Risk Management and Value Creation in ... - Arabictrader.com

148 RISK MANAGEMENT AND VALUE CREATION IN FINANCIAL INSTITUTIONS
and can be easily observed from the bank’s balance sheet. They are defined—
in broad terms—as follows:
■ Tier-1 capital (“basic” equity) 59
– Equity capital 60
– Disclosed reserves
■ Tier-2 capital (“supplementary” capital) 61
– Undisclosed reserves 62
– Revaluation reserves 63
– General provisions/general loan-loss reserves 64
– Hybrid debt capital instruments 65
– Subordinated term debt 66
Note that, since these two capital amounts are determined on the basis
of accounting/balance sheet information, they have the additional 67 advantage
that they are relatively stable over time and can be objectively determined—which
is sensible from a regulatory point of view.
However, one of the problems with regard to this balance-sheet-based
59 Without discussing the specifics, one can deduce, in general, from the regulatory
guidelines that Tier-1 capital—net of goodwill—must at least amount to 50% of
Tier-1 + Tier-2 capital.
60 Issued and fully paid common shares and (perpetual noncumulative) preference
shares are considered equity capital under this definition.
61 Consequently, Tier-2 capital must amount to less than Tier-1 capital.
62 As an exception to the rule, these cannot be identified in the published balance
sheet.
63 In order to reflect their current value, assets valued at historic costs are allowed to
be revalued to their market values under certain circumstances.
64 Reserves held against presently unidentified losses that are freely available to meet
losses that subsequently materialize and that are limited to not exceeding 1.25% of
the bank’s risk-weighted assets.
65 For instance, the following instruments may qualify for inclusion: titres participatifs
and titres subordonnés à durée indéterminée in France, Genussscheine in Germany,
perpetual debt instruments in the United Kingdom, and mandatory convertible debt
instruments in the United States. The qualifying criteria for such instruments are in
line with the above defined characteristics: (1) they are unsecured, subordinated, and
fully paid-up; (2) they are not redeemable at the initiative of the holder or without
the prior consent of the supervisory authority; (3) they are available to participate
in losses without the bank being obliged to close down its operations.
66 Unlike instruments included in the previous category, “hybrid debt capital instruments,”
these instruments are not normally available to participate in the losses of
a bank. For this reason, these instruments are limited to a maximum of 50% of Tier-
1 capital.
67 Meaning, besides meeting the previously defined characteristics.