Capital adequacy is a measure of the financial strength of a bank expressed as a ratio of its capital to its risk weighted assets. This ratio indicates a bank's ability to maintain adequate capital…

Capital adequacy is a measure of the financial strength of a bank expressed as a ratio of its capital to its risk weighted assets. This ratio indicates a bank's ability to maintain adequate capital in the form of equity and subordinated debts to meet any unexpected losses. Directive number 1 of the Unified directives has made provision about the capital adequacy requirement for commercial banks. Under this directive, commercial banks are required to maintain minimum common equity tier I ratio of 6%, Tier I capital ratio of 8.5% and total capital ratio of 11% based on Basel III framework. The following is an extract from the annual report of ABC Bank (Rs in millions)

ParticularsAmount (Rs)Paid up capital✓8,000Statutory general reserve1,200Retained earnings✓800Capital redemption reserve✓300Exchange equalization reserve30Investment adjustment reserve✓200General loan loss provision✓700Intangible assets—50Investment in equity of institutions with financial interest—400Subordinated term debt←100Risk weighted balance sheet exposure for credit risk65,000Risk weighted off balance sheet exposure for credit risk16,000Risk weighted exposure for operational risk3,000Risk weighted exposure for market risk200Adjustment under Pillar II—3,000Perpetual non-cumulative preference share capital50Perpetual debt instruments70Stock premium ↘10

a. Calculate additional tier 1 capital, common equity tier 1 (CET 1) and Tier 1 capital. b. Calculate supplementary capital and total capital of the bank. c. Calculate total risk weighted exposure. d. Calculate capital adequacy ratio of the bank. Does the bank have sufficient capital to meet NRB capital requirements? e. Describe the significance of capital adequacy.