Banking and Insurance - Laws and Practice · Analysis of Financial Statements of Banks

Capital Adequacy Ratio and Provisioning for Banks

Updated 11 October 2026 · Fact-checked

Capital adequacy is the capital a bank must hold against its risk-weighted assets. CRAR = (Tier 1 + Tier 2 capital) ÷ risk-weighted assets × 100. Under RBI's Basel III rules the minimum is 9%, plus a 2.5% capital conservation buffer. Provisioning sets aside profit for expected loan losses, based on asset class.

Understand Capital Adequacy and Provisioning

A bank lends mostly other people's money, deposits. If loans go bad, the loss must fall on the bank's own capital, not on depositors. Capital adequacy rules force banks to keep enough own capital against the risk they carry.

Risk is not the same for all assets. A government security is safer than an unsecured business loan. So the bank does not compare capital to total assets. It converts each asset into a risk-weighted asset (RWA) by multiplying it with a risk weight set by RBI. Then it compares capital to RWA. This ratio is the Capital to Risk-weighted Assets Ratio (CRAR). RWA covers credit risk, market risk and operational risk.

Capital has quality levels. Tier 1 capital absorbs losses while the bank keeps running (going concern). It has Common Equity Tier 1 (CET1): equity share capital, reserves and retained earnings, less regulatory deductions. It also has Additional Tier 1 (AT1): perpetual instruments such as perpetual debt, which can absorb losses or be written off or converted under set triggers. Tier 2 capital absorbs losses when the bank fails (gone concern). It includes subordinated debt with a minimum maturity, revaluation reserves (with a discount) and limited general provisions.

Basel III is the global framework from the Basel Committee on Banking Supervision, brought in after the 2008 crisis. It raised the quality and quantity of capital, added a capital conservation buffer and countercyclical buffer, and added a leverage ratio and liquidity ratios (LCR and NSFR). RBI applies it through its Basel III capital regulations to Indian banks. Its India minimums are higher than the Basel base at all three levels: CET1 5.5% against 4.5%, Tier 1 7% against 6%, and total capital 9% against 8%. These are the RBI minimums before any buffer.

The capital conservation buffer of 2.5% is the buffer used in the figures on this page. It is held in CET1, on top of the 5.5% CET1 minimum, so CET1 must be at least 8%. Because the buffer sits in CET1, adding 2.5% to the Tier 1 minimum (7%) and the total capital minimum (9%) gives 9.5% and 11.5%. These two figures are derived from the CET1 buffer. They are not separate RBI minimums or separate buffers. The countercyclical buffer is currently set at zero by RBI, so it does not change these figures. RBI can raise it when credit growth becomes excessive.

Provisioning is the other half of financial health. When a loan turns non-performing, the bank must charge a part of its profit to the profit and loss account and set it aside. The rate depends on the asset class (substandard, doubtful, loss) and on whether the loan is secured. Provisions protect profit and capital from sudden shocks. Net NPAs are reported after deducting provisions.

Key rules to remember

CRAR: CRAR = (Tier 1 capital + Tier 2 capital) ÷ Total RWA × 100; Total RWA = credit RWA + market RWA + operational RWA. Capital must be after regulatory deductions.
Risk-weighted asset for one exposure: RWA = Exposure amount × Risk weight; Use the exposure after any permitted credit risk mitigation. Add all exposures to get total RWA.
Tier 1 ratio: Tier 1 ratio = (CET1 + AT1) ÷ RWA × 100; CET1 ratio = CET1 ÷ RWA × 100.
RBI minimum capital ratios (Basel III, India): CET1 5.5%; Tier 1 7%; Total capital 9%; plus Capital Conservation Buffer 2.5% in CET1; The buffer is held in CET1, so CET1 must be at least 8%. The Tier 1 figure of 9.5% and the Total figure of 11.5% follow from it and are derived targets, not separate buffers. AT1 is at least 1.5% of RWA. Check the latest RBI master direction for changes.
Provision for substandard assets: Secured portion: 15%; Unsecured portion: 25% (20% for unsecured exposures in infrastructure loan accounts where certain safeguards such as escrow accounts are available); A substandard asset is one that has been NPA for up to 12 months. Split the outstanding into the secured portion (covered by the realisable value of the security) and the unsecured portion, and apply the rates to the two parts separately.
Provision for doubtful assets: Secured portion: 25% (doubtful for up to 1 year), 40% (doubtful for 1 to 3 years), 100% (doubtful for over 3 years); Unsecured portion: 100%; An asset becomes doubtful when it has stayed substandard for 12 months. The periods in the formula are counted from the date the asset became doubtful. The secured portion is the amount covered by the realisable value of the security; the rest is the unsecured portion. Apply the rates to the two parts separately.
Provision for loss assets: 100% of outstanding; Loss assets are identified as uncollectible but not yet written off.
Net NPA: Net NPA = Gross NPA − Provisions held against NPAs (and similar permitted deductions); Net NPA ratio = Net NPA ÷ Net advances × 100.

How to solve Capital Adequacy and Provisioning questions

Use this order for any numerical or descriptive question on capital adequacy and provisioning. Rates and ratios must follow RBI's current directions, so state them as RBI's norms.

1Identify what is asked: CRAR, a tier-wise ratio, a buffer check, or a provision amount.
2For capital questions, list the components: CET1, AT1 and Tier 2. Subtract any deductions the question gives, such as intangibles or losses.
3Compute RWA. Multiply each exposure by its risk weight and add credit, market and operational RWA if given.
4Apply the formula: CRAR = total capital ÷ RWA × 100. Also compute CET1 and Tier 1 ratios if asked.
5Compare each ratio with the minimum, with and without the 2.5% capital conservation buffer, and state the conclusion.
6For provisioning, classify each account first (standard, substandard, doubtful, loss). Split into secured and unsecured parts where needed.
7Apply the correct rate to each part, add the totals, and show the effect on profit or Net NPA if asked.
8End with a one-line conclusion on compliance and the likely RBI consequence, such as restrictions on dividend payout if buffer is dipped.

Quickest way: Three-line CRAR check

When to use it: Use when a numerical question gives capital figures and RWA directly and marks are limited.

Write Tier 1 = CET1 + AT1, then Total capital = Tier 1 + Tier 2.
Divide each of CET1, Tier 1 and Total by RWA and multiply by 100.
Compare against the minimums 5.5 / 7 / 9. Then test the buffer in CET1: CET1 must be at least 8 (5.5 + 2.5). The 9.5 and 11.5 figures for Tier 1 and Total follow from it. Write one sentence: meets minimum or not, and whether CET1 is inside the buffer zone or not.

Common mistakes in Capital Adequacy and Provisioning

Dividing capital by total assets instead of risk-weighted assets.
It looks like a normal leverage-style ratio.
Fix: CRAR always uses RWA in the denominator. A total-assets ratio is the leverage ratio, a separate measure.
Stating the minimum CRAR as 11.5% without explaining the buffer, or as 9% without the buffer.
Students memorise one number.
Fix: Say: minimum 9% total capital, plus 2.5% capital conservation buffer in CET1, giving 11.5% effectively.
Treating Tier 1 and Tier 2 as interchangeable.
Both are called regulatory capital.
Fix: Tier 1 absorbs losses on a going-concern basis, Tier 2 only in gone-concern. Mention CET1, AT1 and Tier 2 examples in the answer.
Applying one provision rate to the whole doubtful asset.
Students forget the secured and unsecured split.
Fix: Provide 100% on the unsecured portion, and the 25%, 40% or 100% rate on the secured portion based on how long it has been doubtful.
Confusing provisioning with write-off or with capital.
All three reduce reported value.
Fix: Provision is a charge to profit that is kept as a reserve for expected loss. A write-off removes the asset from the books. Capital is the owners' funds.
Adding up Basel I, II and III features in one jumbled answer.
The three frameworks overlap in vocabulary.
Fix: Use a short sequence: Basel I credit risk only, Basel II three pillars with market and operational risk, Basel III better quality capital, buffers, leverage and liquidity ratios.

Worked examples

Example 1

A bank has CET1 capital of ₹6,000 crore, AT1 capital of ₹1,000 crore and Tier 2 capital of ₹1,800 crore. Its total risk-weighted assets are ₹80,000 crore. Calculate the CET1 ratio, Tier 1 ratio and CRAR. Does it meet RBI's Basel III minimums, including the capital conservation buffer?

Show the solution

Tier 1 capital = 6,000 + 1,000 = ₹7,000 crore.
Total capital = 7,000 + 1,800 = ₹8,800 crore.
CET1 ratio = 6,000 ÷ 80,000 × 100 = 7.5%.
Tier 1 ratio = 7,000 ÷ 80,000 × 100 = 8.75%.
CRAR = 8,800 ÷ 80,000 × 100 = 11%.
Compare with the base minimums: CET1 5.5%, Tier 1 7%, Total 9%. All three are met.
Test the buffer. It is held in CET1, so CET1 must be at least 5.5% + 2.5% = 8%. The bank's CET1 is 7.5%, which is 0.5 percentage point short. In rupees, 8% of ₹80,000 crore is ₹6,400 crore, against CET1 of ₹6,000 crore, a gap of ₹400 crore.
The buffered Tier 1 figure of 9.5% and Total figure of 11.5% follow from the CET1 buffer and are derived targets, not separate buffers. The bank's Tier 1 ratio of 8.75% and CRAR of 11% are also below them, which is consistent with the CET1 shortfall.
Conclusion: the bank meets the base minimums but its CET1 is below 8%, so it has dipped into the capital conservation buffer.

Answer: CET1 ratio 7.5%, Tier 1 ratio 8.75%, CRAR 11%. The bank meets the base minimums but its CET1 is below the 8% needed with the buffer, so it is within the buffer range. It would face RBI restrictions on distributions such as dividends until it rebuilds CET1.

Example 2

A bank holds these NPAs: (a) a substandard secured loan of ₹10 crore; (b) a substandard unsecured loan of ₹4 crore (not infrastructure); (c) a loan of ₹6 crore that has been doubtful for 2 years (counted from the date it became doubtful) and is fully covered by the realisable value of its security; (d) a loss asset of ₹1 crore. Compute the total provision required.

Show the solution

(a) Substandard secured: 15% of ₹10 crore = ₹1.5 crore.
(b) Substandard unsecured: 25% of ₹4 crore = ₹1.0 crore.
(c) The whole ₹6 crore is covered by realisable value of security, so it is all secured portion. Doubtful for 1 to 3 years: 40% of ₹6 crore = ₹2.4 crore. There is no unsecured portion.
(d) Loss asset: 100% of ₹1 crore = ₹1.0 crore.
Total = 1.5 + 1.0 + 2.4 + 1.0 = ₹5.9 crore.

Answer: Total provision required is ₹5.9 crore, charged to the profit and loss account. It reduces profit and, through that, the bank's reserves and capital unless offset by existing provisions.

Exam tips

In a numerical question, show every ratio, then a one-line comparison with the RBI minimum. Marks are given for the conclusion as well.
Learn the figures 5.5, 7, 9 and 2.5 and the buffered values 8, 9.5, 11.5. Questions usually test whether you know both sets.
For a theory answer on Tier 1 versus Tier 2, use a two-column layout in sentences: loss absorption, components, and limits. Add one example for each.
For provisioning, always classify first, then split secured and unsecured. State that rates follow RBI's current prudential norms.
Link provisioning to financial health: lower profit, lower retained earnings, lower CET1. This connection earns extra marks in case-based questions.

Practice questions from Analysis of Financial Statements of Banks

Capital Adequacy and Provisioning in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Capital Adequacy and Provisioning: frequently asked questions

What is the minimum capital adequacy ratio for Indian banks under Basel III?

RBI requires a minimum total capital ratio of 9% of RWA, with Tier 1 at 7% and CET1 at 5.5%. On top of this, banks must hold a 2.5% capital conservation buffer in CET1, so the effective total is 11.5%. Always check the latest RBI directions for any change.

How do I calculate the CRAR of a bank?

Add Tier 1 and Tier 2 capital, divide by total risk-weighted assets, and multiply by 100. Total RWA includes credit, market and operational risk. Compute CET1 and Tier 1 ratios the same way using their own capital in the numerator.

What is the difference between Tier 1 and Tier 2 capital?

Tier 1 capital is the core capital that absorbs losses while the bank continues operating. It consists of CET1 and AT1. Tier 2 capital is supplementary and absorbs losses mainly when the bank is winding up, and includes items such as subordinated debt and limited general provisions.

Why do banks need provisioning if they already hold capital?

Provisions cover expected losses on specific loans and are charged to profit, while capital covers unexpected losses. Provisioning forces early recognition of stress, so reported profit is not overstated. It keeps capital from being eroded suddenly.