RBI guidelines on Capital Treatment of Banks’ Balance Sheet

In simple words the bank capital is the difference between a bank’s assets and liabilities. However, Banking regulators all over the word have their own definition of regulatory capital of banks in closer alignment with Basel Framework. The core banking regulatory framework across the banking sector consists of international standards enacted by the Basel Committee on Banking Supervision through international accords of Basel I, Basel II, and Basel III. The Basel standards provide a definition of the regulatory bank capital that market and banking regulators closely monitor.

The asset portion of a bank’s capital includes foreign currency translation reserves, deferred tax assets, immovable properties, cash, government securities, loans and advances etc.  It is perceived by the banking regulators that many banks revalue some of these financial assets more often than companies in other industries that hold fixed assets at a historical cost. On a review of the existing capital adequacy guidelines, the Reserve Bank of India made some amendments to the treatment of certain balance sheet items for the purposes of determining banks’ regulatory capital. The amendments made to ensure further aligning the definition of regulatory capital with the internationally adopted Basel III capital standards, issued by the Basel Committee on Banking Supervision (BCBS).

The salient features of the amendments to capital adequacy norms are as under:

• Revaluation reserves arising from change in the carrying amount of a bank’s property consequent upon its revaluation would be considered as common equity tier 1 capital (CET1) instead of Tier 2 capital as hitherto. These would continue to be reckoned at a discount of 55 per cent.
• Foreign currency translation reserves arising due to translation of financial statements of a bank’s foreign operations to the reporting currency may be considered as CET1 capital. These will be reckoned at a discount of 25 per cent.
• Deferred tax assets arising due to timing differences may be recognised as CET1 capital up to 10% of a bank’s CET1 capital.

The capital treatment is also applicable to all failed transactions, including transactions through recognised clearing houses and Central Counterparties. Repurchase and reverse-repurchase agreements as well as securities lending and borrowing that have failed to settle are excluded from this capital treatment.