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Understanding Capital Adequacy Ratio (CAR) for Deposit-Accepting Banks [Copy link] 中文

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Post time 2006-1-20 16:53:57 |Display all floors
CAR is an internationally accepted measure of a deposit-accepting bank's capital base, expressed as a % of its risk weighted credit exposure. It is a rather pompous way of saying that a bank must maintain enough capital to support their market and credit risk without going bankrupt. A 7% CAR means the bank can absorb an outright loss of 7% of its exposure without going bankrupt.

CAR is needed to protect bank customers and to promote the financial stability of China's banking system.

Internationally, CAR is broken down into "Tier 1 Capital" and "Tier 2 Capital". Tier 1 capital is the loss the bank can absorb without becoming insolvent. Tier 2 capital is the losses the bank can absorb in case of the bank winding up business. Tax office generally have first call on Tier 2, shareholders come last.

For banks which accept deposits, an internationally accepted minimum of 7% CAR is the norm. In Hong Kong, the banking ordinance requires a minimum of 8% CAR, but the Hong Kong Monetary Authority can request a bank to have up to 12% CAR. They are very good at that in Hong Kong and China should use that as a model.

Some guidelines for implementing CAR:
**  know the risk that the bank is exposed to and how to quantify them;
**  identify the securities for the risks e.g. if I ask for a business loan, I offer my house as a security. The value of my house goes towards off-setting the risk.
**  continuously monitor the risk exposure and the value of the securities. If the value of the securities drops or the value of the risks rises, then the CAR will drop.
**  train the banking staff in assessing risk. When the bank lends monies, the bank must know the risks that the monies are exposed to.
**  appoint an independent board of directors, at least one of the director must deal with risk and CAR

Collectively, China's banks have a CAR ratio lower than the international minimum of 7%.


References
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http://www.tdctrade.com/econforum/hkma/hkma040302.htm

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Post time 2006-1-21 10:23:23 |Display all floors
Why the banks in a country that people have high saving rates has low Capital Adequacy Ratio?

I think it's because...
1. The country is developing fast
2. It's banks have high non performing loan (NPL) ratio
3. It's banks managements are too optimistic
4. too many banks running not efficiently
5. the managements think Soros is getting too old to do the trick again.
6. do they invest out of their realm?
anymore?
Vision without action is illusion---Y.J.

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Post time 2006-1-21 11:34:50 |Display all floors

Valuation of assets.

When calculating assets owned by banks in the USA, one problem that used to recur with better banks was the valuation of substantial real estate holdings that were carried on their books at the value of the original purchase price.  So property that had appreciated through the years was not scaled up even though it was clearly worth more than its original purchase price, which in some cases was more than 50 years old, and was certainly in excess of the appriased value for tax purposes.  However, banking regulations begun in the wake of the 1929 market crash had made it difficult if not impossible for American banks to revalue their real estate holdings.

Are there similar regulations that prevent China banks from valuing their assets at true levels which would increase the CAR above the internationally accepted 7% level?

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Post time 2006-1-21 12:23:14 |Display all floors

NPL albatross around neck of Chinese banks

Originally posted by amyamy at 2006-1-21 10:23
Why the banks in a country that people have high saving rates has low Capital Adequacy Ratio?

I think it's because...
1. The country is developing fast
2. It's banks have high non perfo ...


Some of the points you made are accurate and topical, non-performing loans (NPL's) made out to state-owned enterprises (SoE's) is one major hurdle to overcome if banks were to raise their collective CAR. Another hurdle is an inadequate understanding of risk and how to manage risks.

It would be nice to say we can absorb a one-off loss in China by revaluing the loan books and cut out the NPL's. Realistically that would put a lot of people employed in SoE's out of a job.

There are a few methods out there to help cash strapped businesses, but an SoE must realize first and foremost that the market economy and therefore competition is here to stay in China. They cannot hide behind the government and be a drag on the Chinese economy anymore. That said, Chinese banks should be looking at ways to help their client SoE's trade their way out of financial troubles. Techniques such as factoring services can bring in much needed cash to finance improvements in productivity, in sales and distribution of goods and services.

I don't doubt that for many SoE's, help is too late. A mix of corruption, lack of understanding of the role and purpose of a bank, lack of risk management knowledge and techniques etc are all contributing factors. A once-off write-off is necessary for these SoE's, and the government might have to come in and bail out some of the banks.  Once the write-off and bail out has been effected, I think a merger of several of these banks might be a good idea too.

Hoping for foreign banks to come in and bail out some of these financially necrotic local banks is not a good solution in the long run. See my answer about foreign ownership of local banks.

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Post time 2006-1-21 12:31:54 |Display all floors

Asset valuation

Originally posted by matt605 at 2006-1-21 11:34
When calculating assets owned by banks in the USA, one problem that used to recur with better banks was the valuation of substantial real estate holdings that were carried on their book ...


Actually USA is not the only country which has inadequate re-valuation of securities. This is one of the many areas that BASEL-2 is addressing. Re-valuation can be quite difficult for various forms of assets put up as collateral, such as a portfolio of shares which need to be marked to market regularly.

However I do take your point that Chinese banks can improve their CAR by revaluing the real estates used as collateral. The sky-rocketing real estate prices in Beijing, Shanghai, Shenzhen should make the asset side of the GL look rosier. Comes Beijing Olympic, I hope some of the local banks will look better - that is, if they do the right thing!

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Post time 2006-1-22 05:24:07 |Display all floors
Not rosier.  It will make things reflect reality.

Market value is the market value.  When market value is not reflected in the balance sheet, then the accounting is not accurate, and less accuracy erodes the credibility of the financial accounting system.

One of the principles of accounting deals with maintaining a conservative approach to change.  So if there is no better way to account for assets and liabilities, then the old method should persist.  However, when a more accurate method of accounting exists, then it should prevail.

The term "rosier" derives from the saying "to look at the world through rose colored glasses."  At one time people would wear rose colored glasses as entertainment, sort of like hi-tech special effects for people in the 18th century.  But seeing reality clearly and valuing assets at true market values isn't being wrongly optimistic.  It's being honest.  What's difficult is for banks to write down assets.  But of all the assets banks own, real estate is the most unlikely to lose its value.  If all banks listed their real estate at 100% of the tax appraisal value, which is set objectively and low to avoid the need for downward adjustment if prices fluctuate, then this would be more accurate.  This holds true especially in the USA, a country where I have some knowledge of accounting systems and banking regulations, and possibly also in China.

Thanks for posting on this topic.  It's good for me to learn terms like CAR and BASEL-2, and for everyone to become familiar with the financial issues facing China as it grows.

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Post time 2006-1-22 09:59:19 |Display all floors

Tax appraisal value of real estate

Originally posted by matt605 at 2006-1-22 05:24
Not rosier.  It will make things reflect reality.

Market value is the market value.  When market value is not reflected in the balance sheet, then the acco ...


Now that would raise hell :)

Council rates, poll tax etc, ( depending which country you are from ) are based on the tax appraisal of the value of your house. No-one wants it to rise because if it does, you have to pay more local tax. So, no, the value of real estate can be worked out with real estate institutions, not the tax value of the house. Investing in real estate in New York, Tri-State or New England area ( possibly with exception of NH ) is almost a zero-sum game. Better sell the house, invest into the stock market and rent.

I don't think the tax system in China is that "sophisticated" yet an I hope it'll never degenerate into the kind of skulduggeries that our western style governments excels at in getting their grubby hands at our hard earned money. But its going to happen sooner or later, as the Chinese middle class grows and the government realises that it is a cash cow, they will help themselve. I see it coming, the Chinese will  get into tax avoidance and tax minimization schemes... sigh   

I'll write about BASEL-2 and CLS as time permits.

[ Last edited by cestmoi at 2006-1-22 03:44 PM ]

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