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FRM Part II · FRM Exam Part II · Solvency, Liquidity and Other Regulation After the Global Financial Crisis

Under Basel III, which change to the definition of regulatory capital best reflects the post-crisis emphasis on loss-absorbing capacity?

Basel III stresses common equity Tier 1 as the dominant, highest-quality capital and tightens deductions such as goodwill and certain deferred tax assets. This improves going-concern loss absorbency, while Tier 3 was eliminated and step-up hybrids were disqualified from core capital.

  1. AIncreasing the share of Tier 3 capital eligible to cover market risk
  2. BFocusing on common equity Tier 1 as the predominant form of Tier 1 capital with stricter deductions such as goodwill and deferred tax assetsCorrect
  3. CAllowing innovative hybrid instruments with step-up features to count as core capital
  4. DPermitting minority interests and holdings in other financial institutions to be fully included in CET1

Explanation

Basel III tightened capital quality by emphasising common equity and applying regulatory deductions (goodwill, certain deferred tax assets, significant holdings in financial institutions). It also eliminated Tier 3 and disallowed step-up hybrids as core capital. The other options reverse these reforms.

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