Tier will include cumulative preferred stock which tier
ECF 520 –FINANCIAL RISK MANAGEMENT
ASSIGNMENT ONE
parentheses.
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| Cash | (0%) K20 | |||
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K3 | |||
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(50%) K70 | Cumulative preferred stock | K5 | |
| Consumer loans | (100%) K70 | |||
| Total Assets | K185 | |||
In addition, the bank has K30 million in performance-related standby letters of credit (SLCs), and K300 million in six-year interest rate swaps. Credit conversion factors follow:
1-5 year foreign exchange contracts 5%
1-5 year interest rate swaps 0.5%
5-10 year interest rate swaps 1.5%
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| | To calculate the Total Capital Required we sum up both on and off-balance- |
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| | We also take into account the Basel Accord requirement that capital must |
To meet the Basel requirement, the Bank needs total capital of K10.36 million as calculated in b above.
According to Basel Accord, Tier 1 capital must be atleast 4% of risk
weighted assets. Therefore K129.5 million ×0.04= K5.18 million. So K5.18million out of the total required K10.36million must be in Tier 1.
[This difference must come from Core capital in Tier 1(Equity)]
Equity for this Bank is K2 million, thus this Bank needs an additional K1.885 million of Equity to satisfy Tier 1 requirements.
| On-Balance-sheet |
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Capital adequacy largely depends on credit risk while other risks such as market risk and operational risk are excluded. Exclusion of market risk from the capital requirements induced Banks to shift their risk exposure from priced credit risk to unpriced market risk.
The Basel 1 does not provide any incentives for credit risk mitigation techniques such as the use of credit derivatives. This had resulted in inadequate assessment of risks.
Under the Basel 1 Accord, there is no model for default correlation.
Finally, the risk weighted ratios do not differentiate adequately between the riskiness of a Banks assets in the Basel 1.
