Basel 2.5,Basel Ill,andDodd-FrankChapter 13RiskManagementandFinanciallnstitutions3e,Chapter13,CopyrightJohnC.Hull2012
Basel 2.5, Basel III, and Dodd-Frank Chapter 13 Risk Management and Financial Institutions 3e, Chapter 13, Copyright © John C. Hull 2012 1
Basel 2.5 (Implementation: Dec 31, 2011). Stressed VaR for market riskCalculated over one year period of stressedmarket conditionsCapital = max(VaRt-1,m. ×VaRavg)+max(sVaRt-1, m, ×VaRavg)Incremental Risk ChargeEnsures that products such as bonds and creditderivatives in the trading book have the samecapital requirement that they would if they were inthe banking book2RiskManagementandFinancialInstitutions3e,Chapter13,CopyrightJohnC.Hull2012
Basel 2.5 (Implementation: Dec 31, 2011) • Stressed VaR for market risk – Calculated over one year period of stressed market conditions – Capital = max(VaRt-1 ,mc ×VaRavg) +max(sVaRt-1 , ms ×VaRavg) • Incremental Risk Charge – Ensures that products such as bonds and credit derivatives in the trading book have the same capital requirement that they would if they were in the banking book Risk Management and Financial Institutions 3e, Chapter 13, Copyright © John C. Hull 2012 2
Basel2.5 continuedComprehensiveRiskMeasureDesigned to make sure sufficient capital iskept for instruments in the trading book thatdepend on on credit default correlationsStandard approach:ABBBBBAAA orBelow BCredit RatingAA4%8%28%1.6%SecuritizationsDeduction3.2%8%18%52%ResecuritizationsDeduction3RiskManagementandFinancialInstitutions3e,Chapter13,CopyrightJohnC.Hull2012
Basel 2.5 continued ⚫ Comprehensive Risk Measure ⚫ Designed to make sure sufficient capital is kept for instruments in the trading book that depend on on credit default correlations ⚫ Standard approach: Risk Management and Financial Institutions 3e, Chapter 13, Copyright © John C. Hull 2012 3 Credit Rating AAA or AA A BBB BB Below B Securitizations 1.6% 4% 8% 28% Deduction Resecuritizations 3.2% 8% 18% 52% Deduction
Basel IllCapital Definitionand RequirementsCapitalConservationBufferCountercyclical BufferLeverage RatioLiquidity RatiosCapital for CVA RiskRiskManagementandFinancialInstitutions3e,Chapter13,CopyrightJohnC.Hull20124
Basel III ⚫ Capital Definition and Requirements ⚫ Capital Conservation Buffer ⚫ Countercyclical Buffer ⚫ Leverage Ratio ⚫ Liquidity Ratios ⚫ Capital for CVA Risk Risk Management and Financial Institutions 3e, Chapter 13, Copyright © John C. Hull 2012 4
Capital Definition andRequirementsThree types:Common equity Tier 1Additional Tier 1Tier 2Definitions tightenedLimitsCommonequity>4.5%ofRWATier 1 > 6% of RWATier 1 plus Tier2 > 8% of RWAPhased implementation of capital levels stretching to January1,2015Phased implementation of capital definition stretchingtoJanuary 1, 2018RiskManagementandFinancialInstitutions3e,Chapter13,CopyrightJohnC.Hull20125
Capital Definition and Requirements • Three types: – Common equity Tier 1 – Additional Tier 1 – Tier 2 • Definitions tightened • Limits – Common equity > 4.5% of RWA – Tier 1 > 6% of RWA – Tier 1 plus Tier 2 > 8% of RWA • Phased implementation of capital levels stretching to January 1, 2015 • Phased implementation of capital definition stretching to January 1, 2018 Risk Management and Financial Institutions 3e, Chapter 13, Copyright © John C. Hull 2012 5