The Reserve Bank of India (RBI) has made an important change in the rules related to bank capital adequacy. These rules decide how much capital a bank must keep to remain financially strong and capable of handling losses. RBI had earlier issued the “Commercial Banks – Prudential Norms on Capital Adequacy Directions, 2025” on November 28, 2025. After reviewing the existing rules, RBI has now amended the provision related to inclusion of quarterly profits in Common Equity Tier 1 (CET1) capital.
First understand what is CET1 capital
CET1 capital is considered the highest quality capital of a bank because it mainly includes equity capital and retained earnings. It acts as a safety cushion for banks during financial stress. Banks are also required to maintain a certain Capital to Risk-weighted Assets Ratio (CRAR), which measures the financial strength of a bank and its ability to absorb losses. Strong CET1 capital helps banks maintain healthy CRAR levels.
New rules on Capital adequacy
Under the new amendment, RBI has allowed banks to include profits earned during the current financial year in their CRAR calculations on a quarterly basis. However, this can be done only if the bank’s quarterly financial statements are either properly audited or at least subjected to a limited review. RBI wants to ensure that the profit figures used by banks are accurate and verified.
At the same time, RBI has clarified that banks cannot directly add the full quarterly profit into CET1 capital. A certain amount must first be reduced from the profit to account for expected dividend payments. For this purpose, RBI has provided a formula under which the eligible profit will be calculated after deducting a portion linked to the average dividend paid during the last three financial years. This means only the remaining profit, after adjusting for likely dividend payouts, can be counted as CET1 capital.
In simple terms, RBI believes that not all profits remain permanently with the bank because a part of the profit is usually distributed to shareholders as dividends. Therefore, RBI wants banks to include only realistic and sustainable profits while calculating their capital strength. This will prevent banks from artificially showing higher capital positions based on profits that may later be paid out as dividends.
RBI has also stated that if a bank suffers cumulative net losses during any quarter, the entire loss must be deducted from CET1 capital immediately. This rule has been introduced to ensure transparency and prevent banks from hiding financial weakness.
How will it impact Banks?
The new RBI rule will have an important impact on banks because it changes the way banks calculate and report their capital strength. The rule mainly affects how banks can include quarterly profits in their Common Equity Tier 1 (CET1) capital, which is one of the most important measures of a bank’s financial health.
Earlier, banks could include quarterly profits in their capital calculations more easily. However, under the new RBI rule, banks will now be allowed to include only a reduced portion of their profits after adjusting for expected dividend payments. This means banks may not be able to show their capital position as strongly as before using temporary or unrealized profits. As a result, capital calculations will become more realistic and conservative.
The rule will improve transparency in the banking system because only audited or reviewed quarterly financial results can be used for capital calculations. This will reduce the chances of banks overstating profits or showing inflated capital strength. Investors, regulators and depositors will get a more accurate picture of a bank’s financial condition.
The amendment may especially impact banks that regularly pay high dividends. Since RBI has linked eligible profits with average dividend payouts of the last three years, banks distributing larger dividends may be able to add a smaller portion of quarterly profits to CET1 capital. Such banks may have to maintain additional capital buffers or reduce aggressive dividend distribution in future.
The rule will also put pressure on weak banks or banks facing losses. RBI has clearly stated that cumulative net losses must be fully deducted from CET1 capital immediately. This means financially stressed banks will no longer be able to delay recognition of losses while calculating their capital ratios. Their CRAR levels may fall faster if losses increase.
At the same time, the rule will strengthen the overall banking system in the long run. By ensuring that only genuine and sustainable profits are included in capital, RBI is trying to make banks financially stronger and more capable of handling future economic shocks or loan defaults. This will improve stability and confidence in the banking sector.
Let’s understand with Example
Suppose a bank earns a profit of ₹1,000 crore in the first two quarters of the financial year. Earlier, the bank could include almost the entire profit in its CET1 capital while calculating its CRAR (Capital Adequacy Ratio). This helped the bank show a stronger financial position.
Now, under the new RBI rule, the bank cannot directly add the full ₹1,000 crore profit to its capital. RBI says that since banks usually distribute part of their profits as dividends to shareholders, a portion of the profit must first be deducted.
For example, assume the bank paid an average annual dividend of ₹200 crore during the last three years. Since the calculation is being done after the second quarter (Q2), RBI’s formula will deduct a portion of this expected dividend from the profit.
The formula is:
EP2 = NP2 – 0.25 × D × 2
Where:
- EP₂ = Eligible profit after Q2
- NP₂ = Net profit after Q2
- D = Average dividend of last 3 years
Now putting the values:
EP2 = 1000 – 0.25 × 200 × 2
Calculation:
- 0.25 × 200 × 2 = ₹100 crore
- Eligible profit = ₹1,000 crore − ₹100 crore
- Final eligible profit = ₹900 crore
So, instead of adding the full ₹1,000 crore profit to CET1 capital, the bank can add only ₹900 crore.
This means the bank’s reported capital strength will be slightly lower but more realistic because RBI assumes that some profit may later be paid out as dividends and will not remain permanently with the bank.
Now consider another example where the bank suffers a loss instead of profit. Suppose after Q2 the bank reports a cumulative loss of ₹500 crore. Under the new RBI rule, the entire ₹500 crore loss must immediately be deducted from CET1 capital. The bank cannot delay recognition of the loss or partially adjust it later.
This rule will mainly affect:
- Banks paying high dividends
- Banks relying heavily on quarterly profits to improve capital ratios
- Weak banks with fluctuating profits or losses
At the same time, strong and stable banks with consistent earnings may not face major difficulties. Overall, RBI wants banks to maintain stronger and more reliable capital rather than temporary or overstated capital positions.
Click here to download RBI Master circular on Capital Adequacy for Banks
