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A study of Capital Adequacy Regime and Analytical Study

of Capital Structure and Capital Adequacy Ratios of
selected Banks in India.


Sr. No.





Literature Review


Objectives of the Study




Research Methodology


Scheme of Chapters



Page No.

1. Introduction:
From the ancient times banking is prevalent in India. The evidences of loans are
found in vedic Period (beginning 1750 BC). During the Mauryas Empire (321 to
185 BC), an instrument called adesha was in use, which was an order on a
banker desiring him to pay the money to a third person, which resembles to a bill
of exchange as known today. During the Buddhist period, there was
considerable use of these instruments. Merchants in large towns used to give
letters of credit to one another. The guarantees were also used to be given in
those days which resembles with the BGs and LCs as known today. The banking
era in actual sense originated in the last decades of the 18th century.

Banking Industry in India:

The General Bank of India (1786) and Bank of Hindustan (1770) were the
first banks, not existing today. The oldest bank existing till now is the State
bank of India which established as the Bank of Calcutta in June 1806; later
know as Bank of Bengal. This was one of the three presidency banks, the
other two being the Bank of Bombay and the Bank of Madras, all three of
which were established under charters from the British East India
Company. The three banks merged in 1921 to form the Imperial Bank of
India, which, upon India's independence, became the State Bank of India
in 1955.
The first foreign banks Comptoir d'Escompte de Paris opened a branch in
Calcutta in 1860, and another in Bombay in 1862; HSBC established itself in
Bengal in 1869.
Nationalization of Banks:
By the 1960s, the Indian banking industry had become an important tool
to facilitate the development of the Indian economy and also emerged
as a large employer, and a debate had ensued about the nationalization
of the banking industry. Indira Gandhi, then Prime Minister of India,
expressed the intention of the Government of India in the annual
conference of the All India Congress Meeting in a paper entitled "Stray
thoughts on Bank Nationalization." Thereafter, The Government of India
issued an ordinance ('Banking Companies (Acquisition and Transfer of
Undertakings) Ordinance, 1969')) and nationalized the 14 largest
commercial banks with effect from the midnight of July 19, 1969. These
banks contained 85 percent of bank deposits in the country. Jayaprakash
Narayan, a national leader of India, described the step as a "masterstroke
of political sagacity." Within two weeks of the issue of the ordinance, the
Parliament passed the Banking Companies (Acquisition and Transfer of
Undertaking) Bill, and it received the presidential approval on 9 August
1969. A second phase of nationalization of 6 more commercial banks

followed in 1980. The stated reason for the nationalization was to give the
government more control of credit delivery. With the second dose of
nationalization, the Government of India controlled around 91% of the
banking business of India. Later on, in the year 1993, the government
merged New Bank of India with Punjab National Bank. It was the only
merger between nationalized banks and resulted in the reduction of the
number of nationalized banks from 20 to 19. After this, until the 1990s, the
nationalized banks grew at a pace of around 4%, closer to the average
growth rate of the Indian economy.

Banking Regulation in India:

The banking sector in India is the most regulated sector and is strictly
regulated by the government and the Apex bank i.e. RBI The banking
Regulation Act, Companies Act, Acts of SBI and respective banks
incorporation, SEBI Regulations RBI master circulars and various local laws
governs the functioning of banks in India.

Capital of Banks:
Every business to be run smoothly needs capital contribution by its owners.
Apart from this capital, the regulator i.e. RBI has prescribed some
norms/regulations/regime for the adequacy of capital for banks, also
known as the regulatory capital of the bank. The capital requirement for
the banks is controlled by regulators. It stands for the amount which the
institution has to compulsorily hold with its regulator. This ensures that the
financial organization has the sufficient amount of capital to sustain its
operating losses. Apart from the concept of regulatory capital, banks

Relevance of the Present Study:

Capital is essential and critical to the perpetual continuity of a bank as a
going concern. A minimum amount of capital is required to ensure the
safety and soundness of the bank and also to build trust and confidence
among the external and internal customers. In course of its operations
banks face risks and potential losses. The banking regulation as well as
banks itself put in place effective controls and risk management strategies
to minimize these risks. As risks in the banks have grown over the years the
regulators have been prescribing various types of requirements to take
care of risks and probable losses arising out of them. E.g. capital
adequacy requirements for credit risk is prescribed by every nations
banking regulator.
It is an acceptable and universal truth that banks need capital to absorb
losses arising out of loans and investments as well as protection against
other business risks.

In 1988, BCBS introduced capital measurement system called Basel

capital accord, also called as Basel 1. India adopted Basel 1 guidelines in
1999. In 2004, Basel II guidelines were published by BCBS, which were
considered to be the refined and reformed versions of Basel I accord. In
2010, Basel III guidelines were released. These guidelines were introduced
in response to the financial crisis of 2008. A need was felt to further
strengthen the system as banks in the developed economies were undercapitalized, over-leveraged and had a greater reliance on short-term
funding. The guidelines aim to promote a more resilient banking system by
focusing on four vital banking parameters viz. capital, leverage, funding
and liquidity.


2. Literature Review:The international financial sector has witnessed several significant

developments in the area of banking supervision and risk management
over the last two decades. Apart from the regulatory pressure, the market
discipline can also play a critical role in the behavior of banks with regards
to the capital adequacy (Genschel and Plumper, 1997)
The implementation of capital adequacy norms will create a competitive
environment where particular with a higher capital ratio can attract a
deposits from customers at lower costs due to fact that consumers prefer
safe returns on their deposits and hence well capitalized banks can
reduce their cost of borrowing in the form of deposit interest. (Keeley
Al-Zubi et al., (2008) studied the effect of risk and regulatory pressure on
capital requirements in the Jordanian banks and concluded that there
was a strong positive correlation between regulatory pressure and banks
capital and their risk levels.
Dr. Duvvuri Subbarao, Governor RBI in his inaugural speech at BANCON
2010 on 3 December 2010 at Mumbai said that our assessment is that
at the aggregate level Indian Banks will not have any problem in adjusting
towards the new capital rules both in terms of quantum and quality. The
decision of the finance minister, as announced in the last budget, to set
up a financial sector legislative reforms commission to rewrite and clean
up the financial sector laws to bring them in line with the requirements of
the sector is therefore very timely and very vital.


3. Objectives of the Study:

1. To study various theories of capital structures. Applicability to banking form of
2. To Study the existing capital adequacy regime applicable to Indian banks
(regulatory capital and economic capital) and its level of compliance.
3. Analytical study of profitability/earnings/NPAs/cost of deposits/Debt Equity
Ratio/ROI-ROA/Advance to Total Assets Ratio/Net Interest Margin of Public
sector and private sector banks in India and its implications on the capital
ratio of the respective institutions.
4. To analyse capital structure (Tier wise) of public sector and private sector
banks in India and its implications.
5. To study the upcoming BASEL III requirements and comparative study of
BASEL II and BASEL III and its challenges and impact.
6. To study the various effects of raising capital by the banks in compliance with
the applicable regime.
7. To study analytically, the components of capital (risk wise capital given in
Basel disclosures) and draw conclusions.


4. Hypothesis
1: Indian banks are adequately capitalized as per the existing capital
adequacy regime.
2: The public sector banks are having lessor mean CAR as compared to
the private sector banks in India.
3: The Mean CAR of different categories of banks is showing increasing
trend for the selected time horizon.
4: The Mean CAR of State bank group is lesser as compared to its peers.
5: There is no relationship between CRAR and profitability/ earnings/ NPAs/
cost of deposits/ Debt Equity Ratio/ROI-ROA/Advance to Total Assets
Ratio/Net Interest Margin.
5: There is No relationship between Interest Income and Total Risk
Weighted Assets.
6: There is no relationship between movement of risk weighted assets and
capital fund. (Alternatively we can say that risk weighted assets have
increased with an increase in capital fund.)


5. Research Methodology
This section deals with the methods of data collection and the
methodology employed in the research analysis
ata Collection
Primary Data
The researcher intends to collect the primary data through
1. Questionnaire (Not followed in my case hence to be deleted)
Interviews of the Professionals and Experts, Senior Employees, Investors and
Customers (Inv
1. D estors) of the Commercial Banks.
Secondary data were collected for the purpose of empirical analysis
Secondary Data
For the present study the major source of secondary data is
RBI Database available at RBI website.
Published Financial statements of the Banks
Basel Disclosures by Banks
Various Information from Newspaper, Magazine, Technical Journals
Reports & Newsletter of various Research organizations
Internet, Websites having authoritative source of relevant data.

Statistical Tools Used

For processing the data and testing hypothesis various appropriate statistical
tools like Measures of Central tendency, Chi Square test, Correlation and
Frequency Distribution Analysis etc. using relevant software at appropriate areas
as per the need of study.

Temporal Scope:

For the purpose of data collection and study, mainly the duration of 2004
to 2013 (i.e. 10 years) shall be considered.
If necessary, reference shall be made about the empirical results and
history of Banking Industry.


Limitations of the Study:

The study requires data from all over the Indian Banks, cost and time
constraints may affect the effectiveness of the study though every
attempt will be made to keep the spirit of the objectives and research
This is the first of its kind survey in capital adequacy of the Indian Banks
and there are neither existing studies nor precedents.
The reliability of the study may depend on authenticity of the information
supplied by the respondents.

6. Scheme of Chapters
The proposed format of the thesis can be placed in eight chapters with selected
bibliography and appendices as below

Capital Adequacy Regime, Risk Management and BASEL Accord:

An Overview


Review of Literature


Objectives & Research Methodology


Role of Commercial Banks in India (Development/Growth



Capital Adequacy norms for the commercial banks in India


Data Analysis & Interpretation




Select Bibliography

Relevant portions of Applicable Regulations.

Base data for validation of research model.

Any other need based addendum.


7. References (To be formatted/style change)

1. Modern Banking Theory and Practice by D. Muraleedharan PHI Learning
PVT Ltd.
2. Banking Theory and Practice by K C Shekhar 19th Edition Vikas Publications
3. Banking Theory Law and Practice by R Rajesh and T Sivagnanasithi Tata
McGraw Hill Companies 2009 Edition.
4. Fallacies, Irrelevant Facts, and Myths in the Discussion of Capital
Regulation: Why Bank Equity is Not Expensive (by Anant R. Adamati, Peter
DeMarzo, Martin Hellwig, Draft dated 23 March 2011)
5. Capital Regulation after the crisis: Business as Usual? (by Martin Hellwing,
Max Planck Society)
6. Indian Banking Industry: Raising above the waves January 2013 (by
Dinodia Capital Advisors, New Delhi, www.dinodiacapital.com
7. Capital Adequacy in Commercial Banks by Kalyan Mitchell, Economic
Review September- October 1984.
8. Annual Report published by The Reserve Bank of India 2011-12
9. Financial Stability Report June 2012 published by RBI.
10. Examining The Impact of the proposed Rules to Implement BASEL III
Capital Standards by Anant R. Adamati 29 Nov 2012.
11. Systematic Risks and Bank Regulation by George G.
Kenneth E. Scott. (The Independent Review Volume VII, November 3,
12. The Theory of Bank Capital by Douglas W. Diamond and Raghuram G.
Rajan, The Journal of Finance Vol LV No. 6 Dec 2000
13. RBI Guidelines on Implementation of BASEL III Capital Regulations in India
DBOD.NO.BP.BC.98/21.06.201/201-12 issued on 2nd May 2012
14. Capital Adequacy Standards: Are They Sufficient? By Rahul Dhumale
ESRC Centre for business research University of Cambridge Working Paper
No 165.
15. Research Methodology by C R Kothari, New age International
16. www.rbi.org.in
17. www.iibf.org.in
18. www.bis.org




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