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).