The capital requirement K

[shanlane]

What exactly is K? Is it a percentage? Is it a dollar amount? Is it comparable to a risk weight? Is it comparable to the 8% in the standardized approach?

It is mentioned a few times but it always seems to be in circular references.

Thanks!
Shannon

 

[ibrahim-1987]

K = PD * LGD * F(M)= %

it is the risk weight under IRB methods, since we r no longer using standarized approach RW.
capital requiremen = k*Adjusted exposure * 8%
RWA, = k * AE * 12.5

 

[David Harper CFA FRM]

Ibrahim, thank you, I answered similarly here http://forum.bionicturtle.com/threa...ngle-risk-factor-operational.2136/#post-17200

 

[Imad]

David,

Is "capital charge" similar to Return on Equity?

Thanks

 

[David Harper CFA FRM]

Hi Imad,

No, capital charge (K) in Basel IRB is nearer to the opposite of ROE than similar.

Say a loan asset represents an exposure of $10 million; i.e., asset = exposure = $10 MM. And assume the net realized return on the loan is $300,000 per year

• ROE represents a return (reward) that is unconcerned with risk (its key weakness). For example, if $9 MM debt (e.g., deposits) plus $1 MM equity fund the purchase of the asset, the loan's ROE = 0.3/1.0 = 30%, which can be boosted with more leverage (more debt)
• On the other hand, maybe the loan is a BBB corporate with risk weight = 100%, such that K = 8% such that the REGULATORY capital charge for the loan = 8% * $10 MM exposure = $800,000. This is a regulatory risk requirement.

So, one is "return" and the other is "risk" but also one is accounting based (ROE) and the other is regulatory (K). Thanks,