Capital Adequacy Norms in India

Need & NecessityA Report on SBI

Group 4

Mehul Chopra 28359

Riddhi Shah 28620

Samkit Shah 30725

Devanshee Sanghavi 30726

Pratik Vora 40142

Rakshit Bhimani 40227

Nirja Kanuga 51308

Introduction Capital is one of a number of factors considered when

assessing the safety and soundness of each financial

institution

The efficient functioning of markets requires participants

to have confidence in each other's stability and ability to

transact business

Capital rules help foster this confidence because they

require each member of the financial community to

have, among other things, adequate capital

This capital must be sufficient to protect a financial

organization's depositors and counterparties from the

risks of the institution's on- and off-balance sheet risks

Introduction

Top of the list are credit and market risks; not

surprisingly, banks are required to set aside capital

to cover these two main risks

Capital standards should be designed to allow a

firm to absorb its losses, and in the worst case, to

allow a firm to wind down its business without loss

to customers, counterparties and without disrupting

the orderly functioning of financial markets

An adequate capital base acts as a safety net for

the variety of risks that an institution is exposed to

in the conduct of its business

Introduction

It is available as a cushion to absorb possible losses

and provides a basis for confidence in the institution by

depositors, creditors and others

The regulation of capital is commonly viewed as the

most important tool available to financial institution

regulators

It is the measure by which an institution’s solvency is

assessed

Meaning of Capital

The net worth of a business; that is, the amount by

which its assets exceed its liabilities

The money, property, and other valuables which

collectively represent the wealth of an individual or

business

The basic funds and assets used by people,

governments and businesses to sustain and equip

their income-earning activity

The accounting concept of capital refers to issued

capital and retained earnings of the company,

representing the owners' or shareholders' initial

contribution to the business and the wealth that

generates

Capital Adequacy

Percentage ratio of a financial institution's primary

capital to its assets (loans and investments), used as a

measure of its financial strength and stability

According to the Capital Adequacy Standard set by

Bank for International Settlements (BIS), banks must

have a primary capital base equal to at least eight

percent of their assets.

Almost all banking regulators require that banks hold

a certain minimum of equity capital against their risk

weighted assets.

Capital Adequacy

The Basel Committee on Bank Supervision, a

coordinating body within the Bank for International

Settlements, supervises the administration of

capital reserves for central bankers around the

world.

It is a ratio that can indicate a bank’s ability to

maintain equity capital sufficient to pay depositors

whenever they demand their money and still have

enough funds to increase the bank’s assets through

additional lending.

Banks list their capital adequacy ratios in their

financial reports.

It is stated in terms of equity capital as a percent of

assets.

Capital Adequacy Norms

Promotion of monetary and financial stability in world

Introduction of Basel Accord in 1988

In India it has been implemented by RBI with effect from

1.4.1992

There were two main objectives:

To develop a framework that would help strengthen

the soundness and stability of the international

banking system by encouraging international banking

organizations to boost their capital positions.

To create a standard approach applied to

internationally active banks in different countries that

would reduce competitive inequalities

Capital Adequacy Norms

Importantly, the framework established a structure that

was intended to:

1. Make regulatory capital more sensitive to

differences in risk profiles among banking

organizations;

2. Take off-balance-sheet exposures explicitly into

account in assessing capital adequacy; and

3. Lower the disincentives to holding liquid, low risk

assets

Basel Committee The Group of Central Bank Governors and Heads of

Supervision is the governing body of the Basel Committee and is comprised of central bank governors and (non-central bank) heads of supervision from member countries

The Committee’s Secretariat is based at the Bank for International Settlements in Basel, Switzerland.

The Basel Committee on Banking Supervision was established in 1974, by the Bank of International Settlements (BIS), an international organization founded in Basel, Switzerland in 1930 to serve as a bank for central banks.

Basel Committee on Banking Supervision is a committee of bank supervisors consisting of members from each of the G10 countries. It is represented by central bank governors of each of the G10 countries.

Basel Committee The Basel Committee on Banking Supervision provides a

forum for regular cooperation on banking supervisory matters

It seeks to promote and strengthen supervisory and risk

management practices globally

The Committee comprises representatives from Argentina,

Australia, Belgium, Brazil, Canada, China, France, Germany,

Hong Kong SAR, India, Indonesia, Italy, Japan, Korea,

Luxembourg, Mexico, Netherlands, Russia, Saudi Arabia,

Singapore, South Africa, Spain, Sweden, Switzerland, Turkey,

the United Kingdom and the United States

What are Basel I and Basel II norms?

While Basel I framework was confined to the

prescription of only minimum capital requirements for

banks,

The Basel II framework expands this approach not only

to capture certain additional risks in the minimum

capital ratio but also includes two additional areas, viz.

Supervisory Review Process and Market Discipline

through increased disclosure requirements for banks

The Basel norm of capital adequacy was introduced in

India following the recommendations of the Narsimham

Committee (1991)

Thus, Basel II framework rests on the following three

mutually- reinforcing pillars:

Basel Norms

Basel II Norms are considered as the reformed

& refined form of Basel I Accord. The Basel II

Norms primarily stress on 3 factors (Three

Pillars) to manage risk, viz.

1. Capital Adequacy,

2. Supervisory Review and

3. Market discipline

Pillar I: Capital Adequacy Requirements

Under the Basel II Norms, banks should maintain a

minimum capital adequacy requirement of 8% of risk

assets

For India, the Reserve Bank of India has mandated

maintaining of 9% minimum capital adequacy

requirement

This requirement is popularly called as Capital

Adequacy Ratio (CAR) or Capital to Risk Weighted

Assets Ratio (CRAR)

Pillar II: Supervisory Review

Banks majorly encounter with 3 Risks, viz. Credit,

Operational & Market Risks

Basel II Norms under this Pillar wants to ensure

that not only banks have adequate capital to

support all the risks, but also to encourage them

to develop and use better risk management

techniques in monitoring and managing their

risks

Pillar III: Market Discipline

Market discipline imposes banks to conduct their banking

business in a safe, sound and effective manner

Mandatory disclosure requirements on capital, risk

exposure (semiannually or more frequently, if appropriate)

are required to be made so that market participants can

assess a bank's capital adequacy

Qualitative disclosures such as risk management objectives

and policies, definitions etc. may be also published

Capital Adequacy Norms

The minimum capital to risk-weighted asset ratio (CRAR) in India is placed at 9%, one percentage point above the Basel II requirement

All the banks have their Capital to Risk Weighted Assets Ratio (CRAR) above the stipulated requirement of Basel guidelines (8%) and RBI guidelines (9%)

As per Basel II norms, Indian banks should maintain tier I capital of at least 6%

Further, the Government of India has emphasized that public sector banks should maintain CRAR of 12%. For this, it announced measures to re-capitalize most of the public sector banks, as these banks cannot dilute stake further, as the Government is required to maintain a stake of minimum 51% in these banks.

Contd.. Under the agreements reached on 26th July 2010 (Group of

governors and heads of supervision, the oversight body of Basel committee on Banking supervision)The Committee’s package of reforms will increase the

minimum common equity requirement from 2% to 4.5%. In addition, banks will be required to hold a capital conservation buffer of 2.5% to withstand future periods of stress bringing the total common equity requirements to 7%

In July, Governors and Heads of Supervision agreed to test a minimum Tier 1 leverage ratio of 3% during the parallel run period. Based on the results of the parallel run period, any final adjustments would be carried out in the first half of 2017 with a view to migrating to a Pillar 1 treatment on 1 January 2018 based on appropriate review and calibration

As of 1 January 2013, banks will be required to meet the following new minimum requirements in relation to risk-weighted assets (RWAs): 3.5% common equity/RWAs; 4.5% Tier 1 capital/RWAs, and 8.0% total capital/RWAs.

Need for Basel Norms

To introduce the concept of minimum standards of capital adequacy

Then the second accord by the name Basel Accord II was established in 1999

To practice banking business at par with global standardsNorms are necessary since India is and will witness

increased capital flows from foreign countries and there is increasing cross-border economic & financial transactions

Capital Adequacy Ratio

Capital adequacy ratio (CAR), also called Capital

to Risk (Weighted) Assets Ratio (CRAR), is a ratio

of a bank's capital to its risk

This ratio is used to protect depositors and

promote the stability and efficiency of financial

systems around the world

Also known as "Capital to Risk Weighted Assets

Ratio (CRAR)"

National regulators track a bank's CAR to ensure

that it can absorb a reasonable amount of loss

and are complying with their statutory Capital

requirements

Capital Adequacy Ratio Capital adequacy ratios ("CAR") are a measure of the amount of a

bank's capital expressed as a percentage of its risk weighted credit exposures.

Capital adequacy ratio is defined as:CAR = Capital / Risk

where Risk can either be weighted assets (a), or the respective national regulator's minimum total capital requirement. If using risk weighted assets,

CAR = (T1+T2) / a ≥ 9%

The percent threshold (9% in this case, a common requirement for regulators conforming to the Basel Accords) is set by the national banking regulator

Capital Adequacy RatioTwo types of capital are measured:

1. Tier one capital, which can absorb losses without a

bank being required to cease trading, and

2. Tier two capital, which can absorb losses in the event

of a winding-up and so provides a lesser degree of

protection to depositors

Tier II elements should be limited to a maximum of 100% of total Tier I elements for the purpose of compliance with the norms.

The elements of Tier I & Tier II capital do not include foreign currency loans granted to Indian parties.

CAR = (Tier 1 Capital + Tier 2 Capital) / Risk Weighted

Assets

Tier I CapitalTier I capital (core capital) is the most reliable form of

capital.

It is the most permanent and readily available support

against unexpected losses. It consists of:

1. Paid up equity capital

2. Statutory reserves

3. Capital reserves

4. Other disclosed free reserves

Less:

5. Equity investments in subsidiaries

6. Intangible assets

7. Current and Accumulated Losses, if any

Tier II CapitalTier II capital (supplementary capital) is a

measure of a bank's financial strength with regard to the second most reliable forms of financial capital. This capital is less permanent in nature

Tier II capital consists of- 1. Undisclosed reserves and cumulative perpetual

preference shares2. Revaluation Reserves (RR)3. General Provisions and Loss Reserves (GPLR)4. Hybrid Debt Capital Instruments5. Subordinated Debts

Note: Tier II capital cannot be more than Tier I capital

Uses of CAR:

1. 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, operational

risk, etc

2. In the most simple formulation, a bank's capital is the

"cushion" for potential losses, which protect the bank's

depositors or other lenders

3. Banking regulators in most countries define and

monitor CAR to protect depositors, thereby

maintaining confidence in the banking system

4. CAR is similar to leverage; in the most basic

formulation, it is comparable to the inverse of debt-to-

equity leverage formulations

5. Unlike traditional leverage, however, CAR recognizes

that assets can have different levels of risk

CAR as per Basel I and Basel II as per 2008

Risk Weighted Assets

Fund Based

Non-funded (Off-Balance sheet) Items 

Reporting requirements

Local regulations establish that cash and government bonds have a 0% risk weighting, and residential mortgage loans have a 50% risk weighting. All other types of assets (loans to customers) have a 100% risk weighting.

Capital Adequacy Ratio-Example

Suppose Bank “A” has Total Asset = 100 units consisting of:

Bank "A" has debt of 95 units, all of which are deposits and equity= 5 units.

Cash 10 units

Government Bonds 15 units

Mortgage Loans 20 units

Other Loans 50 units

Other asset 5 units

Cash10 0% 0

Government Bonds 15 0% 0

Mortgage Loans 20 50% 10

Other Loans50 50% 25

Other asset5 5% 0.25

Risk Weighted Asset

35.25

Equity 5

CAR (Equity/RWA)

14.18%

Advantages In early phases of Basel implementations, bank's capital

adequacy was calculated as assets times’ ratio. This approach

did not take risk profiles of assets into account. It is obvious

that a bank should keep more capital in reserves for riskier

assets.

Since different types of assets have different risk profiles, CAR

primarily adjusts for assets that are less risky by allowing

banks to "discount" lower-risk assets.

So, for example, in the most basic application, government

debt is allowed a 0% "risk weighting". This also means that

government debt is subtracted from total assets for purposes

of calculating the CAR.

On the other hand, investments in junior tranches of

instruments collateralized with subprime mortgages are very

risky, and would be assigned 100% risk weighting

State Bank Of India – An Introduction

History:

Started off as the Bank of Calcutta in 1806.

Re-designed as Bank of Bengal in 1809.

It was the first joint stock bank with the British

India.

Later Bank of Bengal, Bank of Bombay and Bank of

Madras were amalgamated to form Imperial Bank of

India in 1921

It became a nationalized bank in 1955 and was

renamed as State Bank of India.

State Bank Of India – An Introduction

It is the oldest bank of the Indian sub-

continent.

Head quarters in Mumbai.

Largest branches in India about 16000 and

8500 ATMs.

It is listed on NSE and BSE.

SBI is the 29th most reputable bank in the

world according to FORBES.

Subsidiaries of SBI

1. State Bank of Indore

2. State Bank of Bikaner and Jaipur.

3. State Bank of Hyderabad

4. State Bank of Mysore

5. State Bank of Patiala

6. State Bank of Travancore

Capital Adequacy

March-10(%)

- Tier I Capital 9.45

- Capital Adequacy Ratio (%) 13.39

CAR across the years

Conclusion

Capital Adequacy Ratio (CAR) is a ratio that regulators

in the banking system use to watch bank's health,

specifically bank's capital to its risk.

Capital adequacy ratio is the ratio which determines

the capacity of a bank in terms of meeting the time

liabilities and other risk such as credit risk, market

risk, operational risk, and others. It is a measure of

how much capital is used to support the banks' risk

assets.

Bank's capital with respect to bank's risk is the

simplest formulation; a bank's capital is the "cushion"

for potential losses, which protect the bank's

depositors or other lenders.

Thank You