Context:
Shapoorji Pallonji Group has asked the Reserve Bank of India (RBI) to give its unit, Sterling Investment Corp, three years to meet enhanced capital adequacy norms in relation to a recent bond issue, said people with knowledge of the matter.
What is Capital Adequacy Ratio (CAR)?
The Capital Adequacy Ratio (CAR) is a key financial metric used to assess a bank’s ability to withstand financial stress by maintaining sufficient capital reserves. It is a regulatory requirement that ensures banks can absorb potential losses while continuing to operate, thereby protecting depositors and maintaining financial system stability.
Key Features of CAR:
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- Reflects a bank’s financial strength and risk management capability.
- Ensures banks maintain capital buffers against possible losses.
- Higher CAR means lower risk of insolvency.
- Enforced by central banks and regulators to promote a stable banking sector.
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Components of CAR
- Tier 1 Capital (Core Capital):
- Absorbs losses while the bank continues to function.
- Includes: Equity share capital, retained earnings, disclosed reserves.
- Tier 2 Capital (Supplementary Capital):
- Absorbs losses in case of a bank’s winding up.
- Includes: Revaluation reserves, hybrid instruments, subordinated debt.
- Risk-Weighted Assets (RWA):
- Assets adjusted for credit, market, and operational risks.
- Not all assets carry the same risk—this calculation ensures a more accurate risk assessment.
CAR Requirements in India (as per RBI norms):
- 12% for Indian Public Sector Banks
- 9% for Indian Scheduled Commercial Banks
(Note: These are above the Basel III minimum requirement of 6%, reflecting India’s cautious regulatory stance.)
Why is CAR Important?
- Ensures Financial System Stability: Limits risk exposure, preventing systemic collapses.
- Protects Depositors’ Interests: Banks can honor withdrawals even during stress.
- Avoids Economic Disruptions: Minimizes the chance of a banking crisis.
- Compliance with Global Standards: CAR is a key component of Basel III regulations, which aim to enhance bank capital adequacy, stress testing, and liquidity management.
