4_Basel_accord - BASEL ACCORD AND CAPITAL Importance of...

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BASEL ACCORD AND CAPITAL J. Wei, Department of Management, U of T 1 MGTD78 Importance of regulation History of bank regulation Pre-1988 BIS Accord or Basel I (1988) Netting 1996 Amendment Basel II
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IMPORTANCE OF REGULATION J. Wei, Department of Management, U of T 2 MGTD78 Stable economic environment key to economic prosperity. Reliable banking system is a key component of the environment The first regulatory measure is deposit insurance (to avoid “bank runs”) FDIC (Federal Deposit Insurance Corporation) During the Great Depression, a massive scale of bank runs leading to 4,000+ banks closed Inaugurated in 1934, deposit of up to $10,000 insured Currently, $100,000 per customer per institution CDIC (Canada Deposit Insurance Corporation) Inaugurated in 1967, insuring up to $20,000 increased to $60,000 in 1983 increased to $100,000 (current level) in 2005
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IMPORTANCE OF REGULATION J. Wei, Department of Management, U of T 3 MGTD78 The second regulatory measure is requiring minimum amount of bank capital (to avoid frequent bankruptcies) Expected loss can be covered by higher interest charges (e.g., commercial real estate versus residential ones higher mortgage rate for the former) bank capital covers unexpected losses (Fig 11.1) Assets Deposits Capital The bank can endure losses up to this amount without going bankrupt
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HISTORY OF BANK REGULATION J. Wei, Department of Management, U of T 4 MGTD78 Pre-1988 countries required minimum ratio of capital over assets no uniform standard on this ratio 1988 BIS Accord (or Basel Accord or Basel I) Uniform capital requirement: 8% of risk-weighted assets Signed by 12 countries (Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, the Netherlands, Sweden, Switzerland, the United Kingdom, and the United States) 1996: Amendment to BIS Accord Introduced capital requirement for market risk – trading book (VaR) Implemented in 1998 - known as “BIS 98” 1999: Basel II first proposed refinement of Basel I and BIS 98 operational risk three pillars 2007: starting time to implement Basel II
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J. Wei, Department of Management, U of T 5 MGTD78 capital-to-asset ratio varied from country to country enforcement also varied bank leverage increased in 1980s increasing use of off-balance sheet derivatives
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4_Basel_accord - BASEL ACCORD AND CAPITAL Importance of...

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