Usefulness Of Value At Risk And Basel Frameworks Finance Essay - Free Essay Example

Sample details Pages: 10 Words: 3133 Downloads: 10 Date added: 2017/06/26 Category Finance Essay Type Analytical essay Did you like this example? 1. Introduction In order to understand the usefulness of VaR and other risk metrics for the setting of capital adequacy requirements it is useful to compare various measures used by financial institutions and legislative statutes of the Basel Frameworks. Traditional approaches to banking regulation emphasises the understanding that the existence of capital adequacy plays a central role in the long term financing and solvency positions of banks, especially in helping the banks to avoid bankruptcies and their negative externalities on the financial system (Dewaitpont and Tirole 1994) The notion of liquidity must be well defined unfortunately the word, liquidity has so many facets that it is often counter-productive to use it without further and closer definition (Goodhart 2008). Don’t waste time! Our writers will create an original "Usefulness Of Value At Risk And Basel Frameworks Finance Essay" essay for you Create order However; in the context of liquidity risk management, a banks liquidity can be defined as the ability to fund increases in assets and to finance obligations as they fall due. Therefore liquidity refers to the risk resulting (Nier 2005) from a financial institutions failure to pay its debts and obligations when due because of its inability to convert assets into cash readily. Moreover, liquidity risk also refers to the inability to procure sufficient funds due to high costs of liquidity transformation that may affect the financial institutions revenues and capital funding either now or in the future. The main objective of liquidity management is to ensure adequate liquidity in all circumstances so that banks have the ability to meet its cash flow obligations. Since maturity transformation of short-term deposits into long term loans is one of the banks fundamental roles banks are therefore inherently vulnerable to liquidity risk stemming from both an institutional-specific nature and a contagion effect which has the ability to cause a ripple effect throughout global markets. 2. Liquidity Management Several areas are of concern in the context of liquidity risk management, (Nier 2005) firstly data may be scarce and lacking in quality and historical data is not necessarily an accurate predictive agent; thus data may not be a reliable proxy for stress testing. Sound liquidity management for both short term and long run purposes is an integral component of a banks contingency funding plan that would aid banks in the event of a financial crisis. Fundamentally, liquidity risk measurement comprises four measurement systems (i) use of ratio analysis (Dowd 2002) where the applications of ratios are developed to measure various components of a banks balance sheet. Such ratios include the minimum liquid asset (MLA), the capital asset ratio (CAR) and the minimum cash balance (MCB). In addition a banks liquidity position needs to be monitored with the application of these ratios both on-balance-sheet and off-balance-sheet terms (ii) Cash flow measures; where a projection of cash flows base d on both supply and demand for liquidity exists under normal market conditions. The recent global financial crisis has highlighted the importance of adequate liquidity of banks coupled with five key features relating to financial regulation and (Cross 2010) supervision; systematic risk, pro-cyclicality, regulatory arbitrage and transparency. The inadequate regulation and supervision of banks globally has prompted regulators to review current liquidity requirements and statute in order to mitigate liquidity risk and prevent future crises from recurring. The existing approach to capital regulation in the US and E.U is based on Basel I and Basel II and has been identified by regulators and commentators as one of the key factors contributing to the financial crisis. However, Basel I and Basel II focused on capital only, with no internationally agreed (Moodys 2011) quantitative standard for liquidity. In December 2010 the Basel Committee on Banking Supervision published the final for m of a set of reforms to strengthen liquidity risk management by international active banks (the 2010 Liquidity Paper). The liquidity paper is intended to address concerns highlighted in the Economic crisis, where a lack of liquidity and inadequate liquidity risk management operated together to amplify difficulties caused by credit losses and due to the interconnectedness of markets affected all (Moodys 2011) markets with subsequent dire consequences. The Basel iii revises proposals set out in the initial framework for improving liquidity risk management and controlling liquidity risk exposures set out in the Committee paper adopted in September 2008. 3. The Basel Accord and Ratios Whilst the problem of solvency was at the core of the financial crisis between 2007- 2009, it demonstrated that illiquidity can amplify the depth of such a crisis. A bank can face impending illiquidity of two kinds: (i) Market Illiquidity which occurs when banks cannot sell assets without realising large losses and (ii) Funding liquidity when banks that rely on short-term funding cannot refinance long maturity assets (ESFRC 2011). If banks hold enough highly liquid assets and do not place heavy reliance on short-term funding, the contagious effects of capital deficit will be lessened. Market discipline cannot be relied upon to resolve this externally; it however could be addressed by increasing capital requirements. However, the costs to the banking system would be reduced by employing liquidity requirements along with less stringent capital requirements. The Basel Committee has evoked two requirements that must be satisfied by banks regarding maturity transformation. The liquidity coverage ratio (LCR) is designed to promote short term liquidity resilience which compares the stock of high quality liquid assets held by a bank to its net cash outflows (Moodys 2011) during a hypothetical 30-day severe stress scenario. The liquidity ratio will be set at a minimum of 100%, requiring high calibre liquid assets to fully cover the net cash outflows in such a scenario, and the liquidity coverage ratio must be maintained at all times. The Net Stable Funding Ratio (NSFR) refers to a ratio between availability of stable funding relative to the need created by long-term assets. The NSFR limits the degree of maturity transformation of banks, and therefore enhances funding liquidity. 4. Weaknesses of Basel Accord Standards Both sets of ratios are based on a complex set of weighing factors, which could be specified in a simpler manor. Instead of a variety of weighted factors, liquidity requirements could be in the form of a minimum ratio of cash and other highly liquid and riskless assets to total (ESFRC 2011) assets instead of the LCR and a simple measure of maturity mismatch instead of the NSFR. These requirements should be applicable under normal economic conditions; however in a period of a weak economic climate could these conditions be relaxed. Basel iii definition of high quality liquid assets in the context of the LCR ratio consist of cash and high quality government debt plus discounted proportions of high quality corporate and covered bonds. There is a risk that the high quality assets standard is too conservative to the end that it could create a shortage of liquid assets or significant concentration risks (Ref). Thus it is more restrictive than the standards central banks typically mainta in for collateral eligibility under the liquid facilities that serve as a key area to the banking system. Basel iii new liquidity standards should be an addition to firm level risk management and micro-prudential regulation, if combined with micro-prudential regulation and improved supervision. By raising liquidity buffers and reducing mismatches the new standards will indirectly address systemic liquidity risk as it will reduce possibility that banks will have a simultaneous requirement for liquidity. However policymakers will need to ensure that the weights and factors in the calibration of such ratios do not fully restrict banks (ESRFC 2003) in their ability to undertake maturity transformation or in the ability of money markets to act as a buffer for the financial institutions to manage their short term liquidity needs. If the standardization is too restrictive it may encourage migration of some banking activities into less regulated practices including towards shadow banks t hus potentially accentuating rather than alleviating systemic risk. The Basel iii standards could therefore extend the quantitative liquidity requirements to less regulated institutions. A framework that is too rigid may force banks to take risks to reach compliance, resulting in a high correlation amongst particular assets and concentrations in some of them. Consequently, the LCR ratio may inevitably tip towards high holdings in eligible liquid assets that could effectively reduce liquidity during a systemic crisis. Also, by applying unvarying quantitative standards across countries may not be suitable as a number of countries may not have the markets to extend term funding for banks given the absence of a bond market in a domestic currency, which would accordingly require banks to be subject to exchange rate risks. An analysis on the NSFR by (OECD 2010) finds that the ratio would not have indicated problems in the banks that ultimately failed due to poor liquidity management an d overuse of short term wholesale funding. Therefore the NSFR appears to have several limitations and should not be used as an appropriate technique to mitigate liquidity risk. For Basel iii to be effective liquidity requirements will need to be set at a high level for all institutions, resulting in a prohibitive cost to the real economy; otherwise the possibility will always exist that a (OECD 2010) systemic liquidity event will exhaust all available liquidity. In such circumstances central bank support is warranted to ensure that systemic liquidity shortages to not morph into large scale solvency problems. A problem so far has been the lack of analysis of a uniform measure of liquidity risk and to the extent to which an institution contributes to this risk. 5. Liquidity Risk Measurements Metrics Including Value-at-Risk (VaR) The analysis of liquidity requires bank management to identify measure and monitor its positions on an on-going basis as well as to examine how funding requirements are likely to evolve under various scenarios including adverse conditions (Cross 2010). However, liquidity is difficult to define and even more difficult to measure (Persaud 2007), due to the underlying variables driving the exposure can be dynamic and unpredictable. Until recently, managing and measuring liquidity risk was rarely seen as a high priority by most banks and financial institutions. Furthermore, no agreement has existed in the international community on the proper measurement of liquidity; hence there was not an integrated measurement tool to cover all dimensions of liquidity risk available to financial institutions. As to liquidity risk metrics in use, it is considered necessary to distinguish between analytical approaches such as VaR, that are focused on assessing potential effects on profitability, li quidity risk models and measures which aims at assessing cash flow projections of assets and liabilities, or the inability to conduct business as a result of a lack or a reduction of secured and unsecured funding capacities and/or liquid assets. Banks generally apply a variety of measurement techniques dependent on the specific type of risk that they want to assess, (e.g. funding liquidity risk, market liquidity risk etc.) Where institutions have adopted quantitative analyses for the assessment of liquidity risk, this approach has tended to be a deterministic (Cross 2010) one, such as static maturity ladders however; in such cases distributions for determining risk exposures are not utilised as scenario analysis is based on user-defined assumptions and resulting estimates therefore produce only a single view of the future. Therefore a more effective alternative is a stochastic approach which has been proven effective for both market and credit risk management. In this framework, (Cross 2010) the future values of risk factors are calculated under a variety of randomly generated scenarios thus producing probability distributions. See Appendix (1) for Stochastic Approaches Thus in reality most markets are less than (Cross 2003) perfectly liquid. If regulators in countries required banks to use VaR models for risk quantification processes the results from such models would produce inaccurate results as (i) there is no estimate of tail risks and losses (ii) difficulties in identifying the non-linear pay-offs characteristics of many complex and structured products (iii) no consistent method of aggregating risks across different asset classes, (iv) concentration on the distribution of portfolio value changes resulting from movements in the mid-price of each asset and (v) separate modelling of asset prices and portfolio size amongst others. Bangia et al (1999) cites that VaR methodology does not distinguish between market risk and liquidity risk, because historical market prices are supposed to embrace latent liquidity effects. Severe critique has been made regarding VaR as a measurement of liquidity risk; whilst it isnt completely appropriate it does still give an insight into the level of risk of an institution. Hence where VaR is insufficient, through the use of stress testing it becomes an adequate compliment (Kotz Gerhrig 2010). Where VaR reflects price behaviour in everyday markets stress testing simulates portfolio performance during abnormal market periods. The CGFS (2005) cites that stress testing is increasingly viewed as a complement to the previously defined VaR rather than as a supplement. Generally two types of stress testing are differentiated, the Scenario tests where the source and the financial risk parameters that are affected by the shock are well defined, and the Sensitivity test in which neither the shock nor the parameters are defined. The BCBS (2008) strongly recommends that regular stress testing of banks is imple mented as it can be helpful in detecting liquidity risk and checking if the current exposure remains in accordance with the banks established risk tolerance. VaR models assumes model conditions as to the unwinding of the position with one trade at a predetermined price equal to the current quoted mid-price, within a fixed period of time and no consideration of the size of the position. Liquidity in the market is connected to a variety of factors (Cross 2003) including the relative size, frequency, traded volumes, and the credit worthiness of the issuer amongst others, thus in order to account for these variables the standard VaR will require an adjustment to incorporate market liquidity and transaction costs into the VaR framework. See Appendix (2) for VaR calculations. 6. Conclusion It is unlikely that there is a single and uniformly best measure of liquidity risk considering the differing natures of financial institutions and their respective funding arrangements. However analysis finds that standard VaR methodology is an inadequate measure of liquidity risk as it does not distinguish between market and liquidity risk and does not take into account the level of risk within a particular institution. Adjusted VaR methods coupled with stress testing have proven to be a compliment which will incorporate liquidity risk into the computation. Other measurement methods such as the SRL model has the benefit of using daily market data and standard risk management methods to interpret individual contributions to systemic risk into a macro-prudential measure. The SRL can produce opportune and forward looking measures of risk of simultaneous liquidity shortfalls in financial institutions (IMF 2011). Alternatively or as a compliment to the SRL the ST framework could be imp lemented, as with other stress testing techniques it captures systemic solvency risk by assessing the vulnerabilities of institutions to a common macro-financial shock, and then adds this to risk of liquidity shortfalls ad assesses transmission of liquidity risk to the rest of the system through their exposures to the interbank market (2011). References Bangia A., Diebold F.H., Schuermann T., Stronghair J.D (1999), Modelling Liquidity Risk with Implications for Traditional Market Risk Measurement and Management, Working Paper, pp. 99-106, Wharton School, Philadelphia. Bardenhewer, M (2007) Modelling Non-maturing Products, in Matz L., Neu P., Liquidity Risk. Measurement and Management. A Practitioners Guide to Global Best Practices, John Wiley Sons, Chichester. Barrel, R et al (2009) Optimal regulation of bank capital and liquidity: how to calibrate new international standards [Online] Available At: https://www.fsa.gov.uk/pubs/occpapers/op38.pdf [Last Accessed 29 April 2011]. Basel Committee on Banking Supervision, A Framework for Measuring and Managing Liquidity, September 1992. Basel Committee on Banking Supervision, Sound Practices for Managing Liquidity Risk in Banking Organisations, February 2000. Basel Committee on Banking Supervision, The management of liquidity risk in financial groups, Bank for Intern ational Settlement, May 2006. Basel Committee on Banking Supervision (2011), Principles for Sound Liquidity Risk Management and Supervision. Blanco, C (2010) Financial Liquidity Adequacy [Online] Available at: https://www.blackswanrisk.com/pdf/June04RiskDesk.pdf [Last Accessed 28 April 2011]. Cross, A (2010). The new capital and liquidity proposals- Implications for Banks and their Supervisors [Online] Available at: https://siteresources.worldbank.org/FINANCIALSECTOR/Resources/Session4AndrewCross.pdf [Last Accessed 23 May April 2011]. Dowd K., (2002) Measuring Market Risk, John Wiley Sons, Chichester. ESFRC (2011) Basel III The need for simplicity in capital and liquidity requirements [Online] Available at: https://www2.lse.ac.uk/fmg/events/conferences/2011/financialRegulation_24Jan2011/ESFRC_Statement.pdf [Last Accessed 01 May 2011]. IMF(2011) How to address the systemic part of liquidity risk [Online] Available at: https://www.imf.org/external/pubs/ft/gfsr/2011/ 01/pdf/chap2.pdf [Last Accessed 23 May 2011]. Moodys Analytics (2011). Basel III New Capital and Liquidity Standards FAQs [Online] Available at: https://fermat.eu/downloads/basel-iii-faq.pdf [Last Accessed 1 May 2011]. Nier, T Tiesset, M (2005). Liquidity, Banking Regulation and the Macroeconomy [Online] Available at: https://www.bis.org/bcbs/events/rtf05AspachsNierTiesset.pdf [Last Accessed 01 May 2011]. Otker,R, Pazarbasioglu, C (2010), Impact of Regulatory reforms on large and complex financial institutions, Staff position Note no 2010/16 (Washington: International Monetary Fund, November). Reserve Bank of New Zealand (2009) Capital adequacy ratios for banks simplified explanation and example of calculation [Online] Available at: https://pages.stern.nyu.edu/~igiddy/articles/capital_adequacy_calculation.pdf [Last Accessed 26 April 2011]. Wignall, A Atkinson, P (2010). Thinking beyond Basel III: Necessary solutions for capital and liquidity [Online] OEDC Journal: F inancial Market Trends Available at: https://hb.betterregulation.com/external/OECD%20-%20Thinking%20beyond%20Basel%20II%20%20Necessary%20Solutions%20for%20Capital%20and%20Liquidity.pdf [Last Accessed 1 May 2011]. Woschnagg, E (2007) ICAAP Implementation in Austrian Banks [Online] Available at: https://www.oenb.at/en/img/fsr_16_special_topics_02_tcm16-95421.pdf [Last Accessed 29 April 2011]. Vento, G La Ganga, P (2009) Bank liquidity risk management and supervision: Which lessons from the recent market turmoil? [Online] Available at: https://www.eurojournals.com/jmib_10_06.pdf [Last Accessed 1 May 2011]. Appendix 1 This approach is expressed in a formula using Cash Flow at Risk (CFaR) as a measure of the maximum expected loss expected as a deviation from the mean, with a confidence interval alpha for a defined holding period: Where ÃÆ'Ã… ½Ãƒâ€šÃ‚ ± is the confidence interval in which the cash flow at risk will not be exceeded by the maximum loss, CF is the cash flow with left tail confidence interval alpha, and is the cash flow in the reference case (typically the mean of the stochastic distribution). From CFaR, a further risk indicator can be drawn, namely the Liquidity at Risk (LaR) which can be defined as the proportion of the available liquidity that remains with the firm after CFaR has been entirely subtracted from the formula: Where available liquidity is defined as the amount of liquidity can be raised with the level of risk aversion of the bank is willing to endure. Another facet of liquidity risk is market risk, it should be noted that in the standard VaR models are typically based on the assumption of normal markets, and also assumes that any quantities of securities can be traded without influencing markets prices

Definition Of An Existence Of Absolute Truth - 783 Words

1. Forms: In my interpretation , Plato indicates â€Å"Forms† as an existence of â€Å"Absolute Truth†. He doesn’t clearly define what â€Å"Forms† are, but he believes that â€Å"Forms† do exist. I personally under some circumstances believe in the existence of â€Å"Forms†. For example, during the class, Dr. Haney gave an example about the definition of â€Å"Largeness†. He mentions that each individual has his own definition of largeness, and this definition is unique for each person. Thus, all together, the â€Å"Largeness†, according to Plato, isn’t large. I don’t quite understand why it is not. For instance, in my opinion, the individual’s definition is unique, however, it’s all based on some basic standard. For example, we all define largeness based on comparison on sizes or dimensions. Depends on what we compare to, our definition of largeness would be different. Thereby, all definition would share somewhat the idea of â€Å"Largeness†. 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Free Essay Example Star Wars Example For Students

Free Essay Example: Star Wars It centers around Luke, his sister Princess Leila (although he did not find out she was his sister until the sat movie because they were separated at birth), their friend Han Solo and his companion named Chew (a Woke whom he saved). Together, and with the help of droids 23RD and CAPO, the three attempt to overthrow the Empire, which is the dark side government in power over the universe. The success of these movies was more than Lucas had ever dreamed for, and he was financially set for life. In 1994, Lucas began writing a fourth installment in the Star Wars series. He decided that he would create three new prequels which would tell the story of Star Wars before the dark side ruled the galaxy, These movies would focus n the tragedy of talented Jed Nanking Kowalski and his turn towards the dark side (and later become Dearth Evader). So the new movies are titled episode one through three and the older movies are titled episodes four through six. Here is a complete list of the Star Wars movies: Star Wars Episode l: The Phantom Menace Star Wars Episode II: Attack of the Clones Star Wars Episode Ill: Revenge of the Sits Star Wars Episode IV: A New Hope Star Wars Episode V: Empire Strikes Back Star Wars Episode VI: Return of the Jed The Star Wars movies are indeed one long Story Of tragedy. It is the tragedy Of Nanking Jaywalkers life as he turns from a hopeful Jed toward the dark side, later becoming the ruthless Sits Lord, Dearth Evader. EPISODE I Let me start out by giving PU a somewhat obvious background of the time Star Wars takes place. The entire universe is under one government known as the Republic. Within this government is the ruling body, known as the Senate, Each planet has a politician who represents them within the Senate. The Senate has a position similar to that of a president, although this person is called the chancellor. Peace and balance is kept within the Republic by a respected class known as the Jed. The Jed are very wise and skilled in combat. They use The Force which allows them to have a psychic sense, control objects with their mind, and fight exceptionally well. Their weapon is known as the lightfaces, which is viewed as an elegant and respectable way of combat. A person is chosen to train as a Jed if they have show exceptional Jed instinct and are in tune with the Force. Those who are Jed were born to be Jed, it is simply their calling and talent. You start as Pedant learner and train under a Master Jed until you are skilled enough to be granted the title. The Senate is overseen by respect Jed Who form the Jed Council. Heading up this council is respected Master Wood, only two feet tall and almost nine hundred years old. His wisdom is infinite and he is seen as the most skilled and father Of all Jed. Mace Window is also a main member of the council (hes the black guy with the purple lightfaces). The Force is divided by those Who use it. There is a Light (good) Side Of the Force, and a Dark (bad) Side of the force. Those who are of the Dark Side are known as Sits. In the Sits, there can be only two main members at a time. The Sits master is Dearth Sides (who is later known as the emperor when he rules the universe) ND he has an apprentice. Dearth Sides is actually a senator named Palatine who is a well respected member of the senate, Therefore, the dark side is secretly looming in the Republic, and ultimately leads to its downfall by the third movie. The Republic is currently in turmoil, There are many planets who want to be free of the Republic and are leading violent separatist movements to break away. Examples of a Dystopian Society in The Hunger GamesMeanwhile, Palpating is promoted to Supreme Chancellor of the Republic and continues to stir up trouble with the separatists using his new apprentice Count Took (once a student of Wood). Obi Wan travels to the planet of Camino and learns of a clone army being developed to aid the Republic. They are all clones of a man named Jingo Feet (the Bounty Hunter). Obi Wan recognizes him and confronts him with a duel. Jingo and his son Bob escape, but Obi Wan put a tracking device on their ship. He learns that the Jed Council never approved such an army to he built (the army was built under the secret order of Palatine). Followings Feet to the planet of Sessions, Obi Wan is captured by Count Took and learns of an army of droids he has built to aid the separatists. Nanking and Padre try to tree Obi Wan, but are captured as well, Mace Wind, Wood, and the Clone Army battle the separatist druid army to save the trio and the Clone Wars has begun. Now, the Clone Wars are essentially a battle of the Republic (and their clone army) and the Separatists (and their druid army). This afar avgas created behind the scenes by Palatine to gain power. You see, because this is a state of emergency, the senate granted Chancellor Palatine full power. He is now a dictator and his taking over the Republic has gun (although no one yet knows he is evil and of the Sits). Nanking and Obi Wan battle Took and Nanking looses his left arm (replaced by a mechanical arm later on). Wood comes to the rescue and fights Took, although Took escapes. The Clone Wars have begun, and the Dark Side has complete power of the Republic. It is Obvious that now the Story Will continue With Episode Ill: Revenge Of the Sits (in theaters) where the Sits will dismantle the Republic completely and create The Empire. Nanking and Padre married in secret at the end Of Episode II. The Clone Wars have begun. Count Took Nanking Jaywalker Mace Wind The saga will continue with Episode Ill. Obviously, using the older movies which follow a later storyline, we know what will happen. Nanking and Padre will give birth to twins Luke and Leila. Nanking will be guided by Dearth Sides (Palatine) and turn towards the Dark Side of the Force. The Republic will be dismantled now that Palatine has supreme power and the evil Sits Empire will take its place, with Dearth Sides as the Emperor. Those clones will become the Storm Troopers, personal arm, of the Emperor and the Jed will be deemed enemies of the new government. After Took is killed, Nanking turns to the Dark Side and comes Dearth Evader, apprentice to Dearth Suicide, The Jaywalker twins will be separated when babies. Luke will be taken in by Manikins stepbrother Owen Cars, whos father married Manikins mother before she was captured. Leila will be brought up a princess by a man named Organ. Respected Jed will go into hiding and each one will die, including Obi Wan Kenton who dies at the hand of his own pedant Dearth Evader (Nanking) in Episode IV. Although dead, Obi Wan continues to guide Luke as a ghost in the later movies. And remember Wood? Once a respected Council member winds up dying at almost one thousand years Old hidden away in a hut from the government he used to love and honor.