CAIIB – Super-Notes © M S Ahluwalia Sirf Business

Banking Regulation and Capital

Module D: Balance Sheet Management

CAIIB – Super-Notes © M S Ahluwalia Sirf Business

CAIIB – SUPER NOTES

Bank Financial Management: Banking Regulation and Capital

CAIIB – Super-Notes © M S Ahluwalia Sirf Business

Contents

Coverage:

1. Capital and its Components

2. Deduction from Tier I and

Tier II Capital

3. Systemic Risk and Banking

Regulation

CAIIB – Super-Notes © M S Ahluwalia Sirf Business

CAPITAL AND ITS COMPONENTS

1.

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Capital

• Adequate Capital to demonstrate that owners have good

stakes in the business

• Should be sufficient to cover the difference between expected

losses and worst case losses and provide adequate return to

the shareholders

• Cushion to protect a bank from an extremely unfavorable

outcome

CAIIB – Super-Notes © M S Ahluwalia Sirf Business

Types of Capital

Tier I Tier I

•Consists of Share Capital and Disclosed Reserves

•Fully available to cover losses

•Elements:

•Paid Up Capital, statutory reserves and other disclosed free reserves

•Perpetual Non Cumulative Preference Shares(PNCPS)

• Innovative Perpetual Debt Instruments (IPDI)

•Capital Reserves representing surplus arising out of sale proceeds of assets

Tier II Tier II

•Certain reserves and certain types of Subordinated Debt

•Loss Absorption capacity is lower

•Elements:

•Undisclosed Reserves

•Revaluation Reserves (Discount of 55%)

•General Provision and Loss Reserves (Max. 1.25% of RWAs)

•Hybrid Debt Capital Instruments:

•Perpetual Cumulative Preference Shares(PCPS)

•Redeemable Non Cumulative Preference Shares(RNCPS)

•Redeemable Cumulative Preference Shares(RCPS)

•Subordinated Debt (Only 50% of Tier I Capital)

CAIIB – Super-Notes © M S Ahluwalia Sirf Business

DEDUCTION FROM TIER I AND TIER II CAPITAL

2.

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Deductions

•At 50% each from Tier I and Tier II Capital of the Bank

Equity/Non-Equity Investments in Subsidiaries Equity/Non-Equity Investments in Subsidiaries

• First Loss Facility: Deduction shall be capped at the amount of capital that the bank would have been required to hold for the full value of the assets, had they not been securitized. 50% each from Tier I and Tier II Capital of the Bank

• Second Loss Facility: Reduced from the capital funds to the full extent. 50% each from Tier I and Tier II Capital of the Bank

•Credit Enhancements provided by Third Party: To the full extent, similar to First Loss Facility

•Underwriting by an originator: Securities devolved/held in excess of 10% of amount of issue. 50% each from Tier I and Tier II Capital of the Bank

•Underwriting by Third Party Service Providers: If below investment grade - 50% each from Tier I and Tier II Capital of the Bank

Credit Enhancements pertaining to Securitisation of Standard Assets Credit Enhancements pertaining to Securitisation of Standard Assets

•Maximum of 100% of Tier I elements

Limit for Tier II Elements Limit for Tier II Elements

CAIIB – Super-Notes © M S Ahluwalia Sirf Business

SYSTEMIC RISK AND BANKING REGULATION

3.

CAIIB – Super-Notes © M S Ahluwalia Sirf Business

Systemic Risk

• Risk that a default by one financial institution will create a

‘ripple effect’ that leads to default by other banks and

threatens the stability of the financial system

• Deposit insurance helps in maintaining confidence of

investors thus preventing ‘run on the banks’

• Banking Regulation prevents systemic risk by ensuring

sufficient capital adequacy to maintain investor confidence

CAIIB – Super-Notes © M S Ahluwalia Sirf Business

Cooke Ratio

• CRAR = Capital / Risk Weighted Assets

• Both on-balance-sheet and off-balance-sheet items are

considered for calculation of total risk-weighted assets

• Measure of bank’s total credit exposure

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M S Ahluwalia, amongst other things, is a visual artist, blogger,

blog designer and of course an MBA and Banker from New

Delhi, India.

To know more about him you may visit his blog-site: Estudiante De La Vida