Risk based capital

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Risk based capital
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Risk based capital (RBC) is a main point in the world of banking regulation. RBC is approproated to improve the identification of the risk inherent in a bank's operations. Risk based capital refers capital as evaluated in Basel's standards to therisk-weighted assets called RWA [1].

Very important is to assign one of four risk weights (0, 20, 50, 100 percent) off-balance sheet items on the basis of broad judgments of relative credit risk and assets. These classes are used to calculate a risk-based capital ratio. The risk based capital focuses only on credit risk. It is not take into account another factors like liquidity and funding that affect an organization's financial condition. They also ignored factors such as interest rate risk, concentrations of investments and loans, quality and level of earnings, problem and classified assets, and quality of management [2].

Tier 1 and Tier 2 capitals

Capital, in the Basel standards, embraces Tier 1 and Tier 2 capitals [3] :

  • Tier 1 capital is the bank core capital,
  • Tier 2 capital includes complimentary funds, that is, liabilities other than core capital like subordinated debts,
  • Addition of Tier 1 to Tier 2 capital as a proportion of RWA (TCAR) also called total regulatory or total riskbased capital ratio.

Risk based capital in insurance companies

The National Association of Insurance Commissioners (NAIC) attested risk-based capital rules for life insurance companies in 1992. These policies are planned to measure exposure to four main categories of risk exploited by the insurance industry [4]:

  • interest rate,
  • insurance,
  • asset,
  • all other business risk.

Life insurance regulators believe the major strength of the life insurance risk-based capital policies is that the rules allow regulators to close a falling company more easily and quickly that they could in the past.

Footnotes

  1. Salami A.A, 2018, p.540
  2. Alfriend M.C, (1988), p.30
  3. Salami A.A, 2018, p.540
  4. Cluff L.D, 1998, p.10

References

Author: Agnieszka Bednarek