Capital adequacy ratios are a measure of the amount of a bank's capital expressed as a percentage of its risk weighted credit exposures.
Why do we need Capital Adequacy Ratio
Market Risk
Credit Risk
To Standardize Global Banking regulatory Practices
To help Banks maintain a proper and adequate capital structure
To Prevent Banks from going insolvent
Basel Committee Accord
Committee centered in Bank of International Settlements
Established in 1974 representing all the industrialized nations in the world
Effective supervision of banks on a global basis by setting and promoting international standards
Its principal interest has been in the area of capital adequacy ratios
In 1988 the committee issued a statement of principles dealing with capital adequacy ratios
It contains a recommended approach for calculating capital adequacy ratios and recommended minimum capital adequacy ratios for international banks
The Accord was developed in order to improve capital adequacy ratios (which were considered to be too low in some banks) and to help standardize international regulatory practice.
Capital Structure of a bank
Tier I Capital
Tier one capital is capital, which is permanently and freely available to absorb losses without the bank being obliged to cease trading. An example of tier one capital is the ordinary share capital of the bank. Tier one capital is important because it safeguards both the survival of the bank and the stability of the financial system.
Tier II capital
Generally absorbs losses only in the event of a winding-up of a bank, and so provides a lower level of protection for depositors and other creditors.
It comes into play in absorbing losses after the bank has lost tier one capital
Tier II capital
Upper Tier II Capital -Capital has no fixed maturity
Lower Tier II Capital -Limited life span
An example of tier two capital is subordinated debt. This is debt, which ranks in priority behind all creditors except shareholders. In the event of a winding-up, subordinated debt holders will only be repaid if all other creditors (including depositors) have already been repaid.
The Basle Capital Accord also defines a third type of capital, referred to as tier three capital Tier three capital - short term subordinated debt
Can be used to provide a buffer against losses caused by market risks if tier one and tier two capital are insufficient for this.
Market risks are risks of losses on foreign exchange and interest rate contracts caused by changes in foreign exchange rates and interest rates
The Reserve Bank does not require capital to be held against market risk, so does not have any requirements for the holding of tier three capital.
Why do we need Capital Adequacy Ratio
Market Risk
Credit Risk
To Standardize Global Banking regulatory Practices
To help Banks maintain a proper and adequate capital structure
To Prevent Banks from going insolvent
Basel Committee Accord
Committee centered in Bank of International Settlements
Established in 1974 representing all the industrialized nations in the world
Effective supervision of banks on a global basis by setting and promoting international standards
Its principal interest has been in the area of capital adequacy ratios
In 1988 the committee issued a statement of principles dealing with capital adequacy ratios
It contains a recommended approach for calculating capital adequacy ratios and recommended minimum capital adequacy ratios for international banks
The Accord was developed in order to improve capital adequacy ratios (which were considered to be too low in some banks) and to help standardize international regulatory practice.
Capital Structure of a bank
Tier I Capital
Tier one capital is capital, which is permanently and freely available to absorb losses without the bank being obliged to cease trading. An example of tier one capital is the ordinary share capital of the bank. Tier one capital is important because it safeguards both the survival of the bank and the stability of the financial system.
Tier II capital
Generally absorbs losses only in the event of a winding-up of a bank, and so provides a lower level of protection for depositors and other creditors.
It comes into play in absorbing losses after the bank has lost tier one capital
Tier II capital
Upper Tier II Capital -Capital has no fixed maturity
Lower Tier II Capital -Limited life span
An example of tier two capital is subordinated debt. This is debt, which ranks in priority behind all creditors except shareholders. In the event of a winding-up, subordinated debt holders will only be repaid if all other creditors (including depositors) have already been repaid.
The Basle Capital Accord also defines a third type of capital, referred to as tier three capital Tier three capital - short term subordinated debt
Can be used to provide a buffer against losses caused by market risks if tier one and tier two capital are insufficient for this.
Market risks are risks of losses on foreign exchange and interest rate contracts caused by changes in foreign exchange rates and interest rates
The Reserve Bank does not require capital to be held against market risk, so does not have any requirements for the holding of tier three capital.