Lecture 6

Question 1

What and how did Basel 2.5 tried to fix?

Answer 1

Smooth procyclicality and limiti regulatory arbitrage between trading and investing through: Stressed VaR(forward looking), Incremental Risk Change (IRC) (for assets held for trade) and Comprehensive Risk Measure (CRM) (for assets exposed to correlation risk)

Question 2

Goals of Basel 3

Answer 2

Increase the quality of capital required (more Tier 1 capital)
Increase capital requirements
Reduce procyclicality

Question 3

What is the Capital Conservation Buffer?

Answer 3

Extra requirements (extra 2.5%) applied during normal times. Equity: 7% of RWA, Tier 1: 8.5% of RWA and Tier 1 + 2 : 10.5% of RWA
If banks fo below these requirements:
They cannot pay bonuses
They cannot buy back assets
Need to retain a % of thei earnings instead of paying dividends
It is a global buffer

Question 4

What is the Countercyclical Buffer?

Answer 4

Second extra buffer (CCyB) if systemic risk is increased .
Equity: 7% + CCyB of RWA
Tier 1: 8.5% + CCyB of RWA
Tier 1&2: 10.5% + CCyB of RWA
This buffer applies based on the bank’s country
When systemic risk increases-> CCyB increases and decreases when crisis occurs

Question 5

What is the extra buffer?

Answer 5

Extra buffer for global systemically important financial institutions (G-SIFI) extra requirements apply, called “Total
Loss Absorbing Capacity (TLAC)” requirements.

Question 6

What is leverage ratio?

Answer 6

Banks need to have a minimum Tier 1 accoriding to how risky assets they hold
Tier 1 / Total exposure > 3%
For G-SIFIs this is plus the 50%CET1 requirements
it limitis: model error. measurement error, regulatory arbitrage
(-) incentive to increase risk

Question 7

What is the Liquidity Coverage ratio?

Answer 7

Like narrow banking, banks need to have enough liquidity to cover the payments for the next month

Question 8

When does a haircut apply?

Answer 8

A haircut applies for level 2 assets. Equity has a big haircut because its market value is very low.

Question 9

How much outflow is needed?

Answer 9

Net cash outflows need to be at least 25% of outflow, you dont’t just want positive Inflow-outflow

Question 10

Describe operational risk with the standardized approach.

Answer 10

Operational risk = ILM * Σai * BIi
It takes into account historical losses
BI (Basic Indicator): 3-year average of operational “revenues” for the bank
ai : Only depend on the size of business unit
ILM (Internal Loss Multuplier): depends on the size of operational risk exposure and how large were the operational losses a banks has faced the last decade (LC)
For small banks ILM always =1

Question 11

Market risk according to Basel 3.

Answer 11

Expected Shortfall (ES): Average losses in worst case scenario