EXECUTIVE SUMMARY

SBI offer various loans and advances to its customers to achieve their financial plans. A customer is satisfied only when the banker knows, understands and meets the needs the needs and expectations of the customer. ‘Weighted assets’ is a measure of the amount of a bank’s assets, adjusted for risk. By adjusting the amount of each loan for an estimate of how risky it is, we can transform this percentage into a rough measure of the financial stability of a bank. The main use of risk weighted assets is to calculate tier 1 and tier 2 capital adequacy ratios. Basel I used a comparatively simple system of risk weighing. Capital adequacy ratios are a measure of the amount of a bank's capital expressed as a percentage of its risk weighted credit exposures. The minimum capital adequacy ratios have been developed to ensure banks can absorb a reasonable level of losses before becoming insolvent. A minimum capital adequacy ratio serves to protect depositors and promote the stability and efficiency of the financial system. Two types of capital are measured - tier one capital which can absorb losses without a bank being required to cease trading, e.g. ordinary share capital, and tier two capital which can absorb losses in the event of a winding-up and so provides a lesser degree of protection to depositors, e.g. subordinated debt.

CHAPTER – I

INTRODUCTION

1.1 INTRODUCTION TO CAPITAL ADEQUACY

Risk weighted assets is a measure of the amount of a bank’s assets, adjusted for risk. The nature of a bank’s business means it is usual for almost all of a bank’s assets will consist of loans to customers. Comparing the amount of capital a bank has with the amount of its assets gives a measure of how able the bank is to absorb losses. It its capital is 10% of its assets, then it can lose 10% of its assets without becoming insolvent. Capital Adequacy Central Bank Governors of the ten countries formed a committee of banking supervisory in 1975. This committee usually meets at the BIS in Basel, Switzerland. Hence it has come to know as the Basel Committee. The Basel Committee provided the framework for capital adequacy in 1988. The Basel – II accord is expected to establish a minimum level of capital for international active bank. National regulatory are free to set higher standards for international active bank. National regulatory are free to set higher standards for minimum capital. Capital Adequacy Ratios Capital adequacy ratios are a measure of the amount of a bank’s capital expressed as a percentage of its risk weighted credit exposures.

the Indian Banks are forced to maintain adequate capital in both tier I and tier II. tier one plus tier two less certain deductions) to total risk weighted credit exposures to be not less than 8 per cent.e.2 STATEMENT OF THE PROBLEM With the implementation of Basel I and Basel II norms. There are some further standards applicable to tier two capital: • Tier two capital may not exceed 100 percent of tier one capital • Lower tier two capital may not exceed 50 percent of tier one capital • Lower tier two capital is amortized on a straight line basis over the last five years of its life.The Basel Capital Accord sets minimum capital adequacy ratios that supervisory authorities are encouraged to apply. Thus the present study entitled “A Study on Capital Adequacy of State Bank of India” has been taken off. These are: • Tier one capital to total risk weighted credit exposures to be not less than 4 per cent. • Total capital (i. . Capital Adequacy Ratio is a measure of the amount of a bank’s capital expressed as a percentage of its risk weighed credit exposures. CAR is calculated taking into account the RWA. 1.

.6 Limitations of the Study • Due to paucity of time. 1. 1. • The data were kept confidential and hence. The collected data were compiled and analyzed using ratios. more years of data could not be taken. • The data required were collected from the records of SBI and RBI web sites. it was difficult to access the adequate data. The ratios used include Tangible Common Equity ratio and Capital Adequacy ratio.4 Research Methodology • The present study is a case study of State Bank of India.1.3 Objectives of the Study • To study the concept of Capital Adequacy in view of Basel I and Basel II norms.5 Period of the Study The present study has taken into account three years of data from 2006-07 to 2008-09. • The data required for the study were collected from secondary sources. • To check whether the bank has complied with the Basel II norms by using ratios. 1.

Research Methodology. Statement of Problem. • Chapter III deals with Basel I and Basel II norm for capital adequacy. • Chapter II deals with the profile of Indian Banking Industry and that of State Bank of India.7 Chapterisation • Chapter I deals with introduction to Risk Weighted Assets. Limitations and Chapterisation.1. suggestion and conclusion that derived from the study. Objective of the Study. • Chapter V deals with the findings. • Chapter IV deals with the analysis and interpretation of data & information. . Capital Adequacy.

CHAPTER – II PROFILES .

In terms of ownership. 1949 can be broadly classified into two major categories.000 branches spread across the country.1 PROFILE OF THE INDIAN BANKING INDUSTRY The Indian Banking industry. which is governed by the Banking Regulation Act of India. regional rural banks and private sector banks (the old/ new domestic and foreign). Every bank had to earmark a minimum percentage of their loan portfolio to sectors identified as “priority sectors”. the Public Sector Banks (PSB) s found it extremely difficult to compete with the new private sector banks and the foreign banks. The new private sector banks first made their appearance after the guidelines permitting them were . The first phase of financial reforms resulted in the nationalization of 14 major banks in 1969 and resulted in a shift from Class banking to Mass banking. After the second phase of financial sector reforms and liberalization of the sector in the early nineties. These banks have over 67. Scheduled banks comprise commercial banks and the co-operative banks. commercial banks can be further grouped into nationalized banks.2. The next wave of reforms saw the nationalization of 6 more commercial banks in 1980. This in turn resulted in a significant growth in the geographical coverage of banks. the State Bank of India and its group banks. Since then the number of scheduled commercial banks increased four-fold and the number of bank branches increased eight-fold. The manufacturing sector also grew during the 1970s in protected environs and the banking sector was a critical source. non-scheduled banks and scheduled banks.

They have a very good feel of the Indian market and I personally feel that in the longer run they will capitalise on their strengths and opportunities and out play foreign bank competition . . network and growing professionalism and have the capability to effectively provide diversified products and customized solutions in the light of emerging competition but rather than hitting the market overnight with aggressive strategies . vast infrastructure . growth and development and more specially their firm standing in the face of recent global recession are quite reflective of their intrinsic strength and their readiness for future .they might choose a cautious . up-graded technology .pause and proceed" strategy for long term sustainability and market positioning. which in turn helps them to save on manpower costs and provide better services.We shall never underestimate them . Eight new private sector banks are presently in operation. Their national character and identity with the masses and high domestic presence and reach in rural and semi urban areas are the greatest strength which are crucial in Indian environment dominated by sociocultural and psychological factors. Their past history.issued in January 1993.slow and calculated "watch .PSUs have learnt hardways all these years and grown so well.Foreign banks may talk high fi but PSUs understand the grassroot realities. These banks due to their late start have access to state-of-the-art technology. Indian banking system is based on strong fundamentals and more specially PSUs will become stronger in the face of foreign bank competition. Performance shall not be judged by profitability or business volume but by the economic and social contribution which perhaps will be the point PSUs will be scoring over. Although PSU's do have qualified manpower .

Point of Sale Merchant Acquisition. namely corporate banking. the bank has decided to credit link 1. namely finance. branches and employees.2 PROFILE OF STATE BANK OF INDIA The State Bank of India (SBI) is the largest commercial bank in India in terms of profits. deposits. State Bank of India was constituted through an act of Parliament in 1955. Mobile Banking.2. Advisory Services. Keeping in view the exponential growth achieved in self help group (SHG) financing in the recent past and good repayments (over 90%) under the scheme. Business is more than banking because it touches the lives of people anywhere in many ways. The SBI`s international presence is supplemented by a group of overseas and NRI branches in India and correspondent links with over 522 leading banks of the world. SBI is the only bank in India to be ranked among the top 100 banks in the world and among the top 20 banks in Asia in the annual survey by The Banker. SBI`s offshore joint ventures and subsidiaries enhance its global stature. international banking and domestic banking for concentrating on core areas. The bank has a network of 66 offices/branches in 29 countries spanning all time zones.The Bank is actively involved since 1973 in non-profit activity called Community Services Banking. All branches and administrative offices throughout the country sponsor and participate in large number of welfare activities and social causes. The bank is entering into many new businesses with strategic tie ups – Pension Funds. associate banks division for looking after the working of these banks. . General Insurance. Custodial Services. SBI has eight business units. credit division to monitor the overall credit.000. corporate development in house works. and three other business units.000 SHGs by the end of march 2008. Private Equity. assets.

Some of the training programes are attended by bankers from banks in other countries. The bank is also looking at opportunities to grow in size in India as well as internationally. today it offers the largest banking network to the Indian customer. It has also 7 Subsidiaries in India – SBI Capital Markets. mobile banking. debit cards. It is the only Indian bank to feature in the Fortune 500 list. The Bank is also in the process of providing complete payment solution to its clientele with its over 8500 ATMs. SBI . on whole sale banking capabilities to provide India’s growing mid / large Corporate with a complete array of products and services. It is consolidating its global treasury operations and entering into structured products and derivative instruments. It is also focusing at the top end of the market. the Bank is the largest provider of infrastructure debt and the largest arranger of external commercial borrowings in the country. The Bank is changing outdated front and back end processes to modern customer friendly processes to help improve the total customer experience. to expand its Rural Banking base. It presently has 82 foreign offices in 32 countries across the globe. looking at the vast untapped potential in the hinterland and proposes to cover 100. With about 8500 of its own 10000 branches and another 5100 branches of its Associate Banks already networked. etc. Today. and other electronic channels such as Internet banking.structured products etc – each one of these initiatives having a huge potential for growth. With four national level Apex Training Colleges and 54 learning Centre’s spread all over the country the Bank is continuously engaged in skill enhancement of its employees. SBICAP Securities. The Bank is forging ahead with cutting edge technology and innovative new banking models.000 villages in the next two years.

factoring. SBI’s earning profile is characterised by consistency in the return on assets (PAT/Average Assets). Throughout all this change. primary dealership. at around 1% per annum for the past three years. one of the largest insurance companies in France. offers a host of financial services.. SBI along with its associate banks offer a wide range of banking products and services across its different client markets.. The bank has entered the market of term lending to corporates and infrastructure financing. In a recently concluded mass internal communication programme termed ‘Parivartan’ the Bank rolled out over 3300 two day workshops across the country and covered over 130. SBI Factors. to drive home the message of Change and inclusiveness. SBI will maintain a good earnings profile in the medium term despite high pressure on yields due to the increasing competition in the banking sector. It has increased its thrust in retail assets in the last two years. through its non-banking subsidiaries. fund management.forming a formidable group in the Indian Banking scenario. and . and has built a strong market position in housing loans. traditionally the domain of the financial institutions. viz.000 employees in a period of 100 days using about 400 Trainers. It is in the process of raising capital for its growth and also consolidating its various holdings. broking. SBI Life Insurance Company Limited. investment banking and credit cards. SBI. The workshops fired the imagination of the employees with some other banks in India as well as other Public Sector Organizations seeking to emulate the programme. SBI Life and SBI Cards . SBI currently holds 74% equity in the joint venture.DFHI.A. merchant banking. the Bank is also attempting to change old mindsets. attitudes and take all employees together on this exciting road to Transformation. SBI has commenced its life insurance business by setting up a subsidiary. which is a joint venture with Cardiff S.

Sage Capital Value Fund. The company has started a USD 200-million fund. State Bank of India is entering the private equity sector by picking up close to 20% equity stake in Sage Capital Funds Management. that will invest in Indian companies. as a volatile capital market pushes down valuations of firms prompting this class of investors to value-pick stocks in the world`s second-fastest growing economy. .diverse income streams. an asset management company (AMC) floated by Sage Capital.

CHAPTER – III BASEL I & BASEL II NORMS FOR BANKS .

For example. This accord continued to be operative for about fifteen years. Hence it has come to be known as the Basel Committee. Banks in some European countries used to require 8 – 10 % of their assets as their capital. It came for a total overhaul and review during the last few years. This Committee usually meets at the Bank of International Settlement (BIS) in Basel.Central Bank Governors of the Group of Ten Countries formed a Committee of banking supervisory authorities in 1975. The Basel Committee addressed the issue of standardization and provided the requisite framework. which is known as the Basel I accord. all exposures to sovereigns were given 0% risk weight. The norms for adequacy of capital used to differ from bank and country to country. It defined components of capital. of course with some modifications from time to time. All bank exposures had a risk weight of 20%. Switzerland. An extensive consultative process was initiated and the supervisory authorities across the world were roped . allotted risk weights to different types or categories of assets and pronounced as to what should be the minimum ratio of capital to sum total of riskweighted assets. The Basel Committee provided the framework for capital adequacy in 1988. Corporate advances had a risk weight of 100%. Japanese banks used to consider capital to the extent of 1 to 2 % of their assets level as adequate. The Basel-I norms for risk weights were more of a straightjacket nature. The position that an excellent corporate such as L & T could have less risk weight than some of the banks was not recognized under this accord. The first round of proposal for changes in the Basel-I accord came up for deliberations and consultative process in June 1999. Such rigid approach without any consideration for the strengths or weaknesses of individual entities was the main shortcoming of the Basel-I accord.

Basel-II provides incentives for banks to invest and increase the sophistication of their internal risk management capabilities in order to gain reductions in capital. The report of the Committee is titled as “International Convergence of Capital Measurement and Capital Standards – A revised framework”. The new capital accord will require banks to manage risks by not only allocating regulatory capital but also by disclosing greater risk information and setting standards for risk management processes. the framework for capital adequacy was finalized with the approval of all the ten members of the Basel Committee in June 2004. This will help them to increase a bank’s lending which in turn will give higher returns and value to its shareholders. The revised framework is perceived as more forward-looking approach and has a capacity to evolve with time. After five years of deliberations. In India. The Committee intends that the revised framework would be implemented by the end of year 2006. The revised framework would promote the adoption of stronger risk management practices by banks. The fundamental objective of the Committee was to revise the 1988 accord and strengthen the soundness and stability of the banking system. National regulators are free to set higher standards for minimum capital. It demands capital allocation for operational risk for the first time. the parallel runs commenced in April 2006 and implementation was complete on 31st March 2007. . The Basel-II accord is expected to establish a minimum level of capital for internationally active banks. The revised framework provides greater use of assessment of risk provided by Banks’ internal systems as inputs to capital calculations. It also emphasizes the need for consistency in approach. It provides a range of options for determining capital requirements for credit risk and operational risk.in this exercise.

Banks would ensure compliance with the Basel standards to show themselves as good practitioners in risk management. However. banks consider a regulatory requirement as an administrative burden with little or no benefit to their bottom line. The Basel Committee recognizes that home country supervisors have an important role in leading the enhanced cooperation between home and host country supervisors that will be required for the effective implementation. First Pillar Second Pillar Third Pillar Minimum capital requirements Supervisory review process Market discipline The first pillar would replace the existing ‘one-size-fits-all’ framework for the assessment of capital with several options for the banks. The reputation of a bank is very important. the Basel capital requirements are viewed as an opportunity to demonstrate their credentials. The Basel – II accord rests on three pillars. Banks and supervisors are required to give appropriate attention to the second and third pillars. All banking and other relevant financial activities (other than insurance) conducted within a .Generally. SCOPE OF APPLICATION The Basel – II accord aligns regulatory capital with the banks’ risk profiles. The third pillar puts in place disclosure norms about risk management practices and allocation of regulatory capital. The revised framework will be mainly applicable to internationally active banks. This pillar helps to strengthen market discipline as a compliment to supervisory efforts. The second pillar provides guidelines for supervisors to ensure that each bank has robust internal processes for risk management and the adequacy of capital is assessed properly.

Thus the term capital would include Tier-1 or core capital.5% of market risk needs to be supported by tier-1 capital. Please note that any capital requirement arising in respect of credit and counter-party risk needs to be met by tier 1 and 2 capital. less specified deductions. Short term bond must have an original maturity of at least two years. . Tier-2 or supplemental Core capital consists of paid up capital. The definition of eligible regulatory capital largely continues to be as defined in the earlier accord of 1988 and amended to include Tier-3 capital as prescribed in January 96 and September 97. The revised accord provides incentives to banks to improve their risk management systems. The components of the three pillars are presented below: Pillar 1: Minimum Capital Requirement The capital ratio continues to be calculated using the definition of regulatory capital and risk-weighted assets. Tier-3 capital consists of short term subordinated debt for the sole purpose of meeting a proportion of the capital requirement for market risk. free reserves and unallocated surpluses. and limited life preference shares. Tier-3 capital will be limited to 250% of a bank’s tier-1 capital that is required to support market risk. loan loss reserves. investment fluctuation reserves. This means that a minimum of about 28. Tier-2 capital is restricted to 100% of Tier-1 capital as before and long term subordinated debt may not exceed 50% of Tier-I capital. Supplementary capital comprises subordinated debt of more than five years’ maturity.group containing an internationally active bank will be captured through a consolidation process. revaluation reserves.

Evaluate risk assessment 2. Enhance disclosures .5 * Capital requirement for operational risk We shall look at these individual components of risk-weighted assets in detail in the following units. where the internal processes are slack. Ensure maintenance of minimum capital with PCA for shortfall 4.e. Total risk weighted assets include the capital requirement for market risk and operational risk multiplied by 12. Pillar 3: Market Discipline 1. Thus Total Risk weighted assets = Risk weighted assets for credit risk + 12. Ensure soundness and integrity of bank’s internal processes to assess the adequacy of capital 3.5 (i.e. Pillar 2: Supervisory Review 1. The area of operational risk is brought under the ambit of risk-weighted assets for the first time.The scope of risk weighted assets is expanded to include certain additional aspects of market risk and also operational risk. reciprocal of the minimum capital requirement of 8%) along with risk weight assets for credit risk.5 * Capital requirement for market risk + 12. where necessary i. Prescribe differential capital.

The revised framework is more risk sensitive then the 1988 accord. Core disclosures and supplementary disclosures 3. . but envisages processes of supervisory review and market discipline. Timely at least semiannual disclosures Thus the Basel-II accord does not merely prescribe minimum capital requirement. There are incentives for those banks. which have better risk management capabilities.2.

CHAPTER – IV ANALYSIS & INTERPRETATION .

These difficulties are exacerbated by the motivation banks have to distort it. 2c secured by mortgages. then it can lose 10% of its assets without becoming insolvent.RISK WEIGHTED ASSETS. Suppose a bank has the following assets: 1C in gilts. The main use of risk weighted assets is to calculate tier 1 and tier 2 capital adequacy ratios. Risk weighting adjusts the value of a asset for risk. It is not a particularly accurate measure because of the difficulties involved in estimating these risks. Low risk assets are multiplied by a low number. 1). By adjusting the amount of each loan for an estimate of how risky it is. The bank’s risk weighted assets are (0 × 1C) + (50% × 2C) + (100% × 3C) = 4c. and 100% for the corporate loans. 50% for mortgages. Basel I used a comparatively simple system of risk weighting that is used in the calculation above. we can transform this percentage into a rough measure of the financial stability of a bank. simply by multiplying it be a factor that reflects its risk.e. and 3 of loans to businesses. Each class of asset was assigned a fixed risk weight. If its capital is 10% of its assets. Risk weighted assets is a measure of the amount of a bank’s assets. adjusted for risk. The nature of a bank's business means it is usual for almost all of a bank's assets will consist of loans to customers. Basel II . The risk weightings used as 0% for gilts (a risk free asset). Comparing the amount of capital a bank has with the amount of its assets gives a measure of how able the bank is to absorb losses. high risk assets by 100% (i.

If they win their bets. It is: Tangible common equity ÷ total tangible assets In other words it is the shareholders funds belonging to ordinary shareholders as a proportion of a bank's tangible assets (most of which are usually loans to customers). the shareholders (and management) take the profit.uses a different classification of assets with some types having weightings that depend on the borrower’s credit rating or the bank’s own risk models. if they lose then the loss us likely to be shared with debt holders or governments (as banks are rarely allowed to fail). especially given that model risk was quite high even without the incentives the banks had to manipulate the models to understate risk. It is more conservative than the usual capital adequacy ratios (including tier 1) because it excludes preference share capital and all intangible assets. Banks have a motive to take on more risk. The TCE ratio is also usually calculated using actual total assets with no risk weighting. Part of the motivation for Basel II was that banks were able to work around the Basel I system by selecting riskier business within each asset class. . Given this it seems remiss to have allowed the banks to use their own risk models. CALCULATION OF RISK WEIGHTED ASSETS TANGIBLE COMMON EQUITY RATIO The tangible common equity ratio (TCE ratio) is a measure of the financial soundness of banks.

Results computed.The TCE ratio became prominent because it became evident. during the credit crunch. a simple and conservative measure was useful to both regulators and investors. TCE= Tangible Common Equity TTA= Total Tangible Assets TCER=Tangible Common Equity Ratio . With the banks' own risk models discredited. that some banks had apparently healthy capital adequacy ratios only because of large amounts of preference share capital and intangible assets of uncertain value such as deferred tax.65% 2008 631 3139 20% 2009 634 3574 17% Sources: SBI Records.1 YEAR TCE TTA TCER TANGIBLE COMMON EQUITY RATIO 2007 526 2676 19. Table 4.

according to Basel II standards. it has increased in 2008 from 19.This committee usually meets at the of international settlement . in 2009 it has decreased to 17%. This shows that the financial soundness has come down in 2009. CAPITAL ADEQUACY Central bank governors of the ten countries formed a committee of banking supervisory in 1975. the firm is doing good with its financial reserves. But still.65% to 20%. But.GRAPHICAL REPRESENTATION Chart 4.1 Tangible Common Equity Ratio trend INTERPRETATION Considering the trend of the Tangible Common Equity Ratio for the last three years.

The new capital accord will require banks to manage risk by not only allocating regulatory capital but also by disclosing greater risk information and setting standards for risk management processes. Capital adequacy requirements have existed for a long time. but also the wider economy. the second other types such as preference shares and . Switzerland. Regulators try to ensure that banks and other financial institutions have sufficient capital to keep them out of difficulty. National regulatory are free to set higher standards for minimum capital. because the failure of a big bank has extensive knock-on effects. The Basel-2 accord is expected to establish a minimum level of capital for international active bank. The risk of knock-on effects that have repercussions at the level of the entire financial sector is called systemic risk. Basel 1 defined capital adequacy as a single number that was the ratio of a bank’s capital to its assets.(BIS) in Basel. The first is primarily share capital. The Basel committee provided the framework for capital adequacy in 1988. Hence it has come to know as the Basel committee. This will help them to increase a bank’s lending which in turn will give higher returns and value to its shareholders. but the two most important are those specified by the Basel committee of the Bank for International Settlements. There are two types of capital. This not only protects depositors.basel-2 provides incentives for banks to invest and increase the sophistication of their internal risk management capabilities in order to gain reducing in capital. tier one and tier two.

free reserve and unallocated surplus. 4% of risk weighted assets must be core tire-1 capital. In addition to specifying levels of capital adequacy. Tire.2 or supplemental capital. Other assets have weightings somewhere in between.subordinated debt. The weighted value of an asset is its value multiplied by the weight for that type of asset. and Tier-3 capital. high risk assets (such as unsecured loans) have a rating of one. most countries have regulator run guarantee funds that will pay depositors at least part of what they are owed. Core capital consists of paid up capital. . The minimum of 8% of risk weighted assets must be met by Tier-1 plus Tier-2 capital. The key requirement was that tier one capital was at least 8% of assets. Very safe assets such as government debt have a zero weighting. Each class of asset has a weight of between zero and 1 (or 100%). The total capital ratio must not be lower than 8%. It is also usual for regulators to intervene to prevent outright bank defaults MINIMUM CAPITAL REQUIREMENTS The term capital would include Tier-1 or core capital. less specified deductions.

.0 measure of the amount of a bank's Standby letter of credit 1. Applying minimum capital adequacy ratios serves to promote the stability and efficiency of the financial system by reducing the likelihood of banks becoming insolvent. The purpose of having minimum capital adequacy ratios is to ensure that banks can absorb a reasonable level of losses before becoming insolvent.Table 4.2 Assets CAPITAL REQIREMENT FOR 2008-09 Risk weight 0 0 0. When a bank becomes insolvent this may lead to a loss of confidence in the financial system.2 0.5 CAPITAL ADEQUACY RATIO Cash and equivalent Govt securities Interbank loan Mortgage loan Capital adequacy ratios are a Ordinary loan 1. and before depositors funds are lost. causing financial problems for other banks and perhaps threatening the smooth functioning of financial markets. Minimum capital adequacy ratios have been developed to ensure banks can absorb a reasonable level of losses before becoming insolvent.0 capital expressed as a percentage of its risk weighted credit exposures. Applying minimum capital adequacy ratios serves to protect depositors and promote the stability and efficiency of the financial system.

In the event of a winding-up. It contains a recommended approach for calculating capital adequacy ratios and recommended minimum capital adequacy ratios for international banks. Development of Minimum Capital Adequacy Ratios The "Basle Committee" (centred in the Bank for International Settlements). The Accord was developed in order to improve capital adequacy ratios (which were considered to be too low in some banks) and to help standardise international regulatory practice. Capital . the higher the level of protection available to depositors.It also gives some protection to depositors. It has been adopted by the OECD countries and many developing countries. is a committee that represents central banks and financial supervisory authorities of the major industrialised countries (the G10 countries). The higher the capital adequacy ratio. The Reserve Bank applies the principles of the Basle Capital Accord in India. This statement is known as the "Basle Capital Accord". depositors' funds rank in priority before capital. so depositors would only lose money if the bank makes a loss which exceeds the amount of capital it has. Its principal interest has been in the area of capital adequacy ratios. which was originally established in 1974. In 1988 the committee issued a statement of principles dealing with capital adequacy ratios. The committee concerns itself with ensuring the effective supervision of banks on a global basis by setting and promoting international standards.

The Basle Capital Accord also defines a third type of capital. . subordinated debt holders will only be repaid if all other creditors (including depositors) have already been repaid. It comes into play in absorbing losses after tier one capital has been lost by the bank. while lower tier two capital has a limited life span. This is debt which ranks in priority behind all creditors except shareholders. which makes it less effective in providing a buffer against losses by the bank. Tier one capital is capital which is permanently and freely available to absorb losses without the bank being obliged to cease trading. Tier two capital is capital which generally absorbs losses only in the event of a winding-up of a bank. Market risks are risks of losses on foreign exchange and interest rate contracts caused by changes in foreign exchange rates and interest rates. An example of tier two capital is subordinated debt. It can be used to provide a buffer against losses caused by market risks if tier one and tier two capital are insufficient for this.called tier one capital and tier two capital. Tier one capital is important because it safeguards both the survival of the bank and the stability of the financial system. so does not have any requirements for the holding of tier three capital.The calculation of capital (for use in capital adequacy ratios) requires some adjustments to be made to the amount of capital shown on the balance sheet. An example of tier one capital is the ordinary share capital of the bank. Tier two capital is sub-divided into upper and lower tier two capital. Tier three capital consists of short term subordinated debt. referred to as tier three capital. In the event of a winding-up. Two types of capital are measured in India . The Reserve Bank does not require capital to be held against market risk. Upper tier two capital has no fixed maturity. and so provides a lower level of protection for depositors and other creditors.

The calculation of credit exposures recognises and adjusts for two factors: • On-balance sheet credit exposures differ in their degree of riskiness (e. a commercial bill issued by a company or another bank). The risks inherent in a credit exposure are affected by the financial strength of the party owing money to the bank. enforce repayment. Government Stock compared to personal loans). A credit risk is a risk that the bank will not be able to recover the money it is owed. if necessary. market factors which affect the debtor's ability to pay the bank can impact on credit risk. and taken a mortgage on the house as security. movements in the property market have an influence on the likelihood of the bank recovering all money owed to it.The composition and calculation of capital are illustrated by the first step of the capital adequacy ratio calculation example shown later in this article. under a foreign exchange contract). Credit risk is also affected by market factors that impact on the value or cash flow of assets that are used as security for loans. A broad brush approach is taken to .g. if a bank has made a loan to a person to buy a house. The greater this is.g. or has any other arrangement with another party that requires that party to pay money to the bank (e.g. the more likely it is that the debt will be paid or that the bank can. For example. or buys a financial asset (e. This is done by weighting credit exposures according to their degree of riskiness. Credit Exposures Credit exposures arise when a bank lends money to a customer. Capital adequacy ratio calculations recognise these differences by requiring more capital to be held against more risky exposures. Even for unsecured loans or contracts.

in the same way as on-balance sheet credit exposures. This is done by multiplying the nominal principal amount by a factor which recognises the amount of risk inherent in particular types of off-balance sheet credit exposures. The Reserve Bank defines seven credit exposure categories into which credit exposures must be assigned for capital adequacy ratio calculation purposes. The credit exposure categories and the risk weighting process are illustrated by the second step of the calculation example.g. foreign exchange and interest rate contracts) also carry credit risks. Minimum Capital Adequacy Ratios The Basle Capital Accord sets minimum capital adequacy ratios that supervisory authorities are encouraged to apply. The type of debtor and the type of credit exposures serve as proxies for degree of riskiness (e. these are weighted according to the riskiness of the counterparty. guarantees. These are: • tier one capital to total risk weighted credit exposures to be not less than 4 percent. As the amount at risk is not always equal to the nominal principal amount of the contract. Nine credit exposure categories are defined to cover all types of off-balance sheet credit exposures. off-balance sheet credit exposures are first converted to a "credit equivalent amount". Governments are assumed to be more creditworthy than individuals. After deriving credit equivalent amounts for offbalance sheet credit exposures. . • Off-balance sheet contracts (e.g. and residential mortgages are assumed to be less risky than loans to companies).defining degrees of riskiness.

There are some further standards applicable to tier two capital: • • • tier two capital may not exceed 100 percent of tier one capital. • When a registered bank falls below the minimum requirements it must present a plan to the Reserve Bank (which is publicly disclosed) aimed at restoring capital adequacy ratios to at least the minimum level required. • If the registered bank is incorporated in India. then it is the capital adequacy ratios of the whole overseas bank (and not the branch) which are relevant.and maintaining the minimum standards is always made a condition of registration.• total capital (i. The Reserve Bank will not register banks in India that do not meet these standards . tier one plus tier two less certain deductions) to total risk weighted credit exposures to be not less than 8 percent. . lower tier two capital may not exceed 50 percent of tier one capital.e. then the minimum standards apply to the financial reporting group of the bank. If the registered bank is a branch of an overseas bank. Overseas banks which operate as branches are registered in India on the condition that they comply with the capital adequacy ratio requirements imposed by the financial authorities in their home country and that these requirements are no less than those recommended by the Basle Capital Accord. lower tier two capital is amortised on a straight line basis over the last five years of its life.

5 117217 2008 268701.Even though a bank may have capital adequacy ratios above the minimum levels recommended by the Basle Capital Accord. if inadequate provisions have been made against problem loans.5 153929 2009 371036.g. Table 4. Capital adequacy ratios are concerned primarily with credit risks.. or losses could be made on the trading of foreign exchange and other types of financial instruments. Capital adequacy ratios should not be interpreted as the only indicators necessary to judge a bank's financial soundness.3 Capital Adequacy Ratio Exposure Type Unsecured loans Fixed Assets Total Risk Weighed Assets Source: SBI records 3349775 422630 577863. e.6 10 C A Ratio (in %) 2007 2008 2009 .g.5 206827 9. Also capital adequacy ratios are only as good as the information on which they are based.5 Amount 2007 435521 117217 2008 537403 153929 2009 742073 206827 Risk Weight 50% 100% Risk Weight Exposures 2007 217760. then the capital adequacy ratios will overstate the amount of losses that the bank is able to absorb. There are also other types of risks which are not recognised by capital adequacy ratios e. this is no guarantee that the bank is "safe". inadequate internal control systems could lead to large losses by fraud.34 11.

the bank is performing well. Though the ratio has come down in the year 2009.5% (for both tier-I and tier-II) throughout the three years that are considered.GRAPHICAL REPRESENTATION Chart 4.2 Capital Adequacy Ratio trend INTERPRETATION According to Based norms the last three years the capital adequacy ratio is with minimum level the bank maintain the adequate capital structure. according to Basel-II norms. So. . the ratio is always under the Basel-II norms limit which 12.

SUGGESTION AND CONCLUSION .CHAPTER – V SUMMARY OF FINDINGS.

FINDINGS GENERAL FINDINGS • Meeting capital requirement is a big challenge in the near future. • Stress in some sector of the economy like real estate could lead to an increase in Non-Performing Assets. . • The bank had enough cushion in its tier II structures to raise funds. SUGGESTIONS • Risk based supervision is to be strengthened. SPECIFIC FINDINGS • Tangible common equity ratio for the current year is 17% which is less than last year because of global financial crisis. • The Capital Adequacy Ratio is the ratio of a bank capital to its risk weighted assets.

. the greater the level of unexpected losses it can absorb before becoming insolvent. The higher the capital adequacy ratios a bank has. and incorporates the effect of balance sheet contracts on credit risk. the relative riskiness of various types of credit exposures that banks have. The risk weighting process takes into account.CONCLUSION Capital adequacy ratios measure the amount of a bank's capital in relation to the amount of its risk weighted credit exposures. in a stylized way.