Critical Analysis of Basel IV Proposal in the Context of Capital Requirements and Banking Supervisio

The Basel Committee on Banking Supervision (BCBS) has published its new rules, which will come into effect starting this year, that will improve upon Basel III. These rules have been dubbed Basel IV colloquially by bankers and have been discussed extensively in the last couple of years.

This coursework is focused on a critical analysis of the Basel IV proposal and on measuring your ability to estimate capital requirements for a set of operations.

Use the Basel III agreement implementation document in Canada, the BCBS consulting documents, citable sources from journals and companies, official publications , and your knowledge from the course to answer each of the following questions. The answers should be in your own words in a way non-experts can understand, but everything should be properly cited and discussed. Focus on explaining what you did to arrive to your results. Marks will be deducted for just quoting verbatim from any citable source, for not discussing how you arrive at a certain quantity, or for discussing concepts with no adequate citable source. You must prove you are able to create an argument supported by literature, contrasting multiple literary views when necessary.

1. (60%) The file “LoanStock.csv” shows the total loan and bond stock of a small bank in Ontario. The bank focuses mostly on mortgages, and bonds, with an incipient unsecured retail lending business (loans). The bank has been categorized by the OSFI so that it must keep a capital adequacy requirement of 11.5% of its Risk-Weighted Assets. With this information, and assuming the bank does not have any further operations:

1. 1. (15%) Price the bonds at today’s date, so they reflect the current market price for the purposes of capital requirement calculations. For the market rates (yields), use Canada’s bond rate given by https://www.bankofcanada.ca/rates/interest rates/canadian-bonds/.
   2. (30%) Calculate the total provisions and capital requirement each operation brings. Report the total provision per business line (retail, mortgage and bonds) and the total capital requirement per business line. For LGD in corporate, assume the standard Basel weights (i.e. use foundational approach). The rating table for the bank is as follows:

• • PD < 0.001 AAA

• • 0.001 < PD < 0.01 AA

• • 0.01 < PD < 0.12 A

• • 0.12 < PD < 0.36 BBB

• • 0.36 < PD < 0.52 BB

• • 0.52 < PD < 0.75 B

• • 0.75 < PD < 0.85 CCC

• • PD > 0.85 D
    
    
• Note that the LGD for unsecured loans is considered to be 100% and that the mortgage LGD does NOT consider the value of the collateral, which must be discounted from the owed amount. The EAD for mortgages and loans can be calculated as the standing amount minus the collateral (for mortgages). The Basel  III floors for PD and LGD apply.
  
  3. (15%) Using the standard approach’s weights for each of these assets1 , report the total Risk-weighted assets of the bank. What is the regulatory capital the bank must satisfy? Compare with one of the big 5 banks regulatory capital and comment on the size of our bank. Use one of the Pillar 3 reports for Q3, citing which one you used.

2. (40%) The BCBS has proposed, controversially, a set of changes the Basel III agreement, to be implemented until 2029. This is discussed in their new proposal from December 2017.
   
   Comment on the following:

1. 1. (10%) What are the changes proposed by the committee? How are the proposed approaches different from the ones in the current Basel III agreements?
   2. (15%) Contrasting citable sources, discuss the potential impact of each parameter change on banks. Which Canadian banks and financial institutions will be most affected? Why?
   3. (15%) Considering your previous answers, critically evaluate the proposal by the BCBS and the need for banking regulation. Do you agree with the changes? Support your answer with references to external sources but write the analysis and conclusions in your own words.