2 bank capital
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Session- 2
April 18, 2023Shyam Ji Mehrotra1
Bank Capital
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Why an enterprise need Capital?
April 18, 2023Shyam Ji Mehrotra2
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Whether nature of banking business is different to other businesses ?
April 18, 2023Shyam Ji Mehrotra3
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•What triggers bank’s failure?
April 18, 2023Shyam Ji Mehrotra4
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•Is this true that capital reduces risk of failure ?
April 18, 2023Shyam Ji Mehrotra5
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• Whether capital enhances trust of depositors?
April 18, 2023Shyam Ji Mehrotra6
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•Capital adds to Safety, Soundness and systemic stability of the banks
April 18, 2023Shyam Ji Mehrotra7
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Bank Capital Pay off its creditors in event of crisis
Depositors’ protection Confidence to customers, employees and regulators
Check high financial leverage ( constrain undesirable growth of assets )
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Bank CapitalFinancing the operations of a bankCommence Business Support growth of credit business
Enter new product and new markets
Start subsidiaries April 18, 2023Shyam Ji Mehrotra9
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Concepts Accounting capital
Economic capital
Regulatory capital
April 18, 2023Shyam Ji Mehrotra10
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Accounting capital includes Accounting capital represents book value
of capital in bank’s balance sheet CAPITAL (Tier I )
Paid up capital Minus Equity investment in subsidiaries Intangible assets and accumulated losses
Hybrid instruments ( limited to 15% of tier 1 capital) Closely similar to equity Perpetual by nature and unsecured Claim of investors will be subordinate to other creditors
but superior to equity share holders No put option by investors Call option after 10 years with prior RBI approval Interest will not be paid if CRAR is below prescribed level
and interest shall not be cumulative Retail investors can also invest
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Capital – comprises ofSubordinated debt (Tier II)
Carry fixed maturity (minimum 05 years) Not redeemable at the initiative of the holderSubject to progressive discount RBI approval required for redumption
Reserves and surplus Statutory reserves (Tier I) Share premium account( Tier I)Revaluation reserves (Tier II) Investment Fluctuation Reserve (Tier II)General Provision and loss Reserves ( Tier II)
Balance of P & L accountRetained earnings
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Concept of Economic capitalRisk is inherent in banking business and
bank can not survive by avoiding risks Risk is statistically defined “as adverse
deviation of actual results from expected results”
Likelihood can be modeled by statistical techniques to cover probable assessment of potential future losses
This is known as Economic Capital Will be different for different bank as
per risk profile of their assets
April 18, 2023Shyam Ji Mehrotra13
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Concept of Economic capital
“Economic capital is amount of capital considered necessary to absorb potential losses associated with banking risk such as credit, market and operational”
“Represents confidence level looked by banks’ shareholders “
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Concept of regulatory capital Banking failures resulted in capital
regulations Ever evolving concepts due to run on banks Protection to depositors
CRR and SLR regulationsDeposit insurance Lender of last resort Minimum capital requirements
Basel I (1988), II (1999) and III (2013) for prescribed CRAR
Represents confidence level set by regulators in interest of depositors
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04/18/2316
Capital adequacy-view points1. Capital to total deposits ratio
Recommended by James Raj Committee(1978)
2. Capital to total assets ratio Financial leverage
3. Capital to risk weighted assets ratio Also known as Capital to Risk adjusted
Assets ratio(CRAR) Also known as Basel accord
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Walter Bagehot said
“No capital is required for a well run bank and no amount of capital can save a badly run bank. “
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Session recap- Q & A Why capital is so important for banks?
What constitutes bank capital?Why capital is related to assets of a bank?
How accounting, economic and regulatory capital are different to each other?
April 18, 2023Shyam Ji Mehrotra18
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Would increase regulatory capital requirements lead to more consolidation in banking industry in India?
April 18, 2023Shyam Ji Mehrotra19