BASEL III Capital Ratios

[NNath]

Hi @David Harper CFA FRM.

The Capital ratios are 4.5%, 6% and 8% , with CCB its 7%, 8.5% and 10.5%,
Now the RWA is 100 and the buffers are
5 for CE Tier 1, 2 for Additional Tier 1, 3.5 for Tier 2

Bank satisfies capital requirements ? We have 4 options.
a) Yes, because its Total Capital Ratio of 10.5% is sufficient
b) No, because it does not hold enough Common Equity Capital
c) No, because its Tier 1 Capital Ratio is insufficient
d) No, because the bank has no buffer-quality capital to contribute to its Capital Conservation Buffer

If we don't follow an order (i.e check Equity tier 1 then total tier 1 and then total capital) then we can mark option a is correct since 5+2+3.5=10.5 that satisfies total capital. But if we follow an the order to check option b is the correct answer. I believe we should check in an order and mark the first that seem incorrect.
Hence if option b was not there we will mark c as correct (follow the order).

Please verify.

 

[David Harper CFA FRM]

Hi @NNath The question looks good to me. A question should never depend on the sequence (order) of your review of the choices. But I do not think this question depends on the sequence. The question asks, I presume, "does the bank satisfy capital requirements?" The capital rules (copied below) must all be met, so choice (A) is false, as this bank does not meet all of the minimums. The correct answer must be a "No," and only (b) explains correctly why the bank does not satisfy:

• Bank has CE Tier 1 = 5%, which satisfies requirement of CE Tier 1 ratio of 4.5% but does not satisfy CE T 1 + CCB of 7.0%; i.e., the bank does not hold enough common equity capital
  
• Banks has Tier 1 = 7% which does satisfy Tier 1 capital ratio of 6.0% but does not satisfy T1+CCB of 8.5%; I happen to think choice (c) is false because I think this bank does meet its Tier 1 capital ratio of 6.0% but others can disagree (see https://forum.bionicturtle.com/threads/p2-t7-404-basel-iii-capital-ratios.7936). I don't tend to include CCB in the "Tier 1 ratio" because CCB is not an absolute minimum (breaching it just limits dividends).
• Bank has Total 10.5% which does satisfy Total Capital ratio and Total Capital + CCB of 10.5%; i.e., this bank's total capital ratio is sufficient, but (a) is still incorrect because the bank does not satisfy all requirement.
  
• Choice (D) is also false because 0.5% of CE T1 is available for CCB.

So I happen to agree with the question, and I do not think (a) is ever true, however based on the linked discussion, I think some will argue that (c) appears to be viable if you want to interpret the "Tier 1 ratio" as as the full 8.5 (inclusive of CCP). But I do not read Basel III that way. From Basel III:

B. The framework
129. A capital conservation buffer of 2.5%, comprised of Common Equity Tier 1, is established above the regulatory minimum capital requirement. [see footnote 47] Capital distribution constraints will be imposed on a bank when capital levels fall within this range. Banks will be able to conduct business as normal when their capital levels fall into the conservation range as they experience losses. The constraints imposed only relate to distributions, not the operation of the bank.

[footnote 47] Common Equity Tier 1 must first be used to meet the minimum capital requirements (including the 6% Tier 1 and 8% Total capital requirements if necessary), before the remainder can contribute to the capital conservation buffer.