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Sem 5 Prep
← Money & BankingRisk, NPAs and Basel

Formulas for this chapter

Provisioning norms

Sub-standard, secured: 15% of outstanding Sub-standard, unsecured: 25% of outstanding Doubtful: 100% x (outstanding - realisable value of security) Loss: 100% of outstanding, and write off

Any provisioning question. The two traps: 25% not 15% when the exposure is unsecured, and for doubtful assets the uncovered portion only, with the security valued on a realistic basis.

realisable value
What the security would actually fetch, estimated realistically, where the bank has valid recourse

NPA ratios

Gross NPA ratio = Gross NPAs / Gross Advances x 100 Net NPAs = Gross NPAs - Provisions Net Advances = Gross Advances - Provisions Net NPA ratio = Net NPAs / Net Advances x 100 Provision coverage ratio = Provisions / Gross NPAs x 100

Any asset-quality question. Provisions come off the numerator and the denominator of the net ratio; deducting them from the top only overstates the ratio.

Provisions
Amount already set aside to cover potential loan losses
Net NPA
The actual burden on the bank after provisions and recoveries

Capital adequacy ratio

CAR = (Tier I capital + Tier II capital) / RWA Minimum under Basel I: 8% Capital needed for a target ratio = target x RWA RWA allowed at a target ratio = capital / target

Capital questions, including how much capital to raise or how much RWA to shed to reach a target. Moving exposure from a 100% weight to a 0% weight cuts RWA rupee for rupee.

Tier I
Core capital: stock issues and declared reserves
Tier II
Supplementary capital: investment gains, long-term debt over five years, hidden reserves; not short-term unsecured debt
Step 2 of 37
The real wordsTheory

The four categories of risk

Banks face multiple types of risk because of financial intermediation: the business of turning short deposits into long loans is itself the risk.

Effective risk management ensures stability, profitability and compliance.

The four key categories, in the professor's own order: credit risk, market risk, operational risk, liquidity risk.

The deck goes on to treat only the first two in depth, which is a hint about the exam: define all four, then be ready to write at length on credit and market risk.

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