Since the risk weights given to such unsecured advances exceed even 100 percent, it is necessary for the Central Bank to plan for a higher level of reserves than the minimum 15 percent. The Central Bank management, having taken this prudential requirement into account, has decided, as a part of the Bank’s modernization program, to raise the reserve level up to 100 percent of the domestic assets of the Bank. This is being continued by the Bank since 2003 and the reserve level today stands closer to 100 percent. However, it would be prudential to revisit even this percentage today in terms of its adequacy in view of the level of ever rising unsecured provisional advances and Exter’s warning that the profits earned by inflating the economy should not be distributed. The build up of reserves by the Central Bank to be equal to its domestic assets has another monetary dimension. On the liability side of Bank’s Balance Sheet, it has liabilities on account of currency issue and demand deposits maintained by commercial banks. These liabilities are known as monetary liabilities, since they constitute the reserve money of the system. All other liabilities, including the capital and reserves, are, therefore, called nonmonetary liabilities. When reserves are built-up to be equal to the Bank’s domestic liabilities, its monetary liabilities would vary exactly in accordance with the movement of the Bank’s net foreign assets.
Even more difficult, the potential benefits – better differentiation and rank ordering of risk – were undermined by the problems of calibrating overall capital standards, and poor implementation in the rush to achieve compliance. Under Basel I and II, capital ratios were too low to sustain confidence in banks, and thus the system as a whole, through a severe stress, as the crisis sadly demonstrated. The minimum Tier I ratio was 4% of Risk Weighted  BIS central bankers’ speeches  3  Assets. And, crucially as the Tier I ratio included capital instruments with the flaws I described earlier, the core (equity) ratio could be as low as 2%. In the trading book, under the Market Risk Amendment, capital requirements could be less than 1% of trading book assets. To illustrate this last point, here is a quote from the FSA’s report into the failure of RBS. “The capital regime was most deficient, moreover, in respect of the trading books of the banks, when required capital for many instruments was estimated using value-at-risk (VaR) approaches. The acquisition of ABN AMRO meant that RBS’s trading book assets almost doubled between end-2006 and end-2007. The low risk weights assigned to trading assets suggested that only £ of core tier 1 capital was held to cover potential trading losses which might result from assets carried at around £ on the firm’s balance sheet. In fact, in 2008, losses of £ arose in the credit trading area alone (a subset of total trading book assets).