Fine Tuning Capital Adequacy Norms

It is almost ten years since the Basle Committee on Banking Supervision, functioning under the auspices of the Bank for International Settlements, put forward the capital adequacy norms. The 1988 proposals envisaged a capital base of at least eight per cent of risk-weighted assets. Broadly speaking, the risk-weights were 100 per cent for commercial loans, 50 per cent for mortgage loans and zero per cent for assets in the form of the home country's government obligations in domestic currency. The capital too was split into a minimum of four per cent of core capital and three per cent of supplementary capital in the form of a percentage of unrealised capital gains on a bank's investments in equities and real estate.

While the norm found wide acceptance, there have been increasing demands lately from the banking industry for its refinement. It is being argued that clubbing all commercial assets at the same risk-weight with a rough and ready measure does not properly reflect the risks. Consider an extreme case of, say, a Rs 100 crore loan portfolio. Bank A has it distributed among two BBB category borrowers while Bank B has it distributed among say 40 AA or higher category borrowers. Under current norms, both portfolios require to be backed by capital worth Rs 8 crore. Clearly, Bank A's loan portfolio is far riskier than that of Bank B