Introduction: The financial sector has been hit badly by the financial crisis in 2008. The

The banking industry has undergone major upheaval in recent years, largely due to the lingering recessionary environment and increased regulatory environment. Many banks have failed in the face of such tough environmental conditions. These conditions

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.

The recent financial crisis has a huge impact on systemic Important Financial Institutions; it’s distressing effect can be felt in almost every business area and process of a bank. A fairly large literature investigates the impact of financial crisis on large, complex and interconnected banks. The great recession did affect banks in different ways, depending on the funding capability of each bank. Kapan and Minoiu (2013) find that banks that were ex ante more dependent on market funding and had lower structural liquidity reduced supply of credit more than other banks during crisis. The ability of banks to generate interest income during the financial crisis was hampered because there was a vast reduction in bank lending to individuals and

This chapter is about the background of 2007-2008 financial crisis. The 2007-2008 financial crisis has a huge impact on US banking system and how the banks operate and how they are regulated after the financial turmoil. This financial crisis started with difficulty of rolling over asset backed commercial papers in the summer of 2007 due to uncertainty on the liquidity of mortgage backed securities and questions about the soundness of banks and non-bank financial institutes when interest rate continued to go up at a faster pace since 2004. In March 2008 the second wave of liquidity loss occurred after US government decided to bailout Bear Stearns and some commercial banks, then other financial institutions took it as a warning of financial difficulty of their peers. In the meantime banks started hoarding cash and reserve instead of lending out to fellow banks and corporations. The third wave of credit crunch which eventually brought down US financial system and spread over the globe was Lehman Brother’s bankruptcy in August 2008. Many major commercial banks in US held structured products and commercial papers of Lehman Brother, as a result, they suffered a great loss as Lehman Brother went into insolvency. This panic of bank insolvency caused loss of liquidity in both commercial paper market and inter-bank market. Still banks were reluctant to turn to US government or Federal Reserve as this kind of action might indicate delicacy of

2.3. A model where capital regulation may increase risk. To see that capital regulation may work in ways that run counter to intuition, we look at a simple model proposed by Hakenes and Schnabel (2010). It is in many respects close to the one which we used in the discussion of competition and risk (Chapter 11). We assume that there are N banks which are financed either by deposits D j or by equity E j , j = 1, . . . , N. The banks compete for depositors and for loans. Borrowers are entrepreneurs, who may choose risky projects, all of equal size 1, characterized

Capital Adequacy, solvency is the ability for financial institutions to in rich their liabilities their liabilities in the medium to long terms as the fall over due. Financial institutions are obliged to maintain sufficient capital ensuring they can be regarded as solvent and remain a going concern as losses on assets are encountered. Regulations of

As banks become more innovative in their statistic techniques and methods, they are encouraged to look at the more risk a sensitive approach that is related (capital reduction) incentives. Third, credit risk means financial institutions are allowed to choose from one of Standardization approach that uses risk weighting standards and external assessment if available, or the Internal Ratings-Based (IRB) approach that uses data from internal risk management systems. A securitization framework should be use for banks to involve in traditional and synthetic securitizations or similar structures. Fourth, market risk details the risk engaged in trading book roles and treatment of counterparty credit risk so as to effectively catch event and standard risk for trade-debt and equity equipment. Fifth, operational risk defined as " the risk of direct or indirect loss comes from the inability or failure of internal processes, people and techniques or from exterior events ”. 14 Banking organizations are offered three methods for determining operational risk capital expenses including the Basic Signal Approach, the Standard Approach, and the Advanced Measurement Approach (AMA).

Basel III establishes a set of standards for the implementation of a liquidity ratio for international banks , a leverage ratio , counter-cyclical measures , a redefinition of equity and a review of the coverage of certain risks . This set of standards will help to strengthen the resilience of the financial and banking sector in anticipation of further financial and economic stress , regardless of the source. All of its new measures that the Basel Committee has developed to strengthen the regulation, supervision and risk management in the banking sector aims to strengthen transparency and communication within banks,

According to Industry insider’s opinion focusing on big lenders had damaged the reserves of banks after numerous instances of loan defaults. More than half the banks in the country are at risk of becoming bankrupt after losing their capital reserves to high risk big loans. Loan defaults have damaged the banking sector,

* Strengthen the soundness and the stability of the international banking system – minimum capital adequacy ratio by assessing the credit risk of the banks

Figure xx bellows shows an overview of Basel I, in terms of the risks that are incorporated and how banks must calculate them. The framework rests solely on capital requirements for determining the two risk groups as a measure of a bank’s

In the aftermath of the financial crisis of 2007 – 2009, the Basel Committee of Banking Supervision launched a program that substantially revised the existing capital adequacy guidelines. As a result, the Committee released a new version of bank capital and liquidity standards, referred to as “Basel III”, in December 2010. Subsequent guidance was issued in January 2011 regarding minimum requirements for regulatory capital instruments. The G20 , including United States and the European Union, publicly endorsed the Basel III standards at their November 2010 Summit in Seoul, and relevant countries around the world have made efforts to study its impacts on their banking industry and to find the best ways to implement them into law in their respective jurisdictions. There have been numerous worldwide debates and discussions since its introduction. However, the core principle of more stringent capital requirement has not been changed and it is now unavoidable for impacted financial institutions to comply with the new standards. The purpose of this paper is to summarize the key elements for the Basel III capital adequacy framework and discuss its practical implications on the financial industry.

Over the last several years, the banking sector has been facing a number of challenges. This is because many of the loans that were made went into default (which had an impact on their balance sheet). As a result, regulators have been forced to seize different lenders to prevent a system wide collapse. This is important is showing, how the kinds of loans that are underwritten by banks will have an impact on their profit margins. To fully understand what is happening requires examining how the market value of a bank's investments / loans will have an effect on capitalization. This will be accomplished by: comparing a bank with a firm that is not involved in the financial services industry, understanding how this could impede retail functions, studying the significance of capital ratios and discussing possible trade offs in relation to current events. Together, these elements will offer specific insights about how the investment and loan activities of the bank will have an impact on their liquidity position. ("Failed Bank List")

According to Garton (2010), during the period of 2005 and 2006 the number of borrowers to own house increased dramatically were their repayment capacity depends on the price appreciation of those houses. If the house prices raise the lender get profit from the refinance. In order to are attract borrows, the initial interest rate was set at lower but the it is always lender to make decision to refinance after the first period. During the period of 1998 and early 2006, the houses price rose and the prepayment speeds increased where half of the these mortgaged was refinance within five years Bhardwaj and Sengupta study (as citied in Garton, 2010). In contrast the price of house started declining after 2006 and gradually the refinance was not possible due to devaluation of the price. For example, as per the data provided by S&P/Case-Shiller (U.S National) home price declined by 4.5% in 3rd Quarter of 2007 as compare to that of 3rd quarter of 2006. The borrowers under this loan had no any alternative source of repayment. Gradually the prepayment and penalty rate increased higher and borrowers were defaulted (Gorton, 2010). For example, the date showed by Mortgage Banker Associations reflected that miss payments on such finances increased 13.3% and due depreciation of home, the home lenders during this period 65%

THE EFFECTIVENESS OF THE BASEL REGULATORY FRAMEWORK ON BANK CAPITAL Bank activity is characterized by asymmetric information. Depositors cannot monitor the quality of banks’ assets and doubts on the solvency of banks might lead to panic and ‘bank runs’ (Llewellyn, 1999). If this should occur, depositors will be induced to withdraw their savings, causing a liquidity crisis for the bank that can potentially lead to the failure of the intermediary. Moreover, doubts regarding the solvency of one bank can create worries about Comparative Economic Studies A Tanda Capital Regulation and Banks’ Behavior 33 the solvency of other banks, leading to a generalized panic. Bank runs are considered as extreme events that are potentially highly disruptive.