Dreams Bank is a relatively new player in the Australian market. Its main goal is to gain market share in the corporate loan segment quickly, and it prices its loans accordingly. The bank is budgeting its balance sheet for the coming fiscal year (2020-2021). Management's goal is to add $1,000 million in new corporate loans in 2020-2021. For all other asset categories the bank will simply replace maturing assets, i.e. no changes in assets are budgeted except in corporate loans. The balance sheet of Dreams Bank at the end of the current fiscal year (2019-2020) is as follows. The risk weights for assets are shown, and amounts are in millions of dollars. Amount 12,000 4,500 Assets Cash Due from banks Government bonds Mortgage loans Corporate loans Other assets Risk weight (%) 0 20 20 75 125 0 Amount 500 500 3,000 5,000 7,000 2,000 Liabilities Demand deposits Long-term debt Subordinated debt (Tier 2) Share premium reserve Common shares 300 200 1,000 Total 18,000 Total 18,000 In addition, the bank has the following off-balance sheet items at the end of the current fiscal year (2019- 2020). Amounts are in millions of dollars. Risk weights for all off-balance sheet items are 90%. No changes are expected in fiscal year 2020-2021. Current exposure Item Standby letters of credit 4-year forward FX contracts Amount $1,000 $1,400 Credit conversion factor 50% 10% $30 million in the money The Basel III capital framework is the following: Calibration of the Capital Framework Capital requirements and buffers (all numbers in percent) Common Equity Tier 1 Tier 1 Capital Total Capital 4.5 6.0 8.0 2.5 2.5 2.5 7.0 8.5 10.5 Minimum Conservation buffer Minimum plus conservation buffer Dreams Bank intends to fund the new corporate loans with $1,000 million in additional demand deposits in 2020-2021. Assume no further changes to the equity and liabilities in 2020-2021. b. Assume Dreams Bank wants to avoid any restrictions on dividend payouts. Using the Basel III capital framework ratios provided above, does the projected capital structure allow Dreams Bank to issue the budgeted amount of corporate loans? Motivate your answer and show your calculations. Make two suggestions should Dreams Bank be unable to issue the projected amount of corporate loans due to capital regulation, but wishes to proceed with the loan issuance. (5 marks) C. Why do we apply risk weights when analysing capital adequacy? Also, discuss what banks are likely to do if risk weights were abolished. (2 marks) Dreams Bank is a relatively new player in the Australian market. Its main goal is to gain market share in the corporate loan segment quickly, and it prices its loans accordingly. The bank is budgeting its balance sheet for the coming fiscal year (2020-2021). Management's goal is to add $1,000 million in new corporate loans in 2020-2021. For all other asset categories the bank will simply replace maturing assets, i.e. no changes in assets are budgeted except in corporate loans. The balance sheet of Dreams Bank at the end of the current fiscal year (2019-2020) is as follows. The risk weights for assets are shown, and amounts are in millions of dollars. Amount 12,000 4,500 Assets Cash Due from banks Government bonds Mortgage loans Corporate loans Other assets Risk weight (%) 0 20 20 75 125 0 Amount 500 500 3,000 5,000 7,000 2,000 Liabilities Demand deposits Long-term debt Subordinated debt (Tier 2) Share premium reserve Common shares 300 200 1,000 Total 18,000 Total 18,000 In addition, the bank has the following off-balance sheet items at the end of the current fiscal year (2019- 2020). Amounts are in millions of dollars. Risk weights for all off-balance sheet items are 90%. No changes are expected in fiscal year 2020-2021. Current exposure Item Standby letters of credit 4-year forward FX contracts Amount $1,000 $1,400 Credit conversion factor 50% 10% $30 million in the money The Basel III capital framework is the following: Calibration of the Capital Framework Capital requirements and buffers (all numbers in percent) Common Equity Tier 1 Tier 1 Capital Total Capital 4.5 6.0 8.0 2.5 2.5 2.5 7.0 8.5 10.5 Minimum Conservation buffer Minimum plus conservation buffer Dreams Bank intends to fund the new corporate loans with $1,000 million in additional demand deposits in 2020-2021. Assume no further changes to the equity and liabilities in 2020-2021. b. Assume Dreams Bank wants to avoid any restrictions on dividend payouts. Using the Basel III capital framework ratios provided above, does the projected capital structure allow Dreams Bank to issue the budgeted amount of corporate loans? Motivate your answer and show your calculations. Make two suggestions should Dreams Bank be unable to issue the projected amount of corporate loans due to capital regulation, but wishes to proceed with the loan issuance. (5 marks) C. Why do we apply risk weights when analysing capital adequacy? Also, discuss what banks are likely to do if risk weights were abolished. (2 marks)
