CAPITAL ADEQUACY Presented by:

Sairam T A Ramakrishnan Raja Vignesh D

Prasanna Kumar Priyadarshini

What is Capital Adequacy?

Capital Adequacy is a measure of a bank's capital to cushion against or absorb a reasonable amount of losses before they become insolvent and consequently lose depositors' funds. It ensures efficiency and stability of a financial system by lowering the risk of banks becoming insolvent.

Bank for International Settlement (BIS)

The G-10 countries, Spain and Luxembourg formed a standing committee in 1974 under the support of the Bank for International Settlements (BIS), called the Basel Committee on Banking Supervision.

Basel norms make it compulsory for banks to keep aside certain part of their deposits to meet any contingency.

Basel I

Recommended for implementation in 1974, for addressing the issue of risk involved in recovery of loans lent

Covered only Credit Risk, and ignored Market Risk, Operational Risk, and Liquidity Risk

Assets of banks were classified and grouped in five categories to credit risk weights of 0,10,20,50 and up to 100%

Assets like cash and coins usually have zero risk weight, while unsecured loans might have a risk weight of 100%

Basel II

Introduced in 2004 Laid down guidelines for capital adequacy, risk

management, and disclosure requirements. Use of external rating agencies to set the risk

weights for corporate, bank and sovereign claims.

Basel III

Widely felt that the shortcoming in Basel II norms led to the global financial  crisis of 2008

Basel II did not have any regulation on the debt that banks could take on their books

Focused  more on individual financial institutions, while ignoring systemic risk

Formed in 2010, to ensure that banks don’t take on excessive debt, and don’t rely too much on short term funds.

Being implemented since April 1, 2013 in India, in a phased manner. Transitional period for full implementation is extended up to March 31, 2019

Liquidity Coverage Ratio

Highly liquid assets held by financial institutions to meet short-term obligations

Designed to ensure financial institutions have the necessary assets on hand to ride out short-term liquidity disruptions

High Quality Liquid Assets

Aims to ensure that a bank has an adequate stock of unencumbered HQLA that consists of cash or assets that can be converted into cash to meet its liquidity needs for a 30 calendar day liquidity stress scenario

Appropriate corrective actions can be taken by management and supervisors, or that the bank can be resolved in an orderly way

Will improve the banking sector’s ability to absorb shocks arising from financial and economic stress, thus reducing the risk of spill over from the financial sector to the real economy

Capital Adequacy = 9% of Risk Weighted Assets

Risk Rates:CRR - 0%SLR - 0.25%Private Sector Company Bond – 100%Public Sector Company Bond – 20%

                           Tier1 + Tier2 Capital Capital Adequacy Ratio = -----------------------------  Risk Weighted Assets                            Tier 1 Capital = Equity Share Capital + Share Premium + General Reserve (unencumbered)

Tier 2 Capital = Preference Share + Subordinated

Debt Bonds + Revaluation Reserves (45%)

                          

ExampleUsing the following information. Calculate Capital Adequacy Ratio.

The bank's Tier 1 Capital and Tier 2 Capital are $200,000 and $300,000 respectively.

Exposure Risk WeightGovernment Treasury

held as asset1,500,000 0%

Loans to Corporates 15,000,000 10%Loans to Small

Businesses8,000,000 20%

Guarantees and other non-balance sheet

exposures

6,000,000 10%

SolutionBanks's total capital = Tier one capital + Tier two capital

= 200,000 + 300,000 = $500,000

Risk-weighted exposures = $1.5×0% + $15×10% + $8×20% + $6×10%

= $3.7 millionCapital Adequacy Ratio

= Banks's total capital/ Risk-weighted exposures= $0.5 million/ $3.7 million= 14%

In the News

June 23, 2016: Bank of India has raised Rs 1,000 crore through bonds that comply with Basel-III norms for capital adequacy

They have been rated AA (-) by Brickwork and A+ by Crisil and bear a coupon rate of 11.50 per cent

June 28, 2016: Canara Bank to raise Rs 2,000 crore to create capital buffer

By allotting equity shares/preference shares/securities by way of follow on public issue, rights issue and/or on a private placement basis

Bank’s CAR as on March 31, 2016, stood at 11.08%, well above the 9 per cent stipulated by RBI

In the News

June 29, 2016: The Reserve Bank of India (RBI) has raised concerns over the capital adequacy ratio of many lenders (30 of 50)

Could slip below the required level if there’s a surge in bad loans

Gross NPAs could rise to 8.5 per cent of the total by March 2017, from 7.6 per cent in 2016. However, if banks’ asset quality faces any severe stress, it could rise to 9.3 per cent

Public sector banks are a particular concern