1. **Gross Non-Performing Assets (NPA):**
Gross NPA refers to the total value of loans that are classified as non-performing or in default. These are loans on which the borrower has not paid interest or principal for a specified period, usually 90 days. In other words, these are loans where the borrower is not meeting their repayment obligations. Gross NPA does not take into account any provisions made for potential losses due to these non-performing loans.
Example: Let's say a bank has given out loans totaling $1 million. Out of this, $100,000 worth of loans are not being repaid for more than 90 days. So, the gross NPA for the bank is $100,000.
2. **Net Non-Performing Assets (Net NPA):**
Net NPA takes into account the provisions that a bank has set aside to cover potential losses from non-performing loans. It is calculated as Gross NPA minus the provisions made by the bank.
Example: Continuing from the previous example, if the bank has made provisions of $30,000 for potential losses on the non-performing loans, then the Net NPA would be $100,000 - $30,000 = $70,000.
3. **Provision Coverage Ratio (PCR):**
The Provision Coverage Ratio is a measure of the extent to which a bank has set aside provisions to cover its potential losses from non-performing loans. It is calculated by dividing the amount of provisions made by the bank for bad loans by the Gross NPA.
Example: In our ongoing example, if the bank has set aside $30,000 as provisions and the Gross NPA is $100,000, then the Provision Coverage Ratio would be ($30,000 / $100,000) * 100 = 30%.
4. **Capital to Risk-Weighted Assets Ratio (CRAR):**
CRAR, also known as Capital Adequacy Ratio, is a measure of a bank's capital in relation to its risk-weighted assets. It indicates the bank's ability to absorb losses. The ratio is calculated by dividing the bank's Tier 1 and Tier 2 capital by its risk-weighted assets.
Example: Let's say a bank has Tier 1 capital of $200,000, Tier 2 capital of $100,000, and its risk-weighted assets amount to $1,000,000. The CRAR would be (($200,000 + $100,000) / $1,000,000) * 100 = 30%.
Putting it all together:
Suppose Bank A has a loan portfolio of $10 million. Out of this, $2 million are non-performing loans. The bank has set aside $500,000 as provisions for potential losses. Additionally, the bank's Tier 1 capital is $1.5 million, Tier 2 capital is $800,000, and its risk-weighted assets are $8 million.
- Gross NPA: $2 million
- Net NPA: $2 million - $500,000 = $1.5 million
- Provision Coverage Ratio: ($500,000 / $2 million) * 100 = 25%
- CRAR: (($1.5 million + $800,000) / $8 million) * 100 = 28.75%
**Tier 1 & Tier 2 Capital**
Imagine you're running a lemonade stand, which is like your own small bank. You want to make sure you have enough money to cover unexpected losses or situations where some customers might not pay you for the lemonades they buy.
**Tier 1 Capital: Common Equity**
Tier 1 capital is like the money you've invested in your lemonade stand from your own savings. It's the most solid and dependable form of capital. Let's say you've put in $100 of your own money into the stand. This $100 is your Tier 1 capital. It's always available to cover any unexpected costs or losses your lemonade stand might face.
**Tier 2 Capital: Debt and Reserves**
Tier 2 capital is like extra help you get from your family or friends when you're short on cash. Let's say your friend lends you $50 as a backup in case your lemonade stand runs into trouble. This $50 is your Tier 2 capital. It's not as reliable as your own money (Tier 1 capital), but it still gives you more cushion to handle difficulties.
In summary:
- **Tier 1 Capital:** Your own money invested in the business (e.g., your savings), which is the most reliable source of funds.
- **Tier 2 Capital:** Extra help from others (e.g., loans from friends), which adds an extra layer of protection but may not be as dependable as Tier 1 capital.
Just like in banking, having a mix of Tier 1 and Tier 2 capital helps your lemonade stand (or a real bank) be better prepared to handle unexpected challenges while maintaining stability and trust.
**Risk Weighted Assets**
Imagine you have a collection of different toys, each with a different level of risk associated with it. Some toys are more likely to break or be lost, while others are more durable and less likely to cause any issues.
Now, let's say you're a bank, and instead of toys, you have loans to different types of borrowers. Each loan represents a certain amount of money you've lent out. However, not all loans carry the same level of risk. Some borrowers are more reliable and likely to repay their loans, while others might be less dependable.
Here's where the concept of risk-weighted assets comes in:
1. **Assigning Risk Weights:** Just like you assigned risk levels to your toys, financial regulators and banks assign risk weights to different types of loans. Loans with higher risk receive higher risk weights, while loans with lower risk get lower risk weights.
2. **Calculating Risk-Weighted Assets:** To calculate risk-weighted assets, you multiply the amount of each loan by its corresponding risk weight. This gives you a way to measure the total amount of assets your bank is holding, adjusted for the varying levels of risk associated with those assets.
Example:
Let's say your bank has three types of loans:
- Loan A: $1,000 with a risk weight of 20%
- Loan B: $2,000 with a risk weight of 50%
- Loan C: $3,000 with a risk weight of 100%
To calculate risk-weighted assets, you would multiply the loan amounts by their risk weights and then add them up:
Risk-Weighted Assets = (Loan A × Risk Weight) + (Loan B × Risk Weight) + (Loan C × Risk Weight)
Risk-Weighted Assets = ($1,000 × 20%) + ($2,000 × 50%) + ($3,000 × 100%)
Risk-Weighted Assets = $200 + $1,000 + $3,000
Risk-Weighted Assets = $4,200
So, your bank's risk-weighted assets amount to $4,200. This is the adjusted value that takes into account the varying risk levels of your loans.
Why is this important? Regulatory capital requirements are often based on a percentage of a bank's risk-weighted assets. Banks with riskier assets are required to hold more capital as a buffer against potential losses. By assigning risk weights and calculating risk-weighted assets, banks and regulators can ensure that banks are adequately capitalized to handle different levels of risk in their loan portfolios.
No comments:
Post a Comment