Bank Capital: Understanding Capital Adequacy PDF

Bank Capital: Understanding Capital Adequacy Welcome to this presentation on bank capital and capital adequacy. by Yanna Calumpang What is Bank Capital? Bank capital represents the financial cushion that a bank has to It acts as a safety net, protecting depositors and creditors from absorb p...

Bank Capital: Understanding Capital Adequacy Welcome to this presentation on bank capital and capital adequacy. by Yanna Calumpang What is Bank Capital? Bank capital represents the financial cushion that a bank has to It acts as a safety net, protecting depositors and creditors from absorb potential losses. It's the difference between a bank's financial distress in the event of unexpected losses. assets and its liabilities. Importance of Bank Capital 1 Stability and Trust 2 Financial Resilience Adequate capital instills Capital acts as a buffer confidence among depositors against unexpected losses, and investors, enhancing protecting against economic stability. shocks. 3 Lending Capacity Banks with sufficient capital can lend more money to businesses and individuals, stimulating economic growth. Regulatory Requirements for Bank Capital Minimum Capital Capital Ratios Requirements These ratios measure the Regulatory bodies mandate proportion of capital relative to minimum capital levels to a bank's assets, indicating its ensure financial stability. resilience. Supervisory Oversight Regulators monitor bank capital levels to ensure compliance and identify potential risks. Tier 1 and Tier 2 Capital Tier 1 Capital Tier 2 Capital Includes common stock, retained earnings, and non-cumulative Comprises supplementary capital, including subordinated debt perpetual preferred stock. It represents the core capital of a and other instruments. It's less liquid and has higher risk bank. compared to Tier 1. Risk-Weighted Assets and Capital Ratios Risk-Weighted Assets Capital Ratios Banks are required to hold capital Common capital ratios include Tier 1 proportionate to the risk associated Capital Ratio (CET1) and Total with their assets. Capital Ratio (T1). These ratios reflect the percentage of capital held against risk-weighted assets. The Basel Accords on Bank Capital 1 The Basel Accords are a set of international regulatory frameworks that aim to improve the financial stability of the global banking system. 2 Basel I (1988) introduced the concept of risk-weighted assets and capital ratios. Basel II (2004) refined the framework by incorporating 3 operational risk and incorporating internal ratings. 4 Basel III (2010) strengthened capital requirements, introduced liquidity rules, and increased the counter-cyclical buffer. Stress Testing and Capital Adequacy Stress Tests 1 Regulators conduct stress tests to evaluate a bank's capital adequacy under adverse economic conditions. Scenario Analysis Stress tests involve simulating severe economic shocks to 2 assess a bank's ability to absorb losses and maintain capital requirements. Capital Buffering The results of stress tests inform banks' capital planning, 3 enabling them to build adequate capital buffers to withstand potential crises. Challenges in Maintaining Adequate Capital Economic Downturns 1 Recessions and market volatility can lead to increased loan losses and reduced capital. Regulatory Changes 2 Evolving regulations can increase capital requirements and impact a bank's profitability. Competition 3 Competition among banks can put pressure on profitability, making it challenging to maintain sufficient capital. Technological Disruption 4 Emerging technologies can introduce new risks and necessitate investments in capital. Trends in Bank Capital Requirements Higher Capital Requirements 1 Global regulators are continuing to increase capital requirements to enhance financial stability. Focus on Systemic Risk 2 There's a growing emphasis on regulating large, systemically important banks to prevent financial contagion. Digitalization and Innovation 3 Regulators are adapting capital frameworks to address the evolving risks associated with digital banking and fintech.