A summary of Capital Management in Banks from the full e-Learning course in Optimal MRM’s catalog.
This short presentation introduces the concept of capital management and banks using components of the corresponding module found under optimal mrm’s learning service. the asset portion of the balance sheet represents the bank’s investments and assets financed with a combination of debt and equity there are constraints on
The structure of the balance sheet in large deposit taking commercial banks such banks operate with a natural allocation to what can be referred to as structural assets is sometimes referred to as bank capital more accurately bank capital is a disproportionate sum of debt and equity capital it is incumbent on a
Bank to strategically optimize the allocation of its capital within structural constraints in order to maximize its return on equity and return on capital economic capital is the amount of capital that a bank needs to cover the risk of insolvency from unexpected losses regulatory regulation bank shareholders and rating
Agencies generally demand a higher amount of capital than regulation whereas economic capital and regulatory capital are conceptually similar in a number of ways an important difference is that economic capital is calculated using a banks internal risk analysis and capital definition regulatory capital is
Calculated using models that are prescribed by regulators due to the risks that banks are deemed to pose to local and global economies they are subject to domestic and international regulations restrictions are imposed on the maximum amount of leverage that banks can apply to the balance sheet leverage can be expressed
In a number of ways a common general definition is the ratio of assets to capital in more familiar terminology banks are subjected to capital adequacy requirements the second iteration of basel published in 2004 is composed of three pillars and goes into extensive detail in the measurement of risk weighted assets
And capital ratios prior to 2007 a regulatory capital associated with trading risk exposure was tied primarily to a bank simple var measures regulators came to you var in isolation as an unreliable measure to use as a basis for setting capital requirements they sought to correct this weakness by introducing a new set of
Requirements under precursor to basel 3 known as basel 2.5 the intent of these additional exposure measurement requirements is to increase the level of rwa which in turn increases the amount of minimum capital capital is composed of two tiers of capital common equity and retained earnings are referred to as
Core capital or common equity tier 1 or cet 1 other tier 1 capital is referred to as non core t1 capital or additional tier 1 capital tier 2 capital is referred to as supplementary capital the sum of tier 1 and tier 2 capital is referred to as the bank’s total capital base capital ratios are calculated by subtracting from
The space in whole or in part items such as goodwill other intangible assets and deferred assets and dividing by the sum of risk-weighted assets under basel two banks are required to hold a minimum total capital ratio of 8 percent of their rwa of which tier 1 capital is at minimum 4 percent and core or cet
1 capital is at minimum 2 percent leverage can be expressed in terms of the ratio of assets to capital leverage is defined in basel 3 as the ratio of total capital to assets the inverse of basil’s 3 percent minimum leverage ratio means that the size of a bank’s assets cannot be more than 33 times its capital a key bank
Objective is to maximize its return on equity or broadly speaking return on capital it must do so within constraints imposed by regulators shareholders and other constituents it as much as leverage presents banks with opportunities to generate the banks return on equity increases as the size of the law book grows
Funding growth purely with deposits however rapidly decreases capital ratios and increases balance sheet leverage or in basel three terms reduces the bank’s leverage ratio adverse scenarios include a general loss of manifest as a rapid withdrawal of deposits sell assets in a forced liquidation manner or
To replenish capital with that such as additional bond issuance or with equity such as additional common share issuance in 2008 the deflation of the housing bubble globally drove many borrowers into bankruptcy this put downward pressure on the value of bank’s loan assets and in turn eroded capital as a result many banks
Were at risk of insolvency had they not been supported treasuries optimal mrm invites you to visit its store online to learn more about this and other available market risk elearning modules
Transcribed from video
Capital Management | Basel 2 & 3 By Optimal MRM
