Risk Weighted Assets: Basel III (Banking Simplified Book 1) by Anna Michael

Author:Anna Michael [Michael, Anna]
Language: eng
Format: epub
Published: 2019-11-26T06:00:00+00:00

Chapter 2 Risk Weighted Assets

2.1 Introduction

Loan Loss Provisioning covers expected losses from a bank’s exposure. But this covers losses only in some of the years as shown in the graph below for a sample data set. Since, expected loss is an average there will of course be times when loss is more than the provision set aside for expected loss.

What happens in the years where Actual Loss is more than the expected loss? We have an Unexpected Loss. Expected Losses are covered by provisions. What about unexpected losses?

We cannot say that unexpected losses will even out in the long run, because in the short run it will impact our liquidity and our ability to release funds to deposit holders as and when they ask for the same. Hence, the regulators have said that a bank needs to keep sufficient equity to cover unexpected losses. This means that in a downturn, investors will lose money before a depositor will, ensuring excessive risk is not taken by a bank focussed only on maximizing returns.

In the graph below the top half of the graph is the unexpected losses to be covered by equity.

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