CAPITAL ADQUACY

Capital Adequacy
General

With a view to adopting the Basle Committee

framework on capital adequacy norms which takes
into account the elements of risk in various types of
assets in the balance sheet as well as off-balance
sheet business and also to strengthen the capital base
of banks, Reserve Bank of India decided in April 1992
to introduce a risk asset ratio system for banks
(including foreign banks) in India as a capital
adequacy measure.
Essentially, under the above system the balance
sheet assets, non-funded items and other off-
balance sheet exposures are assigned weights
according to the prescribed risk weights and banks
have to maintain unimpaired minimum capital funds
equivalent to the prescribed ratio on the aggregate
of the risk weighted assets and other exposures on
an ongoing basis. The broad details of the capital
adequacy framework are detailed below.
 Norm of Capital Adequacy
Minimum requirement of capital funds
Banks are required to maintain a minimum CRAR of 9%
on an ongoing basis.
Tier II elements should be limited to a maximum of 100%
of total Tier I elements for the purpose of compliance
with the norms.
 Tier-I Capital (Indian Banks)

1. Elements of Tier I capital

a. Paid-up capital, statutory reserves, and other
disclosed free reserves, if any.
b. Capital reserves representing surplus arising out
of sale proceeds of assets.

2. Equity investments in subsidiaries,

intangible assets and losses in the current
period and those brought forward from
previous periods, should be deducted from
Tier I capital.
3. In the case of public sector banks which
have introduced Voluntary Retirement
Scheme (VRS), in view of the extra-ordinary
nature of the event, the VRS related
Deferred Revenue Expenditure would not be
reduced from Tier I capital. However, it will
attract 100% risk weight for capital
adequacy purpose.

4. Creation of deferred tax asset (DTA) results

in an increase in Tier I capital of a bank
without any tangible asset being added to
the banks’ balance sheet. Therefore, DTA,
which is an intangible asset, should be
deducted from Tier I capital.
Tier-I Capital (Foreign Banks)
Interest free funds from H.O. kept in separate
account for meeting capital adequacy.
Statutory Reserves kept in Indian Books
Remittable surplus retained in Indian Books
which are not repatriable so long as the Bank
functions in India.
Capital Reserves arising out of Sale of Assets
in India, held in separate account and are not
repatriable as long as the Bank functions in
India
Interest free funds remitted in India for
Acquisition of property in India and held in a
separate account.
The net credit balance in Inter-Office Account
with H.O. or a Branch Overseas will not be
reckoned as Capital funds. However, any
debit balance will have to be set off from the
Capital.
Elements of Tier II capital
Undisclosed reserves and cumulative perpetual
preference shares (fully paid up)

Revaluation reserves.

General provisions and loss reserves.

Hybrid debt capital instruments.

Subordinated debt.

Investment Fluctuation Reserve (IFR).

Undisclosed reserves should be accumulated
out of post tax profits and not encumbered by
any liability.
Cumulative preference shares should be fully
paid up and should not contain clauses which
permit redemption by shareholders.
Since revaluation reserves may not give full
100% value at the time of selling of the
assets, they need to be discounted by a
minimum of 55% when determining their
value for inclusion in Tier-II Capital.
General Provisions and Loss Reserves
(GPLR). These are available to meet
 Unexpected losses but are not attributable to
any specific/known loss which is foreseeable.
GPLR will be admitted to Tier-II Capital upto a
maximum of 1.25% of Risk weighted assets.
Subordinated Debt Instruments:
-Should not have initial maturity less than 5
years
-If issued in last quarter of FY, should have
initial maturity of 63 months
-Should be fully paid up
-Interest rate should not be more than 200 bp
above the yield on Government Security of
equal residuary maturity at the time of issue.
Subordinated Debt will be limited to 50% of
Tier-I Capital
Subordinated Debt to be included in Tier-II
Capital may be subjected to the following
discounts:
Beyond 4 Years but not exceeding 5 years-
20%
Beyond 3 Years but not exceeding 4 years-
40%
Beyond 2 Years but not exceeding 3 Years-
60%
Beyond 1 Year but not exceeding 2 years-
80%
Maturity not exceeding 1 year – 100%.
Public Sector Banks are required to obtain
permission of GOI before issue.
RBI permission required for issuing to NRI/FII
Subordinated Debt issue should be plain
vanila with no special features like options etc.
GPLR+GP on SA+Investment Fluctuation
Fund – Maximum to be admitted to tier II
capital is 1.25% of RWA
 RISK ADJUSTED ASSETS:
- Weighted aggregate of (Funded + Non
Funded) Assets
- Banks investments in all securities should be
assigned a risk weight of atleast 2.5% for
market risk. This will be in addition to the risk
weight assigned towards credit risk.
- Cash margins or credit balance in CA
earmarked specifically in lieu of cash margin
for the credit facility extended, be deducted
(netting done) before applying weight
 Claims received from DICGC/ECGC/Any
subsidy received e.g. IRDP and not
appropriated to the asset be deducted from
the respective Asset (Netting) before applying
weight
-Equity investment in subsidiaries, intangible
assets which are deducted from Tier-I Capital
should be assigned Zero weight.
-Advances to the extent guaranteed by DICGC/
ECGC may be assigned risk weight of 50% to
that extent.
-Advances against specified securities Fixed
Deposits/NSCs/KVPs/IVPs etc. should be given
zero risk weight
-Loans to staff Zero risk weight
Zero Risk weight under “Other Assets”:
-Income Tax deducted at source
-Advance Tax paid
-Interest due on Govt.Securities
-Accrued interest on CRR balances & other
claims with RBI
Investment in Subordinated debt instruments
of other Banks or Public Financial Institutions
would carry risk weight of 100%.
Foreign Exchange & Gold open position
should carry 100% risk weight.
Other items risk weight as per BOOK
Off Balance-sheet items:
The credit risk exposure attached to off
balance sheet items has to be first calculated
by multiplying the face value of each balance
sheet item by a Credit Conversion factor.
This will again have to be multiplied by the
 weight attributable to the counter party.
-Cash margins/deposits shall be deducted
before applying the credit conversion factors
-All financial guarantees CF 100%
-Performance guarantees CF 50%
-Short Term self-liquidating trade related
contingencies CF 20%
-Note issuance facilities and revolving
underwriting CF 50%
-Certain transactions related contingent
liabilities CF 50%
Guarantees issued by the banks against the
counterguarantee of other banks CF 20%
Rediscounting of documentary bills accepted
by other banks CF 20%
Foreign Exchange Contracts:
Original maturity < 14 days CF 0%
Original maturity < 1 yr CF 2%
Original maturity 1 yr to <2 yr CF 5%
For each additional year 3%
The converted values obtained shall be
multiplied by the risk weight attached to the
counter party.
Consider the following data of the Bank as on
31st March 2009: (Rs./Crs)
Equity 240

Statutory Reserves 40

CapitalReserves(Out of sales) 50

Undisclosed Reserves 40

Equity investment in 44
subsidiaries
Cumulative prepetual preference shares 90
Revaluation Reserves 130
General Provisions & Loss Reserves 80
Subordinated debt:Above 5 years 20
5 years 30
4 to 5 years 40
3 to 4 years 20
2 to 3 years 40
1 to 2 years 30
Below 1 year 140
Cash on hand 80
Balances with RBI 50
Balances with other Banks 84
Investment in Govt. Securities 74
Investment in other Securities 298
Claims on Comm Banks e.g. CDs 46
Loans and advances guaranteed by GOI 382
Loans & advances to Central PSUs 242
Loans & advances to State PSUs 150
Claims to FIs 80
Furniture & Fixtures 130
Buildings & Equipment 150
Stand by LCs to PSU 84
to private Cos. 112
Collatrised credit to Private Co. 100
underlying shipment
Note issuancefacility to Public sector 34
Aggregate outstanding F.E. contracts:
Maturity above 14 days <1 year 32
Maturity Above 2 yr <3 years 24
Apart from these, the Bank has Rs.2800 crs
of Risk weighted assets. Calculate the Capital
Adequacy ratio.
RISK WEIGHTED ASSETS (On balance
sheet)

Asset Bal weit Risk

weit
Cash on hand 80 0% 0
Bal with RBI 50 0% 0
Invst. Govt 74 2.5 1.85
Securities
Bal with other Banks 84 0 0
Inv. Other securities 298 100% 298
Claims on other banks 46 20% 9.20
CD etc.
L & A guaranteed by GOI 382 0% 0
L & A to Central PSUs 242 100% 242
L & A to State PSUs 150 100% 150
Claims to FIs 80 20% 16
Furniture & Fixture 130 100% 130
Building & Equipment 150 100% 150
TOTAL 997.05
Off Balance-Sheet assets: (Rs./crs)
Asset Bal Weit% cf% RWA
SLC PSU 84 100 100 84
SLC Pvt co. 112 100 100 112
Coll.credit 100 100 20 20
topvt.co.
Note issuance Pvt. 100 50 17
to 34
F.E.contract-
<1yr 32 100 2 0.64
-<3yr 24 100 8 1.92
Total 235.5
Total Risk weight assets=
997.05+235.56+2800 = Rs.4032.61 cr
Computation of Tier-I Capital:Amt.Rs/cr

Equity 240
Statutory Reserves 40
Capital Reserves (Sales proceed 50
Total 330
Less: Equity in subsidy 44
Tier-I Capital 286
Computation of Tier-II Capital:
Subordinated debt:
Above 5 yr 20 x 1 20
- 5 yr 30 x 0.8 24
- 4 to 5 yr 40 x 0.8 32
- 3 to 4 yr 20 x 0.6 12
-2 to 3 yr 40 x 0.4 16
-1 to 2 yr 30 x .2 6

- Below 1 yr 140 x 0 0
Total 110
Subordinated Debt should be lower of 50% of
tier-I Capital i.e. 0.50 x 286 =Rs.143 cr or
Rs.110 cr as calculated above i.e. Rs.110cr
General Provisions & Loss Reserves should
be lower of 1.25% of RWA i.e. 1.25% of
4032.61 = Rs.50.41 cr or actual i.e. Rs.80 cr.
Therefore Rs.50.41 cr (Rs./cr)
Undisclosed Reserves 40.00
Cumulative Preference shares 90.00
Revaluation Reserves: 130x.45 58.50
GPLR 50.41
Subordinated debt 110.00
Total Tier –II Capital = Rs.348.91 cr
For computing Capital Adequacy Tier-II can
not be more than Tier- I Capital i.e. Rs.286 cr
Therefore Capital adequacy =
(286+286)/4032.61 = 0.1418 = 14.18%
ILLUSTRATION:
Risk weighted assets of a bank are Rs.3250
cr. Tier-I Capital of Bank stands at Rs.119 cr.
Revaluation reserves and General Provisions
and Reserves stood at Rs.74 cr and Rs.49 cr
resp. The bank wants to find out whether it
meets the capital adequacy requirement of
9% or not. If not, to meet the capital
adequacy requirement, the bank is
contemplating on raising equity and
subordinated debt. Suggest a suitable
alternative to bank, stating the regulations to
be followed.
Total Risk weighted Assets = Rs.3250 crs
Tier-I Capital = Rs. 119 crs
Tier-II Capital = 0.45 x74 + Min. of
0.0125x3250 or Rs.74 = 33.30+40.625 =
Rs.73.925 cr
Total Capital = 119 + 73.925 = Rs.192.925cr
Existing Capital Adequacy=192.925/3250 x100
= 5.9%
Total Required Capital = 9% of 3250 =
Rs.292.50 cr
Capital needed to be raised= 292.50-192.925
= Rs.99.575 cr
Capital to be raised : Equity & Subordinated
Debt
Requirements: (i) Subordinated Debt can not
be more than 50% of equity capital (ii) Tier II
Capital can not be more than Tier I Capital
If we raise whole of additional capital required
by means of subordinated debt, then Tier II
Capital will be= 73.925+99.575=173.50 cr i.e.
more than Tier I Capital of Rs.119 cr. Also
subordinated debt will be =99.575 cr i.e. more
than 50% of Tier I Capital.
Let us assume that subordinated debt raised
 Rs. X crs. Therefore Equity raised will be Rs.
(99.575 – X) crs
Since subordinated debt can not be more
than 50% of Total Equity, therefore
X = 0.5(119+99.575-X) or X= Rs.72.8583cr
Also the other condition that Tier II Capital
can not be more than Tier-I Capital, therefore
X+73.925 = 119+99.575-X or X= Rs.72.325cr
Thus Additional capital will be raised as
Subordinated Debt = Rs.72.325cr
Equity(99.575-72.325)= Rs.27.250cr
TOTAL Rs.99.575cr
Thank You