Abstract

This chapter aims to provide a concise overview of the capital adequacy regulation, importance of the regulation, and evolution of the capital adequacy regulation. Bank capital executes the significant role of preventing the bank from failure and acts as a buffer against possible losses. Capital adequacy is the least amount of capital a bank has to preserve to execute the business, take advantage of profitable growth opportunities, absorb losses, and sustain the customers’ confidence on it. Several bank crises and bank defaults motivate the Basel Committee on Banking Supervision to provide a comprehensive guideline in managing bank capital. The capital adequacy regulation is an international standard to safeguard the banks through setting a risk-sensitive minimum capital requirement. The regulatory authority sets the regulatory capital, and the operating banks are required to maintain the adequate level of capital.

Highlights

  • History of several bank failures evidences how the excessive risk taking can affect the whole economy as well as the global financial scenario

  • Even though the eligible regulatory capital consists of core capital and supplementary capital, to cover the market risk, bank at its discretion can build Tier 3 capital that consists of short-term subordinated debt

  • Risk-weighted asset for credit risk is calculated for credit risk-weighted assets (RWA) for exposure in banking book except the counterparty credit risk arising from equity investment, securitization exposure, and trading book instruments

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Summary

Introduction

History of several bank failures evidences how the excessive risk taking can affect the whole economy as well as the global financial scenario. Since bank deals with different kinds of risks, the regulators strive to minimize this risk exposure through different regulations. The key regulations aiming to minimize the risk and bank failure is the capital adequacy regulation. The principle of the capital adequacy regulation is based on the fact that the minimum capital should be high enough to absorb the potential losses. While capital acts as a buffer for the bank, in the distressed period, the higher the buffer, the lower the risk of default. The importance of maintenance of adequate level of capital is never overestimated. This chapter will present a brief history of capital adequacy regulation and the evolution of the regulation over time

Basel Committee on Banking Supervision
Regulatory capital and economic capital
Basel I
Basel II
Pillar I or minimum capital requirement (MCR)
Credit risk
Operational risk
Market risk
Pillar II or supervisory review process (SRP)
Pillar III or market discipline
Basel III
Capital conservation buffer and countercyclical buffer
Islamic banking and capital regulation
Empirical studies on capital regulation and bank risk
Findings
Conclusion
Full Text
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