• We are pleased to announce that the winner of our Feedback Prize Draw for the Winter 2024-25 session and winning £150 of gift vouchers is Zhao Liang Tay. Congratulations to Zhao Liang. If you fancy winning £150 worth of gift vouchers (from a major UK store) for the Summer 2025 exam sitting for just a few minutes of your time throughout the session, please see our website at https://www.acted.co.uk/further-info.html?pat=feedback#feedback-prize for more information on how you can make sure your name is included in the draw at the end of the session.
  • Please be advised that the SP1, SP5 and SP7 X1 deadline is the 14th July and not the 17th June as first stated. Please accept out apologies for any confusion caused.

April 2005 Q1 (iii)

A

asbes

Member
Hi

The Q asks to:

(a) calculate total capital required under current Basel regulations
(b) calculate capital allocation to each division.

The Examiners Report calculate

(a) 8% of the risk-weighted assets as the total capital requirement (24m)

This is only the requirement for credit risk?? What about interest rate risk?

(b) the EAR for each division as (the std dev of profit):
Mortage = 5.5m
Advisory = 2m
Then they divide by 10% (the Target return on capital) to get the capital requirement. Should you not use the risk-free rate for the EAR method?
Then they say the total required capital is 55+20 = 75 and that the bank actually has a deficit (as the bank has only 50m capital).
I would just use the 5.5 and 2 to ratio the total calculated in (a) between the two divisions (a top down approach).

Please let me know where I make a mistake.
 
Perhaps only Basel 1 is being used. The notes do not explain any standardised method (or IRB method for that matter) for interest rate risk for Basel 2.

I used R_F = 8% (suck thumb)

I also ratioed the available capital and allocated to the 2 divisions.

Basically I did what you did. :0) Will the examiner see things the same way.... I don't know.

Wait till you get to question 2.....

If you have any comments on my april 2007 post please advice.

Thanks!
 
Another thing...

As I understand it EAR is the std dev of net profits. The notes also say (under "the method in practice") that 1.96 times EAR often used - so this is what I did. I suppose 5/6 % for R_F would have been a better suck thumb. The answers one gets are way off from the examiner though!

I take it that VaR method not used because the figures aren't really useful.
 
Basel

Credit risk is the main risk under Basel 1. You are right though - there is a 1993 market risk addition that covers interest rate risk. But we dont have the info to do this, nor are there enough marks.

I am sure that you would have received marks for using the risk free rate when calculating the EAR. That makes it more consistent with the notes. However there are many rates used by different banks, and the clue was that the WACC hadnt been used in any other part of th question.

The EAR can be used for both total capital and for dividing the capital between divisions.

Colin
 
You must log in or register to reply here.
Back
Top