This document discusses capital adequacy ratio (CAR) and non-performing assets (NPAs). It defines CAR as a ratio of a bank's capital to its risk-weighted assets that regulators use to ensure banks can absorb losses. It discusses the types of capital (Tier I and Tier II), risk weights, and implications of not meeting CAR norms. Methods to improve CAR include mergers, better asset management, improved NPA recovery, recapitalization, and raising funds. NPAs are defined as loans overdue over 90-180 days. Factors contributing to NPAs include political interference, willful defaults, targeted lending, lack of monitoring, and hiding NPAs.

1. CAPITAL ADEQUACY RATIO
AND NPA NORMS
CHAPTER 6

2. CHAPTER OBJECTIVES
• Meaning and uses of capital adequacy ratio
• Types of capital
• Concepts of risk-weighted assets
• Implications of not meeting capital adequacy norms
• How to improve CAR
• Non-performing assets
• Factors responsible for NPAs

3. CAPITAL ADEQUACY RATIO—MEANING
• Capital adequacy ratio (CAR),also called Capital to Risk (Weighted) Assets Ratio (CRAR),It is a ratio
of a bank's capital to its risk.National regulators track a bank's CAR to ensure that it can absorb a
reasonable amount of loss and are complying with their statutory capital requirements.
• The capital required by a bank also depends on risk associated with its assets.Therefore the amount
of capital required by a bank should be measured in relation to various assets in its balance sheet.
This will show to what extent the banks capital funds can meet unexpected losses without effecting
the existence of bank.
• Capital adequacy ratio (CAR) is a measure of the amount of a bank's capital expressed as a
percentage of its risk weighted credit exposures.
• The Basel Committee adopted weighted risk approach. It is a ratio of capital fund to risk-weighted
assets (CRAR).It is expressed in percentage terms.

4. USES OF CAR
• Capital adequacy ratio is the ratio which determines the capacity of the bank in terms of meeting
the time liabilities and other risk such as credit risk, operational risk, etc. In the most simple
formulation, a bank's capital is the "cushion" for potential losses, which protect the bank's
depositorsor otherlenders. Banking regulators in most countriesdefine and monitor CAR to
protect depositors, thereby maintaining confidence in the banking system.
• CAR is similar to leverage; in the most basic formulation, it is comparableto the inverse of debt-
to-equityleverage formulations (although CAR uses equity over asets instead of debt-to-equity;
since assets are by definition equal to debt plus equity, a transformation is required). Unlike
traditionalleverage, however, CAR recognizes that assets can have different levels of risk.

5. TYPES OF CAPITAL
Tier I Capital : Actual contributed
equity plus retained earnings.
Tier II Capital : Preferred shares plus
50% of subordinated debt.

6. TIER I CAPITAL—CORE CAPITAL
• Paid up Capital
• Statutory Reserves
• Disclosed free Reserves
• Capital Reserves representing surplus arising out of sale proceeds of assets
MINUS
• Equity investments in subsidiaries
• Losses in current period and those brought forward from previous years and
• Intangible Assets
• Tier I Capital should at no point of time be less than 50% of the total capital. This implies that Tier II cannot
be more than 50% of the total capital.

7. TIER II CAPITAL CONSISTS OF
• Undisclosed Reserves and cumulative perpetual preference Shares.
• Revaluation Reserves.
• General provisions and loss reserves upto a maximum of 1.25% of weighted risk assets.
• Investment fluctuation reserves not subject to 1.25% restriction.
• Hybrid debt capital instruments (Bonds).
• Subordinate debt (Long term unsecured loans).

8. CONCEPTS OF RISK-WEIGHTED ASSETS (RWAS)
I. Category I (Weight 0 percent)
II. Category II (Weight 20 percent)
III. Category III (Weight 50 percent)
IV. Category IV (Weight 100 percent)

9. RISK WEIGHTS FOR IMPORTANT ASSETS
Cash, balance with RBI 0%
Balance with other banks 20%
Govt. Approved Securities 2.5%
Secured loans to Staff Members 20%
Housing Finance loans to individuals secured by Mortgage 75%
Mortgage based securitization of assets 77.5%
Forex and gold open position 100%
– Central/State Govt. guaranteed advances 0%
– Loans to PSUs 100%
– Other loans 100%
– Loans guaranteed by DICGC/ECGC 50%
– SSI advances up to CGF guarantee 0%
– Advances against term deposits, LIC policy, NSCs with adequate margin 0%
– Consumer credit/credit cards 125%
– Exposure to capital market 125%
– Commercial real estate 150%
– Venture capital part of Capital market exposure 150%

10. IMPLICATIONS OF NOT MEETING CAPITAL ADEQUACY NORMS
Credibility of banks will be adversely affected.
Restrict the flexibility and expansion.
Fall in deposits.
Fall in profitability.
Decline in economic growth.
No satisfactory response from Capital market.

11. HOW TO IMPROVE CAR
• 1. Mergers.Weak and Small banks can be merged with big and strong banks in order to improve their profitabilityand
financial health.Withthe help of this,capitalbase will also be automatically increased.New bank of India was merged with
PNB in 1993.
• 2. Better Assets Management. To improve the profitability,which willlead to improvement in CAR, A bank can reduce its
size of assets-composition by includingassets carryinglower or nil risk weights.
• 3. Improved RecoveryMethods. By improving recovery techniquesof NPA's banks can improve CAR.After reforms a no.of
measures were suggested to speed up the recovery of NPA's i.e.banks can undertake compromise proposalsor sale of
NPA's at discount.
• 4. RecapitalisationbyGovernment.Governmenthas undertaken the responsibilityto influence capital base of needy and
weak banks from time to time and for this purpose bail out packages are also being announce for banks to enhance their
capital base.
• 5. EquityParticipation byEmployees.When employeeswill participate in ownershipthey will be motivated and there
will be improvement in productivity,whichwill lead to increase in profits.Which willcertainly improve CAR.
• 6. Raising Funds through Capital Market. Bank can approach capital market to raise funds in order to enchance their
capital base.But the banks approaching the market should have higher profit not only to encourage investors responseas
well as to sustain higher dividend pay out.

12. NON-PERFORMING ASSETS DEFINED
The prudential norms on income recognition issued by the RBI on 4-7-2002 define NPA as :
• Interest and/or instalment of principal remain over due for a period of more than 180 days in respect of term
loan.
• The account remains out of order for a period of more than 180 days, in respect of an overdraft/cash credit,
• The bill remains overdue for a period of more than 180 days in the case of bills purchased and discounted.
• Interest and/or instalment of principal remains overdue for two harvest seasons but for a period not
exceeding two half years in the case of an advance granted for agricultural purpose, and
• Any amount to be received remains overdue for a period of more than 180 days in respect of other accounts.

13. NPA AS DEFINED BY THE RESERVE BANK OF
INDIA AS ON JULY 1, 2014.
• (a) An asset, including a leased asset, becomes non performing when it ceases to generate income for the bank.
• (b)A non performing asset (NPA) is a loan or an advance where;
• interest and/ or instalment of principal remain overdue for a period of more than 90 days in respectof a term loan,
• the account remains ‘out of order’as indicated at paragraph 2.2 below, in respect of an Overdraft/Cash Credit (OD/CC),
• the bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted,
• the instalment of principal or interest thereon remains overdue for two crop seasons for short duration crops,
• the instalment of principal or interest thereon remains overdue for one crop season for long duration crops,
• the amount of liquidity facility remains outstanding for more than 90 days, in respectof a securitisation transaction undertaken in terms of
guidelines on securitisation dated February 1, 2006.
• in respectof derivative transactions, the overdue receivables representing positive mark-to-market value of a derivative contract, if these
remain unpaid for a period of 90 days from the specified due date for payment.
• in case of interest payments, banks should, classify an account as NPA only if the interest due and charged during any quarter is not
serviced fully within 90 days from the end of the quarter.

14. FACTORS RESPONSIBLE FOR EMERGENCE OF NPA'S
Political Interference
Willful defaults
Targeted Lending
Lack of Monitoring
Tendency to Hide