Regulatory Capital and Basel Flashcards
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Read the first 6 Regulatory Capital and Basel flashcards as text
Under Basel III, what is the minimum Common Equity Tier 1 (CET1) capital ratio requirement?
Answer: 4.5%
Basel III raised the minimum CET1 ratio to 4.5% of risk-weighted assets, with an additional 2.5% capital conservation buffer, making the effective minimum 7% CET1 for most banks.
What is the 'capital conservation buffer' under Basel III and what happens when a bank breaches it?
Answer: A 2.5% CET1 buffer above the 4.5% minimum; breaching it restricts dividend payments and discretionary bonuses
The 2.5% conservation buffer acts as a cushion; when a bank dips into it, escalating restrictions on capital distributions (dividends, buybacks, bonuses) are triggered to help rebuild the buffer.
What is the 'countercyclical capital buffer' (CCyB) under Basel III?
Answer: A variable buffer (0–2.5%) that national regulators increase during credit booms and release during downturns to dampen pro-cyclicality
The CCyB is a macroprudential tool: regulators build it up when credit growth is excessive (preventing overheating) and release it during stress to support lending.
What is the 'leverage ratio' under Basel III and what problem does it address?
Answer: Tier 1 capital / total exposure ≥ 3%; acts as a backstop against excessive leverage regardless of risk-weighting
The 3% Tier 1 leverage ratio is a non-risk-sensitive backstop that prevents banks from gaming risk-weighted capital ratios by holding low-risk-weighted but highly leveraged exposures.
What does 'risk-weighted assets' (RWA) mean in the context of bank capital?
Answer: Bank assets adjusted by risk weights assigned to different exposure types, so riskier assets require more capital support
Under Basel, each asset class gets a risk weight (e.g., sovereign bonds = 0%, mortgages = 35–50%, unsecured retail = 75%, unrated corporates = 100%), and capital must be 8% of total RWA.
What is a 'G-SIB surcharge' and which institutions are subject to it?
Answer: An additional CET1 capital buffer of 1–3.5% imposed on Global Systemically Important Banks based on their systemic importance score
G-SIBs are identified annually based on size, interconnectedness, cross-jurisdictional activity, substitutability, and complexity, and must hold additional CET1 capital to reduce the probability of failure of firms that are 'too big to fail.'
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