FINA3304 Banking: Theory & Practice Tutorial 10
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Banking: Theory & Practice (FINA3304)
Tutorial 10 (Week 11)
1. Explain the differences between Tier 1 and Tier 2 capital. Read the attached article on CoCos and explain how they sit within Basel III regulatory reforms.
2. Mercantile Bank has the following balance sheet (in millions of dollars) and has no off- balance-sheet or securitisation activities.
Assets |
Liabilities and equity |
||
Cash |
$20 |
Deposits |
$980 |
Australian Treasury Bonds |
40 |
Subordinated debt |
40 |
Insured standard residential mortgages with LVR of 84% |
600 |
Common equity |
40 |
Other loans rated BB+ |
430 |
Retained earnings |
30 |
Total assets |
$1090 |
Total liabilities and equity |
$1090 |
a) What is the value of the regulated capital measures (that is, Common Equity Tier 1, Total Tier 1, Total capital)
b) What is the value of credit-risk-weighted assets?
c) Assuming that operational risk and market risk are zero, calculate the three capital adequacy ratios, namely Common Equity Tier 1 (CET1), Total Tier 1 and Total Capital).
(Note to students: (a) is asking for the amount of capital whereas (c) is asking you to calculate the capital adequacy ratios.)
3. Onshore Bank has $20 million in assets, with risk-adjusted assets of $10 million. Tier I capital is $700 000, and Tier II capital is $300 000. How will each of the following transactions affect the value of the Tier I and total capital ratios? What will the new values of each ratio be?
a) The bank repurchases $100 000 of ordinary shares.
b) The bank issues $2 million of CDs and uses the proceeds for standard residential mortgages in the 50 per cent risk weighting category.
c) The bank receives $500 000 in deposits and invests them in Australian government bonds.
d) The bank issues $800 000 in ordinary shares and lends it to help finance a new shopping mall.
4. What is the contribution to the asset base, of an Australian bank, of the following individual items when calculating its capital adequacy ratio? What is the Total Regulatory Capital that must be held against each one?
(a) $10m cash reserves
(b) $50m in 13 week Australian Commonwealth Treasury Notes
(c) $2m bond from a local government in NSW with a A-rates.
(d) $500m secured (fully insured) home mortgages with loan to valuation ratio of 80%.
(e) $100m unsecured (no insurance) home mortgages with loan to valuation ratio of 95%
(f) $100,000 direct credit substitutes: standby letter of credit (serving as a financial guarantee) for a C-rates Australian company.
(g) A$3m five year loan commitment (with certain drawdown) to a A-rates overseas government
Use the current exposure methods for the following contracts
(h) $4m five year, interest rate swap, current exposure is $10,000; the counterparty is a A-rates Australian Local Government; Contract has 2 years to run.
(i) $6m four year currencies swap with $50,000 current exposure; counterparty is a BBB-rates non-commercial public sector entity; contract has 1 year remaining.
(Note to students : Please use the table format as in the worked example in the lecture.)
Additional questions for self-study
Q1 Why is the market value definition of capital preferred to book value definition?
Q2 What are the three capital adequacy ratios and the minimum requirements for each?
Q3 What are the two capital buffers introduced under BASEL III and when are they used?
2022-05-26