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8.28 ADVANCED ACCOUNTING 
 
LEARNING OUTCOMES 
UNIT 3:  CAPITAL ADEQUACY NORMS 
 
 
After studying this unit, you will be able to: 
? Definitions of capital funds (Tier I & Tier II) and minimum 
capital requirement,  
? Technique of computing weightage for the purpose of capital 
adequacy norms 
 3.1  CAPITAL FRAMEWORK OF BANKS 
FUNCTIONING IN INDIA 
Capital adequacy is used to describe adequacy of capital resources of a bank in 
relation to the risks associated with its operations.  
Capital Adequacy Ratio (CAR) 
The Basel Committee on Banking Supervision had published the first Basel Capital 
Accord (popularly called as Basel I framework) in July, 1988 prescribing minimum 
capital adequacy requirements in banks for maintaining the soundness and stability 
of the International Banking System and to diminish existing source of competitive 
inequality among international banks. After Basel I framework, Basel II norms were 
released.  The main objectives of Basel committee were: 
(i) to stop reckless lending by bank  
(ii) to strengthen the soundness and stability of the banking system and  
(iii)  to have a comparative footing of the banks of different countries. 
With a view to adopting the Basel Committee on Banking Supervision (BCBS) 
framework on capital adequacy which takes into account the elements of credit risk 
in various types of assets in the balance sheet as well as off-balance sheet business 
and also to strengthen the capital base of banks, Reserve Bank of India decided in 
April 1992 to introduce a risk asset ratio system for banks (including foreign banks) 
Page 2


  
8.28 ADVANCED ACCOUNTING 
 
LEARNING OUTCOMES 
UNIT 3:  CAPITAL ADEQUACY NORMS 
 
 
After studying this unit, you will be able to: 
? Definitions of capital funds (Tier I & Tier II) and minimum 
capital requirement,  
? Technique of computing weightage for the purpose of capital 
adequacy norms 
 3.1  CAPITAL FRAMEWORK OF BANKS 
FUNCTIONING IN INDIA 
Capital adequacy is used to describe adequacy of capital resources of a bank in 
relation to the risks associated with its operations.  
Capital Adequacy Ratio (CAR) 
The Basel Committee on Banking Supervision had published the first Basel Capital 
Accord (popularly called as Basel I framework) in July, 1988 prescribing minimum 
capital adequacy requirements in banks for maintaining the soundness and stability 
of the International Banking System and to diminish existing source of competitive 
inequality among international banks. After Basel I framework, Basel II norms were 
released.  The main objectives of Basel committee were: 
(i) to stop reckless lending by bank  
(ii) to strengthen the soundness and stability of the banking system and  
(iii)  to have a comparative footing of the banks of different countries. 
With a view to adopting the Basel Committee on Banking Supervision (BCBS) 
framework on capital adequacy which takes into account the elements of credit risk 
in various types of assets in the balance sheet as well as off-balance sheet business 
and also to strengthen the capital base of banks, Reserve Bank of India decided in 
April 1992 to introduce a risk asset ratio system for banks (including foreign banks) 
 
 
 8.29 
 
BANKING COMPANIES 
in India as a capital adequacy measure. Having regard to the necessary upgradation 
of risk management framework as also capital efficiency likely to accrue to the 
banks by adoption of the advanced approaches envisaged under the Basel II 
Framework and the emerging international trend in this regard, in July 2009 it was 
considered desirable to lay down a timeframe for implementation of the advanced 
approaches in India. 
Consequently, the Basel Committee on Banking Supervision (BCBS) released 
comprehensive reform package entitled “Basel III: A global regulatory framework 
for more resilient banks and banking systems” (known as Basel III capital 
regulations) in December 2010. Basel III reforms strengthen the bank -level i.e. 
micro prudential regulation, with the intention to raise the resilience of individual 
banking institutions in periods of stress. These new global regulatory and 
supervisory standards mainly seek to raise the quality and level of capital to ensure 
banks are better able to absorb losses on both a going concern and a gone concern 
basis, increase the risk coverage of the capital framework, introduce leverage ratio 
to serve as a backstop to the risk-based capital measure, raise the standards for the 
supervisory review process etc. Reserve Bank issued Guidelines based on the Basel 
III reforms on capital regulation on May 2, 2012, to the extent applicable to banks 
operating in India. The Basel III capital regulations have been implemented from 
April 1, 2013 in India in phases.  
NOTE: The capital adequacy norms given in this unit are as per existing Basel II norms. 
RBI requires Banks to maintain minimum capital risk adequacy ratio of 9 % on an 
ongoing basis
?
.  
Every bank should maintain a minimum capital adequacy ratio based on capital 
funds and risk assets. As per the prudential norms, all Indian scheduled commercial 
banks (excluding regional rural banks) as well as foreign banks operating in India 
are required to maintain capital adequacy ratio (or capital to Risk Weighted Assets 
Ratio) which is specified by RBI from time to time.  At present capital adequacy 
ratio is 9%. 
The capital adequacy ratio is worked out as below: 
   
Capital fund **
Risk weighted assets + off balance sheet items
X 100 
 
?
RBI has issued a master circular No. DBOD.No.BP.BC.5/21.06.001/2014/15 dated July 1, 2014 
on “Prudential Guidelines on Capital Adequacy and Market Discipline- New Capital Adequacy 
Framework (NCAF)”. 
Page 3


  
8.28 ADVANCED ACCOUNTING 
 
LEARNING OUTCOMES 
UNIT 3:  CAPITAL ADEQUACY NORMS 
 
 
After studying this unit, you will be able to: 
? Definitions of capital funds (Tier I & Tier II) and minimum 
capital requirement,  
? Technique of computing weightage for the purpose of capital 
adequacy norms 
 3.1  CAPITAL FRAMEWORK OF BANKS 
FUNCTIONING IN INDIA 
Capital adequacy is used to describe adequacy of capital resources of a bank in 
relation to the risks associated with its operations.  
Capital Adequacy Ratio (CAR) 
The Basel Committee on Banking Supervision had published the first Basel Capital 
Accord (popularly called as Basel I framework) in July, 1988 prescribing minimum 
capital adequacy requirements in banks for maintaining the soundness and stability 
of the International Banking System and to diminish existing source of competitive 
inequality among international banks. After Basel I framework, Basel II norms were 
released.  The main objectives of Basel committee were: 
(i) to stop reckless lending by bank  
(ii) to strengthen the soundness and stability of the banking system and  
(iii)  to have a comparative footing of the banks of different countries. 
With a view to adopting the Basel Committee on Banking Supervision (BCBS) 
framework on capital adequacy which takes into account the elements of credit risk 
in various types of assets in the balance sheet as well as off-balance sheet business 
and also to strengthen the capital base of banks, Reserve Bank of India decided in 
April 1992 to introduce a risk asset ratio system for banks (including foreign banks) 
 
 
 8.29 
 
BANKING COMPANIES 
in India as a capital adequacy measure. Having regard to the necessary upgradation 
of risk management framework as also capital efficiency likely to accrue to the 
banks by adoption of the advanced approaches envisaged under the Basel II 
Framework and the emerging international trend in this regard, in July 2009 it was 
considered desirable to lay down a timeframe for implementation of the advanced 
approaches in India. 
Consequently, the Basel Committee on Banking Supervision (BCBS) released 
comprehensive reform package entitled “Basel III: A global regulatory framework 
for more resilient banks and banking systems” (known as Basel III capital 
regulations) in December 2010. Basel III reforms strengthen the bank -level i.e. 
micro prudential regulation, with the intention to raise the resilience of individual 
banking institutions in periods of stress. These new global regulatory and 
supervisory standards mainly seek to raise the quality and level of capital to ensure 
banks are better able to absorb losses on both a going concern and a gone concern 
basis, increase the risk coverage of the capital framework, introduce leverage ratio 
to serve as a backstop to the risk-based capital measure, raise the standards for the 
supervisory review process etc. Reserve Bank issued Guidelines based on the Basel 
III reforms on capital regulation on May 2, 2012, to the extent applicable to banks 
operating in India. The Basel III capital regulations have been implemented from 
April 1, 2013 in India in phases.  
NOTE: The capital adequacy norms given in this unit are as per existing Basel II norms. 
RBI requires Banks to maintain minimum capital risk adequacy ratio of 9 % on an 
ongoing basis
?
.  
Every bank should maintain a minimum capital adequacy ratio based on capital 
funds and risk assets. As per the prudential norms, all Indian scheduled commercial 
banks (excluding regional rural banks) as well as foreign banks operating in India 
are required to maintain capital adequacy ratio (or capital to Risk Weighted Assets 
Ratio) which is specified by RBI from time to time.  At present capital adequacy 
ratio is 9%. 
The capital adequacy ratio is worked out as below: 
   
Capital fund **
Risk weighted assets + off balance sheet items
X 100 
 
?
RBI has issued a master circular No. DBOD.No.BP.BC.5/21.06.001/2014/15 dated July 1, 2014 
on “Prudential Guidelines on Capital Adequacy and Market Discipline- New Capital Adequacy 
Framework (NCAF)”. 
  
8.30 ADVANCED ACCOUNTING 
** Capital Fund consists of Tier I & Tier II Capital 
The CAR measures financial solvency of Indian and foreign banks. Under Basel II 
norms, Banks can lend only about 22 times of their core Capital. 
 3.2 CAPITAL FUNDS 
Capital is divided into two tiers according to the characteristics/qualities of each 
qualifying instrument.  Tier I capital consists mainly of share capital and disclosed 
reserves and it is a bank’s highest quality capital because it is fu lly available to cover 
losses.  
Tier II capital on the other hand consists of certain reserves and certain types of 
subordinated debt. The loss absorption capacity of Tier II capital is lower than that 
of Tier I capital.  When returns of the investors of the capital issues are counter 
guaranteed by the bank, such investments will not be considered as Tier I/II 
regulatory capital for the purpose of capital adequacy. 
 3.3 TIER-I AND TIER-II CAPITAL FOR INDIAN 
BANKS  
Tier I capital (also known are core capital) provides the most permanent and 
readily available support to a bank against unexpected losses.  
3.3.1 Tier I capital  
The elements of Tier I capital include 
(i) Paid-up capital (ordinary shares), statutory reserves, and other disclosed free 
reserves, including share premium if any. 
(ii) Perpetual Non-cumulative Preference Shares (PNCPS) eligible for inclusion as 
Tier I capital - subject to laws in force from time to time. 
(iii) Innovative Perpetual Debt Instruments (IPDI) eligible for inclusion as Tier I 
capital, and 
(iv) Capital reserves representing surplus arising out of sale proceeds of assets. 
Banks may include quarterly / half yearly profits for computation of Tier I capital 
only if the quarterly / half yearly results are audited by statutory auditors and not 
when the results are subjected to limited review. 
Page 4


  
8.28 ADVANCED ACCOUNTING 
 
LEARNING OUTCOMES 
UNIT 3:  CAPITAL ADEQUACY NORMS 
 
 
After studying this unit, you will be able to: 
? Definitions of capital funds (Tier I & Tier II) and minimum 
capital requirement,  
? Technique of computing weightage for the purpose of capital 
adequacy norms 
 3.1  CAPITAL FRAMEWORK OF BANKS 
FUNCTIONING IN INDIA 
Capital adequacy is used to describe adequacy of capital resources of a bank in 
relation to the risks associated with its operations.  
Capital Adequacy Ratio (CAR) 
The Basel Committee on Banking Supervision had published the first Basel Capital 
Accord (popularly called as Basel I framework) in July, 1988 prescribing minimum 
capital adequacy requirements in banks for maintaining the soundness and stability 
of the International Banking System and to diminish existing source of competitive 
inequality among international banks. After Basel I framework, Basel II norms were 
released.  The main objectives of Basel committee were: 
(i) to stop reckless lending by bank  
(ii) to strengthen the soundness and stability of the banking system and  
(iii)  to have a comparative footing of the banks of different countries. 
With a view to adopting the Basel Committee on Banking Supervision (BCBS) 
framework on capital adequacy which takes into account the elements of credit risk 
in various types of assets in the balance sheet as well as off-balance sheet business 
and also to strengthen the capital base of banks, Reserve Bank of India decided in 
April 1992 to introduce a risk asset ratio system for banks (including foreign banks) 
 
 
 8.29 
 
BANKING COMPANIES 
in India as a capital adequacy measure. Having regard to the necessary upgradation 
of risk management framework as also capital efficiency likely to accrue to the 
banks by adoption of the advanced approaches envisaged under the Basel II 
Framework and the emerging international trend in this regard, in July 2009 it was 
considered desirable to lay down a timeframe for implementation of the advanced 
approaches in India. 
Consequently, the Basel Committee on Banking Supervision (BCBS) released 
comprehensive reform package entitled “Basel III: A global regulatory framework 
for more resilient banks and banking systems” (known as Basel III capital 
regulations) in December 2010. Basel III reforms strengthen the bank -level i.e. 
micro prudential regulation, with the intention to raise the resilience of individual 
banking institutions in periods of stress. These new global regulatory and 
supervisory standards mainly seek to raise the quality and level of capital to ensure 
banks are better able to absorb losses on both a going concern and a gone concern 
basis, increase the risk coverage of the capital framework, introduce leverage ratio 
to serve as a backstop to the risk-based capital measure, raise the standards for the 
supervisory review process etc. Reserve Bank issued Guidelines based on the Basel 
III reforms on capital regulation on May 2, 2012, to the extent applicable to banks 
operating in India. The Basel III capital regulations have been implemented from 
April 1, 2013 in India in phases.  
NOTE: The capital adequacy norms given in this unit are as per existing Basel II norms. 
RBI requires Banks to maintain minimum capital risk adequacy ratio of 9 % on an 
ongoing basis
?
.  
Every bank should maintain a minimum capital adequacy ratio based on capital 
funds and risk assets. As per the prudential norms, all Indian scheduled commercial 
banks (excluding regional rural banks) as well as foreign banks operating in India 
are required to maintain capital adequacy ratio (or capital to Risk Weighted Assets 
Ratio) which is specified by RBI from time to time.  At present capital adequacy 
ratio is 9%. 
The capital adequacy ratio is worked out as below: 
   
Capital fund **
Risk weighted assets + off balance sheet items
X 100 
 
?
RBI has issued a master circular No. DBOD.No.BP.BC.5/21.06.001/2014/15 dated July 1, 2014 
on “Prudential Guidelines on Capital Adequacy and Market Discipline- New Capital Adequacy 
Framework (NCAF)”. 
  
8.30 ADVANCED ACCOUNTING 
** Capital Fund consists of Tier I & Tier II Capital 
The CAR measures financial solvency of Indian and foreign banks. Under Basel II 
norms, Banks can lend only about 22 times of their core Capital. 
 3.2 CAPITAL FUNDS 
Capital is divided into two tiers according to the characteristics/qualities of each 
qualifying instrument.  Tier I capital consists mainly of share capital and disclosed 
reserves and it is a bank’s highest quality capital because it is fu lly available to cover 
losses.  
Tier II capital on the other hand consists of certain reserves and certain types of 
subordinated debt. The loss absorption capacity of Tier II capital is lower than that 
of Tier I capital.  When returns of the investors of the capital issues are counter 
guaranteed by the bank, such investments will not be considered as Tier I/II 
regulatory capital for the purpose of capital adequacy. 
 3.3 TIER-I AND TIER-II CAPITAL FOR INDIAN 
BANKS  
Tier I capital (also known are core capital) provides the most permanent and 
readily available support to a bank against unexpected losses.  
3.3.1 Tier I capital  
The elements of Tier I capital include 
(i) Paid-up capital (ordinary shares), statutory reserves, and other disclosed free 
reserves, including share premium if any. 
(ii) Perpetual Non-cumulative Preference Shares (PNCPS) eligible for inclusion as 
Tier I capital - subject to laws in force from time to time. 
(iii) Innovative Perpetual Debt Instruments (IPDI) eligible for inclusion as Tier I 
capital, and 
(iv) Capital reserves representing surplus arising out of sale proceeds of assets. 
Banks may include quarterly / half yearly profits for computation of Tier I capital 
only if the quarterly / half yearly results are audited by statutory auditors and not 
when the results are subjected to limited review. 
 
 
 8.31 
 
BANKING COMPANIES 
As reduced by: 
? intangible assets and losses in the current period and those brought forward 
from previous period. 
? Creation of deferred tax asset (DTA)results in an increase in Tier I capital of a 
bank without any tangible asset being added to the banks’ balance sheet. 
Therefore, DTA, which is an intangible asset, should be deducted from Tier I 
capital. 
3.3.2 Tier II capital 
comprises elements that are less permanent in nature or are less readily available 
than those comprising Tier I capital. The elements comprising Tier II capital are as 
follows: 
(a) Undisclosed reserves 
(b)  Revaluation reserves 
(c)  General provisions and loss reserves 
(d)  Hybrid debt capital instruments 
(e)  Subordinated debt 
(f)  Investment Reserve Account 
(a) Undisclosed reserves and cumulative perpetual preference assets - These 
elements have the capacity to absorb unexpected losses and can be included in the 
capital, if they represent accumulations of post-tax profits and not encumbered by 
any known liability and should not be routinely used for absorbing normal loan or 
operating losses. Cumulative perpetual preference shares should be fully paid -up 
and should not contain clauses which permit redemption by the holder. 
(b) Revaluation reserves - These reserves often serve as a cushion against 
unexpected losses but they are less permanent in nature and cannot be considered 
as core capital. Revaluation reserves arise from revaluation of assets that are under -
valued in the bank’s books. The extent to which the revaluation reserve can be 
relied upon as cushion for unexpected loss depends mainly upon the level of 
certainty that can be placed on estimates of the market values of the relevant 
assets, the subsequent proportion in values under difficult market conditions or in 
a forced sale, potential for actual liquidation at those values, tax consequences of 
revaluation etc. Therefore, it would be prudent to consider revaluation reserves at 
a discount of 55% while determining their value for inclusion in CET 1capitalinstead 
Page 5


  
8.28 ADVANCED ACCOUNTING 
 
LEARNING OUTCOMES 
UNIT 3:  CAPITAL ADEQUACY NORMS 
 
 
After studying this unit, you will be able to: 
? Definitions of capital funds (Tier I & Tier II) and minimum 
capital requirement,  
? Technique of computing weightage for the purpose of capital 
adequacy norms 
 3.1  CAPITAL FRAMEWORK OF BANKS 
FUNCTIONING IN INDIA 
Capital adequacy is used to describe adequacy of capital resources of a bank in 
relation to the risks associated with its operations.  
Capital Adequacy Ratio (CAR) 
The Basel Committee on Banking Supervision had published the first Basel Capital 
Accord (popularly called as Basel I framework) in July, 1988 prescribing minimum 
capital adequacy requirements in banks for maintaining the soundness and stability 
of the International Banking System and to diminish existing source of competitive 
inequality among international banks. After Basel I framework, Basel II norms were 
released.  The main objectives of Basel committee were: 
(i) to stop reckless lending by bank  
(ii) to strengthen the soundness and stability of the banking system and  
(iii)  to have a comparative footing of the banks of different countries. 
With a view to adopting the Basel Committee on Banking Supervision (BCBS) 
framework on capital adequacy which takes into account the elements of credit risk 
in various types of assets in the balance sheet as well as off-balance sheet business 
and also to strengthen the capital base of banks, Reserve Bank of India decided in 
April 1992 to introduce a risk asset ratio system for banks (including foreign banks) 
 
 
 8.29 
 
BANKING COMPANIES 
in India as a capital adequacy measure. Having regard to the necessary upgradation 
of risk management framework as also capital efficiency likely to accrue to the 
banks by adoption of the advanced approaches envisaged under the Basel II 
Framework and the emerging international trend in this regard, in July 2009 it was 
considered desirable to lay down a timeframe for implementation of the advanced 
approaches in India. 
Consequently, the Basel Committee on Banking Supervision (BCBS) released 
comprehensive reform package entitled “Basel III: A global regulatory framework 
for more resilient banks and banking systems” (known as Basel III capital 
regulations) in December 2010. Basel III reforms strengthen the bank -level i.e. 
micro prudential regulation, with the intention to raise the resilience of individual 
banking institutions in periods of stress. These new global regulatory and 
supervisory standards mainly seek to raise the quality and level of capital to ensure 
banks are better able to absorb losses on both a going concern and a gone concern 
basis, increase the risk coverage of the capital framework, introduce leverage ratio 
to serve as a backstop to the risk-based capital measure, raise the standards for the 
supervisory review process etc. Reserve Bank issued Guidelines based on the Basel 
III reforms on capital regulation on May 2, 2012, to the extent applicable to banks 
operating in India. The Basel III capital regulations have been implemented from 
April 1, 2013 in India in phases.  
NOTE: The capital adequacy norms given in this unit are as per existing Basel II norms. 
RBI requires Banks to maintain minimum capital risk adequacy ratio of 9 % on an 
ongoing basis
?
.  
Every bank should maintain a minimum capital adequacy ratio based on capital 
funds and risk assets. As per the prudential norms, all Indian scheduled commercial 
banks (excluding regional rural banks) as well as foreign banks operating in India 
are required to maintain capital adequacy ratio (or capital to Risk Weighted Assets 
Ratio) which is specified by RBI from time to time.  At present capital adequacy 
ratio is 9%. 
The capital adequacy ratio is worked out as below: 
   
Capital fund **
Risk weighted assets + off balance sheet items
X 100 
 
?
RBI has issued a master circular No. DBOD.No.BP.BC.5/21.06.001/2014/15 dated July 1, 2014 
on “Prudential Guidelines on Capital Adequacy and Market Discipline- New Capital Adequacy 
Framework (NCAF)”. 
  
8.30 ADVANCED ACCOUNTING 
** Capital Fund consists of Tier I & Tier II Capital 
The CAR measures financial solvency of Indian and foreign banks. Under Basel II 
norms, Banks can lend only about 22 times of their core Capital. 
 3.2 CAPITAL FUNDS 
Capital is divided into two tiers according to the characteristics/qualities of each 
qualifying instrument.  Tier I capital consists mainly of share capital and disclosed 
reserves and it is a bank’s highest quality capital because it is fu lly available to cover 
losses.  
Tier II capital on the other hand consists of certain reserves and certain types of 
subordinated debt. The loss absorption capacity of Tier II capital is lower than that 
of Tier I capital.  When returns of the investors of the capital issues are counter 
guaranteed by the bank, such investments will not be considered as Tier I/II 
regulatory capital for the purpose of capital adequacy. 
 3.3 TIER-I AND TIER-II CAPITAL FOR INDIAN 
BANKS  
Tier I capital (also known are core capital) provides the most permanent and 
readily available support to a bank against unexpected losses.  
3.3.1 Tier I capital  
The elements of Tier I capital include 
(i) Paid-up capital (ordinary shares), statutory reserves, and other disclosed free 
reserves, including share premium if any. 
(ii) Perpetual Non-cumulative Preference Shares (PNCPS) eligible for inclusion as 
Tier I capital - subject to laws in force from time to time. 
(iii) Innovative Perpetual Debt Instruments (IPDI) eligible for inclusion as Tier I 
capital, and 
(iv) Capital reserves representing surplus arising out of sale proceeds of assets. 
Banks may include quarterly / half yearly profits for computation of Tier I capital 
only if the quarterly / half yearly results are audited by statutory auditors and not 
when the results are subjected to limited review. 
 
 
 8.31 
 
BANKING COMPANIES 
As reduced by: 
? intangible assets and losses in the current period and those brought forward 
from previous period. 
? Creation of deferred tax asset (DTA)results in an increase in Tier I capital of a 
bank without any tangible asset being added to the banks’ balance sheet. 
Therefore, DTA, which is an intangible asset, should be deducted from Tier I 
capital. 
3.3.2 Tier II capital 
comprises elements that are less permanent in nature or are less readily available 
than those comprising Tier I capital. The elements comprising Tier II capital are as 
follows: 
(a) Undisclosed reserves 
(b)  Revaluation reserves 
(c)  General provisions and loss reserves 
(d)  Hybrid debt capital instruments 
(e)  Subordinated debt 
(f)  Investment Reserve Account 
(a) Undisclosed reserves and cumulative perpetual preference assets - These 
elements have the capacity to absorb unexpected losses and can be included in the 
capital, if they represent accumulations of post-tax profits and not encumbered by 
any known liability and should not be routinely used for absorbing normal loan or 
operating losses. Cumulative perpetual preference shares should be fully paid -up 
and should not contain clauses which permit redemption by the holder. 
(b) Revaluation reserves - These reserves often serve as a cushion against 
unexpected losses but they are less permanent in nature and cannot be considered 
as core capital. Revaluation reserves arise from revaluation of assets that are under -
valued in the bank’s books. The extent to which the revaluation reserve can be 
relied upon as cushion for unexpected loss depends mainly upon the level of 
certainty that can be placed on estimates of the market values of the relevant 
assets, the subsequent proportion in values under difficult market conditions or in 
a forced sale, potential for actual liquidation at those values, tax consequences of 
revaluation etc. Therefore, it would be prudent to consider revaluation reserves at 
a discount of 55% while determining their value for inclusion in CET 1capitalinstead 
  
 
8.32 ADVANCED ACCOUNTING 
of as Tier 2 capital under extant regulations. Such reserves however will have to be 
reflected on the face of the balance sheet as revaluation reserves. 
(c) General provisions and loss reserves - If these are not attributable to the 
actual diminution in value or identifiable potential loss in any specific asset and are 
available to meet unexpected losses, they can be included in Tier-II capital. 
Adequate care must be taken to see that sufficient provisions have been made to 
meet all known losses and foreseeable potential losses before considering general 
provisions and loss reserves to be part of Tier-II capital. However, general 
provisions and loss reserves (including general provision on standard assets) may 
be taken only up to a maximum of 1.25 per cent of weighted risk assets. 
'Floating Provisions' held by the banks, which is general in nature and not made 
against any identified assets, may be treated as a part of Tier II capital within the 
overall ceiling of 1.25 percent of total risk weighted assets. 
Excess provisions which arise on sale of NPAs would be eligible Tier II capital subject 
to the overall ceiling of 1.25% of total Risk Weighted Assets. 
(d) Hybrid Debt Capital instruments -Those instruments which have close 
similarities to equity, in particular when they are able to support losses on an 
ongoing basis without triggering liquidation, may be included in Tier II capital. At 
present the following instruments have been recognized and placed under this 
category: 
i. Debt capital instruments which has a combination of characteristics of both 
equity and debt, eligible for inclusion as Upper Tier II capital; and 
ii. Perpetual Cumulative Preference Shares (PCPS) / Redeemable Non-
Cumulative Preference Shares (RNCPS) / Redeemable Cumulative Preference 
Shares (RCPS) as part of Upper Tier II Capital. 
(e) Subordinated Debt -To be eligible for inclusion in the Tier-II capital the 
instrument should be fully paid up, unsecured, subordinated to the claims of other 
creditors, free of restrictive clauses and should not be redeemable at the initiative 
of the holder or without the consent of the Reserve Bank of India. They often carry 
a fixed maturity and as they approach maturity, they should be subjected to 
progressive discount for inclusion in Tier-II capital. Instrument with an initial 
maturity of less than five years or with a remaining maturity of one year should not 
be included as part of Tier-II capital. Subordinated debt instrument will be limited 
to 50% of Tier-I capital. 
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FAQs on Unit 3: Capital Adequacy Norms: Notes - Advanced Accounting for CA Intermediate

1. What are capital adequacy norms?
Ans. Capital adequacy norms refer to the regulatory requirements imposed on banks and financial institutions to maintain a minimum level of capital to absorb potential losses. These norms are designed to ensure the stability and solvency of banks and protect depositors' interests. The capital adequacy norms specify the minimum capital requirement, the composition of capital, and the risk-weighted assets calculation methodology.
2. Why are capital adequacy norms important for banks?
Ans. Capital adequacy norms are important for banks as they serve as a safety net against unexpected losses. Adequate capital ensures that banks can absorb losses without jeopardizing their financial stability and ability to meet depositors' and creditors' claims. These norms also promote sound risk management practices, encourage banks to hold a buffer against potential risks, and enhance the overall resilience of the banking system.
3. How are capital adequacy norms calculated?
Ans. Capital adequacy norms are calculated based on the Basel III framework, which sets out the international standards for bank capital adequacy. The norms require banks to maintain a minimum common equity tier 1 (CET1) capital ratio of 4.5% of risk-weighted assets (RWAs), a tier 1 capital ratio of 6% of RWAs, and a total capital ratio of 8% of RWAs. The RWAs are determined by assigning specific risk weights to different categories of assets held by banks, reflecting their level of risk.
4. What happens if a bank fails to meet the capital adequacy norms?
Ans. If a bank fails to meet the capital adequacy norms, it may face regulatory penalties, restrictions on its operations, or even closure. Regulators have the authority to impose fines, restrict dividend payments, or require the bank to raise additional capital to meet the minimum requirements. Failing to maintain adequate capital can undermine market confidence in the bank, leading to a loss of depositor trust and potential systemic risks to the financial system.
5. How do capital adequacy norms impact lending activities?
Ans. Capital adequacy norms have a direct impact on banks' lending activities. Banks need to allocate a portion of their capital to support their loan portfolio, and the capital adequacy norms determine the minimum capital requirements for lending. If a bank's capital adequacy ratio falls below the required level, it may have to curtail its lending activities to maintain compliance. This can restrict credit availability and potentially impact economic growth.
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ppt

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practice quizzes

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Semester Notes

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Previous Year Questions with Solutions

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Objective type Questions

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Extra Questions

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Sample Paper

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Important questions

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past year papers

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Exam

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Viva Questions

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pdf

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video lectures

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Unit 3: Capital Adequacy Norms: Notes | Advanced Accounting for CA Intermediate

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Summary

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mock tests for examination

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