Capital Adequacy Norms in India

Need & Necessity

A 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 standards
 Norms 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 Ratio
Two 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 Capital
Tier 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 Capital
 Tier 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
shares
2. Revaluation Reserves (RR)
3. General Provisions and Loss Reserves (GPLR)
4. Hybrid Debt Capital Instruments
5. 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:

Cash 10 units

Government Bonds 15 units

Mortgage Loans 20 units

Other Loans 50 units

Other asset 5 units

 Bank "A" has debt of 95 units, all of which are deposits and

equity= 5 units.
Cash
10 0% 0

Government
Bonds 15 0% 0

Mortgage Loans
20 50% 10

Other Loans
50 50% 25

Other asset
5 5% 0.25

Risk Weighted 35.25

Asset

Equity 5

CAR 14.18%
(Equity/RWA)
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

 March-10
(%)
Capital Adequacy

- 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