Capital Adequacy Management

6 Key excerpts on "Capital Adequacy Management"

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  eBook - PDF

  Handbook of Asset and Liability Management

  From Models to Optimal Return Strategies

  • Alexandre Adam(Author)
  • 2008(Publication Date)
  • Wiley

    (Publisher)

  • The economic equity is the effective consumption of capital. This represents the amount of risk taken by the company in the past. The computation is made using a quantitative risk measure. • The economic capital is the strategic required capital in an allocation approach. The allocation is the basis for capital management. The perspective is business development and strategic planning. Economic capital allocation brings for the shareholder an optimization of the value cre-ation with a better risk comprehension: development decisions are healthier, risk is less concentrated. 26.1.2 Economic capital goals 26.1.2.1 Risk protection (capital adequacy) and rating target Economic capital implementation minimizes risk exposure and secures the regulator, the rating agencies and the shareholders. This capital is an objective capital and a transversal measure of all the risk types for all the business lines. The capital is computed for each business unit and for each risk type: the ALM financial risks (including credit risk, interest rate risk, etc.), market risk, operational risks, business risks, etc. All the risk measurements are aggregated in a unique number for the whole company. This capital is used as a shock absorber for risk taking positions . The capital allows the banks to take risks (but is costlier than debts). In banking activity, economic capital is recognized in the ICAAP (Internal Capital Ade-quacy Assessment Process) . The ICAAP is a process for assuring that the executive man-agement identifies adequately measures, aggregates and monitors the risks. The supervisory authority will review and evaluate this ICAAP and at the same time the internal governance processes. The ICAAP as a part of the Basel II Pillar 2 will form an integral part of the management process and of the decision-making culture of the institution. It assures the regulators and the shareholders that the company holds an adequate internal capital in relation to the company’s risk profile.

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  Value at Risk and Bank Capital Management

  Risk Adjusted Performances, Capital Management and Capital Allocation Decision Making

  • Francesco Saita(Author)
  • 2010(Publication Date)
  • Academic Press

    (Publisher)

  C H A P T E R ♦ 2 What Is “Capital” Management? Questions such as “How much capital is required to cover potential losses deriving from the risks we are undertaking?,” “What is the risk-adjusted return on capital produced by each business unit and by each product?,” and “How should capital be allocated within business units?” are crucial for any bank. Yet before discussing them, the word capital must be defined. In fact, there are different notions of capital and different capital con-straints that the bank should satisfy at the same time. One well-known distinction is between regulatory capital and economic capital. Required regulatory capital is calculated according to regulators’ rules and methodolo-gies, defining for each bank a minimum regulatory capital requirement (MRCR). Regula-tors also clearly identify which components of the bank’s balance sheet can be considered to be eligible as capital (i.e., available regulatory capital). In contrast, economic capital represents an internal estimate of the capital needed to run the business that is developed by the bank itself. This estimate may differ from MRCR since, for instance, the bank may include risks that are not formally subject to regulatory capital or may use different parameters or methodologies. Here we define required economic capital as the amount of capital the bank considers necessary for running the business from its point of view, independent of regulatory constraints. Of course, the bank should also be able to compare it with available economic capital. According to the broad definition we have adopted, required economic capital is therefore an internal estimate of the capital the bank needs. In practice, however, the bank has to decide which notion of capital it considers relevant. Capital in fact could be identified either with book capital , or with the market value of equity (i.e., the market value of assets minus the market value or the fair value of liabilities) or with the market 7

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  Fundamentals of Finance

  Investments, Corporate Finance, and Financial Institutions

  • Mustafa Akan, Arman Teksin Tevfik(Authors)
  • 2020(Publication Date)
  • De Gruyter

    (Publisher)

  Bank performance can be measured by two tools: internal performance and ex-ternal performance (financial ratios). Internal performance evaluations based on economic profit are as follows: risk-adjusted return on capital (RAROC) and eco-nomic value added (EVA). External performance evaluation is conducted with ratios such as profitability ratios, asset utilization ratios, efficiency and expense control ratios, tax manage-ment ratios, liquidity ratios, and risk ratios. When the bank receives deposits, reserves increase by an equal amount; when the bank loses deposits, reserves decrease by an equal amount. The management areas in banking are as follows: liquidity management, asset management, liability management, and Capital Adequacy Management. Liquidity management focuses on maintaining enough liquid assets to meet ob-ligations to depositors (for cash withdrawals). 15.7 Summary 337 Asset management deals with managing assets (loan portfolios) to achieve di-versification and minimize default risk/credit risk and interest rate risk. Liability management aims at acquiring and attracting funds (deposits) at the lowest possible cost. Capital Adequacy Management tries to maintain the appropriate net worth to meet regulations and prevent bank failure. Off-balance-sheet activities of banks, while making money for the bank, involve risk which should be managed. 338 15 Management of Financial Institutions: The Basics

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  Market Consistency

  Model Calibration in Imperfect Markets

  • Malcolm Kemp(Author)
  • 2009(Publication Date)
  • Wiley

    (Publisher)

  8

  Capital Adequacy

  8.1 INTRODUCTION

  An accepted feature of modern developed capitalist economies is the regulation of businesses and organisations operating within the financial sphere. Sometimes this involves self-regulation by the industry concerned but it is much more common for it to be carried out by governments or by government established bodies, e.g. the relevant central bank or some other financial regulatory authority. The work of individual practitioners within these fields, if they belong to professional bodies such as the accountancy or actuarial professions, may also be subject to professional standards or codes of conduct. There may be ‘reserved’ activities that can only be carried out by appropriately qualified professionals (or firms of them). Examples include auditing and approval of life insurance company insurance reserves which in nearly all developed economies are required to be carried out by accountants and actuaries respectively.152

  Why is regulation in this sense so pervasive within the financial services industry?

  It is said that ‘bad money drives out good’.153 Governments of virtually all hues subscribe to the thesis that public confidence in the sound functioning of the financial system is an essential prerequisite for economic stability and prosperity. The perceived need to maintain financial stability is so strong that many regulatory bodies specifically have such a mandate written into their charters or governing framework.154

  In this chapter we explore key characteristics of financial regulatory regimes, with particular focus on their capital adequacy elements. As in Chapter 2 we introduce the topic by considering some of the key characteristics of money itself and how these characteristics can be expected to influence the structures of regulatory regimes relating to monetary matters. We also summarise or comment on a number of existing or soon to be introduced international capital adequacy frameworks, including Basel II (for banks) and Solvency II (for insurers).

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  Managing Banking Risks

  • Eddie Cade(Author)
  • 1997(Publication Date)
  • Woodhead Publishing

    (Publisher)

  Adequate capital is the final safeguard of bank solvency, being the third line of defence behind profits and provisions. As we saw in Chapter 2, solvency risk is a secondary category, hinging on capital adequacy to accommodate unexpected losses emanating from the primary risks incurred in the business of banking. Perhaps because the primary problem is always something else (e.g. credit risk, price risk, operating fraud), there is a fallacious tendency to deny the relevance of capital levels in banking failure. How often have we heard the assertion: 'No bank ever went bust because of its capital ratios'? On closer analysis, however, it would be truer to say that capital inadequacy in relation to the risks being run is behind virtually every bank failure: a proposition oddly dismissed by some writers as hardly worth consideration. Let us compare two cases. During the 1980s and 1990s many leading banks around the world declared annual losses stemming from primary (mainly credit) risk mismanagement, but most of those survived without the need for external support because their capital cushion was adequate (and their solvency risk management thus intact). By contrast, in 1995 Barings collapsed as an independent entity after derivatives trading losses that exceeded its capital and reserves (and would have wiped out part of its deposits as well). The moral is clear: other risk categories may occasion the unexpected losses, but the level of solvency protection then determines whether the bank continues in business or goes under. Solvency is hardly an irrelevant risk category. Walter Bagehot, the nineteenth century banker, journalist and political commentator, is said to have coined the question-begging aphorism that 'a well managed bank needs no capital, whilst no amount of capital can save an ill managed bank.' There is a grain of truth in this, at the extremes, but an all-or-nothing conclusion is far too absolutist to be practical. How 'well managed' and how 'ill 25

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  Capital and Labour in Japan

  The Functions of Two Factor Markets

  • Toshiaki Tachibanaki, Atsuhiro Taki(Authors)
  • 2012(Publication Date)
  • Taylor & Francis

    (Publisher)

  The answer is only partly 'yes'. The capital adequacy constraint encouraged banks to over-react, and banks committed themselves to excessive credit crunch, and thus overshadowed our theoretical anticipation in this chapter. In other words, banks reacted or were enforced to react strongly to the BIS rule, and thus greatly reduced the amount of their lending to non-financial firms. In other words, one of the normal circumstances which were assumed in this chapter was not satisfied. Of course, other important causes helped to produce the long-term recession of the 1990s. The capital adequacy constraint was only one of them.

  In sum, the theoretical framework and simulation approach developed in this chapter is useful to investigate the relationship between capital adequacy constraint and the real economy under intercorporate shareholding like the Japanese capital market. One of the assumptions, however, imposed in this exercise, namely the behaviour of banks departed from our prediction. In other words, the banks' excessive credit crunch in the 1990s together with other important changes modified the course of the real economy in Japan.

  Appendix: a comparison between the capital adequacy constraint considered in this study and the actual one adopted by the BIS rule

  The committee on bank regulation at the BIS submitted a report in 1988 on the measurement of capital adequacy and its rule. This Appendix does not present and discuss it in detail, but provides a discussion on the plausibility of the approach in this study. In other words, we explain here the following property that the definition of the capital adequacy in this study is, in fact, equivalent to the definition by the BIS under a certain condition.

  The capital adequacy constraint requires that the ratio of capital over total assets, i.e. the risk-asset ratio must be kept above a specified level. There are two definitions of capital. The first one is capital at book value, which may be called definition in a strict sense. Definition in a broad sense includes part of accrued capital gains of equity in capital. Thus, the sum of capital at book value and a proportion of accrued capital gains is used. Since accrued capital gains are quite important in Japan, it is worthwhile to examine the role of them.

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