Week 10: Regulation and Capital Adequacy Flashcards
Define capital
• Net worth
: market value of assets minus market value
of liabilities.
– Losses in asset values are borne first by equity holders.
– If losses exceed the value of equity, liability holders will be
affected.
– Sufficient capital levels will protect liability holders from
losses.
What are the major functions of capital?
• To protect against the risks to which the FI is exposed
in the business.
• To absorb unanticipated losses to enable the FI to
continue as a going-concern.
• Reducing the probability of failure of a bank, thereby
protecting the financial system.
• To protect uninsured depositors, bondholders and
creditors in case of insolvency and liquidation.
• To partially fund the FI’s real investment activities.
What is Basel I
1998
– Capital rule (principles of risk-weighting of credit
exposures, minimum capital ratio requirement)
What is Basel II?
2004
– Pillar 1: Capital adequacy requirement (minimum capital
requirement for credit risk, market risk and operational
risk)
– Pillar 2: Supervisory review process
– Pillar 3: Disclosure (i.e. market discipline)
What is Basel III
– Revision of level and quality of capital
– Introduction of macro-prudential measures to protect the
financial system
Explain Basel II in context to NZ
– Pillar 1: minimum capital ratios, determination of exposures (by
either standardised approach or internal model based approach)
– Pillar 2: Internal capital adequacy assessment process (ICAAP)
– Pillar 3: comprehensive quarterly financial and prudential
disclosures
Explain Basel III in context to NZ
– Conservation and counter-cyclical buffers
– Determination of qualifying capital
– Treatment of exposures to central counterparties
– Leverage ratio is not implemented in NZ
What are the minimum capital ratio requirements?
- Common Equity
(CET1) = 4.5% - Tier 1 capital
(CET1+AT1) = 6.0% - Total capital
(Tier1+Tier2) = 8.0%
What are the capital conservation buffer requirements?
– Additional CET1 of 2.5% of risk-weighted
exposures.
so
- Common Equity
(CET1) = 7.0% - Tier 1 capital
(CET1+AT1) = 8.5% - Total capital
(Tier1+Tier2) = 10.5%
What is the Countercyclical capital buffer?
– A macro-prudential tool to protect the risks arising
from a period of above-trend credit growth.
– Vary between zero and 2.5% of total risk
weighted assets with CET1 capital. Applied at
discretion of the regulator.
What are the new capital requirements from July 1, 2021?
For the four large banks:
- Common Equity = 13.5%
- Tier 1 capital = 16%
- Total capital = 18%
For all other banks:
- Common Equity = 11.5%
- Tier 1 capital = 14%
- Total capital = 16%
describe the key attribute of capital quality- Subordination
– Priority in respect of repayment of principal.
– Ordinary shares must be the most subordinated
instrument, followed by AT1 instruments (e.g.
preference shares or perpetual debt)
describe the key attribute of capital quality- Permanence
– Length of time from issuance until obligation date of
repayment.
– Ordinary shares and AT1 instruments must be
perpetual instrument; Tier 2 instrument must have a
minimum term of 5 years.
describe the key attribute of capital quality- Flexibility of payment
– Whether the distributions are obligatory or not.
– Distribution for ordinary shares and AT1 instruments
are non-obligatory and non-cumulative.
describe the key attribute of capital quality- Loss absorbency
– Going-concern: absorb losses without the bank
having to be wound up or liquidated.
– Basel III requires going-concern loss absorbency for
all regulatory capital instruments potentially.
• Ordinary shares must absorb losses on a going-concern
basis.
• AT1 and Tier 2 instruments must be able to either written off
or converted into ordinary shares.
