Master Direction issued by the Reserve Bank of India for Prudential Norms on Capital Adequacy for Regional Rural Banks

This master direction is legal framework for banks to maintain their adequate capital to absorb loses to promote the confidence in the financial system. Bank must maintain adequate capital to commensurate with their risks and the components. That is, banks have to hold enough capital based on the risks.

These Directions serve to specify the prudential norms to regulate and ensure that banks do not take on excessive risk from the perspective of capital adequacy.

Permission for RRBs to undertake transactions in specific instruments/products/activities shall be guided by the regulations, instructions and guidelines on the same issued by Reserve Bank from time to time.

Composition of Regulatory Capital

Minimum regulatory capital

RRBs are required to maintain a minimum "Capital to Risk Weighted Assets Ratio" (CRAR) of 9 per cent on an ongoing basis.

The Calculation for CRAR is

$\sqrt{\mathrm{Total\; Capital\; (CRAR)}}\mathrm{<br>=\; <br>}\sqrt{\frac{\mathrm{Eligible\; Capital\; Funds}}{\mathrm{Total\; Risk\; Weighted\; Assets}}}$

Here, the total Risk Weighted Assets (RWAs) is calculated as the aggregate of RWAs and other off-balance sheet exposures.

Capital Funds - Definition

The Capital Funds for capital adequacy purpose shall consist of Tier 1 and Tier 2 capital.

Tier 1 Capital - Bank's core capital - uses daily to function effectively,

Components of Tier 1 Capital

1. Paid up share capital - is the actual amount of money a company has received from shareholders in exchange for shares and crucial indicator of a company's financial strength,
2. Share premium (the amount of money that a company receives for its shares over and above their nominal value)
3. Share capital deposit (the money a company raises from issuing shares. It's recorded on the balance sheet at par value)
4. Statutory and other free reserves
5. Capital Reserve (the amount of money kept aside to cover a company's unexpected expenses) representing surplus arising out of sale proceeds of assets
6. Revaluation reserves is a capital reserve that reflects the increase in value of a company's assets
7. Balance in Profit & Loss Account at the end of the previous financial year.
8. Perpetual Debt Instruments (PDIs),

Limits in Tier 1 Capital

1. The total Tier 1 capital shall not be less than 7 per cent of RWAs after the regulatory adjustment / deduction
2. Of the minimum Tier 1 capital of 7 percent, the Perpetual Debt Instruments (PDI) will be limited to 1.5 per cent of the total RWAs.
3. Any additional amount raised through PDIs over and above the 1.5 per cent of the RWAs may also be reckoned as Tier 1 capital.

Tier 2 Capital - Bank's Supplementary Capital is held as Reserve

Components of Tier 2 Capital

General provisions and loss reserves will be admitted as Tier 2 capital up to a maximum of 1.25 per cent of the total RWAs.

Limits on Tier 2 Capital

The total of Tier 2 elements will be limited to a maximum of 100 percent of total Tier 1 elements for the purpose of compliance with the capital adequacy framework.