Capital Adequacy and Risk Management in Banks

Supervising and regulating banking institutions to ensure the safety and soundness of the nation's banking and financial system to protect the credit rights of consumers.

This necessitated the need for development of regulatory measures for the industry. Bank regulation is a legal structure by which all financial

Accordingly, banking regulators assessed minimum values for each of these key measures. At 2007, “adequately capitalized” (i.e., minimum) levels were 4% for the Tier 1 capital ratio, 8% for the total capital ratio, and 3% for the leverage ratio; “well capitalized” levels were 6% for Tier 1 capital, 10% for total capital, and 5% for leverage. Well capitalized banks qualified for, among other things, lower premiums assessed by the Federal Deposit Insurance Corporation (FDIC). Undercapitalized banks (e.g., below the 8% minimum required total capital) received a warning from the FDIC; continued violation of capital requirements triggered further regulatory costs, including intervention or (in the extreme) takeover by government regulators.

The three types of capital mentioned in chapter 18 are, equity capital, economic capital, and regulatory capital. Equity capital, economic capital, and regulatory capital were established a capital standard for banks. Equity capital is defined as the book value of assets less the book value of liabilities. Furthermore, equity capital is also said to cushion debt and equity holders from unexpected losses. Regulatory capital includes the subordinated debt and some adjustments for off-balance sheet items. This is also different from economic capital, which is a statistical estimate of risk and capital, it also reflects the bank’s estimate of the amount of capital needed to support its risk-taking activities; it is not the amount of

In addition to the above the internal incentive to bank should be reduced by requiring greater capital requirements as well as improving upon the definition of what qualifies to be capital. Further in line with the answer to question 3, risk management systems in financial institutions need to be redefined and strengthened to more comprehensively identify, evaluate, manage and monitor risks.

Basel III is a global comprehensive collection of restructured regulatory standards on bank capital adequacy and liquidity. It was developed by the Basel Committee on Banking Supervision to strengthen the regulation, supervision and risk management of the banking sector (bis.org, 2010). It introduces new regulatory requirements on bank liquidity and bank leverage in response to the financial downturn caused by the Global Financial Crisis. Stefan Walter, Secretary General of the Basel Committee on banking supervision said in November 2010:

The Bank’s Tier 1, Total capital, and Assets-to-Capital multiple ratios were 13.0%,16.0%, and 17.2%, respectively, on October 31, 2011, compared with 12.2%, 15.5%, and 17.5%, respectively, on October 31, 2010.(Refer to Appendix 2) These changes over the period were influenced by increases in Tier 1 capital and Risk Weighted Assets. Risk Weighted Assets

Since the onset of the financial crisis 2008, the sovereign debt crisis in western economies and the new financial regulation with Basel III coming up, the financial industry faces the challenge of reinventing itself. The ring-fence for Commercial and Investment Banking, and new economic and regulatory capital requirements will determine the kinds of products banks will be able to distribute. It will have a huge impact in the Investment Banking business, which will suffer tough regulation and supervisory procedures. At the same time, credit risk models will be reviewed because they have failed to predict the crisis of 2008. The current financial and economic crisis doesn’t have any precedent in the past.

First, high capital requirements could enable institutions to be more flexible facing financial stress and crises. Second, the CFPB strengthens the oversight responsibilities, lessens the regulatory infrastructure risky gaps, and improves the protection for consumers. Third, the Federal Deposit Insurance Corporation’s (FDIC) single-point-of-entry strategy installs standard procedures to wind down failed financial institutions,

To examine how the stress tests are regulated the process has remained largely unchanged since the 1930’s. As still, “in the United States, depending on the charter type, four federal agencies, as well as state agencies, oversee banking and thrift

The regulatory reform process is currently moving from policymaking to the implementation phase. The implications of regulatory reform for banks has never been greater, and the ability to navigate the new environment will require strong processes that integrate regulatory compliance and changes to the business model. Planning has never been more important as reaction to each regulation could be very costly.

• Compliance: Evaluating adequacy of compliance risk management and assessing banks’ effectiveness in identifying and responding to risks posed by new products, services, or terms. Examiners will also assess compliance with the following: – new requirements for integrated mortgage disclosure under the Truth in Lending Act of 1968 and the Real Estate Settlement Procedures Act of 1974. – relevant consumer laws, regulations, and guidance for banks under $10 billion in assets. – Flood Disaster Protection Act of 1973 and the Service members Civil Relief Act of 2003.

The primary measure used by regulators and analysts to measure a bank’s capital strength is the Tier 1 capital ratio. Analyzing this ratio indicates the strength and the bank’s ability to

Regarding expansion of HQLA, according to Gomes and Wilkins (2013), pool of eligible HQLA was expanded to incorporate a broader range of assets, which results in lower centralization on banks’ balance sheets and decreasing probability of reselling assets. The new requirement reveals that a new category of Level 2B assets has been introduced. Level 2 assets may not in aggregate account for more than 40% of a banks stock of HQLA and Level 2B assets may not account for more than 15% of a banks stock of HQLA (“Basel III: Relaxations to the Liquidity Coverage Ratio”, 2013).

Capital: The bank needs to know what assets the organization owns that can be quickly turned into cash.