CH15 - Management of Capital (Reader) Flashcards
Why did the Basel committee put forward proposals?
To close the gap in international bank
supervision.
To ensure capital adequacy
To level the playing field regarding
internationally active banks
What are documents of the Basel committee?
Principles for the Supervision of Banks’ Foreign Establishments (Basel Concordant)
International Convergence of Capital Measurements and Capital Standards (Capital Accord)
Amendments to the capital accord to incorporate market risks
Principles for the management of interest rate risk
Basel II: Revised international capital framework
Basel III: International regulatory framework for banks
What is the fundamental object of the Basel II Accord?
This framework was intended to align
capital adequacy assessment more
closely with the key elements of banking
risks
To provide incentives for banks to
enhance their risk measurement and
management capabilities
What are the three pillars of the Basel II Capital Accord?
– minimum capital requirements which seeks to develop and expand on the standardized rules
– a supervisory review of an institutions capital adequacy and internal assessment process
– effective use of market discipline as a lever to strengthen disclosure and encourage safe and sound banking practices
What is the underlying principle of Basel II framework?
Its underlying principles were intended to be suitable
for application to banks of varying levels of complexity
and sophistication
How many countries have adopted the Basel II 1988 Accord?
More than 100 countries have adopted the
1988 Accord, and the Committee has consulted with supervisors
world-wide in developing the Basel II framework
Why did the Basel committee consult with supervisors all around the world in developing the Basel II framework?
– to ensure that the principles embodied in the three
pillars of the new framework are generally suitable
to all types of banks around the globe.
– The Committee therefore expected the Basel II
Accord to be adhered to by all significant banks
after a certain period of time
What is the First Pillar of Basel II?
Calculation of the total minimum capital requirements for Credit, Market and Operational risk
What are the primary changes in Basel II?
- are in the approach to credit risk
- and in the inclusion of explicit capital requirements for operational risk
List the three approaches under Credit Risk approach in Basel II
– the standardized approach
– the “foundation” / Securitisation Framework
– “advanced” internal ratings-based (IRB)
approaches
Definition: Capital Adequacy Ratio (CAR)
the ratio of a bank’s capital in relation to its risk weighted assets and current liabilities
What is the formula to calculate CAR?
Qualifying (Eligible) Regulatory Capital / Risk Weighted Assets
What is the minimum requirement of CAR for Basel II?
8%
Pillar 1: How many tiers are under Capital elements?
3 tiers
Pillar 1: What elements are under tier 1?
Paid-up share capital / common stock
Disclosed reserves
Pillar 1: What elements are under tier 2?
Undisclosed reserves
Asset revaluation reserves
General provisions
Hybrid (debit/equity) capital instruments
Subordinated debt
Pillar 1: What elements are under tier 3?
Short-term subordinated debt
List and explain what is included in tier 1?
Includes only permanent shareholders equity and disclosed reserves. In the case of consolidated accounts, this also includes minority interests in the equity of subsidiaries that are less than wholly owned
Tier 2: Explain Undisclosed reserves
are eligible for inclusion within supplementary elements provided these reserves are accepted by the supervisor. Such reserves consist of that part of the accumulated after-tax surplus of retained profits which banks in some countries may be permitted to maintain as an undisclosed reserve
Tier 2: Explain Revaluation reserve
Reflected in two ways
- In some countries, banks are permitted to revalue fixed assets, normally their own premises from time to time in line with the change in market values. These revaluations are reflected in the face of the balance sheet as revaluation reserve
- be present as a result of long-term holdings of equity securities valued in the balance sheet at the historic cost of acquisition
Tier 2: Explain Hybrid (debit/equity) capital requirements
Includes a range of instruments that combine characteristics of equity capital and debit
Should meet these requirements
- they are unsecured, subordinated and fully paid up
- they are not redeemable at the initiative of the holder or without the
prior consent of the supervisory authority;
- they are available to participate in losses without the bank being
obliged to cease trading (unlike conventional subordinated debt)·
Tier 2: Explain Subordinated term debt
include. conventional unsecured subordinated debt capital instruments with a minimum original fixed term to maturity of over five years and limited life redeemable preference shares. These instruments will be limited to a maximum of 50% of Tier 1
List 4 conditions that Tier 3 capital will be subject to
a) It should have an original maturity of at least two years and will be limited to 250% of the bank’s tier l capital that is allocated to support market risk.
b) It is only eligible to cover market risk including foreign exchange risk and commodities risk.
c) Insofar as the overall limits in the 1988 Accord are not breached, tier 2 element may be substituted for tier 3 up to the same limit of 250%.
d) It is subject to a “lock-in” provision which stipulates that neither interest nor principal may be paid if such payment means that the bank’s overall capital would then amount to less than its minimum capita 1 requirement
What are the advantages of using a risk ratio over the simpler gearing ratio approach?
o it provides a fairer basis for making international comparisons between banking systems whose structures may differ
o it allows off-balance-sheet exposures to be incorporated more easily into the measure
o it does not deter banks from holding liquid or other assets which carry low risk
How does Basel II improve sensitivity to the risk of credit losses?
Basel II improves the capital framework’s sensitivity to the risk of credit losses generally by requiring higher levels of capital for those borrowers thought to present higher levels of credit risk
Credit risk: Explain the standarised approach
- Similar to current Basel I approach where exposures are assigned to risk weight categories based on their characteristics
- Supported by external credit assessments
- Dependent on supervisory inputs to determine capital requirements
What are the main categories under standarised approach?
claims on sovereigns
non-central government public sector entities
multilateral development banks
banks
corporate
retail loans
residential real estate
commercial real estate
What is the weight of Retail exposures under standarised approach?
75%
How does Basel II identify higher risk categories?
Basel II identifies certain higher risk assets which are weighted at 150%
