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Answer: Basel II did not require external credit ratings, but Basel III seeks to increase the reliance on external ratings
## Explanation Let's analyze each option: **Option A**: ✅ Correct - Basel II did not formally include liquidity risk requirements, while Basel III introduced the Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR) to explicitly address liquidity risk. **Option B**: ✅ Correct - Basel II was criticized for creating procyclical effects (amplifying economic cycles), while Basel III introduced the countercyclical capital buffer to explicitly address this issue. **Option C**: ❌ INCORRECT - This statement is factually wrong. Basel II actually REQUIRED external credit ratings for the standardized approach to credit risk, while Basel III sought to REDUCE reliance on external ratings after the 2008 financial crisis exposed their limitations. **Option D**: ✅ Correct - Basel II allowed banks to show strong risk-based capital ratios while maintaining high leverage, while Basel III introduced a non-risk-based leverage ratio as a backstop to prevent excessive leverage. Therefore, option C is the exception because it incorrectly describes the relationship between Basel II and Basel III regarding external credit ratings. Basel II actually increased reliance on external ratings, while Basel III aimed to reduce this dependence.
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Each of the following was both (i) a deficiency or omission of Basel II but is, at the same time, (ii) explicitly addressed by new requirement in Basel III except for
A
Basel II did not formally include liquidity risk, but Basel III explicitly covers liquidity risk
B
Basel II could arguably create a procyclical effect, but Basel III explicitly adds a buffer to address this
C
Basel II did not require external credit ratings, but Basel III seeks to increase the reliance on external ratings
D
Basel II allowed many banks to show strong risk-based regulatory capital ratios despite high on- and off-balance sheet leverage; Basel III adds a simple leverage ratio to act as a backstop to the risk-based capital ratio
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