Banking Reforms and Basel Norms Questions for RBI GRADE B

Why Banking Reforms? The Big Picture

Banking reforms arise because banks are the backbone of an economy — if they fail, everything collapses (like Lehman Brothers in 2008). The Basel Committee on Banking Supervision (BCBS), set up at the Bank for International Settlements (BIS) in Basel, Switzerland, creates global standards to make banks safer. India's RBI adopts these norms with some modifications suited to the Indian banking structure. Key domestic reforms include Narasimham Committee recommendations, priority sector lending norms, and prompt corrective action (PCA) framework.

• BCBS was formed in 1974 after the Herstatt Bank collapse in Germany.
• BIS is headquartered in Basel, Switzerland — acts as a bank for central banks.
• India adopted Basel I in 1992, Basel II by 2009, Basel III phased from 2013.
• Narasimham Committee I (1991) and II (1998) are the pillars of Indian banking reforms — deregulation, capital adequacy, NPAs.
• PCA Framework: RBI's tool to restrict weak banks — triggered by low CAR, high NPA, negative ROA.

Basel I: The Foundation (1988)

Basel I was simple — it focused only on credit risk and said banks must hold capital equal to at least 8 percent of their Risk-Weighted Assets (RWA). Think of RWA as the danger-adjusted version of a bank's loans. A loan to the government gets 0 percent risk weight (safe), a corporate loan gets 100 percent (risky). Basel I had two tiers of capital. It was criticised for being too blunt — it treated all corporate loans the same regardless of borrower quality.

• Minimum CAR (Capital Adequacy Ratio) = 8 percent of RWA.
• Tier 1 Capital: Core capital — paid-up equity, retained earnings (going-concern capital).
• Tier 2 Capital: Supplementary — subordinated debt, revaluation reserves, general provisions.
• Risk weights under Basel I: 0 percent (govt), 20 percent (banks), 50 percent (mortgages), 100 percent (corporate).
• Only credit risk covered — market risk and operational risk ignored.

Basel II: Three Pillars (2004)

Basel II expanded beyond credit risk and introduced the famous Three Pillar framework. Pillar 1 is minimum capital (now covering credit, market, and operational risk). Pillar 2 is supervisory review — regulators assess whether a bank's internal risk models are adequate. Pillar 3 is market discipline — banks must disclose enough information so the market can judge their risk. Basel II introduced sophisticated risk models but was criticised post-2008 for allowing banks to underestimate risk.

• Pillar 1: Minimum Capital Requirement — credit risk + market risk + operational risk.
• Pillar 2: Supervisory Review Process (SREP) — RBI reviews banks internal capital adequacy (ICAAP).
• Pillar 3: Market Discipline — mandatory public disclosures about risk and capital.
• Operational Risk methods: Basic Indicator Approach, Standardised Approach, Advanced Measurement Approach.
• India implemented Basel II by March 2009 for foreign banks, March 2010 for domestic banks.

Basel III: Post-Crisis Overhaul (2010, revised 2017)

After the 2008 global financial crisis, it was clear Basel II was not enough. Basel III added more capital, better quality capital, and two brand-new liquidity standards (LCR and NSFR). The key insight: during the crisis, banks had capital on paper but it was not truly loss-absorbing. So Basel III insisted on CET1 (Common Equity Tier 1) as the purest, highest-quality capital. It also introduced buffers on top of the minimum — Capital Conservation Buffer and Countercyclical Buffer.

• Minimum CET1 = 4.5 percent of RWA (pure equity — most loss absorbing).
• Minimum Tier 1 = 6 percent of RWA.
• Minimum Total CAR = 8 percent globally; RBI set 9 percent for India.
• Capital Conservation Buffer (CCB) = 2.5 percent CET1 — must be maintained above minimum; if breached, dividend restrictions apply.
• Countercyclical Capital Buffer (CCyB) = 0 to 2.5 percent — activated by RBI during credit booms.
• Leverage Ratio = Tier 1 Capital / Total Exposure (on+off balance sheet) — minimum 3 percent globally; RBI set 4 percent for DSIBs.
• LCR (Liquidity Coverage Ratio): High Quality Liquid Assets / Net Cash Outflows over 30 days — minimum 100 percent.
• NSFR (Net Stable Funding Ratio): Available Stable Funding / Required Stable Funding — minimum 100 percent (one-year horizon).
• India's Basel III implementation: started April 2013, fully effective April 2019 (later extended).

India-Specific: DSIBs, PCA and Key RBI Thresholds

RBI has been conservative — Indian banks must maintain CAR of 9 percent vs global 8 percent, and Leverage Ratio of 4 percent for Domestic Systemically Important Banks (DSIBs) vs global 3 percent. DSIBs (too-big-to-fail banks) like SBI and HDFC Bank must hold extra capital surcharge of 0.2 to 0.8 percent CET1. The PCA (Prompt Corrective Action) framework restricts weak banks from lending, expansion, paying dividends — activated based on CAR, NPA, and ROA triggers.

• RBI minimum CAR: 9 percent (vs Basel III global 8 percent).
• With Capital Conservation Buffer: effective minimum = 9 + 2.5 = 11.5 percent.
• DSIBs: SBI, HDFC Bank, ICICI Bank — classified annually by RBI based on systemic importance score.
• DSIB surcharge: 0.2 to 0.8 percent additional CET1 depending on bucket.
• PCA triggers: CAR below threshold, Net NPA above 6 percent, ROA negative for two years.

• Confusing Tier 1 and CET1: CET1 is a subset of Tier 1. Tier 1 = CET1 + Additional Tier 1 (AT1 bonds). Many aspirants treat them as equal.
• Mixing up LCR and NSFR time horizons: LCR is short-term (30 days), NSFR is long-term (1 year). A very common trick question.
• Forgetting that India's minimum CAR is 9 percent, not 8 percent. Always quote the RBI number in exams, not the global Basel number.
• Confusing Capital Conservation Buffer (mandatory always) with Countercyclical Capital Buffer (activated by RBI during credit booms — not always active). CCB and CCyB look similar but work very differently.
• Thinking Basel norms are legally binding — they are recommendations from BCBS. Individual central banks (like RBI) make them law in their jurisdiction. BCBS itself has no enforcement power.

• 3 Pillars of Basel II = MCM: Minimum Capital, Check by Supervisor (SREP), Market Discipline. Think 3 legs of a stool — remove one and it falls.
• Basel III new additions over Basel II = LLCC: Leverage ratio, LCR, NSFR (liquidity), CET1 quality, Capital buffers (CCB + CCyB).
• LCR vs NSFR: LCR = Lightning Cover Ratio (fast, 30-day sprint), NSFR = No Short-term Funding Risk (slow, year-long marathon).
• DSIB surcharge memory: D-SIB = Dangerous to Systemic Stability in Banking — hence extra capital penalty of 0.2 to 0.8 percent.

• Phase 1 GA: Expect direct factual questions — minimum CAR percentage, which committee set Basel norms, full form of LCR/NSFR, year India adopted Basel III. These are 1-mark questions solvable in 20 seconds if memorised.
• Phase 2 ESI: Expect application-based questions — why did Basel III add leverage ratio, what is the difference between LCR and NSFR, how does CCyB work in a credit boom. Write answers linking to 2008 financial crisis context.
• RBI Grade B interviewers frequently ask: What is India's CAR threshold and how does it differ from global norms? Always say 9 percent and explain it is RBI's conservative stance.
• Recent trend: Questions on AT1 bonds (Additional Tier 1 instruments) have increased after Yes Bank AT1 write-down controversy. Know that AT1 bonds are a component of Tier 1 capital and can be written down when a bank hits stress triggers.
• Do not skip PCA framework — RBI Grade B examiners link it to Basel III capital requirements. Know the three triggers (CAR, NPA, ROA) and what restrictions a bank faces under PCA.