CAPITAL ADEQUACY

Does it protect investors

ABOUT CAPITAL ADEQUACY RATIO

The Committee on Banking Regulations and Supervisory Practices (Basel Committee) had released the guidelines on capital measures and capital standards in July 1988 which were been accepted by Central Banks in various countries including RBI. In India it has been implemented by RBI w.e.f. 1.4.92 Objectives of CAR : The fundamental objective behind the norms is to strengthen the soundness and stability of the banking system. Capital Adequacy Ratio or CAR or CRAR : It is ratio of capital fund to risk weighted assets expressed in percentage terms i.e. Minimum requirements of capital fund in India: * Existing Banks 09 % * New Private Sector Banks 10 % * Banks undertaking Insurance business 10 % * Local Area Banks 15% Tier I Capital should at no point of time be less than 50% of the total capital. This implies that Tier II cannot be more than 50% of the total capital.

Capital Adequacy Ratio (CAR) or Capital to Risk (Weighted) Assets Ratio (CRAR) is a parameter signifying the financial strength as well as the stability of the banking concern Capital Adequacy Ratio (CAR) or Capital to Risk (Weighted) Assets Ratio (CRAR) = Tier-1 capital + Tier-2 capital/Risk weighted assets

Components of Tier 1 Capital includes free reserve+paid-up capital+ statutory reserves less current and brought forward losses+ equity investments in subsidiary + intangible assets. Components of Tier 2 Capital-It consists of accumulated after-tax surplus of retained earnings, revaluation reserves of fixed assets and long-term holdings of equity securities, general loan-loss reserves, hybrid (debt/equity) capital instruments, and subordinated debt.

Tier-1 capital provides banks with the ability to absorb or mitigate any kind of losses without stalling its banking activity. The tier-2 component of the capital cushions the bank during the winding-up process of the banking institution RBI rolled out Basel III capital norms for banking entities effective from April'2013. As per which, banks need to maintain a CAR of 9% that is otherwise 1% more than the global CAR standards of 8%

BASEL 3 NORMS

Minimum Common Equity Tier 1 capital of 5.5% of RWAs, (international standards require these to be only at 4.5%) banks are also required to maintain a Capital Conservation Buffer (CCB) of 2.5% of RWAs in the form of Common Equity Tier 1 capital. CCB is designed to ensure that banks build up capital buffers during normal times (i.e. outside periods of stress) which can be drawn down as losses are incurred during a stressed period. In case such buffers have been drawn down, the banks have to rebuild them through reduced discretionary distribution of earnings. This could include reducing dividend payments, share buybacks and staff bonus.

FEATURES OF BASEL3
Basil 3 aims to introduce much stricter definition of capital. Better quality capital means loss absorbing capacity , this in turn will mean that banks will be stronger allowing them to better withstand the period of stress. By introduction of Basil 3 norms banks will be required to hold capital conservation buffer of 2.5% this is done to ensure that banks maintain cushion of capital that can be used during economic stress

The counter cyclical buffer has been introduced with the objective to increase capital requirements in good times and decrease the same in bad times .The buffer will range from 0%to 2.5%consiting of common equity Under Basel 3 a frame work for liquidity risk management will be created .A new liquidty Coverage Ratio and Net stable funding ratio are to be introduced in 2015 and 2018

Requirements Minimum Ratio of Total Capital to RWAs Minimum Ratio of Common Equity to RWAs

Under Basel II 8% 2%

Under Basel III 10.50% 4.50% to 7%

Tier I Capital to RWAs Core Tier I Capital to RWAs Capital Conservation Buffers to RWAs Leverage Ration

4% 2% None None

6% 5% 2.50% 3.00%

Countercyclical Buffer
Min Liquidity Converge Ratio Min Net Stable Funding Ratio Systemically important Financial Institution Charge

None
None None None

0% to 2.50%
TBD (2015) TBD (2018) TBD (2011)

CURRENT NEWS ON CAR

Reserve Bank of India may be open to relaxing the initial equity capital requirement of Rs 500 crore for setting up a bank according to the spokesperson of RBI The CAR requirement will increase by 50 basis points to 6.50% from March 2014. P Chidambaram has aid that all banks with capital adequacyratio of less than 8% will be given preference for capitalisation. Dena Bank has the lowest CAR at 7.26% followed by Bank of Maharashtra (7.57%), IDBI(7.68%) and Indian Overseas Bank(7.80%).