Introduction
In Banking sector, Capital is very important as it provides a layer of protection to the bank from unexpected risk and losses. In addition to this it also comforts depositors and the creditors that their deposits or lending are safe, Bank is having enough capacity to repay the liabilities.
Capital Management
Capital is the core strength of any bank. It provides banks with a cushion against unexpected future losses. Bank needs to manage the capital as it is very scarce and imperative for its growth.
Management of capital is one of the most critically important activities for a bank. Management of capital starts with the inception of the new financial year and the most important step in this process is to understand the needs of the business. We have shown the various steps involved in the management of capital.
It is extremely important for a financial institution to calculate the capital adequacy ratio and secure sufficient capital to cover risks.
Capital is scarce for banks due to availability of limited resources. Hence, it should be ensured that the bank is making every effort to conserve the capital through its management.
Importance of Capital Management
Like every other organization or entity, banks also need funds to not only survive but to sustain themselves in the market. Unavailability of funds will hamper their prospect of growth, innovation, and commitment towards growth of economy. As a result, banks are always under constant pressure from investors and regulators to secure more capital.
Composition of Regulatory Capital
As per the guidelines issued by Reserve Bank of India, Banks have been directed to maintain a pillar 1 Capital to Risk weighted Assets Ratio (CRAR) of 9% ( excluding capital conservation buffer).
Components of Capital
Capital of the bank can be divided into following two categories:
- Tier 1 Capital
- Tier 2 Capital
Tier 1 Capital: Tier 1 Capital of the bankconsists of Common Equity Tier 1 and Additional Tier 1 Capital. Reserve Bank of India has instructed to maintain at least 7.00 % of Risk weighted Assets.
Elements of Tier 1 Capital
- Paid-up capital (ordinary shares), statutory reserves, and other disclosed free reserves,
- Perpetual Non-cumulative Preference Shares (PNCPS) eligible for inclusion as Tier I capital
- Perpetual Debt Instruments (PDI) eligible for inclusion as Tier I capital; and
- Capital reserves representing surplus arising out of sale proceeds of assets.
Tier 2 Capital:Tier 2 Capital is consisting of General Provisions, borrowings in foreign currency, revaluation reserves. Banks are directed to maintain at least 2.00% of Risk weighted assets. Following are the items considered under Tier2 Capital:
- General Provisions and Loss Reserves
- Debt Capital Instruments issued by the banks.
- Preference Share Capital Instruments [Perpetual Cumulative Preference Shares (PCPS) / Redeemable Non-Cumulative Preference Shares (RNCPS) / Redeemable Cumulative Preference Shares (RCPS)] issued by the banks.
- Stock surplus (share premium) resulting from the issue of instruments included in Tier 2 capital.
- Revaluation reserves at a discount of 55%
- Any other type of instrument generally notified by the Reserve Bank from time to time for inclusion in Tier 2 capital.
- Less: Regulatory adjustments / deductions applied in the calculation of Tier 2 capital
The capital requirements are illustrated as follows:
| Sr No | Regulatory Capital | % of RWA |
| (i) | Common Equity Tier 1 Ratio | 5.5 |
| (ii) | Additional Tier 1 Capital | 1.5 |
| (iii) | Minimum Tier 1 Capital Ratio | 7.00 |
| (iv) | Tier 2 Capital | 2.00 |
| (v) | Minimum Total Capital Ratio | 9.00 |
| (vi) | Capital Conservation Buffer (comprised of Common Equity) | 2.50 |
| (vii)
|
Minimum Total Capital Ratio plus Capital Conservation Buffer | 11.50 |
Process forManagement of Capital:
As we are aware that banking is capital intensive sector, for every rupee of fresh advance we need to reserve a certain share of our capital due to regulatory requirements. These regulatory requirements make it necessary to manage our capital more efficiently.
For conservation of capital, we have designed six step process for management of capital.
Key Steps in Capital Management
- Business Strategy Plan:Every process starts with the planning; it is one of the most crucial steps. Here it is to be decided where we are heading.
- Business Forecast:Business forecasts need to be prepared for long term basis. Setting long-term goals will certainly help in management of the capital as capital can be used in a much more effective manner with clear objectives.
- Analysis of Balance sheet:Balance sheets and profitability should be analyzed thoroughly to understand and align the objectives.
- Assessment of various risk factors/ICAAP: Capital Planning is done to cover the expected risk/loss the normal course of business. This includes identification of risk through ICAAP. ICAAP is comprehensive assessment of the bank’s entire spectrum of risk,how the bank intends to mitigate those risks and how much current and future capital is necessary for the bank, reckoning other mitigating factors.
- Stress Testing:The use of stress testing framework can provide a bank’s management a better understanding of the bank’s likely exposure in extreme circumstances.
- Final Forecast of Business: Final forecast will be prepared after understanding the present position of the bank and after aligning the business development policies.
- Policies and Action Plan: Action plans will be prepared, which is the last element in the whole exercise.
Key typesof raising the equity capital by Banks:
Primarily, issues made by an Indian company can be classified as Public, Rights, Bonus and Private Placement.The Classification of issues is as illustrated below:
a) Public issue: When a company issue/offer shares or convertible securities is made to fresh investors for becoming part of shareholders’ family of the issuer company, it is called as public issue. Public issue can be further classified into two following categories:
- Initial Public Offer (IPO): When an unlisted company makes fresh issue of shares for the first time to the public, it is called an Initial Public Offer.
- Further Public Offer (FPO): When an already listed company makes either a fresh issue of shares or convertible securities to the public or an offer for sale to the public , it is called a Further Public offer or follow on offer.
b)Rights issue:When an issue of shares or convertible securities is made by an issuer to its existing share holders as on a particular date fixed by issuer (known as Record date), it is called a rights issue. These issues are offered in a particular ratio to the number of shares held as on the record date.
c) Composite Issue: These types of issues are combination of public issue and Right issue. The allotment of shares in both public issue and rights issue is proposed to be made simultaneously, it is called composite issue.
Bonus Issue:When an issuer makes an issue of shares to its existing shareholders without any consideration based on the number of shares already held by them as on a record date it us called bonus issue.
d)Private Placement: When an issuer makes an issue of shares or convertible securities to a select group of persons not exceeding 49, and which is neither a rights issue nor a public issue, it is called a private placement. Private placement of shares or convertible securities can be of three types:
- Preferential allotment:When a listed issuer shares or convertible securities to a select group of persons in terms of provisions of Chapter VII of Sebi (ICDR) Regulations, 2009, it is called a preferential allotment.
- Qualified Institutions Placement (QIP):When a listed issuer issues equity shares or non-convertible debt instruments along with warrants and convertible securities other than warrants to Qualified Institutions Buyers only, in terms of provisions of Chapter VIII of SEBI (ICDR) Regulations, 2009, it is called a QIP.
- Institutional Placement Programme (IPP): When a listed issuer makes further public offer of equity share or offer for sale of shares by promoter/promoter group of listed issuers in which the offer of shares is made only to Qualified institutional buyers for the purpose of achieving minimum public shareholding, it is called IPP.
CRAR of Big Eight Banks in India
| Bank | SBI | PNB | BOB | CANARA | UBI | HDFC | AXIS | ICICI |
| CRAR (June 2022) | 13.43 | 14.82 | 15.46 | 14.91 | 14.42 | 18.10 | 17.83 | 17.47 |
| CRAR (June 2023) | 14.56 | 15.54 | 15.84 | 16.24 | 15.95 | 18.93 | 17.74 | 16.71 |
- Reserve Bank has specified the minimum CRAR of 11% (including the counter cyclic buffer). Banks are maintaining CRAR level above the mandatory requirement set by the reserve bank.
- HDFC Bank is having CRAR of 18.93%, highest among the selected banks at the end of June 2023 quarter.
- Among the selected public sector banks, Canara Bank is having highest CRAR of 16.24% at end of June 2023.
Conclusion
Banks, in addition to meeting the business needs, also comply with the regulatory guidelines issued by the reserve Bank. To meet with the scarcity of capital, hampering the growth of business. Banks start forecasting of thecapital followed by strategy formulation to raise the capital based on the future needs.
We may conclude that Banks in India are well capitalized to meet with any unexpected losses in the business and planning the need of capital through tools like stress testing etc.