Learning outcomes: Describe and calculate ratios intended to improve the management of liquidity risk, including the required leverage ratio, the liquidity coverage ratio, and the net stable funding ratio. Describe the mechanics of contingent convertible bonds (CoCos) and explain the motivations for banks to issue them.
Questions:
522.1. What is the key difference between the Basel III leverage ratio and the other regulatory ratios (i.e., core Tier 1 equity capital ratio, total Tier 1 capital ratio, and total capital ratio)?
a. The numerator of the leverage ratio is not regulatory capital, rather it is adjusted for the risk of the funding source
b. The denominator of the leverage ratio is assets on the balance sheet without risk weighting (plus some off-balance-sheet items such as loan commitments)
c. The leverage ratio is defined in terms of cash inflows and cash outflows and therefore provides an additional buffer against liquidity risk
d. There is no difference in the definition of the ratio; instead, the leverage ratio is simply the "placeholder ratio" which applies until the other regulatory ratios are fully phased-in in order to guard against systemic risk
522.2. In regard to the liquidity coverage ratio (LCR), net stable funding ratio (NSFR) and the credit value adjustment (CVA), each of the following is true EXCEPT which is not accurate?
a. The liquidity coverage ratio is the ratio of high quality liquid assets to net cash outflows during a stressed period of 30 days
b. The net stable funding ratio is the ratio of a weighted sum of the items on the “liabilities and net worth” side of the balance sheet divided by a weighted sum of the items on the “assets” side of the balance sheet
c. The net stable funding ratio will increase if retail deposits are replaced by wholesales deposits and if marketable securities are replaced by residential mortgages
d. The credit value adjustment (CVA) is a charge to income reflecting expected costs from counterparty defaults in derivatives transactions; Basel III requires the exposure of CVA to credit spreads to be included in the calculation of market risk capital
522.3. Which of the following is TRUE about contingent convertible (CoCo) bonds?
a. A drawback of CoCo bonds is that, prior to conversion, then hurt the bank's return on equity (ROE)
b. A popular trigger for CoCo bonds is the ratio of Tier 1 equity capital to risk-weighted assets
c. Regulators do not like CoCo bonds because they encourage regulatory arbitrage
d. CoCo bonds are NOT attractive to banks because they increase the odds of a public sector bailout if the bank experiences financial difficulty
Answers here:
Questions:
522.1. What is the key difference between the Basel III leverage ratio and the other regulatory ratios (i.e., core Tier 1 equity capital ratio, total Tier 1 capital ratio, and total capital ratio)?
a. The numerator of the leverage ratio is not regulatory capital, rather it is adjusted for the risk of the funding source
b. The denominator of the leverage ratio is assets on the balance sheet without risk weighting (plus some off-balance-sheet items such as loan commitments)
c. The leverage ratio is defined in terms of cash inflows and cash outflows and therefore provides an additional buffer against liquidity risk
d. There is no difference in the definition of the ratio; instead, the leverage ratio is simply the "placeholder ratio" which applies until the other regulatory ratios are fully phased-in in order to guard against systemic risk
522.2. In regard to the liquidity coverage ratio (LCR), net stable funding ratio (NSFR) and the credit value adjustment (CVA), each of the following is true EXCEPT which is not accurate?
a. The liquidity coverage ratio is the ratio of high quality liquid assets to net cash outflows during a stressed period of 30 days
b. The net stable funding ratio is the ratio of a weighted sum of the items on the “liabilities and net worth” side of the balance sheet divided by a weighted sum of the items on the “assets” side of the balance sheet
c. The net stable funding ratio will increase if retail deposits are replaced by wholesales deposits and if marketable securities are replaced by residential mortgages
d. The credit value adjustment (CVA) is a charge to income reflecting expected costs from counterparty defaults in derivatives transactions; Basel III requires the exposure of CVA to credit spreads to be included in the calculation of market risk capital
522.3. Which of the following is TRUE about contingent convertible (CoCo) bonds?
a. A drawback of CoCo bonds is that, prior to conversion, then hurt the bank's return on equity (ROE)
b. A popular trigger for CoCo bonds is the ratio of Tier 1 equity capital to risk-weighted assets
c. Regulators do not like CoCo bonds because they encourage regulatory arbitrage
d. CoCo bonds are NOT attractive to banks because they increase the odds of a public sector bailout if the bank experiences financial difficulty
Answers here:
