Bank Capital

Session- 2

Shyam Ji Mehrotra

August 26, 2015

Why an enterprise need

Capital?
2

Shyam Ji Mehrotra

August 26, 2015

Whether nature of banking

business is different to other
businesses
?

Shyam Ji Mehrotra

August 26, 2015

What triggers banks

failure?

Shyam Ji Mehrotra

August 26, 2015

Is this true that capital

reduces risk of failure ?

Shyam Ji Mehrotra

August 26, 2015

 Whether capital enhances

trust of depositors?

Shyam Ji Mehrotra

August 26, 2015

Capital adds to Safety,

Soundness and systemic
stability of the banks

Shyam Ji Mehrotra

August 26, 2015

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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08/26/15

Bank Capital
Financing the operations

of a bank

Commence Business
Support
growth of

credit

business
Enter new product and new
markets
Start subsidiaries
9

Shyam Ji Mehrotra

August 26, 2015

Concepts
Accounting capital
Economic capital
Regulatory capital
10

Shyam Ji Mehrotra

August 26, 2015

Accounting capital includes

Accounting capital represents book value of

capital in banks 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

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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

08/26/15

Capital comprises of
Subordinated debt (Tier II)
Carry fixed maturity (minimum 05 years)
Not redeemable at the initiative of the holder
Subject 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 account

Retained earnings
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08/26/15

Concept of Economic
capital

Risk 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
13

Shyam Ji Mehrotra

August 26, 2015

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
14

08/26/15

Concept of regulatory capital

Banking

failures
resulted in capital
regulations
Ever evolving concepts due to run on banks
Protection to depositors
CRR and SLR regulations
Deposit 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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08/26/15

Capital adequacy-view points

1. 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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08/26/15

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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08/26/15

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?
18

Shyam Ji Mehrotra

August 26, 2015

Would increase regulatory

capital requirements lead to
more consolidation in
banking industry in India?

19

Shyam Ji Mehrotra

August 26, 2015