Basel III

Also called: Basel III norms · Topic: Banking Regulation, NPAs and Financial Stability · NCERT: Beyond NCERT

Meaning

Basel III is a set of global banking rules made after the 2008 crisis. It makes banks hold more capital (the owners' own money) and better-quality capital. It also adds extra capital buffers, a simple leverage ratio and liquidity standards (LCR and NSFR, rules that make banks keep enough cash-like assets to pay people on time).

• Core formula: CRAR = (Tier 1 capital + Tier 2 capital) ÷ Risk-weighted assets × 100
• Why it matters: in the 2008 global financial crisis, many banks did not have enough loss-absorbing capital, so they failed.
• Basel III makes sure capital takes the loss first, before depositors or taxpayers do.
• In India, the RBI applies it and sets stricter levels than the global minimum.

Explanation

Why Basel III came: what went wrong in 2008

• The Basel norms are set by the Basel Committee on Banking Supervision (BCBS).
• It was set up in 1974, after Herstatt Bank in West Germany failed.

• It sits at the Bank for International Settlements (BIS) in Basel, Switzerland.

• Basel I (1988): banks had to hold capital of 8% of risk-weighted assets. It covered credit risk only (the risk that a borrower does not repay).

• Basel II (2004): added market risk and operational risk, and set up three pillars:
• minimum capital
• supervisory review

• market discipline, through public disclosure

• In 2008, Basel II's weak spots showed up:

• Banks' own models gave assets low risk weights, so banks held too little capital.
• Much of that capital was of poor quality.
• Banks had too much leverage (they bought assets mostly with borrowed money).

• They had too few liquid assets (assets that can quickly be turned into cash).

• Basel III (2010) was built to fix all four problems.

The building blocks

• Better-quality capital
• Common Equity Tier 1 (CET1) is the best capital. It includes common shares, share premium, retained earnings (past profits kept in the bank) and disclosed reserves.
• Additional Tier 1 (AT1) instruments are perpetual (they have no maturity date) and non-cumulative (skipped interest is never paid later). They are written down or turned into equity if CET1 falls below a set trigger, or at the point of non-viability (PONV), when the regulator decides the bank cannot survive without help.

• Tier 2 is "gone-concern" capital. It mainly absorbs losses when a bank is wound up. It includes subordinated debt, general provisions (counted only up to 1.25% of credit RWA) and revaluation reserves (counted at a discount).

• Higher minimums (Basel level): CET1 4.5%, Tier 1 6%, total CRAR 8% of risk-weighted assets (RWA).

• Capital conservation buffer (CCB): 2.5% of RWA, held in CET1
• It sits on top of the minimum.
• A bank that falls into the buffer faces limits on dividends, bonuses and share buybacks.

• The profits then stay inside the bank and rebuild its capital. The bank is not shut down.

• Countercyclical capital buffer (CCyB): 0–2.5% of RWA

• "Countercyclical" means it works against the business cycle.
• In a credit boom: the buffer goes up → lending costs more → risky lending slows.
• In a slump: the buffer is released → banks can keep lending instead of cutting loans.

• Its main indicator is the credit-to-GDP gap: how far the credit-to-GDP ratio is above its long-term trend.

• The CCB and CCyB are macroprudential tools

• Macroprudential means they protect the whole financial system, not just one bank.

• They guard banks against periods of excess credit growth. [1]

• Leverage ratio = Tier 1 capital ÷ total exposure (no risk weights)

• Total exposure includes both on-balance-sheet and off-balance-sheet items.
• It is a simple backstop. It still works if banks "game" risk weights by showing assets as safer than they are.

• The Basel minimum is 3%.

• Liquidity standards: LCR and NSFR. Capital alone is not enough. A bank also needs enough liquid funds to pay depositors on time.

Worked example

Asset	Amount (Rs)	Risk weight	RWA (Rs)
G-secs (government bonds)	300	0%	0
Home loans	400	35%	140
Corporate loans	300	100%	300
Total	1,000		440

• Capital = Rs 50 → CRAR = 50 ÷ 440 ≈ 11.4%
• This is above India's 9% minimum.

• It is just below 11.5%, the minimum once the CCB is added. So the bank's dividends are limited.

• CCB check: CET1 + CCB must be at least 8% of Rs 440, which is Rs 35.2.

• If CET1 is Rs 30 (6.8%), the bank meets the 5.5% CET1 minimum.

• But it is inside its buffer, so dividends are limited.

• Leverage check: Tier 1 of Rs 40 ÷ total exposure of Rs 1,000 = 4%.

• This just meets the D-SIB minimum of 4%.

• It is above the 3.5% needed by other banks.

• Trap: capital ÷ total assets (50 ÷ 1,000 = 5%) is not the CRAR. The CRAR always divides by risk-weighted assets.

What pushes capital ratios up or down

• Up: fresh equity (including government recapitalisation of PSBs), retained profits, and moving towards safer assets such as G-secs.
• Down: loan losses and NPAs that eat into capital, fast growth in high-risk-weight loans (for example unsecured or MSME loans), and paying out dividends.

Basel III final reforms ("Basel IV", 2017)

• Output floor: RWA worked out from a bank's own models cannot fall below a set share of RWA under the standardised approach. This limits "model gaming".
• Revised standardised approaches for credit, market and operational risk.

In India

• Regulator: the RBI. The Basel norms are not a treaty and are not legally binding. Each country makes them law through its own regulator. India has been a BCBS member since 2009.
• Start date: Basel III capital rules took effect from 1 April 2013. Banks must meet them on an ongoing basis. [1] The full phase-in was completed in October 2021, after several extensions, including during COVID-19.
• India is stricter than Basel:

Ratio	Basel III	India (RBI)
CET1	4.5%	5.5%
Tier 1	6%	7%
Total CRAR	8%	9%
CCB (in CET1)	2.5%	2.5%
CET1 + CCB	7%	8%
Total CRAR + CCB	10.5%	11.5%
Leverage ratio	3%	4% (D-SIBs), 3.5% (others)

• RBI rules:
• Tier 1 must be at least 7% of RWA on an ongoing basis. [1]
• The minimum Pillar 1 CRAR is 9%, not counting the CCB and CCyB. [1]

• The RBI's definition of CET1 does not include the buffers. They are held on top of the minimum CET1. [1]

• Why India is stricter:

• Public sector banks (PSBs) have a history of high NPAs.
• Borrowers can be concentrated in a few sectors or companies.

• Stricter levels give an extra safety margin.

• D-SIBs (Domestic Systemically Important Banks, the "too big to fail" banks) hold extra CET1 on top of all these minimums.

• CCyB: the RBI framework dates from 2015. In April 2022, the RBI said it was not necessary to activate the CCyB at that time. [2]
• Where banks stand now:
• Scheduled commercial banks' CRAR rose from 12.94% (March 2015) to 17.36% (March 2025). [4]
• Their CET1 rose from 9.98% to 14.81% over the same period. [4]

• In the RBI's Financial Stability Report (June 2026), stress tests (simulations of a bad economy) show total capital staying above the regulatory minimum even in adverse scenarios. The sector has adequate capital and liquidity buffers. [3]

• Why capital improved:

• government recapitalisation of PSBs
• the NPA clean-up after the Asset Quality Review (2015) and the IBC (2016)
• higher profits kept inside the banks

Don't confuse with

• CRAR vs leverage ratio: the CRAR divides total capital (Tier 1 + Tier 2) by risk-weighted assets. The leverage ratio divides Tier 1 only by total exposure, with no risk weights.
• Capital conservation buffer vs countercyclical capital buffer: the CCB is a fixed 2.5% held in CET1 at all times. The CCyB ranges from 0–2.5%, goes up in credit booms and is released in downturns. India has not activated it. [2]
• Basel II vs Basel III: Basel II (2004) brought the three pillars and operational risk. Basel III (2010) raised the quality of capital and added buffers, the leverage ratio and liquidity rules.
• Tier 1 vs Tier 2: AT1 bonds are Tier 1 ("going-concern" capital). General provisions and subordinated debt are Tier 2 ("gone-concern" capital).

Prelims Hooks

• India's Basel III minimums: CET1 5.5%, Tier 1 7%, CRAR 9%. With the CCB they become 8% and 11.5%. The rules took effect from 1 April 2013. [1]
• The CCB (2.5%) must be met with CET1 only. Breaching it limits dividends. It does not close the bank.
• CCyB: 0–2.5%, main indicator the credit-to-GDP gap. It has not been activated (RBI review, April 2022). [2]
• Leverage ratio (India): 4% for D-SIBs, 3.5% for other banks. The Basel minimum is 3%. It uses no risk weights.
• BCBS: set up in 1974 after the Herstatt Bank failure. It sits at the BIS, Basel. India has been a member since 2009. The Basel norms are not legally binding.
• SCB CRAR 17.36%, CET1 14.81% (March 2025). [4]

Mains Points

• Safety vs growth:
• India's stricter-than-Basel norms (9% vs 8%, CET1 5.5% vs 4.5%) protect depositors in a system with a history of NPAs.
• But equity costs banks more than deposits, so lending becomes costlier.
• In 2017-18, several PSBs short of capital were under Prompt Corrective Action (PCA), the RBI's set of limits on weak banks, and credit to MSMEs was squeezed.

• A good answer weighs the fiscal cost of recapitalisation against the growth cost of tight credit.

• No single ratio is enough:

• Banks gamed their internal risk models, which led to the leverage ratio and the output floor.
• Stability needs capital, liquidity (LCR/NSFR), supervision (Pillar 2) and disclosure (Pillar 3) working together.
• It also needs NPA resolution (AQR 2015, IBC 2016). Capital absorbs losses, and resolution removes the bad assets. Neither works alone.

• Today's strong position shows this: CRAR is 17.36% (March 2025) [4], and stress tests are sound [3].

• Macroprudential debate:

• The CCyB is designed to work against the credit cycle, but the RBI has not activated it. [2]
• One can ask whether the credit-to-GDP gap suits a fast-growing, under-banked economy like India.
• In such an economy, credit rises naturally as more people and firms get access to banks, so a rising ratio may not signal a risky boom.

Related concepts

• Leverage
• Basel norms
• Basel I
• Basel II
• Three pillars of Basel
• Capital adequacy ratio
• Risk-weighted assets
• Tier 1 capital
• Common Equity Tier 1
• Additional Tier 1 capital

Read more

• Capital adequacy: Basel I to Basel III