RBI’s oversight over Bank

In News

• The Reserve Bank of India (RBI) has recently placed Dhanlaxmi Bank under tight monitoring due to falling Capital Adequacy Ratio.   

About the current issue 

• It is a Thrissur-based private bank. 
  • The RBI’s move comes in the wake of the intense court battle waged by a group of minority shareholders against the bank’s management team over inadequate financial disclosures, rising expenses, and general mismanagement of the business. 
• Dhanlaxmi Bank’s capital to risk-weighted assets ratio (CRAR) dropped to around 13% at the end of March this year from 14.5% a year ago. Banks are supposed to maintain their CRAR at 9% or above according to Basel-III norms. 
  • The bank has even been placed under the prompt corrective action framework (PCA) by the RBI to deal with serious deteriorations in its financial position.
    • Under the PCA, the RBI places restrictions on lending by troubled banks and keeps a close eye on them until their financial position improves sufficiently. 

Importance of capital adequacy  

• The CRAR is a ratio that compares the value of a bank’s capital (or net worth) against the value of its various assets weighted according to how risky each asset is, and is used to gauge the risk of insolvency faced by a bank. 
  • The riskier a type of asset held in a bank’s balance sheet, the higher the weightage given to the value of the asset while calculating the bank’s capital adequacy ratio. 
  • This causes the capital adequacy ratio of the bank to drop, thus signalling a higher risk of insolvency during crises.
• CRAR tries to gauge the risk posed to the solvency of the bank by the quality or riskiness of the assets on the bank’s balance sheet. 
• A bank cannot continue to operate if the total value of its assets drops below the total value of its liabilities as it would wipe out its capital (or net worth) and render the bank insolvent.
  • The capital position of a bank should not be confused with cash held by a bank in its vaults to make good on its commitment to depositors. 
• Banking regulations such as the Basel-III norms try to closely monitor changes in the capital adequacy of banks in order to prevent major bank failures which could have a severe impact on the wider economy.

Way forward

• The Bank has been trying to issue additional shares in the open market through a rights issue in order to deal with its capital adequacy woes.  
  • Through a rights issue, the bank will be able to raise more equity capital from existing shareholders.
    • The rights issue has been delayed by the ongoing court battle. 
  • This is in contrast to an initial public offering where shares are issued to new shareholders.
• The additional capital could help in raising the bank’s capital adequacy ratio which is necessary to comply with regulations and serve as a buffer that absorbs any losses incurred by the bank on its loan book in the case of any crisis in the future. 

Source: TH