Basel Norms in India: Complete Guide to Basel I, II, III & Beyond

Introduction: Why Do Banks Need Capital Rules?

In 2008, when Lehman Brothers collapsed, it sent shockwaves globally. Banks that seemed “too big to fail” were suddenly failing. Why? They had taken excessive risks with minimal capital buffers. The losses wiped out their equity, and taxpayers had to bail them out.

Basel norms are global banking regulations designed to prevent such crises. They ensure banks maintain enough capital to absorb losses, manage risks, and continue operating during economic shocks. Here’s how these complex rules work and apply in India.

What are Basel Norms?

Definition

Basel norms are international banking regulations issued by the Basel Committee on Banking Supervision (BCBS), housed at the Bank for International Settlements (BIS) in Basel, Switzerland.

Purpose

• Ensure banks have enough capital
• Manage various risks effectively
• Maintain financial system stability
• Create level playing field globally

Evolution

Basel I: The Foundation

Background

After several bank failures in the 1970s-80s, G10 countries created uniform standards.

Key Elements

Capital Adequacy Ratio (CAR):

$$CAR = \frac{Capital}{Risk\ Weighted\ Assets} \times 100$$

Minimum Requirement: 8%

Capital Components

Risk Weights (Simple)

Limitations of Basel I

❌ Only credit risk considered ❌ Same weight for all corporates (AAA or junk) ❌ Operational risk ignored ❌ Market risk ignored ❌ Regulatory arbitrage possible

Basel II: Risk-Based Framework

Introduction

Released in 2004, addressed Basel I shortcomings through three pillars.

Three Pillar Structure

Basel II Framework
        │
        ├── Pillar 1: Minimum Capital Requirements
        │
        ├── Pillar 2: Supervisory Review
        │
        └── Pillar 3: Market Discipline

Pillar 1: Minimum Capital Requirements

Risks Covered:

1. Credit Risk – Borrower default
2. Market Risk – Trading book losses
3. Operational Risk – Fraud, system failures

CAR Formula (Extended):

$$CAR = \frac{Capital}{Credit\ Risk\ RWA + Market\ Risk\ RWA + Operational\ Risk\ RWA}$$

Minimum: 8%

Credit Risk Approaches

IRB = Internal Ratings Based PD = Probability of Default LGD = Loss Given Default

Operational Risk Approaches

Pillar 2: Supervisory Review

Regulators (RBI in India) review:

• Bank’s internal risk assessment
• Capital planning
• Stress testing
• Governance quality

ICAAP: Internal Capital Adequacy Assessment Process

Pillar 3: Market Discipline

Banks must disclose:

• Risk exposures
• Risk management practices
• Capital adequacy details
• Help investors make informed decisions

Basel III: Post-Crisis Reforms

Background

2008 financial crisis exposed Basel II weaknesses:

• Not enough high-quality capital
• Insufficient liquidity buffers
• Procyclical effects
• Systemic risk not addressed

Key Reforms

1. Higher Quality Capital

2. Higher Capital Requirements

3. Capital Buffers (Additional)

Leverage Ratio

$$Leverage\ Ratio = \frac{Tier\ 1\ Capital}{Total\ Exposure} \times 100$$

Minimum: 3% (India: 4% for D-SIBs)

Purpose: Catch risks that RWA might miss.

Liquidity Ratios

1. Liquidity Coverage Ratio (LCR)

$$LCR = \frac{High\ Quality\ Liquid\ Assets\ (HQLA)}{Net\ Cash\ Outflows\ (30\ days)} \times 100$$

Minimum: 100% Purpose: Survive 30-day stress scenario.

2. Net Stable Funding Ratio (NSFR)

$$NSFR = \frac{Available\ Stable\ Funding}{Required\ Stable\ Funding} \times 100$$

Minimum: 100% Purpose: Long-term (1 year) funding stability.

Basel Implementation in India

RBI’s Approach

RBI has implemented Basel norms with India-specific adaptations.

Current Requirements (Basel III)

D-SIB Requirements

Domestic Systemically Important Banks (D-SIBs) require additional buffer.

D-SIB List (India):

Timeline of Implementation

Capital Adequacy in Practice

Sample Calculation

Hypothetical Bank Data:

• CET1 Capital: ₹50,000 crore
• AT1 Capital: ₹5,000 crore
• Tier 2 Capital: ₹10,000 crore
• Risk Weighted Assets: ₹5,00,000 crore

Calculations:

$$CET1\ Ratio = \frac{50,000}{5,00,000} \times 100 = 10%$$

$$Tier\ 1\ Ratio = \frac{50,000 + 5,000}{5,00,000} \times 100 = 11%$$

$$Total\ CAR = \frac{50,000 + 5,000 + 10,000}{5,00,000} \times 100 = 13%$$

Assessment:

• CET1: 10% > 5.5% requirement ✅
• Tier 1: 11% > 7% requirement ✅
• Total: 13% > 11.5% (including buffers) ✅

What If Bank Falls Short?

Consequences:

1. Cannot pay dividends
2. Cannot give bonuses
3. Restrictions on lending growth
4. Must raise capital
5. RBI may impose restrictions

Capital Raising Options:

• Issue equity shares
• Issue AT1 bonds
• Reduce risk-weighted assets
• Improve profitability

Risk Weighted Assets (RWA)

Concept

Not all assets carry equal risk. RWA adjusts for this.

Formula:

$$RWA = Asset\ Value \times Risk\ Weight$$

Risk Weights (India - Standardized)

Impact on Lending

Banks consider RWA when lending:

• Lower risk weight = More profitable
• Higher risk weight = Capital expensive
• Influences credit decisions

Liquidity Standards Deep Dive

LCR Components

High Quality Liquid Assets (HQLA):

Level 2 assets capped at 40% of HQLA

Cash Outflows Include:

• Retail deposit runoff
• Wholesale funding runoff
• Committed credit facilities

Indian Banks’ LCR Position

Most large Indian banks maintain LCR well above 100%:

• SBI: ~130%+
• HDFC Bank: ~120%+
• ICICI Bank: ~125%+

Why Higher? Conservative approach, abundant government securities holdings.

NSFR Explained

Available Stable Funding (ASF):

• Equity capital
• Long-term deposits
• Medium-term wholesale funding

Required Stable Funding (RSF):

• For assets like loans, investments
• Higher for illiquid assets

Stress Testing

What is Stress Testing?

Banks simulate adverse scenarios to assess capital/liquidity impact.

Types of Stress Tests

RBI Stress Tests

RBI conducts:

• Macro stress tests annually
• Publication in Financial Stability Report
• Assesses systemic risks

Common Stress Scenarios

• Interest rate shocks (±200 bps)
• GDP decline scenarios
• Large NPA increases
• Liquidity crisis
• Forex volatility

Global vs Indian Context

Key Differences

India’s Conservative Approach

Advantages:

• Banks more resilient
• Limited impact of global crises
• Lower systemic risk

Challenges:

• Higher cost of capital
• May limit credit growth
• Competitive disadvantage internationally

Recent and Future Developments

Basel III.1 (Final Basel III)

Reforms to be implemented:

• Revised standardized approaches
• Output floor (72.5% of standardized)
• Constraints on internal models
• Implementation: 2028 onwards globally

Climate Risk Integration

Emerging focus:

• Climate-related financial risks
• Stress testing for climate
• ESG considerations

Operational Resilience

• Cyber risk management
• Business continuity planning
• Third-party risk

Impact on You

As a Customer

• Safer banks: Better capitalized, more resilient
• Credit access: May affect loan availability/pricing
• Deposits: More protected from bank failures

As an Investor

• Bank stocks: Capital ratios matter
• AT1 bonds: Higher risk, higher return
• Dividend policies: Constrained by capital rules

As an Employee

• Risk management careers: Growing demand
• Compliance roles: Basel expertise valued
• Technology: RegTech for Basel compliance

Key Takeaways

1. Basel norms ensure bank safety – Capital buffers against losses
2. Three pillars (Basel II) – Capital, supervision, disclosure
3. Basel III added quality – CET1, buffers, liquidity ratios
4. India is conservative – 11.5% CAR vs 10.5% globally
5. LCR and NSFR ensure liquidity – Survive stress scenarios
6. D-SIBs have extra requirements – Too big to fail = more capital
7. Risk weights drive lending – Lower weight = cheaper capital

Disclaimer

This article is for educational purposes only. Basel norms and RBI guidelines are complex and change periodically. Verify current requirements from official RBI circulars. This is not financial advice.

Frequently Asked Questions

Q: What is CAR? A: Capital Adequacy Ratio – capital as percentage of risk-weighted assets. Measures bank’s ability to absorb losses.

Q: Why is India’s requirement higher than global Basel? A: Conservative approach by RBI for financial stability. 9% vs 8% minimum, plus buffers.

Q: What happens if a bank’s CAR falls below requirement? A: Restrictions on dividends, bonuses; must raise capital; can face regulatory action.

Q: What are AT1 bonds? A: Additional Tier 1 bonds – perpetual, can be written off or converted to equity if bank’s capital falls below trigger.

Q: How do Basel norms affect loans? A: Higher risk-weight loans consume more capital, so banks may charge higher interest or limit exposure.

Q: What is LCR? A: Liquidity Coverage Ratio – ensures bank can survive 30-day liquidity stress. Must be 100%+.

Basel norms might seem like arcane regulatory requirements, but they’re the guardrails that keep your money safe. Every time you deposit money in a bank, Basel ensures that bank can withstand shocks and return your money. Strong capital and liquidity = stable banking system = protected depositors.