Regulatory Point : Bank and Management of the Solvency Risk
Due to the nature of its business, the banking system is exposed to a variety of risks: counterparty risk, solvency risk, liquidity risk, market risks, operational risks, systemic risk, etc. The insolvency of a bank generally starts with a liquidity crisis. As soon as markets start to distrust a bank on the basis of information (audited or not) about high losses, the bank can no longer find access to appropriate refinancing sources.
The financial strength of the bank will depend in particular on the level of its shareholders’ funds and the quality of the shareholding in terms of capacity and willingness to eventually bail out the bank.
The successive crises experienced by the international banking and financial system have led the different supervising authorities involved (governments, central banks, etc.) to take a number of measures to further secure the functioning of the international banking system.
Thus, in 1988, the governors of the central banks of the main industrialized countries met in the swiss city of Basel (Headquarters of the Bank for International Settlements) and reached an agreement on the minimum capital level required from banks to face the level of risk represented by each category of counterparties.
This so-called Basel I Agreement thus defined a capital adequacy ratio called “Cooke Ratio” (Cooke being the name of the Governor of the Bank of England who chaired the committee’s work) defined as follows:
(Equity + Quasi Equity) /Risk Weighted Assets > 8%
Successive crises in the markets that triggered bank failures have highlighted the limits of the Cooke Ratio in terms of assets weighting and non-integration of market and operational risks affecting banks.The Basel II Agreement in 1995 came to remedy this with a new prudential framework based on three pillars:
· Pillar 1: Revision of the capital adequacy ratio incorporating the concept of global risks. This with the Mac Donough Ratio = Equity / Global Risks > 8% with Global Risks = (85% Credit Risk + 10% Operational Risk + 5% Market Risk)
· Pillar 2: Implementation of a procedure regarding prudential supervision with the introduction of stress tests conducted by supervisory authorities.
· Pillar 3: Establishment of a market discipline forcing banks to improve their financial transparency
In response to the 2007 financial crisis, new measures were taken in 2010 under the Basel III Agreement aiming at:
- Improving the quality of banks’ own funds: Tier 1, Buffer, …
- Increasing the level of Equity of banks: Capital Adequacy Ratio > 10.5%
- Reducing leverage (balance sheet growth): Equity / Total Assets > 3%
- Improving liquidity management in the short and long term: LCR and NSFR
Tunisia: The BCT circular N ° 2018-06 of 05 June 2018 has, in this same framework, redefined the capital adequacy standards for tunisian banks.
Article 9 states that subject institutions must comply at all time with:
– A capital adequacy ratio that cannot be less than 10%, calculated as the ratio between net capital and risk-weighted assets
– A Tier I ratio that cannot be less than 7%, calculated as the ratio of Net Basic Equity to Risk-Weighted Assets.
Risk-Weighted Assets (Article 10) being equal to the sum of the following aggregates:
-Total weighted credit risks including the amount of counterparty risk on derivative instruments
-Total operational risks, determined by multiplying by 12.5 the capital requirement for those risks calculated in accordance with the provisions of that Circular
-Total market risks, determined by multiplying the required amount by 12.5 in respect of those risks calculated in accordance with the provisions of that circular.