EC No.

88 / DoS - 06/ 2024 10 May 2024

Ref. No. NB. HO. DoS. Pol. / 647 / J-1 / 2024-2025

The Chairman, Regional Rural Banks

The Managing Director, All State Cooperative Banks
The Managing Director/ Chief Executive Officer,
All District Central Cooperative Banks

Madam/Dear Sir,

Guidance Note on Capital Management

As you are aware, an effective capital planning is essential alongside a strong regulatory
framework, enabling banks to ascertain the appropriate amount, type, and structure of
capital necessary to pursue their business goals while navigating stressful scenarios.
Reflecting on lessons from the global financial crisis in relation to the strengthening of
capital planning, the Basel Committee on Bank Supervision (BCBS) outlines four key
components crucial for a robust capital planning process: (i) internal control and
governance, (ii) capital policy and risk assessment, (iii) forward-looking perspective, and
(iv) management framework for capital preservation.

2. The Reserve Bank of India had been initiating number of steps to mitigate risks
faced by the banking system in India. Based on the Basel norms, the RBI also issued
capital adequacy norms for the Indian banks in the year 1998 and as per the extant
regulatory guidelines, the minimum capital adequacy as measured by capital to risk-
weighted assets ratio (CRAR) for Regional Rural Banks and Rural Co-operative Banks in
India is 9% computed based on using standardised risk weighting of assets under Basel-
I.

3. Since the capital adequacy ratio prescribed by RBI is only the regulatory minimum
level, holding additional capital might be necessary for banks, on account of (i) the
possibility of some under-estimation of risks and (ii) the actual risk exposure of a bank
vis-à-vis the quality of its risk management architecture. Consequently, it is essential for
SEs to adopt and implement more effective risk management strategies to observe and
control their risks.

राष्ट्रीर् कृवि और ग्रामीण ववकास बैंक

National Bank for Agriculture and Rural Development

पर्यवेक्षण ववभाग
प्लॉट क्र सी-24, 'जी' ब्लॉक, बाांद्रा-कुर्ाय कॉम्प्प्लेक्स, बाांद्रा (पूवय), मुांबई - 400 051. टे र्ी: +91 22 6812 0039 • फ़ैक्स: +91 22 2653 0103 • ई मेर्: [email protected]
Department of Supervision
Plot No. C-24, 'G' Block, Bandra-Kurla Complex, Bandra (E), Mumbai - 400 051 • Tel.: +91 22 6812 0039• Fax: +91 22 2653 0103 • E-mail: [email protected]
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 4. NABARD has introduced Enhanced CAMELSC (E-CAMELSC) based supervisory
approach with effect from 01 April 2023 for a set of banks based on a differentiated
approach. In tune with the changing scenario of Risk Profiling in the banking industry,
the E-CAMELSC based supervisory rating provides a forward looking, risk oriented and
data driven approach for the pre-eminent assessment of the Supervised Entities. In this
connection, Guidance notes on E-CAMELSC based approach have been issued vide
circulars no. EC No. 105/DoS-27/2023 and EC No. 106/DoS-27/2023 dated 02 June
2023 to RCBs and RRBs, respectively. The introduction of the E-CAMELSC based
supervisory approach emphasizes robust risk management systems to navigate the
dynamic banking scenario.

5. The E-CAMELSC model comprises of seven (7) key factors, i.e., Capital Adequacy,
Asset Quality, Management, Earnings, Liquidity, Systems & Controls, and Compliance.
Each of these parameters further comprises of several quantitative sub-parameters as
well as qualitative value statements. It is pertinent to note that the ‘Capital Adequacy’
aspect, which mandates that banks establish a capital management policy, along with
internal controls and procedures concerning the management of capital. Banks are now
required to enhance both the quantity and quality of their capital, highlighting the
importance of managing and efficiently utilizing equity capital to meet shareholders'
return expectations and drive optimal business decisions. In the circumstances, a need
for issuance of comprehensive guidelines on capital management was felt and accordingly
the Guidance note on Capital Management is being issued underscoring the importance
of managing and efficiently utilising equity capital.

6. Guidance note on capital management aims to encourage SEs to manage the level
of capital, through a well-defined internal process, and maintain an adequate capital
cushion for such risks. The guidance note contains guidance on comprehensive capital
management policy, roles and responsibilities of the Board and senior management,
capital planning process, internal controls around capital management.

7. A comprehensive capital management policy is indispensable within a robust risk

management framework, aiding in determining the optimal capital level to support the
bank's risk profile. Banks are advised to develop a capital management policy and
maintain capital levels that are commensurate with their risk profiles and control
environments. Banks must ensure that the outcome of the capital management policy is
forward looking (i.e. considers a minimum of 3-years projections) and not a static capital
target. Banks must ensure that the capital management policy covers the following:

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 (a) A business plan and evaluation of short-term and long-term capital needs.
(b) All material risks and potential vulnerability to its business and operational
environment.
(c) Capital requirements in benign and adverse forward-looking environments; and
considers capital buffers during benign conditions to help meet any surge in
capital demand under adverse conditions.
(d) Rigorous stress-testing and scenario analysis that identifies possible events or
changes in market conditions that could adversely impact the bank; and
(e) Results of stress tests and analyses are incorporated, where applicable, into the
capital adequacy assessment.

8. We advise that all RRBs, all scheduled StCBs, and other SEs with over Rs. 3000
crores in business size by 31 March 2024, will undergo E-CAMELSC based supervisory
approach based on their financial position by the same date. The remaining banks will
be brought under E-CAMELSC approach in a phased manner. The SEs covered under E-
CAMELSC based supervisory approach are advised to put in place effective and robust
capital management by 30 September 2024.

9. Remaining banks are advised to put in place effective capital management

framework by 31 March 2025.

10. We shall be glad if you will place a copy of this circular before the next meeting of
the Board of Directors of your bank so as to take a suitable decision on implementation
of the guidelines in your bank.

11. Please acknowledge the receipt of this circular to NABARD Regional Office in your
State/ UT.

Yours faithfully

Sd/-
(Sudhir Kumar Roy)
Chief General Manager

Encl: Guidance note

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 Main Document

Document title Guidance Note on Capital Management

Drafted by Department of Supervision
Date of approval 26 March 2024
Document classification External
Document no. / Version no. 1.0

Version history
Version No. FY Changes / Comments Changed by
1.0 2024-25 New -

Version Approval
Date of Changes /
Version No. Approved by
approval Comments
1.0 2024-25 New Board of Supervision

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 Guidance Note
on
Capital Management
Table of Contents

1. General Description ...................................................................................................... 1

2. Objective........................................................................................................................... 1

3. Capital Management Policy ......................................................................................... 1

4. General Requirements ................................................................................................. 2

5. Roles and Responsibilities of Board and Senior Management .......................... 4

6. Development and Dissemination of Internal Limits ............................................ 6

7. Development of Capital Management Framework ............................................... 7

7.1 Capital Budgeting .................................................................................................. 9

7.2 Capital Planning .................................................................................................... 9
7.3 Capital Adequacy ................................................................................................. 10
8. Internal Controls and Governance .......................................................................... 10
 Guidance Note on Capital Management for Supervised Entities (SEs)

1. General Description

An important lesson drawn from the 2008 financial crisis underscores the
requirement for banking institutions (“banks”) to strengthen their capital planning
and management frameworks. Capital management involves the implementation of
measures by banks to uphold adequate capital levels, evaluate internal capital
sufficiency, and compute the capital adequacy ratio. It is of utmost importance for
banks to calculate this ratio and procure adequate capital to mitigate risks, thereby
fostering the establishment of a robust capital management system. This approach is
vital for ensuring the resilience and suitability of the bank's operations.

2. Objective

This guidance note outlines sound practices for banks to enhance their capital
planning and management. Adhering to these practices can assist banks in preventing
breaches of statutory capital requirements and in preparing for future capital needs.
By implementing these guidelines, banks can promptly and efficiently address any
adverse changes in their capital ratios, such as falling below regulatory or internal
thresholds.

3. Capital Management Policy

A capital management policy serves as a crucially important written agreement among

a bank's senior management, delineating the principles and procedures guiding the
effective utilization, allocation, and oversight of the institution's capital resources.

This policy necessitates approval from the bank's Board and should manifest as a
distinct, comprehensive document, encompassing the fundamental elements of the
bank's capital planning processes. Furthermore, it ought to interlink with and draw
support from other pertinent policies, such as risk management protocols and
operational manuals.

Capital management policy is used by banks for capital planning, issuance, usage and
distributions. It should include internal capital goals; strategies for addressing
potential capital shortfalls; and internal governance procedures around capital
management policy.

In detail, the policy should outline the mechanisms through which the bank
supervises, evaluates, and decides on all aspects of capital planning. Moreover, it must

1
delineate the roles and responsibilities of decision-makers, establish robust process
and data controls, and stipulate expectations for the content of the bank's capital plan.

The policy should articulate specific targets for capital levels and composition,
elucidating the bank's objectives in capital management and its alignment with
maintaining a resilient capital position, especially during stress periods.

The policy should provide insights into how management ascertains the
appropriateness, sustainability, and consistency of capital ratios vis-à-vis the bank's
objectives and business model. It should also prescribe the capital metrics that senior
management and the board ought to monitor regularly.

A thorough and comprehensive capital management policy forms an integral pillar of

a robust risk management framework, aiding in determining the optimal capital levels
necessary to adequately support the bank's risk profile.

Contents of Capital Management Policy

Banks must develop a capital management policy that is commensurate with the
nature, size, complexity and scale of the bank’s activities and includes clear statements
on the following matters:

1. The roles and responsibilities of the Board and the senior management
regarding capital management
2. The bank’s risk appetite statement and capital adequacy objectives
3. Organizational frameworks concerning capital management
4. Process for maintaining sufficient capital
5. Internal and regulatory capital limits
6. Calculation of the capital adequacy ratio
7. Assessment, monitoring and control of capital adequacy levels
8. The actions the bank will take in the event of breaching a capital goal
9. Policy on capital allocation process
10. The process of Board level discussions for revision of capital needs or targets

4. General Requirements

4.1 Capital Management to be a Board-approved process

The ultimate responsibility for designing and implementation of the capital

management lies with the board of directors of the bank. The structure, design and
contents of a bank’s capital management policy should be approved by the board of
directors to ensure that the capital management forms an integral part of the
management process and decision-making culture of the bank. Since, a sound risk

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management process provides the basis for ensuring that a bank maintains adequate
capital, its board of directors shall ensure that the bank has an appropriate strategic
plan in place, which, as a minimum, shall duly outline the bank’s:
a. Current and future capital needs
b. Anticipated capital expenditure
c. Desired level of capital

4.2 Submission of the Outcome of Capital Management to the Board

As capital management is an ongoing process, a written record on the outcome of the

capital management should be periodically submitted by the banks to their board of
directors. Such written record of the internal assessment of its capital adequacy should
include, inter alia, the risks identified, the manner in which those risks are monitored
and managed, the impact of the bank’s changing risk profile on the bank’s capital
position, details of stress tests/scenario analysis conducted and the resultant capital
requirements. The reports shall be sufficiently detailed to allow the board of directors
to evaluate the level and trend of material risk exposures, whether the bank maintains
adequate capital against the risk exposures and in case of additional capital being
needed, the plan for augmenting capital. The board of directors would be expected to
make timely adjustments to the strategic plan, as necessary.

4.3 Review of the Capital Management Outcomes

The board of directors shall, at least once a year, assess and document whether the
processes relating to the capital management policy implemented by the bank
successfully achieved the objectives envisaged by the board. The senior management
should also receive and review the reports regularly to evaluate the sensitivity of the
key assumptions and to assess the validity of the bank’s estimated future capital
requirements. In the light of such an assessment, appropriate changes in the capital
management should be instituted to ensure that the underlying objectives are
effectively achieved.

4.4 Forward-looking Approach

Banks must ensure that the outcome of capital management is forward looking (i.e.
considers a minimum of three years projections) and not a static capital target. A
forward-looking approach in capital management policy involves anticipating future
financial needs and planning accordingly to ensure the availability of adequate capital
resources. It involves assessing potential risks and opportunities, setting strategic
goals, and implementing measures to optimize the allocation and utilization of capital
resources to support future business growth and sustainability. This approach

3
typically involves forecasting future cash flows, evaluating investment opportunities,
managing debt levels, and maintaining appropriate levels of liquidity to meet future
obligations.

4.5 Risk-based Approach

A risk-based approach in formulating capital management policy involves assessing

and managing various types of risks that a company may face, such as credit risk,
market risk, liquidity risk, and operational risk. In this approach, the bank identifies
and evaluates its risk exposures, determines the level of risk tolerance, and establishes
appropriate capital buffers to absorb potential losses. The policy may include stress
testing to assess the impact of adverse scenarios on the bank’s financial position and
capital adequacy.

Additionally, it may involve implementing risk mitigation strategies, such as

diversification of investments, hedging techniques, and setting aside reserves to cover
unexpected losses.

Overall, the goal is to ensure that the bank maintains sufficient capital to withstand
potential risks and uncertainties while pursuing its strategic objectives.

4.6 Conduct of Stress Tests and its Utilisation

As part of capital management, the management of a bank shall, as a minimum,

conduct relevant stress tests periodically, particularly in respect of the bank’s material
risk exposures, in order to evaluate the potential vulnerability of the bank to some
unlikely but plausible events or movements in the market conditions that could have
an adverse impact on the bank. The use of stress testing framework can provide a
bank’s management a better understanding of the bank’s likely exposure in extreme
circumstances.

In this context, the attention is also invited to the guidelines issued in this regard. The
banks are urged to take necessary measures so that results of stress tests and analyses
are incorporated, where applicable, into the capital adequacy assessment.

5. Roles and Responsibilities of Board and Senior Management

For a capital planning process to be meaningful, a bank’s senior management and

directors should rely on it to provide them with views of the degree to which a bank’s
business strategy and capital position may be vulnerable to unexpected changes in
conditions.

4
Sound practice entails senior management and the board of directors ensuring that
the capital policy and associated monitoring and escalation protocols remain relevant
alongside an appropriate risk reporting and stress testing framework.

In formulating the capital management policy in a bank, the roles and responsibilities
of the Board of Directors and senior management are crucial and are summarised
below:

Board of Directors

• Setting Strategic Direction: The board sets the overall strategic direction for
the bank, including its capital management objectives and risk appetite.
• Approving Policy Framework: The board approves the capital management
policy framework, which outlines the principles, guidelines, and procedures for
managing capital.
• Oversight and Review: The board provides oversight and periodically reviews
the effectiveness of the capital management policy in achieving strategic goals
and managing risks.
• Ensuring Compliance: The board ensures that the bank complies with
regulatory requirements related to capital adequacy and capital management
practices.
• Risk Oversight: The board oversees the bank’s risk management practices,
including those related to capital adequacy, and ensures that appropriate risk
management processes are in place.

Senior Management

• Implementation: Senior management is responsible for implementing the

capital management policy approved by the Board.
• Risk Assessment: Senior management conducts ongoing risk assessments to
identify and evaluate capital-related risks, including credit risk, market risk,
liquidity risk, and operational risk.
• Capital Planning: Senior management develops and executes capital planning
strategies to ensure that the bank maintains adequate capital levels to support
its business activities and regulatory requirements.
• Reporting and Disclosure: Senior management is responsible for reporting on
capital adequacy and related risks to the board, regulators, and other
stakeholders. This includes providing accurate and timely disclosures in
financial reports and regulatory filings.
• Monitoring and Review: Senior management monitors the bank’s capital
position and performance against established targets and takes corrective

5
 actions as needed. This may involve adjusting capital allocation, capital-raising
activities, or risk management practices.

Overall, the board and senior management work together to establish a robust capital
management framework that aligns with the bank’s strategic objectives, complies with
regulatory requirements, and effectively manages capital-related risks. A detailed role
and responsibilities of board and management are given in Annexure I.

6. Development and Dissemination of Internal Limits

Banks should ensure that all risks are appropriately accounted for when assessing
capital requirement. In designing and implementing a capital management policy for
a bank, the development and dissemination of internal limits play a crucial role. Bank
should put in place a risk appetite and its limit framework for capital which sets hard
limits on balance sheet and RWAs consumption, among others. The following steps
need to be followed:

Establish a Risk Appetite Framework

• Define the bank’s risk appetite, considering factors such as its business strategy,
risk tolerance, regulatory requirements, and market conditions.
• Engage the board of directors, senior management, and key stakeholders in the
development of the risk appetite framework to ensure alignment with the
bank’s objectives and values.

Identify Key Capital Management Metrics

• Determine the key metrics and indicators that will be used to monitor and
manage capital adequacy, such as capital ratios, liquidity measures, leverage
ratios, and risk-weighted assets.
• Consider regulatory requirements, industry best practices, and the bank’s
specific risk profile when selecting these metrics.

Set Internal Limits

• Based on the risk appetite framework and identified metrics, establish internal
limits for each key aspect of capital management.
• Ensure that internal limits are clear, measurable, and enforceable, taking into
account the bank’s risk profile, business activities, and strategic objectives.
• Involve risk management experts, finance professionals, and relevant
stakeholders in the process of setting internal limits to ensure robustness and
accuracy.

6
Document Internal Limits

• Document the internal limits in the capital management policy and other
relevant policy documents.
• Clearly articulate the rationale behind each limit, the process for monitoring
and enforcing them, and the consequences of breaching the limits.
• Ensure that the documentation is accessible to all relevant stakeholders within
the organization, including board members, senior management, risk
managers, and front-line staff.

Communicate and Disseminate Internal Limits

• Develop a communication plan to effectively disseminate internal limits

throughout the organization.
• Conduct training sessions and workshops to educate staff members on the
internal limits and their implications for the bank’s operations.
• Use multiple communication channels, such as internal memos, training
materials, intranet portals, and town hall meetings, to reach different segments
of the organization.
• Encourage open dialogue and feedback from staff members to ensure
understanding and buy-in.

Monitor, Review, and Adjust

• Implement robust monitoring and reporting mechanisms to track compliance

with internal limits and identify any breaches or exceptions.
• Conduct regular reviews of internal limits to assess their effectiveness in
managing capital-related risks and achieving strategic objectives.
• Be prepared to adjust internal limits as necessary based on changes in the
bank’s risk profile, regulatory requirements, market conditions, or business
strategy.

By following these steps, the bank can effectively design and implement internal limits
as part of its capital management policy, ensuring prudent risk management and
alignment with strategic goals.

7. Development of Capital Management Framework

The bank's business strategy for the current year and the next three years should align
with the capital management process. Capital management involves assessing future
capital requirements, optimizing return on capital, and allocating capital across
various channels. The bank should develop a framework for capital management

7
through establishment of risk appetite, internal limits on capital, comprehensive
capital planning process and assessment of capital adequacy.

Capital management should be an integral part of the management and decision-

making culture of a bank.

The bank’s business strategy for the year and plan for next 3 years should be aligned
with capital management process. The business strategy of the bank may be based on
targets on profit, net income, growth in loans and advances, growth in deposits.
Alternatively, banks may track profitability ratio such as return on equity, return on
total assets, return on average working fund, etc. The bank should align the capital
management decisions with the strategic plan set by the board.

The cycle that links bank strategy, capital budgeting and capital allocation with
performance measurement is shown below:

Bank
strategy

Performance Capital
measurement budgeting

Capital
allocation

Management of capital involves the aspects related with an assessment of capital

requirements with a futuristic outlook, return on capital, and allocation of capital
through various channels.

Alignment of Strategy with Capital Management

Capital budgeting

Capital planning

Capital adequacy

Internal controls & governance

8
7.1 Capital Budgeting

Banks translate their strategic plans into detailed capital budgets. A bank’s strategic
plan sets out the strategy such as where to grow, which businesses to downsize and
where to make strategic investments to secure future, profitable growth.

7.2 Capital Planning

Banks with sound capital planning processes should have a formal process in place to
identify situations where competing assumptions are made. Capital planning process
involves planning of level of internal capital to be maintained, composition of capital,
avenues for raising capital, allocation of capital and usage of capital. The planning
process also entails plan for distribution of surplus to shareholder / members.

The bank’s capital plan should aim at the sound practice of producing an internally
consistent and coherent view of a bank’s current and future capital needs. The capital
planning process forecasts capital requirements for determining optimum levels
capital.

Capital planning process should reflect inputs of different experts from across a bank,
including but not limited to staff from business, risk, finance and treasury
departments.

Key elements to include in the capital plan are:

1. Summary of bank’s business strategy.

2. Narrative on the business, local market and economic scenario for the next five
years.
3. Analysis of the balance sheet and profitability.
4. Assessment of key risks and uncertainties, including credit, interest rate,
liquidity, price, operational, compliance, strategic, and reputation.
5. Summary of key capital policies, including dividends and capital adequacy
6. Sources, cost, availability of capital

Develop an internal strategy for maintaining capital levels which must not only reflect
the desired level of risk coverage, but also incorporate factors such as portfolio growth
expectations, future sources and uses of funds, and dividend policy. Banks must state
their objectives in deciding how much capital to hold. Banks must ensure that the
capital objectives go beyond the regulatory minimum to support risks and to consider
the following:

a. Fluctuations in capital adequacy ratios, because of changes in type and volume

of activities and risk exposures in the normal course of business.
9
 b. Cost of capital-raising, especially in situations where capital injections need to be
carried out quickly, or at a time when market conditions are unfavorable.
c. Potential breach of the minimum regulatory capital requirements and regulatory
actions in such an event.
d. Limitations in risk assessment infrastructure and methodologies.

An outline of capital planning process is given in Annexure II.

7.3 Capital Adequacy

Banks must ensure that adequate capital is held against all material risks not just at a
point in time, but over time, to account for changes in their strategic direction, evolving
economic conditions and volatility in the financial environment.

For instance, banks may choose to base their capital adequacy on the results of the
capital calculation (as done in capital planning process) combined with the additional
capital for significant & material risks (e.g. credit risk, operational risk, market risk,
etc.) assessed separately and added to the existing level of capital.

8. Internal Controls and Governance

8.1 System for Internal Regulation of Capital

The board shall specify matters or events that require reporting and those that require
approval. The board shall ensure that the senior management reports to them, without
delay, any matters that would seriously affect capital management.

The board must regularly and timely enable the appropriate assessment and judgment
of the matters listed below:

• The levels and trends of major risks and their impact on the bank’s capital.
• The definition of capital and the methods of determining the range of risks
to be covered by capital management and evaluating such risks.
• Status of internal capital adequacy in light of the scale and nature of the
bank’s business and its risk profile.
• Consistency among the capital level, objectives and the risk profile.
• Necessity for revising capital plans.

8.2 Independent validations

The bank may involve exposing capital plans and their underlying processes and
models to regular independent validation. This layer of review is important for

10
confirming that the processes are strong, are applied consistently and remain relevant
for the bank’s business model and risk profile.

8.3 Development of Internal Audit Guidelines & an Internal Audit Plan

The board shall form an Internal Audit Division which appropriately identifies the
matters to be audited with regard to capital management, develop guidelines that
specify the matters subject to internal audit and the audit procedure (hereinafter
referred to as “Internal Audit Guidelines”) and an internal audit plan, and form such
guidelines and plan.

The following matters shall be clearly specified in the Internal Audit Guidelines or the
internal audit plan and provide a system to have these matters appropriately audited:

• Status of development of the capital management system.

• Eligibility of the bank’s capital under regulations on capital requirements.
• Status of compliance with the capital management policy and the capital
management limits.
• Appropriateness of the internal capital adequacy assessment process
commensurate with the scale and nature of business and the risk profile.
• Validity of the internal capital adequacy assessment method (technique,
assumptions).
• Accuracy and completeness of the data used in the internal capital adequacy
assessment.
• Validity of scenarios, etc., used in stress tests.
• Appropriateness of the process of calculating the capital adequacy ratio.
• Status of improvement of matters pointed out in an internal audit or on the
occasion of the last inspection.

11
 Annexure I
Roles and Responsibilities of Board and Senior Management

a. Roles and Responsibilities of Board of Directors

• It should attach importance to capital management, fully recognizing that
the lack of such an approach could seriously hinder the attainment of
strategic objectives.
• It should establish a policy regarding capital management (hereinafter
referred to as the “Capital Management Policy”) and disseminate it
throughout the bank.
• It should oversee establishing an adequate capital management system
with a full understanding of the assessment, monitoring and control
techniques of capital adequacy.
• It shall be responsible for approving and periodically reviewing the capital
management policy of the bank.
• It shall have the overall responsibility for management of capital.
• It shall set limits in lines with the bank’s risk appetite.
• It shall decide the capital management policy of the bank and make sure
that the regulatory requirements are fulfilled.
• It shall analyse how much capital the bank needs presently and will need
in the future considering the bank’s strategic objectives and take into
consideration the desirable level of capital thus determined, the amount of
capital that must be raised to achieve that level and suitable capital-raising
methods.
• It shall ensure consistency between capital management with the bank’s
risk profile and the situation surrounding its business.
• It shall hold a management team accountable for demonstrating that
adherence to a capital management policy which will allow the bank to
maintain ready access to funding, meet its obligations to creditors and
other counterparties, and continue to serve as a credit intermediary under
normal and stress scenarios.

b. Responsibilities of Senior Management

• Senior management of a bank shall be responsible for implementing the
capital management policy approved by the board.
• They will ensure that bank personnel involved in capital management
activities have the adequate skills, including complex financial risk
management skills, and that employees are adequately enabled through
training.

1
• They will ensure that they have adequate understanding of the material
risks that are impacting the business, as well as an awareness of emerging
risks and vulnerabilities.
• They will ensure effective implementation of relevant policies, procedures,
systems and controls.
• They will ensure that they communicate the internal controls and written
policies and procedures throughout the bank.
• They will be monitoring risk exposures in accordance with the risk appetite
and limits approved by the board.
• They will ensure that the board receives adequate information pertaining
to risk management and capital management, under both normal and
stressed business conditions.
• They will be monitoring and reporting of status against ICAAP to the board.
• The roles and responsibilities of risk management, financial control and
compliance in relation to ICAAP must be clearly documented in the related
policies and procedures.

2
 Annexure II
An illustrative outline of the Capital Planning Process

1. Capital Planning Process

The board in their capital management policy shall develop capital plans designed to
achieve an appropriate level of capital targeted by the bank.

2. Contents
Capital planning process should contain the following sections:
I. Executive Summary
II. Background
III. Summary of current and projected financial and capital positions
IV. Methodologies and assumptions for capital planning
V. Aggregation and diversification

I. Executive Summary
The purpose of the executive summary is to present an overview of the capital planning
process and results. This overview would typically include:
a) The purpose of the report and the regulated entities within a banking group that are
covered by the capital planning process.
b) The main findings of the capital planning process:
i. How much and what composition of internal capital the bank considers it should
hold as compared with minimum CRAR requirement.
ii. The adequacy of the bank’s risk management processes.
c) A summary of the financial position of the bank, including the strategic position of the
bank, its balance sheet strength, and future profitability.
d) Brief descriptions of the capital raising and dividend plan including how the bank
intends to manage its capital in the days ahead and for what purposes.

1
e) Commentary on the most material risks to which the bank is exposed, why the level of
risk is considered acceptable or, if it is not, what mitigating actions are planned.
f) Commentary on major issues where further analysis and decisions are required.
g) Who has carried out the assessment, how it has been challenged / validated / stress
tested, and who has approved it.

II. Background
This section would cover the relevant organisational and historical financial data for the
bank, operating profit, profit before tax, profit after tax, dividends, shareholders’ funds,
capital funds held vis-à-vis the regulatory requirements, customer deposits, deposits by
banks, total assets, and any conclusions that can be drawn from trends in the data which
may have implications for the bank’s future.
Definition of Capital
It would be necessary to clearly spell out in the document whether what is being presented
represents the bank’s view of the amount of capital required to meet minimum regulatory
needs or whether it represents the amount of capital that a bank believes it would need to
meet its business plans. For instance, it should be clearly brought out whether the capital
required includes buffers for strategic purposes or seeks to minimise the chance of
breaching regulatory requirements.
If the bank uses the regulatory own funds as a starting point for its internal capital
definition, it is expected that a large part of internal capital components will be expressed
in Common Equity Tier 1 (CET1) own funds.
Banks may, however, for the purpose of allocation, make certain simplification
adjustments to the way CET1 capital is calculated for regulatory purposes. One example
of those adjustments is to not use the same deductions as specified in the regulatory
framework or not make any deductions at all when computing allocated CET1 capital.

III. Summary of current and projected financial and capital positions

This section would explain the present financial position of the bank and expected
changes to the current business profile, the environment in which it expects to operate,
its projected business plans (by appropriate lines of business), projected financial
position, and future planned sources of capital.
The starting balance sheet used as reference and date as of which the assessment is carried
out should be indicated.

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The projected financial position could reckon both the projected capital available and
projected capital requirements based on envisaged business plans. These might then
provide a basis against which adverse scenarios might be compared.

IV. Methodologies and assumptions for capital planning

There are multiple approaches a bank may adopt for capital planning process. A
description of methodology adopted by bank for assessment and planning of capital along
with main assumptions made may be provided.

Risk-weighted Asset (RWA) based

Risk-based capital requirements specify the amount of capital that banks need to have,
based on their RWAs. Banks may also maintain additional CET1 capital to cover the
deterioration in their capital positions under stress situations.
Under the RWAs-based approach, the amount of CET1 capital to be maintained is
determined on the basis of their RWAs usage. The advantage of this approach is the ease
of use and transparency. Given that banks already calculate RWAs at the granular level of
individual assets and exposures and have well-embedded RWAs reporting capabilities,
RWAs lend themselves well to an allocation mechanism that can be applied at all levels of
the organisation. The product / sector returns can also be easily aligned with the targets
set under the banks’ overall Return on Equity (RoE), Return on Capital Employed (RoCE)
and Return on Total Assets (RoTA).
Banks may use RWAs in their capital allocation framework either as a standalone metric
or in combination with other regulatory metrics. Among banks that use RWAs as a
standalone metric, some choose to allocate to business lines only the minimum
component of their risk-based capital requirements. Others have opted to allocate all the
components of their regulatory capital requirements, i.e. capital buffers as well. This aims
to make business lines accountable for the full suite of regulatory capital requirements
that banks have to meet.
Banks determine a target CET1 capital ratio as part of their business strategy. A target
capital ratio is the level of capital ratio that banks aim to maintain in normal conditions.
They take into account all of the components of the risk-based CET1 requirements
including regulatory capital buffers as well as an internal operating buffer to determine
this target ratio. The internal operating buffer is an additional capital buffer determined
by banks’ management to avoid falling below the regulatory capital requirements because
of unexpected fluctuations in the equity capital due to market-related factors.

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Figure 1 depicts an example in which a bank uses RWAs as a standalone metric to
allocate CET1 capital. In this example, we have assumed for simplicity that the bank’s
CET1 target capital ratio is 10% of RWAs.

Return on
Allocated capital
Capital
employed

RWA Profit
(Rs. 100) (Rs. 2)

Capital
Target ratio (Rs. 10)
10%

Rs. 10 20%

This target capital ratio is applied to the RWAs consumed by various sectors that the bank
operates in, to determine the CET1 capital allocated to them. If the RWAs consumed by a
sector are Rs. 100 and the profits it generates are Rs. 2, the CET1 capital allocated would
be Rs. 10 (Rs. 100 *10%) and the return on the capital allocated would be 20% (Rs. 2 /Rs.
10*100)
The advantage of using this approach is its transparency and its linkage to the bank-wide
target for RoE / RoCE / RoTA. However, if the bank has significantly higher levels of CET1
capital compared to its RWAs-based requirement, it will need to adjust the target return
on CET1 capital allocated for each sector to ensure that the bank-wide RoE target is met.

V. Aggregation and diversification

This section would describe how the results of the various separate risk assessments are
brought together and an overall view taken on capital adequacy. At a technical level, this
would, therefore, require some method to be used to combine the various risks using
some appropriate quantitative techniques. At the broader level, the overall

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reasonableness of the detailed quantification approaches might be compared with the
results of an analysis of capital planning and a view taken by senior management as to
the overall level of capital that is considered appropriate.
In undertaking an overall assessment, the bank should describe how it has arrived at its
overall assessment of the capital it needs taking into account such matters as:
i) The inherent uncertainty in any modelling approach.
ii) Weaknesses in the bank’s risk management procedures, systems or controls.
iii) The differences between regulatory capital and internal capital.
iv) The differing purposes that capital serves: shareholder returns, rating
objectives for the bank as a whole or for certain debt instruments the bank has
issued, avoidance of regulatory intervention, protection against uncertain
events, depositor protection, working capital, capital held for strategic
acquisitions, etc.