Degree of risk expressed % weights assigned by the Reserve Bank of India

The degree of risk expressed % weights assigned by the Reserve Bank of India. The following
table shows the Risk weights for some important assets assigned by RBI in an increasing order.

Asset Weighted Risk

Cash 0%
Balance with Reserve Bank of India 0%
Central/ state Government Guaranteed advances 0%
SSI advances up to CGF guarantee 0%
Loans against FD (Fixed Deposits), LIC Policy 0%
Government approved Securities 2.50%
Balance with Banks other than RBI which maintain the 9% CRAR 20%
Secured Loan to the Staff Members 20%
Housing Loans <="" td=""> 50%
Housing Loans >Rs. 30 Lakhs 75%
Loans against Gold and Jewellery <="" td=""> 50%
Retail Lending up to Rs. 5 crore 75%
Loans Guaranteed by DGCGC / ECGC 50%
Loans to Public Sector Undertakings 100%
Foreign Exchange and Gold in Open Position 100%
Claims on unrated corporates 100%
Commercial Real estate 100%
Consumer Credit 125%
Credit Cards 125%
Exposure to Capital Markets 125%
Venture Capital Investment as a part of Capital Market exposure 150%

In the above table we can have a broad idea that the assets which are in the form of Cash,
Government Guaranteed securities, against the LIC policies etc. are safest assets with 0% Risk
weighted assigned to them. On the other hand, the venture Capital Investment as a part of Capital
Market exposure has the maximum risk weight assigned to them.

How does this work?

Lets take this example, For a AAA client, the risk weight is 20%, which means banks have to
set aside its own capital of ` 1.80 for every Rs 100 loan (this means 20% of 9% of ` 100).
Similarly, in case of 100% risk weight (such as capital markets exposures) , banks have to keep
aside its own capital of Rs 9 on the loan.

Calculation of the Ratio

Under Basel-III, banks are to compute ratio as follows:

Common Equity Tier-I Capital Ratio = Common Equity Tier-I Capital / RWA for (Credit
risk + Market risk + Operational risk)
Tier-I capital ratio = Tier-I Capital / RWA for (Credit risk + Market risk + Operational
risk)
Total capital ratio (CRAR) = Eligible Total Capital / RWA for (Credit risk + Market risk
+ Operational risk)
Capital adequacy ratio (CAR) is a specialized ratio used by banks to determine the adequacy of
their capital keeping in view their risk exposures. Banking regulators require a minimum capital
adequacy ratio so as to provide the banks with a cushion to absorb losses before they become
insolvent. This improves stability in financial markets and protects deposit-holders. Basel
Committee on Banking Supervision of the Bank of International Settlements develops rules
related to capital adequacy which member countries are expected to follow.

The committee's latest pronouncement on capital adequacy is Basel III, issued December 2010,
revised June 2011. Complete text is available here.

The pronouncement requires banks to maintain the following minimum ratios as of 1 January
2013:

Common Equity Tier 1 Risk-weighted Exposures 3.5%

Tier 1 Capital Risk-weighted Exposures 4.5%

Total Capital Risk-weighted Exposures 8%

Since such pronouncements are frequently updated, please consult the Bank of International
Settlements website for latest guidance.

Formula
Tier 1 Capital + Tier 2 Capital
Capital Adequacy Ratio =
Risk-weighted Exposures

Tier 1 Capital = Common Equity Tier 1 + Additional Tier 1

Total Capital = Tier 1 Capital + Tier 2 Capital

Risk-weighted exposures include weighted sum of the banks credit exposures (including those
appearing on the bank's balance sheet and those not appearing). The weights are determined in
accordance with the Basel Committee guidance for assets of each credit rating slab.

Example

Calculate capital adequacy ratio i.e. total capital to risk weighted exposures ratio for Small Bank
Inc. using the following information:
 Exposure Risk Weight

Government Treasury held as asset 1,500,000 0%

Loans to Corporates 15,000,000 10%

Loans to Small Businesses 8,000,000 20%

Guarantees and other non-balance sheet exposures 6,000,000 10%

The bank's Tier 1 Capital and Tier 2 Capital are $200,000 and $300,000 respectively.

Solution

Banks's total capital = 200,000 + 300,000 = $500,000

Risk-weighted exposures = $1.50% + $1510% + $820% + $610% = $3.7 million

$0.5 million
Capital Adequacy Ratio = = 14%
$3.7 million

If the national regulator requires a capital adequacy ratio of 10%, the bank is safe. However, if
the required ratio is 15%, the bank might have to face regulatory actions.

Please note that guarantees and other non-balance sheet exposures are included in the calculation
of risk-weighted exposures.