IFR sop to see banks raise fresh Rs 11,100 cr

The Reserve Bank of India's (RBI) move to allow banks to include investment fluctuation reserves (IFR) as part of their Tier-I capital will allow banks additional room to raise Rs 11,100 crore of capital through subordinate bonds.

This room for additional capital provides potential for the banking industry to grow their loan assets by 32 per cent, according to a study by rating agency Crisil. The study covers 85 per cent of the banking system's risk weighted assets.

For the banks considered in the study, the total IFR amounted to Rs 18,800 crore. If this quantum were moved from Tier-II capital to Tier-I capital, the Tier-I capital would go up from 8.1 per cent to 9.6 per cent. Tier-I capital includes equity and reserves, while Tier-II consists of subordinate bonds and revaluation reserves.

Crisil's analysis reveals that the banking system, even after growing assets by 32 per cent, will still remain more than adequately capitalised from a regulatory perspective.

The rating agency said this is a positive development for the banking system, in the context of robust credit growth over the last one and a half years, and the expectation of continued credit growth due to burgeoning retail credit demand and a pick-up in corporate credit demand.

This credit growth will in turn need to be supported by capital, so that capital adequacy ratios can be maintained.

From here, raising adequate deposits to fund credit growth to the potential will be the next key challenge for Indian banks. In a recent notification, RBI has announced that banks maintaining capital of at least 9 per cent of risk-weighted assets for both credit risk and market risk for held-for-trading (HFT) and available-for-sale (AFS) categories of their investment portfolio as on March 31, 2006, will be permitted to treat the entire balance in their IFR as Tier-I capital.

Over the last few years, many banks had built a sizeable IFR quantum in an endeavour to meet the 5 per cent stipulation by March 31, 2007. In fact 28 per cent of the banks covered by Crisil in the study (comprising 61 per cent of the Indian banking sector's risk-weighted asset base) had an IFR of more than Rs 500 crore of provisions in IFR. Crisil believes that on an aggregate basis the banks covered in its study would have had an IFR of over 5 per cent as at March 31, 2005.

What RBI's notification does is to enable banks to raise additional Tier-II capital, in particular subordinate bonds. Banks can raise subordinate bonds to the extent of 50 per cent of their Tier-I capital.

As at March 31, 2005, the total Tier-I capital of the banks covered in the study amounted to Rs.1,00,600 crore. After the transfer of Rs18,800 crore to Tier-I capital, the revised Tier-I capital would stand at Rs 1,19,400 crore.

The existing subordinate debt of these banks as at March 31, 2005 stood at Rs.355 billion, and Crisil estimates that these banks can borrow additional subordinate debt of Rs 9,400 crore without any further addition to Tier-I capital.

Even without the notification, the banks considered under the study had existing headroom to raise Rs 148 billion of subordinate bonds. Now, the total amount of additional permissible subordinate bonds that can be raised by these banks is Rs 242 billion.

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Impact of IFR transfer provision on capital adequacy

Existing Tier I Capital (%) 8.1
Existing Tier-II Capital (%) 4.5
Existing Total CAR (%) 12.6

Figures in Rs cr
Existing IFR 18,800
Existing Subordinate Bonds 35,500
Headroom Subordinate Bonds 14,800
Tier I Capital after IFR impact 1,19,400
Tier I CAR after IFR impact (%) 9.6