Bank capital is the equity of the owners of the bank. Under the Basel II guideli

Question

Bank capital is the equity of the owners of the bank.

Under the Basel II guidelines, government securities would have zero weight in assets. Calculate the capital ratio of this bank. (NOte all reserves carry zero weight in the calculation of risk-weighted assets)

SUppose the government securities are actually as risky as non-government securities. Calculate the true capital ratio. Is the ratio lower or greater than initially calculated?  

Assets Liabilities Reserves $50m Checkable deposits $230 M securities $25 M Gov't Securities $25 M Loans $150 M Bank Capital $20 M

Explanation / Answer

a) Capital ratio is the percentage of the Banks capital to its total risk weighted assets.

Bank capital = $20M

Risk weighted assets are banks assets which weighted according to this risk associated with it.

Risk weighted assets = securities + loans = 25 + 150 = $175M

capital ratio = bank capital/risk weighted assets

capital ratio = (20/175)*100

capital ratio = 11.43%

b) If government securites are as risky as non-government securities then

True risk weighted asset = risk weighted asset + government securities = 175 + 25 = $200M

True capital ratio = bank capital/True risk weighted asset

True capital ratio = (20/200)*100

True capital ratio = 10%

True capital ratio is lower than the initial capital ratio.

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