W 3 Flashcards
Regulatory Capital is first and foremost Maret Value or Book Value of Equity?
Regulatory Capital is first and foremost Book Value of Equity
Book value compaired to Market value is…
…much less volatile, leading to more stable assessment.
RWA is ? and calculated as ?
Risk Weighted Assets
Amount of Assets x risk weight
(more risk → higher weight)
Which are the accepted methods to compute credit equivalent under Basel I?
- Current Exposure Method
- Original Exposure Method
NRR stands for:
Net Replacement Ratio,
Ratio between the sum of the market value of all positions and the sum of the market value of only positions with a positive value
CEA stands for:
Credit Equivalent Amount
Used to compute capital reqments for off-balance sheet items under Basel
What are some of the critisism of Basel I?
▪ Only credit risk is considered, not market risk nor operational risk.
▪ Assets with different credit risk and same weight or viceversa
▪ Governance not considered
▪ No role given to market monitoring
Regulatory arbitrage occurs when …
…a loophole allows to “formally” abide the rules, while violating the “spirit” of the rule.
This allows to increase risk while keeping tier ratios constant.
Interest Rate Risk is:
change in value due to change in market cost of
capital
Liquidity Risk:
forced liquidation unfeasible, or feasible only at big discount
Currency Risk:
change in value due to change in exchange rates
Market risk is …
…the possibility that an individual or other entity will experience losses due to factors that affect the overall performance of investments in the financial markets.
Claim: Internal Approach thus computes first the capital requirement and then the corresponding RWA.
True
What are the 3 pillars of Basel II?
- Minimum Capital Requirements
- Supervisory Review
- Market Discipline
Operational Risk is:
the risk of losses resulting from inadequate or failed internal process, people and systems, or external events
Two main inovations from Basel I to II allowed for…
Credit risk and Operational Risk
EAD stands for:
Exposed Assets to Default
Amount expected to be held of an asset by the time the latter may defaul
IRB stands for:
Internal Rating Based approach to credit risk.
Can be Foundation (F-IRB) or Advanced (A-IRB)
WCDR stands for:
Worst-Case Default Rate
Claim: Basel II generally has lower capital requirements for credit risk than Basel I?
True
Claim: Equity is the most reliable source of capital to protect other stakeholders
True
Sos: why equity is used as the main form of regulatory capital?
Due to its Loss Absorption properties
Equity has the highest level of loss absorption capacity within a financial institution’s capital structure.
In the event of financial distress or losses, equity holders are the last to be paid, making equity capital an effective buffer against insolvency.
SOS: Discuss briefly one reason why the market value of equity could have been potentially considered to be a better measure of regulatory capital than the book value of equity
Using market value would be preferred because it shows the bank’s ability to repay claimants in case of forced liquidation.
Assuming efficient financial markets, market value would reflect the value of the bank (what can it get in the market for its assets?).
It is a right proxy to repay claimants. In principle, a bank can alway sell its assets for repayment.
Sos: Discuss briefly one reason why the book value of equity is preferable to the market value of equity as a measure of regulatory capital.
The book value of equity is much less volatile, giving a more stable assessment.
