Question

2. If the bank has $ 20 million in Tier I capital and $7 million in Tier II capital which one of the following actions will bring the bank in to compliance with Basel I standards?

		A. Sell 100 million in commercial loans and $100 million in Treasury securities
		B. Sell 100 million in municipal bonds and $100 million in residential mortgages
		C. Sell 100 million in municipal bonds and $100 million in Treasury securities
		D. Sell 100 million in commercial loans and $100 million in municipal bonds

3. Basel I standards did not take into account:

		A. Off balance sheet obligations that produced risk exposures.
		B. Credit risk of various assets on the balance sheet.
		C. The book value of the assets.

4. The major difference in the way Fed treats the reserves before 2008 and after 2008 is:

		A. The reserves could not converted cash before 2008.
		B. The reserves were taxed before 2008,
		C. The reserves did not earn any interest before 2008.
		D. The reserves were not shown in the balance sheet of the banks before 2008.

Answer 1

Ans) 2.Base 1 are the global standard put forward to minimise the credit risk of the banks  that operate internationally. Here there is Tier 1 capital which is the core capital and is consits of share holders equity and reseves and surplus this is relatively safe and is an indicator of the bank financial health. The tier 2 capital is a supplymentary capital and it is not easy to measure as it is consits of undisclosed reserves and hybrid financial instruments. Hence it is used as supplymentary capital along with tier 1 capital. According to Basel 1 the bank should maintain capital (Tier 1 + Tier 2) at least 8 % of risk weighted assets. For this we need to find out capital to risk weighted asset or capital adequacy ratio. First we need to calculate risk weighted assets. According to Basel 1 banks assets are classified into five risk category as 0 %, 10%, 20% , 50%, 100%. The 0 % category is for central bank related products like treasury ,municipal bond comes under 50% category and residential mortagages is also 50%, commercial loans 100 % , hence risk weighted are calculated as follows:

Assets Class Risk Risk weighted assets

Commercial loan 100 mn 1 100

Treasuary securities 100mn 0 0

Municipal bond 100 mn 0.5 50

Residential mortagaes 100mn 0.5 50

for option d ) we have commercial loan and municipal bond as risk weighted assets = 150 mn

Since the Tier 1 + Tier 2 capital should be minimum 8% of risk weighted capital according to Basel 1

hence 8*150/100 =12 million hence this is less than tier 1 and Tier 2 capital hence the most suitable option.

Ans 3 ) a . Basel 1 did not take into account the off balance sheet obligation that produce risk exposures such as foreign exchange contracts .

Ans 4.) option a The reserve could not converted cash before 2008.That is shown with the expansion of Fed balance sheet which is doubled by using bank reserve