Short introduction to a simple metric to assess impact in Capital Adequacy Ratio of Financial Institutions

1. Asif Rajani, FRM
(Draft)

2. 


IRB Shortfall
Integrated view of RWA and IRB Shortfall
Importance of dynamic ratio adjustment

3. 


Expected Loss (EL) = PD x LGD
Difference between EL and Impairment is
deducted from Capital
Example:
◦ A Bank portfolio has a total EL of $1B and an
Impairment of $0,8B
◦ The Bank has to deduct $0,2B from its Capital

4. 



Both RWA and EL depend on PD and LGD
RWA and EL (or IRB Shortfall) should be
integrated
One alternative way to complete assessment
on CAR is by using a RWA equivalency
concept:
RWA Equivalent=
RWA + Impairment Gap*(1/Capital Ratio)

5. 


Instead of using the abovementioned
formula:
RWA + Impairment Gap*(1/Capital Ratio)
Some simplify by using Capital Ratio=0,08,
thus:
RWA + Impairment Gap*12,5
This can lead to an incorrect assessment of
the impact on CAR

6. RW
RW_Eq_0,08
RW_Eq50_0,12
RW_Eq100_0,16
RW_Eq50_0,24
96,0%
93,0%
90,0%
87,0%
84,0%
81,0%
78,0%
75,0%
72,0%
69,0%
66,0%
63,0%
60,0%
57,0%
54,0%
51,0%
48,0%
45,0%
42,0%
39,0%
36,0%
33,0%
30,0%
27,0%
24,0%
21,0%
18,0%
15,0%
12,0%
9,0%
6,0%
3,0%
PD
6
5
4
3
2
1
0

7. Asif Rajani
asif_rajani@hotmail.com
+351 96 633 52 00