BFW 2401

Week 05 tutorial questions

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1. What are the three capital adequacy ratio? What are the minimum requirements for each for
2016?
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2. Under BASEL 2 ( BASEL 3) the regulator has identified three key risks credit risk,
market risk and operational risk. Define each risk as it applies in this context and give examples.
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3. Assume there is a bank with following details:
Total capital $230
Capital Charge for credit risk $70
Capital Charge for market risk $25
Capital Charge for operational risk $42
Capital Charge for IR risk in banking book $30
What is the capital adequacy ratio?
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4. Mercantile Bank has the following balance sheet (in millions of dollars) and has no off-balance-sheet
or securitisation activities.
Balance Sheet for the year ended 31/12/ 2016
Assets Liabilities and equity
Cash $20 Deposits $980
Australian Treasury Bonds 40 Subordinated debt 40
Insured standard residential 600 Common Equity 40
mortgages with LVR of 84%
Other loans rated BB+ 430 Retained earnings 30
Total assets $1090 Total liabilities and equity $1090

(a) What is the value of the regulated capital measures (that is, Common Equity Tier 1, Total Tier 1,
Total capital)?
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(b) What is the value of credit risk weighted assets?
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(c) 1.Assuming that operational risk and market risk, interest rate risk and securitization risk are zero,
calculate the three capital adequacy ratios?
2. Are you satisfying Basel III requirement?
3. Would your Answer be different if you are calculating Mercantile Bank capital position for 2015?
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5. What is the general approach to the measurement of operational risk capital charge using the
standardised approach?
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6. (a) Explain how off-balance-sheet market contracts, or derivative instruments, differ from non-
market-related off-balance-sheet or contingent guarantee contracts
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(b) What is counterparty credit risk?
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(c) Why do exchange-traded derivative security contracts have no capital requirements?

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(d) What is the difference between the potential exposure and the current exposure of over-the-counter
derivative contracts?
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(e) Why are the credit conversion factors for the potential exposure of foreign exchange contracts greater
than they are for interest rate contracts?
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(f) Why do regulators not allow banks to benefit from positive current exposure values?

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7. Third Bank has the following balance sheet (in millions of dollars) with the risk weights in parentheses

Assets Liabilities and equity

Cash (0%) $20 Deposits $175
Interbank deposits with AA rated 25 Subordinated debt (5 years) 3
banks (20%)
Standard residential mortgages non- 70 Non- Cumulative preference 5
insured with LVR of 85% (50%) shares
Business Loans to BB rated 70 Common Equity 2
borrowers (100%)
Total assets $185 Total liabilities and equity $185

In addition, the bank has $30 million in performance-related standby letters of credit (SLCs), $40 million
in two-year forward FX contracts that are currently in the money by $1 million, and $300 million in six-
year interest rate swaps that are currently out of the money by $2 million. Credit conversion factors (taken
from Tables 18.6 and 18.7 in the textbook) are:

Performance-related standby LCs 50%

15 year foreign exchange contracts 5%
15 year interest rate swaps 0.5%
510 year interest rate swaps 1.5%

(a) What are the risk-adjusted on-balance-sheet assets of the bank as defined under the Basel Accord?

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(b) What is the total capital required for both off- and on-balance-sheet assets?
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Does the bank have enough capital to meet the regulatory capital requirements? If not, what minimum
Tier 1 or total capital does it need to meet the requirement?

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Discussion question:

7. Identify and discuss the problems in the risk-based capital approach to measuring capital adequacy
(see Appendix 18B).

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