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Key aspects of bank capital

Business
Capital management is one of the fundamental aspects of bank management. This is so because banks must be capitalised in a manner consistent with their risk profile, regulatory standards and economic capital standards.

Capital management is one of the fundamental aspects of bank management. This is so because banks must be capitalised in a manner consistent with their risk profile, regulatory standards and economic capital standards.

FINANCIAL SECTOR SPOTLIGHT WITH OMEN MUZA

If that were not the case, then the risk that banks might be unable to maintain adequate levels of capital, which could easily lead to an inability to support business activity or failure to meet regulatory requirement, would be immense. This type of risk is called capital risk.

In order to enhance understanding of capitalisation and its impact on the well-being of banks, this installment discusses some key aspects of bank capital.

Composition of capital

A bank’s capital is made up of three levels or tiers — Tier 1, Tier 2 and Tier 3. Tier 1 or core capital comprises of components such as share capital, share premium, capital awaiting allotment and retained earnings including accumulated profits or losses for the current period.

According to the latest Monetary Policy Statement, the banking sector’s aggregate core capital base increased significantly by 19% from $753,3 million reported as at June 30 2014 to $899,10 million as at June 30 2015. Growth in the aggregate core capital position was largely underpinned by increased retained earnings. This means banks are not returning capital to shareholders, as they strive to grow their capital.

Tier 2 capital also called supplementary capital comprises of general provisions such as impairment allowance and other reserves. Tier 2 capital should not exceed 50% of Tier 1 capital. Tier 3 capital (tertiary capital) is that part of the capital base which is allocated to meet market and operational risks.

The table shows local banks’ and building societies’ composition of capital as at June 30, 2015, with the ranking based on total capital. Please note that Steward Bank’s position is as at February 28, 2015.

Capital Adequacy Ratio (CAR)

The sum of Tier 1, Tier 2 and Tier 3 capital is total regulatory capital, which when expressed as a percentage of total risk weighted assets (RWAs) results in the capital adequacy ratio. Risk weighted assets are arrived at by applying the appropriate risk factor as determined by the RBZ to the monetary value of the various assets as they appear on banks’ balance sheets.

The Reserve Bank of Zimbabwe requires each bank to maintain a core capital adequacy ratio of 8% and total capital adequacy ratio of 12%.

According the apex bank, capital adequacy measures the sufficiency of the bank’s capital in relation to the risk inherent in the institution’s operations, which level of risk is determined by the nature, scope and complexity of the institution’s banking operations. Capital adequacy is therefore an important determinant of the financial condition of banks.

Limits and Compliance

Various limits apply to elements of the capital base. The core capital (Tier 1) shall comprise not less than 50% of the capital base and the regulatory reserves and portfolio provisions are limited to 1,25 % of RWAs. As at June 30 2015, all operating banking institutions were in compliance with the prescribed minimum capital requirements.

Tier 1 capital requirement is currently a minimum of $25 million for banks but will increase to $100 million by 2020. In the meantime, banks have had to submit capitalisation plans on how they intend to meet the new minimum regulatory capital by requirement, for consideration and approval by the central bank. The plans target a combination of retained earnings and fresh capital injection by shareholders.

The Reserve Bank expects institutions facing capitalisation challenges to take decisive action by consolidating operations and/or merging with appropriate suitors; accepting dilution of shareholding by potential investors or converting their banking licences to deposit taking microfinance institutions (microfinance banks).

Supervision

For supervisory purposes, capital adequacy and the regulatory capital are based on guidelines developed by the Basel Committee on Banking Supervision (BCBS) as implemented by the Reserve Bank of Zimbabwe. The Reserve Bank of Zimbabwe monitors capital levels of financial institutions through quarterly BSD1 returns.

l Feedback: [email protected]. You can view Omen’s LinkedIn profile and initiate contact at zw.linkedin.com/pub/omen-n-muza/30/641/3b8