Page 195 - DCOM208_BANKING_THEORY_AND_PRACTICE

Banking Theory and Practice Tanima Dutta, Lovely Professional University

Notes Unit 12: Capital Adequacy

CONTENTS
Objectives
Introduction

12.1 Capital Adequacy in Indian Banks
12.1.1 Capital Adequacy
12.1.2 Approaches to Capital Adequacy
12.2 Basel II Norms (New Capital Adequacy Framework)
12.2.1 Minimum Capital Requirement (Pillar I)
12.3 Summary
12.4 Keywords

12.5 Review Questions
12.6 Further Readings
Objectives

After studying this unit, you will be able to:
Discuss the capital adequacy in Indian banking

Describe several approaches to capital adequacy
Explain Basel II norms

Introduction

In the previous unit, we dealt with the reforms brought about in the banking sector by their
liberalization. The unit also discussed about the Narsimham Committee. This unit will help you
to understand the meaning of capital adequacy and its various approaches. The various section
and sub section of this unit will also summarize the Basel II norms and new capital adequacy
framework. Regulators try to ensure that banks and other financial institutions have sufficient
capital to keep them out of difficulty. This not only protects depositors, but also the wider
economy, because the failure of a big bank has extensive knock-on effects. The risk of knock-on
effects that have repercussions at the level of the entire financial sector is called systemic risk.
Capital adequacy requirements have existed for a long time, but the two most important are
those specified by the Basel committee of the Bank for International Settlements.

12.1 Capital Adequacy in Indian Banks

Economist definition of capital may differ from an accountant’s definition, which in turn, can
differ from the definition used by regulators. Specifically, the economic definition of a bank’s
capital or owner’s equity stake a financial institution (FI) is the difference between the market
values of its assets and its liabilities.

This is also called the net worth of an FI. While this is the economic meaning of capital, regulators
have found it necessary to adopt different definitions of capital that depart by some greater or
lesser degree from economic net worth. The concept of an FI’s economic net worth is really a
market value accounting concept.

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