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If a bank creates assets -loans or investment, they are required to be backed up by bank Capital. The amount of backed up capital they have depends on the risk of the individual assets that the bank acquires. The riskier the asset, the larger would be the capital required. This is there because bank capital provides a cushion against unexpected losses. Riskier assets would require larger amounts of capital to act as cushion.
Capital Adequacy Reporting module is based on the generic Basel II module and enables banks to comply with the standards specified in the Basel II accord. The Basel Committee for Bank Supervision (BCBS) has prescribed a set of norms for the capital requirement for the banks for all countries to follow. These norms ensure that capital should be adequate to absorb unexpected losses. In addition, all countries, including India, establish their own guidelines for risk based capital framework known as Capital Adequacy Norms.
A key norm of the Basel committee is the Capital Adequacy Ratio (CAR), also known as Capital Risk Weighted Assets Ratio. It is a simple measure of the soundness of a bank. The ratio is the capital with a bank as a percentage of its risk-weighted assets. Given the level of capital available with an individual bank, this ratio determines the maximum extent to which the bank can lend.
The Basel committee specifies a CAR of at least 8% for banks. This means that the capital funds of a bank must be at least 8 percent of the bank’s risk weighted assets. In India, the RBI has specified a minimum of 9%, which is more stringent than the international norm. All scheduled commercial banks (SCBs) in India stood at 13.2% in March 2009. The RBI also provides guidelines about how much risk weights banks should assign to different classes of assets (such as loans).
Each individual bank has to maintain a minimum level of capital, which commensurate with the risk profile of the bank’s assets. This regulatory requirement plays a critical role in the safety and soundness of individual banks and the banking system.
Credit Exposure Limits
As a measure aimed at better risk management, the Reserve Bank has fixed limits on bank exposure to the capital market as well as to individual and group borrowers with reference to a bank’s capital.
Limits on inter-bank exposures have also been placed. Banks are encouraged to place internal caps on their sectoral exposures, their exposure to commercial real estate, and to unsecured exposures. These exposures are closely monitored by the Reserve Bank. Norms on banks’ exposures to Non-Banking Financial Companies (NBFCs) and to related entities are also in place. Reports must be submitted that include large exposures (credit risk, market risk, interest rate risk, and concentration risk), exposures to capital market, unsecured guarantees and unsecured advances, and structural liquidity position (consolidated bank and subsidiaries).
RBI issued guidelines on October 21, 1999 for risk management in banks which broadly cover credit, market and operational risks. Older guidelines were issued in 1999 on asset-liability management system which covered management of liquidity and interest rate risks. Together they are purported to serve as benchmark to banks.
