Introduction

• The capital adequacy ratio (CAR) is an international standard that measures a bank’s risk of insolvency from excessive losses. 
• Expressed as a formula, the CAR equals the sum of the bank’s tier one capital plus tier two capital, divided by its risk-weighted assets. 
• CAR is also known as CRAR (capital to risk assets ratio).
• A bank’s tier one capital is the ordinary capital of the bank. This capital can absorb bank losses without the bank having to suspend trading.  Tier two capital is the bank’s subordinated debt.  This is the capital that can absorb losses if the bank has to shut down. 

TIER 1 CAPITAL = (paid up capital + statutory reserves + disclosed free reserves) - (equity investments in subsidiary + intangible assets + current & brought-forward losses)

TIER 2 CAPITAL = A) Undisclosed Reserves + B) General Loss reserves + C) hybrid debt capital instruments and subordinated debts

• Risk weighted assets are calculated by looking at the bank's loans and evaluating their riskiness. Each loan is assigned a percentage number. The higher the percentage, the riskier the loan. 
• A government loan gets a low percentage, often zero.  Loans to individuals can go as high as 100%.
• The risk percentage is multiplied against the loan amount, and then added to the other loan amounts multiplied against their risk percentages. 

Analysis

• Gross NPA rose four-fold between fiscal 2014 and fiscal 2018 to ?10.4 trillion (11.6 % of aggregate bank assets).
• While there has some improvement in this ratio over the past fiscal year, with gross NPAs projected to reach 10.3% in March 2019, India’s NPA ratio is still one of the worst among the largest economies of the world that constitute the G-20 grouping.

The impact of the banking crisis was felt most on bank balance sheets with bank capital eroding fast. To shore up the capital base of state owned banks, a recapitalization program was put in place because of which banks look healthier today than they did a couple of years ago.

The capital to risk weighted assets ratio (CRAR) of India’s banking system --- a measure of its ability to withstand shocks --- has grown from 12.5% in 2014 to 16% in 2018. Compared to G-20 economies, India’s CRAR puts it among the middle, IMF data shows.

Present Scenario and Future Prospects

• The Reserve Bank of India (RBI) feels easing capital norms for banks in haste could be harmful for the economy.
• A comparison of the capital adequacy ratios of banks in both developed and emerging markets can give a clue about the RBI’s reasoning.
• The capital adequacy ratio denotes how much capital a bank has against its loans. Under Basel III norms, the minimum required is 10.5 per cent.
• According to the RBI’s capital adequacy norms, banks are required to maintain the minimum CRAR at 9 percent (higher than the Basel-III requirements of 8 percent). On top of this, they were mandated to keep a capital conservation buffer of 2.5 percent in phases by March 2019. Making it 11.5%.
• A Parliamentary Standing Committee on Finance has expressed concern over the capital adequacy ratio (CAR) mandate set for the banks by the Reserve Bank of India.
• The finance ministry and the central bank have differed on capital adequacy norms for banks.
• The ministry wants the stipulation aligned with the international practices as well, so that banks are able to lend more and spur economic growth.
• According to the report, stipulated additional capital requirement if waived will release approximately Rs 5.34 lakh crore.
• Because of the ongoing NPA troubles in public sector banks and they have suffered from erosion of their capital base.
• Hence, The RBI's board in November, 2018 decided to ease capital pressure on banks by allowing them one more year to meet the Capital Conservation Buffer (CCB). This buffer is aimed at ensuring that banks build up capital buffers during non-stress periods so that they can be drawn down when losses are incurred.
• The transition period to implement the last tranche of 0.625 per cent under CCB has been extended by one year — up to March 31, 2020. Now, banks can achieve CCB of 2.5 per cent of their risk-weighted assets by March-end 2020