Banking and Securities Law
(Basel Accords Capital Adequacy and Personal Property Securities Legislation)
Abstract
This paper examines the new governance principles of the Basel Accords Capital Adequacy and Personal Property Securities Legislation that was enacted to streamline the operations of financial institutions and also to provide a regulatory body. The recent financial trend of incorporating the diverse proprietary internal risks operational models into the capital regulatory stem from the aftermath of the 2008 subprime financial crisis that occasioned most governments globally to provide a form of regulation and supervision of financial institutions.
Introduction
The development of the Minimum Capital Adequacy ratios begun in 1974 when the Basle Committee was formed. (Wyatt, 2011) The committee represented several central banks and other financial supervisory bodies from the most industrialized nations (the G10 countries) The major objective of the Basle committee was to control the Capital Adequacy ratios and which later became known as the Basle Capital Accord. It recommended the methods and approach of calculating the Capital adequacy Ratios and the recommended minimum levels or ratios. These recommendations have been adopted by the entire OECD countries. (Basel II, 2005)
1.1 To provide for the risks that banks often face, the assets of the bank are mostly weighted according to their risk they are exposed to. These calculations concerning the off-balance sheet exposures are used to determine the total capital requirements or the Capital Adequacy Ratio also known by its initial as CAR. The Basel 1 group Committee on the Banking Supervision explained the concept of the risk-weighted approach, its importance and application procedures.
(http://www.bis.org/publ/bcbsc111, 1998) in 1987 in a G-10 group of industrialized nations meeting. The Basel committee provided that its easier for banks to be compared globally using a uniform approach, the inclusion of all the off-balance sheet exposures that could be included in the capital adequacy calculations and all banks are literally not deterred from including assets with liquidity in their books. The Basel II provided that assets like the debentures be assigned higher risks than others which are relatively safe like government securities and bonds.
Different assets have different asset risk profiles, banks weight the assets according to their level which allows the banks to provide or discount the lower risk assets. In most countries, the government is weighted as 0% which is subtracted from the bank’s total assets when calculating the CAR. The major objective of the Basel I, II, and III was that banks were to hold a recommended 8% of the total risk- weighted assets. These comparison rates depend on the version of the Basel Accord being followed.
| Mossie Bank ($m) | ||||||
| x | x/100 | |||||
| Cash | 100 | 1 | ||||
| Cash deposits (RBA) | 100 | 1 | ||||
| commonwealth Gov Securities | 1125 | 11.25 | ||||
| Other Public sector securities | 750 | 7.5 | ||||
| Private securities | 125 | 1.25 | ||||
| Housing loans | 2500 | 25 | ||||
| All other loans | 8500 | 85 | ||||
| Convertible notes | 400 | 4 | ||||
| Redeemable Pref shares | 400 | 4 | ||||
| Total Assets | 14000 | 140 | ||||
| N/B The convertible notes have been assumed that | ||||||
| all will be converted to ordinary shares | ||||||
| The redeemable shares options will remain unchanged | ||||||
| Tier 1 | ||||||
| Convertible notes | 4 | |||||
| Tier 2 | ||||||
| Upper tier 2 | 0 | |||||
| lower tier 2 | ||||||
| Redeemable Pref shares | 4 | |||||
| Total capital | 8 | |||||
| Credit Exposure | Percentage Risk Weighting | ||
| Cash | 0 | ||
| Short term claims on govt | 0 | ||
| Long-term claims on gvt(>1yr) | 10 | ||
| Claims on bank | 20 | ||
| Claims on public sector entities | 20 | ||
| Residential mortgage | 50 | ||
| All other credit exposures | 100 |
| x | x/100 | Risk weighting | R/weighted Exposures | |||
| commonwealth Gov Securities | 1125 | 11.25 | 10 | 1.125 | ||
| Other Public sector securities | 750 | 7.5 | 10 | 0.75 | ||
| Private securities | 125 | 1.25 | 50 | 0.625 | ||
| Housing loans | 2500 | 25 | 50 | 12.5 | ||
| All other loans | 8500 | 85 | 100 | 85 | ||
| Total Assets | 13200 | 132 | ||||
| Total risks weighted exposures | 100 | 100 | ||||
| Off-balance sheet | Amount * | Credit conversion* | Risk weighting = | R/weighted expos | ||
| Asset resale and repurchase | 200 | 100 | 2 | 100 | 2 | |
| Note issuance facility | 300 | 100 | 3 | 100 | 3 | |
| Forward FX contracts | ||||||
| Unused overdraft limits | 2700 | 100 | 7 | 20 | 5.4 | |
| Unused credit card limits | 700 | 20 | 7 | 20 | 1.4 | |
| Total risks weighted exposures b/forward | 100 | |||||
| 111.8 | ||||||
| Calculation of total Capital Adequacy ratios | ||||||
| Tier 1 Capital to total weighted exposures 4 divided by 111.8 = 3.6% | ||||||
| Total Capital to total risk weighted exposures = 8 divided by 111.8 = 7.2% |
The other Basel groups, that’s Basel. III was charging 4.5% in 2010 on the common equity while the Basel II was charging 2% initially before it was reviewed to 4.5% and tier 1 capital maintained its minimum ratio balance equivalent to 6% from the initial 4%. The calculations remain the same for the three sets of Basel only the comparisons are compared to the required percentages. However, Basel three increased several other regulators like 2.5% compulsory capital conservation buffer. It also increased leverage and liquidity new standards and ratio requirements.
1.2 Mossie bank needs to clarify its ordinary share capital. The total capital adequacy ratios of Mossie are 3.6%. The ratio is below the recommended 8% of the total capital adequacy ratio requirement under the minimal Basle Capital Accord that sets the ratio of the total capital to the total risk weighted credit exposures to 8% and the tier 1 risk weighted exposures to 4% or more. The tier 1 capital to the total risk weighted exposures is 3.6% for Mossie Bank. Mossie Bank can also improve its Capital Adequacy ratio by also reducing the amount of loan issued to customers under the other loans bank products. It has also exceeded the 50% standard that it should not surpassed the tier 1 capital. Mossie Bank needs to restructure its financial management.
Mossie bank has to increase the ordinary share capital in order to improve its Basle Capital Accord ratio requirement. The share capital has to increase by at least four times in order to satisfy the requirements of the Basel Accord. The other alternative is to reduce the credit exposures by to minimum levels like for example reducing the unused overdraft and credit card facilities.
2.1
| A Co. | ($m) |
| Annual sales | 2 |
| Land | 1 |
| Buildings | 0.6 |
| Stock | 1 |
A fixed charge refers to a mortgage that’s secured on a specific fixed asset such as piece of land to act as collateral against the loan. The asset is secured on the creditor and signed against him. The borrower will have to seek the consent of the creditor in order to sell it. The creditor registers the charge that is signed against the asset and it remains active until the loan is fully paid. A fixed charge may be secured on the land and building at the face value of $1.6 million. B Bank would be safer if it secures its loan to A Co. on a fixed charge on the land and building. The fixed charge would be registered and incase of liquidation then B Bank will have a priority over the registered property.
A floating charge refers to a mortgage on the assets of a debtor whose values or quantities change or fluctuate over time, to act as security or collateral on the loan. These are assets like inventory or the trading stock. In A. Co. no charge is registered on any asset under the floating charge arrangement. The debtor has all the rights over the asset and he can use it as he pleases. If the debtor defaults on payments or in case of bankruptcy or if the company goes under receivership, then the floating asset position changes and it freezes in its current state and the floating charge crystallizes into fixed charge and the creditor turns to the number one priority. The floating is not as secure as the fixed charge but it has more flexibility. Under this arrangement, if B Bank secures the assets of Aco under the floating charge it would not register the charge. Aco will however not be under any obligation not to sell or interfere with the assets held under the floating charge. The floating charge can be secured under the inventory or the trading stock which is currently valued at $1m.
2.2 XCo sells its products to ACo and seeks to secure a charge or security over the assets of Aco as per its present and future book debts. The nature of the transactions of XCo makes it prudent for the company to secure a floating charge on the ACo’s that will entail all inventories that are consistent with the business between the two companies. The floating charge enables XCo to have a flexible lien over the charge on the assets of ACo. The extra stock that XCo delivers to ACo will eventually freeze and crystallize into a fixed charge in case ACo goes into liquidation. These agreements however may not be enforceable in a court of law as in the case of Hoffman H/L in BCC Int’l SA (no. 8) 1998 and also Spiegelman in the case of Cinema plus NSW CA (2000)
The retention of title by XCo for the products supplied to ACo is possible to the extent that the inventory is still in the possession of ACo and they are part of the stock and the charge is still under XCo. When the products are sold and their possession crosses over to third parties then the retention of titles will only apply to the inventory that is still in stock and incase the whole inventory is sold then the retained titles will be useless. If the stock of ACo turns faster and the risks of having low stock is high then the two companies have to work out a strategy that will provide for a minimum stock balance to facilitate a balance of the value of the outstanding book debt and the floating charge. The Romalpa agreements and also some key provisions of the Australian PPSA apply to these cases.
The seller, in a pre-PPSA can claim the goods they didn’t belong to the person selling them. In a post-PPSA, the goods can be claimed by the seller only if the he registers a statement of financing within the required time limits. PPSA section 20 provides that all agreements and contracts on security must be evidenced in writing containing a brief description of the collateral which must be signed by the grantor.
3. The Personal Property Securities Act 2009 that is also known as the PPSA is practically a large wholesale law reform that governs secured transaction over personal property and it plays a major role in the development of the Australian commercial law. Under section s 19(2) of PPSA it provides that to make or create an enforceable interest, the person granting the loan must have some collateral rights in the property. Where all the goods are sold on conditional sale to a grantor, then he is said to have the rights to the goods when they come or she obtains possession. Depending on the type or nature of goods and the way the buyer had planned to use them, the PPSA provision reserves the title or ownership in the goods that have been supplied until they are fully paid by the supplier. An interest is directly granted to the creditor by his debtor over the assets that the creditor owns. (Steicke and Spurrit, 2012) The non application of the charges and the general provisions of the PPSA and the interest the seller has in the goods but subject to the provisions of the common law. (McCormack, 2004) The implications are two-fold. a) If the buyer is insolvent, then the seller has the right to claim the goods from the receiver manager or the administrator on the legal grounds that the goods actually belong to the seller and not the buyer. If charge created was a floating one and its registered under a third a party and buyer was unable to pay then the seller still has a right over the goods and also still ahead of the charge under the reasons that the goods were not the property of the buyer and so they were not even on the floating charge scope. (Beale, 2007)
If the buyer, created a competing charge that covered the same collateral but in favor of another third party, the charge will definitely have an upper hand if the sellers claim was not registered.
Certain charges are favorable to different kinds of securities. Land and building are securities are favorable to the fixed charge as their cost is certain and fixed. The only way their cost can increase or decrease is through valuation. Floating charge is favorable to the inventories and the nature of the debt stems from the suppliers products that ultimately ends up as inventory on the buyers company. The floating charge is flexible and applicable to that nature of transactions. In case of liquidation the seller has the right to claim the goods from the receiver manager or the administrator on the legal grounds that the goods actually belong to the seller and not the buyer.
The Australian courts recognize that under pre-PPSA 2009, a mortgage debenture can be utilized to create either a fixed or floating charge on any asset or undertaking of a business. The same act also recognizes the fixed charges over the present and the future assets. The principle nemo dat quod non habet (a person can’t give what he doesn’t have) which means that someone cannot make or create a charge over some property he presently doesn’t own. However, in the case of Graham v Portacom New Zealand ltd (2004) NZLR 528 the principle of nemo dat quod non habet has been modified to meet the principles and commercial objectives of PPSA 2009. Section 18 (2) of the PPSA 2009 act provides that the security interests may be provided after the property has been acquired while section 18 (3) provides that the security interests may be provided after the property has been attached without specific appropriation by grantor.
To conclude, the Basle Committee Accord on the Capital adequacy ratios has brought uniformity in the banking industry and it’s now possible to know the nature of the banks business and how they can positively or negatively have an impact in your life. The Basle requirement is a way of controlling and monitoring the activities of the financial institutions to avoid a near collapse of the industry like what happened in the year 2008 when major banks when under because of mismanagement and poor planning techniques. These developments target more accountability and transparency in the financial institutions. The charges on properties that are flexible make it possible for other types of securities to be accommodated in the market just as much as the fixed charges are preferred on collateral on some loans.
References
Wyatt, E. (20 December 2011). “Fed Proposes New Capital Rules for Banks”. New York Times. Retrieved 6 July 2012.
Basel II (2005) Comprehensive version part 2: The First Pillar – Minimum Capital Requirements” (November 2005. p. 86)
McCormack, G. (2004) Secured Credit under English and American Law, Cambridge University Press.
Steicke, K. and Spurrit, M. (2012) Preventing the Release of Commercially Sensitive Information under the Personal Property Securities Act 2009
Beale, H. (2007) The Law of Personal Property Security, Oxford University Press
