Basel III: Post-Crisis Reforms
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Impact of Basel I, Basel II, and Basel III on Letters of Credit and Trade Finance
Impact of Basel I, Basel II, and Basel III on Letters of Credit and Trade Finance Requirement Basel I Basel II Basel III 2013 2015 2019 Common Equity 2.0% of 3.5% of RWA 4.5% of RWA 4.5% of RWA RWA Tier 1 Capital 4.0% of 4.0% of 4.5% of RWA 6.0% of RWA 6.0% of RWA RWA RWA Total Capital 8.0% of 8.0% of 8.0% of RWA 8.0% of RWA 8.0% of RWA RWA RWA Capital Conversion -0- -0- +2.5% of RWA Buffer Leverage Ratio Observation Observation (4% of direct assets) (based on Total Capital) 3% of total direct and contingent assets Counter Cyclical Buffer +Up to 2.5% of RWA Liquidity Coverage Observation 30 days 30 days Net Stable Funding Observation Observation 1 year Additional Loss +1% to 2.5% of RWA Absorbency Color Code Key (US Applicability): (Applies only in the US) In the US, applies only to “Large, Internationally-Active Banks” Not yet implemented in the US Depending on the bank and the point in the economic cycle, under Basel III, the total capital requirement for a bank in 2019 may be as much as 15.5% of Risk-Weighted Assets (“RWA”), compared with 8% under Basel I and Basel II. The amount of Risk-Weighted Assets (“RWA”) is computed by multiplying the amount of each asset and contingent asset by a risk weighting and a Credit Conversion Factor (“CCF”) Under Basel I, risk weightings are set: 0% for sovereign obligors, 20% for banks where tenors ≤ one year, 50% for municipalities and residential mortgages, 100% for all corporate obligors Under Basel II, risk weightings are based on internal or external (rating agency) risk ratings with no special distinction for banks; capital requirements for exposures to banks are increased by as much as 650% (from 20% to as much as 150%) The Credit Conversion Factor for Letters of Credit varies under Basel I vs. -
Reducing Procyclicality Arising from the Bank Capital Framework
Joint FSF-BCBS Working Group on Bank Capital Issues Reducing procyclicality arising from the bank capital framework March 2009 Financial Stability Forum Joint FSF-BCBS Working Group on Bank Capital Issues Reducing procyclicality arising from the bank capital framework This note sets out recommendations to address the potential procyclicality of the regulatory capital framework for internationally active banks. Some of these recommendations are focused on mitigating the cyclicality of the minimum capital requirement, while maintaining an appropriate degree of risk sensitivity. Other measures are intended to introduce countercyclical elements into the framework. The recommendations on procyclicality form a critical part of a comprehensive strategy to address the lessons of the crisis as they relate to the regulation, supervision and risk management of internationally active banks. This strategy covers the following four areas: Enhancing the risk coverage of the Basel II framework; Strengthening over time the level, quality, consistency and transparency of the regulatory capital base; Mitigating the procyclicality of regulatory capital requirements and promoting the build up of capital buffers above the minimum in good economic conditions that can be drawn upon in stress; and Supplementing the capital framework with a simple, non-risk based measure to contain the build up of leverage in the banking system. The objective of these measures is to ensure that the Basel II capital framework promotes prudent capital buffers over the credit cycle and to mitigate the risk that the regulatory capital framework amplifies shocks between the financial and real sectors. As regulatory capital requirements are just one driver of bank lending behaviour, the proposals set out should be considered in the wider context of other measures to address procyclicality and reduce systemic risk. -
Basel II, Sovereign Ratings and Transfer Risk External Versus Internal Ratings
Basel II, Sovereign Ratings and Transfer Risk External versus Internal Ratings by Stijn Claessens and Geert Embrechts* 07 May 2002 Abstract Basel II puts great emphasis on external ratings, including from rating agencies, to quantify credit risks, but it also allows financial institutions to use their internal risk ratings. This is also the case for international lending, but following recent emerging markets’ crises, the quality of sovereign ratings has received much criticism. At the same time, little is known about the quality of internal ratings of country risk. Using data from a major international bank, we assess the relative performance of internal and external country ratings. We find that internal and external ratings are driven by similar factors and both underestimate “event risks”, but that external ratings are somewhat slower in adjusting to a financial crisis. ------------------------------------------------------------------------------------------------------------ University of Amsterdam and Rabobank International, the Netherlands respectively. For presentation at the conference Basel II: An Economic Assessment, Bank for International Settlements, Basel, 17-18 May 2002, organized by the Centre for Economic Policy Research, Journal of Financial Intermediation, and the Basel Committee on Banking Supervision. The opinions do not necessarily express those of the Rabobank. The authors would like to thank Peter Boswijk and Martijn Krijger for help with the statistical analysis and Michiel van Voorst, Leendert Colijn, Adriaan Kukler, Frank Ligtenberg and Leonhardt van Efferink for comments on an earlier version. 1 Introduction In January 2001 the Basel Committee on Banking Supervision issued a consultative document on a new Basel Capital Accord (the ‘Basel II’ proposal). Under the standardized approach, Basel II puts greater emphasis on the role of external ratings, including from rating agencies, to assess credit risks. -
Personal Loans 101: Understanding Your Credit Risk Loans Have Some Risk for Both the Borrower and the Lender
PERSONAL LOANS 101: Understanding YoUr credit risk Loans have some risk for both the borrower and the lender. The borrower takes on the responsibilities and terms of paying back the loan. The lender’s risk is the chance of non-payment. Consumers can choose from several types of loans. As a borrower, you need to understand the type of loan you are considering and its possible risk. This brochure provides information to help you make a smart choice before applying for a loan. 2 It is important to review your financial situation to see if you can handle another monthly payment before applying for a loan. Creating a budget will help you apply for the loan that best meets your present and future needs. For an interactive budget, visit www.afsaef.org/budgetplanner or www.afsaef.org/personalloans101. You will need to show the lender that you can repay what you borrow, with interest. After you have made a budget, consider these factors, which maY redUce or add risk to a Loan. 3 abiLitY to repaY the Loan Is the lender evaluating your ability to repay the loan based on facts such as your credit history, current and expected income, current expenses, debt-to- income ratio (your expenses compared to your income) and employment status? This assessment, often called underwriting, helps determine if you can make the monthly payment and raises your chances of getting a loan to fit your needs that you can afford to repay. It depends on you providing complete and correct information to the lender. Testing “your ability to repay” and appropriate “underwriting” reduces your risk when taking out any type of loan. -
Contagion in the Interbank Market with Stochastic Loss Given Default∗
Contagion in the Interbank Market with Stochastic Loss Given Default∗ Christoph Memmel,a Angelika Sachs,b and Ingrid Steina aDeutsche Bundesbank bLMU Munich This paper investigates contagion in the German inter- bank market under the assumption of a stochastic loss given default (LGD). We combine a unique data set about the LGD of interbank loans with detailed data about interbank expo- sures. We find that the frequency distribution of the LGD is markedly U-shaped. Our simulations show that contagion in the German interbank market may happen. For the point in time under consideration, the assumption of a stochastic LGD leads on average to a more fragile banking system than under the assumption of a constant LGD. JEL Codes: D53, E47, G21. 1. Introduction The collapse of Lehman Brothers turned the 2007/2008 turmoil into a deep global financial crisis. But even before the Lehman default, interbank markets ceased to function properly. In particular, the ∗The views expressed in this paper are those of the authors and do not nec- essarily reflect the opinions of the Deutsche Bundesbank. We thank Gabriel Frahm, Gerhard Illing, Ulrich Kr¨uger, Peter Raupach, Sebastian Watzka, two anonymous referees, and the participants at the Annual Meeting of the Euro- pean Economic Association 2011, the Annual Meeting of the German Finance Association 2011, the 1st Conference of the MaRs Network of the ESCB, the FSC workshop on stress testing and network analysis, as well as the research seminars of the Deutsche Bundesbank and the University of Munich for valu- able comments. Author contact: Memmel and Stein: Deutsche Bundesbank, Wilhelm-Epstein-Strasse 14, D-60431 Frankfurt, Germany; Tel: +49 (0) 69 9566 8531 (Memmel), +49 (0) 69 9566 8348 (Stein). -
Chapter 5 Credit Risk
Chapter 5 Credit risk 5.1 Basic definitions Credit risk is a risk of a loss resulting from the fact that a borrower or counterparty fails to fulfill its obligations under the agreed terms (because he or she either cannot or does not want to pay). Besides this definition, the credit risk also includes the following risks: Sovereign risk is the risk of a government or central bank being unwilling or • unable to meet its contractual obligations. Concentration risk is the risk resulting from the concentration of transactions with • regard to a person, a group of economically associated persons, a government, a geographic region or an economic sector. It is the risk associated with any single exposure or group of exposures with the potential to produce large enough losses to threaten a bank's core operations, mainly due to a low level of diversification of the portfolio. Settlement risk is the risk resulting from a situation when a transaction settlement • does not take place according to the agreed conditions. For example, when trading bonds, it is common that the securities are delivered two days after the trade has been agreed and the payment has been made. The risk that this delivery does not occur is called settlement risk. Counterparty risk is the credit risk resulting from the position in a trading in- • strument. As an example, this includes the case when the counterparty does not honour its obligation resulting from an in-the-money option at the time of its ma- turity. It also important to note that the credit risk is related to almost all types of financial instruments. -
Financial Risk&Regulation
Financial Risk&Regulation Sustainability in finances – opportunities and regulatory challenges Newsletter – March 2021 In addition to the COVID-19 pandemic, last year has been characterized by a green turnaround that involved the financial sector as well. Sustainability factors are increasingly integrated into the regulatory expectations on credit institutions and investment service providing firms, as well as new opportunities provided by capital requirement reductions. In addition to a number of green capital requirement reductions, the Hungarian National Bank (MNB) recently issued a management circular on the adequacy of the Sustainable Financial Disclosure Regulation (SFDR) applicable from March 10. In our newsletter, we cover these two topics. I. Green Capital Requirement Discount construction the real estate should have an energy for Housing rating of “BB” or better. In course of modernization the project should include at least one modernization In line with the EU directive and in addition to the measure specified by the MNB (e.g. installation of “green finance” program of several other central solar panels or solar collectors, thermal insulation, banks, MNB also announced its Green Program facade door and window replacement). In the in 2019, which aimed to launch products for the case of a discounted loan disbursed this way, the Hungarian financial sector that support sustainability, central bank imposes lower capital requirement on and to mobilize the commercial banks and disbursing institutions, if the interest rate or the APR investment funds. All this is not only of ecological (THM) on the “green” loan is at least 0.3 percentage significance: under the program, banks can move points more favourable (compared to other similar towards the “green” goals by reducing their credit products). -
Revised Standards for Minimum Capital Requirements for Market Risk by the Basel Committee on Banking Supervision (“The Committee”)
A revised version of this standard was published in January 2019. https://www.bis.org/bcbs/publ/d457.pdf Basel Committee on Banking Supervision STANDARDS Minimum capital requirements for market risk January 2016 A revised version of this standard was published in January 2019. https://www.bis.org/bcbs/publ/d457.pdf This publication is available on the BIS website (www.bis.org). © Bank for International Settlements 2015. All rights reserved. Brief excerpts may be reproduced or translated provided the source is stated. ISBN 978-92-9197-399-6 (print) ISBN 978-92-9197-416-0 (online) A revised version of this standard was published in January 2019. https://www.bis.org/bcbs/publ/d457.pdf Minimum capital requirements for Market Risk Contents Preamble ............................................................................................................................................................................................... 5 Minimum capital requirements for market risk ..................................................................................................................... 5 A. The boundary between the trading book and banking book and the scope of application of the minimum capital requirements for market risk ........................................................................................................... 5 1. Scope of application and methods of measuring market risk ...................................................................... 5 2. Definition of the trading book .................................................................................................................................. -
Basel IV Quantitative Impact Study on Cyprus Banks September 2020 1 Basel IV | Quantitative Impact Study on Cyprus Banks
Basel IV | Quantitative Impact Study on Cyprus Banks Basel IV Quantitative Impact Study on Cyprus Banks September 2020 1 Basel IV | Quantitative Impact Study on Cyprus Banks The aim of this paper is to provide an (especially SME) and retail customers, Summary overview of the changes in Credit Risk as well as project financing (as part of quantification under Basel IV, focusing on specialised lending). Banking-book credit risk requirements both Our most recent publication from a Standardised and Internal Ratings Analysing and understanding how the examines the impact of Basel IV Based (IRB) approach. reforms will affect the various portfolios of on Cyprus Banks. a bank and how these drive the decrease Our paper also provides guidance on the in required capital, is of paramount In particular, this article steps required to begin understanding importance to Cyprus Banks to ensure focuses on the updated Credit the impact of the reforms on required required capital is allocated appropriately Risk assessment framework. data, changes in processes, modelling and to each of the components of a bank. governance. Banks are therefore challenged to start Our analysis indicates that collecting new data as required by the Cyprus Banks are expected to For our analysis, we have performed reforms. a Quantitative Impact Study (QIS) to have a reduction in capital understand the impact across the different Separate to the Standardised approach requirements as a consequence portfolios of a typical Cyprus Bank, (SA) reforms, our paper considers the Basel of the revised risk-weights shedding a light on which components of IV changes under the IRB approach. -
Basel III: a Global Regulatory Framework for More Resilient Banks and Banking Systems
This standard has been integrated into the consolidated Basel Framework: https://www.bis.org/basel_framework/ Basel Committee on Banking Supervision Basel III: A global regulatory framework for more resilient banks and banking systems December 2010 (rev June 2011) Copies of publications are available from: Bank for International Settlements Communications CH-4002 Basel, Switzerland E-mail: [email protected] Fax: +41 61 280 9100 and +41 61 280 8100 © Bank for International Settlements 2010. All rights reserved. Brief excerpts may be reproduced or translated provided the source is stated. ISBN print: 92-9131-859-0 ISBN web: 92-9197-859-0 Contents Contents ...................................................................................................................................3 Introduction...............................................................................................................................1 A. Strengthening the global capital framework ....................................................................2 1. Raising the quality, consistency and transparency of the capital base ..................2 2. Enhancing risk coverage........................................................................................3 3. Supplementing the risk-based capital requirement with a leverage ratio...............4 4. Reducing procyclicality and promoting countercyclical buffers ..............................5 Cyclicality of the minimum requirement .................................................................5 Forward -
Credit Risk Models
Lecture notes on risk management, public policy, and the financial system Credit risk models Allan M. Malz Columbia University Credit risk models Outline Overview of credit risk analytics Single-obligor credit risk models © 2020 Allan M. Malz Last updated: February 8, 2021 2/32 Credit risk models Overview of credit risk analytics Overview of credit risk analytics Credit risk metrics and models Intensity models and default time analytics Single-obligor credit risk models 3/32 Credit risk models Overview of credit risk analytics Credit risk metrics and models Key metrics of credit risk Probability of default πt defined over a time horizon t, e.g. one year Exposure at default: amount the lender can lose in default For a loan or bond, par value plus accrued interest For OTC derivatives, also driven by market value Net present value (NPV) 0 ( counterparty risk) S → But exposure at default 0 ≥ Recovery: creditor generally loses fraction of exposure R < 100 percent Loss given default (LGD) equals exposure minus recovery (a fraction 1 − R) Expected loss (EL) equals default probability × LGD or fraction πt × (1 − R) Credit risk management focuses on unexpected loss Credit Value-at-Risk related to a quantile of the credit return distribution Differs from market risk in excluding EL Credit VaR at confidence level of α defined as: 1 − α-quantile of credit loss distribution − EL 4/32 Credit risk models Overview of credit risk analytics Credit risk metrics and models Estimating default probabilities Risk-neutral default probabilities based on market -
The Market Risk Premium: Expectational Estimates Using Analysts' Forecasts
The Market Risk Premium: Expectational Estimates Using Analysts' Forecasts Robert S. Harris and Felicia C. Marston Us ing expectatwnal data from f711a11cial a 11 a~r.11s. we e~ t ima t e a market risk premium for US stocks. Using the S&P 500 a.1 a pro1·1•.fin· the market portfolio. the Lll'erage market risk premium i.lfound to be 7. 14% abo1·e yields on /o11g-ter111 US go1·ern 111 e11t honds m·er the period I 982-l 99X. This ri~k premium 1•aries over time; much oft his 1·aria1io11 can he explained by either I he /e1 1el ofi11teres1 mies or readily availahle fonrard-looking proxies for ri.~k . Th e marke1 ri.1k p remium appears to 111 onz inversely with gol'ern111 e11 t interes1 ra/es .rngges1i11g Iha/ required rerurns 011 .~locks are more stable than interest rates themse!Pes. {JEL: GJI. G l 2] Sfhc notion of a market ri sk premium (th e spread choice has some appealing chara cteri sti cs but is between in vestor required returns on safe and average subject to many arb itrary assumptions such as the ri sk assets) has long played a central rol e in finance. 11 releva nt period for tak in g an average. Compound ing is a key factor in asset allocation decisions to determine the difficulty or usi ng historical returns is the we ll the portfolio mi x of debt and equity instruments. noted fa ct that stand ard model s or consum er choice Moreover, the market ri sk premium plays a critica l ro le would predi ct much lower spreads between equity and in th e Capital Asset Pricing Model (CAPM ), the most debt returns than have occurred in US markets- the widely used means of estimating equity hurdle rates by so ca lled equity risk premium puzzle (sec Welch, 2000 practitioners.