Prudential Norms on Capital Adequacy for Local Area Banks · RBI/DOR/2025-26/227

RBI/DOR/2025-26/227 DOR.CAP.REC.146/21-01-002/2025-26 November 28, 2025

Reserve Bank of India (Local Area Banks - Prudential Norms on Capital Adequacy) Directions, 2025

Table of Contents

• Chapter I Preliminary
  • A Short title and commencement
  • B Applicability
  • C Definitions
• Chapter II Regulatory capital
  • A Minimum regulatory capital
  • B Definition of capital funds
  • C Tier 1 capital
  • D Tier 2 capital
  • E Deductions from computation of capital funds
  • F Limit for Tier 2 elements
  • G Norms on cross holdings
  • H Capital for subsidiaries
• Chapter III Calculation of risk weighted assets (RWAs)
  • A Capital charge for credit risk
  • B Capital charge for market risk
  • C Capital charge for interest rate derivatives
  • D Calculation of total risk weighted assets (RWAs) and capital ratio
• Chapter IV Repeal and Other provisions
  • A Repeal and Saving
  • B Application of other laws not barred
  • C Interpretations
• Annex I Reporting format for details of investments by FIIs and NRIs in Perpetual Non-Cumulative Preference Shares qualifying as Tier 1 Capital

In exercise of the powers conferred by section 35A of the Banking Regulation Act (BR Act), 1949 the Reserve Bank of India being satisfied that it is necessary and expedient in the public interest and in the interest of banking policy so to do, hereby, issues the Directions hereinafter specified.

Chapter I

Preliminary

A Short title and commencement

1. These Directions shall be called the Reserve Bank of India (Local Area Banks - Prudential Norms on Capital Adequacy) Directions, 2025.
2. These Directions shall come into effect immediately upon issuance.

B Applicability

3. These Directions shall be applicable to Local Area Banks (hereinafter collectively referred to as 'banks' or ‘LABs’ and individually as a 'bank' or ‘LAB’).

C Definitions

4. In these directions, unless the context otherwise requires, the terms herein shall bear the meanings assigned to them below.: (1) ‘Banking book’ shall mean all items which are not included under trading book as per these Directions; (2) ‘Basis Risk’ is the risk that the interest rate of different assets, liabilities and off-balance sheet items may change in different magnitude; (3) ‘Credit Risk’ is defined as the potential that a bank's borrower or counterparty may fail to meet its obligations in accordance with agreed terms. It is also the possibility of losses associated with a diminution in the credit quality of borrowers or counterparties; (4) ‘Deferred Tax Assets (DTA)’ and ‘Deferred Tax Liabilities (DTL)’ shall have the same meaning as assigned to them under the extant Accounting Standards.; (5) ‘Derivative’ shall have the same meaning as assigned to it in section 45U(a) of the RBI Act, 1934; (6) ‘Duration’ (Macaulay Duration) measures the price volatility of fixed income securities. It is often used in the comparison of the interest rate risk between securities with different coupons and different maturities. It is the weighted average of the present value of all the cash flows associated with a fixed income security. It is expressed in years. The duration of a fixed income security is always shorter than its term to maturity, except in the case of zero-coupon securities where they are the same; (7) ‘Hedging’ is taking action to eliminate or reduce exposure to risk; (8) ‘Horizontal disallowance’ is a disallowance of offsets to required capital used for assessing market risk for regulatory capital. In order to calculate the capital required for interest rate risk of a trading portfolio, offsetting of long and short positions is permitted. However, interest rate risks of instruments at different horizontal points of the yield curve are not perfectly correlated. Hence, this method requires that a portion of these offsets be disallowed; (9) ‘Interest Rate Risk’ is the risk that the financial value of assets or liabilities (or inflows / outflows) will be altered because of fluctuations in interest rates; (10) ‘Long Position’ refers to a position where gains arise from a rise in the value of the underlying; (11) ‘Market Risk’ is the risk of losses in on-and off-balance sheet positions arising from movements in market prices; (12) ‘Modified Duration’ or volatility of an interest-bearing security is its Macaulay Duration divided by one plus the coupon rate of the security. It represents a percentage change in the securities' price for a 100 basis points change in yield. It is generally accurate for only small changes in the yield. MD = - dP / dY x 1 / P Where, MD = Modified Duration P = Gross price (i.e., clean price plus accrued interest) dP = Corresponding small change in price dY = Small change in yield compounded with the frequency of the coupon payment; (13) ‘Mortgage-backed Security’ is a bond-type security in which the collateral is provided by a pool of mortgages. Income from the underlying mortgages is used to meet interest and principal repayments; (14) ‘Open Position’ is the net difference between the amounts payable and amounts receivable in a particular instrument or commodity. It results from the existence of a net long or net short position in the particular instrument or commodity; (15) ‘Short Position’ refers to a position where gains arise from a decline in the value of the underlying. It also refers to the sale of a security in which the seller does not have a long position; (16) ‘Trading Book’ shall include all instruments that are classified as ‘Held for Trading’ as per Reserve Bank of India (Local Area Banks – Classification, Valuation and Operation of Investment Portfolio) Directions, 2025; (17) ‘Vertical Disallowance’ means a reversal of the offsets of a general market risk charge of a long position by a short position in two or more securities in the same time band in the yield curve under the method followed for determining regulatory capital necessary to cushion market risk.
5. All other expressions, unless defined herein, shall have the same meaning as have been assigned to them under the applicable Acts, rules / regulations made thereunder, or any statutory modification or re-enactment thereto or as used in commercial parlance, as the case may be.

Chapter II

Regulatory capital

A Minimum regulatory capital

6. An LAB shall maintain a minimum Capital to Risk-weighted Assets Ratio (CRAR) of 9 per cent on an ongoing basis. It shall compute CRAR in the following manner:

B Definition of capital funds

7. The capital funds for capital adequacy purpose shall consist of Tier 1 and Tier 2 Capital.

C Tier 1 Capital

8. Tier 1 Capital shall consist of: (i) Paid-up capital (ordinary shares), statutory reserves, AFS reserve, and other disclosed free reserves, if any; Note- (1) AFS – Reserve shall be as per the Reserve Bank of India (Local Area Banks – Classification, Valuation and Operation of Investment Portfolio) Directions, 2025; and (2) Any negative balance in the AFS - Reserve shall be deducted from Tier 1 capital; (ii) Perpetual Non-Cumulative Preference Shares (PNCPS), subject to compliance with the minimum regulatory requirements specified in paragraph 9; (iii) Perpetual Debt Instruments (PDI) subject to compliance with the minimum regulatory requirements specified in paragraph 10; (iv) Capital reserves representing surplus arising out of sale proceeds of assets; and (v) An LAB may include quarterly / half yearly profits for computation of Tier 1 Capital only if the quarterly / half yearly results are audited by statutory auditors and not when the results are subjected to limited review.

C.1 Criteria for inclusion of Perpetual Non-Cumulative Preference Shares (PNCPS) in Tier 1 Capital

9. The PNCPS issued by an LAB shall meet the following terms and conditions to qualify for inclusion in Tier 1 Capital for capital adequacy purposes: (1) Limits The outstanding amount of Tier 1 PNCPS along with Tier 1 PDIs shall not exceed 40 per cent of total Tier 1 Capital at any point of time. The above limit shall be based on the amount of Tier 1 Capital after deduction of goodwill and other intangible assets but before the deduction of investments. Tier 1 PNCPS issued in excess of the overall ceiling of 40 per cent shall be eligible for inclusion under upper Tier 2 Capital, subject to limits prescribed for Tier 2 Capital. However, investors' rights and obligations shall remain unchanged. (2) Amount The amount of PNCPS to be raised shall be decided by the Board of Directors of an LAB. (3) Maturity The PNCPS shall be perpetual. (4) Options (i) PNCPS shall not be issued with a 'put option' or ‘step up option’. (ii) An LAB may, however, issue the instruments with a ‘call option’ at a particular date subject to following conditions: (a) The call option on the instrument is permissible after the instrument has run for at least ten years; and (b) Call option shall be exercised only with the prior approval of the Reserve Bank (Department of Regulation). While considering the proposals received from an LAB for exercising the call option, the Reserve Bank shall, among other things, take into consideration the LAB's CRAR position, both at the time of exercise of the call option and after exercise of the call option. (5) Dividend The rate of dividend payable to the investors shall be either a fixed rate or a floating rate referenced to a market determined rupee interest benchmark rate. (6) Payment of Dividend (i) An issuing LAB shall pay dividend subject to availability of distributable surplus out of current year's earnings, and if, (a) The LAB’s CRAR is above the minimum regulatory requirement prescribed by the Reserve Bank; (b) The impact of such payment does not result in LAB’s CRAR falling below or remaining below the minimum regulatory requirement prescribed by the Reserve Bank; (c) In the case of half yearly payment of dividends, the balance sheet as at the end of the previous year does not show any accumulated losses; and (d) In the case of annual payment of dividends, the current year's balance sheet does not show any accumulated losses. (ii) The dividend shall not be cumulative. Dividend missed in a year shall not be paid in future years, even if adequate profit is available and the level of CRAR conforms to the regulatory minimum. When dividend is paid at a rate lesser than the prescribed rate, the unpaid amount shall not be paid in future years, even if adequate profit is available and the level of CRAR conforms to the regulatory minimum. (iii) All instances of non-payment of dividend / payment of dividend at a lesser rate than prescribed in consequence of conditions as at (i) above shall be reported by the issuing LAB to the Chief General Managers-in-Charge of the Department of Regulation and the Department of Supervision (DoS) of the Reserve Bank. (7) Seniority of Claim The claims of the investors in PNCPS shall be senior to the claims of investors in equity shares and subordinated to the claims of all other creditors and the depositors. (8) Other Conditions (i) PNCPS shall be fully paid-up, unsecured, and free of any restrictive clauses. (ii) Investment by Foreign Institutional Investors (FIIs) and Non-Resident Indians (NRIs) shall be within an overall limit of 49 per cent and 24 per cent of the issue respectively, subject to the investment by each FII not exceeding 10 per cent of the issue and investment by each NRI not exceeding 5 per cent of the issue. Investment by FIIs in these instruments shall be outside the External Commercial Borrowings (ECB) limit for rupee denominated corporate debt as fixed by Government of India from time to time. (iii) An LAB shall comply with the terms and conditions, if any, stipulated by the Securities and Exchange Board of India (SEBI) / other regulatory authorities in regard to issue of the instruments. (9) Compliance with Reserve Requirements (i) The funds collected by various branches of the LAB or other banks for the issue and held pending finalisation of allotment of the Tier 1 preference shares shall be taken into account for the purpose of calculating reserve requirements. (ii) The total amount raised by the LAB by issue of PNCPS shall, however, not be reckoned as liability for calculation of net demand and time liabilities for the purpose of reserve requirements and, as such, shall not attract CRR / SLR requirements. (10) Reporting Requirements (i) An LAB issuing PNCPS shall submit a report to the Chief General Manager-in-Charge, Department of Regulation of the Reserve Bank, giving details of the capital raised, including the terms of issue together with a copy of the offer document soon after the issue is completed. (ii) The issue-wise details of amount raised as PNCPS qualifying for Tier 1 Capital by the LAB from FIIs / NRIs shall be reported within 30 days of the issue to the Chief General Manager-in-Charge, Foreign Exchange Department of the Reserve Bank in the proforma given at Annex I. The details of the secondary market sales / purchases by FIIs and the NRIs in these instruments on the floor of the stock exchange shall be reported by the custodians and designated banks, respectively to the Reserve Bank as per the applicable Foreign Exchange Management Act (FEMA) guidelines. (11) Investment in PNCPS issued by other banks / Financial Institutions (FIs) (i) An LAB’s investment in PNCPS issued by other banks and FIs shall be reckoned along with the investment in other instruments eligible for capital status while computing compliance with the overall ceiling of 10 per cent of the investing LAB’s total regulatory capital prescribed in paragraph 19 of this chapter. (ii) LAB’s investments in PNCPS issued by other banks / FIs shall attract risk weight for capital adequacy purposes as prescribed in paragraph 19(4) of this chapter. (iii) An LAB’s investments in the PNCPS of other banks shall be treated as exposure to capital market and be reckoned for the purpose of compliance with the prudential ceiling for capital market exposure as fixed by the Reserve Bank. (12) Grant of Advances against Tier 1 Preference Shares An LAB shall not grant advances against the security of the PNCPS issued by them. (13) Classification in the Balance Sheet These instruments shall be classified as capital and shown under 'Schedule I -Capital' of the Balance Sheet.

C.2 Criteria for inclusion of Perpetual Debt Instrument (PDI) in Tier 1 Capital

10. The PDI issued by an LAB shall meet the following terms and conditions to qualify for inclusion in Tier 1 Capital for capital adequacy purposes: Terms of issue of PDIs denominated in Indian rupees (1) Amount The amount of PDI to be raised shall be decided by the Board of Directors of the LAB. (2) Limits The total amount raised by an LAB through PDI [including the existing Innovative Perpetual Debt Instruments (IPDI)] shall not exceed 15 per cent of total Tier 1 Capital. The eligible amount shall be computed with reference to the amount of Tier 1 Capital as on March 31 of the previous financial year, after deduction of goodwill, DTA, and other intangible assets but before the deduction of investments. PDI in excess of the above limits shall be eligible for inclusion under Tier 2 Capital, subject to limits prescribed for Tier 2 Capital. However, investors’ rights and obligations shall remain unchanged. (3) Maturity Period The PDI shall be perpetual. (4) Rate of Interest The interest payable to the investors shall be either at a fixed rate or at a floating rate referenced to a market determined rupee interest benchmark rate. (5) Options PDI shall not be issued with a ‘put option’ or a ‘step-up option’. However, an LAB may issue the instruments with a ‘call option’ subject to strict compliance with each of the following conditions: (i) Call option on the instrument is permissible after the instrument has run for at least ten years; and (ii) Call option shall be exercised only with the prior approval of the Reserve Bank (Department of Regulation). While considering the proposals received from an LAB for exercising the call option, the Reserve Bank shall, among other things, take into consideration the LAB’s CRAR position, both at the time of exercise of the call option and after exercise of the call option. (6) Lock-in Clause (i) PDI shall be subjected to a lock-in clause in terms of which the issuing LAB shall not be liable to pay interest, if (a) the LAB’s CRAR is below the minimum regulatory requirement prescribed by the Reserve Bank; or (b) the impact of such payment results in the LAB’s CRAR falling below or remaining below the minimum regulatory requirement prescribed by the Reserve Bank; (ii) However, an LAB can pay interest with the prior approval of the Reserve Bank when the impact of such payment may result in net loss or increase the net loss, provided the CRAR remains above the regulatory norm. For this purpose, ‘net loss’ shall mean either (a) the accumulated loss at the end of the previous financial year; or (b) the loss incurred during the current financial year. (iii) The interest shall not be cumulative. (iv) All instances of invocation of the said lock-in clause shall be notified by the issuing banks to the Chief General Managers-in-Charge, Department of Regulation and Department of Supervision of the Reserve Bank. (7) Seniority of claim The claims of the investors in any outstanding IPDI and PDI shall be: (i) Superior to the claims of investors in equity shares and Tier 1 preference shares; and (ii) Subordinated to the claims of all other creditors and depositors. (8) Discount The PDI shall not be subjected to a progressive discount for capital adequacy purposes. (9) Other conditions (i) PDI shall be fully paid-up, unsecured, and free of any restrictive clauses. (ii) Investment by FIIs in PDI raised in Indian rupees shall be outside the ECB limit for rupee denominated corporate debt, as fixed by the Government of India from time to time, for investment by FIIs in corporate debt instruments. Investment in these instruments by FIIs and NRIs shall be within an overall limit of 49 per cent and 24 per cent respectively, of the issue, subject to the investment by each FII not exceeding 10 per cent of the issue and investment by each NRI not exceeding 5 per cent of the issue. (iii) An LAB shall comply with the terms and conditions, if any, stipulated by SEBI / other regulatory authorities in regard to issue of the instruments. (10) Terms of issue of PDI denominated in foreign currency An LAB may augment its capital funds through the issue of PDI in foreign currency without seeking the prior approval of the Reserve Bank, subject to compliance with the under-mentioned requirements: (i) PDI issued in foreign currency shall comply with all terms and conditions as applicable to the instruments issued in Indian Rupees. (ii) Not more than 49 per cent of the eligible amount can be issued in foreign currency. (iii) PDI issued in foreign currency shall be outside the limits for foreign currency borrowings indicated below: (a) The total amount of Upper Tier 2 Instruments issued in foreign currency shall not exceed 25 per cent of the unimpaired Tier 1 Capital. This eligible amount shall be computed with reference to the amount of Tier 1 Capital as on March 31 of the previous financial year, after deduction of goodwill and other intangible assets but before the deduction of investments, as per paragraph 17(1) of this chapter. (b) This shall be in addition to the existing limit for foreign currency borrowings by Authorised Dealers, stipulated by the Reserve Bank under Foreign Exchange Management Act, 1999. (11) Compliance with Reserve Requirements The total amount raised by an LAB through PDI shall not be reckoned as liability for calculation of net demand and time liabilities for the purpose of reserve requirements and, as such, shall not attract CRR / SLR requirements. (12) Reporting requirements An LAB issuing PDI shall submit a report to the Chief General Manager-in-Charge, Department of Regulation of the Reserve Bank giving details of the debt raised, including the terms of issue, together with a copy of the offer document, soon after the issue is completed. (13) Investment in PDI issued by other banks / FIs (i) An LAB's investment in PDI issued by other banks and financial institutions shall be reckoned along with the investment in other instruments eligible for capital status while computing compliance with the overall ceiling of 10 percent prescribed in paragraph 19 of this chapter. (ii) LAB's investments in PDI issued by other banks shall attract risk weight for capital adequacy purposes, as prescribed in paragraph 19(4) of this chapter. (14) Grant of advances against PDI An LAB shall not grant advances against the security of the PDI issued by them. (15) Classification in the Balance Sheet An LAB shall indicate the amount raised by issue of PDI in the Balance Sheet under Schedule 4 - ‘Borrowings’.

D Tier 2 Capital

11. Tier 2 Capital shall consist of: (i) Revaluation reserves Revaluation reserves shall be subjected to a discount of 55 per cent while determining their value for inclusion in Tier 2 Capital. Such reserves shall be reflected on the face of the Balance Sheet as revaluation reserves. (ii) General Provisions and Loss Reserves General provisions and loss reserves shall be included in Tier 2 Capital provided they are not attributable to the actual diminution in value or identifiable potential loss in any specific asset and are available to meet unexpected losses. Adequate care shall be taken to ensure that sufficient provisions have been made to meet all known losses and foreseeable potential losses before considering general provisions and loss reserves to be part of Tier 2 Capital. General provisions and loss reserves shall be admitted up to a maximum of 1.25 per cent of RWAs. General provisions / loss reserves shall include: (a) 'Floating Provisions' held by an LAB, which is general in nature and not made against any identified assets. (b) Excess provisions which arise on sale of Non-Performing Assets (NPAs). (c) General provisions on standard assets. (d) Incremental provisions in respect of unhedged foreign currency exposures as prescribed under Reserve Bank of India (Local Area Banks – Credit Risk Management) Directions, 2025. (iii) Hybrid Debt Capital Instruments The following instruments shall be eligible for inclusion in upper Tier 2 Capital: (a) Debt capital instruments subject to compliance with minimum regulatory requirements specified in paragraph 13. (b) Perpetual Cumulative Preference Shares (PCPS) / Redeemable Non-Cumulative Preference Shares (RNCPS) / Redeemable Cumulative Preference Shares (RCPS) subject to compliance with minimum regulatory requirements specified in paragraph 14. (iv) Subordinated Debt Rupee denominated subordinated debt shall be eligible for inclusion in Tier 2 Capital, subject to the terms and conditions specified in paragraph 15. Swap Transactions
12. An LAB shall not enter into swap transactions involving conversion of fixed rate rupee liabilities in respect of Tier 1 / Tier 2 bonds into floating rate foreign currency liabilities.

D.1 Criteria for inclusion of debt capital instruments in Upper Tier 2 Capital

13. The debt capital instruments that are issued as bonds / debentures by an LAB shall meet the following terms and conditions to qualify for inclusion as Upper Tier 2 Capital for capital adequacy purposes. (1) Currency of issue An LAB shall issue Upper Tier 2 instruments in Indian Rupees. An LAB may also issue these instruments in foreign currency without seeking the prior approval of the Reserve Bank, subject to compliance with the under-mentioned requirements: (i) The total amount of Upper Tier 2 instruments issued in foreign currency shall not exceed 25 per cent of the unimpaired Tier 1 Capital. This eligible amount shall be computed with reference to the amount of Tier 1 Capital as on March 31 of the previous financial year, after deduction of goodwill and other intangible assets but before the deduction of investments; (ii) The amount raised shall be in addition to the existing limit for foreign currency borrowings by Authorised Dealers stipulated by the Reserve Bank under the Foreign Exchange Management Act (FEMA), 1999; and (iii) Investment by FIIs in Upper Tier 2 Instruments raised in Indian rupees shall be outside the limit for investment in corporate debt instruments. Investments by FIIs in these instruments shall be subject to a separate ceiling of USD 500 million. (2) Amount The amount of Upper Tier 2 Instruments to be raised shall be decided by the Board of Directors of the LAB. (3) Limit Upper Tier 2 Instruments along with other components of Tier 2 Capital shall not exceed 100 per cent of Tier 1 Capital. The above limit shall be based on the amount of Tier 1 Capital after deduction of goodwill and other intangible assets but before the deduction of investments. (4) Maturity Period The Upper Tier 2 instruments shall have a minimum maturity of 15 years. (5) Rate of Interest The interest payable to the investors shall be either at a fixed rate or at a floating rate referenced to a market determined rupee interest benchmark rate. (6) Options Upper Tier 2 instruments shall not be issued with a ‘put option’ or a ‘step-up option’. However, an LAB may issue the instruments with a ‘call option’ subject to strict compliance with each of the following conditions: (i) Call options on the instrument is permissible after the instrument has run for at least ten years; and (ii) Call options shall be exercised only with the prior approval of the Reserve Bank (Department of Regulation). While considering the proposals received from an LAB for exercising the call option, the Reserve Bank shall, among other things, take into consideration the LAB’s CRAR position both at the time of exercise of the call option and after exercise of the call option. (7) Lock-in clause (i) Upper Tier 2 instruments shall be subjected to a lock-in clause in terms of which the issuing LAB shall not be liable to pay either interest or principal, even at maturity, if (a) the LAB’s CRAR is below the minimum regulatory requirement prescribed by the Reserve Bank; or (b) the impact of such payment results in LAB’s CRAR falling below or remaining below the minimum regulatory requirement prescribed by the Reserve Bank. (ii) However, an LAB can pay interest with the prior approval of the Reserve Bank when the impact of such payment may result in net loss or increase the net loss provided CRAR remains above the regulatory norm. For this purpose, 'Net Loss' shall mean either (a) the accumulated loss at the end of the previous financial year; or (b) the loss incurred during the current financial year. (iii) The interest amounts due and remaining unpaid can be allowed to be paid in the later years subject to the LAB complying with the above regulatory requirement. While paying such unpaid interest and principal, an LAB is allowed to pay compound interest at a rate not exceeding the coupon rate of the relative Upper Tier 2 bonds, on the outstanding principal and interest. (iv) All instances of invocation of the said lock-in clause shall be notified by the issuing LAB to the Chief General Managers-in-Charge of Department of Regulation and Department of Supervision of the Reserve Bank of India, Mumbai. (8) Seniority of claim The claims of the investors in Upper Tier 2 instruments shall be: (i) Superior to the claims of investors in instruments eligible for inclusion in Tier 1 capital; and (ii) Subordinate to the claims of all other creditors including those in Lower Tier 2 and the depositors. Amongst the investors of various instruments included in Upper Tier 2, the claims shall rank pari-passu with each other. (9) Discount The Upper Tier 2 instruments shall be subjected to a progressive discount for capital adequacy purposes as in the case of long-term subordinated debt over the last five years of their tenor. As they approach maturity, these instruments shall be subjected to progressive discount as indicated in the table below for being eligible for inclusion in Tier 2 Capital.