Solvency Risk

Solvency is associated with the overall health of the bank. No single factor or act or event may be regarded as responsible for the solvency or insolvency of a bank. Credit risk may contribute to insolvency in the form of bad loans, defaults, writing-offs, and late payments. Liquidity risk may contribute to solvency as negative cash flow, withdrawal runs on the bank, loss on assets conversions, and lack of refinancing from other banks. The reputational and legal risks may contribute to the blacklisting of activities, and cancellation of licenses. Market risk and operational risk may cause insolvency in the form of low activities, high competition, noncommercial location, etc.

 The solvency of a bank greatly depends upon a robust capital base, Strong control and use of the latest technology and delivery channels, creation of quality assets backed by long-term liabilities, and qualified and trained human resources. Insolvency may be caused by the following factor where the net worth of the bank becomes negative at any given point in time;

•  Lack of cash flow and cash equivalents
• Over borrowing
• Major debt repayment due
• Low capital
• High level of gearing
• Negative cash flow to meet the operating expense
• A legal decision against the bank
• Deterioration of assets
• Long-term assets against short-term liabilities
• High administrative & intermediation cost

Capital Adequacy

Tier I capital; should include only paid-up capital and disclosed reserves that appear on the balance sheet of the bank. It should be 6% of the risk-weighted assets (RWA). Tier I represent core capital and is more liquid and more secure than Tier II.

Tier II Capital; should include supplementary capital, undisclosed reserves, and unsecured subordinated debt instruments. It should be 2% of the risk-weighted assets (RWA).

Tier III capital; has been done away with. However, a fresh rule has been introduced as a Countercyclical Buffer Capital of 2.5% of the risk-weighted assets (RWA). Buffer capital should be based on Tier I capital.