TW3421x - An Introduction to Credit Risk Management ... · Liquidity Risk Liquidity risk is the...
Transcript of TW3421x - An Introduction to Credit Risk Management ... · Liquidity Risk Liquidity risk is the...
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Week 1Lesson 3
TW3421x - An Introduction to Credit Risk Management
IntroductionThe Basel Accords: Basel III
Dr. Pasquale Cirillo
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2007-2008: The Crisis
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The flaws of Basel II
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The flaws of Basel II
Insufficient Capital Reserve
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The flaws of Basel II
Insufficient Capital Reserve
No uniform definition of capital
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The flaws of Basel II
Insufficient Capital Reserve
No uniform definition of capital
Inadequate risk management approach
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The flaws of Basel II
Insufficient Capital Reserve
No uniform definition of capital
Inadequate risk management approach
Underestimation of liquidity risk and excessive leverage
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The flaws of Basel II
Insufficient Capital Reserve
No uniform definition of capital
Inadequate risk management approach
Pro-cyclicality
Underestimation of liquidity risk and excessive leverage
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Basel III
✤ (Basel 2.5 in 2011)
✤ First Basel III proposals in 2009.
✤ First version in 2011.
✤ Many amendments.
✤ The implementation is now ongoing.
✤ Fully operative in 2018/2019.
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The key points
✤ Capital definitions and requirements.
✤ Capital conservation buffer.
✤ Countercyclical buffer.
✤ Leverage ratio.
✤ Liquidity risk.
✤ Counterparty Credit Risk.
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The key points
✤ Capital definitions and requirements.
✤ Capital conservation buffer.
✤ Countercyclical buffer.
✤ Leverage ratio.
✤ Liquidity risk.
✤ Counterparty Credit Risk.
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TIER 1
Core capital:•Share Capital•Retained Earnings
Does not include goodwill or deferred tax assets.
At least 4.5% of RWA at all times!
Capital Definitions & Requirements
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TIER 1
Core capital:•Share Capital•Retained Earnings
Does not include goodwill or deferred tax assets.
At least 4.5% of RWA at all times!
ADDITIONAL TIER 1
Items like non-cumulative preferred stocks.
At least 6% of RWA
Capital Definitions & Requirements
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TIER 1
Core capital:•Share Capital•Retained Earnings
Does not include goodwill or deferred tax assets.
At least 4.5% of RWA at all times!
ADDITIONAL TIER 1
Items like non-cumulative preferred stocks.
TIER 2
Supplementary capital, e.g. debt subordinated to depositors, with an original maturity of 5 years.
TOTAL CAPITAL at least 8% of RWA at all times
Capital Definitions & Requirements
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Capital Definitions & Requirements
TIER 1
Core capital:•Share Capital•Retained Earnings
Does not include goodwill or deferred tax assets.
At least 4.5% of RWA at all times!
ADDITIONAL TIER 1
Items like non-cumulative preferred stocks.
TIER 2
Supplementary capital, e.g. debt subordinated to depositors, with an original maturity of 5 years.
TOTAL CAPITAL at least 8% of RWA at all times
TIER 3
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Capital Buffers
✤ Basel III asks banks to have additional capital buffers, in order to hedge risk.
✤ They must be met with Tier 1 capital.
CONSERVATIONBUFFER
COUNTERCYCLICALBUFFER
2.5% of RWA
0-2.5% of RWA
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✤ Basel III asks banks to have additional capital buffers, in order to hedge risk.
✤ They must be met with Tier 1 capital.
CONSERVATIONBUFFER
COUNTERCYCLICALBUFFER
2.5% of RWA
0-2.5% of RWA
Compulsory To the discretion of national authorities
Capital Buffers
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✤ Basel III asks banks to have additional capital buffers, in order to hedge risk.
✤ They must be met with Tier 1 capital.
CONSERVATIONBUFFER
COUNTERCYCLICALBUFFER
2.5% of RWA
0-2.5% of RWA
Compulsory To the discretion of national authorities
TOTAL CAPITAL at least 10.5% of RWA at all times
Capital Buffers
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Leverage
✤ In addition to the capital requirements based on RWA, banks are supposed to keep a minimum leverage ratio of 3%.
✤ The leverage ratio is the ratio of capital to total exposure.
✤ Regulators may impose stricter regulations.In the US, for some Systemically Important Financial Institution (SIFI) the leverage ratio is at least 6%.
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Liquidity Risk
✤ Liquidity risk is the risk that manifests itself in situations in which a party interested in trading an asset cannot actually do it because nobody in the market wants to trade for that asset.
✤ For banks it generally arises because banks have the tendency to finance long-term needs with short-term funding.
✤ In good times, this is not generally a problem.
✤ In bad times, it can lead a bank to the impossibility of rolling over and financing itself.
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Counterparty Credit Risk
✤ Under Basel III, for each of its derivatives counterparties, a bank has to compute a quantity known as credit value adjustment, or CVA.
✤ CVA can vary because of changes in the market variables influencing the value of the derivatives, or because of variations in the credit spreads applicable to the counterparty.
✤ If you are interested, this can be the topic of Week 7.
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Thank You