05. Management and Regulation

Question 1

Finding expected losses:

Answer 1

Loss Rate * Default Rate

Question 2

Capital
* Capital acts as …
* This can help absorb losses and …
* Capital can increase…
* Now banks have something to lose so …

Answer 2

a buffer against losses.

prevent costly bank failures.

banks’ skin in the game.

they invest more prudently.

Question 3

Capital Regulation
* One of the …
* International Banking Act of 1978.
* Level playing field between …
* Requirements comparable to those of the U.S. banks.

Answer 3

major pillars of bank regulation.

U.S. banks and their foreign competitors operating in the U.S.

Question 4

Basel I
* Basel I was introduced in 1988 and implemented in 1993.
* A group of central bankers come together to … Rules were enforced by law in G-10 countries in 1992.
* Sets …for banks.
* Banks are required to … as capital.

Answer 4

set capital requirements internationally.

minimum capital requirements

hold a minimum of 8% of their risk-weighted assets (RWA)

Question 5

Basel I
* Total capital = Tier 1 + Tier 2 capital.
* Tier 1 capital has to be at least 50% of total capital.
* Tier 1 capital ≥ 4% of RWA

Differentiate between tier 1 and tier 2 capital.

• Tier 1 (Core):….
• Tier 2 (Supplementary) Capital:
• Loan loss allowances
• …
• Subordinated obligations (both stock and debt) an original average maturity of at least 7 years
• ….
• …

Answer 5

Common stock; Retained earnings; Capital surplus; Disclosed capital reserves

• Preferred stock with maturity of at least 20 years
• Undisclosed capital reserves
• Hybrid capital instruments

Question 6

Basel I: Risk-weighted assets
* Bank needs to hold more capital against more risky assets.
* Hence, it is not total assets…
* w1 = 0: cash, central bank and government debt, any OECD government debt, loan commitments with maturities less than 1 year.
* w2 = 0.2: …
* w3 = 0.5: secured mortgage loans, unused loan commitments with maturities exceeding 1 year.
* w4 = 1.0: …

Answer 6

it is the risk-weighted assets.

loans to international organizations, OECD banks, short–term loans to non-OECD banks, non-OECD public sector debt.

all other loans, non-OECD bank debt (maturity over a year).