Capital Adequacy Ratio &

Policy Distortion-B.V.Raghunandan, SVS College, Bantwal

^National Conference on

‘Dynamics of Bank Management’Department of Commerce and Management

University of Calicut, March 21-22, 2011

Banking Business: A Fair Weather Enterprise

• Banking: European Discovery

• Money Lending: Compatible to Indian Practice

• Stability is valued more than the growth

• Shaky American Banking

American Banking

• Growth orientation• Taking unlimited risks• Always on the look-out

for financial engineering• Asset-based financing• First to create

impressive business practices and the first one to breach them

Financial Innovation: the way of the US

• All types of risk management tools• All types of insurance• Deposit-loan ratio was a golden principle

of lending• Asset-based lending• Credit rating of customers• Lending to sub-investment category of

borrowers

Cause for Failures

• Deposit-Loan Ratio not a logical principle

• Loan is risky investment

• Deposit is not risk-bearing source

• Only equity shares are risk-bearing

• Relation between capital and loan

Capital Adequacy Ratio: ‘The Great Discovery’

• The discoverer is Bank of International Settlement

• Came to be known as Basel norms, the town in Switzerland, where BIS is headquartered

• Too ashamed to use the BIS name• BIS has a black history, of being bankers

to the Nazis and later to the gambling houses of Europe

Significance of CAR

• The black history of BIS in no way dilutes the significance of CAR to ensure healthy banking

• It vindicates the eastern philosophy of owners capital being important as in the case of money-lending

• But, as usual, they complicated a simple concept

CAR: Indian Scenario

• RBI, as usual, brought it in a hurry• Applied them to non-banking finance

companies• NBFCs not possessing the minimum

capital requirement were prevented from accepting fresh deposits

• With the Receipt counter becoming defunct, many finance companies wound up, thus becoming the first casualty

The G -10 Scenario

• Many American banks including JP Morgan Chase and Citibank refused to accept even the 8% capital requirement, on the ground that their loans were covered by CDS

• Many other member countries are going slow in the implementation

Impact on Indian Banking

• Many banks became listed companies in order to access the market

• The Government has been recapitalising the PSU Banks

• The private insurance companies, frantically searching for delivery channels started taking stakes in Indian banks

• Banks are regularly accessing the capital market

The Great Hurdles

• CAR, being a percentage of the loan portfolio is unrealistic and impractical

• Loan portfolio expansion is a daily affair, but accessing the capital market can not be a routine affair

• There is a big risk and huge expenses attributable with each public issue

• Market appetite for bank shares will wane

RBI’s Solution for the Problem

• Perpetual Bonds can be issued by the banks

• Perpetual preference shares can be issued by banks

• These will form part of Tier I capital for the purpose of CAR

• Insurance companies subscribe to the bonds and preference shares

The Distortion

• Banks were not at all allowed to issue preference shares

• Companies can not issue irredeemable preference shares

• Companies also can not issue irredeemable bonds

• An attitude of blind compliance on the part of RBI

Alternative

• Take more time for compliance• Fix the size of the capital rather than a

percentage• Also can fix a maximum amount of capital• No need for complex risk weightage• More proactive attitude towards Islamic

Banking for loans and deposits• A better contextual orientation than

compliance with international standards

THANK YOU