12.24           ndian       onom
     shock-absorbers to banks has seen three major                     cushion against probable losses in investments and
     developments:35                                                   loans. In 1988, this ratio capital was decided to be
           (i) The provision of keeping a cash ratio                   8 per cent. It means that if the total investments
                 of total deposits mobilised by the banks              and loans forwarded by a bank amounts to Rs.
                 (known as the CRR in India);                          100, the bank needs to maintain a free capital 39
          (ii) the provision of maintaining some assets                of Rs. 8 at that particular time. The capital
                 of the deposits mobilised by the banks                adequacy ratio is the percentage of total capital
                 with the banks themselves in non-cash                 to the total risk—weighted assets (see footnote
                 form (known as the SLR in India); and                 40).
         (iii) The provision of the capital adequacy                        CAR, a measure of a bank’s capital, is
                 ratio (CAR) norm.                                     expressed as a percentage of a bank’s risk weighted
           The capital adequacy ratio (CAR) norm has                   credit exposures:
     been the last provision to emerge in the area of                       CAR= Total of the Tier 1 & Tier 2 capitals ÷
     regulating the banks in such a way that they can                  Risk Weighted Assets
     sustain the probable risks and uncertainties of                        Also known as ‘Capital to Risk Weighted
     lending. It was in 1988 that the central banking                  Assets Ratio (CRAR)’ this ratio is used to protect
     bodies of the developed economies agreed upon                     depositors and promote the stability and efficiency
     such a provision, the CAR—also known as the                       of financial systems around the world. Two types
     Basel Accord.36 The accord was agreed upon                        of capital were measured as per the Basel II norms:
     at Basel, Switzerland at a meeting of the Bank                    Tier 1 capital, which can absorb losses without a
     for International Settlements (BIS).37 It was at                  bank being required to cease trading, and Tier 2
     this time that the Basel-I norms of the capital                   capital, which can absorb losses in the event of
     adequacy ratio were agreed upon—a requirement                     a winding-up and so provides a lesser degree of
     was imposed upon the banks to maintain a certain                  protection to depositors. The new norms (Basel
     amount of free capital (i.e., ratio) to their assets38            III) has devised a third category of capital, i.e.,Tier
     (i.e., loans and investments by the banks) as a                   3 capital.
       35.    Through various legislations, since the RBI
                                                                            The RBI introduced the capital-to-risk
              Nationalisation Act, 1949 and the Banking Regulation     weighted assets ratio (CRAR) system for the
              Act, 1949 were enacted – and further Amendments to       banks operating in India in 1992 in accordance
              the Acts, Ministry of Finance, Government of India,
              New Delhi.
                                                                       with the standards of the BIS—as part of the
       36.    Simon Cox (ed.), ‘Economics’, The Economist, 2007,
                                                                       financial sector reforms.40 In the coming years
              p. 75.                                                   the Basel norms were extended to term-lending
       37.    The BIS is today a central bank for central bankers set
              up in 1930 in a round tower near Basel railway station     39.    he capital of a an was classified into ier and ier
              in Switzerland as a private company owned by a number           II. While Tier-I comprises share capital and disclosed
              of central banks, one commercial bank (Citibank)                reserves, Tier-II includes revaluation reserves, hybrid
              and some private individuals. Today it functions as a           capital and subordinated debt of a bank. As per the
              meeting place for the bank regulators of many countries,        provision, Tier-II capital should not exceed the Tier I
              a multilateral regulatory authority and a clearing house        capital. The risk-weighting depends upon the type of
              for many nations’ reserves (i.e. foreign exchange). See         assets for example it is      per cent on private sector
              Tim Hindle, ‘Pocket Finance’ The Economist, 2007,               loans, while only 20 per cent for short-term loans.
              pp. 35–36.                                                 40.  The RBI is a member of the Board of the BIS. The
       38.    Investments made and loans forwarded by banks are               financial sector reforms commenced in India in the
              known as risky assets.                                          fiscal 1992–93 after the report submitted by the
                                                                              Narasimham Committee on Financial system (CFS).