EuroSystem Fractional Reserve

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fujisan's picture
fujisan
Status: Gold Member (Offline)
Joined: Nov 5 2008
Posts: 296
EuroSystem Fractional Reserve

Hi,

I'm currently translating the CC in French and localizing for EuroSystem.

There seems to be various fractional reserve requirements for commercial banks in EU:

The ECB says minimum reserve requirements are 2%, which is VERY low! (money multiplier = 50)

But it seems European banks are also subject to Basel II capital requirements, where Tier 1 minimum capital requirements is 8% (money multiplier = 12.5)

Is this correct?

Am I missing something?

roswell_6's picture
roswell_6
Status: Member (Offline)
Joined: Nov 20 2008
Posts: 3
Re: EuroSystem Fractional Reserve

Hi Fujisan,

I am not sure about the 2% from ECB. Indeed, it seems quite low.

Regarding Basel II, the 8% is not exactly correct. Actually, it is not 8% of the money that is loaned that has to be kept as reserves in Tier1 capital. It is 8% of what is called the 'Risk Weighted Assets (RWA)'. The concept of risk weighted assets is that the bank first multiplies the money it has at risk, called exposures (loans, facilities, securitizations,...), by a multiplier called the risk weight (RW) that depends on the riskiness of these exposures. The result of this multiplication gives you the RWA. There are several methods used to determine the right RW for each exposure depending on how advanced is the specific bank risk management perceived by the regulator. For example, take a bank that is not too advanced in risk management. It must apply fixed RW. The low range of RW goes from 0% for a sovereign loan to a country with a good rating (like the US :d ), 20% for a loan to a bank with a good rating, 50% for a corporate loan with a good rating, 75% for a retail loan. The high range goes from 100% for poorly rated sovereigns, banks and corporate, to 200% for some equities and up to 1250% for some securitization exposures.

All in all, the weighted average RW of a bank differs quite much from bank to bank, but an average mid-size retail bank would normally stay under 100%. And by the way, this percentage is also lowered whenever there are credit risk mitigants (such as mortgages) that cover exposures. Eventually, you'd see that the percentage of Tier1 capital due to credit risk can be inferior to 8% in many cases.

Banks that are more advanced in risk management can use their own risk factor models to estimate some parameters that determine the RW to be applied. Mainly, these RW will be lower than the fixed ones in some cases, and higher in other cases.

Eventually, the 8% as defined by Basel II does not only consider credit risk, but also market risk and operational risk, for which calculations are different. All this makes it quite hard to give a single percentage for fractional reserve.

I am very interested by your French translation, I live in Europe and my native language is French.

Cheers

fujisan's picture
fujisan
Status: Gold Member (Offline)
Joined: Nov 5 2008
Posts: 296
Re: EuroSystem Fractional Reserve

The 2% minimum reserve requirement can be found on the ECB site. This is also described in wikipedia

According to wikipedia, some countries like UK, Canada, Australia do NOT require any minimum reserve (0%). It seems they expect the financial market to regulate itself. We know what this means!

I knew the 8% Basel II Tier 1 requirement is more complex than the basic minimum reserve requirement, but looking at ECB money supply data, I found that the ratio M3 / currency in circulation is roughly 12.5 (8%). Reason I asked...

Concerning the French translation, you could help by joining the Volonteer Brigade. At least to check I did not make big  mistakes...

TIA 

veerleke's picture
veerleke
Status: Member (Offline)
Joined: Apr 13 2009
Posts: 2
Re: EuroSystem Fractional Reserve

I am not nearly as advanced as the above commentators in financial knowledge, actually i am a total noob.

But i was wondering about how "american" all of this got with this federal reserve system and all and very much wondering what was going on in the rest of the world and in europe (i also live in Belgium, land of the absurd political landscape). Anyway, does anyone know if most other financial sytems are very similar, slightly better, slightly worse or a lot better or worse than the american system? Thereby enabling me to panic some more or to get a little more hopeful :)

 

Greetings,

 

Veerle

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