ANALYSIS OF CAPITAL TO RISK ASSETS RATIO (CRAR) AND BASEL NORMS

Dr.DeepaliJain

ABSTRACT

This paper revisits

KEYWORDS:CapitalAdequacyRatio,Risk,Basel,Banks.

SECTIONI

1.1

INTRODUCTION:

BaselisaninternationalfinancialinstitutionownedbyCentralBank.Itprovides internationalmonetaryandfinancialcooperationBaselwasestablishedin1930 by an inter-governmental agreement between Germany, Belgium, France, the UK,Italy,Japan,theUSA,andSwitzerland.InFebruary1995,onepersonsingle-handedlybankruptedthebankfoundedin1762;bearingbankwasBritain's oldest merchant bank and Queen Elizabeth's bank. In 1996, BCBS introduced Market risk Basel I. In India, the first Narasimhan Committee Report recommendedtheintroductionofcapitaltotherisk-weightedassetssystemforbanksin April1992.In1999IndiaadoptedtheBaselIguidelinesandBaselII

1.2

OBJECTIVEOFSTUDY:

1. TostudyneedforanddeterminationofCapitalAdequacyRatio(CAR)with an example of 3 banks having a different capital base, deposits, loan/ advances,income,andexpenses.

2. Toanalyzeandcomparetheprovisionsof BaselI,II,andIII.

1.3

RESEARCHMETHODOLOGY:

SecondarydataareusedtostudytheneedforanddeterminationofCapitalAdequacyRatio(CAR)withanexampleof3bankshavingadifferentcapitalbase, deposits,loan/advances,income,andexpenses.

1.4CAPITALFUNDSOFBANKS:

Capitalfundsofbanksaredividedintotwosegments,i.e.,TierIcapitalandTier ii IIcapital. Thecompositionofthesecapitalfundsisasfollows:

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CompositionofTierICapital:

andsuggestionsarepresentedinSectionIII.

loans, and some are very high risk, like education loans and vehicle loans. It dependsontheriskthatdifferentweightageisgivenlowrisk,mediumrisk,and high risk. Banks are required to maintain a minimum CapitalAdequacy Ratio (CRAR)of9percentonanongoingbasis.TheyarerequiredtodisclosethefollowinginformationintheNotestoAccountsinthisregard:

1. TotalCapitalAdequacyRatio

2. CapitalAdequacyRatio-TierICapital.

3. CapitalAdequacyRatio-TierIICapital.

4. AmountofsubordinateddebtraisedasTierIICapital.

Capital adequacy requirements safeguard the banks against the possibility of theirfailureandprotectinvestors.Italsostrengthensmarketdiscipline.

NeedandDeterminationofCapitalAssetRatio(CAR):

BankswerealsoadvisedtoformulateandoperationalizetheCapitalAdequacy AssessmentProcess(CAAP)requiredunderPillarIIofBaselII.Toensureadequate capital with the banks measured by the capital adequacy ratio or capital. Thefocusofthenormwastoensureadequatecapital,whichismeasuredbycapitaladequacyorcapitaltorisk-weightedassetratio.RatioorCARortoensureadequatecapitalwiththebanksistheobjectofthefocusofthesenorms.

The bank's capital is invested money by owners or owner's equity or common equity InIndia,CARshouldbegreaterthanorequalto9%.

ButasperBaselnorms,itis8%,butRBIis9%formoresecurityandsafety

letustakeanexample:

Assume BankAhas Rs 5 crore in tier 1 capital and R 3 crore in tier 2 capital. Banksinvestallthisamountandearnaconsiderableamountofinterest.BankA loanedRs5croretoABCCorporation,whichhas25%riskiness,andRs70crore toXYZCorporation,whichhas55%riskiness.BankAhasrisk-weightedassets ofRs39.75crore(Rs5crore*0.25+Rs70crore*0.55).ItalsohasacapitalofRs. 8 crores (Rs 5 crore + Rs3 crore). Its resulting total capital adequacy ratio is 20.12% (Rs8 crore /Rs 39.75crore* 100), and its Tier 1 ratio is 12.57% (Rs5 crore/Rs39.75crore*100).Similarly,theBankBandBankCcalculateCARand analyze that is necessary to maintain adequate capital to save the amount of depositor

Case1: Bankhavegoodtimes:-

1.5

iv

CAPITALADEQUACYRATIO :

Capital to Risk Assets Ratio (CRAR), popularly called the Capital Adequacy ratio,isdeterminedbydividingTotalCapitalbyTotalRisk-WeightedAssets.In theformulaform:

1CapitalAdequacyRatio=TotalCapital/TotalRisk-WeightedAssets*

2Risk-weightedassetmeansthebookvalueofanassetmultipliedbythepercentageofitsweightallottedbytheRBI.Risk-weightedassetsaretheassetsofbank loans. Loans have specific risks. Some of the loans are low risk, like housing

AssociateProfessor,DrBhimRaoAmbedkarCollege,UniversityofDelhi,Delhi.India.

the implementation of Basel I, II, and III by the RBI in the Indian banks.Theglobal financial crisis in 2007, the Basel Committee on Banking i Supervision (BCBS) proposed specific reforms to strengthen global capital and liquidity regulations to promote a more resilient banking sector India introduced BaselIIInormsinMarch2019.TheBaselIIIreformshavebeenproposedtobeimplementedfrom1January2023andwillbespreadoverfiveyears.Thepaperhas threesections.SectionI emphasizestheneedforanddeterminationofCapitalAdequacyRatio(CAR)withanexampleof3bankshavingadifferentcapitalbase, deposits,loan/advances,income,andexpenses. SectionIIincludesacomparisonofBaselI,II,andIII.Conclusions

TotalExpenses (salary,infrastructure)(B)

Rs.5.50crore Rs.3.70crore Rs3.50crore

NetIncome(A)-(B) Rs.5crore Rs.4crore Rs.1.40crore

Loan:(Category1),which has25%riskiness, 5crore 5crore 5crore Loan:(CategoryII), whichhas55% riskiness,(Morerisky moreinterestincome)

70crore 50crore 40crore

TotalLoanamount 75crore 55crore 45crore

Riskweightedassets (loanamountofcategory I*0.25+loanamountof categoryII*0.55).

CAR (TIERICAPITAL+TIERII

CAPITAL/Riskweighted assets

Rs.39.75crore Rs.28.75 crore Rs.23.25 crore

20.12% 10.4% 12.9%

TierI= (TierI capital / Riskweightedassets 12.57% 8% 8.8%

All three above banks fulfill the BASEL II condition and RBI guidelines in CRAR.

Now,suppose,duetoabadmarketsituationorpandemic,thebankcannotgetthe interestamount-themaximumamountoflossfromtherangeof(0.70to3)crore. Abankisalimitedliabilitycompany Thebank'sliabilityistotheextentoftheir shareholding Liability, but the loss of Rs from (0.70 to 3)crore. This loss is to depositors.Sotoprotectthedepositor'sbankhastomaintainCARorCRAR.

Case2:Bankshavenotgoodtimes:-

Particulars(let)

Tier1capital Rs.5crore Rs.2.3crore Rs.2.05crore

TierIIcapital Rs.3crore Rs.0.7crore Rs.0.70crore

TotalCapital Rs.8crore Rs.3crore Rs.3crore Deposit 100crore 75crore 50crore

SLRandCRR(Let25%) 25crore 20(approx.) 15(approx.)

Amountavailabletoloan 75crore 55crore 35crore

Incomefrom Loan(14%average)(A) Rs.7.50= (10.50-3.00) Rs.7.00= (7.70-0.70) Rs.3.00= (4.90-1.90)

TotalExpenses(salary, infrastructure)(B) Rs.5.50crore Rs.3.70crore Rs.3.50crore

NetIncome/Loss(A)-(B) Rs.5crore Rs.3.30crore (Rs.0.50)crore

Loan:(Category1),which has25%riskiness, 5crore 5crore 5crore Loan:(CategoryII), whichhas55% riskiness,(Morerisky moreinterestincome)

70crore 50crore 40crore

IncaseBankC,afterthelossofinterestincomethebankhaveRs0.85crore

Rs0.85crore = 3.65%

= Rs0.85/3.65%*9% = Rs2.09crore

Therefore,Tomaintain9%CAR,bankCshouldmaintainminimumtotalcapital 2.09croreascorecapital/ownerscapital.

SimilarlyBankBhastomaintaintheminimum/adequatecapital=Rs2.58crore for9%CAR.

SECTIONII

2.1BASEL-III: ThegoalofBaselIIInormsis toremovetheshortcomingsofBaselIandBaselII toensuretransparencyofthecapitalbaseofbanks.BaselIIIintroducedaCapital ConservationBuffer(CCB)andaCountercyclicalCapitalBuffer AsperBasel III,Tier1capitalisdividedintwoparts:CommonEquityTier1(CET1)andAdditionalTier1capital(At1).

Itisrepresentedbytable:

TotalLoanamount 75crore 55crore 45crore

Riskweightedassets (loanamountofcategory I*0.25+loanamountof categoryII*0.55).

Rs.39.75 crore Rs.28.75 crore Rs.23.25crore

TotalCapital(TierI+Tier II),afterlossinincome Rs.(8-3)= 5crore Rs.(3-0.70) =2.30crore Rs.(2.75-1.90) =0.85crore CAR (TIERICAPITAL+TIERI

ThecontrastbetweenTier1andTierII isthatTierI hastwoparts:CETIandAT I.CETIisaCORECAPITALthatincludescommonsharesandretainedearningscapitalandadditionalTierIcapitalthatmayconvertintoequityatthetimeof crisis.Itisalsocalledahybridinstrument.TierIICapitalisthesubordinatecapitalofTierIcapital.Itisanotherlayerofreservecapital.

(i) InIndia,bankswillmaintainaminimumtotalcapital(MTC)of9%of total risk-weighted assets (RWAs), i.e., capital to risk-weighted assets (CRAR).

(ii) Common Equity Tier 1 (CET1) capital must be at least 5.5% of riskweightedassets(RWAs),i.e.,forcreditrisk+marketrisk+operational riskonanongoingbasis.

(iii) Tier1capitalmustbeatleast7%ofRWAs,andAdditionalTier1(AT1) capitalcanbeadmittedfor1.5%ofRWAs.

(iv).TotalCapital(Tier1CapitalplusTier2Capital)mustbeatleast9%of RWAsonanongoingbasis.

BanksmustmaintaintheminimumTier1andTier2capitalratiosat9percent. Furthermore,banksmustmaintainthreetypesofbufferstock:

ICAPITAL/Risk weightedassets

12.57% 8% 3.65% TierI= (TierI capital)*/ Riskweightedassets

3.125/39.75 =7.86% 1.77/28.75 =6.15% 0.64/23.25 =2.75%

*(Lossininterestincomeisproportionallyreducedfromthecapitalintheproportion of Tier I and Tier II) For *Bank A (Tier I capital-(5crore1.875crore=3.125crore),Bank B Tier I capital=(2.30crore-0.53crore=1.77) and BankCTierIcapital=(2.05crore-1.41=0.64)

InthecaseofBankC,Duetodefaultersresultsinalossofdefaulters'incomeor bankisinadifficultsituation.ThereforeCAR ensureadequatecapitalwiththe banksthataretheobjectofthefocusofthesenorms...AsperRBI,9%istheminimumCRAR

Ÿ

Ÿ

Ÿ

v

Firstisacapitalconservationbufferof2.5percent.

Second, the bank should keep the counter-cyclical buffer at 0-2.5 percent.

The third is the Leverage coverage ratio.The leverage rate must be at least3%.Theleveragerateisabank'stier-1capitalratiotoanaverageof totalconsolidatedassets.

Ÿ

Ÿ

Basel-IIIestablishedtwoliquidityratios:LCRandNSFR.

Liquiditycoverageratio(LCR)willrequirebankstomaintainabuffer of high-quality liquid assets sufficient to deal with cash outflows encounteredinanacuteshort-termstressscenarioasspecifiedbyregulators.

Ÿ

Ÿ

Toavoidsituationslike"BankRun."LCRensuresthatbankshaveadequate liquidity to manage any situation if a 30-day stress scenario occurs.

Abankrunoccurswhenmanybanksorotherfinancialinstitutioncustomerswithdrawtheirdepositssimultaneouslyoverconcernsaboutthebank'ssolvency As morepeoplewithdrawtheirfunds,theprobabilityofdefaultincreases,promptingmorepeopletowithdrawtheirdeposits:

Ÿ

NetStableFundsRate(NSFR):Banksmaintainaconsistentfundingprofileregardingtheiroff-balance-sheetassetsandactivities.

Ÿ

Ÿ

The NSFR requires banks to fund their operations with stable funding sources(reliableovertheone-yearhorizon).

Ÿ TheNSFRmustbeatleast100percent.

As a result, LCR assesses short-term (30-day) resilience while NSFR assessesmedium-term(1-year)resilience.

2.2IMPLEMENTATIONOFBASELIIIININDIA:

IndiaintroducedBaselIII normsinMarch2019. Duetothepandemicperiod, theRBIdecidedtoimplementBaselIIIstandardsonJanuary2023.

ConsequencesofBaselIII:

Extending the period under Basel III results in a lower capital burden on banksregardingprovisioningrequirements,includingNPAs.

Ÿ Thecostofincreasingcapitalratiosmaycausebankstoraiselendingrates, resultinginadecreaseinlending.

It will significantly impact the economy because it will lower investment, exports,andconsumption.

ThecomparisonoftheBaselI,IIandIIIarecompiledintableasbelow: TableIV

Particulars

MinimumCRAR asperBCBS CRAR=8% CRAR=8% TIERI=4%

CRAR=10.5% Tier1=6%

MinimumCRAR asperRBI CRAR=9% CRAR=9% TIERI=6% CRAR=11.5% Tier1=6%

AssetsRisk Classification 4categories: 0%, 20%,50%, 100% 4categories:0%, 20%,50%,100% 4categories: 0%, 20%,50%, 100%

Capital conservation BufferstoRWAs

None None 2.50%

LeverageRatio None None 3.00%

Countercyclical Buffer None None 0%to2.50%of commonequity orotherfullyloss absorbingcapital

2.3CAPITALCONSERVATIONBUFFER[CCB]

CCBisintroducedundertheInternationalBaselIIInorms.Duringboomtimes, banksmustbuildacapitalbufferthatcanbewithdrawnwhenthereistightness. .CCBensuresthatbanksbuildupacapitalbufferoutsideperiodsoffinancialtensionthatcanbewithdrawnwhenbanksfacefinancial(systemicoridiosyncratic) problems. For this bank must have a definite plan to replenish the buffer and facecapitaldistributionconstraints.

BaselIIIprescribesthetworatiosviz.

(1) LiquidityCoverageRatio(LCR)and

(2) NetStableFundingRatio(NSFR)

Itachievestwoseparatebutcomplementaryobjectives.

2.4

CapitalMeasure

LeverageRatio= ExposureMeas

InIndia,RBIdirectedbankstoaverageLR3%-3.5%.InIndia,banksmusthold liquid assets to maintain the Statutory Liquidity Ratio (SLR). Because liquid assetsunderSLRandLCRareprimarilythesame

8

2.5NETSTABLEFUNDINGRATIO(NSFR):

OverlongtermperiodNSFRshallprovideelasticityforbanks.Bankswillhave to find more long term , reliable and permanent funds on regular basis. The NSFR is also called "Available Stable Funding" [ASF]. Banks must diversify their funding sources and reduce their dependency on short-term assets. The amountofAvailableStableFunding[ASF]includesvariousassetsheldbythat institutionandthoseofitsoff-balancesheet(OBS)exposures.

NSFR=

(AvailableStableFunding)[ASF] ≥ 100%

RequiredStableFunding[RSF]

COUNTERCYCLICALCAPITALBUFFER(CCCB) [0%TO2.5%]

viii

CountercyclicalCapitalBuffer shallberequiredasabufferofcapitalthatbanks shouldkeepoverandabovetheminimumcapitalrequirementswhichwillhelpto reducethecyclicalrisk.

Countercyclical Capital Buffer (CCCB) fulfils two objectives. Firstly, banks make the buffer capital in the boom period, which may maintain the flow of creditunderchallengingtimes.Secondly,itachievesthebroadergoalofcontainingtherecklessorhighrisklending bythebanksseekingambitiousgrowth.

TheCCCBmaymaintainintheformofCommonEquityTier1(CET1)capital or other fully loss-absorbing capital only The portion of the CCCB may vary from0to2.5%ofthebanks'totalrisk-weightedassets(RWA).AspertheRBI, (attableDF-11ofAnnex18as banksmustholdCCCBataboomtimeandmaydisclosethesame. indicatedinBaselIIIMasterCircula

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LEVERAGERATIO :

TheLCRpromotestheshort-termliquiditystrengthofbanks.Theleverageratio isexpressedinpercentages.

3.1CONCLUSION:

SECTIONIII

Thestudyindicatesthatthecoefficientofcapitaladequacyispositiveandhighly significant,withboththemeasuresofprofitabilityreflectingthesoundfinancial conditionofIndianbanks.ThedifferencesbetweenBasel1,2,and3accordsdue totheirestablishedobjectives.However,all3arefocussingonmanagingriskin light of the changing international business environments.TheRBI has implemented these guidelines to bring bank regulation and compliance processes in line with those of other global banks, ensuring that Indian banks are in a solid positiontoabsorbanyfinancialrisk.

3.2SUGGESTIONS:

However, financial liberalization and fiscal control will not ensure stable economicgrowthandfinancialstability.Concretestepsstillneedtobetaken.Due considerationhasbeengiventodiversificationofownershipofbankinginstitutionsforgreatermarketaccountabilityandimprovedefficiency

Thepublicsectorbanksexpandedtheircapitalbasebyaccessingthecapitalmarket, diluting government ownership.The RBI has issued guidelines on ownershipandgovernanceinprivatesectorbanksandemphasizeddiversifiedownership.

Despiteallthis,theRBIhastogostillfarfordisclosurepractices.Banksshould highlight "Change in Accounting Policy" and its impact on profit, and they shouldalsodisclosewhatpromptedthemtochangeanexistingaccountingpolicyunderadistinctheading.Auditorsarealsorequiredtoplayamoresignificant influential role in disclosure rather than remaining confined to the accounting aspect only Investors place greater reliance on the role of auditors. Therefore, theymustverifyandcommentonthecompliancestatuswithallregulatorymeasures.

Since the exact regulatory mechanism and standards govern banks, all banks must implement disclosure requirements uniformly Banks' risk management needstolookatamuchmorecomprehensiverangeofriskssuchasinterestrate

risk,foreignexchangerisk,liquidityrisk,businesscyclerisk,strategicrisk,etc. The risk management function helps identify, evaluate, monitor, manage, control,andmitigaterisks.Toimprovetheoverallefficiencyandmaintaingoodprofitability, enhance the bank's Human Resource(HR) practices and rotate Public SectorBanks(PSB)staff.UseArtificialIntelligence(AI)tosupervisefinancial transactionstopreventfinancialfraud.Ontheotherhand,apositive,significant leverageratioanddiversifiedportfolioarenecessarytomaintainfuturestability andreduceriskanduncertainty

REFERENCES:

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II. Pillar 3 requirements as introduced vide circular DBOD.No.BP.BC.98/21.06.201/ 2012-13 dated May 28, 2013 on Guidelines on Composition of Capital Disclosure Requirements.TheseguidelineswouldbecomeeffectivefromJuly1,2013.Therefore, thefirstsetofdisclosuresasrequiredbytheseguidelineswillbemadebybanksason September 30, 2013. The new disclosure requirements are in addition to the Pillar 3 guidancecontainedinNCAF

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IV Master Circular– disclosure in FinancialStatements– Notes toAccounts RBI/200607/32DBOD.BP.BCNo.3/21.04.018/(2016-17

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NOTES:

I. BaselIII:Aglobalregulatoryframeworkformoreresilientbanksandbankingsystems,BankforInternationalSettlement,ISBNprint:92-9131-859-0ISBNweb:929197-859-0,2010.

II. circulars DBOD No BPBC 90/20 06 001/2006-07 dated April 27, 2007 and DBOD.No.BP.BC.66/21.06.001/2007-08datedMarch26,2008

III. refertotheMasterCircularNo.DBOD.BP.BC.15/21.01.002/2012-2013datedJuly 2,2012

IV ScopeofApplicationofCapitalAdequacyFramework.,circularsDBOD.No.BP.BC. 72/21 04 018/2001-02 dated February 25, 2003 and DBOD No FSD BC 46/ 24.01.028/2006-07datedDecember12,2007

V https://rbidocs.rbi.org.in/rdocs/content/pdfs/FBSEIII020512_I.pdf

VI. RefertocircularDOR.BP.BC.No.15/21.06.201/2020-21datedSeptember29,2020

VII. ‘BaselIIIleverageratioframeworkanddisclosurerequirements’issuedbytheBasel CommitteeonBankingSupervisioninJanuary2014

VIII. Guidelines for implementation of Countercyclical Capital Buffer (CCCB), DBR.No.BP.BC.71/21.06.201/2014-15datedFebruary5,2015.

FOOTNOTES:

2. GuidanceNotesonManagementofCreditRiskandMarketRiskissuedvidecircular DBOD.No.BP.520/21.04.103/2002-03datedOctober12,2002

3. Scope of Application of Capital Adequacy Framework. , circulars DBOD.No.BP BC 72/21 04 018/2001-02 dated February 25, 2003 and DBOD No FSD BC 46/24.01.028/2006-07datedDecember12,2007

4. www.online.citibank.co.in

6. SectionVofBaselIII:Aglobalregulatoryframeworkformoreresilientbanksand bankingsystems,December2010(revJune2011)

7. Refer to circular

DOR.BP.BC.No.45/21.06.201/2019-20 dated March 27, 2020 on ‘BaselIIICapitalRegulations-Reviewoftransitionalarrangements’.

8. circular DBR.BP.BC.No.106/21.04.098/2017-18 dated May 17, 2018 on Basel III FrameworkonLiquidityStandards-NetStableFundingRatio(NSFR)-FinalGuidelines (‘NSFR Guidelines’) and circular DOR.BP.BC.No.16/21.04.098/2020-21 datedSeptember29,2020