Question

1)

The following sources of capital make up A) Common Equity Tier-1 Capital (CET-1) and B) Tier-1 Capital - Check all that apply

a. Common Equity b. Preferred Equity c. Non-Controlling Minority Interests d. Controlling Interests e. Retained Earnings f. Other Current Income g. Goodwill

2)

Risk Weighted Capital (RWA) is a standardized methodology of assessing a bank’s balance sheet vs the Total Assets approach. Calculate the CET-1 and Leverage Ratios for the following two hypothetical Banks. Which bank is more profitable in your opinion (why?). Which bank is more risky in your opinion (why?)

	Bank1	Bank2
Short Term Assets, i.e. Liquidity: (Cash or Cash Equivalents)	500	100
Long Term Assets, i.e Investments (US Treasury Notes and Bond	1000	5000
Other Assets, i.e. Secured Loans (Revolvers/Lines of Credit, Term Loans, Asset Based Lending)	5000	1400
OCI (Commissions, Fees, Non-Recurrent Income)	25	25
Net Income or Net Earnings	250	50
Retained Earnings	150	0
RWA
Total Avg Assets	6500	6500
Preferred Stock	250	750
Common Stock	750	250
CET-1 Capital
Tier-1 Capital
CET-1 Capital Ratio
Tier-1 Leverage Ratio

3)

3. Answer Trueor False

   1. POTUS can fire for cause the Chairman of the FED

   2. All banks licensed to do business in the US are subject to an annual CCAR stress

      testing

   3. If a bank fails CCAR, they are given the opportunity to repair any deficiency and

      re-submit the plan

   4. The min CET-1 Capital Ratio is 4.5% while the minimum Tier-1 Capital Ratio is

      6%

      The following questions are based on the chart below

   5. European Banks are less profitable than their US counterparts

   6. US Banks have higher operating cost margin

   7. US vs European banks are equally well capitalized

   8. US Banks have maintained the size of their balance sheet during 2018-2019

   9. European Banks have taken more loss provisions during 2018-2019

   10. European banks drove to profitability by reducing expenses and taking less loss provisions vs their US counterparts in 2018-2019

Answer 1

1. The Bank for International Settlements (BIS) provides the definition of capital, the latest being the BASEL III framework. See below.

Note that only those categories which have the highest loss-absorbing capacity are categorised as the Tier-1 capital of the bank.

So, Common Equity Tier-1 Capital (CET-1) includes Common Equity, Retained Earnings and Other Current Income

Tier-1 Capital includes CET-1 capital, Preferred Equity, Non-Controlling Minority Interests, Controlling Interests

Note that Goodwill is not part of the capital. In reality, goodwill and other intangible assets are actually subtracted from the retained earnings to arrive at the CET-1 and Tier-1 capital number. This is because Goodwill is just an accounting entry and does not provide any loss absorbing capacity.