Page 196 - DCOM208_BANKING_THEORY_AND_PRACTICE

Unit 12: Capital Adequacy

12.1.1 Capital Adequacy Notes

It is the test of a financial business’s ability to meet its financial obligation. Capital adequacy
rules mean that a bank/financial institution has to have enough money to conduct its business.
The Committee on Banking Regulations and Supervisory Practices (Basel Committee) had
released the guidelines on capital measures and capital standards in July 1988, which were been
accepted by Central Banks in various countries including RBI. In India, it has been implemented
by RBI w.e.f. 1.4.92.

Capital Adequacy Ratio or CAR

It is ratio of capital fund to risk weighted assets expressed in percentage terms.
Objectives of Capital Adequacy Ratio (CAR)

The fundamental objective behind the norms is to strengthen the soundness and stability of the
banking system.
Minimum requirements of capital fund in India:

Existing banks 09%
New private sector banks 10%
Banks undertaking insurance business 10%
Local area banks 15%
Tier I Capital should at no point of time be less than 50% of the total capital. This implies that
Tier II cannot be more than 50% of the total capital.

Capital Fund

Capital Fund has two tiers – I and II
Tier I capital includes:

paid-up capital,
statutory reserves,
other disclosed free reserves, and
capital reserves representing surplus arising out of sale proceeds of assets.

Minus

equity investments in subsidiaries,
intangible assets, and
losses in the current period and those brought forward from previous periods, to work
out the Tier I capital.

Tier II capital consists of:
Undisclosed reserves and cumulative perpetual preference shares,
Revaluation reserves (at a discount of 55 percent while determining their value for inclusion
in Tier II capital),

General Provisions and Loss Reserves up to a maximum of 1.25% of weighted risk assets,
Investment fluctuation reserve not subject to 1.25% restriction,

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