Capital Adequacy Ratio (CAR) is the ratio of a bank’s capital in relation to its risk weighted assets and it is decided by central banks and bank regulators to prevent banks from taking excess leverage and becoming insolvent in the process.
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CAR =
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Tier I Capital + Tier II Capital |
| Risk Weighted Assets |
Journey from Basel I to Basel III
With a view to enhance the financial stability through the improvement of supervisory knowledge and ensuring continuous advancement of the quality of banking supervision worldwide, Basel Committee was established by the Governors of Central Banks in the G10 Countries at the end of 1974.
Capital adequacy became the main priority for the Committee. Backed by the G10 Governors, the Committee resolved to arrest and eradicate the erosion of capital standards within the banking system. This ensuing result was a broad consensus on a weighted approach to the measurement of risk, both on and off the Banks’ balance sheets.
Introduced in 2004, Basel II encompasses guidelines for capital adequacy embedding more refined definitions for disclosures and risk management, which includes market risk and operational risk.
Towards Basel III
Basel III is part of the continuous effort to enhance the banking regulatory framework. It builds on the Basel I and Basel II documents and seeks to improve the banking sector’s ability to deal with financial stress, improve risk management and strengthen the Banks’ transparency. A focus of Basel III is to foster greater resilience at the individual bank level in order to reduce the risk of system-wide shocks.
The three pillars as established by Basel II have been revised and strengthened, while the framework itself was extended with astute innovative features:
- An additional layer of common equity – the capital conservation buffer – that, when breached, restricts payouts of earnings to help protect the minimum common equity requirement;
- a countercyclical capital buffer, which places restrictions on participation by banks in system-wide credit booms with the aim of reducing their losses in credit busts;
- a leverage ratio – a minimum amount of loss-absorbing capital, relative to all of a bank’s assets and off-balance sheet exposures regardless of risk weighting. Leverage ratio will be implemented in Sri Lanka from 1 January 2018 with observation period commencing from 1st quarter 2017, which will be monitored by the Central Bank of Sri Lanka.
- Liquidity requirements – a minimum liquidity ratio, the liquidity coverage ratio (LCR), intended to provide enough cash to cover funding needs over a 30-day period of stress; and a longer-term ratio, the net stable funding ratio (NSFR), intended to address maturity mismatches over the entire balance sheet; and
- Additional proposals for domestic systemically important banks (D-SIBs), including requirements for supplementary capital, augmented contingent capital and strengthened arrangements for cross-border supervision and resolution. According to the Central Bank of Sri Lanka, banks with a total asset base of over LKR 500 billion, in the latest Annual Audited Financial Statements will be identified as D-SIBs in the banking sector.
| Basel III | ||
| Pillar 1 | Pillar 2 | Pillar 3 |
| Enhanced Minimum Capital and Liquidity Requirement |
Enhanced Supervisory Review Process for Firm-wide Risk Management and Capital Planning |
Enhanced Risk Disclosure and Market Discipline |
The Central Bank of Sri Lanka, emphasising the need to improve the quantity and quality of capital prevalent within the banking system, issued new banking Act Direction No. 01 of 2016 to all Licensed Commercial Banks and Licensed Specialised Banks on the 29 December 2016, determining the framework for the implementation of Basel III minimum capital requirements across the banking sector which will be effective from the 1 July 2017.
Bank of Ceylon has already begun imbuing the directives within this framework, using a parallel calculation of Basel III from the third quarter of 2015. This is being calculated based on the Central Bank of Sri Lanka Guidelines. The Bank’s ratio remains above regulatory requirements as of 31 December 2016. Despite challenging conditions, BoC is well-positioned to meet the Basel III requirements when regulations become completely effective in 1 January 2019.
Basel III Transitional Phase-in-arrangement of capital requirements for banks with assets of LKR 500 billion and above
| Components of Capital |
01.07.2017 % |
01.01.2018 % |
01.01.2019 % |
| Common Equity Tier I | 4.50 | 4.50 | 4.50 |
| Capital Conservation Buffer | 1.25 | 1.875 | 2.50 |
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Surcharge on Domestic – Systematically Important Banks (D-SIBs) |
0.50 | 1.00 | 1.50 |
| Additional Tier I Capital | 1.50 | 1.50 | 1.50 |
| Total Tier I Capital | 7.75 | 8.875 | 10.00 |
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Minimum Total Capital Ratio including Capital Conservation Buffer and Capital surcharge on D-SIBs |
11.75 | 12.875 | 14.00 |
| Bank | Group | |||
|
2016 LKR million |
2015 LKR million |
2016 LKR million |
2015 LKR million |
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| Tier I: Core Capital | ||||
| Paid-up ordinary shares | 15,000 | 10,000 | 15,000 | 10,000 |
| Permanent reserve fund | 7,996 | 5,210 | 7,996 | 5,210 |
| Published retained profits | 54,155 | 51,086 | 55,659 | 53,888 |
| General and other reserves | 1,209 | 1,044 | 1,764 | 1,957 |
| Non-controlling interests (Consistent with the above capital constituents) | – | – | 879 | 1,010 |
| Deductions | ||||
| 50% of investments in unconsolidated banking and financial subsidiaries | (2,179) | (2,179) | ||
| Other deductions | (2,053) | (953) | (2,150) | (953) |
| Total eligible core capital (Tier I capital) | 74,128 | 64,207 | 79,148 | 71,112 |
| Tier II: Supplementary Capital | ||||
| Revaluation Reserves (as approved by Central Bank of Sri Lanka) | 2,373 | 2,373 | 2,373 | 2,373 |
| General Provisions | 4,648 | 3,857 | 4,647 | 3,857 |
| Approved Subordinated Term Debt | 27,378 | 24,567 | 27,377 | 24,567 |
| Deductions | (3,669) | (2,759) | (1,489) | (580) |
| Total eligible supplementary capital (Tier II capital) | 30,730 | 28,038 | 32,909 | 30,217 |
| Total capital base | 104,858 | 92,245 | 112,057 | 101,329 |
Risk-Weighted Assets
Risk weighted assets are computed as per the CBSL direction which specifies the risk-weight factors to be assigned to various asset classes as enumerated below.
| Computation of Risk-Weighted Assets | Bank | Group | |||||||
| 2016 | 2015 | 2016 | 2015 | ||||||
| Risk-Weight Factor | On Balance Sheet Assets & Credit Equivalent of Off Balance Sheet Assets LKR million | Risk- Weighted Assets LKR million | On Balance Sheet Assets & Credit Equivalent of Off Balance Sheet Assets LKR million | Risk- Weighted Assets LKR million | On Balance Sheet Assets & Credit Equivalent of Off Balance Sheet Assets LKR million | Risk- Weighted Assets LKR million | On Balance Sheet Assets & Credit Equivalent of Off Balance Sheet Assets LKR million | Risk- Weighted Assets LKR million | |
| Assets | |||||||||
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Claims on Government of Sri Lanka and Central Bank of Sri Lanka |
0 | 604,897 | – | 670,543 | – | 611,663 | 676,228 | ||
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Claims on foreign sovereigns and their Central Banks |
0-150 | 18,047 | 17,217 | 20,542 | 19,923 | 18,047 | 17,217 | 20,542 | 19,923 |
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Claims on Public Sector Entities (PSEs) |
20-150 | 72,847 | 72,847 | 60,154 | 60,154 | 72,847 | 72,847 | 60,154 | 60,154 |
| Claims on banks | 20-150 | 63,910 | 33,074 | 71,114 | 37,754 | 65,167 | 34,331 | 71,494 | 38,134 |
| Claims on financial institutions | 20-150 | 26,260 | 13,486 | 8,996 | 5,443 | 26,260 | 13,486 | 8,996 | 5,443 |
| Claims on corporates | 20-150 | 200,222 | 195,155 | 147,338 | 145,371 | 226,381 | 221,314 | 178,877 | 176,910 |
| Retail claims | 75-100 | 374,859 | 307,972 | 261,303 | 217,016 | 374,859 | 307,973 | 261,303 | 217,016 |
| Claims secured by residential property | 50-100 | 54,492 | 36,135 | 57,358 | 38,135 | 54,491 | 36,135 | 57,358 | 38,135 |
| Non-performing assets (NPAs) | 50-150 | 4,457 | 5,797 | 15,549 | 22,434 | 4,457 | 5,797 | 15,549 | 22,434 |
| Cash items | 0-20 | 55,742 | 2,673 | 49,119 | 734 | 61,280 | 2,673 | 52,925 | 734 |
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Exposures collateralised by cash, gold & Government Securities |
0 | 242,523 | 253,269 | 242,523 | 253,269 | ||||
| Property, plant and equipment | 100 | 15,584 | 15,584 | 16,430 | 16,430 | 26,464 | 26,464 | 26,728 | 26,728 |
| Other assets | 100 | 34,879 | 34,873 | 34,769 | 34,769 | 35,806 | 35,806 | 35,543 | 35,543 |
| Total exposure | 1,768,719 | 734,820 | 1,666,484 | 598,163 | 1,820,245 | 774,043 | 1,718,966 | 641,154 | |
| Off balance sheet exposures | Credit conversion Factor % | Assets | Credit equivalent | Assets | Credit equivalent | Assets | Credit equivalent | Assets | Credit equivalent |
| Direct credit substitutes | 100 | 42,383 | 42,383 | 34,636 | 34,636 | 42,383 | 42,383 | 34,636 | 34,636 |
| Transaction-related contingencies | 50 | 33,839 | 16,919 | 41,819 | 20,909 | 33,839 | 16,919 | 41,819 | 20,909 |
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Short-term self-liquidating trade-related contingencies |
20 | 150,448 | 30,090 | 159,923 | 31,985 | 150,448 | 30,090 | 159,923 | 31,985 |
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Other commitments with an original maturity of up to one year or which can be unconditionally cancelled at any time |
0 | 81,126 | 83,858 | 81,126 | 83,858 | ||||
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Commitments with an original maturity up to 1 year & maturity of over one year |
20-50 | 31,393 | 15,589 | 35,305 | 17,091 | 31,393 | 15,589 | 35,305 | 17,091 |
| Foreign exchange contracts | 2-5 | 157,776 | 3,155 | 110,472 | 2,209 | 157,776 | 3,155 | 110,472 | 2,209 |
| Total off balance sheet exposure | 496,965 | 108,136 | 466,013 | 106,830 | 496,965 | 108,136 | 466,013 | 106,830 | |
Market Risk – The Standardised Measurement Approach
| Bank | Group | |||
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2016 LKR million |
2015 LKR million |
2016 LKR million |
2015 LKR million |
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| Capital Charge for | ||||
| Interest rate risk | 77 | 122 | 77 | 122 |
| Equity | 551 | 682 | 551 | 682 |
| Foreign exchange & gold | 1,359 | 1,725 | 1,359 | 1,725 |
| Total capital charge for market risk | 1,987 | 2,529 | 1,987 | 2,529 |
| Total risk-weighted assets for market risk | 19,872 | 25,294 | 19,872 | 25,294 |
Operational Risk – The Basic Indicator Approach
| Bank | Group | |||
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2016 LKR million |
2015 LKR million |
2016 LKR million |
2015 LKR million |
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| Capital Charge for Operational Risk | ||||
| Total gross income of three consecutive years | 190,071 | 164,837 | 209,143 | 186,910 |
| Average gross income | 63,357 | 54,946 | 69,714 | 62,303 |
| Total capital charge for operational risk – (15%) | 9,503 | 8,241 | 10,457 | 9,345 |
| Total risk weighted assets for operational risk | 95,035 | 82,418 | 104,572 | 93,455 |
In the Basic Indicator Approach (BIA), the Bank shall calculate its annual gross income for the most recent year by aggregating the gross income of the last four financial quarters and follow same to calculate annual gross income for each of the two years preceding the most recent year.
The Central Bank of Sri Lanka has given the guidelines to the Sri Lankan banks to move to the standardised approach (TSA) or alternative standardised approach (ASA) subject to the prior approval.
| Bank | Group | |||
|
2016 LKR million |
2015 LKR million |
2016 LKR million |
2015 LKR million |
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| Computation of Ratios | ||||
| Total Risk Weighted Assets | ||||
| Total risk weighted assets for credit risk | 734,820 | 598,163 | 774,043 | 641,154 |
| Total risk weighted assets for market risk | 19,872 | 25,294 | 19,872 | 25,294 |
| Total risk weighted assets for operational risk | 95,036 | 82,419 | 104,572 | 93,455 |
| Sub total | 849,728 | 705,876 | 898,487 | 759,903 |
| Minimum Capital Charge | ||||
| Credit risk | 73,482 | 59,816 | 77,404 | 64,115 |
| Market risk | 1,987 | 2,529 | 1,987 | 2,529 |
| Operational risk | 9,503 | 8,241 | 10,457 | 9,345 |
| Total eligible core capital (Tier I capital) | 74,128 | 64,207 | 79,148 | 71,112 |
| Total eligible supplementary capital (Tier II capital) | 30,730 | 28,038 | 32,909 | 30,217 |
| Total capital base | 104,858 | 92,245 | 112,057 | 101,329 |
| Core capital ratio (%) | 8.7 | 9.1 | 8.8 | 9.4 |
| Total capital adequacy ratio (%) | 12.3 | 13.1 | 12.5 | 13.3 |