CAPITAL ADEQUACY

 Definition:
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.
 Objective:

To strengthen the soundness and

stability of the banking system.
CAPITAL ADEQUACY RATIO (CAR)
CAR: It is ratio of capital fund to risk weighted assets expressed in
percentage terms.
Tier-I Capital + Tier-II Capital
=
Risk Weighted Asset
Tier-I Capital - Capital which is first readily available to protect the
unexpected losses. It consist of
 Paid-up capital
 Statutory reserves, other disclosed free reserves, capital reserves
Tier-II Capital- Capital which is second readily available to predict the
unexpected losses. It consist of
 Paid-up perpetual preference shares
 Revaluation results
 Hybrid capital
 Subordinated profit
 General provision & loss reserves
Risk weighted assets- The value of each asset is assigned with a risk
factor in percentage terms.
 BASEL

The Basel Accords were developed

over a number of years, starting in
the 1980s. The BCBS (Basel
Committee on Banking Supervision)
was founded in 1974 as a forum for
regular cooperation between its
member countries on bank
BASEL COMMITTEE MEMBERS
 Currently committee members are Argentina,
Australia, Belgium, Brazil, Canada, China,
France, Germany, Hong Kong, India, Indonesia,
Italy Japan, Korea, Luxembourg, Mexico,
Netherlands, Russia, Saudi Arabia, Singapore,
South Africa, Spain, Sweden, Switzerland,
Turkey, United Kingdom, United States. The
Committee's Secretariat is located at the Bank
for International Settlements(BIS) in Basel,
Switzerland.
BASEL I
 In 1988,The Basel Committee on Banking
Supervision (BCBS) introduced capital
measurement system called Basel capital accord,
also called as Basel 1. . It focused almost entirely
on credit risk, It defined capital and structure of
risk weights for banks.
 The minimum capital requirement was fixed at
8% of risk weighted assets (RWA).
 India adopted Basel 1 guidelines in 1999.
 BASEL II
 In 2004, Basel II guidelines were published by BCBS, which were
considered to be the refined and reformed versions of Basel I accord.
 The guidelines were based on three parameters which are as
follows-
 Banks should maintain a minimum capital adequacy requirement of
8% of risk assets.
 Banks were needed to develop and use better risk management
techniques in monitoring and managing all the three types of risks
that is credit and increased disclosure requirements.
 The three types of risk are- operational risk, market risk, capital
risk.
 Banks need to mandatory disclose their risk exposure, etc to the
central bank.
 Basel II norms in India and overseas are yet to be fully
implemented.
 BASEL III

 Basel III or Basel 3 released in December,

2010 is the third in the series of Basel
Accords. These accords deal with risk
management aspects for the banking sector. In
a nut shell we can say that Basel III is the global
regulatory standard (agreed upon by the
members of the Basel Committee on Banking
Supervision) on bank capital adequacy, stress
testing and market liquidity risk.
BASEL II & BASEL III
INTERNATIONAL STANDARDS OF CAPITAL ADEQUACY
 The main international effort to establish rules around capital
requirements has been the Basel Accords, published by the Basel
Committee on Banking Supervision housed at the Bank for
International Settlements.
 BASEL-I: In 1988, the BASEL committee on banking
supervision in Switzerland published a set of minimum capital
requirements for banks. These were known as BASEL-I. It
focused almost on credit risk. It defined capital requirements &
structure of risk weights for banks.

 BASEL-II: It was introduced in 2004, laid down guidelines for

capital adequacy, risk management and disclosure requirements.

 BASEL-III: It is widely felt that the shortcoming in BASEL-II
norms, is what laid to global financial crisis of 2008 i.e., because
BASEL-II did not have explicit regulation on the debt that banks
could take on their books & focused more on individual financial
institutions while ignoring systematic risks.
APPROACHES TO CAPITAL ADEQUACY
Approaches to Capital Adequacy
Ratio approach Risk-based Capital Portfolio
• In this method ratio
Asset approach approach
standards are • Under this • It is based on the
generally expressed proposal, off- recognition of the
in terms of Ratio- balance sheet complex set of
Total Assets. Ratio claims such as intersections
standards may be credit guarantees involved in a
developed for equity, financial
primary total
would also be institution.
capital. given a weight
and added to
actual assets.
SOURCES OF BANK FUNDS
Sources of funds

Deposit products
• Savings
• Current account
• Demand deposits
• Certificate of deposit
• Term/ time deposit

Non- deposit sources

• Service tax
• Cash handling charges
• Penalties
• Interest
• Money market
DESIGNING OF DEPOSIT SCHEMES
Identification of all competitive products which
offers more or less the same benefits.

Approximate determination of new product/

service’s place that it would occupy in price
hierarchy.

Estimation of the sales volume hat can be

obtained at the chosen price level and
calculation of afferent costs.

Combination of interdependent variables such

as price, volume, sales and expenses.

Based on the feasibility of proposition the

product is launched in the test market / general
scale.
PRICING OF DEPOSIT SOURCES
Strategies of pricing

Cost plus
profit

Taking the
cream

Competitive
pricing

On the
market
pricing

On the value
pricing

Penetration
pricing
APPLICATION OF BANK FUNDS

Investment
functions
Application
of funds
Lending
functions
 INVESTMENT FUNCTIONS

Money market Capital market Debt market

instruments instruments instruments
• Treasury bills • Book building • Bonds
• Commercial papers • Venture capital • Straight/ fixed
• Certificate of deposits • Debentures rate bonds
• Inter-bank • Global Depository • Callable bonds
participation Reserves (GDR) • Convertible
certificate • American Depository bonds
• Money market Reserves (GDR) • Sinking fund
bonds
• Currency option
funds
• Securitization
• Syndication
 LENDING FUNCTIONS

Lending
functions

Classification of
loans based on
Types of lending Types of loans
their activity
and purpose
TYPES OF LENDING

Fund Non- fund

Asset based
based based
• Secured • Overdraft • Letter of
loans • Term loans credit
• Demand • Guarantees
drafts • Co-
• Cash credit acceptance
advances of bills
• Bill finance
• Packing
credit
TYPES OF LOANS

Term loans

Cash credit

Overdraft facilities

Discounting of bills of exchange

 CLASSIFICATION OF LOANS

Based on activity Based on purpose

•Priority sector •Personal loans

loans •Car/auto loans
•Commercial loans •Loan against
•Corporate loans shares
•Retail loans •Home loans
•Loans for •Education /
automobiles Student loans
•Loans for durable
items
MAJOR COMPONENTS OF LOAN POLICY DOCUMENT
List of documents most lenders will require in order to process the
mortgage application.
Information about the Purchase
o Copy of ratified purchase contract.
o Copy of cancelled deposit check on asset.
Verification of income
o Earning statements
o Profit and loss statements of 2 yrs.
o Additional income if any
Verification of assets
o List of bank account numbers
o List of saving bonds
o Copies of titles to motor vehicles
Verification of Debts
o Credit card bills
o Consumer debts
o Evidence of motgage/ rental payments
o Copies of alimony / child support
 CREDIT ANALYSIS
Credit analysis is a technique of analyzing the credit worthiness of
a borrower. It checks whether the borrower is able to meet its
financial obligations or not. Credit analysis involves various
financial techniques such as :
 Ratio analysis

 Trend analysis

 Analysis of financial statements

 Analysis of cash flow statement

5C’s that are involved in credit analysis are:

 Capital
 Capacity
 Collateral
 Character
 Conditions
 CREDIT DELIVERY AND ADMINISTRATION
The key elements needed for effective Credit delivery and administration:
 Nominated senior management individuals to support, own the
credit management process and lead on credit management.
 Credit management policies and the benefits, clearly communicated
to staffs.
 Existence and adoption of a framework for management of credit
i.e., transparent and repeatable.
 Existence of an organizational structure that supports well
thought- through risk taking and innovation.
 Management of credit fully embedded in management processes
and consistently applied.
 Management of credit closely linked to achievement of objectives.
 Risks associated in working with other organizations explicitly
assessed and managed.
 Risks actively monitored and regularly reviewed on a constructive
‘no-blame’ basis.
 Risk actively monitored and regularly reviewed on a constructive
basis.
CREDIT APPRAISAL TECHNIQUES AND
VIABILITY STUDIES

Parameters to determine the eligibility

of a customer

Technical Economic Bankability

feasibility viability parameters
• Living standards • Installment to • Bank statements
• Locality Income ratio • Business continuity
• Telephonic • Fixed obligation to proof
verification income ratio • Credit interview
• Educational • Loan to cost ratio • Profile of customer
qualification • Security
• Political influence • Ownership title
• References • CIBIL report
PRICING OF LOANS

 Commercial loans

 Consumer loans

 Rates below the Prime Lending rates

 Determination of Benchmark Prime Lending rate

 Interest rate on Non- resident deposits

CONSUMER PROFITABILITY ANALYSIS
Customer profitability analysis is an important tool
in understanding which customer relationships are
better than others, it is useful for the firms in the
following ways:
 Identifying the most profitable customers as well as
least profitable customers.
 Planning and implementing strategies in retaining most
profitable customers.
 Identifying the factors that could have negative impact
of the company.
 Helps firm in expanding and diversifying the customer
base if it is not so wide and profitable.