Professional Documents
Culture Documents
Basel Accords
Under the Auspices of the Bank for International Settlements, the Basle Committee (which consists of the G-10 countries central bank governors), have agreed upon a scheme of regulation which will be applied to international banks. (What is the BIS?) The key element of this scheme is a set of requirements relating a minimum amount of bank capital relative to a risk based measure of assets. Why capital?
Interest
Recovery %
.5 1
.5 0
.2 .05
0 N/A
Bankers payoffs
Under the safe scheme, the bankers will get a payoff of 5. Under the risky scheme the bankers will get an expected payoff of 10. They will prefer the destructive, risky scheme. Why? Bankers get upside pay-off of risky scheme but put downsize risk on depositors.
http://www2.fdic.gov/hsob/SelectRpt.asp?EntryTyp=10
Since 1987, the Basel Accords imposed in HK and CAR > .08. What is regulatory capital? How do you adjust for risk?
Types of Capital
Tier 1 capital is thought to be more stable and more aligned with the concept of capital as the funds that owners have invested in the banks (i.e. equity capital, perpetual preferred stock and retained earnings) Tier 2 capital are funds that protect depositors but may be withdrawn (subordinated debt) or is already somewhat committed to other purposes (reserves).
Measuring Capital
For regulatory purposes, capital is divided into two tiers.
Tier 2 1. Subordinated Debt 2. General Loan Reserves (LLA) 3. Other Reserves (similar to undivided profits) Tier 1 1. Common Stock at Par + Surplus 2. Undivided Profits/Retained Earnings 3. Minority Interests
Different assets are differentiated into buckets which have different risk weights.
Domestic Central Govt. Public Entities, Foreign Governments (OECD), Banking. Secured Residential Lending. Commercial and consumer loans
3. 4.
50% 100%
Timeline
Basel Accords signed in 1987 imposed riskbased capital requirements Basel Market Risk Amendment in 1996.
Impose market risk requirement
Set of risk weights (ranging from 0 to 150%) for different types of assets with different credit ratings claims on
Sovereign Public Entities MDB Banks Securities Firms Corporate Residential Lending Cash Regulatory Retail Other Assets Past Due
Market Risk
Banks with significant trading activity (trading assets+liabilities > 10% of total assets) must have additional capital beyond 8% of credit risk adjusted assets. Banks should calculate VAR of foreign exchange and securities positions and allocate some capital equal to 8% of VAR.
IRB Approach
Only banks that can demonstrate competence can use IRB approach
Operations Risk
Loss of funds through operating circumstances may be a source of risk for banks. Standardized Approach: Allocate capital to equal 15% of 3year lagged moving average of revenues. Subject to regulatory approval, most sophisticated banks may design their own systems for operations risk.
Basel II Accords
In what ways have recent events challenged the Basel Accords?
Reading List
Bank for International Settlements Basel II Overview International Convergence of Capital Standard KPMG Canada, 2006, Basel II: A Worldwide Challenge for the Bankin