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Introduction to Capital Adequacy Norms

Introduction to Capital Adequacy Norms

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Published by Mayur N Malviya

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Published by: Mayur N Malviya on Nov 03, 2011
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Introduction to Capital Adequacy Norms
Along with profitability and safety,banksalso give importance to Solvency.
Solvency
refers tothe situation where assets are equal to or more than liabilities. A bank should select its assets insuch a way that the shareholders and depositors' interest are protected.Image Credits ©light_breeze2010.
1. Prudential Norms
The norms which are to be followed while investing funds are called "
Prudential Norms
." Theyare formulated to protect the interests of the shareholders and depositors. Prudential Norms aregenerally prescribed and implemented by the central bank of the country.Commercial Banks have to follow these norms to protect the interests of the customers.For international banks, prudential norms were prescribed by the
Bank for InternationalSettlements
popularly known as
BIS
. TheBISappointed a
Basle Committee
on BankingSupervision in 1988.
 
2. Basel Committee
Basel committee appointed by BIS formulated rules and regulation for effective supervision of the central banks. For this it, also prescribed international norms to be followed by the centralbanks. This committee prescribed
Capital Adequacy Norms
in order to protect the interests of the customers.
3. Definition of Capital Adequacy Ratio
Capital Adequacy Ratio (CAR) is defined as the ratio of bank's capital to its risk assets. CapitalAdequacy Ratio (CAR) is also known as Capital to Risk (Weighted) Assets Ratio (CRAR).
India and Capital Adequacy Norms
The Government of India (GOI) appointed theNarasimham Committeein 1991 to suggestreforms in the financial sector. In the year 1992-93 the Narasimhan Committee submitted its firstreport and recommended that all the banks are required to have a minimum capital of 8% to therisk weighted assets of the banks. The ratio is known as
Capital to Risk Assets Ratio (CRAR)
.All the 27 Public Sector Banks in India (except UCO and Indian Bank) had achieved the CapitalAdequacy Norm of 8% by March 1997.The Second Report of Narasimham Committee was submitted in the year 1998-99. Itrecommended that the CRAR to be raised to 10% in a phased manner. It recommended anintermediate minimum target of 9% to be achieved by the year 2000 and 10% by 2002.
Concepts of Capital Adequacy Norms
 
Capital Adequacy Norms included different Concepts, explained as follows :-
1. Tier-I Capital
Capital which is first readily available to protect the unexpected losses is called as Tier-I Capital.It is also termed as Core Capital.Tier-I Capital consists of :-1.Paid-Up Capital.2.Statutory Reserves.
3.
Other Disclosed Free Reserves
: Reserves which are not kept side for meeting anyspecific liability.
4.
Capital Reserves
: Surplus generated from sale of Capital Assets.
2. Tier-II Capital
Capital which is second readily available to protect the unexpected losses is called as Tier-IICapital.Tier-II Capital consists of :-

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