Chapter 8: Regulatory Capital Modelling Flashcards
What are the two sources of funding for financial companies?
Capital (own funds) and debt.
Why do banks need own funds or capital?
To absorb what?
To absorb losses and prevent defaulting on debt obligations, avoiding systemic consequences.
What was the Glass-Steagall Act’s main purpose?
To separate commercial and investment banking to avoid conflicts of interest.
What was the significance of the Basel Committee established in 1974?
It laid principles for the supervision of foreign banks and cooperation between banking authorities.
What did Basel I recommend in 1988?
I SAID LET HIM………RATIO
A minimum level of capital to cover credit risk, known as the Cooke ratio (8% of risk-weighted assets).
When did regulatory capital for operational risks first appear?
In what year and under which regulation?
In 2002, under Basel II.
What are the three pillars of Basel II regulation?
What do they mean?
- Pillar 1: Regulatory capital
- Pillar 2: Supervisory review process
- Pillar 3: Market discipline.
What is the purpose of Pillar 1 in Basel II?
Covers which risks?
To set a mandatory minimum level of capital to cover credit, market, and operational risks.
What is the role of Pillar 2 in Basel II?
To adjust capital requirements based on the specific risk profile and quality of risk management
What is the aim of Pillar 3 in Basel II?
Through mandatory what?…..
To encourage market discipline through mandatory information disclosures.
What percentage of total capital was operational risk capital expected to represent in the early 2000s?
12%
What is the standardized measurement approach (SMA) in Basel III?
Based on gross and history?
A revised version of the standardized approach for operational risk capital, based on gross income and loss history.
What was a major factor leading to the financial crisis of 2007/2008?
The repeal of the Glass-Steagall Act and proliferation of misunderstood financial products.
What is the basic indicator approach (BIA) for operational risk capital?
What is the regulatory capital equal to?
Regulatory capital is equal to 15% of the gross income.
What are beta factors in the standardized approach?
Factors used to determine regulatory capital for operational risk based on business lines.
What is the advanced measurement approach (AMA) for operational risk?
Allows banks to assess their own capital needs using internal models, subject to regulatory approval.
What are the four types of input required for AMA models?
Internal, external, Scenario and BE….
- Internal loss data
- External data
- Scenario data
- Business environment and internal control factors (BEICF).
What is the loss distribution approach (LDA) in operational risk modeling?
FTA?
A method that decomposes risk events into frequency and severity to model loss distributions.
What is the purpose of scenario analysis in operational risk?
To assess the potential impact of operational risk disasters and the organization’s resilience.
What is the role of business environment and internal control factors (BEICF) in operational risk models?
To include information on the internal control environment and external factors affecting risk.
What is the supervisory review process (SREP) in Pillar 2?
process for regulators to evaluate a firm’s risk exposure and capital sufficiency.
What is ICAAP in Europe?
Internal capital adequacy assessment process for evaluating capital sufficiency in banks.
What is CCAR in the U.S.?
Comprehensive capital analysis and review for assessing capital sufficiency in financial firms.
What is stress testing in operational risk?
Evaluating a firm’s resilience to internal and external shocks through various stress scenarios.
