Solvency ratio is the best known indicator of banking prudence, with the priority to ensure the ability of credit institutions to meet the borrowers default and mitigate competitive inequalities between different national systems.caution, solvency, own funds

Csegedi Sándor

Popa Anamaria

Tiplea Augustin Liviu

English

Research Papers in Economics

646 
 
SOLVENCY INDICATOR IN THE CREDIT COOPERATIVES 
Tiplea Augustin Liviu 
Faculty of Economics and Business Administration  
Babes-Bolyai University, Cluj-Napoca, Romania 
Popa Anamaria 
Faculty of Economics  
Bogdan Voda University, Cluj-Napoca, Romania 
Csegedi Sándor  
Faculty  of  Economics  and  Business  Administration  Faculty  of  Economics  and  Business 
Administration  
 
Abstract 
Solvency ratio is the best known indicator of banking prudence, with the priority to ensure the 
ability of credit institutions to meet the borrowers default and mitigate competitive inequalities 
between different national systems. 
Key words: caution, solvency, own funds 
Cod JEL:G32 
 
Introduction  
Banking capital is the necessary tool to protect the bank in case of unexpected losses. As 
a restriction on capital adequacy of banks is, in fact, determining the size of conventional 
capital according to certain criteria that were proposed and accepted by the partners.  
Basel agreement established the capital adequacy system, namely:  
￿ minimum capital requirements are related to credit risk, depending on the structure of 
bank  assets.  It  creates  a  specific  relationship:  the  more  risky  loans,  the  capital 
requirement is higher;  
￿ shareholders intake is considered the most important type of capital, each bank itself 
must participate with a minimum rate required depending on the degree of risk;  
￿ minimum total capital requirements are set at 8% of total risk weighted assets;  
￿  risk  for  off-balance  sheet  transactions  is  included  in  the  calculation  by  converting 
specific commitments in equivalent credits; 
￿ capital requirements were roughly standardized between countries, which removes the 
competitive advantage that banks in a country could have on banks in other countries, 
according to the rules or different accounting systems. 
Solvency ratio,  of capital adequacy, has been an ongoing concern of bank management 
and prudential regulations, due to its significance on bank soundness and safety deposit. 
Furthermore, it has an important competitive dimension, well capitalized banks are more 
attractive and competitive to attract resources and to expand business. 
 
Solvency ratio 1 
Under existing banking legislation
416, banks are required to compute and report NBR 
solvency level indicators, which is determined as follows:  
                                                       
416 26/04/1999 NBR Norms No. 8, to limit credit risk of banks 
published in M.Of.nr.245 of 1.06.1999 647 
 
-Indicator of solvency 1, calculated as a percentage ratio between the equity level 1 and 
net exposure ( total assets and off- balance sheet items, weighted according to their 
degree of risk), an indicator whose minimum is 12%. 
 
Formula 
 
 
Own funds/[net assets (after deduction of liabilities AB) + off ballance 
sheet items, converted to equivalent credit depending on their degree of 
credit risk processing] weighted according to their degree of credit risk 
    Periodicity  monthly 
    Development limits    >15%    Well capitalized               (rating 1) 
12-14,9%  Adequately capitalized    (rating 2) 
 8-11,9%  Undercapitalized    (rating 3) 
 5- 7,9%  Significantly undercapitalized  (rating 4) 
 < 5%    Major undercapitalized    (rating 5) 
              
Table 1 Evolution of the solvency ratio at the credit unions examined 
 Indicator of solvency  1 (SI1)=OF*100/NE                   
 
 
  
2005  2006  2007  2008  2009 
Own funds level 1  OF  8.815.052  10.823.266  22.245.640  28.071.974  28.287.224 
Net exposure (assets and 
elements outside 
balance sheet risk-weighted) 
NE 
23.027.670  27.409.985  58.809.356  69.932.111  69.732.207 
Indicator of solvency 1  IS1  38,28%  39,49%  37,83%  40,14%  40,57% 
Dynamic of indicator of solvency 1  DIS1  100,00%  103,15%  98,82%  104,86%  105,97% 
Source: Own calculations based on the aggregated financial statements 
 
Figure 1 Indicator of solvency 1 at the examined credit unions 
 
 
Source: own illustration based on the aggregated financial statements 
 
From the graphic above is noted that the indicator of solvency 1 throughout the period 
under review stood at a level exceeding 37% and 12% upper limit, something which 
highlights the state of solvency of credit cooperatives analyzed. It is also higher than the 
average recorded in the banking system in Romania. 
  
Figure 2 Evolution of the indicator of solvency in 
Source: NBR Periodical publications 
 
Solvency ratio 2 
Indicator of solvency  2, calculated as a percentage ratio between equity 
exposure, indicating whose minimum level is 8%.
 
Table 2 Development of the solvency ratio 2 at the 
Indicator of solvency  2 (SI2) =E*100/NE      
  
 
  
2005
Equity  E  7.966.648
Net exposure (assets and off balance sheet items 
weighted by risk) 
NE  23.027.670
Indicator of solvency 2   SI2  34,60%
Dynamic of Indicator of solvency  2  DSI2  100,00%
Source: Own calculations based on the aggregated fi
 
Figure 3 Indicator of solvency 2 to examined credit
 
Source: own illustration based on the aggregated fi
 
The indicator of solvency  2 was higher  than the threshold of 8% required by Ba
follows: 36.60% in 2005, 36.47% in 2006, 36.72% in
in June 2009. 
  
Equity Rates  (Leverage effect) 
Formula   Equity / Total assets (net)
Periodicity  monthly 
Development limits  > 6%               well capitalized
4 – 5,9%  adequately capitalized
3 – 3,9%  undercapitalized
2 – 2,9%  significantly undercapitalized
2005 2006
IS1- SBR 21.07 18.12
2
5
8
11
14
17
20
23
26
29
648 
Figure 2 Evolution of the indicator of solvency in romanian banking system  
 
2, calculated as a percentage ratio between equity and net 
minimum level is 8%. 
Table 2 Development of the solvency ratio 2 at the examined credit unions  
              
2005  2006  2007  2008  2009 
7.966.648  9.996.581  21.597.200  27.528.455  27.577.437
23.027.670  27.409.985  58.809.356  69.932.111  69.732.207
34,60%  36,47%  36,72%  39,36%  39,55% 
100,00%  105,42%  106,15%  113,78%  114,31% 
Source: Own calculations based on the aggregated financial statements 
Figure 3 Indicator of solvency 2 to examined credit unions  
 
Source: own illustration based on the aggregated financial statements 
was higher  than the threshold of 8% required by Basel II, as 
follows: 36.60% in 2005, 36.47% in 2006, 36.72% in 2007 39.36% in 2008 and 39.55% 
Equity / Total assets (net) 
well capitalized                         (rating 1) 
adequately capitalized             (rating 2) 
undercapitalized              (rating 3) 
significantly undercapitalized  (rating 4) 
2006 2007 2008 2009
18.12 13.78 12.78 13.50
27.577.437 
69.732.207 
sel II, as 
2007 39.36% in 2008 and 39.55%  
 < 2%               
   
Table 3 Evolution of the Equity rate 
Equity rates  (ER)=E*100/TA   
    
Equity   E
Total assets  TA
Equity rates  ER
Dinamyc of equity rates    DER
Source: Own calculations based on the aggregated fi
 
Figure 4 Equity Rates at credit unions examined
Source: own illustration based on the aggregated fi
 
Equity rate evolved increased from 29.18% in 2005 t
assets  increased faster than the equity.
 
Figure 5 Evolution of Equity rate indicator in the romanian 
Source: NBR Periodical publications
 
The  indicator  in  the  banking  system  in  Romania  reac
in June 2009. 
 
The ratio of equity capital  
Formula   Equity/ Capital
Periodicity  monthly 
Development limits  > 150%              
150 - 100,0%
 80 - 99,9% 
 50 - 79,9% 
 < 50%  
2005
CP-SBR 8.93
5.00
6.00
7.00
8.00
9.00
10.00
649 
        major undercapitalized              (rating 5) 
 
Table 3 Evolution of the Equity rate  
                 
   2005  2006  2007  2008  2009
E  7.966.648  9.996.581  21.597.200  27.528.455  27.577.437
TA  27.298.882  32.142.935  69.366.139  83.830.681  85.288.738
ER  29,18%  31,10%  31,14%  32,84%  32,33%
DER  100,00%  106,57%  106,69%  112,52%  110,80%
Source: Own calculations based on the aggregated financial statements 
4 Equity Rates at credit unions examined 
   
Source: own illustration based on the aggregated financial statements 
Equity rate evolved increased from 29.18% in 2005 to 32.33% in June 2009 because the 
assets  increased faster than the equity. 
Evolution of Equity rate indicator in the romanian banking system 
 
Source: NBR Periodical publications 
The  indicator  in  the  banking  system  in  Romania  reached  the  8.13  level
Equity/ Capital 
             well-capitalized               (rating 1) 
100,0%  adequately capitalized    (rating 2) 
  undercapitalized    (rating 3) 
  significantly undercapitalized  (rating 4) 
major undercapitalized    (rating 5)￿ 
2006 2007 2008 2009
9.18 8.63 7.32 8.13
2009 
27.577.437 
85.288.738 
32,33% 
110,80% 
o 32.33% in June 2009 because the 
 
hed  the  8.13  level 650 
 
Defining  related 
capital  adequacy 
ratings: 
Rating 1: indicates a strong level of capital compared to the bank's risk 
profile. 
Rating 2: indicates a satisfactory level of capital compared to the bank's 
risk profile. 
Rating 3: shows a less satisfactory level of capital that can not fully 
support the bank's risk profile. Rating indicate the need for 
improvement even if the capital exceeds the minimum required by 
regulations. 
Rating 4: indicates a deficiency of capital, the bank's viability could be 
threatened. In this case, shareholders may request the assistance or 
financial support from external institutions. 
Rating 5: indicates a critical deficiency of capital, threatening the 
viability of the bank. It requires immediate financial aid of shareholders 
or an external funding agency. 
 
Table 4 Evolution of the ratio of equity and capital to credit unions examined  
Equity / Capital (>100%)                   
      2005  2006  2007  2008  2009 
Equity  E  7.966.648  9.996.581  21.597.200  27.528.455  27.577.437 
Equity  C  2.948.630  4.370.190  10.555.010  12.447.020  12.646.170 
Equity / Capital  E/C  270,18%  228,74%  204,62%  221,17%  218,07% 
Dinamyc of  Equity / Capital  D E/C  100,00%  84,66%  75,73%  81,86%  80,71% 
Source: Own calculations based on the aggregated financial statements  
 
Figure 6 Equity /Capital in credit unions examined 
   
Source: own illustration based on the aggregated financial statements 
 
The indicator fell during 2005-June 2009 from 270.18% to 218.07% because the equity 
increased faster than the capital.  
 
A bank may be considered:  
Well capitalized (rating 1) if it meets the following conditions:  
•  solvency ratio 1 is 15% or more;  
•  solvency ratio 2 is 10% or more;  
•  Equity ratio (leverage effect) is 6% or more;  
•  It is not in danger of not fitting within the terms of any legislation 
aimed at maintaining a specific level of capital. 
Adequately capitalized (rating 2) if it meets the following conditions: 
•   solvency ratio 1 is 12% or more, 651 
 
•   solvency ratio2  is 8% or greater;  
•  Equity ratio (leverage effect) is 4% or higher.  
Undercapitalized (rating 3) if:  
•  solvency ratio 1 is below 12% and / or  
•  solvency ratio 2  is below 8% and / or  
•  Equity ratio (leverage effect) is less than 4%.  
Significantly undercapitalized (rating 4) if:  
•  solvency ratio 1 is below 8% and / or  
•  solvency ratio2  is below 6% and / or  
•  Equity ratio (leverage) is less than 3%.  
Major undercapitalized (rating 5) if:  
•  solvency ratio 1 is below 5% and / or  
•  solvency ratio 2 is below 4% and / or  
•  Equity ratio (leverage) is less than 2%.  
 
 Conclusions  
A bank is expected to maintain adequate capital icompared with the nature and extent of 
risk, and management's ability to identify, measure and control these risks.  
To  determine  the  adequacy  of  capital  is  taken  into  account  the  effect  of  credit  risk, 
market and other risks to the financial condition of the bank. Types and size of risk in 
bank activity, determine whether the capital should be above the minimum level required 
by regulations to cope with unintended consequences.  
 
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SOLVENCY INDICATOR IN THE CREDIT COOPERATIVES

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SOLVENCY INDICATOR IN THE CREDIT COOPERATIVES

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