In a move aimed at supporting the capital adequacy of commercial banks, the Reserve Bank of India (RBI) on Wednesday proposed to ease norms for including quarterly profits in the computation of the Capital to Risk-Weighted Assets Ratio (CRAR) and to withdraw the requirement of maintaining an Investment Fluctuation Reserve (IFR).
Announcing the outcome of the Monetary Policy Committee meeting, RBI Governor Sanjay Malhotra said the changes had been under consideration for some time. “Both measures have been in the works for some time and banks have been requesting us. NBFCs already had similar provisions, so it was time that we aligned it,” he said.
Faster Capital Recognition
Under current guidelines, commercial banks can include quarterly net profits in CRAR calculations only if incremental provisions for non-performing assets (NPAs) at the end of any four quarters of the previous financial year do not deviate by more than 25% from the average of those four quarters. The proposed removal of this condition would allow banks to recognise profits more quickly in their capital base. “The guidelines regarding the change in the calculation of CRAR are a better reflection of the capital that banks have,” Malhotra added.
Salee S Nair, MD & CEO of Tamilnad Mercantile Bank, said the move would enable banks to bolster their Tier-I capital on a quarterly basis. “By removing this restriction, banks can now recognise profits faster, boosting their Tier-I capital on a quarterly basis. It eases capital requirement constraints, freeing up capital for lending and other productive activities,” he said.
Sachin Sachdeva, sector head – financial sector ratings at ICRA, noted that Tier-I capital ratios typically decline during interim quarters due to growth-led capital consumption. “With the inclusion of quarterly profits, this trend is likely to shift towards a more stable capital trajectory,” he said.
Streamlining Reserves
The central bank also proposed to withdraw the requirement of maintaining the Investment Fluctuation Reserve, a 2% mandatory buffer on available-for-sale and held-for-trading investments, maintained to cushion against mark-to-market (MTM) losses.
Malhotra said that with existing prudential frameworks in place — including capital charge for market risk and revised norms on classification, valuation and operation of investment portfolios — the additional reserve was no longer necessary.
Currently, commercial banks maintain capital charge for market risk in addition to the IFR. “The existing guidelines for other bank categories are also being revised to address operational challenges in complying with regulatory thresholds on IFR and to harmonise instructions across bank categories,” the RBI said in its Statement on Developmental and Regulatory Policies.
Analysts expect the move to provide a marginal uplift to Tier-I capital ratios. Anil Gupta, senior vice president and co-group head – financial sector ratings at ICRA, said the removal of IFR, which is currently included in Tier-II capital, would improve reported Tier-I ratios. “We expect this change to have a positive impact of 6–12 basis points on the Tier-I capital ratio of banks,” Gupta said.
A report by SBI said that based on certain assumptions. Indian commercial banks could a rise in the IFR corpus by 35,000-40,000 crore that can be used CET-1 and P&L accounts even when yields have moved substantially during the last quarter.
However, Nair cautioned that the removal of the IFR cushion would make earnings more sensitive to MTM fluctuations, especially in a rising bond yield environment. “At TMB, we propose to use the freed-up IFR to strengthen our core Tier-I capital (CET1) rather than treat it as distributable profit, thereby directly increasing our lending capacity. We are also enhancing internal risk management practices to manage interest rate risks and MTM volatility,” he added.