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negotiable instrument

negotiable instrument

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Publicado porMomna Amjad

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Published by: Momna Amjad on Apr 30, 2011
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The capital assets or leverage ratio measures the ration of a bank's
book value of primary or core capital to its assets. The lower this ratio
the more leveraged it is primary or core capital is a bank's common
equity (book value) plus qualifying cumulative perpetual preferred stock
plus minority interests equity accounts of consolidated subsidiaries.


With the passage of the FDIC Improvement action 1991, a bank's
capital adequacy is assessed according to where its leverage ratio (L) falls
in one of five target Zones. The leverage ratio is: L = Core Capital/Assets

Risk Based Capital Ratios: In light of the weaknesses of the
simple capital assets ratio just described, U. S. bank regulators formally
agreed with other member countries of the bank for international
settlements to implement two are risk based capital ratios for all
commercial banks under their jurisdiction. The BIS phased in and fully
implemented these risk-based capital ratios on January 1, 1993, under
what has become to be known as the Basle (or Basle Agreement).

Regulators currently enforce the Basel agreement along side the
traditional leverage ratio. To be adequately capitalized a bank has to hold
a minimum total to risk-adjusted assets ratio of 8 percent that is:

Total risk-based Capital Ratio = Total capital (Tier 1 plus Tier
2)/Risk adjusted assets > 8%

In addition, the tier 1 core capital component of total capital has
its own minimum guideline:

Tier 1(core) capital Ratio = Core Capital (tier 1) / Risk adjusted

assets > 4%

That is, of 8 percent total risk-based capital ratio, a minimum of 4
percentages has to be held in core or primary capital.

Capital: A bank's capital is divided into Tier 1 and Tier 2. Tier 1
capital is primary or core capital and must be minimum of 4 percentage
of a bank's risk-adjusted assets while Tier 2, or supplementary capital is
the make-weight such that:

Tier 1 capital + Tier 2 capital > 8% of risk-adjusted Assets


Tier 1 Capital: Tier 1 capital is closely linked to bank's book value
of equity reflecting the concept of the core capital contribution of a
bank's owners. It includes the value of common equity, plus an amount
of perpetual preferred stock, plus minority equity interest's held by the
bank in subsidiaries, minus goodwill. Goodwill is an accounting item
that reflects the excess a bank pays over market value in purchasing or
acquiring other banks or subsidiaries.

Tier 2 Capitals: Tier 2 capitals are broad array of secondary
capital resources. Tier 2 includes bank's loan loss reserves up to a
maximum of 1.25 percent of risk-adjusted assets plus various
convertibles and subordinated debt instruments with maximum caps.

Risk Adjusted Assets: Risk-adjusted assets are the denominator
of risk-based capital ratios. Two components comprise risk-adjusted

Risk-adjusted Assets = Risk-adjusted on Balance-sheet assets +
Risk-adjusted off balance-sheet assets.

Capital Adequacy Norms: Risks of Urban co-op banks: Urban
cooperative banks are in the news and for wrong reasons. From the
mashavpura collapse, the ills of the UCBs are being brought home to
people. But on what framework so they work? The capital adequacy
norms suggested by the Basle committee have been accepted and
adopted by the Reserve Bank of India.

It has come up with a uniform methodology of computing the
capital adequacy ratio (CAR) of banks and the same is applicable to all
urban co-operative banks from March 31.

Banks failing to maintain 75 percent of the required CAR will be
classified as weak and those failing to maintain 50 percent of the


required ratio would be classified as sick. The weights have not been
appreciated by a majority of urban co-operative banks because in
assigning the weights, there is a large number of the banks being
pushed into the weak category.

In terms of guidelines provided, the balance kept with the RBI
alone will carry zero weight whereas the deposits kept with other banks
including nationalized banks will carry a risk weight of 20. The risk
weight assigned to government securities is only 2.5. However, the
government borrowings under government securities have a risk weight
of 2.5. The nationalized banks are wholly owned by the centre but the
risk weight assigned is 20.

Capital Adequacy in BSE and NSE: At BSE, there is an anomaly
in capital adequacy norms. NSE requires up front capital from brokers of
12% and BSE requires upfront capital of 5%. This state of affairs-where
BSE uses much weaker capital adequacy norms than NSE has persisted
for years. This state of affairs is as unsatisfactory as one where RBI
might ask certain bank to have a 9% capital adequacy norm but allow
others to get away with 3.75%. A bank, which used 3.75% capital
adequacy, would be fragile indeed and it is no surprise that BSE is
fragile. Matters are worsened when we consider that margin enforcement
at BSE is reputed to be quite spotty.

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