FM303 Tutorial Question week 5-6

Topic: International Banking Regulation and the Basel Accords

1. A bank has four asset categories classified by the level of risk they embody. The most risky
asset is assigned a weight of 1. The following are the asset categories, as well as their values in
AUD million:

(a) Calculate, without accounting for risk, the regulatory capital required to maintain a capital
ratio of 8%.
(b) What is the risk-adjusted capital ratio if the bank holds AUD 40 million as capital?

2. Consider two banks, A and B, which are equal in size in terms of total assets. The asset
distribution of the two banks' risky assets, as well as the weights, are as follows:

(a) Calculate, without accounting for risk, the regulatory capital required for each bank to
maintain a capital ratio of 10%.

(b) What is the risk-adjusted capital ratio for each bank?

(c) Comment on your results with reference to the perceived risk insensitivity of the Basel
accords.

3. Consider the following asset distribution with the associated probabilities of default and rates
of return:
(a) Calculate the regulatory capital to be held for the bank to maintain a capital ratio of 12%
without accounting for risk.

(b) Assume that risk weights are proportional to the probabilities of default. By assigning a
weight of 1 to the most risky asset, calculate the risk-adjusted capital ratio.

(c) Calculate the rate of return on the asset portfolio.

(d) Assume now that the bank indulges in regulatory capital arbitrage by moving out of assets 3,
4, and 5 equally into 1 and 2. What is the rate of return on the portfolio? What is the regulatory
capital to be held to maintain a capital ratio of 12% without and with the risk factor?

(e) Calculate the regulatory capital required to maintain a capital ratio of 12% with and without
taking account of risk if the bank decided to securities assets 1 and 2.

4. Consider a bank that holds five different kinds of loans. The following table shows the
probability of default (PD), loss given default (LGD) and exposure at default (EAD) for each
type.

If the probabilities of default are independent, calculate the total expected loss.

5. Using the basic indicators approach to operational risk, calculate the regulatory capital
required to be Basel II-compliant for a bank that has the following figures for gross income
over the past three years: 250, -60, 750. Take α = 0.15.
6. Consider a firm with the following gross incomes over a period of three years:

(a) Calculate capital charge under BIA and STA, and comment on the results