Banks lend out most of the money people deposit with them. If too many loans go bad, a bank can fail and hurt millions of depositors. To prevent this, banks must keep a cushion of their own money, called capital. The global rules on how much capital banks should keep are called the Basel norms. Exams ask about Basel I, II and III, the three pillars, capital ratios and how India applies them. This post explains them in simple words. It ends with 15 previous year questions.
Key Points (Quick Revision)
- Basel norms are set by the Basel Committee on Banking Supervision (BCBS), based at the Bank for International Settlements in Basel, Switzerland.
- Basel I came in 1988, Basel II in 2004 and Basel III in 2010, after the 2008 crisis.
- Basel II introduced three pillars - minimum capital, supervisory review and market discipline.
- Basel III's global minimum total capital is 8% of risk-weighted assets, but the RBI requires 9%.
- Basel III added a capital conservation buffer of 2.5%, plus liquidity and leverage rules.
1. The Basel Committee
The Basel Committee on Banking Supervision was set up in 1974 by the central bank governors of the G10 countries, after the failure of some international banks. It works from the Bank for International Settlements (BIS) in Basel, Switzerland.
Its rules are not laws. Each country's regulator - in India, the RBI - adopts them, often with stricter limits.
2. Key terms
- Capital - the bank's own money, such as share capital and reserves, that can absorb losses.
- Risk-weighted assets (RWA) - the bank's loans and investments, weighted by how risky they are. A home loan has a lower weight than an unsecured loan.
- Capital to Risk-weighted Assets Ratio (CRAR) - capital divided by RWA. It is also called the capital adequacy ratio.
- Tier 1 capital - the core, best-quality capital, like equity and reserves.
- Tier 2 capital - supplementary capital, like some types of bonds and provisions.
3. Basel I (1988)
- Focused only on credit risk - the risk that borrowers do not repay.
- Required banks to keep capital of at least 8% of risk-weighted assets.
- India adopted it in 1992, following the Narasimham Committee (1991) on banking reforms.
4. Basel II (2004) and the three pillars
| Pillar | Meaning |
|---|---|
| Pillar 1 - Minimum capital | Capital for credit, market and operational risk |
| Pillar 2 - Supervisory review | Regulators check each bank's risks and ask for more capital if needed |
| Pillar 3 - Market discipline | Banks must disclose their risks and capital, so the market can judge them |
Basel II added operational risk - losses from failed systems, fraud or human error - to the earlier credit risk.
5. Basel III (2010)
The 2008 global financial crisis showed that banks had too little high-quality capital and too little cash. Basel III tightened the rules:
| Measure | Global Basel III minimum |
|---|---|
| Common Equity Tier 1 (CET1) | 4.5% of RWA |
| Tier 1 capital | 6% of RWA |
| Total capital | 8% of RWA |
| Capital conservation buffer | 2.5% of RWA (CET1) |
| Countercyclical buffer | 0 to 2.5%, set by the regulator in boom times |
| Leverage ratio | At least 3% |
| Liquidity Coverage Ratio (LCR) | 100% - enough liquid assets for 30 days of stress |
| Net Stable Funding Ratio (NSFR) | 100% - stable funding for a one-year horizon |
6. Basel norms in India
- The RBI requires a minimum total capital (CRAR) of 9%, higher than the global 8%.
- With the 2.5% capital conservation buffer, banks need a total of 11.5%.
- The RBI's minimum CET1 is 5.5%, or 8% with the buffer.
- Domestic Systemically Important Banks (D-SIBs) - such as SBI, ICICI Bank and HDFC Bank - must keep extra CET1 capital, since their failure would hurt the whole system.
Exact ratios are revised by the RBI from time to time, so check the latest circulars.
7. Why capital rules matter
- More capital means banks can absorb losses without failing.
- Liquidity rules help banks meet withdrawals during panic.
- But high capital needs can make loans costlier and slow credit growth, so regulators try to strike a balance.
- The government has recapitalised public sector banks in the past to help them meet these norms.
8. Previous year questions
- Where is the Basel Committee on Banking Supervision based? – Basel, Switzerland (BIS)
- In which year was the Basel Committee set up? – 1974
- When was Basel I introduced? – 1988
- Basel I mainly dealt with which risk? – Credit risk
- When did India adopt Basel I? – 1992
- When was Basel II introduced? – 2004
- What are the three pillars of Basel II? – Minimum capital, supervisory review and market discipline
- Which new risk did Basel II add? – Operational risk
- Which crisis led to Basel III? – 2008 global financial crisis
- What is the capital conservation buffer under Basel III? – 2.5%
- What is the minimum CRAR required by the RBI? – 9%
- What is the global minimum total capital under Basel III? – 8%
- What does LCR stand for? – Liquidity Coverage Ratio
- What is the minimum leverage ratio under global Basel III? – 3%
- Name one Domestic Systemically Important Bank in India. – SBI (also ICICI Bank, HDFC Bank)
9. How to revise this topic
Start with the body: Basel Committee, 1974, G10 governors, at the BIS in Basel, Switzerland.
Next, learn the three versions: Basel I 1988 (credit risk, 8%), Basel II 2004 (three pillars, operational risk), Basel III 2010 (after the 2008 crisis).
Then fix the Basel III numbers: CET1 4.5%, Tier 1 6%, total 8%, buffer 2.5%, leverage 3%, LCR and NSFR 100%.
Finally, remember India: RBI CRAR 9% (11.5% with buffer), CET1 5.5% (8% with buffer), D-SIBs SBI, ICICI Bank and HDFC Bank.
10. Frequently Asked Questions
What are Basel norms?
Basel norms are international banking rules set by the Basel Committee on Banking Supervision, at the Bank for International Settlements in Basel, Switzerland. They say how much capital and liquidity banks must keep.
What are the three pillars of Basel II?
Pillar 1 is minimum capital for credit, market and operational risk; Pillar 2 is supervisory review by regulators; Pillar 3 is market discipline through disclosure.
What is CRAR?
CRAR, or Capital to Risk-weighted Assets Ratio, is a bank's capital divided by its risk-weighted assets. The RBI requires at least 9%, higher than the global 8%.
What did Basel III add?
Basel III raised the quality and amount of capital, added a 2.5% capital conservation buffer and a countercyclical buffer, and introduced a leverage ratio and liquidity rules (LCR and NSFR).
What is a D-SIB?
A Domestic Systemically Important Bank is a bank so large that its failure would hurt the whole system. In India, SBI, ICICI Bank and HDFC Bank are D-SIBs and must keep extra capital.
For more Economy topics in simple language, see our RBI and its Functions, Deposit Insurance and RBI Ombudsman and Monetary Policy, Repo, CRR and SLR posts, or browse the Economy section. Preparing for a bank exam? Start with the RBI Grade B guide or join the 100 Hour GS Course.