Bank Regulatory Capital
The capital allocation requirements of a financial institution are behind overall banking strategy. Asset allocation decisions are influenced to a great extent by the capital considerations that such allocation implies. Lower capital requirements for derivatives explain to a great extent why derivatives are used by banks and corporates instead of cash products. This is as true of the money markets as it is of the bond markets. For that reason, a book on global money markets must cover banking itself, otherwise it will be incomplete. And an understanding of banking is not possible without an understanding one if its key aspects, regulatory capital.
For instance, a large part of the money markets involves securitised products, for example asset-backed commercial paper. One of the key motivations behind securitisation is the requirement to obtain capital relief. This leads to mortgages, trade receivables, and other assets being securitised. We can see that it is vital to understand the implications of capital costs. Additionally, the issue of cost of capital that we introduced in Chapter 7 must also take into account the regulatory capital implications of any asset allocation taken by a trading desk. Money market participants must know about regulatory capital issues – whether they trade CD, bills, repo, FRNs, ABCP – or they will not fully understand the cost of their own capital and hence return on capital.
Banking activity and the ...