Economics • Banking & FinanceHard
Examine the capital adequacy standards prescribed under the Basel III norms. How is 'Tier 2 Capital' defined in terms of loss-absorption capacity for commercial banks?
A. It represents the highest quality, permanent, and loss-absorbing equity capital available to absorb losses during ongoing operations
B. It consists of supplementary capital instruments that absorb losses only in the event of a bank's winding up or going-concern failure✓ Correct Answer
C. It includes all short-term commercial paper and unsecured interbank borrowings maturing within ninety days
D. It refers strictly to foreign exchange reserves deposited with international central clearing houses
💡 Solution & Explanation
Under Basel III guidelines, Tier 2 capital serves as secondary or supplementary bank capital that provides a lower degree of loss absorption compared to Common Equity Tier 1 capital. It absorbs losses primarily when the bank ceases operations or undergoes liquidation, whereas Tier 1 capital absorbs losses on a going-concern basis. Tier 2 instruments include subordinated debt and undisclosed reserves meeting regulatory criteria. Total capital adequacy ratios require a balanced mix of both tiers.
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