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Module: 4 Computation of Capital Adequacy Ratio as per Guidelines of RBI

Computation of Capital Adequacy Ratio (CAR) of Banks in India

For computation of CAR, we need to calculate

  • Tier I capital

  • Tier II capital

  • Risk Weighted Assets (RWA)

Step 1: Compute Tier I capital:

Tier I capital is the most permanent and readily available support against unexpected losses. It consists of-

  1. Paid up equity capital

  2. Statutory reserves

  3. Capital reserves

  4. Other disclosed free reserves

Less:

  1. Equity investments in subsidiaries

  2. Intangible assets

  3. Current and Accumulated Losses, if any

Step 2: Calculation of Risk Weighted Assets (RWA)

RWA are calculated by multiplying the relevant weights to the value of assets and off-balance sheet items.

The weights assigned to each of the items are as follows:

Domestic Operations

Funded Risk Assets Percentage weights
1. Cash, balances with RBI, balances with other banks, money at call and short notice and investments in Govt. and other trustees securities 0
2. Claims on commercial banks such as certificates of deposits etc. 20
3. Other Investments 100
4. Loans and advances including bills purchased and discounted and other credit facilities
A. Loans guaranteed by GOI 2.5
B. Loans guaranteed by State Govt. 2.5
C. Loans guaranteed by PSUs of GOI. 100
D. Loans guaranteed by PSUs of State Govt.. 100
E. Others 100
5. Premises, furniture & fixtures. 100
6.Other Assets 100

Off Balance Sheet Items

Off balance sheet items are first multiplied by the corresponding credit conversion factors. Then it is multiplied by the risk weights attributable to the item.

Items Credit conversion factors
1. Direct Credit Substitutes 100
2. Certain transaction related to contingent items 50
3. Short term self liquidating trade related contingencies 20
4. Sale and repurchase agreement and asset sales with recourse, where the credit risk remains with the bank 100
5. Forward and asset purchases, forward deposits and partly paid shares and securities 100
6. Note issuance facilities and underwriting facilities 50
7. Other commitments with an original maturity of over 1 year 50
8. Similar commitments with an original maturity of over 1 year, or which can be cancelled at any time. 0
9. Aggregate outstanding foreign exchange contracts of original maturity
Of less than 1 year 2
For each additional year or part thereof 3

Note:

In the Mid-term Statement on Monetary and Credit Policy for 1998-99, a risk weight of 2.5 per cent was introduced for the risk arising out of market price variations for investments in Government and other approved securities, with effect from the year ending March 31, 2000. In view of the growing share of investments in the assets of banks, the risk weight of 2.5 per cent is being extended to cover all investments including securities outside the SLR. This, however, will take effect from the year ending March 31, 2001.

Step 3: Compute Tier II Capital

These are not permanent in nature or, are not readily available.

Tier II capital consists of-

  1. Undisclosed reserves and cumulative perpetual preference shares- Cumulative preference shares should be fully paid and should not contain clauses which permit redemption from shareholders.

  2. Revaluation Reserves (RR)- 45% of RR is only taken in calculation of tier II capital

  3. General Provisions and Loss Reserves (GPLR)- Actual GPLR or 1.25% of Risk Weighted Assets, whichever is lower, is taken.

  4. Hybrid Debt Capital Instruments- These combine characteristics of both equity and debt. As they are more or less similar to equity, they are included in the Tier II

  5. Subordinated Debts- These must be fully paid up, unsecured, subordinated to the claims of other creditors, also there should be no such clause, which permits redemption. The amount of subordinate debts to be taken as Tier II capital depends upon the maturity of debt. Subordinate Debt Instruments will be limited to 50% of Tier I capital.

Remaining term to maturity Discount
Rate (%)		 Amount to be
taken in %
1.Where the date of maturity is above 5 years 0 100
2.Where the date of maturity is above 4 years but doesn't exceed 5 years 20 80
3.Where the date of maturity is above 3 years but doesn't exceed 4 years 60 40
4.Where the date of maturity is above 2 years but doesn't exceed 3 years 80 20
5.Where the date of maturity is above 1 year but doesn't exceed 2 years 80 20
6.Where the date of maturity does not exceed 1 year 100 10

Note: Tier II capital cannot be more than Tier I capital.

Capital Adequacy Ratio:

Capital Adequacy Ratio = (Tier I capital + Tier II capital) / RWA

According to the present norm, the Capital Adequacy Ratio of bank as defined earlier should be at least 9%. - Worked example in next article


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