BUT, we have a default risk of counterparty.

Hedge can be constructed on balance sheet or off balance sheet.

On - balance-sheet hedge requires duration matching and currency matching.

Off-balance-sheet hedge involves forwards, futures, options or swaps.

No balance sheet rebalancing;

No immediate cash flow only future contingent cash flow;

Lower costs and administration.

BUT, we have a default risk of counterparty.

5) h = change in a spot rate / change in the forward(future) rate.

6) Exchange of principal and interest payments in one currency for principal and interest payments in another currency.

The principal should be specified for each of two currencies;

The principal is usually exchanged at the beginning and at the end of the life of the swap (note, in an interest rate swap the principal is not exchanged)

7)

8) Absorb unanticipated losses and preserve confidence of the FI;

Protect uninsured depositors and other stakeholders;

Protect FI owners against increases in insurance premiums and liquidity premiums;

Acquire real investments in order to provide financial services.

OBJECTIVES:

Development of more internationally uniform prudential standards for the capital required for banks

Promote convergence of national capital standards , removing the competitive inequalities among banks;

Develop a more meaningful link between banks on- and off- balance sheet risk exposures and the capital supporting them;

Enhance market discipline through better information about banks' risk profiles, risk measurement techniques and capital;

Develop a framework that was adaptive to rapid financial innovation.

9) The difference between Book Value and Market Value is that BV show only historical cosy basis for asset and liability values rather than MV allow balance sheet value to reflect current rather than historical prices.

10) MV and Credit and Interest Rate Risk – credit and interest risk shocks that result in losses in the market value of assets are borne directly by the equity holders in the sense that such losses are changes against the value of their ownership claims in the FI.

BV and Credit and Interest Rate Risk - book value accounting recognizes the value of assets and liabilities at the time they were placed on the books or incurred by the firm, losses are not recognized until the assets are sold or regulatory requirements force the firm to make balance sheet accounting adjustments. In the case of credit risk, these adjustments usually occur after all attempts to collect or restructure the loans have occurred. In the case of interest rate risk, the change in interest rates will not affect the recognized accounting value of the assets or the liabilities.

11) The leverage ratio is ratio of book value of core capital to total assets, where core capital is book value of equity plus qualifying cumulative perpetual preferred stock plus minority interests in equity accounts of consolidated subsidiaries.

Problems with leverage ratio:

Market value may not be adequately reflected

Fails to reflect differences in credit and interest rate risks

Off-balance-sheet activities escape capital requirements

Allows regulatory arbitrage

n Banks are able to increase their asset risk without changes in the ratio

12) Pillar 1: Minimum capital requirements for credit risk (on- and off-balance sheet) , market risk( Standardized vs. Rating Based Approach) and operational risk (Basic indicator vs. Standardized vs. Advanced Measurement Approach).

Pillar 2: Supervisory review of capital adequacy.

Pillar 3: Market discipline.

13) Tier 1 (Core Capital) = Issued and fully paid common stocks + non-cumulative perpetual preferred stocks + retained earnings + minority interest in equity accounts of consolidated subordinates + disclosed reserves – (goodwill + increase in equity resulting from a securitization exposure)

Tier 2 (Supplementary capital) = cumulative perpetual preferred sticks + undisclosed reserves + asset revaluation reserves + general loan loss reserves + hybrid (Debt/Equety) capital instruments + subordinated long-term debt – (50% from Tier 1 and Tier 2 capital: investments in unconsolidated subsidiaries engaged in banking and financial activities

Tier 3 (to cover market risk only) = subordinated short-term debt

14) LIMITS AND RESTRICTIONS:

Tier 2 capital cannot exceed Tier 1 capital (maximum split is 50/50);

Tier 3 capital cannot exceed 250% of Tier 1 capital;

Subordinated long-term debt is limited to 50% Tier 1 capital;

Amount of loan loss reserves (Tier 2) is limited to 1.25% of risk adjusted assets;

Asset revaluation reserves are subject to a discount of 55% to the difference between the historic book value and market value.

15)

16) Basic Indicator Approach - Operational capital = alpha (.15) * gross income

Standardized Approach – beta * Gross income from the Corporate Finance line of business for the bank

Beta – specified broad indicator, that reflects the scale or volume of DI

activities in the area

17) R.W. ASSETS = R.A.B/S ASSETS + R.A. Off B/S ASSETS

n

R.W. B/S ASSETS = ∑ Risk Weight i x Asset amount i

i=1

R.W.Off B/S ASSETS:

1) Amount j x Convergent factor j = Credit Equivalent Amount j (CEAj)

m

2) R.A.Off B/S ASSETS = ∑ CEAj x Risk Weight for B/S Assets

j=1

N m

R.W. ASSETS = ∑ RWi x Ai + ∑ CEAJ x RWJ

i=1 j=1

19)Calculated according to the Basel III definitions, the Core Tier One ratio would have been 5.7% instead of 11.1% according to the old definitions

18) Banks are allowed to use their internal estimates of borrower creditworthiness to assess credit risk in their portfolios.

Distinct analytical frameworks will be provided for different types of loan exposures.

The IRB approach relies on four quantitative inputs:

n Probability of default (PD) = likelihood that a borrower will default over the given time horizon;

n Loss Given Default (LGD) = the proportion of the exposure that will be lost if a default occurs;

n Exposure at Default (EAD) = the amount of the loan that will be lost if a default occurs;

n Maturity (M) = remaining economic maturity of the exposure.

Granularity scaling factor – higher capital will be required for more concentrated books than average.

For Retail loans there is only a single advanced IRB approach (no foundation alternative) and banks will set all inputs.

20)

Date: 2015-12-24; view: 855