Basel norms

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

Meaning

Basel norms (also called the Basel Accords) are international rules on how much capital a bank must hold, how much liquidity (enough cash to pay depositors on time) it must keep, and how it should manage risk. They are set by the Basel Committee on Banking Supervision (BCBS). They are not a treaty and are not legally binding. Each country makes them law through its own regulator. In India, that regulator is the RBI.

They matter because banks run mostly on borrowed money (deposits). Capital is the cushion that takes losses before depositors lose anything. The core measure is:

CRAR = (Tier 1 capital + Tier 2 capital) ÷ Risk-weighted assets × 100

Explanation

Why capital, and who sets the rules

• Capital is the owners' own money in the bank. It is not borrowed.
• If loans go bad, capital takes the loss first.

• Depositors lose only after all the capital is used up.

• Leverage means buying assets with borrowed money. For a bank, this is mostly deposits.

• Example: a bank has Rs 100 of assets, with Rs 92 of deposits and Rs 8 of capital. A loss of Rs 8 wipes out all its capital, so the bank is insolvent (it owes more than it owns). With Rs 12 of capital, the same loss leaves Rs 4, and the bank survives.

• BCBS was set up in 1974, after the Herstatt Bank (West Germany) failed. Its office is at the Bank for International Settlements (BIS) in Basel, Switzerland. India has been a member since 2009.

The three stages: Basel I → II → III

• Basel I (1988)
• Capital must be at least 8% of risk-weighted assets (RWA).
• It covered credit risk only, which is the risk that a borrower does not repay.
• Assets went into a few risk-weight buckets from 0% to 100%. Government debt got 0% and most corporate loans got 100%.

• Weakness: the buckets were too rough. A strong company and a weak company both got 100%. It also ignored market and operational risk.

• Basel II (2004) added market risk (losses when bond prices, share prices, exchange rates or interest rates move) and operational risk (losses from fraud, system failure or human error). It rests on three pillars:

• Pillar 1, minimum capital: banks use either the standardised approach (the regulator sets weights, based on external credit ratings) or the internal ratings-based approach (the bank's own models).
• Pillar 2, supervisory review: the bank checks its own risks through ICAAP (Internal Capital Adequacy Assessment Process). The RBI checks that work through SREP (Supervisory Review and Evaluation Process).
• Pillar 3, market discipline: banks publish their capital and risk data, so investors and depositors can punish risky banks.

• What the 2008 crisis showed: banks' own models gave low risk weights, so banks held too little capital. Much of that capital was also of poor quality.

• Basel III (2010) was the rebuild after the 2008 crisis. Banks had held too little capital, poor-quality capital, too much leverage and too few liquid assets. Basel III added:

• A larger, better-quality core of CET1 capital
• A capital conservation buffer (CCB) of 2.5% of RWA, held in CET1
• A countercyclical capital buffer (CCyB) of 0-2.5% of RWA
• A leverage ratio of Tier 1 ÷ total exposure, with no risk weights and a Basel minimum of 3%

• Liquidity ratios (LCR/NSFR)

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

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

Quality of capital: Tier 1 and Tier 2

• Tier 1 capital is "going-concern" capital. It absorbs losses while the bank keeps running.
• CET1 (Common Equity Tier 1) is the best quality. It includes common shares, share premium, retained earnings (past profits kept in the bank) and disclosed reserves.

• AT1 (Additional Tier 1) instruments are perpetual (no maturity date) and non-cumulative (skipped interest is never paid later). They are written down or converted into equity if CET1 falls below a trigger, or at the point of non-viability (PONV).

• Tier 2 capital is "gone-concern" capital. It absorbs losses mainly when the bank is wound up.

• It includes subordinated debt (paid back only after depositors and other creditors).
• It includes general provisions, counted only up to 1.25% of credit RWA.
• It includes revaluation reserves, counted at a discount.

Buffers and what makes them rise or fall

• Capital conservation buffer (CCB): banks can use it up in bad times.
• A bank that falls into the buffer faces limits on dividends, bonuses and share buybacks.

• Profits then stay inside the bank and rebuild its capital.

• Countercyclical capital buffer (CCyB): "countercyclical" means it works against the business cycle.

• In a boom: the buffer goes up → lending costs more → risky lending slows.
• In a slump: the buffer is released → banks keep lending instead of cutting loans.

• Its main indicator is the credit-to-GDP gap, meaning how far credit-to-GDP is above its long-term trend. [2]

• Both buffers are macroprudential tools. They protect the whole financial system, not just one bank, and guard against periods of excess credit growth. [1]

Worked example: CRAR

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

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

• It is just below 11.5% (the minimum with the CCB), so the bank faces limits on dividends.

• Trap: 50 ÷ 1,000 = 5% is capital ÷ total assets. That ratio is close to the leverage ratio, not the CRAR.

• Buffer example: with RWA of Rs 440, CET1 + CCB must be at least 8%, which is Rs 35.2. If CET1 is Rs 30 (6.8%), the bank meets the 5.5% minimum but is inside its buffer, so dividends are limited.
• Leverage example: Tier 1 of Rs 40 ÷ total exposure of Rs 1,000 = 4%. This just meets the D-SIB minimum.

In India

• Regulator: the RBI turns the Basel norms into Indian rules and often sets stricter levels than Basel.
• Basel I: adopted in 1992, during the post-1991 financial sector reforms (Narasimham Committee-I era). The minimum was raised to 9% CRAR from 2000.
• Basel II: implemented in 2008-09.
• Basel III: capital regulations took effect from 1 April 2013, and banks must meet the minimums on an ongoing basis. [1] Full phase-in came in October 2021, after several extensions, including during COVID-19.

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 + CCB	10.5%	11.5%
Leverage ratio	3%	4% (D-SIBs), 3.5% (others)

• Under the RBI's rules, Tier 1 capital must be at least 7% of RWA, and the minimum Pillar 1 CRAR is 9%, not counting the CCB and CCyB. [1]
• The RBI's definition of CET1 does not include the CCB or CCyB. The buffers are held on top of the minimum CET1. [1]
• D-SIBs (Domestic Systemically Important Banks, which are "too big to fail") 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]
• Why India is stricter: PSBs have a history of high NPAs, and lending can be concentrated in a few sectors or companies. Stricter levels add a safety margin.
• Where banks stand: the CRAR of scheduled commercial banks (SCBs) rose from 12.94% (March 2015) to 17.36% (March 2025), and CET1 rose from 9.98% to 14.81% over the same period. [4]
• Stress tests: SCBs' total capital stays above the regulatory minimum even in adverse scenarios, and the banking sector has adequate capital and liquidity buffers (Financial Stability Report, June 2026). [3]
• Why capital improved: government recapitalisation of PSBs, the NPA clean-up after the Asset Quality Review (2015) and the IBC (2016), and higher profits kept in the banks.

Don't confuse with

• CRAR vs Leverage ratio: CRAR = (Tier 1 + Tier 2) ÷ risk-weighted assets. The leverage ratio = Tier 1 only ÷ total exposure, with no risk weights.
• Tier 1 vs Tier 2: Tier 1 is going-concern capital (CET1 + AT1). Tier 2 is gone-concern capital (subordinated debt, general provisions up to 1.25% of credit RWA, revaluation reserves). AT1 bonds are Tier 1. General provisions are Tier 2.
• CCB vs CCyB: the CCB is a fixed 2.5% held in CET1. The CCyB varies from 0-2.5%, rises in credit booms, is released in downturns, and has not been activated in India. [2]
• Basel I vs Basel II: Basel I covered credit risk only. Operational risk and market risk first came with Basel II, together with the three pillars.

Prelims Hooks

• BCBS was set up in 1974 after the Herstatt Bank failure. It is housed at the BIS, Basel, and India has been a member since 2009. Basel norms are not legally binding.
• Basel I (1988): 8% of RWA, credit risk only. India adopted it in 1992 and moved to 9% CRAR from 2000.
• Basel II's three pillars: minimum capital, supervisory review (ICAAP/SREP) and market discipline (disclosure).
• India's Basel III minimums: CET1 5.5%, Tier 1 7%, CRAR 9%. With the CCB, these become 8% and 11.5%. Basel III took effect in India from 1 April 2013. [1]
• The CCB (2.5%) must be met with CET1 only. Breaching it limits dividends. It does not shut the bank. Leverage ratio (India): 4% for D-SIBs and 3.5% for other banks, against a Basel minimum of 3%.
• SCB CRAR was 17.36% and CET1 was 14.81% in March 2025. [4]

Mains Points

• Safety vs growth: India's stricter-than-Basel norms (9% vs 8% CRAR, 5.5% vs 4.5% CET1) protect depositors in a system with a history of NPAs.
• But equity costs more than deposits: loans with high risk weights, such as MSME and unsecured loans, need more capital, so they cost more to give.
• PCA years (2017-18): PSBs short of capital were under Prompt Corrective Action (RBI restrictions 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.

• Risk weights vs simple rules: banks gamed their internal models before 2008. This led to the leverage ratio and the output floor. No single ratio is enough. Stability needs capital, liquidity (LCR/NSFR), supervision (Pillar 2) and disclosure (Pillar 3) together. The CCyB has not been activated. [2] A good answer can ask whether the credit-to-GDP gap suits an under-banked economy, where credit rises naturally as more people and firms get access to banks.

• Capital + resolution = stability: strong buffers (CRAR 17.36%, March 2025) [4] and good stress test results [3] are linked to NPA recognition (AQR 2015) and resolution (IBC 2016). Capital absorbs losses, and resolution removes bad assets. Neither works alone.

Related concepts

• Leverage
• 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
• Tier 2 capital

Read more

• Capital adequacy: Basel I to Basel III