Suspected Mistake in Spreasheet 7.d.1 (capital adequacy ratio)

[Liming]

Dear David,o

I suspect that there is mistake made with spreadsheet 7.d.1 when you calculate the total tier 1 capital and the capital adequacy ratio. I think similar to tier 2 and tier 3 capital calculation, tier1 capital should be 300+100+400 = 800, instead of 900 in your original answer. And this makes the capital ratio = 8% not 8.55%.

Thank you.

Cheers
Liming
22/10/2009

 

[David Harper CFA FRM]

Hi Liming,

The tier 1 is different in the respect that it is not limited; e.g., Tier 2 cannot exceed Tier 1 and notice some of the Tier 3 is unused b/c it can only be used for market risk and can only be 2.5 of Tier 1.
... so all of the "available" Tier 1 counts toward the adequacy ratio. It is high quality; e.g., if the example only had Tier 1, then it could be used for everything and the ratio could have no limit as Tier 1 / RWA
...we might think of it in reverse to the way it is shown: all of the Tier 1 is counted, and then it is a matter of what fraction of Tier 2 & Tier 3 are counted

Thanks, David

 

[David Harper CFA FRM]

...I did not express very well. The "logic" of the XLS (and the eligible capital) is:

1. how much Tier 3 can be used? Since only for market risk and limit 2.5x Tier 1 and MRC = 350, most of Tier 3 that can be used = 250
(i.e., x + 2.5X = 350, so x = 100 = tier 1)
2. how much Tier 2 can be used? since limit is 1x Teir 1, can use limit of 300 for CRC ... but only 100 remains ... so Tier 2 = 300 for CRC and 100 for ORC...Tier 2 fully used
3. The rest is Tier 1 and can be used entirely

hope that helps, David

 

[hsuwang]

Hello David,

I think cell L13 (Tier 1) should be the sum of all L1 capital used, which is 300(credit)+100(market)+400(operation) = 800 instead of the 900 you showed in cell L13. Or we are not simply adding how much Tier 1 capital we have used, but how much is available?

Thanks.

 

[David Harper CFA FRM]

Hi Jack,

I think that is tempting, but (and I am consistent with Jorion Table 29.4 in the handbook well, because, let's face it, I built it from that table!) ... 300+ 100+400 = the minimum Tier 1 capital that is required to cover the three risks. But the extra $100 Tier 1 still accrues to capital adequacy; it is not needed but it is "eligible buffer" ... it can be used for any of the categories (unlike Tier 2 & 3)...

put simply, all Tier 1 counts ... the exercise can be viewed as necessary only b/c T2 & T3 have constraints.

David