Question

DISCUSS THE CAPITAL ADEQUACY OF BANKS AND EXAMINE HOW CAPITAL ADEQUACY FORM LINKS AMONG REGULATORY BODIES;DEPOSITORS, BORROWERS AND PUBLIC.

Answer 1

CAPITAL ADEQUACY OF BANKS

Capital adequacy measures the financial soundness of a bank. Capital adequacy ratio measures the bank's available capital as a percentage of its risk weighted assets. It determines the capital adequate to absorb the losses.

Capital adequacy measures Tier 1 & Tier 2 capital.

Tier 1 Capital : It is the equity capital that can absorb losses

Tier 2 Capital : It is the subordinated debt which absorb losses

Link of CAPITAL ADEQUACY with REGULATORY BODIES, DEPOSITORS, BORROWERS AND PUBLIC

Capital Adequacy Ratio (CAR) is used to protect the depositors. It also promotes stability in the banking system. Minimum CAR is essential to absorb the losses before the bank become insolvent. Otherwise the fund of depositors will be lost. It is important to retain the confidence of depositors in the bank. Higher the CAR, higher will be the protection to depositors

The regulatory bodies in the financial system function for stable monetary and banking system. These regulatory bodies instructs the banks to ensure minimum CAR to comply with regulatory requirements. Thus banks as well as other financial institutions have to maintain a minimum amount of capital with them.

The amount of money available to lend to the general public is based on the CAR. By keeping minimum CAR, the balance amount only will be available for the banks to provide loans to general public.

Capital Adequacy Ratio is critical for borrowers also. Borrowers will be concerned about the financial stability of the banks. Higher CAR in a bank decreases the amount of money available for lending. When there are less amount to lend, it will decrease the no of borrowers.