The Reserve Bank of India (RBI) has asked banks to set aside more risk capital and implement Basel 3 norms faster than its global peers. Banks in India have to migrate fully to RBI’s version of Basel 3 by March 31, 2018 whereas globally, the deadline is January 1 2019.
RBI on Wednesday in its Basel 3 notification said that Indian banks are required to set aside minimum common equity of 5.5 per cent (Tier –I) capital for its risky assets (loans).
Banks also have to bring in additional equity at a minimum of 1.5 per cent of its risky assets (loans). To counter liquidity crunch, banks have to set aside a capital conservation buffer of 2.5 per cent in the form of common equity.
Banks have to build this buffer when they make bumper profits. This buffer would be drawn down when banks face losses due to a downturn in business. Banks also have to set aside two per cent Tier-2 capital.
Finally banks are also expected to counter the cyclical nature of their business by setting aside 2.5 per cent common equity as counter cyclical buffer. This buffer has been designed to take care of losses due to bad loans that occur when a downturn is preceded by a period of excess growth in loans.
If a boom in loans goes bad it can wipe out a bank’s balance sheet. Hence this buffer has been created. So the total capital that banks need to set aside is 14 per cent.
In addition RBI has also prescribed minimum capital conservation standards for banks. Banks having up to 6.125 per cent equity capital set aside for risk cannot pay dividends. Those with risk capital of up to 6.75 per cent can pay out a maximum of 20 per cent as dividend.
Banks with risk capital up to 7.375 per cent are eligible for paying 40 per cent dividend and those up to eight can pay 60 per cent dividend. Only those banks that have more than eight per cent equity set aside as risk capital can pay 100 per cent of their earnings as dividend to shareholders.