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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 3 of 37
The real wordsTheory

Credit risk, twice defined

Section A's version: the risk of loss from a borrower's failure to meet obligations. It is the largest risk for banks, and the examples are loan defaults, counterparty failure and sovereign defaults.

Section B gives the Basel Committee's own wording, which is the one to quote: the potential that a bank borrower, or counterparty, will fail to meet its payment obligations regarding the terms agreed with the bank.

He also frames it against market risk as Credit VaR: the risk of adverse price movements due to credit events such as borrower defaults or rating downgrades.

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