Capital Adequacy


Vikash Jain ROLL NO.- 70. MBA 3rd sem

Capital adequacy ratio

The Committee on Banking Regulations and Supervisory Practices (Basel Committee) had released the guidelines on capital measures and capital standards in July 1988 which were been accepted by Central Banks in various countries including RBI. In India it has been implemented by RBI w.e.f. 1.4.92


thereby maintaining confidence in the banking system. operational risk. a bank's capital is the "cushion" for potential losses. etc. which protect the bank's depositors or other lenders.Capital Adequacy Ratio or CAR : Capital adequacy is a ratio that can indicate a banks ability to maintain the equity capital sufficient to pay the depositors whenever they demand the money & still have enough funds to increase the banks assets through additional lending. In the simplest formulation. Banking regulators in most countries define and monitor CAR to protect depositors . Capital adequacy ratio is the ratio which determines the capacity of the bank in terms of meeting the time liabilities and other risk such as credit risk. 4/12/2011 .

loans.‡ Formula: CAR= Tier one capital + Tier two capital Risk weighted Assets  Risk weighted assets means fund based assets such as cash. investments & other assets. .

This implies that Tier II cannot be more than 50% of the total capital 4/12/2011 .Minimum requirements of capital fund in India: ‡ Existing Banks 09 % ‡ New Private Sector Banks 10 % ‡ Banks undertaking Insurance business 10 % ‡ Local Area Banks 15% ‡ Tier I Capital should at no point of time be less than 50% of the total capital.

Minus *equity investments in subsidiaries.Capital Fund has two tiers :‡ Tier one capital includes: *paid-up capital *statutory reserves *other disclosed free reserves *capital reserves representing surplus arising out of sale proceeds of assets. . and *losses in the current period and those brought forward from previous periods to work out the Tier I capital. *intangible assets.

‡ Tier two capital includes: *Un-disclosed reserves and cumulative perpetual preference shares: *Revaluation Reserves (at a discount of 55 percent while determining their value for inclusion in Tier II capital) *General Provisions and Loss Reserves upto a maximum of 1.25% restriction *Hybrid debt capital Instruments (say bonds): *Subordinated debt (long term unsecured loans: .25% of weighted risk assets: *Investment fluctuation reserve not subject to 1.

The capital adequacy ratio of commercial banks shall not be lower than 8% and the core capital adequacy ratio shall not be lower than 4%. ‡ Article 6. Commercial banks shall calculate the capital adequacy ratio on the basis of consolidated operations as well as separated operations at the same time. .CAPITAL ADEQUACY RATIO OF COMMERCIAL BANKS ‡ The calculation of capital adequacy ratio of a commercial bank shall be on the basis that full account has been taken of the reserves to compensate losses in loans and various other losses. ‡ . ‡ Article 5. The capital of commercial banks shall be able to withstand credit risks and market risks.

such capital be raised with reduction in govt. ‡ Public sector banks need more capital. . shareholdings.GUIDELINES OF RBI ‡ RBI has been prescribing prudential norms for banks consistent with international practice. ‡ To meet the minimum capital adequacy norms set by RBI & to enable the banks to expand operations.

‡ It measures the relationship between firm s market value of assets & liabilities with the corresponding book value.FEATURES OF CAPITAL ADEQUACY ‡ Capital adequacy provides protection to depositors & creditors. ‡ Capital adequacy relates to the firm s overall use of financial leverage. .

.NEED OF CAPITAL ADEQUACY ‡ Adequate capital is required:  To support the growth  To absorb losses not covered by earnings  To ensure the public confidence in trust company system.

 This committee is best known for its international standards on capital adequacy. the core principles of banking supervision and the expert on cross-border banking supervision.Basel History«  Basel Committee was constituted by the Central Bank Governors of the G-10 countries.  Its objective is to enhance understanding of key supervisory issues and quality improvement of banking supervision worldwide. . Switzerland.  The Committee's Secretariat is located at the Bank for International Settlements in Basel.

.  Basel I is now widely viewed as outdated. and a more comprehensive set of guidelines. the Basel committee (BCBS) in Basel. published a set of minimal capital requirements for banks.  It primarily focused on credit risk . and in 1988. known as Basel II are in the process of implementation by several countries. Switzerland.Basel I  Basel I is the round of deliberations by central bankers from around the world.

 The objective of Basel II is to create an international standard that banking regulators can use when creating regulations about how much capital banks need to put aside to guard against the types of financial and operational risks banks face. and market discipline.  Basel II includes recommendations on three main areas: risks. .Basel II  Basel II is a type of recommendations on banking laws and regulations issued by the Basel Committee on Banking Supervision that was initially published in June 2004. supervisory review.

The Accord in operation The 3 Pillar Approach Minimum Capital Requirements Supervisory Review Market Discipline & Disclosure .

.The First Pillar. Other risks are not considered fully quantifiable at this stage. ‡ The first pillar deals with maintenance of regulatory capital calculated for three major components of risk that a bank faces: credit risk.. operational risk and market risk.

pension risk. reputation risk. ‡ The second pillar deals with the regulatory response to the first pillar. ‡ It also provides a framework for dealing with all the other risks a bank may face. strategic risk. giving regulators much improved 'tools' over those available to them under Basel I. liquidity risk and legal risk. . concentration risk.. such as systemic risk.The Second Pillar. It gives bank a power to review their risk management system. which the accord combines under the title of residual risk.

. . ‡ The third pillar greatly increases the disclosures that the bank must make.The Third Pillar. This is designed to allow the market to have a better picture of the overall risk position of the bank and to allow the counterparties of the bank to price and deal appropriately.

Basel III Key Facts Basel III is an update to the existing Basel II guidelines The updated rules will affect the Capital Requirements Directive that banks use to determine the minimum capital they should hold to adequately fund them through periods of financial stress Basel III is currently in the consultation phase and here are numerous changes to the framework that are being considered. 4/12/2011 .

4/12/2011 .to promote the short-term resiliency of the liquidity risk profile of institutions by ensuring that they have sufficient high quality liquid resources to survive an acute stress scenario lasting for one month. Net Stable Funding Ratio To promote resiliency over longer-term time horizons by creating additional incentives for banks to fund their activities with more stable sources of funding on an ongoing structural basis. The Net Stable Funding Ratio has been developed to capture structural issues related to funding choices.There are two new ratios that will be used in Basel III: New Proposed Ratios to measure and monitor Liquidity Risk Liquidity Coverage Ratio Introduction of a Liquidity Coverage Ratio .

closer to tangible common equity . 4/12/2011 . Better measurement of off-balance-sheet risks and risks of complex derivatives like credit default swaps Requirements for banks to build extra capital reserves if early warning signs show abnormal credit growth or asset price bubbles.Proposed improvements include: A better measurement of capital. Less reliance on ratings agencies.

4/12/2011 .

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