UNIT: 3 BANK CAPITAL AND TREASURY MANAGEMENT

Bank capital : Bank capital is the difference between a bank's assets and its liabilities, and it
represents the net worth of the bank or its equity value to investors. The asset portion of a
bank's capital includes cash, government securities, and interest-earning loans (e.g.,
mortgages, letters of credit, and inter-bank loans).

What is another term for bank capital?

Bank Capital, also known as the bank's net worth, is the difference between a bank's
assets and liabilities. It primarily acts as a reserve against unexpected losses and
protects the creditors in case of bank liquidation.

Why do banks need to hold capital?

23 May 2019

Capital is a key ingredient for safe and sound banks and here is why. Banks take on
risks and may suffer losses if the risks materialise. To stay safe and protect
people’s deposits, banks have to be able to absorb such losses and keep going in
good times and bad. That’s what bank capital is used for.

But how much capital should a bank hold? The answer lies in the risks it takes. The
bigger the risks, the more capital it needs. That’s why it’s essential that banks
continuously assess the risks they are exposed to and the losses they may incur.
Their assessments are checked and challenged by banking supervisors. Supervisors
are responsible for monitoring banks’ financial health, and checking their capital
levels is an important part of this.

What exactly is bank capital? How does it keep banks safe? And what are the levels
of capital banks need to hold?

What is capital?

Put simply, capital is the money that a bank has obtained from its shareholders and
other investors and any profit that it has made and not paid out. Consequently, if a
bank wants to expand its capital base, it can do so for example by issuing more
shares or retaining profits, rather than paying them out as dividends to
shareholders.

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 Overall, every bank has two sources of funds: capital and debt. Debt is the money
that it has borrowed from its lenders and will have to pay back. Debt includes
among other things deposits from customers, debt securities issued and loans
taken out by the bank. Funds from these two sources are employed by the bank in
a number of ways, for example to give loans to customers or to make other
investments. These loans and other investments are the bank’s assets, along with
funds that are held as cash.

How does capital keep banks safe?

Capital acts like a financial cushion against losses. When, for example, many
borrowers are suddenly unable to pay back their loans, or some of the bank’s
investments fall in value, the bank will make a loss and without a capital cushion
might even go bankrupt. However, if it has a solid capital base, it will use it to
absorb the loss and continue to operate and serve its customers.

How much capital do banks need to hold?

In European banking supervision, the capital requirements for a bank consist of

three main elements:

 minimum capital requirements, known as Pillar 1 requirements

 an additional capital requirement, known as the Pillar 2 requirement

 buffer requirements
First, all banks under European banking supervision have to comply with the
European law that sets the minimum total capital requirement (called Pillar 1
requirement) at 8% of banks’ risk-weighted assets. But what are risk-weighted
assets? They are the total assets a bank has, multiplied by their respective risk
factors (risk weights). Risk factors reflect how risky a certain asset type is
perceived to be. The less risky an asset, the lower its risk-weighted asset amount
and the less capital a bank needs to hold to cover for it. For example, a mortgage
loan that is secured with collateral (a flat or a house) is less risky – has a lower risk
factor – than a loan that is unsecured. As a result, a bank needs to hold less capital
to cover for such a mortgage loan than it does to cover for an unsecured loan.

Second, there is the additional capital requirement set by supervisors (called the
Pillar 2 requirement). This is where European banking supervision comes in.
Supervisors from the ECB and the supervisory authorities of participating countries
look at individual banks in detail and assess the risks that each of them is exposed
to. They do this via an annual Supervisory Review and Evaluation Process (SREP).

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If the supervisors conclude that the bank’s risks are not sufficiently covered by
minimum capital requirements, they ask it to hold additional capital.

Both minimum and additional capital requirements are binding and there are legal
consequences if they are not adhered to. These consequences depend on how
serious the breach is. The supervisor may, for example, ask the bank to draw up a
plan showing how it will restore its compliance with the capital requirements. Or, if
the breach is very serious, the bank may lose its banking licence.

The third capital requirement for banks is that they have additional buffers for
different purposes (for general conservation of capital and against cyclical and non-
cyclical systemic risk).

In addition to these three sets of capital requirements, supervisors expect banks to

reserve certain amounts of capital for times of stress (this is called Pillar 2
guidance).

On top of the amounts regulators and supervisors demand, banks are expected to
determine themselves how much capital they need to be able to sustainably follow
their business models.

Why do banks need capital?

Bank capital acts as a protection to the bank from unexpected risks and losses. It
is the net worth available to the equity holders. It assures the depositors and the
creditors that their funds are safe and indicates the bank's ability to pay for its liabilities.

The 3 characteristics of bank capital

Defining “capital”
The first term we need to understand is “capital.” “Capital” for a bank is somewhat
different from the way we generally understand the word in our day-to-day lives. We
understand capital as money. But in a banking sense, it means that and more.
“Capital” in banking generally refers to a part of a bank’s assets that doesn’t need to be
repaid. In a few exceptional cases, it may include a part of a bank’s assets that needs to
be repaid far ahead in future.
Many times “capital” is also referred to as “reserve.” This is because it’s the amount a
bank would have available in case things go wrong and it’s unable to make money from
its routine operations .
Bank capital has three primary features:

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1. Bank capital does not need to be repaid
2. No dividends or interest payments are due on bank capital
3. The claim priority on bank capital in case of bankruptcy is low
Capital at all banks like JPMorgan (JPM), Goldman Sachs (GS), Morgan Stanley (MS),
Wells Fargo (WFC), and other banks in an ETF like the Financial Select Sector SPDR
Fund (XLF) have the same features.
In the next part of this series, we’ll look at the different types of capital a bank has. Keep
reading to know more.
Common Stocks

What are Common Stocks?

Common stocks can be defined as securities that represent individuals’ ownership in a said
corporation and their claim on the venture’s accrued profits. Such stock option offers
individuals a power to elect the company’s board of directors and further extends them voting
rights to formulate corporate policies.
Usually, in the long term, common shares are said to generate returns at a high rate. Common
stockholders are compensated with dividend income, which is paid to them after distributing
the accrued profits to the preference shareholders.

In the event of bankruptcy, creditors, preference shareholders and bondholders are likely to
receive their share before those who have invested in a company’s common stocks. They are
more likely to receive the remaining assets after others have been paid accordingly. Such stocks
are issued in the market through an initial public offering.

Common Stock can be expressed as –

Number of Outstanding shares = Number of Issued Shares – Treasury Stocks

Why are Common Stocks Issued?

Typically, issuance of common stocks is an alternative option for selling debt bonds or
issuing preference stock. The primary reason behind the issuance of common stocks is to raise
capital.

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 What are characteristics of common stock?
Features of Common Stocks?
 Dividend Right – Entitled to earn dividends.
 Asset Rights – Entitled to receive remaining assets in the event of a liquidation.
 Voting Rights – Power to elect the board of directors.
 Pre-emptive Rights – Entitled to receive consideration.

 Returns

Common stocks allow its investors to generate earnings in two ways, namely, in the form
of capital gains and through dividend income. Investors are likely to earn higher capital gains
when the company’s stock valuation increases. Similarly, if the company is left with substantial
revenue after paying off maintenance charges and other expenses, they may declare dividends
for its investors.

 Investment option:
 Generally, individuals can invest in common stocks in these following ways.

1 Through a direct stock plan.

2 Via dividend reinvestment plan.

3 Through stock exchange.

4 By investing in a mutual fund.

Financial flexibility refers to the ability of a firm to respond in a timely and

value-maximizing manner to unexpected changes in the firm's cash flows or
investment opportunity set.

What Is Capital Adequacy Ratio – CAR?

The capital adequacy ratio (CAR) is a measurement of a bank's available
capital expressed as a percentage of a bank's risk-weighted credit exposures.
The capital adequacy ratio, also known as capital-to-risk weighted assets

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ratio (CRAR), is used to protect depositors and promote the stability and
efficiency of financial systems around the world. Two types of capital are
measured: tier-1 capital, which can absorb losses without a bank being
required to cease trading, and tier-2 capital, which can absorb losses in the
event of a winding-up and so provides a lesser degree of protection to
depositors.

What is capital adequacy of a bank?

Capital adequacy – the adequate amount (usually defined by regulators) of capital
(shareholder money) a bank needs to hold, as a percentage of its risk-weighted
assets.
What is capital adequacy and why is it important?
The capital adequacy ratios ensure the efficiency and stability of a nation's
financial system by lowering the risk of banks becoming insolvent. Generally, a
bank with a high capital adequacy ratio is considered safe and likely to meet its financial
obligations.

Treasury management: Treasury Management services can streamline

business finances by managing cash, investments, and other financial assets.
It's a management system that optimizes your business's liquidity, while
also mitigating its financial, operational, and reputational risk.

What is Treasury Management?

Every business has a set of financial obligations that must be met. The objective of
treasury management is to ensure the business in question has the right mix of cash
and cash equivalents to ensure financial risk is mitigated. Under the treasury
management umbrella, procedures and policies are designated with the goal of helping
businesses to improve the management of their cash flow from interest rates to
payables and receivables.

Even highly profitable businesses can fail if they don’t have enough financial resources
to cover their financial obligations. Treasury management also helps businesses to
decrease the amount of time it takes to collect payments from customers.

Treasury management is highly specialized.  It falls under investment banking and

offers services and products to assist with the functions of financial planning. Some
ways treasury management can help are through the automation of accounts
receivable, by infusing bank data with internal business systems to improving
forecasting, and by addressing account inefficiencies. Treasury management can also
help with fraud.

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 Learn more about ProcessMaker’s workflow software and treasury services for banking
Benefits
How do you know if your business can benefit from treasury management? Often,
financial institutions already have guidelines in place to determine the types of banking
services that will provide the most benefits to their customers. The overarching objective
is to ensure your business has a persistent cash flow…

The largest benefit of treasury management is time and cost reduction. A treasury
management system can streamline payment processes to ensure less time is spent on
payment initiation and authorization. 

There are also cost benefits where businesses can use various tools to better manage
related bank transaction fees they might not have noticed otherwise. As a result, you
save time, improve productivity, and enhance efficiency. Although, it does boil down to
cash flow. With treasury management, businesses can make better bottom line
decisions. Further, you get forecasting tools and detailed variance analysis.

Instead of having multiple, disparate departments and systems managing various

aspects of financial obligations, a treasury management system offers payments,
reporting, accounting, banking information, and more from one centralized hub.
Organizations can have much more control over their finances. 

Treasury management systems can also handle capital management, currency

management, collections, reporting, and disbursement. All businesses need cash flow
to continue effective operations. Not to mention, businesses of all sizes can benefit from
treasury management. 

Why is treasury management important?

 Liquidity optimization – Monitor timing of cash inflows and outflows.

 Collection management – Set the right policies for accounts payable and receivables.
 Risk hedging – Decrease financial risk.
 Information sharing – Obtain real time data around current financial status.

It’s about maximizing the financial outlook. For example, a treasury management
system can consolidate any redundancies around accounts to minimize service fees. It
can also ensure that receivables are posted quickly while reducing vendor disruptions or
processing delays. And, various services are designed for fraud prevention. 

Businesses with a treasury management system in place can spend more time on
strategic business tasks and less time worrying about finances.  CFOs want to know
where their cash reserves are and in what currency. In addition, they need to know
whether they should invest or borrow. Moreover, it’s always important to know if they
are financially over exposed, are over borrowed, or are under invested.

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 Treasury management services in banks
 

Treasury management services were built to help companies improve processing of

cash flows, manage funds better, and enhance banking visibility. 

Treasury management can be categorized into five different services:

 Liquidity management
 Fraud
 Receivables
 Information
 Disbursements
 FX risk management
 Digital treasury services

Let’s go through these categories in more depth…

1. Liquidity management — Liquidity management is important because it helps to ensure

businesses have cash flow when they need it and any excess can be stored in interest-bearing
accounts.
2. Fraud management — Fraud solutions are offered to mitigate potential risks before any
permanent damage is incurred.
3. Receivables management — Collecting, and processing, receivables is one of the most
important activities for any business. Yet, this process can be both costly and time consuming.
Receivables management aims to streamline receivables and accelerate processing times.
4. Information management — Effective decision making requires having the right data on hand,
when needed. It’s always crucial to have an accurate view of the company’s financial position.
5. Payables management — Businesses must also distribute funds, but it should be done both
quickly and efficiently.
6. FX risk management — There is always a risk with foreign exchanges. Treasury management
offers services that will identify risks and exposure while analyzing risks using metrics such
as Value at Risk (VaR). Then, risks may be treated with hedges and daily monitoring to ensure
the hedging strategy works.
7. Digital treasury services — Company CFOs need to make decisions from their devices. They
want interactive dashboards and connected technologies.

The use of treasury services is a growing trend, especially in today’s business climate
and online markets. The potential for fraud continues to surge, while efficiency is a
mandate. In addition, businesses can have access to financial experts who understand
how to keep a company in operational flux. Treasury services can be complex –
depending on the circumstances – so it’s not an activity suitable for anyone other than
experts.

What is the concept of treasury?

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Treasury involves the management of money and financial risks in a business. Its
priority is to ensure the business has the money it needs to manage its day-to-day
business obligations, while also helping develop its long term financial strategy and
policies.

What are the concepts of treasury management?

Treasury Management includes a firm's collections, disbursements, concentration,
investment and funding activities. In larger firms, it may also include financial risk
management.

Treasury Management Best Practices

Broadly speaking, from my experiences, treasuries are underutilized due to

them being too reactive and on tunnel vision to follow set processes without
the autonomy to be flexible. Below are my treasury management best practices
for how to build and operate a capable team, for the benefit of the whole
business.

1. Structure and Compensation

Starting right at the top, a business must place its treasury in the correct area
of the organization. An effective team must be:

1. Impartial: Not allied or biased toward any commercial area of the

business
2. Empowered: Both in terms of human and capital resources and
flexibility to “roam”
3. Incentivized: In the absence of being a profit center, team members
must have quantifiable goals.

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Too many companies fail by having treasuries as operational offshoots of
teams like accounting, working out of a back cupboard in the suburbs. Instead,
they should report to the CFO directly and be relied upon as lieutenants in the
business for their insight into the balance sheet. Similarly, all roles and
functions should be contained within the same team. Trying to create a “cloud
team” with roles scattered among the company will ultimately result in
crossed wires and less effectiveness.

Below is my recommendation for key functional roles and focus within

treasury teams.

To give an example of why it’s important to contain all of these roles in the
same team, here is a simple example of the four pillars working together:

1. Operations notices that terms on a lease have been incorrectly

interpreted and it’s actually longer.
2. Risk models up the effect of the longer asset life and confirms that
liquidity horizons have shortened, due to shorter-dated borrowing.
3. Relationship managers canvas banking contacts and find a willing
lender for a revolving credit facility.
4. The investing team drawdowns the loan, using an FX swap to convert
a portion to cover short-term requirements.

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AGENCY COSTS OF INCENTIVES

It’s also important from a performance mindset to get compensation and

incentives right. This comes optically from how the team is created and to
literally where they are seated in the office. Treasuries interface externally,
and thus must project confidence and the corporate image to external parties.

Because the team is not a profit center (profits flow to the central company
entity), there can be perverse incentives. For example, taking an ultra high-
risk policy of raising long-dated cash and lending it out short term is not a
commercially sound practice, outside of severe market stress. But, if the
treasury team is not incentivized, they may indeed take this option, because
it’s safe and they will get paid regardless. Equally so, because the P&L is just
swallowed by the company and performance is not related to it, this can lead
to best execution policies going out the door.

Establishing suitable and compelling incentives for treasury staff reduces

agency costs. I believe that variable compensation related to FTP movement is
an interesting tool for measuring holistic team performance.

2. Get FTP Right

Costing up a balance sheet is an arduous task and one that can become
difficult if there is a high turnover of items and/or weak IT treasury
management systems. Getting it right, though, will ensure that new business
activities using the balance sheet are value-additive by ensuring that the
mentality of fully-loaded margin is the minds of business units.

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In doing this, having an agreed-upon floating interest rate benchmark (like
what LIBOR used to be used for) for the whole company is the best method for
pricing up FTP. This removes arbitrage opportunities, interest rate curve risk,
and also makes things a lot easier for the ALM team’s monitoring.
It’s also worth mentioning that FTP should be disassociated from credit risk.
Pricing deals should be done on a case-by-case basis by credit/deal teams with
counterparties scored for risk and then charged appropriately on top of FTP.
This further establishes the agnostic nature of a treasury towards the business:
the team is an enabler, not an arbitrator.

3. Communicate Effectively

As the ears to the financial markets and the straddlers of the balance sheet, the
treasury management function is an important news source for the company.
It should translate macroeconomic events into resultant risks, or conversely,
opportunities. Instead of forwarding information on, such intel should be
packaged as actionable insights: “How does this affect our company?”

Reporting the cash position of a business is a vital end-of-day reporting task,

but it should not stop there. Reporting to the executive committee should be
communicated in a concise manner, and not just a dump of mundane reports.

When reporting data, focus on key metrics to give a snapshot of:

 Liquidity Horizon: How long you will survive if liabilities stopped

rolling
 FTP Cost
 Weighted Average Yield: Earned on assets under your control

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  Value at Risk (VAR): Of assets and derivative positions
Using a traffic light system helps to give relativity and emphasize urgency.
Equally as important is to give commentary to the data to explain qualitatively
why has something changed.

4. Shop Around

Treasuries are buy-side institutions; they need market makers to provide them
with financial products ranging from vanilla deposit accounts up to esoteric
derivatives. The key mistake I regularly see here is when a team does not
properly shop around and have a wide bench of liquidity providers. Usually,
the dealer sticks to a couple of providers, either because they are not proactive
enough and/or enjoy the client entertainment that their wide spreads are
unwittingly paying for.

As a footnote to the above, a treasury should interact directly with the market.
Going through other teams within the same company is an exercise of P&L
pass the parcel and breeds inefficiency.

An effective treasury should manage external clients in the same way that a
sales-focussed SaaS startup would. Maintain a CRM with links into banks,
brokers, and funds with rankings of their pros and cons. This will ensure that
competitive pricing is achieved and that there is a large phonebook of liquidity
providers for when markets go south.

Electronic trading platforms are great for getting good comparisons on

pricing, saving time, and measuring execution performance.

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5. Don’t Be a Hero

The investment portfolios that treasuries manage are the equivalent of the
change that you keep in a jar by your front door. This money is money that is
left in the pile every day that is not being used. It is white-hot and could be
deployed the next day. Investing it is important, though, because the yield
gained lowers the dead-weight loss of undeployed capital and can bring
tangential hedging and counterparty relationship benefits.

The three pillars of treasury portfolio management are liquidity, risk,

and capital efficiency. These conservative targets are different from most
other portfolio managers (notice the absence of yield) and might seem boring
to some, but it actually gets quite interesting in the way that you can employ
certain instruments in cash management strategies. Yield is an optional fourth
choice, but my view is that the opportunity cost of not investing is 0%, thus
any yield (positive) is immediately a success.
I remember poring over Basel III capital rule requirements, at matrices of
bond types vs. credit ratings, looking for the highest yielding instrument that
would comply with the lowest treasury risk weighting for my bank. For a
couple of months in 2012, I became an expert on unloved Slovenian
government bonds due to their high yield, yet efficient credit ratings.
The point is though that no-one will remember the Treasurer that earned a
humble 50bp of yield on their investment portfolio, but everyone, including
the press, will remember the London Whale who lost $6.2 billion. So don’t be
a hero with the cash management process of the liquidity portfolio.

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6. Build an ERP and Take the Time to Get It Right

Treasurers are blind without effective software to splice up the balance sheet
and communicate liquidity positions and risk exposures. Money moves by the
second and if you are not ahead of this, then you will be chasing shadows
trying to reconcile positions. Treasuries need systems that can account for a
full range of functionality, the fewer systems the better for ensuring smooth
crossover of workflows.

Treasury software is notoriously difficult to get right. Pre-packaged solutions

come with promises but then require constant tweaking to ensure that internal
trades and movements get captured. Oftentimes the ERP is a derivative of a
trading platform or accountancy ledger software, which can mean that
treasury functionality is a compromised add-on.
Internally-built software can be tailor-made but becomes a mid-term
engineering task, my advice is to invest in getting it right and starting from a
clean slate. The concept of artificial intelligence seems almost tailor-made for
applications in predicting treasury cash flows. This is one big reason why I can
see new fintech neobanks having an increasing competitive edge as they scale.

7. Lead Inside the Organization

A treasury function has the platform of being able to emphasize with asset and
liability focused teams, acting as counsel between the two. In banks, this is the
deposit takers and lenders, but in a corporate, it could be the property team
vs. the payables department.

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Being impartial and involved with the business units and providing solutions
over roadblocks will ultimately help the wider organization and increase buy-
in.

Roles/Functions of Treasury Management

Following are the some of the main functions of Treasury Management

 Cash Management: It involves efficient collection and repayment of

cash to both insider and third party.
 Funding Management: It helps in planning and sourcing firm’s short,
medium and long term cash needs. Treasury management assists in
capital structuring, forecasting of future interest and foreign exchange
rates decision making process i.e., management of foreign exchange
rate risks, in accordance with the Company policy.
 Currency Management: It helps in managing the foreign currency
risk, exchange rate risks and directs towards the currency to be used
for overseas billing etc.
 Corporate Finance: It involves in merger and acquisition, capital
structure, right issue, etc.
 Banking: Treasury Management helps in maintaining good
relationship with bankers and carryout initial negotiation with them for
any short-term loan.
 Venture Capital Financing: It involves in new high-risk venture of
getting venture capitalist.
What is Asset Liability Management ALM in banks?
Asset-liability management addresses the protection of both income and capital
from interest rate risk, which originates from mismatches in the repricing of
assets and liabilities. Interest rate risk management aims to maintain interest rate
risk exposures within authorized levels.

What Is an Asset-Liability Committee?

An asset-liability committee (ALCO), also known as surplus management, is
a supervisory group that coordinates the management of assets
and liabilities with a goal of earning adequate returns. By managing a
company's assets and liabilities, executives are able to influence
net earnings, which may translate into increased stock prices.

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KEY TAKEAWAYS

 Asset-liability committees (ALCOs) are responsible for overseeing the

management of a company or bank's assets and liabilities.
 An ALCO at the board or management level provides important
management information systems (MIS) and oversight for effectively
evaluating on- and off-balance-sheet risk for an institution.
 An ALCO's strategies, policies, and procedures should relate to the
board’s goals, objectives, and risk tolerances for operating standards.
 One of the ALCO’s goals is ensuring adequate liquidity while managing
the bank’s spread between the interest income and interest expense.

What is credit risk means?

Credit risk is the possibility of a loss resulting from a borrower's failure to
repay a loan or meet contractual obligations. Traditionally, it refers to the risk that
a lender may not receive the owed principal and interest, which results in an
interruption of cash flows and increased costs for collection.

Types of Credit Risk

The following are the main types of credit risks:

1. Credit default risk

Credit default risk occurs when the borrower is unable to pay the loan
obligation in full or when the borrower is already 90 days past the due date of
the loan repayment. The credit default risk may affect all credit-sensitive
financial transactions such as loans, bonds, securities, and derivatives.

The level of default risk can change due to a broader economic change. It can
also be due because of a change in a borrower’s economic situation, such as
increased competition or recession, which can affect the company’s ability to
set aside principal and interest payments on the loan.

2. Concentration risk

Concentration risk is the level of risk that arises from exposure to a single
counterparty or sector, and it offers the potential to produce large amounts of
losses that may threaten the lender’s core operations. The risk results from the

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observation that more concentrated portfolios lack diversification, and
therefore, the returns on the underlying assets are more correlated.

For example, a corporate borrower who relies on one major buyer for its main
products has a high level of concentration risk and has the potential to incur a
large amount of losses if the main buyer stops buying their products.

3. Country risk

Country risk is the risk that occurs when a country freezes foreign currency
payments obligations, resulting in a default on its obligations. The risk is
associated with the country’s political instability and macroeconomic
performance, which may adversely affect the value of its assets or operating
profits. The changes in the business environment will affect all companies
operating within a particular country.

What is default risk?

What Is Default Risk? Default risk is the risk that a lender takes on in the chance
that a borrower will be unable to make the required payments on their debt
obligation. Lenders and investors are exposed to default risk in virtually all forms of
credit extensions.

Risk Exposure
Risk is everywhere and is part of all activities. We have all had to deal with risk in our own lives. In
general terms, risk is the possibility of loss. Sometimes, we discuss risk in terms of exposure. Risk
exposure is a measure of possible future loss (or losses) which may result from an activity or
occurrence. In business, risk exposure is often used to rank the probability of different types of
losses and to determine which losses are acceptable or unacceptable. These losses may include
legal liability, property loss or damage, unexpected employee turnover, or changes in consumer
demand, to name a few.

What Is Credit Exposure?

Credit exposure is a measurement of the maximum potential loss to a lender
if the borrower defaults on payment. It is a calculated risk to doing business
as a bank.

For example, if a bank has made a number of short-term and long-term loans
totaling $100 million to a company, its credit exposure to that business is
$100 million.

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Recovery Risk

Definition
Recovery Risk denotes the risk that following a Default Event, contracts of the
defaulting entity cannot be honoured in full, thereby leading to financial loss to the
lender or other counterparty. Recovery risk is the complement of LGD Risk
What do you mean by collateral?
Collateral is an asset or form of physical wealth that the borrower owns like house,
livestock, vehicle etc. It is against these assets that the banks provide loans to the
borrower. The collateral serves as a security measure for the lender.

What are collateral risks?

The Law Dictionary defines collateral risk as: The risk of loss arising from errors in
the nature, quantity, pricing, or characteristics of collateral securing a transaction
with credit risk.

What is the meaning of third party guarantee?

Third-party guarantees are a form of securing loans, where the guarantor is liable
for the outstanding debt including interest in case the borrower defaults. By
granting a guarantee one can help family and friends to gain access to credit.

What is third party risk in banking?

Third-party risks are the potential risks that arise from financial institutions. relying
upon outside parties to perform services or activities on their behalf. The
fundamental principle regarding banks' overarching responsibility for all. activities,
regardless of whether performed by a third party or internal.

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