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Institutions & Financial Services
Capital Adequacy of Financial Intermediaries (FI)
What is a Financial Intermediary (FI)
The term financial intermediary includes Banks,
Investment Companies, Insurance Companies, Development Financial
Institutions, Non-Banking Finance Companies, Mutual Funds,
etc. All these financial institutions assist in the transfer
of savings from economic units/individuals with excess money
to those that need capital for investments.
Need for Capital:
Financial Intermediaries need capital for
two reasons:
Adequate capital helps financial intermediaries
to survive even during substantial losses. It gives time
to re-establish the business and avoid any break in operations.
To ensure the good performance of FIs the
regulatory authority (RBI) has specified the minimum capital
for the FI.
This requirement is called Capital Adequacy,
and it is specified for Banks and Non Banking Financial
Corporations (NBFCs).
Computation of capital adequacy ratio (CAR)
of banks:
For computation of CAR, we need to calculate:
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: Compute Risk Weighted Assets click
here...
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 capital
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.
Subordianate 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 |
40 |
60 |
| 4.Where the date of maturity is above 2 years but
doesn't exceed 3 years |
60 |
40 |
| 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 |
0 |
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
10%.
Example
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