After the Centre did its bit to support public sector banks by setting aside ₹25,000 crore for recapitalisation in the Budget, the RBI has come forward to offer some respite to banks with low capital.
As indicated in the last policy review, the RBI has allowed some of the currently non-recognisable capital on banks’ balance sheets to count as capital according to Basel norms.
Also, revaluation reserves at 55 per cent discount are included for Tier II capital calculation.
Revaluation reserves arise from the revaluation of assets that are undervalued on the bank’s books, typically bank premises.
Now, the RBI has allowed revaluation reserves (at 55 per cent discount) to be included in Tier I (CET 1 — common equity) capital, instead of Tier II. How does this re-jig of including revaluations reserves from Tier II to Tier I matter to banks?
Tier 1 capital is the core capital and is used to absorb losses. Tier II, on the other hand, is supplementary capital. Thus, it is Tier I capital that is a true measure of a bank’s financial health.
According to Basel III norms, banks have to maintain 7 per cent Tier I capital. Including revaluation reserves in Tier I capital can hence shore up banks’ capital and help them meet Basel III norms.
Some banks, such as Union Bank, IOB, Syndicate Bank, Allahabad Bank, Central Bank, Vijaya Bank, Union Bank and Bank of India, have Tier I capital ratio of just above the mandated 7 per cent but below the RBI’s comfort level of 8 per cent.
These banks have revaluation reserves that are 7-10 per cent of their equity (capital plus reserves).
Some of these banks have already included revaluation reserves to calculate Tier II capital.
Accounting for these reserves in Tier I can add 40-50 basis points to their Tier I capital. With the RBI allowing banks to account for 75 per cent of their foreign currency translation reserves while calculating Tier I capital, banks with higher share of overseas operations will benefit.
As of March 2015, SBI, Bank of Baroda, Bank of India and IOB have foreign currency translation reserves that form 4-5 per cent of their total equity. Recognising these reserves as capital can add 15-20 basis points to the Tier I capital of these banks.
The RBI has also allowed counting deferred tax assets — up to 10 per cent of CET 1 capital — as part of core capital. Deferred tax assets (DTAs) are created from taxes paid or carried forward but not yet recognised in the P&L account. Earlier, Indian banks had to deduct all DTAs, irrespective of their origin, from CET 1 capital.
The RBI has now allowed DTAs related to temporary differences to be accounted for in CET 1 (up to 10 per cent).
While it is difficult to assess the actual impact of this on banks’ capital, some bankers believe that it will add 30-40 basis points to the Tier I capital of banks.