Since the global financial crisis, regulatory authorities, financial institutions and financial markets globally have increasingly focused...

Since the global financial crisis, regulatory authorities, financial institutions and financial markets globally have increasingly focused on risk and resilience in the banking sector. One of the main changes in the international framework was to increase the amount and quality of capital.

a. What are the rationales behind these stricter capital requirements? (3.5 marks)

b. Discuss the implications of the capital requirements on financial institutions taking into account the current coronavirus pandemic.

Expert Solution

A. Since the financial crisis multiple agencies have analyzed the reasons for the crisis and have unanimously voiced the concern on the risk and return trade off of financial participants especially Banks. All Global agencies especially the BIS and Basel committee have highlighted the need for risk assessed capital requirements which can help the Banks survive extreme market conditions (like that of Global recession in 2009) and thus avoid a financial contagion in Global markets. The norms included minimum capital requirements by tiers, capital to endure cyclical changes in balance sheets, leverage and liquidity measures etc. All these measures where aimed at bringing more transparency in Banking sector and avoid a Lehmann crisis kind of a scenario.

2. Current coronavirus pandemic scenario has impacted people from all walks of life to a great extent. Lockdowns across the Globe has put businesses to a standstill and many have failed for bankruptcy. This has increased the credit risk a Bank faces with increase in the risk of default of the borrowers. Banks will now have to price this risk into their pricing mechanism to ensure that they have considered the environment factors while determining the default risk in their portfolio. Also Banks will also have to access the riskiness of different businesses in the current scenario (travel and tourism maybe more riskier than a EPC industry). These new changes in the market place needs to be analyzed before making any decisions in order to avoid huge losses.

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