The basle capital accord

Risk Weighted Capital Adequacy Ratio

Introduction

The Basle Capital Accord, or the agreed framework on international convergence of capital measurement and capital standards of the Committee on Banking Regulations andSupervisory Practices (Basle Committee), is based on a concept of weighting both on balance Sheet assets and off-balance sheet exposures according to their perceived level of Risk. The sum of risk weighted assets and risk assessed off-balance sheet exposures isrelated to a bank's capital base and the resulting "risk asset ratio" is used as a measure of Capital adequacy. The risk-based approach to capital adequacy focuses on credit risk that is the risk that the counterparty in any given transaction will default.

The Basle Committee has set the minimum standard at 8 per cent. National authorities are, however, free to adoptarrangements that set higher levels.Two fundamental objectives lay at the heart of the Basle Capital Accord. These are, firstly, that the new framework should serve to strengthen the soundness and stability of the banking system and, secondly, that the framework should be fair and have a high degree of Consistency in its application to banks in different countries with a view to diminishing an existing source of competitive inequality among international banks.

For the purposes of assessing capital adequacy, capital will be split into two tiers -

Tier 1 core capital and Tier 2 supplementary capital. While Tier 1 capital provides the most permanent and readily available support to a bank against unexpected losses,

A tier 2 capital contains elements that are less permanent in nature or are less readily available.

The broad details of the capital framework which is to be implemented are indicated

In the following paragraphs.

Tier 1 - Core Capital

Tier 1 capital will consist of paid up capital or assigned capital, as the case may be,

Share premium, statutory reserve, surplus arising from sale of fixed assets, general reserve,

Other disclosed free reserves created by appropriations from post-tax retained earnings and undistributed balance in profit and loss account attributable to previous years. Accumulated losses, current year's interim losses, goodwill and other intangible assets will be deducted from Tier 1 capital.

The current year's interim retained profits may be included in Tier 1 capital if they

have been verified by the bank's external auditors. In the absence of such verification,

current year's interim profits will not be included in the capital base. The verification by

external auditors should entail at least the following:

  1. Satisfying themselves that the figures forming the basis of the interim
  2. profits have been properly extracted from the underlying accounting records;
  3. Reviewing the accounting policies used in calculating the interim
  4. profits so as to obtain comfort that they are consistent with those
  5. normally adopted by the bank in drawing up its annual financial statements;
  6. Performing analytical procedures on the result to date, including
  7. comparisons of actual performance to date with budget and with the results of prior period(s);
  8. Discussing with management the overall performance and financial position of the bank;
  9. Obtaining adequate comfort that the implications of current and prospective litigation, all known claims and commitments, changes in business activities and provisioning for bad and doubtful debts have been properly taken into account in arriving at the interim profits; and
  10. Following up problem areas of which the auditors are already aware in
  11. the course of auditing the bank's financial statements.

The external auditors must submit an opinion to the bank on whether the interim results are fairly stated. The required report, set out in Annexure II, should be attached to the Quarterly Capital Adequacy Return.

Tier 2 - Supplementary Capital

Tier 2 supplementary capital will consist of:

  1. Undisclosed reserves

These may be inherently of the same intrinsic quality as published retained earnings,but the Basle framework treats undisclosed freely available reserves as supplementary capital because of their lack of transparency. Accordingly, undisclosed reserves representing accumulations of post-tax profits which are not encumbered by any known liability and are not routinely used for absorbing normal loan or operating losses may be included in the supplementary capital.

  1. Fixed assets revaluation reserves

These reserves arise mainly from revaluation of a bank's own premises to reflect their current value, or something closer to their current value than historic cost. The extent to which the revaluation reserves can be relied upon as a cushion for unexpected losses depends mainly on the level of certainty that can be placed on estimates of the market values of the relevant assets. The assets must, therefore, be prudently valued. Revaluation of premises should be carried out by independent professional valuers, on a basis satisfactory to both the external auditors and the Bank of Mauritius. The reserves arising from revaluation of fixed assets should be explicitly reported in the balance sheet or by way of notes to the audited accounts. Only 75 per cent of the amount of reserves arising from the revaluation of tangible fixed assets will be eligible for inclusion in Tier 2 capital.

  1. General provisions/general loan loss reserves

General provisions or general loan loss reserves are created against the possibility of losses. Where they do not reflect a known deterioration in the valuation of particular assets, these provisions or reserves qualify for inclusion in Tier 2 capital. Where, however, the provisions or reserves have been created against identified losses or in respect of an identified deterioration in the value of any asset or group of assets, they are not freely available to meet unidentified losses which may subsequently arise elsewhere in the portfolio and do not possess an essential characteristic of capital. Such provisions or reserves should therefore not be included in the capital base. Adequate care must be taken to see that sufficient provisions or reserves have been made to meet all known losses and foreseeable potential losses before considering general provisions and/or general loan loss reserves to be part of Tier 2 capital. General provisions and/or general loan loss reserves held against unidentified and unforeseen losses will be included in Tier 2 capital subject to an amount not exceeding 1.25 per cent of total weighted risk assets.

  1. Subordinated debt

Subordinated debt as approved by the Bank of Mauritius may be included in Tier 2 supplementary capital. Broadly, to be eligible for inclusion, it should satisfy the following conditions:

  1. the subordinated debt must be unsecured;
  2. it must have an original maturity of over five years;
  3. it may be redeemed before maturity only at the option of the bank concerned and with the prior written approval of the Bank of Mauritius;
  4. notwithstanding the provisions of any other enactment, in the event of the winding up of the bank concerned, the subordinated debt shall not be repaid until the claims of depositors and other creditors have been fully satisfied;and
  5. Such further conditions, if any, as may be prescribed by the Bank of Mauritius.

During the last five years to maturity, a cumulative discount (or amortisation) factor of 20 per cent per year should be applied to reflect the diminishing value of the subordinated debt as a continuing source of strength. The amount of subordinated debt included in Tier 2 capital will be limited to a maximum of 50 per cent of Tier 1 core capital.

Minimum Requirement of Capital Funds

The on-balance sheet assets, non-funded items and other off-balance sheet exposures

will be assigned the prescribed risk weights and banks should maintain minimum capital funds equivalent to eight per cent of the aggregate of the risk weighted assets and other exposures. The minimum risk weighted assets ratio of eight per cent should be achieved as early as possible as but not later than the 30th June 1994. Tier 1 core capital should not be less than 50 per cent of total capital funds and Tier 2 supplementary capital will be limited to a maximum of 100 per cent of Tier 1 core capital for the purpose of compliance with the norm.

The Development Research Group (DRG) in the Reserve Bank of India has brought out a study entitled "Capital Adequacy Requirements and the Behaviour of Commercial Banks in India : An Analytical and Empirical Study", the twenty-second in the DRG Study Series. The study is authored by Prof. D.M.Nachane, Shri Aditya Narain, Shri Saibal Ghosh and Shri Satyananda Sahoo.In the wake of the introduction of prudential regulation as an integral part of financial sector reforms in India, there has been a growing debate as to whether capital adequacy requirements are the best means to regulate the banking system. From cross country experiences,

There is some evidence of a positive association between capitalisation and risk assumption by banks due to the possibility that the one-size-fits-all capital adequacy ratio (CAR) causes bank leverage and asset risk to become substitutes. At policy levels, this has driven research into alternative regulatory methods.

Against this background, the study investigates the relationship between changes in risk and capital in the Indian banking sector, with reference to public sector banks (PSBs). The study seeks to identify key variables impinging upon the capital adequacy of banks and to examine evidence for a shift in bank portfolios towards greater riskiness after the introduction of capital adequacy norms. The study also attempts to draw implications of the new capital adequacy framework proposed by the Basel Committee on Banking Supervision (BCBS) for the Indian financial system and evaluates alternative regulatory arrangements as complements to the CAR.

The major findings of the study are :

  1. Given the wide heterogeneity in terms of products and customer preferences among PSBs as well as the adjustment response of PSBs, the regulatory framework should be designed to encourage individual banks to maintain higher CAR, over and above the stipulated minimum, so as to reflect differential risk profiles.
  2. While capital remains a useful regulatory tool for influencing bank behaviour, there is no conclusive evidence that the introduction of CAR has led to risk aversion among banks.
  3. Prompt Corrective Action (PCA) based on capital might prove to be an effective strategy for arresting bank portfolio
  4. deterioration.
  5. Capital ratios of banks are a crucial determinant of banks ratings, in the short-term; this has implications for India in terms of the new BCBS proposal which are built on ratings.
  6. Alternative approaches such as value at risk (VaR) and Pre-commitment Approach (PA) are no substitutes for the wider risk management process of analysing stress scenarios and monitoring operational and legal risk; they also suffer from limited applicability i.e. for entities with material trading activities. The PA needs to be further examined and refined before it can be considered for application in Indian banks.

The DRG Studies series have an accent on policy-oriented research. They are released for wide circulation with a view to generating constructive discussion among professional economists and policy makers on subjects of current interest. The views expressed in these studies are those of the authors and do not reflect the views of the Reserve Bank.

Bank capital plays a very important role in the safety and soundness of individual banks and the banking system. Basel Committee for Bank Supervision (BCBS) has prescribed a set of norms for the capital requirement for the banks in 1988 known as Basel Accord I. These norms ensure that capital should be adequate to absorb unexpected losses or risks involved. If there is higher risk, then it would be needed to backed up with Capital and Vice versa. All the countries establish their own guidelines for risk based capital framework known as Capital Adequacy Norms. Capital Adequacy measures the strength of the bank. Capital Adequacy Ratio is also known as Capital Risk Weighted Assets Ratio.

The focus of Capital Adequacy Ratio under Basel I norms was on credit risk and was calculated as follows:

Capital Adequacy Ratio = Tier I Capital+Tier II Capital / Risk Weighted Assets

Basel Committee has revised the guidelines in the year June 2001 known as Basel II Norms. There are Three Pillars of Basel Accord II.

  1. Minimum Capital Requirement: Based on certain calculations minimum capital requirement has to be maintained.
  2. The Supervisory Review Process: The Central Bank (RBI) of the country has to ensure that each bank has an adequate capital to adopt better management techniques.
  3. Market Discipline: There should be a mandatory disclosure on risk management practices with transparency.

Capital Adequacy Ratio in New Accord of Basel II:

Capital Adequacy Ratio = Total Capital(Tier I Capital+Tier II Capital)/ Market Risk+ Credit Risk + Operation Risk

Calculation of Capital Adequacy Ratio:

Total Capital:

Total Capital constitutes of Tier I Capital and Tier II Capital less shareholding in other banks.

Tier I Capital = Ordinary Capital+Retained Earnings& Share Premium - Intangible assets.

Tier II Capital = Undisclosed Reserves+General Bad Debt Provision+ Revaluation Reserve + Subordinate debt+ Redeemable Preference shares

Tier III Capital:

Tier III Capital includes subordinate debt with a maturity of at least 2 years. This is addition or substitution to the Tier II Capital t6o cover market risk alone. Tier III Capital should not cover more than 250% of Tier I capital allocated to market risk.

Types of Risks involved in Basel II & their computation:

Credit Risk:

If the counter party do not settle the dues within the stipulated time or thereafter, this type of risk arises. It includes risks on derivatives, replacement risk and Principal risk. For measuring the risk the following approach are used:

  1. Standardised Approach
  2. Internal Rating Based Foundation Approach
  3. Internal Rating Based Advanced Approach

Market Risk:

This is the risk or loss arising on or off Balance Sheet due to the movement of prices in foreign currencies, commodities, equities and bonds.With regard to market risk,there are two method for computation.

  1. Standardised Approach
  2. Internal Model Approach

Operation Risk:

This type of risk or loss results from inadequate or failure in the corporate governance or internal processes, people or system.RBI adopts the following measurement techniques for calculation

  1. Basic Indicator Approach
  2. Standardised Approach
  3. Advanced Measurement Approach

Though different approaches are available for calculation of Risk, RBI advises Indian Banks to adopt the standardized approach initially before transition to Advanced Approaches.

Standardised Approach:

Basel Committee for Banking Supervision (BCBS) suggests various risk weighted percentages for different category of assets in the Balance Sheet and Off Balance sheet items (such as guarantees,letter of Credit,Underwriting,Sale &repurchase of transaction etc) known as Risk Buckets. The BCBS has fixed various risk weights from 0% to 100% based on the risk perceived on each of that particular on and off balance sheet items.In case of Balance sheet asset, the face value of credit risk asset amount should be multiplied by risk bucket to arrive at the amount of risk weighted asset exposure.

For off balance sheet items,the face value credit risk exposure amount has to be multiplied with credit conversion factor to arrive at the credit risk exposure.Then,it has to be multiplied to relevant weight percentage to arrive at amount risk of risk weighted exposure.

Banks have to disclose Tier I capital,Tier II Capital under disclosure norms in the Balance Sheet.They also have to submit a report on capital funds,conversion of on and off balance sheet items,calculation of risk weighted assets,capital to risk asset ratio.

Minimum Requirement of Capital Adequacy Ratio (CAR):

Under Basel II norms,8% is the prescribed Capital Adequacy Norm.

In case of Scheduled Commercial Banks CAR= 9%

For New Private Sector Banks CAR = 10%

For Banks undertaking Insurance Business CAR = 10%

For Local Area Banks CAR =15%

At the end of March 2008, there were 2 Scheduled Commercial Banks(1 Private Sector Bank & 1 Foreign bank)having 0-9% of Capital Adequacy Ratio,55 Scheduled Commercial Banks( 28 Public Sector Banks,17 Private Sector Banks & 10 Foreign Banks)were having CAR between 10%-15% and 22 Scheduled Commercial Banks (19 Foreign Banks & 3 Private Sector Banks) having CAR of 15% and above according to RBI Publications.

24% rise in Banks NPAs in 2nd QR and Capital Adequacy Ratio declines by 2% Points,

If NPAs and CAR reported by the commercial banks are an indication of the financial strength, the second quarter results of the Indian banking sector do not portray a healthy picture. This is because the net non-performing assets have risen by an average 24 per cent while capital adequacy ratio reduced by 2 percentage points in Q2 of current fiscal as compared to the corresponding period of previous year, according to the ASSOCHAM Eco Pulse (AEP) Study. The ASSOCHAM Study titled "Solvency Analysis of the Indian Banking Sector", reveals that on an average 24 per cent rise in net non performing assets (NPAs) have been registered by 25 public sector and commercial banks during the second quarter of the FY'09 as against Q2-FY'08. However, the average capital adequacy ratio (CAR) of the banks slipped to 12.68 per cent in Q2-FY '09 from 13.41 per cent in the previous year.

The analysis of the Indian banking sector was based on the quarterly results posted by 25 Indian banks on Bombay Stock Exchange (BSE) from 20th - 29th October 2008. For a macro analysis, the total 25 banks included an aggregation of 15 public sector banks (PSBs) and 10 private sector banks. The AEP analysis of the Indian banking sector's solvency is based on two broad parameters including net non performing assets and capital adequacy ratio.

"Although the Indian banking sector has remained insulated from the global financial crisis, the emerging trends as found in the AEP do not give positive signals", says the ASSOCHAM spokesman.

As per the AEP, the aggregate net non-performing assets (NPA) of 25 banks increased by24.36 per cent to Rs 17,522.82 crore in second quarter of 2008-09 from Rs 15,462.84 crore in the same period of FY'08. Karur Vysya Bank recorded maximum rise of 275.36 per cent in net NPAs in Q2-FY'09 with Rs. 50.03 crore as against Rs 13.33 crore in Q2-07. It was followed by HDFC bank with an increase by 139 per cent, Vijaya Bank (132 per cent), State Bank of Hyderabad (81.42 per cent) and IDBI (57 per cent).

On the contrast, seven major PSBs recorded a significant decrease in net NPAs, including Central Bank of India (-87.39 per cent), Oriental bank of Commerce (-82.18 per cent), Union Bank of India (-73.38 per cent), Dena Bank (-17.24 per cent), Bank of India (-14.80 crore), Bank of Maharashtra (-7.75 crore) and Indian Bank (-1.54 per cent) have shown improvement in net NPA levels. Whereas, among the private sector banks only South Indian Bank registered an improvement in net NPAs by -29.82 per cent.

In terms of capital adequacy ratio, out of the 25 banks posting their results for the quarter ending September 2008-09, it was found that 16 banks witnessed a fall in their CAR from the previous fiscal, but they still managed to remain above the prescribed limit of nine per cent posed by the Basel II accord.

The AEP study also revealed that in FY'09, there were 11 public sector banks out of the total 16 banks that registered decline in CAR from the previous year. Axis bank registered the maximum decline in CAR from 17.59 per cent in Q2 FY'08 to 12.2 per cent in Q2 FY'09

It was followed by HDFC bank from 14.9 per cent to 11.4 per cent, Bank of Maharashtra from 13.6 per cent to 10.78 per cent and ICICI bank recorded a decline from 16.79 per cent to 14.01 per cent respectively.

In the second quarter of current financial year, the Central Bank of India registered a 9.85 per cent CAR from the previous 12.38 per cent. It was the only bank whose CAR dipped just around the thresh hold limit of 9 per cent CAR posed by the Basel II.

However, Federal Bank had the maximum rise in CAR upto 20.81 per cent in Q2 FY 2008-09 from 13.08 per cent a year earlier.

South Indian Bank at the second position registered a mere increase from 14.36 per cent to 14.44 per cent in the second quarter of current financial year.

Other banks which registered a significant rise in CAR include Yes Bank, whose ratio rose to 14.28 per cent over 13.02 per cent in previous year, City Union Bank from 12.85 per cent to 13.24 per cent, Karnataka Bank from 13.03 per cent in the second quarter of the previous fiscal to 13.21 per cent in the current fiscal and Dena Bank registered an increase in the ratio from 11.47 per cent in Q2 FY'09 to 12.34 per cent in same quarter of the last fiscal.

Study capital adequacy norms (baseII)for commercial banks

PANAJB NATIONAL BANK

Investors with a more than a one-year horizon can consider adding the Punjab National Bank (PNB) stock to their portfolio. Trading at a modest valuation, PNB appears well-placed to sustain business growth that is superior to peers, given that its lending rates are among the lowest in the sector.

Apart from being comfortably capitalised (capital adequacy ratio at 14.5 per cent), PNB boasts of strong profitability ratios. A high proportion of low-cost deposits enables it to sustain higher-than-industry margins (at 3.4 per cent) despite competitive lending rates. At the current market price of Rs 705, the stock is trading at 6.5 times its trailing one year earnings and 1.6 times its adjusted June 2009 book values). Loan book PNB managed to expand its loan book at a strong pace in recent quarters, with aggressive rate cuts improving its credit-deposit ratio to 72.1 per cent in June 2009. The bank also increased its market share in advances from 4.7 per cent to 5.4 per cent over the last one year. Operating profits expanded by 24 per cent in the first quarter of 2009-10, excluding treasury gains. The bank's investment book has seen a fall in its modified duration, suggesting that it may be able to limit any treasury losses from rising interest rates. Though a rise in net Non Performing Assets to 0.19 per cent in the June quarter is a concern, the bank is shielded by high provision coverage of 90 per cent. The restructuring of advances which are to the tune of 5 per cent of total advances is, however, on the higher side. PNB is comfortably placed on capital adequacy, having taken advantage of surplus liquidity to raise Rs 1,000 crores this quarter. It still has sufficient head room to raise capital through instruments such as perpetual bonds and preference shares towards Tier-1 capital and Tier-2 debt, as it has high core equity and reserves. Limited risk Rising interest rates do pose a risk to margins and earnings of all banks. However, the impact of a rising interest rate cycle on bank earnings (particularly treasury profits) may be limited this time round as the investment-deposit ratio has moderated.

ICICI BANK

ICICI Bank, India`s leading private sector lender announced a jump in consolidated net profit for the quarter ended September 2009, driven primarily by the sharp reduction in losses of ICICI Prudential Life Insurance Company and increase in profit of other subsidiaries. During the quarter, the profit of the bank rose 75.69% to Rs 11,445.70 million from Rs 6,514.80 million in the same quarter last year. Consolidated total income for the quarter fell 6.38% to Rs 145,958.50 million compared with the prior year period.

Onstandalone basis, the bank announced a marginal rise in net profit for the quarter ended September 2009. During the quarter, the profit of the bank rose 2.56% to Rs 10,401.30 million from Rs 10,142.10 million in the same quarter last year.Interest earned declined 15.04% to Rs 66,569 million, while total income for the quarter fell 12.68% to Rs 84,807.30 million, when compared with the prior year period.It reported earnings of Rs 9.34 a share during the quarter, registering 2.52% growth over previous year period.

Capital adequacy

The bank`s capital adequacy at September 30, 2009 as per Reserve Bank of India`s Basel II norms was 17.7% and Tier-1 capital adequacy was 13.3%, well above RBI's requirement of total capital adequacy of 9.0% and Tier-1 capital adequacy of 6.0%.

Asset quality

At September 30, 2009, the bank`s net non-performing asset ratio was at the same level as June 30, 2009 at 2.19%. Total provisions decreased sequentially by 19% to Rs 10,710 million in Q2-2010 from Rs 13,240 million) in Q1-2010.

Capital adequacy of SBI

The country's largest bank would need Rs 36,000-50,000 crore over the next five years to fund expansion plans and maintain capital adequacy ratio close to 12% by 2013.

Capital adequacy ratio is the amount of funds (equity+debt) that banks need to have in proportion to its loan books. Base(ii ) 2009 capital adequacy ratio is 14.3%.

At the end of September 30, 2009, the capital adequacy ratio of the bank was 14% of which tier-I capital or equity share capital was 9.38%. SBI, which has opened 550 branches and 3,000 automated teller machines (ATMs) between April and September this financial year plans to expand its branch network and open another 5,000-6,000 ATMs by March, which requires a lot of funding.

IMPLICATION OF CAPITAL ADEQUACY OF THREE BANK

Capital adequacy of the panjab national bank is 14.0%.Bank raise capital through instruments such as perpetual bonds and preference shares towards Tier-1 capital and Tier-2 debt, as it has high core equity and reserves and also rise the percentage in the non-performing asset so it is sound for the bank.

The ICICI bank`s capital adequacy at September 30, 2009 as per Reserve Bank of India`s Basel II norms was 17.7% and Tier-1 capital adequacy was 13.3%, well above RBI's requirement of total capital adequacy of 9.0% and Tier-1 capital adequacy of 6.0%.IT mean company profit is increasing as compare to previous year 2008-2009 but company non-performing asset ratio at a same level 2.9%.bank's capital is increasing through share, debt.

The capital adequacy of the state bank of India is 14.3%. Capital adequacy ratio is the amount of funds (equity+debt) that banks need to have in proportion to its loan books. it mean bank position is sound, less risky. But capital adequacy ratio of the bank is less than the icici bank so we can say icici bank's market value is more as compared to sbi bank.

Conclusion

capital adequacy norms of the icici bank is better as compare to panjab national bank and state bank of India. According to banking definition higher the capital adequacy ratio better the picture of bank. it mean icici bank having a less risk as compare to other bank. bank is raising so much money through share and debt. So all bank should having a higher capital adequacy ratio for enjoying great future. but state bank of India want to be maintain their capital adequacy ratio 12% till 2012.

References:

  • www.capitaline.com
  • www.sbi.com
  • www.pnb.com
  • www.icicibank.co.in

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