Credit Exposures
Credit exposures arises when a bank lends money to a customer, or buys a financial asset (e.g. a commercial bill issued by a company or another bank), or have any other arrangement with another party that requires that party to pay money to the bank (e.g. under a foreign exchange contract).
A credit risk is a risk that the bank will not be able to recover the money it is owed. Risk affected by financial strength of a party
For example, if a bank has made a loan to a person to buy a house, and taken a mortgage on the house as security,movements in the property market have an influence on the likelihood of the bank recovering all money owed to it
On-balance sheet credit exposures Capital adequacy ratio calculations recognize these differences by requiring more capital to be held against more risky exposures.
This is done by weighting credit exposures according to their degree of riskiness.
(e.g. Governments are assumed to be more creditworthy than individuals, and residential mortgages are assumed to be less risky than loans to companies).
Seven credit exposure categories
Off-balance sheet contracts
The amount at risk is not always equal to the nominal principal amount of the contract, off-balance sheet credit exposures are first converted to a "credit equivalent amount".Multiplying the "credit equivalent amount“ by the risk weight we get the risk weighted assets Nine credit exposure categories
Minimum Capital Adequacy Ratios
Basle Capital Accord has set minimum capital adequacy ratios as follows:-
Tier one capital to total risk weighted credit exposures to be not less than 4 percent;
Total capital (i.e. tier one plus tier two less certain deductions) to total risk weighted credit exposures to be not less than 9 percent;
Some further standards applicable to tier two capital:
Tier two capital may not exceed 100 percent of tier one capital;
Lower tier two capital may not exceed 50 percent of tier one capital;
Lower tier two capital is amortized on a straight-line basis over the last five years of its life.
Credit exposures arises when a bank lends money to a customer, or buys a financial asset (e.g. a commercial bill issued by a company or another bank), or have any other arrangement with another party that requires that party to pay money to the bank (e.g. under a foreign exchange contract).
A credit risk is a risk that the bank will not be able to recover the money it is owed. Risk affected by financial strength of a party
For example, if a bank has made a loan to a person to buy a house, and taken a mortgage on the house as security,movements in the property market have an influence on the likelihood of the bank recovering all money owed to it
On-balance sheet credit exposures Capital adequacy ratio calculations recognize these differences by requiring more capital to be held against more risky exposures.
This is done by weighting credit exposures according to their degree of riskiness.
(e.g. Governments are assumed to be more creditworthy than individuals, and residential mortgages are assumed to be less risky than loans to companies).
Seven credit exposure categories
Off-balance sheet contracts
The amount at risk is not always equal to the nominal principal amount of the contract, off-balance sheet credit exposures are first converted to a "credit equivalent amount".Multiplying the "credit equivalent amount“ by the risk weight we get the risk weighted assets Nine credit exposure categories
Minimum Capital Adequacy Ratios
Basle Capital Accord has set minimum capital adequacy ratios as follows:-
Tier one capital to total risk weighted credit exposures to be not less than 4 percent;
Total capital (i.e. tier one plus tier two less certain deductions) to total risk weighted credit exposures to be not less than 9 percent;
Some further standards applicable to tier two capital:
Tier two capital may not exceed 100 percent of tier one capital;
Lower tier two capital may not exceed 50 percent of tier one capital;
Lower tier two capital is amortized on a straight-line basis over the last five years of its life.