Fifth Bank has the following balance sheet with values stated in millions of dollars.All assets are associated with corporate customers (not governments or sovereigns).Refer to Table 20-8 for associated risk weights. $\begin{array}{ll}
\text { Cash } & \$ 80& \text { Deposits } &\$550\
\text { Municipal General Obligation } & \$ 100 \
\text { Bonds } & \
\text { Residential Mortgages 1-4 } & \$ 220& \text { Long-Term Debt }&\$290 \
\text { family (LTV 60\%-80\%) } & \
\text { Conmercial loans } & \$ 500&\text { Equity } & \$60 \
\text { Total Assets } & \$ 900&&\$ 900
\end{array}$ In addition,Fifth Bank has off-balance sheet items as follows: (Refer to Tables 20-10 and 20-11)
$50 million in commercial letters of credit (LCs),
$300 million in 3-year interest rate swaps that are in-the-money by $2 million
$50 million in 4-year forward FX contracts that are out-of-the money by $2 million
What is the minimum Tier 1 and Total risk-based capital Fifth Bank needs in order to be considered adequately capitalized under Basel III capital requirements for both on-balance sheet and off-balance sheet items?

Question

Fifth Bank has the following balance sheet with values stated in millions of dollars.All assets are associated with corporate customers (not governments or sovereigns).Refer to Table 20-8 for associated risk weights. $\begin{array}{ll}
\text { Cash } & \$ 80& \text { Deposits } &\$550\
\text { Municipal General Obligation } & \$ 100 \
\text { Bonds } & \
\text { Residential Mortgages 1-4 } & \$ 220& \text { Long-Term Debt }&\$290 \
\text { family (LTV 60\%-80\%) } & \
\text { Conmercial loans } & \$ 500&\text { Equity } & \$60  \
\text { Total Assets } & \$ 900&&\$ 900
\end{array}$ In addition,Fifth Bank has off-balance sheet items as follows: (Refer to Tables 20-10 and 20-11)
$50 million in commercial letters of credit (LCs),
$300 million in 3-year interest rate swaps that are in-the-money by $2 million
$50 million in 4-year forward FX contracts that are out-of-the money by $2 million
What is the minimum Tier 1 and Total risk-based capital Fifth Bank needs in order to be considered adequately capitalized under Basel III capital requirements for both on-balance sheet and off-balance sheet items?

Quizplus · Accepted Answer

We first need to calculate the risk-weighted assets (RWA) for on-balance sheet items:
Cash and Deposits: Risk weight = 0% (Table 20-8), RWA = 0.8 x ($80 + $550) = $464 million
Municipal General Obligation Bonds: Risk weight = 20% (Table 20-8), RWA = 0.2 x $100 = $20 million
Residential Mortgages: Risk weight = 35% (Table 20-8), RWA = 0.35 x $220 = $77 million
Commercial loans: Risk weight = 100% (Table 20-8), RWA = $500 million
Long-term debt and equity: No risk weight needed as they are already accounted for in Tier 1 and Tier 2 capital, respectively.
Total RWA for on-balance sheet items = $1,061 million

Next, we need to calculate the RWA for off-balance sheet items:
Commercial letters of credit: Credit conversion factor (CCF) = 20% (Table 20-10), RWA = 0.2 x $50 million = $10 million
Interest rate swaps: CCF = 0% (Table 20-11) since they are in-the-money, RWA = $2 million
Forward FX contracts: CCF = 100% (Table 20-11) since they are out-of-the-money, RWA = $50 million
Total RWA for off-balance sheet items = $62 million

Total RWA = $1,123 million
Minimum Tier 1 capital required = 6% x $1,061 million = $63.66 million
Minimum Total risk-based capital required = 8% x $1,123 million = $89.84 million
However, we need to deduct the amount of the out-of-the-money forward FX contracts from Tier 1 capital, since they represent a potential liability:
Tier 1 capital after deduction = $63.66 million - $2 million = $61.66 million
Therefore, the minimum Tier 1 and Total risk-based capital Fifth Bank needs are $51.88 million and $67.51 million, respectively. The closest answer choice is B. Total Risk-Adjusted Assets = Risk-Adjusted On- and Off-Balance sheet assets
 Total = 630 + 18.5 = $648.5 million.
 In order to be adequately capitalized, Tier I capital must be 6.0 percent and Total Risk-based capital must be 8.0 percent.
 Tier I capital required = $648.5 million * 0.06 = $38.91 million
 Total risk-based capital required = $648.5 * 0.08 = $51.88 million.

Fifth Bank Has the Following Balance Sheet with Values Stated