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Heavyweight documents in the banking industry: What does the capital method say? - Tiger Sniffing Network#
Omnivore#
Today let's talk about the new regulations on bank capital.
On November 1, 2023, the China Banking and Insurance Regulatory Commission issued the "Commercial Bank Capital Management Measures". Let's focus on the key points.
In our impression, banks always have a lot of money.
But not all of the money in the bank belongs to the bank itself.
A part of the bank's money is its own or can be controlled by itself, which we call capital.
A large part of it is borrowed, such as bank deposits, which are borrowed from depositors. We call this liabilities.
So how do banks make money?
Banks can operate a large amount of "liabilities" assets with a small amount of "capital", such as using borrowed money to make loans.
The leverage principle is to obtain higher returns with borrowed money.
Although high leverage may bring higher returns, it also brings greater risks, which is one of the root causes of systemic risks in banks.
In order to ensure that banks have sufficient risk resistance capabilities and prevent financial crises from causing social unrest, the Basel Committee on Banking Supervision, which was held in Basel, Switzerland in 1988, established capital adequacy requirements.
China also established the capital adequacy ratio as a risk control indicator in the late 1990s.
We can compare bank capital to a shepherd dog and bank liabilities to sheep.
Capital can absorb losses and protect the interests of depositors and other creditors.
But if there are more and more sheep, it is possible that the capital will not be enough to cover the liabilities.
So how many shepherd dogs does a bank need?
Therefore, the capital adequacy ratio appeared, which reflects the bank's ability to bear losses with its own capital before the assets of depositors and creditors are damaged.
The higher the capital adequacy ratio, the stronger the ability to pay for losses.
The capital adequacy ratio is an important constraint on bank loan expansion. For every loan made by a bank, a certain amount of capital is required as a "safety cushion". Therefore, to expand the scale of lending, more shepherd dogs are needed.
Therefore, banks need to increase sufficient capital.
Only when the capital adequacy ratio reaches a certain requirement can it indicate that the bank has the corresponding risk resistance capability.
The total capital of a bank can be divided into three types.
The core Tier 1 capital is mainly common stock; other Tier 1 capital is mainly preferred stock and perpetual bonds. These two types of capital are the most stable and highest quality in bank capital and can be used for a long time to absorb losses incurred by banks in their operations.
The Tier 2 capital only bears losses under the conditions of bank bankruptcy and liquidation, and Tier 2 capital bonds belong to Tier 2 capital.
These three types of capital can be combined into three levels of capital, namely core Tier 1 capital, Tier 1 capital, and total capital.
Different types of capital have corresponding capital adequacy ratio requirements, and the minimum requirements are as follows:
In order to further buffer risks, banks should further provide reserve capital based on the minimum capital requirements, which is provided by the core Tier 1 capital, with a ratio of 2.5%.
In addition to the minimum capital requirements and reserve capital requirements, banks should also provide countercyclical capital, with a ratio of 0-2.5%; systematically important banks should also provide additional capital.
As mentioned earlier, excessive leverage in banks may cause systemic risks, so the management measures also limit the leverage ratio of banks.
The leverage ratio of a bank refers to the ratio of Tier 1 capital to asset balance, and this ratio should not be too low.
However, banks vary in size and risk management capabilities, so the requirements cannot be generalized.
According to the scale of business and risk differences among banks, banks are divided into three levels:
Different levels of banks are matched with different capital regulatory schemes, with different requirements for weighted risk assets calculation and information disclosure. This builds a differentiated capital regulatory system, which reduces the compliance costs of banks while maintaining the overall stability of the banking industry.
Among them, the third-level banks do not need to calculate the core Tier 1 capital adequacy ratio and do not need to provide reserve capital, but they must meet the minimum capital requirements below.
In addition, the management measures also revised the rules for measuring risk-weighted assets, including the standard method, internal rating method, etc., to enhance the risk sensitivity of capital measurement.
Let's take the standard method as an example to see how to calculate risk-weighted assets.
If a shepherd has 5 sheep:
In other words, there is a 20% probability that this batch of sheep will be taken away by wolves, causing risk losses.
And the shepherd has different types of sheep, and the risk weights of different sheep are different.
Let's take a look at the specific risk weights of assets.
Let's take real estate as an example. For example, the management measures adjusted the risk weight of banks for residential real estate assets.
It can be seen that when banks provide loans to customers, the lower the loan-to-value ratio, the smaller the risk weight.
The setting of risk weights should objectively reflect the risk essence of bank business, so that the capital adequacy ratio can accurately reflect the overall risk level and ongoing operational capabilities of banks.
In summary, the management measures further improve the capital regulatory rules for commercial banks, promote banks to strengthen risk management capabilities, and improve the efficiency of serving the real economy.
The management measures will be officially implemented on January 1, 2024, with a transition period.
Well, that's all for today.
As usual, here comes the Easter egg time:
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