Free Essay

Bank Capital Requirements

In:

Submitted By seapadan
Words 726
Pages 3
Bank Capital Requirements

http://wfhummel.cnchost.com/capitalrequirements.html

.

.

MONEY
WHAT IT IS HOW IT WORKS
Next Article Home

Bank Capital Requirements
A bank's capital is equal to its assets minus its liabilities. It is the margin by which its creditors would be covered if assets were liquidated and its liabilities paid off. A measure of a bank's financial health is its capital/asset ratio, which is required to be above a prescribed minimum. Requirements In 1989 the U.S. adopted the capital requirements established by the Bank for International Settlements (BIS) in Basel, Switzerland. The minimum capital is specified as a percentage of the risk-weighted assets of the bank. The following table shows the weight assigned to each type of asset.

Asset Cash and equivalents Government securities Interbank loans Mortgage loans Ordinary loans Standby letters of credit

Risk Weight 0 0 0.2 0.5 1.0 1.0

The BIS rules set requirements on two categories of capital, Tier 1 capital and Total capital: Tier 1 capital is the book value of its stock plus retained earnings. Tier 2 capital is loan-loss reserves plus subordinated debt.** Total capital is the sum of Tier 1 and Tier 2 capital. Tier 1 capital must be at least 4% of total risk-weighted assets. Total capital must be at least 8% of total risk-weighted assets.
**Subordinated debt is long term debt that, in case of insolvency, is paid off only after depositors and other creditors have been paid. Thus it can be used like equity to provide those creditors some

1 of 3

5/17/11 4:36 PM

Bank Capital Requirements

http://wfhummel.cnchost.com/capitalrequirements.html

protection against insolvency.

An Example Assume a bank has the following assets:

Asset Cash and equivalents Government securities Interbank loans Mortgage loans Ordinary loans Standby letters of credit

Amount $40m $80m $100m $200m $300m $80m

The total risk-weighted assets is 0 x $40m + 0 x $80m + 0.2 x $100m + 0.5 x $200m + 1.0 x $300m + 1.0 x $80m = $500m. The bank must have Tier 1 capital of at least .04 x $500m = $20m and Total capital of at least .08 x $500m = $40m. Leverage Requirement In addition to the BIS capital requirement, the U.S. imposes a separate leverage requirement on banks. This is based on the unweighted sum of all balance sheet assets. Off-balance sheet assets such as standby letters of credit are not counted. The minimum allowable ratio of Tier 1 capital to total assets is 3%. Bank regulators can increase that to as much as 6% depending on the quality of a bank’s assets. No leverage requirement is specified for total capital. In the example above, balance sheet assets total $720m. Assuming the bank must meet a 4% leverage requirement, it must hold Tier 1 assets of at least .04 x $720m = $28.8m. Since that exceeds the $20m BIS Tier 1 capital requirement, the leverage requirement governs. Meeting the New Standards If a bank is having difficulty meeting the BIS capital ratio requirements, there are a number of ways for it to increase the ratio. If it is publicly traded, it can issue new stock or sell more subordinated debt. However

2 of 3

5/17/11 4:36 PM

Bank Capital Requirements

http://wfhummel.cnchost.com/capitalrequirements.html

that may be costly if the bank is in a weak position. Small banks generally do not have the option of selling new stock since most are not publicly traded. If the bank cannot increase its equity, it can reduce its assets to improve the capital ratio. However shrinking the balance sheet is not attractive because it hurts profitability. Another option is to seek a merger with a stronger bank. Updating the Requirements Since the BIS capital adequacy requirements were defined and adopted in 1989, banking has become far more complex. The BIS has been working to better assess the risks in the various assets that banks hold. While the basic methodology of limiting a bank's risk-weighted assets relative to its capital will be retained, more categories and revised weightings are now proposed. How soon these revisions will be universally accepted however is difficult to predict.
Next Article Home

3 of 3

5/17/11 4:36 PM

ank

Similar Documents

Free Essay

Internship Report of Corporate Credit in Bank

...CHAPTER I INTRODUCTION 1.1 Background Basel Capital accord is a capital adequacy framework developed by the Basel committee. In 1988, the Basel Committee decided to introduce a capital measurement system commonly referred to as the Basel Capital Accord. This system provided for the implementation of a credit risk measurement framework with a minimum capital requirement of 8% on banks Risk Weighted Assets (RWA). The 1988 framework is also known as "Basel – I". Since 1988, this framework has been progressively introduced not only in member countries but also virtually in all other countries. The "international convergence on capital measurement and capital standard -2004" is popularly known as Basel-II. It is a capital adequacy related standard framed by Basel committee. After the successful implementation of 1988 accord in more than 100 countries, the Basel Committee on Banking Supervision reached an agreement on a number of important issues for promoting best and uniform banking practices as well as setting standards and guidelines for supervisory function. Following extensive interaction with banks, industry groups and supervisory authorities that are not members of the Committee, the revised framework was issued on 26 June 2004, which is being regularly revised and updated. The Basel-II aims to replace Basel I and to make the capital framework more risk sensitive. Basel II has recommended major revision on...

Words: 2395 - Pages: 10

Free Essay

Capital Adequacy

...strengths, weaknesses and effects of Capital adequacy, moral hazard and banking operations using current financial regulations in the UK. Basel 3 After the recent global financial crisis, the Basel Committee on Banking Supervision (BCBS) decided to revise its previous Basel Accords and reform it; resulting in the implementation of Basel III. Basel I was considered extremely simple in its application and relatively easy to reduce capital with very little risk, through off-balance sheet activities therefore reducing the value of capital the bank required. There was poor management of the risk taken by banks and the guidelines were subject to “regulatory arbitrage, this is where banks keep on their books assets that have the same risk-based capital requirements but are quite risky i.e loans to companies with high credit ratings.” /\ /\ /\ BOOK Basel II although was more risk sensitive through its use of three pillars; which were minimum capital requirements, supervisory review and market discipline, it wasn’t adequate enough to prevent the global financial crisis. The first pillar sets capital requirements against the risks; credit risk, market risk, and operational risk. The second pillar allows supervisors to review the banks performance and activities and thus decide whether they require holding more capital than what was calculated within pillar one. The third pillar motivates banks to manage their risks sensibly through increasing the banks transparency and allowing the...

Words: 678 - Pages: 3

Free Essay

Basel

...vulnerable to a variety of risks. The financial crisis episodes surfaced since 2006 have highlighted this paradox to a number of central banks operating in different countries and RBI and Indian banking sector is no exception to this phenomenon. Basel framework has been drawn by Bank for International Settlements (BIS) in consultation with supervisory authorities of banking sector in fifteen emerging market countries with the basic objective of advocating codes of bank supervision and promoting financial stability amidst economic crises. This research paper is divided in three parts .The opening part attempts to briefly describe the changes in the banking scenario since 1991 reforms and the necessity of introducing Basel III to the Indian Banking sector. Part II presents the Basel standards framework and explains why the transition from Basel II to Basel III norms has become necessary to bring in measures and safety standards which would equip the banks to become more resilient during the financial crises and prevent the banks being subject to liquidations /closures. Part III brings out a discussion on the compliance process by the Indian banks to Basel standards in recent period and finally, the issues and challenges faced by the Indian Banking sector are posed in the conclusion. Keywords: Basel III guidelines, New Capital Adequacy requirement, Regulatory...

Words: 5175 - Pages: 21

Free Essay

Capital Requirementations

...The standardized requirements in place for banks and other depository institutions, which determines how much capital is required to be held for a certain level of assets through regulatory agencies such as the Bank for International Settlements, Federal Deposit Insurance Corporation or Federal Reserve Board. These requirements are put into place to ensure that these institutions are not participating or holding investments that increase the risk of default and that they have enough capital to sustain operating losses while still honoring withdrawals. Also known as "regulatory capital". A vital element of the work of any industry regulator is to ensure that the firms operating in the industry are prudently managed. The aim is to protect the firms themselves, their customers and the economy, by establishing rules and principles that should ensure the continuation of a safe and efficient market, able to withstand any foreseeable problems. The Basel Accords, published by the Basel Committee on Banking Supervision housed at the Bank for International Settlements, sets a framework on how banks and depository institutions must calculate their capital. In 1988, the Committee decided to introduce a capital measurement system commonly referred to as Basel I. This framework has been replaced by a significantly more complex capital adequacy framework commonly known as Basel II. After 2012 it will be replaced by Basel III.[2] Another term commonly used in the context of the frameworks is...

Words: 696 - Pages: 3

Free Essay

Basel I and Ii

...ICRA Indonesia Comment June 2013        Minimum Capital Provisioning for Credit Risk – a Comparative  Study of Basel I and Basel II  Contact: Pradnya Desai Manager– Rating Analyst +62 21 576 1516 desai.pradnya@icraindonesia.com   Drafted in  1988 and 2004 respectively, Basel I and II have, through quantitative   and technical benchmarks, helped develop a level playing field in the banking The “Basel Committee on Banking Supervision” (BCBS) is comprised of the central banks and regulatory authorities of mainly the G20 countries (including Indonesia) and other leading nations. The committee issues broad guidelines and standards to ensure best practices in the banking supervision and risk   management. (Source: www.bis.org)                        supervision, regulation and capital adequacy standards across the signatory nations. As of today, more than 100 countries have implemented Basel I and around 112 countries are implementing Basel II (Source: Wikipedia, Basel committee on banking supervision survey, 2010). Basel II generated more interest on account of the multitude of financial crises that the world economy faced during the 1990s and early 2000s. Further, its implementation gained momentum among the emerging economies after the 2008 crisis. While many countries have already commenced Basel III (drafted in 2010) implementation, Indonesia is yet to finalise the norms on the subject. Basel III while relevant at a future date will not be implemented in...

Words: 3956 - Pages: 16

Free Essay

Banking

...with different risks. 4. In banking, the risk is the possibility that a borrower or counterparty will fail to meet its obligations in accordance with the agreed terms, both in terms of time and quantity. 5. Risk does not come alone – the default of one firm may cripple affiliated firms such as suppliers, customers and banks. RISK MANAGEMENT: 1. Risk Management is a planned method of dealing with the potential loss or damage. It is an ongoing process of risk appraisal through various methods and tools. 2. Risk Management involves not only to protect oneself against some risks but also to decide which risks are to be exploited and how to exploit them. 3. Risk Management covers credit decision making, performance assessment, pricing, capital computation, provisioning etc. 4. Risk Management covers the following: a. It assesses what could go wrong b. It determines which risks are important to be dealt with c. It implements strategies to deal with those risks. 5. Risk Management is not – d. A guarantee to avoid all future losses e. Limited to compliance and disclosure requirements f. A method to eliminate all risks g. A substitute for internal controls to detect fraud etc. BASEL ACCORD: 1. In 1988, Basel I accord was introduced with the central focus on credit risk. 2. In 1996, Basel I was modified to include Market Risks. 3. In 2004,...

Words: 5577 - Pages: 23

Premium Essay

Finance

...BASEL III Overview: BASEL III is a new global regulatory standard on bank capital adequacy and liquidity agreed upon by the members of the Basel Committee on Banking Supervision. The main purpose was developed in a response to the deficiencies in financial regulation revealed by the global financial crisis. Basel III strengthens bank capital requirements and introduces new regulatory requirements on bank liquidity and bank leverage. Basel III will require banks to hold 4.5% of common equity (up from 2% in Basel II) and 6% of Tier I capital (up from 4% in Basel II) of risk-weighted assets (RWA). Basel III also introduces additional capital buffers, (i) a mandatory capital conservation buffer of 2.5% and (ii) a discretionary countercyclical buffer, which allows national regulators to require up to another 2.5% of capital during periods of high credit growth. Moreover, Basel III introduces a minimum 3% leverage ratio and two required liquidity ratios. The Liquidity Coverage Ratio requires a bank to hold sufficient high-quality liquid assets to cover its total net cash flows over 30 days; the Net Stable Funding Ratio requires the available amount of stable funding to exceed the required amount of stable funding over a one-year period of extended stress. Summary of proposed changes First, the quality, consistency, and transparency of the capital base will be raised. Second, the risk coverage of the capital framework will be strengthened. Third, the Committee will introduce...

Words: 322 - Pages: 2

Premium Essay

Securitisation

...role is intermediation between ultimate savers and ultimate investors. Initially, it was banks which were the intermediaries. As the financial sector evolved, other types of financial institutions came on the scene to undertake such intermediation directly, or between and among other intermediaries. A parallel development is the emergence of varieties of financial products, far removed from simple deposits and advances, delivering such intermediation. Securitization, as we all know, is among the latest of such intermediating product. Securitization is basically defined as a financial practice of taking illiquid assets and pooling various types of contractual debts like residential mortgage, commercial mortgages, auto loans, credit card debt obligations and selling them as securities to third party investors which may be described as bonds, pass-through securities, or collateralized debt obligations (CDOs). Securitization helps in diversifying the credit market as the process of lending and borrowing is broken into several discrete leading to economies of scale. Consider the case of a limited company and its financing advantages over a partnership firm. A partnership firm is based on relationships, which is cumbersome to handle, and whose changes in composition could affect the firm’s liquidity. In the case of limited company, share is issued to each ‘partner’ and the company’s capital structure does not change with a change in the composition of its ‘partner’. Shareholders...

Words: 9567 - Pages: 39

Free Essay

Basel Ii

...Members |   | Argentina | Central Bank of Argentina | Australia | Reserve Bank of Australia Australian Prudential Regulation Authority | Belgium | National Bank of Belgium | Brazil | Central Bank of Brazil | Canada | Bank of Canada Office of the Superintendent of Financial Institutions | China | People's Bank of China China Banking Regulatory Commission | European Union | European Central Bank European Central Bank Single Supervisory Mechanism | France | Bank of France Prudential Supervision and Resolution Authority | Germany | Deutsche Bundesbank Federal Financial Supervisory Authority (BaFin) | Hong Kong SAR | Hong Kong Monetary Authority | India | Reserve Bank of India | Indonesia | Bank Indonesia Indonesia Financial Services Authority | Italy | Bank of Italy | Japan | Bank of Japan Financial Services Agency | Korea | Bank of Korea Financial Supervisory Service | Luxembourg | Surveillance Commission for the Financial Sector | Mexico | Bank of Mexico Comisión Nacional Bancaria y de Valores | Netherlands | Netherlands Bank | Russia | Central Bank of the Russian Federation | Saudi Arabia | Saudi Arabian Monetary Agency | Singapore | Monetary Authority of Singapore | South Africa | South African Reserve Bank | Spain | Bank of Spain | Sweden | Sveriges Riksbank Finansinspektionen | Switzerland | Swiss National Bank Swiss Financial Market Supervisory Authority FINMA | Turkey | Central Bank of the Republic of Turkey Banking...

Words: 1869 - Pages: 8

Premium Essay

Credit Risk Management of Sonali Bank Limited

...An internship report on “Credit risk management practices in Sonali Bank Ltd.” Executive Summary   Sonali Bank Ltd. is the largest state owned commercial bank in Bangladesh with a total of 1203 branches. Total of 858 branch in rural and 343 branch in urban area. The functions of the bank covered a wide range of banking and functional activities to individual, firms, corporate bodies, Multinational agencies and the rural area. The bank provides more than 21 types of free services on behalf of the government of Bangladesh through its rural and urban branches as part of their commitment to society. Sonali bank Ltd. follows the rules and regulation prescribed by the Bangladesh bank. To manage credit risk, the Bank applies credit limits to its customers and obtains adequate collaterals. Credit risk in the Sonali Bank Ltd.'s portfolio is monitored, reviewed and analyzed by the Credit Risk Management (CRM). Sonali Bank Ltd. has established Asset-Liability Management Committee (ALCO) to determine the maximum risk exposure. Management is aware about guidelines of Bangladesh Bank and implemented new capital accord BASEL-II.   Sonali Bank Ltd. constantly monitors, reviews and analyzes its credit portfolio to minimizing potential losses and ensuring efficient credit process. To manage the Non-Performing Loans (NPL), Sonali Bank Ltd. has a comprehensive remedial management policy, which includes a framework of controls to identify weak credits and monitoring of these accounts constantly...

Words: 14721 - Pages: 59

Premium Essay

Finance 1

...1. Banks may be willing to borrow funds from other banks at a higher rate than they can borrow from the FED. There are 2 reasons. First, the borrowing bank may find it easier with less requirements to borrow from another bank, as long as they can make a profit via their lending. For instance, When a bank borrows from the FED it often has to put forward collateral. Borrowing in an inter-bank market may be accomplished on an unsecured basis thereby requiring a higher rate but without a need for a pledge of collateral. Secondly, the borrowing bank may need the money immediately for an investment or immediate lending and borrowing at a higher rate from another bank could be much more quickly than borrowing from the Fed 2. Commercial loans(3rd) Securities(2nd) Reserves(1st) Physical capital (4th) 3. The answer is depends o other risks that the bank are exposed to. In this case the president is telling us that the bank has a very low liquidity risk that it has never had to call in loans, sell securities, or borrow as a result of a deposit outflow. However, financial institutions are also exposed to other risks such as profitability risk, interest rate risk, capital adequacy risk, credit risks, and foreign exchange risk. We will need to analyze deeper and look at other risks before we decide to buy or not. 4. No. When you turn a customer down, we are forgoing income from loan , which is extremely costly. Instead, we should go out and borrow from other banks, corporations...

Words: 1307 - Pages: 6

Free Essay

Risk Managemnet

...the article “Credit Risk Rating at Large U.S. Banks” authors William F. Treacy and Mark S. Care say that risk ratings are the primary summary indicator of risk for banks’ individual credit exposures. They both shape and reflect the nature of credit decisions that banks make daily. The specifics of internal rating system architecture and operation differ substantially across banks. The number of grades and the risk associated with each grade vary across institutions, as do decisions about who assigns ratings and about the manner in which rating assignments are reviewed. In general, in designing rating systems, bank management must weigh numerous considerations, including cost, efficiency of information gathering, consistency of ratings produced, staff incentives, the nature of the bank’s business, and the uses to be made of internal ratings. RATINGS MIGRATION SYSTEM An Internal Ratings Migration Study by Michel Araten, Michael Jacobs Jr., Peeyush Varshney, and Claude R. Pellegrino-- This article discusses issues in evaluating banks’ internal ratings of borrowers. Ratings migration analysis entails the actuarial estimation of transition probabilities for obligor credit risk ratings, with emphasis on estimation of empirical default probabilities. Measurement of changes in borrower credit quality over time is important as obligor risk ratings are a key component of a bank’s credit capital methodology. These analyses permit banks to more accurately assess and price credit risk...

Words: 13861 - Pages: 56

Premium Essay

Camel Model

...Stenius Banking supervision has been increasingly concerned due to significant loan losses and bank failures from the 1980s till now. In the light of the banking crisis in recent years worldwide, CAMEL is a useful tool to examine the safety and soundness of banks, and help mitigate the potential risks which may lead to bank failures. The research has been conducted as a case study of American International Assurance Vietnam (AIA). It aims to determine whether the CAMEL framework plays a crucial role in banking supervision. Furthermore, the purpose is to identify the benefits as well as drawbacks which the CAMEL system brings to AIA. The research problem was explored by quantitatively analyzing a bank’s overall performance. The paper firstly starts to collect theory relevant to the empirical research, and then draws conclusions from the findings by relating them back to the literature stated in the early stage. Although this study is based on collected data and numerical figures, it is a qualitative study. The findings revealed that CAMEL rating system is a useful supervisory tool in the U.S. CAMEL analysis approach is beneficial as it is an internationally standardized rating and provides flexibility between on-site and off-site examination; hence, it is the main model in assessing banks’ performance in AIA. On the other hand, it has disadvantages of not following the Vietnamese bank closely, ignoring the interaction with bank’s top management and overlooking the provisions as...

Words: 12113 - Pages: 49

Premium Essay

Term Paper

...11/3/2008 FIN720 | Baitshepi Tebogo| 9302747|MBA | term paper | CAPITAL STRUCTURE AND DIVIDEND POLICY DISCUSSION: How does Standard Chartered Bank Botswana contribute to this discussion? | TABLE OF CONTENTS Abstract 3 Historical Background 4 Literature Review 6 Research Objectives 21 Methodology 22 Challenges 23 Methods 24 Data Analysis 25 Conclusion and Recommendations 27 References 28 Appendices 32 ABSTRACT The paper begins by highlighting the historical background of Standard Chartered Bank, and its evolution over the years, and how it eventually got to set up in business in Botswana. After this, the paper delves into the capital structure and dividend policy theories at length. The theories are at first discussed separately, and then meticulously blended as the report progresses. In addition, after a more general discussion, the topic is narrowed down to reflect on the capital structure subsisting under a banking environment. Empirical evidence from Standard Chartered Bank Botswana is then presented to assist future researchers reflect on how it stands against conventional theory. The result of the empirical study shows positive correlation between capital structure and dividend payment; and an even stronger correlation is evident between earnings per share and dividend payment. The paper, however, ends by recommending further studies using larger...

Words: 7155 - Pages: 29

Premium Essay

Regulations Within the Ghanaian Banking Industry: a Case of Increasing the Minimum Capital Requirement.

...CHAPTER ONE INTRODUCTION 1.1 Background Banking reached colonial Africa through the activities of colonial merchants, and the first bank in West Africa was established in 1894, that is the British Bank for West Africa (BBWA), which extended its operations to Ghana soon after in 1896. In Ghana, the Bank of Ghana is responsible for the banking sector. The Bank of Ghana was established in 1957 to oversee the health of the nation’s financial sector. Presently the Bank of Ghana is empowered by the banking act of 2004, Act 673 (amended in 2007) and the Bank of Ghana Act 2002, Act 612 to regulate banks in Ghana. The mission of the central bank is “to pursue sound monetary and financial policies aimed at price stability and create an enabling environment for sustainable economic growth.” In maintaining a stable banking industry, the Bank of Ghana ensures that banks playing a part in the pursuit of its goals are well leveraged to withstand any unforeseen circumstances. One way the central bank does this is to ensure that banks have capital adequacy to a certain level through the regulation of the minimum capital requirement. The issue of the minimum capital requirement, its increases and implications has always been an issue of hot debates amongst economists, and even politicians. The minimum capital requirement is the minimum level of security below which the amount of financial resources should not fall (European Parliament legislative resolution of 22 April...

Words: 10367 - Pages: 42