How does RBI gauges the safest banks in India?

The Reserve Bank of India (RBI) recently released the list of the safest and most reliable banks in the country. The RBI’s list of Domestic Systematically Important Banks (D-SIBs) included two commercial banks and public banks, which are considered the safest institutions.

So, how exactly does the RBI decide whether a particular banking entity is the safest? In order to meet the regulatory requirements, these financial institutions are mandated to maintain a certain percentage of capital to risk-weighted asset ratio (CRAR) as tier-I equity. 

The CRAR or the capital adequacy ratio (CAR) is the ratio of a banking institution’s capital to its risk. Simply put, it is the amount of money that a bank has in its reserve to cover any losses in its loans. A higher CRAR reveals that a banking institution is better capitalised to overcome any financial issue. 

The CAR is calculated by dividing the capital of a particular bank by its risk-weighted assets. The capital used to calculate the CAR is divided into two tiers. The tier-1 capital, or core capital, comprises equity capital, ordinary share capital, intangible assets, and audited revenue reserves, while tier-2 capital consists of unaudited retained earnings, unaudited reserves, and general loss reserves. 

Risk-weighted assets are the loans and other assets of a bank, weighted (that is, multiplied by a percentage factor) by risk. Generally, banks have different asset classes, such as cash, debentures and bonds, among others. Each asset class is associated with a different level of risk. 

Risk weighting is taken into account based on the possibility of an asset decreasing in value. For example, debentures are known to carry comparatively higher risk weight than cash, government securities, or bonds, which are considered low-risk. 

The RBI mandates that nationalised banks such as the State Bank of India (SBI) put aside 0.60% of its reserved assets as tier-I equity, while private banks such as HDFC and ICICI Bank are need to set up 0.20%.

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