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Credit Risk
Main business of banks is to lend to lenders, but there is an inherent risk of that loan going bad, so banks must make appropriate provisions in their balance sheet for such "credit risks" and must keep a certain amount of capital aside. Banks are required to
maintain a minimum "Capital to Risk-weighted Assets Ratio" (CRAR) of 9% on an ongoing basis. Capital funds are broadly classified as Tier 1 and Tier 2 Capital.
Elements of Tier 1 Capital
Paid-up equity capital, Statutory Reserves, and other disclosed free reserves, if any;
Capital reserves representing surplus arising out of sale proceeds of assets;
Innovative perpetual debt instruments eligible for inclusion in Tier 1 Capital which comply with regulatory requirements (limited to 15% of total Tier 1 Capital and excess will be eligible for inclusion under Tier 2 Capital, subject to limits prescribed for Tier 2 Capital).
Elements of Tier 2 Capital (should not exceed 100% of Tier 1 Capital)
Revaluation Reserves
General Provisions and Loss Reserves
Hybrid debt capital instruments
Subordinated Debt
Methods of Measuring Capital Allocation for Credit Risk
Standardised Approach
Foundation Internal Rating Based Approach
Advanced Internal Rating Based Approach (Securitisation Framework)
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* Contributed by: -
Vijay Singh Poonia,
PGDM 2007-09,
IIM Calcutta.
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