Child of Divorce Essay Example for Free

Child of Divorce Essay Divorce is becoming a norm in the society nowadays. This refers to the complete termination of marriage between the couple who demands for it. Through the dissolution of the bonds of matrimony, both parties are allowed to marry again (Gallagher, 1996). However, opposing views are prevailing regarding divorce. For those who are in favor of it, divorce can be regarded as the only legitimate remedy when happiness and affection are no longer provided in the marriage (Scanzoni 1965). For those who are against it, divorce causes psychological problems and damage to social cohesion (Diefenbach, 2007). Divorce is not just the story of the couple parting ways but it is more of a story of the children who are products of a divorced marriage. â€Å"Human children need parents longer than any other species and are totally dependent on parents for food, shelter, and protection for the first several years of life. This dependency spawns a fear of abandonment. In divorce, one of the parents leaves. When one parent leaves, the children feel rejected. The loss children feel at divorce is similar to that experienced when a parent dies. Divorce might actually be harder on children because it lacks the concrete cause and finality of death (Bryner, 2001). † This causes most of the children of divorce to be more aggressive, impulsive and develop antisocial behavior compared to children from intact families (Hetherington, 1999). Others also exhibit lower academic performance (Kelly, 1998). However, some children manage to develop without these deleterious effects of divorce. As a matter of fact, these children are found to have less stereotyped sex behavior, greater maturity and greater independence (Emery, 1995). The developmental stage of the child when the divorce of his parents occurs is predictive of the child’s behavior and reaction towards the situation. An infant or a toddler will not react at all to his parents’ divorce because he can’t still comprehend the situation. However, a preschooler will tend to blame himself as the culprit of his parents’ divorce. Because he feels guilty and fears that the remaining parent may also leave him, he becomes more possessive of his parent (Roseby, 1998). For a young school-aged child, the divorce of his parents gives him a sense of responsibility. He feels that he should bring his parents together again and think of strategies that will make his parents interact in any way (Lansky, 1996). On the other hand, older school-aged children tend to blame one parent and take the side of the other parent. They become anxious and worrisome of the situation which makes them prone to illnesses such as headaches, sleeping disorders, chest pains, diabetes and asthma (Kimball, 1994). The reaction is more deleterious with adolescents who entirely mask their reactions. They switch to other outlets such as peers, sex, alcohol and drugs because they hate being bothered by their parents’ lives (Thompson, 1998). I have a friend named Diane. Fourteen years ago, her parents separated by divorce. Back then, she was only turning three and didn’t know anything about the chaotic situation between her parents. She was left to the custody of her mother while her father was just obliged by the court to provide some financial assistance. Everything went well with this arrangement until she entered primary school where she had greater monetary needs. Unfortunately, her father had another family and was compelled to reduce the money sent to her. This was the reason why her mother was obligated to work in order to support her. Because her mother became busy in her work, Diane was always left with her grandmother whenever she was off from school. It was only through her grandmother that everything regarding her family became clear. She hated the fact that her own mother concealed their broken family from her and would always say that her father is just working in a far away place. She realized that she will never have his father back and that her fantasies of having a complete family would never be real. That time, she began to skip classes in school and whenever she would attend a lecture, she never participates in the recitation. She also failed our exams. I was really worried about the big change in her behavior because she used to be the top student of our class. I just learned about her family problem when she never attended classes for a week and her mother came to our school looking for her. One of our classmates revealed that Diane eloped with her boyfriend. I can’t forget the face of Diane’s mother crying and blaming herself for what had happened to her daughter. After that, I never saw Diane again. The last news I heard about her was that she is living with her mother again. She broke up with her boyfriend but gave birth to a baby boy, who, like her, is a child of divorce. Diane’s story is just one of the millions of stories which we can get from the life of a child from a broken family. In her case, the effects of divorce were appalling because of the lack of effective communication. It would have been better if both her parents explained to her the situation and the reasons why they should have divorce. When Diane learned that her parents were already divorced, she was very frustrated because she fantasized of having a complete family when her father returns from work. She also felt betrayal because her mother never told her what’s real. These extreme negative emotions changed her attitude and made her rebel against the situation. Also, Diane’s mother was very preoccupied in her work that’s why she was not able to keep an eye on the performance of her daughter in school. If only she did, maybe she was able to help Diane solve her emotional problems at an early stage. After all, divorce can really cause a big scar but it doesn’t really have to. References: Bryner, C. L. (2001). Children of Divorce. Journal of the American Board of Family Medicine Practice;14:201–10. Diefenbach, H. and Opp, K. D. (2007). When and Why Do People Think There Should Be a Divorce? http://rss. sagepub. com/cgi/content/abstract/19/4/485. Emery, R. E. and Coiro, M. J. (1995). Divorce: consequences for children. Pediatric Review;16:306 –10. Gallagher, M. (1996). The Abolition of Marriage. Regnery Publishing. Hetherington, E. M. and Stanley-Hagan M. (1999). The adjustment of children with divorced parents: a risk andresiliency perspective. Journal of Child Psychology; 40:129–40. Kelly, J. B. (1998). Marital conflict, divorce, and children’s adjustment. Child Adolescent Psychiatry;7:259 –71. Kimball, G. (1994). How to survive your parents’ divorce: kids’ advice to kids. Chico, California: Equality Press. Lansky, V. (1996). Divorce book for parents helping your child cope with divorce and its aftermath. Minnetonka, MN: Book Peddlers. Roseby, V. and Johnston J. R. (1998). Common developmental threats in high-conflict divorcing families. Child Adolescent Psychiatry;7:295–309. Scanzoni, J. (1965). A Reinquiry into Marital Disorganization. Journal of Marriage and the Family 27: 483–91. Thompson, P. (1998). Adolescents from families of divorce: vulnerability to physiological and psychological disturbances. Journal of Psychosocial Nursing and Mental Health Service;36(3):34 –9.

Overview Of Krump Dancing Drama Essay

Overview Of Krump Dancing Drama Essay Krumping is an urban art form, reflecting the African American expressive culture and the street culture. The regional location and its history of violence has propelled the style into the mainstream. Born in 1990s from the slumps of Los Angeles, it blends elements of spiritual and physical energy. Krumping is an emerging movement that is quite fresh on the dance scene, exploding with positive energy it comes from a torn world of poverty and oppression. As a spiritual art form it encompasses core elements of its history and religion through its powerful movements and sounds. Through its spiritually Krump transforms its African American dance form to a communal public art form while incorporating its street culture through its music as a creative outlet for the hardships of urban life. Each element in Krump excretes pure energy in a unique way that releases the pent up frustration of each performer, from its highly energetic movements, expressiveness and the physical toll on the perfo rmers body, the art form has yet to hit its peak. The history of Krump and its spiritual energy originates from the hard streets of South Central Los Angeles, California, but can also be traced back to its African tribal culture. Born amongst the 1965 Watts riots, a large-scale riot which lasted 6 days in protest to the American Civil Rights Act leaving the African American community a feeling of injustice and despair, and the 1992 Rodney King riots, were the acquittal of LAPD officers in the trial of the beating of Rodney King sparked a further 6 days crime spree, the dance created an escape for the youth. Being brought up in a community upheaved by of violence and oppression blighted by racism, left the youths pursuing a sense of belonging and nurturance from there distressed families of substance abuse and violence. Turning to gangs for a sense of compassion, the ongoing harassment and recruitment of gangs left a sense of hopelessness, were within a dance movement emerge, from the dissatisfaction of their daily struggles, classif ied as an urban hip-hop variation, Krump like Capoeira started as a way for trouble youths to express themselves, and escape their gang filled lives. Krump dancers would form structured and organised crews or families, a tight-knit group of individuals whose loyalties and commitment extends beyond dance. These dance circles of fellow Krumpers provide the support and stability many in their community dont receive from their own families at home. Thus through their oppressed urban culture a sub-culture of Krumping immerged, providing an alternative to the gang life style. Seen as an aggressive competitive dance due to its release of the performers personal anger, hiding beneath the rebellious exterior, lays a religious imagery of enslavement calling out for protest. There is a spirit in the midst of krump-ness. There is a spirit thereà ¢Ã¢â€š ¬Ã‚ ¦most people think, theyre just a bunch of rowdy, ghetto, heathen thugs. No, what we are is oppressed. (Julie Malnig, 2009) Krumping at its roots are connected by its history but also at its core there are traces of the African tribal culture, Dancers would perform in a circle, as a way for them to assert their wholeness. The circle is an arena of a warrior, the ring shout of slave times, in which slaves would move in a round circle while stomping and clapping. The circle of the dance is a permissive circle: it protects and permits. At certain times on certain days, men and women come together at a given place, and there, under the solemn eye of the tribe, fling themselves into a seemingly unorganized pantomime, which is in reality extremely systematic, in which by various meansshakes of the head, bending of the spinal column, throwing of the whole body backward -may be deciphered as in an open book the huge effort of a community to exorcise itself, to liberate itself, to explain itself. There are no limitsinside the circle. Frantz Fanon (1961) But also a spiritual ritual; combat, competition and artistry build a world within and the circle contains elements of a spiritual energy, a holy dance and religious trances. Even as their paths in lives may seem fray and unbound Dancers accomplishments in krumping gain them street credibility, earning respect and absorption from a life of violence. Furthermore embodied with competitiveness and spiritual aspect krumping provides sanctuary of the urban city, a state of mind with no boundaries, lines or limitations, just a sense of freedom. Rize follows the practitioners of krumping from its origins at childrens clown parties to the popular dance form that has reached mainstream audiences. LaChapelle never explores krumping beyond its inner-city setting, enforcing the krumping as an authentic art form in the city of Los Angeles in direct opposition of the materialistic, commercialism of mainstream. Beginning with Tommy the Clown, an American dancer and the inventor of clowning style, it quickly spread and evolved in to dance-battles serving as an alternative to gangs. Tommys performances developed loyal followers, growing throughout Los Angeles. Taking it upon himself he used this opportunity to give the youth a chance by being a model living positive at all times. As dancers got older the style continued to morph into even more outrageous styles. The abrasive nature of Krump makes it difficult to locate its sacred connotations; the spiritual energy brewing within its movements often convey sexuality, violence and suffe ring, but within the circle of Krumping this is the only way of making ourselves feel like we belong. (Julie Malnig, 2009) During these moments of belonging, the dancers become a contest of physical and spiritual energy, revealing their spirit and raw emotion that Krump demands. The energy and vigor of Krumping in a spiritual sense exorcises the demons and conjure spirits, but thought Krumping look wild and out of control to the unaware, it is actually self-governing and defies claims that youths are inherently violent and disruptive. The music in Krumping is danced to hardcore, beat-heavy hip-hop tracks, sometimes with no vocals. These amorphous circles and repetitive rhythmic loops entrances dancers to a spiritual state. During Rize a dancer falls under a trance which then she loses spiritual control and consciousness, collapsing into the arms of a fellow Krumper, when she is asked what has happened, she answers, I dont knowà ¢Ã¢â€š ¬Ã‚ ¦ I just let go. (Rize, 2005) The circle of spiritual energy is also used as organised healing and cathartic release, Krumpers channel their anger into a positive form , making Krumping more than a dance art form; its a coping mechanism that reveals this sub-culture to be something another than youths engaging in criminal behaviours and mentalities. Derived from Hip-Hop and Breaking, Krumping fires up people with its energetic enthusiasm of its powerful emotional expressiveness in certain Krump movements, it may represent elements joyful and painful emotions; in which can help the performer in alleviating anxiety and depression while also sharing emotions artistically. The movement exhibits an electric body shock which moulds and distortions in the body of the head, arms, face, legs and pelvis. Krump is intended as an outlet for anger or to release pent-up energy, the dance movements reflect this type of physical release, both males and females display combinations of movements similar to a blend of street fighting, moshing, spiritual possession and aerobic striptease. It is described as a volatile, warrior-like, spastic and quaking dance that involves the vigorous banding of the spine, the thrusting and popping of the chest. While the overall appearance of Krumping may look violent with battles between dancers a central compone nt, Krumpers hit each other to get energised to dance in the radical expressive and explosive ways the dance is known for. The Physical Energy is used as an outlet for frustration this passionate dance is adapted to each performers unique style, with the level of intensity differing by the emotions felt in that moment, giving the dance its own personality. When performing these actions I noticed the energy involve, initially it was about the visual actions of throwing, tossing, grabbing smashing, breaking and slashing but the more I performed these movements the more I noticed the actions that require a lot of energy, momentum and physical power to execute. In power moves, the dancers relies more on upper body strength and is usually on his or her hands during moves. An arm swing entails the arm to be tense up; as they tighten into a stiff plank, and the hand is crunched into a fist. The basic arm swing motion, the arm tended to rise and fall into the body, the movement is rhythmic with each swing. There is lift upwards and outwards where the swing is grasping for contact, each swing is flung with a strong and fierce force, while tearing at the arms socket. As the arm falls it loosens and bends, contracting into the body. The hands and arms in each one of these movements begin a chain reaction that spreads through the body, resulting i n being covered with a cloak of pure powerful energy. Wavelike movements in the torso, arms and hips are descendent from the African origin. Theres a sense of being, and a connection to your body but also a sense of power and strength. Each movement is skilfully controlled to the beat of the music. Form the Arm swing to the power moves the movements in Krump give you a sense of being untouchable while being empowering. Krumpers face off one-on-one and try to out-Krump one another, this fusion of sport, dancing and fighting With a semblance of physical combat and African tribal culture in their dance movements, Krumping allows dancers to pop their limbs, gyrate their torsos and stomp their feet to hip hop music (Rize, 2005) The pace and intensity of the music is so frantic that it suggests a kind of spiritual possession, dancers seemingly and often are instructed to lose control, this loss of control has been lyrically manifested allowing the dancers to slip out of their constraints and boxes and just let go. After losing control in the beats, they recognise that there are both limits and no limits within the circle. This expression of their true self runs on their remaining energy before passing out. The Krumping dance style makes explicit claims to the importance of its regional location and history of violence as a major propellant of the style. Spiritual Energy Religion Sound Physical Energy Movement Journal (in body experience) Expression Toll

What Is Knowledge According To Plato Philosophy Essay

What Is Knowledge According To Plato Philosophy Essay Plato had a strong belief that what we know in this life is recollected knowledge that was obtained in a former life, and that our soul has all the knowledge in this world, and we learn new things by recollecting what the soul already knew in the first place. Plato offers three observations of knowledge and he puts Socrates to reject all three of them. Platos first observation is that true belief is knowledge. Socrates rejects this by stating that when a jury believes the accused to be guilty by just hearing the prosecuting attorneys argument, rather than of any concrete evidence, it cannot be known if a defendant is guilty even if he is guilty. The jurys true belief is therefore not knowledge. The second observation is that knowledge and perception are the same. Socrates rejects this by saying that we can perceive without knowing and we can know without perceiving. For example, we can see and hear a sound without us knowing what or where it is coming from. If we can perceive without knowing, then knowledge cannot be the same as perception. Platos third observation is that true belief along with a logical account is knowledge, but true belief without a logical account is different from knowledge. The only problem with this observation is the word account. All the definitions of the word account are not valid for this argument. These observations are a great example of attacking the insufficient theories of knowledge, but Plato never gives a complete answer on what is the definition of knowledge. Plato preferred truth as the highest value, stating that it could be found through reason and logic in discussion. He called this dialectic. Plato preferred rationality rather than emotional appeal, for the purpose of persuasion, discovery of truth, and as the determinant of action. To Plato, truth was the higher good, and every person should find the truth to guide his or her life. Platos doctrine of recollection says that rather than learning in the common sense, what is actually happening when people are thinking about a problem, and find a solution to that problem, is that they are recollecting things that they already knew. The reason that Plato came up with this theory was because of the learners paradox. The learners paradox is that how can someone learn something if they dont even know what it is. As Meno points out if we dont know what something is then how will we know when we have it? When, for example, we say that we dont know what 946308 divided by 22 is, how can it be that we can find the answer to be 43014? If we dont already know that 946308 / 22 = 43014 then when someone tells us this we should not be able to know that answer is right. Aristotle also believes that knowledge is a form of recollection. He believes that there are universal causes and particular causes, however, unlike Plato; he believes that particulars carry an essence of the form. The four causes, or what makes an object what it is, are its efficient, material, formal, and final causes. The efficient cause is the primary source of the change. The material cause is the material of which it consists. The formal cause is its form. The final cause is its aim or purpose. Using the example of a skyscraper, the efficient cause is the act of building the skyscraper, the material cause is the material used to build it, the formal cause is the blueprint, and the final cause is using the skyscraper as a skyscraper. Everything has these four causes, but substantially changing any of them will cause the skyscraper to lose its skyscraperness. If you know all of a particulars causes, you know its essence. Everything has to have a cause. To truly understand something, we must know its explanation and that it cannot be otherwise. Demonstration must be from things that are true because deducing something from a falsehood would not give understanding of it. Things that are less general and closer to perception are prior relative to us. Things that are more general and further from perception are prior by nature. Demonstrations must be from things that are prior by nature. The premises of demonstrations must give the reason why the conclusion is true. Aristotle defines syllogism as a discourse in which, certain things having been supposed, something different from the things supposed results of necessity because these things are so. One syllogism that he used was: Socrates is a man, All men are mortal, therefore Socrates is mortal. Plato and Aristotles understanding of knowledge are complimentary in that they both believe knowledge is obtained by recollection. Also, they both value truth as the best way to obtain knowledge. What makes it contradictory is that Aristotle goes deeper into the subject of knowledge by stating that particulars have to carry an essence of the form and gives four causes that aid in finding the essence. Therefore, their understanding of knowledge is both complimentary and contradictory. I think we have abandoned the dialectical and demonstrative methods to a certain extent, but not completely. Most classes teach in the way that sophists teach, by just giving us the facts. An example could be my college algebra class, that teaches me how to do a problem but it doesnt tell me why it is like that. But then we have other classes, for example Mr. Hindmans classes, that do use those 2 methods. I think we need to incorporate these valuable methods more into our public school systems and it might help in raising grades up.

All the Pretty Horses Essay -- Character Analysis, John Grady

The inevitable outcomes of fate in our lives are like a boundless chain of dominos falling successively. Every action is calculated and deliberate; our lives are a predetermined path that only someone as powerful as God could change. Cormac McCarthy demonstrates both the good and evil that the power of fate brings for his character John Grady in All the Pretty Horses. John Grady’s journey starts in Texas, where he realizes after his grandfather’s death that there isn’t much left for him there. He idealizes a cowboy way of life not found in Texas. He journeys with his buddy Rawlins across the border to Mexico, a lawless desert land where trouble never seems too far away. Fate leads him to a capricious kid named Blevins, whose erratic behavior and rare, expensive, and thought to be stolen horse creates a series of dilemmas for John Grady when he arrives at La Purà ­sima, a Mexican ranch. He finds more than just the cowboy way of life he longs for at the ranch; h e also finds Alejandra, the owner’s attractive daughter. As fate would have it, he falls in love with her, but fate would also have it that their love is forbidden. Matters only get worse when John Grady falls in trouble with law insuring only more chaos. The series of events that Cormac McCarthy writes in All the Pretty Horses are meant to unfold as if the hands of fate put John Grady through all the pain, and suffering to be reborn, matured, and find salvation at the end of journey. The mysterious ways of predestination and fate first occur to push John Grady away from home and towards Mexico. The first â€Å"push† comes when John Grady loses his grandfather: â€Å"He looked at the face so caved and drawn among the fold of the funeral cloth, the yellow mustache, the eyelids paper ... ... and cured of his childish fantasy of a cowboy life. The road to his new found salvation was paved with suffering, but worth all the pain. The author uses fate to unfurl the events in the book so that each builds upon one another, to lead to John Grady’s purpose for suffering: his rebirth. Throughout the book, fate tempts him away from perhaps his morals or the logical decision, because consciously he wouldn’t have made those decisions himself. It’s also through this journey that John Grady finds God- the controller of fate. Despite suffering, John Grady doesn’t develop a bitter relationship, but a closer one with God as God bring him closer to salvation. Still struggling internally with the crimes and events of Mexico, John Grady hasn’t lost his adventurous nature back home in Texas. The book is left with the possibility that yet another adventure awaits him.

The Model Theory Of Dedekind Algebras :: Algebra Mathematics Essays

The Model Theory Of Dedekind Algebras ABSTRACT: A Dedekind algebra is an ordered pair (B, h) where B is a non-empty set and h is a "similarity transformation" on B. Among the Dedekind algebras is the sequence of positive integers. Each Dedekind algebra can be decomposed into a family of disjointed, countable subalgebras which are called the configurations of the algebra. There are many isomorphic types of configurations. Each Dedekind algebra is associated with a cardinal value function called the confirmation signature which counts the number of configurations in each isomorphism type occurring in the decomposition of the algebra. Two Dedekind algebras are isomorphic if their configuration signatures are identical. I introduce conditions on configuration signatures that are sufficient for characterizing Dedekind algebras uniquely up to isomorphisms in second order logic. I show Dedekind's characterization of the sequence of positive integers to be a consequence of these more general results, and use configuration signat ures to delineate homogeneous, universal and homogeneous-universal Dedekind algebras. These delineations establish various results about these classes of Dedekind algebras including existence and uniqueness. 1. INTRODUCTION One of the more striking accomplishments of foundational studies prior to 1930 was the characterization of various mathematical systems uniquely up to isomorphism (see Corcoran [1980]). Among the first systems to receive such a characterization is the sequence of the positive integers. Both Dedekind and Peano provided characterizations of this system in the late 1880's. Dedekind's characterization commenced by considering B, a non-empty set, and h, a "similar transformation" on B (i.e. an injective unary function on B). In deference to Dedekind, the ordered pair B = (B,h) is called a Dedekind algebra. While the study of Dedekind algebras can naturally be viewed as a continuation of Dedekind's work, the focus here is different. Rather than investigating whether a particular Dedekind algebra (the sequence of the positive integers) is characterizable, we proceed by investigating conditions on Dedekind algebras which imply that they are characterizable. In the following we review some of the results obtained in the model theory of Dedekind algebras and discuss some of their consequences. These results are stated without proofs. Weaver [1997a] and [1997b] provide the details of these proofs. Attention is restricted here to the model theory of the second order theories of Dedekind algebras. Weaver [1998] focuses on the model theory of the first order theories of these algebras. 2. CONFIGURATIONS Given a Dedekind algebra B = (B,hB), AB is the transitive closure of hB.

Downloading music Essay

* Does the growing popularity of downloading music from the Internet give rise to a new music industry value chain that differs considerably from the traditional value chain? Explain why or why not. I think it might have an effect in the traditional value chain for the fact that nowadays it is very normal to download music from the internet illegally and legally. Due to this fact the sales in albums in the music industry have decreased. People prefer to download music rather than buy the CD because is more economic and they save money. For the reasons I mentioned before I think the traditional value chain might change. It is harder for artists to sell CD’s and they obtain more profit from the concerts performance. * What costs are cut out of the traditional value chain or by passed when online music retailers (Apple, Sony, Microsoft, Musicmatch, Napster, Cdigix, and others) sell songs directly to online buyers? (Note: In 2005, online music stores were selling download-only titles for $0.79 to $0.99 per song and $9.99 for most albums). The price to buy a song on the internet is cheap, so several costs are cut out of the traditional value chain. Retailers at the moment of sell songs directly on the internet do not have to take into account costs like: record company direct production costs, pressing of CD and packaging, distribution of the CD, stock of CD’s. That is why the final price to consumer online is cheap. The problem is when the people download music from internet programs like Ares, Free music video, Lime wire, among others. In that case the artist is not receiving any gain and that’s the situation that affects the music industry. * What costs would be cut out of the traditional value chain (or bypassed) in the event that recording studios sell downloadable files of artists’ recordings directly to online buyers? I think in this event would be very similar to an electronic commerce business. All the benefits from e commerce would be applied here. The main cost that would be cut out is the stock as I said before because there would not be a physic place to keep the CD’s. Also there would be a reduction of costs in the sales department for the fact that the consumer might choose any song that he wants without going to a store. In the other hand generally in the e-commerce consumers must pay a cost of delivery service but in this case there is not a cost like that because the file or song would be downloaded directly. I found these questions very interesting; the way in which the technology has changed many industry facts and the effects that it has. Nowadays is very easy to obtain the music but, is true that the music industry and the artists do not have the same profits as it used to be long time ago.

Bank6003 Notes

BANK6003 Final Exam Notes TOPIC 4A: Credit Risk – Estimating Default Probabilities Overview * Theory of credit risk less developed than VaR based models of market risk. * Much less amenable to precise measurement than market risk – default probabilities are much more difficult to measure than dispersion of market movements. * Measurement on individual loans is important to FI for pricing and setting limits on credit risk exposure. Default Risk Models 1. Qualitative Models * Assembling relevant information from private and external sources to make a judgement on the probability of default. Borrower specific factors (idiosyncratic or specific to individual borrower) include: reputation, leverage, volatility of earnings, covenants and collateral. * Market-specific factors (systematic factors that impact all borrowers include): business cycle and interest rate levels. * FI manager weighs these factors to come to an overall credit decision. * Subjective 2. Credit Scoring Mod els * Quantitative models that use data on observed borrower characteristics to calculate a score that represents borrower’s probability of default or sort borrowers into different default risk categories.Linear Probability Models (LPMs) * Econometric model to explain repayment experience on past/old loans. * Regression model with a â€Å"dummy† dependent variable Z; Z = 1 default and Z=0 no default. * Weakness: no guarantee that the estimated default probabilities will always lie between 0 and 1 (theoretical flaw) Logit and Probit Models * Developed to overcome weakness of LPM. * Explicitly restrict the estimated range of default probabilities to lie between 0 and 1. * Logit: assumes probability of default to be logistically distributed. Probit: assumes probability of default has a cumulative normal distribution function. Linear Discriminant Analysis * Derived from statistical technique called multivariate analysis. * Divides borrowers into high or low default risk cl asses. * Altman’s LDM = most famous model developed in the late 1960s. Z < 1. 8 (critical value), there is a high chance of default. * Weaknesses * Only considers two extreme cases (default/no default). * Weights need not be stationary over time. 3. New Credit Risk Evaluation Models Newer models have been developed – use financial theory and financial market data to make inferences about default probabilities. * Most relevant for evaluating loans to larger corporate borrowers. * Area of very active continuing research by FIs. Credit Ratings * Ratings change relatively infrequently – objective of ratings stability. * Only chance when there is reason to believe that a long-term change in the company’s creditworthiness has taken place. * S&P: AAA, AA, A, BBB, BB, B and CCC * Moody’s: Aaa, Aa, A, Baa, Ba, B and Caa Bonds with ratings of BBB and above are considered to be â€Å"investment grade† Estimating Default Probabilities 1. Historical Data * Provided by rating agencies e. g. cumulative average default rates * If a company starts with a: * Good credit rating, default probabilities tend to increase with time. * Poor credit rating, default probabilities tend to decrease with time. * Default Intensity vs Unconditional Default Probability * Default intensity or hazard rate is the probability of default conditional on no earlier default. * Unconditional default probability is the probability of default as seen at time zero. Default intensities and unconditional default probabilities for a Caa rated company in the third year * Unconditional default probability = Caa defaulting during the 3rd year = 39. 709 – 30. 204 = 9. 505% * Probability that Caa will survive until the end of year 2 = 100 – 30. 204 = 69. 796%. * Probability that Caa will default in 3rd year conditional on no earlier default = 0. 09505/0. 69796 = 13. 62% Recovery Rate * Usually defined as the price of the bond 30 days after default as a perce nt of its face value. * Recovery rate % = 1 – LGD% * Ranking of bonds * Senior Secured * Senior Unsecured Senior Subordinated * Subordinated * Junior Subordinated Credit Default Swaps * Instrument that is very useful for estimating default probabilities is a CDS. * Buyer of the insurance obtains the right to sell bonds issued by the company for their face value when a credit event occurs and the seller of the insurance agrees to buy the bonds for their face value when a credit event occurs. * The total value of the bonds that can be sold is known as the CDS’ notional principal. * Total amount paid per year, as a percent of the notional principal, to buy protection is known as the CDS spread. Buyer of the instrument acquires protection from the seller against a default by a particular company or country (the reference entity) * Example: buyer pays a premium of 90bps per year for $100m of 5-year protection against company X. * Premium is known as the credit default sprea d. It is paid for the life of contract or until default. * If there is a default, the buyer has the right to sell bonds with a face value of $100m issued by company X for $100m. * Payments are usually made quarterly in arrears * In the event of default, there is a final accrual payment by the buyer * Attractions of the CDS market Allows credit risks to be traded in the same way as market risks * Can be used to transfer credit risks to a third party * Can be used to diversify credit risk Credit Indices * Developed to track credit default swap spreads. * Two important standard portfolios are: * CDX NA IG, portfolio of 125 investment grade companies in North America * iTraxx Europe, portfolio of 125 investment grade companies in Europe * Updated on March 20 and September 20 each year. * Example * 5 year CDX NA IG index is bid 165bp, offer 166bp. Quotes mean that a trader can buy CDS protection on all 125 companies in the index for 166 basis points per company. * Suppose an investor wan ts $800,000 of protection on each company. * The total cost is 0. 0166 x 800,000 x 125 = $1,660,000. * When a company defaults, the investor receives the usual CDS payoff and the annual payment is reduced by 1,660,000/125 = $13,280. * Index is the average of the CDS spreads on the companies in the underlying portfolio. Use of Fixed Coupons * Increasingly CDS and CDS indices trade like bonds so that the periodic protection payments remain fixed. A coupon and a recovery rate is specified. * Quoted spread > coupon, buyer of protection makes an initial payment. * Quoted spread < coupon, seller of protection makes an initial payment. Credit Spreads * Extra rate of interest required by investors for bearing a particular credit risk. CDS Spreads and Bond Yields * CDS can be used to hedge a position in a corporate bond. * Example: investor buys a 5-year corporate bond yielding 7% per year for its face value and at the same time enters into a 5-year CDS to buy protection against the issuer o f the bond defaulting. CDS spread is 2% p. . Effect of the CDS is to convert the corporate bond to a risk-free bond. If the bond issuer does not default, the investor earns 5% per year. If the bond issuer defaults, the investor exchanges the bond for its face value and this can be invested at the risk-free rate for the remainder of the five years. The Risk-Free Rate * The risk-free rate used by bond traders when quoting credit spreads is the Treasury rate. * Traditionally used LIBOR/swap rate * Normal market conditions: risk free rate is 10bp less than the LIBOR/swap * Stressed conditions, the gap is much higher Asset Swaps Provide a direct estimate of the excess of a bond yield over the LIBOR/swap rate. * Example: asset swap spread for a particular bond is quoted as 150 basis points. 3 possible situations: 1. Bond sells for its par value of 100. Company A pays the coupon and Company B pays LIBOR plus 150bp. 2. Bond sells below par, say 95. Company A pays $5 per $100 of principal at the outset. After that, Company A pays the coupon and Company B pays LIBOR plus 150bp. 3. Bond sells above par, say 108. Company B pays $8 per $100 of principal at the outset. After that, Company A pays the coupon and Company B pays LIBOR plus 150bp. Therefore, the present value of the asset swap spread is the present value of the cost of default. CDS-Bond Basis * CDS-Bond Basis = CDS spread minus the bond yield spread * Bond yield spread is usually calculated as the asset swap spread * Should be close to zero, but there are a number of reasons why it deviates: 1. Bond may sell for a price significantly different from par (above par = positive basis, below par = negative basis) 2. There is counterparty risk in a CDS (negative direction) 3. There is a cheapest-to-deliver bond option in a CDS (positive direction) 4.Payoff in a CDS does not include accrued interest on the bond that is delivered (negative direction) 5. Restructuring clause in a CDS contract may lead to a payoff when th ere is no default (positive direction) 6. LIBOR is greater than the risk-free rate assumed (positive direction) Estimating Default Probabilities from Credit Spreads * Average hazard rate between time zero and time t * s(t) = credit spread, t = maturity, R = recovery rate * s = 240bps, R = 0. 40, hazard rate = 0. 04 = 4% Real World vs Risk-Neutral Default Probabilities * Real world = backed out of historical data Risk-neutral = backed out of bond prices or credit default swap spreads * Produce very different results. Why? * Corporate bonds are relatively illiquid * Subjective default probabilities of bond traders may be much higher than the estimates from Moody’s historical data * Bonds do not default independently of each other. This leads to systematic risk that cannot be diversified away. * Bond returns are highly skewed with limited upside. The non-systematic risk is difficult to diversify away and may be priced by the market. * Use real world for calculating credit VaR an d scenario analysis. Use risk-neutral for valuing for credit derivatives and PV of cost of default Option Models * Based on the idea that equity prices can provide more up-to-date information for estimating default probabilities. * Employ option pricing methods e. g. KMV. * Used by many of the largest banks to monitor credit risk. Merton’s Model * 1974 – company’s equity is an option on the assets of the company. * Equity value at time T as max(VT – D, 0) * VT is value of the firm * D is the debt repayment required * Option pricing model enables value of a firm’s equity today to be related to the value of its assets today and the volatility of its assets. Read also Recording General Fund Operating Budget and Operating TransactionsVolatilities * Equation together with the option pricing relationship enables value and volatility of assets to be determined from value and volatility of equity. Example * Company equity = $3m * Volatility of equity = 80% * Risk-free rate is 5% * Debt = $10m * Time to debt maturity = 1 year * Value of assets = $12. 40m * Volatility of assets = 21. 23% * Probability of default is 12. 7% * Market value of debt = $9. 40m * PV of payment is 9. 51 * Expected loss 1. 2% * Recovery rate 91% Use of Merton’s Model to estimate real-world default probability (e. g. Moody’s KMV) * Choose time horizon Calculate cumulative obligations to time horizon (D) * Use Merton’s model to calculate a theoretical probability of default * Use historical data to develop a one-to-one mapping of theoretical probability into real-world probability of default. * Distance to default TOPIC 4B: Credit Value at Risk Backgr ound * Credit risk is the risk of loss over a certain time period that will not be exceeded with a certain confidence level. * Calculate credit risk to determine both regulatory capital and economic capital. * Time horizon for credit risk VaR is often longer than that for market risk. Market risk usually one-day time horizon and then scaled up to 10 days for the calculation of regulatory capital. * Credit risk VaR, for instruments that are not held for trading, is usually calculated with a one-year time horizon/ * Historical simulation is the main tool used to calculate market risk VaR, but a more elaborate model is usually necessary to calculate credit risk VaR. * Key aspect is credit correlation. Defaults (or downgrades or credit spread changes) for different companies do not happen independently of each other. * Credit correlation increases risks for a financial institution with a portfolio of credit exposures.Introduction * Internal economic capital allocations against credit ri sk are based on bank’s estimate of their portfolio’s probability density function of credit losses. * Probability of credit losses exceeding some level, say X, is equal to the shaded area under the PDF. * A risky portfolio is one whose PDF has a relatively long, fat tail i. e. where there is a significant likelihood that actual losses will be substantially larger than expected losses. * Target insolvency rate = shaded area under PDF to right of X * Allocated economic capital = X – expected credit losses Expected vs Unexpected Credit Loss Expected = amount of credit loss expected on credit portfolio over the chosen time horizon * Unexpected = amount by which actual credit losses exceed expected credit loss. Economic Capital Allocation * Economic capital = estimated capital required to support credit risk exposure. * Process is similar to VaR methods used for allocation of capital for market risk. * Probability of unexpected credit loss exhausting economic capital is less than the bank’s target insolvency rate. * Target insolvency rate usually consistent with desired credit rating. * â€Å"AA† rating implies a 0. 3% chance of default. Need enough economic capital to be 99. 97% certain that credit losses will not cause insolvency. * Based on two inputs: 1. Bank’s target insolvency rate 2. Bank’s estimated PDF for portfolio credit losses * Two banks with identical portfolios could have very different economic capital for credit risk, owing to: 1. Differences in attitudes to risk taking (reflected in target insolvency rates) 2. Differences in methods of estimating PDFs (reflected in credit risk models) Measuring Credit Losses * Credit loss = current value –future value at the end of some time horizon. Precise definition of current/future values contingent on specific credit loss paradigm. * Current generation of credit risk models employ either of two conceptual paradigms: 1. Default-Mode (DM) Paradigm * Most common. * Credit loss arises only if default occurs within the time horizon. * â€Å"Two-state† model – only two outcomes, default and non-default. * If borrower defaults, credit loss = bank’s credit exposure – present value of future net recoveries (cash payments less workout expenses). * Current values are known but future values are uncertain. Estimate joint probability distribution with respect to 3 types of random variables: 1. Associated credit exposure 2. Indicator denoting whether facility defaults during planning horizon 3. In the event of default, the loss given default (LGD). Unexpected losses approach: * Assumption that PDF is well-approximated by mean and standard deviation. * Set capital at some multiple of estimated standard deviation of losses. * Requires estimates of expected and unexpected credit loss from default. * Expected loss (? ) depends on 3 key components: 1. LGD = loss given default, expressed as a decimal . PD = probability of default 3. EAD = expect credit exposure at default. * Standard deviation of portfolio credit losses * i = stand-alone standard deviation of credit losses from ith facility; * i = correlation between credit losses from ith facility and those on the overall portfolio; 2. Mark-to-Market (MTM) Paradigm * Credit loss can arise in response to decline in credit risk quality. * â€Å"Multi-state† model: default is only one of several possible credit ratings a loan could ‘migrate’ to over the horizon. * Credit portfolio marked to market at the beginning and end of planning horizon. Likelihood of a customer migrating from its current risk rating to any other category within the planning horizon is typically expressed in terms of a rating transition matrix. Row = current rating Column = prob of migrating to another risk grade * Complex estimation – need to estimate credit risk migrations at end of horizon as well as future credit spreads (risk-premium associated with end-of-period credit rating). * Two approaches: 1. Discounted contractual cash flow (DCCF) approach 2. Risk-neutral valuation (RNV) approach: an option valuation framework. In each methodology, a loan’s value is constructed as a discounted PV of its future cash flows. * Approaches differ mainly in how discount factors and yield spreads are estimated or calculated. TOPIC 5: OPERATIONAL RISK Overview * Definition: the risk of loss resulting from inadequate of failed internal processes, people and systems or from external events. * Harder to quantify and manage operational risk than credit or market risk. * FIs make a conscious decision to take a certain amount of credit and market risk but operational risk is a necessary part of doing business. Operational risk has become a more significant issue as a result of: * Increased use of highly automated technology and sophisticated systems * Growth of e-commerce * New wave of M&A * Increased risk mitigation techniques that may produ ce other risks * Increased prevalence of outsourcing * Over 100 operational loss events exceeding USD 100m since the end of the 1980s: * Internal fraud * External fraud * Employment practices and workplace safety * Clients, products and business practices * Damage to physical assets * Business disruption and system failures Execution, delivery and process management Regulatory Capital for Operational Risk * Three methods which represent a continuum of approaches characterised by increasing sophistication and risk sensitivity: 1. Basic Indicator Approach (15% of gross income) 2. Standardised Approach (different % for each business line) 3. Advanced Measurement Approach 1. Basic Indicator Approach * KBIA=GI ? ? GI = average annual gross income (net interest income + non-interest income) ? = 15% 2. Standardised Approach Bank activities divided into 8 business lines.Capital charge for each line is calculated by multiplying its gross income by the denoted beta. Total capital charge: KTSA = (GI1-8 ? ?1-8) To qualify for use of this approach, a bank must satisfy, at a minimum: – Its board of directors and senior management, as appropriate, are actively involved in the oversight of the operational risk management framework – It has an operational risk management system that is conceptually sound and implemented with integrity. – It has sufficient resources in the use of the approach in the major business lines as well as the control and audit areas. 3.Advanced Measurement Approach (AMA) * Regulatory capital requirement is determined using the quantitative and qualitative criteria for the AMA. * Banks can only use this approach if their local regulators/supervisory authorities have provided approval. * Qualitative Standards 1. Bank must have independent operational risk management function that is responsible for the design and implementation of banks’ operational risk management framework. 2. Bank’s internal operational risk measureme nt system must be closely integrated into the day-to-day risk management processes of the bank. 3.There must be regular reporting of operational risk exposures and loss experience to business unit management, senior management, and to the board of directors. 4. Bank’s operational risk management system must be well documented. 5. Internal and/or external auditors must perform regular reviews of the operational risk management processes & measurement systems. * Quantitative Standards 1. Banks must demonstrate that its approach captures potentially severe tail loss events. 2. Required to calculate regulatory capital requirement as the sum of expected loss (EL) and unexpected loss (UL) 3.Must be sufficiently ‘granular’ to capture the major drivers of operational risk. 4. Operational risk measurement system must include the use of internal data, relevant external data, scenario analysis and factors reflecting the business environment and internal control systems. Dis tributions important in estimating potential operational risk losses: 1. Loss frequency distribution * Distribution of number of losses observed during the time horizon (usually 1 year). * Loss frequency should be estimated from the banks own data as far as possible. One possibility is to assume a Poisson distribution: only need to estimate an average loss frequency. 2. Loss severity distribution * Distribution of the size of a loss given that a loss has occurred. * Based on both internal and external historical data. * Lognormal probability distribution is often used: only need to estimate mean and SD. AMA * The two distributions above are combined for each loss type and business line to determine the total loss distribution. * Monte Carlo simulation can be used to combine the two distributions. Four elements specified by the Basel Committee 1. Internal Data Operational risk losses have not been recorded as well as credit risk losses * Important losses are low-frequency high-severi ty losses * Loss frequency should be estimated from internal data 2. External Data * Data sharing or data vendors * Data from vendors: * Based on publicly available information biased towards large losses * Only be used to estimate the relative size of the mean losses and SD of losses for different risk categories. 3. Scenario Analysis * Aim is to generate scenarios covering all low frequency high severity losses * Can be based on both internal and external experience Aggregate scenarios to generate loss distributions 4. Business Environment and Internal Control Factors * Takes account of: * Complexity of business line * Technology used * Pace of change * Level of supervision * Staff turnover rates Power Law * Prob (v > x) = Kx-a * Power law holds well for the large losses experienced by banks. * When loss distributions are aggregated, the distribution with the heaviest tails tends to dominate. This means that the loss with the lowest alpha defines the extreme tails of the total los s distribution. Insurance * Important decision re operational risk is the extent to which it should be insured against.Moral Hazard * Risk that the existence of the insurance contract will cause the bank to behave differently than it otherwise would. * Example: a bank insures itself against robberies. As a result of the insurance policy, it may be tempted to be lax in its implementation of security measures – making a robbery more likely than it would otherwise have been. * Solution * Deductible – bank is responsible for bearing the first part of any loss * Coinsurance provision – insurance company pays a predetermined percentage of losses in excess of the deductible. * Policy limit – on total liability of the insurer.Adverse Selection * This is where an insurance company cannot distinguish between good and bad risks. * To overcome this, an insurance company must try to understand the controls that exist within banks and the losses that have been experien ced. Sarbanes-Oxley * Sarbanes-Oxley Act passed in the US in 2002. * Requires board of directors to become much more involved with day-to-day operations. They must monitor internal controls to ensure risks are being assessed and handled well. * Gives the SEC the power to censure the board or give it additional responsibilities. A company’s auditors are not allowed to carry out any significant non-auditing services. * Audit committee of the board must be made aware of alternative accounting treatments. * CEO and CFO must return bonuses in the event that financial statements are restated. TOPIC 6: LIQUIDITY RISK Overview * Liquidity refers to the ability to make cash payments as they become due. * Solvency refers to having more assets than liabilities, so that equity value is positive. Types of Liquidity Risk * Liquidity trading risk – markets can become illiquid very quickly.Cannot unwind asset position at a fair price fire sale prices. * Liquidity funding risk – risk of being unable to service cash flow obligations. Liquidity needs are uncertain. Liquidity Trading Risk * Price received for an asset depends on: * The mid market price * How much is to be sold * How quickly it is to be sold * The economic environment Bid-Offer Spread as a Function of Quantity * Dollar bid – offer spread, p = Offer price – Bid price * There is a spread which is constant up to some quantity. After a critical level (size limit of market makers), the spread widens.Proportional bid-offer spread= Offer price-bid priceMid-market price * Cost of liquidation in normal markets i=1n12si? i * N is the number of positions, alpha is the position of the instrument, s is the proportional bid-offer spread for the instrument. * Spread widens if market is in stressed conditions. * Cost of liquidation in stressed markets i=1n12(? i+ i)? i * Mean and SD, lambda is required confidence level Liquidity Adjusted VaRLiquidity-Adjusted Stressed VaR VaR+i=1n12si? i VaR+i= 1n12(? i+ i)? i Unwinding a Position Optimally (Two Options) Unwind quickly: trader will face large bid-offer spreads, but the potential loss from the mid-market price moving against the trader is small. * Unwind over several days: bid-offer spread each day will be lower, but the potential loss from the mid-market price moving against the trader is larger. Liquidity Funding Risk * Sources of liquidity * Liquid assets * Ability of liquidate trading positions (funding risk and trading risk are interrelated) * Wholesale and retail deposits * Lines of credit and the ability to borrow at short notice * Securitisation * Central bank borrowing (lender of last resort) Basel III Regulation * Liquidity Coverage Ratio: designed to make sure that the bank can survive a 30 day period of acute stress * Net Stable Funding Ratio: a longer term measure designed to ensure that stability of funding sources is consistent with the permanence of the assets that have to be funded. Liquidity Black Holes * Occurs when most market participants want to take one side of the market and liquidity dries up. Positive and Negative Feedback Trading * Exacerbates the direction of price movements * Positive feedback trader buys after a price increase and sells after a price decrease. Negative feedback trader buys after a price decrease and sells after a price increase. * Positive feedback trading can create or accentuate a black hole. Reasons for Positive Feedback Trading * Computer models incorporating stop-loss trading. Stop-loss trading = discarding position to prevent further losses. * Dynamic hedging a short option position. Example: if you have â€Å"sold an option† – cover yourself by going long i. e. buy underlying asset when price rises and sell when price decreases. * Creating a long option position synthetically * Margin calls The Leveraging CycleThe Deleveraging CycleIs Liquidity Improving? * Spreads are narrowing but arguably the risks of liquidity black holes are now greater than they used to be. * We need more diversity in financial markets where different groups of investors are acting independently of each other. Principles for Sound Liquidity Risk Management and Supervision (June 2008) * GFC regulators responded by undertaking a fundamental review of existing guidance of liquidity management and issued a revised set of principles on how banks should manage liquidity. Fundamental Principle for the Management and Supervision of Liquidity Risk 1.Sound management of liquidity risk – robust risk management framework. Governance of Liquidity Risk Management 2. Clearly articulate a liquidity risk tolerance 3. Strategy, policies and practices to manage liquidity risk 4. Incorporate liquidity costs, benefits and risks for all significant business activities. Measurement and Management of Liquidity Risk 5. Framework for comprehensively projecting cash flows arising from assets, liabilities and OBS items. 6. Actively monitor and control liquidi ty risk exposures and funding needs within and across legal entities. 7.Establish a funding strategy that provides effective diversification. 8. Effectively manage intraday liquidity positions and risks to meet payment and settlement obligations. 9. Actively manage collateral positions. 10. Conduct stress tests on a regular basis. 11. Formal contingency funding plan (CFP) in case of emergency. 12. Maintain a cushion of unencumbered, high quality liquid assets in case of stress scenarios. Public Disclosure 13. Publicly disclose information on a regular basis The Role of Supervisors 14. Regularly perform a comprehensive assessment of a bank’s overall liquidity risk management framework. 15.Supplement point 14 by monitoring a combination of internal reports, prudential reports and market information. 16. Should intervene to require effective and timely remedial action to address liquidity deficiencies. 17. Should communicate with other regulators e. g. central banks – coo peration TOPIC 7: CORE PRINCIPLES OF EFFECTIVE BANKING SUPERVISION Overview * Most important global standard for prudential regulation and supervision. * Endorsed by vast majority of countries. * Provides benchmark against which supervisory regimes can be assessed. * 1995: Mexican and Barings Crises Lyon Summit in 1996 for G7 Leaders. 1997: Document drafted and endorsed at G7 meeting. Final version presented at annual meetings of World Bank and IMF in Hong Kong. * 1998: G-22 endorsed * 2006: Revision of the Core Principles * 2011: Basel Committee mandates a major review, issues revised consultative paper. The Core Principles (2006) * 25 minimum requirements that need to be met for an effective regulatory system. * May need to be supplemented by other measures. * Seven major groups * Framework for supervisory authority – Principle 1 * Licensing and structure – Principles 2-5 * Prudential regulations and requirements – Principles 6-18 *Methods of ongoing banking s upervision – Principles 19-21 * Accounting and disclosure – Principle 22 * Corrective and remedial powers of supervisors – Principle 23 * Consolidated and cross-border banking – Principles 24-25. * Explicitly recognise: * Effective banking supervision is essential for a strong economic environment. * Supervision seeks to ensure banks operate in a safe and sound manner and hold sufficient capital and reserves. * Strong and effective supervision is a public good and critical to financial stability. * While cost of supervision is high, the cost of poor supervision is even higher. Key objective of banking supervision: * Maintain stability and confidence in the financial system * Encourage good corporate governance and enhance market transparency Revised Core Principles (2011) * Core Principles and assessment methodology merged into a single document. * Number of core principles increased to 29. * Takes account of several key trends and developments: * Need to deal with systemically important banks * Macroprudential focus (system-wide) and systemic risk * Effective crisis management, recovery and resolution measures. Sound corporate governance * Greater public disclosure and transparency enhance market discipline. * Two broad groups: 1. Supervisory powers, responsibilities and functions. Focus on effective risk-based supervision, and the need for early intervention and timely supervisory actions. Principles 1-13. 2. Prudential regulations and requirements. Cover supervisory expectations of banks, emphasising the importance of good corporate governance and risk management, as well as compliance with supervisory standards. Supervisory powers, responsibilities and functions 1.Clear responsibilities and objectives for each authority involved. Suitable legal framework. 2. Supervisor has operational independence, transparent processes, sound governance and adequate resources, and is accountable. 3. Cooperation and collaboration with domestic a uthorities and foreign supervisors. 4. Permissible activities of banks is controlled. 5. Assessment of bank ownership structure and governance. 6. Power to review, reject and impose prudential conditions on any changes in ownership or controlling interests. 7. Power to approve or reject major acquisitions. 8.Forward-looking assessment of the risk profile of banks and banking groups. 9. Uses appropriate range of techniques and tools to implement supervisory approach. 10. Collects, reviews and analyses prudential reports and statistical returns. 11. Early address of unsafe and unsound practices. 12. Supervises banking group on consolidated basis (including globally) 13. Cross-border sharing of information and cooperation. Prudential regulations and requirements 14. Robust corporate governance policies and processes. 15. Banks have a comprehensive risk management process, including recovery plans. 6. Set prudent and appropriate capital adequacy requirements. 17. Banks have an adequate credit risk management process. 18. Banks have adequate policies and processes for the early identification and management of problems assets, and maintain adequate provisions and reserves. 19. Banks have adequate policies re concentration risk. 20. Banks required to enter into any transactions with related parties on an arm’s length basis. 21. Banks have adequate policies re country and transfer risk. 22. Banks have an adequate market risk management process. 23.Banks have adequate systems re interest rate risk in the banking book. 24. Set prudent and appropriate liquidity requirements. 25. Banks have an adequate operational risk management framework. 26. Banks have adequate internal controls to establish and maintain a properly controlled operating environment for the conduct of their business. E. g. delegating authority and responsibility, separation of the functions that involve committing the bank. 27. Banks maintain adequate and reliable records, prepare financial state ments in accordance with accounting policies etc. 8. Banks regularly publish information on a consolidated and solo basis. 29. Banks have adequate policies and processes e. g. strict customer due diligence. Preconditions for Effective Banking Supervision 1. Provision of sound and sustainable macroeconomic policies. 2. A well established framework for financial stability policy formulation. 3. A well developed public infrastructure 4. A clear framework for crisis management, recovery and resolution 5. An appropriate level of systemic protection (or public safety net) 6. Effective market discipline 001: IMF and World Bank Study on Countries’ Compliance with Core Principles * 32 countries are compliant with 10 or few BCPs * Only 5 countries were assessed as fully compliant with 25 or more of the BCPs. * Developing countries less compliant than advanced economies. * Advanced economies generally possess more robust internal frameworks as defined by the ‘preconditions’ 2008: IMF Study on BCP Compliance * Based on 136 compliance assessments. * Continued work needed on strengthening banking supervision in many jurisdictions, particularly in the area of risk management. More than 40% of countries did not comply with the essential criteria of principles dealing with risk management, consolidated supervision and the abuse of financial services. * More than 30% did not possess the necessary operational independence to perform effective supervision nor have adequate ability to use their formal powers to take corrective action. * On average, countries in Western Europe demonstrated a much higher degree of compliance (above 90%) with BCP than their counterparts in other regions. * Africa and Western Hemisphere weak. Generally, high-income countries reflected a higher degree of compliance. TOPIC 8: CAPITAL ADEQUACY Overview * Adequate capital better able to withstand losses, provide credit through the business cycle and help promote public confidence in ba nking system. Importance of Capital Adequacy * Absorb unanticipated losses and preserve confidence in the FI * Protect uninsured depositors and other stakeholders * Protect FI insurance funds and taxpayers * Protect deposit insurance owners against increases in insurance premiums * To acquire real investments in order to provide financial services e. . equity financing is very important. Capital Adequacy * Capital too low banks may be unable to absorb high level of losses. * Capital too high banks may not be able to make the most efficient use of their resources. Constraint on credit availability. Pre-1988 * Banks regulated using balance sheet measures e. g. ratio of capital to assets. * Variations between countries re definitions, required ratios and enforcement of regulations. * 1980s: bank leverage increased, OBS derivatives trading increased. * LDC debt = major problem 1988 Basel Capital Accord (Basel I) * G10 agreed to Basel I Only covered credit risk * Capital / risk-adjusted assets > 8% * Tier 1 capital = shareholders equity and retained earnings * Tier 2 capital = additional internal and external resources e. g. loan loss reserves * Tier 1 capital / risk-adjusted assets > 4% * On-balance-sheet assets assigned to one of four categories * 0% – cash and government bonds * 20% – claims on OECD banks * 50% – residential mortgages * 100% – corporate loans, corporate bonds * Off-balance-sheet assets divided into contingent or guarantee contracts and FX/IR forward, futures, option and swap contracts. Two step process (i) derive credit equivalent amounts as product of FV and conversion factor then (ii) multiply amount by risk weight. * OBS market contracts or derivative instruments = potential exposure + current exposure. * Potential exposure: credit risk if counterparty defaults in the future. * Current exposure: cost of replacing a derivative securities contract at today’s prices. 1996 Amendment * Implemented in 1998 * Requi res banks to measure and hold capital for market risk. * k is a multiplicative factor chosen by regulators (at least 3) VaR is the 99% 10-day value at risk SRC is the specific risk charge Total Capital = 0. 08 x [Credit risk RWA + Market risk RWA] where market risk RWA = 12. 5 x [k x VaR + SRC] Basel II (2004) * Implemented in 2007 * Three pillars 1. New minimum capital requirements for credit and operational risk 2. Supervisory review: more thorough and uniform 3. Market discipline: more disclosure * Only applied to large international banks in US * Implemented by securities companies as well as banks in EU Pillar 1: Minimum Capital Requirements * Credit risk measurement: * Standardised approach (external credit rating based risk weights) * Internal rating based (IRB) Market risk = unchanged * Operational risk: * Basic indicator: 15% of gross income * Standardised: multiplicative factor for income arising from each business line. * Advanced measurement approaches: assess 99. 9% wor st case loss over one year. * Total capital = 0. 08 x [Credit risk RWA + market risk RWA + Operational risk RWA] Pillar 2: Supervisory Review * Importance of effective supervisory review of banks’ internal assessments of their overall risks. Pillar 3: Market discipline * Increasing transparency – public disclosure Basel 2. 5 (Implemented 2011) * Stressed VaR for market risk * Incremental risk charge Ensures products such as bonds and derivatives in the trading book have the same capital requirement that they would if they were in the banking book. * Comprehensive risk measure (re credit default correlations) Basel III (2010) * Considerably increase quality and quantity of banks capital * Macroprudential overlay – systemic risk * Allows time for smooth transition to new regime * Core capital only retained earnings and common shares * Reserves increased from 2% to 4. 5% * Capital conservation buffer – 2. 5% of RWA * Countercyclical capital buffer * Tracing/ monitoring of liquidity funding Introduction of a maximum leverage ratio Capital Definitions and Requirements * Common equity > 4. 5% of RWA * Tier 1 > 6% of RWA * Phased implementation of capital levels stretching to Jan 1, 2015 * Phased implementation of capital definition stretching to Jan 1, 2018 Microprudential Features * Greater focus on common equity * Loss-absorbing during stress/crisis period capital conservation buffer * Promoting integrated management of market and counterparty credit risk. * Liquidity standard introduced introduced Jan 1, 2015 Introduced Jan 1, 2018 Available Stable Funding FactorsRequired Stable Funding Factors Macroprudential Factors * Countercyclical buffer * Acts as a brake in good times of high credit growth and a decompressor to restrict credit during downturns. * Within a range of 0-2. 5% * Left to the discretion of national regulators * Dividends restricted when capital is below required level * Phased in between Jan 1, 2016 – Jan 1, 2019 * Leverage Ratio * Target 3% * Ratio of Tier 1 capital to total exposure > 3% * Introduced on Jan 1, 2018 after a transition period * SIFIs * Required to hold additional loss absorbency capital, ranging from 1-2. 5% in common equity