The regulatory capital framework placed by RBI under Pillar 1 has increased importance on risk management and banks are required to employ suitable procedures and systems in order to ensure their capital adequacy. Such procedures employed by the banks are referred collectively as the Internal Capital Adequacy Assessment Process (ICAAP). The purpose of the Internal Capital Adequacy Assessment Process (ICAAP) is to ultimately build a risk profile that becomes the basis for allocating capital. The ICAAP process involves ongoing assessment of the bank’s risks, how the bank intends to mitigate those risks and how much current and future capital is necessary having considered other mitigating factors. The capital adequacy frame work in banking business underlines adequate resource to absorb any losses arising from the risks in its business.
Since the capital adequacy ratio prescribed by the RBI under the Pillar 1 of the Framework is only the regulatory minimum level, addressing only the three specified risks (viz., credit, market and operational risks), holding additional capital may be necessary in order to evaluate the potential vulnerability of the bank to some unlikely but plausible events or movements in the market conditions that could have an adverse impact on the bank’s capital. Therefore, the onus is on the concerned banks to make their own internal assessment including stress test and scenario analysis of their various risk exposures, through a well-defined internal process, and maintain an adequate capital cushion for such risks to demonstrate that its ICAAP is comprehensive