Capital, Liquidity, and Risk Management

6.1 The Evolution of Banking Capital Standards

The Basel Committee on Banking Supervision (BCBS) has established a succession of capital standards :

  • Basel I (1988): Focused on credit risk with a simple risk-weighting system for assets.

  • Basel II (2004): Introduced a three-pillar framework covering minimum capital, supervisory review, and market discipline.

  • Basel III (Post-2008): Enhanced capital requirements, introduced capital conservation buffers, and introduced global liquidity standards.

6.2 Key Pillars of Basel III/IV

  • Minimum Capital Requirements:

    • Common Equity Tier 1 (CET1): At least 4.5% of risk-weighted assets (RWA).

    • Tier 1 Capital: At least 6% of RWA.

    • Total Capital: At least 8% of RWA.

  • Liquidity Requirements:

    • Liquidity Coverage Ratio (LCR): Banks must hold enough high-quality liquid assets to survive a 30-day stress scenario.

    • Net Stable Funding Ratio (NSFR): Banks must maintain a stable funding profile over a one-year horizon .

  • Leverage Ratio: A non-risk-based backstop measure requiring banks to hold a minimum level of Tier 1 capital against total exposure.

  • Capital Conservation and Countercyclical Buffers: Additional capital requirements imposed during periods of high credit growth.

6.3 Internal Capital and Liquidity Assessment Processes

Supervisory review is a key component of Basel. The mandates include two critical processes for banks :

  • ICAAP (Internal Capital Adequacy Assessment Process): The bank’s own assessment of its capital adequacy considering all material risks.

  • ILAAP (Internal Liquidity Adequacy Assessment Process): The bank’s assessment of its liquidity needs.

6.4 Impact on Banking Activities

The Basel standards impact the commercial or risk policy of a bank and directly affect the day-to-day work of front officers, such as loan officers .

 
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