CAPITAL ADQUACY

Capital Adequacy
General
With a view to adopting the Basle Committee framework on capital adequacy norms which takes into account the elements of risk in various types of assets in the balance sheet as well as off-balance sheet business and also to strengthen the capital base of banks, Reserve Bank of India decided in April 1992 to introduce a risk asset ratio system for banks (including foreign banks) in India as a capital adequacy measure.

Essentially, under the above system the balance sheet assets, non-funded items and other offbalance sheet exposures are assigned weights according to the prescribed risk weights and banks have to maintain unimpaired minimum capital funds equivalent to the prescribed ratio on the aggregate of the risk weighted assets and other exposures on an ongoing basis. The broad details of the capital adequacy framework are detailed below.

Norm of Capital Adequacy

Minimum requirement of capital funds
Banks are required to maintain a minimum CRAR of 9% on an ongoing basis.

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

Tier-I Capital (Indian Banks)

1.

Elements of Tier I capital

a.

b.

Paid-up capital, statutory reserves, and other disclosed free reserves, if any. Capital reserves representing surplus arising out of sale proceeds of assets.

2.

Equity investments in subsidiaries, intangible assets and losses in the current period and those brought forward from previous periods, should be deducted from Tier I capital.

3.

Creation of deferred tax asset (DTA) results in an increase in Tier I capital of a bank without any tangible asset being added to the banks balance sheet. Therefore, DTA, which is an intangible asset, should be deducted from Tier I capital.

Tier-I Capital (Foreign Banks) Interest free funds from H.O. kept in separate account for meeting capital adequacy. Statutory Reserves kept in Indian Books Remittable surplus retained in Indian Books which are not repatriable so long as the Bank functions in India. Capital Reserves arising out of Sale of Assets in India, held in separate account and are not repatriable as long as the Bank functions in India Interest free funds remitted in India for

Acquisition of property in India and held in a separate account. The net credit balance in Inter-Office Account with H.O. or a Branch Overseas will not be reckoned as Capital funds. However, any debit balance will have to be set off from the Capital.

Elements of Tier II capital

Undisclosed reserves and cumulative perpetual preference shares (fully paid up) Revaluation reserves. General provisions and loss reserves. Hybrid debt capital instruments. Subordinated debt. Investment Fluctuation Reserve (IFR).

Undisclosed reserves should be accumulated out of post tax profits and not encumbered by any liability. Cumulative preference shares should be fully paid up and should not contain clauses which permit redemption by shareholders. Since revaluation reserves may not give full 100% value at the time of selling of the assets, they need to be discounted by a minimum of 55% when determining their value for inclusion in Tier-II Capital. General Provisions and Loss Reserves (GPLR). These are available to meet

Unexpected losses but are not attributable to any specific/known loss which is foreseeable. GPLR will be admitted to Tier-II Capital upto a maximum of 1.25% of Risk weighted assets. Subordinated Debt Instruments: -Should not have initial maturity less than 5 years -If issued in last quarter of FY, should have initial maturity of 63 months -Should be fully paid up -Interest rate should not be more than 200 bp above the yield on Government Security of equal residuary maturity at the time of issue.

Subordinated Debt will be limited to 50% of Tier-I Capital Subordinated Debt to be included in Tier-II Capital may be subjected to the following discounts: Beyond 4 Years but not exceeding 5 years20% Beyond 3 Years but not exceeding 4 years40% Beyond 2 Years but not exceeding 3 Years60%

Beyond 1 Year but not exceeding 2 years80% Maturity not exceeding 1 year 100%. Public Sector Banks are required to obtain permission of GOI before issue. RBI permission required for issuing to NRI/FII Subordinated Debt issue should be plain vanila with no special features like options etc. GPLR+GP on SA+Investment Fluctuation Fund Maximum to be admitted to tier II capital is 1.25% of RWA

RISK ADJUSTED ASSETS: - Weighted aggregate of (Funded + Non Funded) Assets - Banks investments in all securities should be assigned a risk weight of atleast 2.5% for market risk. This will be in addition to the risk weight assigned towards credit risk. - Cash margins or credit balance in CA earmarked specifically in lieu of cash margin for the credit facility extended, be deducted (netting done) before applying weight

Claims received from DICGC/ECGC/Any subsidy received e.g. IRDP and not appropriated to the asset be deducted from the respective Asset (Netting) before applying weight -Equity investment in subsidiaries, intangible assets which are deducted from Tier-I Capital should be assigned Zero weight. -Advances to the extent guaranteed by DICGC/ ECGC may be assigned risk weight of 50% to that extent. -Advances against specified securities Fixed

Deposits/NSCs/KVPs/IVPs etc. should be given zero risk weight -Loans to staff Zero risk weight Zero Risk weight under Other Assets: -Income Tax deducted at source -Advance Tax paid -Interest due on Govt.Securities -Accrued interest on CRR balances & other claims with RBI

Investment in Subordinated debt instruments of other Banks or Public Financial Institutions would carry risk weight of 100%. Foreign Exchange & Gold open position should carry 100% risk weight. Other items risk weight as per BOOK Off Balance-sheet items: The credit risk exposure attached to off balance sheet items has to be first calculated by multiplying the face value of each balance sheet item by a Credit Conversion factor. This will again have to be multiplied by the

weight attributable to the counter party. -Cash margins/deposits shall be deducted before applying the credit conversion factors -All financial guarantees CF 100% -Performance guarantees CF 50% -Short Term self-liquidating trade related contingencies CF 20% -Note issuance facilities and revolving underwriting CF 50% -Certain transactions related contingent liabilities CF 50%

Guarantees issued by the banks against the counterguarantee of other banks CF 20% Rediscounting of documentary bills accepted by other banks CF 20% Foreign Exchange Contracts: Original maturity < 14 days CF 0% Original maturity More than 14 d to1 yr CF 2% Original maturity More than1 yr to 5 yr CF 10% More than 5 year 15% The converted values obtained shall be multiplied by the risk weight attached to the counter party.

Consider the following data of the Bank as on 31st March 2009: (Rs./Crs) Equity 240 Statutory Reserves CapitalReserves(Out of sales) Undisclosed Reserves Equity investment in subsidiaries 40 50 40 44

Cumulative prepetual preference shares

Revaluation Reserves

90
130

General Provisions & Loss Reserves

Subordinated debt:Above 5 years 5 years 4 to 5 years 3 to 4 years 2 to 3 years 1 to 2 years

80
20 30 40 20 40 30

Below 1 year

140

Cash on hand Balances with RBI

Balances with other Banks Investment in Govt. Securities Investment in other Securities Claims on Comm Banks e.g. CDs

80 50
84 74 298 46

Loans and advances guaranteed by GOI Loans & advances to Central PSUs
Loans & advances to State PSUs Claims to FIs

382 242
150 80

Furniture & Fixtures

Buildings & Equipment Stand by LCs to PSU

130
150 84

to private Cos.
Collatrised credit to Private Co. underlying shipment Note issuancefacility to Public sector Aggregate outstanding F.E. contracts: Maturity above 14 days to1 year Maturity Above 2 yr <3 years

112
100 34

32 24

Apart from these, the Bank has Rs.2800 crs of Risk weighted assets. Calculate the Capital Adequacy ratio. RISK WEIGHTED ASSETS (On balance sheet) Asset Cash on hand Bal with RBI Invst. Govt Securities Bal 80 50 74 weit 0% 0% 2.5 Risk weit 0 0 1.85

Bal with other Banks Inv. Other securities Claims on other banks CD etc. L & A guaranteed by GOI L & A to Central PSUs L & A to State PSUs

84 46

0.20 20%

16.80 298 9.20

298 100%

382

0%

0
242 150

242 100% 150 100%

Claims to FIs
Furniture & Fixture Building & Equipment TOTAL

80

20%

16
130 150 1013.85

130 100% 150 100%

Off Balance-Sheet assets: (Rs./crs) Asset Bal Weit% cf% SLC PSU
SLC Pvt co. Coll.credit topvt.co. Note issuance to F.E.contract<1yr -<3yr Total

RWA

84
112 100 Pvt. 34 32 24

100
100 100 100

100
100 20 50

84
112 20 17

100 100

2 10

0.64 2.40 236

Total Risk weight assets= 1013.85+236+2800 = Rs.4049.85 cr Computation of Tier-I Capital:Amt.Rs/cr

Equity Statutory Reserves Capital Reserves (Sales proceed Total 240 40 50 330

Less: Equity in subsidy

Tier-I Capital

44
286

Computation of Tier-II Capital: Subordinated debt:

Above 5 yr - 5 yr - 4 to 5 yr - 3 to 4 yr -2 to 3 yr -1 to 2 yr - Below 1 yr Total 20 x 1 30 x 0.8 40 x 0.8 20 x 0.6 40 x 0.4 30 x .2 140 x 0 20 24 32 12 16 6 0 110

Subordinated Debt should be lower of 50% of tier-I Capital i.e. 0.50 x 286 =Rs.143 cr or Rs.110 cr as calculated above i.e. Rs.110cr General Provisions & Loss Reserves should be lower of 1.25% of RWA i.e. 1.25% of 4049.85 = Rs.50.41 cr or actual i.e. Rs.80 cr. Therefore Rs.50.41 cr (Rs./cr) Undisclosed Reserves 40.00 Cumulative Preference shares 90.00 Revaluation Reserves: 130x.45 58.50 GPLR 50.41 Subordinated debt 110.00

Total Tier II Capital = Rs.348.91 cr For computing Capital Adequacy Tier-II can not be more than Tier- I Capital i.e. Rs.286 cr Therefore Capital adequacy = (286+286)/4049.85 = 0.1413 = 14.13%

ILLUSTRATION: Risk weighted assets of a bank are Rs.3250 cr. Tier-I Capital of Bank stands at Rs.119 cr. Revaluation reserves and General Provisions and Reserves stood at Rs.74 cr and Rs.49 cr resp. The bank wants to find out whether it meets the capital adequacy requirement of 9% or not. If not, to meet the capital adequacy requirement, the bank is contemplating on raising equity and subordinated debt in suitable proportion so that interest of present shareholders may be diluted only to limited extent. Suggest a suitable alternative to bank, stating the regulations to be followed.

Total Risk weighted Assets = Rs.3250 crs Tier-I Capital = Rs. 119 crs Tier-II Capital = 0.45 x74 + Min. of 0.0125x3250 or Rs. 49 = 33.30+40.625 = Rs.73.925 cr Total Capital = 119 + 73.925 = Rs.192.925cr Existing Capital Adequacy=192.925/3250 x100 = 5.9% Total Required Capital = 9% of 3250 = Rs.292.50 cr Capital needed to be raised= 292.50-192.925 = Rs.99.575 cr

Capital to be raised : Equity & Subordinated Debt Requirements: (i) Subordinated Debt can not be more than 50% of equity capital (ii) Tier II Capital can not be more than Tier I Capital If we raise whole of additional capital required by means of subordinated debt, then Tier II Capital will be= 73.925+99.575=173.50 cr i.e. more than Tier I Capital of Rs.119 cr. Also subordinated debt will be =99.575 cr i.e. more than 50% of Tier I Capital. Let us assume that subordinated debt raised

Rs. X crs. Therefore Equity raised will be Rs.(99.575 X) crs Since subordinated debt can not be more than 50% of Total Equity, therefore X = 0.5(119+99.575-X) or X= Rs.72.8583cr Also the other condition that Tier II Capital can not be more than Tier-I Capital, therefore X+73.925 = 119+99.575-X or X= Rs.72.325cr Thus Additional capital will be raised as Subordinated Debt = Rs.72.325cr Equity(99.575-72.325)= Rs.27.250cr TOTAL Rs.99.575cr

Thank You