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CAPITAL ADEQUACY FRAMEWORK FOR BANKS
&BASEL I & II CAPITAL ACCORD
SLIDE – 19B
OUTLINES/LEARNING OBJECTIVES
• WHY BANKS ARE HIGHLY REGULATED ?
• WHY BANKS SHOULD BE ADEQUATELY CAPITALISED ?
• IMPORTANCE OF CAPITAL ADEQUACY OF BANKS
• CAPITAL ADEQUACY NORMS/FRAMEWORK FOR BANKS – BASEL I ACCORD
• BASEL II ACCORD – THREE PILLARS
• SPECIAL FEATURES OF BASEL II ACCORD
• DIFFERENT TYPES OF RISKS IN BANKING AND ITS MEASURES UNDER BASEL II
KEY WORDS/TERMINOLOGIES/GLOSSARY - 1
• BIS (Bank for International Settlements), BCBS (Basel Committee on Banking Supervision), Basel-I Accord, Capital Adequacy Ratio (CAR) or Capital to Risk-Weighted or Adjusted Asset Ratio (CRAR), Capital Fund (CF), Tier-I Capital or Core/Permanent/Readily available Capital, Tier-II Capital or Non-Core/Non-Permanent/ Not so readily available Capital, Risk Weight (RW), Risk Weighted Assets (RWA).
KEY WORDS/TERMINOLOGIES/GLOSSARY - 2
• Credit Conversion Factors (CCF), Counter Party Risk Weight, Basel-II Capital Accord, Three Pillars, Minimum Capital Requirement, Supervisory Review Process, Market Discipline, Credit, Market & Operational Risk. Bank Loan Rating, Regulatory Capital or Risk Based Capital, Economic Capital.
BANKING RISKS• BANKS EARN THEIR INCOME IN 2 WAYS
• ONE, BY GIVING CUSTOMER SERVICE
• SECOND, BY MANAGING RISKS
• SO RISK TAKING AND RISK MANAGEMENT IS THE NAME OF THE GAME FOR THE BANKS
• BANKING RISKS LIES ON WHICH SIDE OF THE BALANCE SHEET ?
BANKING RISKS
GOVERNMENTMonetary/Fiscal/industrialTrade policies
OTHER FIs/BANKSLending/ investmentPolicies/dealing/trading
CORPORATESBusiness/trade/market
CREDIT RISK
EXCHANGE RISK
INTEREST RISK
LIQUIDITY RISK
COUNTRY RISK
OTHER NON-FINANCIAL RISKS
BANKS
6
LOAN AND OTHER LOSSES
• Two types of losses are possible in respect of a borrower or class of borrowers:
– Expected Losses [EL]
– Un-expected Losses [UL]
7
04/21/23 D2K Technologies8
Capital Charge on Credit Risk
• Expected Losses (EL) indicates the average loss that the Bank might incur on a portfolio.
• EL = PD x LGD x EAD
• Unexpected losses (UL) is the uncertainty around EL. It is the SD of EL .
04/21/23 D2K Technologies9
Applications - Provisioning
Expected Loss
Expected Losscan be used forAnticipatory Provisioning
Pro
babi
lity
Den
sity
Amount of Loss
04/21/23 D2K Technologies10
Economic CapitalP
roba
bilit
y D
ensi
ty
Amount of Loss
Expected Loss
99th Percentile
Unexpected Loss
Can be usedfor allocationof Economic
Capital
04/21/23 D2K Technologies11
Risk Measures
Standard Deviation Measures the absolute deviation from the average
value
Percentile Level 99th percentile Loss gives the Maximum Loss that will occur 99 times out of 100
EXPECTED LOSSES [EL]
• These are part of the normal business risks banks carry and can be provided for
• EL is a function of three parameters:
– Probability of Default [PD]
– Exposure at default [EAD]
– Loss Given Default [LGD]
12
EXPECTED LOSSES AND CREDIT RISK
• EL can be modelled
• EL = PD X EAD X LGD
• EL can be aggregated at level of individual loans or at portfolio level
• Does EL constitute credit risk?
13
EXPECTED LOSSES AND UNEXPECTED LOSSES
• EL can be managed/covered by Provisions like Loan Loss or NPA Provisions, Provision for Depreciation of Investments etc.
• Whereas Unexpected Losses are taken care of by having adequate capital
• So Capital acts as a cushion or shock absorber for a bank to meet unforeseen losses and Contingencies
14
THE IMPORTANCE OF BANK CAPITAL
• Why is ‘capital’ so important for banks?
• What does bank ‘capital’ constitute?
• When values of other assets and liabilities of a bank changes, what happens to the ‘capital’?
• What should ‘capital’ be ideally related to, in order to determine ‘safety’ of a bank?
15
ECONOMIC CAPITAL• Risk associated with banking depends on
types of services rendered
• Risk is defined as the adverse deviation of actual results from expected results
• Capital estimated to cover the probabilistic assessment of potential future losses is called ‘Economic capital’ – can be defined as the amount of capital considered necessary to absorb potential losses arising from banking risks
16
REGULATORY CAPITAL
• Regulatory capital depends on ‘confidence level’ set by regulator
• Both regulatory and economic capital are concerned with banks’ financial staying power
• Different from ‘accounting capital’ on balance sheet
• In the long run, stability of banks depends on capital to support economic/banking risks
17
REGULATORY CAPITAL- RISK BASED CAPITAL STANDARDS
• In 1980s, concerns about bank safety increased
• Bank for International Settlements [BIS], the world’s oldest international financial organization, established the Basle Committee for Banking Supervision [BCBS]
• In 1988, BCBS introduced bank capital measurement system popularly known as Basle Capital Accord
18
BASLE CAPITAL ACCORD I
• 1988 – ‘internationally active banks’ in G10 countries agreed that bank capital should be at least 8% of assets measured according to risk profile
• Portfolio approach to risk – assets can have 0, 10, 20, 50, 100% risk weight
• Accord adopted world standard in 1990s – more than 100 countries
19
Basel Capital Accord I (1988) 1988 Basel Capital Accord I
Capital Funds (CF)
CAR =----------------------------------------------
Total Risk Weighted Assets (TRWA)
Capital funds = Tier I Capital + Tier II Capital
Risk Weighted/Adjusted Assets consist of both On-Balance Sheet and Off- Balance Sheet Items.
Basel Capital Accord I initially in 1988 prescribed Regulatory Capital to take care of Credit Risk only. By virtue of an amendment to the Accord in 1996, Capital was prescribed for Market Risk also.
Capital Adequacy Ratio (CAR) aka Capital to Risk-weighted/adjusted Asset Ratio (CRAR)
Meaning of Capital Adequacy Capital adequacy means a bank must have a minimum level
of capital proportionate to its total risk adjusted value of assets as prescribed by the Central Bank of the country.
Minimum requirements of Capital Funds/Prescribed Level of Capital Adequacy : For India Minimum CAR/CRAR is 9% of total risk-weighted assets (TRWAs) w.e.f. March 31, 2000 both under Basel I and II as against the International norm of 8%
For computing the CAR/CRAR, one has to find out the (a) Total Risk-Weighted Assets (TRWA) for both on-Balance Sheet and Off-Balance Sheet items and (b) Total Capital Fund (Tier I and Tier II Capital) by strictly following the guidelines prescribed by RBI
Tier I and Tier II Capital
Tier ITier I1. 1. Paid up CapitalPaid up Capital
2. Statutory Reserves2. Statutory Reserves
3. Other Disclosed Free Reserves3. Other Disclosed Free Reserves
4. Capital Reserves4. Capital Reserves
5. Investment Fluctuation Reserve5. Investment Fluctuation Reserve
6. Innovative Perpetual Debt 6. Innovative Perpetual Debt Instruments (IPDI)Instruments (IPDI)
7. Perpetual Non-cumulative 7. Perpetual Non-cumulative Preference Shares (PNCPS)Preference Shares (PNCPS)
Less : Deductions for Intangible Less : Deductions for Intangible Assets like Accumulated Losses, Assets like Accumulated Losses, Deficit in NPA Provision and Equity Deficit in NPA Provision and Equity Investments in SubsidiariesInvestments in Subsidiaries
Tier IITier II1.1.Undisclosed Reserves and perpetual Undisclosed Reserves and perpetual cumulative preference shares (PCPS)cumulative preference shares (PCPS)
2. Fixed Asset Revaluation Reserves 2. Fixed Asset Revaluation Reserves at a discount of 55% while at a discount of 55% while determining the value of Tier II Capitaldetermining the value of Tier II Capital
3.General Provisions and loss reserves 3.General Provisions and loss reserves up to a max of 1.25% of Total Risk up to a max of 1.25% of Total Risk Weighted AssetsWeighted Assets
4.Hybrid Debt Capital4.Hybrid Debt Capital
5. Subordinated Debt/Tier II Bonds5. Subordinated Debt/Tier II Bonds
BROAD DEFINITION OF CAPITAL
• Accounting definition of capital as seen in banks’ financial statements different from regulatory definition
• Regulatory capital set in two tiers
• Tier I – shareholders’ equity and retained earnings
• Tier II – additional internal and external sources available to the bank
23
MINIMUM CAPITAL REQUIREMENTS
• Capital required to compensate for credit risk, market risk [and operational risk in Basel II]
• Capital ratio – regulatory capital to risk weighted assets [credit risk+ market risk+ operational risk]
• Capital ratio not to be less than 9% in India currently as ag. international norm of 8%.
• Tier 2 capital should be limited to 100% of tier 1 capital, i.e., Not more than 50% of total capital fund
• Tier 3 capital will be limited to 250% of a bank's tier 1 capital that is required to support market risks. – Tier 3 Capital not implemented in India so far.
24
CAPITAL ADEQUACY REQUIREMENTS - INDIA
• The Basle framework was adopted by the RBI, prescribing a higher norm of 9% on risk weighted assets [as against 8% by the Basle Accord] for all banks operating in India.
• The aggregate of Tier 1 and Tier 2 capital forms the total capital funds for banks for the purpose of computing ‘Capital Adequacy’
• Tier 1 Capital @ minimum = 50% of Total Capital Fund; Tier 2 Capital @ maximum = 50% of Total Capital Fund; i.e., Tier 2 Capital Not to exceed Tier 1 Capital 25
COMPONENTS OF TIER 1 CAPITAL IN INDIA [RBI. July 2009]
• Equity capital & free reserves
• Innovative Perpetual Debt Instruments [IPDI - limited to 15% of tier 1 capital]
• Perpetual Non Cumulative Preference Shares [IPDI + this component limited to 40% of tier 1 capital]
• All the above subject to regulations in force
26
DEDUCTIONS FROM TIER 1 CAPITAL
• Equity investment in subsidiaries
• Intangible assets and losses
• Deferred Tax Assets
• Gain on sale on securitization of standard assets, where profit is recognized
• Others as specified by RBI
27
KEY COMPONENTS OF TIER 1 CAPITAL OF FOREIGN BANKS IN INDIA
• Interest free funds from head office for meeting capital requirements in India
• Statutory reserves in India
• Non repatriable surplus from Indian operations
• Capital reserves from sale of assets in India
• Foreign currency borrowings from ho for meeting capital adequacy
28
COMPONENTS OF TIER 2 CAPITAL IN INDIA - 1
• Revaluation reserves – discount of 55%. Such reserves arise from revaluation of Fixed Assets which have book values much less compared to their current market price.
• General provisions and loss reserves/GPLR (including provision on standard loan assets) – up to maximum of 1.25% of total risk weighted assets
• Hybrid debt capital instruments
• IPDI > 15% of tier 1 capital
• IPDI +PNCPS > 40% of tier 1 capital
29
COMPONENTS OF TIER 2 CAPITAL IN INDIA - 2
• Subordinated debt/Tier-2 bonds (Unsecured, fully paid and subordinate to the claim of all other creditors) – initial/original maturity of more than 5 years - at a discount for bonds with remaining/residual maturity of < 5 years as it approaches maturity. Subordinated Debt with initial maturity of less than 5 years and unexpired maturity of less than 1 year cannot be included in Tier II Capital.
• The total amount of Subordinated debt should not exceed 50% of Tier I Capital.
30
COMPONENTS OF TIER 2 CAPITAL IN INDIA - 2
• Remaining Term to maturity for Tier 2 bond Discount Rate
(n = in years) (%)
n > 5 years 0
4 < n < or = 5 20
3 < n < or = 4 40
2 < n < or = 3 60
1 < n < or = 2 80
n < or = 1 100
31
Assignment of Risk Weights to Different Assets
• Cash & Balance with RBI 0%
• Balances with Other Banks 20%
• Government / Approved Securities (market risk) 2.5%
• Loans to Staff fully secured by superannuation
benefits/mortgage of house 20%
• Residential Housing Loan to Individuals (up to 30 L) 50%
• Loan to PSUs 100%
• Other Loans 100%
• Exposure to Capital Markets/Consumer Loans 125%
• Commercial Real Estates 150%
Calculation of Risk Adjusted orRisk Weighted Value of Assets - 1
• Calculation of Risk Weighted Value of On-Balance Sheet Assets (RWA for On-Balance Sheet Assets) : RWAs for On-Balance Sheet Items are calculated by multiplying the value of the assets (Ai) as appearing on the balance sheet with the risk-weight (rwi) assigned to it. For example, if the Bank has an investment of Rs.100 Cr. In Govt. Bonds carrying a risk-weight of 2.5%, the RWA will be Rs.2.5 Cr.
• The Total Risk-Weighted Assets for all On-Balance Sheet Items will be; TRWA = A1 * rw1 + A2 * rw2 + ……… + An * rwn = Ai * rwi
33
Calculation of Risk Adjusted orRisk Weighted Value of Assets - 2
• Notional Conversion of Off-Balance Sheet Items to Fund Based Facility and Calculation of their Risk Weighted Value (RWA for Off-Balance Sheet Items) : All Off-Balance Sheet (OBS) items like LC, LG or BG etc. are to be first converted notionally into fund-based facility or Credit Equivalent or Equivalent On-Balance Sheet Item by multiplying them with the prescribed credit conversion factor (CCF). The CCF may be 20% (Documentary LC), 50% (Performance LG), 100% (Financial LG) etc. depending on the type of OBS item.
34
Calculation of Risk Adjusted orRisk Weighted Value of Assets - 3
• The risk weighted/adjusted values of this notional fund based amount is then calculated by multiplying the same with the risk-weight assigned to the counter-party on whose behalf the bank has taken the exposure (i.e., the applicant of the LC/LG etc.)
• Risk-Weighted Value of an Off-Balance Sheet Item = Value of the OBS Exposure * CCF * Counter-Party Risk-Weight
• Where Govt. is the Counter-Party, rw is 0%, where Bank is the Counter-Party, rw is 20%, and for any other Counter-Party, rw is 100%.
35
Calculation of Risk Adjusted orRisk Weighted Value of Assets - 3
• The Total Risk-Weighted Assets (TRWAs) for both On-Balance Sheet and Off-Balance Sheet Items will be; TRWA = TRWA (for On-BS Items + Off-BS Items)
36
BASLE ACCORD I - DRAWBACKS
• One shoe /size fits all approach
• The regulatory measures were seen to be in conflict with increasingly sophisticated internal measures of economic capital
• The simple bucket approach with a flat 8% charge for claims on the private sector has resulted in banks moving high quality assets off their balance sheets, thus reducing the average asset quality
• The Accord did not sufficiently recognize credit risk mitigation techniques
37
BASLE II ACCORD
• Revised framework - a spectrum of approaches ranging from simple to advanced for measurement of credit risks, market risks and operational risks, all of which could lead to asset quality and value deterioration.
• The framework also builds in incentives for better and more accurate risk management by individual banks.
38
BASLE II – THE THREE PILLARS
• Three mutually reinforcing ‘pillars’, which together are expected to contribute to the safety and soundness of the international financial system
• First Pillar: Minimum Capital requirement
• Second Pillar: Supervisory Review Process
• Third Pillar: Market discipline and enhanced disclosures
39
40
Basel II(Three-pillar structure)
Pillar 1: sets out minimumcapital requirement for a bank’s credit, market andoperational risks
Pillar 3: requires a bankto enhance its public disclosures on its risk profile, capital adequacy and key financial information
Pillar 2: deals with other risks not covered under Pillar 1; requires banks to hold capital to cover these risks; and requires supervisors to review banks’ capital planning
Basel II has led to reevaluation of capital framework across the
world"Basel II will provide one of the biggest structural shocks to the banking industry for decades. Is the industry ready?"
Mercer Oliver Wyman, Dec 2003
"Basel II will provide one of the biggest structural shocks to the banking industry for decades. Is the industry ready?"
Mercer Oliver Wyman, Dec 2003
Capital framework AdvancedRudimentary
Basel I Basel II Economic capital More closely aligns regulatory
capital with economic risks
Standardized
Distinguishes capital charge by asset quality based on rating agency scoring
External ratings correspond to PD
Internal Ratings Based
Foundation: Allows banks to estimate PD while LGD and EAD are provided
Advanced: Allows banks to estimate PD, LGD and EAD
BIS II doesn't address concentration risk explicitly Single name, industry, country
Economic capital framework based on internal models PD, LGD, EAD Maturity, correlation Spread migration
Does not rely on calibration established by regulator, i.e., not average risk
Static risk weights based on asset type, i.e., sovereign, banks, corp, etc.
No distinction within risk weighting bands for asset quality "One size fits all"
Amendment ('97) allows for use of VaR to estimate market risk
However, measurement of credit risk remains rudimentary
Does not distinguish between market, credit or operational risk per se
3
The Three Pillars of Basel II Pillar 1 Pillar 2 Pillar 3
Requirements for calculation of regulatory capital
Supervisor’s Role Disclosure requirements
Use of rating, loss exposure and risk mitigation
Explicit requirement for operational risk capital
Banks to assess solvency relative to risk
Supervisory review of risk management and capital practices
Greater disclosure of risk profile, capital structure and risk management practices
Quantitative aspects critical for capital calculations
Fresh look at control practices
Solvency assessment covers ALL risks
Application of supervisor judgement critical
Improved transparency
Expectations
Consistency with accounting and local regulatory requirements
4
04/21/23 43
Basel I to Basel II
Basel I Basel II
Focus on single risk measure More emphasis on banks’ own internal risk management methodologies, supervision review and market discipline.
‘One size fits all’ Flexibility, menu of approaches, capital incentives for better risk management. Granularity in valuation of assets and type of business and in the risk profiles of their system and operations.
Broad brush approach More risk sensitivity by structuring business class and asset class. Multidimensional, focus on all operational components of a bank
BASLE II- PILLAR I – MINIMUM CAPITAL REQUIREMENTS
Capital for Credit risk:
• A] Standardized approach
• B] Internal Ratings Based [IRB] – Foundation
• C] Internal Ratings Based [IRB] – Advanced
Capital for Market Risk:
• A] Standardized approach [ maturity method]
• B] Standardized approach [duration method]
• C] Internal models method
Capital for operational risk
• A] Basic indicator approach (BIA)
• B] The Standardized approach (TSA)
• C] Advanced Measurement Approach [AMA] 44
DEFINITIONS OF RISKS• Credit risk is the probability that a borrower or a
counterparty will fail to meet obligations in accordance with agreed terms
• Operational risk is the risk of loss from inadequate or failed internal processes, people, systems or external events.
• Market risk is the possibility of loss over a given period of time related to uncertain movements in market risk factors, such as interest rates, currencies, equities, and commodities. Also includes specific risk due to composition of bank’s investment portfolio
45
PROCESS FOR CALCULATING CREDIT RISK
– Classify assets/on-balance sheet items into appropriate risk categories and assign risk weights
– Convert off balance sheet commitments/contingent liabilities and guarantees like LC, BG and Forward Exchange Contracts etc. to a notional on balance sheet ‘credit equivalent’ by multiplying the appropriate Credit Conversion Factors (CCF) and classify these in the appropriate risk categories depending on the Counter Party
– Multiply the rupee amount of assets in each risk category by the appropriate risk weight. The result equals ‘risk weighted assets’ 46
TOTAL RISK WEIGHTED ASSETS
• Arrived at by
– Multiplying market risk and operational risk by 12.5 [reciprocal of minimum capital ratio of 8%]. For India Minimum CAR/CRAR is 9% wef March 31, 2000.
– And adding the resulting figure to credit risk
47
Credit risk- standardized approach
• Salient features
– The Standardized approach for credit risk retains some part of the 1988 Accord, such as the definition of ‘capital’.
– Its novelty lies in the replacing the existing risk weighting scheme by a system where risk weights are determined by the borrower’s credit rating by External Credit Rating Agencies like CRSIL, ICRA, CARE & FITCH.
48
Credit risk – IRB approach
• Salient features
– Banks can use their internal estimates of borrower creditworthiness to assess credit risk
– These banks may rely on their own internal estimates of PD, LGD, EAD and effective maturity [M] in determining the capital requirement for a given exposure.
– Banks may be required to use values prescribed by supervisors in lieu of internal estimates for some of the risk components.
49
CREDIT RISK- IRB APPROACH
• Two broad approaches for many asset classes- ‘foundation’ and ‘advanced’
• Under the foundation approach banks generally provide their own estimates of PD and rely on supervisory estimates for other risk components.
• Under the advanced approach, banks provide more of their own estimates of PD, LGD and EAD, and their own calculation of M, subject to meeting minimum standards.
50
MARKET RISK
• Capital required for both general market risk as well as specific market risk.
• General market risk - the impact of broad market movements on the market value of on balance sheet assets and off balance sheet items, including risks common to all securities, such as changes in the general level of interest rates, exchange rates, commodity prices or stock prices.
• Specific market risk- inherent risks of a particular security, such as the credit risk of the institution, which issued the security.
51
OPERATIONAL RISK• BASIC INDICATOR APPROACH
– KBIA = [(GI1…n x )]/n
Where
– KBIA = the capital charge under the Basic Indicator Approach
– GI = annual gross income, where positive, over the previous three years, GI = Net Int. Income + Net Non-Int. Income
– n = number of the previous three years for which gross income is positive
– = 15%, which is set by the Committee, relating the industry wide level of required capital to the industry wide level of the indicator.
52
OPERATIONAL RISK- STANDARDIZED APPROACH
• Banks’ activities divided into eight business lines: corporate finance, trading & sales, retail banking, commercial banking, payment & settlement, agency services, asset management, and retail brokerage.
• Within each business line, gross income is a broad indicator that serves as a proxy for the scale of business operations and thus the likely scale of operational risk exposure within each of these business lines.
• The capital charge for each business line is calculated by multiplying gross income by a factor (denoted beta) assigned to that business line.
53
OPERATIONAL RISK- AMA
• Under the AMA, the regulatory capital requirement will equal the risk measure generated by the bank’s internal operational risk measurement system using the quantitative and qualitative criteria for the AMA.
• Use of the AMA is subject to supervisory approval.
54
BANKS IN INDIA- MIGRATION TO ADVANCED APPROACHES
• Up to 2009, banks in India followed standardized approach for credit risk, standardized approach [modified duration] for market risk and basic indicator approach for operational risk
• From 2010 onwards, banks are expected to migrate to more advanced approaches in a phased manner, so that process is completed by 2014
55
KEY WORDS/TERMINOLOGIES/GLOSSARY - 1
• BIS (Bank for International Settlements), BCBS (Basel Committee on Banking Supervision), Basel-I Accord, Capital Adequacy Ratio (CAR) or Capital to Risk-Weighted or Adjusted Asset Ratio (CRAR), Capital Fund (CF), Tier-I Capital or Core/Permanent/Readily available Capital, Tier-II Capital or Non-Core/Non-Permanent/ Not so readily available Capital, Risk Weight (RW), Risk Weighted Assets (RWA).
KEY WORDS/TERMINOLOGIES/GLOSSARY - 2
• Credit Conversion Factors (CCF), Counter Party Risk Weight, Basel-II Capital Accord, Three Pillars, Minimum Capital Requirement, Supervisory Review Process, Market Discipline, Credit, Market & Operational Risk. Bank Loan Rating, Regulatory Capital or Risk Based Capital, Economic Capital.
Numerical on CAR Calculation• Q 1. What should be the Minimum
unimpaired Capital Requirement and break-up of Tier-I and Tier-II Capital, to be maintained by a bank in India, if the Total Risk Weighted Assets (TRWAs) is Rs.10,000 Crore.
• Suggested Solution: Minimum unimpaired Capital Requirement @9% of TRWAs=Rs.900 Cr. With Tier I Capital (Minimum) 50% of CF @ Rs.450 Cr. And Tier II Capital (Maximum) 50% of CF @ Rs.450 Cr.
Numerical on CAR Calculation• Q 2. The RWAs of a bank is Rs.12,450/- Crore as
ag. the total assets of Rs.16,600/- Crore. The Capital Structure of the Bank is given below :
(Rs. in Crores)» Equity
280
» Free Reserves 465
» Subordinated Debt/Tier-2 bonds 325
(remaining maturity 3.5 years)
Revaluation Reserves 428
Numerical on CAR Calculation• Q 2. (contd…)
• N.B. : Tier-2 bonds to be reckoned @ 40% discount
• (a) Verify whether the bank has achieved the Capital adequacy level of 9%.
• (b) If the Bank expects to increase the total fund during the year by 15% and propose to deploy funds at an average RW of 64%, compute the requirement of additional capital to maintain CAR of 9%.
Suggested Solution - 1• Verify whether the bank has achieved the capital adequacy level of 9%Elements of Capital/Amount
Reckoning Rate for Capital Fund Calculation
Contribution to Capital Fund
Equity Capital/Tier 1/280 100% 280Free Reserves/Tier 1/465 100% 465Subordinated Debt/Tier 2 bonds(Remaining maturity 3.5 years)@ 40% discount/325
60% 195
FA Revaluation Reserves/428@ 55% discount (Tier 2)
45% 192.60
Total Capital Fund Available (CF)/(Tier 1 + Tier 2) Capital
1,132.60
Suggested Solution - 2• Verify whether the bank has achieved the capital adequacy level of 9%
• Total Risk-Weighted Assets (TRWA) = 12,450 Cr.
• CAR or CRAR = CF/TRWA = 1,132.60/12,450 = 9.10%
• If the bank expects to increase the total funds during the year by 15% and proposes to deploy the funds at an average risk weight of 64%, compute the requirement of capital to maintain CAR of 9%.
• Solution: Total Funds now = 16,600, Increase in funds @ 15% = 16,600*0.15 = 2,490
Suggested Solution - 3• Addition to risk Weighted Assets= 2,490 * 0.64 =
1,593.60
• Total Risk-weighted assets = 12,450 + 1,593.60 = 14,043.60
• Capital Fund required @ 9% CAR = 14,043.60 * 0.09 = 1,263.92
• Capital Fund available now = 1,132.60
• Additional Capital Fund Required = 1,263.92 – 1,132.60 = Rs.131.32 Cr.
Topics for Next Class – All of you Should get prepared before coming to the class
• Management of Bank’s Investment Portfolio
• Risk Management in Banks, Credit Risk Management, Interest Rate Risk Management & Asset-Liability Management (ALM)