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Lecture 10 (part II) - Coggle Diagram
Lecture 10 (part II)
Risk- based capital ratios
proposed by BIS (Bank for International Settlements)
introduction: page 28 - 32
3 main parts
Tier 1 capital
Total capital
Common Equity Tier (CET) 1
Risk- based capital ratios = capital / risk- adjusted assets
2 approaches
Standardized approaches to calculate risks (used by most
smaller banks
)
Internal ratings- based (
IRB
) models if approved by APRA
Measurement of regulatory capital
Tier 1 (going concern) capital
common equity Tier 1: common equity + retained earnings
additional Tier 1 capital:
non- common equity
elements, subordinated with
non- cumulative dividends
and no maturity (i.e: non- cumulative preferences shares)
Tier 2 (gone concern) capital
Tier 1 + subordinated to depositors and general creditors (i.e: subordinated bonds, cumulative preferences shares)
capital adequacy ratios (p.37)
general:
capital / total risk- adjusted assets
higher risk => require more capital => satisfy the required ratios
Measuring risk- adjusted assets
resulting from credit, operational, market and securitisation risks
credit risk- adjusted assets
= risk- adjusted (
on + off balance sheet
) assets
approach
Identify risk weights for each asset (
table 18.5
)
Add weighted assets
3.
Min capital = Risk weighted assets x required capital
Risk- adjusted off- balance sheet assets
2 types of OBS items (p.44)
OBS contingent guarantee contracts (standby and commercial letters of credit, loan commitments, ...)
OBS market contracts or derivative instruments (futures or forwards)
Calculating
OBS contingent guarantee contracts
Convert OBS values into on- balance- sheet
credit equivalent amounts (CEA)
(
table 18.8
)
Multiply the OBS
CEA
by the
appropriate risk category weight
(
table 18.5
)
OBS market contracts or derivative instruments (p.51 - 53)
Other risks
Operational risk- weighted equivalent assets
= operational risk capital charge x 12.5 (i.e: fraud, technology failure)
Market risk
(due to changes in prices) = Market risk capital charge x 12.5
Non- traded interest rate risk capital charge
securitisation credit risk
Basel III
2 capital buffers
Capital conservation buffer (p.63)
Countercyclical capital buffer (p.64)
Pillar 1: Capital adequacy
Capital adequacy ratios
Leverage ratios
Capital buffers
New definition of capital
Pillar 2: Risk assessment and supervision (p.67)
Pillar 3: Capital and risk disclosure (p.68)
Capital management
FI's capital guided by two key factors
regulated capital adequacy requirements
risk- return trade- offs
available from the use of leverage
regulation introduces
moral hazard
(excessive risk- taking)
measures of capital adequacy
risk- based capital ratio
leverage ratio
L = core capital/ assets
based on
book value
problems
Ignores Non- equity capital (eg: long- term debt)
Bank only ratio:
subsidiaries
not included in leverage ratio
Ignore off- balance sheet activities
Different risk appetites of DIs:
not all FIs have the same risk
Assets risk:
fails to consider different risks
in asset portfolio
Market value (based on book value)
backstop
measure