2. 14-2
NARSIMHAN COMMITTEE
REFORMS
I & II
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Bank Management and Financial Services, 6/e

3. The Management Of
Capital
The purpose of this session is to discover why
capital – particularly equity capital – is so
important for financial institutions, to learn
how managers and regulators assess the
adequacy of an institution’s capital position,
and to explain the ways that management can
raise new capital.

4. 14-4
SW Analysis of Indian Banking
Strength
Massive Branch Network
Weaknesses
Scarcity of skilled manpower
New branches incurred losses for prolonged period
specially those in rural and semi-urban centers
Customer service deteriorated
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Bank Management and Financial Services, 6/e

5. 14-5
SW Analysis of Indian Banking
Weaknesses
Lack of competition
Low capital base
Low productivity
High intermediation cost
Technology use minimum
No proper risk management system
Prudential norms were weak
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Bank Management and Financial Services, 6/e

6. 14-6
SW Analysis of Indian Banking
Weaknesses
Indifferent attitude of bank officials at all levels
Monitoring by central office becomes difficult in view
of large geographical spread
Increasing overdue in advances
Political interference
High degree of directed credit
Impounding of huge resources of banks due to high
CRR and SLR
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Bank Management and Financial Services, 6/e

7. 14-7
Recommendations
Deregulation of interest rates
Preemption of banks’ resources through SLR and CRR
to be reduced
No further nationalisation of banks
Branch licensing to be abolished
RBI policy towards foreign banks should be more
liberal
There should be level playing field between foreign
and domestic banks
Streamlining and rationalisation of foreign operations
of indian banks
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Bank Management and Financial Services, 6/e

8. 14-8
Recommendations
Internal organisation of banks be left to
judgment of individual banks
Computerisation should be speedier to handle
ever growing volumes
Individual banks should be free to make their
own recruitment
Duality of control between RBI and Ministry of
Finance should end
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Bank Management and Financial Services, 6/e

9. 14-9
Recommendations
Appointment of CMD should be free from
political interference
Capital of banks should be raised to
4% by March 1993
8% by March 1996
Of which 50% to be Tier I capital
Banks should access capital markets for raising
capital
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Bank Management and Financial Services, 6/e

10. 14-10
Recommendations
Banks should not take into account income from NPA
where interest remains past due for a period of 180
days
Assets should be classified under four categories and
provision made as under:
Standard Nil
Sub-standard 10% of total outstanding
Doubtful 100% of security shortfall
20% to 50% depending on the
period asset is doubtful
Loss asset 100% provision or writeoff
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Bank Management and Financial Services, 6/e

11. 14-11
Recommendations
Criterion for income recognition to be
recognised by tax authorities
Special tribunals be set up for speedy recovery
of bank dues
Establishment of Asset Reconstruction Fund
Bad and doubtful assets to be transferred to
ARF in a phased manner
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Bank Management and Financial Services, 6/e

12. 14-12
Recommendations
Banks to be restructured on the following lines
3 to 4 large international banks
8 to 10 national banks having all India network
Local Area Banks operating in specific regions
RRBs confined to rural areas
The revised system should be market driven and
based on profitability considerations and brought
about throughout a process of mergers and
acquisitions
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Bank Management and Financial Services, 6/e

13. 14-13
Tasks Performed By Capital
Provides a Cushion Against Risk of Failure
Provides Funds to Help Institutions Get Started
Promotes Public Confidence
Provides Funds for Growth
Regulator of Growth
Role in Growth of Bank Mergers
Regulatory Tool to Limit Risk Exposure
Protects the Government’s Deposit Insurance System
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Bank Management and Financial Services, 6/e

14. 14-14
Types of Capital
Common Stock Minority Interest in
Preferred Stock Consolidated
Subsidiaries
Surplus
Equity Commitment
Undivided Profits Notes
Equity Reserves
Subordinated
Debentures
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Bank Management and Financial Services, 6/e

15. 14-15
Reasons for Capital Regulation
To Limit the Risk of Failures
To Preserve Public Confidence
To Limit Losses to the Central Government
Arising from Deposit Insurance Claims
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Bank Management and Financial Services, 6/e

16. 14-16
The Basle Agreement on
International Capital Standards
An International Treaty Involving the U.S.,
Canada, Japan and the Nations of Western
Europe to Impose Common Capital
Requirements On All Banks Based in
Those Countries
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17. 14-17
Tier 1 Capital
Common Stock and Surplus
Undivided Profits
Qualifying Noncumulative Preferred Stock
Minority Interests in the Equity Accounts of
Consolidated Subsidiaries
Selected Identifiable Intangible Assets Less
Goodwill and Other Intangible Assets
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Bank Management and Financial Services, 6/e

18. 14-18
Tier 2 Capital
Allowance for Loan and Lease Losses
Subordinated Debt Capital Instruments
Mandatory Convertible Debt
Cumulative Perpetual Preferred Stock with
Unpaid Dividends
Equity Notes
Other Long Term Capital Instruments that
Combine Debt and Equity Features
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Bank Management and Financial Services, 6/e

19. 14-19
Basle Agreement Capital
Requirements
Ratio of Core Capital (Tier 1) to Risk Weighted
Assets Must Be At Least 4 Percent
Ratio of Total Capital (Tier 1 and Tier 2) to
Risk Weighted Assets Must Be At Least 8
Percent
The Amount of Tier 2 Capital Limited to 100
Percent of Tier 1 Capital
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Bank Management and Financial Services, 6/e

20. 14-20
Calculating Risk-Weighted Assets
Compute Credit-Equivalent Amount of Each Off-
Balance Sheet (OBS) Item
Find the Appropriate Risk-Weight Category for Each
Balance Sheet and OBS Item
Multiply Each Balance Sheet and Credit-Equivalent
OBS Item By the Correct Risk-Weight
Add to Find the Total Amount of Risk-Weighted
Assets
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Bank Management and Financial Services, 6/e

21. 14-21
What Was Left Out of the Original
Basle Agreement
The Most Glaring Hole with the Original Basle
Agreement is its Failure to Deal with Market Risk
In 1995 the Basle Committee Announced New Market
Risk Capital Requirements for Their Banks
In the U.S. Banks Can Create Their Own In-House
Models to Measure Their Market Risk Exposure
Regulators Would Then Determine the Amount of
Capital Required Based Upon Their Estimate
Banks That Continuously Estimate Their Market Risk
Poorly Would Be Required to Hold Extra Capital
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Bank Management and Financial Services, 6/e

22. 14-22
Basle II
Aims to Correct the Weaknesses of Basle I
Three Pillars of Basle II:
Capital Requirements For Each Bank Are Based on
Their Own Estimated Risk Exposure
Supervisory Review of Each Bank’s Risk
Assessment Procedures and the Adequacy of Its
Capital
Greater Disclosure of Each Bank’s True Financial
Condition
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Bank Management and Financial Services, 6/e

23. 14-23
Capital Adequacy Categories Based
on Prompt Corrective Action
Well Capitalized
Adequately Capitalized
Undercapitalized
Significantly Undercapitalized
Critically Undercapitalized
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Bank Management and Financial Services, 6/e

24. 14-24
Internal Capital Growth Rate
= ROE X Retention Ratio
= Profit Margin X Asset Utilization
X Equity Multiplier X Retention
Ratio
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Bank Management and Financial Services, 6/e

25. 14-25
Planning to Meet a Bank’s Capital
Needs
Raising Capital Internally
Dividend Policy
Internal Capital Growth Rate
Raising Capital Externally
Issuing Common Stock
Issuing Preferred Stock
Issuing Subordinated Notes and Debentures
Selling Assets and Leasing Facilities
Swapping Stock for Debt Securities
Choosing the Best Alternative
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Bank Management and Financial Services, 6/e