Capital Management | Basel 2 & 3

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

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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

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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