Question

Using the following information for ABC Bank, calculate the bank’s ratios of Tier 1- capital- to-risk-weighted assets and Total-capital- to-risk-weighted assets under Basel II norms.

(Rupees in million)

Cash	4.5	SLCs backing CPs	17.5
G-Secs	25.6	Long term unused loan commitments to companies	30.5
Deposits with other banks	4.0	Total OBS	48.0
Secured mortgaged loans	50.8	Tier 1 capital	7.5
Loans to pvt companies	105.3	Tier 2 capital	9.5
Total assets	190.2

Ignore market risks & operational risks.

Comment on your ratios from the following regulatory perspectives:

(a)   Indian,

(b)   Global (‘BCBS’)

Answer 1

Base II norms:

Base II is an international business standard that requires financial institutions to maintain enough cash reserves to cover risks incurred by operations. The Basel accords are a series of recommendations on banking laws and regulations issued by the Basel committee on Banking Supervision (BCBS).

The 3 essential requirements of Basel II are:

1. Mandating that capital allocations by institutional managers are more risk sensitive.

2. Separating credit risks from operational risks and quantifying both.

3. Reducing the scope or possibility of regulatory arbitrage by attempting to align the real or economic risk precisely with regulatory assessment.

Tier 1 Capital Explained

Tier 1 capital includes a bank's shareholders' equity and retained earnings. Risk-weighted assets are bank's assets weighted according to their risk exposure. For example, cash carries zerro risk, but there are various risk weightings that apply to particular loans such as mortgages or commercial loans. The risk weighting is a percentage that's applied to the corresponding loans to achieve the total risk- weighted assets.

Currently, the minimum ratio of capital to risk-weighted assests is 8% under Base II.

Capital Adequacy Ratio = Tier 1 Capital + Tier 2 capital / Risk Weighted Assets.

Therefore

Risk-Weighted Assets = Tiier 1 Capital + Tier2 Capital / Capital Adequacy Ratio.

Calculation of the Risk-Weighted Assets.

The risk Weighted average can be calculated as below:

Particualrs	ABC Bank ($)
Tier 1 Capital	7500000
Tier 2 Capital	9500000
Capital Adequacy Ratio	8
Risk-Weighted Asset	2125000

Working notes 7500000+9500000 / 8 = 2125000.

(a) Comments on Indian

In India, the Reserve Bank of India (RBI) implemented Basel I norms from 1992 onwards.In 1996, the Basel Committee suggested that banks maintan capital funds against market risk by following either the standardised approach (IMA) to meet the unforseen losses arising out of marker risks.

(b) Comments on (Globe) BSBS

Basel Committee on Banking Supervison has forulated the Basel Accord that provides recommendations on risks related to banking operations. The aim if theses accord, namely Basel I, Basel II and Basel III is to ensure that banks and financial institutions have the required amout of capital to absorb the unexpected losses.

It looks at foreseeing potential risks and mitigating the risk as much as possible.