Banking Regulation, NPAs and Financial Stability

1. From nationalisation to reform: evolution and structure of Indian banking

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The core idea running through this note. A bank borrows short-term (deposits that can be withdrawn on demand) and lends long-term (loans). Class 12, Money and Banking shows this with the goldsmith Lala: he lends out gold that others have deposited, betting that not all depositors will come back at once. That makes a bank a leveraged, maturity-transforming business built on trust. Every rule in this note deals with one of three failures:

• Hidden bad loans, handled by classification and provisioning (Sections 4-7)
• Too little capital, handled by Basel norms and PCA (Sections 8-9)
• A run on liquidity, handled by LCR/NSFR, deposit insurance and the lender of last resort (Section 9)

Evolution

• Banking Regulation Act 1949 gave RBI licensing and supervisory powers. RBI (set up 1935) was nationalised in 1949. The Imperial Bank became the State Bank of India in 1955.
• Nationalisation, 19 July 1969: 14 banks with deposits of at least Rs 50 crore. 1980: 6 more with deposits of at least Rs 200 crore.
• Gains: "social banking", rural branch expansion, credit to farms and small industry.

• Costs: financial repression, meaning interest-rate caps, directed lending and high compulsory holdings of government bonds. These pushed savings to the government at below-market rates. SLR peaked at 38.5% and CRR at 15% around 1990-91. Result: low profits and weak asset quality.

• Narasimham Committee I (1991):

• Cut SLR and CRR, and deregulated interest rates
• Brought in prudential norms (income recognition, asset classification, provisioning, capital adequacy)

• Allowed new private banks: licences in 1993-94, then 2001, 2014, and on-tap licensing from 2016

• NCERT view (Class 11, Liberalisation, Privatisation and Globalisation: An Appraisal):

• Financial-sector reform was meant to move RBI "from regulator to facilitator".
• Private Indian and foreign banks entered.
• Banks that met set conditions could open branches without RBI approval.

• (NCERT: "foreign investment limit in banks was raised to around 74 per cent". Correct position: 74% is the FDI cap for private-sector banks; the cap for PSBs is 20%.)

• Narasimham Committee II (1998): higher CRAR, narrow banking for weak banks, and mergers of strong banks. Narrow banking means a bank puts deposits only into safe, liquid assets such as government securities, so it carries little credit risk.

• Universal banking means one institution offers commercial banking, investment banking, insurance and other services. Khan Working Group, 1997. Development finance institutions (DFIs) became banks: ICICI (2002) and IDBI (2004).
• Islamic banking is interest-free banking based on profit-and-loss sharing and asset-backed contracts. RBI considered it and dropped it in 2017.

Structure today

• Scheduled bank: listed in the Second Schedule of the RBI Act. It must keep CRR with RBI and can use RBI refinance and liquidity windows. Non-scheduled banks are outside this list.

Segment	Key facts
Public sector banks	Government stake above 50%. Merged down from 27 to 12: SBI associates (2017), BoB-Vijaya-Dena (2019), April 2020 mega-merger
Private banks	Old and new private banks
Foreign banks	Branch mode or wholly owned subsidiary
SFBs, payments banks	Differentiated banks (Section 2)
RRBs	Being merged under "One State One RRB", 2025 (verify current)
Local area banks	Small, few in number

• Cooperative banks:
• Urban cooperative banks (UCBs) are cooperative societies licensed to bank in urban and semi-urban areas. RBI regulates their banking functions. Banking Regulation (Amendment) Act 2020 widened RBI's powers. A four-tier regulatory framework came in 2022, and the NUCFDC umbrella body in 2024. Dual control remains a problem: state registrars still handle registration and administration.

• Rural cooperatives: StCBs, DCCBs and PACS.

• PSB governance reform: P.J. Nayak Committee (2014) → Indradhanush (2015) → Banks Board Bureau (2016) → FSIB (2022).

• Privatisation: Budget 2021-22 announced privatisation of two PSBs. IDBI Bank strategic sale is under way (verify current).
• Banking Laws (Amendment) Act 2025: up to four nominees per account. The "substantial interest" threshold rises from Rs 5 lakh to Rs 2 crore (verify current).

2. Beyond universal banks: differentiated banks, NBFCs and shadow banking

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Differentiated banks

• Differentiated banking means licensing specialised banks that may do only a limited set of activities, to serve particular needs. The idea came from the Nachiket Mor Committee (2013). Guidelines followed in 2014, licences in 2015, and on-tap SFB licensing in 2019.

	Payments bank	Small finance bank
Purpose	Deposits and remittances for migrants and low-income users	Savings and credit for small farmers, micro firms and the unorganised sector
Deposits	Capped at Rs 2 lakh per customer (raised from Rs 1 lakh in 2021)	No cap
Lending	None; no credit cards (debit cards allowed)	Yes. At least 50% of loans must be up to Rs 25 lakh
Asset rule	At least 75% of demand deposits in SLR government securities	PSL target 75% of ANBC (cut to 60% from 2025-26, verify current)
Minimum capital	Rs 100 crore	Rs 200 crore
Path	—	Can become a universal bank

• Standard example: RBI restrictions on Paytm Payments Bank (January 2024), over compliance and KYC failures.
• A neobank is a digital-only provider with no branches. In India it has no banking licence of its own and works through partner licensed banks.

NBFCs

• A Non-Banking Financial Company (NBFC) lends, invests or finances assets.
• It is regulated under Chapter IIIB of the RBI Act and registered under s.45-IA.
• Principal-business (50-50) test: financial assets are more than 50% of total assets, and income from them is more than 50% of gross income.

• It cannot take demand deposits or issue cheques drawn on itself, and its depositors get no DICGC cover.

• Types: investment and credit companies, NBFC-MFIs, housing finance companies (moved from NHB to RBI regulation in 2019), infrastructure finance companies, core investment companies.

• Scale-based regulation (SBR): announced October 2021, effective October 2022. NBFCs sit in four layers, and rules get tighter as size and systemic importance grow:
• Base layer: small, lightly regulated
• Middle layer: deposit-taking NBFCs and larger non-deposit NBFCs
• Upper layer: identified by RBI. Must list within 3 years and keep CET1 of 9%
• Top layer: ideally empty; used if an upper-layer NBFC becomes a serious risk
• PCA also extended to NBFCs.

Shadow banking

• Shadow banking means credit intermediation by entities outside regular banking, such as NBFCs and money-market funds. Regulation is lighter and there is no deposit insurance. Paul McCulley coined the term in 2007. The FSB now calls it "non-bank financial intermediation".
• Asset-liability mismatch is a gap between the maturity of assets and liabilities, such as funding 15-year loans with 3-month borrowing. This creates liquidity risk.
• IL&FS default (September 2018): infrastructure loans funded with short-term money
• DHFL (2019): long-term housing loans funded with commercial papers (CPs). It was the first financial-service provider taken to IBC under s.227.

• Contagion: mutual funds and banks held NBFC paper, and funding for NBFCs froze.

• Bank-NBFC interlinkage: banks are the largest lenders to NBFCs. In November 2023 RBI raised risk weights on bank loans to NBFCs and on unsecured consumer credit. These were partly rolled back in 2025 (verify current).

• Digital lending means loans sourced, assessed, disbursed and recovered through apps or platforms.
• RBI guidelines, September 2022: money flows only between the borrower's account and the regulated entity's account. Borrowers get a Key Fact Statement and a cooling-off period to exit.
• Default loss guarantees (DLG/FLDG) are capped at 5% of the portfolio (DLG guidelines, 2023).
• Digital Lending Directions 2025 and a public directory of lending apps (verify current).

3. Bank business: funding, the price of credit and credit delivery

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How a bank earns: the spread

• NCERT base: a bank pays depositors less than it charges borrowers. The difference is the spread (Class 12, Money and Banking).
• Worked example (Class 7, Banks and the Magic of Finance): Anand deposits Rs 200 at 2% interest. The bank lends it to Shreya at 5%.
• Shreya pays Rs 10 in interest.
• Anand receives Rs 4.
• The bank earns Rs 6.

• NCERT adds that banks keep reserves and do not lend out all deposits.

• Deposit types (Class 7): savings (earns interest, limits on withdrawals), current (no interest, unlimited transactions, used by businesses), fixed (locked for a period at a higher rate).

• CASA ratio is the share of cheap current and savings deposits in total deposits. A higher ratio means cheaper funding. It is under pressure as savers move to mutual funds and term deposits.
• Credit-deposit ratio is the share of deposits lent out as credit. It was around 80% in 2024-25, because deposit growth lagged credit growth (verify current).
• Net interest margin (NIM) = (interest earned − interest paid) ÷ average earning assets.

Lending-rate regimes

Each regime was replaced because the earlier one passed on RBI's rate changes too weakly. (Monetary transmission itself is covered in banking-monetary-policy.)

Regime	Year	Basis	Why replaced
Administered rates	pre-1994	Set by RBI	Financial repression
PLR	1994	Bank's prime lending rate	Rigid
BPLR	2003	Benchmark PLR	Opaque; widespread lending below BPLR
Base rate	July 2010	Average cost of funds; a floor below which banks could not lend	Slow to move
MCLR	April 2016	Marginal cost of funds; set for each tenor, with reset periods	Still an internal benchmark, slow to change
EBLR	1 Oct 2019	External benchmark (repo rate, 3- or 6-month T-bill yield, or another FBIL benchmark) plus a spread	Current regime

• External Benchmark Lending Rate (EBLR) is mandatory for new floating-rate retail and MSME loans.
• Loan-to-value (LTV) ratio = loan ÷ value of the pledged asset. Regulators cap it to limit risk.
• Housing: 90% (loans up to Rs 30 lakh), 80% (Rs 30-75 lakh), 75% (above Rs 75 lakh)

• Gold loans: 75%, with revised slabs for small gold loans in 2025 (verify current)

• Green deposits are deposits whose proceeds are earmarked for climate- and environment-friendly projects. RBI framework, April 2023.

Credit delivery and information

• Adverse selection: when lenders cannot see how risky a borrower is, riskier borrowers are more likely to seek loans (Akerlof, "market for lemons", 1970).
• Stiglitz-Weiss (1981) credit rationing: raising the interest rate drives away safe borrowers and draws in risky ones. So banks ration credit instead of simply raising rates.

• Fixes: collateral, credit scores, relationship lending.

• A credit information company (CIC) collects borrowers' repayment histories and produces credit reports and scores. Regulated by the CIC (Regulation) Act 2005. The four CICs are TransUnion CIBIL, Equifax, Experian and CRIF High Mark. More frequent reporting from 2025 (verify current).

• Trade and working-capital finance:
• Letter of credit: the importer's bank undertakes to pay the exporter once the specified documents are presented. Governed by UCP 600 rules.
• Factoring: a firm sells its receivables to a financier at a discount for immediate cash. Factoring Regulation Act 2011, amended in 2021 to allow more NBFCs to act as factors.

• TReDS (Trade Receivables Discounting System): an electronic platform where MSME invoices on large buyers are auctioned to many financiers. RBI guidelines 2014. Platforms: RXIL, M1xchange, Invoicemart. Companies with turnover above Rs 250 crore and CPSEs must join. It supports the MSMED Act 45-day payment rule (verify current).

• PSL, PSL certificates and co-lending: see financial-inclusion-rural-credit.

4. Recognising bad loans: SMA, NPA classification and provisioning (IRAC norms)

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Classification ladder (IRAC = Income Recognition and Asset Classification)

• Standard asset: the borrower pays on schedule, and the loan carries no more than normal business risk.
• Special Mention Accounts (SMA) are early-warning classes before a loan turns bad:

Class	Days overdue
SMA-0	1-30
SMA-1	31-60
SMA-2	61-90

• Banks report large exposures (Rs 5 crore and above) to CRILC, RBI's central database of large credits.
• Non-Performing Asset (NPA): a loan on which interest or principal is overdue for more than 90 days. The rule was 180 days before 2004.
• Farm loans: overdue for two crop seasons (short-duration crops) or one crop season (long-duration crops).

• Overdraft or cash-credit accounts: NPA once "out of order" for 90 days.

• NPA sub-classes:

• Sub-standard asset: has been an NPA for up to 12 months
• Doubtful asset: has stayed sub-standard for 12 months. D1 = up to 1 year in this class, D2 = 1-3 years, D3 = over 3 years

• Loss asset: identified as uncollectible by the bank, its auditors or RBI inspection, but not yet written off

• November 2021 clarification:

• NPA status is tagged daily, on the date of the overdue run.

• An NPA is upgraded to standard only when all arrears (interest and principal) are cleared.

• NCERT link: Class 12, Money and Banking gives Assets = Reserves + Loans and Net Worth = Assets − Liabilities. A bad loan shrinks the asset side, while deposits (liabilities) stay the same. So the loss comes straight out of net worth.

Provisioning

Loan-loss provisioning means setting aside part of profits to cover expected losses. The rate rises as the loan's classification worsens.

Category	Provision
Standard	0.25-1% (general 0.40%; farm/SME 0.25%; commercial real estate 1%)
Sub-standard	15% (unsecured exposures 25%)
Doubtful: secured part	D1 25% · D2 40% · D3 100%
Doubtful: unsecured part	100%
Loss	100%

Metrics

• Gross NPA is the total of all non-performing loans. Net NPA = Gross NPA − provisions held.
• Provisioning Coverage Ratio (PCR) = provisions ÷ Gross NPA. It shows how much of the bad loans is already covered. RBI earlier used a 70% benchmark.
• Worked example:
• Gross NPA = Rs 100 crore and provisions = Rs 75 crore.

• Net NPA = Rs 25 crore, and PCR = 75%.

• Stressed assets = Gross NPA + restructured standard advances + written-off loans. This gives a fuller picture than NPAs alone.

• Expected Credit Loss (ECL) provisioning: banks provide for expected losses from the day a loan is made, instead of waiting for default (the old "incurred-loss" model).
• Based on IFRS 9 / Ind AS 109, with three stages: performing, significant rise in credit risk, credit-impaired.

• RBI discussion paper January 2023. Framework applies from 1 April 2027 (verify current).

• Data: Scheduled commercial bank GNPA peaked at about 11.2% (March 2018) and fell to 2.15% (September 2025). By bank group: PSBs 2.50%, private 1.73%, foreign 0.80% (verify current: latest FSR).

5. The NPA crisis: twin balance sheets, evergreening and the clean-up

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Genesis

• 2004-2011 credit boom: heavy lending to infrastructure, power, steel and telecom, much of it for PPP projects.
• Shocks that followed:
• Land-acquisition and environmental-clearance delays
• Cancellation of coal blocks (2014) and 2G spectrum licences (2012)

• The global commodity-price crash

• Twin balance sheet problem: over-leveraged companies and stressed banks at the same time (Economic Survey 2016-17).

• Companies could not invest.
• Banks would not lend.
• Investment and credit growth stalled.

• The Survey proposed a PARA (Public Sector Asset Rehabilitation Agency).

• How the stress was hidden:

• Regulatory forbearance: restructured loans could be counted as standard assets until April 2015.
• Evergreening: fresh loans given to a struggling borrower so it can repay old dues, hiding the true size of bad loans.

• Loan restructuring: changing tenure, rate or repayment schedule to avoid default. The schemes failed one after another: CDR (2001), JLF, 5/25, SDR, S4A (2014-16).

• Asset Quality Review (AQR), 2015-16, under Governor Rajan: RBI checked whether banks were classifying and provisioning bad loans correctly. It exposed the hidden NPAs, and GNPA jumped.

• 12 February 2018 circular:
• One day of default triggered action.
• The loan had to be resolved within 180 days or taken to IBC.

• The Supreme Court struck it down in Dharani Sugars (April 2019).

• Prudential Framework (7 June 2019):

• 30-day review period after default
• Inter-creditor agreement among lenders

• Additional provisions if resolution is delayed

• COVID period: loan moratorium and Resolution Frameworks 1.0 and 2.0.

Clean-up

• 4R strategy: Recognition, Resolution, Recapitalisation, Reform. PSB performance is tracked through the EASE reform index.
• Bank recapitalisation means fresh capital put into banks, mainly PSBs, to meet capital norms.
• October 2017: Rs 2.11 lakh crore package, including Rs 1.35 lakh crore of non-tradable recapitalisation bonds.
• Debate: these bonds kept the cost off the headline fiscal deficit.
• About Rs 3.1 lakh crore infused over FY17-FY21 (verify current).

• PSBs posted record profits by FY24-25.

• Write-off vs waiver:

Loan write-off	Waiver
Fully provided loan removed from the balance sheet	Debt legally extinguished
Borrower still owes; recovery continues	Borrower owes nothing
Technical write-off (kept at branch level) vs prudential write-off	Farm-loan waivers: see financial-inclusion-rural-credit

• Large cumulative write-offs over the past decade (verify current).
• One-time settlement (OTS): the lender accepts a smaller lump sum in full settlement.
• June 2023 compromise-settlement framework: also covers wilful-defaulter and fraud accounts.

• For technical write-offs and settled accounts, a 12-month cooling-off period applies before fresh credit.

• Wilful defaulter: a borrower who has the capacity to pay but does not, or who diverts funds, or who sells pledged assets without the lender's knowledge.

• Master Direction 2024: applies to dues of Rs 25 lakh and above.
• No additional credit.
• Barred from floating new ventures and from boards of other companies.

6. Recovery channels: DRTs, SARFAESI, securitisation, ARCs and the bad bank

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The pre-IBC toolkit

Channel	Law and year	Mechanism
Lok Adalats	Legal Services Authorities Act	Small-value settlement
Debt Recovery Tribunals	RDDBFI Act 1993	Special tribunals for bank dues
SARFAESI	2002	Lender enforces security without going to court

• Enforcement of security interest (SARFAESI):
• The secured lender issues a 60-day demand notice under s.13(2).
• If the borrower does not pay, the lender takes possession under s.13(4) and sells the asset.
• No court is needed.

• Extended to larger NBFCs (verify current thresholds).

• Securitisation: pooling illiquid loans and turning them into tradable securities sold to investors. This frees up the lender's capital.

• RBI Master Directions 2021 cover securitisation of standard assets and transfer of loan exposures.
• A minimum retention requirement makes the originator keep some risk ("skin in the game").

• Contrast: the US subprime MBS/CDO chain, where originators kept no risk (Section 10).

• Asset Reconstruction Company (ARC): buys bad loans from banks at a discount and tries to recover dues through restructuring, settlement or sale of collateral.

• Registered with RBI under SARFAESI.
• Pays partly in cash and partly in security receipts (SRs). SRs are instruments giving holders a share in whatever the ARC later recovers.
• Minimum net owned fund raised to Rs 300 crore (2022).
• ARCs must hold part of the SRs themselves as skin in the game (verify current).
• Reviewed by the Sudarshan Sen Committee (2021).
• Weakness: low recovery rates.

The bad bank

• Bad bank: an entity that takes over stressed assets from banks. This cleans the banks' balance sheets, and recovery is handled separately.
• Global models:
• US Resolution Trust Corporation (1989, savings-and-loan crisis)
• Sweden's Securum (1992), the classic success
• Malaysia's Danaharta (1998)

• Ireland's NAMA (2009)

• India: the PARA idea (Economic Survey 2016-17) led to the Budget 2021-22 announcement.

• NARCL (National Asset Reconstruction Company Ltd), set up in 2021, majority-owned by PSBs. It buys and holds the loans.
• IDRCL (India Debt Resolution Company Ltd), majority private, manages and resolves them.
• 15:85 structure: 15% paid in cash, 85% in SRs.
• The SRs carry a government guarantee of up to Rs 30,600 crore for 5 years. The guarantee covers any shortfall between face value and what is actually realised.
• Progress: accounts acquired and resolved so far (verify current).

7. The Insolvency and Bankruptcy Code: CIRP, pre-packs and haircuts

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Framework

• Insolvency: unable to pay debts as they fall due (a financial condition).
• Bankruptcy: a legal status declared by the adjudicating authority for an insolvent person or firm.
• IBC 2016 replaced SICA/BIFR (1985). It shifted control from "debtor in possession" to "creditor in control". Its validity was upheld in Swiss Ribbons (SC, 2019).
• Four pillars:
• IBBI, the regulator
• NCLT/NCLAT for companies, DRT for individuals
• Insolvency professionals

• Information utilities, which hold records of debts and defaults

• Threshold: default of Rs 1 crore (raised from Rs 1 lakh in March 2020).

• Financial vs operational creditors:
• Financial creditors lent money (banks, bondholders).
• Operational creditors are owed for goods, services, wages or government dues.

Corporate Insolvency Resolution Process (CIRP)

1. Application admitted by NCLT.
2. Moratorium under s.14: no suits, recovery or asset sales against the company.
3. The Interim Resolution Professional, later the Resolution Professional (RP), runs the company and the process. The RP is a licensed professional.
4. The Committee of Creditors (CoC), made up of financial creditors, approves a plan with 66% of the vote by value.
5. Deadline: 180 days + 90-day extension, with an outer limit of 330 days including litigation (2019 amendment).
6. No approved plan leads to liquidation.

• s.29A bars defaulting promoters and connected persons from bidding.
• Essar Steel (SC, 2019): upheld the CoC's "commercial wisdom" over court review of plan terms.
• Liquidation waterfall (s.53), the order in which liquidation proceeds are paid: 1. Insolvency process and liquidation costs 2. Secured creditors, and workmen's dues for 24 months (ranked equally) 3. Other employees' dues for 12 months 4. Unsecured financial creditors 5. Government dues and the secured creditors' shortfall 6. Other debts 7. Preference shareholders 8. Equity shareholders

Outcomes and reform

• A haircut is the loss creditors accept when they recover less than they are owed. (The word also means the discount applied to collateral value.)
• Realisation is about one-third of admitted claims, so haircuts are high.
• But this is well above liquidation value.

• Average resolution time runs far beyond 330 days (verify current IBBI data).

• Pre-packaged insolvency (2021): the debtor and creditors agree on a plan before formal proceedings start.

• For MSMEs only, with a default of Rs 10 lakh or more.
• The debtor keeps control.
• Must finish in 120 days.

• Uptake has been low.

• Cross-border insolvency: the debtor has assets or creditors in more than one country, so courts must cooperate. India has not yet adopted the UNCITRAL Model Law. Example: Jet Airways, with parallel Dutch proceedings. Group insolvency is also under discussion.

• IBC (Amendment) Bill 2025 (introduced 12 August 2025) proposes a Creditor-Initiated Insolvency Resolution Process:
• Starts out of court, triggered by notified financial creditors holding 51% by value.
• The debtor stays in possession, overseen by an RP.

• The Bill went to a Lok Sabha Select Committee (verify current status).

• World Bank Doing Business "resolving insolvency" rank: 108 → 52 (2019 to 2020 editions).

8. Capital adequacy: Basel I to Basel III

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Why capital

• Capital is the owners' own money. It absorbs losses before depositors lose anything. (Class 12's net worth = assets − liabilities is the same idea.)
• Leverage means funding assets with borrowed money. It magnifies both gains and losses.

• Example: a bank with Rs 100 of assets and Rs 8 of capital is wiped out by an 8% loss on its assets.

• Basel norms are international standards on bank capital, liquidity and risk, set by the Basel Committee on Banking Supervision (BCBS).

• BCBS was set up in 1974 after the Herstatt Bank failure and is housed at the BIS in Basel.
• India has been a member since 2009.

Basel I and II

• Basel I (1988): capital of at least 8% of risk-weighted assets. It covered credit risk only, with risk-weight buckets of 0-100%. India adopted it in 1992 and moved to 9% CRAR from 2000.
• Basel II (2004; India 2008-09) added market and operational risk. It rests on three pillars:
• Pillar 1: minimum capital for credit, market and operational risk (standardised approach or internal-ratings approach)
• Pillar 2: supervisory review of the bank's own risk and capital assessment (ICAAP, checked through RBI's SREP)
• Pillar 3: market discipline through public disclosure

Measuring capital

• Capital adequacy ratio (CRAR) = (Tier 1 + Tier 2) ÷ Risk-weighted assets.
• Risk-weighted assets (RWA) weight each asset by its risk:
• Government securities: 0%
• Home loans: weight varies with the LTV band

• Unsecured consumer credit: higher weights

• Worked example:

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

• With capital of Rs 50, CRAR = 50 ÷ 440 ≈ 11.4%.

• This is above India's 9% minimum but just below the 11.5% that includes the conservation buffer.

• Tier 1 capital absorbs losses while the bank keeps running ("going concern"):

• Common Equity Tier 1 (CET1): common shares, share premium, retained earnings and disclosed reserves. The highest-quality capital.

• Additional Tier 1 (AT1): perpetual, non-cumulative instruments. They are written down or converted to equity if CET1 falls below a trigger or at the point of non-viability. (Instrument details are in financial-markets-instruments.)

• Tier 2 capital absorbs losses mainly in liquidation ("gone concern"):

• Subordinated debt
• General provisions up to 1.25% of credit RWA
• Revaluation reserves, counted at a discount

Basel III

Agreed in 2010 after the 2008 crisis. India phased it in from April 2013, fully by October 2021.

Ratio	Basel III	India (RBI)
CET1	4.5%	5.5%
Tier 1	6%	7%
Total CRAR	8%	9%
Capital conservation buffer (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)

• Capital conservation buffer (CCB): extra CET1 held above the minimum and drawn down in stress. A bank that breaches it faces limits on dividends.
• Countercyclical capital buffer (CCyB): extra capital built up in credit booms and released in downturns, which damps boom-bust lending.
• Range 0-2.5%.
• RBI framework 2015, with the credit-to-GDP gap as the main indicator.

• Not yet activated (verify current).

• Leverage ratio = Tier 1 capital ÷ total exposure, with no risk weights. It is a simple backstop in case risk weights are gamed.

• A D-SIB surcharge is added on top of these minimums (Section 9).
• Basel III final reforms ("Basel IV", 2017): an output floor on internal models and revised standardised approaches. RBI implementation timelines (verify current).
• Trade-off: higher capital makes banks safer but can slow credit growth, especially at capital-short PSBs.

9. Liquidity, systemic importance and the safety net

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Liquidity rules

• NCERT logic (Class 12, Money and Banking): "being able to repay depositors on demand is crucial to the bank's survival". An asset-liability mismatch is what turns stress into a bank run.
• High-Quality Liquid Assets (HQLA): cash and government securities that can be turned into cash quickly with little loss of value.
• Level 1: cash, excess CRR, G-secs above SLR, and G-secs within SLR allowed under the FALLCR carve-out

• Level 2: certain corporate bonds and equities, counted after haircuts

• Liquidity Coverage Ratio (LCR) = HQLA ÷ net cash outflows over 30 days of stress ≥ 100%. The 100% level has applied since January 2019.

• Revised LCR norms (2025) add an extra run-off factor for digitally accessible retail deposits (UPI/net-banking withdrawals are faster), effective 1 April 2026 (verify current).

• Net Stable Funding Ratio (NSFR) = available stable funding ÷ required stable funding over one year ≥ 100%, from October 2021. It limits reliance on short-term funding.

Systemic importance

• Global Systemically Important Banks (G-SIBs): banks whose distress would disrupt the global system.
• The FSB publishes the list each year.
• They hold 1-3.5% extra loss-absorbing capital plus TLAC.

• No Indian bank is on the list.

• Domestic Systemically Important Banks (D-SIBs): banks whose failure would seriously disrupt India's system. They hold extra CET1 and face closer supervision.

• RBI framework 2014.
• Added to the list: SBI (2015), ICICI Bank (2016), HDFC Bank (2017).

• Additional CET1 from April 2025: SBI 0.80%, HDFC Bank 0.40%, ICICI Bank 0.20% (verify current list).

• Too big to fail: the belief that the state will not let a giant bank fail.

• The implicit guarantee lowers the bank's funding costs.
• This encourages risk-taking, which is moral hazard: taking more risk when protected from the consequences.

Supervisory and safety-net tools

• Prompt Corrective Action (PCA): introduced 2002; revised framework from 1 January 2022.
• Triggers: CRAR, CET1, net NPA (risk thresholds at 6%, 9%, 12%) and the Tier 1 leverage ratio.
• Restrictions grow with the threshold breached: dividends, branch expansion, lending, and management pay.
• 11 PSBs were under PCA in 2017-18. All exited by September 2022 (Central Bank of India last).

• PCA now also applies to NBFCs and UCBs (verify current).

• Deposit insurance: protects depositors up to a set limit if a bank fails or is placed under restrictions.

• Provided by DICGC (Act 1961; merged form 1978), a wholly owned subsidiary of RBI.
• Cover: Rs 5 lakh per depositor per bank, "in the same right and capacity", from 4 February 2020. It was Rs 1 lakh from 1993.
• Covers commercial banks, RRBs, LABs and cooperative banks. Does not cover NBFCs or PACS.
• DICGC (Amendment) Act 2021: interim payment within 90 days of RBI placing restrictions. This was the lesson from PMC Bank.
• Premium: flat 12 paise per Rs 100 of assessable deposits, with a move to risk-based premiums (verify current).

• Moral-hazard concern: insured depositors stop checking bank quality.

• Bail-out vs bail-in:

Bail-out (outside money, usually taxpayer or state-directed)	Bail-in (creditors and depositors absorb losses)
Yes Bank Reconstruction Scheme (March 2020): SBI-led capital	FRDI Bill 2017: its bail-in clause caused depositor panic; withdrawn 2018
Lakshmi Vilas Bank merged into DBS India (2020)	Cyprus (2013): large deposits converted to equity
	AT1 write-downs as contractual bail-in: Yes Bank (2020), Credit Suisse (2023)

10. Frauds, crises and the financial-stability framework

Read the detailed note →

Frauds

• RBI Annual Report data:
• Frauds tied to loans (advances) dominate by value.
• Card and digital frauds dominate by number.

• Reported amounts rose again in FY25, as old cases were re-classified after SBI v. Rajesh Agarwal (SC, March 2023). That ruling says borrowers must be heard before their account is declared fraudulent (verify current).

• Master Directions on Fraud Risk Management (July 2024):

• Early warning signals
• Red-flagged accounts

• Reporting to RBI's Central Fraud Registry

• PNB-Nirav Modi case (2018):

• Letters of Undertaking (LoUs) were bank guarantees that let a customer raise short-term credit from overseas branches of Indian banks.
• They were issued through SWIFT but never entered in the core banking system.
• RBI discontinued LoUs in March 2018.

• Response: Fugitive Economic Offenders Act 2018.

• KYC and anti-money-laundering:

• Know Your Customer (KYC) is the identity and due-diligence checking that financial institutions must do to prevent fraud and money laundering.
• Rules: PMLA 2002 and the RBI KYC Master Direction 2016.
• CKYC registry run by CERSAI; video-KYC allowed from 2020.

• Legal Entity Identifier (LEI) is a unique 20-character global code for parties to financial transactions. Mandatory for large borrowers and market participants.

• Unregulated finance:

• A Ponzi scheme pays earlier investors out of new investors' money and collapses when inflows stop. Example: Saradha (2013).
• A chit fund is a savings-cum-borrowing group. Members pay in regularly, and each round's pooled sum goes to one member by auction or lot. It is state-regulated under the Chit Funds Act 1982.

• Banning of Unregulated Deposit Schemes Act 2019.

• Cooperative-bank failures: PMC Bank (2019) and New India Co-operative Bank (2025). Both show governance gaps and the problem of dual control.

• NCERT hook (Class 7, Banks and the Magic of Finance):
• Never share OTPs, PINs or bank details.
• Avoid unknown links.
• Report fraud on helpline 1930 or the National Cybercrime Reporting Portal.
• Details are in payment-systems-digital-finance.

Financial stability

• Systemic risk: the failure of one institution or market sets off a chain of failures across the system. It spreads through:
• Interconnectedness (institutions owe each other money)
• Common exposures (many hold the same assets)

• Fire sales (forced selling pushes prices down for everyone)

• 2008 global financial crisis chain:

• Subprime lending (loans to borrowers with weak credit histories) for US home mortgages
• Mortgages securitised into MBS/CDOs and sold worldwide
• Insurance on them through CDS (AIG)
• Collapse of Lehman Brothers, 15 September 2008

• Lessons: Basel III, macroprudential policy (in banking-monetary-policy), the FSB (2009) and the G-SIB regime.

• Indian architecture:

• FSDC (2010), chaired by the Finance Minister, coordinates regulators.
• RBI's half-yearly Financial Stability Report (June and December) carries the Systemic Risk Survey.

• A stress test simulates how banks would cope with severe scenarios such as a deep recession. The FSR runs baseline, medium and severe scenarios. System CRAR stays above the minimum even under severe stress (verify current).

• Emerging risks (FSR December 2025): unsecured retail credit, bank-NBFC interlinkage, climate risk, private credit and stablecoins.

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Exam angles

Prelims — high-yield facts and traps

• SMA-0/1/2 = 1-30 / 31-60 / 61-90 days overdue. NPA = overdue more than 90 days. Farm loans use crop seasons (2 short / 1 long).
• Sub-standard = NPA up to 12 months. Doubtful: D1 up to 1 year, D2 1-3 years, D3 over 3 years. Loss = uncollectible, not yet written off.
• Provisioning: standard 0.40% (general), sub-standard 15% (unsecured 25%), doubtful 25/40/100% on the secured part and 100% on the unsecured part, loss 100%.
• Net NPA = Gross NPA − provisions. PCR = provisions ÷ Gross NPA. Stressed assets = NPA + restructured standard loans + write-offs.
• India vs Basel: CET1 5.5 vs 4.5, Tier 1 7 vs 6, CRAR 9 vs 8, CCB 2.5, leverage ratio 4%/3.5% vs 3%, CCyB 0-2.5% (not activated).
• Basel I (1988, credit risk only) → Basel II (2004, three pillars) → Basel III (2010: buffers, leverage ratio, LCR, NSFR).
• "Tier 2 is going-concern capital." FALSE: Tier 2 is gone-concern. CET1 and AT1 are going-concern.
• D-SIBs: SBI, ICICI Bank, HDFC Bank. "An Indian bank is a G-SIB." FALSE.
• Lending-rate chronology: BPLR (2003) → Base Rate (2010, average cost of funds) → MCLR (2016, marginal cost) → EBLR (1 October 2019, external benchmark for new floating retail and MSME loans).
• DICGC: Rs 5 lakh per depositor per bank. "It covers NBFC deposits." FALSE. Interim payment within 90 days under the 2021 amendment.
• Institution matches:
• NARCL buys and holds bad loans; IDRCL manages and resolves them.
• ARCs issue security receipts.
• IBBI is the regulator; NCLT is the adjudicating authority.
• FSDC is chaired by the Finance Minister.
• FSIB replaced the Banks Board Bureau.

• TReDS is for MSME invoice discounting.

• IBC numbers:

• Threshold Rs 1 crore
• Deadline 180 + 90 days, 330-day outer limit
• CoC approval 66%
• s.29A bars defaulting promoters

• s.14 moratorium

• "Pre-pack is open to all companies." FALSE: MSMEs only, Rs 10 lakh default, debtor keeps control, 120 days.

• "A write-off frees the borrower from repayment." FALSE: only a waiver does that.
• Bail-in: creditors or depositors bear the loss. Bail-out: taxpayers bear it.
• Payments banks cannot lend or issue credit cards (Rs 2 lakh deposit cap). SFBs: 75% PSL target and 50% of loans up to Rs 25 lakh. NBFCs cannot take demand deposits or issue cheques drawn on themselves.
• SBR layers: base, middle, upper, top. Upper layer: CET1 9% and listing within 3 years.
• 1969 nationalisation: 14 banks, deposits of Rs 50 crore or more. 1980: 6 banks, Rs 200 crore or more. FDI cap: private banks 74%, PSBs 20%.

Mains — GS-III themes

1. Twin balance sheet problem: causes (infrastructure overreach, weak governance, evergreening, regulatory forbearance), the 4R response and AQR. Is the clean-up durable? Lessons for the next credit cycle: unsecured retail lending and NBFC interlinkage.
2. IBC after a decade: the shift to creditor-in-control, delays well past 330 days, the haircut controversy, judicial intervention vs CoC commercial wisdom, the CIIRP and pre-pack reforms. Compare the bad bank (NARCL) with the ARC route.
3. PSB reform: governance (Nayak Committee, BBB to FSIB), consolidation from 27 to 12 banks, the fiscal cost of recapitalisation and recap bonds, the privatisation debate. Social-banking mandate vs commercial efficiency, linked back to 1969.
4. Shadow banking and systemic risk: IL&FS and DHFL, asset-liability mismatch, scale-based regulation, regulatory arbitrage, digital lending and consumer protection.
5. Safety-net design: deposit-insurance limits and cooperative-bank failures, moral hazard and too-big-to-fail, the politics of bail-in (FRDI Bill), Basel III capital vs credit growth.
6. Frauds and governance: early warning signals, auditors' role, the PNB LoU case, fugitive offenders, due process after Rajesh Agarwal.
7. Financial-stability architecture: division of labour between RBI, the government and FSDC; macroprudential tools; lessons from 2008 and 2023 (SVB, Credit Suisse AT1 write-down).

Current-affairs hooks

• RBI Financial Stability Report (June and December): GNPA/NNPA, CRAR, stress-test results, emerging risks. Also the Report on Trend and Progress of Banking and the fraud statistics in RBI's Annual Report.
• RBI's annual D-SIB list. Basel III dates: ECL from April 2027, revised LCR from April 2026, revised standardised approaches. PCA entries and exits.
• Union Budget and Economic Survey chapters on banking and financial intermediation. PSB profits and dividends. Updates on privatisation and the IDBI sale.
• IBC amendments (IBC Amendment Bill 2025 and its Select Committee), IBBI quarterly data, landmark Supreme Court rulings, NARCL resolutions.
• Bank failures and restrictions (Yes Bank, PMC, Lakshmi Vilas, New India Co-op Bank, Paytm Payments Bank). DICGC payouts, premium and cover changes. Global episodes (SVB, Credit Suisse).
• Rules under the Banking Laws (Amendment) Act 2025, UCB regulation, RRB consolidation, Digital Lending Directions and the lending-app directory.