Among the key instruments for regulating the activity of commercial credit institutions by the Central Bank is the establishment of a capital adequacy ratio. What is its specificity? What could be its optimal value?
What is the essence of the capital adequacy ratio?
The capital adequacy ratio (or equity) is considered one of the main tools for regulating the activities of credit organizations by the state. It reflects the ratio of cash available to the bank to its obligations (first of all, on the payment of deposits and interest on them).
It can be noted that the capital adequacy ratio is an indicator that is used to evaluate the performance of not only credit institutions, but also organizations of other sectors of the economy, for example, credit cooperatives. In this case, it determines the likelihood of a bankruptcy of the company based on its obligations (to pay salaries to employees, to compensate for existing loans, to transfer dividends).
Moreover, according to some economists, the capital adequacy ratio of credit cooperatives should be higher than that of banks. This is due to the fact that in the relevant organizations the criteria for assessing the solvency of borrowers are usually less stringent than in specialized credit and financial institutions. In this regard, customers of cooperatives can more often allow delays in loans, as a result of which the company may have a deficit of its own funds to pay off existing obligations.
How is the standard for bank capital calculated?
The bank’s capital adequacy ratio is defined as the ratio of the size of the base, fixed capital of a financial institution, as well as equity to amounts reflecting credit risks for those assets that are recorded on balance sheets, for contingent liabilities, as well as for derivative instruments for managing financial flows. In addition, the calculation of the considered standard may take into account the risk of a decrease in the solvency of counterparties that are borrowers, as well as operational and market risks.
It should be noted that, in fact, the Central Bank established a capital adequacy standard in several varieties. Let's consider them in more detail.
Types of capital adequacy ratios
So, the Central Bank of the Russian Federation determines for financial institutions such indicators as:
- capital adequacy ratio of the bank - H1.0;
- the indicator on the basic capital of a credit institution - H1.1;
- standard for fixed assets - H1.2.
It can be noted that the noted classification of capital ratios for Russian banks was introduced in 2014. Previously, a single indicator was used - H1. Its analogue was the new standard - H1.0.
The structure of standardized reserves of the bank
The standards of sufficiency of own funds (capital) are defined as an indicator fixed in relation to specific varieties of financial reserves of a financial institution.
In order to correctly determine, for example, indicator H1.0, it is necessary to fix the total amount of equity capital of the institution. In accordance with the criteria established by the Bank of Russia, the equity of a credit institution consists of:
- fixed capital;
- additional reserves.
In turn, both types of capital are classified on other grounds.
Fixed capital structure
So, fixed capital includes:
- authorized capital - formed on the basis of contributions from the founders of the bank;
- emission revenue - generated, as a rule, as a result of sales of securities;
- organization reserve fund - formed in accordance with the requirements of the law;
- profit, the value of which is confirmed by the results of the audit of the credit institution.
Additional capital structure
In turn, the additional capital of the bank consists of:
- increase in property value following revaluation;
- funds presented by the reserve fund, which is formed from profits not officially confirmed by the results of audits;
- current profits, also not confirmed by auditors, but not related to the reserve fund;
- subordinated loans;
- established types of preferred shares.
It should be noted that when calculating the amount of the bank’s equity, by which the considered norm is determined, it is necessary to exclude from the calculations:
- value of intangible assets;
- repurchased own shares from investors;
- not compensated by the bank for losses of the current year, as well as previous years.
Certain features may characterize the allocation of equity in the structure of reserves of credit cooperatives. These calculations are governed by separate rules of law.
The optimal standard for banks
One way or another, the capital adequacy ratio is still a typical indicator for banks. As we noted above, it is one of the instruments by which the Central Bank regulates the activities of commercial credit institutions. What could be its optimal value?
In this case, it is fair to say that, depending on the specific economic situation, the bank’s own capital (capital) adequacy ratio may be different. If there is a crisis in the national economy of the state, then in many cases the corresponding indicator is lowered by the regulator. This is due to the fact that banks may accumulate distressed assets in the form of overdue debt of borrowers. With a more favorable economic environment, it can be increased.
There is a special procedure for calculating the considered indicators. Let's study it
Formula for calculating bank capital ratios
In general, regardless of what kind of indicator we are talking about - be it H1.0 or the standard of capital adequacy ratio - H.1.1, the calculation formula is the same (but with a different sequence of calculations). It, one way or another, takes into account:
- the amount of the base capital of the credit institution;
- value of fixed capital;
- amount of own funds of the bank;
- risk ratios;
- institution assets;
- bank reserves;
- indicators reflecting the application of special requirements for the use of capital, based on international recommendations;
- the amount of credit requirements of the bank.
Depending on what specific norm a person is interested in studying the financial condition of the bank, the components of the formula discussed above are taken into account in different sequences.
The optimal value of the bank’s equity
What should be the indicator in question (sometimes it is denoted not by the letter h, but by Russian H because of their similarity), H1, is the capital adequacy ratio? The minimum value set by the Central Bank is 8%. For other indicators considered, the values are set different. So, the standard H1.1 should not be lower than 4.5%. H1.2 should be at least 6%.
It can be noted that in addition to the mandatory, there are also recommended values of the standards in question. For example, in certain periods, the CBR advised banks not to lower the indicator in question below 14%. This is noticeably higher than the numbers indicated by us.Thus, it is fair to say that there are minimum acceptable indicators for the considered standards, and there are those that it is advisable to adhere to institutions that in practice conduct activities in the banking market. We will study this aspect in more detail.
Capital ratio in the banking market
So, we examined the basic legislative requirements for capital adequacy standards of a credit institution established by the Central Bank of the Russian Federation. It will now be useful to study what are the actual sizes of the relevant indicators established by specific banks.
In 2010, Expert RA agency conducted a study that showed that banks that ensure capital adequacy at the minimum level set by the Central Bank of the Russian Federation - 10%, may experience significant difficulties. Especially if they have significant operational risks.
In such cases, therefore, it is advisable for financial institutions to exceed the mandatory capital adequacy ratios of a commercial bank established by the regulator. In addition, if the indicator in question is not high enough, commercial risks increase in the case of poor reservation, analysts say so. The main criterion for the high level of carrying out this procedure is the use in the reservation formula of indicators reflecting potential defaults in long-term loans.
That is, banks providing not too high capital adequacy should be especially careful about distressed assets. In 2010, the Russian economy emerged from the crisis of 2008-2009. Now the country's national economy is back in crisis. What are the current priorities of the Central Bank in terms of regulating the level of capital adequacy, and how do banks feel in connection with possible adjustments to the policy of the main regulator in the corresponding direction?
Regulator policy regarding regulatory setting: crisis factor
As we noted above, in a crisis, the Central Bank of the Russian Federation can soften the requirements for one or another financial sustainability indicators commercial banks. This is the policy the Central Bank adheres to now. In 2015, the capital adequacy ratio of financial institutions H1.0, as well as H.1.1, was reduced. What effect did this have on the banking market?
According to analysts of Expert RA agency, credit and financial organizations have become, despite liberalization of the Central Bank’s policy, more sensitive to a decrease in the value of assets. This is due, according to financiers, too high requirements for H1.2. In this case, we can say that for the policy of the Central Bank of the Russian Federation it may be inherent to consider the significance of the relevant standards separately.
Mitigation of the H1.0 indicator, therefore, does not always mean that the regulator is ready to reduce other standards that are adjacent to it. As a result, as Expert RA analysts found out, during the crisis period, the number of banks falling into the risk zone associated with insufficient volumes of fixed capital increased significantly by about 30%. And if these financial institutions cannot increase profitability, then they may need additional capitalization, which may be one of the sources of increasing the H1.0 standard. Let's consider this aspect in more detail.
Recapitalization of banks as a resource for increasing the capital ratio
The bank capitalization program aimed at increasing the H1.0 indicator can be implemented as part of government programs. So, in the period from May 2015 to February 2016, the liquidity of the banking system of the Russian Federation was increased by 803 billion rubles in the corresponding way. At the same time, according to analysts, the stocks of credit and financial organizations according to the H1.2 standard, despite the support of the H1.0 indicator through recapitalization, decreased significantly due to the low profitability of economic activity.
The role of bank owners in recapitalization
An important role in supporting the liquidity of banks is played by their owners. The capitalization with their participation in 2015 was also significant: the owners of credit and financial institutions invested more than 100 billion rubles in their businesses.However, significant investments in bank capital should be accompanied by real optimization of the business model of financial institutions. Reducing the requirements for the amount of capital adequacy of the Central Bank only helps banks withstand formal sustainability criteria. In practice, they need to have a significantly higher H1.0 ratio than the one set by the regulator, as well as make significant efforts to increase profitability.
Summary
So, we examined the essence of the bank capital adequacy ratio, represented by several varieties. This indicator determines the bank's resistance to risk factors, for example, in the form of a deterioration in the dynamics of repayment of payments by borrowers.
The adequacy ratios of equity (capital) are defined as the ratio of the bank’s reserves to the risks identified by the Central Bank of the Russian Federation. The value of the relevant indicators may be different. Depending on the situation in the economy, the Central Bank may increase or decrease the H1.0 indicator or, for example, the standard of capital adequacy. The formula for calculating all the considered standards is the same in structure. Only the sequence of calculations that it provides will differ, depending on which indicator the financier is interested in.
An increase in H1.0 of the bank is possible due to various sources. In 2015, when the crisis worsened in the Russian economy, large-scale state programs were implemented aimed at recapitalizing credit and financial institutions. A significant amount of funds in the reserves of banks was invested by their owners.
The capital adequacy ratio of a bank is of great importance from the point of view of risk assessment in the economic activity of a financial institution. But from the point of view of the analysis of a real business, its information content is limited. If the bank has a low profitability or a significant share of bad debts, then high rates according to the relevant standard, in particular, exceeding the minimum or even the recommended level by the Central Bank, may not be of great importance.
