Bank Capital and Liquidity Requirements

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Questions and Answers

Why might more demanding capital and liquidity requirements be necessary for systemically important banks?

They operate with less regulatory oversight.

They are less likely to lend to the economy.

They are more likely to impact financial stability. (correct)

They tend to have higher profit margins.

What is one potential consequence of capital and liquidity regulation on banks' lending?

Greater willingness to lend to higher-risk borrowers.

Improved quality of loan applications from borrowers.

Diminished capacity or incentives to lend at different business cycle points. (correct)

Increased capacity to lend during economic downturns.

Which of the following is included in the EU definition of a 'credit institution'?

Does not have to take deposits from the public.

Engages in the business of granting credits. (correct)

Can only operate within one member state.

Only offers long-term loans to consumers.

What does the US legal definition of a bank emphasize as central to its business model?

Making commercial loans. Signup and view all the answers

What does not matter according to the legal definitions of a bank?

The name of the institution. Signup and view all the answers

Which of the following types of institutions might be classified as a bank according to the definitions provided?

A building society that borrows short term. Signup and view all the answers

What is a significant feature omitted from legal definitions of banks?

Their involvement in investment banking. Signup and view all the answers

What role does regulation play concerning systemically important banks?

It provides systemic protection. Signup and view all the answers

What is the primary risk that capital should be held against according to the commercial banking model?

Credit risk Signup and view all the answers

Which Basel framework amendment incorporated trading risks explicitly?

Market risk amendment of 1996 Signup and view all the answers

What major shift did banks experience in credit intermediation?

Transition from loans to investment banking activities Signup and view all the answers

What was a major source of fragility for banks identified prior to the crisis?

Trading risk Signup and view all the answers

Which of the following was NOT a major component of banks' non-loan assets around the time of the crisis?

Cash reserves Signup and view all the answers

What type of risk is defined as a decline in the market value of securities held for market-making purposes?

Trading risk Signup and view all the answers

What did banks primarily hold in the wake of the financial crisis that contributed to large losses?

Complex credit instruments Signup and view all the answers

How did banks calculate potential losses on their trading portfolios before the crisis?

By estimating losses until the securities could be disposed of Signup and view all the answers

Which of the following banks are categorized as Global Systemically Important Banks (G-SIBs) with a surcharge of 2.5%?

JP Morgan Chase Signup and view all the answers

What is the cap percentage for the G-SIB surcharge proposed by the Federal Reserve under Basel III?

4.5% Signup and view all the answers

Which Act instituted provisions for the assessment of systemic risk in banks?

Dodd–Frank Act Signup and view all the answers

What do supporters of 'narrow banking' advocate regarding deposit insurance?

Insurance should focus solely on high-quality liquid assets. Signup and view all the answers

According to the provided content, which measure is proposed to evaluate a bank's run-risk?

Short-term wholesale funding Signup and view all the answers

Which financial theory is mentioned as having limited relevance for bank regulation?

Modigliani–Miller Hypothesis Signup and view all the answers

How many G-SIBs have a surcharge of 1.5% according to the content?

Seven Signup and view all the answers

Which of the following banks is NOT listed as a G-SIB with a 1.0% surcharge?

Deutsche Bank Signup and view all the answers

Which organization reports that broker-dealers operate at twenty-two times leverage?

Financial Stability Oversight Council (FSOC) Signup and view all the answers

What is the deadline for the full implementation of Basel III capital and liquidity requirements?

January 2019 Signup and view all the answers

What aspect of Basel III saw the least progress among the 100 largest internationally active banks by the end of 2014?

Liquidity requirements Signup and view all the answers

How does the minimum capital requirement in some corporate laws differ from that in Basel III?

It is only a one-time calculation. Signup and view all the answers

Which document addresses the Basel Committee's response to the financial crisis?

Response Report to the G20 Signup and view all the answers

What is claimed about broker-dealer leverage in comparison to the typical commercial bank?

Broker-dealers operate on higher leverage. Signup and view all the answers

Under Basel III, which of the following is specifically addressed as a consistency assessment?

Risk-weighted assets for market risk Signup and view all the answers

In what way is the implementation of Basel III handled within the EU?

Implementation is dictated by Union law. Signup and view all the answers

What is the primary concern raised regarding higher equity in banks?

It may raise the costs of borrowing. Signup and view all the answers

What do Admati and Hellwig propose regarding equity requirements?

An equity requirement of 20-30% of non-risk-weighted assets. Signup and view all the answers

What is suggested about banks' funding structures according to the Modigliani-Miller theorem?

The funding structure does not affect the firm's overall value. Signup and view all the answers

What does the current Basel III requirement represent in terms of capital levels?

Lower than what UK and US banks have historically achieved. Signup and view all the answers

How might prohibiting banks from using debt financing affect loan supply?

It would lead to a reduction in the supply of loans. Signup and view all the answers

In discussing bank equity versus debt, what is a significant trade-off identified?

Higher borrowing costs must be balanced with the benefits of stability. Signup and view all the answers

What aspect is particularly emphasized by Admati and Hellwig regarding capital requirements?

The significance of having too little equity. Signup and view all the answers

What is a potential result of increased equity financing in banks, according to the content?

A decrease in bank operational efficiency. Signup and view all the answers

Study Notes

Capital and Liquidity Requirements for Banks

Systemically important banks may require more stringent capital and liquidity regulations for better systemic protection.
The balance between capital regulation and banks' ability to lend to the real economy is crucial, especially across different business cycle phases.

Legal Definitions of Banks

EU Definition: A "credit institution" is an organization that accepts deposits and provides credit, as defined under Regulation (EU) No 575/2013, Article 4.1(1).
US Definition: According to the Bank Holding Company Act of 1956, a bank accepts demand deposits and engages in commercial lending.
Both definitions underline the risks associated with funding short-term deposits and making loans.

Risks in the Banking Model

Traditional banking focuses primarily on credit risk—potential borrower default on loans.
The Basel I framework mandated banks only to hold capital against credit risk.
It's recognized that significant portions of credit intermediation have transitioned to market intermediaries, reducing commercial banks' roles.

Emergence of Trading Risks

The rise of investment banking activities initiated growth in trading risks, impacting bank stability.
The "market risk amendment" of 1996 acknowledged trading risks under Basel regulations.
Prior to the financial crisis, banks increasingly held complex credit instruments leading to substantial losses during the crisis.

Basel III Capital Requirements

Discussions surrounding Basel III highlight the debate on whether the Common Equity Tier 1 (CET1) capital levels are adequately set.
Equity is often considered more expensive than debt for banks, representing a trade-off regarding funding structures.
Some academics argue that equity may not be more expensive than debt, advocating for higher equity requirements to enhance stability.

Equity Requirements and Market Structures

Admati and Hellwig propose equity levels of 20-30% of non-risk-weighted assets, significantly exceeding current Basel standards.
The Modigliani–Miller theorem posits that a company's value is not affected by its capital structure under certain conditions.
The balance between equity financing and long-term debt is vital for maintaining the loan supply to businesses and households.

Additional Considerations

The US Financial Stability Oversight Council (FSOC) noted broker-dealers operate at higher leverage than typical commercial banks, raising concerns about systemic risk.
Basel III implementation deadlines stretch until January 2019 for full compliance, with ongoing analyses of capital and liquidity impacts on banking operations.
Awareness of systemic risks related to short-term wholesale funding is increasing, prompting regulatory updates to safeguard financial stability.

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Description

This quiz explores the capital and liquidity requirements for banks, particularly focusing on systemically important institutions. It also delves into the legal definitions of banks in the EU and US, as well as the inherent risks within the banking model. Examine how these regulations impact lending in various economic cycles.