Differential Car For Banks Likely

Reserve Bank of India governor C Rangarajan has mooted a differential capital adequacy ratio (CAR) for banks. He said the existing eight per cent norm cannot be operated using a one-size-fits-all formula.

The governor also indicated that weak banks should restrict themselves to narrow banking till they achieve a turnaround in their profitability, capital adequacy and non-performing assets.

Rangarajan was speaking at the 20th Bank Economists Conference hosted by Bank of India here yesterday.

The concept of narrow banks mooted by the governor is different from the one proposed by the Tarapore committee report.

The Tarapore committee has laid down that narrow banks should be made deposit-taking companies and, in some cases, should restrict further expansion of deposits. It had stated that these banks be allowed to invest only in government securities.

Rangarajan, however, said he was against a cap on deposit-taking and suggested increasing balance sheet size with only less risky assets.

On capital adequacy, Rangarajan said: It is true that the eight per cent norm cannot be operated like a one-size-fits-all formula. This reflects only the minimum and it is for each regulatory authority to prescribe capital ratios for individual banks.

The merit of the eight per cent prescription is that it is superior to a regime of no prescriptions, and to countries introducing these norms in the initial phase, the objective has to be to attain this minimum and then make prescription bank specific, he said, in essence, hinting at a higher CAR for some banks.

The governor said: The concerns over the broad weighting categorisations, and the lack of allowance for differences in quality between borrowers, are being met by countries setting individual target ratios above eight per cent bank-wise where the regulatory perception is that the banks portfolio carries a higher element of risk.

The current minimum prescribed CAR is based on the Basle Committee report on International Convergence of Capital Measurement and Capital Standards published in July 1988.

The operational environment has, however, changed over the years. The concept of financial engineering followed by banks has also rendered this system obsolete. The prescription of the Basle CAR of eight per cent has drawn adverse comments as it seems to follow a one size fits all formula.

The desired CAR should be an appropriate way of controlling and reflecting the riskiness of banks portfolios. The uniform application of a 100 per cent weightage to non-bank private sector corporates does not recognise the different quality of borrowers. Further, the treatment of collateral is overly restrictive as no credit is given for collateral which is not in the form of cash or government securities.

Another argument doing the rounds, particularly in India, is that there is no need for this solvency-based measure for government-owned banks. The basis of this argument being that when the government is the owner (of the banks) it will meet all the obligations and there is no possibility of a public sector bank failing.

CAR is improved by not downsizing the asset base but by changing the combination of assets. It is not possible for all banks to adjust the capital base to meet the stipulated CAR. The weak banks can achieve a turnaround by relocating the assets by sifting to a zero risk weighted portfolio.