RBI may offer respite for banks running low on capital

The Reserve Bank of India (RBI) may reportedly soon offer respite to banks with low levels of capital, as weak credit growth and increasing bad loans weigh down on India's bank earnings. RBI is trying to identify currently non-recognisable capital that is already on the bank balance sheets, such as undervalued assets, as it could allow some of these to be counted as capital according to Basel norms.

Weak credit growth and increasing bad loans have weighed on banks’ earnings. The RBI’s recent assessment of the stressed accounts in the system, which led to banks recognising certain accounts as NPAs, has only added to banks’ woes.

But the RBI may soon offer some respite to banks running thin on their capital.

In its policy review on Tuesday the RBI indicated that it is working on identifying currently non-recognizable capital that is already on the bank balance-sheets, such as undervalued assets. The RBI could allow some of these to be counted as capital according to Basel norms.

A financially sound bank needs a large buffer of capital, so that it doesn’t have to rely heavily on loan repayments to meet demands from depositors. This is the reason why regulatory efforts to strengthen banks usually start with the Capital Adequacy Ratio (CAR).

At present, regulations require banks to have total capital amounting to 9 per cent of their risk-weighted assets, this is termed as the CAR.

RBI regulations make sure that the CAR is pegged to the profile of its borrowers; riskier the borrowers, higher the capital needed. RBI assigns different ‘risk weights’ to different types of loans based on the possible defaults for each category.

The CAR is further divided into Tier I capital, which is the bank’s own equity, and Tier-2. According to Basel III norms, banks need to maintain Tier-I capital of 7 per cent, apart from a total CAR of 9 per cent.

In his interaction with the media, the RBI Governor said that there are some instances where the RBI has been more stringent than Basel norms in recognising assets. There are assets that are on the banks’ books and can be a source of value in future.

While it is unclear now, what the changes would be, some market players believe that tweaking rules around revaluation reserves could be one possible move.

While calculating the Tier-I capital, banks include share capital, share premium and other reserves (excluding revaluation reserves). In case of Tier-II capital, revaluation reserves (after 55 per cent discount) are included for calculation of Tier-II capital.

Revaluation reserves arise from revaluation of assets that are undervalued on the bank’s books, typically bank premises. For PSU banks, revaluation reserves range from 3 per cent to 17 per cent of their equity (capital plus reserves). Including revaluation reserves in the computation of Tier-I capital can be one way through which banks’ capital can be shored up. But, according to market players, this may not be construed as good international practice.

The other way could be to monetise banks’ non-core assets. In India many banks have real estate that can fetch high value. SBI Chairperson Arundhati Bhattacharya, in a recent interaction with BusinessLine , had indicated that the bank plans to monetise non-core assets and list some of its subsidiaries for meeting the capital needs.

While the finer print on the RBI’s move is awaited, PSU banks, particularly those that are thin on capital adequacy, can look forward to some respite.

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