BASEL II: RECOMMENDATIONS ON CAPITAL CHARGE

The ability of a bank to absorb unexpected shocks and losses rests on its capital base. Basel II norms are centered on sustain economic development over the long haul and include
(1) promotion of safety and soundness in the financial systems,
(2) the enhancement of competitive equality, and
(3) the constitution of more comprehensive approach to address risk.
The new proposal is based on three mutually reinforcing pillars that allow banks and supervisors to evaluate properly the various risk that banks face and realign the regulatory capital more closely with the underlying risk.

SINKING-FUND METHOD OF RETIRING A DEBT

A common method of paying off long-term loan is to pay the interest on the loan at the end of each interest period and create a sinking-fund to accumulate the principle at the end of the term of the loan. Usually, the deposit into the sinking fund are made at the same times as the interest payments on the debt are made to the lender. The sum of the interest payment and the sinking-fund payment, is called the periodic expense or cost of the debt. It should be noted that the sinking fund remains under the control of the borrower. At the end of the term of the loan, the borrower returns the whole principal as a lump-sum payment by transferring the

SINKING FUND

When a specified amount of money is needed at a specified future date, it is good practice to accumulate systematically a fund by means of equal periodic deposit. Such a fund is called a sinking fund. Sinking funds are used to pay-off debts, to redeem bond issues, to replace worn-out equipment, to by new equipment, or in one of the depreciation method. Since the amount needed in sinking fund, the time the amount is needed and interest rate that the fund earns are known, we have an annuity problem in which the size of payment, sinking

ANNUITIES

At some point of your life, you may have had to make a series of fixed payments over a period of time- such as rent or car payment- or have received a series of payments over a period time, such as bond coupons. These are called annuities. If you under stand the time value of money and have an understanding of the future and present value, it would be easy to understand annuities.
The most common famous frequencies are yearly, semi-annually, quarterly and monthly. There are two basic types of annuities : ordinary annuities and annuities due
Ordinary annuities: Payment are required at the end of each period, For an illustration, straight bonds usually make coupon payments at the end of every six months until the bond's maturity date
Future Value of Ordinary Annuity = C*[{(1+i)^n-1}/i]
Present Value of Ordinary Annuity = C*[{(1+r)^n-1}/r(1+r)^n]

C = Cash flow per period
i = Interest rate
n = number of payment

FIXED AND FLOATING INTEREST RATES

Fixed Rate: In the fixed rate, the rate of interest is fixed. It will not change during entire period of the loan. For example, if a home loan, taken at an interest rate of 12%, is repayable in 10 years, the rate will remain the same during the entire tenure of 10 years even if the market rate increase or decrease. The fixed rate is, normally higher than the floating rate, as it is not affected by market fluctuation.

EQUATED MONTHLY INSTALLMENTS(EMI)

This is the most common method of repayment of loan is adopted in banking. Under this system, the principal and interest thereon is repaid through equal monthly installment over the fixed tenure of loan.
The formula for calculation of EMI
 EMI = [(P*r)*(1+r)^n]/[1+r)^n-1]
Where P = principal (amount of loan)
           r = rate of interest per installment period
           n = no. of installments in the tenure
For Example, for a loan of Rs. 1,00,000 at an interest rate of 12% p.a. is to be repaid in 12 months, the EMI is
P = 1,00,000
r = 12%/12 = 1% i.e. 1/100 = 0.01

Compound Interest

If the interest is charges more than once during the period and the interest is reinvested , we need to compound the interest.
Compound interest is paid on the original principal and accumulated part of interest.
P = Principal ( Initial amount you borrowed or deposit.)
r = Annual rate of interest (per cent)
n = Number of year the amount of deposit.
A = Amount of money accumulated after n year including interest.
When interest is compound once in a year for n years
             A=P(1+r)^n
if you borrow for 5 years the formula is
            A=P(1+r)^5
Annual Compounding = P(1+r)
Quarterly Compounding = P(1+r/4)^4
Monthly Compounding = P(1+r/12)^12

The basic formula is
     

Simple Interest

When money is loaned, the borrower usually pays a fee to the lender. this fee is called 'interest'. Simple interest or flat rate interest is the amount of interest paid each year in a fixed percentage of the amount borrowed or lent at the start.
The formula foe calculating simple interest is as follows:
Interest = Principal * Rate * Time

Illustration
A Student purchase a computer by obtaining a loan on simple interest. The computer cost Rs. 1,500 and the interest rate on the loan is 12 %. If, the loan is to be paid back on weekly installments over two years,,
Interest: =  (1,500*12*2)/100
             = Rs. 360
Total Repayments = Principal + Interest
                            = Rs. 1,500 + Rs.360
                            = Rs. 1,860
Weekly payment amount =        Total repayment       
                                          Loan period, T, in weeks
                                      = Rs. 1,860/(2*52)
                                      = Rs. 17.88 per week