Dear,
Last weeks we looked at the Credit Risk module of Bank Analyzer and reviewed some of its competitive advantages for running the Comprehensive Capital Assessment Reviews that FED is running in the US banks, and ECB is running in the European Banks.
Amongst them, the main one is the holistic vision of Risk and Accounting that the Integrated Financial and Risk Architecture offers.
Today, we’re finalizing this collection of posts about the Comprehensive Capital Assessment Reviews, by looking at the final objective of the Capital Reviews.
Capital Reviews must measure the Capital Coverage of the bank, verifying if the Bank has a capital buffer, big enough for supporting stressed scenarios, like those suffered by the Financial System during the worst days of the 2008 financial crisis.
In case the analyzed bank has enough capital, there’re no more actions to be taken; but in case the bank is suffering a capital shortage, the regulatory authorities will take immediate actions for assuring the regulatory capital levels are recovered.
These recapitalization actions have an impact in the Banks reputation and reduce the stock value of the shareholders.
As the systemic crisis evolves, capital requirements will become higher, making it more expensive; consequently shareholders will request higher returns on their investments.
On the other hand stocks value depend on the banks’ profits, and require the bank investing, and assuming risks, that will increase the bank’s Risk Weighted Assets and consumed Capital.
This is a difficult equation, executives have to optimize the return on bank´s investments, minimizing, at the same time, the capital consumed.
There’re many techniques and actions for Capital Optimization; a particularly relevant one is the optimal distribution of collaterals.
Basel agreements, including Basel III, recognize the importance of collateralization as risk mitigation technique for reducing the Capital requirements of the Bank.
In the simplistic case, collateralization is built in a one-to-one relationship to the risk exposure, but in many cases, the relationship is established between several risk exposures and a collateral pool (containing several individual collateral assets).
In the second case, there’s an optimal distribution of the collaterals to the risk exposures, limiting individual over-collateralizations and assuring the reduction of the total capital requirements of the collateralized exposures.
The risk of the collateralized exposures and value of the collaterals change dynamically, as the probabilities of default, ratings and hair-cuts are dynamic magnitudes, dependent on the economic conditions of the business segments; consequently the optimal distribution of collaterals also changes dynamically.
Bank Analyzer Credit Risk supports (in the Level 2 of the Credit Risk calculation) the dynamic calculation of the optimal distribution of a collateral pool to the individual collateralized exposures, reducing the capital requirements (capital consumed).
This optimal distribution of collateral rights is the foundation of the Dynamic Collateral Management; a new discipline with a growing recognition in the last years.
We’ll talk about it in more detail in a future post.
Looking forward to read your opinions.
K. Regards,
Ferran.
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