets: each loan or investment is multiplied by a risk weight (0% for central government securities, higher for riskier loans) before being added up. If the RBI raises the risk weight on a class of loans, as it did for certain unsecured consumer loans in November 2023, the risk-weighted assets rise. The same capital is then spread over a larger base, so the CRAR falls. This is exactly how risk weights work as a macroprudential tool to cool a fast-growing loan segment. Statement-II is wrong because a ratio of capital to total, unweighted assets is the leverage ratio, not the CRAR.

Statements 1 and 2 are correct. The RBI applies Basel III more strictly than the Basel Committee. It sets minimum CET1 at 5.5% against Basel's 4.5%, Tier 1 at 7%, and total capital at 9% against Basel's 8% of risk-weighted assets. On top of these minimums, banks must hold a capital conservation buffer (CCB) of 2.5%, so that the CET1 requirement including the buffer becomes 8% and total capital becomes 11.5%. Statement 3 is wrong: the CCB must be made up of CET1, the highest-quality capital. The buffer is meant to absorb losses in bad times, and a bank that eats into it faces limits on paying dividends.

Statements 1, 2 and 4 are correct. Tier 1 capital, the bank's core capital, is CET1 plus AT1. CET1 is the purest layer: paid-up equity, share premium, statutory and other disclosed reserves, and retained earnings, so statement 4 is correct. AT1 bonds have no maturity date and must absorb losses, through write-down or conversion, if CET1 falls below the trigger or the bank reaches the point of non-viability. Yes Bank's AT1 bonds were written off in 2020 under its reconstruction scheme. Statement 3 is wrong: Tier 2, made up of instruments such as subordinated debt and some provisions, is 'gone-concern' capital. It absorbs losses mainly when the bank fails, after equity and AT1 have been used up.

The sub-indices are Access, Usage and Quality (c). The RBI launched the FI-Index in August 2021. It covers banking, investments, insurance, postal services and pension, and gives one value between 0 and 100. Its three parameters are Access (35%), Usage (45%) and Quality (20%). Options (a), (b) and (d) list areas or ideas that are not its sub-indices; GDP contribution and affordability are not parameters.

Notice the logic: usage has the most weight, because an account that is never used does not mean real inclusion. Quality includes financial literacy and consumer protection. The index is published every July, and it has risen steadily, helped by Jan Dhan (2014) and UPI.

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Statements 1 and 4 are correct (a). The RBI lists how an NBFC differs from a bank. Statement 1 is right: NBFCs cannot accept demand deposits. Statement 4 is right: depositors of NBFCs get no DICGC insurance cover. Statement 3 is wrong: NBFCs are not part of the payment and settlement system and cannot issue cheques drawn on themselves. Statement 2 is wrong: not every NBFC registers with the RBI; insurers report to IRDAI, merchant bankers and brokers to SEBI, and chit funds to State governments. So options (b), (c) and (d) fail.

Notice the current rules: since 2021, the RBI regulates NBFCs through a Scale-Based Regulation in four layers: Base, Middle, Upper and Top. DICGC covers bank deposits up to ₹5 lakh.

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All three statements are correct (c). Statement 1 is right: the Liquidity Adjustment Facility (repo and reverse repo) is open to banks and to standalone primary dealers, which are themselves NBFCs registered with the RBI. Statement 2 is right: foreign portfolio investors may hold G-Secs within limits, and some bonds are fully open to them under the Fully Accessible Route (FAR). Statement 3 is right: NSE and BSE run separate debt segments for trading bonds.

Notice the big change: from 2024, Indian government bonds entered global indices such as JP Morgan's, bringing in large foreign money. The FAR, introduced in 2020, made this possible. Primary dealers help the RBI sell government bonds.

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Neither statement is correct (d). Statement 1 is wrong: under the RBI's 2013 scheme, a foreign bank's wholly owned subsidiary needs a minimum paid-up capital of ₹500 crore. Statement 2 is wrong as worded: on the board, at least 50% must be Indian nationals, NRIs or PIOs, and at least one-third must be Indian nationals resident in India. Statement 2 narrows the rule to Indian nationals alone, so UPSC treated it as wrong.

Notice why the RBI prefers subsidiaries to branches: a subsidiary is a separate Indian company with its own capital, so it is easier to control in a crisis. Subsidiaries also get near national treatment. SBM Bank and DBS Bank India were among the first to take this route.

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Open Market Operations are used for sterilisation (a). When the RBI buys dollars to stop the rupee rising too fast, it pays in rupees, which adds money to the system and can push up inflation. To soak up that extra money, it sells government securities through open market operations. Cancelling the effect of forex operations on money supply this way is called sterilisation. Option (b) is wrong: overseeing payment systems is a separate RBI role. Option (c) is wrong: debt and cash management for governments is its banker role. Option (d) is wrong: regulating NBFCs is supervision.

Notice other sterilisation tools: the Market Stabilisation Scheme (2004), the Standing Deposit Facility (2022) and forex swaps, which avoid selling bonds.

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Statements 2 and 3 are correct (b). Statement 1 is wrong: no local boards regulate Urban Cooperative Banks. They have dual control: the State Registrar of Cooperative Societies handles registration and management, and the RBI regulates their banking business. Statement 2 is right: the 2020 amendment to the Banking Regulation Act allowed UCBs to raise capital through equity shares, preference shares and bonds, with RBI approval. Statement 3 is right: cooperative banks came under the Banking Regulation Act through an amendment in 1966.

Notice the PMC Bank crisis of 2019, which pushed the 2020 amendment giving the RBI more power over cooperative banks. Multi-State cooperative banks are registered under the Central Registrar instead.

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