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Q. 6 What is the role of ECAIs on Basel Accord . Answer: The standardised approach relies on credit ratings of borrowers assigned by “external credit assessment institutions” (ECAIs) to compute banks’ regulatory capital for credit risk. While the recognition and validation of a particular ECAI’s assessments are the responsibility of national supervisors, the choice of the identity and number of ECAIs that banks work with is left to their discretion.
Q7. What is RWA ? How it is computed ? Answer: A bank’s assets typically include cash, securities and loans made to individuals, businesses, other banks, and governments. Each type of asset has different risk characteristics. A risk weight is assigned to each type of asset, as an indication of how risky it is for the bank to hold the asset. To work out how much capital banks should maintain to guard against unexpected losses, the value of the asset (ie the exposure) is multiplied by the relevant risk weight. Banks need less capital to cover exposures to safer assets and more capital to cover riskier exposures Example of computation of RWA
Sl
|
Exposure
|
Rating grade
|
Risk weight
|
Exposure
|
RWA
|
1
|
2
|
3
|
4
|
5
|
6 (4*5)
|
|
Credit Risk
|
|
0%
|
10
|
0
|
1
|
Cash
|
|
0%
|
10
|
0
|
2
|
Claims on banks
|
A (2)
|
50%
|
10
|
5
|
3
|
Claims on corporate I
|
A (2)
|
50%
|
40
|
20
|
|
Claims on corporate II
|
BBB (3)
|
100%
|
25
|
25
|
4
|
SME
|
BBB (3)
|
100%
|
10
|
10
|
A
|
Total Credit Risk
|
|
|
100
|
60
|
B
|
RWA Market Risk (Invest in share )
|
|
|
5
|
5
|
C
|
RWA for operational risk (Gross profit)
|
|
|
|
5
|
D
|
Total RWA (A+B+C)
|
|
|
|
70
|
E
|
Regulatory capital
|
|
|
|
7
|
E
|
CRAR (E/D)
|
|
|
|
10.00%
|
Q8. What is capital conservation buffer? What is the Individual bank minimum capital conservation standards?
Answer: A capital conservation buffer comprising common equity of 2.5% of risk-weighted assets brings the total common equity standard to 7%. Constraints on a bank’s discretionary distributions will be imposed when it falls into the buffer range.
Q9. What is Countercyclical buffer? What are the purposes of Countercyclical buffer?
Answer: The Basel III countercyclical capital buffer is calculated as the weighted average of the buffers in effect in the jurisdictions to which banks have a credit exposure. It is implemented as an extension of the capital conservation buffer. It consists entirely of Common Equity Tier 1 capital and, if the minimum buffer requirements are breached, capital distribution constraints will be imposed on the bank. Consistent with the capital conservation buffer, the constraints imposed relate only to capital distributions, not the operation of the bank. The countercyclical buffer aims to ensure that banking sector capital requirements take account of the macro-financial environment in which banks operate. It will be deployed by national jurisdictions when excess aggregate credit growth is judged to be associated with a build-up of system-wide risk to ensure the banking system has a buffer of capital to protect it against future potential losses. This focus on excess aggregate credit growth means that jurisdictions are likely to only need to deploy the buffer on an infrequent basis. The buffer for internationally-active banks will be a weighted average of the buffers deployed across all the jurisdictions to which it has credit exposures. This means that they will likely find themselves subject to a small buffer on a more frequent basis, since credit cycles are not always highly correlated across jurisdictions. (See details: https://www.bis.org/bcbs/ccyb/) Q10. Does the countercyclical capital buffer apply to total RWA (credit, market, and operational risk), or only to credit risk exposures?
Answer:
The bank-specific buffer add-on rate (ie the weighted average of countercyclical capital buffer rates in jurisdictions to which the bank has private sector credit exposures) applies to bank-wide total RWA (including credit, market, and operational risk) as used in for the calculation of all risk-based capital ratios, consistent with it being an extension of the capital conservation buffer.
Q. 11. Explain the LCR and NFSR ?
Answer:
The Liquidity Coverage Ratio (LCR) is an essential component of the Basel III reforms, which are global regulatory standards on bank capital adequacy and liquidity endorsed by the G20 Leaders. The LCR promotes the short-term resilience of a bank's liquidity risk profile. It does this by ensuring that a bank has an adequate stock of unencumbered high-quality liquid assets (HQLA) that can be converted into cash easily and immediately in private markets to meet its liquidity needs for a 30 calendar day liquidity stress scenario. It will improve the banking sector's ability to absorb shocks arising from financial and economic stress, whatever the source, thus reducing the risk of spillover from the financial sector to the real economy. In a word, The Liquidity Coverage Ratio (LCR) requires banks to have sufficient high-quality liquid assets to withstand a 30-day stressed funding scenario that is specified by supervisors.
The Net Stable Funding Ratio (NSFR) is a significant component of the Basel III reforms. It requires banks to maintain a stable funding profile in relation to their on- and off-balance sheet activities, thus reducing the likelihood that disruptions to a bank's regular sources of funding will erode its liquidity position in a way that could increase the risk of its failure and potentially lead to broader systemic stress. In a word, the longer-term, structural Net Stable Funding Ratio (NSFR) is designed to address liquidity mismatches. It covers the entire balance sheet and provides incentives for banks to use stable sources of funding.
Q. 12. Explain the Regulatory capital and its components as per Basel Accord III guidelines.
Answer:
Regulatory capital consists of three categories, each governed by a single set of criteria that instruments are required to meet before inclusion in the relevant category. Banks fund their investments with capital and debt, such as customer deposits. Capital can absorb losses in a way that reduces the likelihood of a bank failing and the impact if it does. Regulatory capital consists of
❖ Common Equity Tier 1 – common shares, retained earnings and other reserves.
❖ Additional Tier 1 – capital instruments with no fixed maturity.
❖ Tier 2 – subordinated debt and general loan-loss reserves
(See details https://www.bis.org/basel_framework/chapter/CAP/10.htm?inforce=20191215&published=20200605 )
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