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

158 RISK MANAGEMENT AND VALUE CREATION IN FINANCIAL INSTITUTIONS
Second, we will ignore the deposit insurance and the deposits and savings
tranche, for the following reasons:
■
■
■
The insured amount will be paid from external sources (mostly backed
by a government guarantee). Therefore, there is no need for the bank
to hold capital internally.
The part of deposits and savings exceeding the insured amount is
very small. Trying to estimate the extreme tail of the assumed value
distribution is associated with very high uncertainty and can, therefore,
hardly be done with meaningful accuracy.
All of this only becomes relevant when the bank is in default and the
bank run has already occurred. Regulators will intervene in order to
minimize the probability of this happening as early as possible.
Therefore, we can simplify the illustration in Figure 5.2 to the one
depicted in Figure 5.3. Note that the asset distribution is drawn without the
three tranches that we have ignored. It, therefore, has a slightly different
shape and does not cover all possible losses. Even though the tranches “left”
of the senior debt tranche are ignored, the critical threshold level is still driven
by the concern to secure the repayment of all of these tranches by avoiding
a bank run. To differentiate the estimated capital requirement up to this
critical threshold level from the amount of risk capital derived previously,
we use the industry-standard label for this and call it Economic Capital.
Critical
Threshold
for Bank Run
Expected
Return
Probability
Losses
100%
Senior uninsured creditors
Junior uninsured creditors
Shareholders
Returns
Expected Losses
0
Gains
Economic Capital
Figure 5.3 Economic capital.
Note: Again, the Expected Return should be farther to the left than actually
depicted.