Prudential requirements Flashcards
(19 cards)
what is BCBS? what are its powers?
The Basel Committee on Banking Supervision (BCBS) is not an international supervisory
authority, but rather an informal group of central banks and supervisory agencies.
Given the nature of the BCBS, its decisions do not have any legal force. Soft
law rules for the best practice with which states are expected to comply, in order to achieve a greater degree of harmonization. They become hard law rules when legislators transpose them into their legal systems by passing a specific law.
what are the three pillars of supervision set in basel agreements?
▪ Pillar I: (minimum capitalrequirements) sets the binding minimum level of capital banks need to face major risks
▪ Pillar II: (supervisory review) allows supervisors to evaluate institution specific risks and impose additional capital charges
▪ Pillar III: (market discipline) aims to increase transparency in banks’ financial reporting allowing marketplace participants to reward well
managed banks
what is tier one capital? what’s the regulatory threshold? what are the characteristics that make T1 capital a solid base to absorb losses?
is going concern capital as it prevents insolvency by absorbing losses when the institution is alive. it is composed of CET1 (>4.5% of RWA) and AT1 ( total T1>6% of RWA).
-T1 items are not to be repaid up until the moment of liquidation
- there are no obligatory distributions related to them (dividend)
- they are not bound by any obligation of reimbursement and are junior to all other forms of capital
what is the defining characteristics of CET1 items?
- shares, retained earnings, funds and reserves
-they are perpetual and shall not be repaid or reduced outside of cases of liquidation or other discretionary means of repayment (div/repurchase) previously approved by the relevant authority.
what are AT1 items?
convertible items that turn into Cet1 or are written down whenever the bank’s capital falls under minimum thresholds.
what is tier 2 capital?
-reserve re-evaluation, undisclosed reserves, some hybrid instruments and subordinated loans
it’s gone concern capital that protects depositors in case of insolvency.
which methods can bank employ to weight their exposures (assess the amount or RWA)
-standardized approach based on credit rating by recognized institutions
-foundation internal rating based approach
-advanced internal rating based approach
what are buffers? what does their breach imply?
Additional prudential reserves on top of the capital requirements that can be set by the ECB. their breach does not affect operational capacity, however it limits the ability of banks to make distributions to shareholders.
what are the 4 types of buffers?
The “Capital Conservation Buffer” requires an additional amount of CET 1 equal to 2.5% of a bank’s total risk-weighted exposures.
The “Countercyclical Capital Buffer” is a macro-prudential tool designed as an extension of the Capital Conservation Buffer aimed at countering pro-cyclicality. It must be accumulated in periods of economic expansion to be available, as a protection, during downturns. Maximum level: 2.5%
It is periodically calculated by the local regulatory authorities on the basis of the credit-to-GDP ratio in the regions where the bank operates, applied to the bank’s exposures, indicating the additional CET 1 that must be retained.
The “Systemic Risk Buffer” may vary across institutions or sets of institutions as well as across subsets of exposures. It relates to specific risks, rather than to the overall credit-to-GDP ratio.
Member States, through a procedure that might require approval by the European Commission, have a certain discretion in imposing this prudential tool, which might require additional CET 1
“SII Buffer”
consisting of CET 1 Capital of up to 3,5%
What are the 2 liquidity ratios used to set requirments?
The first ratio is called Net Stable Funding Ratio (NSFR), and its purpose is to monitor and reduce the risk that banks are not able to cope efficiently with both expected and unexpected cash outflows by drawing on new and additional sources of funding.
NSFR considers firm-specific liquidity risks, limiting overreliance on short-term funds. Long-term illiquid assets are weighted more, and correspondingly require more stable sources of funding (long-term liabilities), and vice-versa.
The second requirement is Liquidity Coverage Ratio (LCR), designed to strengthen the liquidity profile of the institution over a thirty-day period stress scenario. Institutions shall hold liquid assets, the sum of which covers the liquidity outflows less the liquidity inflows under stressed conditions.
what is leverage ratio requirement?
T1 capital must cover at least 3% of non-RW exposures
what is ICAAP?
The Internal Capital Adequacy Assessment Process (ICAAP) is a process by which the bank autonomously assesses its current and future capital adequacy by considering all relevant risks and its ability to manage them.
what is SREP?
the Supervisory Review and Evaluation Process
(SREP), i.e. a periodic review (carried out by regulators) of the quality and efficiency of internal process by which a bank assesses its own capital adequacy, its risk, the quantity and quality of the capital held.
what does the SREP determine? what are they?
P2R and P2G are determined via SREP
The Pillar 2 Requirement (P2R) is a bank-specific capital requirement which applies in addition to, the minimum capital requirement.The P2R is binding and breaches can have direct legal consequences for banks.
The capital the Competent Authorities ask banks to keep based on the SREP also includes the Pillar 2 Guidance (P2G), which indicates to banks the adequate level of capital to be maintained to provide a sufficient buffer to withstand stressed situations. Unlike the P2R, the P2G is not legally binding.
which system is the evaluation of the financial soundness of banks based on? what are its elements?
CAMEL system
First, an assessment is made of five critical aspects of an institution’s operations
and condition: Capital adequacy, Asset quality, Management, Earnings and Liquidity (thus, the acronym CAMEL), which are rated on a scale of 1 through 5, with
The second element combines the five factor ratings into a composite rating.
what’s the rationale behind the third pillar?
regulators oblige banks to show the material information
on the risks they face and the capital set aside.
Those disclosure requirements should allow market participants to assess banks’ capital adequacy and make it possible to compare the various banks only financing the best ones.
what is the scope of the BRRR and BRRD
Neither the BRRD nor BRRR replaces national rules on banks’ insolvency.
Indeed, the new European rules are aimed at managing
banks’ crises before insolvency or, if the bank is already insolvent, giving resolution tools that are alternatives to the ordinary winding-up and liquidation procedures.
This means that the
liquidation of a distressed bank is still
regulated by national law
on which principles are the new directives on resolution of insolvent banks based?
internalisation of losses that replaces bailout
–> all losses of the bank should be covered by shareholders for a value of at least 8% ot total liabilities
what are the 4 resolution tools?
Bail-in (write down)
Sale of business
Bridge institution (partial sale of the bank to a public entity)
Asset separation (sale of some assets or liabilities to a public asset management vehicle)
