Earlier in June, BBC reported that The Prudential Regulation Authority (PRA) had said Britain’s top banks and building societies had to fill £ 27.1bn shortfall in their balance sheets.

Earlier in June, BBC reported that The Prudential Regulation Authority (PRA) had said Britain’s top banks and building societies had to fill £ 27.1bn shortfall in their balance sheets. The list of banks included the Royal Bank of Scotland (RBS) with a deficit of £ 13.6bn, Lloyds Banking Group accounted for £ 8.6bn, Barclays £ 3bn and Nationwide had a deficit of £ 400m. Five of those banks had already put in place plans to fill the £ 27.1 bn gap to the tune of £ 13.7bn, the watchdog reported, although some of their proposed measure still needed regulatory approval.

Last week, South Korean banks also saw their capital adequacy ratios slip in the second quarter on hike in risk weighted assets according to the Financial Supervisory Service. The average capital adequacy ratio of 18 local banks reached 13.88 percent at the end of June, down 0.12 percent point from the previous quarter.

What is Capital Adequacy Ratio ?

Capital Adequacy Ratio (CAR) is used by financial regulators to ascertain how well a bank is protected against risks. The principle of the ratio is to divide the bank’s current capital against its current risks, in many countries; a bank’s ratio must be kept at a fixed percentage or above it as stipulated by the regulator. Most countries abide by the Basel Accords, the original Basel 1988 accord, known as Basel I, required banks which had an international presence to maintain a capital adequacy ratio of 8 percent. The Basel accords have been revised over the years to take account the solidity of assets owned by the banks, the CAR is used to protect depositors and promote the stability and efficiency of financial systems around the world, while calculating the CAR two types of capital are measured

Tier I Capital: Which can absorb losses without the bank being required to cease trading.

Tier II Capital: This type of capital can absorb losses in the event of a winding up and thereby offering lesser degree of protection to depositors. It is calculated by the following formula:

CAR= Tier One Capital + Tier Two Capital

                   Risk Weighted Assets

How to overcome CAR Deficit ?

Banks which do not meet the CAR imposed by the regulators should either raise additional capital (numerator in the CAR) or reduce their risk weighted assets (the denominator). Banks usually meet the norms of the CAR, either through the sale of assets, restructuring and other sources of income generation. Central banks and regulators also ensure that the banks do not reduce their lending in order to meet the 7 percent ratio, it would have an undesirable effect on the economy and impact businesses who rely on banks for lending.

Basel III Capital Adequacy Requirements

A new set of regulations known as “Basel III” was developed by the Bank of International Settlements in order to avoid a repeat of another financial crisis. Headquartered in Basel, Switzerland the Bank for International Settlements is often called “the central bank of central banks”. The Basel III will require banks to hold up top quality capital totalling 7 percent of their risk bearing assets, banks are given time up to 2019 to comply with the Basel III norms.

Basel III is a comprehensive set of reform measures, developed by the Basel Committee on Banking Supervision to strengthen the regulation, supervision and risk management of the banking sector: It aims to

 

i) Improve the banking sector’s ability to absorb shocks arising from financial and economic stress                                        

ii) Improve governance and risk management

iii) Strengthen the bank’s transparency and disclosures

http://www.internationalfinancemagazine.com/article/Capital-Adequacy-in-Banks.html