Reserve Bank of India revised capital adequacy norms to simplify CET1 calculations and align counterparty credit risk rules with global Basel standards.
Key Changes in Capital Adequacy Ratio (CAR)
- Simplified CET1 Inclusion: The RBI removed the earlier condition linking inclusion of quarterly profits in CET1 capital with deviations in NPA provisioning patterns.
- Revised Counterparty Risk Norms: Banks must now include trading-partner exposures of all consolidated entities while calculating capital adequacy at the group level.
- Updated Add-on Percentages: The RBI revised “add-on” factors used for estimating future exposure arising from off-balance-sheet transactions such as derivatives.
- Risk Weight for Cleared Trades: Trades cleared through regulated central counterparties will attract a lower 2% risk weight, reducing additional capital burden on banks.
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What is Capital Adequacy Ratio (CAR)?
- Capital Adequacy Ratio (CAR), also known as Capital-to-Risk Weighted Assets Ratio (CRAR), measures a bank’s capital as a percentage of its risk-weighted assets.
- Tier 1 Capital: Tier 1 capital represents core capital, including equity and retained earnings, capable of absorbing losses without stopping banking operations.
- Tier 2 Capital: Tier 2 capital includes supplementary reserves and subordinated debt available to absorb losses during liquidation or financial stress.
- Risk-Weighted Assets: Risk-weighted assets are bank assets adjusted according to their risk profile, with riskier loans requiring higher capital backing.
- Consequences of Non-Compliance: Banks failing to maintain the prescribed Capital Adequacy Ratio (CAR) may face regulatory actions such as:
- Restrictions on providing loans and credit to customers
- Limitations on payment of dividends to shareholders
- Curbs on business expansion and new investment activities
Significance of CAR
- Depositor Protection: A higher CAR provides banks with a financial cushion to absorb unexpected losses and protect depositor funds during crises.
- Financial Stability: CAR reduces the possibility of bank failures spreading across the financial system, thereby strengthening macroeconomic stability.
- Prudent Lending: Banks are discouraged from excessive risky lending because higher-risk assets increase risk-weighted assets and capital requirements.
- Investor Confidence: Strong CAR levels improve investor confidence, lower funding costs, and reduce the probability of panic-driven bank runs.
Limitations of Capital Adequacy Ratio (CAR)
- CAR does not account for liquidity risk or the possibility of sudden runs on the bank.
- The ratio can be influenced by accounting practices, potentially understating risk exposure.
- CAR measures capital adequacy but does not directly indicate profitability or operational efficiency.
Basel III Norms
- Global Regulatory Framework: Basel III is an international banking regulatory framework developed after the 2008 global financial crisis to strengthen banking resilience.
- Minimum Capital Requirement: Basel III prescribes a minimum total CAR of 8% of risk-weighted assets for banks globally.
- CET1 Requirement: Banks must maintain a minimum Common Equity Tier 1 (CET1) ratio of 4.5% under Basel III norms.
- Capital Conservation Buffer: An additional Capital Conservation Buffer of 2.5% CET1 increases the effective minimum requirement to 10.5% for Indian banks.
- RBI’s Stricter Norms: The RBI mandates scheduled commercial banks in India to maintain a minimum CAR of 9%, higher than global Basel standards.
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Impact of Changes in CAR Framework
- Limited Impact on CET1: Most domestic banks are unlikely to face major reductions in CET1 ratios because derivative trades are largely cleared through regulated counterparties.
- Moderate Rise in RWAs: Inclusion of exposures from consolidated entities may slightly increase risk-weighted assets for some banks.
- Improved Risk Management: The revised framework strengthens transparency and standardisation in measuring counterparty credit risk from trading activities.
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Conclusion
The revised CAR framework strengthens banking resilience, simplifies capital calculations, and aligns India’s banking regulations more closely with international Basel standards.
9 May 2026
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