Introduction

The capital requirements also referred to as capital adequacy ratio refers to the capital amount that the financial institutions have to maintain in accordance with the regulations of the financial institutions. It is expressed as a percentage. The variables involved are the equity ratio and the debts. The requirement is vital as it prevents the firms in the financial sector from becoming insolvent by not taking advantage of the leverages (Acharya, et al., 2011).

Personally, I feel the Capital Adequacy Requirement is capable of reducing the risk of Authorised Deposit-taking Institutions from collapsing. This is based on the fact that the capital requirement uses the ratio of the equity that is dependent on the liability of a firm as well as the equities that it holds. As such, it assists firms to make informed decisions based on their equities and debts. Furthermore, I believe, according to Docherty & Viort, (2013), it assists firms in making timely liabilities as well as other risks such as the credit and operational. Besides, firms can determine the minimum of the CAR, thus, offer the know-how of the opportune periods for expansion. As a result, firms can expand based on the amount of their capital.

The CAR accounts for other factors that are pertinent to the bank’s evaluation of their capital adequacy. The factors take into consideration the assets quality, the provisioning adequacy, the effectiveness of the management systems of the bank to control as well as manage their credit risks. It also includes the risks of the market and profitability. The Australian Regulatory Prudential Regulation Authority (APRA) assists banks to determine their capital adequacy (Drumond, 2009). Hence, it ensures that there is adequacy of the resources for banks based on their type, size, and quality. It adopts an approach that is based on the risk that evaluates the adequacy of the bank’s capital. Thus, it is in accordance with the aspects that were recommended by the Basle Committee on Banking Supervision.

The regulatory evaluates the risks that have the highest probability of occurring especially those that are associated with the debt defaults.  It also takes into consideration the transfer risks associated with a change in the country. Risk weightings consider the basis of the portfolio on the chances that are relative of the counterparties that are in compromised positions to assist banks in meeting their obligation (Sayer, 2011). Thus, the risk weights which are used are based on the judgment of the potential of the risks for the various kinds of counterparties. These offer no guidance on the risks of the credit associated with the individual’s counterparties exposure.  The banks that are foreign fail to be under the guide, however, there is the expectation of standards of capital adequacy from the home country of the banks (Francis & Osborne, 2010).

The Greater as well as the Hume Bank have their core capitals in accordance with Tier 1 standards. It includes the share capital and the preference shares that are irredeemable and noncumulative. The focus of the guideline was on a worldwide level that takes into consideration the bank’s operation as well as the subsidiaries consolidated in accordance with the accounting standards of Australia. There is a need for the incorporation for the equity of the shareholders at the onset of the bank capital, as well as the reserves that are disclosed. In light of this fact, there is adherence of the essential capital as well as an account for the resources of the capital. It contributes to the bank’s flexibility as well as resilience, especially those with financial challenges (Sayer, 2011).

Conclusion

The authorities with the mandate of regulating the banks need to constantly monitor the ratio of the capital adequacy to ensure that ADIs are able to mitigate their losses, as well as their requirements of their capital. The introduction if the capital adequacy bars banks from becoming insolvent because of the lack of taking leverage (Docherty & Viort, 2013).

References

Acharya, V. V., Kulkarni, N. & Richardson, M., 2011. Capital, Contingent Capital, and Liquidity Requirements. Regulating Wall Street: The Dodd-Frank Act and the New Architecture of Global Finance, pp. 143-180.

Docherty, A. & Viort, F., 2013. Regulation of the Banking Industry. Better Banking: Understanding and Addressing the Failures in Risk Management, Governance and regulation, pp. 113-174.

Drumond, I., 2009. Bank Capital Requirements, Business Cycle Fluctuations and The Basel Accords: A Synthesis. Journal of Economic Surveys, 23(5), pp. 798-830.

Francis, W. B. & Osborne, M., 2010. On the Behavior and Determinants of Risk-Based Capital Ratios: Revisiting the Evidence from UK Banking Institutions. International Review of Finance, 10(4), pp. 485-518.

Sayer, S., 2011. Bank Capital Requirements, Business Cycle Fluctuations and the Basel Accords: A Synthesis. Issues in Finance: Credit, Crises and Policies, pp. 5-37.