Bank Notes Essay

Linear Probability Models (LPMs) * Econometric sham to explain quittance experience on past/old loans. * Regression model with a dummy dependent variable Z Z = 1 default and Z=0 no default. * Weakness no guarantee that the estimated default probabilities will always lie between 0 and 1 (theoretical flaw) Logit and Probit Models * Developed to overcome impuissance of LPM. * Explicitly restrict the estimated range of default probabilities to lie between 0 and 1. * Logit assumes probability of default to be logistically distributed. Probit assumes probability of default has a cumulative design distribution function. Linear Discriminant Analysis * Derived from statistical technique called multivariate analysis. * Divides borrowers into steep or low default try classes. * Altmans LDM = most famous model developed in the late 1960s. Z < 1. 8 (critical value), there is a high chance of default. * Weaknesses * Only considers two extreme shimmys (default/no default). * Weights need no t be stationary over time. 3. New Credit Risk Evaluation Models Newer models have been developed use fiscal theory and financial market information to make inferences about default probabilities. * Most relevant for evaluating loans to larger corpo tread borrowers. * Area of very active continuing research by FIs. Credit Ratings * Ratings miscellanea relatively infrequently objective of ratings stability. * Only chance when there is reason to believe that a long-term change in the companys beliefworthiness has interpreted place. * S&P AAA, AA, A, BBB, BB, B and CCC * Moodys Aaa, Aa, A, Baa, Ba, B and Caa Bonds with ratings of BBB and above are considered to be investment grade Estimating default on Probabilities 1. historical Data * Provided by rating agencies e. g. cumulative average default casts * If a company starts with a * Good credit rating, default probabilities tend to amplification with time. * Poor credit rating, default probabilities tend to decrease with tim e. * Default Intensity vs Unconditional Default Probability * Default intensity or hazard rate is the probability of default conditional on no earlier default. * Unconditional default probability is the probability of default as seen at time zero. Default intensities and unconditional default probabilities for a Caa rated company in the third yearSupplement point 14 by monitoring a combination of natural reports, prudential reports and market information. 16. Should intervene to require effective and timely remedial action to address liquidity deficiencies. 17. Should communicate with other regulators e. g. central banks cooperation TOPIC 7 CORE PRINCIPLES OF EFFECTIVE BANKING SUPERVISION Overview * Most important global standard for prudential regulation and supervision. * Endorsed by vast majority of countries. * Provides benchmark against which supervisory regimes open fire be assessed. * 1995 Mexican and Barings Crises Lyon Summit in 1996 for G7 Leaders. 1997 Document drafted and endorsed at G7 meeting. Final version presented at annual meetings of World Bank and IMF in Hong Kong. * 1998 G-22 endorsed * 2006 Revision of the upshot Principles * 2011 Basel Committee mandates a major review, issues revised consultative paper. The message Principles (2006) * 25 minimum requirements that need to be met for an effective regulatory system. * May need to be supplemented by other measures. * Seven major groups * Framework for supervisory authority Principle 1 * Licensing and structure Principles 2-5 * Prudential regulations and requirements Principles 6-18 *Methods of ongoing banking supervision Principles 19-21 * Accounting and revelation Principle 22 * Corrective and remedial powers of supervisors Principle 23 * Consolidated and cross-border banking Principles 24-25. * Explicitly recognise * Effective banking supervision is essential for a strong economical environment. * Supervision seeks to ensure banks operate in a safe and sound manner and hold sufficient great and reserves. * Strong and effective supervision is a public unafraid and critical to financial stability. * While cost of supervision is high, the cost of poor supervision is even high. Key objective of banking supervision * exercise stability and confidence in the financial system * Encourage good corporate governance and enhance market transparency Revised Core Principles (2011) * Core Principles and assessment methodology merged into a single document. * Number of core principles increased to 29. * Takes account of several key trends and developments * Need to deal with generalally important banks * Macroprudential counseling (system-wide) and systemic put on the line * Effective crisis management, recovery and resolution measures. Sound corporate governance * Greater public disclosure and transparency enhance market discipline. * 2 broad groups 1. supervisory powers, responsibilities and functions. Focus on effective risk-based supervision, and the nee d for early intervention and timely supervisory actions. Principles 1-13. 2. Prudential regulations and requirements. Cover supervisory expectations of banks, emphasising the importance of good corporate governance and risk management, as well as compliance with supervisory standards. Supervisory powers, responsibilities and functions 1.Clear responsibilities and objectives for each authority involved. Suitable legal framework. 2. Supervisor has operational independence, transparent processes, sound governance and adequate resources, and is accountable. 3. Cooperation and collaboration with domestic authorities and foreign supervisors. 4. Permissible activities of banks is controlled. 5. Assessment of bank ownership structure and governance. 6. major power to review, reject and impose prudential conditions on any changes in ownership or controlling interests. 7. Power to approve or reject major acquisitions. 8. modern assessment of the risk profile of banks and banking groups. 9. U ses appropriate range of techniques and tools to implement supervisory approach. 10. Collects, reviews and analyses prudential reports and statistical returns. 11. Early address of unsafe and unsound practices. 12. Supervises banking group on consolidated basis (including globally) 13. Cross-border sharing of information and cooperation. Prudential regulations and requirements 14. Robust corporate governance policies and processes. 15. Banks have a comprehensive risk management process, including recovery plans. 6. dress out prudent and appropriate not bad(p) adequacy requirements. 17. Banks have an adequate credit risk management process. 18. Banks have adequate policies and processes for the early identification and management of problems assets, and celebrate adequate provisions and reserves. 19. Banks have adequate policies re concentration risk. 20. Banks required to enter into any transactions with related parties on an arms aloofness basis. 21. Banks have adequate policie s re country and transfer risk. 22. Banks have an adequate market risk management process. 23.Banks have adequate systems re interest rate risk in the banking book. 24. Set prudent and appropriate liquidity requirements. 25. Banks have an adequate operational risk management framework. 26. Banks have adequate midland controls to name and maintain a properly controlled operating environment for the conduct of their business. E. g. delegating authority and responsibility, separation of the functions that involve committing the bank. 27. Banks maintain adequate and reliable records, prepare financial statements in accordance with accounting policies etc. 8. Banks regularly publish information on a consolidated and solo basis. 29. Banks have adequate policies and processes e. g. strict guest due diligence. Preconditions for Effective Banking Supervision 1. Provision of sound and sustainable macroeconomic policies. 2. A well established framework for financial stability policy formula tion. 3. A well developed public infrastructure 4. A clear framework for crisis management, recovery and resolution 5. An appropriate level of systemic protection (or public gumshoe net) 6. Effective market discipline 001 IMF and World Bank Study on Countries Compliance with Core Principles * 32 countries are compliant with 10 or a few(prenominal) BCPs * Only 5 countries were assessed as fully compliant with 25 or more of the BCPs. * Developing countries less compliant than advanced economies. * Advanced economies generally cause more robust internal frameworks as defined by the preconditions 2008 IMF Study on BCP Compliance * Based on 136 compliance assessments. * Continued work take on strengthening banking supervision in many jurisdictions, particularly in the area of risk management. More than 40% of countries did not comply with the essential criteria of principles relations with risk management, consolidated supervision and the abuse of financial services. * More than 30% did not possess the necessary operational independence to perform effective supervision nor have adequate ability to use their formal powers to take corrective action. * On average, countries in Western Europe demonstrated a much higher degree of compliance (above 90%) with BCP than their counterparts in other regions. * Africa and Western Hemisphere weak. Generally, high-income countries reflected a higher degree of compliance. TOPIC 8 CAPITAL ADEQUACY Overview * decent capital better able to withstand losses, provide credit through the business cycle and help promote public confidence in banking system. immenseness of big(p) Adequacy * Absorb unanticipated losses and preserve confidence in the FI * treasure uninsured depositors and other stakeholders * Protect FI insurance funds and taxpayers * Protect deposit insurance owners against increases in insurance premiums * To acquire real investments in order to provide financial services e. . equity financing is very important. C apital Adequacy * Capital too low banks may be unable to absorb high level of losses. * Capital too high banks may not be able to make the most efficient use of their resources. Constraint on credit availability. Pre-1988 * Banks regulated using balance sheet measures e. g. ratio of capital to assets. * Variations between countries re definitions, required ratios and enforcement of regulations. * 1980s bank supplement increased, OBS deriveds trading increased. * LDC debt = major problem 1988 Basel Capital Accord (Basel I) * G10 agreed to Basel I Only cover credit risk * Capital / risk-adjusted assets > 8% * Tier 1 capital = shareholders equity and retained earnings * Tier 2 capital = additional internal and external resources e. g. loan loss reserves * Tier 1 capital / risk-adjusted assets > 4% * On-balance-sheet assets assigned to one of four categories * 0% cash and government bonds * 20% claims on OECD banks * 50% residential mortgages * 100% corporate loans, corporate bonds * Off-balance-sheet assets divided into contingent or guarantee contracts and FX/IR forward, futures, option and swap contracts. Two ill-use process (i) derive credit equivalent amounts as product of FV and conversion factor then (ii) multiply amount by risk weight. * OBS market contracts or derivative instruments = potential exposure + current exposure. * Potential exposure credit risk if counterparty defaults in the future. * Current exposure cost of replacing a derivative securities contract at todays prices. 1996 Amendment * Implemented in 1998 * Requires banks to measure and hold capital for market risk. * k is a multiplicative factor elect by regulators (at least 3) VaR is the 99% 10-day value at risk SRC is the specific risk charge Total Capital = 0. 08 x Credit risk RWA + mart risk RWA where market risk RWA = 12. 5 x k x VaR + SRC Basel II (2004) * Implemented in 2007 * Three pillars 1. New minimum capital requirements for credit and operational risk 2. Supervisory re view more thorough and uniform 3. Market discipline more disclosure * Only applied to large global banks in US * Implemented by securities companies as well as banks in EU Pillar 1 Minimum Capital Requirements * Credit risk measurement * Standardised approach (external credit rating based risk weights) * Internal rating based (IRB) Market risk = unchanged * Operational risk * Basic indicator 15% of gross income * Standardised multiplicative factor for income arising from each business line. * Advanced measurement approaches assess 99. 9% worst case loss over one year. * Total capital = 0. 08 x Credit risk RWA + market risk RWA + Operational risk RWA Pillar 2 Supervisory inspection * Importance of effective supervisory review of banks internal assessments of their overall risks. Pillar 3 Market discipline * Increasing transparency public disclosure Basel 2. 5 (Implemented 2011) * Stressed VaR for market risk * Incremental risk charge Ensures products such as bonds and derivatives in the trading book have the same capital requirement that they would if they were in the banking book. * Comprehensive risk measure (re credit default correlations) Basel III (2010) * Considerably increase quality and quantity of banks capital * Macroprudential overlay systemic risk * Allows time for smooth transition to new regime * Core capital only retained earnings and common shares * Reserves increased from 2% to 4. 5% * Capital conservation buffer 2. 5% of RWA * Countercyclical capital buffer * Tracing/monitoring of liquidity funding Introduction of a maximum leverage ratio Capital Definitions and Requirements * Common equity > 4. 5% of RWA * Tier 1 > 6% of RWA * Phased implementation of capital levels reach to Jan 1, 2015 * Phased implementation of capital definition stretching to Jan 1, 2018 Microprudential Features * Greater focus on common equity * Loss-absorbing during stress/crisis period capital conservation buffer * Promoting integrated management of market and counterparty credit risk. * fluidity standard introduced introduced Jan 1, 2015 Introduced Jan 1, 2018 Available Stable Funding FactorsRequired Stable Funding Factors Macroprudential Factors * Countercyclical buffer * Acts as a brake in good times of high credit growth and a decompressor to restrict credit during downturns. * Within a range of 0-2. 5% * Left to the discretion of national regulators * Dividends restricted when capital is on a lower floor required level * Phased in between Jan 1, 2016 Jan 1, 2019 * Leverage Ratio * Target 3% * Ratio of Tier 1 capital to total exposure > 3% * Introduced on Jan 1, 2018 after a transition period * SIFIs * Required to hold additional loss absorbency capital, ranging from 1-2. 5% in common equity