CAIIB-ABM-MOD-D-Capital Adequacy - The Basel-II Overview

Capital Adequacy - The Basel-II Overview

• The Basel Committee provided the framework for capital adequacy in 1988, which is known as the Basel-I accord.The Basel-I accord provided global standards for minimum capital requirements for banks.

• The Revised Framework consists of three-mutually reinforcing pillars, viz., minimum capital requirements, supervisory review of capital adequacy, and market discipline.

• The Framework offers three distinct options for computing capital requirement for credit risk and three other options for computing capital requirement for operational risk.

• The options available for computing capital for credit risk are Standardised Approach, Foundation Internal Rating Based Approach and Advanced Internal Rating Based Approach.

• The options available for computing Market risk is standardized approach (based on maturity ladder and duration baSed) and advanced approach, i.e., internal models such as VAR

• The options available for computing capital for operational risk are Basic Indicator Approach, Standardised Approach and Advanced Measurement Approach.
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• The revised capital adequacy norms shall be applicable uniformly to all Commercial Banks (except Local Area Banks and Regional Rural Banks).

• A Consolidated bank is defined as a group of entities where a licensed bank is the controlling entity.

• All commercial banks in Indiashall adopt Standardised Approach (SA) for credit risk and Basic Indicator Approach (BIA) for operational risk.

• Banks shall continue to apply the Standardised Duration Approach (SDA) for computing capital requirement for market risks.

• The term capital would include Tier-I or core capital, Tier-II or supplemental capital, and Tier-Ill capital

• Core capital consists of paid up capital, free reserves and unallocated surpluses, less specified deductions.

• Supplementary capital comprises subordinated debt of more than five years' maturity, loan loss reserves, revaluation reserves, investment fluctuation reserves, and limited life preference shares.

• Tier-II capital is restricted to 100% of Tier-I capital as before and long-term subordinated debt may not exceed 50% of Tier-I capital.

• Tier-Ill capital will be limited to 250% of a bank's Tier-1 capital that is required to support market risk. This means that a minimum of about 28.5% of market risk needs to be supported by Tier-I capital. Any capital requirement arising in respect of credit and counter-party risk needs to be met by Tier-I and Tier-II capital.

• Capital adequacy ratio(C)  = Regulatory capital(R)/Total risk weighted assets(T).

• Regulatory Capital ‘R’=C*T  and Total Risk weighted Assets ‘T’= R/C
  
  
• Total Risk weighted assets =(Risk weighted assets for credit risk) +(12.5*Capital requirement for market risk)+(12.5*Capital requirement for operational risk)

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