Financial Regulation Repricing Gap of Planning

Question: Describe about the Financial Regulation for Repricing Gap of Planning. Answer: Part A. Repricing gap if planning period is 3 month Maturity Assets Liability Cumulative Gap 3 months 150 -150 Maturity Assets Liability Gap Cumulative Gap 3 months 150 -150 -150 6 months 50 50 -100 9 months 150 -150 -250 1 year 520 -520 -770 2 years 100 200 -100 -870 2.) Interest foregone on the rate sensitive assets: 14.91 (0.6% on 2485 for 6 months) Interest to be paid on the rate sensitive liabilities: 6.0125(0.25% on 2405) Hence net interest income would come down by 20.9225 3.) Under asset liability management financial institutions seeks to minimize the hazards related with mismatch arising between asset items and liability items on the balance sheet of a bank. If the in demand deposits decrease it would lead to a mismatch between assets and liabilities. The assets would decrease and hence the banks volatility would increase. 4.) Basel III norms demand that any time a bank maintains common equity and retained earnings which is not less than 4.5% of the Risk Weighted Assets. CET1 is given by Equity + Retained earnings/Risk weighted assets. In the following table RWA is calculated by assigning risk weight as er Basel III directives as follows: Givt securities and cash:0% Corporate exposure:100% Personal Loans: 100% Foreign exposure with credit rating B, BB:100% Total Equity and retained earnings as per the balance sheet is 80. Hence value of Risk Weighted assets can be a maximum of 1777 as per the formula applicable. However, from the table above we find that the value of RWAs is calculated as 2290. Hence as per Basel 3 norms the bank is not equipped to handle an economic downturn. Part B 5. Amount Duration(years) Weighted Duration(years) 250 5 12.5 100 10 10 350 10 35 Average Duration 57.5 Total value of assets is 700 million Amount Duration Weighted Duration 250 0.5 1.25 200 3 6 100 3 3 50 Average Duration 10.25 Total value of liabilities is 700 million Hence duration gap is Dur gap=Dura-(L/A*Durl) 57.5- (1*10.25) Duration gap is 47.25 years 6.) Change in net worth/Assets is given by -Dur gap* (Change in interest rate/1+i) Since change in interest rate is 1.5% and interest rate earlier was 6.5% plugging the values we get change in net worth as -0.66%. 7.) Maturity gap of banks seeks to measure albeit in a traditional way the interest rate risk arising by the changes in quantum of value of assets and liabilities which are bound to be affected by fluctuations in interest rate at relevant intervals. Each different class of asset or liability defines an interval that must be assessed. Part C Difference between Basel and Basel 3 norms The global financial crisis of 2007-2008 which led to a greater need for capital mountainous by the banks so they be better equipped to handle any crisis and financial or economic downturn. (Kubat, 2014)The table below summarises the key differences between Basel 2 and Basel 3. Basel II Requirement Basel III 8% Minimum ratio of Total capital to RWAs 10.5% 2% Minimum ratio of common equity to RWAs 4.5-7% 4% Tier 1 capital to RWAs 6% 2% Core tier 1 Capital to RWAs 5% None Capital conversation buffer to RWAs 2.5% None Leverage Ratio 3% None Countercyclical buffer 0-2.5% None Minimum liquidity Coverage ratio Tbd None Minimum Net stable funding ratio Tbd None Systematically important financial institutional change Tbd *Tbd stands for to be decided. Let us look at the various areas where Basel III seeks to improve over Basel II Changes in definition of capital When we compare Basel III with Basel II one striking difference is how the two norms define capital. There is stress on definition of key items. A notable omission is that of T3 as a capital component which was deemed so essential earlier to cover market risks, now only Tier and Tier 2 remain and there is clear purpose and intent seen of consolidating the Tier 1 component. The main aim of this change would be to improve the quality, consistency and transparency of the capital. Industry experts and veterans and the committee members of Basel themselves opine that the changing and inconsistent definition of capital across all levels might have been the biggest reasons why Basel II norms couldnt avoid the GFC of 2007-08 Capital requirements changes Capital requirements were made more stringent which means that banks need to hold more liquidity and more capital. As a result of this the banks cannot indulge in excessive leveraging the way they did in Pre Basel III era, one of the key reasons for the downfall of behemoths such as Lehman and Bear Sterns. Problems faced in implementing Basel III Even though the measures implemented in Basel III seek to tighten the capital requirements on banks and seek to avoid any financial crisis akin to the one that happened in 2007 industry veterans have criticised the complexity of Basel III. While Basel I had seven risk Basel III has more than 200,000 categories with more than 200 million calculations.(Caprio, 2014) Therefore its but natural the banks have been facing problems in implementing Basel III norms. Apart from its complexity the increased quantity and quality of capital required is going to be time taking and time consuming.(Jayadev, 2013) References Caprio, G., 2014. Financial Regulation after the Crisis:How Did We Get Here, and How Do We Get Out?, s.l.: s.n. Hussain, M. S., Akhtar, W. Ahmad, K., 2015. Challenges and failure of Implementation of Basel Accord II and reasons to adopt asons to adopt, s.l.: s.n. Jayadev, M., 2013. Basel III implementation: Issues and challenges for Indian banks. IIMB Management Review, 25(2), pp. 115-130. Kubat, M., 2014. DOES BASEL III BRING ANYTHING NEW? A COMPARISON. Vienna, s.n.