The Capital And Liquidity Risks Of NAB And Bank Of Queensland (Essay Sample)

Capital and Liquidity Risks of NAB & Bank of Queensland Name: Institutional Affiliation: Capital and Liquidity Risks of NAB & Bank of Queensland Capital Risk Introduction The capital risk is the possibility that a loss will occur on a portion or on the entire business’s investment. Capital risk applies to all the assets, which firms cannot be sure of their complete return of the initial capital. Investors such as banks have the challenge of capital risk whenever they put their money in shares, bonds from private entities, properties, foreign exchange commodities, and other securities (Lebedeva, Akhmetshin, Dzagoyeva, Kobersy, and Ikoev (2016). Additionally, once, a corporation invests in a specified project, it enters into a risk because it cannot be sure whether that project will produce adequate future returns or not in order to cover the capital that the firm invests. The Australian Prudential Regulation Authority (APRA) requires that any authorized deposit-taking organization especially the banks plans for making their capital requirements strong. The institutions should be prepared to increase the capital given the outstanding concerns that comprise the essential evaluation of the trading book in order to tackle the capital requirements and the local market risk, and the loss that absorbs capital to deal with the ‘too big to fail’ recovery and resolution. Additionally, the banks should increase the capital following the Basel Committee’s suggestions to change the risk weights in many of the components. Furthermore, the Australian Prudential Regulation Authority requires that the advanced Basel II banks should have more capital, which is why APRA improved the risk weight for the residential mortgage lending (Castelnuovo, Lim, & Robinson, 2016). In order to improve the capital efficiency, APRA has made many banks to focus on making their businesses simple with less risks through the restructuring of departments including the management delayering. Furthermore, the banks simplify their businesses through the discontinuation of the businesses with low profits. The banks also divest the assets that yield low returns and the dealings that require substantial capital such as the life assurance. Therefore, the banks prioritize the dealings that require less capital and concentrate on profitable loaning, such as residential mortgages. Capital Adequacy Ratio (CAR) Organizations measure their capital risk using the capital adequacy ratio, which is the capital to risk ratio of financial institutions such as the bank. A good bank's capital adequacy ratio shows that the bank can absorb high losses and has enough capital as required by the law. Capital adequacy ratio = (Tier 1 capital + Tier 2 capital)/ Risk-weighted assets. Tier 1 capital can absorb high losses with the bank still continuing with its trading activities while Tier 2 capital can absorb the bank‘s losses during its winding-up, hence, does not protect the depositors fully (Curcio & Hasan, 2015). For the risk-weighted assets, the bank regulators assign the credit risk’s degrees in terms of percentage weights (Laeven, Ratnovski, & Tong, 2016). The following are the percentage weights.   Asset Risk weighting (%) Cash and government bonds 0 Residential mortgage loans 50 Other assets and loans 100 Capital Adequacy Ratio for NAB (National Australia Bank Ltd, 2018). Tier 1 capital = Common Equity (Total) – (investment in unconsolidated subsidiary + intangible assets + Loan Loss Allowances (Reserves) Tier 2 capital= Preference shares Tier 1 capital (AUD Millions) = 48,386– (549 + 5,601 + (3,224)) = 45, 460 Tier 2 capital (AUD Millions) = 2,920 Risk-weighted assets for National Australia Bank Ltd is given as follows (AUD Millions). Total Cash & Due from Banks =6,269 X 0% =0 Consumer & Installment Loans =13,082 X 100% =13,082 Interbank Loans =37,066 X 100% =37,066 Real Estate Mortgage Loans =329,534 X 100% =329,534 Lease Financing Loans =11,674 X 100% =11,674 Unspecified/Other Loans =189,474 X 100% =189,474 Investments – Total =183,793 X 100% =183,793 Other Assets (Including Intangibles) = 9,453 X 100% =9,453 Risk-weighted assets 774,076 Capital adequacy ratio = (Tier 1 capital + Tier 2 capital)/ Risk-weighted assets = ([45, 460 + 2,920] /774,076) X 100 = (48,380/774,076) X 100 = 6.25% Capital Adequacy Ratio for Bank of Queensland (Bank of Queensland Ltd, 2018). Tier 1 capital = Common Equity (Total) – (investment in unconsolidated subsidiary + intangible assets + Loan Loss Allowances (Reserves) Tier 1 capital (AUD Millions) = 3,788 – (15 + 872+ (227)) = 3,128 Tier 2 capital= Preference shares The Bank of Queensland does not have the Tier 2 capital Risk-weighted assets for Bank of Queensland is given as follows (AUD Millions). Total Cash & Due from Banks = 705 X 0% =0 Consumer & Installment Loans = 555 X 100% =555 Interbank Loans = 58 X 100% =58 Real Estate Mortgage Loans = 29,853 X 100% =29,853 Lease Financing Loans = 4,780 X 100% =4,780 Unspecified/Other Loans =0 X 100% =0 Investments – Total = 5,880 X 100% =5,880 Other Assets (Including Intangibles) = 1,295X 100% =1,295 Risk-weighted assets 42,421 Capital adequacy ratio = (Tier 1 capital + Tier 2 capital)/ Risk-weighted assets = (3,128/42,421) X 100 = 7.37% According to Shingjergji and Hyseni (2015), the percent threshold of the capital adequacy ratio differs from one bank to the other, but the bank regulators require the percent threshold to be at least 10%. Both the National Australia Bank Ltd and the Bank of Queensland CAR percentages are less than the 10% threshold. Since, the two banks’ CARs are low, it means that they are somehow weak financially looking at their capital and assets. Therefore, the banks should try to maintain higher levels of both Tier 1 and Tier 2 capitals in order to make their depositors safe and promote the institutions’ stability. The Bank of Queensland has a higher capital adequacy ratio (7.37%) than that of National Australia Bank Ltd (6.25%). Therefore, the Bank of Queensland is safer and probably able to meet its financial obligations better than National Australia Bank Ltd. On the other hand, the Bank of Queensland does not have the Tier 2 capital, hence, it might not be able to absorb losses if by bad luck the bank is liquidated or wound up.  Both banks are more likely to be bankrupt in the unforeseen circumstances of arising of losses. Conclusion From the calculations above, the two banks’ thresholds are below the 10% that is required, hence, are financially weak. Therefore, there is some relative riskiness in the two banks and the management should begin deliberating on the way forward in order to increase capital adequacy ratios for them to have enough cushion. When the banks have enough cushion, they will be able to absorb a lot of losses before becoming bankrupt, hence, lose monies for their depositors. The banks will then become more efficient and stable as their risk of becoming insolvent reduces. The riskiness in the bank of Queensland is higher than that of National Australia Bank Ltd that the former does not have the Tier 2 capital, hence, it might not be able to absorb losses if by bad luck the bank is liquidated or wound up. Since, when a bank is liquidated, the law allows the depositors’ monies to get the first priority than the capital of the bank. Depositors will not lose their money if by chance the Bank of Queensland gets a loss that is more than its total capital, which will make the bank to close its doors for the lack of cash to continue operating. The Bank of Queensland should bring on board more Tier 2 capital to increase its capital adequacy ratio, hence, protect the assets of the depositors. From the below the 10% CARs, both banks are more likely to be bankrupt in the unforeseen circumstances of arising of losses. Therefore, the banks need to increase items such as the ordinary and preference share capitals to be on the safe side. So, the low capital to risk-weighted assets’ ratios of the two banks will be enhanced because of the improved capitalization of the institutions. Capital will become efficient and then think of improving the assets quality.  The two banks have not fully met the Australian Prudential Regulation Authority’s requirements because it seems like they do not prioritize the transactions that would require them to use less capital and concentrate on profitable loaning, such as residential mortgages. The balance sheets of both banks do not have any residential mortgages, hence, showing that the institutions are not aggressive to have them on board to increase their revenue. There are some areas that the two banks have met the Australian Prudential Regulation Authority’s requirements like divesting the transactions that require substantial capital such as the life assurance because in the balance sheets of the two banks, no one shows any participation in the life assurance business. Liquidity Risk Introduction Liquidity risk occurs when an institution such as a bank becomes not able to meet its current financial demands. This inability typically happens because of the inability of the bank to change solid assets or securities to liquid money without losing the rev...