In a notification to commercial banks, the RBI said, "Banks which will maintain capital of at least 9 per cent of the risk-weighted assets for both credit risk and market risk for held-for-trading and available-for-sale categories (of government securities in their portfolio) on March 31, 2006, will be permitted to treat the entire balance in the IFR as tier-I capital."
Banks were asked to create a 5 per cent IFR in five years, from March 2002, out of their profits to cushion interest rate risk for investment portfolios under the HFT and AFS categories.
In other words, banks have been drawn down from their IFR to ward off the adverse impact of rising interest rates on their debt portfolios.
The RBI move will help increase banks' tier-I capital base to the extent of the provisions made towards IFR. In addition, it will also help banks raise their tier-II capital base as the size of tier-II capital can be as much as tier-I capital, which includes equity and reserves.
This will particularly benefit some of the public sector banks that have hit a roadblock on raising capital. For instance, Allahabad Bank, Dena Bank and Oriental Bank of Commerce cannot enter the market to raise capital as the government's stakes in these banks have come down to close to 51 per cent, the floor prescribed by banking laws.
The Basel II norms, once implemented, will also shave banks' capital adequacy ratio. The RBI has been talking about the introduction of hybrid capital instruments to help banks tide over the capital crisis.
Banks have been demanding for over a year now that IFR be treated as tier-I capital as they need to maintain 9 per cent capital adequacy on investment portfolios and create IFR through appropriation of profits.
The RBI said if provisions created on account of depreciation in the AFS or in the HFT categories are found to be in excess of the required amount in any year, the excess should be credited to the profit and loss account.
More from rediff