Commercial Banks and Basel III

Flashcards about commercial banks, their activities, sources and uses of funds, off-balance-sheet business, regulation, and Basel III.

Commercial banks

Provide a full range of financial services.

Liability management

Managing deposit base and funding sources to meet loan demand, including borrowing from capital markets and providing other financial services.

Current account deposits

Funds held in a cheque account, highly liquid, may or may not be interest-bearing.

Call or demand deposits

Funds in savings accounts withdrawable on demand, including passbook and electronic statement accounts.

Term deposits

Funds lodged for a fixed term at a specified interest rate, with higher rates than current accounts but loss of liquidity.

Negotiable certificates of deposit (CDs)

Paper issued by a bank at a discount, repaying face value at maturity, highly negotiable and short term (30-180 days).

Bill of exchange

A security issued at a discount, repaid at face value at maturity; bank acceptance guarantees repayment.

Acceptance

Bank accepts primary liability to repay face value of bill to holder

Debt liabilities

Medium- to longer-term debt instruments issued by a bank.

Debenture

A bond supported by a security, like a floating charge over assets.

Unsecured note

A bond issued without supporting security.

Foreign currency liabilities

Debt instruments in foreign currency, diversifying funding and matching foreign exchange assets.

Loan capital and shareholders’ equity

Sources of funds with debt and equity characteristics, e.g., subordinated debentures.

Mortgage

Housing finance, amortized loan.

Fixed-term loan

A loan with negotiated terms and conditions, including interest rates and repayment schedules.

Fixed-term loan

A loan with negotiated terms and conditions, including interest rates and repayment schedules.

Overdraft

A facility allowing a business to take its operating account into debit.

Treasury notes

Short-term discount securities issued by the government.

Treasury bonds

Medium- to longer-term government securities paying a specified coupon.

Off-balance-sheet (OBS) business

Transactions that are not reflected on a bank's balance sheet but involve contingent liabilities and potential risks.

Direct credit substitutes

Undertakings by a bank to support a client's financial obligations, such as stand-by letters of credit.

Trade- and performance-related items

Guarantees provided for non-performance of a commercial contract, such as documentary letters of credit.

Commitments

Contractual financial obligations yet to be completed, such as forward purchases and underwriting.

Foreign exchange, interest-rate- and other market-rate- related contracts

Use of derivatives to manage exposures to foreign exchange, interest rate, equity price, and commodity risk.

Regulation and prudential supervision

Program of financial system reform culminating in Basel III, addressing leverage and stability.

Prudential supervision

Maintaining standards to ensure the soundness and stability of the financial system.

Reserve Bank of Australia (RBA)

System stability and payments system oversight.

Australian Prudential Regulation Authority (APRA)

Prudential regulation and supervision of deposit-taking institutions.

Australian Securities and Investments Commission (ASIC)

Market integrity and consumer protection.

Australian Competition and Consumer Commission (ACCC)

Competition policy.

Functions of capital

Capital acts as a buffer against abnormal business losses.

Basel III capital adequacy standards

Minimum capital adequacy for banks, designed to promote financial system stability.

Basel III main features

Focuses on the denominator of the capital ratio and internal models used to measure risk-weighted assets.

Capital adequacy standard

Minimum risk-based capital ratio of 8%, with at least 4% as Tier 1 capital (core capital).

Tier 1 capital

Includes common shares, retained earnings, and other reserves.

Tier 2 capital

Includes subordinated debt and general loan-loss reserves.

Credit risk

Risk that borrower will not meet commitments.

Standardised approach

Risk weights applied to balance-sheet and OBS items to calculate minimum capital requirement.

OBS items conversion

Converting OBS items to balance-sheet equivalents using credit conversion factors.

Internal ratings-based approach

Banks using their own risk measurement model factors, subject to approval.

Foundation internal ratings-based approach (FIRB)

Bank determines probability of default and effective maturity.

Advanced internal ratings-based approach (AIRB)

Bank provides estimates of all credit risk components.

Value at Risk (VaR)

Became widely used to set aside enough capital to cover losses that could be incurred in a 30-day period with 95% confidence

Operational risk

Risk of loss from inadequate internal processes, people, systems, or external events.

Market risk

Risk of losses resulting from changes in market rates (FOREX, interest rates, equities, commodities).

General market risk

Changes in the overall market for interest rates, equities, FOREX and commodities.

Specific market risk

Changes in the value of a security due to issuer-specific factors.

Pillar 2—Supervisory review of capital adequacy

Ensuring banks have sufficient capital and improved risk management.

Pillar 3—Market discipline

Develop disclosure requirements to allow the market to assess an institution's capital adequacy.

Basel III liquidity standards

liquidity coverage ratio (LCR) & net stable fund ratio (NSFR)

Liquidity

Access to sources of funds to meet day-to-day expenses and commitments.

Strategies to manage liquidity

setting limits on maturity mismatches between assets and liabilities – holding high-quality liquid assets – diversifying liability sources to maintain a stable funding base