ALMA Capital Basics Flashcards
What is leverage?
Leverage = Equity / Assets
What are the shortcomings of the leverage ratios?
Leverage ratios do not differentiate between ‘safe’ and ‘risky’ assets
It is therefore not an ideal solution for assessing the risks of banks or dictating the amount of capital they should hold
What are the different types of capital requirements?
Pillar 1 - Min. Capital Requirements
(Covering Credit risk, Market risk and Operational risk)
Pillar 2 - Supervisory review
(ICAAP and SREP - results in additional capital requirements specific to the bank)
Pillar 3 - Market discipline
(‘Pillar 3’ report)
What are the two approaches to calculating RWAs?
1) Standardized approach
2) Internal Ratings based (IRB) approach
What is the standardized approach to modelling RWAs?
- Risk weights are prescribed by the regulations
- No credit risk modelling is required
What is the IRB (Internal ratings based) approach to modelling RWAs?
- Foundation approach: models used to calculate
probability of default (“PD”) - Advanced approach: models used to calculate
PD, loss given default (“LGD”) and exposure at
default (“EAD”) - Risk weights calculated as a function of PD, LGD
and EAD
What is the primary driver of the Pillar 1 requirements for most commercial banks?
Credit Risk (Loans)
1) What is the aim of Pillar 2A capital requirement?
1) Aims to access all material risks not covered under P1. E.g. Interest rate risk, concentration risk
What Risks does the Pillar 1 capital requirements aim to address?
1) Credit risk (loans)
2) Market risk (Trading activities)
3) Operational Risk (How the business works)
What is the aim of the Pillar 2B buffers?
P2B aims to ensure sufficient capital over a 3-5 year horizon. Including stressed conditions
How is the P2B buffer set?
P2B buffers are set based on regulations and stress testing
Crucially they can be used in times of stress
2) How is the P2A requirement set?
P2A is ultimately set by the PRA following the review of the bank and its ICAAP
What are the 3 types of capital resources (Under CRR)?
1) CET1
2) AT1
3) Tier 2
What is CET1? and what is it made up of?
Common Equity Tier 1
Retained earnings and share capital, less deductions for assets that cannot absorb losses or are difficult to monetize
What is AT1 and what is it made up of?
Additional Tier 1
Principally hybrid debt instruments that convert to equity (or are written down) if the firm’s CET1 position breaches a pre-defined trigger, thus reducing liabilities
What is Tier 2 made up of?
Mainly long-dated subordinated debt that amortizes for regulatory capital purposes
