Welcome to Scribd. Sign in or start your free trial to enjoy unlimited e-books, audiobooks & documents.Find out more
Standard view
Full view
of .
Look up keyword
Like this
0 of .
Results for:
No results containing your search query
P. 1
Capital Adequacy Ratio for Banks_1

Capital Adequacy Ratio for Banks_1

|Views: 686|Likes:
Published by Jignesh Nayak

More info:

Published by: Jignesh Nayak on Dec 22, 2010
Copyright:Attribution Non-commercial


Read on Scribd mobile: iPhone, iPad and Android.
download as DOC, PDF, TXT or read online from Scribd
See more
See less





Capital adequacy ratio
), also called
Capital to Risk (Weighted) Assets Ratio
), is aratioof a bank 's capitalto itsrisk .  National regulatorstrack a bank's
toensure that it can absorb a reasonable amount of loss and are complying with their statutoryCapital requirements.This ratio is used to protect depositors and promote the stability andefficiency of financial systems around the world.
What Does
 Basel Accord 
A set of agreements set by the Basel Committee on Bank Supervision (BCBS), which provides recommendations on banking regulations in regards to capital risk, market risk andoperational risk. The purpose of the accords is to ensure that financial institutions haveenough capital on account to meet obligations and absorb unexpected losses.The first Basel Accord, known as Basel I, was issued in 1988 and focuses on the capitaladequacy of financial institutions. The capital adequacy risk, (the risk that a financialinstitution will be hurt by an unexpected loss), categorizes the assets of financial institutioninto five risk categories (0%, 10%, 20%, 50%, 100%). Banks that operate internationally arerequired to have a risk weight of 8% or less.The second Basel Accord, known as Basel II, is to be fully implemented by 2015. It focuseson three main areas, including minimum capital requirements, supervisory review and marketdiscipline, which are known as the three pillars. The focus of this accord is to strengtheninternational banking requirements as well as to supervise and enforce these requirements.
Capital adequacy ratios ("CAR") are a measure of the amount of a bank'score capital expressed as a percentageof itsassetsweightedcredit exposures. Capital adequacy ratio is defined asTIER 1 CAPITAL -A)Equity Capital, B) Disclosed ReservesTIER 2 CAPITAL -A)Undisclosed Reserves, B)General Loss reserves, C)Subordinate TermDebtswhereRisk  can either be weighted assets() or the respective national regulator's minimum total capitalrequirement. If using risk weightedassets, ≥ 10%.The percent threshold varies from bank to bank (10% in this case, a common requirement for regulators conforming to theBasel Accords) is set by the national banking regulator of different countries.
Two types of capital are measured:tier one capital(
above), which can absorb losseswithout a bank being required to cease trading, and tier two capital(
above), which canabsorb losses in the event of a winding-up and so provides a lesser degree of protection todepositors.
Capital adequacy ratio is the ratio which determines the capacity of the bank in terms of meeting the time liabilities and other risks such ascredit risk, operational risk, etc. In the most simple formulation, a bank's capital is the "cushion" for potential losses, which protectsthe bank's depositors or other lenders. Banking regulatorsin most countries define and monitor 
to protect depositors, thereby maintaining confidence in the banking system.CAR is similar to leverage; in the most basic formulation, it is comparable to the inverse of  debt-to-equityleverage formulations (although CAR uses equity over  assetsinstead of  debt- to-equity; sinceassets are by definition equal todebtplus equity, a transformation is required). Unlike traditionalleverage, however, CAR recognizes thatassetscan have different levels of risk .
Risk weighting
Since different types of assets have differentrisk profiles, CAR primarily adjusts for  assets  that are lessriskyby allowing banks to "discount" lower-risk  assets. The specifics of CAR  calculation vary from country to country, but general approaches tend to be similar for countries that apply theBasel Accords. In the most basic application,government debtis allowed a 0% "risk weighting" - that is, they are subtracted from total assetsfor purposes of  calculating the CAR.
Risk weighting example
Risk weighted assets - Fund Based
: Risk weighted assets mean fund based assets such ascash, loans, investments and other assets. Degrees of credit risk expressed as percentageweights have been assigned by RBI to each such assets.
Non-funded (Off-Balance sheet) Items
: The credit risk exposure attached to off-balancesheet items has to be first calculated by multiplying the face amount of each of the off- balance sheet items by the credit conversion factor. This will then have to be again multiplied by the relevant weightage.Localregulationsestablish that cashandgovernment bonds have a 0% risk weighting, and residential mortgage loanshave a 50% risk weighting. All other types of assets(loans to customers) have a 100% risk weighting.
 Bank "A" 
hasassetstotaling 100 units, consisting of:
Cash: 10 units.
Government bonds: 15 units.
Mortgage loans: 20 units.
Other  loans: 50 units.
Other  assets: 5 units.
 Bank "A" 
has debt of 95 units, all of which are deposits. By definition,equityis equal toassetsminus debt, or 5 units. Bank A's risk-weighted assets are calculated as followsCash
10 * 0% = 0
Government securities
15 * 0% = 0
Mortgage loans
20 * 50% = 10
Other loans
50 * 100% = 50
Other assets
5 * 100% = 5
Total risk Weighted Assets = 65
CAR (Equity/RWA) 7.69% Even though
 Bank "A" 
would appear to have a debt-to-equity ratioof 95:5, or equity-to-assets  of only 5%, its CAR is substantially higher. It is considered lessriskybecause some of itsassetsare less risky than others.
Types of capital
TheBasel rulesrecognize that different types of equity are more important than others. Torecognize this, different adjustments are made:1.Tier I Capital: Actual contributed equity plus retained earnings.
Tier II Capital: Preferred shares plus 50% of  subordinated debt.  Different minimum CAR ratios are applied: minimumTier I equitytorisk -weightedassets may be 4%, while minimum CAR includingTier II capital may be 8%. There is usually a maximum of Tier II capitalthat may be "counted" towards CAR,depending on the jurisdiction.
Capital Adequacy Ratio in India
The Committee on Banking Regulations and Supervisory Practices (Basel Committee)had released the guidelines on capital measures and capital standards in July 1988 whichwere been accepted by Central Banks in various countries including RBI. In India it has been implemented by RBI w.e.f. 1.4.92
Objectives of CAR :
The fundamental objective behind the norms is to strengthen thesoundness and stability of the banking system.
Capital Adequacy Ratio or CAR or CRAR :
It is ratio of capital fund to risk weightedassets expressed in percentage terms i.e.

Activity (3)

You've already reviewed this. Edit your review.
1 thousand reads
1 hundred reads
iwitowschi liked this

You're Reading a Free Preview

/*********** DO NOT ALTER ANYTHING BELOW THIS LINE ! ************/ var s_code=s.t();if(s_code)document.write(s_code)//-->