Capital Adequecy Ratio (CAR) for Commerical Banking

1. Prudential norms for capital
adequacy
• Introduced with a view to adopt Basel
committee norms
• Risk element in various types of assets
are considered
• Each assets are assigned prescribed risk
weight
• Banks have to maintain prescribed ratio of
capital funds on the aggregate of risk
weighted assets on an ongoing basis

2. Example
Book
value of
assets
Risk
weight
Total
Risk
weighted
assets
Loans to Govt 500 0 0
Secured loans 800 0.50 400
Unsecured loans 200 1 200
TOTAL 1500 600
Total risk weighted assets is 600
9 % on 600 = 54
Capital required is 54

3. Capital adequacy framework
• Capital funds
• Risk adjusted assets
• Off balance sheet items
• Capital adequacy for subsidiaries

4. Capital funds
• Capital adequacy norms were introduced
in April 1992
• Made effective from March 1996

5. Capital funds
• Until 2003 CAR was applicable only to
credit risk
• For market risk for investment
– For Held For Trading category introduced
during 2004 – 05
– For Available For Sale category introduced in
2006
• Under Basel II CAR is also for operational
risk

6. Elements of capital fund for Indian
banks
• Tier I Capital (Core Capital)
– Permanent shareholders equity – consist of
paid up capital, statutory and other reserves,
less: Investment in subsidiaries, intangible
assets, and cumulative losses, if any
– Perpetual debt instruments
– Perpetual non cumulative preference shares

7. Capital funds for Indian banks..
• Tier II Capital (Supplementary capital)
– Redeemable preference shares
– Revaluation reserve
– Hybrid debt capital instruments
– Long term subordinated debt
– Debt capital instruments – bonds / debentures

8. Limit
• Tier II capital is limited to 100 % of Tier I
capital
• Tier II capital can be considered for the
purpose of capital adequacy only up to an
amount equal to Tier I capital
• Subordinated debt is limited to 50 % of
Tier I capital

9. Capital funds for Indian banks..
• Tire III capital
– It includes only short term subordinated debt
• Tire III capital can be considered for
supporting market risk only. Not for credit
risk
• Tire I & II capital can be used to support
market risk

10. Capital funds for foreign banks
• Tier I capital
– Interest free funds from HO kept in Indian books for
the purpose of meeting CAR
– Statutory reserve kept in Indian books
– Capital reserve arising due to sale of assets in India
not eligible for repatriation till bank function in India
– Interest free funds remitted from abroad for
acquisition of property in India
– Inter office adjustment bal. with HO or overseas
branches. If it is credit bal. – ignore. If it is debit bal. it
is to be set-off against capital

11. Capital funds for foreign banks
• Tier II capital
– Same as applicable to Indian banks
• Minimum CAR
– For Indian as well as foreign banks 9 % on an
ongoing basis

12. Risk adjusted assets
• Bank should maintain CAR for
– Credit risk
– Market risk on securities (Held for Trading & Available
for Sale)
– Open gold position
– Open forex position
– Trading position in derivatives
– Derivatives for hedging
• Each of the above assets is to be assigned
prescribed weight in percentage

13. Off balance sheet items
• Multiply face value of off balance sheet
items by credit conversion factor
• This should then be again multiplied by the
prescribed risk weight

14. Capital adequacy for subsidiaries
• While computing capital fund parent bank
(holding co.) may consider following points
– Non bank subsidiaries have to maintain CAR
prescribed by their respective regulator
– In case of any short fall by subsidiary the
parent bank should maintain capital in
addition to its own CAR