2 Bank Capital

transcript

Session- 2

April 18, 2023Shyam Ji Mehrotra1

Bank Capital

Why an enterprise need Capital?

Whether nature of banking business is different to other businesses ?

•What triggers bank’s failure?

•Is this true that capital reduces risk of failure ?

• Whether capital enhances trust of depositors?

•Capital adds to Safety, Soundness and systemic stability of the banks

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Bank Capital Pay off its creditors in event of crisis

Depositors’ protection Confidence to customers, employees and regulators

Check high financial leverage ( constrain undesirable growth of assets )

Bank CapitalFinancing the operations of a bankCommence Business Support growth of credit business

Enter new product and new markets

Start subsidiaries April 18, 2023Shyam Ji Mehrotra9

Concepts Accounting capital

Economic capital

Regulatory capital

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Accounting capital includes Accounting capital represents book value

of capital in bank’s balance sheet CAPITAL (Tier I )

Paid up capital Minus Equity investment in subsidiaries Intangible assets and accumulated losses

Hybrid instruments ( limited to 15% of tier 1 capital) Closely similar to equity Perpetual by nature and unsecured Claim of investors will be subordinate to other creditors

but superior to equity share holders No put option by investors Call option after 10 years with prior RBI approval Interest will not be paid if CRAR is below prescribed level

and interest shall not be cumulative Retail investors can also invest

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Capital – comprises ofSubordinated debt (Tier II)

Carry fixed maturity (minimum 05 years) Not redeemable at the initiative of the holderSubject to progressive discount RBI approval required for redumption

Reserves and surplus Statutory reserves (Tier I) Share premium account( Tier I)Revaluation reserves (Tier II) Investment Fluctuation Reserve (Tier II)General Provision and loss Reserves ( Tier II)

Balance of P & L accountRetained earnings

Concept of Economic capitalRisk is inherent in banking business and

bank can not survive by avoiding risks Risk is statistically defined “as adverse

deviation of actual results from expected results”

Likelihood can be modeled by statistical techniques to cover probable assessment of potential future losses

This is known as Economic Capital Will be different for different bank as

per risk profile of their assets

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Concept of Economic capital

“Economic capital is amount of capital considered necessary to absorb potential losses associated with banking risk such as credit, market and operational”

“Represents confidence level looked by banks’ shareholders “

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Concept of regulatory capital Banking failures resulted in capital

regulations Ever evolving concepts due to run on banks Protection to depositors

CRR and SLR regulationsDeposit insurance Lender of last resort Minimum capital requirements

Basel I (1988), II (1999) and III (2013) for prescribed CRAR

Represents confidence level set by regulators in interest of depositors

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Capital adequacy-view points1. Capital to total deposits ratio

Recommended by James Raj Committee(1978)

2. Capital to total assets ratio Financial leverage

3. Capital to risk weighted assets ratio Also known as Capital to Risk adjusted

Assets ratio(CRAR) Also known as Basel accord

Walter Bagehot said

“No capital is required for a well run bank and no amount of capital can save a badly run bank. “

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Session recap- Q & A Why capital is so important for banks?

What constitutes bank capital?Why capital is related to assets of a bank?

How accounting, economic and regulatory capital are different to each other?

Would increase regulatory capital requirements lead to more consolidation in banking industry in India?

2 Bank Capital

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