‘Banking is an overly leveraged industry where often profits come first, and losses come later. Growth here is easier to get but tougher to sustain. It is also an industry where the interest of depositors takes precedence over the interest of shareholders. While investor confidence is easier to understand and possibly easier to fix, it is the depositor confidence that the bank has to be maintained at all costs.’


The Financial Year 2020-21 is unprecedented for Indian banking in many counts viz Business Continuity Planning (BCP) challenges amid the global outbreak of Covid-19 pandemic, PSBs amalgamation, external benchmarks in loan pricing and crisis in Cooperative bank, NBFC and few small private banks and Basel Committee on Banking Supervision (BCBS) deferral of Basel III implantation among other significant developments. All these challenges affected banks’ capital level directly or indirectly, but the Yes Bank crisis is the one important incidence that has highlighted the capital issue in banking and makes a worth case for analysis. The Yes Bank crisis has brought irreversible changes in perception about Additional Tier-I (AT-I) bonds because it is the first time in the history of Indian Banking, AT-I investors have lost their entire investment, and it will have wide ramification on various banks, planning to raise capital as it will heighten the cost of raising capital as the investors will demand a high-risk premium on their investment. Nonetheless, this crisis has necessitated improvement upon existing banks risk management framework and also address ‘Capital Planning Process’ more systematically and meaningfully.


Before we delve into the Yes Bank crisis and capital issues in Indian banks, particularly in PSBs, it would be pertinent to develop insight into the bank’s capital, its components and its importance in banks as a ‘Going Concern’.


For the purpose of the RBI’s Capital Adequacy Norms, banks are measuring and monitoring the CRAR (Capital to Risk-Weighted Asset Ratio). CRAR is a measure of a bank's capital and is expressed as a percentage of a bank's risk-weighted exposures (loans and investments). Detailed calculation of the CRAR is being published by scheduled commercial banks (SCBs) as part of Basel-III disclosures (Pillar-III) on their website on a quarterly / yearly basis. The CRAR ratio is also considered as one of the benchmarks for the safety of depositor money and to promote the stability and efficiency of the financial system. Regulators try to ensure that banks have sufficient capital to cover their expected losses emerging from various risks, especially from loans and advances. It not only protects the depositors but also the wider economy because the failure of banks will have repercussions at the level of the entire financial sector and on the economy. Further, banks’ failure also has significant social costs because depositors face severe financial difficulty in the wake of restrictions imposed on withdrawals; at times, it is life-threatening for some depositors, such as senior citizens.


The Yes Bank crisis reminds us that in addition to covering expected losses, such as provisioning capital also serves as an important cushion against unexpected losses. Unexpected losses are deviations from the average that may put an institution’s stability at risk. Thus, it plays a crucial role in the safety and soundness of banks and the banking system. Further, it also shows the capacity of the bank to absorb shocks without hurting the depositors. One of the challenging assignments in risk management is to set the appropriate level of capital to cover unexpected losses in banks and financial institutions.


Let’s develop more insight into supervisory capital. For supervisory purposes, there are two tiers (hierarchies) of capital (money), namely Tier-I and Tier-II. The Tier-I or core capital consists mainly of share capital and disclosed reserves. From the bank’s perspective, Tier-I capital is the bank’s highest quality capital because it is fully available to recover losses, albeit the riskiest category of capital from investor’s perspective. Then there are different types of bonds (such as Additional Tier-I and Additional Tier-II), which a bank floats to raise money from the market. Last is the depositor who parks money in the bank’s deposits. The rule of the game is simple, when banks busts, the depositor is paid back first and the equity owner last, whereas when the bank is flourishing, the depositor earns less as interest on deposits while the equity owner earns good returns on investment.

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