Week 4 Lecture:

OZ Bank has the following balance sheet (in millions) and has no off-balance sheet activities:

Assets Liabilities and Equity

Deposits $2,900
Residential mortgages 400
Commercial loans, CCC+ rated 2,200 Subordinated debentures 170
Cash 50
U.S. Government Securities 50
Common stock 100
Commercial loans, BB+ rated 500 Retained earnings 30
Total assets $3,200 Total liabilities and equity $3,200

The banks assets fall in four categories with various levels of credit risk. And residual
mortgages are viewed generally as safe as A-rated commercial loans in terms of default risk. The
risk weight assigned to each category is one of the following four numbers: 0, 0.5, 1, 1.5. Each
weight corresponds to one asset category.

1) What is the leverage ratio for OZ Bank? If a bank is perceived as adequately capitalized if its
leverage ratio is 4% or above. Is this bank adequately capitalized according to the leverage ratio?

2) What are the banks risk-adjusted assets?

3) What are the Tier-1 capital ratio and the total risk-based capital ratio for OZ Bank? Under
Basel II accord, the minimum capital ratios for capital adequacy are 4% and 8% for Tier-1
capital ratio and the total risk-based capital ratio, respectively. Is the bank adequately capitalized
under Basel II Accord?

4) If you arrive at different conclusions in question 1) and question 3) about the banks capital
adequacy, which one should be used to judge the banks capital adequacy? Why?
End-of-chapter questions:

Chapter 20

1. Identify and briefly discuss the importance of the five functions of an FIs capital?

3. What is the difference between the economic definition of capital and the book value
definition of capital?
a. How does economic value accounting recognize the adverse effects of credit risk?
b. How does book value accounting recognize the adverse effects of credit risk?

4. Why is the market value of equity a better measure of an FI's ability to absorb losses than
book value of equity?

6. What are the arguments for and against the use of market value accounting for DIs?

10. What are the definitional differences between CET1, Tier I and Tier II capital?

11. Under Basel III, what four capital ratios must DIs calculate and monitor?

12. What are the credit risk-adjusted assets in the denominator of the common equity Tier I
(CET1) risk-based capital ratio, the Tier I risk-based capital ratio, and the total risk-based capital
ratio?

13. How is the leverage ratio for an FI defined?

15. Explain the process of calculating credit risk-adjusted on-balance-sheet assets.

19. What is the capital conservation buffer? How would this buffer affect your answers to
question 18?

20. What is the countercylical capital buffer? If the home country set a countercyclical capital
buffer of 1.5 percent, how would this buffer affect your answers to question 18?

22. Explain the process of calculating risk-adjusted off-balance-sheet contingent guaranty

contracts?

24. What are G-SIBs? How do capital ratio requirements differ for these FIs?

25. Identify and discuss the problems in the risk-based capital approach to measuring capital
adequacy.
 Please
change it to non-cumulative preferred stock

a. What are the risk-adjusted on-balance-sheet assets of the bank as defined under the Basel
Accord? What are the Risk-adjusted Off Balance Sheet assets?
b.To be adequately capitalized, what are the required CET1, Tier I, and total capital?
c. Disregarding the capital conservation buffer, does the bank have enough capital to meet the
Basel requirements? If not, what minimum CET1, additional Tier 1, or total capital does
it need to meet the requirement?
d. Does the bank have enough capital to meet the Basel requirements, including the capital
conservation buffer requirement? If not, what minimum CET1, additional Tier 1, or total
capital does it need to meet the requirement?