Capital Adequacy Measures in India
In India, the statutes governing various types of banks lay down the minimum capital requirements for them. Besides, there are also requirements for maintenance of statutory reserves. Considering the variations in minimum capital requirements applicable to different types of banks and taking into account the approach adopted by Basel Committee, the Reserve Bank prescribed, in year 1992, a uniform methodology for determining the capital adequacy of scheduled commercial banks (other than regional rural banks). The Master Circular No. RBI/2015-16/85 DBR.No.BP.BC.4./21.06.001/2015-16 dated July 1, 2015 on “Prudential Guidelines on Capital Adequacy and Market Discipline – New Capital Adequacy Framework (NCAF)” provides the guidelines to be followed by banks for capital adequacy. Some of the important aspects of the circular are covered below.
The basic approach of capital adequacy framework is that a bank should have sufficient capital to provide a stable resource to absorb any losses arising from the risks in its business. Capital is divided into tiers according to the characteristics/qualities of each qualifying instrument. For supervisory purposes capital is split into two categories: Tier I and Tier II, representing different instruments’ quality as capital.
Tier I capital consists mainly of share capital and disclosed reserves and it is a bank’s highest quality capital because it is fully available to cover losses.
Tier II capital consists of certain reserves and certain types of subordinated debt. The loss absorption capacity of Tier II capital is lower than that of Tier I capital.
When returns of the investors of the capital issues are counter guaranteed by the bank, such investments will not be considered as Tier I/II regulatory capital for the purpose of capital adequacy.
The 2015 Master Circular on Prudential Norms on Capital Adequacy and Market Discipline – New Capital Adequacy Framework (NCAF) also covers the concept of ‘Capital Adequacy Requirement for Credit Default Swap (CDS) Positions in the Banking Book’. Readers may refer to the Circular for detailed guidelines in this regard.