Capital adequacy ratio of commercial banks rises to 13%

Indian households are jittery. They are afraid of the backlash of the US financial crisis on our banks, where they have put larger part of their savings following sharp rise in interest rate last year. The share of bank deposits in total household savings that hovered at around 35% in the early part of the current decade has jumped to more than 55% in 2007-08.

A severe dollar shortage in the international markets has had its impact felt in India too as banks have almost stopped large lending to tide over the liquidity crisis. But this is purely a business decisions and the banks��� underlying strength is quite robust.

A close look at their capital adequacy ratio ��� an indicator to their capital strength ��� can be handy to drive this point home. All of our banks have capital adequacy ratio (CAR), also
called capital to risk weighted assets ratio (CRAR) in conformation with the Basel II accord.

CRAR is the measure of the amount of a bank���s capital expressed as a percentage of its risk weighted credit exposures. The ratio determines the capacity of the bank to meet the time liabilities and other risk such as credit risk and operational risk.

In the most simple formulation, a bank���s capital is the cushion for potential losses, which protect the bank���s depositors or other lenders. Banking regulators in most countries define and monitor CRAR to protect depositors, thereby maintaining confidence in the banking system.

An ET survey of 79 commercial banks finds that all of them have more than 8% CRAR in 2007-08, the minimum that the Basel II accord demands. The average CRAR for the sample banks was estimated at 13%. What is significant is that the CRAR has increased steadily in recent years ��� it has gone up 0.7 percentage point last year to 13% from 12.3% in 2006-07.

The private sector banks seem to have done better than their public sector or foreign counterparts in terms of CRAR. The average CRAR of 23 private sector banks was estimated at 14.3% in 2007-08 compared to 13.2% of the eight banks of the State Bank group, 12.1% of the 20 nationalised banks and 13.1% of the 28 foreign banks.

The private sector banks not only have the highest CRAR in 2007-08, they have also witnessed the sharpest rise ��� up by 2.2 percentage points to 14.3% last year from 12.1% in 2006-07. Foreign banks rose 1.1 percentage point and SBI group saw rise of 0.9 percentage point. The nationalised banks, in contrast, have witnessed a 0.4 percentage point fall in CRAR last year over 2006-07.

The CRAR of ICICI Bank has increased by a huge 2.28 percentage point last year from 11.69% in 2006-07 to 13.97%. Interestingly, the CRAR of ICICI Bank was estimated at 10.36% in 2003-04. And if the CRAR of HDFC Bank has not increased as sharply as that of ICICI Bank last year, in actual terms, at 13.6%, it was considerably higher than that of the average of the sample banks.

But the banks have not only increased their capital adequacy ratios, they have also brought down their net non-performing assets (NPA) ratio during this period, thereby enhancing the quality of capital. Net non-performing assets as percentage of net advances of the sample banks has declined from 1.31% in 2005-06 to 1.01% in 2006-07 and further to 1% last year.

The nationalised banks, which were haunted by huge NPA till recently, seem to have done well here. The net NPA ratio of 20 nationalised banks has declined from 1.27% in 2006-07 to 0.92% last year.

The net NPA ratio of 23 private sector banks has declined from 1.05% to 0.97% during the same period.

Interestingly, even as the banks have enhanced the quality of their capital and have improved the capital adequacy ratio last year, they have also witnessed an improvement in return on advances. The return on advances adjusted to cost of funds of the sample banks has increased from 3.8% in 2005-06 to 4.1% in 2007-08.

The private sector banks with 4.87% return on advances was way ahead of both the nationalised banks and the SBI group. The return on the nationalised banks and the SBI group was estimated at 3.67% and 3.65% respectively, in 2007-08.