Discuss the difference between the leverage ratio and the capital adequacy ratio.

A bank has the following balance sheet (in millions):
Cash 24 Retail Deposits 620 OECD Bank Deposits (BBB) 120 Wholesale Deposits 300 Corporate Bonds (BBB) 90 Common Equity 50 Mortgage Loans 130 Subordinated Debt (>5 years) 4 Small Business Loans 300 Consumer Loans 320 Reserve for Loan Losses (10) Total 974 Total 974
The bank has the following transactions with a BBB+ rated company:
• A two-year forward contract on a foreign currency, currently worth £3 million, to buy foreign currency worth £140 million. • A six-month forward contract on the FTSE100. The principal is £20 million and the current value is £2.5 million. • A two-year swap involving oil. The principal is £6 0 million and the current value of the swap is -£7 million.
Note:
Basel I credit conversion factors are 0% to cash and government bonds; 20% to claims on OECD banks; 50% to residential mortgages; 100% to corporate loans, corporate bonds, and consumer loans.
Rating AAA to AA-
A+ to A- BBB+ to BBB-
BB+ to BB-
B+ to B- Below B- Unrated
Country 0% 20% 50% 100% 100% 150% 100% Banks 20% 50% 50% 100% 100% 150% 50% Corporates 20% 50% 100% 100% 150% 150% 100%
Retail lending (secured) 35% Retail lending (unsecured) 75% 1- to 5-year foreign exchange contracts 5% 1- to 5-year interest rate swaps 0.5% 5- to 10-year interest rate swaps 1.5%
Add-on factors
Remaining Maturity (yr)
Interest Rate
Exchange Rate and Gold
Equity Other Precious Metals
Other Commodities < 1 0.0 1.0 6.0 7.0 10.0 1 to 5 0.5 5.0 8.0 7.0 12.0 > 5 1.5 7.5 10.0 8.0 15.0
Required:
(a) Estimate the capital required under Basel I (assume no netting for the off-balance sheet items) and discuss whether the bank has sufficient capital to meet the Basel requirements. (b) Calculate the capital required under Basel II if the Standardized Approach is used and show whether the bank has sufficient capital to meet the Basel requirements. If not, calculate the total capital the bank needs to meet the requirement.
(c) Calculate the leverage ratio. Briefly discuss the difference between the leverage ratio and the capital adequacy ratio.