Discuss How the Risk-Based Capital Guidelines Attempt to Recognize Credit

Question

Examlex · Accepted Answer

The Answer is First, capital is defined as consisting of Tier 1 and Tier 2 capital. Minimum requirements are established for each tier. Tier 1 capital is considered core capital; it consists basically of common stockholders' equity, certain types of preferred stock, and minority interest in consolidated subsidiaries. Tier 2 capital is called supplementary capital; it includes loan-loss reserves, certain types of preferred stock, perpetual debt (debt with no maturity date), hybrid capital instruments and equity contract notes, and subordinated debt.
Second, the guidelines establish a credit risk weight for all assets. The weight depends on the credit risk associated with each asset. There are four credit risk classifications for banks:0%, 20%, 50%, and 100%, arrived at on no particular scientific basis. The below table lists examples of assets that fall into each credit risk classification.

Discuss How the Risk-Based Capital Guidelines Attempt to Recognize Credit

Definitions: