Why in the news?
The RBI has revised the capital adequacy norms for commercial banks, small finance banks and payments banks, removing previous restrictions tied to non-performing asset (NPA) provisioning.
More on the news
- The RBI has now allowed banks to include quarterly profits earned in Common Equity Tier 1 (CET1) capital for the computation of the CRAR.
Understanding Capital to Risk-Weighted Assets Ratio (CRAR)
- Also known as the Capital Adequacy Ratio (CAR), it is the primary metric used by the RBI to ensure a bank can absorb a reasonable amount of loss before it becomes insolvent.
- CRAR = ((Tier 1 Capital + Tier 2 Capital) ÷ Risk-Weighted Assets)) *100
- Significance: Can help ensure the efficiency and stability of a nation's financial system by lowering the risk of banks collapsing.
- In general, bank with a high capital adequacy ratio is considered safe and likely to meet its financial commitments.
- Key Components of CRAR
- Risk-Weighted Assets (RWA): Banks are required to hold a minimum amount of capital to remain solvent and protect their depositors' investments.
- These are referred to as RWAs, and they're assigned risk in the form of a percentage. Riskier loans carry higher weights and require more capital backing.
- Tier 1 Capital (Core): Highly liquid capital that acts as the primary defense against financial stress (e.g., shareholder equity, disclosed reserves). It is split into two categories:
- Common Equity Tier 1 (CET1): Sum of common shares (equivalent for non-joint stock companies) and stock surplus, retained earnings, other comprehensive income, qualifying minority interest and regulatory adjustments
- Additional Tier 1 (AT1): Sum of capital instruments meeting the criteria for AT1 and related surplus, additional qualifying minority interest and regulatory adjustments.
- Tier 2 Capital (Supplementary): Sum of capital instruments meeting the criteria for Tier 2 and related surplus, additional qualifying minority interest, qualifying loan loss provisions and regulatory adjustments
- Risk-Weighted Assets (RWA): Banks are required to hold a minimum amount of capital to remain solvent and protect their depositors' investments.
About Common Equity Tier 1 (CET1)
- Introduced globally under the Basel III framework to prevent systemic banking failures and acts as the ultimate shock absorber to keep banks solvent during economic downturns.
- Composition: Comprises qualifying common shares and their related stock surplus, retained earnings, and accumulated other comprehensive income along with other disclosed reserves.
- Additionally, it includes qualifying minority interest with the final total reflecting any applicable regulatory adjustments.
- Common Equity Tier 1 Ratio = (Common Equity Tier 1 Capital ÷ Risk-Weighted Assets) *100
- Composition: Comprises qualifying common shares and their related stock surplus, retained earnings, and accumulated other comprehensive income along with other disclosed reserves.
Regulatory Standards: RBI vs. Basel IIIIndia applies a more conservative baseline than the Base III standards set by the Bank for International Settlements (BIS).
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