minimum capital in Basel II

Discussion in 'SP9' started by teddybear2012, Jun 21, 2012.

  1. teddybear2012

    teddybear2012 Member

    I found this is not clear to me:

    minimum capital - Overall a bank's capital ratio must be greater than 8%, ie. it must hold additional capital worth at least 8% of its risk-weighted assets.

    The total risk-weighted assets include the risk-weighted assets in respect of credit risk plus the capital requirements for market and operational risk multiplied by 12.5%.

    How to determine this total risk-weighted assets actually? Anyone knows? Thanks in advance.
     
    teddybear2012, Jun 21, 2012
    #1
  2. DevonMatthews

    DevonMatthews Member

    Hi,

    The RWA for credit risk can be determined directly, either using an IRB model or the prescribed method.

    There is no such thing as RWA for either credit/market risk.

    There is a such thing as Risk capital held to cover losses arising from operational/market risk.

    Given that a firm must hold atleast 8% of it's risk weighted assets, you can determine the risk weighted assets by adding RWA for credit risk and 12.5 (1/0.08) times the risk capital for credit and operational risk. There is no 'actual' way to determine RWA, it's more implied from the MCR.

    Hope this makes sense.
     
    DevonMatthews, Jul 1, 2012
    #2
  3. David Wilmot

    David Wilmot ActEd Tutor Staff Member

    Basel II risk capital requirements are discussed in Section 2 of Chapter 3 of the ActEd course notes and in Chapter 19 of Sweeting.

    Risk capital is required under pillar 1 in respect of credit, market and operational risks.

    In respect of credit risk (your specific question), each risky asset's value is multiplied by the appropriate specified risk weight for that asset category (examples are given in section 2.1 of ActEd's notes). Capital must be held which is at least 8% of the sum of these risk-weighted assets.

    Further capital must be held in respect of market risk (based on a VaR - see section 2.2 of ActEd's notes) and operational risk (section 2.3). However, these additional capital requirements are not based on the risk-weighted values used for the credit risk capital calculation (above).

    OK?
     
    David Wilmot, Jul 2, 2012
    #3
  4. ActPass

    ActPass Member

    So is it correct to think of the credit risk capital charge = Asset amount * (Risk weighting * 8%). eg a bank has a 100m loan with 50% risk weighting, the capital charge for credit risk = 100 * 50% * 8% = 4m.

    If that's the case, why would they bother to introduce the intermediate step "risk weighting", rather give a prescribed factor directly, say 4% (i.e. 50%*8%) for this class of loan?

    Also, for the market risk, is [ VaR * (1/0.08)] equivalent to Risk Weighted Asset in credit risk? In other words, the VaR itself is the capital charge for market risk. Is it correct?
     
    Last edited by a moderator: Aug 22, 2012
    ActPass, Aug 22, 2012
    #4
  5. ActPass

    ActPass Member

    The capital requirements for Basel I and II seem to be only focused on the asset side.

    Aren't there any capital requirements on the liabilities for a bank (as those in the context of insurance)?

    I am coming from insurance background. Any feedback is much appreciated.
     
    ActPass, Sep 1, 2012
    #5
  6. David Wilmot

    David Wilmot ActEd Tutor Staff Member

    For a (retail) bank the key liabilities of concern are the liabilities to the depositors. The banks capital acts as a protection for the depositors (see attached). The larger and better quality the assets, the better protected the depositors. This is the logic underlying the Basel approach, which requires a higher level of capital if the assets are of poorer (credit) quality.
     

    Attached Files:

    David Wilmot, Sep 3, 2012
    #6
  7. DevonMatthews

    DevonMatthews Member

    Insurance liabilities (as you probably know) can not be known with certainty since there are such things as IBNR and development on case estimates. As such more uncertain liabilities (e.g long tail business lines) require more risk capital.

    Bank liabilities are real in nature. 100 pound deposited with a bank will always be a 100 pound liability (on the banks balance sheet). The key risk is how the bank decides to invest this 100 pounds..
     
    DevonMatthews, Sep 3, 2012
    #7
  8. ActPass

    ActPass Member

    Thanks both for the info and comments. It makes sense to me.
     
    ActPass, Sep 4, 2012
    #8

Share This Page