2.3.3 NPA and Capital Adequacy

INSTITUTE - USB
DEPARTMENT - BBA
Subject Name- Banking
Subject Code- 22BAT-324
Faculty Name – Mr. Vivek Sharma (E13500)
Features and Objectives of RRB’s DISCOVER . LEARN . EMPOWER

NPA and Capital Adequacy
Course Objectives:
1. To create awareness among the students regarding banking and insurance
concepts for better careers in this field
2. To apply the practical knowledge of Banking and Insurance in a dynamic
business environment.
Course Outcome
CO Title Level
Number Image Address
4
https://i.ytimg.com/vi/0xCOlq8b_tM/
To appraise the changing scenario of Analysis maxresdefault.jpg
banking practices, products, and
services
2
Table of Contents
S No. Contents Slide No.
1 Concept of NPA 4
2 Concept of Capital Adequacy 5
3 Inter-relationship Between Capital Adequacy 6-9

and NPA
3
1. Concept of NPA
Non-performing assets (NPAs) are loans and advances that are in

default or arrears. Typically, a loan is classified as non-performing
when interest payments or principal repayments are overdue by 90
days or more.
Key Points:
 Indicator of Asset Quality: High levels of NPAs indicate poor
asset quality and can reflect inefficient credit risk management.
 Impact on Profitability: NPAs do not generate income and often
require provisioning, which directly impacts the bank’s profitability.
4
2. Concept of Capital Adequacy
The Capital Adequacy Ratio (CAR), also known as the Capital to Risk
(Weighted) Assets Ratio (CRAR), is a measure of a bank’s capital. It is
expressed as a percentage of a bank's risk-weighted credit exposures.
•Key Points:
 Indicator of Financial Strength: CAR ensures that banks can
absorb a reasonable amount of loss and complies with statutory
capital requirements.
 Components of CAR: It includes Tier 1 capital (core capital, which
absorbs losses without requiring a bank to cease operations) and
Tier 2 capital (supplementary capital).
5
3.
3.Inter-relationship Between Capital Adequacy and NPA
A. Impact of NPAs on CAR:

 Reduction in Profits: High NPAs lead to higher provisioning requirements,
reducing the bank’s net income. Lower profits result in less retained earnings,
which is a component of Tier 1 capital.
 Increased Risk-Weighted Assets (RWA): NPAs increase the risk weight of
assets. Higher risk weights increase the total RWAs, which in turn lowers the
CAR unless additional capital is raised.
 Erosion of Capital: Prolonged periods of high NPAs can erode a bank’s capital
base. If the provisions for NPAs are not sufficient, the bank may have to dip into
its capital to cover the losses, further reducing CAR.
6
B. Regulatory Requirements and Buffer:
 Minimum CAR Requirements: Regulatory authorities, under

Basel III guidelines, require banks to maintain a minimum CAR.
High levels of NPAs can make it challenging for banks to meet
these requirements, potentially leading to regulatory action.
 Capital Buffers: Banks are required to hold capital buffers above
the minimum CAR to absorb shocks. High NPAs can quickly
deplete these buffers, leaving the bank vulnerable to further
financial stress.
7
C. Strategic Responses by Banks
Capital Infusion: To counter the negative impact of NPAs, banks

might need to raise additional capital. This can be through equity
issuance or other instruments, which can be dilutive and costly.
Risk Management Practices: Improving risk management practices
to reduce future NPAs can help in maintaining a healthier CAR. This
includes better credit assessment, stricter loan approval processes, and
effective monitoring of existing loans.
8
Summary
• The relationship between NPAs and CAR is intricate and significant. High
NPAs erode a bank’s profitability and capital base, leading to a lower
CAR. Maintaining a healthy CAR in the face of rising NPAs requires
effective risk management, adequate provisioning, and sometimes external
capital infusion.
• Regulatory requirements for minimum CAR levels further underscore the

importance of managing NPAs to ensure financial stability and
compliance. Understanding this relationship is essential for stakeholders,
including bank management, regulators, and investors, to safeguard the
banking sector's resilience and stability.
9
Applications
• Gain knowledge about the Indian Banking & Insurance System
and how it is evolved over a number of years
• Banking & Insurance sector offers a fast-paced, continuously
challenging career
• Banking & Insurance Sector provides Professional training &
development opportunities
10
REFERENCES
• Reference Books
1.Indian Banking – S. Natarajan and Dr. R Parameswaran – S Chand
Company and Ltd.
2.Introduction to Banking - Vijayaragavan Iyengar – Excel books
• Reference Website
 https://www.investopedia.com/terms/n/nonperformingasset.asp
 Rajan, R. G., & Dhal, S. C. (2003). Non-performing Loans and Terms of Credit of Public Sector Banks in
India: An Empirical Assessment. Reserve Bank of India Occasional Papers, 24(3).
 Basel Committee on Banking Supervision. (2006). International Convergence of Capital
Measurement and Capital Standards: A Revised Framework. Bank for International
Settlements.
11
THANK YOU
For any queries

Kindly Email: vivek.e13500@cumail.in

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INSTITUTE - USB

Features and Objectives of RRB’s DISCOVER . LEARN . EMPOWER

2 Concept of Capital Adequacy 5

3 Inter-relationship Between Capital Adequacy 6-9

Non-performing assets (NPAs) are loans and advances that are in

A. Impact of NPAs on CAR:

 Minimum CAR Requirements: Regulatory authorities, under

Capital Infusion: To counter the negative impact of NPAs, banks

• Regulatory requirements for minimum CAR levels further underscore the

For any queries

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