What changed
Earlier, only the IFR balance exceeding 5% of HFT and AFS securities could be treated as Tier I capital. Now, banks with at least 9% capital adequacy for both credit and market risks for both HFT and AFS categories as of March 31, 2006, can treat the full IFR balance as Tier I capital. Additionally, excess provisions on AFS/HFT depreciation can be credited to P&L and then appropriated (net of taxes and statutory transfers) to an Investment Reserve Account under Tier II capital, subject to the 1.25% ceiling.
What it means for you
This gives banks more flexibility to strengthen their Tier I capital base using existing IFR balances, which supports smoother adoption of Basel II norms. For lenders, it reduces the pressure to raise fresh capital for market risk charges. The Tier II option for excess provisions also provides an additional buffer within regulatory limits.
What you must do
- Verify that your bank meets the 9% capital adequacy threshold for both credit and market risks for both HFT and AFS categories as of March 31, 2006.
- If eligible, transfer the entire IFR balance to Statutory Reserve, General Reserve, or balance of Profit & Loss account to treat it as Tier I capital.
- For any excess provisions on AFS/HFT depreciation, appropriate the equivalent amount (net of taxes and net of transfer to Statutory Reserves) to an Investment Reserve Account under Tier II capital.
- Ensure compliance with the 1.25% overall ceiling for General Provisions/Loss Reserves when using the Tier II option.
Who it affects
All commercial banks excluding RRBs, Treasury and risk management teams, Capital planning and finance departments
What is the key condition to treat the entire IFR as Tier I capital?
Banks must have maintained capital of at least 9% of risk-weighted assets for both credit risk and market risks for both HFT and AFS categories as on March 31, 2006.
Can excess provisions on AFS/HFT depreciation be used for Tier II capital?
Yes, if provisions exceed the required amount in any year, the excess can be credited to P&L and then appropriated (net of taxes and net of transfer to Statutory Reserves) to an Investment Reserve Account, which qualifies as Tier II capital within the 1.25% ceiling.