INTRODUCTION:
India’s banking sector is currently valued at Rs 81 trillion (US$ 1.31 trillion). It has the potential to become the fifth largest banking industry in the world by 2020 and the third largest by 2025, according to an industry report. The face of Indian banking has changed over the years. Banks are now reaching out to the masses with technology to facilitate greater ease of communication, and transactions are carried out through the Internet and mobile devices.
With the Parliament passing the Banking Laws (Amendment) Bill in 2012, the landscape of the sector will likely change. The bill allows the Reserve Bank of India (RBI) to make final guidelines on issuing new bank licenses. This could lead to a greater number of banks in the country; the style of operation could also evolve with the integration of modern technology into the industry.
Why is capital so important for
banks?
A manufacturing firm like Tata Motors, or a commodity company like Coal India have plants, machinery, reserves etc as their assets. These tangible assets, can be sold in times of distress or to meet their dues. Banks on the other hand, do not own any significant tangible assets. Their assets are mainly loans, and their liabilities are deposits.
A manufacturing firm like Tata Motors, or a commodity company like Coal India have plants, machinery, reserves etc as their assets. These tangible assets, can be sold in times of distress or to meet their dues. Banks on the other hand, do not own any significant tangible assets. Their assets are mainly loans, and their liabilities are deposits.
Assets =
Liabilities + Owners' Equity
Loans will get amortized, and deposits will have to be returned at some point. Since bank's assets and liabilities are just 'paper transactions', these entities need to maintain certain levels of liquid cash and equity capital as a buffer.
DISCUSSION:
The '3-6-3 rule' used to be common
in banking.
This means that a banker would borrow funds at 3%, lend at 6%, and then be playing golf by 3 PM. The bank would keep the 3% spread (the difference between the borrowing and lending rate), and that would be enough to manage all its expenses, as well as keep a decent profit.
But, things have now changed. The business of banking is not that simple anymore. We are living in an increasingly difficult environment where uncertainty is the name of the game.
The banking industry is central to any economy. And thus regulation of this industry is crucial as well. The RBI has done a commendable job so far in regulating the industry. While global banks, and economies are still recovering from the aftermath of the 'subprime crisis' and 'euro zone' debt crisis, Indian banks have stayed relatively strong. They came off the crisis relatively unscathed. However, the rising interest rate scenario currently may be more of a challenge. Without sufficient capital to grow and meet capital adequacy and provision norms Indian banks may face some issues. Especially, ones which do not have enough equity set aside to absorb the same.
This means that a banker would borrow funds at 3%, lend at 6%, and then be playing golf by 3 PM. The bank would keep the 3% spread (the difference between the borrowing and lending rate), and that would be enough to manage all its expenses, as well as keep a decent profit.
But, things have now changed. The business of banking is not that simple anymore. We are living in an increasingly difficult environment where uncertainty is the name of the game.
The banking industry is central to any economy. And thus regulation of this industry is crucial as well. The RBI has done a commendable job so far in regulating the industry. While global banks, and economies are still recovering from the aftermath of the 'subprime crisis' and 'euro zone' debt crisis, Indian banks have stayed relatively strong. They came off the crisis relatively unscathed. However, the rising interest rate scenario currently may be more of a challenge. Without sufficient capital to grow and meet capital adequacy and provision norms Indian banks may face some issues. Especially, ones which do not have enough equity set aside to absorb the same.
PSUs shoring up capital
The 2011-12 Union Budget tabled in the parliament, stated that the government was going to infuse Rs 201.6 bn into the PSU (public sector) banks to maintain their Tier-I capital ratio adequacy ratio (CAR) at 8%. The plan is also to increase the government stake in some of them to 58%. According to the Basel framework, Tier-I capital consists of core capital which mainly includes common stock and reserves (including retained earnings). It may also include non-redeemable non-cumulative preferred stock.
The Tier 1 capital ratio is the ratio of a bank's core equity capital to its total risk-weighted assets (RWA). Bank's assets are weighted by a certain factor according to their credit risk. This is usually determined by the central bank. For example, giving out real estate loans will be much riskier versus investing in sovereign bonds. Accordingly the former will receive a higher risk weighting.
According to the Basel III norms banks need to shore up their CAR and maintain an equity capital at a minimum of 7% of RWA. This includes a common equity capital requirement of 4.5% plus a 2.5% capital conservation buffer. This buffer will help absorb losses during periods of financial or economic stress. All these requirements need to be in place by end 2018.
Indian banks currently have higher Total CAR against the requirement under Basel III of 8%. However, their Tier I ratio, and equity capital base needs to be augmented. The RBI and the government intend to have these in place well before the Basel III deadline.
The 2011-12 Union Budget tabled in the parliament, stated that the government was going to infuse Rs 201.6 bn into the PSU (public sector) banks to maintain their Tier-I capital ratio adequacy ratio (CAR) at 8%. The plan is also to increase the government stake in some of them to 58%. According to the Basel framework, Tier-I capital consists of core capital which mainly includes common stock and reserves (including retained earnings). It may also include non-redeemable non-cumulative preferred stock.
The Tier 1 capital ratio is the ratio of a bank's core equity capital to its total risk-weighted assets (RWA). Bank's assets are weighted by a certain factor according to their credit risk. This is usually determined by the central bank. For example, giving out real estate loans will be much riskier versus investing in sovereign bonds. Accordingly the former will receive a higher risk weighting.
According to the Basel III norms banks need to shore up their CAR and maintain an equity capital at a minimum of 7% of RWA. This includes a common equity capital requirement of 4.5% plus a 2.5% capital conservation buffer. This buffer will help absorb losses during periods of financial or economic stress. All these requirements need to be in place by end 2018.
Indian banks currently have higher Total CAR against the requirement under Basel III of 8%. However, their Tier I ratio, and equity capital base needs to be augmented. The RBI and the government intend to have these in place well before the Basel III deadline.
CONCLUSION:
I strongly
disagree from the statement that banks are equipped with sufficient capital to
operate there functions in a smooth way.
The RBI has done a commendable job so far in regulating the
industry. While global banks, and economies are still recovering from the aftermath
of the 'subprime crisis' and 'euro zone' debt crisis, Indian banks have stayed
relatively strong.
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