Page 197 - DCOM208_BANKING_THEORY_AND_PRACTICE

Banking Theory and Practice

Notes Hybrid debt capital Instruments (say bonds),
Subordinated debt (long-term unsecured loans).
Risk weighted assets (Fund based): Risk weighted assets mean fund-based assets, such as cash,
loans, investments and other assets. Degrees of credit risk expressed as percentage weights have
been assigned by the RBI to each such assets.
Non-funded (off-balance sheet) items: The credit risk exposure attached to off-balance sheet
items has to be first calculated by multiplying the face amount of each of the off-balance sheet
items by the credit conversion factor. This will then have to be again multiplied by the relevant
weightage.
Reporting requirements: Banks are also required to disclose in their balance sheet the quantum
of Tier I and Tier II capital fund, under disclosure norms.
An annual return has to be submitted by each bank indicating capital funds, conversion of off-
balance sheet/non-funded exposures, calculation of risk-weighted assets, and calculations of
capital to risk assets ratio.
The adequacy of firm’s capital depends on many variables.

Example: It would be considered appropriate for a financial firm to have more capital,
everything else held constant, in the following circumstances:

The institution has a high percentage of risky assets.
The institution has a large unmatched interest rate risk position.
The institution employs a high percentage of wholesale funding sources.

The institution lacks diversification of assets by having a high concentration of
assets in a few markets.
The net worth to total assets ratio tells us about the firm’s overall financial leverage relating to
those assets held on the balance sheet. The higher the ratio, the lower the financial risk of the
company.

12.1.2 Approaches to Capital Adequacy

The different approaches to capital adequacy in modern times:

Figure 12.1: Approaches to Capital Adequacy

Approaches to Capital Adequacy

Risk-based Capital
Asset Approaches
Ratio Approaches to
Capital Adequacy

Portfolio Approaches to
Capital Adequacy

Source: C. Gulati Neelam (2010),”Principles of Banking Management”, Excel Books.

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