Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: Capital Requirements – Credit risk – Operational risk – Market risk Supervisory Review Process – Evaluate Risk Assessment. – Bank’s own capital strategy. – Supervisor’s review. – Ensure soundness and integrity of bank’s internal processes to assess the adequacy of capital. Market Discipline – Enhanced disclosure –Core disclosures and supplementary disclosures. – Ensure maintenance of minimum capital 02/23/13 – Prescribe differential capital where internal controls are slack. Capital Adequacy Framework 7 The Three Pillars All three pillars together are intended to achieve a level of capital commensurate with a bank’s overall risk profile. Tier I capital and Tier II capital. Core and supplementary capital. Limits on components of capital. 02/23/13 Capital Adequacy Framework 8 Banks Typically Face Three Kinds of Banks Major Risks Major Type of Risk Example Risk of loss due to unexpected re­ pricing of assets owned by the bank, caused by either Exchange rate fluctuation Interest rate fluctuations • Market price of investment • fluctuations “Stocks” Daily price change (%) Unexpected price volatility Market Market Time Risk of loss due to unexpected borrower default Default rate (%) “Loans with credit rating 3” Unexpected default Avg. default Credit Time Operational 02/23/13 Risk of loss due to a sudden reduction in operational margins, caused by either internal or external factors Capital Adequacy Framework Monthly change of revenue to cost (%) “Business unit A” Unexpected low cost utilization Time 9 Pillar I – Credit Risk Pillar Pillar 1 – Credit Risk stipulates three levels of increasing sophistication. The more sophisticated approaches allow a bank to use its internal models to calculate its regulatory capital. Banks who move up the ladder are rewarded by a reduced capital charge . In as cr e Standardized Approach eS is oph tic n at i o Foundation Internal Ratings Based Approach Advanced Internal Ratings Based Approach Banks use internal estimations of PD, loss given default (LGD) and exposure at default (EAD) to calculate risk weights for exposure classes Banks use internal estimations of probability of default (PD) to calculate risk weights for exposure classes. Other risk components are standardized. Risk weights are based on assessment by external credit assessment institutions 02/23/13 Reduce Capital requirements Capital Adequacy Framework 10 Pillar I – Operational Risk Pillar re Inc as ph So e at stic i ion Advanced Measurement Approach. Standardized approach Basic Indicator Approach . Reduce Capital requirements 02/23/13 Capital Adequacy Framework 11 Pillar I – Market Risk Pillar re Inc as ph So e ion c at isti Internal Models Method (VaR based approaches) Standardized Duration Method. Reduce Capital requirements 02/23/13 Capital Adequacy Framework 12 Advantages of Capital Advantages 02/23/13 Provides safety and soundness Depositor protection Limits leveraging Cushion against unexpected losses Brings in discipline in risk taking Capital Adeq...
View Full Document

This note was uploaded on 02/23/2013 for the course BANKING 101 taught by Professor Mehta during the Spring '13 term at Albany State University.

Ask a homework question - tutors are online