Capital Buffer, Dividend and a Single-Obligor Breach
Shree Janata Commercial Bank has paid-up capital of NPR 20 billion, retained earnings of NPR 3 billion and a general reserve of NPR 2 billion. Risk-weighted assets are NPR 190 billion. The central bank's directive in this jurisdiction requires minimum total capital of 11%, Tier 1 of 8.5%, CET1 of 6.5%, and a 2.5% capital conservation buffer on top of each minimum. During annual classification, the bank's NPL ratio jumps from 2.1% to 4.8% after a large hydropower group stops servicing loans; the bank also has NPR 3.5 billion of restructured loans. Its provision balance is NPR 1.2 billion short of the regulatory requirement, and the bank plans to declare a cash dividend of NPR 1.5 billion. Separately, exposure to the same hydropower group is 28% of Tier 1 capital against a 25% single-obligor limit. The bank argues that the group is temporarily stressed and asks for a waiver.
1. Compute the bank's CET1, Tier 1 and total capital ratios after recognizing the NPR 1.2 billion provision shortfall. Assess each ratio against the minimum plus conservation buffer.
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Before the shortfall: CET1 = paid-up 20 + retained 3 = NPR 23 billion; Tier 1 = NPR 23 billion; total capital = 23 + general reserve 2 = NPR 25 billion. Ratios on RWA of NPR 190 billion: CET1 12.11%, Tier 1 12.11%, total 13.16%. After the NPR 1.2 billion provision shortfall, retained earnings fall to NPR 1.8 billion. CET1 = 21.8, Tier 1 = 21.8, total = 23.8. Ratios: CET1 11.47%, Tier 1 11.47%, total 12.53%. Requirements including the 2.5% buffer are CET1 9.0%, Tier 1 11.0% and total 13.5%. The bank meets CET1 and Tier 1, but total capital is 0.97 percentage points short, equivalent to about NPR 1.85 billion (13.5% of 190 = 25.65; 25.65 - 23.8 = 1.85). The breach is in the total capital layer, so the bank needs Tier 2 capital or retained earnings, not just a promise to recover loans.
2. Can the bank pay the proposed NPR 1.5 billion cash dividend? Show the effect on the ratios if it does, and state the supervisory response.
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No. A bank below its capital conservation buffer is expected to restrict distributions. Paying NPR 1.5 billion from the remaining NPR 1.8 billion retained earnings would leave retained earnings of NPR 0.3 billion. CET1 and Tier 1 would both fall to NPR 20.3 billion, or 10.68% of RWA, below the 11.0% Tier 1 buffer requirement; total capital would fall to NPR 22.3 billion, or 11.74%, far below 13.5%. The dividend would turn a modest total-capital shortfall into a Tier 1 breach. The supervisor should direct the bank to suspend the dividend, submit a capital restoration plan, and rebuild capital through retained earnings or eligible Tier 2 issuance. A dividend cannot be justified by reported profit when the provision shortfall has not been recognized.
3. The single-obligor exposure is 28% of Tier 1 against a 25% limit. Compute the excess and outline the corrective and administrative process the central bank should follow, including the bank's waiver request.
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Using post-provision Tier 1 of NPR 21.8 billion, the 25% limit is NPR 5.45 billion. Exposure at 28% is NPR 6.104 billion, so the excess is about NPR 0.654 billion. The bank must reduce the exposure or increase Tier 1 capital; a waiver should not be granted merely because the borrower is temporarily stressed, since that would convert a prudential limit into a negotiable one. Procedurally, the central bank should issue a written show-cause notice, give the bank access to the material relied on, allow a hearing, and pass a reasoned order. Any penalty should be proportionate and explain why a waiver is refused. The bank should submit a time-bound exposure-reduction plan, and the supervisor should monitor large-exposure concentration and classification of the group's loans until the breach is cured.