Capital Adequacy Management
Capital adequacy management refers to the process by which financial institutions ensure they have enough capital to cover potential losses and risks. It involves maintaining a balance between risk and capital, as well as complying with regulatory requirements. Effective capital adequacy management is crucial for the stability and resilience of financial institutions, as it helps protect against insolvency and financial crises.
8 Key excerpts on "Capital Adequacy Management"
eBook - ePubAdvances in Management Research
Innovation and Technology
- Avinash K. Shrivastava, Sudhir Rana, Amiya Kumar Mohapatra, Mangey Ram, Avinash K. Shrivastava, Sudhir Rana, Amiya Kumar Mohapatra, Mangey Ram(Authors)
- 2019(Publication Date)
- CRC Press(Publisher)
...The Basel Committee on Banking Supervision endorsed that banks should maintain capital at a level so as to diminish the chance of bank failures. This is termed as capital adequacy requisite, and it requires banks to maintain a minimum capital-to-assets ratio to remain in operation. This requirement of more capital would eventually make the banks safer, though it will increase their cost of capital. The objectives of the constraint can result in either preventing the banks from taking more risk to enhance their profits or promoting financial stability that provides a safeguard against systemic crises. The Basel Accord was mainly devised as an instrument to control and monitor banks’ risk-taking behavior. The reducing chance of investments through increasing capital adequacy and will be insolvent. The lower the profitability of banks in terms of higher the risk-weighted capital adequacy ratios. In order to reduce insolvency and promote stability, recently bank supervisors advised banks to hold minimum regulatory capital levels (Aggarwal & Jacques, 2001). This supervisory stress conveys disciplinary guidance to bank managers. Capital adequacy is also considered as an indispensable instrument to safeguard banks’ creditworthiness and profitability. This is because of the existence of probable information asymmetry between banks and parties that may end in default of loans. Banks are required to have sufficient capital, not only to stay solvent, but also to withstand catastrophes in the financial system and to ensure operational efficiency (Aggarwal & Jacques, 2001). Allen and Rai (1996) stated that to bring operational efficiency banks must provide quality banking services to the customers at the lowest possible cost. More specifically, banks operate efficiently by supplying loans to those customers who have been well screened and have a good record of repayment (Athanasoglou, Brissimis, & Delis, 2008)...
eBook - ePubRaising Capital or Improving Risk Management and Efficiency?
Key Issues in the Evolution of Regulation and Supervision in European Banks
- Fabiano Colombini, Fabiano Colombini(Authors)
- 2018(Publication Date)
- Palgrave Macmillan(Publisher)
...© The Author(s) 2018 Fabiano Colombini (ed.) Raising Capital or Improving Risk Management and Efficiency? https://doi.org/10.1007/978-3-319-71749-4_5 Begin Abstract 5. Capital Constraints by Regulation in Europe Paola Ferretti 1 (1) Department of Economics and Management, University of Pisa, Pisa, Italy Paola Ferretti End Abstract 5.1 Introduction In order to ensure that a bank has a sufficient capital to conduct its business, taking into account the risks that weigh on banking institutions, each bank is required to respect the rules imposed by the supervisory authorities concerning capital adequacy. Therefore each bank is required to define the amount extent of its capital as well as the optimal combination of the capital instruments of which the capital itself is made up. Additionally, banks are required to classify and measure and/or assess the various risk types and take into account the relationship between capital and level of risk. This chapter aims to analyse the evolution of the rules on banking capital adequacy, from Basel I to Basel III, as well as the latest developments on this issue (the forthcoming Basel IV). 5.2 Capital Rules: Nature, Origins and Aims In general, capital serves as a foundation for a bank’s future growth and as a cushion against unexpected losses. Adequately capitalised and well-managed banks are in a good condition to withstand losses and, furthermore, to provide credit to the economy throughout the business cycle. Adequate levels of capital help to promote public confidence in the banking system. Therefore, from the point of view of the banks and the supervisors, it is crucial to determine how much capital is necessary to serve as a sufficient buffer against unexpected losses...
eBook - ePubCredit Engineering for Bankers
A Practical Guide for Bank Lending
- Morton Glantz, Johnathan Mun(Authors)
- 2010(Publication Date)
- Academic Press(Publisher)
...In effect, this latter method is the foundation of the Basel Accord’s treatment of capital requirements for market foreign-exchange risk. 3. Stating explicit capital adequacy goals with respect to risk. Institutions need to establish explicit goals for capitalization as a standard for evaluating their capital adequacy with respect to risk. These target capital levels might reflect the desired level of risk coverage or, alternatively, a desired credit rating for the institution that reflects a desired degree of creditworthiness and, thus, access to funding sources. These goals should be reviewed and approved by the board of directors. Because risk profiles and goals may differ across institutions, the chosen target levels of capital may differ significantly as well. Moreover, institutions should evaluate whether their long-run capital targets might differ from short-run goals, based on current and planned changes in risk profiles and the recognition that accommodating new capital needs can require significant lead time. An institution’s internal standard of capital adequacy for credit risk could reflect the desire that capital absorb ‘‘unexpected losses’’—that is, some level of potential losses in excess of that level already estimated as being inherent in the current portfolio and reflected in the allowance. In this setting, an institution that does not maintain its allowance at the high end of the range of estimated credit losses would require more capital than would otherwise be necessary to maintain its overall desired capacity to absorb potential losses...
- Xiaochuan Zhou, China Development Research Foundation, China Development Research Foundation(Authors)
- 2016(Publication Date)
- Routledge(Publisher)
...The problem is that this performance criterion can never achieve its full purpose. Financial institutions have all kinds of policy loans on their books, the legacy of history. Any constraint on them becomes a kind of one-on-one bargaining instead of a powerful incentive mechanism overall. In this period of economic transition, it is actually quite hard to find clear incentive mechanisms that serve operating goals as well as the need to have constraints on behavior. Internationally, the most comprehensive and effective incentive mechanisms were incorporated in the Basel Accord of 1988. The New Basel Accord has already been formulated and is being discussed, and has even more positive aspects to it. Why do we feel that the Basel Accord is a comprehensive system in terms of regulatory supervision and the auditing of internal operations? The reason is that capital adequacy ratios are its core substance. These embrace the operating targets of banks and profitability on the one hand, while still putting effective constraints on bank expansion on the other hand. The numerator of the capital adequacy ratio indicates the degree of adequacy—that is, it shows how capable the institution is of withstanding risk. The more capital a bank has at its disposal, the greater its ability to cope. “Capital” is dynamic, and depends on the ability of the institution to build up profits. That is, if an institution hopes to rely on external sources of funds, to supplement its coffers, any external investor will first scrutinize the profit-making abilities of the institution. If they come up short, that external investor may well decide not to put in funds. Moreover, when a bank expands through the use of mergers and acquisitions, it must still live within its capital constraints. This carries within it a hidden condition, namely that each country sets its own rules for acceptable levels of risk...
eBook - ePubThe Money Markets Handbook
A Practitioner's Guide
- Moorad Choudhry(Author)
- 2011(Publication Date)
- Wiley(Publisher)
...All bank’s have internal rules dictating the extent of lending, across all money market products, to their counterparties. Capital allocation, targeted rates of return (which are a function of capital costs) and extent of counterparty risk aversion all dictate the extent to which funds may be lent to counterparties of various credit ratings. For this reason the money market desk needs to be keenly aware of the approximate extent of capital allocation that results from its operations. This chapter reviews the main aspects of the capital rules and also introduces the Basel II proposals, and how credit risk exposure determines the extent of capital allocation. It also indicates the interplay between the money market desk and longer-term traders, whose capital allocation requirements are greater. This will enable the money market participant to place his/her operations in the context of banking specifically and capital markets business generally. Banking Regulatory Capital Requirements Banks and financial institutions are subject to a range of regulations and controls, a primary one of which is concerned with the level of capital that a bank holds, and that this level is sufficient to provide a cushion for the activities that the bank enters into. Typically an institution is subject to regulatory requirements of its domestic regulator, but may also be subject to cross-border requirements such as the European Union’s Capital Adequacy Directive. 1 A capital requirements scheme proposed by a committee of central banks acting under the auspices of the Bank for International Settlements (BIS) in 1988 has been adopted universally by banks around the world...
eBook - ePubThe Bank Credit Analysis Handbook
A Guide for Analysts, Bankers and Investors
- Jonathan Golin, Philippe Delhaise(Authors)
- 2013(Publication Date)
- Wiley(Publisher)
...The amount of the loss will depend, among other things, upon the scale of the default and any corresponding recovery from the borrowers in default. If a loss is incurred, it will either come out of other profits (directly, or indirectly through loan-loss reserves); or, if profits are insufficient, the losses will be deducted from capital. Since a modicum of capital is required to maintain confidence and sustain operations, any capital lost must be replenished out of future profits or, absent a crisis severe enough to engender an offer of government assistance, from the very same risk-averse shareholders mentioned. Capital as a Regulatory Standard A bank’s depositors and bondholders are not the only parties keeping a weather eye on its capital strength. Bank supervisors also watch capital ratios closely; that modicum of capital just mentioned is likely nowadays to represent an elaborately defined regulatory requirement. In addition to the discipline exercised by the market, banks must comply with minimum capital requirements imposed by regulators. These rules form a significant part of the regulator’s arsenal, together with the other prudential regulations to which banks are subject, and related enforcement powers. Since the early 1990s, minimum bank capital requirements have become more uniform and increasingly ubiquitous, to the extent that another function of capital exists that is specifically applicable to banks: regulatory compliance. Capital as an Organizing Principle Finally, another function of capital within the banking sector derives from developments in financial theory, notably the concept of economic capital discussed later in this chapter. Briefly put, the relative level of bank capital has come to be seen as an organizing principle with which to measure a bank’s capacity to respond to risk events...
eBook - ePubCredit Rating and Bank-Firm Relationships
New Models to Better Evaluate SMEs
- Michele Modina(Author)
- 2015(Publication Date)
- Palgrave Macmillan(Publisher)
...Introduction The entry into force of the capital adequacy rules (Basel II) has required banks to allocate significant investments in the development and in the implementation of tools to support the entire credit process. These actions range from the assessment of the creditworthiness of the counterparties and the determination of risk-adjusted pricing to the management of loan portfolios. In this context, the internal rating systems represent a strong element of novelty. Their introduction, which took place at the height of the economic crisis, has produced a strong impact on bank management and on the relationship between banks and businesses. In particular, small and medium enterprises have experienced this innovation of the rating system, but at the same time the worsening of financial results and the occurrence of liquidity tensions, aggravated by stricter conditions of access to bank credit. The deep divisions in the competitive, productive and financial dynamics of the economic system require a verification of the approach followed until now in the daily use of rating systems. It means to fully understand if the assessments of the creditworthiness of counterparties, which guide the granting of credit and the management of credit relations in the long run, are sufficiently articulated, meet the counterparties’ actual competitive ability and prove farsightedness in guiding with efficiency the relationships between lenders and borrowers. The control of the quality, the completeness and the adequacy of rating models plays a fundamental role for two reasons. On the one hand, we must avoid the risk of a simplistic use, if not misleading, of the instrument that plays a role in the delicate relationship between banks and businesses...
eBook - ePubBank Asset Liability Management Best Practice
Yesterday, Today and Tomorrow
- Polina Bardaeva(Author)
- 2021(Publication Date)
- De Gruyter(Publisher)
...within its business, because of the geographical scale of business and differences of the banks within the group. Thus, each Group Treasury must deal with: Different regulatory requirements on markets, where subsidiary banks operate. Every country usually has its own financial market/banking authority, which as a minimum translates world-known recommendations (e.g., Basel or EBA recommendations) into law, or if acting outside of the group of countries that follow such recommendations – introducing its own vision. The largest group of restrictions is represented by capital management indicators: Local lending limits define the maximum amount of exposure to one borrower/group of connected clients. From group management perspective it means that not all the subsidiaries will be able to equally participate in such deals as syndications of loans, trade finance deals, funded, and unfunded risk participations. Capital adequacy ratios and their components differ from bank to bank even within the same regulatory environment. If one speaks about different regulatory areas and regimes, then differences may occur even on a wider range of requirements. Inside one banking group the banks can be reporting to different regulators and, thus, the group and the local requirements may differ significantly. Box 12.1. Decomposition of Regulatory Capital Requirements In line with Basel III 1 recommendations, banks should differentiate three levels of capital: common equity tier 1 (CET1) capital, tier 1 (T1) capital, and total capital (see Figure 12.1). Common equity tier 1 capital consists of share capital and share premium, retained earnings, other comprehensive income and prudential filters/deductions, such as intangible assets, goodwill, deferred tax assets, etc. 2 Figure 12.1: Layers of capital. Tier 1 capital consists of CET1 capital and additional tier 1 (AT1) capital. Total capital consists of T1 capital and tier 2 (T2) capital...
