Daily Prelims Notes 18 November 2023
- November 18, 2023
- Posted by: OptimizeIAS Team
- Category: DPN
Daily Prelims Notes
18 November 2023
Table Of Contents
- The new flare-up in Myanmar
- India targets $40bn in technical textiles
- Uncertain future in sea of poppies
- HC quashes Haryana law for 75% quota in pvt sector jobs
- Why water reserves in southern India are fast depleting in 2023
- What a US-China climate deal means for COP28
- India has a critical role in Dubai climate conference: UAE official
- Sand and dust storms are increasing, human activities contribute 25% emissions: UNCCD
- Extreme weather events may be driving replacement of native species with exotic ones
- Risk Weights in Banking
Section: Places in news
Context; The Ministry of External Affairs expressed “deep concern” over the ongoing fighting in the Rikhawdar area in Myanmar’s Chin State
More about the news:
- Myanmar has been in flames ever since the military seized power on February 1, 2021
- The Ethnic Armed Organizations (EAOs) and People’s Defence Forces (PDFs),armed civilian groups, have joined hands against the military, aligning with the self-declared National Unity Government in exile.
- In intense clashes, they successfully took control of two towns near the India-Myanmar border, i.e Rikhawdar, close to Zokhawthar in Mizoram, and
Khampat in Sagaing region, around 60 km from Moreh in Manipur causing a refugee influx into Mizoram.
- The recent conflict, known as Operation 1027, initiated by the Three Brotherhood Alliance on October 27 in Shan State, resulted in the capture of over 100 military outposts and crucial border towns.
- The alliance is a front of three EAOs:
- the Myanmar National Democratic Alliance Army (MNDAA),
- the Ta’ang National Liberation Army, and
- the Arakan Army.
- Chinshwehaw, a vital point on the China-Myanmar border trade route and a key revenue source for the junta, was among the seized locations.
- Simultaneously, local resistance forces ignited fighting in various parts of the country.
- Khampat in Sagaing region is also part of the proposed India-Myanmar-Thailand trilateral highway project.
Subject: Science and Tech
- India’s market for technical textiles is targeted to touch $40 billion by 2030 from the current $23 billion.
- The export of technical-textile products was expected to touch $10 billion from the current $2.5 billion in seven years.
- The National Technical Textile Mission, unveiled three years ago, has been extended till 2026.
- The government allocated ₹1,000 crore under the Mission for research and development and so far, 126 projects, with a total value of ₹371 crore, have been approved.
- A portal for start-ups in technical textiles segment to submit applications for support under the Mission would be unveiled soon.
What are Technical Textiles?
- Technical textiles are functional fabrics that have applications across various industries including automobiles, civil engineering and construction, agriculture, healthcare, industrial safety, personal protection etc.
- Technical Textile products derive their demand from the development and industrialization in a country.
- Based on usage, there are 12 technical textile segments: Agrotech, Meditech, Buildtech, Mobiltech, Clothtech, Oekotech, Geotech, Packtech, Hometech, Protech, Indutech and Sportech.
- For example, ‘mobiltech’ refers to products in vehicles such as seat belts and airbags, airplane seats; geotech, which is incidentally the fastest growing sub-segment, used to hold back soil, etc.
What do we know about the National Technical Textiles Mission (NTTM)?
- It was approved in 2020 by the Cabinet Committee on Economic Affairs (CCEA) with total outlay of Rs.1480 Crore.
- The implementation period is four years, from FY 2020-21 to FY 2023-24.
- The aim of the mission is to position India as a global leader in Technical Textiles by taking the domestic market size from USD 40 billion to USD 50 billion by 2024.
- It also supports the ‘Make in India’ Initiative promoting domestic manufacturing of related machinery and equipment.
- First component: It will focus on research, development and innovation with an outlay of Rs. 1,000 crores.
- The research will be at both fiber level and application-based in geo, agro, medical, sports and mobile textiles and the development of biodegradable technical textiles.
- Research activities will also focus on the development of indigenous machinery and process equipment.
- Second component: It will be for the promotion and development of the market for technical textiles.
- The penetration level of technical textiles is low in India varying between 5-10% against the level of 30-70% in developed countries.
- The Mission will aim at an average growth rate of 15-20% per annum by 2024.
- Third component: It will focus on export promotion so that technical textile exports from the country reach from Rs 14,000 crores to Rs 20,000 crores by 2021-2022 and ensure 10% average growth every year till the Mission ends.
- An export promotion council for technical textiles will be set up.
- Fourth component: It will focus on education, training and skill development.
- The Mission will promote technical education at higher engineering and technology levels related to technical textiles and its application areas.
Subject : Geography
Section: Economic geography
- New challenges arised from the intersection of cultural pride and economic shifts in opium cultivation in India and various concerns surrounding the government’s policy shift, addressing potential impacts on livelihoods, national security and transparency.
- Opium Farmers in India: About 1 lakh farmers across 22 districts in Madhya Pradesh, Rajasthan, and Uttar Pradesh have licenses to cultivate opium.
- Major Opium-Producing Districts: Mandsaur, Neemuch, and Chittorgarh contribute to 80% of India’s opium production.
- Change in Government Policy (2021): Government policy shift in 2021 allows private players to produce CPS, aiming to boost alkaloid yield.
- Economic Impact on Farmers: Opium farmers face economic challenges, citing stagnant procurement rates, increased input costs, and reduced poppy seed yield under the new system.
- Cultural Significance of Opium Cultivation: Opium farming is a source of cultural pride, termed “agriculture of dignity” in the Mewar region, linking social status to this traditional trade and reflecting generations’ engagement.
- Government Policy Shift in 2021: In 2021, the government allowed private players to produce Concentrate of Poppy Straw (CPS) alongside traditional opium gum, aiming to boost alkaloid yield and align India with global practices.However, this shift faces resistance from opium farmers.
- Concerns about Private Players: Opium farmers express worries about the entry of private companies, fearing threats to livelihood, profits, and national security.Farmers argue that private involvement may lead to misuse of opium, increased drug trafficking, and rising costs of life-saving medicines.
- Impact on Farmers and Traditional Practices: Opium farmers face economic challenges, citing stagnant procurement rates, increased input costs, and reduced poppy seed yield under the new system. The shift to CPS raises concerns about transparency, farmer consultation, and the potential decline in income for traditional opium cultivators.
- Threat to Livelihood and National Security: Opium farmers fear that private entry may endanger their profession and lead to increased drug-related issues. There is a possibility of drug mafia influence and security threats if alkaloids fall into the wrong hands.
- Impact of Policy Shift on Farmers: Economic challenges for opium farmers, including reduced poppy seed yield and concerns about transparent practices under CPS.Farmers worry about income loss and express dissatisfaction with the lack of government consultation.
- Safety and Security of Alkaloids: Opium farmers question the safety and security of alkaloids under private production.Fears that private involvement may compromise the integrity of life-saving medicines made from opium.
- Division among Farmers and Lack of Transparency: Farmers express concerns about the government creating divisions with two production systems. Calls for transparent policies and farmer involvement, alleging a lack of transparency in the CPS mechanism.
Some prominant Phrases regarding opium
- Swabhiman ki Kheti (Agriculture of Dignity): Opium cultivation holds cultural pride in the Mewar region, reflecting social status.
- Afeem and Aulat Barabar (Poppy Plants and Children Deserve Similar Treatment): Highlights the cultural significance of opium, equating it with the care given to children.
- Concentrate of Poppy Straw (CPS): New method introduced in 2021, allowing private players to extract alkaloids from poppy straw alongside traditional opium gum.
- Make in India: Farmers question the government’s commitment to “Make in India” while allowing imports of poppy seeds.
- The Punjab and Haryana high court on Friday set-aside the Haryana law providing 75% reservation for state domiciles in private sector, observing that “the state cannot direct private employers to do what has been forbidden to do under the Constitution.”
What is Haryana State Employment of Local Candidates Act, 2020?
- It requires firms with 10 or more employees to reserve 75% of all jobs offering a salary of less than Rs. 30,000 a month for eligible candidates of State domicile.
- It will be mandatory for all these employers to register all their employees drawing gross monthly salary or wages not more than Rs 30,000 on the designated portal available on the official website of the Labour Department, Haryana.
Similar Attempts in other States:
- Job reservation Bills or laws for domiciles have also been announced in other States including Andhra Pradesh, Madhya Pradesh and Jharkhand.
- The job quota Bill passed in the Andhra Pradesh Legislative Assembly in 2019, also reserving three-fourths of private jobs for locals.
What are the Pros and Cons of Local Reservation in Jobs?
- Constitutionally Valid: Article 16 of the constitution of India doesn’t prohibit reservation based on the domicile and the residence. It seems constitutionally valid to provide first opportunities to the locals in local jobs because these people wear all the negative externalities generated by job creating establishments.
- Equality: Reservation in local jobs provides equality among the weakest section of the society, because reservation is only confined to low strata jobs, and it is as per the spirit of the Equal Protection of Law as per Article 14 of the constitution of India.
- Suitable Solution for Unemployment: Reservation in local jobs seems a suitable solution amid unemployment and stagnant job creation.
- In the constitution of India, there are special provisions for jobs and education for states of Andhra Pradesh and Telangana under the article 371 D and E, due to their special circumstances. So, the reservation in local jobs amid the unemployment situation seems justified and as per the special provisions of the constitution of India.
- Boost Local Economy: When companies hire local people, they tend to spend their earnings in the local economy, which can help to create jobs and generate economic growth.
- Hiring local people means companies do not have to bear the relocation costs of employees. This can help to reduce their operational costs, which can be passed on to customers in the form of lower prices.
- Improve Productivity: Local employees are more likely to be familiar with the local language, culture, and business environment, which can help to improve their productivity and efficiency.
- Can Trigger Exodus of Investors: It could trigger an exodus of large domestic and multinational investors across sectors such as auto, IT that rely on highly skilled manpower.
- In the case of Haryana, investment fell 30% in 2022 to Rs 39,000-odd crore from nearly Rs 56,000 crore in 2021-22, pushing it from the ninth-best State in terms of new investment projects to the 13th rank in 2022-23 because of local reservation law.
- Affect Existing Industries: Raising the son of the soil issue and preventing free movement of manpower resources in the State from other regions can have an adverse effect on the existing industries in the State.
- This may force those tech giants and other industries to shift their base from Haryana to other States and drain out the State’s monetary resources to that extent.
- Can Cause Extreme Talent Crunch: Imposing the reservations on gig and platform companies could create a crippling talent crunch.
- Against the Constitution: The Constitution of India guarantees freedom of movement and consequently employment within India through several provisions.
- Article 14 provides for equality before law irrespective of place of birth.
- Article 15 guards against discrimination based on place of birth.
- Article 16 guarantees no birthplace-based discrimination in public employment.
- Article 19 ensures that citizens can move freely throughout the territory of India.
Subject : Geography
Section: Physical geography
- According to a recent report from the Central Water Commission (CWC), water levels in India’s Southern states’ reservoirs are low compared to last year and compared to other regions of the country in 2023.
- During normal monsoon years over the country, the available water reserves in southern India touch 91 per cent of the total storage capacity.
|State||Reservoir stocks (% of total storage capacity)|
Reservoirs of South India are:
- Andhra Pradesh- Srisailam, Nagarjuna Sagar, Somasila, Yeleru, Kandaleru, Donkarayi.
- Karnataka- Krishnaraja Sagar, Tungabhadra, Bhadra, Linganamakki, Narayanpur, Malaprabha, Hemavathy, Mani dam, Almatti, Tattihalla,
- Kerala- Malampuzha, Idukki,
- Tamil Nadu- Lower Bhawani, Mettur, Aliyar, Sholayar
Why are the stocks low?
- Vast inter-seasonal rainfall variability,
- Large-scale rainfall deficits during monsoon,
- October over southern peninsular India remained the sixth driest in 123 years,
- Development of cyclone Hamoon,
- Irrigated farming can face water unavailability
- Water deficit in high water-intensive paddy cultivation in Andhra and Tamil Nadu region.
- Lack of availability of drinking water
Source: Indian Express
Subject : Environment
Section: International conventions
- The United States and China announced an agreement to sharply increase clean energy, displace fossil fuels and reduce emissions that are warming the planet.
About the deal:
- The United States is the biggest climate polluter in history, and China is currently the largest polluter. Together, they account for 38% of the world’s greenhouse gases.
- The countries agreed to “pursue efforts to triple renewable energy capacity globally by 2030,” with the intention “to accelerate the substitution for coal, oil and gas generation.”
- Both countries anticipate that they will achieve “meaningful absolute power sector emission reduction” this decade.
- Both countries agreed that in their next set of national climate pledges, they would set reduction targets for all greenhouse gas emissions — not just carbon dioxide but also methane, nitrous oxide and other planet-warming gases.
- China has agreed in principle to cut methane, which was absent in its earlier pledges during the Paris Agreement 2015. Also, China is the world’s largest methane emitter.
Criticism of the deal:
- The deal does not include any promises by China to phase out its use of coal or to stop issuing permits for new coal plants and building them.
- There is no mention of an ‘enforcement mechanism’ in the deal.
E3G (Third Generation Environmentalism):
- Established in 2004.
- E3G is an independent climate change think tank with a global outlook.
- They work on the frontier of the climate landscape tackling the barriers and advancing the solutions to a safe climate.
- Their goal is to translate climate politics, economics and policies into action.
- Based in Brussels, Berlin, London and Washington, D.C..
Source: Indian Express
Subject : Environment
Section: International conventions
- The 28th edition of the Conference of Parties (COP) to the UNFCCC is going to be held in Dubai, UAE.
- This year, the President of CoP 28 is Sultan Al-Jaber, who is also the head of one of the world’s largest oil companies, Abu Dhabi National Oil Company. This brings in the criticism that he would as COP President be less inclined to push the world away from fossil fuels.
- President Sultan Al-Jaber said that their economy is today 70% non-oil and gas. And they have also established a renewable energy company named Masdar.
Post of CoP president: Their role and responsibilities:
- The government of the host country holds the presidency for one year.
- It usually names one of its ministers as the president.
- The role of the CoP president is to facilitate and guide the negotiations.
- The President does not have any special powers but does play a key role in prioritising the agenda of discussions and helping forge a consensus on important issues.
- They are usually extremely active behind the scenes, brokering deals and compromises, mediating conflicts, and acting as crisis managers.
- However, the final decisions are always taken by consensus.
- Extended role of COP presidents:
- For the past few years, COP presidents have engaged in pre-conference diplomacy, travelling all over the world to hold discussions with governments in order to understand their priorities and to get a sense of the kind of agreement that could be realistically achieved at the conference.
- There have been several instances when a single country– and not one from among the most powerful- has stood up and disagreed with the rest of the world, and the conference had to accommodate its concerns.
Source of this article: The Hindu
Subject : Environment
Section: International conventions
- United Nations Convention to Combat Desertification (UNCCD) released policy recommendations on sand and dust storms during a five-day meeting in Uzbekistan.
Sand and Dust Storms:
- It is a meteorological phenomenon characterised by strong and turbulent winds lifting an ensemble of small particles to great heights. They are known to have adverse impacts on human health, the environment and economies.
- Human activities contribute 25 per cent of global dust emissions, with agriculture being the main anthropogenic source.
- Every year, more than two billion tonnes of sand and dust travel over thousands of kilometres through the Earth’s atmosphere.
- Policy Recommendation of UNCCD: The strengthening of risk governance of sand and dust storms and increased investment and financing in sand and dust storm risk reduction and impact mitigation measures in agriculture along with developing national capacity and raising awareness of sand and dust storms.
Food and Agriculture Organisation (FAO) Report on Sand and Dust Storms:
- Report title: Sand and dust storms: A Guide to Mitigation, Adaptation, Policy, and Risk Management Measures in Agriculture.
- Key findings:
- Sand and dust storms present a formidable challenge to achieving 11 of the 17Sustainable Development Goals.
- The main sources of sand and dust storms are the world’s drylands. About 75 per cent of emissions come from natural sources such as hyper-arid regions, topographic depressions in arid areas and dry ancient lake beds with little vegetative cover.
- Anthropogenic factors such as land-use change, agriculture, water diversion and deforestation contribute to the remaining 25 per cent.
- Creation of new sources of sand and dust storms:
- Water consumption in agriculture shrinks water bodies, creating new sources of sand and dust storms.
- The excessive diversion of water from rivers in Central Asia over several decades towards agriculture has shrunk the Aral Sea, a pre-existing lake between Kazakhstan to its north and Uzbekistan to its south. It has now become the Aralkum Desert, a significant new source of sand and dust storms.
- Role of Climate Change:
- Extreme wind events, aridity and frequent, severe and longer droughts worsen the storms.
- Other factors such as high air temperature, minimal precipitation and strong winds also act as drivers.
- Impact of sand and dust storms:
- Sand and dust storms lower the yields and productivity of crops, trees, pastures, and livestock. However, many of these impacts have not yet been well-quantified.
- There is no policy to address the risks posed by sand and dust storms.
- FAO Recommendation:
- Establishment of risk monitoring and early warning systems. This will enable the timely issuing of alerts and early warnings.
About United Nations Convention to Combat Desertification (UNCCD)
- UNCCD is one of three Conventions that originated at the 1992 Earth Summit in Rio de Janeiro.
- Signed on 14 October 1994 -13 October 1995
- Location (Headquarters)- Bonn, Germany.
- Effective 26 December 1996
- Parties – 197
- UNCCD declared 2006 the “International Year of Deserts and Desertification”.
- In 2013, Canada became the first country to withdraw its membership from UNCCD but later rejoined it in 2016.
- The Holy See (Vatican City) is the only state that is not a party to the convention that is eligible to accede to it.
Source of this article: Down To Earth
Subject : Environment
- Extreme weather events are affecting land, marine and freshwater ecosystems by influencing the displacement of native species with non-native ones, a recent analysis has found.
- The increasing frequency of extreme weather events such as heatwaves, cold waves, droughts and floods due to climate change is influencing ecosystems.
- Marine animals overall remained insensitive to extreme weather events, irrespective of whether they were native or non-native however, native molluscs, corals and anemones showed negative effects due to heatwaves.
- Heatwaves and storms affected non-native species in terrestrial and freshwater habitats.
Impact of extreme weather events on Native and non-native species:
|Native Species||Non-native species|
Why do non-native animals show less sensitivity to extreme weather events compared to native species belonging to the same taxonomic class?
- The non-native or invasive species have higher growth rates, higher phenotypic plasticity, stronger competitive abilities, quicker recovery and proliferation and broader tolerance of disturbance compared to the native species.
- Plasticity is the capacity of an individual organism to alter its behaviour, physiology/gene expression, and/or morphology in direct response to changing environmental conditions.
- Severe drought events deceased native invertebrates and fishes by increasing water salinity, facilitating the establishment of non-native salt-tolerant counterparts.
Source: Down To Earth
Section: monetary policy
Risk weights in banking refer to the assigned measure of risk associated with various assets held by banks.
These weights are used in the calculation of regulatory capital requirements, determining how much capital a bank needs to hold based on the riskiness of its assets.
The higher the risk weight assigned to an asset, the more capital the bank must set aside to cover potential losses.
- Regulatory Requirement: Risk weights are a crucial component of the Basel III regulatory framework, which establishes international standards for bank capital adequacy.
- Asset Risk Assessment: Different types of assets carry different levels of risk. For example, unsecured consumer loans, including credit cards, are often considered riskier than secured loans. The risk weight reflects this difference.
- Calculation of Capital Requirements: The calculation involves multiplying the risk weight assigned to each category of assets by the total amount of assets in that category. The sum of these weighted assets determines the minimum capital a bank must maintain.
- Impact on Capital Adequacy Ratio (CAR): Changes in risk weights can impact a bank’s Capital Adequacy Ratio (CAR), which is the ratio of a bank’s capital to its risk-weighted assets. An increase in risk weights may necessitate a higher capital buffer.
Recent Example: In the provided context, the Reserve Bank of India (RBI) increased the risk weights on unsecured consumer loans, including credit cards, by 25 percentage points for banks and Non-Banking Financial Companies (NBFCs), bringing the risk weight to 125 percent.
This move is expected to increase the capital requirements for banks and may lead to a decline in the Common Equity Tier-I (CET1) capital levels.
Impact on Banks:
- The increase in risk weights is expected to result in a 5 percent increase in capital requirements for banks, amounting to ₹84,000 crores.
- CET1 capital levels are anticipated to decline by 35-100 basis points (bps) for various banks.
- Banks may pass on the impact through higher lending rates to maintain risk-adjusted returns.
- The move could moderate credit growth in segments affected by the risk weight hike.
- Consumer credit has been growing at a significant rate.
- The impact is estimated to be around 9.8 percent of total outstanding loans.
- Sectors like unsecured lending, credit cards, and personal loans are likely to be affected.
- Shares of banks and financial companies declined following the announcement.
- There may be an impact on the Return on Equity (ROE) of lenders.
- The cost of borrowing for NBFCs is expected to increase, leading to a rise in the cost of funds.
Impact of the increase in risk weights on unsecured consumer loans
The impact of the increase in risk weights on unsecured consumer loans, including credit cards, by the Reserve Bank of India (RBI) has several potential implications for the Indian economy:
- Credit Growth Moderation:
- The move is expected to lead to a moderation in the growth of unsecured lending, particularly in segments like personal loans and credit cards.
- Higher risk weights mean that banks will have to set aside more capital for these types of loans, potentially making them less attractive for lenders.
- Interest Rate Increase:
- Banks may respond to the increased capital requirements by raising interest rates on unsecured consumer loans to maintain their return on capital.
- Higher interest rates on consumer loans could impact borrowing costs for individuals, leading to reduced consumer spending.
- Impact on Consumer Spending:
- The cost of borrowing for consumers, especially those relying on unsecured credit, may increase.
- This could impact consumer spending patterns, as individuals may cut back on discretionary spending due to higher interest rates.
- Banks’ Capital Adequacy and Profitability:
- Banks will need to ensure that they meet the higher capital requirements, which could impact their capital adequacy ratios.
- The decline in the Common Equity Tier-I (CET1) capital levels for banks may affect their profitability and lending capacity.
- Sectoral Impact:
- Sectors heavily reliant on consumer credit, such as retail and consumer goods, may experience a slowdown in demand.
- Financial institutions, particularly those with a significant portfolio of unsecured consumer loans, may see a temporary impact on their financial performance.
- Market Dynamics:
- The stock prices of banks and financial companies may be influenced by the market’s perception of the impact on their profitability and growth prospects.
- Investors may re-evaluate their positions in financial stocks based on the anticipated changes in the lending environment.
- Risks Mitigation:
- The regulatory measure is aimed at mitigating risks associated with the rapid growth of unsecured consumer loans. It reflects a proactive approach by the RBI to address concerns related to asset quality and systemic risks.
- Competitive Landscape:
- The changes in risk weights could influence the competitive dynamics among financial institutions, with some players more affected than others.
- Institutions with a higher share of unsecured consumer loans may face greater challenges in maintaining growth.
- Overall Economic Growth:
- The impact on consumer spending and lending activities can have broader implications for economic growth.
- A slowdown in credit growth and consumer spending may contribute to a more cautious economic environment.
It’s important to note that the full extent of the impact will depend on various factors, including how banks adjust their lending practices, consumer behaviour, and the overall economic context.
Basel III Norms:
Basel III refers to a set of international regulatory standards developed by the Basel Committee on Banking Supervision (BCBS) to strengthen regulation, supervision, and risk management within the banking sector.
The framework was introduced in response to the global financial crisis of 2007-08 with the aim of enhancing the resilience of banks and reducing the likelihood of future financial crises.
Here are key components and objectives of Basel III:
- Capital Adequacy:
- Basel III introduces more stringent capital adequacy requirements, aiming to improve the ability of banks to absorb losses during economic downturns or financial crises.
- Common Equity Tier 1 (CET1) Capital:
- One of the central elements of Basel III is the emphasis on Common Equity Tier 1 (CET1) capital, which represents a bank’s core equity capital. CET1 capital includes common equity, retained earnings, and certain regulatory adjustments.
- Capital to Risk-Weighted Assets Ratio (CRAR):
- Basel III mandates banks to maintain a minimum Capital to Risk-Weighted Assets Ratio (CRAR) of at least 8%. CRAR is a ratio that compares a bank’s capital to the risk-weighted value of its assets, where assets are assigned different weights based on their risk.
- Leverage Ratio:
- Basel III introduces a leverage ratio, which is a measure of a bank’s capital to its total exposure. This ratio is designed to mitigate the risk of excessive leverage and acts as a backstop to the risk-weighted capital requirements.
- Liquidity Standards:
- The framework includes new liquidity standards to ensure that banks maintain an adequate level of high-quality liquid assets to meet short-term liquidity needs.
- Systemically Important Banks:
- Basel III identifies systemically important banks and imposes additional capital requirements on these institutions to mitigate the risks they pose to the broader financial system.
About Additional Tier-1 (AT1) bonds
Additional Tier-1 (AT1) bonds are a type of financial instrument issued by banks to strengthen their core capital base and meet regulatory requirements, particularly under the Basel III framework.
Here are key features and characteristics of AT1 bonds:
- Nature of AT1 Bonds:
- AT1 bonds are unsecured, perpetual bonds, meaning they have no maturity date and do not need to be redeemed by the issuing bank.
- These bonds are a form of hybrid instrument, combining features of both debt and equity.
- Purpose of Issuance:
- Banks issue AT1 bonds to enhance their capital structure and fulfill regulatory capital requirements, particularly the Common Equity Tier 1 (CET1) capital ratio mandated by Basel III.
- Coupon Payments:
- AT1 bonds pay a fixed or floating coupon to investors. However, the issuing bank has the discretion to skip coupon payments if it incurs losses, and it can only make payments from profits or revenue reserves.
- Yield and Risk:
- AT1 bonds typically offer higher yields compared to other types of bonds issued by the same bank, reflecting the higher risk associated with these instruments.
- Investors are attracted to AT1 bonds for the potential of earning a higher yield, but they also bear the risk of non-payment of coupons and potential write-downs.
- Call Option:
- The issuing bank has the option to call back the AT1 bonds or repay the principal after a specified period, usually five years. This gives the bank flexibility in managing its capital structure.
- Risk of Write-Down:
- In the event of severe financial distress, if the bank’s Common Equity Tier 1 (CET1) capital ratio falls below a certain threshold (Point of Non-Viability Trigger or PONV), the AT1 bonds can be written down or converted into equity.
- The risk of write-down or conversion into equity is a unique feature of AT1 bonds and reflects their role as a form of contingent capital.
- AT1 bonds typically receive credit ratings that are lower than those of secured bonds issued by the same bank. The lower rating reflects the higher risk associated with these instruments.
In summary, AT1 bonds play a crucial role in a bank’s capital structure, providing a source of contingent capital that can absorb losses during periods of financial stress.
Investors in AT1 bonds accept higher risks in exchange for potentially higher yields, and the regulatory framework ensures the stability and resilience of the banking system.
About Common Equity Tier 1 (CET1) capital
Common Equity Tier 1 (CET1) capital is a key component of a bank’s regulatory capital and is considered the highest quality of capital. It represents the core capital that provides a financial institution with a substantial cushion against potential losses.
CET1 capital is a measure of a bank’s financial strength and its ability to absorb losses without jeopardizing the stability of the financial system.
Here are key features and characteristics of CET1 capital:
- Core Capital:
- CET1 capital is part of the Basel III regulatory framework, which sets international standards for bank capital adequacy.
- It is considered the most reliable form of capital as it consists mainly of common equity, which includes common shares and retained earnings.
- Common Equity Tier 1 capital includes common equity elements such as common shares and retained earnings.
- It may also include other comprehensive income and certain regulatory adjustments.
- Quality of Capital:
- CET1 capital is classified as “going concern” capital, meaning that it is available to absorb losses while the bank continues its normal operations.
- It is meant to provide resilience to a bank during economic downturns and financial stress.
- Regulatory Requirements:
- Regulatory authorities, such as central banks and banking regulators, set minimum CET1 capital requirements that banks are required to maintain.
- These requirements are part of the broader capital adequacy standards aimed at ensuring the stability and solvency of financial institutions.
- Risk-Based Capital Ratio:
- CET1 capital is expressed as a ratio to risk-weighted assets (RWA). The CET1 capital ratio is calculated by dividing CET1 capital by the risk-weighted assets.
- The formula is CET1 Capital Ratio = CET1 Capital / Risk-Weighted Assets.
Maintaining an adequate level of CET1 capital is essential for banks to meet regulatory requirements, support sustainable business operations, and instill confidence in depositors, investors, and other stakeholders.
About ‘Point of Non-Viability Trigger’ (PONV)
The ‘Point of Non-Viability Trigger’ (PONV) is a regulatory mechanism that allows a regulatory authority, such as a central bank, to take over the management and operations of a distressed or failing bank.
This trigger is particularly relevant in the context of Additional Tier-1 (AT1) bonds issued by banks.
Here’s how the PONV mechanism works:
- Identification of Non-Viability:
- If a bank reaches a point where it is no longer considered viable due to severe financial losses, regulatory authorities, such as the central bank, may determine that the bank has reached the “Point of Non-Viability.”
- Activation of PONV Trigger:
- Once the regulatory authority determines that the bank is non-viable, it can activate the Point of Non-Viability Trigger. This triggers a set of actions and measures aimed at addressing the distressed situation of the bank.
The PONV mechanism is designed to ensure that regulatory authorities have the tools and powers needed to intervene in a timely manner when a bank is facing severe financial distress. By activating the PONV trigger, the regulatory authority can take swift actions to prevent the failure of the bank and protect the interests of depositors, creditors, and the broader financial system. This mechanism is part of the broader regulatory framework, such as the Basel III norms, aimed at enhancing the stability of the banking sector.
About Capital to Risk-Weighted Asset Ratio (CRAR):
- CRAR is a financial ratio used to measure a bank’s capital in relation to its risk exposure.
- It indicates the amount of capital a bank holds as a buffer to cover potential losses on its loans and other assets.
- The CRAR ratio is calculated by dividing a bank’s capital (Tier 1 and Tier 2 capital) by its risk-weighted assets.
- CRAR = (Tier 1 Capital + Tier 2 Capital) / Risk-Weighted Assets.
Components of Capital:
- Tier 1 Capital (Core Capital): This includes equity capital, ordinary share capital, intangible assets, and audited revenue reserves.
- Tier 2 Capital: This comprises unaudited retained earnings, unaudited reserves, and general loss reserves.
Importance of CRAR:
- CRAR is a critical tool for assessing a bank’s financial health.
- It ensures that banks have sufficient capital to absorb potential losses and continue lending safely.
- It protects depositors and provides assurance of a bank’s ability to sustain its operations.
Benefits of CRAR:
- Risk Management: CRAR helps banks manage and mitigate risks effectively.
- Depositor Protection: It safeguards depositors’ funds by ensuring banks have enough capital to cover losses.
- Sustainability: It contributes to the stability and sustainability of banks’ operations.
- Lending Capacity: Maintaining a healthy CRAR allows banks to continue lending money to businesses and individuals.
About Capital Adequacy Ratio (CAR)
The Capital Adequacy Ratio (CAR) is a key financial metric that measures a bank’s capital adequacy and its ability to absorb potential losses arising from various risks.
It is a crucial component of the regulatory framework designed to ensure the stability and soundness of financial institutions. The CAR is expressed as a percentage and is calculated by dividing a bank’s capital by its risk-weighted assets.
The formula for calculating the Capital Adequacy Ratio is as follows:
CAR=(Tier 1 Capital + Tier 2 Capital/Risk-Weighted Assets)×100
- Tier 1 Capital:
- Tier 1 capital, also known as the “core capital,” includes the most reliable and liquid forms of capital. Common elements of Tier 1 capital include common equity, retained earnings, and certain qualifying preferred stock.
- Tier 2 Capital:
- Tier 2 capital consists of subordinated debt, undisclosed reserves, and other less liquid forms of capital. It serves as a supplementary layer of protection for depositors and creditors in case of a bank’s financial distress.
- Risk-Weighted Assets (RWA):
- Risk-weighted assets represent a bank’s total assets adjusted for risk.
- Different categories of assets carry different risk weights, reflecting the varying degrees of risk associated with each type of asset. The risk weights are determined by regulatory authorities based on the perceived riskiness of the assets.
- Calculation Basis:
- The numerator (Tier 1 Capital + Tier 2 Capital) represents the bank’s total capital, while the denominator (Risk-Weighted Assets) adjusts this total for the riskiness of the bank’s asset portfolio. The resulting ratio is expressed as a percentage.
- Regulatory Requirement:
- Regulatory authorities, such as central banks and banking regulators, set minimum capital adequacy requirements that banks must meet. Common international standards, such as those outlined in the Basel Accords (Basel I, II, and III), provide guidelines for calculating and maintaining the Capital Adequacy Ratio.
- Minimum Requirement:
The minimum acceptable level of CAR is specified by regulators to ensure that banks have a sufficient cushion to absorb potential losses and withstand financial shocks.