RBI proposes measures to ease capital requirements for banks

Mumbai: The Reserve Bank of India (RB) on Wednesday proposed two measures aimed at easing banks’ capital requirements by allowing quarterly profits to be added to the calculation of capital adequacy levels and doing away with the mandate to maintain an investment fluctuation reserve (IFR).

Currently, banks are permitted to include their quarterly profits in the computation of their capital to risk-weighted assets ratio (CRAR). However, this is subject to incremental provisions for non-performing assets (NPAs) at the end of any of the four quarters of the previous financial year, provided they have not deviated by more than 25% from the average of the four quarters.

“On a review, it is proposed to dispense with this condition,” RBI governor Sanjay Malhotra announced on Wesnesday as part of the statement on developmental and regulatory policies released alongside the monetary policy statement on Wednesday. The move comes amid a benign credit cycle, with banks reporting decadal low NPAs.

At present, banks do not include quarterly profits in their statutory capital reporting if there is high volatility in NPA provisioning in earlier quarters. With the proposed delinking, banks will be able to include these profits, said Sachin Sachdeva, vice president and sector head - financial sector ratings, Icra. “Tier I capital ratios tend to decline steadily over interim quarters due to growth-led capital consumption; this trend is likely to change into a more stable capital trajectory with the inclusion of quarterly profits,” he said.

The monetary policy committee kept rates unchanged at 5.25% while maintaining a ‘neutral stance’, citing geopolitical uncertainty and higher upside risks to inflation from the West Asia war.

As per the draft circular issued later in the evening, banks can include quarterly profits in the computation of their common equity tier 1 (CET1) capital, subject to a new formula which accounts for a bank’s cumulative profit or loss accumulated over each quarter of a financial year, as well as the average dividend paid by the bank during the last three financial years.

Dispensing investment fluctuation reserve

At the post-policy conference, the RBI chief said that banks have been requesting relief, which is expected to ease access to capital amid unfavourable market conditions. “NBFCs already had some of the provisions. So, it was time that we aligned it,” Malhotra said, adding that it does not change the calculation of net profit but changes the way capital adequacy is measured. “It is a better reflection of the capital that the banks have.”

“This proposal gives considerable flexibility to banks to internal plough back,” State Bank of India group chief economic adviser Soumya Kanti Ghosh said in a note.

The central bank on Wednesday also proposed eliminating the requirement for banks to maintain an investment fluctuation reserve as an additional buffer against depreciation in the value of their investments, subject to mark-to-market (MTM) requirements.

In his statement, the RBI governor said banks already maintain a capital charge for market risk and also follow revised norms on classification, valuation and the operation of investment portfolios, which have warranted a review of the need for such a reserve. This will help enhance regulatory clarity and consistency, he said.

Opening up of the IFR corpus could free up around ₹35,000-40,000 crore for banks, SBI’s Ghosh said, adding that this corpus can be used ‘optimally and judiciously’ by banks between CET-1 and P&L (profit and loss) account even when yields have moved substantially up during the last quarter.

Suresh Ganpathy, analyst at Macquarie Research, was more optimistic, pegging the impact of the IFR reversal at 20-30bps for most banks. “However, we believe banks are unlikely to reverse and may stop making incremental IFR every year. Banks, anyway, today have excess capital,” he said in a note. As per the research firm, IFR for most large private and PSU banks is around 0.1-0.8% of their risk-weighted assets.

In a later draft, the RBI proposed dispensing with the IFR requirement for bank categories, maintaining a capital charge for market risk, and asked banks to instead follow the revised norms on classification, valuation, and the operation of investment portfolios. It proposed letting banks meet IFR requirements on balance sheet dates instead of continuously, and plans to harmonize IFR instructions across bank categories to remove inconsistencies and improve clarity.

Feedback on IFR

The RBI has sought feedback on both the draft circulars by 29 April.

“With regard to the investment fluctuation reserve, there has been a checkered history. It was there, then it was withdrawn, and then again brought in. This is something which is not there in any other jurisdiction, and there was a lack of clarity,” governor Malhotra said in the post-policy conference.

Malhotra explained that the reserve originally allowed banks to spread investment losses, but the RBI now favours mark-to-market pricing to reflect a bank's ‘correct position’. “If they price it as per the market, then the very need of this fluctuation reserve goes away completely.”

Deputy governor Swaminathan J. said that while initially thought to be essential, the reserve was introduced as a ‘below the line appropriation item’ out of the profits generated from the sale of investments in a financial year. However, since then, a revamp of the capital adequacy guidelines and new norms on the valuation and disclosure of the investment book have deemed the IFR ‘no longer relevant’.

“This was an appropriation item considered no longer relevant in the given circumstances. It has been generated more in the nature of a simplification,” Swaminathan said, adding that an issue was also varying levels of compliance across banks, which led to supervisory observations. “By removing that particular requirement, we are making it a little easier in terms of complying with the applicable norms.”