Economics

Capital Adequacy
The Capital Adequacy (CA) is the capital required by a bank as a regulation by the banking governing body by setting a framework on how banks and depository institutions must handle its capital (Gallati, 2003).  In this case, the categorization of assets and capital is uniformly standardized so that it can be risk weighted in case of any un-eventuality.  The international body for setting CA is known as the Basel Committee on Banking Supervision (BSCB) located at the Bank for International Settlements.  BSCB governs each countrys banking capital as the set requirements known as the capital measurement system were established in 1988 in Basel Switzerland thus, the requirement came to be known as the Basel Accord (Scott, 2005).

However, in the recent times, this framework is now being replaced by a new and significantly more substantial and complex capital adequacy framework commonly known as the Basel II.  This new framework has significantly altered the calculation of the risk weights but left the calculation of the capital known as the Capital Ratio (CR) alone (Scott, 2005).  CR is the percentage of a banks capital set aside for its risk-weighted assets which are defined by risk-sensitivity ratios whose calculation is dictated under the relevant Accord.

Capital Adequacy Ratio (CAR)
Capital adequacy ratio (CAR) is commonly known as the Capital to Risk or  Weighted Assets Ratio (CRAR). It pertains to the ratio of a certain banks capital to cushion it against its risks. These risks are governed by National Bank s regulation bodies in order to regulate and track the banks CAR with the intention of ensuring that a specific bank can absorb a reasonable amount of loss without it closing down, which could be catastrophic for the bank s investors (Canning, Pitman,  Williams, 1988). Therefore, it is important for the banks to comply with the CRAR and adhere to all the statutory capital requirements as laid down by the Basel Accord. The CAR is determined by measuring the amount of a bank, which is the core capital as expressed as the percentage of its assets as weighted by credit exposures (Canning et al., 1988).

Capital adequacy ratio is calculated as where Risk can either be weighted assets () or the respective national regulators minimum total capital requirement. If risk weighted assets would be used, CAR is determined by the following formula

The percent (10) is the threshold required by the regulators as the conform to the Basel Accords as well as the set regulations by the national banking regulations, while the T1 and T2 are the two types of capital measured. Tier one capital (T1) is the capital above so that it can absorb losses without a bank going down while the tier two capital (T2) is the ability of a bank to absorb losses in case a banking is closing down, providing a lesser degree of protection to depositors (Canning et al., 1988).

Risk Weighting (RW)
Risk Weighting (RW) involves the different types of assets owned by a bank since a bank has different risk profiles such that CAR would primarily adjust the assets which have less risk, enabling a bank to  discount  these lower-risk assets (Gallati, 2003).  However, the specific CAR calculation may vary from country to country, but general approaches tend to be similar for countries that apply the Basel Accords.

Fund-based means that the RW s assets funds are based on assets such as cash, loans, investments and other assets whereby the degree of credit risk is expressed by the percentage weights which has been assigned by national reserve banks to each such assets (Gallati, 2003).

The Non-funded (Off-Balance sheet) are the Items that credit risk exposure attached to the off-balance sheet items has to be first calculated by multiplying the face amount of each of the off-balance sheet item by the credit conversion factor which in turn shall be multiplied by the relevant weight as defined by the country s local regulations (Scott, 2005). This establishes that cash and government bonds have a 0 risk weighting, and residential mortgage loans have a 50 risk weighting so that all other types of assets which have been loaned customers have a 100 risk weighting (Scott, 2005).

Tier 1 Capital
A bank s capital is its cornerstone hence, the strength of a certain bank is measured by how much the capital is since the presence of substantial capital reassures creditors and engenders confidence among its investors such that they do not fear losing their money (Scott, 2005). The foundation of the bank s capital also is assured through permanent shareholders  equity and disclosed reserves which are s either created or increased by its appropriation of retained earnings or other surplus. These are the elements that should fully meet the essential characteristics of capital and represent capital resources which can best contribute resilience and flexibility of a bank in case it would experience any future financial difficulties (Scott, 2005).

Therefore, Tier 1 capital could be defined as the issued share capital and non-cumulative irredeemable preference shares, and it might also include innovative capital instruments other than ordinary shares and non-cumulative irredeemable preference shares (Canning et al.,1988). Some other instruments may be issued through special means, and they may be subject to the conditions of the governing bank.

The partly-paid shares including other capital instruments might qualify for inclusion in capital in case the value of funds is actually received including the general reserves and retained earnings which are measured by all the year s net earnings as well as the expected dividends and taxation paid. Tier 1 is sometimes distributable, but it is generally met by all the attributes bound down by Tier 1 capital which has the minority interests in subsidiaries combined by other named capital (Canning et al., 1988).

Tier 2 Capital
Tier 2 Capital is the other capital elements that strengthen the bank s position in the capital bases, but it comes in varying degree since it usually does not match the financial position of Tier 1 s capital capabilities. Therefore, Tier 2 capital usually included in the bank s capital base generally has the same value equal to the bank s Tier 1 capital, i.e., goodwill net, intangible assets from other sources and future income tax benefits and payment (Canning et al., 1988).

In this case, Tier 2 capital is divided into two segments, Upper and Lower Tier 2 capitals. Upper Tier 2 capital includes capital elements that are usually permanent and having a characteristic of both equity and debt while Lower Tier 2 capital consists of elements which are temporal. In this case, Tier 2 capital may be included in Tier 2 capital to a maximum and amounts to 50 of Tier 1 capital, i.e., net of goodwill, various intangible assets, and future income tax exemptions (Canning et al., 1988).

Banking Regulation
Banking regulations are governmental regulations which have been set aside with the aim of making banks to comply with certain terms, requirements, restrictions, and guidelines in order to protect the bank s creditors and investors (Barth, Caprio,  Levine, 2008). The reason behind these banking regulation and objectives is to emphasize on various jurisdictions intended to adhere with the following objectives

Prudential intends to reduce the level of risk bank creditors, depositors. and investors who are very vulnerable to losses in case a bank would go down (Barth et al., 2008).

Systemic Risk Reduction intends to reduce all the banking risks or disruptions which might result from various adverse trading conditions and might make a bank to wide down  (Barth et al., 2008).

Bad Banking Policies some banks might induce unfavorable trading techniques which might harm the creditors hence, these are set to discourage those misuses  (Barth et al., 2008).

Credit allocation these regulations shall direct credit to favored sectors so that the creditors are not misinformed and conned  (Barth et al., 2008).

To protect banking confidentiality these are intended for making a bank comfortable while trading such that it does not risk losing its assets from bad government or banking policies (Barth et al., 2008).

Principles of Banking Regulations
These regulations can vary from one country to another because of their outstanding jurisdictions. However, various principles and bank regulations are general more or less in the world and they work as follows

Minimum Requirements
These are regulations that have been imposed by the Banking regulations with the aim of promoting the objectives of the regulator, whereby a bank is supposed to maintain minimum capital ratios set aside as a minimum requirement (Levine, 2004).

Supervisory Review
The bank regulation should issue an operating license so that a bank could carry on its business as a bank. A supervisory review shows that a certain bank has the credibility to operate without any doubts from the banks creditors (Levine, 2004). This review makes sure that a bank complies with its requirements while at the same time responding to various breaches of the requirements needed in undertakings, giving directions, imposing penalties, or revoking the banks license in case a bank violates them (Levine, 2004).

Market Discipline
The regulator requires a bank to publicly disclose financial and other relevant banking information and policies so that the depositors and other creditors would be able to use this information to assess the level of risk they are taking while investing with them (Levine, 2004). Therefore, due to this discipline, the bank is subjected to standard policies for financial transparency, and the regulator can also use market pricing information as an indicator of the banks financial health so as not to trick a creditor into banking with them (Levine, 2004).

Capital Requirement
Capital requirement and framework governs how banks must handle their capital in relation to their assets so that a bank might not use its status in practicing bad or unacceptable banking process. This requirement is imposed by an international governing body known as the Bank for International Settlements based in Basel Committee on Banking Supervision, Switzerland (Beck, Demirguc-Kunt, Laeven,  Levine, 2004). This body influences each countrys capital requirements according to the 1988 regulations known as the Basel Capital Accords, when the Committee decided to introduce a capital measurement system as a standard of governing various nations  capital requirements (Beck, Demirguc-Kunt,  Levine, 2004).

Conclusion
Both capital adequacy and bank regulation appear to be sure ways of ascertaining that various commercial banks running in any nation have what it takes to be a bank. The most important factor in a bank is to make sure that a bank would weather down any un-eventuality without transferring enormous loses to the investor and creditors. Due to this two polices, we have seen that the creditor is the one who is most protected in order to boost his or her investment confidence that his or her finances are in the safe hands. This confidence makes a bank operate well without fear that the depositors might flock to the bank and withdraw all their deposits which might lead into bank s financial collapse. Capital adequacy ratio is also needed by banks to calculate their operational ratio so that they may foresee the current operating trends and future trends, which in turn would enable them to make a proper decision to assure their operations.