Question

a) Explain what “capital adequacy” means.

-Capital adequacy is a ratio of the bank's ability to hold sufficient capital to increase its bank assets through additional loans while maintaining enough equity capital to pay for depositors each time they demand money. The bank records the ratio of equity capital to its financial report. It is expressed as a percentage of assets in terms of equity capital. The capital requirements required by national regulators tend to be modest machine rules rather than applying classy risk models. Businesses have many stakeholders expected to meet their needs, shareholders want high returns, maximize wealth, creditors and society expect risk coverage for potential losses.

b)Then explain how it has been used to try and address risk management of banks.

-Capital adequacy ratio equals bank’s tier I capital plus bank’s tier II capital divided by risk-weighted asset. Tier I capital is the capital that can buffer and permanently resolve the losses the bank has suffered without requiring an outage. A good example of a bank's tier I capital is usually its ordinary share capital. Bank’s tier II capital is low to protect depositors and creditors, as it is to cover losses if the bank collapses. The bank is used to absorb the loss if all the bank’s tier I capital stage loses capital. When measuring credit exposures, adjust the asset values ??listed in the lender's balance sheet. All loans issued by banks are weighted according to degree of risk.

Shareholders’ demand on returns of capital invested in banks is very high, therefore ensuring that capital is not unnecessarily high is important. On the other hand, in the case of creditors and society, it is important for banks to maintain sufficient buffer or risk capital to cover potential losses. Therefore, the capital adequacy rules set minimum requirements for the buffer size based on the degree of risk that the bank will bear.

c) Finally, as an opinion, relate if you think this has been helpful through the Basel Accords.

please let me know if you see any error on question a) and b) then please help me with question c).

it worth lots of points so please provide details for the answer. thank you

Answer 1

c. Yes, Basel Accords has been helpful while addressing risk management of banks. Under the Basel III a bank has to maintain a minimum capital adequacy ratio of 8%. This means that a bank’s capital in relation to its risk-weighted assets has to be 8%.

Norms and regulations of Basel Accords help in strengthening the stability of banking system. The focus is on capital and liquidity. Good quality capital helps to ensure stable long term sustenance for a bank. This will lead to compliance with liquidity covers. As a result a bank will be able to absorb shocks of any short term economic and financial stress. It will also help banks to strengthen its liquidity profile. As was experienced in the 2008 financial crisis many banks with adequate capital levels had faced difficulties.

A bank can use its capital adequacy and risk management report to get a consolidated risk profile by customer categories as well as by risk asset classes. A bank will be able to assess incremental risk types that it is potentially exposed to and hence it will be able to quantify the amount of capital required for the identified risks.

(There are no errors in “a” and “b”).