Basel III

It is the third set of banking rules agreed by central bankers and regulators from around the world at meetings in Basel, Switzerland, hence the name. Banks will have to raise hundreds of billions of euros in fresh capital over the next few years. More specifically, they will have to increase their core tier-one capital ratio – a key measure of banks’ financial strength – to 4.5% by 2015. In addition, they will have to carry a further “counter-cyclical” capital conservation buffer of 2.5% by 2019.

Why does it matter?
The idea is that if banks hold a bigger capital cushion they will be better prepared for another downturn so we avoid a re-run of the financial crisis. Instead of holding capital equivalent to just 2% of their risk-bearing assets, banks will have to hold 7% of top-quality capital in reserve.

What were Basel I and II?
In 1988, the Basel Committee on Banking Supervision published a set of minimal capital requirements for banks, mainly focused on credit risk, which was enforced in the Group of 10 countries in 1992. The second of the Basel accords, published in 2004, was designed to create an international standard on banks’ capital requirements. Not all of it has been implemented yet.

Learn more : Basel III

Reference :http://www.guardian.co.uk/business/2010/sep/13/basel-iii-q-and-a

Image Reference: http://mthink.com/revenue/content/delivering-profitability-through-basel-ii-compliance

Measure of Risk

Different level of reserves could influence rating. We define several measures within each category of variables.

Reserves (CIOTH): a firm which tends to view reserves positively is perceived as a favorable to receive lines so could influence positively the evaluation of credit rating agencies.

Cash flow derivative reserve (CIDERGL): reserve can supply funds to leverage state and provide cash flow until major revenues. The level of reserve could predicate the vulnerability of revenues.

Sale financial instrument reserve (CISEC): total balance includes sometimes reserves for encumbrances, inventories and expenditures which tend to influence wildly fluctuations.

Currency translation reserve (CICURR): are not recognized under the narrow concept of income because the exchange rate may change before the exchange losses or gains are realized (SFAS, 52). Subramanyam and al. (1999) find no evidence correlation between this ratio and value relevant.

Opening comprehensive income (CIBEGNI): gains and losses would be recognized under a definition of income because the subsidiary’s net assets can be calculated
dependably.

Reference: Measure of Risk

Tools for measuring Financial Risk

Earnings (earn): designed by return on equity as we see in introduction, the rating influence the common stock prices and more with downgrade which generate or not income for common stockholders.

Return on assets (ROA) and Standard deviation of return of assets (sdROA):calculated using 5 years. This ratio motivates efficient management of the firm by the utilization of asset.

Operating cash flow (CFO): there are two cash flow ratios funds from operations relative to debt and free operating cash flow relative to debt.

Interest coverage (intcov): calculated as operating income before depreciation and interest expense, high earnings margins signify to the firm to generate cash so to minimize risk and to have better rating (Amato, 2004). A firm with problems of liquidity may be to default on current obligations.

Leverage (LEV): designed book value of liabilities to market value of equity. It tends to reduce free cash flow (Jensen, 1986) but an excess of debt can increase the capacity of bankruptcy and can reduce the rating.

Capital intensity (capint): calculated as property, plant and equipment net of depreciation deflated by total assets, strategic planning is critical for capital intensive 8 firms and can affect performance of the firm (difficulty of prevision of capital asset requirement) (Kukalis, 1991).

Reference: http://www.edhec-risk.com/edhec_publications/all_publications

Standard & Poor’s Risk Solutions

Standard & Poor’s Risk Solutions help institutions worldwide manage, measure, and mitigate credit risk, and make informed decisions that can improve risk-adjusted return and gain a competitive advantage.

By leveraging Standard & Poor’s experience in credit risk assessment and analysis, Risk Solutions has developed integrated and transparent solutions to help clients with their credit risk management needs. Solutions include risk data products, quantitative models, a risk workflow platform, and analytical services.

Trade Finance Services : Assesses the creditworthiness in the structured trade finance arena, which is a particular challenge, due to the lack of defaults and the disparate activities within the sector.

Credit Risk Services :incorporates all the best of what Standard & Poor’s has to offer: data, tools, access to a comprehensive platform, and analytical rigor. Institutions can further develop internal rating systems, risk management methodologies, validation processes, and support systems.

Standard & Poor’s Risk Assessment Services: comprehensive suite of solutions for assessing credit risk that complies with Basel requirements, including a thorough evaluation based on credit and market risk implications, credit assessment, credit scoring, and quantitative modeling. The results provide institutions with predictive analyses and benchmarks that align with other institutions to better manage credit risk.

Standard & Poor’s Validation Services : provides a comprehensive suite of validation services, including a review of developmental evidence, conceptual soundness, confirmation of operations, and performance testing, which includes diagnosis, backtesting, benchmarking, and an annual health check.

Ratings System Validation Services :help institutions evaluate the effectiveness of their internal rating methodologies, systems, and processes as compared to Standard & Poor’s methodologies, systems, and processes.

Reference: http://www.standardandpoors.com/products-services/firms/en/us