Basel II, Pillar 3

[Xin Zhan]

Pillar 3 required banks to disclose: A list of instrument comprising the bank's Tier 1 capital, just wondering, what other instrument is in Tire 1 capital, other than common stock and perferred stock.

 

[David Harper CFA FRM]

Hi @cindyzhan

In Basel II, the capital elements are defined in the appendix (http://www.bis.org/publ/bcbs128.htm) with Tier 1 elements as follows

D. Definition of capital elements
(i) Tier 1: includes only permanent shareholders' equity (issued and fully paid ordinary shares/common stock and perpetual non-cumulative preference shares) and disclosed reserves (created or increased by appropriations of retained earnings or other surplus, e.g. share premiums, retained profit, general reserves and legal reserves). Disclosed reserves also include general funds (such as fund for general banking risk in certain EC countries) of the same quality that meet the following criteria:

• Allocations to the funds must be made out of post-tax retained earnings or out of pre-tax earnings adjusted for all potential tax liabilities;
• The funds and movements into or out of them must be disclosed separately in the bank’s published accounts;
• The funds must be available to a bank to meet losses for unrestricted and immediate use as soon as they occur;
• Losses cannot be charged directly to the funds but must be taken through the profit and loss account.

In the case of consolidated accounts, this also includes minority interests in the equity of subsidiaries which are less than wholly owned. This basic definition of capital excludes revaluation reserves and cumulative preference shares.

And, as you say, Pillar 3 disclosures of Tier 1 capital are required ...

[Basel II Part 4: The Third Pillar – Market Discipline]
C. Capital > Capital Structure
The amount of Tier 1 capital, with separate disclosure of:

• paid-up share capital/common stock;
• reserves;
• minority interests in the equity of subsidiaries;
• innovative instruments;
• other capital instruments;
• surplus capital from insurance companies;
• regulatory calculation differences deducted from Tier 1 capital; 188 and
• other amounts deducted from Tier 1 capital, including goodwill and investments.

I hope that helps, thanks!

 

[Srilakshmi]

Hi David,

Some of the syllabus talks about credit equivalent amount under Basel 1 and its calculations. Are we required to know this for exam sake?

Thank you,
Sri

 

[emilioalzamora1]

Are you purely taking the FRM 'for exam sake' or to enrich your skillset in the long run?

The question has always to be 'YES'. An eager FRM candidate must strive for the best knowledge and not speculate on sth. what might show up on the exam.

Anthony Saunders 'Credit Risk Management In and Out of the Financial Crisis' writes:

'For the purposes of capital regulation under Basel I codes, the calculation of risk-adjusted asset values of Off-Balance-Sheet market contracts requires a two step approach: 1. credit equivalent amounts are calculated for each contract 2. and the credit equivalent amounts are multiplied by an approporiate risk weight.
The notional or face values of all non-exchange traded swap, forward and derivative contracts are first conversted into credit-equivalent amounts (as if they are on-balance sheet instruments)'

 

[Srilakshmi]

Well, I was just asking where in David's notes I can look up this as the notes start with Basel 2. Thanks for the reference and take it easy.