The capital requirement K

Discussion in 'P2.T7. Operational Risk & ERM (25%)' started by shanlane, May 14, 2012.

  1. shanlane

    shanlane Active Member

    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
  2. ibrahim-1987

    ibrahim-1987 Active Member

    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
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  3. Imad

    Imad Member

    David,

    Is "capital charge" similar to Return on Equity?

    Thanks
  4. 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,

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