Lecture 5

Question 1

What is insolvency risk?

Answer 1

• the risk that a financial institution may not have sufficient capital to offset a sudden decline in the value of its assets relative to its liabilities
• the value of the ADIs liabilities exceeds that of its assets
• it is often defined for corporates as firm being unable to fulfil its financial obligations when they come due

Question 2

What is net worth?

Answer 2

• market value of assets minus market value of liabilities

Question 3

What is book value?

Answer 3

• asset and liability values based on historical cost

Question 4

What is book value?

Answer 4

• asset and liability values based on historical cost

Question 5

Who bears the losses in asset values due to adverse interest rate changes first?

Answer 5

• equity holders first and if this is not enough to cover liability holders will be affected

Question 6

ADI capital is guided by what two factors?

Answer 6

• regulated capital adequacy requirements

- the risk-return trade-offs available from the use of leverage

Question 7

How do you measure capital adequacy?

Answer 7

• leverage ratio

- risk-based capital ratio

Question 8

How do you measure capital adequacy?

Answer 8

• leverage ratio

- risk-based capital ratio

Question 9

The Basel 1 1988 agreement covered what four major changes?

Answer 9

• risk adjusted asset weightings
• worldwide consolidations of banking group assets
• including off balance sheet items
• adjustments for market transactions

Question 10

What are the three pillars of basel 3?

Answer 10

Pillar 1 - capital adequacy requirements: credit risk, market risk & operational risk
Pillar 2 - risk assessment and supervision
Pillar 3 - capital and risk disclosure

Question 11

What is Pillar 1: capital adequacy?

Answer 11

• a new definition of capital
• changes to the capital adequacy ratios
• inclusion of a leverage ratio within the framework of Pillar 1
• new capital conservation buffer - 2.5% of risk-weighted assets comprised of common equity tier 1 only

Question 12

What is Pillar 2: risk assessment and supervision?

Answer 12

• stress managerial responsibility and accountability for risk management

Question 13

What is Pillar 2: risk assessment and supervision?

Answer 13

• stress managerial responsibility and accountability for risk management
• APRA adjusts capital adequacy ratios (CARs) for each ADI, not less than the regulated minimums

Question 14

What is Pillar 3: capital and risk disclosure?

Answer 14

• allow market participants (Shareholders, bondholders, depositors) to assess the risk profile of banks and exert corporate governance
• the transparency of bank disclosure is a key factor for effective market discipline

Question 15

What categories are risk-based capital ratios divided into?

Answer 15

• common equity tier 1 capital risk-based ratio
• tier 1 capital risk based ratio
• total capital risk-based ratio

Question 16

CAR requirements in regards to common equity tier 1

Answer 16

• must be at least 4.5% of risk-weighted assets at all times
  = (common equity tier 1 capital)/(total risk adjusted assets) >= 4.5 per cent

Question 17

CAR requirements in regards to total tier 1 capital

Answer 17

• must be at least 6% of risk weighted assets at all times

= (total tier 1 capital)/(total risk adjusted assets) >= 6%

Question 18

CAR requirements in regards to total capital (tier 1 & tier 2)

Answer 18

• must be at least 8% of risk weighted assets at all times

= (total regulatory capital)/(total risk adjusted assets)>= 8%

Question 19

CAR requirements in regards to total capital (tier 1 & tier 2)

Answer 19

• must be at least 8% of risk weighted assets at all times

= (total regulatory capital)/(total risk adjusted assets)>= 8%