Basel-II, low risk weights up bank CARs

Indian banks may be facing serious headwinds with regards to non-performing assets but they are on a strong wicket with another important banking parameter — the capital adequacy ratio (CAR). CAR of banks has generally gone up in 2008-09 versus the previous year as lower risk weights, implementation of Basel II norms and slower credit growth has freed up capital.

A study by New Delhi-based industry lobby group Assocham released on Tuesday showed that average capital adequacy ratio of 10 commercial banks improved to 13.48% in 2008-09 from 12.35% in 2007-08 as per Basel-II norms. Assocham listed the CARs of State Bank of Bikaner and Jaipur, State Bank of Mysore, Indian Overseas Bank, Bank of Baroda, Indian Bank, Bank of India, Uco Bank, Syndicate Bank, Punjab National Bank and State Bank of Travancore.

Only these ten banks have announced their CAR for 2007-08 under Basel II to compare it with the new norms which were introduced in 2008-09. Banks shifted to the higher Basel-II risk and capital management requirement in April 2008. The new norms allowed them to do away with uniform risk weights and to provide less for loans to high-rated companies.

Vaibhav Agarwal, banking analyst at Angel Broking, said the fact that banks have to keep aside less capital for AAA-rated companies under Basel-II propped up ratios.
“Also, risks weights were reduced for some sectors like real estate from 150% to 100% — that also helped,” he said. A bank’s capital adequacy ratio is calculated by dividing its total capital by the risk-weighted assets. Risk weights in India are determined by RBI guidelines and the bank’s perception of risk.

Banks have to support the risk for every asset they have according to Basel-II norms through capital. So, for example, if a bank lends Rs 100 to a sector with a risk weight of 150%, it will have to keep aside Rs 150 for the same. Since the risk weights were reduced by the RBI, banks had the freedom to employ less capital.

Suresh Ganapathy, banking analyst with Deutsche Bank, said the lower risk weight is the biggest plus point for banks. “Earlier all loans to companies used to have a minimum risk weight of 100%. Now, weights for even unrated companies and mortgage loans have been reduced. Higher rated companies have even lesser risk weights,” Ganapathy said.

A decline in the credit growth versus 2007-08 also means that banks didn’t have to raise much capital last year. “When the loan book does not grow, banks don’t have to keep more capital aside for risk weights. This was particularly true for private banks last year,” said an analyst with a private brokerage.

But Ganapathy said it will be difficult for the CAR to improve from the current levels this year. “Even with a CAR of 12%, banks are well placed to absorb losses even if NPAs double in the next one year. Moreover, as growth picks up, the incremental CAR will come down. For public sector banks, CAR will not go up unless the government infuses liquidity,” he said.

Also, the fact that some of these risk weight concessions (like reduction in weights for real estate) could be temporary (due to the economic downturn) may mean that the strong CAR numbers may not continue.