Capital Adequacy Ratio of Zam Bank – A case Study

By Prof Kamal Kishore

1. Zam bank is a well known bank in India. Though its operations are small, it has good
presence in urban areas and has 463 branches. It is a private sector bank owned by
Manav group who have interest in varied group of business in financial sector
including Mutual Funds, Insurance, Housing finance, NBFC etc. Mr Prakash Dave is
Managing Director and it has a well diversified board of professional directors from
relevant areas. Bank’s registered office is in Gurgaon. It has also 11 foreign branches.

2. RBI has laid down an elaborate capital adequacy framework for banks in India in line
with Basel III norms. Bank assets are risky and any potential losses are to be absorbed
by capital. The capital should be such that it has loss absorption features built into it
and it can be used in time of crisis. During financial crisis of 2008-09, it was
experienced that many banks did not have adequate capital that could be used for loss
absorption. As a result, many banks became bankrupt or had to receive capital funds
from Governments to survive. Questions were raised on the quality of capital
elements in banks’ balance sheet. After protracted deliberations at Basel Committee
on Bank Supervision, new capital framework called Basel III was evolved which is
currently in vogue. The capital elements included for capital measure are those which
are embedded with strong loss absorption features at specified trigger points. The
most desirable component is common equity and banks are expected to possess
maximum amount of it. Some non equity elements are included. Students are advised
to refer to RBI Circular for various capital elements and their characteristics for
inclusion for CAR purposes.

3. The measure of capital required for banks is capital adequacy ratio, which is
internationally recognized parameter for soundness and resilience of banks. Capital
has to adequate to absorb losses represented by assets after converting them to risk
weighted assets by application of risk weights. The risk weights depend upon the
riskiness of asset measured by nature of asset and its counterparty and are prescribed
by RBI. Bank management have to be circumspect in applying risk weight not merely
go by numbers given in RBI guidelines. They have to seriously evaluate the overall
quality of assets and its risk characteristics to determine a rational risk element of the
assets concerned. CAR is thus measured as:

CAR = Capital Funds/ Risk weighted assets (expressed as %)

Capital Funds = Common equity Tier 1 +Additional tier 1 + Tier 2

The prescribed CAR in India is 9%, with Common Equity CAR at 5.5% and
Additional Tier CAR at 1.5% (max).
4. According to the framework, banks are required to maintain a total CAR 0f 9% with
Common equity CAR at 5.5 % and Tier 1 CAR at 7%. The Additional Tier 1 Capital
can not exceed 1.5% of total Risk weighted assets (RWAs).

5. Leverage ratio: Basel III introduced another ratio, Leverage ratio, calculated as
proportion of Tier 1 capital to Exposure (assets without risk factoring). It is a
supplementary measure to CAR and reflects built up of excessive leverage while
showing strong capital ratios. This exposes the risk innovations banks are used to
factor in their calculation of risk weighted assets. Both ratios are examined in
conjunction to understand risk profile of bank assets and adequacy of available capital
in relation to it.

6. Components of Capital of Zam Bank are as under:

Rs in cr Rs in cr
Paid up Equity Capital 2500 General provisions 3800
Redeemable non 1900 Perpetual Debt 1300
cumulative pref shares Instruments

Revaluation Reserves 3400 Premium on Redeemable 1200

shares
Cumulative Preference 1400 Capital Reserves 400
shares

Subordinate Debt – 240 Debt instruments ( initial 2000

(due after 5 months) maturity- 4 yrs)
Statutory Reserves 1200 Equity share premium 2300

7. According to RBI guidelines, bank assets are subject to risk and while calculating risk
weighted assets for CAR purpose, it needs to provide risk weights as prescribed in
capital regulations. Risk weights are to be provided to both balance sheet and off
balance sheet items or contingent liabilities. Currently , risk weights for balance sheet
assets are as under:

Assets Risk weight (%)

Cash and bank balance : 0
Balance with RBI : 0
State Govt. Securities : 50
Corporate Loans : 100
Loans to Govt 10
Housing Loans : 80
Staff Loans : 20
8. The Bank has following assets:

Assets Rs cr
Cash and bank balance : 10500
Balance with RBI : 1500
State Govt. Securities : 13500
Housing Loans : 4000
Corporate Loans : 12300
Staff Loans : 250
Loans to Govt : 1200

9. Banks take exposure in various contingent liabilities. These are liabilities which are
not yet crystallised. Their existence depends upon occurrence or non occurrence of
some events. These liabilities also constitute risk for banks and RBI has been
exhorting banks from time to time to reduce them to reasonable level. Risk weighting
of contingent liabilities is don in a different manner. Firstly all such liabilities are
translated to credit exposure by applying credit conversion factor and then risk
weights are applied to credit equivalents so derived.

10. Zam Bank has following Contingent liabilities:

Guarantees given on behalf of Central Govt.: Rs. 1500 cr,

Letters of Credit issued: Rs. 560 cr,
Unpaid Amount on investments: Rs. 500 cr,
Underwriting obligations: Rs. 140 cr

The regulation provides for credit conversion factor for contingent liabilities at 110%
except for Underwriting obligations where it is 60%. The risk weights for all
Contingent liabilities have to be provided at 90% except 110% for guarantees.

11. Students should get famliarised with capital framework of Zam Bank and compute
following and comment on it:

(a) Classify bank capital components into Common Equity Tier 1, Additional Tier 1
and Tier 2 capital.
(b) Calculate Risk weighted Assets of Bank.
(c) Compute RWAs on account of Contingent liabilities of bank
(d) Compute CAR for common equity Tier1, and Total CAR
(e) Compute Leverage ratio of Zam Bank.