Risk management and capital Management are two sides of the same coin. Both of these indicate that the sufficient capital contribution in the business provides stable resources to help the owner to absorb any losses arising from the risks in a business.
The objective of Capital management as well as its risk appetite is to reach solvency ratio adequate for its lending activities during a period of difficult business conditions. The available capital in the business must be enough to satisfy regulatory and internal capital requirements. Additional capital is also required to weather heavy unexpected losses. The Capital of banking business is divided into different tiers according to the characteristics / qualities of each qualifying instrument. For management purposes capital is primarily split into two categories viz. Tier I and Tier II.
The bank’s capital to its risk is arrived at by dividing the capital of the bank with aggregated risk weighted assets for credit risk, market risk and operational risk. This is known as Capital Adequacy Ratio (CAR) or Capital to Risk (Weighted) Assets Ratio (CRAR).The capital adequacy ratio prescribed by the banking regulator (RBI) under the Pillar 1 of the Framework is only the regulatory minimum level, addressing only the three specified risks (viz., credit, market and operational risks), holding additional capital may be necessary in order to evaluate the potential vulnerability of the bank to some unlikely but plausible events or movements in the market conditions that could have an adverse impact on the bank’s capital. Therefore, the onus is on the concerned banks to make their own internal assessment including stress test and scenario analysis of their various risk exposures, through a well-defined internal process, and maintain an adequate capital cushion for such risks to demonstrate that its ICAAP is comprehensive.
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What is Internal Capital Adequacy Assessment Process (ICAAP)?
