Risk Indicators of Banks

Risk Indicators of Banks

Subject: Economy

Context:

GNPA ratio falls to seven-year low of 5% in Sept 2022: RBI

Details:

• The gross non-performing assets (GNPA) ratio (seven-year low) – 5 per cent in September 2022 and would reach 4.9 per cent by September 2023.
• As of September 2022, the net non-performing assets (NNPA) ratio (ten-year low) -1.3 per cent, whereas private sector banks’ (PVBs’) NNPA ratio was below 1 per cent.
• The GNPA ratios of public sector banks (PSBs) may increase from 6.5 per cent in September 2022 to 9.4 per cent in September 2023, whereas it would go up from 3.3 per cent to 5.8 per cent for private sector banks (PVBs) and from 2.5 per cent to 4.1 per cent for foreign banks (FBs), under the severe stress scenario.
• The banks are well capitalised
  • The aggregate Capital to Risk Weighted Assets Ratio (CRAR) of 46 major banks is projected to slip from 15.8 per cent in September 2022 to 14.9 per cent by September 2023.
    • It may go down to 14 per cent in the medium stress scenario and to 13.1 per cent under the severe stress scenario, which is well above the minimum capital requirement, including capital conservation buffer (CCB) requirements-11.5 per cent.
    • None of the 46 banks would breach the regulatory minimum capital requirement of 9 per cent in the next one year, even in a severely stressed situation.
  • The common equity tier-1 (CET1) capital ratio of the selected 46 banks may decline from 12.8 per cent in September 2022 to 12.1 per cent by September 2023 .
• Banks’ credit concentration – showed that in the extreme scenario of the top three individual borrowers of respective banks failing to repay, no bank will face a drop in CRAR below the regulatory requirement of 9 per cent. However, three banks would see a decline in CRAR below 11.5 per cent – the regulatory minimum inclusive of CCB.

Concept:

Capital Adequacy Ratio (CAR)

• It is the ratio of a bank’s capital to its risk. It is also known as the Capital to Risk (Weighted) Assets Ratio (CRAR).
• In other words, it is the ratio of a bank’s capital to its risk-weighted assets and current liabilities. This ratio is utilized to secure depositors and boost the efficiency and stability of financial systems all over the world.
• This is calculated by summing a bank’s tier 1 capital and tier 2 capitals and dividing the total by its total risk-weighted assets.

Capital is divided into three categories as per BASEL III norms:

• Tier 1 capital is the bank’s core capital because it is the primary measure of the bank’s financial strength. The majority of core capital is made up of disclosed reserves (also known as retained earnings) and paid-up capital. It also includes non-cumulative and non-redeemable preferred stock.
  • Tier 1 Capital is used to fund a financial institution’s business activities. It includes Common Equity Tier 1 (CET1) capital and Additional Tier 1 (AT1) capital.
    • Common Equity Tier 1 covers liquid bank holdings such as cash and stock. The CET1 ratio compares a bank’s capital against its assets.
    • Additional Tier 1 capital is composed of instruments that are not common equity.
• Tier 2 capital – It is used as supplemental funding since it is less reliable than the first tier.It consists of undisclosed reserves, preference shares, and subordinate debt.
• Tier 3 Capital: This type of capital includes market risk, commodities risk, and foreign currency risk and is the lowest quality of the three.

The capital conservation buffer

• It was introduced in Basel III to ensure that banks have an additional layer of usable capital that can be drawn down when losses are incurred. The buffer was implemented in full as of 2019 and is set at 2.5% of total risk-weighted assets.
•  It must be met with Common Equity Tier 1 (CET1) capital only, and it is established above the regulatory minimum capital requirement.
• Whenever the buffer falls below 2.5%, automatic constraints on capital distribution (for example, dividends, share buybacks and discretionary bonus payments) will be imposed so that the buffer can be replenished.